1. Chapter 4
Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value
Note: Students sometimes like to print slides as “handouts” with 1, 2, 3, 4, 6, or 9 slides per page for taking notes in class. It is sometimes best to print them using the “pure black and white” option on the color/gray scale dropdown menu to avoid dark boxes that are not conducive to note taking. Be aware that many instructors will only cover a sub-set of the slides available in this file. Also note that we have removed slides containing solutions to group or individual in-class exercises. You may want to print some slides (such as worksheets or slides with a large quantity of calculations) as a full page slide to facilitate working the exercise in class.

2. Learning Objective 1
Understand and make equity-method journal entries related to the differential.

3. Basic Concepts: Parent and Subsidiary
Parent’s books
Investment account initially contains the acquisition cost
FMV of net assets,
Plus goodwill, or
Minus bargain purchase price
Parent can use the cost or equity method
Subsidiary’s books
Balance sheet: Assets and Liabilities are recorded at BOOK values.
Income statement: Expenses calculated based on BOOK values

4. Basic Concepts: Parent and Subsidiary
What happens when you consolidate the parent’s and subsidiary’s books?
Remember:
The parent’s investment account is based on the actual acquisition price.
The sub’s books contain only historical book values.
The parent needs to make adjustments for both
Balance Sheet, and
Income Statement accounts.
Why wasn’t this a problem with created subs?
No goodwill
No undervalued assets at the time of creation

5. Basic Concepts: Income Statement Impacts
Big Picture: Essentially, we switch the sub’s books from BV to FMV in the consolidation process.
Income Statement effects
Asset
Related Expense
(as the asset expires)
Equipment
Inventory
Patent
Goodwill

6. Basic Concepts: Income Statement Impacts
Income Statement Effects
When Acquisition Price > Book Value
Asset
Related Expense
(as the asset expires)
Income Statement Effect
Equipment
Inventory
Patent
Goodwill
If expenses are _________________, then income is too high____________________.
To fix the problem, Parent needs to _______________ expenses.

7. Example: Acquisition Price > Book Value
Pepper Inc., a calendar-year reporting company, acquired 100% of Salt Inc.’s outstanding common stock at a cost of $442,500 on 12/31/X8. The analysis of the parent’s Investment account as of the acquisition date shows:
Book value element Life remaining
Common Stock $130,000
Retained Earnings 117,000
Under- or Over-valuation
Inventory (6,500) 2 months
Land 39,000 Indefinite
Equipment 85, years
Covenant-not-to-compete 52,000 4 years
Goodwill element ,000 Indefinite
Total Cost $442,500

8. Example: Acquisition Price > Book Value
Price = BV + Identifiable Excess + GW
Results for 20X9 (based on Book Values):
Reported Income
Dividends Declared
What would the Sub’s income be based on Fair Values?
Lower COGS (because inventory is worth less)
Extra depreciation on equipment
Extra amortization of contract
Total increase in expenses / decrease in income

9. Consolidation: Equity Method
The Parent’s initial investment in a sub is based on the FMV of the sub’s net assets (+/- GW).
Equity method entries:
Recording share of sub’s income
Recording share of sub’s dividends
They should be based on the same FMV basis.
Problem: Sub reports income based on BOOK VALUES
Solution: Parent has to record an adjustment to the income and investment “Equity Method” accounts.

10. Example: Equity Method
Results for 20X9 (based on Book Values):
Reported Income $78,000
Dividends Declared 45,500
Adjustment to Salt’s 20X9 income on Parent’s books:
Lower COGS (because inventory is worth less) $ (6,500)
Extra depreciation on equipment ,500
Extra amortization of contract ,000
Total increase in expenses / decrease in income $ 15,000
What entries would Pepper record in its general ledger related to Salt’s income and dividends for 20X9 under the equity method?

11. Example: Equity Method Journal Entries
To record 100% share of Salt’s reported income:
2. To record 100% of Salt’s dividends declared:
3. To record additional expenses (based on FMV):

12. Example: Equity Method Investment Adjustment
Calculate the correct ending balance in Pepper’s Investment in Salt account using the equity method:
Investment in Salt

13. Practice Quiz Question #1
A parent charges the amortization of its cost in excess of book value to:
a. Goodwill expense.
b. Excess cost expense.
c. Excess cost & goodwill expense.
d. Income from subsidiary.
e. None of the above.

14. Learning Objective 2
Understand and explain how consolidation procedures differ when there is a
differential.

15. Consolidation Concepts by Chapter
Wholly Owned Subsidiary
Partially Owned Subsidiary
Investment = Book Value
Chapter 2
Chapter 3
No Differential
Investment > Book Value
Chapter 4
Chapter 5
Differential
No NCI Shareholders
NCI Shareholders
4-15

16. Excess value of identifiable assets =
Simple Example
Assume the BV of Sub’s net assets is $800 and that the FMV of the net assets is $1,000. Finally, assume that the acquisition price was $1,500. The acquisition price consists of three parts:
Goodwill = P S
Stock
Sub
Shareholders $
Excess value of identifiable assets =
Book value of
net assets =

17. Understanding Components of Acquisition Cost
Acquisition FMV of
Price = Assets + Goodwill
FMV of Extra
Assets = BV + Value
Acquisition Extra
Price = BV + Value + Goodwill
Key: We need to keep track of each element of the purchase price separately!
Why??

18. The Consolidation Process
When a subsidiary is acquired (instead of created), the consolidation process is more complicated:
Must eliminate intercompany items (same)
Must update Sub’s assets and liabilities to FMV
Must recognize goodwill

19. Summary of Consolidation Entries
The basic elimination entry:
The excess value reclassification entry:
Common Stock (S) XX
Additional Paid-in Capital (S) XX
Retained Earnings, Beginning Balance (S) XX
Income from Sub XX
Investment in Sub BV
Dividends Declared XX
Asset 1 XX
Asset 2 XX
Goodwill XX
Investment in Sub Excess

20. Summary of Consolidation Entries
The amortized excess value reclassification entry:
This entry reclassifies the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the sub used FMV instead of BV.
4. The accumulated depreciation elimination entry:
Cost of Sales XX
Other Expenses XX
Income from Sub XX
Accumulated Depreciation XX
Buildings and Equipment XX

21. Practice Quiz Question #2
When P company pays more than the book value of net assets of the acquired company (S), how does the consolidation process differ?
a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.

22. Learning Objective 3
Make calculations and prepare elimination entries for the consolidation of a
wholly owned subsidiary when there is a complex positive differential at the
acquisition date.

23. Group Exercise 1: Analyzing Acquisition Costs
Prince Inc. acquired 100% of She-Ra Inc.’s outstanding common stock for $1,600,000 cash. Divide the cost into its major elements and prepare the consolidation entries as of the acquisition date.

24. Group Exercise 1: Solution
How would this affect your worksheet elimination entries?

25. Group Exercise 1: Solution Acquisition Costs
What did we pay for?
Investment in Sub
1,600,000
Goodwill
Excess value of identifiable assets
Book value of
net assets of
the acquired
firm

26. Group Exercise 1: Solution Investment Account
Investment in Sub
1,600,000
The basic elimination entry:
The excess value reclassification entry:
980,000
Common Stock 120,000
Additional Paid-in Capital 480,000
Retained Earnings 380,000
Investment in Sub 980,000
620,000
Inventory 50,000
Land 130,000
Buildings and Equipment 110,000
Patent 90,000
Long-term Debt 70,000
Goodwill (new) 340,000
Notes Receivable 60,000
Goodwill (old) 110,000
Investment in Sub 620,000

27. Group Exercise 1: Solution Worksheet Entries
The basic elimination entry:
The excess value reclassification entry:
The accumulated depreciation elimination entry:
Common Stock 120,000
Additional Paid-in Capital 480,000
Retained Earnings 380,000
Investment in Sub 980,000
Inventory 50,000
Land 130,000
Buildings and Equipment 110,000
Patent 90,000
Long-term Debt 70,000
Goodwill (new) 340,000
Notes Receivable 60,000
Goodwill (old) 110,000
Investment in Sub 620,000
Accumulated Depreciation 98,000
Building and Equipment 98,000

28. Group Exercise 1: Solution Depreciation Entry
3. The accumulated depreciation elimination entry: The book values at acquisition – remember the 610,000 was net of 98,000 in accumulated depreciation.
Buildings & Equipment
Accumulated Depreciation
708,000
98,000

29. Group Exercise 1: Solution Depreciation Entry
3. The accumulated depreciation elimination entry:
Accumulated Depreciation 98,000
Building and Equipment 98,000
Buildings & Equipment
Accumulated Depreciation
708,000
98,000
98,000
98,000
610,000
Shows the Buildings and Equipment “as if” they have been recorded on the sub’s books as new assets at book value.

30. Group Exercise 1: Solution Reclass Entry
3. The accumulated depreciation elimination entry:
Accumulated Depreciation 98,000
Building and Equipment 98,000
Buildings & Equipment
Accumulated Depreciation
708,000
98,000
98,000
98,000 BV
610,000
The excess value reclassification elimination entry
brings the Buildings and Equipment up to fair value.
Excess Value Reclass
FMV
720,000
110,000

31. Group Exercise 2: Worksheet at Acquisition
Pepper acquired 100% of Salt’s outstanding stock for $442,500. Required: Prepare the consolidation entries and worksheet.

32. Group Exercise 2: Worksheet Entries
Book Value Analysis:
Pepper’s Salt’s Equity Accounts, BV
Investment Common Retained
Account, BV Stock Earnings
Balances, 12/31/X8
Investment in Salt
EB 442,500 = +
The Basic Elimination Entry:
Common Stock
Retained Earnings
Investment in Salt
Excess Value Analysis:
Pepper’s Salt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land Equipment Covenant Goodwill
Balances, 12/31/X8 =
The Excess Value Reclassification Entry:
Land
Building & Equipment
Covenant N-T-C
Goodwill
Inventory
Investment in Salt
The Accumulated Depreciation
Elimination Entry:
Accumulated Depreciation
Building & Equipment

33. Group Exercise 2: Worksheet at Year End

34. Practice Quiz Question #3
An account of the acquired company that cannot be revalued to its current value under acquisition accounting is:
a. Notes receivable.
b. Bonds payable.
c. Investment in marketable securities.
d. Patents.
e. None of the above.

35. of a wholly owned subsidiary when there is a complex bargain-purchase
Learning Objective 4
Make calculations and prepare elimination entries for the consolidation
of a wholly owned subsidiary when there is a complex bargain-purchase
differential.

36. Acquired at Less than Fair Value of Net Assets
Bargain purchase
A business combination where the sum of
the acquisition-date fair values of the consideration given,
any equity interest already held by the acquirer, and
any noncontrolling interest
is less than the amounts at which the identifiable net assets must be valued at the acquisition date as specified by FASB 141R.
The acquirer recognizes a gain for the difference. 36

37. Income Statement Effect
Basic Concepts
Income Statement Effects
When Acquisition Price < BV
Asset
Related Expense
(as the asset expires)
Income Statement Effect
Equipment
Inventory
Patent
Goodwill
If expenses are ________________, then income is too low______________________.
To fix the problem, Parent needs to ____________________expenses.

38. Practice Quiz Question #4
How do the elimination entries differ in a bargain purchase scenario from an acquisition at an amount greater than book value?
a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the differential increases reported expenses.
d. The elimination entry to reclassify expenses related to the differential decreases reported expenses.

39. Learning Objective 5
Prepare equity-method journal entries, elimination entries, and the consolidation
worksheet for a wholly owned subsidiary when there is a complex positive
differential.

40. Group Exercise 3
Pepper Inc., a calendar-year reporting company, acquired 100% of Salt Inc.’s outstanding common stock at a cost of $442,500 on 12/31/X8. The analysis of the parent’s Investment account as of the acquisition date shows:
Book value element Life remaining
Common Stock $130,000
Retained Earnings 117,000
Under- or Over-valuation
Inventory (6,500) 2 months
Land 39,000 Indefinite
Equipment 85, years
Covenant-not-to-compete 52,000 4 years
Goodwill element ,000 Indefinite
Total Cost $442,500

41. Group Exercise 3
Update the analyses of the Investment account through 12/31/X9.
Prepare all consolidation entries as of 12/31/X9.
3. Prepare a consolidation worksheet at 12/31/X9. (The parent’s retained earnings as of 1/1/X9 were $455,000.

42. Group Exercise 3: Worksheet Entries
Book Value Calculations:
Pepper’s Salt’s Equity Accounts, BV
Investment Common Retained
Account, BV Stock Add PIC Earnings
Balances, 1/1/X9
Add: Net Income
Less Dividends
Balances, 12/31/X9 = + +
The Basic Elimination Entry:
Common Stock
Retained Earnings, 1/1/X9
Income from Salt
Dividends Declared
Investment in Salt

43. Group Exercise 3: Worksheet Entries
Excess Value Calculations:
Pepper’s
Investment Salt’s Under- or (Over-) Valuation of Net Assets Element
Account Inventory Land Equipment Acc Dep Covenant Goodwill
Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9
Less: Amortization
Balances, 12/31/X9 =
The Excess Value Reclassification Entry:
The Amortized Excess Value
Reclassification Entry:
Land
Building & Equipment
Covenant N-T-C
Goodwill
Accumulated Depreciation
Investment in Salt
Depreciation Expense
S&A Expense
Cost of Sales
Income from Salt
The Accumulated Depreciation
Elimination Entry:
Accumulated Depreciation
Building & Equipment

44. Group Exercise 3: Solution Investment Account
Beginning Balance:
Goodwill =
26,000
Investment in Salt
BB 442,500
Identifiable Excess =
169,500
NI ,000
45,500 Dividend
Book value =
247,000
15,000 Excess Amort.
EB 460,000
Ending Balance:
Goodwill =
26,000
Look back at the beginning and ending balances in the two charts you just prepared to find the numbers!
Identifiable Excess =
154,500
Book value =
279,500

45. Group Exercise 3: Worksheet Entries
Notice how the worksheet entries “eliminate” Pepper’s equity method accounts:
Investment in Salt
Income from Salt
BB 442,500
NI ,000
78,000 NI
45,500 Dividend
15,000 Excess Amort. 15,000
EB 460,000
63,000 Adj. Balance
279,500 Basic ,000
180,500 Excess Reclass
15,000
15,000 Excess Amort.

46. Group Exercise 3: Completed Worksheet

47. Learning Objective 6
Understand and explain the elimination of basic intercompany transactions.

48. Road Map: Intercompany Transactions
Typical intercompany transactions
Intercompany reciprocal accounts (Chapter 4)
Inventory transfers (Chapter 6)
Fixed asset transfers (Chapter 7)
Intercompany Indebtedness (Chapter 8)

49. Arm’s-Length Transactions
Q: What are “Arm’s-length” Transactions? A: “Transactions that take place between completely independent parties.”

50. Categories of Transactions
Arm’s Length Transactions
The only transactions that can be reported in the consolidated statements.
We want to report the results of our interactions with outside parties!
Non-Arm’s Length Transactions
Usually referred to as “related party transactions.”
Include all intercompany transactions.

51. Types of “Related Party” Transactions
Involving only Individuals
Transactions among family members.
Involving Corporations
With management and other employees.
With directors and stockholders.
With affiliates (controlled entities).
Probably constitutes at least 99% of all corporate related-party transactions.

52. Necessity of Eliminating Intercompany Transactions
Eliminate all intercompany transactions in consolidation:
Because they are internal transactions from a consolidated perspective.
Not because they are related-party transactions.
Only transactions with outside unrelated parties can be reported in the consolidated statements.

53. Intercompany Transactions: Additional Opportunities for Fraud
Intercompany transactions sometimes occur to
Conceal embezzlements.
Overstate reported profits.
= 5

54. Group Exercise 4: Intercompany Loan & Interest
Princess Inc. owns 100% of Solo Inc.’s common stock. On 11/1/X8, Princess lent $150,000 to Solo. The loan is to be repaid on 1/30/X9 along with $6,000 of interest. All aspects of the intercompany transaction were properly recorded by each company in its separate books.
Required:
What amounts should be reported in each company’s separate 20X8 income statement and 12/31/X8 balance sheet (asset and liability sections only)?
Prepare and post to your format the consolidation entries as of 12/31/X8, relating only to these accounts.

55. Group Exercise 4: Solution
Three things to think about:
Note receivable / payable
Interest revenue / expense
Interest receivable / payable
How would you
eliminate each item?
1. Note Payable (sub) XXX
Note Receivable (parent) XXX
2. Interest Revenue (parent) XXX
Interest Expense (sub) XXX
3. Interest Payable (sub) XXX
Interest Receivable (parent) XXX

56. Practice Quiz Question #5
Intercompany income statement accounts are eliminated in consolidation because they are deemed to be:
Artificial transactions.
Potentially manipulative transactions.
Internal transactions.
At amounts that are not determined on arms-length basis.
none of the above.

57. Practice Quiz Question #6
In 20X8, Scott incurred $90,000 of inter-company interest charges. Of this amount, Scott paid $70,000 cash to its parent and capitalized $40,000 to a discrete construction project. The unrealized intercompany profit at 12/31/X8 is: $0
$10,000
$20,000
$30,000
$40,000

58. Understand and explain the basics of push-down accounting.
Learning Objective 7
Understand and explain the basics of push-down accounting.

59. Purchase Price > Book Value
What happens if you pay more than the book value of the subsidiary’s assets?
This is the case MOST of the time!
Parent has two options:
Push-Down Accounting
Force Sub to revalue to FMV
Non-Push-Down Accounting
Account for the “extra” value separately.
Parent
Sub

60. Push-Down Accounting: The EASIER Way
Push-Down Accounting (an absolute gem)
In the subsidiary’s general ledger:
Adjust assets and liabilities to FV based on the parent’s acquisition price.
This establishes a new basis of accounting.
Record goodwill.
Record “Revaluation Capital” for the difference
A = L E
Revaluation Capital X

61. Nonpush-Down Accounting: The HARDER Way
Don’t touch the subsidiary’s general ledger (treat like a “sacred cow”).
Make fair value adjustments and record goodwill in consolidation (on the worksheets).

62. Consolidation Consequences: Push-Down vs. Non-Push-Down
Push-down accounting:
Consolidation effort is minimal (has received the “Better Book-keeping” stamp of approval).
Non-push-down accounting:
Consolidation effort is cumbersome (often a headache).
The consolidated financial statement amounts are the SAME either way!
ONLY the accounting procedures differ
Who does the work– parent or sub?

63. Parent’s Amortization of Cost in Excess of Book Value: How Handled?
Non-push-down accounting
Equity Method
Recorded in parent’s general ledger
Maintains built-in checking features
Cost Method
Recorded on consolidation worksheets
Push-down accounting
Parent has no amortization – sub records the amortization

64. Consolidated Financial Statements
Actually, these numbers are only part of the consolidated financial statements.
Non-push-down Accounting
Push-down Accounting
Sub’s
Income Statement
(Based on
Book Values)
Balance Sheet
Parent’s
Adjustments
For
Excess
Value
(Consolidation
Process)
Sub’s
Income Statement
(Based on
Fair Values)
Balance Sheet + =

65. Postacquisition Subsidiary Earnings: Reportable Earnings Under Acquisition Method
ONLY the subsidiary’s postacquisition earnings are reported in the consolidated financial statements.
For a mid-year acquisition, only consolidate earnings after the acquisition date.
The same is true for dividends declared.
The subsidiary’s preacquisition earnings (included in its retained earnings account) are always eliminated against the parent’s Investment account in consolidation.

66. Practice Quiz Question #7
A parent records amortization of excess value under which method?
a. Push-down basis of accounting.
b. Non-push down basis of accounting.
c. Both A and B.
d. None of the above.

67. Practice Quiz Question #8
Push-down-accounting can be used:
a. Only in a goodwill situation.
b. Only in a bargain purchase situation.
c. In either a goodwill situation or a bargain purchase situation.
d. Only in a cost = book value situation.
e. None of the above.

68. Practice Quiz Question #9
The consolidated financial statements are identical regardless of whether the parent:
a. Uses push-down or non-push-down accounting.
b. Acquires 100% of the common stock or 100% of the assets.
c. Both A and B.
d. Neither A or B.

69. Conclusion
The End
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