Module1 Business Combination and Consolidation
.0/msohtmlclip1/01/clip_image001.gif”>Stock Acquisition Consolidated Financial Statements AFTERDateofAcquisition
Instructor Comment:The followinglesson module was developed to assist students in their understandingofthe corresponding subject matterin the coursetextbook. The followingis nota replacementfor thedetailedpresentation providedby theauthors ofthe text, but instead is an attempt to providestudents with a pragmaticdirect review with heavyemphasis on process.
Myrecommendation is to approach the coursematerial in the followingsequence.
1. Read/studytheassignedcorrespondingsections of thetext.
2. Read the Chapter Review (PowerPoint)posted in D2L.
3. Read/completethe correspondinginstructordeveloped InstructorSubject Matter Presentation (THIS DOCUMENT)posted in D2L.
4. Completethe assigned text questions, exercises and problems (author recommended solutions for assigned odd exercises posted in D2L).
5. Reviewthe correspondinginstructordevelopedInstructorProblemSolving Modulesposted in D2L.
As discussed inISMP #1(DateofAcquisition) forstock acquisitions wheresignificant influence and control exist, the acquirer (parent)is required bytheSEC, for financialreportingpurposes, to consolidatethe acquired company(subsidiary).Wediscussed a3-StepProcess(below)to be followed in the creationof consolidated financialstatements. The same3-Step Process is appliedin Stock Acquisition AfterDateofAcquisition but involves increasedcomplexitydueto the fact that timehas passed(ongoingoperations ofthe acquired companymust be consolidated).
Unlikethe accountingforstock acquisitions as ofthedateofacquisition (which required the preparation of the consolidated balancesheet only)the accounting for stock
acquisitionsafterthedateof acquisition requireconsolidation for all financial statements (incomestatement, statement of retainedearnings, balancesheet and statement of cash flows). The focus ofthisISMP will beon theincomestatement, statement of retained earningsand the balancesheet.
3-Step Process:
.0/msohtmlclip1/01/clip_image003.gif” alt=”*”> Step 1 Assess theBusiness Scenario.0/msohtmlclip1/01/clip_image003.gif” alt=”*”> Step 2 PreparetheCAD
.0/msohtmlclip1/01/clip_image003.gif” alt=”*”> Step 3 Determine Workpaper Entries
Note:RefertoISMP#1forfurtherdetail.
.0/msohtmlclip1/01/clip_image004.gif”>The first two steps ofthethreestep process arethesame forstockacquisitions on thedateof acquisition as theyareforstock acquisitions afterthedateofacquisition. The keychanges take placein Step 3.
Step3- Determine theRequired Workpaper Entries
Complete Workpaper
Complete Financial Statement(s)
.0/msohtmlclip1/01/clip_image005.gif”>To determinetherequired workpaper entriesforstock acquisitions afterthedateofacquisition themethod of accounting used bytheparent companyfortheInvestment in Subsidiarymust be determined. Thecompanyhas two accountingoptions formaintaining theinvestment in subsidiaryaccount, the Cost Methodorthe Equity Method.The accounting method used dictates the workpaper entries requiredfor consolidation.In eithercase, the resulting consolidated financial statements areidentical. Thekeyto accurate consolidated financial statements is thedevelopment and application ofthe appropriate workpaper entries.
RECORDING ANDMAINTAININGTHE INVESTMENT INSUBSIDIARY
COST METHOD
RecordingtheinitialInvestment in Subsidiaryis the same whethertheCost Method orthe EquityMethod is applied.
Account
Debit
Credit
Investmentin Subsidiary
$1,000,000
*Cash
$1,000,000
* – Themethod ofpayment in this exampleis cash, but othersources of funds could also beused
to payfortheinvestment(i.e. issuanceofstock).
MaintainingtheInvestment in Subsidiaryis wheresignificant differencesexist between the Cost Method and EquityMethod, creatingtheneed for different workpaperentries. Maintaining
theInvestment in Subsidiary account using theCost Methodcould bedescribedas NOT maintainingtheInvestment in Subsidiaryaccount. UndertheCost Method thereis no adjustment to theInvestment in Subsidiaryaccount balance(with the exception ofinstances wherealiquidatingdividend occurs). Thus, theonlyinvestment related entry,aftertheinitial investment (purchase) entry, is therecordingofdividend income.
When adividend is received theparent companymakes the followinginvestment related entry:
Account
Debit
Credit
Cash
$40,000
Dividend Income
$40,000
Asyoucan see bythe entryabovetheinvestment in subsidiaryaccount is not affected. Therefore, thebalanceoftheinvestment in subsidiaryremains at theinitial investment cost recorded on the dateofacquisition.
EQUITYMETHOD
RecordingtheinitialInvestment in Subsidiaryis the same whethertheCost Method orthe EquityMethod is applied.
Account
Debit
Credit
Investmentin Subsidiary
$1,000,000
*Cash
$1,000,000
* – Themethod ofpayment in this exampleis cash, but othersources of funds could also beused
to payfortheinvestment(i.e. issuanceofstock).
MaintainingtheInvestment in Subsidiaryaccount usingtheEquity Method of accounting could bedescribed as a continuous effort to maintain an accuratevaluationfor reporting purposes. The EquityMethod attempts to account for all income and dividends (based on the ownership %)recorded by thesubsidiary. Essentially, the changein theinvestment in subsidiary balancereflects the truevalueoftheinvestment assumingincomeless dividends is atrue reflection ofvalue change.
Therefore, the investment related entries,aftertheinitial investment (purchase) entry, is the recordingofincome anddividends. The recording ofincomeis accounted for usingthe followingentry(assume thesubsidiaryis 80% owned and had incomeof$250,000):
Account
Debit
Credit
Investmentin Subsidiary
$200,000
Equity in Subsidiary Income
$200,000
Clearly, the aboveentryimpacts the investment in subsidiaryaccount balance (increasingthe account balanceby$200,000).
The accounting fordividend declared and paid follows thesamelogic.Iftheparentcompanyis receivingdividends, the parent is essentiallytakingvalueout of theinvestment. The recording ofdividendreceived is accounted forusing thefollowingentry(assume thesubsidiaryis 80% owned and declared adividend of$50,000):
Account
Debit
Credit
Cash
$40,000
Investmentin Subsidiary
$40,000
Clearly, the aboveentryimpacts the investment in subsidiaryaccount balance (decreasingthe account balanceby$40,000).
Q1. Calculation What it the Investment in Subsidiaryaccount balance at the end ofthe year (in theexample above)usingtheCost Method and EquityMethod?
WORKPAPERENTRIES ELIMINATIONOFTHE INVESTMENTINSUBSIDIARY
Theinvestment relatedentries (discussed above)must betaken into account when developing workpaper entries. Theworkpaperentries essentiallyeliminatetheinvestment in subsidiary(key offset is the equityaccounts ofthesubsidiary)which upon elimination allows forthe consolidation of theparent and subsidiary,whichcombines the related incomestatement, statement of retained earnings, and balancesheetaccounts oftheparentand subsidiary.
COST METHOD
Workpaper entriesrequired fortheCost Methodmust account for all oftheinvestment entries made (ornot made)to theinvestment in subsidiaryaccount. Inaddition, fortheCost Method, thetimingofthe consolidation impacts the application ofthe workpaperentries. The two time periods arethe Yearof Acquisition and After Yearof Acquisition.
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Cost Method -YearofAcquisitionIs thefirstyearofownership of thesubsidiary. Thus, ifthe subsidiarywas purchasedon January1, 2010 andwe are reporting fortheyear endingDecember31, 2010, we would bereportingYearof Acquisition.
Assumethefollowing baseinformation:
COST METHOD USEDBYPARENT
REALEntry
Debit
Credit
Jan.1,2010
InvestmentinSubsidiary
$
500,000
Cash
$
500,000
Purchased80%ofsubsidiary.
SubsidiaryEquityPositionasof1/1/2010:
CommonStock
$ 10,000
APIC
$ 300,000
RetainedEarnings
$ 240,000
$ 550,000
CAD
80%
Ownership
80%
20%
100%
Parent
NCI
TotalImplied
FairValueGiven Up
$
500,000
$
125,000
$
625,000
BookValueReceived
$
440,000
$
110,000
$
550,000
Difference
$
60,000
$
15,000
$
75,000
Land
$
60,000
$
15,000
$
75,000
Balance
$
–
$
–
$
–
100%
80%
During2010,Subsidiarydeclareddividendsintheamountof
$
50,000
$
40,000
During2010,Subsidiaryhadnetincomeinthe amountof
$
250,000
$
200,000
SubsidiaryRetainedEarningsasof12/31/2009was
$
240,000
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.0/msohtmlclip1/01/clip_image010.gif”>For theYearof AcquisitionCOSTMETHOD-thefollowingthree workpaperentries arerequired:
1
Eliminate(parentsshare)ofcurrentyearsubsidiarydividendincome.
REALEntry
Debit
Credit
Cash
$ 40,000
DividendIncome
$ 40,000
WorkpaperEntry(1) Debit
DividendIncome $ 40,000
DividendDeclared-Subsidiary
$
Credit
40,000
2 EliminatetheInvestmentinSubsidiaryaccountagainst(offsetby)thesubsidiary equityaccounts.
WorkpaperEntry(2) Debit Credit
A
CommonStock-Subsidiary
$ 10,000
A
APIC-Subsidiary
$ 300,000
B
RetainedEarnings-Subsidiary
$ 240,000
C
Difference
$ 75,000
D
InvestmentinSubsidiary
$ 500,000
E
NCI
$ 125,000
Notes:
Remember,100%ofthesub’s equityaccount balancesneed
tobeeliminated.
A
No changefromthedateofacquisition.
B
Weneedto eliminateREbalanceas ofthebeginnngofthecurrentyear.
C
Neverchanges.
D
Investment inSubsidiary(Investment AccountValueattheBeg.OftheCurrent Year)
E
NCI(NCIAccountValueat theBeg.OftheCurrentYear)
.0/msohtmlclip1/01/clip_image011.gif”>.0/msohtmlclip1/01/clip_image011.gif”>.0/msohtmlclip1/01/clip_image011.gif”>.0/msohtmlclip1/01/clip_image009.gif”>Q2. Short Answer- The adjustment to theInvestment in Subsidiary account is as ofthe beginningoftheyear. What is the logicorreasonthe adjustment is as ofthebeginningofthe year?