Accounting Financial & Reporting 3(B)
Please note that this chapter is to be used for exams beginning in July, 2009. If you are planning to sit for the CPA exam prior to July, 2009, then you will want to study with the Financial 3(A) chapter, which is also included in this textbook.
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Marketable securities ..................................................................................................... 3 Business combinations / Consolidations ............................................................................ 9 Cost method (external reporting) ................................................................................... 11 Equity method (external reporting) ................................................................................ 13 Consolidated financial statements .................................................................................. 21 Acquisition method (external reporting) .......................................................................... 22 Intercompany transactions............................................................................................ 46 Combined financial statements / Push down accounting .................................................... 53 Homework reading: Pooling-of-interests method .............................................................. 54 Simulation .................................................................................................................. 65 Class questions ........................................................................................................... 71
Financial Accounting & Reporting 3(B)
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Financial Accounting & Reporting 3(B)
MARKETABLE SECURITIES I. INVESTMENTS IN CERTAIN DEBT AND EQUITY SECURITIES SFAS No. 115 addresses investments in certain equity securities that have readily determinable fair values. SFAS No. 115 also addresses investments in debt securities, which is covered in the Financial 5 class. Equity securities are defined as securities that represent an ownership interest in an enterprise or the right to acquire or dispose of an ownership interest in an enterprise at fixed or determinable prices. A. DEFINITION OF EQUITY SECURITIES 1. Equity securities may be represented by: a. b. c. 2. a. b. c. B. Ownership shares (common, preferred, and other forms of capital stock), Rights to acquire ownership shares (stock warrants, rights, and call options), and Rights to dispose of ownership shares (put options). Preferred stock redeemable at the option of the investor or stock that must be redeemed by the issuer, Treasury stock (the company's own stock repurchased and held), and Convertible bonds.
MARKETABLE EQUITY SECURITIES
Equity securities do not include:
CLASSIFICATION Securities should be classified into one of three categories, based on the intent of the company. 1. Trading Securities Trading securities are those securities (both debt and equity) that are bought and held principally for the purpose of selling them in the near term. Trading securities generally reflect active and frequent buying and selling with the objective of generating profits on short-term differences in price. Securities classified as trading securities are generally reported as current assets, although they can be reported as noncurrent, if appropriate. 2. Available-for-Sale Securities Available-for-sale securities are those securities (both debt and equity) not meeting the definitions of the other two classifications (trading or held-to-maturity). Securities classified as available-for-sale securities are reported as either current assets or noncurrent assets, depending on the intent of the corporation. If the security represents cash available for current operations, it would be appropriate to report the security as a current asset. 3. Held-to-Maturity Securities (Debt Securities Only)
HELD-TOMATURITY SECURITIES AVAILABLE-FORSALE SECURITIES TRADING SECURITIES
Investments in debt securities are classified as held-to-maturity securities only if the corporation has the positive intent and ability to hold these securities to maturity. If the intent is to hold the security for an indefinite period of time, but not necessarily to maturity, then the security would be classified as available-forsale. If a security can be paid or otherwise settled in a manner that the holder may not recover substantially all of its investment, the held-to-maturity category may not be used for the investment. Securities classified as held-to-maturity are reported as current or noncurrent assets, based on their time to maturity.
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II.
VALUATION Both categories of equity securities (trading and available-for-sale) are to be reported at fair value at the end of the current reporting period. Fair value is considered to be the market price of the security or what a willing buyer and seller would pay and accept to exchange the security, consistent with SFAS No. 157 Fair Value. Changes in the fair value of trading and available-forsale securities result in unrealized holdings gains or losses. How these gains or losses are reported in the financial statements depends upon the classification of the securities. Note that although two general ledger accounts are normally maintained (i.e., one for the original cost of the security and the other for the valuation account), the presentation on the balance sheet is one net amount. Held-to-maturity debt securities are valued at amortized cost. A. UNREALIZED GAINS AND LOSSES--TRADING SECURITIES Unrealized holding gains and losses on trading securities are included in earnings. Therefore, the unrealized loss on trading securities is shown in the income statement.
Journal Entry: To record loss on the Income Statement DR Unrealized loss on trading securities CR Valuation account (fair value adjustment)
B.
XXX XXX
UNREALIZED GAINS AND LOSSES--AVAILABLE-FOR-SALE SECURITIES Unrealized holding gains and losses on available-for-sale securities (including those classified as current assets) are reported in other comprehensive income.
Journal Entry: To record unrealized loss reported in other comprehensive income DR Unrealized loss on available-for-sale securities XXX CR Valuation account (fair value adjustment) XXX
In the subsequent period, the security value will again be adjusted from the value it was carried at to the new fair value. For example, assume a stock is purchased on March 1, Year 2, at $24 and is valued at $27 at year-end, December 31, Year 2, and $28 on December 31, Year 3. There would be an unrealized gain in Year 2 of $3 and $1 in Year 3. Realized gains or losses are recognized when a security is disposed of. All realized gains or losses are recognized on the income statement.
SFAS 115 - Investments
Classification Trading Available-for-Sale Securities Held-to-Maturity Debt Securities
Balance Sheet Current or Noncurrent Current or Noncurrent Current or Noncurrent
Reported Fair Value Fair Value Amortized Cost
Unrealized Gain/Loss Income Statement Other Comprehensive Income (PUFE) NONE
Cash Flow Operating Investing Investing
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Financial Accounting & Reporting 3(B)
C.
RECLASSIFICATION
Any transfer of a particular security from one group (trading, available-for-sale, or held-to-maturity) to another group (trading, available-for-sale, or held-tomaturity) is accounted for at fair value. Any unrealized holding gain or loss on that security is accounted for as follows: 1. From Trading Category The unrealized holding gain or loss at the date of transfer is already recognized in earnings and shall not be reversed. 2. To Trading Category The unrealized holding gain or loss at the date of transfer shall be recognized in earnings immediately. 3. Debt Security Classified as Held-to-Maturity Transferred to Available-for-Sale The unrealized holding gain or loss at the date of transfer shall be reported in other comprehensive income. Remember that this debt security was valued at amortized cost as a held-to-maturity security and is being transferred to a category valued at fair value. 4. Debt Security Classified as Available-for-Sale Transferred to Held-to-Maturity The unrealized holding gain or loss at the date of transfer is already reported in other comprehensive income. The unrealized holding gain or loss shall be amortized over the remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount.
SUMMARY OF TRANSFERS BETWEEN CATEGORIES FROM Trading Any other Held-to-Maturity (Debt Securities) Available-for-Sale (Debt Securities) TO Any other Trading Available-for-Sale Held-to-Maturity (Debt Securities) TRF ACCT FOR FV FV FV UNREALIZED HOLDING GAIN/LOSS It has already been recognized in income so no adjustment is necessary Recognized in current earnings Record in Other Comprehensive Income Amortize gain or loss from Other Comprehensive Income with any bond premium/discount amortization
TRANSFERS BETWEEN CATEGORIES
FV
D.
IMPAIRMENT OF SECURITIES The enterprise needs to determine whether the decline in value below the adjusted or amortized cost of any security classified as either available-for-sale or held-to-maturity is other than temporary. If the decline in fair value is other than temporary, the cost basis of the individual security is written down to fair value as the new cost basis and the amount of the write-down is accounted for as a realized loss and included in earnings. The new cost basis shall not be changed for subsequent recoveries in fair value. If the security is classified as available-for-sale, a subsequent increase in fair value shall be included in other comprehensive income. Subsequent decreases in fair value of availablefor-sale securities, if not other than temporary, are also included in other comprehensive income and accounted for as an unrealized loss.
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III.
FINANCIAL INSTRUMENTS USED TO HEDGE THE FAIR VALUE OF INVESTMENTS A. USED TO HEDGE TRADING SECURITIES Gains and losses on financial instruments that hedge trading securities should be reported in earnings, consistent with the reporting of unrealized gains and losses on the trading securities (covered in detail in class F-7). B. USED TO HEDGE AVAILABLE-FOR-SALE SECURITIES Gains and losses on derivative instruments that hedge available-for-sale securities are recognized currently in earnings together with the offsetting losses or gains on the availablefor-sale securities attributable to the hedged risk (covered in detail in class F-7).
IV.
SALE OF SECURITY A sale of a security from any category results in a realized gain or loss and is reported on the income statement for the period. The valuation account, if used, would also have to be removed on the sale of a security. For trading securities, the realized gain or loss reported when the security is sold is the difference between the adjusted cost (original cost +/- unrealized gains/losses previously recognized on the income statement) and the selling price. For available-for-sale securities, the realized gain or loss reported when the security is sold is the difference between the selling price and the original cost of the security. Any unrealized gains or losses in accumulated other comprehensive income must be reversed at the time the security is sold.
Trading Securities DR Cash CR Trading security CR Realized gain on trading security (IDEA) Available-for-Sale Securities DR Cash DR Unrealized gain on available-for-sale security (PUFE) CR Available-for-sale security CR Realized gain on available-for-sale security (IDEA) XXX XXX XXX XXX XXX XXX XXX
V.
INCOME TAX EFFECTS Tax effects of unrealized gains or losses entering into the determination of net income must be reflected in the computation of deferred income taxes, because unrealized gains and losses are not deductible for tax purposes. However, the tax effects of unrealized capital losses should only be recognized when it is absolutely certain that the benefit will be realized by the offset of the capital losses against capital gains.
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Financial Accounting & Reporting 3(B)
VI.
REQUIRED DISCLOSURES
The following information concerning securities classified as available-for-sale and separately for held-to-maturity securities must be disclosed in the financial statements or appropriate notes thereto: (i) (ii) (iii) (iv) Aggregate fair value, Gross unrealized holding gains and losses, Amortized cost basis by major security type, and Information about the contractual maturities of debt securities.
DISCLOSURES OF SECURITIES
Marketable Securities The following information pertains to Dayle, Inc.'s portfolio of marketable investments for the year ended December 31, 20X2: Cost Held-to-maturity securities Security ABC
COMPREHENSIVE EXAMPLE
Fair value at 12/31/X1
20X2 activity Purchases Sales $100,000
Fair value at 12/31/X2 $ 95,000
Trading securities Security DEF Available-for-sale securities Security GHI Security JKL
$150,000
$160,000
155,000
190,000 170,000
165,000 175,000
$175,000 160,000
Security ABC was purchased at par. All declines in fair value are considered to be temporary.
Required: 1. Calculate the carrying amount of each security on the balance sheet at December 31, 20X2. 2. Calculate any realized gain or loss on the 20X2 income statement. 3. Calculate any unrealized gain or loss on the 20X2 income statement. 4. Calculate any unrealized gain or loss to be reported at December 31, 20X2 as other comprehensive income.
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1
Carrying amount of each security at December 31, 20X2: Security ABC $100,000 At year end, held-to-maturity investments are reported at their carrying value (amortized cost), not fair value. Carrying value of security ABC is the purchase price of $100,000. Security DEF $155,000 The year end carrying amount of trading investments is the fair value at year end. Fair value of security DEF is $155,000. Security GHI was sold Security JKL $160,000 The year end carrying amount of available for sale investments is the fair value at year end. Fair value of security JKL is $160,000.
2
Realized gain or loss on income statement: Security GHI The $175,000 sales proceeds less the $190,000 cost yields a realized loss of $15,000. ($15,000)
3
SOLUTION
Unrealized gain or loss on income statement: Security DEF ($5,000) Only adjustments to trading securities valuations are reported on the income statement. The $160,000 carrying value of the trading securities must be reduced to the $155,000 fair value and an income statement unrealized loss of $5,000 is recognized.
4
Unrealized gain or loss (current year change)--other comprehensive income: Security JKL & GHI (net) Valuation Allowance Account (contra-asset account) DR <CR> Beginning Balance: JKL ($175,000 170,000) = GHI ($165,000 190,000) = Activity: JKL ($160,000 175,000) GHI (Sold / Reverse) Subtotal Close Ending Balance <10,000> 5,000 <25,000> Current Year Unrealized <Gain> Loss OCI DR <CR> $10,000 Accumulated OCI (contra-equity account) DR <CR>
<20,000> <15,000> 25,000 15,000 <25,000> <10,000> $10,000 --
20,000
= =
<10,000> 10,000
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Financial Accounting & Reporting 3(B)
BUSINESS COMBINATIONS / CONSOLIDATIONS
I.
PRESUMPTION The presumption is that consolidated financial statements are more meaningful than parent company financial statements and/or parent company financial statements together with separate subsidiary financial statements. A. B. C. Consolidated financial statements (including segment reporting) are necessary for fair presentation. The equity method is not a valid substitute for consolidation (SFAS 94). Consolidate regardless of method of acquisition (acquisition or pooling of interests).
CONSOLIDATED STATEMENTS
II.
CONSOLIDATED FINANCIAL STATEMENTS Consolidated financial statements ignore important legal relationships and emphasize economic substance over form. Consolidated financial statements are an economic truth but a legal fiction.
III.
LIMITATIONS OF CONSOLIDATED FINANCIAL STATEMENTS A. B. C. Minority shareholders, creditors, and bondholders of the subsidiary remain uninformed regarding the subsidiary's financial statements. Weak performance of one company (entity) may be offset by the strong performance of another company. Ratio analysis of consolidated data is not reliable. For example: 1. 2. D. Poor income statement results of individual subsidiaries are hidden. Intercompany eliminations affect ratios.
Retained earnings available for parent shareholders (the account from which dividends are paid) are not segregated nor otherwise indicated.
1 C/S Parent C/S Sub
2 C/S Parent C/S Sub
3
C/S Parent
Parent Company Parent Company Parent Company
Sub Co.
Sub Company
Sub Company
Sub Company
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IV.
CRITERIA OF WHEN TO AND WHEN NOT TO CONSOLIDATE A. Consolidate ALL majority-owned subsidiaries (over 50% of the voting interest is owned by parent company) to have one management and one economic entity. This includes domestic, foreign, similar, and dissimilar subsidiaries (per SFAS 94, 141-R, 160). DO NOT consolidate when: Control is not with owners (e.g., under legal reorganization or when control of a subsidiary is with a trustee). C. It is OK to consolidate companies that have different year ends. The subsidiary merely prepares special financial statements to correspond closely with the parent's fiscal year end. If the year ends differ by three months or less, the parent company can use the subsidiary's regular financial statements of a different period, giving recognition to material intervening events, to expedite the consolidation process. In a vertical chain, where parent company owns more than 50% of a subsidiary company and the subsidiary owns more than 50% of a third company, consolidate: 1. 2. Third company into subsidiary company. Subsidiary company (now consolidated with third company) into parent company.
B.
D.
V.
DEGREE OF CONTROL The degree of control the investor has over the investee dictates how the investor accounts for the investment in corporate equity securities. Consolidation: A combination of the financial statements of two or more entities into a single set of financial statements representing a single economic unit.
ACQUISITION
0 COST 20 EQUITY 50 CONSOLIDATE
COST OR EQUITY USED INTERNALLY
100
DO NOT CONSOLIDATE
A.
COST METHOD/DO NOT CONSOLIDATE = NO SIGNIFICANT INFLUENCE (TYPICALLY <20%) The investor accounts for the investment using the cost method if the investor does not have the ability to exercise significant influence over the investee. Follow the rules of marketable equity securities and account for the investment as either trading or available-for-sale securities.
B.
EQUITY METHOD/DO NOT CONSOLIDATE = SIGNIFICANT INFLUENCE BUT 50% OR LESS OWNERSHIP (TYPICALLY 20% - 50%) The investor accounts for the investment using the equity method of accounting if the investor can exercise significant influence over the investee and holds 50% or less of the voting stock.
C.
CONSOLIDATE = CONTROL (GREATER THAN 50% OWNERSHIP) The investor should prepare consolidated financial statements with its investees when the investor has control (more than 50% ownership) of the subsidiary. Internally, the investor may use either the cost method or the equity method to account for its investments.
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COST METHOD (External Reporting)
INVESTMENT IN INVESTEE ____ MARKETABLE EQUITY SECURITIES ____ COST METHOD
I.
COST METHOD (<20% / DOES NOT EXERCISE SIGNIFICANT INFLUENCE) The cost method should be used when the investor owns less than 20% of the investee's voting stock and does not exercise significant influence. Lacking evidence to the contrary, it is assumed that no significant influence can be exercised from 0%-20%. The original investment under the cost method is accounted for in the same manner as marketable equity securities.
If a company owns less than 20% of the stock of an investee company, but exercises significant influence, the equity method must be used. A. BALANCE SHEET: "INVESTMENT IN INVESTEE" 1. The carrying amount of the investments account on the investor's (parent's) books is "original cost," measured by the FV of the consideration given, including legal fees. The investment account stays the same from the date of acquisition unless: a. b. c. d. 2. Shares of stock in the subsidiary are purchased or sold. There is an accumulated dividend in excess of accumulated earnings resulting in a return of capital (called a liquidating dividend). The basis is adjusted to FV as required for marketable equity securities (SFAS 115). The subsidiary incurs losses that substantially reduce net worth from the date of acquisition. All costs of acquisition. (FV of consideration plus legal fees)
Record at Cost a.
DR CR
3.
Investment in investee Cash
$XXX $XXX
Marketable Securities Adjust to FV a. Adjust to FV at year-end. (Decrease in FV)
DR CR
b.
Unrealized holding losses $XXX Investment in investee (or valuation account)
$XXX
Adjust to FV at year-end. (Increase in FV)
DR CR
Investment in investee (or valuation account) Unrealized holding gains
$XXX $XXX
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4.
Reduce Investment in Investee for Return of Capital Distributions a. Return of capital/liquidating dividend--(dividend in excess of investor's share of retained earnings).
DR CR
Cash Investment in investee
$XXX $XXX
Note: For tax purposes, a return of capital/liquidating dividend exists when the dividend is in excess of the investor's share of the corporation's earnings and profits. Earnings and profits is a very similar concept to retained earnings, but the two are not always calculated the same way. B. INCOME STATEMENT Record cash dividends from the investee's earnings and profits. Do not recognize stock dividends. 1. Dividends to the Investor/Parent (from Investee) are Income (Earnings) to the Investor/Parent The cost method does not recognize a pro rata share of the investee's earnings as income to the investor/parent.
DR CR
2.
Cash
Dividend income
$XXX
$XXX
Distribution that Exceeds Investor's Share of the Investee's Retained Earnings (Reduce Basis / Return of Capital Distribution)
DR CR
Cash Investment in investee
PASS KEY
$XXX $XXX
The following three issues are the most frequently tested "cost" concepts: The "Investment in Investee" is not adjusted for investee earnings. The "Investment in Investee" is adjusted to FV (per FASB 115). Cash dividends from the investee are reported as income by the investor (parent).
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Financial Accounting & Reporting 3(B)
EQUITY METHOD (External Reporting) I. EQUITY METHOD (20%50% / EXERCISES SIGNIFICANT INFLUENCE)
EQUITY METHOD
The equity method is used to account for investments if significant influence can be exercised by the investor over the investee. The critical criterion for using the equity method is that the investor exerts significant influence over the operating and financial policies of the investee. If no direct evidence of significant influence exists, ownership of 20% to 50% of the investee's voting stock is deemed to represent significant influence. Under the equity method the investment is originally recorded at the price paid to acquire the investment. The investment account is subsequently adjusted as the net assets of the investee change through the earning of income and payment of dividends. The investment account increases by the investor's share of the investee's net income with a corresponding credit to the investor's income statement account, Equity in Subsidiary/Investee Income. The distribution of dividends by the investee reduces the investment balance. Continuing losses by a subsidiary/investee may result in a decrease of the investment account to a zero balance. In addition, consolidated statements should be presented when ownership is greater than 50%. A. EXERCISES SIGNIFICANT INFLUENCE A company that owns 20%50% of voting stock of another "investee" company is presumed to be able to exercise "significant influence" over the operating and financial policies of that investee and, therefore, must use the equity method when presenting the investment in that investee in: 1. 2. 3. Consolidated financial statements that include other consolidated entities, but not that investee, or Unconsolidated parent company financial statements. Equity method not appropriate (even if investor owns 20% to 50% of subsidiary): a. b. c. d. e. f. g. Bankruptcy of subsidiary. Investment in subsidiary is temporary. A lawsuit or complaint is filed. A "standstill agreement" is signed (under which the investor surrenders significant rights as a shareholder). Another small group has majority ownership and they operate the company without regard to the investor. The investor cannot obtain the financial information necessary to apply the equity method. The investor cannot obtain representation on the Board of Directors. PASS KEY The CPA Examination frequently presents questions where the ownership percentage is below 20%, but the "ability to exercise significant influence" exists. The equity method is the correct method of accounting for these investments.
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B.
BALANCE SHEET "Investment in investee" using equity.
1.
Record at cost (FV of consideration plus legal fees) DR Investment in investee CR Cash $XXX $XXX
2.
Increase by the Investor's/Parent's ownership percentage of earnings of investee DR Investment in investee CR Equity in earnings/investee income $XXX $XXX
3.
Decrease by the Investor's/Parent's ownership percentage of cash dividends from investee (stock dividends reduce unit cost of stock owned in investee) DR Cash CR Investment in investee $XXX $XXX
C.
INCOME STATEMENT Record the Investor's/Parent's ownership percentage of earnings as income (dividends are not income, treat as bank withdrawals).
1.
Investee earnings (Investor's/Parent's percentage ownership of investee) DR Investment in investee CR Equity in earnings/investee income $XXX $XXX
2.
Investee cash dividends (Not income/lower investment like bank withdrawal) DR Cash CR Investment in investee
PASS KEY
$XXX $XXX
An easy way to remember all the GAAP accounting rules for the "equity method" is to think of it like a bank account and use your base account analysis:
B A S E
Beginning Balance Add: Investee's earning (like bank interest; it is income when earned, not when taken out). Subtract: Investee's dividends (like bank withdrawals; and it is not income) Ending Balance
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Financial Accounting & Reporting 3(B)
Equity Method On January 1, Year 1, Big Corporation acquired a 40% interest in Small Company for $300,000. Total stockholders' equity on the date of acquisition consisted of capital stock (common, $1 par) of $500,000 and $250,000 in retained earnings, therefore, no differentiation [$300,000 = .40(500,000 + 250,000)]. During Year 1 Small Co. had net income of $90,000 and paid a $40,000 dividend. Journal Entry: To record the initial investment of 40% DR Investment in Small Co. (40%)
EXAMPLE
$300,000 $300,000
CR
Cash
Journal Entry: To recognize the investee's net income (40% x $90,000) DR CR Investment in Small Co. (40% x $90,000) Equity in investee income $36,000 $36,000
Journal Entry: To recognize the dividend paid by the investee (40% x $40,000) DR Cash $16,000 CR Investment in Small Co. (40% x $40,000) $16,000 On December 31, Year 1, the investment account on the balance sheet would show $320,000 ($300,000 + $36,000 - $16,000), and the income statement would show $36,000 as Big's equity in subsidiary income.
AMORTIZATION OF DIFFERENTIAL
D.
DIFFERENCES BETWEEN THE PURCHASE PRICE AND BOOK VALUE (NBV) OF THE INVESTEE'S NET ASSETS Additional adjustments to the investment account under the equity method result from differences between the price paid for the investment and the book value of the investee's net assets. This difference is first attributable to: 1. 2. Asset FV Differences between the book value and fair value of the net assets acquired. Goodwill Any remaining difference is goodwill.
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PASS KEY An easy way to solve this type of question is to set up a building block box and plug in the respective dollar amounts and then compare to the purchase price:
Goodwill FV NBV
Excess X % X %
= = =
$ $ $ Purchase Price
3.
Amortize Asset FV Difference (Premium) Over Related Asset Life The fair value excess (asset FV) would be amortized over the life of the underlying asset (excess caused by land is not amortized). This additional amortization causes the investor's share of the investee's net income to decrease. Amortization of cost (purchase price) over NBV of assets acquired only affects the parent's investment account, "investment in subsidiary," on the books of the parent under the "Equity Method," not under the "Cost Method."
DR CR
4.
Equity in investee income Investment in investee
$XXX $XXX
Goodwill Difference: Not Amortized and No Impairment Test The fair value excess attributable to goodwill is not subject to the impairment test. Acquired goodwill is no longer amortized. PASS KEY
To better understand the journal entry and its impact, think of the amortization of excess purchase price (premium) as a bank service charge. The "equity method", which we treat like a bank account, will have the account balance (balance sheet asset) reduced by this "bank service charge" and also will have the net earnings from the account reduced by this (service) charge.
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Financial Accounting & Reporting 3(B)
Equity Method On January 1, Year 1, Big Corporation acquired a 40% interest in Small Company for $500,000 cash. At the date of acquisition, Small Co.'s net assets had a book value of $875,000 and a fair value of $1,000,000. The difference between the book value and fair value relates to equipment being depreciated over a remaining useful life of ten years. Small Co.'s net income for Year 1 was $320,000. During Year 1, Small Co. declared and paid $120,000 in cash dividends. 1. Investment and Subsidiary Activity: Journal Entry: To record the initial investment DR Investment in Small Co. (40%) CR Cash Journal Entry: To recognize the investee's net income DR Investment in Small Co. (40% x $320,000) CR Equity in investee income
$500,000 $500,000 $128,000 $128,000
EXAMPLE
Journal Entry: To recognize the dividend paid by the investee DR Cash $48,000 CR Investment in Small Co. (40% x $120,000) 2. Asset Adjustment and Depreciation:
Goodwill FV NBV $1,000,000 $875,000 Excess X 40% X 40% = = = $400,000 $350,000
$48,000
$500,000 Purchase Price
Journal Entry: To record depreciation on undervalued equipment ($50,000 10 years) DR Equity in investee income $5,000 CR Investment in Small Co. $5,000 3. Goodwill: Goodwill, the excess of the purchase price over the fair value of net assets: Purchase price of the investment in Small Co. $500,000 Less: Fair value of Big's Co. equity in net assets of Small Co. (40% x 1,000,000) (400,000) Goodwill $100,000 On December 31, Year 1, Big's Co. investment in Small Co. account would show a balance of $575,000 ($500,000 + $128,000 - $48,000 - $5,000), and the income statement would show $123,000 ($128,000 - $5,000) equity in investee income.
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E.
UNCONSOLIDATED INVESTMENT OF OVER 50% (EQUITY METHOD REQUIRED) A parent company that does not consolidate a 50%+ owned subsidiary (e.g., lack of control due to a company being controlled by a bankruptcy trustee, or a subsidiary that is likely to be a temporary investment) must use the equity method when presenting the investment in that sub in: 1. 2. Consolidated financial statements (without that sub being consolidated). Unconsolidated parent company financial statements are NOT allowed to be issued to stockholders as the "primary reporting entity" (SFAS 94). However, they may be presented as a supplemental disclosure.
II.
COMPARISON OF COST AND EQUITY METHODS
DO NOT CONSOLIDATE
NO SIGNIFICANT INFLUENCE
COST
EQUITY
SIGNIFICANT INFLUENCE
<20%
PURCHASE PRICE
DR INVESTMENT IN INVESTEE CR CASH
20% 50%
PURCHASE PRICE
DR INVESTMENT IN INVESTEE CR CASH DR INVESTMENT IN INVESTEE CR EQUITY IN EARNINGS DR EQUITY IN EARNINGS CR INVESTMENT IN INVESTEE
+INVESTEE INCOME COMPLY WITH SFAS 115
"ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBTAND EQUITY SECURITIES"
BALANCE SHEET "INVESTMENT ACCOUNT"
-- AMORTIZE FV > NBV -- INVESTEE DIVIDENDS
DR CASH CR INVESTMENT IN INVESTEE
INVESTEE DIVIDENDS
DR CASH CR DIVIDEND INCOME
INVESTEE INCOME
DR INVESTMENT IN INVESTEE CR EQUITY IN EARNINGS
INCOME STATEMENT "REPORTABLE INCOME"
ASSET AMORTIZE FV > NBV
DR EQUITY IN EARNINGS CR INVESTMENT IN INVESTEE
GOODWILL (Equity Method Only)
NOT AMORTIZED NOT IMPAIRED
F3(B)-18
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Financial Accounting & Reporting 3(B)
III.
STEP-BY-STEP ACQUISITION (STILL NOT CONSOLIDATING) A corporation may acquire an investment in investee in more than one transaction. In this case, any goodwill must be computed at the time of each transaction. A. CHANGE FROM COST METHOD TO EQUITY METHOD When significant influence is acquired, it is necessary to record a change from the cost/available-for-sale classification to the equity method. The investment account and the retained earnings account are adjusted retroactively for the difference between the available-for-sale classification/cost method to the equity method. 1. To Equity from Cost When two or more purchases of stock cause ownership in an investee corporation to go from not having significant influence (< 20%) to having significant influence ( 20% but less than 50%): a. b. 2. The equity method should be used and the periods during which the cost method (fair value) was used are retrospectively adjusted. The year-end ownership percentage is used to make all equity entries.
ACCOUNTING CHANGES
Equity in Investee Income Calculation: When the additional investment is made sometime during the year, the investor will calculate its share of the investee's income by multiplying the: a. b. Investee's income by the fraction of the year that the cost method (available-forsale) was used and the percentage ownership before the change. This will then be added to the investee's income multiplied by the fraction of the year remaining and the percentage of ownership after the change.
3.
Common Stock and Preferred Stock If an investor company owns both common and preferred stock of an investee company: a. b. The "significant influence" test is mostly met by the amount of common stock owned (which is usually the only voting stock). The calculation of equity in earnings of subsidiary / income from subsidiary (or investee) includes: (1) (2) Preferred stock dividends, and Share of earnings available to common shareholders (net income reduced by preferred dividends). PASS KEY
The key to answering questions relating to this issue correctly is to: Apply the new method (equity) to the prior period's old percentage (1 - < 20%). Do not apply the new percentage to the prior period (you did not own that percentage back then!).
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Adjustments to Convert from Available-for-Sale Classification to Equity Method On January 1, Year 1, Big Co. paid $20,000 for a 15% interest in Small Co. Big Co. does not have significant influence over Small Co. The book value of net assets was $120,000. Any excess is attributable to a building with a 40-year life. Net income reported by Small Co. during Year 1 was $35,000. Big Co.'s share of dividends declared by Small Co. amounted to $750. The market value of the investment was $17,000 on December 31, Year 1. Under the cost method (available-for-sale treatment), in Year 1 Big Co. would record dividend income but would not recognize net income reported by Small Co. nor amortize any asset premium (related to the building). On January 1, Year 2, Big Co. increased its ownership in Small Co. to 50%, paying $60,000. The fair value and book value of Small Co.'s net assets at January 1, Year 2 were $108,000. On January 1, Year 2, Big Co. would record its additional investment and make the following adjustments to retroactively convert from the available-for-sale treatment to the equity method. Schedule 1: Building (premium) resulting from the investment on January 1, Year 1. Price paid/Cost of the January 1, Year 1 investment NBV of the net assets acquired ($120,000 x 15%) Building (premium) $20,000 (18,000) $ 2,000
EXAMPLE
Building (premium) will be amortized over 40 years (equity method only) 40 yrs. $2,000 40 = $50 amortization per year (equity method only) $ 50.00 Schedule 2: Calculation of the retroactive adjustment to the equity method at January 1, Year 2. Equity Method: Year 1 investment (at cost) $20,000 B Equity method adjustments: A Plus: Share of Small Co.'s net income ($35,000 x 15%) 5,250 Less: Dividends received (750) S Less: Amortization of building (premium) ($2,000 40) (50) E Balance of the investment account under the equity method $24,450 [1] Cost/Available-for-Sale Treatment: Yr 1 Dec. 31, investment balance at market value $17,000 [2] Total adjustment to investment ([1] [2]) $ 7,450 Adjustment to unrealized loss on available-for-sale securities (3,000) Retroactive adjustment to Retained Earnings $ 4,450 Journal Entry: To record the retroactive adjustment to the investment and retained earnings account and write off the unrealized loss on available-for-sale securities DR Investment in Small Co. $7,450 CR Retained earnings $4,450 CR Unrealized loss on available-for-sale securities $3,000 Journal Entry: To record the additional investment at January 1, Year 2 DR Investment in Small Co. $60,000 CR Cash
$60,000
F3(B)-20
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Financial Accounting & Reporting 3(B)
CONSOLIDATED FINANCIAL STATEMENTS I. CONSOLIDATED FINANCIAL STATEMENTS A. CONTROL (OVER 50%) Consolidated financial statements are prepared when a parent-subsidiary relationship has been formed. An investor is considered to have parent status when control over an investee is established or more than 50% of the voting stock of the investee has been acquired. All majority-owned subsidiaries (domestic and foreign) must be consolidated except when significant doubt exists regarding the parent's ability to control the subsidiary, such as when: 1. 2. B. The subsidiary is in legal reorganization or Bankruptcy and/or the subsidiary operates under severe foreign restrictions.
ACQUISITION METHOD VS. POOLING OF INTERESTS Acquisition and pooling of interests are methods used to record the acquisition of a subsidiary and are each acceptable in accounting for business combinations under certain circumstances. An investment in the stock or net assets of another corporation is accounted for as a pooling of interests if all of the conditions necessary for a pooling of interests have been met (and it had been completed and/or initiated prior to June 30, 2001).
1 C/S Parent C/S Sub
2 C/S Parent C/S Sub
3 C/S Parent
50
100
CONSOLIDATE
Parent Company
Sub Company
Parent Company
Parent Company Sub Company
Sub Co.
Sub Company
C.
ACQUISITION METHOD: FUNDAMENTAL PRINCIPLES Main principles for applying the Acquisition Method: 1. 2. Recognition Principle The acquirer recognizes all of the assets acquired and all of the liabilities assumed. Measurement Principle The acquirer measures each recognized asset acquired and each liability assumed and any noncontrolling interest at its acquisition date fair value.
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ACQUISITION METHOD
ACQUISITION METHOD
(External Reporting)
I.
ACQUISITION METHOD In a business combination accounted for as an acquisition, the subsidiary may be acquired for cash, stock, debt securities, etc. The investment is valued at the fair value of the consideration given or the fair value of the consideration received, whichever is the more clearly evident. The accounting for an acquisition begins at the date of acquisition. (i) Acquistion for Cash
DR CR
(ii)
Investment in subsidiary Cash
$XXX $XXX
Acquistion for Parent Common Stock (use FV at Date Transaction Closes)
DR CR CR
Investment in subsidiary Common stock (Parent at par) A.P.I.C. (Parent/FV--par)
$XXX $XXX $XXX
Date of Purchase Stock Price Goes Up FACTS: TAG Inc. announces that it has agreed to buy a Sub Co. on April 1, 200X for 1 million shares of its own common stock. Transaction closes on September 30, 200X 1 million shares issued. Market Price of Stock Stock Price Goes Up 4/1/0X (Announced) $10 9/30/0X (Closed) $14 Acquisition Price 1,000,000 x $14 = SFAS 141-R $14,000,000
EXAMPLE 1
Date of Purchase Stock Price Goes Down FACTS: TAG Inc. announces that it has agreed to buy a Sub Co. on April 1, 200X for 1 million shares of its own common stock.
EXAMPLE 2
Transaction closes on September 30, 200X 1 million shares issued. Market Price of Stock Stock Price Goes Up 4/1/0X (Announced) $10 9/30/0X (Closed) $ 7 Acquisition Price 1,000,000 x $7 = SFAS 141-R $7,000,000
F3(B)-22
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Financial Accounting & Reporting 3(B)
A.
APPLICATION OF THE ACQUISITION METHOD The acquisition method has two distinct accounting characteristics: (1) 100% of the net assets acquired (regardless of percentage acquired) are recorded at fair value with any unallocable balance remaining creating goodwill, and (2) when the companies are consolidated, the subsidiary's entire equity (including its common stock, APIC, and retained earnings) is eliminated (not reported). PASS KEY
The parent's basis is the acquisition price, which is also the fair market value of the subsidiary on the day of acquisition. The easy to remember formula is: FV = Acquisition Price = Investment in Sub An acquiring corporation should adjust the following items during consolidation: 1. Common Stock, A.P.I.C. and Retained Earnings of Subsidiary are Eliminated The pre-acquisition equity (common stock, APIC and retained earnings) of the subsidiary is not carried forward in an acquisition. Consolidated equity will be equal to the parent's equity balance (plus any Noncontrolling (Minority) Interest). The subsidiary's equity is eliminated by debiting each of the subsidiary's equity accounts in the Eliminating Journal Entry (EJE) on the consolidating workpapers. 2. Investment in Subsidiary is Eliminated The parent company will eliminate the "Investment in Subsidiary" account on their balance sheet as part of the Eliminating Journal Entry (EJE). This credit will be posted on the consolidating workpapers. 3. Noncontrolling (Minority) Interest is Created As part of the Eliminating Journal Entry (EJE) on the consolidating workpapers, the fair value of any portion of the subsidiary that is not acquired, must be recorded to an account reported in the equity section of the consolidated financial statements.
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4.
Balance Sheet of Subsidiary is Adjusted to Fair Value All of the subsidiary's balance sheet accounts are to be adjusted to fair value on the acquisition date. This is accomplished as part of the Eliminating Journal Entry (EJE) on the consolidating workpapers. This adjustment is done, regardless of the amount paid to acquire the subsidiary. The adjustment is for the full (100%) fair value, even if less than the entire subsidiary is acquired.
5.
Identifiable Intangible Assets of the Subsidiary are Recorded at their Fair Value As part of the Eliminating Journal Entry (EJE) on the consolidating workpapers, it is required that the parent record the fair value of all Identifiable Intangible Assets of the subsidiary. This is done, even if no amount was incurred to acquire these items in the acquisition.
6.
Goodwill (or Gain) is Required If there is an excess of the acquisition cost (plus any Noncontrolling (Minority) Interest) over the fair value of the subsidiary, then the remaining/excess is debited to create Goodwill. If there is a deficiency in the acquisition cost compared to the subsidiary's fair value, then the shortage/negative amount is credited to Gain Extraordinary.
PURCHASE ILLUSTRATION 1 C/S Parent C/S Sub 2 C/S Parent C/S Sub 3 C/S Parent
50 100
CONSOLIDATE
Parent Company
Sub Company
Parent Company
Parent Company Sub Company
Sub Co.
Sub Company
7.
The Consolidating Workpaper Eliminating Journal Entry The year end consolidating journal entry known as the consolidating workpaper eliminating journal entry (EJE) is: C DR A DR R DR I
CAR IN BIG
Common Stock - Sub A.P.I.C. - Sub Retained Earnings - Sub Investment in Subsidiary Non-Controlling Interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill
$ XXX XXX XXX $ XXX XXX XXX XXX XXX
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CR
N CR B DR I DR G DR
F3(B)-24
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Financial Accounting & Reporting 3(B)
PASS KEY Sub's Total (100%) Fair Value Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment Book Value (CAR) DR B. "CAR": SUBSIDIARY EQUITY ACQUIRED 1. CAR Formula The following formula is used to determine the book value of the assets acquired from the subsidiary: 2. Assets - Liabilities = Equity Assets - Liabilities = Net Book Value Assets - Liabilities = CAR
CAR IN
NCI
Investment in Subsidiary (Acquisition Price)
CR
BIG
Acquisition Date Calculation (of CAR) The determination of the difference between book value and fair value must be computed as of the acquisition date. When the subsidiary's financial statements are provided for a subsequent period, it is necessary to reverse the activity (income and dividends) in the subsidiary's retained earnings in order to squeeze back into the book value (Assets - Liabilities = CAR) at the acquisition date.
Acquisition
"Car" Common stock - Sub A.P.I.C. - Sub Retained earnings - Sub Investment in Sub Noncontrolling Minority Interest Balance sheet adjusted to FV Identifiable Intangible Assets FV Goodwill
Date Same all year Same all year Squeeze back to purchase date amount
B A S E
Beg. retained earnings Add: income Subtract: dividends End retained earnings
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C.
INVESTMENT IN SUBSIDIARY 1. 2.
CAR IN BIG
The original carrying amount of the investment in subsidiary account on the parent's books is: Original cost Measured by the FV (on the date the acquisition is completed) of the consideration given (Debit: Investment in Sub); Business combination costs/expenses in an acquisition are treated as follows: a. b. Direct out-of-pocket costs such as a finder's fee or a legal fee are expensed. (Debit: Expense) Stock registration and issuance costs such as SEC filing fees are a direct reduction of the value of the stock issued. (Debit: Additional Paid-in Capital account) Indirect costs are expensed as incurred. (Debit: Expense) Bond issue costs are capitalized and amortized. (Debit: Bond Issue Costs)
c. d.
Business Combination Accounted for as an Acquisition On January 1, Year 1, Big Company exchanged 10,000 shares of $10 par value common stock with a fair value of $415,000 for 100% of the outstanding stock of Sub Company in a business combination properly accounted for as an acquisition. In addition Big Co. paid $35,000 in legal fees. At the date of acquisition, the fair and book value of Sub Co.'s net assets totaled $300,000. Registration fees were $20,000. Journal Entry: To record the acquisition price and legal fees DR Investment in Sub $415,000 DR Legal Expense 35,000 CR Common stock - $10 par value CR Additional Paid-in capital Big Co. ($315,000 - $20,000) CR Cash ($35,000 + $20,000)
EXAMPLE
$100,000 295,000* 55,000
*APIC Big Co. = $415,000 - $100,000 = $315,000 - $20,000 = $295,000 Sub's Total (100%) Fair Value Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment BV (CAR) $115,000 -0$415,000 Investment in Subsidiary -0NCI
-0$300,000
DR
CR
F3(B)-26
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Financial Accounting & Reporting 3(B)
EXAMPLE CONTINUED
C A R I N B I G
DR DR DR CR CR DR DR DR
Common stock Sub A.P.I.C. Sub Retained earnings - Sub Investment in Subsidiary Non-controlling interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill -0-0115,000 $415,000 -0$300,000
PASS KEY When the CPA Examination tests this issue, remember to look carefully for the acquisition related costs that must be expensed.
3.
Step Acquisition Consolidation and Deconsolidation Owner Percentage Change Non-control control (step transition) Accounting Treatment Remeasure previously held equity interests to fair value The income statements will reflect this adjustment Equity transaction (no gain or loss recognition) Recognize the gain or loss of the sale of the stock Control non-control Remeasure the remaining nonconsolidating interest to fair value Recognize the adjustment to fair value on the income statement
Control "more" or "less" control
PASS KEY Gaining control/losing control is a remeasurement event. Concept: The parent exchanges a noncontrolling investment asset for a controlling financial interest in all of the underlying assets and liabilities of the target. (SFAS 153 "Commercial Substance")
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Step Acquisitions with Noncontrolling Interest (Minority Interest) FACTS: On July 1, 2004: Investment in Sub (25% ownership) $ 500,000 Sub Co.'s FV (100%) on August 1, 2009 $4,000,000 On August 1, 2009: Purchase extra 50% for $2,000,000 Original Interest 25% $ 500,000 500,000* 1,000,000 Acquired Interest 50% $2,000,000 -$2,000,000 Noncontrolling Interest 25% -$1,000,000 + $1,000,000 = Total Fair Value $4,000,000
EXAMPLE
Original SFAS 141-R Adj. New Carrying Amount
+
*$500,000 write up of original interest is a GAIN.
DR: CR: Investment in Sub Gain $500,000 $500,000
To record the adjustment to fair value in the previously held 25% ownership in sub.
PASS KEY If the parent acquires the remaining 25% from the noncontrolling interest (minority interest) shareholders, it is an equity transaction (not an acquisition).
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Financial Accounting & Reporting 3(B)
Partial Acquisitions FACTS: In 20X1, TAG Inc. buys 10% of Gearty Co.'s equity for $20,000 when the fair value of Gearty Co.'s net identifiable assets is $180,000. Four years later, in 20X5, TAG Inc. acquires an additional 50% (total now is 60% = 10% + 50%) interest for $400,000 in cash. At the date of this additional acquisition, Gearty Co. had the following: Net identifiable assets Net identifiable assets Minority interest (NCI) FV FV = = $640,000 $520,000 $320,000 NBV =
GAAP SOLUTION:
EXAMPLE
$ X X $
400,000 2 800,000 10% 80,000 20,000 60,000
FV for 50% FV for 100% Prior % owned FV prior 10% Paid Gain
DR: CR: Investment in Sub Gain $60,000 $60,000
To record the adjustment to fair value in the previously held 10% investment in Gearty Co.
Beginning Balance $20,000 + + Investment in Sub: FV Adjustment + New Acquisition $60,000 + $400,000 = = Ending Balance $480,000
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Sub's Total (100%) Fair Value = $800,000 Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment Book Value (CAR)
EXAMPLE
$160,000 -0-
$320,000
NCI
$120,000
$480,000
Investment in Subsidiary
$520,000
DR CR
C A R I N B I G
DR DR DR CR CR DR DR DR
Common stock - Sub A.P.I.C. Sub Retained earnings Sub Investment in Subsidiary Non-controlling interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill $120,000 -0160,000 $800,000 $800,000 $480,000 320,000 $520,000
F3(B)-30
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Financial Accounting & Reporting 3(B)
D.
NON-CONTROLLING (MINORITY) INTEREST 1. Overview
CAR IN BIG
Business combinations that do not establish 100% ownership of a NONCONTROLLING MINORITY INTEREST subsidiary by a parent will result in a portion of the subsidiary's equity being attributed to noncontrolling (minority) interest shareholders. Noncontrolling (minority) interest must be disclosed in the consolidated balance sheet. If the parent does not acquire 100% of the ownership of the subsidiary, then the percentage of the ownership that is not owned shall be reported at fair value on the consolidated financial statements as Noncontrolling (Minority) Interest. This will include its share of any Goodwill (even though there is no cost basis). Valuation of NCI FACTS:
EXAMPLE
Gearty Co. purchased 600,000 shares (60%) of Foxy, Inc. from Becker Ltd. for $70,000,000 (control premium of $1,000,000 included) There is an implied "control premium" in this purchase price over traded market price Foxy, Inc.'s remaining 400,000 shares (40%) are publicly traded at $112.50 per share at acquisition date
GAAP Solution: Estimation of Fair Value of 100% Equity Interest in Foxy, Inc. Purchase price for 60% of Foxy, Inc. Publicly traded price (fair value) at purchase date Times: Outstanding shares (40%) Equals: Fair Value Fair Value of 100% Equity Interest $ 112.50 x 400,000 45,000,000 $115,000,000 $ 70,000,000
Acquisition of less than 100% of the equity interests in the target FACTS:
EXAMPLE
Gearty Co. acquires 60% of Foxy, Inc. for $70,000,000. The purchase price is equal to 60% of the total fair value of Foxy (60% x $115,000,000 = $69,000,000) plus a control premium of $1,000,000 Fair value of Foxy, Inc. (includes goodwill) = Fair value of Foxy, Inc. identifiable assets net of liabilities = Book value of Foxy, Inc. net assets = $115,000,000 $100,000,000 $ 80,000,000 $20,000,000 $15,000,000
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Sub's Total (100%) Fair Value = $115,000,000 Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment
EXAMPLE CONTINUED
$15,000,000 -0-
$45,000,000
NCI
$20,000,000 $80,000,000
$70,000,000
Investment in Subsidiary
Book Value (CAR)
C A R I N B I G
DR DR DR CR CR DR DR DR
Common stock - Sub A.P.I.C. Sub Retained earnings - Sub Investment in Subsidiary Non-controlling interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill 20,000,000 -015,000,000 $115,000,000 $115,000,000 $ 70,000,000 45,000,000 $ 80,000,000
F3(B)-32
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Financial Accounting & Reporting 3(B)
Partial Acquisitions FACTS: TAG Inc. purchases 60% of Gearty Co.'s equity for $80,000,000 in cash. Gearty Co.'s net identifiable assets: fair value is $25,000,000; carrying amount is $5,000,000; NCI fair value is $45,000,000.
Sub's Total (100%) Fair Value = $125,000,000 Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment
EXAMPLE
$100,000,000 -0-
$45,000,000
NCI
$20,000,000 $5,000,000
$80,000,000
Investment In Subsidiary
Book Value (CAR)
DR
CR
C A R I N B I G
DR DR DR CR CR DR DR DR
Common stock - Sub A.P.I.C. Sub Retained earnings Sub Investment in Subsidiary Non-controlling interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill 20,000,000 -0100,000,000 $125,000,000 $125,000,000 $80,000,000 45,000,000 $ 5,000,000
2.
Financial Statement Presentation a. Income Statement The consolidated income statement will include 100% of the subsidiary's revenues and expenses (after the date of acquisition). However, the noncontrolling (minority) interest portion of the subsidiary's net income should be allocated to the noncontrolling (minority) interest, within a sub-account of retained earnings.
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(1)
Computation Compute by multiplying the subsidiary's net income times the noncontrolling (minority) interest percentage.
Sub's Income <Sub's Expenses> Sub's Net Income x Noncontrolling (Minority) Interest % Noncontrolling (Minority) interest in Net Income
b.
Balance Sheet The consolidated balance sheet will include 100% of the subsidiary's assets and liabilities (not the sub's equity / CAR). The noncontrolling (minority) interest's share of the subsidiary's net assets should be presented on the balance sheet as part of stockholders' equity, and is often referred to as the noncontrolling (minority) interest. (1) Computation If there is no control premium, compute the noncontrolling (minority) interest by multiplying subsidiary total fair value times the noncontrolling (minority) interest percentage:
Fair Value of Sub x Noncontrolling (Minority) Interest % Noncontrolling (Minority) Interest
The noncontrolling interest can also be computed as the difference between the fair value of the subsidiary and the controlling interest in the subsidiary (the purchase price paid by the parent company): Noncontrolling (Minority) Interest = Fair Value of Sub Controlling Interest in Sub This formula works when there is a control premium and when there is no control premium. (2) Allocation of Subsidiary Net Losses Allocate to noncontrolling interest (minority interest) even if allocation exceeds the equity attributable to the minority interest/noncontrolling interest (negative carrying balance). PASS KEY GAAP Theory: Noncontrolling interest holders participate proportionately in the risks and rewards of the subsidiary.
F3(B)-34
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Financial Accounting & Reporting 3(B)
Noncontrolling (Minority) Interest On June 30, Parent Co. acquired 90% of Sub Co. for $8,100,000. Sub Co.'s net book value equaled the fair value on the date of acquisition. The stockholders' equities immediately before the combination were: Common stock Additional paid-in capital Retained earnings Total P $ 6,500,000 4,400,000 6,100,000 $17,000,000 S $ 2,000,000 1,600,000 5,400,000 $9,000,000
Sub's Total (100%) Fair Value $9,000,000 Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment Book Value (CAR) -0$900,000 NCI
-0Investment in Subsidiary
EXAMPLE
-0-
$8,100,000
$9,000,000
DR CR
Net income and dividends for the year were:
PARENT Net Income Six months ended 6/30 Six months ended 12/31 Dividends paid April 5 October 12 $ 800,000 $ 600,000 1,500,000
SUB $ 200,000 1,000,000
$ 100,000
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B A S E
EXAMPLE CONTINUED
C 2,000,000 -- -- 2,000,000
A 1,600,000 -- -- 1,600,000
R 5,400,000 1,000,000 (100,000) 6,300,000
Beginning Sub--Income Sub--Dividend Ending
I 8,100,000 900,000 (90,000) 8,910,000
N 900,000 100,000 (10,000) 990,000
B -0-- -- - 0-
I -0-- -- - 0-
G -0-- -- -0-
Year-End (Workpaper) Eliminating Journal Entry: C DR A DR R DR I CR N CR B DR I DR G DR Common stock Sub A.P.I.C. Sub Retained earnings Sub Investment in Sub Noncontrolling (Minority) interest Balance sheet adj. To FV Identifiable intangible assets Goodwill -0-0-0CAR IN BIG
$2,000,000 1,600,000 6,300,000 $8,910,000 990,000
E.
BALANCE SHEET ADJUSTMENT TO FAIR VALUE, IDENTIFIABLE INTANGIBLE ASSET ADJUSTMENT TO FAIR VALUE, AND GOODWILL (GAIN) 1. Acquisition Cost + Noncontrolling (Minority) Interest reconciliation to Fair Value of the Subsidiary (Balance Sheet Adjustment, Identifiable Intangible Assets and Goodwill (Gain) Under the Acquisition Method, the parent's acquisition of the subsidiary is recorded at the fair value of the consideration surrendered. This acquisition price (and any Noncontrolling Interest at fair value) must be compared to the respective assets and liabilities of the subsidiary at the date of acquisition. Any difference between the fair value paid (and fair value of NCI) and the book value acquired will require an adjustment to the following three areas: a. b. c. Balance Sheet Adujstment of the subsidiary's records from book value to fair value. Identifiable Intangible Assets related to the acquisition of the subsidiary are to record at fair value. Goodwill is recognized for any excess/negative in Gain. PASS KEY In Process Research and Development
Recognize as an intangible asset separately from goodwill at the acquisition date (need valuation) Do not immediately write off FAC 6 meets the definition of an "asset" it has probable future economic benefit
F3(B)-36
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Financial Accounting & Reporting 3(B)
2.
Determining Acquisitions with Goodwill
CAR IN
BIG
Rule: When acquiring a corporation/subsidiary with an acquisition cost (acquisition price paid + liabilities assumed) that is greater than the fair value of 100% of the underlying assets acquired, the following steps are required: a. Step 1 / Balance Sheet Adjusted to Fair Value Allocate the acquisition cost to the fair value of 100% of the Balance Sheet accounts. b. Step 2 / Identifiable Intangible Assets to Fair Value Allocate the remaining acquisition cost to the fair value of 100% of the Identifiable Intangible Assets acquired. Illustrative List of Identifiable Intangible Assets Agreements & Contracts Rights Permits Patents Copyrights Trademarks & Trade Names Franchises Computer Software & Licenses Technical Drawings & Manuals Customer Lists Unpatented Technology In-Process Research and Development Noncompetes
These Identifiable Intangible Assets are separated into two categories. The two categories are: (1) Finite life Amortize over the remaining life. Subject to the two step impairment test (see F2 for details). (2) Indefinite life Do not amortize. Subject to the one step impairment test (see F2 for details).
c.
Step 3 / Goodwill Allocate any remaining acquisition cost to Goodwill. This Goodwill is not amortized. Acquisition Goodwill is subject to impairment testing. Accordingly, in the period it is determined to be impaired, it is written down and charged as an expense against income on the Income Statement. See the F2 Impairment for detail on the determination of goodwill impairment. Intangibles Now Subsumed into Goodwill Assembled Workforce Distribution Channels Technical Expertise Training and Recruiting Product/Service Support Advertising Programs Geographic Presence Technological Know-How Government Relations
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3.
Determining Acquisition with Gain Rule: When acquiring a corporation/subsidiary with an acquisition cost (acquisition price paid + liabilities assumed) that is less than the fair value of 100% of the underlying assets acquired, the following steps are required: a. Step 1 / Balance Sheet Adjusted to Fair Value Allocate the acquisition cost to the fair value of 100% of the Balance Sheet accounts (even if the acquisition cost is less than the fair value to be assigned). This will create a negative balance in the acquisition cost account. b. Step 2 / Identifiable Intangible Assets to Fair Value Allocate any remaining acquisition cost (if any) to the fair value of 100% of the Identifiable Intangible Assets acquired (even if the remaining acquisition cost is less than the fair value to be assigned). This will create or increase the negative balance in the acquisition cost account. c. Step 3 / Gain The negative balance in the acquisition cost account (due to the fair value of the Balance Sheet Assets and the Identifiable Intangible Assets have been greater than the acquisition cost) is to be recorded as a Gain. PASS KEY Indefinite Life Finite Life Useful life is limited Over useful economic life Two-step test (FASB 121)
Characteristics Amortization Impairment Test
Life extends beyond the foreseeable future None One-step test (fair value based)
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Financial Accounting & Reporting 3(B)
Goodwill Allocation FACTS: Gearty Co. purchases 65% of Sub Co. for $1,500,000 (including any control premium). Total fair value of Sub Co. is $2,200,000. Total net book value of Sub Co. is $1,000,000. The purchase price of $1,500,000 is equal to 65% of the total fair value of Sub Co. ($2,200,000 x 65% = $1,430,000) plus a control premium of $70,000. Fair value of 100% of Sub Co.'s identifiable net assets is $1,600,000. Sub's Total (100%) Fair Value = $2,200,000 Goodwill Identifiable Intangible Assets FV Balance Sheet FV Adjustment
EXAMPLE
$600,000 -0-
$700,000
NCI
$600,000
$1,500,000
Investment in Subsidiary
Book Value (CAR)
$1,000,000
DR CR
C A R I N B I G
DR DR DR CR CR DR DR DR
Common stock Sub A.P.I.C. Sub Retained earnings Sub Investment in Subsidiary Non-controlling interest Balance Sheet Adjustments to FV Identifiable Intangible Assets to FV Goodwill 600,000 -0600,000 $2,200,000 $2,200,000 $1,500,000 700,000 $1,000,000
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CONCEPT EXERCISE On January 1, 20X7, Gearty Corporation (parent) acquired 100% of Olinto Corporation. Gearty Corp. issued 100,000 shares of its $10 par common stock, with a market price of $15 on the date the acquisition was announced and $25 on the date the acquisition was completed, for all of Olinto Corp.'s common stock. On that date the fair value of Olinto Corp.'s assets and liabilities equaled their respective carrying amounts with the exception of land, which had a fair value that exceeded its book value by $200,000. The fair value of Olinto Corp.'s identifiable intangibles (other than goodwill) is $100,000. For the year ending December 31, 20X7, Olinto reported net income of $350,000 and paid cash dividends of $150,000. The stockholders' equity section of each company's balance sheet as of December 31, 20X7, was: Common stock Additional paid-in capital Retained earnings SOLUTION: REQUIRED: Calculate the acquisition date consolidation workpaper eliminating journal entry (1) (2) (3) (4) (5) (6) Determine the carrying/book value (CAR) of the subsidiary at the date of acquisition. Determine the acquisition price (investment in subsidiary). Determine the fair value of any noncontrolling (minority) interest. Determine the balance sheet accounts fair value adjustments. Determine the fair value of any identifiable intangible assets. Determine the amount of goodwill. Gearty $5,000,000 1,000,000 3,000,000 $9,000,000 Olinto $1,000,000 400,000 500,000 $1,900,000
ANSWERS: Common Stock Sub A.P.I.C. Sub Retained Earnings Sub (at purchase date) $1,000,000 400,000 300,000 300,000 350,000 <150,000> 500,000 1,700,000 2,500,000 800,000 -0800,000 200,000 600,000 100,000 500,000
B A S E
Beginning Add: income Subtract: dividends Ending
Net Book Value Investment (100,000 shares x $25 FV) Difference Noncontrolling Interest Difference Balance Sheet Adjustment to Asset Land Difference Identifiable Intangible Assets Goodwill
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Sub's Total (100%) Fair Value $2,500,000 Goodwill $500,000 -0NCI
Identifiable Intangible Assets FV
$100,000 Investment in Subsidiary
Balance Sheet FV Adjustment
$200,000
$2,500,000
Book Value (CAR)
$1,700,000 DR CR
CONSOLIDATING WORKSHEET: ELIMINATING JOURNAL ENTRY DR: DR: DR: CR: CR: DR: DR: DR : Common Stock Sub A.P.I.C. Sub Retained Earnings Sub Investment in Sub Noncontrolling Interest Balance Sheet Adjustment FV Identifiable Intangible Assets FV Goodwill 200,000 100,000 500,000 $1,000,000 400,000 300,000 $2,500,000 -0-
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Acquisition of 100% Interest in Investee Example Current Assets L.T. Investment Marketable Securities Noncurrent Assets Identifiable Intangible Assets Liabilities Common Stock A.P.I.C. Retained Earnings Sub NBV $100,000 25,000 200,000 -050,000 100,000 100,000 75,000 Sub FV $100,000 25,000 250,000 100,000 50,000
EXAMPLE
PREMIUM 1 Investment in Sub Liabilities Assumed Amount to be Assigned Step #1: Balance Sheet Adjusted Fair Value Difference Step #2: Identifiable Intangibles Step #3: Goodwill <Gain> $75,000 -0<100,000> <100,000> <375,000> $175,000 <375,000> $100,000 $500,000 50,000 $550,000 2 $425,000 50,000 $475,000
DISCOUNT 3 $10,000 50,000 $60,000
<375,000> <$315,000>
<100,000>
<$415,000>
PASS KEY The trick to properly calculating the proper amounts is to remember to always use fair value of the assets in Steps 1 and 2.
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Financial Accounting & Reporting 3(B)
PURCHASE: CONSOLIDATING (WORKPAPER) ELIMINATING JOURNAL ENTRIES Example #1 DR DR DR CR CR DR DR DR DR DR DR CR CR DR DR DR DR DR DR CR CR DR DR CR Common stock Sub A.P.I.C. Sub Retained earnings Sub Investment in Sub Noncontrolling (minority) interest Balance sheet adjust FV Identifiable Intangible Assets Goodwill Common stock Sub A.P.I.C. Sub Retained earnings Sub Investment in Sub Noncontrolling (minority) interest Balance sheet adjust FV Identifiable Intangible Assets Goodwill Common stock Sub A.P.I.C. Sub Retained earnings Sub Investment in Sub Noncontrolling (minority) interest Balance sheet adjust FV Identifiable Intangible Assets Gain $100,000 100,000 75,000 $500,000 -050,000 100,000 75,000 $100,000 100,000 75,000 $425,000 -050,000 100,000 0 $100,000 100,000 75,000 $10,000 -050,000 100,000 $415,000
Example #2
Example #3
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F.
JOURNAL ENTRY FLOW CHART--ACQUISITION DATE CALCULATION
Common stock Sub A.P.I.C. Sub Retained earnings Sub
<
Investment in Sub
>
DIFFERENCE
+ Noncontrolling (minority) interest
DIFFERENCE
Balance Sheet FV Adjustment
DIFFERENCE
Identifiable Intangible Assets
DIFFERENCE
Goodwill
Gain
PASS KEY It is important to note that even if the parent acquired less than 100% of the subsidiary, the adjustment of the subsidiary's assets to FV (purchase price) will always be the FV (100%).
CONSOLIDATION DISCLOSURES
G.
DISCLOSURE FOR THE ACQUISITION METHOD The following disclosures should be made in the period in which a business combination accounted for by the acquisition method occurs. 1. 2. 3. 4. 5. 6. Name, brief description, and total cost of the acquisition. Method of accounting, that is, the acquisition method. Period for which results of operations of the acquisition are included in the income statement (usually commences from the date of acquisitions). Other pertinent information such as contingent payments, options, or other commitments. Amount of subsidiary net income/loss allocated to the noncontrolling interest. Amount of retained earnings applicable to the noncontrolling interest.
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Financial Accounting & Reporting 3(B)
The following supplemental information should be disclosed in the notes to the financial statements of an acquiring company in the year of acquisition. These disclosures are not required in the financial statements of nonpublic enterprises. 1. 2. Results of operations for the current period combining the acquisition as though it were acquired at the beginning of the period. If comparative statements are presented, results of operations should include the acquisition as though it were acquired at the beginning of the comparative statement period.
C
Common Stock
A
R
Retained Earnings Beginning + Income - Dividend
I
APIC
Investment
N Noncontrolling Minority Interest
B
I
G
B/S Identifiable Adj. Intangible Assets Assets Goodwill
B A S E
End
H.
ACQUISITION METHOD SUMMARY Acquisition Assets .......................................................................................... FV Liabilities ...................................................................................... FV Retained Earnings ........................................................ Parent Only Income .................................................................. After Acquisition Acquisition Cost .............................................................. Expensed Goodwill .................................................................................... Yes Noncontrolling (Minority) Interest ........................... Yes (1% - 49%) Investment in Sub .............................................................Eliminate
Asset Adjustment ........................................................... Depreciate Identifiable Intangible Assets ...................................... Amortization Goodwill Adjustment ............................................. Impairment Test Intercompany Transactions ...............................................Eliminate
PASS KEY Acquired (purchased) goodwill is not amortized, it is subject to the impairment test.
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INTERCOMPANY TRANSACTIONS
INTERCOMPANY TRANSACTIONS
I.
INTERCOMPANY TRANSACTIONS A. ELIMINATE INTERCOMPANY TRANSACTIONS Intercompany transactions must be eliminated since they lack the criteria of being "arm's length." 1. Balance Sheet a. b. c. d. 2. a. b. c. B. Advances Receivable / Advances Payable Accounts Receivable / Accounts Payable Dividends Receivable / Dividends Payable Bonds Receivable / Bonds Payable Interest Expense / Interest Income (Bonds) Gain on Sale / Depreciation Expense (Fixed Assets Sold) Sale and Cost of Goods Sold (Inventory - on hand)
Income Statement
ELIMINATE 100% (EVEN WHEN NONCONTROLLING (MINORITY) INTEREST EXISTS) Eliminate entire amount, even if ownership is less than 100% when you consolidate. 1. Balance Sheet Eliminate 100% a. Group I Eliminate 100% of all Interco Payables and Receivables DR: CR: DR: CR: DR: CR: DR: CR: 2. Accounts Payable Accounts Receivable Bonds Payable (Interco portion only) Bonds Investment (in affiliate) Accrued Bond Interest Payable Accruerd Bond Interest Receivable Dividends Payable (affiliate portion only) Dividends Receivable (from affiliate) $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX
Income Statement Eliminate 100% a. Group II Eliminate All Interco Gross Profit Sitting in Ending Inventory and Fixed Assets of Parent or Subsidiary
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Financial Accounting & Reporting 3(B)
IMPORTANT: The portion eliminated does not depend on who is selling: 1. Parent Was the Seller: Eliminate 100% of the: a. b. Balance sheet write-up (or write-down) relating to the inventory or fixed asset that was transferred Income Statement (1) (2) 2. a. b. Open (Presented): Sale and cost of goods sold Closed (to Retained Earnings): Profit (or loss) relative to the sale.
Subsidiary was the seller: Eliminate 100% of the: Balance Sheet Gross profit from ending inventory and/or fixed assets. Income Statement (1) (2) Open (Presented): Sale and cost of goods sold Closed (to Retained Earnings & Minority Interest): Profit (or loss) relative to the sale.
3.
Fixed asset cost and accumulated depreciation are based on original costs from the OUTSIDE world and remains the same on the consolidated financial statements. Only the intercompany gains and losses and their effect on accumulated depreciation are eliminated.
C.
NOT CONSOLIDATED = NOT ELIMINATED Do not eliminate intercompany accounts if you do NOT consolidate. 1. 2. Separate report in financial statements Footnote disclosure
D.
INTERCOMPANY INVENTORY / MERCHANDISE TRANSACTIONS It is common for affiliated companies to sell inventory/merchandise to one another. Often this inventory/merchandise is sold at a profit. The total amount of this intercompany sale and cost of goods sold should be eliminated prior to preparing consolidated financial statements. In addition, the intercompany profit must be eliminated from the ending inventory and the cost of goods sold of the purchasing affiliate. The profit to be eliminated is based upon the gross profit (markup on selling price) recognized by the selling affiliate. 100% of the profit should be eliminated even if the parent's ownership interest is less than 100%. The intercompany profit in beginning inventory that was recognized by the selling affiliate in the previous year must be eliminated by an adjustment (debit) to retained earnings. Workpaper Elimination Entry for Intercompany Merchandise Transactions
DR: Intercompany sales DR: Retained earnings (profit in beginning inventory) CR: CR: CR: Intercompany cost of goods sold Cost of goods sold (intercompany profit included in cost of goods sold of the purchasing affiliate) Ending inventory (intercompany profit in the inventory remaining)
$XXX $XXX $XXX $XXX $XXX
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PASS KEY When inventory has been sold intercompany and the CPA Examination requires you to correct the accounts, remember to reverse the original intercompany transaction (sale and cost of goods sold, internally) and: Inventory sold to outsiders Inventory still on hand correct Cost of Goods Sold correct Ending Inventory
Intercompany Profit in Inventories Potato Company owns 80% of the common stock of Soup Company. Potato sells merchandise to Soup at 10% above its cost. Such sales amounted to $1,100,000 during Year 1. The Year 1 ending inventory of Soup included goods purchased from Potato for $660,000. Potato reported $1,586,000 in net income from its independent operations in Year 1. Soup reported net income of $855,000 in Year 1 and did not declare dividends. Potato records its investment in Soup using the equity method. There were no intercompany sales prior to Year 1. Year 1 Workpaper Elimination Entry DR CR CR CR Step [1] Sales = Cost + (10% x Cost)
EXAMPLE
Intercompany sales P Intercompany cost of goods sold P Cost of goods sold S Inventory S
$1,100,000 $1,000,000 [1] 40,000 [2] 60,000 [3]
$1,100,000 = 110% x Cost Intercompany cost of goods sold Step [2] Beginning inventory Purchases Cost of goods available Ending inventory Cost of goods sold Intercompany profit based on Potato's markup on selling price * Markup on selling price = Markup on cost = 9.091% 1 + Markup on cost $ 40,000 [2] $ 0 1,100,000 1,100,000 660,000 440,000 9.091%* $1,000,000 [1]
Intercompany profit in Soup's cost of goods sold Step [3] Ending inventory Markup Intercompany profit in ending inventory
$ 660,000 x 9.091% $ 60,000 [3]
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Financial Accounting & Reporting 3(B)
E.
INTERCOMPANY BOND TRANSACTIONS If one member of the consolidated group acquires an affiliate's debt from an outsider, the debt is considered to be retired and a gain/loss is recognized. The gain/loss is reported as a gain/loss. This gain/loss on extinguishment of debt is calculated as the difference between the price paid to acquire the debt and the book value of the debt. This gain/loss is not reported on either company's books, but is recorded through an elimination entry. All intercompany account balances are also eliminated.
Intercompany Bond Transactions On December 31, Year 1, Parent Company issued bonds with a carrying value of $300,000, and a face value of $250,000. The premium on bonds payable was recorded as $50,000. Journal Entry: To record the sale of the bonds on the Parent's books DR CR CR Cash Bonds payable Premium on bonds payable $300,000 $250,000 50,000
EXAMPLE
On December 31, Year 1, before any portion of the premium was amortized, Sub Company acquires all the outstanding bonds from the original purchasers at a price of $275,000. Journal Entry: To record the purchase of the bonds on the Sub's books DR CR Investment in parent bonds Cash $275,000 $275,000
Workpaper Elimination Entry: Eliminated intercompany balances and recognizes the gain on extinguishment of debt. DR DR CR CR
1.
Bonds payable Premium (parent's records) Investment in parent bonds (sub's records) Gain on extinguishment of bonds
Intercompany Interest
$250,000 50,000 $275,000 25,000
Eliminate intercompany accounts such as interest expense, interest income, interest payable, and interest receivable. 2. Amortization of Discount or Premium Eliminate amortization of the discount or premium, which serves as an increase, or decrease in the amount of interest expense/revenue that is recorded. The unamortized discount or premium on the intercompany bond is eliminated. 3. Subsequent Years The elimination for realized but unrecorded gain/loss on extinguishment of bonds in subsequent years would be adjusted to retained earnings. Minority interest would be adjusted if the bonds were originally issued by the subsidiary.
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F.
INTERCOMPANY SALE OF LAND The intercompany gain/loss on the sale of land remains unrealized until the land is sold to an outsider. A workpaper elimination entry in the period of sale eliminates the intercompany gain/loss and adjusts the land to its original cost.
Intercompany Sale of Land On January 1, Year 1, Parent Company sold land to Subsidiary Company for $200,000. The initial cost of the land to Parent was $175,000. Journal Entry: To record the sale by Parent on their books DR Cash CR Land CR Intercompany gain on sale of land Journal Entry: To record the purchase by Sub on their books DR Land CR Cash $200,000 $175,000 25,000 $200,000 $200,000
EXAMPLE
Workpaper Elimination Entry: Elimination of the intercompany gain and adjustment of land to its original cost DR Intercompany gain on sale of land $25,000 CR Land ($200,000 - $175,000) $25,000
In the subsequent year and every year thereafter until the land is sold to a third party, retained earnings (Parent) would be debited and land would be credited to eliminate the intercompany profit. Retained earnings is debited in subsequent years since the gain would have been closed to this account. Since Parent was the seller of the land and Sub was the purchaser, there is no need to divide the intercompany gain between retained earnings and minority interest.
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Financial Accounting & Reporting 3(B)
G.
INTERCOMPANY PROFIT ON SALE OF DEPRECIABLE FIXED ASSETS The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidated financial statement perspective until the asset is sold to an outsider. A working paper elimination entry in the period of sale eliminates the intercompany gain/loss and adjusts the asset and accumulated depreciation to their original balance on the date of sale.
Intercompany Sale of Equipment FACTS: Sub Company, a partially owned (90%) subsidiary of Parent Company, sold equipment on Jan.1, 20X1 to Parent for $100,000. The equipment had a net book value of $70,000 (cost of $90,000 and accumulated depreciation of $20,000), and a remaining life of ten years. Journal Entry: To record the sale by Sub on their books DR Cash DR Accumulated depreciation CR Machinery (original cost) CR Intercompany gain on sale of machinery $100,000 20,000 $90,000 30,000
Jan. 1, 20X1:
Jan. 1, 20X1:
Journal Entry: To record the purchase by Parent on their books DR Machinery $100,000 CR Cash Journal Entry: To record depreciation by Parent on their books DR Depreciation expense ($100,000 10) CR Accumulated depreciation $10,000
$100,000
Dec. 31, 20X1:
EXAMPLE
$10,000
Dec. 31, 20X1:
Workpaper Elimination Entry: Elimination of intercompany gain and adjustment of the machine and accumulated depreciation accounts to their original balance. DR Intercompany gain on sale of machinery $30,000 CR Machinery ($100,000 90,000) $10,000 CR Accumulated depreciation $20,000
The depreciation expense recorded by Parent is overstated by the intercompany profit included in the cost of the machinery.
GAAP Original $70,000 10 Yrs $ 7,000 Non-GAAP Intercompany $100,000 10 Yrs $10,000 Difference $30,000 10 Yrs $ 3,000
NBV Depr. Yrs Depreciation
Workpaper Elimination Entry: Elimination of excess depreciation DR Accumulated depreciation $3,000 CR Depreciation expense
$3,000
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Subsequent Year Work Paper Elimination Journal Entry In the subsequent years the intercompany gain/loss on the sale of the asset and the excess depreciation have been closed to Retained Earnings. The elimination entries in subsequent years therefore adjusts Retained Earnings, and if appropriate, Minority Interest for the original gain or loss less the excess depreciation previously recorded (Unrealized gain/loss at the beginning of the year). Continuing with the previous example, in Year 2 the workpaper elimination entries would be:
Journal Entry: Adjust fixed asset DR
EXAMPLE CONTINUED
Retained Earnings Minority interest in net assets Machinery Accumulated depreciation
$24,300 2,700 $10,000 17,000
[1] [2] [3]
DR CR CR
Journal Entry: Adjust depreciation DR CR [1] [2] [3] Accumulated depreciation Depreciation expense $ 3,000 $ 3,000
Original gain - Excess depreciation previously recorded = Unrealized gain at the beginning of the year. $30,000 - $3,000 = $27,000 x 90% (Parent's ownership percentage) = $24,300 $27,000 x 10% (Minority shareholder's ownership percentage) = $2,700 Original accumulated depreciation difference of $20,000 less excess depreciation of $3,000 previously recorded.
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Financial Accounting & Reporting 3(B)
COMBINED FINANCIAL STATEMENTS / PUSH DOWN ACCOUNTING
I.
COMBINED FINANCIAL STATEMENTS Combined financial statements of a group of related companies (not consolidated because there is no parent company): A. TYPES: 1. 2. 3. B. 1. 2. 3. 4. Companies are under common control (e.g., individual owns many companies), or Companies are under common management, or Unconsolidated subsidiaries (e.g., many foreign subs) are combined. Intercompany transactions and balances among these companies eliminated. Noncontrolling (minority) interests, etc., be treated like consolidated financial statements. Capital stock and retained earnings be added across, not eliminated. Income statements be added across.
PUSH DOWN ACCOUNTING COMBINED FINANCIAL STATEMENTS
REQUIRES:
II.
PUSH DOWN ACCOUNTING
Push down accounting reports assets and liabilities at fair value in separate financial statements of the subsidiary. In effect, consolidation adjustments are pushed down into the records (and separate financial statements) of each subsidiary. A. B. C. D. Assets and liabilities are adjusted. Retained earnings of the subsidiary are transferred to paid-in capital (to the extent of parent company's percentage of ownership). Net income of each subsidiary includes depreciation, amortization, and interest expense based on fair values rather than historical cost. The SEC requires push down accounting for each substantially wholly-owned subsidiary.
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HOMEWORK READING: POOLING-OF-INTERESTS METHOD I. POOLING-OF-INTERESTS METHOD (90%+ AND ALL OTHER CRITERIA) For transactions, which had previously qualified, or for transactions initiated before June 30, 2001, that met the following criteria, the pooling of interest method is to be used to account for the acquisition. The following conditions must be met if the pooling-of-interests method is to be used to account for a business combination. If any of the following conditions are not met, the business combination must be accounted for as a purchase. If all of the conditions are met and the transaction was completed and/or initiated before June 30, 2001, the business combination must be accounted for as a pooling of interest. A pooling is accomplished through the issuance, by the acquirer, of voting common stock for 90% or more of the voting common stock or 100% of the net assets of the pooled company. The pooling method never results in goodwill because the investment is recorded at the book value of the subsidiary's net assets.
POOLING ILLUSTRATION 1 C/S Parent C/S Sub 2 C/S Parent C/S Sub 3 C/S Parent
90 100
P O O L I N G C/S Parent new
Parent Company
Sub Company
Parent Company
Parent Company Sub Company
Sub Co.
Sub Company
II.
CONDITIONS FOR THE POOLING-OF-INTERESTS METHOD A. CONDITIONS FOR USE OF THE POOLING OF INTERESTS METHOD (ALL MUST BE MET OR THE BUSINESS COMBINATION IS A PURCHASE) 1. Classifications Pertain To: a. b. c. 2. a. Attributes of combining companies. Manner of combining interests. Absence of planned transactions. Must be autonomous for two years before the plan is initiated. They cannot have been a subsidiary or division of another corporation within the two years before the plan of combination is initiated. No combining company can own more than 10% of another combining company for two years before the plan of combination is initiated. Each of the combining companies must be independent.
Attributes of Combining Companies Criteria
b.
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3.
Manner of Combining Interest Criteria a. b. The combination must be completed within one year after the plan is initiated. The issuing corporation must issue voting common stock in exchange for at least 90% of the voting common stock of another combining company after the date the plan of combination is initiated, The combining companies (1) (2) d. (1) (2) e. Reacquire their common stock during the combination except for purposes not related to the combination (e.g., employee stock option plans) or Cannot make equity interest changes for two years before the combination. The ratio of interest of predecessor owners must remain the same, and The voting rights of all shareholders must be the same.
c.
Following the combination
There can be no contingencies related to the exchange of stock (contingent buyout). For example, additional shares of stock to be issued based on future earnings. No agreements concerning post-combination reacquisition or retirement of stock just acquired are allowed (e.g., a deal with dissident shareholders to reacquire their stock). No agreements offering post-combination benefits are allowed (e.g., an agreement to guarantee loans on stock issued in the combination that would permit shareholders to get cash from their stock, or, in effect, "sell" their stock). No intent or plan to dispose of a significant part of the acquired assets of the combining companies (except duplicate facilities) within two years after the combination can exist.
4.
Absence of Planned Transactions Criteria a.
b.
c.
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B.
PROCEDURES FOR RECORDING THE INITIAL INVESTMENT UNDER A POOLING OF INTERESTS The following basic journal entry is required when the par value of the two companies common stock are equal: DR Investment in Subsidiary (for NBV of Sub) CR CR CR Common Stock Parent (shares issued x par value) A.P.I.C. (for the subsidiary, A.P.I.C.) Retained Earnings (for the subsidiaries R.E.)
I CAR
Recording the Initial Investment under a Pooling of Interests Poolgood Company merged with Sub-Way Co. in a business combination accounted for as a pooling. Poolgood issued 20,000 shares of its $5 par common stock for all the outstanding capital stock of SubWay. In addition, Poolgood paid $10,000 in legal fees and $10,000 in SEC fees. Sub-Way's stockholders' equity (NBV) at the beginning of the year of the business combination: Common stock outstanding Additional paid-in capital in excess of par Retained earnings Total capital $100,000 20,000 70,000 $190,000
The investment is recorded at the book value of Sub-Way's net assets, which equals the parent's share of the subsidiary's stockholders' equity at the beginning of the year.
EXAMPLE
Par value of parent's shares issued Par value of subsidiary share transferred Adjustment to additional paid-in capital (Plug)
$100,000 100,000 $ 0
Journal Entry: To record the initial investment under the pooling-of-interests method DR Investment in Sub-Way $190,000 ($100,000 + $20,000 + $70,000) CR Common stock (Poolgood) $100,000 (20,000 x $5) CR Additional paid-in capital $ 20,000 (Poolgood for Sub-Way) [($100,000 + $20,000) - $100,000] CR Retained earnings (Sub-way's) $ 70,000 All of the expenses incurred in the pooling are expenses of the combined corporation. Journal Entry: To record business combination expenses in a pooling DR Business combination expense $20,000 CR Cash
$20,000
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C.
PROCEDURE FOR RECORDING THE INITIAL INVESTMENT WHEN DIFFERENT PAR VALUE AMOUNTS
I CAR
When preparing the journal entry for recording the initial investment is S Company stock under a pooling of interests, the following steps should be applied in the order given: 1. Debit: Investment in S Company account for the book value or recorded amount of S Company's net assets (Sub's: Assets Liabilities = Equity). 2. Credit: Common stock Parent: for the par value of the shares issued by the parent company (number of shares issued x the par value of the parent's stock). 3. Plug: a. b. Credit: (Increase) (1) (1) (2) 4. Credit: Retained Earnings of S Company for an amount equal to the parent's share of S Company's retained earnings at the beginning of the year. Additional Paid-in Capital to balance Parent's A.P.I.C. (to extent it exists), and if necessary, Parent's retained earnings for any remaining difference. Debit: (Decrease)
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NOTE: EXCHANGE OF STOCK WITH DIFFERENT PAR VALUE AMOUNTS Plug Additional Paid-in Capital to balance, but if a debit is required, debit paid-in capital of the parent to the extent its exists and if necessary debit the parent's retained earnings for any remaining difference.
NEGATIVE DIFFERENCE 2 C/S Parent Parent par value issued greater than sub-contributed capital Parent Company 100 Sub Company C/S Sub Debits Required * Debit APIC -- Parent (Until zero) * Remained retained earnings -- Parent
POSITIVE DIFFERENCE 2 C/S Parent Parent par value issued less than sub-contributed capital C/S Sub
Credit Required * Credit APIC -- Parent
Parent Company
+100
Sub Company
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Recording the Initial Investment under a Pooling of Interests The following four assumptions based on information from the previous example will further illustrate the recording of the initial investment under pooling account. Poolgood Company has $40,000 additional paid-in capital on its books. Shares issued by Poolgood (P) $5 Par Par value sub share transferred Par value of parent's shares issued Difference Sub's A.P.I.C. forfeited Difference
EXAMPLE
10,000 Shs $100,000 $ 50,000 + $ 50,000 -- + 50,000 -- -- $ 50,000 $190,000
20,000 Shs $100,000 $ 100,000 -0-- -- -- -- -- $190,000
30,000 Shs $100,000 $ 150,000 $ 50,000 20,000 30,000 $ 30,000 -- -- $190,000 30,000
40,000 Shs $100,000 $200,000 $100,000 20,000 80,000 $ 40,000 $ 40,000 -- $190,000 40,000 40,000 $200,000 0 70,000
Parent A.P.I.C. reduced Negative: decrease parent R.E. Positive: increase A.P.I.C. DR Investment account DR Additional paid-in capital (P) DR Retained earnings (P) CR CR CR Common Stock (P) Additional paid-in capital Retained earnings of sub
$50,000 70,000 70,000
$100,000 20,000 70,000
$150,000 0 70,000
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III.
POOLING-OF-INTEREST (90%+ AND ALL OTHER CRITERIA) For transactions that had previously qualified, or for transaction initiated before June 30, 2001, which met the other criteria for the pooling-of-interest method, this method was, and is, GAAP.
POOLING-OF INTEREST
A pooling-of-interest was accomplished through the issuance, by the acquirer, of voting common stock for 90% or more of the voting common stock for 100% of the net assets of the pooled company. The pooling method never results in goodwill because the investment is recorded at the book value of the subsidiary's net assets.
POOLING ILLUSTRATION 1 C/S Parent C/S Sub 2 C/S Parent C/S Sub 3
90 100
P O O L I N G
C/S C/S Parent new Parent
Parent Company
Sub Company
Parent Company
Parent Company Sub Company
Sub Co.
Sub Company
A.
APPLICATION OF THE POOLING-OF-INTERESTS METHOD The pooling-of-interests method is intended to present as a single interest two or more common stockholder interests that were previously independent. A review of the procedures follows: 1. Balance Sheet (NBV) Assets, liabilities, and stockholders' equity are combined and recorded at historical cost in conformity with GAAP at the date the combination is consummated. 2. Income Statement (Retroactive for Whole Year) Income statements are retroactively combined for entire year, regardless of when pooling actually occurs. 3. Report as of Beginning of Year All financial statements for the period in which the combination occurred should be reported as though the combination occurred at the beginning of the period. 4. 5. Restate Prior Financial Statements Prior-year financial statements should be restated on a consolidated basis. Acquisition Cost (Expensed) Expenses relating to the combination are expenses of the combined group and should be deducted from combined net income. Examples of such expenses are registration fees, finder's and consultant fees, and costs and losses resulting from combining the separate companies.
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6. 7. 8.
No Goodwill Created Goodwill is not recognized. Minority Interest (Maximum 10%) Minority interest is recognized (the 10% or less not acquired). Equity Method Internally Required The equity method is always used in conjunction with the pooling-of-interests method. PASS KEY
In a pooling, never use fair market values! B. POOLING-OF-INTERESTS METHOD AT YEAR-END Under the equity method the parent accrues its proportionate share of the net income reported by the subsidiary. The pooling-of-interests method is accounted for as if the parent and subsidiary had always been combined. Therefore, in the year of acquisition the parent's share of subsidiary's annual net income is included. Dividends declared or paid by the subsidiary are a reduction of the investment in subsidiary account and are not recorded as dividend income. In a pooling all prior financial statements are restated to reflect the combined operations of the pooled companies.
1.
Year End Elimination Entry $XXX XXX XXX $XXX XXX
C A R I M
DR: Common stock - Sub DR: A.P.I.C. - Sub DR: Retained earnings - Sub CR: CR: Investment in sub Minority interest
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Pooling-of-Interests Method at Year-End PoolGood Company merged with Sub-Way Co. in a business combination accounted for as a pooling-of-interest. PoolGood's investment account at the beginning of the current year is $190,000 (100% ownership). Sub-Way's equity section at the beginning of the year is: Common Stock A.P.I.C. Retained Earnings Total $100,000 20,000 70,000 $190,000
Assume Sub-Way has reported $20,000 in net income for the year ended December 31, Year 2001. Sub-Way declared and paid a dividend of $5,000 during Year 2001. Journal Entry: To recognize Sub-Way net income using the equity method DR CR
EXAMPLE
Investment in Sub-Way Equity in subsidiary income (Sub-Way)
$20,000 $20,000
Journal Entry: To recognize dividends received under the equity method DR CR Cash Investment in Sub-Way $5,000 $5,000
CAR I M
C 100,000 -- -- 100,000
A 20,000 -- -- 20,000
R 70,000 20,000 (5,000) 85,000
Beginning Sub--Income Sub--Dividend Ending $100,000 20,000 85,000
I 190,000 20,000 (5,000) 205,000
M 0 -- -- 0
C A R I M
DR DR DR CR CR
Common Stock: Sub-Way Additional paid-in capital: Sub-Way Retained Earnings: Sub-Way Investment in Sub-Way Minority Interest
$205,000 - 0-
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C.
DISCLOSURE FOR POOLING-OF-INTERESTS COMBINATIONS Consolidated financial statements should include the following disclosures in the period in which the pooling occurs. 1. 2. 3. 4. 5. Brief description of the companies combined.
CONSOLIDATION DISCLOSURES
Method of accounting for the combination, that is, the pooling-of-interests method. Description and amount of shares of stock issued to effect the combination. Details of the results of operations for each separate company, prior to the date of combination, that are included in the current combined net income. Description of the nature of adjustments in net assets of the combining companies necessary to adapt to the same accounting policies.
D.
ACQUISITING VS. POOLING OF INTEREST COMPARISON Acquisition FV............................................ FV............................................ Parent Only ............................. After Acquisition ...................... Expense .................................. Yes .......................................... Yes (1% - 49%) ....................... Eliminate.................................. Depreciate............................... Amortize .................................. Impairment Test ...................... Eliminate.................................. Assets ............................................... Liabilities ........................................... Retained Earnings ............................ Income .............................................. Acquisition Cost ................................ Goodwill ............................................ Minority Interest ................................ Investment in Sub ............................. Asset Adjustment .............................. Identifiable Intangible Assets ............ Goodwill Adjustment ......................... Intercompany Transactions............... Pooling NBV NBV Both Whole Yr./Retroactive Expense No Yes (1% - 10%) Eliminate N/A N/A N/A Eliminate
PASS KEY Many CPA Examination questions have required candidates to distinguish the proper accounting rules between the purchase method and the pooling-of-interests method. The summary chart above will assist in your mastering the differences.
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NOTES
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SIMULATION
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20X8.
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FINANCIAL ACCOUNTING & REPORTING 3(B) Class Questions Answer Worksheet
MC Question Number
First Choice Answer
Correct Answer
NOTES
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19.
Grade: Multiple-choice Questions Correct / 19 = __________% Correct Detailed explanations to the class questions are located in the back of this textbook.
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CLASS QUESTIONS 1. CPA-00265 A company has adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (as amended by SFAS 130). It should report the marketable equity securities that it has classified as trading at: a. Lower of cost or market, with holding gains and losses included in earnings. b. Lower of cost or market, with holding gains included in earnings only to the extent of previously recognized holding losses. c. Fair value, with holding gains included in earnings only to the extent of previously recognized holding losses. d. Fair value, with holding gains and losses included in earnings. 2. CPA-00273 Information regarding Stone Co's available-for-sale portfolio of marketable equity securities is as follows: Aggregate cost as of 12/31/X2 Market value as of 12/31/X2 Net realized gains during 20X2 $170,000 148,000 30,000
At December 31, 20X1, Stone reported an unrealized loss of $1,500 to reduce investments to market value. This was the first such adjustment made by Stone on these types of securities. According to SFAS No. 115, in its 20X2 statement of comprehensive income, what amount of unrealized loss should Stone report? a. b. c. d. $30,000 $20,500 $22,000 $0
3. CPA-00284 When a parent-subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of: a. b. c. d. Reliability. Materiality. Legal entity. Economic entity.
4. CPA-00283 Consolidated financial statements are typically prepared when one company has a controlling financial interest in another unless: a. b. c. d. The subsidiary is a finance company. The fiscal year-ends of the two companies are more than three months apart. The subsidiary is in bankruptcy. The two companies are in unrelated industries, such as manufacturing and real estate.
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5. CPA-00287 An investor uses the cost method to account for an investment in common stock. Dividends received this year exceeded the investor's share of investee's undistributed earnings since the date of investment. The amount of dividend revenue that should be reported in the investor's income statement for this year would be: a. The portion of the dividends received this year that were in excess of the investor's share of investee's undistributed earnings since the date of investment. b. The portion of the dividends received this year that were not in excess of the investor's share of investee's undistributed earnings since the date of investment. c. The total amount of dividends received this year. d. Zero. 6. CPA-00285 Plack Co. purchased 10,000 shares (2% ownership) of Ty Corp. on February 14, 2001. Plack received a stock dividend of 2,000 shares on April 30, 2001, when the market value per share was $35. Ty paid a cash dividend of $2 per share on December 15, 2001. In its 2001 income statement, what amount should Plack report as dividend income? a. b. c. d. $20,000 $24,000 $90,000 $94,000
7. CPA-00320 On January 2, 1993, Well Co. purchased 10% of Rea, Inc.'s outstanding common shares for $400,000. Well is the largest single shareholder in Rea, and Well's officers are a majority on Rea's board of directors. Rea reported net income of $500,000 for 1993, and paid dividends of $150,000. In its December 31, 1993, balance sheet, what amount should Well report as investment in Rea? a. b. c. d. $450,000 $435,000 $400,000 $385,000
8. CPA-00303 Band Co. uses the equity method to account for its investment in Guard, Inc. common stock. How should Band record a 2% stock dividend received from Guard? a. b. c. d. As dividend revenue at Guard's carrying value of the stock. As dividend revenue at the market value of the stock. As a reduction in the total cost of Guard stock owned. As a memorandum entry reducing the unit cost of all Guard stock owned.
9. CPA-00289 Birk Co. purchased 30% of Sled Co.'s outstanding common stock on December 31, 2000, for $200,000. On that date, Sled's stockholders' equity was $500,000, and the fair value of its identifiable net assets was $600,000. On December 31, 2000, what amount of goodwill should Birk attribute to this acquisition? a. b. c. d. $0 $20,000 $30,000 $50,000
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10. CPA-00348 Park Co. uses the equity method to account for its January 1, 1990, purchase of Tun, Inc.'s common stock. On January 1,1990, the fair values of Tun's FIFO inventory and land exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect Park's reported equity in Tun's 1990 earnings? a. b. c. d. Inventory excess Decrease Decrease Increase Increase Land excess Decrease No effect Increase No effect
11. CPA-00288 Puff Co. acquired 40% of Straw, Inc.'s voting common stock on January 2, 2001 for $400,000. The carrying amount of Straw's net assets at the purchase date totaled $900,000. Fair values equaled carrying amounts for all items except equipment, for which fair values exceeded carrying amounts by $100,000. The equipment has a five-year life. During 2001, Straw reported net income of $150,000. What amount of income from this investment should Puff report in its 2001 income statement? a. b. c. d. $40,000 $52,000 $56,000 $60,000
12. CPA-00324 On January 1, 1992, Point, Inc. purchased 10% of Iona Co.'s common stock. Point purchased additional shares bringing its ownership up to 40% of Iona's common stock outstanding on August 1, 1992. During October 1992, Iona declared and paid a cash dividend on all of its outstanding common stock. How much income from the Iona investment should Point's 1992 income statement report? a. 10% of Iona's income for January 1 to July 31, 1992, plus 40% of Iona's income for August 1 to December 31, 1992. b. 40% of Iona's income for August 1 to December 31, 1992 only. c. 40% of Iona's 1992 income. d. Amount equal to dividends received from Iona. 13. CPA-00430 Company J acquired all of the outstanding common stock of Company K in exchange for cash. The acquisition price exceeds the fair value of net assets acquired. How should Company J determine the amounts to be reported for the plant and equipment and long-term debt acquired from Company K? a. b. c. d. Plant and equipment K's carrying amount K's carrying amount Fair value Fair value Long-term debt K's carrying amount Fair value K's carrying amount Fair value
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14. CPA-00423 Penn Corp. paid $300,000 for the outstanding common stock of Star Co. At that time, Star had the following condensed balance sheet: Carrying amounts $ 40,000 380,000 200,000 220,000
Current assets Plant and equipment, net Liabilities Stockholders' equity
The fair value of the plant and equipment was $60,000 more than its recorded carrying amount. The fair values and carrying amounts were equal for all other assets and liabilities. What amount of goodwill, related to Star's acquisition, should Penn report in its consolidated balance sheet? a. b. c. d. $20,000 $40,000 $60,000 $80,000
15. CPA-00389 A business combination is accounted for as an acquisition. Which of the following expenses related to the business combination should be included, in total, in the determination of net income of the combined corporation for the period in which the expenses are incurred? Fees of finders and consultants Yes Yes No No Registration fees for equity securities issued Yes No Yes No
a. b. c. d.
16. CPA-00391 On September 29, 1995, Wall Co. paid $860,000 for all the issued and outstanding common stock of Hart Corp. On that date, the carrying amounts of Hart's recorded assets and liabilities were $800,000 and $180,000, respectively. Hart's recorded assets and liabilities had fair values of $840,000 and $140,000, respectively. In Wall's September 30, 1995, balance sheet, what amount should be reported as goodwill? a. b. c. d. $20,000 $160,000 $180,000 $240,000
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17. CPA-00455 Wright Corp. has several subsidiaries that are included in its consolidated financial statements. In its December 31, 1992, trial balance, Wright had the following intercompany balances before eliminations: Current receivable due from Main Co. Noncurrent receivable from Main Cash advance to Corn Corp. Cash advance from King Co. Intercompany payable to King Debit $ 32,000 114,000 6,000 Credit
$15,000 101,000
In its December 31, 1992, consolidated balance sheet, what amount should Wright report as intercompany receivables? a. b. c. d. $152,000 $146,000 $36,000 $0
18. CPA-00448 Perez, Inc. owns 80% of Senior, Inc. During 1992, Perez sold goods with a 40% gross profit to Senior. Senior sold all of these goods in 1992. For 1992 consolidated financial statements, how should the summation of Perez and Senior income statement items be adjusted? a. b. c. d. Sales and cost of goods sold should be reduced by the intercompany sales. Sales and cost of goods sold should be reduced by 80% of the intercompany sales. Net income should be reduced by 80% of the gross profit on intercompany sales. No adjustment is necessary.
19. CPA-00484 On January 1, 1990, Poe Corp. sold a machine for $900,000 to Saxe Corp., its wholly-owned subsidiary. Poe paid $1,100,000 for this machine, which had accumulated depreciation of $250,000. Poe estimated a $100,000 salvage value and depreciated the machine on the straight-line method over 20 years, a policy which Saxe continued. In Poe's December 31, 1990, consolidated balance sheet, this machine should be included in cost and accumulated depreciation as: Cost $1,100,000 $1,100,000 $900,000 $850,000 Accumulated depreciation $300,000 $290,000 $40,000 $42,500
a. b. c. d.
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