ACC 401-3


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ADVANCED ACCOUNTING STUDY GUIDE-JETER/CHANEY 4 TH ED. CHAPTER FOUR – CONSOLIDATED FINANCIAL STATEMENTS AFTER ACQUISITION I. THREE METHODS OF REPORTING ON PARENT’S BOOKS A. Investments in voting stock of other companies may be consolidated, or they may be separately reported in the financial statements at cost, at fair value, or at equity. The method of reporting adopted depends on a number of factors including the size of the investment, the extent to which the investor exercises control over the activities of the investee, and the marketability of the securities. B. Generally speaking, there are three levels of influence or control by an investor over an investee, which determine the appropriate accounting treatment. There are no absolute percentages to distinguish among these levels, but there are guidelines. The three levels and the corresponding accounting treatment are summarized as follows: Level Guideline Percentages Usual Accounting Treatment No significant influence Less than 20% Investment carried at fair value at current year- end (trading or available for sale securities) – method traditionally referred to as “Cost” method with an adjustment for market changes. Significant influence (no control) 20 to 50% Investment measured under the equity method Effective control Greater than 50% Consolidated statements required (investment eliminated, combined financial statements): investment recorded under cost, partial equity, or complete equity method. C. Differences among the three methods in accounting for the investment on the books of the parent are also summarized in Figure 4-1. D. Cost Method on Books of Investor P Company acquired 90% of the outstanding voting stock of S Company at the beginning of Year 1 for $800,000. Income (loss) of S Company and dividends declared by S Company during the next three years were: During the third year,
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the firm pays a liquidating dividend (i.e. the cumulative dividends declared exceeds the cumulative income earned). Year Income (Loss) Dividends Declared Cumulative Income Over (Under) Dividends 1 $90,000 $30,000 $60,000 2 (20,000) 30,000 10,000 3 10,000 30,000 (10,000) P’s books Year 1 – P’s Books Investment in S Company 800,000 Cash 800,000 To record the initial investment Cash 7,000 Dividend Income 27,000 To record dividends received .9($30,000). Year 2 – P’s Books Cash 7,000 Dividend Income 27,000 To record dividends received .9($30,000). Year 3 – P’s Books Cash 7,000 Dividend Income 18,000 Investment in S Company 9,000 To record dividends received, $9,000 of which represents a return of investment. After these entries are posted, the investment account will appear as follows: Investment in S company (Cost Method) Year 1 Cost 800,000 Year 3 Liquidating dividend 9,000 Year 3 Balance 791,000 Year 1 entries record the initial investment and the receipt of dividends from S Company. In Year 2, although S Company incurred a $20,000 loss, there was a
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