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Consolidated Financial Statement - At More than Book Value

The document discusses the complexities of consolidating financial statements during the acquisition of a subsidiary, particularly when the acquisition occurs at more than book value. It explains the adjustments needed for both balance sheets and income statements, as well as the impacts of different valuation methods on reported income. Additionally, it provides examples illustrating the differential between fair market value and book value, and the necessary accounting entries for accurately reflecting these differences in financial statements.

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Consolidated financial statement: Acquisition at more than book value Arthik Davianti
What’s coming: Differential Complex differential Consolidation procedures Illustrations
Basic Concepts: Parent and Subsidiary Parent’s books Investment account initially contains the acquisition cost • FMV of net assets, • Plus goodwill, or • Minus bargain purchase price Parent can use the cost or equity method Subsidiary’s books Balance sheet: Assets and Liabilities are recorded at BOOK values. Income statement: Expenses calculated based on BOOK values
Basic Concepts: Parent and Subsidiary What happens when you consolidate the parent’s and subsidiary’s books? Remember: • The parent’s investment account is based on the actual acquisition price. • The sub’s books contain only historical book values. The parent needs to make adjustments for both • Balance Sheet, and • Income Statement accounts. Why wasn’t this a problem with created subs? • No goodwill • No undervalued assets at the time of creation
Differential: Investment Cost over the Underlying Book Value of Equity
Acquisition Price and Underlying Book Value Difference The purchase price normally is based on the market value – different with the investee’s net assets: Book Value (BV) vs Fair Market Value (FMV) - DIFFERENTIAL Differential is frequently positive The differential pertaining each asset of the investee must be ascertained. When the parent uses equity method – differential pertaining to limited life assets (including identifiable intangible) must be amortized (in the remaining economic life).
Basic Concepts: Income Statement Impacts Big Picture: Essentially, we switch the sub’s books from BV to FMV in the consolidation process. Income Statement effects Asset Related Expense (as the asset expires) Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss
Basic Concepts: Income Statement Impacts Income Statement Effects When Acquisition Price > Book Value Asset Related Expense (as the asset expires) Income Statement Effect Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss Too Low (understated) If expenses are UNDERSTATED, then income is too high (OVERSTATED). To fix the problem, Parent needs to INCREASE expenses (but how?)
Excess Investment Cost over Underlying Book Value of Equity: Assignment Information on the individual assets and liabilities to account for any difference between the investment cost and the underlying book value of equity – DIFFERENTIAL Book value and fair value information for Sloan Co at January 1 (this is from last week’s illustration) Book Value Fair Value Cash 1,500 1,500 Receivable - net 2,200 2,200 Inventories 3,000 400 Other current assets 3,300 3,100 Equipment - net 5,000 8,000 Total assets 15,000 18,800 Account payeble 1,000 1,000 Note payable, due in five years 2,000 1,800 Common stock 10,000 Retained earnings 2,000 Total liabilities and stockholders' equity 15,000
Excess Investment Cost over Underlying Book Value of Equity: Assignment 5,000 (3,600) 1,400 Fair Value Book Value Differential % Interest Acquired Amount Assigned Inventories 4,000 3,000 1,000 30% 300 Other current assets 3,100 3,300 (200) 30% (60) Equipment 8,000 5,000 3,000 30% 900 Note payable 1,800 2,000 200 30% 60 Total assigned to identifiable net assets 1,200 Remainder assigned to goodwill 200 Total excess of cost over book value acquired 1,400 Assignment to identifiable net assets and goodwill Investment in Sloan Book value of the interest acquired (30% X $12,000,000 equity of Sloan) Total excess of cost over book value acquired
Excess Investment Cost over Underlying Book Value of Equity: Accounting Sloan pay dividends $1,000,000 on July 1 and reports net income of $3,000,000. The excess cost over book value is amortized as follows: Amortization Rates Excess allocated to: Inventories – sold in the current year 100% Other current assets – disposed of in the current year 100% Equipment – depreciated over 20 years 5% Note payable – due in 5 years 20%
Excess Investment Cost over Underlying Book Value of Equity: Accounting Payne’s entries: July 1: Cash (+A) 300 Investment in Sloan (-A) 300 To record dividends received from Sloan ($1,000,000 X 30% December 31 Investment in Sloan (+A) 900 Income from Sloan (+R, +SE) 900 To record dividends received from Sloan ($1,000,000 X 30%) December 31 Income from Sloan (-R, -SE) 300 Investment in Sloan (-A) 300 To record write-off of excess allocated to inventory items that were sold in the current year 1 2
Excess Investment Cost over Underlying Book Value of Equity: Accounting December 31 Investment in Sloan (+A) 60 Income from Sloan (R, +SE) 60 To record income credit overvalued other current assets disposed of in the current year December 31 Income from Sloan (-R, -SE) 12 Investment in Sloan (-A) 12 To amortize the excess allocated to the overvalued note payable over the remaining life of the note ($60,000 : 5 years) December 31 Income from Sloan (-R, -SE) 45 Investment in Sloan (-A) 45 To record depreciation on excess allocated to undervalued equipment with a 20-year remaining useful life ($900,000 : 20) 5 4 3
Excess Investment Cost over Underlying Book Value of Equity: Accounting December 31 Investment in Sloan (+A) 603 Income from Sloan (R, +SE) 603 To record equity income from 30% investment in Sloan 1-5 Equity in Sloan’s reporting income ($3,000,000 X 30%) 603 Amortization of excess cost over book value: Inventories sold in the current year ($300,000 X 100%) (300) Other current assets sold in the current year ($60,000 X 100%) 60 Equipment ($900,000 X 5%) depreciation rate Note payable ($60,000 X 20%) amortization rate (12) Total investment income from Sloan $603
Book value element Life remaining Common Stock $130,000 Retained Earnings 117,000 Under- or Over-valuation Inventory (6,500) 2 months Land 39,000 Indefinite Equipment 85,000 10 years Covenant-not-to-compete 52,000 4 years Goodwill element 26,000 Indefinite Total Cost $442,500 Example: Acquisition Price > Book Value Pepper Inc., a calendar-year reporting company, acquired 100% of Salt Inc.’s outstanding common stock at a cost of $442,500 on 12/31/X8. The analysis of the parent’s Investment account as of the acquisition date shows:
Acquisition Price = BV + Identifiable Excess + GW Results for 20X9 (based on Book Values): Reported Income $78,000 Dividends Declared 45,500 What would the Sub’s income be based on Fair Values? Lower COGS (because inventory is worth less) $ (6,500) Extra depreciation on equipment 8,500 Extra amortization of contract 13,000 Total increase in expenses / decrease in income $ 15,000 $63,000 ($78,000 - $15,000) Example: Acquisition Price > Book Value 442,500 = 247,000 + 169,500 + 26,000
Consolidation in Equity Method for Diffeential
Consolidation procedures differ when there is a differential.
Differential in Equity Method The Parent’s initial investment in a sub is based on the FMV of the sub’s net assets (+/- GW). Equity method entries: • Recording share of sub’s income • Recording share of sub’s dividends They should be based on the same FMV basis. Problem: Sub reports income based on BOOK VALUES Solution: Parent has to record an adjustment to the income and investment “Equity Method” accounts.
Results for 20X9 (based on Book Values): Reported Income $78,000 Dividends Declared 45,500 Adjustment to Salt’s 20X9 income on Parent’s books: Lower COGS (because inventory is worth less) $ (6,500) Extra depreciation on equipment 8,500 Extra amortization of contract 13,000 Total increase in expenses / decrease in income $ 15,000 What entries would Pepper record in its general ledger related to Salt’s income and dividends for 20X9 under the equity method? Example: Differential in Equity Method
Example: Equity Method Journal Entries 1. To record 100% share of Salt’s reported income: Investment in Salt 78,000 Income from Salt 78,000 2. To record 100% of Salt’s dividends declared: Dividend Receivable 45,500 Investment in Salt 45,500 3. To record additional expenses (based on FMV): Income from Salt 15,000 Investment in Salt 15,000
Called “amortization of excess value” Example: Equity Method Investment Adjustment Calculate the correct ending balance in Pepper’s Investment in Salt account using the equity method: Investment in Salt Beginning Balance 442,500 Net Income 78,000 Ending Balance 460,000 Dividend 45,500 Income Adjustment 15,000
Simple Example P S Stock Sub Shareholders $ Book value of net assets = $800 Excess value of identifiable assets = $200 Goodwill = $500 Assume the BV of Sub’s net assets is $800 and that the FMV of the net assets is $1,000. Finally, assume that the acquisition price was $1,500. The acquisition price consists of three parts:
Understanding Components of Acquisition Cost Acquisition FMV of Price = Assets + Goodwill Key: We need to keep track of each element of the purchase price separately! Why?? FMV of Extra Assets = BV + Value Acquisition Extra Price = BV + Value + Goodwill
The Consolidation Process When a subsidiary is acquired (instead of created), the consolidation process is more complicated: • Must eliminate intercompany items (same) • Must update Sub’s assets and liabilities to FMV • Must recognize goodwill
Summary of Consolidation Entries 1. The basic elimination entry: 2. The excess value reclassification entry: Asset 1 XX Asset 2 XX Goodwill XX Investment in Sub Excess Common Stock (S) XX Additional Paid-in Capital (S) XX Retained Earnings, Beginning Balance (S) XX Income from Sub XX Investment in Sub BV Dividends Declared XX
Summary of Consolidation Entries 3. The amortized excess value reclassification entry: This entry reclassifies the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the sub used FMV instead of BV. 4. The accumulated depreciation elimination entry: Cost of Sales XX Other Expenses XX Income from Sub XX Accumulated Depreciation XX Buildings and Equipment XX
Understand and explain how consolidation process differ when there is a differential
Wholly-owned Subsidiary (100 Percent) at More than Book Value (Baker p. 162) Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $340,000 cash, an amount equal to Special Foods’ fair value as a whole. This includes $40,000 in excess of Special Foods’ book value of $300,000. Fair value consideration 340,000 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 40,000 Investment in Special Foods 340,000 Cash 340,000 To record the initial investment in Special Food
Book value of net assets CS + RE = 300,000 Identifiable assets = 40,000 $340,000 Initial Investment Special Foods Goodwill = 0 1/1/X1 Wholly-owned Subsidiary (100 Percent) at More than Book Value
Wholly-owned Subsidiary (100 Percent Ownership) at more than Book Value Book Value calculation Total Common Retained Book Value Stock Earnings Original Book Value 300,000 200,000 100,000 = + Common Stock 200,000 Retained Earnings 100,000 Investment in Special Foods 300,000 Excess value reclassification entry: Land 40,000 Investment in Special Foods 40,000
Wholly-owned Subsidiary (100 Percent Ownership) at more than Book Value Excess value reclassification entry: Land 40,000 Investment in Special Foods 40,000 In this example, the differential is the additional $40,000 payment, because of Special Foods’ land was worth $40,000 more than its book value at acquisition date. A second elimination entry is required to re-assign the $40,000 from the investment account to the land account.
Wholly-owned Subsidiary (100 Percent Ownership) at More than Book Value at Acquisition Date – Worksheet (Baker p. 164) Peerless Product Special Foods Consolidated Assets Cash 10,000 50,000 60,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 160,000 Investment in Special Food 340,000 300,000 0 40,000 Land 175,000 40,000 40,000 255,000 Buildings and equipment 800,000 600,000 1,400,000 Accumulated depreciation (400,000) (300,000) (700,000) Total assets 1,100,000 500,000 40,000 340,000 1,300,000 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 200,000 100,000 300,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 Total liabilities and equity 1,100,000 500,000 300,000 0 1,300,000 Elimination Entries
Existence of Goodwill Excess value reclassification entry: Goodwill 40,000 Investment in Special Foods 40,000 For example, assume in the Peerless Product and Special Foods illustration the acquisition-date fair value of Special Foods’ assets and liabilities equal to their book values, then the $40,000 difference between the $340,000 consideration exchanged and the $300,000 fair value of the subsidiary’s net identifiable assets should be attributed to goodwill
Treatment of a Complex Differential
Make calculation and prepare elimination entries for the consolidation of a wholly owned subsidiary when there is a complex positive differential at the acquisition date.
Wholly-owned Subsidiary (100 Percent) at More than Book Value (Baker p. 166) Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $400,000 on January 1, 20X1, by issuing $100,000 of 9% bonds, with fair value of $100,000, and paying cash of $300,000. The resulting ownership situation: Fair value consideration 400,000 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 100,000
Wholly-owned Subsidiary (100 Percent) at More than Book Value (Baker p. 167) Investment in Special Foods 400,000 Bond Payable 100,000 Cash 340,000 To record the initial investment in Special Food Book Value Fair Value Difference Cash 50,000 50,000 Account receivable 50,000 50,000 Inventory 60,000 75,000 15,000 Land 40,000 100,000 60,000 Buildings and equipment 600,000 Accumulated depreciation (300,000) 300,000 290,000 (10,000) 500,000 290,000 Account payable 10,000 100,000 Bonds payable 10,000 135,000 (35,000) Common stock 20,000 Retained earnings 10,000 50,000 235,000 30,000
Book value of net assets CS + RE = 300,000 Identifiable assets = 30,000 $400,000 Initial Investment Special Foods Goodwill = 70,000 1/1/X1 Wholly-owned Subsidiary (100 Percent) at More than Book Value
Wholly-owned Subsidiary (100 Percent Ownership) at more than Book Value (Baker p. 168) Basic elimination entry Total Common Retained Book Value Stock Earnings Original Book Value 300,000 200,000 100,000 = + Common Stock 200,000 Retained Earnings 100,000 Investment in Special Foods 300,000
Wholly-owned Subsidiary (100 Percent Ownership) at more than Book Value Total = Inventory Land Building Goodwill Bonds Payable 100,000 15,000 60,000 (100,000) 70,000 (35,000) Excess value (differential) reclassification entry: Inventory 15,000 Land 60,000 Goodwill 9,500 Building 10,000 Bonds Payable 35000 Investment in Special Foods 100,000
Wholly-owned Subsidiary (100 Percent Ownership) at More than Book Value at Acquisition Date – Worksheet (Baker p. 169) Peerless Product Special Foods Consolidated Assets Cash 50,000 50,000 100,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 15,000 175,000 Investment in Special Food 400,000 300,000 0 100,000 Land 175,000 40,000 60,000 275,000 Buildings and equipment 800,000 600,000 10,000 1,390,000 Accumulated depreciation (400,000) (300,000) (700,000) Goodwill 70,000 Total assets 1,200,000 500,000 75,000 410,000 1,435,000 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 300,000 100,000 400,000 Premium on Bonds Payable 35,000 35,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 Total liabilities and equity 1,200,000 500,000 300,000 35,000 1,435,000 Elimination Entries
Situation 2 Worksheet at the Date of Acquisition (100% ownership)
Prepare equity method journal entries, elimination entries, and the consolidated worksheet for a wholly owned subsidiary when there is a complex positive differential.
Wholly-owned Subsidiary (100 Percent) at More than Book Value – Initial Year Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $387,500, an amount $87,500 in excess of the book value. The acquisition price includes cash of $300,000 and a 60-day note for $87,500 (paid at maturity during 20X1). Fair value consideration 387,500 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 87,500
Wholly-owned Subsidiary (100 Percent) at More than Book Value Fair values of Special Foods’ assets and liabilities: Book Value Fair Value Differential Inventory 60,000 65,000 5,000 Land 40,000 50,000 10,000 Buildings and Equipment 300,000 360,000 60,000 400,000 475,000 75,000 • The remaining $12,500 is goodwill • The entire amount of inventory is sold during 20X1 • The buildings and equipment have 10 years remaining economic life and depreciated using straight line depreciation
Wholly-owned Subsidiary (100 Percent Ownership) at More than Book Value – Initial Year of Ownership Investment in Special Foods 50,000 Income from Special Foods 50,000 To record Peerless 100% share of Special Food’s 20X1 income During 20X1, Peerless records operating earnings of $140,000, excluding its income from investing in Special Foods, and declares dividends of $60,000. Special Foods reports 20X1 net income of $50,000 and declares dividends of $30,000. Cash 30,000 Investment in Special Foods 30,000 To record Peerless 100% share of Special Food’s 20X1 dividend Investment in Special Foods 387,500 Cash 300,000 Notes Payable 87,500 To record the initial investment in Special Food
Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership (Baker p.173) Parent Company Entry Income from Special Foods 14,000 Investment in Special Foods 14,000 To record amortization of excess acquisition price • A portion of the differential ($5,000) – Special Foods’ inventory sold during 20X1. • $60,000 of the differential – Special Foods’ buildings and equipment – amortization $6,000 ($60,000 : 10 years) • Impairment of goodwill by $3,000 is recognized. • The total of differential written off = $5,000 inventory + $6,000 depreciation + $3,000 goodwill impairment = $14,000
Book value of net assets CS + RE = 300,000 Identifiable assets = 75,000 $387,500 Initial Investment Special Foods Goodwill = 12,500 Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Book value of net assets CS + RE = 320,000 Identifiable assets = 64,000 $393,500 Net Investment Special Foods Goodwill = 9,500 1/1/X1 31/12/X1
Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Basic Elimination Entry Total Common Retained Investment Stock Earnings Original Book Value 300,000 200,000 100,000 + Net Income 50,000 50,000  Dividends (30,000) (30,000) Ending Book Value 320,000 200,000 120,000 = + Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 50,000 Dividends Declared 30,000 Investment in Special Foods 320,000 Book Value Calculation
Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Amortized excess value reclassification entry: Cost of goods sold 5,000 Depreciation expense 6,000 Goodwill impairment loss 3,000 Income from Special Foods 14,000 Total Inventory Land Building Acc. Dep. Goodwill Beginning balance 87,500 5,000 10,000 60,000 0 12,500 (-) Changes (14,000) (5,000) 6,000 (3,000) Ending balance 73,500 0 10,000 60,000 6,000 9,500 Excess value (differential) reclassification entry: Land 10,000 Building 60,000 Goodwill 9,500 Accumulated depreciation 6,000 Investment in Special Foods 73,500
Do… the Working Sheet for 20X1 and self-practice for 20X2
Consolidation Process on a More than Book Value Acquisitions with (less than 100% ownership)
Understand and explain how the consolidation process differs when the subsidiary is less-than-wholly owned and there is a differential.
How Do the Elimination Entries Change? 1. The basic elimination entry: 2. The excess value reclassification entry: Asset 1 XXX Asset 2 XXX Goodwill XXX Investment in Sub % Excess NCI in NA of Sub % Excess Common Stock (S) XXX Additional Paid-in Capital (S) XXX Retained Earnings, Beginning Balance (S) XXX Income from Sub % NI NCI in NI of Sub % NI Dividends Declared XXX Investment in Sub % BV NCI in NA of Sub % BV
3. The amortized excess value reclassification entry: This entry reclassifies the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the Sub used FMV instead of BV. 4. The accumulated depreciation elimination entry: Accumulated Depreciation XXX Building & Equipment XXX Cost of Sales XXX Other Expenses XXX Income from Sub % Adj. NCI in NI of Sub % Adj. Acquisition Date How Do the Elimination Entries Change?
Issue Should Parent revalue the land by the full $39,000 in consolidation or only its share of the excess value ($31,200)? Partial Ownership Example Assume Parent owns land with a book value of $400,000. Parent’s 80%-owned subsidiary also owns land. At the time of the acquisition, Sub’s land has a FMV of $100,000 and a book value of $61,000. Thus, the land has excess value of $39,000. Parent Sub 80%20% NCI
Partial Ownerships: Partial or Full Valuation? We learned earlier that full consolidation is required, as opposed to partial consolidation. •Thus, we consolidate 100% of the sub. •This, however, refers to the BV of the subsidiary. What about revaluation of assets to FMV? •The extent of revaluation of undervalued assets and goodwill can vary. • Parent Company Concept: Partial valuation • Entity Concept: Full valuation
Partial Ownership Example • Both were used in the past. • SFAS 141R requires the Entity Concept. Parent Sub 80%20% NCI Parent Sub DR CR Consolidated Land $400,000 $61,000 $31,200 $492,200 Parent Sub DR CR Consolidated Land $400,000 $61,000 $39,000 $500,000 Parent Company Concept Economic Unit Concept
Partial Ownership: Undervalued Assets & GW How much to revalue the Subsidiary’s undervalued assets and goodwill? Parent company concept: < 100% of FMV Revalued only to the extent of the parent’s percent ownership Entity concept: 100% of FMV The offsetting credit for the additional valuation increases the NCI in net assets
Situation 2 Worksheet at the Initial Year (less than 100% ownership)
Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value Peerless Products acquires 80% of Special Foods common stock on January 1 20X1, for $310,000. At that date, the fair value of the noncontrolling interest is estimated to be $77,500. The ownership situation: Fair value consideration 387,500 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 87,500 Parent Sub 80%20% NCI
Peerless Product and Special Foods balance sheets. Peerless Product Special Foods Assets Cash 350,000 50,000 Account receivable 75,000 50,000 Inventory 100,000 60,000 Land 175,000 40,000 Buildings and equipment 800,000 600,000 Accumulated depreciation (400,000) (300,000) Total assets 1,100,000 500,000 Liabilities and stockholder's equity Account payable 100,000 100,000 Bonds payable 200,000 100,000 Common stock 500,000 200,000 Retained earnings 300,000 100,000 Total liabilities and equity 1,100,000 500,000 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value Investment in Special Foods 310,000 Cash 310,000 To record purchase of Special Food stock
Peerless Product Special Foods Assets Cash 40,000 50,000 Account receivable 75,000 50,000 Inventory 100,000 60,000 Land 175,000 40,000 Buildings and equipment 800,000 600,000 Accumulated depreciation (400,000) (300,000) Investment in Special Food 310,000 Total assets 1,100,000 500,000 Liabilities and stockholder's equity Account payable 100,000 100,000 Bonds payable 200,000 100,000 Common stock 500,000 200,000 Retained earnings 300,000 100,000 Total liabilities and equity 1,100,000 500,000 The separate financial statements of Peerless and Special Foods immediately after the combination. Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
Fair values of Special Foods’ assets and liabilities: Book Value Fair Value Differential Inventory 60,000 65,000 5,000 Land 40,000 50,000 10,000 Buildings and Equipment 300,000 360,000 60,000 400,000 475,000 75,000 • The remaining $12,500 is goodwill • The entire amount of inventory is sold during 20X1 • The buildings and equipment have 10 years remaining economic life and depreciated using straight line depreciation Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
80% Book value of net assets CS + RE = 240,000 80% Identifiable assets = 60,000 $310,000 Initial Investment Special Foods 80% Goodwill = 10,000 1/1/X1 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Investment Elimination Entry Basic investment account elimination entry Common Stock 200,000 Retained Earnings 100000 Investment in Special Foods 240,000 NCI in NA of Special Foods 60,000 Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 =
NCI 20% Peerless 80% = Inventory Land Building Acc. Dep. Goodwill Beginning balance 17,500 70,000 5,000 10,000 60,000 0 12,500 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Excess value (differential) reclassification entry: Inventory 5,000 Land 10,000 Building 60,000 Goodwill 12,500 Investment in Special Foods 70,000 NCI in NA of Special Foods 17,500
Worksheet at date of acquisition, January 1, 20X1 Peerless Product Special Foods Consolidated Assets Cash 40,000 50,000 90,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 5,000 165,000 Investment in Special Food 310,000 240,000 0 70,000 Land 175,000 40,000 10,000 225,000 Buildings and equipment 800,000 600,000 60,000 1,160,000 Accumulated depreciation (400,000) (300,000) 300,000 (400,000) Goodwill 12,500 12,500 Total assets 1,100,000 500,000 387,500 240,000 1,377,500 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 200,000 100,000 300,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 NCI in NA of Special Foods 60,000 77,500 17,500 Total liabilities and equity 1,100,000 500,000 300,000 77,500 1,377,500 Elimination Entries
Peerless Products Special Foods 20X1: Separate operating income, Peerless Net income, Special Foods Dividends 140,000 60,000 50,000 30,000 20X2: Separate operating income, Peerless Net income, Special Foods Dividends 160,000 60,000 75,000 40,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Information
Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Recognition Investment in Special Foods 40,000 Income from Special Foods 40,000 To record Peerless 80% share of Special Food’s 20X1 income Cash 24,000 Investment in Special Foods 24,000 To record Peerless 80% share of Special Food’s 20X1 dividend
Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Recognition Income from Special Foods 11,300 Investment in Special Foods 11,300 To record amortization of excess acquisition price • A portion of the differential ($5,000) – Special Foods’ inventory sold during 20X1. Peerless’ $4,000 portion ($5,000 X 80%) must be written off • Peerless portion of $60,000 of the differential on Special Foods’ buildings and equipment – amortization $4,800 ($48,000 : 10 years) • Impairment of goodwill by $3,125 is recognized – $2,500 (80% X $3,125) • The total of differential written off = $4,000 inventory + $4,800 depreciation + $2,500 goodwill impairment = $11,300
80% Book value of net assets CS + RE = 240,000 80% Identifiable assets = 60,000 $387,500 Initial Investment Special Foods 80% Goodwill = 10,000 Goodwill = 7,500 1/1/X1 Book value of net assets CS + RE = 256,000 Identifiable assets = 51,200 $314,700 Net Investment Special Foods 31/12/X1 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 + Net income 10,000 40,000 50,000 - Dividend (6,000) (24,000) (30,000) Ending book value 64,000 256,000 200,000 120,000 = Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Initial Year of Ownership
Basic investment account elimination entry: Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 40,000 NCI in NI of Special Foods 10,000 Dividends Declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Initial Year of Ownership
NCI 20% Peerless 80% = Inventory Land Building Acc. Dep. Goodwill Beginning balance 17,500 70,000 5,000 10,000 60,000 0 12,500 Amortization (2,825) (11,300) (5,000) (6,000) (3,125) Ending balance 14,675 58,700 0 10,000 60,000 (6,000) 9,375 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Amortized excess value reclassification entry: Cost of Goods Sold 5,000 Depreciation expense 6,000 Goodwill impairment loss 3,125 Income from Special Foods 11,300 NCI in NA of Special Foods 2,825
Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Excess value (differential) reclassification entry: Land 10,000 Building 60,000 Goodwill 9,375 Accumulated depreciation 6,000 Investment in Special Foods 58,700 NCI in NA of Special Foods 14,675
Do… the Working Sheet for 20X1 and self-practice for 20X2
Excess of Book Value over Cost
Acquired at Less than Fair Value of Net Assets Bargain purchase • A business combination where the sum of • the acquisition-date fair values of the consideration given, • any equity interest already held by the acquirer, and • any noncontrolling interest is less than the amounts at which the identifiable net assets must be valued at the acquisition date as specified by FASB 141R. • The acquirer recognizes a gain for the difference.
Basic Concepts Income Statement Effects • When Acquisition Price < BV Asset Related Expense (as the asset expires) Income Statement Effect Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss Too High (overstated) If expenses are OVERSTATED, then income is too low (UNDERSTATED). To fix the problem, Parent needs to DECREASE expenses.
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Consolidated Financial Statement - At More than Book Value

  • 1.
    Consolidated financial statement: Acquisition atmore than book value Arthik Davianti
  • 2.
  • 3.
    Basic Concepts: Parentand Subsidiary Parent’s books Investment account initially contains the acquisition cost • FMV of net assets, • Plus goodwill, or • Minus bargain purchase price Parent can use the cost or equity method Subsidiary’s books Balance sheet: Assets and Liabilities are recorded at BOOK values. Income statement: Expenses calculated based on BOOK values
  • 4.
    Basic Concepts: Parentand Subsidiary What happens when you consolidate the parent’s and subsidiary’s books? Remember: • The parent’s investment account is based on the actual acquisition price. • The sub’s books contain only historical book values. The parent needs to make adjustments for both • Balance Sheet, and • Income Statement accounts. Why wasn’t this a problem with created subs? • No goodwill • No undervalued assets at the time of creation
  • 5.
    Differential: Investment Cost over theUnderlying Book Value of Equity
  • 6.
    Acquisition Price andUnderlying Book Value Difference The purchase price normally is based on the market value – different with the investee’s net assets: Book Value (BV) vs Fair Market Value (FMV) - DIFFERENTIAL Differential is frequently positive The differential pertaining each asset of the investee must be ascertained. When the parent uses equity method – differential pertaining to limited life assets (including identifiable intangible) must be amortized (in the remaining economic life).
  • 7.
    Basic Concepts: Income StatementImpacts Big Picture: Essentially, we switch the sub’s books from BV to FMV in the consolidation process. Income Statement effects Asset Related Expense (as the asset expires) Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss
  • 8.
    Basic Concepts: Income StatementImpacts Income Statement Effects When Acquisition Price > Book Value Asset Related Expense (as the asset expires) Income Statement Effect Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss Too Low (understated) If expenses are UNDERSTATED, then income is too high (OVERSTATED). To fix the problem, Parent needs to INCREASE expenses (but how?)
  • 9.
    Excess Investment Costover Underlying Book Value of Equity: Assignment Information on the individual assets and liabilities to account for any difference between the investment cost and the underlying book value of equity – DIFFERENTIAL Book value and fair value information for Sloan Co at January 1 (this is from last week’s illustration) Book Value Fair Value Cash 1,500 1,500 Receivable - net 2,200 2,200 Inventories 3,000 400 Other current assets 3,300 3,100 Equipment - net 5,000 8,000 Total assets 15,000 18,800 Account payeble 1,000 1,000 Note payable, due in five years 2,000 1,800 Common stock 10,000 Retained earnings 2,000 Total liabilities and stockholders' equity 15,000
  • 10.
    Excess Investment Costover Underlying Book Value of Equity: Assignment 5,000 (3,600) 1,400 Fair Value Book Value Differential % Interest Acquired Amount Assigned Inventories 4,000 3,000 1,000 30% 300 Other current assets 3,100 3,300 (200) 30% (60) Equipment 8,000 5,000 3,000 30% 900 Note payable 1,800 2,000 200 30% 60 Total assigned to identifiable net assets 1,200 Remainder assigned to goodwill 200 Total excess of cost over book value acquired 1,400 Assignment to identifiable net assets and goodwill Investment in Sloan Book value of the interest acquired (30% X $12,000,000 equity of Sloan) Total excess of cost over book value acquired
  • 11.
    Excess Investment Costover Underlying Book Value of Equity: Accounting Sloan pay dividends $1,000,000 on July 1 and reports net income of $3,000,000. The excess cost over book value is amortized as follows: Amortization Rates Excess allocated to: Inventories – sold in the current year 100% Other current assets – disposed of in the current year 100% Equipment – depreciated over 20 years 5% Note payable – due in 5 years 20%
  • 12.
    Excess Investment Costover Underlying Book Value of Equity: Accounting Payne’s entries: July 1: Cash (+A) 300 Investment in Sloan (-A) 300 To record dividends received from Sloan ($1,000,000 X 30% December 31 Investment in Sloan (+A) 900 Income from Sloan (+R, +SE) 900 To record dividends received from Sloan ($1,000,000 X 30%) December 31 Income from Sloan (-R, -SE) 300 Investment in Sloan (-A) 300 To record write-off of excess allocated to inventory items that were sold in the current year 1 2
  • 13.
    Excess Investment Costover Underlying Book Value of Equity: Accounting December 31 Investment in Sloan (+A) 60 Income from Sloan (R, +SE) 60 To record income credit overvalued other current assets disposed of in the current year December 31 Income from Sloan (-R, -SE) 12 Investment in Sloan (-A) 12 To amortize the excess allocated to the overvalued note payable over the remaining life of the note ($60,000 : 5 years) December 31 Income from Sloan (-R, -SE) 45 Investment in Sloan (-A) 45 To record depreciation on excess allocated to undervalued equipment with a 20-year remaining useful life ($900,000 : 20) 5 4 3
  • 14.
    Excess Investment Costover Underlying Book Value of Equity: Accounting December 31 Investment in Sloan (+A) 603 Income from Sloan (R, +SE) 603 To record equity income from 30% investment in Sloan 1-5 Equity in Sloan’s reporting income ($3,000,000 X 30%) 603 Amortization of excess cost over book value: Inventories sold in the current year ($300,000 X 100%) (300) Other current assets sold in the current year ($60,000 X 100%) 60 Equipment ($900,000 X 5%) depreciation rate Note payable ($60,000 X 20%) amortization rate (12) Total investment income from Sloan $603
  • 15.
    Book value elementLife remaining Common Stock $130,000 Retained Earnings 117,000 Under- or Over-valuation Inventory (6,500) 2 months Land 39,000 Indefinite Equipment 85,000 10 years Covenant-not-to-compete 52,000 4 years Goodwill element 26,000 Indefinite Total Cost $442,500 Example: Acquisition Price > Book Value Pepper Inc., a calendar-year reporting company, acquired 100% of Salt Inc.’s outstanding common stock at a cost of $442,500 on 12/31/X8. The analysis of the parent’s Investment account as of the acquisition date shows:
  • 16.
    Acquisition Price = BV+ Identifiable Excess + GW Results for 20X9 (based on Book Values): Reported Income $78,000 Dividends Declared 45,500 What would the Sub’s income be based on Fair Values? Lower COGS (because inventory is worth less) $ (6,500) Extra depreciation on equipment 8,500 Extra amortization of contract 13,000 Total increase in expenses / decrease in income $ 15,000 $63,000 ($78,000 - $15,000) Example: Acquisition Price > Book Value 442,500 = 247,000 + 169,500 + 26,000
  • 17.
  • 18.
    Consolidation procedures differ whenthere is a differential.
  • 19.
    Differential in EquityMethod The Parent’s initial investment in a sub is based on the FMV of the sub’s net assets (+/- GW). Equity method entries: • Recording share of sub’s income • Recording share of sub’s dividends They should be based on the same FMV basis. Problem: Sub reports income based on BOOK VALUES Solution: Parent has to record an adjustment to the income and investment “Equity Method” accounts.
  • 20.
    Results for 20X9(based on Book Values): Reported Income $78,000 Dividends Declared 45,500 Adjustment to Salt’s 20X9 income on Parent’s books: Lower COGS (because inventory is worth less) $ (6,500) Extra depreciation on equipment 8,500 Extra amortization of contract 13,000 Total increase in expenses / decrease in income $ 15,000 What entries would Pepper record in its general ledger related to Salt’s income and dividends for 20X9 under the equity method? Example: Differential in Equity Method
  • 21.
    Example: Equity MethodJournal Entries 1. To record 100% share of Salt’s reported income: Investment in Salt 78,000 Income from Salt 78,000 2. To record 100% of Salt’s dividends declared: Dividend Receivable 45,500 Investment in Salt 45,500 3. To record additional expenses (based on FMV): Income from Salt 15,000 Investment in Salt 15,000
  • 22.
    Called “amortization of excessvalue” Example: Equity Method Investment Adjustment Calculate the correct ending balance in Pepper’s Investment in Salt account using the equity method: Investment in Salt Beginning Balance 442,500 Net Income 78,000 Ending Balance 460,000 Dividend 45,500 Income Adjustment 15,000
  • 23.
    Simple Example P S Stock Sub Shareholders $ Book valueof net assets = $800 Excess value of identifiable assets = $200 Goodwill = $500 Assume the BV of Sub’s net assets is $800 and that the FMV of the net assets is $1,000. Finally, assume that the acquisition price was $1,500. The acquisition price consists of three parts:
  • 24.
    Understanding Components of AcquisitionCost Acquisition FMV of Price = Assets + Goodwill Key: We need to keep track of each element of the purchase price separately! Why?? FMV of Extra Assets = BV + Value Acquisition Extra Price = BV + Value + Goodwill
  • 25.
    The Consolidation Process Whena subsidiary is acquired (instead of created), the consolidation process is more complicated: • Must eliminate intercompany items (same) • Must update Sub’s assets and liabilities to FMV • Must recognize goodwill
  • 26.
    Summary of ConsolidationEntries 1. The basic elimination entry: 2. The excess value reclassification entry: Asset 1 XX Asset 2 XX Goodwill XX Investment in Sub Excess Common Stock (S) XX Additional Paid-in Capital (S) XX Retained Earnings, Beginning Balance (S) XX Income from Sub XX Investment in Sub BV Dividends Declared XX
  • 27.
    Summary of ConsolidationEntries 3. The amortized excess value reclassification entry: This entry reclassifies the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the sub used FMV instead of BV. 4. The accumulated depreciation elimination entry: Cost of Sales XX Other Expenses XX Income from Sub XX Accumulated Depreciation XX Buildings and Equipment XX
  • 28.
    Understand and explainhow consolidation process differ when there is a differential
  • 29.
    Wholly-owned Subsidiary (100Percent) at More than Book Value (Baker p. 162) Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $340,000 cash, an amount equal to Special Foods’ fair value as a whole. This includes $40,000 in excess of Special Foods’ book value of $300,000. Fair value consideration 340,000 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 40,000 Investment in Special Foods 340,000 Cash 340,000 To record the initial investment in Special Food
  • 30.
    Book value of netassets CS + RE = 300,000 Identifiable assets = 40,000 $340,000 Initial Investment Special Foods Goodwill = 0 1/1/X1 Wholly-owned Subsidiary (100 Percent) at More than Book Value
  • 31.
    Wholly-owned Subsidiary (100Percent Ownership) at more than Book Value Book Value calculation Total Common Retained Book Value Stock Earnings Original Book Value 300,000 200,000 100,000 = + Common Stock 200,000 Retained Earnings 100,000 Investment in Special Foods 300,000 Excess value reclassification entry: Land 40,000 Investment in Special Foods 40,000
  • 32.
    Wholly-owned Subsidiary (100Percent Ownership) at more than Book Value Excess value reclassification entry: Land 40,000 Investment in Special Foods 40,000 In this example, the differential is the additional $40,000 payment, because of Special Foods’ land was worth $40,000 more than its book value at acquisition date. A second elimination entry is required to re-assign the $40,000 from the investment account to the land account.
  • 33.
    Wholly-owned Subsidiary (100Percent Ownership) at More than Book Value at Acquisition Date – Worksheet (Baker p. 164) Peerless Product Special Foods Consolidated Assets Cash 10,000 50,000 60,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 160,000 Investment in Special Food 340,000 300,000 0 40,000 Land 175,000 40,000 40,000 255,000 Buildings and equipment 800,000 600,000 1,400,000 Accumulated depreciation (400,000) (300,000) (700,000) Total assets 1,100,000 500,000 40,000 340,000 1,300,000 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 200,000 100,000 300,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 Total liabilities and equity 1,100,000 500,000 300,000 0 1,300,000 Elimination Entries
  • 34.
    Existence of Goodwill Excessvalue reclassification entry: Goodwill 40,000 Investment in Special Foods 40,000 For example, assume in the Peerless Product and Special Foods illustration the acquisition-date fair value of Special Foods’ assets and liabilities equal to their book values, then the $40,000 difference between the $340,000 consideration exchanged and the $300,000 fair value of the subsidiary’s net identifiable assets should be attributed to goodwill
  • 35.
  • 36.
    Make calculation andprepare elimination entries for the consolidation of a wholly owned subsidiary when there is a complex positive differential at the acquisition date.
  • 37.
    Wholly-owned Subsidiary (100Percent) at More than Book Value (Baker p. 166) Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $400,000 on January 1, 20X1, by issuing $100,000 of 9% bonds, with fair value of $100,000, and paying cash of $300,000. The resulting ownership situation: Fair value consideration 400,000 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 100,000
  • 38.
    Wholly-owned Subsidiary (100Percent) at More than Book Value (Baker p. 167) Investment in Special Foods 400,000 Bond Payable 100,000 Cash 340,000 To record the initial investment in Special Food Book Value Fair Value Difference Cash 50,000 50,000 Account receivable 50,000 50,000 Inventory 60,000 75,000 15,000 Land 40,000 100,000 60,000 Buildings and equipment 600,000 Accumulated depreciation (300,000) 300,000 290,000 (10,000) 500,000 290,000 Account payable 10,000 100,000 Bonds payable 10,000 135,000 (35,000) Common stock 20,000 Retained earnings 10,000 50,000 235,000 30,000
  • 39.
    Book value of netassets CS + RE = 300,000 Identifiable assets = 30,000 $400,000 Initial Investment Special Foods Goodwill = 70,000 1/1/X1 Wholly-owned Subsidiary (100 Percent) at More than Book Value
  • 40.
    Wholly-owned Subsidiary (100Percent Ownership) at more than Book Value (Baker p. 168) Basic elimination entry Total Common Retained Book Value Stock Earnings Original Book Value 300,000 200,000 100,000 = + Common Stock 200,000 Retained Earnings 100,000 Investment in Special Foods 300,000
  • 41.
    Wholly-owned Subsidiary (100Percent Ownership) at more than Book Value Total = Inventory Land Building Goodwill Bonds Payable 100,000 15,000 60,000 (100,000) 70,000 (35,000) Excess value (differential) reclassification entry: Inventory 15,000 Land 60,000 Goodwill 9,500 Building 10,000 Bonds Payable 35000 Investment in Special Foods 100,000
  • 42.
    Wholly-owned Subsidiary (100Percent Ownership) at More than Book Value at Acquisition Date – Worksheet (Baker p. 169) Peerless Product Special Foods Consolidated Assets Cash 50,000 50,000 100,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 15,000 175,000 Investment in Special Food 400,000 300,000 0 100,000 Land 175,000 40,000 60,000 275,000 Buildings and equipment 800,000 600,000 10,000 1,390,000 Accumulated depreciation (400,000) (300,000) (700,000) Goodwill 70,000 Total assets 1,200,000 500,000 75,000 410,000 1,435,000 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 300,000 100,000 400,000 Premium on Bonds Payable 35,000 35,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 Total liabilities and equity 1,200,000 500,000 300,000 35,000 1,435,000 Elimination Entries
  • 43.
    Situation 2 Worksheet atthe Date of Acquisition (100% ownership)
  • 44.
    Prepare equity methodjournal entries, elimination entries, and the consolidated worksheet for a wholly owned subsidiary when there is a complex positive differential.
  • 45.
    Wholly-owned Subsidiary (100Percent) at More than Book Value – Initial Year Peerless Products acquires all of Special Foods common stock on January 1 20X1, for $387,500, an amount $87,500 in excess of the book value. The acquisition price includes cash of $300,000 and a 60-day note for $87,500 (paid at maturity during 20X1). Fair value consideration 387,500 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 87,500
  • 46.
    Wholly-owned Subsidiary (100Percent) at More than Book Value Fair values of Special Foods’ assets and liabilities: Book Value Fair Value Differential Inventory 60,000 65,000 5,000 Land 40,000 50,000 10,000 Buildings and Equipment 300,000 360,000 60,000 400,000 475,000 75,000 • The remaining $12,500 is goodwill • The entire amount of inventory is sold during 20X1 • The buildings and equipment have 10 years remaining economic life and depreciated using straight line depreciation
  • 47.
    Wholly-owned Subsidiary (100Percent Ownership) at More than Book Value – Initial Year of Ownership Investment in Special Foods 50,000 Income from Special Foods 50,000 To record Peerless 100% share of Special Food’s 20X1 income During 20X1, Peerless records operating earnings of $140,000, excluding its income from investing in Special Foods, and declares dividends of $60,000. Special Foods reports 20X1 net income of $50,000 and declares dividends of $30,000. Cash 30,000 Investment in Special Foods 30,000 To record Peerless 100% share of Special Food’s 20X1 dividend Investment in Special Foods 387,500 Cash 300,000 Notes Payable 87,500 To record the initial investment in Special Food
  • 48.
    Wholly-owned Subsidiary (100Percent Ownership) at Book Value – Initial Year of Ownership (Baker p.173) Parent Company Entry Income from Special Foods 14,000 Investment in Special Foods 14,000 To record amortization of excess acquisition price • A portion of the differential ($5,000) – Special Foods’ inventory sold during 20X1. • $60,000 of the differential – Special Foods’ buildings and equipment – amortization $6,000 ($60,000 : 10 years) • Impairment of goodwill by $3,000 is recognized. • The total of differential written off = $5,000 inventory + $6,000 depreciation + $3,000 goodwill impairment = $14,000
  • 49.
    Book value of netassets CS + RE = 300,000 Identifiable assets = 75,000 $387,500 Initial Investment Special Foods Goodwill = 12,500 Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Book value of net assets CS + RE = 320,000 Identifiable assets = 64,000 $393,500 Net Investment Special Foods Goodwill = 9,500 1/1/X1 31/12/X1
  • 50.
    Wholly-owned Subsidiary (100Percent Ownership) at Book Value – Initial Year of Ownership Basic Elimination Entry Total Common Retained Investment Stock Earnings Original Book Value 300,000 200,000 100,000 + Net Income 50,000 50,000  Dividends (30,000) (30,000) Ending Book Value 320,000 200,000 120,000 = + Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 50,000 Dividends Declared 30,000 Investment in Special Foods 320,000 Book Value Calculation
  • 51.
    Wholly-owned Subsidiary (100Percent Ownership) at Book Value – Initial Year of Ownership Amortized excess value reclassification entry: Cost of goods sold 5,000 Depreciation expense 6,000 Goodwill impairment loss 3,000 Income from Special Foods 14,000 Total Inventory Land Building Acc. Dep. Goodwill Beginning balance 87,500 5,000 10,000 60,000 0 12,500 (-) Changes (14,000) (5,000) 6,000 (3,000) Ending balance 73,500 0 10,000 60,000 6,000 9,500 Excess value (differential) reclassification entry: Land 10,000 Building 60,000 Goodwill 9,500 Accumulated depreciation 6,000 Investment in Special Foods 73,500
  • 52.
    Do… the Working Sheetfor 20X1 and self-practice for 20X2
  • 53.
    Consolidation Process on aMore than Book Value Acquisitions with (less than 100% ownership)
  • 54.
    Understand and explainhow the consolidation process differs when the subsidiary is less-than-wholly owned and there is a differential.
  • 55.
    How Do theElimination Entries Change? 1. The basic elimination entry: 2. The excess value reclassification entry: Asset 1 XXX Asset 2 XXX Goodwill XXX Investment in Sub % Excess NCI in NA of Sub % Excess Common Stock (S) XXX Additional Paid-in Capital (S) XXX Retained Earnings, Beginning Balance (S) XXX Income from Sub % NI NCI in NI of Sub % NI Dividends Declared XXX Investment in Sub % BV NCI in NA of Sub % BV
  • 56.
    3. The amortizedexcess value reclassification entry: This entry reclassifies the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the Sub used FMV instead of BV. 4. The accumulated depreciation elimination entry: Accumulated Depreciation XXX Building & Equipment XXX Cost of Sales XXX Other Expenses XXX Income from Sub % Adj. NCI in NI of Sub % Adj. Acquisition Date How Do the Elimination Entries Change?
  • 57.
    Issue Should Parent revalue theland by the full $39,000 in consolidation or only its share of the excess value ($31,200)? Partial Ownership Example Assume Parent owns land with a book value of $400,000. Parent’s 80%-owned subsidiary also owns land. At the time of the acquisition, Sub’s land has a FMV of $100,000 and a book value of $61,000. Thus, the land has excess value of $39,000. Parent Sub 80%20% NCI
  • 58.
    Partial Ownerships: Partialor Full Valuation? We learned earlier that full consolidation is required, as opposed to partial consolidation. •Thus, we consolidate 100% of the sub. •This, however, refers to the BV of the subsidiary. What about revaluation of assets to FMV? •The extent of revaluation of undervalued assets and goodwill can vary. • Parent Company Concept: Partial valuation • Entity Concept: Full valuation
  • 59.
    Partial Ownership Example •Both were used in the past. • SFAS 141R requires the Entity Concept. Parent Sub 80%20% NCI Parent Sub DR CR Consolidated Land $400,000 $61,000 $31,200 $492,200 Parent Sub DR CR Consolidated Land $400,000 $61,000 $39,000 $500,000 Parent Company Concept Economic Unit Concept
  • 60.
    Partial Ownership: UndervaluedAssets & GW How much to revalue the Subsidiary’s undervalued assets and goodwill? Parent company concept: < 100% of FMV Revalued only to the extent of the parent’s percent ownership Entity concept: 100% of FMV The offsetting credit for the additional valuation increases the NCI in net assets
  • 61.
    Situation 2 Worksheet atthe Initial Year (less than 100% ownership)
  • 62.
    Less than Wholly-ownedSubsidiary (Less than 100 Percent) at More than Book Value Peerless Products acquires 80% of Special Foods common stock on January 1 20X1, for $310,000. At that date, the fair value of the noncontrolling interest is estimated to be $77,500. The ownership situation: Fair value consideration 387,500 Book value of Special Food's net assets Common stock - Special Food 200,000 Retained earnings - Special Food 100,000 300,000 Difference between fair value and book value 87,500 Parent Sub 80%20% NCI
  • 63.
    Peerless Product and SpecialFoods balance sheets. Peerless Product Special Foods Assets Cash 350,000 50,000 Account receivable 75,000 50,000 Inventory 100,000 60,000 Land 175,000 40,000 Buildings and equipment 800,000 600,000 Accumulated depreciation (400,000) (300,000) Total assets 1,100,000 500,000 Liabilities and stockholder's equity Account payable 100,000 100,000 Bonds payable 200,000 100,000 Common stock 500,000 200,000 Retained earnings 300,000 100,000 Total liabilities and equity 1,100,000 500,000 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value Investment in Special Foods 310,000 Cash 310,000 To record purchase of Special Food stock
  • 64.
    Peerless Product Special Foods Assets Cash 40,000 50,000 Accountreceivable 75,000 50,000 Inventory 100,000 60,000 Land 175,000 40,000 Buildings and equipment 800,000 600,000 Accumulated depreciation (400,000) (300,000) Investment in Special Food 310,000 Total assets 1,100,000 500,000 Liabilities and stockholder's equity Account payable 100,000 100,000 Bonds payable 200,000 100,000 Common stock 500,000 200,000 Retained earnings 300,000 100,000 Total liabilities and equity 1,100,000 500,000 The separate financial statements of Peerless and Special Foods immediately after the combination. Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
  • 65.
    Fair values ofSpecial Foods’ assets and liabilities: Book Value Fair Value Differential Inventory 60,000 65,000 5,000 Land 40,000 50,000 10,000 Buildings and Equipment 300,000 360,000 60,000 400,000 475,000 75,000 • The remaining $12,500 is goodwill • The entire amount of inventory is sold during 20X1 • The buildings and equipment have 10 years remaining economic life and depreciated using straight line depreciation Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
  • 66.
    80% Book value of netassets CS + RE = 240,000 80% Identifiable assets = 60,000 $310,000 Initial Investment Special Foods 80% Goodwill = 10,000 1/1/X1 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
  • 67.
    Less than wholly-ownedSubsidiary (80 Percent Ownership) at Book Value – Investment Elimination Entry Basic investment account elimination entry Common Stock 200,000 Retained Earnings 100000 Investment in Special Foods 240,000 NCI in NA of Special Foods 60,000 Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 =
  • 68.
    NCI 20% Peerless 80% = InventoryLand Building Acc. Dep. Goodwill Beginning balance 17,500 70,000 5,000 10,000 60,000 0 12,500 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Excess value (differential) reclassification entry: Inventory 5,000 Land 10,000 Building 60,000 Goodwill 12,500 Investment in Special Foods 70,000 NCI in NA of Special Foods 17,500
  • 69.
    Worksheet at dateof acquisition, January 1, 20X1 Peerless Product Special Foods Consolidated Assets Cash 40,000 50,000 90,000 Account receivable 75,000 50,000 125,000 Inventory 100,000 60,000 5,000 165,000 Investment in Special Food 310,000 240,000 0 70,000 Land 175,000 40,000 10,000 225,000 Buildings and equipment 800,000 600,000 60,000 1,160,000 Accumulated depreciation (400,000) (300,000) 300,000 (400,000) Goodwill 12,500 12,500 Total assets 1,100,000 500,000 387,500 240,000 1,377,500 Liabilities and stockholder's equity Account payable 100,000 100,000 200,000 Bonds payable 200,000 100,000 300,000 Common stock 500,000 200,000 200,000 500,000 Retained earnings 300,000 100,000 100,000 300,000 NCI in NA of Special Foods 60,000 77,500 17,500 Total liabilities and equity 1,100,000 500,000 300,000 77,500 1,377,500 Elimination Entries
  • 70.
    Peerless Products Special Foods 20X1: Separate operating income,Peerless Net income, Special Foods Dividends 140,000 60,000 50,000 30,000 20X2: Separate operating income, Peerless Net income, Special Foods Dividends 160,000 60,000 75,000 40,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Information
  • 71.
    Less than wholly-ownedSubsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Recognition Investment in Special Foods 40,000 Income from Special Foods 40,000 To record Peerless 80% share of Special Food’s 20X1 income Cash 24,000 Investment in Special Foods 24,000 To record Peerless 80% share of Special Food’s 20X1 dividend
  • 72.
    Less than wholly-ownedSubsidiary (80 Percent Ownership) at More than Book Value – Income and Dividend Recognition Income from Special Foods 11,300 Investment in Special Foods 11,300 To record amortization of excess acquisition price • A portion of the differential ($5,000) – Special Foods’ inventory sold during 20X1. Peerless’ $4,000 portion ($5,000 X 80%) must be written off • Peerless portion of $60,000 of the differential on Special Foods’ buildings and equipment – amortization $4,800 ($48,000 : 10 years) • Impairment of goodwill by $3,125 is recognized – $2,500 (80% X $3,125) • The total of differential written off = $4,000 inventory + $4,800 depreciation + $2,500 goodwill impairment = $11,300
  • 73.
    80% Book value of netassets CS + RE = 240,000 80% Identifiable assets = 60,000 $387,500 Initial Investment Special Foods 80% Goodwill = 10,000 Goodwill = 7,500 1/1/X1 Book value of net assets CS + RE = 256,000 Identifiable assets = 51,200 $314,700 Net Investment Special Foods 31/12/X1 Less than Wholly-owned Subsidiary (Less than 100 Percent) at More than Book Value
  • 74.
    Book Value Calculations Investment AccountCommon Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 + Net income 10,000 40,000 50,000 - Dividend (6,000) (24,000) (30,000) Ending book value 64,000 256,000 200,000 120,000 = Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Initial Year of Ownership
  • 75.
    Basic investment accountelimination entry: Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 40,000 NCI in NI of Special Foods 10,000 Dividends Declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at More than Book Value – Initial Year of Ownership
  • 76.
    NCI 20% Peerless 80% = InventoryLand Building Acc. Dep. Goodwill Beginning balance 17,500 70,000 5,000 10,000 60,000 0 12,500 Amortization (2,825) (11,300) (5,000) (6,000) (3,125) Ending balance 14,675 58,700 0 10,000 60,000 (6,000) 9,375 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Amortized excess value reclassification entry: Cost of Goods Sold 5,000 Depreciation expense 6,000 Goodwill impairment loss 3,125 Income from Special Foods 11,300 NCI in NA of Special Foods 2,825
  • 77.
    Less than wholly-ownedSubsidiary (80 Percent Ownership) at Book Value – Differential reclassification entry Excess value (differential) reclassification entry: Land 10,000 Building 60,000 Goodwill 9,375 Accumulated depreciation 6,000 Investment in Special Foods 58,700 NCI in NA of Special Foods 14,675
  • 78.
    Do… the Working Sheetfor 20X1 and self-practice for 20X2
  • 79.
  • 80.
    Acquired at Lessthan Fair Value of Net Assets Bargain purchase • A business combination where the sum of • the acquisition-date fair values of the consideration given, • any equity interest already held by the acquirer, and • any noncontrolling interest is less than the amounts at which the identifiable net assets must be valued at the acquisition date as specified by FASB 141R. • The acquirer recognizes a gain for the difference.
  • 81.
    Basic Concepts Income StatementEffects • When Acquisition Price < BV Asset Related Expense (as the asset expires) Income Statement Effect Equipment Inventory Patent Goodwill Depreciation Expense Cost of Goods Sold Amortization Expense Impairment Loss Too High (overstated) If expenses are OVERSTATED, then income is too low (UNDERSTATED). To fix the problem, Parent needs to DECREASE expenses.
  • 82.