Consolidation of Wholly-Owned Subsidiaries Acquired at More than Book Value
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Transcript of Consolidation of Wholly-Owned Subsidiaries Acquired at More than Book Value
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 4Chapter 4
Consolidation of Consolidation of Wholly-Owned Wholly-Owned
Subsidiaries Acquired at Subsidiaries Acquired at More than Book ValueMore than Book Value
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Learning Objective 1Learning Objective 1
Understand and make equity-method journal entries related to the
differential.
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Basic Concepts: Parent and SubsidiaryBasic 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
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Basic Concepts: Parent and SubsidiaryBasic 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
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Basic Concepts: Income Statement ImpactsBasic Concepts: Income Statement Impacts
Big Picture: Essentially, we switch the sub’s books from BV to FMV in the consolidation process.
Income Statement effects
AssetRelated Expense
(as the asset expires)
Equipment
Inventory
Patent
Goodwill
Depreciation Expense
Cost of Goods Sold
Amortization Expense
Impairment Loss
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Basic Concepts: Income Statement ImpactsBasic Concepts: Income Statement Impacts
Income Statement Effects When Acquisition Price > Book Value
AssetRelated 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.
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Book value element Life remainingCommon Stock $130,000Retained Earnings 117,000
Under- or Over-valuation Inventory (6,500) 2 monthsLand 39,000 IndefiniteEquipment 85,000 10 yearsCovenant-not-to-compete 52,000 4 yearsGoodwill element 26,000 Indefinite
Total Cost $442,500
ExampleExample: Acquisition Price > Book Value: 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:
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Acquisition Price = BV +Identifiable Excess + GW
Results for 20X9 (based on Book Values):
Reported Income $78,000Dividends 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 8,500Extra amortization of contract 13,000Total increase in expenses / decrease in income $ 15,000
$63,000
ExampleExample: Acquisition Price > Book Value: Acquisition Price > Book Value
442,500 = 247,000 + 169,500 + 26,000
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Consolidation: Equity MethodConsolidation: 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.
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Results for 20X9 (based on Book Values):
Reported Income $78,000Dividends 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 8,500Extra amortization of contract 13,000Total 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?
ExampleExample: Equity Method : Equity Method
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ExampleExample: Equity Method Journal Entries: Equity Method Journal Entries
1. To record 100% share of Salt’s reported income:
Investment in Salt 78,000Income from Salt 78,000
2. To record 100% of Salt’s dividends declared:
Dividend Receivable 45,500Investment in Salt 45,500
3. To record additional expenses (based on FMV):
Income from Salt 15,000Investment in Salt 15,000
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Called “amortizationof excess value”
ExampleExample: Equity Method Investment Adjustment: 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 442,500Net Income 78,000
Ending Balance 460,000
Dividend 45,500Income Adjustment 15,000
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Practice Quiz Question #1Practice Quiz Question #1
A parent charges the amortization of its cost in excess of book value to:
a. Goodwill expense.b. Excess cost expense.c. Excess cost & goodwill expense.d. Income from subsidiary.e. None of the above.
A parent charges the amortization of its cost in excess of book value to:
a. Goodwill expense.b. Excess cost expense.c. Excess cost & goodwill expense.d. Income from subsidiary.e. None of the above.
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Practice Quiz Question #1 Practice Quiz Question #1 SolutionSolution
A parent charges the amortization of its cost in excess of book value to:
a. Goodwill expense.b. Excess cost expense.c. Excess cost & goodwill expense.d. Income from subsidiary.e. None of the above.
A parent charges the amortization of its cost in excess of book value to:
a. Goodwill expense.b. Excess cost expense.c. Excess cost & goodwill expense.d. Income from subsidiary.e. None of the above.
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Learning Objective 2Learning Objective 2
Understand and explain how consolidation procedures
differ when there is adifferential.
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Consolidation Concepts by ChapterConsolidation Concepts by Chapter
Wholly Owned Subsidiary
Partially Owned Subsidiary
Investment = Book Value Chapter 2 Chapter 3 No
Differential
Investment > Book Value Chapter 4 Chapter 5 Differential
No NCI Shareholders
NCI Shareholders
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Simple ExampleSimple Example
P
S
Stock
SubShareholders
$
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:
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Understanding Components of Acquisition CostUnderstanding 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??Why??
FMV of Extra Assets = BV + Value
Acquisition Extra Price = BV + Value + Goodwill
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The Consolidation ProcessThe 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
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Summary of Consolidation EntriesSummary of Consolidation Entries
1. The basic elimination entry:
2. The excess value reclassification entry:
Asset 1 XXAsset 2 XXGoodwill XX
Investment in Sub Excess
Common Stock (S) XXAdditional Paid-in Capital (S) XXRetained Earnings, Beginning Balance (S) XXIncome from Sub XX
Investment in SubBV
Dividends DeclaredXX
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Summary of Consolidation EntriesSummary 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 XXOther Expenses XX
Income from Sub XX
Accumulated Depreciation XXBuildings and Equipment XX
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Practice Quiz Question #2Practice Quiz Question #2
When P company pays more than the book value of net assets of the acquired company (S), how does the consolidation process differ?a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.
When P company pays more than the book value of net assets of the acquired company (S), how does the consolidation process differ?a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.
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Practice Quiz Question #2 Practice Quiz Question #2 SolutionSolution
When P company pays more than the book value of net assets of the acquired company (S), how does the consolidation process differ?a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.
When P company pays more than the book value of net assets of the acquired company (S), how does the consolidation process differ?a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.
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Learning Objective 3Learning Objective 3
Make calculations and prepare elimination entries for the
consolidation of awholly owned subsidiary when
there is a complex positive differential at theacquisition date.
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Group Exercise 1: Group Exercise 1: Analyzing Acquisition CostsAnalyzing Acquisition Costs Prince Inc. acquired 100% of She-Ra Inc.’s outstanding common stock for $1,600,000 cash. Divide the cost into its major elements and prepare the consolidation entries as of the acquisition date.
Book Value Current Value DifferenceCash 60,000 60,000 - Accounts Receivable 160,000 160,000 - Inventory 300,000 350,000 50,000 Notes Receivable 100,000 40,000 (60,000) Land 500,000 630,000 130,000 Buildings & Equipment 610,000 720,000 110,000 Patent 50,000 140,000 90,000 Goodwill 110,000 - (110,000) Total Assets 1,890,000 2,100,000
Payables & Accruals 160,000 160,000 - Long-term Debt 750,000 680,000 70,000 Total Liabilities 910,000 840,000
Common Stock 120,000 Additional PIC 480,000 Retained Earnings 380,000 Total Equity 980,000
Buildings and equipment net of $98,000 accumulated depreciation. Goodwill is from a prior acquisition.
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Group Exercise 1: Group Exercise 1: SolutionSolution
How would this affect your worksheet elimination entries?
Splitting of the Investment account:Total Cost 1,600,000 Less: BV element (CS + Add PIC + RE) (980,000) Total Excess Cost 620,000
Analysis of the Investment account -- excess cost elements:Under- or (over-) valuation of identifiable net assets Inventory 50,000 Notes Receivable (60,000) Land 130,000 Buildings & Equipment 110,000 Patent 90,000 Goodwill (110,000) Long-term Debt 70,000
280,000 Goodwill 340,000
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1,600,000
Book value of net assets of the acquired
firm
980,000
Excess value of identifiable
assets280,000
340,000
Group Exercise 1: Group Exercise 1: Solution Acquisition CostsSolution Acquisition Costs
What did we pay for?
1,600,000
Investment in Sub
Goodwill
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1,600,000980,000
620,000
0
Group Exercise 1: Group Exercise 1: Solution Investment AccountSolution Investment Account
1. The basic elimination entry:
2. The excess value reclassification entry:
Inventory 50,000Land 130,000Buildings and Equipment 110,000Patent 90,000Long-term Debt 70,000Goodwill (new) 340,000
Notes Receivable 60,000Goodwill (old) 110,000Investment in Sub 620,000
Common Stock 120,000Additional Paid-in Capital 480,000Retained Earnings 380,000
Investment in Sub980,000
Investment in Sub
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Group Exercise 1: Group Exercise 1: Solution Worksheet EntriesSolution Worksheet Entries 1. The basic elimination entry:
2. The excess value reclassification entry:
3. The accumulated depreciation elimination entry:
Inventory 50,000Land 130,000Buildings and Equipment 110,000Patent 90,000Long-term Debt 70,000Goodwill (new) 340,000
Notes Receivable 60,000Goodwill (old) 110,000Investment in Sub 620,000
Common Stock 120,000Additional Paid-in Capital 480,000Retained Earnings 380,000
Investment in Sub980,000
Accumulated Depreciation 98,000Building and Equipment
98,000
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Group Exercise 1: Group Exercise 1: Solution Depreciation EntrySolution Depreciation Entry 3. The accumulated depreciation elimination entry: The book
values at acquisition – remember the 610,000 was net of 98,000 in accumulated depreciation.
708,000
Buildings & Equipment
98,000
Accumulated Depreciation
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Group Exercise 1: Group Exercise 1: Solution Depreciation EntrySolution Depreciation Entry 3. The accumulated depreciation elimination entry:
Accumulated Depreciation 98,000Building and Equipment
98,000
708,000
Buildings & Equipment
98,000
Accumulated Depreciation
98,000 98,000
610,000 0
Shows the Buildings and Equipment “as if” they have been recorded on the sub’s books as new assets at book value.
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Group Exercise 1: Group Exercise 1: Solution Reclass EntrySolution Reclass Entry 3. The accumulated depreciation elimination entry:
Accumulated Depreciation 98,000Building and Equipment
98,000
708,000
Buildings & Equipment
98,000
Accumulated Depreciation
98,000 98,000
610,000 0BV110,000
The excess value reclassification elimination entrybrings the Buildings and Equipment up to fair value.
Excess Value ReclassFMV 720,000
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Elimination Entries Consoli-Pepper Salt DR CR dated
Balance SheetCash 38,500 26,000 Accounts Receivable 97,500 91,000 Inventory 136,500 104,000 Investment in Sub: Book Value 247,000 Excess Value 195,500 Land 130,000 91,000 Build & Equipment 325,000 265,200 Acc Depreciation (195,000) (57,200) Covenant N-T-CGoodwill Total Assets 975,000 520,000 Payables & Accruals 104,000 78,000 Long-term Debt 26,000 195,000
Common Stock 390,000 130,000 Additional PICRetained Earnings 455,000 117,000 Total Liab. & Equity 975,000 520,000
Pepper, Inc. and Salt, Inc.Consolidated Worksheet as of December 31, 20X8
Group Exercise 2: Worksheet at Acquisition Group Exercise 2: Worksheet at Acquisition Pepper acquired 100% of Salt’s outstanding stock for $442,500.
Required: Prepare the consolidation entries and worksheet.
Book Value Element:Common Stock 130,000 Retained Earnings 117,000
Under-valuation Element:Inventory (6,500) Land 39,000 Equipment 85,000 Covenant N-T-C 52,000 Goodwill 26,000
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8
+=
The Basic Elimination Entry:
Common StockRetained Earnings
Investment in Salt
EB 442,500
Investment in Salt
Cons.
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8
=
The Excess Value Reclassification Entry:
LandBuilding & EquipmentCovenant N-T-CGoodwill
InventoryInvestment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common StockRetained Earnings
Investment in Salt
EB 442,500
Investment in Salt
Cons.
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8
=
The Excess Value Reclassification Entry:
LandBuilding & EquipmentCovenant N-T-CGoodwill
InventoryInvestment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings 117,000
Investment in Salt 247,000
EB 442,500
Investment in Salt
Cons.
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8
=
The Excess Value Reclassification Entry:
LandBuilding & EquipmentCovenant N-T-CGoodwill
InventoryInvestment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings 117,000
Investment in Salt 247,000
EB 442,500
Investment in Salt
Cons.
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8 195,500 (6,500) 39,000 85,000 52,00026,000
=
The Excess Value Reclassification Entry:
LandBuilding & EquipmentCovenant N-T-CGoodwill
InventoryInvestment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings 117,000
Investment in Salt 247,000
EB 442,500
Investment in Salt
Cons.
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8 195,500 (6,500) 39,000 85,000 52,00026,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 52,000Goodwill 26,000
Inventory 6,500Investment in Salt 195,500
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings 117,000
Investment in Salt 247,000
EB 442,500
Investment in Salt
247,000 Basic
Cons. 0
195,500 Excess Value Reclass
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8 195,500 (6,500) 39,000 85,000 52,00026,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 52,000Goodwill 26,000
Inventory 6,500Investment in Salt 195,500
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet EntriesGroup Exercise 2: Worksheet Entries
Book Value Analysis:Pepper’sSalt’s Equity Accounts, BV
Investment CommonRetained
Account, BV StockEarnings
Balances, 12/31/X8 247,000 130,000117,000
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings 117,000
Investment in Salt 247,000
EB 442,500
Investment in Salt
247,000 Basic
Cons. 0
195,500 Excess Value Reclass
Excess Value Analysis:Pepper’sSalt’s Under- or (Over-) Valuation of Net Assets Element
Investment Inventory Land EquipmentCovenant Goodwill
Balances, 12/31/X8 195,500 (6,500) 39,000 85,000 52,00026,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 52,000Goodwill 26,000
Inventory 6,500Investment in Salt 195,500
Accumulated Depreciation 57,200Building & Equipment 57,200
The Accumulated Depreciation Elimination Entry:
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Group Exercise 2: Worksheet at Year EndGroup Exercise 2: Worksheet at Year End
Consoli-Pepper Salt DR CR dated
Balance Sheet 64,500 Cash 38,500 26,000 188,500 Accounts Receivable 97,500 91,000 234,000 Inventory 136,500 104,000 6,500 Investment in Sub: Book Value 247,000 247,000 Excess Value 195,500 195,500 Land 130,000 91,000 39,000 260,000 Build & Equipment 325,000 265,200 85,000 57,200 618,000 Acc Depreciation (195,000) (57,200) 57,200 (195,000) Covenant N-T-C 52,000 52,000 Goodwill 26,000 26,000 Total Assets 975,000 520,000 259,200 506,200 1,248,000 Payables & Accruals 104,000 78,000 182,000 Long-term Debt 26,000 195,000 221,000 Common Stock 390,000 130,000 130,000 390,000 Additional PICRetained Earnings 455,000 117,000 117,000 455,000 Total Liab. & Equity 975,000 520,000 247,000 0 1,248,000
Pepper, Inc. and Salt, Inc.Consolidated Worksheet as of December 31, 20X8
Elimination Entries
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Practice Quiz Question #3Practice Quiz Question #3
An account of the acquired company that cannot be revalued to its current value under acquisition accounting is:
a. Notes receivable.b. Bonds payable.c. Investment in marketable securities.d. Patents.e. None of the above.
An account of the acquired company that cannot be revalued to its current value under acquisition accounting is:
a. Notes receivable.b. Bonds payable.c. Investment in marketable securities.d. Patents.e. None of the above.
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Practice Quiz Question #3 Practice Quiz Question #3 SolutionSolution
An account of the acquired company that cannot be revalued to its current value under acquisition accounting is:
a. Notes receivable.b. Bonds payable.c. Investment in marketable securities.d. Patents.e. None of the above.
An account of the acquired company that cannot be revalued to its current value under acquisition accounting is:
a. Notes receivable.b. Bonds payable.c. Investment in marketable securities.d. Patents.e. None of the above.
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Learning Objective 4Learning Objective 4
Make calculations and prepare elimination entries for the
consolidationof a wholly owned subsidiary
when there is a complex bargain-purchase
differential.
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Acquired at Less than Fair Value of Net AssetsAcquired 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.
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Basic ConceptsBasic Concepts
Income Statement Effects When Acquisition Price < BV
AssetRelated 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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Practice Quiz Question #4Practice Quiz Question #4
How do the elimination entries differ in a bargain purchase scenario from a acquisition at an amount greater than book value?a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the differential increases reported expenses.
e. The elimination entry to reclassify expenses related to the differential decreases reported expenses.
How do the elimination entries differ in a bargain purchase scenario from a acquisition at an amount greater than book value?a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the differential increases reported expenses.
e. The elimination entry to reclassify expenses related to the differential decreases reported expenses.
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Practice Quiz Question #4 Practice Quiz Question #4 SolutionSolution
How do the elimination entries differ in a bargain purchase scenario from a acquisition at an amount greater than book value?a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the differential increases reported expenses.
e. The elimination entry to reclassify expenses related to the differential decreases reported expenses.
How do the elimination entries differ in a bargain purchase scenario from a acquisition at an amount greater than book value?a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the differential increases reported expenses.
e. The elimination entry to reclassify expenses related to the differential decreases reported expenses.
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Learning Objective 5Learning Objective 5
Prepare equity-method journal entries, elimination entries, and
the consolidationworksheet for a wholly owned
subsidiary when there is a complex positive
differential.
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Book value element Life remainingCommon Stock $130,000Retained Earnings 117,000
Under- or Over-valuation Inventory (6,500) 2 monthsLand 39,000 IndefiniteEquipment 85,000 10 yearsCovenant-not-to-compete 52,000 4 yearsGoodwill element 26,000 Indefinite
Total Cost $442,500
Group Exercise 3Group Exercise 3
Pepper Inc., a calendar-year reporting company, acquired 100% of Salt Inc.’s outstanding common stock at a cost of $442,500 on 12/31/X8. The analysis of the parent’s Investment account as of the acquisition date shows:
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1. Update the analyses of the Investment account through 12/31/X9.
2. Prepare all consolidation entries as of 12/31/X9.
3. Prepare a consolidation worksheet at 12/31/X9. (The parent’s retained earnings as of 1/1/X9 were $455,000.
Group Exercise 3Group Exercise 3
Consoli-Pepper Salt DR DR dated
Income StatementSales 1,235,000 780,000Cost of Sales (598,000) (370,500)Depreciation Expense (78,000) (19,500)S&A Expense (481,000) (312,000)Income from Salt 63,000 Net Income 141,000 78,000Statement of Retained EarningsBalance, 1/1/X9 455,000 117,000Add: Net Income 141,000 78,000Less: Dividends (104,000) (45,500)Balance, 12/31/X9 492,000 149,500Balance SheetCash 77,500 32,500Accounts Receivable 123,500 78,000Inventory 149,500 156,000Investment in Salt: Book Value 279,500 Excess Cost 180,500Land 130,000 91,000Build & Equip 325,000 291,200Acc Depreciation (273,000) (76,700)Covenant N-T-CGoodwill Total Assets 992,500 572,000Payables & Accruals 84,500 97,500Long-term Debt 26,000 195,000Common Stock 390,000 130,000Retained Earnings 492,000 149,500 Total Liab & Equity 992,500 572,000
Consolidated Worksheet as of December 31, 20X9Pepper, Inc. and Salt, Inc.
Elimination Entries
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet Entries
Book Value Calculations:Pepper’sSalt’s Equity Accounts, BV
Investment Common RetainedAccount, BV Stock Add PIC Earnings
Balances, 1/1/X9
Add: Net Income
Less Dividends
Balances, 12/31/X9
+=
The Basic Elimination Entry:
Common StockRetained Earnings, 1/1/X9Income from Salt
Dividends DeclaredInvestment in Salt
+
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet Entries
Book Value Calculations:Pepper’sSalt’s Equity Accounts, BV
Investment Common RetainedAccount, BV Stock Add PIC Earnings
Balances, 1/1/X9 247,000 130,000 0 117,000
Add: Net Income 78,000 78,000
Less Dividends (45,500) (45,500)
Balances, 12/31/X9 279,500 130,000 0 149,500
+=
The Basic Elimination Entry:
Common StockRetained Earnings, 1/1/X9Income from Salt
Dividends DeclaredInvestment in Salt
+
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet Entries
Book Value Calculations:Pepper’sSalt’s Equity Accounts, BV
Investment Common RetainedAccount, BV Stock Add PIC Earnings
Balances, 1/1/X9 247,000 130,000 0 117,000
Add: Net Income 78,000 78,000
Less Dividends (45,500) (45,500)
Balances, 12/31/X9 279,500 130,000 0 149,500
+=
The Basic Elimination Entry:
Common Stock 130,000Retained Earnings, 1/1/X9 117,000Income from Salt 78,000
Dividends Declared 45,500Investment in Salt 279,500
+
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet EntriesExcess Value Calculations:
Pepper’sInvestment Salt’s Under- or (Over-) Valuation of Net Assets Element
Account Inventory Land EquipmentAcc Dep Covenant Goodwill Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9
Less: Amortization
Balances, 12/31/X9
=
The Excess Value Reclassification Entry:
LandBuilding & EquipmentCovenant N-T-CGoodwill
Accumulated DepreciationInvestment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
The Amortized Excess Value Reclassification Entry:Depreciation ExpenseS&A Expense
Cost of SalesIncome from Salt
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet Entries
LandBuilding & EquipmentCovenant N-T-CGoodwill
Accumulated Depreciation
Investment in Salt
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
The Amortized Excess Value Reclassification Entry:
Depreciation ExpenseS&A Expense
Cost of SalesIncome from Salt
Excess Value Calculations:Pepper’s
Investment Salt’s Under- or (Over-) Valuation of Net Assets ElementAccount Inventory Land Equipment
Acc Dep Covenant Goodwill Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9 195,500 (6,500) 39,000 85,00052,000 26,000
Less: Amortization (15,000) 6,500 0 (8,500) (13,000)
Balances, 12/31/X9 180,500 0 39,000 85,000 (8,500)39,000 26,000
=
The Excess Value Reclassification Entry:
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet EntriesExcess Value Calculations:
Pepper’sInvestment Salt’s Under- or (Over-) Valuation of Net Assets Element
Account Inventory Land EquipmentAcc Dep Covenant Goodwill Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9 195,500 (6,500) 39,000 85,00052,000 26,000
Less: Amortization (15,000) 6,500 0 (8,500) (13,000)
Balances, 12/31/X9 180,500 0 39,000 85,000 (8,500)39,000 26,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 39,000Goodwill 26,000
Accumulated Depreciation8,500Investment in Salt180,500
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
The Amortized Excess Value Reclassification Entry:
Depreciation ExpenseS&A Expense
Cost of SalesIncome from Salt
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet EntriesExcess Value Calculations:
Pepper’sInvestment Salt’s Under- or (Over-) Valuation of Net Assets Element
Account Inventory Land EquipmentAcc Dep Covenant Goodwill Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9 195,500 (6,500) 39,000 85,00052,000 26,000
Less: Amortization (15,000) 6,500 0 (8,500) (13,000)
Balances, 12/31/X9 180,500 0 39,000 85,000 (8,500)39,000 26,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 39,000Goodwill 26,000
Accumulated Depreciation8,500Investment in Salt180,500
Accumulated DepreciationBuilding & Equipment
The Accumulated Depreciation Elimination Entry:
The Amortized Excess Value Reclassification Entry:
Depreciation Expense 8,500S&A Expense 13,000
Cost of Sales 6,500Income from Salt 15,000
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Group Exercise 3: Worksheet EntriesGroup Exercise 3: Worksheet EntriesExcess Value Calculations:
Pepper’sInvestment Salt’s Under- or (Over-) Valuation of Net Assets Element
Account Inventory Land EquipmentAcc Dep Covenant Goodwill Remaining Life Excess Cost 2 months Indefinite 10 years 4 years
Balances, 1/1/X9 195,500 (6,500) 39,000 85,00052,000 26,000
Less: Amortization (15,000) 6,500 0 (8,500) (13,000)
Balances, 12/31/X9 180,500 0 39,000 85,000 (8,500)39,000 26,000
=
The Excess Value Reclassification Entry:
Land 39,000Building & Equipment 85,000Covenant N-T-C 39,000Goodwill 26,000
Accumulated Depreciation8,500Investment in Salt180,500
Accumulated Depreciation 57,200Building & Equipment 57,200
The Accumulated Depreciation Elimination Entry:
The Amortized Excess Value Reclassification Entry:
Depreciation Expense 8,500S&A Expense 13,000
Cost of Sales 6,500Income from Salt 15,000
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Book value = 247,000
Identifiable Excess =169,500
Group Exercise 3: Group Exercise 3: SolutionSolution Investment AccountInvestment Account
BB 442,500
Investment in SaltGoodwill =
26,000
Look back at the beginning and ending balances in the two charts you just prepared to
find the numbers!Book value = 279,500
Identifiable Excess =154,500
Goodwill =26,000
NI 78,00045,500 Dividend15,000 Excess Amort.EB 460,000
Beginning Balance:
Ending Balance:
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Group Exercise 3: Group Exercise 3: Worksheet EntriesWorksheet Entries
Investment in Salt
Income from Salt
Notice how the worksheet entries “eliminate” Pepper’s equity method accounts:
BB 442,500NI 78,000
45,500 Dividend 15,000 Excess Amort. 15,000
EB 460,000
78,000 NI
279,500 Basic 78,000
180,500 Excess Reclass
0 0
63,000 Adj. Balance
15,000 Excess Amort.15,000
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Group Exercise 3: Completed WorksheetGroup Exercise 3: Completed Worksheet
Consoli-Pepper Salt DR DR dated
Income StatementSales 1,235,000 780,000 2,015,000
Cost of Sales (598,000) (370,500) 6,500 (962,000)
Depreciation Expense (78,000) (19,500) 8,500 (106,000)
S&A Expense (481,000) (312,000) 13,000 (806,000)
Income from Salt 63,000 78,000 15,000 0 Net Income 141,000 78,000 99,500 21,500 141,000Statement of Retained EarningsBalance, 1/1/X9 455,000 117,000 117,000 455,000Add: Net Income 141,000 78,000 99,500 21,500 141,000Less: Dividends (104,000) (45,500) 45,500 (104,000)Balance, 12/31/X9 492,000 149,500 216,500 67,000 492,000Balance SheetCash 77,500 32,500 110,000Accounts Receivable 123,500 78,000 201,500Inventory 149,500 156,000 305,500Investment in Salt: Book Value 279,500 279,500 0 Excess Cost 180,500 180,500 0Land 130,000 91,000 39,000 260,000Build & Equip 325,000 291,200 85,000 57,200 644,000Acc Depreciation (273,000) (76,700) 57,200 8,500 (301,000)Covenant N-T-C 39,000 39,000Goodwill 26,000 26,000 Total Assets 992,500 572,000 246,200 525,700 1,285,000Payables & Accruals 84,500 97,500 182,000Long-term Debt 26,000 195,000 221,000Common Stock 390,000 130,000 130,000 390,000Retained Earnings 492,000 149,500 216,500 67,000 492,000 Total Liab & Equity 992,500 572,000 346,500 67,000 1,285,000
Consolidated Worksheet as of December 31, 20X9Pepper, Inc. and Salt, Inc.
Elimination Entries
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Learning Objective 6Learning Objective 6
Understand and explain the elimination of basic
intercompany transactions.
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Road Map: Intercompany TransactionsRoad Map: Intercompany Transactions
Typical intercompany transactions Intercompany reciprocal accounts (Chapter 4) Inventory transfers (Chapter 6) Fixed asset transfers (Chapter 7) Intercompany Indebtedness (Chapter 8)
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Arm’s-Length Transactions Arm’s-Length Transactions
Q: What are “Arm’s-length” Transactions?
A: “Transactions that take place between completely independent parties.”
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Categories of TransactionsCategories of Transactions
Arm’s Length Transactions The only transactions that can be reported in the
consolidated statements. We want to report the results of our interactions
with outside parties!
Non-Arm’s Length Transactions Usually referred to as “related party transactions.” Include all intercompany transactions.
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Types of “Related Party” TransactionsTypes of “Related Party” Transactions
Involving only Individuals Transactions among family members.
Involving Corporations With management and other employees. With directors and stockholders. With affiliates (controlled entities).
Probably constitutes at least 99% of all corporate related-party transactions.
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Necessity of Eliminating Intercompany Necessity of Eliminating Intercompany TransactionsTransactions
Eliminate all intercompany transactions in consolidation: Because they are internal transactions from a
consolidated perspective. Not because they are related-party transactions. Only transactions with outside unrelated parties
can be reported in the consolidated statements.
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Intercompany Transactions: Additional Intercompany Transactions: Additional Opportunities for FraudOpportunities for Fraud
Intercompany transactions sometimesoccur to Conceal embezzlements. Overstate reported profits.
2 + 2 = 5
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Princess Inc. owns 100% of Solo Inc.’s common stock. On 11/1/X8, Princess lent $150,000 to Solo. The loan is to be repaid on 1/30/X9 along with $6,000 of interest. All aspects of the intercompany transaction were properly recorded by each company in its separate books.
Group Exercise 4: Intercompany Loan & Group Exercise 4: Intercompany Loan & Interest Interest
Required:
1. What amounts should be reported in each company’s separate 20X8 income statement and 12/31/X8 balance sheet (asset and liability sections only)?
2. Prepare and post to your format the consolidation entries as of 12/31/X8, relating only to these accounts.
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How would you eliminate each item?
Group Exercise 4: Group Exercise 4: SolutionSolution
Three things to think about:
1. Note receivable / payable
2. Interest revenue / expense
3. Interest receivable / payable
1. Note Payable (sub) XXXNote Receivable (parent) XXX
2. Interest Revenue (parent) XXXInterest Expense (sub) XXX
3. Interest Payable (sub) XXXInterest Receivable (parent) XXX
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Practice Quiz Question #5Practice Quiz Question #5
Intercompany income statement accounts are eliminated in consolidation because they are deemed to be:
a. Artificial transactions. b.Potentially manipulative transactions.c. Internal transactions. d.At amounts that are not determined on
arms-length basis. e. none of the above.
Intercompany income statement accounts are eliminated in consolidation because they are deemed to be:
a. Artificial transactions. b.Potentially manipulative transactions.c. Internal transactions. d.At amounts that are not determined on
arms-length basis. e. none of the above.
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Practice Quiz Question #5 Practice Quiz Question #5 SolutionSolution
Intercompany income statement accounts are eliminated in consolidation because they are deemed to be:
a. Artificial transactions. b.Potentially manipulative transactions.c. Internal transactions. d.At amounts that are not determined on
arms-length basis. e. none of the above.
Intercompany income statement accounts are eliminated in consolidation because they are deemed to be:
a. Artificial transactions. b.Potentially manipulative transactions.c. Internal transactions. d.At amounts that are not determined on
arms-length basis. e. none of the above.
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Practice Quiz Question #6Practice Quiz Question #6
In 20X8, Scott incurred $90,000 of inter-company interest charges. Of this amount, Scott paid $70,000 cash to its parent and capitalized $40,000 to a discrete construction project. The unrealized intercompany profit at 12/31/X8 is: a.$0b.$10,000c.$20,000d.$30,000e.$40,000
In 20X8, Scott incurred $90,000 of inter-company interest charges. Of this amount, Scott paid $70,000 cash to its parent and capitalized $40,000 to a discrete construction project. The unrealized intercompany profit at 12/31/X8 is: a.$0b.$10,000c.$20,000d.$30,000e.$40,000
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Practice Quiz Question #6 Practice Quiz Question #6 SolutionSolution
In 20X8, Scott incurred $90,000 of inter-company interest charges. Of this amount, Scott paid $70,000 cash to its parent and capitalized $40,000 to a discrete construction project. The unrealized intercompany profit at 12/31/X8 is: a.$0b.$10,000c.$20,000d.$30,000e.$40,000
In 20X8, Scott incurred $90,000 of inter-company interest charges. Of this amount, Scott paid $70,000 cash to its parent and capitalized $40,000 to a discrete construction project. The unrealized intercompany profit at 12/31/X8 is: a.$0b.$10,000c.$20,000d.$30,000e.$40,000
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Learning Objective 7Learning Objective 7
Understand and explain the basics of push-down
accounting.
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Purchase Price > Book ValuePurchase Price > Book Value
What happens if you pay more than the book value of the subsidiary’s assets? This is the case MOST of the time!
Parent has two options: Push-Down Accounting
Force Sub to revalue to FMV
Non-Push-Down Accounting Account for the “extra” value
separately.
Parent
Sub
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Push-Down Accounting: The EASIER WayPush-Down Accounting: The EASIER Way
Push-Down Accounting (an absolute gem) In the subsidiary’s general ledger:
Adjust assets and liabilities to FVbased on the parent’s acquisition price. This establishes a new basis of accounting.
Record goodwill. Record “Revaluation Capital” for the difference
A = L + EX
Revaluation Capital
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Nonpush-Down Accounting: The HARDER WayNonpush-Down Accounting: The HARDER Way
Non-Push-Down Accounting: Don’t touch the subsidiary’s general ledger
(treat like a “sacred cow”). Make fair value adjustments and record
goodwill in consolidation (on the worksheets).
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Consolidation Consequences: Push-Down vs. Consolidation Consequences: Push-Down vs. Non-Push-DownNon-Push-Down
Push-down accounting: Consolidation effort is minimal (has received the
“Better Book-keeping” stamp of approval).
Non-push-down accounting: Consolidation effort is cumbersome (often a
headache).
The consolidated financial statement amounts are the SAME either way! ONLY the accounting procedures differ Who does the work– parent or sub?
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Push-Down vs. Non-Push-Down Accounting: Push-Down vs. Non-Push-Down Accounting: The Bottom LineThe Bottom Line
The consolidated financial statement amounts are the SAME whether the parent selects: Push-down accounting or Non-push-down accounting.
ONLY the accounting procedures differ.
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Parent’s Amortization of Cost in Excess of Parent’s Amortization of Cost in Excess of Book Value: How Handled?Book Value: How Handled?
Non-push-down accountingEquity Method
Recorded in parent’s general ledger Maintains built-in checking features
Cost Method Recorded on consolidation worksheets
Push-down accountingParent has no amortization – sub
records the amortization
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Consolidated Financial StatementsConsolidated Financial Statements
Sub’s Income Statement
(Based on Book Values)
Sub’s Balance Sheet
(Based on Book Values)
Sub’s Income Statement
(Based on Fair Values)
Sub’s Balance Sheet
(Based on Fair Values)
Parent’s Adjustments
ForExcess Value
(ConsolidationProcess)
+
+
=
=
Push-down AccountingNon-push-down Accounting
Actually, these numbers are only part of the consolidated financial statements.
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Postacquisition Subsidiary Earnings: Reportable Postacquisition Subsidiary Earnings: Reportable Earnings Under Acquisition MethodEarnings Under Acquisition Method
ONLY the subsidiary’s postacquisition earnings are reported in the consolidated financial statements. For a mid-year acquisition, only consolidate earnings
after the acquisition date. The same is true for dividends declared.
The subsidiary’s preacquisition earnings (included in its retained earnings account) are always eliminated against the parent’s Investment account in consolidation.
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Practice Quiz Question #7Practice Quiz Question #7
A parent records amortization of excess value under which method?
a. Push-down basis of accounting.b. Non-push down basis of accounting.c. Both A and B.d. None of the above.
A parent records amortization of excess value under which method?
a. Push-down basis of accounting.b. Non-push down basis of accounting.c. Both A and B.d. None of the above.
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Practice Quiz Question #7 Practice Quiz Question #7 SolutionSolution
A parent records amortization of excess value under which method?
a. Push-down basis of accounting.b. Non-push down basis of accounting.c. Both A and B.d. None of the above.
A parent records amortization of excess value under which method?
a. Push-down basis of accounting.b. Non-push down basis of accounting.c. Both A and B.d. None of the above.
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Practice Quiz Question #8Practice Quiz Question #8
Push-down-accounting can be used: a. Only in a goodwill situation.
b. Only in a bargain purchase situation. c. In either a goodwill situation or a
bargain purchase situation. d. Only in a cost = book value situation. e. None of the above.
Push-down-accounting can be used: a. Only in a goodwill situation.
b. Only in a bargain purchase situation. c. In either a goodwill situation or a
bargain purchase situation. d. Only in a cost = book value situation. e. None of the above.
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Practice Quiz Question #8 Practice Quiz Question #8 SolutionSolution
Push-down-accounting can be used: a. Only in a goodwill situation.
b. Only in a bargain purchase situation. c. In either a goodwill situation or a
bargain purchase situation. d. Only in a cost = book value situation. e. None of the above.
Push-down-accounting can be used: a. Only in a goodwill situation.
b. Only in a bargain purchase situation. c. In either a goodwill situation or a
bargain purchase situation. d. Only in a cost = book value situation. e. None of the above.
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Practice Quiz Question #9Practice Quiz Question #9
The consolidated financial statements are identical regardless of whether the parent:
a. Uses push-down or non-push-downaccounting.
b. Acquires 100% of the common stock or 100% of the assets.
c. Both A and B.d. Neither A or B.
The consolidated financial statements are identical regardless of whether the parent:
a. Uses push-down or non-push-downaccounting.
b. Acquires 100% of the common stock or 100% of the assets.
c. Both A and B.d. Neither A or B.
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Practice Quiz Question #9 Practice Quiz Question #9 SolutionSolution
The consolidated financial statements are identical regardless of whether the parent:
a. Uses push-down or non-push-downaccounting.
b. Acquires 100% of the common stock or 100% of the assets.
c. Both A and B.d. Neither A or B.
The consolidated financial statements are identical regardless of whether the parent:
a. Uses push-down or non-push-downaccounting.
b. Acquires 100% of the common stock or 100% of the assets.
c. Both A and B.d. Neither A or B.
Conclusion
The EndThe EndThe EndThe End
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