accounting-Stock Acquisition – Consolidated Financial Statements – AFTERDateofAcquisition

Module1 – Business Combination
and Consolidation

Stock Acquisition – Consolidated
Financial Statements – AFTERDateofAcquisition

Instructor Comment:The
followinglesson
module was developed to assist
students in their understandingofthe corresponding
subject matterin
the coursetextbook.
The
followingis nota replacementfor thedetailedpresentation
providedby theauthors
ofthe text, but instead is an
attempt
to providestudents with a
pragmaticdirect
review with
heavyemphasis
on process.

Myrecommendation is to approach the coursematerial in the
followingsequence.

1.
Read/studytheassignedcorrespondingsections
ofthetext.

2.
Read
the “Chapter Review”
(PowerPoint)posted in D2L.

3. Read/completethe correspondinginstructordeveloped “InstructorSubject Matter
Presentation” (THIS DOCUMENT)posted in D2L.

4. Completethe assigned text
questions, exercises
and problems (author
recommended
solutions for assigned odd
exercises
posted in D2L).

5. Reviewthe correspondinginstructordeveloped“InstructorProblemSolving
Modules”posted in D2L.

As discussed inISMP #1(DateofAcquisition) forstock acquisitions
wheresignificant
influence and control exist, the
acquirer (parent)is required bytheSEC,
for
financialreportingpurposes,
to consolidatethe acquired company(subsidiary).Wediscussed a3-StepProcess(below)to be followed in the creationof consolidated financialstatements.
The
same3-Step
Process
is appliedin Stock Acquisition –AfterDateofAcquisition
but involves increasedcomplexitydueto
the fact that timehas passed(ongoingoperations ofthe acquired companymust
be consolidated).

Unlike
the accountingforstock acquisitions
as ofthedateofacquisition (which required
the preparation of
the consolidated balancesheet
only)the accounting
for
stock

acquisitions after
thedateof acquisition
requireconsolidation
for
all financial
statements (incomestatement,
statement of retainedearnings,
balancesheet
and statement
of cash flows).
The
focus ofthisISMP will
beon theincomestatement,
statement of retained
earningsand
the balancesheet.

3-Step Process:

Step 1 – Assess the
Business Scenario
Step
2 – PreparetheCAD

Step
3 – DetermineWorkpaper Entries

Note:RefertoISMP#1forfurtherdetail.

The first two
steps ofthethreestep process
arethesame forstockacquisitions
on thedateof acquisitionas theyareforstock
acquisitions afterthedateofacquisition.
The
keychanges take
placein Step 3.

Step3- Determine theRequired Workpaper Entries

•Complete Financial
Statement(s)

To determine
therequired
workpaper entriesforstock
acquisitions afterthedateofacquisition themethod of accounting used bytheparent
companyfortheInvestment
in Subsidiarymust be determined. Thecompanyhas
two
accountingoptions formaintaining
theinvestment in subsidiaryaccount,
the “Cost Method”orthe “Equity Method.”The accountingmethod
used dictates the
workpaper entries
requiredfor consolidation.In
eithercase, the resulting consolidated financial
statements areidentical. Thekeyto
accurate consolidated financial
statements is thedevelopment and
application ofthe appropriate workpaper entries.

RECORDING ANDMAINTAININGTHE
INVESTMENT
INSUBSIDIARY

COST METHOD

RecordingtheinitialInvestment
in Subsidiaryis thesame whethertheCost Method
orthe EquityMethod
is applied.

Account	Debit	Credit
Investment in Subsidiary	$1,000,000
*Cash		$1,000,000

* – Themethod of
payment in this exampleis
cash, but othersources of funds
could also beused

to payfortheinvestment(i.e. issuanceofstock).

MaintainingtheInvestment
in Subsidiaryis wheresignificant
differencesexist between the Cost Method and EquityMethod,
creatingtheneed
for
different workpaperentries. Maintaining

the“Investment in Subsidiary” account usingtheCost Methodcould bedescribedas NOT
maintainingthe“Investment in Subsidiary”account.
UndertheCost
Method thereis no adjustment
to the“Investment in Subsidiary”account balance(with the
exception ofinstances
wherealiquidatingdividend
occurs). Thus,
theonlyinvestment
related
entry,aftertheinitial
investment (purchase) entry,
is therecordingofdividend
income.

When adividend is received
theparent companymakes the
followinginvestment
related entry:

Account	Debit	Credit
Cash	$40,000
Dividend Income		$40,000

Asyoucan seebythe entryabovetheinvestment
in subsidiaryaccount
is not affected.
Therefore,
thebalanceoftheinvestment in subsidiaryremains at
theinitial investment cost
recorded on the
dateofacquisition.

EQUITYMETHOD

RecordingtheinitialInvestment
in Subsidiaryis thesame whethertheCost Method
orthe EquityMethod
is applied.

Account	Debit	Credit
Investment in Subsidiary	$1,000,000
*Cash		$1,000,000

* – Themethod of
payment in this exampleis
cash, but othersources of funds
could also beused

to payfortheinvestment(i.e. issuanceofstock).

Maintainingthe“Investment in Subsidiary”account using
theEquity Method
of accounting could
bedescribed
as a continuous effort to maintain an
accuratevaluationfor reporting purposes. The EquityMethod
attempts
to account for all income and
dividends (based on the ownership %)recorded
by
thesubsidiary. Essentially, the
changein
theinvestment in subsidiary balancereflects the
truevalueoftheinvestment assumingincomeless
dividends is atrue
reflection ofvalue change.

Therefore,
theinvestment related
entries,aftertheinitial investment (purchase) entry,
is the recordingofincome anddividends. The recording
ofincomeis accounted
for
usingthe followingentry(assume
thesubsidiaryis 80%
owned and had
incomeof$250,000):

Account	Debit	Credit
Investment in Subsidiary	$200,000
Equity in Subsidiary Income		$200,000

Clearly, the aboveentryimpacts the
investment in subsidiaryaccount
balance (increasingthe
account balanceby$200,000).

The accounting
for
dividend declared and
paid
follows the
samelogic.Iftheparentcompanyis receivingdividends, the
parent is essentiallytakingvalueout of
theinvestment. The recording ofdividendreceived
is accounted forusingthefollowingentry(assume
thesubsidiaryis
80% owned and declared adividend
of$50,000):

Account	Debit	Credit
Cash	$40,000
Investment in Subsidiary		$40,000

Clearly, the aboveentryimpacts the
investment in subsidiaryaccount
balance (decreasingthe
account balanceby$40,000).

Q1.– Calculation– What it the“Investment
in Subsidiary”account
balance at the
end ofthe year (in
theexample above)usingtheCost Method
and EquityMethod?

WORKPAPERENTRIES
– ELIMINATIONOFTHE INVESTMENTINSUBSIDIARY

Theinvestment
relatedentries (discussed
above)must
betaken into account
when
developing workpaper entries.
Theworkpaperentries essentiallyeliminatetheinvestment in subsidiary(key offset is the
equityaccounts ofthesubsidiary)which
upon elimination allows forthe consolidation of
theparent and subsidiary,whichcombines the
related incomestatement, statement
of retained earnings,
and balancesheetaccounts oftheparentand subsidiary.

COST
METHOD

Workpaper entriesrequired
for
theCost Methodmust
account for all oftheinvestment entries
made (ornot made)to
theinvestment in subsidiaryaccount.
Inaddition, fortheCost Method,
thetimingofthe consolidation impacts
the application ofthe workpaperentries.
The
two time periods arethe Yearof Acquisition
and After Yearof Acquisition.

Cost Method -YearofAcquisition–Is thefirstyearofownership of
thesubsidiary.
Thus, ifthe subsidiarywas
purchasedon
January1, 2010 andwe are reporting fortheyear endingDecember31,
2010, we would bereportingYearof Acquisition.

Assumethefollowing
base
information:

COST METHOD USEDBYPARENT
REALEntry			Debit	Credit
Jan.1,2010	InvestmentinSubsidiary	$	500,000
			Cash		$	500,000
		Purchased80%ofsubsidiary.

SubsidiaryEquityPositionasof1/1/2010:
CommonStock	$ 10,000
APIC		$ 300,000
RetainedEarnings	$ 240,000
		$ 550,000

CAD
80%	Ownership		80%	20%		100%
			Parent	NCI		TotalImplied
	FairValueGiven Up	$	500,000	$	125,000		$	625,000
	BookValueReceived	$	440,000	$	110,000		$	550,000
	Difference		$	60,000	$	15,000		$	75,000
	Land		$	60,000	$	15,000		$	75,000
	Balance		$	–	$	–		$	–

				100%		80%
During2010, Subsidiarydeclareddividendsintheamountof	$	50,000		$	40,000
During2010,Subsidiaryhadnetincomeinthe amountof	$	250,000		$	200,000
SubsidiaryRetainedEarningsasof12/31/2009was	$	240,000

For theYearof Acquisition–COSTMETHOD-thefollowingthree workpaperentries arerequired:

		1	Eliminate(parentsshare)ofcurrentyearsubsidiarydividendincome.
	REALEntry			Debit	Credit
			Cash		$ 40,000
				DividendIncome		$ 40,000
			WorkpaperEntry(1) Debit DividendIncome $ 40,000 DividendDeclared-Subsidiary		$	Credit 40,000

2 EliminatetheInvestmentinSubsidiaryaccountagainst(offsetby)thesubsidiary equityaccounts.
WorkpaperEntry(2) Debit Credit
A	CommonStock-Subsidiary		$ 10,000
A	APIC-Subsidiary		$ 300,000
B	RetainedEarnings-Subsidiary		$ 240,000
C	Difference			$ 75,000
D		InvestmentinSubsidiary			$ 500,000
E		NCI				$ 125,000
Notes:						Remember,100%ofthesub’s equityaccount balancesneed to beeliminated.
A	No changefromthedateofacquisition.
B	Weneedto eliminateREbalanceas ofthebeginnngofthecurrentyear.
C	Neverchanges.
D	Investment in Subsidiary(Investment AccountValueattheBeg.OftheCurrent Year)
E	NCI(NCIAccountValueat theBeg.OftheCurrentYear)

Q2. –Short Answer- The adjustment
to the“Investment
in Subsidiary” account is as
ofthe beginningoftheyear. What is the
logicorreasonthe adjustment
is as ofthebeginningofthe year?

3 Distributethedifferencebetweenimpliedandbook valueoftheequity acquired.
WorkpaperEntry(3) Debit Credit
	Land			$ 75,000
		Difference				$ 75,000

Cost Method –
After YearofAcquisition–Is
the
secondyearofownership
and beyond. Thus, if
thesubsidiarywas
purchased
on January1, 2010
(continuingwith thesame example) and we
are
reportingfortheyearending
December31, 2013,
we
would bereportingAfterYearof Acquisition.

Additional Data:

				100%		80%
During2013,Subsidiarydeclareddividendsintheamountof	$	100,000		$	80,000
During2013,Subsidiaryhadnetincomeintheamount of	$	350,000		$	280,000
SubsidiaryRetainedEarningsasof12/31/2009 was	$	240,000
SubsidiaryRetainedEarningsasof12/31/2012 was	$	450,000

CostMethod-AfterYearofAcquisition	-thefollowingworkpaperentriesaremade:
1	EstablishReciprocity(catchupimpactofparent’sshareofthesubsidiary’sincome
	lessdividends).

	Subsidiary’sRetainedEarningsatthebeginningofthecurrentyear(January1,2013)		$ 450,000
	Subsidiary’sRetainedEarningsatacquisition(January1,2010)			$ 240,000
	Difference-Representsthenetearningschange(netincomelessdividends)	$ 210,000	NETEarningsChange
	Parent’sShare							80%
							$ 168,000	InvestmentinSub
	WorkpaperEntry		Debit		Credit	$ 42,000	NCI’s%is	20%
	InvestmentinSubsidiary		$ 168,000
		RetainedEarnings1/1CurrentYear-Parent		$ 168,000

<

		2	Eliminate(parentsshare)ofcurrentyearsubsidiarydividendincome.
	REALEntry			Debit	$	Credit 80,000
	2013		Cash		$	80,000
				DividendIncome
						$	Debit 80,000