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 Workpaper
•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 |
||||||||||
| WorkpaperEntry | Credit | ||||||||||
| DividendIncome | |||||||||||
| DividendDeclared-Subsidiary | $ | 80,000 | |||||||||
3 EliminatetheInvestmentinSubsidiary accountagainst(offsetby) the subsidiary’sequity accounts.
AtAcquisition Beg.CurrentYear
CAD 80%Ownership 80% 20% 100% CommonStock $Parent NCI TotalImplied APIC $
10,000
300,000
$ 10,000
$ 300,000
FairValueGivenUp
BookValueReceived Difference
Land(1)
Balance
$ 500,000 $
$ 450,000 $
$ 50,000 $
$ 50,000 $
$ – $
125,000
50,000
75,000
75,000
–
$ 625,000
$ 550,000
$ 75,000
$ 75,000
$ –
RetainedEarn. $
$
240,000
550,000
$ 450,000
WorkpaperEntry Debit Credit
$ 125,000 NCI(Atacquisition)
$ 42,000 NCI’s%ofNetEarningsChange
A CommonStock- Subsidiary
A APIC- Subsidiary
B Retained Earnings- Subsidiary C Difference
D InvestmentinSubsidiary
E NCI
$ 10,000
$ 300,000
$ 450,000
$ 75,000
$ 835,000
$ 668,000
$ 167,000
$ 835,000
$ 167,000
$ 500,000 Invest.inSub (Atacquisition)
$ 168,000 ReciprocityEntry
$ 668,000
Notes: Remember, 100%ofthesub’s
equityaccountbalancesneed
A Nochangefromthe dateof acquisition. tobeeliminated.
B We needtoeliminateREbalanceasof the beginnngof thecurrentyear. C Neverchanges.
D InvestmentinSubsidiary(InvestmentAccountValueattheBeg.Of theCurrentYear+Reciprocity) E NCI(NCIValueatacquisition+NCI%of SubsidiaryNetEarningssinceacquisition)
| 4 | Distributethedifferencebetweenimpliedandbookvalueoftheequityacquired. | ||||||
| Land | $ 75,000 | ||||||
| Difference | $ 75,000 | ||||||
Equity Method -YearofAcquisition–Is the firstyearofownership of thesubsidiary. Thus, if thesubsidiarywas purchased on January1, 2010 and wearereportingfortheyearending December31, 2010, wewould be reportingYearof Acquisition.
Reviewthefollowingbasedata:
| EQUITYMETHOD USEDBYPARENT | |||||||||||
| REALEntry | Debit | Credit | |||||||||
| Jan.1,2010 | InvestmentinSubsidiary | $ 500,000 | |||||||||
| Cash | $ 500,000 | ||||||||||
| Purchased80%ofsubsidiary | |||||||||||
| SubsidiaryEquityPositionasof1/1/2010: | |||||||||||
| Common Stock | $ 10,000 | ||||||||||
| APIC | $ 300,000 | ||||||||||
| RetainedEarnings | $ 240,000 | ||||||||||
| $ 550,000 | |||||||||||
| CAD | |||||||||||
| 80% | Ownership | 80% | 20% | 100% | |||||||
| Parent | NCI | TotalImplied | |||||||||
| FairValueGivenUp | $ 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,Subsidiaryhadnet incomeintheamountof | $ 250,000 | $ 200,000 | |||||||||
| 100% | 80% | ||||||||||
| During2011,Subsidiarydeclareddividendsintheamountof | $ 125,000 | $ 100,000 | |||||||||
| During2011,Subsidiaryhadnet incomeintheamountof | $ 125,000 | $ 100,000 | |||||||||
| 100% | 80% | ||||||||||
| During2012,Subsidiarydeclareddividendsintheamountof | $ 125,000 | $ 100,000 | |||||||||
| During2012,Subsidiaryhadnet incomeintheamountof | $ 135,000 | $ 108,000 | |||||||||
| 100% | 80% | ||||||||||
| During2013,Subsidiarydeclareddividendsintheamountof | $ 100,000 | $ 80,000 | |||||||||
| During2013,Subsidiaryhadnet incomeintheamountof | $ 350,000 | $ 280,000 | |||||||||
| InvestmentinSubsidiary | |||||||||||
| RETAINEDEARNINGS | 80% | Balance | |||||||||
| SubsidiaryRetainedEarnings as of12/31/2009 was $ 240,000 | $ 500,000 | asof1/1/2010 | |||||||||
| SubIncome2010 | $ 250,000 | $ 200,000 | $ 200,000 | ||||||||
| SubDividend2010 | $ (50,000) | $ (40,000) | $ (40,000) | ||||||||
| SubsidiaryRetainedEarnings as of12/31/2010 was $ 440,000 | $ 660,000 | asof12/31/2010 | |||||||||
| SubIncome2011 | $ 125,000 | $ 100,000 | $ 100,000 | ||||||||
| SubDividend2011 | $ (125,000) | $ (100,000) | $ (100,000) | ||||||||
| SubsidiaryRetainedEarnings as of12/31/2011 was $ 440,000 | $ 660,000 | asof12/31/2011 | |||||||||
| SubIncome2012 | $ 135,000 | $ 108,000 | $ 108,000 | ||||||||
| SubDividend2012 | $ (125,000) | $ (100,000) | $ (100,000) | ||||||||
| SubsidiaryRetainedEarnings as of12/31/2012 was $ 450,000 | $ 668,000 | asof12/31/2012 | |||||||||
| Required: | |||||||||||
| PREPARETHE WORKPAPER (andrelatedworkpaper entries)THATWOULDBEMADEINTHEPREPARATIONOF | |||||||||||
| THECONSOLIDATEDFINANCIALSTATEMENTSONDECEMBER31,2010 | |||||||||||
| EquityMethod-YearofAcquisition | -thefollowingworkpaper entriesaremade: | ||||||||||
Usingtheaboveinformation, the workpaper entries for theEquity Method – Yearof Acquisitionare as follows:
