Module 2 Handout 3

Consolidated
Statements
Subsequent to
Acquisition:
Part 1, The Theory

Student Learning Outcomes

• Simple equity method versus cost method
– How to determine which method is used
– How to change from cost to equity
• Income impact of multiple adjustments
resulting from price paid versus book value
at date of acquisition
• Income distribution schedule
• Completing the loop

The Investment Account

• Must feel comfortable with Chapter
2 material.
• Record investment at cost
– What about dividends received?
– What about year‐end adjustments?
• Cost versus equity method.
– Cost : Investment account is static
– Equity: Investment account changes

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 Timing of D&D Schedule versus
Eliminations
• ALWAYS prepared on the date of acquisition
• Elimination Entries – ALWAYS prepared on the date of
consolidation, AND elimination entries of previous years
are never recorded by the parent or the subsidiary

Subsequent Year’s Consolidations

• Each year’s consolidation procedures begin
as if there had never been a previous
consolidation
• Income statement and statement of
retained earnings
• Not an issue in Chapter 2, but is an issue now

Determination of Excess
Company Parent NCI
Value Analysis Schedule Implied Value Price (100%) Value (0%)

Company fair value $450,000 $450,000 $0

Less book value of Investment: equity method
interest acquired (income – dividends)
Common stock $50,000
Paid in capital 70,000

Retained earnings 130,000 Changes (income – dividends)

Total stockholders’ equity $250,000 $250,000 $0

Interest acquired – 100% 100% 0%

Book value $250,000 $0

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2
 Distribution of Excess
Excess fair value over book value $200,000 $200,000 $0
Adjustment of identifiable accounts:
Inventory (140,000 – 120,000) $20,000 Debit COGS R/E (S)

Land (45,000 – 35,000) 10,000 Debit

Building & Equip (225,000 – 180,000) 45,000 Debit Depreciate

Copyright (25,000 – 10,000) 15,000 Debit Amortize

Premium on B/P (105,000 – 100,000) (5,000) Credit Amortize

Goodwill 115,000 Debit Test for impairment

Total $200,000

Cost versus Equity Method

Cost Method Equity Method
Purchase Record at cost Record at cost
Stock
Dividends Recorded as Recorded as reduction
Received income in investment
Year‐end Value at market Increase investment
Adjustments by parent’s share of
subsidiary income

Example: Stock Purchase

• P purchased 100% of the stock of S
for $510,000
• Cost Method
Investment in S 510,000
Cash 510,000
No
• Equity Method Difference
Investment in S 510,000
Cash 510,000

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 Example: Dividends Received

• S pays $10,000 in dividends Investment

• Cost Method $510,000
Cash 10,000
Dividend Income 10,000
• Equity Method $510,000 –
Cash 10,000 10,000 =
Investment in S 10,000 $500,000

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Example: Year‐end Adjustments

• S reports $100,000 in Income;

Market value of stock is unchanged Investment
• Cost Method – No entry $510,000

• Equity Method
$500,000 +
Investment in S 100,000 100,000 =
Subsidiary income 100,000 $600,000

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The Issues
• Elimination entries ALWAYS made at the
date of consolidation
• First elimination entry – eliminates book
value of subsidiary’s stockholders’ equity
against investment account
– Cost method: investment account unchanged
– Equity method: investment account changes
• Subsidiary income – subsidiary dividends
– Subsidiary Retained Earnings – changesMove
• Subsidiary income – subsidiary dividends together

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 The Solution
• Change from Cost to Equity
Investment in Subsidiary
Retained Earnings‐Parent
% x (R/E‐S trial balance – R/E‐S date of acquisition)
• Why R/E‐Parent?
– Cost method – Parent’s R/E increases by its share of
subsidiary dividends
– Equity method – Parent’s R/E increase by its share of
subsidiary income
– Net difference in Parent’s R/E is % x (subsidiary income
– subsidiary dividends)  Change in Investment 13

Identify Cost versus Equity

• Cost method – No subsidiary income
on parent’s books
• Equity method – Parent’s books will
have subsidiary income.
• Let’s see how simple this is!
– Problem 2 – Equity method
– Problem 4 – Cost method
– Problem 5 – Cost method
– Problem 6 – Equity method
– Problem 7 – Equity method
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The Process of Consolidation

• Record the investment at cost
– Acquisition costs expensed
– Stock issue costs reduce PIC

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 The Process of Consolidation
• Each year’s consolidation procedures begin
as if there had never been a previous
consolidation
• D&D Schedule  Additions
• Elimination Entries  Additions
• Income Distribution Schedule  New
• Worksheet  Trial Balances, Eliminations,
Income Statement, Non‐controlling Interest
(if less than 100%), Retained Earnings
Statement, Balance Sheet)
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D&D Schedule
• D&D Schedule: Date of Acquisition
– Include income impacts from revaluations for current
year and all prior years back to the date of acquisition.
• Inventory: Year of acquisition  COGS (S);
Subsequent years  R/E(P) & R/E(S)
• Bonds Payable: Year of acquisition  Expense (S);
Subsequent years  Expense (S) current year, and R/E (P)
& R/E(S) for all prior years to date of acquisition
• Depreciable Assets: Year of acquisition  Expense (S);
Subsequent years  Expense (S) current year, and R/E (P)
& R/E(S) for all prior years to date of acquisition
• Amortizable Intangibles: Year of acquisition  Expense
(S); Subsequent years  Expense (S) current year, and R/E
(P) & R/E(S) for all prior years to date of acquisition
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Elimination Entries
• Prior year’s entries have not been recorded in either the
parent’s or subsidiary’s books.
• Elimination Entries: Date of Consolidation
– Cost versus equity: If cost, change to equity; if equity, do nothing
– Eliminate parent’s share of subsidiary stockholders’ equity ON
THE TRIAL BALANCE: Subsidiary R/E will be different from date of
acquisition
– Distribute the excess (revaluations) from D&D schedule based on
date of acquisition – same as in Chapter 2
– For each revaluation, record current year and prior years income
effects, charging income and R/E to the parent
– Eliminate subsidiary income (if any) against Investment
– Eliminate subsidiary dividends (if any) against either Dividend
Income (if Cost) or Investment (if Equity)
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 Income Distribution Schedules

Parent Income w/o Sub Dividend

Subsidiary Income Income or Sub Income

Expense XXXX YYYY

from Expense
Eliminations from
Eliminations

% x Adjusted NI Adjusted NI % x Adjusted NI

Non-controlling Controlling
Interest NI Interest NI

Combined Net Income – Check figure

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The Worksheet
Trial Balance Eliminations Consol Controlling Consolidated
Accounts P S DR CR I/S NCI R/E B/S

Make sure it Make sure

balances to DR=CR
“0” Balance =
Combined NI
from Income
Distribution
Schedules
NCI Interest
Cont. Interest
NCI
Controlling
R/E
“0” 20

Concluding Comments
• Each year’s consolidation procedures begin as if
there had never been a previous consolidation
– Everything from Chapter 2
– Cost versus Equity: If cost, change to equity; if equity,
do nothing
– Expand D&D Schedule for income impact
– Elimination entries, including party charged and prior
years impact
– Income Distribution Schedule
– Worksheet: Added Consolidated Net Income and
Controlling Interest R/E
• Part 2 – Putting it all together
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