Chapter 4
Consolidation After Date of Acquisition
Item / Topic Covered / Level / TimeQ4.1 / Explanation of why the various steps in the consolidation process must be repeated each reporting period. / Low / 5-10
Q4.2 / Exploration of effect of choice of working paper format. / Low / 5-10
Q4.3 / Explanation of advantage of using complete equity method. / Low / 5-10
Q4.4 / Why the equity method produces equivalence between P=s net income and retained earnings and the respective consolidated amounts. / Low / 5-10
Q4.5 / Explanation of how amortization of purchase premium is reflected on P=s income statement. / Low / 5-10
Q4.6 / Explanation of why a parent company might reasonably use the cost method to account for its investment in a subsidiary. / Low / 5-10
Q4.7 / Cash flow statement treatment of minority interest changes and equity method events. / Mod / 10-15
Q4.8 / Explanation of how the passage of time affects the calculation of the equity method income accrual and the consolidation process. / Mod / 10-15
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeQ4.9 / Difference between Minority Interest in Subsidiary and Minority Interest in Net Income. / Mod / 10-15
Q4.10 / Explanation of how the Minority Interest in Subsidiary changes during the year and discussion of working paper entries needed. / Mod / 10-15
Q4.11 / How consolidation procedures differ when pooling, rather than purchase, accounting is used. / Mod / 10-15
Q4.12 / Effect of cost method on consolidation elimination. / Low / 5-10
E4.1 / Preparation of acquisition entry and equity method entries. / Mod / 20-30
E4.2 / Preparation of consolidation elimination entries at end of first year. / Mod / 20-30
E4.3 / Equity method entries and working paper eliminations; purchase premium allocation and amortization. / Mod / 30-40
E4.4 / Determination of investment balance,
minority interest, and minority interest in net income. / Mod / 20-30
E4.5 / Prepare consolidation elimination entries several years after acquisitionCpooling. / Mod / 20-30
E4.6 / Prepare consolidation elimination entries several years after acquisitionCpurchase. / Mod / 20-30
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeE4.7 / Determination of future consolidation elimination entries. / Mod / 15-20
E4.8 / Allocate purchase premium associated with an investment in a subsidiary, several years after acquisition. / Mod / 20-30
E4.9 / Interpreting elimination entries to answer questions regarding the method of recording a stock acquisition, the percentage of ownership interest, the date of acquisition, and purchase premium allocation. / Mod / 20-30
E4.10 / Preparation of consolidated income statement, incorporating purchase premium amortization and minority interest in net income. / Mod / 20-30
E4.11 / Preparation of the cash flow fromoperating activities section of a consolidated statement of cash flows. / Mod / 20-30
E4.12 / Determination of the balance in the
investment account under the equity
and cost methods, and preparation of a
journal entry to convert from the cost to the equity method. / Mod / 20-30
E4.13 / (Appendix) Preparation of journal entries after acquisition relative to the investment account for two consecutive years and elimination entries for those years assuming the cost method is used. / Mod / 20-30
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeP4.1 / Consolidated statements after date of
acquisition; equity method accrual;
purchase premium. / Mod / 35-45
P4.2 / Equity method, investment balance, elimination entries, and minority interest, three years since acquisition. / Mod / 30-40
P4.3 / Parent company entries and working paper eliminations under the equity method; computation of consolidated net income, retained earnings and minority interest; purchase premium. / Mod / 30-40
P4.4 / Updating investment and stockholders' equity balances; preparation of consolidation elimination entries. / Mod / 20-30
P4.5 / Calculate consolidated total assets, retained earnings and net income;profitability analysis using separate and consolidated statements; incomplete equity method. / High / 40-50
P4.6 / Computation of equity method income accrual and preparation of consolidated financial statement working paper; purchase premium. / Mod / 30-40
P4.7 / Computation of equity method income accrual and preparation of consolidated financial statement working paper; purchase discount. / Mod / 40-50
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeP4.8 / Comprehensive recording of prior period acquisition, investment account entries, and consolidation elimination entries. / High / 50-60
P4.9 / Inferring acquisition and consolidation information from actual financial statements. / High / 40-50
P4.10 / Preparation of computerized spreadsheetto solve consolidation problems. / High / 60-80
P4.11 / Compute return on assets under equity method and full consolidation; treatment of minority interest and net income. / Mod / 25-35
P4.12 / Consolidated statement of cash flows
for the current year. / Mod / 35-45
P4.13 / Consolidated statement of cash flows
for the current year. / Mod / 35-45
P4.14 / (Appendix) Parent company entries and working paper eliminations under cost and equity methods; computation of consolidated net income; purchase
premium. / Mod / 30-40
P4.15 / (Appendix) Consolidated trial balance working paper two years after acquisition; cost method used by parent; explanation of differences which would arise if the business combinations had been a pooling instead of a purchase. / Mod / 30-40
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CARRYBACK TABLE
The carryback table identifies the assignment items which are new in this edition and those which are carried over from the seventh edition. For the latter, the problem number in the seventh edition is shown.
NewProblem Number / Source / New Problem Number / Source / New Problem Number / Source
Q4.1 / Q4.1 / E4.1 / E4.11,2 / P4.1 / P4.11
Q4.2 / Q4.2 / E4.2 / E4.21,2 / P4.2 / P4.21
Q4.3 / Q4.3 / E4.3 / E4.31 / P4.3 / P4.31
Q4.4 / Q4.4 / E4.4 / E4.41 / P4.4 / P4.41
Q4.5 / Q4.5 / E4.5 / E4.5 / P4.5 / P4.51
Q4.6 / Q4.6 / E4.6 / E4.61 / P4.6 / P4.61
Q4.7 / new / E4.7 / E4.7 / P4.7 / P4.7
Q4.8 / Q4.8 / E4.8 / E4.81 / P4.8 / P4.81,2
Q4.9 / Q4.9 / E4.9 / E4.91 / P4.9 / P4.9
Q4.10 / Q4.10 / E4.10 / E4.10 / P4.10 / P4.101
Q4.11 / Q4.11 / E4.11 / EA.6 / P4.11 / P4.111
Q4.12 / Q4.12 / E4.12 / E4.111 / P4.12 / PA.41
E4.13 / E4.12 / P4.13 / PA.51
P4.14 / P4.121
P4.15 / P4.131
1 Revised for SFAS 141 and 142 requirements.
2 Requirements revised.
Carryforward tables for all chapters, identifying the disposition of seventh edition assignment items, appear at the beginning of the solutions manual.
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ANSWERS TO QUESTIONS
Q4.1
Consolidation elimination entries must be repeated each time consolidated financial statements are prepared because the entries are not recorded on the books of either P or S. Since the entries are not recorded, the information is not automatically carried forward from period to period.
Q4.2
The consolidation process is the same, no matter which working paper format is used. The trial balance format simply lists accounts, while the financial statement format organizes the accounts according to their appearance on the financial statements.
Q4.3
The complete equity method parallels the consolidation process, reflecting the amortization of purchase premium or discount and the consolidation treatment of intercompany gains and losses. When the complete equity method is used, P's financial statements will reconcile to the consolidated financial statements--specifically P's net income will equal consolidated net income and P's retained earnings will equal consolidated retained earnings.
Q4.4
Following APBO 18, application of the equity method is viewed as a oneline consolidation. Thus, in computing the equity method accrual, all working paper adjustments that enter into the computation of consolidated net income must be considered. Items such as purchase premium or discount amortization and elimination of unconfirmed intercompany gains and losses are reflected in the equity method accrual. On the working paper, the equity methodaccrual is eliminated or reversed and all adjustments which caused it to differfrom P's share of S's reported net income are made directly on the working paper. The result is that consolidated net income equals the parent's net income including the equity method accrual. Consolidated retained earnings reflect consolidated net earnings and is reduced by dividends paid to the controlling shareholders. This will be identical with P's retained earnings which include the equity method accrual and are reduced by dividends paid to P's shareholders (the controlling shareholders).
Q4.5
No. Rather than appear as an expense, the amortization of purchase premium will be reported as a reduction of P's "equity in the income of S" on P's income statement.
Q4.6
A parent company might reasonably use the cost method to account for its investment in a majority-owned subsidiary because financial statements will be prepared on a consolidated basis. In the consolidation process, the investment account will be eliminated. The method used to maintain the investment account on the parent's books will therefore be irrelevant to the financial statements. While the details of the consolidation process will vary somewhat depending on the method used by the parent, the consolidated financial statements will be the same.
If the parent company issues separate financial statements, however, use of the equity method is required.
Q4.7
The minority interest in net income, a noncash deduction on the consolidated income statement, is added back to consolidated net income in the operating activities section. Dividends paid to minority shareholders are reported as financing cash outflows. Together these make up the current year=s change in minority interest.
Equity method events related to unconsolidated equity investees are similar. The equity method income accrual is not a cash inflow and is subtracted from consolidated net income in the operating activities section. Dividends from equity investees represent realizations of those equity accruals and are added in the operating activities section. The net effect is a subtraction of undistributed equity method income, the amount not received in cash.
Q4.8
As time passes, most elements of the purchase premium or purchase discount are amortized. Once fully amortized, the steps of establishing, allocating, and amortizing the purchase premium or purchase discount drop out of the equity method income accrual and the consolidation process. Items not subject to periodic depreciation/amortization, such as land and goodwill, remain as part of the premium until impaired or disposed of.
Q4.9
Students often become confused over the meaning of the "minority interest" on the balance sheet and the "minority interest" on the income statement. Note that stockholders' equity at a point in time balance sheet date is a stock while net income over a period of time is a flow. Minority Interest in Subsidiary on the balance sheet represents the portion of the subsidiary's total stockholders' equity at the balance sheet date that is owned by outside or minority shareholders. Alternatively, it is the book value of the subsidiary's shares not owned by P.
Each year, the Minority Interest in Subsidiary (balance sheet) is increased by the minority's share of S's net income and decreased by the minority's share of S's dividends. S's net income is a flow; the controlling interest's share becomes part of consolidated net income. In computing consolidated net income, the minority's share of S's net income is deducted from the combined net income of the affiliates on the consolidated income statement. Thus Minority Interest in Net Income relates only to the flow of S's current period income and not to the cumulative stock of S's contributed capital and retained earnings at a point in time. Each year's Minority Interest in Net Income (income statement) is reflected in the Minority Interest in Subsidiary (balance sheet).
Q4.10
The change in the minority interest during the year is the difference between the book value of the minority's shares at the end of the year and the book value of those shares at the beginning of the year. Although the minority interest will change if S issues or retires shares or P purchases or sells shares of S, these matters will not be considered in the book until Chapter 11. At this point in the text, the Minority Interest in Subsidiary changes only because (1) the subsidiary reported net income or loss during the year and (2) the subsidiary declared dividends during the year. The minority's share of S's reported income (loss) will increase (decrease) the Minority Interest in Subsidiary. Therefore, Minority Interest in S = (1α)(Net Income (Loss) Dividends of S).
Working paper entries are made specifically to enter the minority's share of S's reported net income and dividends in the Minority Interest in Subsidiary on the balance sheet. The entries are:
Minority Interest in Net Income / XXXMinority Interest in Subsidiary / XXX
To increase the book value of the minority's shares by the
minority's portion of S's reported net income.
Minority Interest in Subsidiary / XXXDividends S / XXX
To decrease the book value of the minority's shares by the
minority's portion of S's dividends.
These entries could also be combined with the net increase (decrease) in the minority interest being credited (debited) to Minority Interest in Subsidiary.
Q4.11
In a pooling, the investment account is always carried at the book value of P's share of S's stockholders' equity; no purchase premium or discount exists. (In Chapters 5 and 6 we'll see that unconfirmed intercompany gains and losses can create a difference between the investment account and the related portion of the subsidiary's stockholders' equity; however, book values and not fair values continued to provide the basis for the investment account). Therefore, no purchase premium or discount exists to be reclassified and amortized on the working paper or to be amortized in computing the equity method accrual.
It is important to recognize, however, that aside from the absence of purchase premium or discount, consolidation procedures for a pooling are the same as for a purchase. The subsidiary's retained earnings are also eliminated on the working paper in a pooling because they were recorded by P as part of recording the stock acquisition.
Q4.12
Under the cost method, P will record as income its share of any dividends declared by S. This item must be eliminated in consolidation.
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SOLUTIONS TO EXERCISES
E4.1ACQUISITION AND EQUITY METHOD ACCOUNTING
Requirement 1:
1/1/X3
Investment in Williams / 450,000Various stockholder equity accounts / 450,000
To record investment in Williams.
12/31/X3
Cash / 24,000Investment in Williams / 24,000
To record dividends received from Williams.
12/31/X3
Investment in Williams / 78,000Equity in Income of Williams / 78,000
To record equity method income accrual - James= share
of the net income of Williams (100% x $80,000) less
$2,000 depreciation of purchase premium (plant assets,
$50,000/25).
Requirement 2:
1/1/X3
Investment in Williams / 450,000Various stockholder equity accounts / 450,000
To record investment in Williams.
12/31/X3
Cash / 19,200Investment in Williams / 19,200
To record dividends received from Williams (80% x $24,000).
12/31/X3
Investment in Williams / 62,400Equity in Income of Williams / 62,400
To record equity method income accrual - James' share of
the net income of Williams ($64,000 = 80% x $80,000)
less $1,600 amortization of purchase premium (plant assets
are $40,000 = (.8 x $50,000), depreciated over 25 years).
E4.2CONSOLIDATION AT END OF FIRST YEAR
Equity in Income of M / 30,000Dividends - S / 9,000
Investment in S / 21,000
Note: $30,000 = (.9 x $100,000) - $50,000 (COGS) -
$10,000 (Depr = $150,000/15).
Common Stock / 400,000Retained Earnings / 600,000
Purchase Premium / 500,000
Investment in S / 1,400,000
Minority Interest in S / 100,000
Current Assets / 50,000
Property, Plant & Equipment / 150,000
Goodwill / 300,000
Purchase Premium / 500,000
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Cost of Goods Sold / 50,000Depreciation Expense / 10,000
Current Assets / 50,000
Plant, Property & Equipment / 10,000
Minority Interest in Net Income / 10,000
Dividends - S / 1,000
Minority Interest in S / 9,000
E4.3ELIMINATION ENTRIES AFTER FIRST AND SECOND YEARS
Requirement 1:
Cash (or Dividends Receivable) / 420,000Investment in S / 420,000
To record P's share of S's dividends; $420,000 = .7 x $600,000.
Investment in S / 890,000Income from S / 890,000
To record the equity method income accrual for 20X2,
per the following schedule.
P's share of S's net income (.7 x $1,600,000) / $1,120,000Less amortization of purchase premium:
Sale of revalued inventory (.4 x $200,000) / $ 80,000
Additional depreciation ($500,000/5) / 100,000
Impairment of goodwill / 50,000
Total amortization / (230,000)
Net equity method income accrual for 20X2 / $ 890,000
E4.3 (cont=d.)
Consolidated Financial Statement Working Paper
Income from S / 890,000Investment in S / 470,000
Dividend S / 420,000
To eliminate the equity method entries made by P in 20X2
thereby adjusting the investment account to its balance on
1/2/X2.
Purchase Premium / 1,000,000Stockholders' Equity: S (($5,200,000 $1,000,000)/.7) / 6,000,000
Investment in S / 5,200,000
Minority Interest in S (.3 x $6,000,000) / 1,800,000
To reclassify the purchase premium, eliminate the
Investment in S against 70 percent of the stockholders'
equity of S and reclassify the remaining stockholders'
equity as minority interest, all as of 1/2/X2.
Inventory / 200,000Equipment / 500,000
Goodwill / 300,000
Purchase Premium / 1,000,000
To allocate the purchase premium to the assets of S
Company and goodwill as of 1/2/X2.
Cost of Goods Sold (or Inventory, 1/1, I/S) / 80,000Depreciation Expense / 100,000
Impairment Loss / 50,000
Inventory / 80,000
Equipment / 100,000
Goodwill / 50,000
To recognize current year amortization of the purchase
premium in the consolidated income statement for 20X2.
E4.3 (cont=d.)
Minority Interest in Net Income (.3 x $1,600,000) / 480,000Dividends S (.3 x $600,000) / 180,000
Minority Interest in S / 300,000
To record the change in the minority interest during 20X2
consisting of the minority's interest in net income decreased
by S Company's dividends paid to minority shareholders.
Requirement 2:
Consolidated Financial Statement Working Paper
Purchase Premium / 770,000Investment in S / 770,000
To reclassify the unamortized purchase premium at 1/1/X3;
$770,000 = $1,000,000 $230,000.
Inventory / 120,000Equipment / 400,000
Goodwill / 250,000
Purchase Premium / 770,000
To allocate the unamortized purchase premium at 1/1/X3
among the assets of S Company and goodwill.
Cost of Goods Sold (or Inventory, 1/1 I/S) / 120,000Depreciation Expense / 100,000
Inventory / 120,000
Equipment / 100,000
To recognize current year amortization of the purchase
premium in the consolidated income statement for 20X3.
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E4.4EQUITY METHOD AND MINORITY INTEREST
Requirement 1:
Investment - January 1, 20X8 / $2,600,000Equity method income accrual for 20X8:
Brussels' net income ($400,000 x 80%) / 320,000
Amortization of purchase premium:
Equipment (($300,000)/10) / 30,000
Buildings ($400,000/20) / (20,000)
Long-term debt ($250,000/10) / (25,000)
Less 80% of Brussels= dividends / (72,000)
Investment - December 31, 20X8 / $2,833,000
Requirement 2:
Brussels' stockholders equity - January 1, 20X8 / $2,400,000Net income for 20X8 / 400,000
Dividends / (90,000)
Brussels' stockholders' equity - December 31, 20X8 / $2,710,000
Minority interest: $2,710,000 x 20% = $542,000
Requirement 3:
Minority interest in net income: $400,000 x 20% = $80,000
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E4.5CONSOLIDATION AFTER SEVERAL YEARSBPOOLING
Equity in Income of S / 190,000Dividends - S / 38,000
Investment in S / 152,000
Stockholders' Equity - S / 5,900,000
Investment in S / 5,605,000
Minority Interest in S / 295,000
Minority Interest in Net Income / 10,000
Dividends - S / 2,000
Minority Interest / 8,000
E4.6CONSOLIDATION AFTER SEVERAL YEARS
Equity in Income of S / 430,000Dividends - S / 80,000
Investment in S / 350,000
Stockholders' Equity - S / 3,500,000
Purchase Premium / 550,000
Investment in S / 3,350,000
Minority Interest in S / 700,000
NOTE: $550,000 = $1,000,000 - $200,000 - (5 x $50,000)
Land / 300,000Equipment / 250,000
Purchase Premium / 550,000
Depreciation Expense / 50,000
Accumulated Depreciation / 50,000
Minority Interest in Net Income / 120,000
Dividends - S / 20,000
Minority Interest in S / 100,000
E4.7PROJECTING CONSOLIDATION ENTRIES
Requirement 1:
Land / 80,000Equipment / 18,000
Purchase Premium / 98,000
Depreciation Expense / 6,000
Equipment / 6,000
Requirement 2:
Land / 80,000Purchase Premium / 80,000
Requirement 3:
No entry required.
E4.8ALLOCATION OF PURCHASE PREMIUM AFTER SEVERAL YEARS
The allocation of purchase premium as of January 1, 20X7 would be:
Component / Original Amount / Prior Amortization / 1/1/X7 AmountAccounts Receivable / $(3,000) / Fully amortized / $ 0
Inventory / 12,000 / Fully amortized / 0
Equipment / 75,000 / 6 years at $7,500 / 30,000
Patents / 30,000 / Fully amortized / 0
Goodwill / 100,000 / $15,000 impairment loss / 85,000
$214,000 / $115,000
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E4.9INTERPRETING ELIMINATION ENTRIES
Requirement 1:
The acquisition was recorded as a purchase, because a purchase premium is shown in the consolidation elimination entries.
Requirement 2:
The parent owns 85 percent of the stock of S. Minority interest is $135,000/($600,000 + $300,000) = 15%.
Requirement 3:
Observe that 4 years' depreciation had been recorded prior to 20X6; thus the acquisition occurred at the beginning of 20X2.
Requirement 4:
Patents balance 1/1/X6 / $60,000Prior amortization: $3,750 x 4 / 15,000
Original balance / $75,000
Requirement 5:
The patents are being amortized over 20 years ($75,000/20 = $3,750).
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E4.10CONSOLIDATED INCOME STATEMENT