Investment in a Subsidiary Accounted for As a Pooling of Interests

FTC Ch. 2

Investment in a Subsidiary Accounted for as a Pooling of Interests

When the pooling criteria are met, as discussed in Chapter 1, the acquisition of a controlling interest in the common stock of another company is recorded as a pooling of interests. Consolidated financial statements will also be required when the operations of the pooled companies are integrated.

Consolidating a 100% Interest under Pooling

The recording and consolidation of a pooling achieved through a stock acquisition can be better understood by first reviewing the recording of a pooling achieved through an asset acquisition. Assume Company C (the combiner) had the following balance sheet just prior to pooling with Company I (the issuer):

Company C

Balance Sheet

December 31, 19X1

Current assets…………………..$10,000 Liabilities$10,000

Property, plant, and Stockholders’ equity:

equipment Common stock

(net)………………………….. 30,000 ($10 par)………. $10,000

Retained earnings..20,00030,000

Total liabilities

Total assets……………………..$40,000 and equity………. $40,000

Also, Company I is willing to issue 3,000 shares of its stock for the $30,000 net assets of Company C. Company I stock has a par value of $2 and a market value of $15 per share. Since pooling principles ignore market values and combine book balances, the entry to record the pooling on Company I’s books would be

Current Assets………………………………………………….10,000

Property, Plant, and Equipment (net)…………………………..30,000

Liabilities……………………………………………………... 10,000

Common Stock ($2 per share  3,000 shares)……………….. 6,000

Paid-In Capital in Excess of Par……………………………… 4,000

Retained Earnings……………………………………………. 20,000

The original amount of the Company C total paid-in capital is preserved, although it is redistributed between the par value and paid-in capital in excess of par accounts of Company I. The full amount in the Company C retained earnings account is transferred to the Company I retained earnings account, since a reduction was not necessary to meet a par or stated value requirement of the issuer.

In this example, which portrays a pooling through an asset acquisition, the combiner was dissolved and its accounts were merged with those of the issuer. Assume now that Company I exchanges its shares for the shares of Company C by dealing with stockholders and that all other pooling criteria are met. In addition, Company I elects not to dissolve Company C but to let Company C continue as a separate legal entity with its own accounting records. In effect, a pooling through a stock acquisition occurs. Since the assets and liabilities of Company C remain on Company C’s books, Company I can record only an investment in Company C. However, this investment must be recorded at the book value of the underlying net assets in order to comply with pooling principles. The market value of the securities exchanged is ignored. Normally, Company I must add, to its paid-in capital, an amount equal to the paid-in capital of Company C. The issuer must acknowledge as retained earnings its equity in the Company C retained earnings, unless it is needed to meet a par or stated value requirement and Company I has no additional paid-in capital available for redistribution. From these principles, the following entry is derived:

Investment in Subsidiary C………………………………30,000

Common Stock ($2 per share  3,000 shares)……………. 6,000

Paid-In Capital in Excess of Par………………………….. 4,000

Retained Earnings………………………………………… 20,000

This entry would lead to the separate trial balances for Companies I and C shown in the first two columns of Worksheet 2-1P (at end). In this worksheet, intercompany balances are eliminated and the balance sheets of the parent and subsidiary are consolidated as of the date of the pooling.

When properly recorded, the investment in the subsidiary account will always be eliminated against the stockholders’ equity of the subsidiary, with no excess of any type remaining after the elimination. This procedure must be followed because the recorded value of the investment account equals the subsidiary stockholders’ equity multiplied by the parent’s ownership percentage (100% in this example). As a result of this equality, no determination and distribution of excess schedule is needed when pooling.

Consolidating a Less-Than-100% Interest under Pooling

Often, the issuer will not acquire 100% of the combiner stock, although it must acquire at least 90% in exchange for its voting common stock to pool. In such a case, the issuer records only the pro rata book value acquired. If Company I of the previous example exchanges only 2,700 shares ($2 par) for 90% of Company C stock, the entry to record the investment would be

Investment in Subsidiary C………………………………………27,000

Common Stock ($2 per share  2,700 shares)…………………. 5,400

Paid-In Capital in Excess of Par (90%  $4,000)……………… 3,600

Retained Earnings (90%  $20,000)…………………………… 18,000

Subsequent worksheet eliminations would cancel the investment in the subsidiary account against 90% of the Company C equities, with a 10% minority interest remaining. Procedures for displaying the minority interest parallel those previously discussed.

There is a lack of clarity in the accounting literature for the procedures used to account for the possible acquisition of shares not a part of the original exchange of voting common shares. There is agreement that they are not to be recorded or consolidated under pooling principles. The position of this text is that the acquisition of fractional shares for cash and/or the cash payment for the shares of dissenting minority shareholders who will not exchange for parent shares should be treated as a retirement of the shares. This would be accomplished by recording the shares at cost on the parent’s books and retiring them on the consolidated worksheet. Where the cost exceeds the original issue price, there would be a decrease in parent retained earnings. Where the cost is less than the issue price, there would be an increase in parent paid-in capital in excess of par.

Recognizing and Correcting the ImproperlyRecorded Investment Account

Ordinarily, when a corporation issues stock, it must increase its total paid-in capital by the entire amount of consideration received. When it issues stock to acquire noncash assets, including shares of another company’s stock, the consideration received is the market value of the assets received or the shares issued, whichever is more readily determinable. The only exception to these principles is an investment in a subsidiary to effect a pooling. In this case, only the net book value of the assets received should be recorded, as was previously illustrated. However, it is common to find a company that ignores this exception. Such a company will increase both its investment and paid-in capital accounts by an amount equal to the market value of the shares given or received. When this mistake is found, the issuer’s accounts should be corrected prior to preparing the consolidated worksheet.

To illustrate, assume Company I made the following incorrect investment entry when it acquired 90% of the stock of Company C, although pooling criteria were met:

Investment in Subsidiary C ($15 per share market value
 2,700 shares)…………………………………………… 40,500

Common Stock ($2 per share  2,700 shares)…………….. 5,400

Paid-In Capital in Excess of Par………………………….. 35,100

Prior to preparing the consolidated worksheet, the issuer’s books would be corrected by reversing the original incorrect entry and recording the investment as a pooling. The following entries would be made:

Common Stock ($2 per share  2,700 shares)…………………. 5,400

Paid-In Capital in Excess of Par……………………………….35,100

Investment in Subsidiary C…………………………………... 40,500

Investment in Subsidiary C (90% of Company C equity)……..27,000

Common Stock ($2 per share  2,700 shares)……………….. 5,400

Paid-In Capital in Excess of Par ($9,000 – $5,400)…………. 3,600

Retained Earnings (90%  $20,000)………………………… 18,000

When these corrections have been made and the proper amounts have been recorded by the issuer, the subsequent worksheet eliminations would be identical to those for a less-than-100% interest pooling.

Pooling Questions

Q-1P. Under the pooling method, the investment in a subsidiary account should be eliminated against the parent’s share of the subsidiary stockholders’ equity, with no excess. If this result does not occur, what is the likely cause and how is it corrected?

Q-2P. Why is a determination and distribution of excess schedule really not needed in a pooling of interests? If one were prepared, what would it contain in terms of an excess of cost or book value?

Pooling Exercises

E-1P. Varsity Company and Top Company had the following balance sheets prior to a pooling of interests:

Varsity will exchange its stock for all of the outstanding stock of Top Company. On Varsity’s books, record the investment for each of the following situations. Support each entry with an equity transfer schedule.

1.Varsity issues 80,000 shares.

2.Varsity issues 100,000 shares.

3.Varsity issues 150,000 shares.

4.Varsity issues 250,000 shares.

E-2P. Assume that AA Airlines exchanges a sufficient number of its shares to acquire a 90% interest in Benson and that the transaction meets the criteria for a pooling of interests.

a) Determine how many shares of AA Airlines common stock will be exchanged.

b) Record the investment in Benson shares and provide an equity transfer schedule.

c) Prepare the elimination entries that would be made on a consolidated worksheet prepared on the acquisition date.

E-3P. Subtra Inc. had the following balance sheet on December 31, 19X7:

AssetsLiabilities and Equity

Prior to a pooling of interests in which Parma was the issuer, Parma had the following stockholders’ equity:

Common stock ($10 par) $ 500,000

Retained earnings2,000,000

$2,500,000

Less treasury stock, 5,000 shares at cost 300,000

Total stockholders’ equity$2,200,000

Parma exchanged the 5,000 shares of treasury stock plus 5,000 new shares of common stock for 90% of the common stock of Subtra. Parma paid $10,000 in direct acquisition costs.

Record the acquisition of Subtra as a pooling of interests. Prepare an equity transfer schedule as support.

E-4P.Wright Enterprises has given you the following balance sheet on December 31, 19X5:

Wright Enterprises

Balance Sheet

December 31, 19X5

AssetsLiabilities and Equity

Wright Enterprises acquired a 90% interest of Mazurek Company on October 1, 19X5, by exchanging 20,000 shares of $40 market value ($5 par) common stock directly with Mazurek’s stockholders. On the exchange date, Mazurek Company had the following stockholder’s equity:

Common stock ($2 par)$50,000

Paid-in capital in excess of par250,000

Retained earnings 300,000

$600,000

Initially, the transaction was erroneously recorded as a purchase. No entries have been made in the investment account since the inception of the pooling.

Prepare the necessary journal entry to correctly portray the above combination as a pooling of interests. Provide an equity transfer schedule as support.

Pooling Problems

P-1P.The balance sheets of Lewis Company and Ace Company are as follows on December 31, 19X4:

On this date, Lewis exchanged one share of its newly issued common stock for every two shares of Ace stock. Lewis acquired all outstanding shares of Ace Company. The market value of a share of Lewis stock was $30 on the acquisition date. Ace’s assets are fairly stated except for the property, plant, and equipment which has a market value of $450,000.

Required:

Assume that the acquisition meets the pooling of interest criteria.

a) Record the investment in Ace stock.

b) Prepare a consolidated balance sheet for December 31, 19X4, immediately subsequent to the pooling.

P-2P.Kippers Steel has approached the management of Gage Company and has made an offer to acquire 90% of Gage’s outstanding stock on July 1, 19X6. Kippers Steel will give 20,000 shares of its previously unissued, $1 par, $35 market value, common stock in exchange for a 90% ownership interest. If this offer is accepted, it is unclear whether all the criteria for a pooling of interests will be met.

Out-of-pocket costs of the acquisition incurred by Kippers Steel would be as
follows:

Direct acquisition costs (legal fees and finder’s fees) $27,000

Stock issuance costs18,000

Comparative balance sheets for the two companies just prior to the combination are as follows:

On July 1, 19X6, Gage Company’s book values approximate market values, except for the following:

Marketable securities$ 60,000

Property, plant, and equipment 950,000

Patents 80,000

Bonds payable 296,000

Required:

1. Prepare the entry that Kippers Steel would make on July 1, 19X6, to record the investment in stock of Gage Company as: (a) a purchase and (b) a pooling of interests.

2. Prepare a consolidated balance sheet for July 1, 19X6, immediately subsequent to the acquisition assuming that the acquisition is regarded as (a) a purchase and (b) a pooling of interests.

1. Compare the differences on the 19X6 fiscal year income statement that would occur as a result of the purchase versus a pooling treatment.

Worksheet 2-1P

100% Interest; Pooling of Interests

Company I and Subsidiary Company C

Worksheet for Consolidated Balance Sheet

December 31, 19X1

Eliminations

Trial Balanceand Adjustments Consolidated Balance Sheet

Company ICompany CDr.Cr.Dr.Cr. _

Current Assets...... 20,00010,00030,000

Property, Plant, and Equipment (net)...... 70,00030,000100,000

Investment in Subsidiary C...... 30,000 (1)30,000

Total...... 120,00040,000

Credits:

Liabilities...... 15,00010,000 25,000

Common Stock, Co. I...... 56,00056,000

Paid-In Capital in Excess of Par, Co. I.....4,0004,000

Retained Earnings, Co. I...... 45,00045,000

Common Stock , Co. C...... 10,000(1)10,000

Retained Earnings, Co. C...... 20,000(1)20,000

Total...... 120,000 40,00030,00030,000130,000130,000 ______

Eliminations and Adjustments:

(1)Eliminate the investment account against the subsidiary equity accounts