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Accounting for investment on parents books

By Clifford Moore,2014-04-18 18:20
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This and all other adjustments are made only on the consolidation workpapers. Also, short examples of parent company accounting under Parent Co and

Acct 415/515 Prof. Teresa Gordon

    Accounting for Investments under FASB No. 115

     A Review

    Change in Fair Value For commercial enterprises Presentation on Other than (nonprofit entities follow SFAS No.124) Financial Statements Temporary Temporary

    Loss Does the investor have substantial influence or control?

    On BS at historical cost Investor owns 20% to 50% of stock and has plus share of earnings Realized significant influence but not control of the since acquisition less loss on IS, corporation N/A dividends received new basis (amortization may also on BS Use Equity Method be required)

    Investor owns over 50% of stock or otherwise

    controls the corporation Consolidated financial N/A N/A statements

     Consolidation required

    Realized Does a readily determinable fair value exist? loss on IS, On BS at historical cost N/A new basis If not, use Cost Method on BS

    On BS at amortized

    cost

    For debt securities, does the enterprise have the Realized positive intent and ability to hold to maturity? IS includes loss on IS, amortization of N/A new cost Classify as held-to-maturity premiums & discounts basis on BS

    Disclose fair value in

    notes

    Is the investment objective to generate profits on On BS at fair value Recognized No short-term differences in price? on IS and additional IS reports unrealized included in entries Classify as Trading Securities gain/loss for period RE needed

    All other debt and equity securities are classified On BS at fair value Reported Realized as on SCI and loss on IS, SCI reports holding included in new cost Available-for-Sale Securities gain/loss for period AOCI basis on BS

    BS = balance sheet; IS = income statement; SCI = statement of comprehensive income;

    AOCI = accumulated other comprehensive income (owners’ equity account); FV = fair value; N/A = not applicable since investments are not carried at fair value

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    Accounting for investment on parent’s books Acct 415/515 Prof. Teresa Gordon

    Cost Method versus Equity Method

Cost Method

    The original cost of the investment is recorded on the parent’s books.

    No adjustments are made to reflect subsequent changes in fair value

    (unless serious doubt as to the realization of the investment exists in

    which case a permanent write-down is made).

    When dividends are declared, dividend income is recognized.

    Undistributed earnings have no affect on parent’s books. Consolidation procedures:

    Both the investment account and dividend income are eliminated when

    the subsidiary and parent financial statements are consolidated.

    This and all other adjustments are made only on the consolidation

    workpapers.

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Acct 415/515 Prof. Teresa Gordon

    Equity Method

    At acquisition, the investment is recorded at cost.

    Subsidiary earnings after acquisition increase the investment account and increase earnings on the income statement.

    Subsidiary losses after acquisitions decrease the investment account and decrease earnings on the income statement.

    Dividends received from the subsidiary reduce the investment account. When the fair value of identifiable assets exceeds their carrying value on the subsidiary’s books, the excess is amortized over the remaining

    economic life of the assets. This amortization reduces the investment account on the parent’s books and reduces subsidiary earnings reported on the income statement.

    Consolidation procedures:

    The investment account and earnings of subsidiary accounts are eliminated in the consolidation process.

    Check figures:

    Consolidated net income will be the same as the parent company’s net income.

    Consolidated retained earnings will be the same as the parent company’s retained earnings.

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Acct 415/515 Prof. Teresa Gordon

    Equity Method on Parent’s Books

    Investment in subsidiary (balance sheet account)

    Historical cost of investment Share of reported losses of

    subsidiary Share of reported earnings of Dividends received from

    subsidiary subsidiary

     Amortization of excess value

    of identifiable assets of

    subsidiary

    Earnings of subsidiaries (income statement account)

    Share of reported losses of Share of reported earnings of

    subsidiary subsidiary Amortization of excess value

    of identifiable assets of

    subsidiary

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Acct 415/515 Prof. Teresa Gordon

    Both methods are widely used but each has advantages

    and disadvantages

    Cost Method Equity Method Financial analysis complicated Facilitates financial analysis

    because amounts needed must such as return on investment for

    subsidiaries be tracked on working papers

    rather than through the general

    ledger

    Less bookkeeping is involved Parent company financial

    statements are more useful for

    internal management purposes No self-checking feature Self-checking feature useful

    when consolidated financial

    statements are prepared

Note:

    The consolidated financial statements will be identical regardless of

    which bookkeeping method is used internally by the parent company.

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Acct 415/515 Prof. Teresa Gordon

    The COMPLETE EQUITY method gives rise to a

ONE LINE CONSOLIDATION THEORY.

    Consolidated Net Income = Parent’s Net Income Consolidated Retained = Parent’s Retained Earnings

    Earnings

    Consolidated Stockholders’ = Parent’s Stockholders’ Equity

    Equity (if 100% Subsidiary) Consolidated Stockholders’ = Parent’s Stockholders’ Equity

    Equity + minority interest

    (if < 100% Subsidiary) 50319903.doc as of 4/18/10 Page 6

Acct 415/515 Prof. Teresa Gordon

    Tips for tackling consolidation problems

1. Identify the nature of the problem

    Parent accounting (equity method vs. cost method)

    Noncontrolling (Minority) interest

    Intercompany transactions

    2. Note important details

    Cost of investment

    Fair value of assets acquired

    Amortization of fair values

    Ownership interest of parent

    DATES

    3. Identify specific requirements

    Journal entries

    Worksheet entries

    Completion of worksheet

    Explanation of items

    Tips for tackling consolidation problems

It is helpful to start with a global analysis:

    1. Determine investment cost

    2. Determine book value of net assets

    3. Determine fair value of net assets

    4. Investment cost - Book value of net assets

    = “Differential”

5. Investment cost - Fair value of net assets

     = Goodwill

6. Fair value of net assets - Book value of net assets

     = “Excess value component”

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Acct 415/515 Prof. Teresa Gordon

    Parent uses Equity Method

Consolidation worksheet entries needed

    (assumes non-pushdown accounting)

    1. Basic elimination entry (subsidiary net assets book value at

    beginning of year plus earnings and dividends for year)

    2. Eliminate excess cost element (at end of period values) 3. Amortization of the allocated differential. 4. Eliminate accumulated depreciation at acquisition

    5. Elimination of intercompany transactions

Parent uses Cost Method

    Consolidation worksheet entries needed

    (assumes non-pushdown accounting

    1. Basic elimination entry (book value of net assets at acquisition, this

    entry is always the same)

    2. Record excess cost elements (amounts at acquisition, this entry is

    always the same)

    3. Amortization of the differential (prior periods affect on retained

    earnings, current affect on income statement and balance sheet)

    4. Eliminate dividend income.

    5. Eliminate accumulated depreciation at acquisition 6. Elimination of intercompany transactions 50319903.doc as of 4/18/10 Page 8

Acct 415/515 Prof. Teresa Gordon

    Index to Consolidation Examples

    Poo creates Soo Created 100%-owned subsidiary

    At acquisition plus work papers for two years, cost

    and equity methods

    Pebble & Stone Created subsidiary with noncontrolling interest

    A. Pebble sells 20%

    Work papers for cost and equity methods, 3

    years each

    B. Stone issues more stock

    Work papers for cost and equity methods, 3

    years each

Business Combinations: PA and Sun Illustrations of acquisition of assets, acquisition of

    Examples stock, statutory merger, statutory consolidation, etc.

    Also, short examples of parent company accounting

    under Parent Co and Economic Unit approaches Plate & Saucer 100%-owned acquired subsidiary

    At acquisition plus three years cost and equity

    method work papers.

    Play & Swing Less than 100% owned acquired subsidiary

    At acquisition plus three years cost and equity

    method work papers. Uses GAAP Economic Unit

    approach.

    Pound & Sound Downstream sales to wholly-owned created subsidiary Pup & Sup Upstream sales from partially-owned created

    subsidiary

Other files available (notes)

    Cost vs. Equity Method.doc

    Created partially owned sub.doc

    BusComb.doc

    Acquired Sub with NCI.doc

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Acct 415/515 Prof. Teresa Gordon

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