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 of
thetext.
2.
Read the
“Chapter Review”
(PowerPoint)posted in D2L.
3. Read/completethe correspondinginstructordeveloped “InstructorSubject MatterPresentation” (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).
Unlikethe accountingforstock acquisitions
as ofthedateofacquisition (which required
the preparation of
the consolidated balancesheet
only)the accounting
for
stock
acquisitionsafterthedateof 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.
The first
two steps ofthethreestep
process arethesame forstockacquisitions on thedateofacquisition
as theyareforstock
acquisitions afterthedateofacquisition.
The
keychanges take
placein Step 3.
Step3- Determine theRequired Workpaper Entries
•Complete Workpaper
•Complete Financial
Statement(s)
To determinetherequired
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 accounting
method 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.
RecordingtheinitialInvestment in Subsidiaryis the
same whethertheCost Method
orthe EquityMethod
is applied.
Account
Debit
Credit
Investmentin Subsidiary
$1,000,000
*Cash
$1,000,000
* - Themethod
ofpayment
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
using
theCost 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
see
bythe entryabovetheinvestment
in subsidiaryaccount
is not affected.
Therefore,
thebalanceoftheinvestment in subsidiaryremains at
theinitial investment cost
recorded on the
dateofacquisition.
EQUITYMETHOD
RecordingtheinitialInvestment in Subsidiaryis the
same whethertheCost Method
orthe EquityMethod
is applied.
Account
Debit
Credit
Investmentin Subsidiary
$1,000,000
*Cash
$1,000,000
* - Themethod
ofpayment
in this exampleis cash,
but othersources of funds could
also beused
to payfortheinvestment(i.e. issuanceofstock).
Maintainingthe“Investment
in Subsidiary”account
usingtheEquity 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, the
investment 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
Investmentin Subsidiary
$200,000
Equity in Subsidiary
Income
$200,000
Clearly,
the
aboveentryimpacts the
investment in subsidiaryaccount
balance (increasingthe
account balanceby$200,000).
The accounting fordividend
declared and paid follows
thesamelogic.Iftheparentcompanyis
receivingdividends, the
parent is essentiallytakingvalueout of
theinvestment. The recording ofdividendreceived is accounted
forusing
thefollowingentry(assume
thesubsidiaryis
80% owned and declared adividend
of$50,000):
Account
Debit
Credit
Cash
$40,000
Investmentin 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?
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 fortheCost
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.
Q2. –Short Answer- The adjustment
to the“Investment
in Subsidiary” account is as
ofthe beginningoftheyear. What is the
logicorreasonthe adjustment
is as ofthebeginningofthe year?
Solution: stock acquisition homework help