Consolidated Financial Statements Flashcards
What are three different ways to account for one company’s investment in another?
Cost method (lack significant influence: 0-20% ownership)
Equity method (has significant influence: 20-50% ownership)
Consolidation (has control: >50% ownership)
Besides voting stock, what else is evidence of “significant influence” in another company?
Participating in policy-making or directorship
Level of intercompany transactions or dependency
Ownership concentrated with few stockholders
Under the cost method, how is the investment initially recorded?
At cost, including broker’s fees and other acquisition costs
How is the investment account changed under the cost method?
Unlike equity method, not adjusted to show investor’s share in earnings or dividends
Adjustment is made for liquidating dividends
Carrying value of investment is allocated among shares in stock split or stock dividend
How are stock rights recorded under the cost method?
Carrying value of investment is allocated between investment and stock right (based on relative FV)
How are disposals of investments accounted for under the cost method?
Report realized gain or loss on diff. between CV and FV
Carrying amount may be determined by specific identification, FIFO, or average method
Is it possible for a company to have 20% ownership of voting stock (or more) and still lack significant influence?
Yes – the major exception is if the subsidiary is in a foreign country with major operating restrictions
What are other reasons why 20% ownership is not sufficient for significant control?
- legal/litigious opposition by investee
- investor agrees not to
- a small number of other stockholders essentially run the business w/o regard for the investor in question
- the investor wants more info to apply the equity method (e.g. quarterly reports) but fails
- investor tries to get on board of directors but fails
How should the original acquisition be recorded under the equity method?
At cost
What happens if a company previously has less than 20% and then gains >20% ownership in a company?
Equity method needs to be retroactively applied, yet still as if the subsidiary were acquired step-by-step
Includes retroactive adjustments to Investment account, RE account, and results of operations
Under the equity method, what is the JE for the investor to recognize a share in the investee’s earnings?
Dr: Investment
Cr: Investment Income
Cumulative preferred dividends should be subtracted from earnings/loss to determine investor’s share in earnings/loss
Under the equity method, how is preferred stock recorded?
Simply at cost (since it’s nonvoting stock)
Preferred dividends recorded, ordinarily, as dividend income
What happens if an investor and investee have different fiscal years?
Investor can still report share in earnings from most recent financial statements of investee, so long as the time lag is consistent
How are dividends recorded under the equity method?
Treated as a distribution of previously-recognized earnings
Upon declaration,
Dr: Receivable
Cr: Investment
“Investment” is reduced since equity is reduced by the dividend, but “Investment Income” is not altered
What happens when an investor pays more than the book value to acquire a company’s common stock?
Any excess price is recorded as goodwill
Very rare for book value to equal purchase price
What happens if investee assets have a different FV than BV, and if an excess purchase price by the investor can be identified with those assets?
If the asset has a limited useful life, the excess is amortized over it
Amortization entry:
Dr: Investment Income
Cr: Investment
If FV < BV, then do the opposite
Under the equity method, how are intercompany profits and losses recorded?
They are eliminated until they are realized
E.g. investee sells inventory to investor at a profit; if 25% of the inventory is unsold at year-end, then the ownership interest in 25% of the investee’s profits from that sale should be removed (e.g. 20% ownership x 25% of the profits from that sale)
Under the equity method, how are intercompany receivables and payables recorded?
As normal – they should be eliminated only if the two are consolidated
How are capital transactions recorded under the equity method?
As if the investee were consolidated (e.g. someone else investing in the investee increases the investor’s APIC)
Stock dividends and stock splits don’t affect investor’s ownership, so no income is recorded (only a memo entry needed)
How are deferred income taxes recorded under the equity method?
Should be recognized for temporary difference arising from difference between income recognized and dividends received
Also, dividends-received deduction is a permanent difference
How do changes in common stock’s FV affect the investor’s Investment accounts?
They affect neither Investment nor Investment Income
Suppose X has 20% ownership in Y, and that Y sold X $8000 of inventory to get a $2000 profit. If half of this inventory has not been sold by X at year-end, what profit does X deduct from its investment income?
$200
$1000 is the profit which Y has from the unsold inventory, and 20% of that is $200
Dr: Investment Income (200)
Cr: Investment (200)
If X has 20% ownership in Y and Y distributes $4000 of cash dividends, what is the appropriate JE for X?
Dr: Cash (800)
Cr: Investment (800)
20% x $4000 = 800
How do liquidating dividends affect the Investment account under the equity method?
They decrease it
Technically, all dividends over the investor’s share of the investee’s income reduce the Investment account
What happens if ownership drops below 20%?
Change to cost method:
- Investor should stop accruing a share of investee income
- New cost basis = carrying amount of investment at date of change
If a company changes to the equity method (i.e. exceeds 20% ownership), how much should RE be adjusted?
By the interest the investor had in the investee’s income for the previous years, minus dividends received
E.g. if a company had 10% for two years and then had 30%, the first two years’ income x 10% minus dividends received from those years = prior period adjustment for RE
Debit Investment and credit RE when the stock is purchased to exceed 20% (also debit Investment and credit Cash for the cost of the stock purchased)
How are losses reported on the equity method?
Any non-temporary losses should be reported
For investees with repeated net losses, the investor should not write down the investment below zero, but should simply record memo entries
-If the investee begins having a profit, the investor should recognize it only after the unrecognized losses are made up
What should be reported on the financial statement under the equity method?
Investor’s common-stock investment as single item on B/S
Investor’s share in earnings as single item on I/S
Exception: investee’s extraordinary items and prior period adjustments should be separately reported if material
What is a chain of interests?
A succession of ownership interests
E.g. X owns 80% of Y and Y owns 60% of Z, so X has 48% of Z
The strict product is not really a determinant for consolidation (e.g. even for this 48% number, consolidation would still be proper)
How should business combinations be accounted for?
Acquisition method:
- identifying acquirer
- determining acquisition date
- recognizing assets and liabilities acquired, & any noncontrolling interest
- recognizing goodwill or a gain from a bargain purchase
For a business combination, what are the closing date and the control date?
Closing date = when the acquirer pays to get the assets and liabilities of the acquiree
Control date = when the acquirer obtains control
Usually these coincide, but not necessarily
What are the criteria for acquired assets and liabilities to qualify as part of the acquisition method?
- meet the definitions of assets/liabilities at the acquisition date
- be part of the business combination transaction, not a separate one
What can happen when the acquirer recognizes assets and liabilities?
It recognizes assets/liabilities previously unrecognized (e.g. brand name)
How does the acquirer account for contingencies?
If (and only if) it is more likely than not (>50%) that a contingency gives rise to an asset or liability, then it should be recognized
How does the acquirer recognize valuation allowances on acquired assets?
He doesn’t – all assets are recognized at FV, so valuation allowances are built in
How does the acquirer treat assets that are part of operating leases in which the acquiree is the lessor?
Assets should be measured at FV separately from the lease contract
Asset/liability is separately recognized if lease terms deviate from market terms
How does the acquirer treat assets he intends not to use fully?
Still measures them at FV (i.e. for the asset’s highest and best use)
Both for initial measurement and for later impairment testing
How does the acquirer measure a noncontrolling interest?
The interest’s FV can be measured by the market prices for shares that the acquirer doesn’t have
-per-share FV of acquirer’s interest and noncontrolling interest may differ (e.g. control premium for acquirer’s shares)
If market values are unavailable, there are other valuation techniques
How is goodwill recognized in an acquisition?
Both acquirer’s interest and noncontrolling interest must have goodwill allocated to it
Acquirer is allocated his portion first, remaining goodwill goes to noncontrolling interest
How is goodwill measured?
(1) - (2)
(1) Acquirer’s payment + FV of noncontrolling interest + acquisition-date FV of acquirer’s previous interest (if applicable)
(2) Assets - liabilities, as of the acquisition date
If only equity interests are exchanged in an acquisition, how should goodwill be measured?
By using the acquisition-date FV for the acquiree’s equity interests, since those are generally more reliable than the acquirer’s
