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
If no consideration is transferred in an acquisition, how should goodwill be measured?
Acquisition-date FV of acquirer’s interest shall be determined using a valuation technique instead of (1) in the original goodwill formula
How is goodwill allocated to the acquirer and to a noncontrolling interest?
Take the FV of acquirer’s interest (usually the cost) and subtract the FV of the acquirer’s share of acquiree’s FV to get the acquirer’s goodwill
The rest goes to the noncontrolling interest – it is NOT simply by % of ownership
E.g. if goodwill = $200k, acquiree’s net assets/liabilities = $700k and FV of acquirer’s 80% interest is $750k, then acquirer’s share of goodwill = 750k - (700k x 80%) = 190k
What is a bargain purchase?
If there is “negative goodwill” (i.e. if (2) exceeds (1) in the formula)
Recognized as a gain in earnings on the acquisition date
How is the gain on a bargain purchase split between the acquirer and the noncontrolling interest?
Goes entirely to acquirer
What must happen before an acquirer recognizes a gain on a bargain purchase?
He has to reassess the measurement of the acquiree’s FV
What happens if the acquirer gives consideration whose carrying amount differs from its FV?
Acquirer shall remeasure them to FV, record gain/loss in earnings
If the acquirer maintains control of these assets/liabilities in the acquiree after giving them as consideration (i.e. if they don’t exit from the combined businesses), then they should be reverted back to acquisition-date CV and the gain/loss removed
Does the consideration paid by the acquirer include contingent consideration?
Yes
What is it called if a company acquires another after already having a (non-owning) equity interest in it?
A business combination achieved in stages
Also called a step acquisition
Since new acquirers have to measure the noncontrolling interest at FV, what do step-acquirers do with their own equity interest?
Remeasure its FV at the acquisition date
Gain/loss recognized in earnings
-If there is already is gain/loss on the interest in OCI, then that needs to be reclassified and included in the gain/loss calculation at the acquisition date
How can a company acquire another without paying consideration?
Acquiree buys enough of its own stock
Acquirer already has majority voting rights, and then minority veto rights expire
Acquirer and acquiree agree to combine by contract alone
-in this case, acquirer holds no equity interest, either on acquisition date or before
If an acquirer and acquiree agree to combine by contract alone, what is done with the other equity interests?
Acquirer shall attribute to them the amount of the acquiree’s net assets recognized
They are treated as noncontrolling interest in the acquirer’s financials, even if all equity interests are part of this noncontrolling interest
What happens if the accounting for a business combination is not done by the end of the period in which the combo occurred?
The acquirer reports provisional amounts for the incomplete items
He has a “measurement period” after the acquisition date when these amounts can be changed
When an acquirer changes provisional amounts during the measurement period, how are they recognized?
Assets are increased by a decrease in goodwill and vice versa; opposite for liabilities
Recognized as if all accounting for the combination had been complete from the acquisition date
How long does the measurement period last?
When the acquirer receives all the necessary info that he can to adjust provisional amounts, or one year, whichever is greater
After measurement period, any changes in recognition are accounted for as error-corrections
What are included in acquisition-related costs?
Finder’s fees
Advisory, legal, accounting, valuation, consulting fees
Cost to register and issue securities
How should acquisition-related costs be accounted for?
Expensed as incurred
Exception: costs to issue securities are under ordinary GAAP
How are contingencies treated under the acquisition method?
Assets or liabilities arising from contingencies should still be reported without any further information about the contingency’s outcome
When there’s new info, assets/liabilities are evaluated and measured
For contingencies under the acquisition method, how are assets/liabilities measured?
Liability = either acquisition-date FV or amount that would be recognized from ordinary GAAP on contingenices – whichever is higher
Asset = either acquisition-date FV or estimated future settlement amount, whichever is lower
When consolidating financial statements, how are intercompany balances and transactions recorded?
Eliminated for presentation, but eliminating JEs are NOT entered into any books
What are the three steps of consolidation?
Eliminate Capital and Investment Accounts
Eliminate Intercompany Balances
Eliminate Intercompany Transactions
What happens when capital and investment accounts are eliminated?
Subsidiary’s capital accounts (except for noncontrolling interest) are erased
If the subsidiary has any shares of the parent, they should be reflected as treasury stock, not outstanding stock
What happens for income taxes paid on intercompany transactions?
Taxes shall be deferred or intercompany profits (which are going to be eliminated) shall be reduced
For a consolidation, when a subsidiary’s asset’s FV is higher than its BV, what is the parent’s JE to record it?
For higher FV…
Dr: Asset
Cr: Investment in subsidiary
Vice versa if FV is lower
For a consolidation, how does the parent record the subsidiary’s income attributable to the parent?
Dr: Investment in subsidiary
Cr: R/E
amount = (ownership %) x (income)
For a consolidation, how does the parent record goodwill?
Dr: Goodwill
Cr: Investment in subsidiary
For a 100% consolidation, how does the parent record the closing of the subsidiary’s capital and investment accounts?
Dr: Common Stock (and whatever else)
Dr: R/E
Cr: Investment in subsidiary
How does a noncontrolling interest affect the JEs which the parent will make in a consolidation?
Certain entries will be split between the parent and the NCI
E.g., if an asset has a higher FV than BV, then the difference will be split
E.g., when the subsidiary’s stock and capital are emptied, that amount is split
For consolidations, what must be done with intercompany receivables, payables, and loans?
All removed, including interest income/expense
What are the JEs to remove loans (payables) and interest income/expense for consolidations?
Simply offset the items against each other
E.g. debit note payable and credit note receivable; debit interest expense and credit interest income
What is important to remember about interest income/expenses for subsidiaries in consolidation?
Though they are removed from consideration for the consolidated entity’s profit calculation, they are still included to determine the subsidiary’s income, which has bearing on any NCI
What are three problems arising from intercompany sales of inventory?
(1) Sales and COGS are counted twice (as the parent sells inventory to the sub and the sub to someone else)
(2) Gross Profit (the seller of inv. to the other will have an unrealized GP that is realized when it is sold to a third party)
(3) Noncontrolling interest (subsidiary’s income determines NCI and is based on sales and COGS)
What is the best way to make calculations for intercompany inventory sales?
Use the COGS formula (BI + Sales - EI), get the parent’s sales price and the parent’s cost of sales for each category, and then take the difference to get gross profits for each category
Once you have calculated gross profits for intercompany inventory sales, what do you do next?
Gross profit on BI is realized, but on EI is unrealized
Thus debit R/E and credit COGS for realized gain, but debit COGS and credit Inv. for unrealized
Also make a JE to offset parent sales and sub. purchases
What are two problems emerging from intercompany sales of fixed assets?
(1) Gains/losses on sales need to be removed
(2) Asset will be recorded at FV when sold, when it should remain at BV; this requires adjustments to depreciation expense
What change should be made to the recorded amounts of fixed assets traded between companies?
Restore carrying amount of asset to original BV and remove the seller’s gain/loss
What change should be made to depreciation expense for fixed assets traded between companies?
Depreciation and expense and accumulated depreciation should both reflect the asset’s original BV
How should RE be affected by fixed assets traded between companies?
For periods after the year of sale, R/E should be adjusted to eliminate gain/loss
- If parent is seller, its RE absorbs all of it
- If sub (less than 100%) is seller, then adjustment should be apportioned between CI and NCI based on ownership
Which JE is necessary immediately after an intercompany fixed-asset transaction?
Dr: Gain
Dr: Asset
Cr: Accumulated Depreciation
This eliminates the gain on the sale, reduces the asset back to its BV, and restores acc. depr.
Which JE is necessary periodically after an intercompany fixed-asset transaction?
Acc. depreciation and depreciation expense have to be adjusted accordingly
E.g. if an asset with a 5-year life is bought for $1500 when its carrying value was $1000, then its depreciation will be $300 when it should be $200 per year, thus for first year…
Dr: Accumulated Depreciation (100)
Cr. Depreciation Expense (100)
Second year will be 200, third year 300, etc.
What are the JEs for intercompany fixed-assets transactions after year 1?
RE needs to be offset instead of the gain
- debit RE
- debit the asset by the same amount as in year 1 (to get it to original carrying value)
- credit accumulated depreciation
For intercompany fixed-assets transactions after year 1, by how much is accumulated depreciation credited?
By the amount to restore it to what it WOULD have been if never sold
This will equal the same AD adjustment as in the previous year, except with one more year of depr. exp. applied (i.e. at that rate of depreciation before it was sold)
For intercompany fixed-assets transactions after year 1, by how much is RE debited?
By the amount of the gain minus the amount of adjusted depreciation expense
How is an intercompany direct sale of bonds accounted for?
The premium/discount and bonds payable entry are canceled out with the “Investment in Bonds” entry
For the consolidating entry in later years, it is the same thing, except interest income and expense will also need to be canceled out
What happens if bonds have been issued by one company, sold to a third party, and then repurchased by another (consolidated) company?
Bonds are treated as if they were retired
The reacquisition of the bonds will then involve a gain or loss on their “retirement”
For intercompany bond transactions with a third party, how is the retirement gain/loss measured?
Calculate investment on reacquirer’s books by discounting principal and interest payments to PV
Carrying amount on issuer’s books (net of premium/discount)
- Investment on reacquirer’s books
= Gain/loss on retirement
For intercompany bond transactions with a third party, what are the year-end adjustments?
Dr: Bonds Payable (at face amount)
Dr. Interest Income (effective rate x net bond investment at beg. of yr.)
Cr. Interest Expense (stated rate x face amount)
Cr. Investment (net bond investment at year-end)
Cr. Gain on retirement
Total on each side should equal face value of bond + interest income for the year
For intercompany bond transactions with a third party, what different adjustment must be made after the first year?
Adjustment to RE
Amount = gain on retirement minus any amortized amount to that point
For intercompany bond transactions with a third party, what happens if the bond is originally issued at a discount or premium?
The issuer’s book value is altered by the discount/premium, but otherwise the calculations are the same
Only difference in year-end adjustments is that bond payable at face amount AND discount or premium have to be undone
How does a NCI affect any income between the parent and subsidiary?
Any intercompany income/loss can be allocated between the parent and the NCI
How are rev/exp/G/L/income/OCI reported in consolidated financial statements if there is a NCI?
Reported at consolidated amounts (i.e. not split up)
What happens if losses attributable to the parent or the NCI exceed their equity interests?
Losses are still attributed to those interests, even if they go negative
If a parent has a decrease or increase in its equity interest, how is it accounted for?
Treated as equity transactions (contributions by and distributions to owners)
Thus, no gain/loss recognized
If a parent has a decrease or increase in its equity interest, how does it affect the NCI?
Carrying amount of NCI is adjusted accordingly
If FV of consideration paid or received differs from the NCI adjustment, then recognize that difference as part of the parent’s equity interest
If a parent has a decrease or increase in its equity interest, how might OCI be affected?
Any accumulated OCI will be adjusted to reflect the change in ownership interest
Charge or credit to parent’s equity
When should a parent deconsolidate a subsidiary?
On the date it loses a controlling interest (can happen in a number of ways)
How should deconsolidations be recognized?
If it occurs through a nonreciprocal transfer to owners (e.g. a spinoff), then use nonmonetary transaction guidance
Otherwise, use special rules for deconsolidation
What are the special rules for a parent’s recognizing a deconsolidation?
Measure aggregate of (1) FV of payment received, (2) FV of remaining investment in sub (as of deconsolidation date), and (3) carrying amount of NCI at date of deconsolidation
Measure carrying amount of sub’s assets and liabilities
Parent recognizes difference as gain/loss
If a parent loses its controlling interest through two or more transactions, how should it be reported?
May need to be treated as a single transaction – depends on the transactions’
- timing
- form
- dependence
- economic justification
How are a subsidiary’s books affected by a business combination?
They’re ordinarily not
Only are affected under push-down accounting
When are combined (rather than consolidated) financial statements appropriate?
Whenever they’re more meaningful, e.g.:
- group of related companies
- one company has a controlling interest in several companies related to each other
These are prepared essentially the same as consolidated statements
What would be a good reason to prepare financials for the parent company (apart from the consolidated statements)?
To provide info on creditors (e.g. bondholders) or preferred stockholders for the parent
Not allowed instead of consolidated, but consolidated statements normally already include parent info in a column
If a subsidiary owns stock in the parent, how is it reported on the consolidated statements?
Still reported as normal (e.g. Common Stock and APIC)
Remember: the parent’s investments accounts cancel out the sub’s capital accounts (except for the NCI), but this doesn’t mean the sub’s investment in the parent is canceled
