Chapter 2 : Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

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1 Types of Business expansion 1- Internal Expansion Through: establishment of New Subsidiary 2- External Expansion ( Business Combination ) Through: a. Statutory Merger P + S = P Note : S Company Dissolved b. Statutory Consolidation P + S = N Note : S Company Dissolved c. Stock Acquisition P + S = P & S Accounting for Stock Acquisition: There are three methods used to account for Investment in Stock. The selection of Method used depending on the level of influence or control that the investor is able to exercise over the investee. The Following Table show the different levels of Influence and its related accounting method. No Significant Influence Significant Influence Less Than 20% Between 20% to 50% Control l More Than 50% Fair Value Method Equity Method Or Fair Value Option Equity Method And Consolidation (but cost method is also okay here) Difference between Fair Value and Equity Method Investor Investee 15% of Dividends Dividends $6,000 25% of Net Income and Dividends Net Income $10,000 Page 1 of 8

2 Difference between Fair Value and Equity Method 1- Purchase 2- Dividends 3- Net income 4- Net Loss Investment in. Fair Value Method Dividends income.. (Investee Dividends * Equity %) (Number of shares Dividends Per share) No Entry No Entry Investment in.. Investment in Equity Method (Investee Dividends * Equity % ) Investment in.. Income from. (Investee Income * Equity % * Period /12 ) Income from Investment In.. (Investee Loss * Equity % * Period / 12 ) 5- Fair Value Adjustment Fair Value adjustment Unrealized Gain Equity or Income No Entry Income : When investments is classified as : ( Trading ) Equity : When investments is classified as : Available for Sale ( Non Trading ) Page 2 of 8

3 Exercise 1: July 1 Dec 31 Pilzner Company acquires 2000 of the 10,000 outstanding shares of Soud Corporation at $50 per share, and there is evidence of an Inability to exercise significant influence in Soud Corporation. Soud Corporation paid dividends of $10,000 cash. Soud Corporation reported net income of $30,000, and the fair market value of Soud corporation investments is $120,000, and these investments are classified as fair value throught profit or loss Instructions; 1. Prepare all required Journal Entries. 2. What is the balance of Investment Account at end of year. 3. What is the amount of income from investment that should be reported at year end. Solution: ( investments treated as Trading securities) 1- Journal Entries: July 1 Investment in Soud 2000 shares * $50 = 100, , ,000 Dividends Income $10,000*20% = 2, Dec 31 No Entry for recognizing net income Dec 31 Fair Value Adjustment Unrealized holding Gain income F.M.V 120,000 Cost 100,000 = 20,000 Gain 20,000 20, The balance of Investment at end = Fair Market Value = $120, The Amount of Investment Income = ( Investee Dividends * Equity %) = ( $10,000 * 20%) = $2, ,000 Page 3 of 8

4 Exercise 2: July 1 Dec 31 Pilzner Company acquires 2000 of the 10,000 outstanding shares of Soud Corporation for $100,000. Soud Corporation paid dividends of $3 Per Share. Soud Corporation reported net income of $30,000, and the fair market value of Soud corporation investments is $120,000, and these investments are classified as trading securities Instructions; 1. Prepare all required Journal Entries. 2. What is the balance of Investment Account at end of year. 3. What is the amount of income from investment that should be reported at year end. Solution: ( investments treated as Available for Sale) 1- Journal Entries: July 1 Investment in Soud 100, ,000 Investment in Soud 2,000 Shares *$3 = 6,000 6,000 6,000 Investment in Soud Income from Soud ($30,000 * 20% * 6/12) 3,000 3, The balance of Investment at end Initial Investment (Cost of Investment) 100,000 (+) Share of Investee Income ($30,000*20%*6/12) 3,000 (-) Share of Investee Dividends (2000 shares * $3) (6,000) (=) Balance of Investment at end $97, The Amount of Investment Income = Share of Investee Income = ( Investee Income * Equity % * Period/12) = ($30,000*20%*6/12) = $3,000 Page 4 of 8

5 Consolidation Method: When Parent Company Acquired More Than 50% interest in Subsidairy Company, the Equity method is used ( or Fair Value option ) to account for Investment during the year and the Financial Statements for both combanies must be consolidated at end of Year. Overview of the Consolidation Process. Consolidation Process for A wholly Owned Subsidiary When Investment = Book Value. Exercise 3: Pea Corporation created Soup Corporation with a transfer of $500 cash. During Soup Corp. s first year of operations, it generated a net loss of $100 and paid no dividends. During Soup Corp. s second year of operations, it generated net income of $200 and paid dividends of $50. Instructions: 1. What is the balance in the Investment in Sub account on Parent s books at the end of year 2 using the equity method? Solution: $ What is the balance in the Investment in Sub account on Parent s books at the end of year 2 using the Fair Value method? Solution : $500 Page 5 of 8

6 Exercise 3: Pea Corporation created Soup Corporation with a transfer of $500 cash. During Soup Corp. s first year of operations, it generated a net loss of $100 and paid no dividends. During Soup Corp. s second year of operations, it generated net income of $200 and paid dividends of $50. Instructions: Prepare the consolidated financial statements using a worksheet at the end of the next year, using the separate financial statement for both companies that given below. Pea Corp. Soup Corp. Income Statement Sales 1, Less: COGS Less: Other Expenses Income from Soup Corp. 200 Net Income Elimination Entries DR CR Consolidated Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Investment in Soup Corp. 550 PP&E (net) Total Assets 1, Liabilities Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity 1, Page 6 of 8

7 Solution: Elimination Entries Pea Corp. Soup Corp. DR CR Consolidated Income Statement Sales 1, Less: COGS Less: Other Expenses Income from Soup Corp Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Investment in Soup Corp PP&E (net) Total Assets 1, Liabilities Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity 1, Page 7 of 8

8 How to Compute the consolidated Balances Without Worksheet: Sales Cost of Goods Sold Other Expenses Income from Subsidiary = Zero Consolodated Net Income = Parent = Consolidated ( Sales COGS Other Expenses) Beginning Retained Earnnings = Parent Net Income = Consolidated Net Income Dividends = Parent Ending Retained Earnnings = Parent Assets Investment In Subsidiary Liabilities Equity = Zero = Parent Page 8 of 8