This supplement discusses additional issues related to the pooling of interests

Transcription

1 C H A P T E R 3 ELECTRONIC SUPPLEMENT TO CHAPTER 3 This supplement discusses additional issues related to the pooling of interests method of accounting for business combinations. Chapter 3 in your text introduced the preparation of consolidated financial statements using the purchase method. The same topics are discussed here, modified to reflect combinations accounted for as poolings of interest. POOLED SUBSIDIARIES The pooling of interests method of accounting for business combinations was covered in Chapter 1 and its supplements, where the conditions for poolings of interests were discussed in some detail. It was assumed in that chapter that the combining corporations, other than the one issuing the stock, were dissolved. However, neither merger nor consolidation is necessary in a pooling. Paragraph 49 of APB Opinion No. 16 clearly established this point: Dissolution of a combining company is not a condition for applying the pooling of interests method of accounting for a business combination. One or more combining companies may be subsidiaries of the issuing corporation after the combination is consummated if the other conditions are met. If the other combining entities are not dissolved in a pooling of interests, the issuing corporation records the stock acquired as an investment at the subsidiary book value for the pooled net assets. In this case, a parent-subsidiary relationship is established between the issuing corporation (parent) and the other combining corporations (subsidiaries), and consolidated financial statements best reflect the combined operations of the separate entities for external reporting. The discussion in this supplement assumes that the combining corporations are not dissolved and that parent-subsidiary accounting and reporting procedures are appropriate. Except for initial differences in recording the investment in pooled companies and combining stockholders equities in the year of combination, the parent company accounts for its investments in pooled corporations under the usual equity method. The parent company increases the investment account for investment income and decreases it for subsidiary dividends and losses. Electronic Supplement to Chapter 3 1

2 Accounting for Subsidiary Investments in Poolings of Interests The parent company (issuer) records its investments in pooled companies at the book value of the net assets acquired in the other combining companies. In recording its investment in a pooled company, the parent company also combines its retained earnings with the retained earnings of the other combining company and adjusts its additional paid-in capital to reflect the paid-in capital of the pooled corporation. To illustrate the initial recording, assume that Pink Corporation issued its own capital stock for all the outstanding voting stock of Silver Corporation on January 1, Immediately before the pooling, the stockholders equity accounts for the combining corporations were as follows (in thousands): Pink Corporation Silver Corporation Capital stock, $10 par $1,500 $ 500 Additional paid-in capital Retained earnings Total stockholders equity $2,000 $1,000 If Pink Corporation issued 50,000 shares of its own stock for the outstanding stock of Silver, Pink records the investment as follows: Investment in Silver (+A) 1,000 Capital stock Pink (+SE) 500 Additional paid-in capital (+SE) 200 Retained earnings (+SE) 300 The par value of stock issued by Pink is equal to the outstanding stock of Silver, so Pink records all of Silver s retained earnings and additional paid-in capital on Pink Corporation s books. This entry assumes that the parent will record the additional paid-in capital and retained earnings from the pooling in its existing equity accounts. The assumption is consistent with the pooling concept that a single entity emerges from the combining of previously separate companies, but the separate companies do continue to exist as separate legal entities when the combining companies are not dissolved. Legal considerations affect retained earnings and other capital accounts, so it may be desirable to maintain separate accounts for equity changes that result from a pooling without dissolution. If such separation is deemed necessary, we can achieve it by designating the accounts Additional Paid-in Capital from Pooling and Retained Earnings from Pooling. This type of account separation is not used in the entries illustrated in this supplement. Pink records the issuance of 90,000 shares of Pink Corporation in the pooling as follows: Investment in Silver (+A) 1,000 Additional paid-in capital ( SE) 100 Capital stock (+SE) 900 Retained earnings (+SE) 200 In this case, the par value of capital stock issued by Pink ($900,000) exceeds the paid-in capital of Silver ($700,000) plus the additional paid-in capital of Pink ($100,000). Accordingly, the retained earnings that would otherwise be combined has to be reduced by the $100,000 difference. If Pink Corporation issued 40,000 shares for all of Silver Corporation s stock, Pink s records its investment as follows: Investment in Silver (+A) 1,000 Capital stock (+SE) 400 Additional paid-in capital (+SE) 300 Retained earnings (+SE) 300 This entry combines the maximum retained earnings of Silver and credits Pink s additional paid-in capital for $300,000. This credit to additional paid-in capital consists of the additional paidin capital of Silver ($200,000), plus the excess of capital stock of Silver ($500,000) over the par value of shares issued by Pink ($400,000). 2 ADVANCED ACCOUNTING

3 In each of the three situations, the stockholders equity of Pink Corporation increases by $1,000,000, such that Pink s stockholders equity reflects the $3,000,000 stockholders equity of the pooled entity. In consolidating the balance sheets of Pink Corporation and Silver Corporation on the date of the pooling, we eliminate the reciprocal investment in Silver and stockholders equity of Silver amounts, and the consolidated balance sheet shows the stockholders equity accounts of Pink Corporation. The consolidation working paper entries are the same in all three situations: Capital stock Silver ( SE) 500 Additional paid-in capital Silver ( SE) 200 Retained earnings Silver ( SE) 300 Investment in Silver ( A) 1,000 Note that the investment account is equal to the equity of Silver so there is no excess of investment balance over underlying equity of Silver. After the pooling, Pink Corporation increases its investment in Silver account for 100% of Silver s income and decreases it for 100% of Silver s dividends, thereby maintaining the reciprocal relationship between the investment in Silver account and the total stockholders equity of Silver. Under the equity method of accounting, Pink s net income is equal to consolidated net income, and Pink s retained earnings equals consolidated retained earnings. Pooling of Interests with Minority Interest The parent company in a pooling combination must acquire at least 90% of the outstanding shares of each combining subsidiary. Shares not acquired by the parent are accounted for as a minority interest. The minority interest can be no greater than 10% of the outstanding subsidiary shares before the pooling because additional holdings by minority interests would violate the 90% substantially all test for poolings. If the substantially all test is met, could a minority stockholder exchange some, but not all, of his or her shares for shares in the issuing corporation? The APB responded to this question by stating that under the pooling method each common stockholder of the combining company must either agree to exchange all of his shares for shares of the issue corporation or refuse to exchange any of this shares. 1 If Pink Corporation in the previous illustration had issued 50,000 shares of its own stock for 90% of the outstanding voting stock of Silver, the investment would have been recorded as follows: Investment in Silver (+A) 900 Capital stock (+SE) 500 Additional paid-in capital (+SE) 130 Retained earnings (+SE) 270 This entry on Pink s books records the investment in Silver at 90% of the book value of Silver s net assets and combines $270,000 of Silver s retained earnings with Pink s retained earnings. Pink acquired only 90% of Silver s stock, so a maximum of 90% of Silver s retained earnings can be combined. The $130,000 credit to additional paid-in capital is the excess of 90% of the paid-in capital of Silver over the par value of capital stock issued by Pink [($700,000 90%) $500,000 $130,000]. Total paid-in capital of the combining entities less the minority stockholders share can also be compared with the parent s outstanding capital stock after the pooling. If total paid-in capital is greater, the excess is the parent s additional paid-in capital after the pooling. If capital stock is greater, additional paid-in capital of the parent will be zero, and the excess is the amount by which maximum pooled retained earnings must be reduced. To illustrate, Pink s $1,600,000 paid-in capital plus 90% of Silver s $700,000 paid-in capital exceeds Pink s $2,000,000 capital stock after the pooling by $230,000. This represents Pink s $100,000 additional paid-in capital before the pooling plus the $130,000 added here. If Pink issued 40,000 shares of its own stock for the 90% interest in Silver, Pink would have recorded the following: 1 AICPA Accounting Interpretations of APB Opinion No. 16, Interpretation No. 25, November Electronic Supplement to Chapter 3 3

4 EXHIBIT 3-1 Comparison of Stockholders Equity Pooling Under Different Assumptions Consolidated (Pooled) Stockholders Equity Pink Silver Balance Sheet A. Issuance of 50,000 Shares for a 90% Interest Capital stock, $10 par $2,000 $ 500 $2,000 Additional paid-in capital Retained earnings Minority interest 100 Stockholders equity $2,900 $1,000 $3,000 B. Issuance of 90,000 Shares for a 90% Interest Capital stock, $10 par $2,400 $ 500 $2,400 Additional paid-in capital 200 Retained earnings Minority interest 100 Stockholders equity $2,900 $1,000 $3,000 C. Issuance of 40,000 Shares for a 90% Interest Capital stock, $10 par $1,900 $ 500 $1,900 Additional paid-in capital Retained earnings Minority interest 100 Stockholders equity $2,900 $1,000 $3,000 Investment in Silver (+A) 900 Capital stock (+SE) 400 Additional paid-in capital (+SE) 230 Retained earnings (+SE) 270 Exhibit 3-1 illustrates the effects of the 10% minority interest in Silver under the various assumptions discussed earlier. The stockholders equity of Pink is $2,900,000 immediately after the pooling, regardless of the number of shares issued. This $2,900,000 represents Pink s $2,000,000 stockholders equity before the pooling, plus the $900,000 book value recorded in the investment in Silver account. The $3,000,000 stockholders equity shown in the consolidated or pooled balance sheet consists of Pink Corporation s stockholders equity immediately after the pooling, plus $100,000 minority interest (10% of Silver s $1,000,000 stockholders equity. Consolidation working papers require the following entry to eliminate the reciprocal investment and equity amounts in all three situations: Capital stock Silver ( SE) 500 Additional paid-in capital Silver ( SE) 200 Retained earnings Silver ( SE) 300 Investment in Silver ( A) 900 Minority interest (+L) 100 This entry eliminates the equity accounts of Silver and the investments in Silver, and it establishes the 10% minority interest. Net assets in a pooling are accounted for on the basis of book value, so there is no excess of investment account balance over book value acquired to allocate the identifiable assets or goodwill. Acquisition of Minority Shares APB Opinion No. 16 specifically precluded firms from using the pooling method for acquisition of shares held my minority stockholders. If Pink Corporation acquired the remainder of Silver 4 ADVANCED ACCOUNTING

5 Corporation s outstanding shares after consummation of the business combination, the acquisition was not accounted for as a pooling of interests, even if the transaction was consummated through an exchange of shares. Although not a business combination, we account for the acquisition of the additional shares under the purchase method, and GAAP usually requires the transaction be recorded on a fair value basis. The result revalues 10% of the net assets of Silver Corporation. SUMMARY The pooling of interests method of accounting governs combination through the exchange of shares. If only the issuing corporation survives, the accounting is done as explained in Chapter 1. If the combining corporations continue to exist as separate legal entities, we account for the companies according to parent-subsidiary procedures with the following amendments: 1. The parent company/issuer records the subsidiary investment at its book value. Stock issued is credited for the par value of shares issued, retained earnings are combined to the extent possible, and additional paid-in capital is increased or decreased as necessary to account for differences between the par value of stock issued and paid-in capital of the other combining company. 2. Maximum retained earnings that can be combined with the parent s retained earnings is equal to the parent s ownership percentage times the subsidiary s retained earnings. 3. Earnings of combining companies are pooled for the entire year in which the business combination is consummated. The equity method is used in accounting for investments in pooled subsidiaries. If it is correctly applied, the parent company s investment account will be equal to the underlying subsidiary equity, parent company income will be equal to consolidated (pooled) income, and parent company equity account balances will equal the consolidated (pooled) equity balances. These equalities are established in the year in which the pooling takes place. In subsequent years, the parent company accounts for its investments in pooled subsidiaries in the same manner as for purchased subsidiaries, and the consolidation procedures are the same as those for purchased subsidiaries. ASSIGNMENT MATERIAL W 3-1 W 3-2 W 3-3 W 3-4 When are parent-subsidiary accounting procedures applicable to a pooling business combination? How does a parent company account for its investments in pooled subsidiaries? Under what conditions does a parent company pool (or combine) all the retained earnings of its 100%-owned subsidiaries? Assume that a parent company makes the following journal entry to record its investment in a subsidiary under the pooling method: Investment in Schwan (+A) 1,300 Capital stock, $10 par (+SE) 1,000 Additional paid-in capital (+SE) 120 Retained earnings (+SE) 180 W 3-5 Explain the components of this entry in terms of what you would expect each of the amounts to represent. Assume that the following entry is made by a parent company in recording its investment in a pooled subsidiary: Investment in Starling (+A) 1,250 Additional paid-in capital ( SE) 150 Capital stock, $10 par (+SE) 1,000 Retained earnings (+SE) 400 Electronic Supplement to Chapter 3 5

6 W 3-6 W 3-7 Did the parent company pool maximum retained earnings? Explain. Will the pooled additional paid-in capital be more or less than the parent company s additional paid-in capital before the pooling? Explain. A parent company acquires 92% of the voting stock of a subsidiary in a pooling of interests that was consummated in 1999 and an additional 4% of the subsidiary stock in How should the acquisition of the additional 4% be accounted for by the parent company? On January 1, 2001, Pascal Corporation issued 50,000 previously unissued shares of $10 par common stock for 90% of Sunset Corporation s outstanding common shares in a business combination accounted for as a pooling of interests. Balance sheet information for Pascal and Sunset at December 31, 2000, follows (in thousands): Pascal Sunset Sunset Book Value Book Value Fair Value Current assets $ 4,000 $ 800 $ 900 Plant assets net 6,000 1,400 1,500 $10,000 $2,200 $2,400 Liabilities $ 4,000 $ 800 $ 800 Capital stock, $10 par 3, Additional paid-in capital 2, Retained earnings 1, $10,000 $2,200 REQUIRED 1. Prepare the journal entry on Pascal s books to account for the business combination. 2. Prepare a consolidated balance sheet for Pascal and Subsidiary on January 1, 2001, immediately after the business combination. W 3-8 Pholmes Corporation and Shurlock Corporation consummated a pooling of interests business combination on January 1, 2000, with both companies continuing their operations in a parentsubsidiary relationship. Stockholders equities of the two companies immediately before the pooling consisted of the following (in thousands): Pholmes Shurlock Common stock, $10 par $ 500 $300 Additional paid-in capital Retained earnings Total stockholders equity $1,200 $500 REQUIRED Prepare partial balance sheets showing consolidated stockholders equity for Pholmes Corporation and Subsidiary on January 1, 2000, immediately after the pooling, under each of the following assumptions: 1. Pholmes Corporation issued 25,000 shares of previously unissued common stock with a market value of $25 per share for all of the outstanding stock of Shurlock Corporation. 2. Pholmes Corporation issued 35,000 shares of previously unissued common stock with a market value of $25 per share for 90% of the outstanding stock of Shurlock Corporation. W 3-9 Penguin Corporation and Salty Corporation consummated a business combination on December 31, 2000, with Penguin exchanging its previously unissued $10 par common shares for common stock held by Salty s stockholders. The combination met all the requirements for a pooling of interests, and the companies expected to continue their own operations in a parent company subsidiary relationship. Summary balance sheet data for the two companies at December 31, 2000, were as follows (in thousands): Penguin Salty Assets Current assets $ 8,000 $4,000 Plant assets 12,000 3,000 Total assets $20,000 $7,000 (Continued) 6 ADVANCED ACCOUNTING

7 Penguin Salty Liabilities and Stockholders Equity Current liabilities $ 1,000 $2,000 Long-term liabilities 3,000 Common stock, $10 par 10,000 3,000 Additional paid-in capital 1,000 1,500 Retained earnings 5, Total equities $20,000 $7,000 REQUIRED Prepare a partial balance sheet showing consolidated stockholders equity for Penguin Corporation and Subsidiary at December 31, 2000, immediately after the pooling of interests under each of the following assumptions: 1. Penguin issued 300,000 shares of its common stock for all the outstanding shares of Salty Corporation. 2. Penguin issued 500,000 shares of its common stock for all the outstanding shares of Salty Corporation. 3. Penguin issued 300,000 shares of its common stock for 90% of the outstanding shares of Salty Corporation. 4. Penguin issued 500,000 shares of its common stock for 90% of the outstanding shares of Salty Corporation. Electronic Supplement to Chapter 3 7