Consolidated Financial Statements

Question 1

What are three different ways to account for one company’s investment in another?

Answer 1

Cost method (lack significant influence: 0-20% ownership)

Equity method (has significant influence: 20-50% ownership)

Consolidation (has control: >50% ownership)

Question 2

Besides voting stock, what else is evidence of “significant influence” in another company?

Answer 2

Participating in policy-making or directorship

Level of intercompany transactions or dependency

Ownership concentrated with few stockholders

Question 3

Under the cost method, how is the investment initially recorded?

Answer 3

At cost, including broker’s fees and other acquisition costs

Question 4

How is the investment account changed under the cost method?

Answer 4

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

Question 5

How are stock rights recorded under the cost method?

Answer 5

Carrying value of investment is allocated between investment and stock right (based on relative FV)

Question 6

How are disposals of investments accounted for under the cost method?

Answer 6

Report realized gain or loss on diff. between CV and FV

Carrying amount may be determined by specific identification, FIFO, or average method

Question 7

Is it possible for a company to have 20% ownership of voting stock (or more) and still lack significant influence?

Answer 7

Yes – the major exception is if the subsidiary is in a foreign country with major operating restrictions

Question 8

What are other reasons why 20% ownership is not sufficient for significant control?

Answer 8

• 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

Question 9

How should the original acquisition be recorded under the equity method?

Answer 9

At cost

Question 10

What happens if a company previously has less than 20% and then gains >20% ownership in a company?

Answer 10

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

Question 11

Under the equity method, what is the JE for the investor to recognize a share in the investee’s earnings?

Answer 11

Dr: Investment
Cr: Investment Income

Cumulative preferred dividends should be subtracted from earnings/loss to determine investor’s share in earnings/loss

Question 12

Under the equity method, how is preferred stock recorded?

Answer 12

Simply at cost (since it’s nonvoting stock)

Preferred dividends recorded, ordinarily, as dividend income

Question 13

What happens if an investor and investee have different fiscal years?

Answer 13

Investor can still report share in earnings from most recent financial statements of investee, so long as the time lag is consistent

Question 14

How are dividends recorded under the equity method?

Answer 14

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

Question 15

What happens when an investor pays more than the book value to acquire a company’s common stock?

Answer 15

Any excess price is recorded as goodwill

Very rare for book value to equal purchase price

Question 16

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?

Answer 16

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

Question 17

Under the equity method, how are intercompany profits and losses recorded?

Answer 17

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)

Question 18

Under the equity method, how are intercompany receivables and payables recorded?

Answer 18

As normal – they should be eliminated only if the two are consolidated

Question 19

How are capital transactions recorded under the equity method?

Answer 19

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)

Question 20

How are deferred income taxes recorded under the equity method?

Answer 20

Should be recognized for temporary difference arising from difference between income recognized and dividends received

Also, dividends-received deduction is a permanent difference

Question 21

How do changes in common stock’s FV affect the investor’s Investment accounts?

Answer 21

They affect neither Investment nor Investment Income

Question 22

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?

Answer 22

$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)

Question 23

If X has 20% ownership in Y and Y distributes $4000 of cash dividends, what is the appropriate JE for X?

Answer 23

Dr: Cash (800)
Cr: Investment (800)

20% x $4000 = 800

Question 24

How do liquidating dividends affect the Investment account under the equity method?

Answer 24

They decrease it

Technically, all dividends over the investor’s share of the investee’s income reduce the Investment account

Question 25

What happens if ownership drops below 20%?

Answer 25

Change to cost method: - Investor should stop accruing a share of investee income - New cost basis = carrying amount of investment at date of change

Question 26

If a company changes to the equity method (i.e. exceeds 20% ownership), how much should RE be adjusted?

Answer 26

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)

Question 27

How are losses reported on the equity method?

Answer 27

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

Question 28

What should be reported on the financial statement under the equity method?

Answer 28

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

Question 29

What is a chain of interests?

Answer 29

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)

Question 30

How should business combinations be accounted for?

Answer 30

Acquisition method: - identifying acquirer - determining acquisition date - recognizing assets and liabilities acquired, & any noncontrolling interest - recognizing goodwill or a gain from a bargain purchase

Question 31

For a business combination, what are the closing date and the control date?

Answer 31

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

Question 32

What are the criteria for acquired assets and liabilities to qualify as part of the acquisition method?

Answer 32

- meet the definitions of assets/liabilities at the acquisition date - be part of the business combination transaction, not a separate one

Question 33

What can happen when the acquirer recognizes assets and liabilities?

Answer 33

It recognizes assets/liabilities previously unrecognized (e.g. brand name)

Question 34

How does the acquirer account for contingencies?

Answer 34

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

Question 35

How does the acquirer recognize valuation allowances on acquired assets?

Answer 35

He doesn't -- all assets are recognized at FV, so valuation allowances are built in

Question 36

How does the acquirer treat assets that are part of operating leases in which the acquiree is the lessor?

Answer 36

Assets should be measured at FV separately from the lease contract Asset/liability is separately recognized if lease terms deviate from market terms

Question 37

How does the acquirer treat assets he intends not to use fully?

Answer 37

Still measures them at FV (i.e. for the asset's highest and best use) Both for initial measurement and for later impairment testing

Question 38

How does the acquirer measure a noncontrolling interest?

Answer 38

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

Question 39

How is goodwill recognized in an acquisition?

Answer 39

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

Question 40

How is goodwill measured?

Answer 40

(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

Question 41

If only equity interests are exchanged in an acquisition, how should goodwill be measured?

Answer 41

By using the acquisition-date FV for the acquiree's equity interests, since those are generally more reliable than the acquirer's

Question 42

If no consideration is transferred in an acquisition, how should goodwill be measured?

Answer 42

Acquisition-date FV of acquirer's interest shall be determined using a valuation technique instead of (1) in the original goodwill formula

Question 43

How is goodwill allocated to the acquirer and to a noncontrolling interest?

Answer 43

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

Question 44

What is a bargain purchase?

Answer 44

If there is "negative goodwill" (i.e. if (2) exceeds (1) in the formula) Recognized as a gain in earnings on the acquisition date

Question 45

How is the gain on a bargain purchase split between the acquirer and the noncontrolling interest?

Answer 45

Goes entirely to acquirer

Question 46

What must happen before an acquirer recognizes a gain on a bargain purchase?

Answer 46

He has to reassess the measurement of the acquiree's FV

Question 47

What happens if the acquirer gives consideration whose carrying amount differs from its FV?

Answer 47

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

Question 48

Does the consideration paid by the acquirer include contingent consideration?

Answer 48

Yes

Question 49

What is it called if a company acquires another after already having a (non-owning) equity interest in it?

Answer 49

A business combination achieved in stages Also called a step acquisition

Question 50

Since new acquirers have to measure the noncontrolling interest at FV, what do step-acquirers do with their own equity interest?

Answer 50

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

Question 51

How can a company acquire another without paying consideration?

Answer 51

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

Question 52

If an acquirer and acquiree agree to combine by contract alone, what is done with the other equity interests?

Answer 52

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

Question 53

What happens if the accounting for a business combination is not done by the end of the period in which the combo occurred?

Answer 53

The acquirer reports provisional amounts for the incomplete items He has a "measurement period" after the acquisition date when these amounts can be changed

Question 54

When an acquirer changes provisional amounts during the measurement period, how are they recognized?

Answer 54

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

Question 55

How long does the measurement period last?

Answer 55

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

Question 56

What are included in acquisition-related costs?

Answer 56

Finder's fees Advisory, legal, accounting, valuation, consulting fees Cost to register and issue securities

Question 57

How should acquisition-related costs be accounted for?

Answer 57

Expensed as incurred Exception: costs to issue securities are under ordinary GAAP

Question 58

How are contingencies treated under the acquisition method?

Answer 58

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

Question 59

For contingencies under the acquisition method, how are assets/liabilities measured?

Answer 59

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

Question 60

When consolidating financial statements, how are intercompany balances and transactions recorded?

Answer 60

Eliminated for presentation, but eliminating JEs are NOT entered into any books

Question 61

What are the three steps of consolidation?

Answer 61

Eliminate Capital and Investment Accounts Eliminate Intercompany Balances Eliminate Intercompany Transactions

Question 62

What happens when capital and investment accounts are eliminated?

Answer 62

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

Question 63

What happens for income taxes paid on intercompany transactions?

Answer 63

Taxes shall be deferred or intercompany profits (which are going to be eliminated) shall be reduced

Question 64

For a consolidation, when a subsidiary's asset's FV is higher than its BV, what is the parent's JE to record it?

Answer 64

For higher FV... Dr: Asset Cr: Investment in subsidiary Vice versa if FV is lower

Question 65

For a consolidation, how does the parent record the subsidiary's income attributable to the parent?

Answer 65

Dr: Investment in subsidiary Cr: R/E amount = (ownership %) x (income)

Question 66

For a consolidation, how does the parent record goodwill?

Answer 66

Dr: Goodwill | Cr: Investment in subsidiary

Question 67

For a 100% consolidation, how does the parent record the closing of the subsidiary's capital and investment accounts?

Answer 67

Dr: Common Stock (and whatever else) Dr: R/E Cr: Investment in subsidiary

Question 68

How does a noncontrolling interest affect the JEs which the parent will make in a consolidation?

Answer 68

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

Question 69

For consolidations, what must be done with intercompany receivables, payables, and loans?

Answer 69

All removed, including interest income/expense

Question 70

What are the JEs to remove loans (payables) and interest income/expense for consolidations?

Answer 70

Simply offset the items against each other E.g. debit note payable and credit note receivable; debit interest expense and credit interest income

Question 71

What is important to remember about interest income/expenses for subsidiaries in consolidation?

Answer 71

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

Question 72

What are three problems arising from intercompany sales of inventory?

Answer 72

(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)

Question 73

What is the best way to make calculations for intercompany inventory sales?

Answer 73

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

Question 74

Once you have calculated gross profits for intercompany inventory sales, what do you do next?

Answer 74

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

Question 75

What are two problems emerging from intercompany sales of fixed assets?

Answer 75

(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

Question 76

What change should be made to the recorded amounts of fixed assets traded between companies?

Answer 76

Restore carrying amount of asset to original BV and remove the seller's gain/loss

Question 77

What change should be made to depreciation expense for fixed assets traded between companies?

Answer 77

Depreciation and expense and accumulated depreciation should both reflect the asset's original BV

Question 78

How should RE be affected by fixed assets traded between companies?

Answer 78

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

Question 79

Which JE is necessary immediately after an intercompany fixed-asset transaction?

Answer 79

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.

Question 80

Which JE is necessary periodically after an intercompany fixed-asset transaction?

Answer 80

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.

Question 81

What are the JEs for intercompany fixed-assets transactions after year 1?

Answer 81

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

Question 82

For intercompany fixed-assets transactions after year 1, by how much is accumulated depreciation credited?

Answer 82

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)

Question 83

For intercompany fixed-assets transactions after year 1, by how much is RE debited?

Answer 83

By the amount of the gain minus the amount of adjusted depreciation expense

Question 84

How is an intercompany direct sale of bonds accounted for?

Answer 84

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

Question 85

What happens if bonds have been issued by one company, sold to a third party, and then repurchased by another (consolidated) company?

Answer 85

Bonds are treated as if they were retired The reacquisition of the bonds will then involve a gain or loss on their "retirement"

Question 86

For intercompany bond transactions with a third party, how is the retirement gain/loss measured?

Answer 86

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

Question 87

For intercompany bond transactions with a third party, what are the year-end adjustments?

Answer 87

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

Question 88

For intercompany bond transactions with a third party, what different adjustment must be made after the first year?

Answer 88

Adjustment to RE Amount = gain on retirement minus any amortized amount to that point

Question 89

For intercompany bond transactions with a third party, what happens if the bond is originally issued at a discount or premium?

Answer 89

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

Question 90

How does a NCI affect any income between the parent and subsidiary?

Answer 90

Any intercompany income/loss can be allocated between the parent and the NCI

Question 91

How are rev/exp/G/L/income/OCI reported in consolidated financial statements if there is a NCI?

Answer 91

Reported at consolidated amounts (i.e. not split up)

Question 92

What happens if losses attributable to the parent or the NCI exceed their equity interests?

Answer 92

Losses are still attributed to those interests, even if they go negative

Question 93

If a parent has a decrease or increase in its equity interest, how is it accounted for?

Answer 93

Treated as equity transactions (contributions by and distributions to owners) Thus, no gain/loss recognized

Question 94

If a parent has a decrease or increase in its equity interest, how does it affect the NCI?

Answer 94

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

Question 95

If a parent has a decrease or increase in its equity interest, how might OCI be affected?

Answer 95

Any accumulated OCI will be adjusted to reflect the change in ownership interest Charge or credit to parent's equity

Question 96

When should a parent deconsolidate a subsidiary?

Answer 96

On the date it loses a controlling interest (can happen in a number of ways)

Question 97

How should deconsolidations be recognized?

Answer 97

If it occurs through a nonreciprocal transfer to owners (e.g. a spinoff), then use nonmonetary transaction guidance Otherwise, use special rules for deconsolidation

Question 98

What are the special rules for a parent's recognizing a deconsolidation?

Answer 98

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

Question 99

If a parent loses its controlling interest through two or more transactions, how should it be reported?

Answer 99

May need to be treated as a single transaction -- depends on the transactions' - timing - form - dependence - economic justification

Question 100

How are a subsidiary's books affected by a business combination?

Answer 100

They're ordinarily not Only are affected under push-down accounting

Question 101

When are combined (rather than consolidated) financial statements appropriate?

Answer 101

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

Question 102

What would be a good reason to prepare financials for the parent company (apart from the consolidated statements)?

Answer 102

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

Question 103

If a subsidiary owns stock in the parent, how is it reported on the consolidated statements?

Answer 103

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