Chapter 3
Consolidations—Subsequent to
the Date of acquisition
ANSWERS TO QUESTIONS
1. a. CCES Corp., for its own recordkeeping, may apply the equity method to the investment in Dawkins. Under this approach, the parent's records parallel the activities of the subsidiary. Income will be accrued by the parent as it is earned by the subsidiary. Dividends paid by Schmaling cause a reduction in book value; therefore, the investment account is reduced by CCES in a corresponding manner. In addition, any excess amortization expense associated with the allocation of CCES's purchase price is recognized through a periodic adjustment. By applying the equity method, both the income and investment balances maintained by the parent accurately reflect consolidated totals. The equity method is especially helpful in monitoring the income of the business combination. This method can be, however, rather difficult to apply and a timeconsuming process.
b. The cost method. The cost method can also be utilized by CCES Corporation. Any dividends received will be accounted for as Income but no other investment entries are recorded. Thus, the cost method is quite easy to apply. However, the balances found within the parent's financial records may not provide a reasonable representation of the totals that will result from consolidating the two companies.
c. The partial equity method combines the advantages of the previous two techniques. Income is accrued as earned by the subsidiary in the same manner as the equity method. Similarly, dividends are reported as a reduction in the investment account. However, no other entries are recorded; more specifically, amortization is not recognized by the parent. The method is, therefore, easier to apply than the equity method but the subsidiary's individual totals will still frequently approximate consolidated balances.
2. a. The consolidated total for equipment is made up of the sum of Maguire’s book value, Williams’ book value, and any unamortized excess cost attributable to Williams’ equipment.
b. Although an Investment in Williams account is appropriately maintained by the parent, from a consolidation perspective the balance is intercompany in nature. Thus, the entire amount will be eliminated in arriving at consolidated financial statements.
c. Only dividends paid to outside parties are included in consolidated statements. Because Maguire owns 100 percent of Williams, all of the subsidiary's dividends are intercompany. Consequently, only the dividends paid by the parent company will be reported in the financial statements for this business combination.
d. Any goodwill recognized within Maguire's original acquisition price must still be reported for consolidation purposes. Reductions to the goodwill balance are made if good will is determined to be impaired.
e. Unless intercompany revenues have been recorded, consolidation is achieved in subsequent periods by adding the two book values together.
f. Consolidated expenses can be determined by adding the parent's book value to that of the subsidiary and then including any amortization expense associated with the purchase price. As will be discussed in detail in Chapter Five, intercompany expenses can also be present which require elimination in arriving at consolidated figures.
g. Only the common stock outstanding for the parent company is included in consolidated totals.
h. The net income for a business combination is calculated as the difference between consolidated revenues and consolidated expenses.
3. a. In a pooling of interests, consolidated equipment is always the total of the two separate book values.
b. All amounts within the Investment in Williams account should be eliminated within the consolidation process.
c. Only dividends paid to outside parties are included in consolidated financial statements. Thus, only Maguire's dividends should be reported.
d. Goodwill is never applicable in a pooling of interests.
e. Unless intercompany revenues have been recognized, the consolidated total is the summation of the separate balances reported by the two companies.
f. Because no amortization is created in consolidating a pooling of interests, the two expense accounts can be added together to determine the total to be reported. As indicated in the answer to Question 2, if intercompany expenses exist, they must be eliminated within the consolidation process (see Chapter 5).
g. Only the common stock of Maguire (as the acquiring company) will be included in the consolidated totals. However, this account balance was increased at the date the combination was formed by the shares issued to create the pooling of interests.
h. Consolidated net income is always the difference between consolidated revenues and consolidated expenses.
4. When using the equity method, subsidiary earnings are accrued and amortization expense (associated with the acquisition price in a purchase) is recognized in the same manner as in the consolidation process. The equity method parallels consolidation. Thus, the net income and retained earnings reported by the parent company each year will equal the consolidated totals.
5. In the consolidation process, excess amortizations must be recorded annually for any portion of the purchase price that is allocated to specific accounts (other than land or to goodwill). Although this expense can be simulated in total on the parent's books by an equity method entry, the actual amortization of each allocated cost is appropriate for consolidation. Hence, the effect of the parent's equity method amortization entry is removed as part of Entry I so that the amortization of specific accounts (e.g., depreciation) can be recorded (in consolidation Entry E).
6. When the cost method is applied by the parent company, no accrual is recorded to reflect the subsidiary's change in book value during the years following acquisition. Furthermore, recognition of excess amortizations relating to the acquisition price is also omitted by the parent. The partial equity method, in contrast, records the subsidiary’s book value increases and decreases but not amortizations. Consequently, for both of these methods, a technique must be established within the consolidation process to record the omitted figures. Entry *C simply brings the parent's records (more specifically, the beginning retained earnings balance and the investment account) uptodate as of the first day of the current year. If the cost method has been applied by the acquiring company, any changes in the subsidiary's book value in previous years must be recorded on the worksheet along with the appropriate amount of amortization expense. For the partial equity method, only the amortization relating to these prior years needs to be recognized.
No similar entry is needed if the equity method has been applied; changes in the subsidiary's book value as well as excess amortization expense will be recorded each year by the parent. Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established without further adjustment.
7. Lambert's loan payable and the receivable held by Jenkins are intercompany accounts. As such, the reciprocal balances should be offset in the consolidation process. The $100,000 is not a debt to or a receivable from an unrelated (or outside) party and should, therefore, not be reported in consolidated financial statements. Additionally any interest income/expense recognized on this loan is also intercompany in nature and must likewise be eliminated.
8. Since the equity method has been applied by Benns, the $920,000 is composed of four balances:
a. The original purchase price paid by the parent
b. The annual accruals made by Benns to recognize income as it is earned by the subsidiary;
c. The reductions that are created by the subsidiary's payment of dividends;
d. The periodic amortization recognized by Benns in connection with the allocations identified with its purchase price.
9. The $100,000 attributed to goodwill is reported at its original amount unless a portion of goodwill has been impaired or sold.
10. The additional consideration is merely an extra component of the price paid by Remo to purchase Albane. Thus, any goodwill recognized at the original date of acquisition will be increased in 2004 by $100,000. However, if a bargain purchase occurred on January 1, 2003, this new payment reduces the allocations to noncurrent assets previously recognized for consolidation purposes.
11. At present, the Securities and Exchange Commission requires the use of pushdown accounting for the separate financial statements of a subsidiary where no substantial outside ownership exists. Thus, if Company A owns all of Company B, the pushdown method of accounting would be appropriate for the separately issued statements of Company B. The SEC normally requires pushdown accounting where 95 percent of a subsidiary is acquired and the company has no outstanding public debt or preferred stock.
Pushdown accounting may be required if 8095 percent of the outstanding voting stock is purchased. Pushdown accounting is justified in that the cost figures paid by the present owners are being reported. For example, if a piece of land costs Company B $10,000 but Company A pays $13,000 for the land when acquiring Company B, the land has a cost to the current owners of B of $13,000. If B's financial records had been united with A at the time of the acquisition, the land would have been reported at $13,000. Thus, leaving the $10,000 figure simply because separate incorporation is maintained is viewed, by proponents of pushdown accounting, as unjustified.
12. When pushdown accounting is applied, the subsidiary adjusts the book value of its assets and liabilities based on the allocations made at the date of the acquisition. Periodic amortization expense is recognized subsequently by the subsidiary on each of these allocations (except for land). Therefore, the income recorded by the subsidiary is a fair representation of that company's impact on consolidated earnings.
The parent uses no special procedures when pushdown accounting is being applied. However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary.
See Library Assignment Number Two in the textbook for articles on pushdown accounting.
13. Pushdown accounting has become popular for the parent's internal reporting purposes for two reasons. First, this method simplifies the consolidation process each year. If purchase price allocations and subsequent amortization are recorded by the subsidiary, they do not need to be repeated each year on a consolidation worksheet. Second, recording of amortization by the subsidiary enables that company's information to provide a good representation of the impact that the acquisition has on the earnings of the business combination. For example, if the subsidiary earns $100,000 each year but annual amortization is $80,000, the acquisition is only adding $20,000 to the income of the combination each year rather than the $100,000 that is reported by the subsidiary unless pushdown accounting is used.
14. A pooling of interests consolidation is based on the book values of the companies involved. No acquisition price is determined so that no amounts are allocated to either specific accounts or to goodwill. Consequently, amortization is not recognized. The consolidation process is simplified by the elimination of allocations and amortization and reliance on book values.
15. A parent should consider recognizing an impairment loss for goodwill associated with a purchased subsidiary when, at the reporting unit level, the fair value is less than its carrying amount. Goodwill is reduced when its carrying value is less than its fair value. To compute fair value for goodwill, its implied value is calculated by subtracting the fair values of the reporting unitsd identifiable net assets from its total fair value. The impairment is recognized as a loss from continuing operations.
ANSWERS TO PROBLEMS
1. A
2. B
3. A
4. D Willkom equipment book value –12/31/04 $210,000
Szabo book value – 12/31/04 140,000
Original purchase price allocation to Szabo's equipment
($300,000 $200,000) 100,000
Amortization of allocation
($100,000/10 years for 3 years) (30,000)
Consolidated equipment $420,000
5. A
6. C
7. B
8. C
9. C $60,000 allocation to equipment is "pusheddown" to subsidiary and increases balance from $330,000 to $390,000. Consolidated balance is $420,000 plus $390,000.
10. B Annual Excess Amortization Expenses
—Equipment $66,000/10 years = $6,600
—Goodwill – indefinite life 0
Total $6,600
Consolidated Net Income
—Revenues (add book values) $1,600,000
—Expenses (add book values and include excess
amortizations) 906,600
Consolidated Net Income $ 693,400
11. A Annual Amortization Expense
—Equipment $66,000/10 years = $6,600
—Goodwill – indefinite life 0
Total $6,600
Investment in Sysk initial cost $310,000
Income Accrual 2002 150,000
Excess Amortization 2002 (6,600)
Dividends Collected 2002 (60,000)
Income Accrual 2003 180,000
Excess Amortization 2003 (6,600)
Dividends Collected 2003 (60,000)
Income Accrual 2004 (revenues minus expenses) 200,000
Excess Amortization 2004 (6,600)
Dividends Collected 2004 (60,000)
Investment in Sysk, 12/31/04 $640,200
12. C Because the cost method has been applied, the parent's retained earnings balance will not include the amount of the subsidiary's income that exceeds dividends paid. In addition, excess amortization expense ($6,600 per year) will not have been recorded by the parent.
Parent's Retained Earnings, 1/1/04 $700,000
Additional Equity Accrual—2002 ($150,000 $60,000) 90,000
Additional Equity Accrual—2003 ($180,000 $60,000) 120,000
Excess Amortizations, 2002-03 ($6,600 x 2 years) (13,200)
Consolidated Retained Earnings, 1/1/04 $896,800
13. (35 Minutes) (Determine consolidated retained earnings when parent uses various accounting methods. Determine Entry *C for each of these methods.)
a. CONSOLIDATED RETAINED EARNINGS
—EQUITY METHOD
Herbert (parent) balance 1/1/01 $400,000
Herbert Income 2001 40,000
Herbert dividends 2001 (subsidiary dividends are
intercompany and, thus, eliminated) (10,000)
Rambis Income 2001 (not included in parent's income) 20,000
Amortization 2001 (12,000)
Herbert Income 2002 50,000
Herbert dividends—2002 (10,000)
Rambis income 2002 30,000
Amortization 2002 (12,000)
Consolidated Retained Earnings, 12/31/02 $496,000
13. a. (continued)
—PARTIAL EQUITY METHOD AND COST METHOD
Consolidated retained earnings are the same regardless of the method in use: the beginning balance plus the income of the parent less the dividends of the parent plus the income of the subsidiary less amortization expense. Thus, consolidated retained earnings on December 31, 2002 is $496,000 as computed above.
b. Investment in Rambis – Equity Method