advance accounting ch09

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Intercompany Intercompany Bond Holdings and Miscellaneous Bond Holdings and Miscellaneous Topics—Consolidated Financial Topics—Consolidated Financial StatementsStatements

Advanced Accounting, Fifth Edition

99

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1. Describe the term “constructive retirement of debt.”2. Describe how the gain or loss on constructive retirement of

intercompany bond holdings is allocated between the purchasing and issuing companies.

3. Explain the impact on the consolidated financial statements when a company issues a note to an affiliated company, which then discounts the note with an outside company.

4. Determine the effect on the consolidated financial statements when a subsidiary issues a stock dividend.

5. Understand the difference in how stock dividends and cash dividends issued by a subsidiary company affect the consolidated financial statements.

Learning ObjectivesLearning Objectives

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6. Determine the impact on the investment account when a subsidiary issues a stock dividend from preacquisition earnings and from postacquisition earnings.

7. Explain how the purchase price is allocated when the subsidiary has both common and preferred stock outstanding.

8. Determine the controlling interest in income when the parent company owns both common and preferred stock of the subsidiary.

Learning ObjectivesLearning Objectives

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Intercompany Bond HoldingsIntercompany Bond Holdings

LO 1 Constructive retirement of debt.LO 1 Constructive retirement of debt.

An affiliate company may purchase bonds issued by another affiliate.Intercompany

bond investments (receivable), bonds payable (liability),intercompany interest expense and, Intercompany interest revenue,

must be eliminated.Bonds not held by external parties are viewed as being constructively retired in the consolidated financial statements. This is viewed as early retirement of debt.

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Illustration: Three year bonds with a par value of $100,000 are issued on Jan. 2, 2010, for $85,000. The bonds pay 7% interest each December 31. Assume straight-line amortization of the discount.

Accounting for Bonds - A ReviewAccounting for Bonds - A Review


7% Discount CarryingDate I nterest Amortized Amount

1/ 1/ 10 85,000$ 12/ 31/ 10 7,000$ 5,000$ 90,000 12/ 31/ 11 7,000 5,000 95,000 12/ 31/ 12 7,000 5,000 100,000

**

* * $100,000 – 85,000 = 15,000 / 3 years = $5,000$100,000 – 85,000 = 15,000 / 3 years = $5,000

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Journal entries for 2010:

Jan. 2 Cash 85,000Discount on bonds payable 15,000

Bonds payable 100,000

Dec. 31 Interest expense 7,000Cash 7,000

Interest expense 5,000Discount on bonds payable 5,000



Illustration - Issuing Company.

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Journal entries for 2010:

Jan. 2 Investment in bonds 85,000Cash 85,000

Dec. 31 Cash 7,000Interest revenue 7,000

Investment in bonds 5,000Interest revenue 5,000



Illustration - Investor Company.

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Constructive Gain or Loss on IntercompanyConstructive Gain or Loss on IntercompanyBond HoldingsBond Holdings


The acquisition of an affiliate’s outstanding bonds from outsiders is considered a constructive retirement by the consolidated entity.The constructive gain or loss is recognized in the consolidated income statement prior to the recognition of the gain or loss on the books of the individual companies.In the period the bonds are purchased, workpaper entries are made to accelerate the recognition of the gain or loss. After the bonds are purchased, workpaper entries are needed to eliminate the portion of the gain or loss recorded during the period on the books of the individual companies.

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Constructive Gain or LossConstructive Gain or Loss

LO 2 Allocating the constructive gain or loss.LO 2 Allocating the constructive gain or loss.

Allocation of Constructive Gain or LossFour methods for allocating the constructive gain or loss between the parent and subsidiary:

1. Entirely to the issuing company.

2. Entirely to the purchasing company.

3. Entirely to the parent company.

4. Allocated between the purchasing and issuing companies.

The authors consider the fourth method to be the soundest

conceptually.

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Computing the Constructive Gain or LossOn the date bonds of an affiliate are purchased, a constructive gain or loss is computed.

The portion allocated to the issuing company is the difference between the book value (carrying value) of the bonds issued and their par value; The portion allocated to the purchasing company is the difference between the par value of the bonds and their cost.

There is no constructive gain or loss if the bonds are issued or purchased at par value.

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Computing the Constructive Gain or LossIf the issue price and purchase price were not equal to par value, there are four possible combinations that can result:Issuing Co. Purchasing Co.

Book Value Par Value Purchase Price1. 110,000$ > 100,000$ > 85,000$ 2. 90,000 < 100,000 < 115,000 3. 110,000 > 100,000 < 115,000 4. 90,000 < 100,000 > 85,000

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Computing the Constructive Gain or LossIssuing Co. Purchasing Co.Book Value Par Value Purchase Price

3. 110,000 > 100,000 < 115,000

+ $10,000 Constructive

gain

- $15,000 Constructive

loss

- $5,000 Net constructive loss

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Computing the Constructive Gain or LossIssuing Co. Purchasing Co.Book Value Par Value Purchase Price

4. 90,000 > 100,000 < 85,000


loss

+ $15,000 Constructive

gain

+ $5,000 Net constructive gain

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Accounting for Intercompany Bonds Accounting for Intercompany Bonds IllustratedIllustrated


Illustration: P Company acquired an 80% interest in S Company for $1,200,000 on January 2, 2009, when the retained earnings and common stock accounts of S Company were $500,000 and $1,000,000, respectively. On December 31, 2012, P Company acquired $300,000 of S Company’s par value bonds (60% of S Company’s bonds) on the open market for $310,000 after the semiannual interest payment had been made. At the time of purchase there were $500,000 par value bonds outstanding with a book value of $480,000. The bonds mature in four years on December 31, 2016, and carry an interest rate of 9%. Interest is paid semiannually on June 30 and December 31. Both companies use the straight-line method to amortize bond discounts and premiums. The fiscal year-end of both companies is December 31.

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Book Entry Related to Bond Book Entry Related to Bond InvestmentInvestment


Dec. 31

Prepare the entry made by P Company to record the bond investment on December 31, 2012:

Note: The usual practice of recording a bond investment does

not separate the discount or premium. Since the bonds were purchased on the open market,

there is no entry made on the issuing company’s books.

Investment in S Company Bonds 310,000Cash 310,000

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Compute the Constructive Gain or LossS Company P CompanyBook Value Par Value Purchase Price

288,000 > 300,000 < 310,000


loss


loss

- $22,000 Net constructive loss

Book Entry Related to Bond Book Entry Related to Bond InvestmentInvestment


On the books of the individual

companies, the constructive loss is

not recorded.

The constructive loss is recognized in the determination of

consolidated income.

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P S Consolidated Income Statement Company Company Debit Credit NCI Balances Sales 3,104,000 2,200,000 5,304,000 Dividend income 16,000 16,000 -

Total revenue 3,120,000 2,200,000 5,304,000 Cost of goods sold 1,700,000 1,360,000 3,060,000 Interest expense 50,000 50,000 Other expenses 1,124,000 665,000 1,789,000 Loss on constructive 10,000

retirement of bonds 12,000 22,000 Total cost and expense 2,824,000 2,075,000 4,921,000

Net income 296,000 125,000 383,000 Noncontrolling interest 22,600 (22,600) Net income 296,000 125,000 38,000 - 22,600 360,400

Retained Earnings StatementRetained earnings, 1/1 1,650,000 700,000 700,000 160,000 1,810,000 Net income 296,000 125,000 38,000 - 22,600 360,400 Dividends declared (150,000) (20,000) 16,000 (4,000) (150,000) Retained earnings, 12/31 1,796,000 805,000 738,000 176,000 18,600 2,020,400

Balance SheetInvestment in S Co. bonds 310,000 10,000 -

300,000 Investment in S. Co. stock 1,200,000 160,000 1,360,000 - Other assets 5,420,000 2,620,000 8,040,000

Total assets 6,930,000 2,620,000 8,040,000 9% bonds payable 500,000 300,000 200,000 Discount on bonds payable (20,000) 12,000 (8,000) Other liabilities 2,134,000 335,000 2,469,000 Capital stock 3,000,000 1,000,000 1,000,000 3,000,000 Retained earnings 1,796,000 805,000 738,000 176,000 18,600 2,020,400 NCI in net assets 1/1 340,000 340,000 - NCI in net assets 12/31 358,600 358,600

Total liab. & equity 6,930,000 2,620,000 2,198,000 2,198,000 8,040,000

Eliminations

(1)

(5)

(4)

Consolidated Statements Workpaper—2012 Consolidated Statements Workpaper—2012

(2)(3)

(6)

(5)

(2)(4)(6)(1)

(6)

(6)

Cost Method

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P S Consolidated Income Statement Company Company Debit Credit NCI Balances Sales 3,104,000 2,200,000 5,304,000 Dividend income 16,000 16,000 -

Total revenue 3,120,000 2,200,000 5,304,000 Cost of goods sold 1,700,000 1,360,000 3,060,000 Interest expense 50,000 50,000 Other expenses 1,124,000 665,000 1,789,000 Loss on constructive 10,000

retirement of bonds 12,000 22,000 Total cost and expense 2,824,000 2,075,000 4,921,000

Net income 296,000 125,000 383,000 Noncontrolling interest 22,600 (22,600) Net income 296,000 125,000 38,000 - 22,600 360,400

Retained Earnings StatementRetained earnings, 1/1 1,650,000 700,000 700,000 160,000 1,810,000 Net income 296,000 125,000 38,000 - 22,600 360,400 Dividends declared (150,000) (20,000) 16,000 (4,000) (150,000) Retained earnings, 12/31 1,796,000 805,000 738,000 176,000 18,600 2,020,400

Eliminations

(1)

(5)


(2)(3)

(6)

(5)


* ($125,000 $12,000) x 20% = $22,600

*

Cost Method

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P S Consolidated Balance Sheet Company Company Debit Credit NCI Balances Investment in S Co. bonds 310,000 10,000 -


Total assets 6,930,000 2,620,000 8,040,000 9% bonds payable 500,000 300,000 200,000 Discount on bonds payable (20,000) 12,000 (8,000) Other liabilities 2,134,000 335,000 2,469,000 Capital stock 3,000,000 1,000,000 1,000,000 3,000,000 Retained earnings 1,796,000 805,000 738,000 176,000 18,600 2,020,400 NCI in net assets 1/1 ** 340,000 340,000 - NCI in net assets 12/31 358,600 358,600


Eliminations

(2)


(4)(6)(1)

(4)

(3)

(6)

(6)


** $300,000 ($700,000 - $500,000) x 20% = $340,000

Cost Method

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Investment in S Company Stock 160,000Beginning Retained Earnings—P Company 160,000

To establish reciprocity, or convert to equity

Worksheet entries for 2012.

Retained earnings balance—January 1, 2012 $ 700,000Retained earnings balance—date of acquisition 500,000Increase in retained earnings 200,000Percentage interest held by P Company 80%Amount to establish reciprocity

$ 160,000


1.

Consolidated Statements Workpaper—2012Consolidated Statements Workpaper—2012

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Loss on Constructive Retirement of Bonds 10,000Investment in S Company Bonds 10,000

To recognize the constructive loss not recorded by P Company and adjust the bond investment to par value.



2.

Loss on Constructive Retirement of Bonds 12,000Discount on Bonds Payable 12,000

To recognize the constructive loss not recorded by the subsidiary and adjust the intercompany bonds to par value.

3.

Entries (2) and (3) recognize the constructive loss allocated to each company and adjust bond investment and carrying value of the intercompany debt to par value.


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Bonds Payable 300,000Investment in S Company Bonds 300,000

To eliminate intercompany bond investment and liability.



4.

Dividend Income 16,000Dividends Declared—S Company 16,000

To eliminate intercompany dividends.

5.

Beginning Retained Earnings—S Company 700,000Common Stock—S Company 1,000,000

Investment in S Company Stock 1,360,000Noncontrolling Interest in Equity 340,000

To eliminate investment account and create NCI.

6.


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If the complete equity method is used, entry (1), the reciprocity entry, is not needed and the following entry replaces entry (5) above.


Equity in S Company Income 80,400Dividends Declared 16,000Investment in S Company Stock 64,400

To eliminate the intercompany income and dividends.

Consolidated Statements Workpaper—2012Consolidated Statements Workpaper—2012Complete Equity Method

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P S Consolidated Income Statement Company Company Debit Credit NCI Balances Sales 3,104,000 2,200,000 5,304,000 Equity income 80,400 80,400 -

Total revenue 3,184,400 2,200,000 5,304,000 Cost of goods sold 1,700,000 1,360,000 3,060,000 Interest expense 50,000 50,000 Other expenses 1,124,000 665,000 1,789,000 Loss on retirement 22,000 22,000

Total cost and expense 2,824,000 2,075,000 4,921,000 Net income 360,400 125,000 383,000 Noncontrolling interest 22,600 (22,600) Net income 360,400 125,000 102,400 - 22,600 360,400

Retained Earnings StatementRetained earnings, 1/1 1,810,000 700,000 700,000 1,810,000 Net income 360,400 125,000 102,400 - 22,600 360,400 Dividends declared (150,000) (20,000) 16,000 (4,000) (150,000) Retained earnings, 12/31 2,020,400 805,000 802,400 16,000 18,600 2,020,400

Balance SheetInvestment in S Co. bonds 310,000 10,000 -

300,000 Investment in S. Co. stock 1,424,400 64,400 -

1,360,000 Other assets 5,420,000 2,620,000 8,040,000

Total assets 7,154,400 2,620,000 8,040,000 9% bonds payable 500,000 300,000 200,000 Discount on bonds payable (20,000) 12,000 (8,000) Other liabilities 2,134,000 335,000 2,469,000 Capital stock 3,000,000 1,000,000 1,000,000 3,000,000 Retained earnings 2,020,400 805,000 802,400 16,000 18,600 2,020,400 NCI in net assets 1/1 340,000 340,000 - NCI in net assets 12/31 358,600 358,600


Eliminations

(3)

(3)

(2)

Consolidated Statements Workpaper —2013Consolidated Statements Workpaper —2013

(1)

(4)

(2)(3)(4)

(4)

(4)

Complete Equity Method

(1)

(1)

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P Company’s BooksEntries on June 30 and December 31


Cash 13,500Interest Revenue 13,500

To record receipt of interest ($300,000 x 9% x 6/12).

Interest Revenue 1,250Investment in S Company Bonds 1,250

To amortize premium on outstanding bonds ($10,000/ 8 periods).

Year Subsequent to Acquisition of Bonds, Year Subsequent to Acquisition of Bonds, Entries on the Books of Affiliated Companies—Entries on the Books of Affiliated Companies—20132013

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S Company’s BooksEntries on June 30 and December 31


Interest Expense 22,500Cash 22,500

To record payment of interest ($500,000 x 9% x 6/12).

Interest Expense 2,500Discount on Bonds Payable 2,500

To amortize discount on outstanding bonds ($20,000 / 8 periods).

Year Subsequent to Acquisition of Bonds, Year Subsequent to Acquisition of Bonds, Entries on the Books of Affiliated Companies—Entries on the Books of Affiliated Companies—20132013

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Investment in S Company Stock 244,000Beginning Retained Earnings—P Company 244,000

To establish reciprocity, or convert to equity

($805,000 - $500,000) x 80% = $244,000

Worksheet entries for December 31, 2013.


1.

Consolidated Statements Workpaper EntriesConsolidated Statements Workpaper Entries

Beginning Retained Earnings—P Company 10,000Investment in S Company Bonds 10,000

To adjust beginning retained earnings for constructive loss (recorded in prior year as workpaper entry only; see 2012 entry (2) and to adjust investment to par.

2.

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Beginning Retained Earnings—P Company * 9,600Beginning Noncontrolling Interest ** 2,400

Discount on Bonds Payable ($15,000 x 60%) 12,000To adjust beginning retained earnings balances for unrecorded constructive loss at beginning of the year (recorded in 2012 as workpaper entry only; see 2012 entry (3)) and adjust intercompany bonds to par value.



3.

* ($12,000 x 80%)** ($12,000 x 20%)


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Investment in S Company Bonds 2,500Interest Revenue ($1,250 + $1,250) 2,500

To reverse the amortization of premium on investment recorded by P Company during the current year (and not needed by consolidated entity since the constructive loss was recorded in its entirety in 2012).



4.


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Discount on Bonds Payable ($5,000 x 60%) 3,000Interest Expense 3,000

To reverse amortization of discount on bonds payable recorded by S Company during current year (and not needed by consolidated entity since the constructive loss was recorded in its entirety in 2012).



5.

Interest Revenue * 27,000Interest Expense 27,000

To eliminate intercompany interest.

6.

* ($45,000 x 60%) or ($13,500 + $13,500)


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Bonds Payable ($500,000 x 60%) 300,000Investment in S Company Bonds 300,000

To eliminate intercompany bond investment and bonds payable.



7.


8.

Beginning Retained Earnings—S Company 805,000Common Stock—S Company 1,000,000

Investment in S Company Stock 1,444,000Noncontrolling Interest in Equity 361,000

9.


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P S Consolidated Income Statement Company Company Debit Credit NCI Balances Sales 3,546,000 2,020,000 5,566,000 Dividend income 48,000 48,000 - Interest income 24,500 27,000 2,500 -

Total revenue 3,618,500 2,020,000 5,566,000 Cost of goods sold 2,040,000 1,200,000 3,240,000 Interest expense 50,000 3,000 20,000

27,000 Other expenses 1,124,500 630,000 1,754,500

Total cost and expense 3,164,500 1,880,000 5,014,500 Net income 454,000 140,000 551,500 Noncontrolling interest 28,600 (28,600) Net income 454,000 140,000 75,000 32,500 28,600 522,900

Retained Earnings StatementRetained earnings, 1/1 10,000

P Company 1,796,000 9,600 244,000 2,020,400 S Company 805,000 805,000 -

Net income 454,000 140,000 75,000 32,500 28,600 522,900 Dividends declared (150,000) (60,000) 48,000 (12,000) (150,000) Retained earnings, 12/31 2,100,000 885,000 899,600 324,500 16,600 2,393,300

Balance SheetInvestment in S Co. bonds 307,500 2,500 10,000 -


Total assets 7,320,000 2,690,000 8,502,500 9% bonds payable 500,000 300,000 200,000 Discount on bonds payable (15,000) 3,000 12,000 (6,000) Other liabilities 2,220,000 320,000 2,540,000 Capital stock 3,000,000 1,000,000 1,000,000 3,000,000 Retained earnings 2,100,000 885,000 899,600 324,500 16,600 2,393,300 NCI in net assets 1/1 2,400 361,000 358,600 - NCI in net assets 12/31 375,200 375,200


Eliminations

(8)


(2)

Cost Method

(6) (4)

(5)(6)

(3)(9)

(1)

(1)

(2)(7)(9)

(3)

(9)

(4)

(1)

(7)(5)

(9)

(3)

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Had the bonds been held during 2012, P Company would have amortized a portion of the premium and S Company would have amortized a part of the discount.Assuming that P Company amortized $500 and S Company amortized $600 during 2012, the original workpaper entries (2) and (3) for constructive losses) are modified as follows:

Interim Purchase of Intercompany Interim Purchase of Intercompany BondsBonds

2. Loss on Constructive Retirement Bonds 10,000Interest Revenue 500Investment in S Company Bonds 9,500

Loss on Constructive Retirement of Bonds 12,000Interest Expense 600Discount on Bonds Payable 11,400

3.

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Notes:1. The consolidated income statement will still show a total loss on the constructive retirement of $22,000.2. The credits to interest revenue and interest expense add back the portion of the loss that was recorded by the individual companies, but which is reported in total in 2012.3. Failure to add back the $1,100 ($500 + $600) to the reported income of the individual companies will result in reporting this portion of the loss twice.

Interim Purchase of Intercompany Interim Purchase of Intercompany BondsBonds

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A company may issue a note to an affiliated company that may then discount the note with an outside party.

OR A company holding a note receivable from an outside

party may discount the note with an affiliated company.

Notes Receivable DiscountedNotes Receivable Discounted

LO 3 Discounting a note issued to an LO 3 Discounting a note issued to an affiliated company with an outside affiliated company with an outside company.company.

From a consolidation point of view, a receivable held by one of the affiliated companies should be reported in the consolidated balance sheet only if the note is due from an outside party.

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Stock Dividends Issued by a Subsidiary CompanyStock Dividends Issued by a Subsidiary Company

LO 4 Stock dividends issued by a subsidiary.LO 4 Stock dividends issued by a subsidiary.

Parent company records receipt of shares in a memorandum entry only.

Subsidiary records the declaration of a stock dividend as a transfer from retained earnings to one or more paid-in capital accounts.

Amount transferred is dependent on whether the dividend is a large or small stock dividend.• For consolidated purposes, the stock dividend does

not alter the investor’s proportionate interest in the sub.

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Illustration: Assume that P Company purchased 4,000 shares of S Company’s $100 par value common stock on January 2, 2012, for $560,000. At the time of purchase, S Company reported common stock and retained earnings balances of $500,000 and $200,000, respectively. If consolidated statements were prepared on January 2, 2012, the investment eliminating entry would be:

Capital Stock—S Company 500,0001/1 Retained Earnings—S Company 200,000

Investment in S Company 560,000Noncontrolling Interest in Equity 140,000

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Illustration: Now assume that S Company reports net income of $50,000 and declares a 30% stock dividend (1,500 shares) on December 31, 2012. S Company would record the dividend as follows (par value):

Stock Dividend Declared (or R/E) 150,000Capital Stock (1,500 shares $100) 150,000

The only entry made by P Company in 2012 is a memorandumentry to record the receipt of 1,200 shares from S Company.

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P S Consolidated Income Statement Company Company Debit Credit NCI Balances Net/consolidated income 240,000 50,000 290,000 Noncontrolling interest 10,000 (10,000) Net income 240,000 50,000 - - 10,000 280,000

Retained Earnings StatementRetained earnings, 1/1

P Company 460,000 460,000 S Company 200,000 200,000 -

Net income 240,000 50,000 - - 10,000 280,000 Dividends declared (150,000) 120,000 (30,000) - Retained earnings, 12/31 700,000 100,000 200,000 120,000 (20,000) 740,000

Balance SheetInvestment in S Company 560,000 560,000 - Fixed assets 1,240,000 800,000 2,040,000

Total assets 1,800,000 800,000 2,040,000 Total liabilities 200,000 50,000 250,000 Capital stock

P Company 900,000 900,000 S Company 650,000 120,000 30,000 -

500,000 Retained earnings 700,000 100,000 200,000 120,000 (20,000) 740,000 NCI in net assets 1/1 140,000 140,000 - NCI in net assets 12/31 150,000 150,000

Total liab. & equity 1,800,000 800,000 820,000 820,000 2,040,000

Eliminations

Consolidated Statements Workpaper—2009Consolidated Statements Workpaper—2009Cost Method

(2)

(1)

(2)

(2)

(1)(2)


Consolidated Statement Workpaper December 31, 2012

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Capital Stock—S Company 120,000Stock Dividends Declared—S Company 120,000

To reverse effects of stock dividend ($150,000 x 80%).

1/1 Retained Earnings—S Company 200,000Capital Stock—S Company 500,000


To eliminate investment account and recognize noncontrolling interest.

Worksheet Entries – Year Stock Dividends Are Declared

1.

2.



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If the stock dividend had been more than retained earnings ($200,000), some of the postacquisition earnings of the subsidiary would have been capitalized. FASB ASC paragraph 810-10-45-9:

Occasionally, subsidiary companies capitalize retained earnings arising since acquisition, by means of a stock dividend or otherwise. This does not require a transfer to capital surplus on consolidation.

Stock Dividends Issued from Postacquisition Earnings


LO 6 Subsidiary stock dividends issued from postacquisition LO 6 Subsidiary stock dividends issued from postacquisition earnings.earnings.

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Effects of a liquidating dividend on the consolidated statements workpaper entries:Assume that P Company acquired an 80% interest in S Company on January 2, 2012, for $560,000. At the time of purchase, S Company had capital stock and retained earnings in the amounts of $500,000 and $200,000, respectively. During the first year that the investment was held, S Company reported net income of $200,000. On December 31, 2012, the subsidiary declared and paid a cash dividend of $250,000.

Dividends from Preacquisition Earnings


LO 6 Subsidiary stock dividends issued from preacquisition LO 6 Subsidiary stock dividends issued from preacquisition earnings.earnings.

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Liquidating dividends are accounted for as a return of part of the original investment.




Cash 200,000Dividend Income ($200,000 x 80%) 160,000Investment in S Company ($50,000 x 80%) 40,000

To record receipt of a cash dividend from S Company.This entry reduces the investment account to $520,000.

P Company’s Books

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The December 31, 2012, eliminating entries are as follows:





To eliminate intercompany dividends.

Investment in S Company 40,000Dividends Declared—S Company 40,000

To reverse the liquidating dividend.

1.

2.

45

The December 31, 2012, eliminating entries are as follows:




Beginning Retained Earnings—S Co. 200,000Capital Stock—S Company 500,000


To eliminate investment account and create noncontrolling interest.

3.

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Subsidiary company preferred shares not held by the parent company are considered part of the noncontrolling interest.

Determining Equity Interest of Each Class of Stockholders

Subsidiary with Preferred and Common Stock Subsidiary with Preferred and Common Stock OutstandingOutstanding

LO 7 Allocating the purchase price LO 7 Allocating the purchase price between common and preferred between common and preferred stockholders.stockholders.

In consolidation, each class of stockholders has an interest in the net assets of the firm, so it is necessary to allocate:

Subsidiary’s Stockholders’ Equity between preferred and common stock interests.

Retained Earnings and Net Income amounts to each class of stockholders, based on dividend preference.

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Illustration: Assume the following information concerning the capital accounts of S Company as of January 2, 2012:

Consolidating with Preferred Stock OutstandingConsolidating with Preferred Stock Outstanding


8%, $100 par value preferred stock, cumulative, nonparticipating, dividends in arrears for 2011, call price is $103,5,000 shares outstanding $ 500,000Common stock, $10 par value 1,000,000Other contributed capital—excess on issue of common stock over par 305,000Retained earnings 200,000

Total stockholders’ equity $2,005,000

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On January 2, 2012, P Company acquired 80% of the outstanding common stock for $1,160,000 and 30% of the outstanding preferred stock for $180,000. During the year, S Company reported net income of $200,000 and declared no cash dividends. The entry to record the purchase is:



Investment in S Co. preferred stock 180,000Investment in S Co. Common Stock 1,160,000

Cash 1,340,000

P Company’s Books

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Computation and Allocation of Difference Between Implied and Book Value Acquired—Preferred Stock

* Noncontrolling interest after adjustment $420,000 - $31,500 = $388,500** ($103 call + $8 dividends in arrears - $100 par) x 5,000 shares = $11 x 5,000 = $55,000

Parent NCI Total30% 70% 100%

Purchase price and implied value 180,000$ 420,000$ 600,000$ Less: Book value of equity acquired:$100 par preferred stock - 8% (150,000) (350,000) (500,000) Retained earnings ** (16,500) (38,500) (55,000)

Difference between implied and BV 13,500 31,500 45,000 Reduce Paid-in-Capital—Parent (13,500) Reduce Noncontrolling Interest in Equity * (31,500) Total allocated (45,000) Balance 0 0 0

Date of Acquisition - 1/2/ 2012



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Cost Method or Partial Equity MethodBeginning Retained Earnings—S Co. 55,000Preferred Stock—S Co. 500,000Difference Between Implied and BV 45,000

Investment in S Co. Preferred Stock 180,000Noncontrolling Interest in Equity 420,000

To eliminate the preferred stock investment account and recognize the noncontrolling interest in equity.

1a.



Consolidated Statements Workpaper Entries—2012

51

Cost Method or Partial Equity MethodOther Contributed Capital—P Company 13,500Noncontrolling Interest in Equity 31,500

Difference Between Implied and Book Value 45,000

To allocate the difference between implied and book values of preferred stock to equity.

1b.




52

Computation and Allocation of Difference Between Implied and Book Value Acquired—Common Stock

* $200,000 - $55,000 = $145,000

Parent NCI Total80% 20% 100%

Purchase price and implied value 1,160,000$ 290,000$ 1,450,000$ Less: Book value of equity acquired:$10 par common stock (800,000) (200,000) (1,000,000) Contributed capital -common stock (244,000) (61,000) (305,000) Retained earnings* (116,000) (29,000) (145,000)

Difference between implied and BV 0 0 0

Date of Acquisition - 1/2/2012



53

Cost Method or Partial Equity MethodBeginning Retained Earnings—S Co. 145,000Common Stock—S Co. 1,000,000Other Contributed Capital—S Co. 305,000

Investment in S Co. Common Stock 1,160,000

NCI in Equity 290,000To eliminate the common stock investment account and recognize NCI.

2.




54

Noncontrolling interest in the consolidated income for 2012 is computed as follows:

Contributionto Consolidated

Income NCI % NCIReported net income of S Company 200,000$ Income allocated to preferred stock 40,000 70% 28,000$ Income allocated to common stock 160,000$ 20% 32,000 NCI in consolidated income 60,000$



55

P S Consolidated Income Statement Company Company Debit Credit NCI Balances Net/consolidated income 800,000 200,000 1,000,000 Noncontrolling interest

in Dividend incomePreferred stock 28,000 Common stock 32,000 (60,000)

Net income 800,000 200,000 - - 60,000 940,000

Retained Earnings StatementRetained earnings, 1/1

P Company 1,450,000 1,450,000 S Company -

Preferred stock 55,000 55,000 - Common stock 145,000 145,000 -

Net income 800,000 200,000 60,000 940,000 Dividends declared (500,000) (500,000) Retained earnings, 12/31 1,750,000 400,000 200,000 - 60,000 1,890,000

Balance SheetInvestment in S Company

Preferred stock 180,000 180,000 - Common stock 1,160,000 1,160,000 -

Difference Implied and BV 45,000 45,000 - Other assets 5,410,000 2,805,000 8,215,000

Total assets 6,750,000 2,805,000 8,215,000

Eliminations

(1a)

Consolidated Statement Workpaper December 31, 2012Consolidating with Preferred Stock OutstandingConsolidating with Preferred Stock Outstanding

(2)

(1a)(2)

(1a) (1b)

Cost Method Page 1

56

Retained earnings, 1/1P Company 1,450,000 1,450,000 S Company -

Preferred stock 55,000 55,000 - Common stock 145,000 145,000 -

Net income 800,000 200,000 60,000 940,000 Dividends declared (500,000) (500,000) Retained earnings, 12/31 1,750,000 400,000 200,000 - 60,000 1,890,000

Balance SheetInvestment in S Company

Preferred stock 180,000 180,000 - Common stock 1,160,000 1,160,000 -

Difference Implied and BV 45,000 45,000 - Other assets 5,410,000 2,805,000 8,215,000

Total assets 6,750,000 2,805,000 8,215,000 Total liabilities 1,600,000 600,000 2,200,000 Preferred stock S Co. 500,000 500,000 - Common stock 3,000,000 1,000,000 1,000,000 3,000,000 Other contributed capital

P Company 400,000 13,500 386,500 S Company 305,000 305,000 -

Retained earnings 1,750,000 400,000 200,000 - 60,000 1,890,000 NCI in net assets 1/1 31,500 420,000 678,500 -

290,000 NCI in net assets 12/31 738,500 738,500


(2)


(1a)(1b)

(2)(1b)

(2)

(1a)

(1a) (1b)

(2)(1a)

Cost Method Page 2

57

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