CHAPTER 4 CONSOLIDATED FINANCIAL STATEMENTS AFTER ACQUISITION Revis e the section on pag e 119 Compl e t e Equity Method on Books

of Inves tor as follo!s" Complete Equity Method on Books of Investor #he complete equity method is usually required to report common stock investments in the $%& to '%& range( assuming the investor has the a)ility to e*ercise significant influence over the operating activities of the investee+ In addition( a parent company may use the complete equity method to account for investments in su)sidiaries that !ill )e consolidated+ #his method is similar to the partial equity method up to a point( )ut it requires additional entries in most instances+ Continuing the illustration a)ove( assume additionally that the ,-%%(%%% purchase price e*ceeded the )ook value of the underlying equity of . Company )y ,1%%(%%%/ and that the difference !as attri)uted half to good!ill 0,'%(% % % 1 and half to an e*ce s s of mark e t over )ook value s of depr e ci a )l e ass e t s 0,'%(% % %1+ 2nder ne! 34.B regula tio n s ( good!ill !ould )e capitali5e d and not amorti5 e d + #he addition al depr e ci a tio n e*p e n s e implied )y the differe n c e )et! e e n mark e t and )ook value s( ho! ev e r( mus t still )e accou n t e d for+ #he depr e ci a tio n of the e*ce s s ( if spre a d over a life of ten year s( !ould result in a charg e to earning s of ,'(%% % per year+ #his charg e has the impact of lo!ering the equity in su)sidiary inco m e ( or incre a sin g the equity in su)sidiary loss( record e d )y the par e n t + #he entries for the first three years under the complete equity method are" 6R47 B89 for :arent Company Entries Year 1 Ps Books Investment in . Company Cash #o record the initial investment+ Investment in . Company Equity in .u)sidiary Income +90,9%(%%%1 #o record equity in su)sidiary income+

-%%(%%% -%%(%%%

-1(%%% -1(%%%

Equity in .u)sidiary Income '(%%% Investment in . Company 0,'%(%%%;1%1 #o ad<ust equity in su)sidiary income for the e*cess depreciation Cash Investment in . Company $=(%%%

'(%%%

$=(%%%

#o record dividends received +90,>%(%%%1+ ?ote" #he entries to record equity in su)sidiary income and dividends received may )e com)ined into one entry( if desired+ Year 2 Ps Books Equity in .u)sidiary @oss Investment in . Company #o record equity in su)sidiary loss +90,$%(%%%1+ 1-(%%% 1-(%%%

Equity in .u)sidiary Income '(%%% Investment in . Company 0,'%(%%%;1%1 #o ad<ust equity in su)sidiary loss for e*cess depreciation Cash Investment in . Company #o record dividends received +90,>%(%%%1+ $=(%%%

'(%%%

$=(%%%

Year

Ps Books 9(%%% 9(%%%

Investment in . Company Equity in .u)sidiary Income #o record equity in su)sidiary income +90,1%(%%%1+

Equity in .u)sidiary Income '(%%% Investment in . Company 0,'%(%%%;1%1 #o ad<ust equity in su)sidiary income for e*cess depreciation Cash Investment in . Company #o record dividends received +90,>%(%%%1+ $=(%%%

'(%%%

$=(%%%

4fter these entries are posted( the investment account !ill appear as follo!s"
I?AE.#ME?# I? . C8M:4?7 0C8M:@E#E

EB2I#7 ME#C8D1 '(%%% $=(%%% 1-(%%%

7ear 1 Cost 7ear 1 Equity in su)sidiary income 7ear 1 Balance

-%%(%%% -1(%%% -E9(%%%

7ear 1 4dditional depreciation 7ear 1 .hare of dividends declared 7ear $ Equity in .u)sidiary @oss

7ear $ 4dditional depreciation 7ear $ .hare of dividends Declared 7ear $ Balance 7ear > Equity in .u)sidiary Income 7ear > Balance =99(%%% 9(%%% ==F(%%%

'(%%% $=(%%%

7ear > 4dditional depreciation '(%%% 7ear > .hare of Dividends Declared $=(%%%

#he additional entry to ad<ust the equity in su)sidiary income for the additional depreciation in 7ear 1 may )e vie!ed as reversing out a portion of the income recogni5ed/ the result is a net equity in su)sidiary income for 7ear 1 of ,=F(%%% 0,-1(%%% minus ,'(%%%1+ In 7ear $( ho!ever( since the su)sidiary sho!ed a loss for the period( the additional depreciation has the effect of increasing the loss from the amount initially recorded 0,1-(%%%1 to a larger loss of ,$>(%%%+ 4 solid understanding of the entries made on the )ooks of the investor 0presented a)ove1 !ill help greatly in understanding the eliminating entries presented in the follo!ing sections+ In some sense these entries may )e vie!ed as undoing the a)ove entries+ It is important to reali5e( ho!ever( that the eliminating entries are not parent only entries+ In many cases an eliminating entry !ill affect certain accounts of the parent and others of the su)sidiary+ 3or e*ample( the entry to eliminate the investment account 0a parent company account1 against the equity accounts of the su)sidiary affects )oth parent and su)sidiary accounts+ .ome accounts do not need eliminating )ecause the effects on parent and su)sidiary are offsetting+ 3or e*ample( in the entries a)ove( !e sa! that the parent de)ited cash !hen dividends !ere received from the su)sidiary+ Ge kno! that cash on the )ooks of the su)sidiary is credited !hen dividends are paid+ #he net effect on cash of the consolidated entry is thus 5ero+ ?o entry is made to the cash account in the consolidating process+ .ee 3igure EH1 for a comparison of the three methods on the )ooks of the parent+ I!ser" F#$%re 4&1 'ere F#$%re 4&1 Co()ar#so! o* "'e I!+es"(e!" T a,,o%!"s -Cos" +s. Par"#a/ E0%#"1 +s. Co()/e"e E0%#"1 Me"'o23 Cos" Me"'o2 Investment in . Company H Cost Method 7ear 1 4cquisition cost 7ear 1 and $ Balance -%%(%%% -%%(%%% 7ear > .u)sidary liquidating dividend 7ear > Balance =91(%%% 9(%%%

Par"#a/ E0%#"1 Me"'o2

Investment in . Company H :artial Equity Method 7ear 1 4cquisition cost 7ear 1 Equity in su)idary income 7ear 1 Balance -%%(%%% -1(%%%7ear 1 .hare of dividends declared -'E(%%% 7ear $ Equity in su)idiary loss 7ear $ .hare of dividend declared -%9(%%% 9(%%%7ear > .hare of dividend declared =91(%%%

$=(%%% 1-(%%% $=(%%% $=(%%%

7ear $ Balance 7ear > Equity in su)idiary income 7ear > Balance

Co()/e"e E0%#"1 Me"'o2 Investment in . Company H Complete Equity Method 7ear 1 4cquisition cost 7ear 1 Equity in su)idary income 7ear 1 Balance -%%(%%% -1(%%%7ear 1 4dditional Depreciation 7ear 1 .hare of dividend declared -E9(%%% 7ear $ Equity in su)idary loss 7ear $ 4dditional Depreciation 7ear $ .hare of dividend declared =99(%%% 9(%%%7ear > 4dditional Depreciation 7ear > .hare of dividend declared ==F(%%%

'(%%% $=(%%% 1-(%%% '(%%% $=(%%% '(%%% $=(%%%

7ear $ Balance 7ear > Equity in su)idary income 7ear > Balance

End of Chapt e r E E*ercis e s" Modify E*ercis e EH 1( as follo!s" E4er,# s e 4& 1 Par e ! " Co( ) a ! 1 E!"r# e s 5 L#0%#2 a " # ! $ D#+#2 e ! 2 :ercy Comp a n y purch a s e d -%& of the outs t a n di n g voting shar e s of .ong Comp a n y at the )eginnin g of 1999 for ,>-=( % % % + 4t the time of purch a s e ( .ong Comp a n yI s total stockh old e r s I equity amo u n t e d to ,E='(% % % + Incom e and dividen d distri)ution s for .ong Comp a n y from 1999 throu g h $%%1 are as follo!s" ?et incom e 0loss1 1999 ,F>(' % % $%%% ,'$(' % % $%%1 0,''(% % %1

Dividen d distri)ution Re0 % #r e 2 6

$'(%% %

'%(%% %

>'(%% %

:rep a r e <ourn al entrie s on the )ooks of :ercy Comp a n y from the dat e of purch a s e throu g h $%%1 to accou n t for its inves t m e n t in .ong Comp a n y und er eac h of the follo!ing ass u m p tio n s " A + :ercy Comp a n y use s the cost met h o d to record its inves t m e n t + B + :ercy Comp a n y uses the partial equity met h o d to record its inves t m e n t + C+ :ercy Comp a n y uses the compl e t e equity met h o d to record its inves t m e n t + #he differe n c e )et! e e n cost and the )ook value of equity acquir e d !as attri)u t e d solely to an e*ce s s of mark e t over )ook value s of depr e ci a )l e ass e t s ( !ith a rem ai ning life of ten years + ?ote" #he solution to this e*ercis e should )e the sa m e as in the 1 st edition .olutions Manual( e*c e p t that amorti5 a tion of good!ill not a tion s are replac e d )y e*c e s s depr e ci a tio n+