UGBA-120B Discussion Section 7

jenny_zha@haas.berkeley.edu 10/12/12

Finish up CH 1.
Sale of investment FV method Dr. Cash XX Cr. Investment in Denton (carrying value=cost) Cr. Gain on sale of investment XX XX Equity method Dr. Cash XX

Cr. Investment in Denton (whatever carrying value is at point of sale) XX Cr. Gain on sale of investment XX OR Dr. Loss on sale of investment XX *realized gain/loss go into Net Income

OR Dr. Loss on sale of investment XX

*realized gain/loss go into Net Income

CH 1. CPA practice problem 1

On January 2, 1993, Well Co. purchased 10% of Rea, Inc.'s outstanding common shares for $400,000. Well is the largest single shareholder in Rea, and Well's officers are a majority on Rea's board of directors. Rea reported net income of $500,000 for 1993, and paid dividends of $150,000. In its December 31, 1993, balance sheet, what amount should Well report as investment in Rea? a. $450,000 b. $435,000 c. $400,000 d. $385,000 Choice "b" is correct. Even though Well has only a 10% ownership, one can presume that Well has significant influence on Rea since it is the largest single shareholder and has a majority on Rea's board of directors. The equity method is the appropriate accounting method. Beginning Investment $ 400,000 Add % Sub's Income (10% $500,000) + 50,000 Subtract % Sub's dividends (10% $150,000) 15,000 Ending Investment $435,000

Choice "a" is incorrect. The investment account must also be decreased for Well's share of the dividends paid by Rea. Choice "c" is incorrect. The equity method is the correct accounting method for this investment. Choice "d" is incorrect. The investment account must also be increased for equity in earnings of Rea.

CH 1. CPA practice problem 2

Puff Co. acquired 40% of Straw, Inc.'s voting common stock on January 2, 2001 for $400,000. The carrying amount of Straw's net assets at the purchase date totaled $900,000. Fair values equaled carrying amounts for all items except equipment, for which fair values exceeded carrying amounts by $100,000. The equipment has a five-year life. During 2001, Straw reported net income of $150,000. What amount of income from this investment should Puff report in its 2001 income statement? a. $40,000 b. $52,000 c. $56,000 d. $60,000 Choice "b" is correct. Puff's share of Straw's income: $150,000 40% = $60,000 Less: Excess fair value amortization (8,000) Equity method investment income $52,000 Undervalued Equipment $100,000 40% ownership = $40,000 / 5 years = $8,000

Three legal names of types of business combinations

Statutory Merger A buys B; only A survives Statutory Consolidation C is formed to buy A and B

Acquisition A buys B; both A and B survive

Clarify multiple ways consolidation and acquisition can be used

When to use acquisition method /accounting for business combinations

Dissolution of the acquired company

All account balances are actually consolidated into the survivors financial statements Permanent consolidation at the combination date Survivor picks up all the A and L of the sub Records are closed out

Separate existence

All account balances are financially consolidated into the survivors financial statements, periodically at year-ends and quarter-ends, in order to prepare consolidated F/S Both companies continue to update own records Use Eliminating journal entry at year-ends and quarter-ends

When theres dissolution of sub = you acquired 100% of it

Key takeaways:
1.

100% of the net assets acquired (regardless of percentage acquired) are recorded at fair value with any unallocated balance remaining to Debit Goodwill or Cr. Bargain purchase. Know the journal entries, (also in textbook pages 51-54 in green boxes)

2.

Dr. Assets of Sub, at FV (list out the specific assets) Dr. Goodwill, if applicable Cr. Liab of Sub, at FV (list out the specific liab) Cr. Cash (paid by purchaser/survivor, if applicable) Cr. Common stock (of purchaser/survivor), par Cr. APIC (of purchaser/survivor) Cr. Gain on bargain purchase, if applicable Dr. Expenses/fees, if applicable Cr. Cash, if applicable

When theres separate existence

Key takeaways:
o

Make a journal entry when Big Co. acquires Small Co. as an investment When companies are consolidated for F/S:
o o

Add the balance sheet of Big Co. and Small Co. together, THEN Make the consolidation entries

Consolidation entries include:

o o o o o o

Eliminate the subsidiarys entire Equity section, including: common stock, APIC, and retained earnings. Eliminate the Bigs Investment in Small account. Adjust Smalls assets up to FV, Dr. Adjust Smalls liabilities up to FV, Cr. Adjust Smalls intangible assets up to FV, Dr. If applicable, record goodwill = (FV of Bigs cost to acquire Small Smalls Net Assets FV) Adjustment of Smalls assets (incl intangible assets) minus liabilities to FV. ***DO AN EXAMPLE HERE.*** If theres not 100% ownership, create noncontrolling interest account in the Equity section of the B/S, Cr.

Lecture slides 2-15 and 2-16 list the steps for consolidation worksheet

To help you remember the consolidating entry

ei?

eliminate

A&L FVs
Intangibles, goodwill, non-controlling create

adjust

2 sets of journal entries, when theres separate existence

DR. Investment in sub Dr. Expenses/fees, if applicable CR. Contingent performance liability, if applicable CR. Common stock (of purchaser), par CR. APIC (of purchaser) CR. Cash, if applicable

Youre not permanently eliminating any accounts Eliminating journal entries are for year-end only, as youre preparing the consolidated financial statements

DR. Common stock, sub DR. APIC, sub DR. Retained Earnings, sub CR. Investment in Sub CR. Non-controlling interest (create), if applicable DR. Balance sheet adjustments to FV DR. Goodwill, if theres excess of acquisition cost (plus noncontrolling interest) over FV of subsidiarys net assets

Costs of Business Combinations

Whether theres dissolution or separate existence (doesnt matter which), follow these rules for expenses and fees. Immediately expense (Debit expense): Finders fee Legal/attorneys fee Appraisers/accountant/investment banker fees Reduce value of parents stock issued (Debit APIC): Stock registration cost Stock issuance cost SEC filing fees

CH 2 CPA practice question 1

When a parent-subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of a. Reliability. b. Materiality. c. Legal entity. d. Economic entity. Choice "d" is correct. Reporting consolidated financial statements is consistent with the concept that the economic entity can be identified with a unit of accountability. Choice "a" is incorrect. The concept of reliability requires that information is verifiable, neutral, and representationally faithful, but does not address the parent subsidiary relationship. Choice "b" is incorrect. Materiality relates to the presentation and accounting treatment of specific transactions, but does not address the parent subsidiary relationship. Choice "c" is incorrect. Consolidated financial statements reflect the economic substance of the parent-subsidiary relationship not legal form.

CH 2 CPA practice question 2

Consolidated financial statements are typically prepared when one company has a controlling financial interest in another unless a. The subsidiary is a finance company. b. The fiscal year-ends of the two companies are more than three months apart. c. Such control is likely to be temporary. d. The two companies are in unrelated industries, such as manufacturing and real estate. Choice "c" is correct. A majority-owned subsidiary shall not be consolidated if control is likely to be temporary or if it does not rest with the majority owner. The other exceptions to not consolidating a majority-owned subsidiary are when the subsidiary is in legal reorganization or bankruptcy and/or the subsidiary operates under severe foreign restrictions. Choice "a" is incorrect. Consolidation of finance companies is generally required. Choice "b" is incorrect. A difference in fiscal periods of a parent and a subsidiary does not of itself justify the exclusion of the subsidiary from consolidation. Choice "d" is incorrect. There is no exception for nonhomogeneous operations.

Real world example

If time permits: show example of a conglomerate: Proctor & Gamble Non-homogeneous operations Gillette, Ivory, Puma, Scope, Vicks, Pampers, Mr. Clean, Bounce, and many more Have to consolidate Pull up 10-K http://investing.businessweek.com/research/stocks/financia ls/secfilings.asp?ticker=PG Note that theres no Investment in account, which have been eliminated for consolidation reporting. Theres no Equity accounts from Subsidiaries, which have been eliminated for consolidation reporting.

CH. 2 CPA practice problem 3

Company J acquired all of the outstanding common stock of Company K in exchange for cash. The acquisition price exceeds the fair value of net assets acquired. How should Company J determine the amounts to be reported for the plant and equipment and long-term debt acquired from Company K? Plant and equipment a. K's carrying amount b. K's carrying amount c. Fair value d. Fair value Long-term debt K's carrying amount Fair value K's carrying amount Fair value

Choice "d" is correct. When the acquisition price exceeds the FMV of net assets acquired, assets and liabilities should be presented at fair value.

Business Combination JE Example

On January 1 20X1, Big Company exchanged 10,000 shares of $10 par value common stock with a fair value of $415,000 for 100% of the outstanding stock of Sub Company in a business combination properly accounted for as an acquisition. In addition, Big Co. paid $35,000 in legal fees. Registration fees were $20,000. At the date of acquisition, the fair and book value of Sub Co.s net assets totaled $300,000. Sub Co.s Equity comprised of: Common stock, par 10,000 APIC 90,000 Retained Earnings 200,000

1. What is the journal entry to record Big Co.s acquisition of Sub Co. and the fees incurred? 2. What is the journal entry when you need to consolidate?

Business Combination JE Example

Big Co.s journal entry for acquisition: Dr. Investment in Sub

415,000, incl Subs 300k net assets and 115k GW

Dr. Legal Expense 35,000 Cr. Common stock (of Big Co.), par 100,000* Cr. APIC (of Big Co.) 295,000* Cr. Cash 55,000 *100,000 + 295,000 = 415,000 = FV of Big Co.s stock issued and used as payment for the acquisition of Sub Co.

Business Combination JE Example

Big Co.s consolidating journal entry, for when it has to make consolidated F/S: Dr. Common stock of sub, par 10,000 Dr. APIC of sub 90,000 Dr. RE of sub 200,000 Cr. Investment in Sub 415,000 Dr. Balance sheet asset adjustment to FV 0 Cr. Balance sheet liability adjustment to FV 0 Dr. Identifiable intangible assets 0 Dr. Goodwill 115,000 Cr. Non controlling interest 0