Slide 8-1
Slide 8-2
Changes inChanges inOwnership InterestOwnership Interest
Advanced Accounting, Fourth Edition
8888
Slide 8-3
1. Identify the types of transactions that change the parent company’s ownership interest in a subsidiary.
2. Describe the process needed when the parent acquires subsidiary shares through multiple open market purchases.
3. Explain how the parent reports the difference between selling price and book value when shares are sold subsequent to acquisition.
4. Compute the controlling interest in income after the parent sells some shares of the subsidiary company.
5. Describe the effect on the eliminating process when the subsidiary issues new shares entirely to the parent, and the parent pays either more or less than the book value of the subsidiary shares.
6. Describe the impact on the parent’s investment account when the subsidiary issues new shares and either the new shares are purchased ratably by the parent and noncontrolling shareholders or entirely by the noncontrolling shareholders.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
Slide 8-4
Changes in Ownership InterestChanges in Ownership InterestChanges in Ownership InterestChanges in Ownership Interest
LO 1 Changes in ownership and LO 1 Changes in ownership and differences between current and differences between current and proposed GAAP.proposed GAAP.
Parent company can increase its ownership interest in a subsidiary by either
1. buying additional subsidiary shares directly from third parties or
2. having a subsidiary purchase its (subsidiary’s) shares from third parties.
Parent company can decrease its ownership interest in a subsidiary by either
1. selling some subsidiary shares directly to third parties or
2. having a subsidiary sell additional shares (including treasury shares) to third parties.
Slide 8-5
Changes in Ownership InterestChanges in Ownership InterestChanges in Ownership InterestChanges in Ownership Interest
LO 1 Changes in ownership and LO 1 Changes in ownership and differences between current and differences between current and proposed GAAP.proposed GAAP.
Prior GAAP:
Acquisitions of additional shares are handled in a
step-by-step manner.
Sales of shares are handled the same as any sale
of an asset.
Slide 8-6
Changes in Ownership InterestChanges in Ownership InterestChanges in Ownership InterestChanges in Ownership Interest
LO 1 Changes in ownership and LO 1 Changes in ownership and differences between current and differences between current and proposed GAAP.proposed GAAP.
Current GAAP:
Acquisitions that take place in stages or partial sales:
a. Measure and recognize acquiree’s identifiable assets
and liabilities at 100% of their fair values on date the
acquirer obtains control, and
b. Recognize all acquiree’s goodwill (not just parent’s
share), measured as difference between fair value of
acquiree on acquisition date and fair value of
identifiable net assets. (Continued)
Slide 8-7
Changes in Ownership InterestChanges in Ownership InterestChanges in Ownership InterestChanges in Ownership Interest
LO 1 Changes in ownership and LO 1 Changes in ownership and differences between current and differences between current and proposed GAAP.proposed GAAP.
Current GAAP:
Acquisitions that take place in stages or partial sales:
c. Any previously held noncontrolling equity interests should be remeasured to fair value, with resulting adjustment recognized in income.
d. After control is achieved, subsequent adjustments due to increased ownership are shown as Additional Contributed Capital, not as income.
e. If parent loses control, retained investment should be remeasured to fair value with adjustments recognized in net income.
Slide 8-8
When more than one purchase is made before control is obtained, acquisition date is date when control is achieved.
Parent Acquires Subsidiary Stock Parent Acquires Subsidiary Stock Through Several Open-Market PurchasesThrough Several Open-Market Purchases—Cost Method—Cost Method
Parent Acquires Subsidiary Stock Parent Acquires Subsidiary Stock Through Several Open-Market PurchasesThrough Several Open-Market Purchases—Cost Method—Cost Method
Current GAAP (Interpretation No. 2 of APB Opinion No.
17):
Requires purchasing company to identify the cost of
each investment, the fair value of the underlying
assets acquired, and the difference between cost and
book value for each step purchase.
Previously held interests are not revalued at the date
of subsequent purchases.
Slide 8-9
Parent Acquires Subsidiary Stock Parent Acquires Subsidiary Stock Through Several Open-Market PurchasesThrough Several Open-Market Purchases—Cost Method—Cost Method
Parent Acquires Subsidiary Stock Parent Acquires Subsidiary Stock Through Several Open-Market PurchasesThrough Several Open-Market Purchases—Cost Method—Cost MethodCurrent GAAP (SFAS No. 141R, Business Combinations, [ASC 805-10-25-9]:
Previously held noncontrolling equity interest should
be remeasured to fair value when control is
achieved, and the resulting adjustment should be
recognized in net income.
If a parent loses control but retains a noncontrolling
interest, the portion retained should be remeasured
to fair value on the date control is surrendered and
the adjustment reflected in the income statement.
Slide 8-10
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodIllustration: S Company had 10,000 shares of $10 par value common stock outstanding during 2007–2010 and retained earnings as follows:
January 1, 2007 (1st stock purchase) $ 40,000January 1, 2009 (control achieved) 120,000January 1, 2010 185,000December 31, 2010 265,000
P Co. purchased S Co. common stock on the open market for cash:
January 1, 2007 1,500 shares (15%) $ 24,000
January 1, 2009 7,500 shares (75%) 187,500
Total 9,000 shares (90%) $211,500
Slide 8-11
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodThus on P’s books, the following entries are made:
Assumptions:
1. Any difference between implied and book values of the purchases
relates solely to goodwill and is, therefore, not subject to
amortization or depreciation but is reviewed periodically for
impairment.
2. S Company distributes no dividends during the periods under
consideration. Solution on note page
Slide 8-12
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodCalculation of IMPLIED Value of S Company:
Solution on note page
Payment by P Company for 75% interest 187,500$
Percent acquired 75%
Implied value of S Company 250,000
Ownership interest 90%
Implied value of 90% ownership interest 225,000$
Slide 8-13
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodBecause P Company has owned a percentage of S Company (15%) since January 1, 2007, an entry is needed on P’s books to revalue the 1,500 shares purchased in 2009 to their fair value as of the date of control ( January 1, 2009).
Initial purchase price (1,500 shares at $16/share)
$24,000
Change in retained earnings of S since acquisition 15%:
[.15 x ($120,000 - $40,000)]
12,000
Carrying value (implied) of initial investment
$36,000
Thus the gain on revaluation of the initial shares is computed as:
Implied value ($25/share 1,500)
$37,500
Implied carrying value of initial shares
36,000
Revaluation gain
$ 1,500
Slide 8-14
The following entry is made on P company books.
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethod
Investment in S Company 1,500
Gain on revaluation 1,500
A workpaper entry is needed on December 31, 2009, to
convert to equity (establish reciprocity) from 2007 to the
beginning of 2009.Investment in S Company 12,000
1/1 Retained Earnings—P Company 12,000
[.15 x ($120,000 - $40,000) change in retained earnings]
Slide 8-15
On the workpaper, the investment is eliminated by the following entry:
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethod
Common Stock—S Company 100,000
1/1 Retained Earnings—S Company 120,000
Difference between Implied and Book Value 30,000
Investment in S Company ($187,500 + $37,500) 225,000
Noncontrolling Interest in Equity 25,000
Slide 8-16
Comparison to IFRS
IFRS 3, Business Combinations, provides the
guidance for step acquisitions under international
standards. Under IFRS 3, all previous ownership
interests are adjusted to fair value, with any gain or
loss recorded in earnings. This is similar to the rules
issued by the FASB.
Several Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethodSeveral Open-Market Purchases—Cost Several Open-Market Purchases—Cost MethodMethod
Slide 8-17
Comparison to IFRS
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Under SFAS No. 160 [ASC 810–10–45–22, 24] the
treatment of the sale of a portion of its investment by a
parent company depends on whether or not the sale
results in the loss of effective control of the subsidiary.
If control is maintained, no gain or loss is recognized
in the income statement.
If control is lost, the entire interest is adjusted to fair
value, and a gain or loss recorded in income on all
shares owned prior to sale.
Slide 8-18
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Illustration: P Company owns 9,000 shares of S
Company that were revalued to $25 a share on the date
of acquisition, or $225,000. Assume that P Company sold
1,800 shares of the 9,000 shares of S Company stock on
July 1, 2010, for $84,600 ($47/share). The cost of the
1,800 shares sold equals $45,000 (or 20% of $225,000).
After the sale, P Company retains control with a 72%
((9,000 x 80%)/10,000) interest. It should be noted that
the 1,800 shares sold represent 18% of total S Company
shares. To record the sale of the shares, P Company
makes the following entry in its books on July 1, 2010.
Slide 8-19
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Illustration: To record the sale of the shares, P
Company makes the following entry in its books on July 1,
2010.Cash 84,600
Investment in S Company (20% x $225,000) 45,000
Additional Contributed Capital—P Company 39,600
After this entry, the balance in the investment in S
Company account on P Company books will be $168,000 (or
$24,000 $187,500 $1,500 $45,000).
Slide 8-20
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
From a consolidated standpoint, the cost of the shares
sold ($45,000) needs to be adjusted for 18% of the
undistributed earnings since the date of acquisition.
Slide 8-21
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
The correct consolidated amount of additional contributed
capital on is:
An adjustment is needed on the workpapers to reduce
additional contributed capital:
Slide 8-22
Slide 8-23
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
When more than one purchase is made before
control is obtained, the acquisition date is defined as
the date at which control is achieved.
To illustrate the procedures followed for open-
market purchases and sales of subsidiary stock
under the equity method, the previous cost method
example will be used.
Slide 8-24
Illustration: S Company had 10,000 shares of $10 par value common stock outstanding during 2007–2010 and retained earnings as follows:
January 1, 2007 (1st stock purchase) $ 40,000January 1, 2009 (control achieved) 120,000January 1, 2010 185,000December 31, 2010 265,000
P Co. purchased S Co. common stock on the open market for cash:
January 1, 2007 1,500 shares (15%) $ 24,000
January 1, 2009 7,500 shares (75%) 187,500
Total 9,000 shares (90%) $211,500
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Slide 8-25
Assumptions:
1. Any difference between implied and book value of net assets
acquired relates to goodwill.
2. S Company distributed no dividends during the periods under
consideration. Since no dividends were declared, the change in
retained earnings represents the net income for that year.
3. P Company sold 1,800 shares of S Company stock on July 1,
2010, for $84,600.
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Slide 8-26
Since P Company now has a 90% interest in S Company and intends to apply the equity method, the investment account must be restated to recognize P Company’s share (15%) of the increase in S Company’s retained earnings from January 1, 2007, to January 1, 2009.
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Investment in S Company 12,000
1/1 Retained Earnings—P Company 12,000
[.15 x ($120,000 x $40,000) or the change in retained earnings from 1/1/07 to 1/1/09].
Slide 8-27
To adjust the investment to fair value as of the date of acquisition, the gain on revaluation of the initial shares is computed as:
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
P Company’s Books
Investment in S Company 1,500
Gain on revaluation 1,500
Slide 8-28
P Company will recognize its share of S Company income for 2009 as follows:
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Investment in S Company 58,500
Equity in Subsidiary Income 58,500
[90% x ($185,000 - $120,000)]
Slide 8-29
Assuming P Company received a six month interim income statement from S Company reporting $40,000 of net income, the following entry will be made by P Company on June 30, 2010.
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Investment in S Company 36,000
Equity in Subsidiary Income 36,000
(90% x $40,000)
1/1/07 Purchase (15%) $ 24,0001/1/09 Adjustment of 15% to fair value 1,5001/1/09 Purchase (75%) 187,5001/1/09 Adjustment 12,00012/31/09 Subsidiary Income 58,5006/30/10 Subsidiary Income 36,000Balance $319,500
Investment in S
Company
Slide 8-30
To record the sale of the S Company shares on July 1, 2010, P Company will make the following entry (recall that P Company is selling 20% of its shares):
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Cash 84,600
Investment in S Company* 63,900
Additional contributed capital 20,700
* $63,900 20% of $319,500, the carrying value of the investment.
Slide 8-31
After the sale of the 1,800 shares, P Company holds a 72% interest in S Company. For the second six months of 2010 (and for subsequent periods), P Company will recognize 72% of the reported income and dividends received from S Company. The December 31, 2010, book entry by P Company is:
Equity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStockEquity Method—Purchase and Sale of Equity Method—Purchase and Sale of StockStock
Investment in S Company 28,800
Equity in Subsidiary Income 28,800
Slide 8-32
Slide 8-33
Loss of Control
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Under SFAS No. 160 [ASC 810–10–45–22, 24] the
treatment of the sale of a portion of its investment by a
parent company depends on whether or not the sale
results in the loss of effective control of the subsidiary.
If control is maintained, no gain or loss is recognized
in the income statement.
If control is lost, the entire interest is adjusted to fair
value, and a gain or loss recorded in income on all
shares owned prior to sale.
Slide 8-34
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
The parent accounts for the deconsolidation by recognizing a gain or loss in net income attributable to the parent, measured as the difference between:
1. The carrying value of S Company
2. The sum of the following:
a. The fair value of the consideration received
b. The fair value of the retained noncontrolling interest (at the date of deconsolidation)
c. The carrying value of the former noncontrolling interest (at the date of deconsolidation).
Slide 8-35
Illustration: Suppose P Company owns 9,000 shares of S
Company (90% of S Company) that were acquired at $25 a
share (or $225,000) on January 1, 2009. During 2009, S
Company reported $60,000 of income and did not pay any
dividends.Investment (9,000 x $25) 225,000
Cash 225,000
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Slide 8-36
On January 1, 2010, P Company sold two-thirds of its
investment (6,000 shares) of S Company stock, for $180,000
($30/share). After the sale, P Company has lost control and
now only maintains a 30% ((9,000 - 6,000)/10,000) interest.
The carrying value of S company, on January 1, 2010, is
computed as follows:
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Slide 8-37
The gain or loss in net income attributable to P Company is
computed as follows:
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Slide 8-38
To record the sale of the shares, P Company makes the
following entry in its books on January 1, 2010.
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Slide 8-39
Because P Company now holds a 30% (not controlling)
interest in S Company, the investment must be carried on the
books using the equity method.
Thus the investment account must be adjusted for previous
earnings of S Company (i.e., the reciprocity entry usually
made on the consolidated workpaper).
Sell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethodSell Investment on Open-Market—Cost Sell Investment on Open-Market—Cost MethodMethod
Investment in S Company (60,000 x .90) 54,000
1/1 Retained Earnings-P Company 54,000
Slide 8-40
The newly issued shares may be purchased
1. entirely by the parent company,
2. partly by the parent company and partly by the
noncontrolling stockholders, or
3. entirely by the noncontrolling stockholders.
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Slide 8-41
New Shares Issued above Existing Carrying
Value per Share
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Illustration: P Company purchased 14,000 shares (70%) of
S Company’s $10 par value common stock on January 1,
2003, for $210,000, which included a $20,000 excess of
implied over book value; the excess cost was assigned to
land. S Company’s retained earnings on January 1, 2003,
were $50,000.
Slide 8-42
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Slide 8-43
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
On January 1, 2011, P Company purchased 4,000 additional
shares of S Company stock directly from S Company at its
current market price of $22 per share ($88,000). This price is
greater than the existing book value per share of S Company.
Noncontrolling stockholders elected not to participate in the
new issue. S Company’s stockholders equity on January 1,
2008, was:
Slide 8-44
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Slide 8-45
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Slide 8-46
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
If a workpaper were prepared immediately after the purchase
of the new shares, the workpaper entries to establish
reciprocity (convert to equity) and eliminate the investment
account would be:
Slide 8-47
New Shares Issued at or below the Existing
Carrying Value per Share
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Illustration: The shares are issued at their book value of
$17.50 per share (or $70,000), the computation is as
follows:
Slide 8-48
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Although the noncontrolling stockholders’ percentage of
ownership decreases from 30% to 25%, their share of the
net assets of S Company decreased only by the land value
transferred, as shown here:
Slide 8-49
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Assume the new shares were issued at $14 per share (or
$56,000). The excess of book value over cost is computed as
follows:
Slide 8-50
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Journal entry by P Company to record the purchase of the new
shares is:
Slide 8-51
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
Workpaper entries:
Slide 8-52
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
New Shares Purchased Ratably by Parent and
Noncontrolling Stockholders
If the noncontrolling stockholders had elected to exercise their
rights, the percentage of stock owned by the parent and
noncontrolling stockholders after the new issue would be the
same as their respective interests prior to the new issue.
Slide 8-53
Subsidiary Issues StockSubsidiary Issues StockSubsidiary Issues StockSubsidiary Issues Stock
New Shares Purchased Entirely by Noncontrolling
Stockholders
As long as the number of new shares issued is not so large that
it reduces the parent’s percentage of ownership below that
needed for control, new financing can be made available and
control retained.
Issuance of new shares to noncontrolling stockholders
reduces the parent’s percentage of ownership.
Economic substance of the transaction is a sale of
interest by P Company.
Slide 8-54
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