Chapter 7: Special Issues

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Chapter 7
Special Issues in Accounting
for an Investmentin a Subsidiary
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Special issues in accounting for an investment in
a subsidiary

• Stock acquired directly from subsidiary
• Piecemeal acquisition
• control with first block
• control achieved with later block
• Sale of investment in subsidiary
• control lost
• control maintained
• Effect of subsidiary preferred stock

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Stock acquired directly from subsidiary

• Part of original issuance
• Price paid and book value are equal, no excess to
  account for.
• Sub issues more shares
• Parent purchases enough of new issue to gain
  control. Parents interest is a percent of total
  sub. equity. There will be an excess as in any
  other purchase.

4
Block purchasePrior control

• Parent already has control and buys an additional
  block.
• Current practice views this as a separate
  investment with its own DD of excess and
  separate amortizations.
• values assigned are independent of DD on control
  date.
• there will be two sets of distribution and
  amortization entries for the two blocks on the
  worksheet (see WS 7-1)
• Future This may be viewed as a treasury stock
  transaction with an adjustment to paid-in excess
  and no new DD.

5
Block purchaseControl with later purchase

• Separate blocks with separate DDs, excess
  distributions and amortizations.
• Consolidations procedures are applied to the
  early (non-controlling) block retroactively.
• The prior investment will be under sophisticated
  equity if it was a 20 or greater interest. The
  DD exists and is used.
• The prior investment will be maintained at cost
  if it is less than a 20 interest. No DD it is
  done now, retroactively.
• Future The cost of the first block may be
  rolled into the second. One DD on date of
  control prepared.

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Sale of entire investment

• Could be a Discontinued Operation if it meets
  criteria for discontinued operation.
• To sell the investment, it must reflect share of
  subs past incomes and past amortizations of
  excess.
• the investment account balance is not ready for a
  sale. It is not adjusted for income (cost method)
  and excess amortizations (cost and simple equity
  method) unless the sophisticated equity method
  has been used.
• adjustment needed if cost or simple equity
  methods have been used.

7
Sale of entire investmentAdjustments

• Simple Equity
• Adjust for sum of prior year excess
  amortizations. These were done in prior years on
  WS, but are not reflected in investment balance.
• Cost
• Convert to simple equity to pick up share of
  prior undistributed income, then adjust for sum
  of prior year excess amortizations.
• Example follows

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Sale of entire investmentExample

• DD Schedule
• Price 1/1/X1 300,000
• Equity 1/1/X1
• Total Paid-in 100,000
• Retained earnings 150,000
• Total equity 250,000
• Interest purchased 80 200,000
• Excess Patent, 10 yr (10,000 per year) 100,000

Additional Information RE 1/1/X4 240,000 Income
1/1/X4 - 7/1/X4 30,000 Sold entire investment on
7/1/X4 400,000
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Sale of entire investmentExample (continued)

• Cost Balance 300,000
• Share of prior years income
• 80 ? 90,000 RE increase 72,000
• 80 of income 1/1/X4 to 7/1/X4
• 80 ? 30,000 24,000
• Simple equity balance 396,000
• Amortization 3½ years ? 10,000 (35,000)
• Sophisticated equity balance 361,000

Gain 400,000 - 361,000 39,000
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Sale of entire investmentEntries

• Cost Method (for prior years)
• Investment in Sub 72,000
• RE 72,000
• Cost and Simple Equity Methods (for prior years)
• RE (3 years ? 10,000 amortization) 30,000
• Investment in Sub 30,000

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Sale of entire investmentEntries (continued)

• Cost and Simple Equity (for current year)
• Investment in Sub 24,000
• Investment Income 24,000
• Investment Inc (½ yr amort of excess)
  5,000 Investment in Sub 5,000
• Cash 400,000
• Investment in Sub 361,000
• Gain on sale of Sub 39,000
• could be discontinued operation

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Partial saleControl lost

• All of the adjustments made for the entire sale
  would be made. The unsold portion of the
  investment should be be stated at the
  sophisticated equity balance on the day of sale.
• If remaining ownership is 20 or more, the
  sophisticated equity method is used in the
  future.
• If remaining ownership is under 20, the cost
  method will be used (only income recorded is
  dividends received).

13
Partial saleControl retained

• All of the adjustments made for the entire sale
  would be made only for the interest sold. The
  unsold portion of the investment will continue to
  be consolidated and may be accounted for under
  cost or simple equity methods.
• An apparent gain is an increase in paid-in excess
  resulting from equity transactions. An apparent
  loss is a distribution of retained earnings
  resulting from an equity transaction
• Income on the interest sold is income sold to the
  NCI. (see WS 7-3)

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Subsidiary preferred stockTwo issues

• A portion of the retained earnings may have to
  be allocated to preferred stock to meet
  cumulative or participation requirements. The
  retained earnings applicable to common stock is
  the residual balance.
• Any preferred stock owned by a parent, must be
  treated as retired in the consolidation process.

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Subsidiary preferred stockExample

• Worksheet 7-5 illustrates both issues
• Elim PS allocated 24,000 retained earnings to
  preferred shareholders. This would be done even
  if the parent did not own subsidiary preferred.
• Elim EL eliminates 80 of only the RE applicable
  to the controlling interest in common (84,800).
• Elim ELP retires the 60 parent ownership of the
  preferred stock. The price/book value difference
  is an adjustment to parent paid-in equity.

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AppendixBalance sheet only procedures
This topic is only of concern for CPA Exam
preparation purposes.

• Procedures are as follows
• Investment Account Date alignment is exists
  under simple equity. Cost requires conversion to
  end of year.
• Excess Amortizations All (including current) go
  to Retained Earnings.
• Merchandise Sales Only concern is ending
  inventory adjustment for intercompany profit and
  elimination of trade balance.

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AppendixBalance sheet only procedures (contd)

• Fixed Asset Sales Remove remaining year-end
  amount of intercompany profit from asset and
  adjust accumulated depreciation. Net adjustment
  is to RE.
• Leases
• Operating reclassify assets as owned.
• Financing eliminate intercompany
  payable/receivables.
• Sales Type financing steps plus adjust RE for
  profit remaining at year end.
• Bonds Retire at end of year balances. Remaining
  gain or loss on retirement is adjustment of RE