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Accounting
Jeter ● Chaney

Intercompany Bond
Holdings and
Miscellaneous Topics—
Consolidated Financial
Statements

1
Prepared by Sheila Ammons, Austin Community College
Learning Objectives
• Describe the term “constructive retirement of debt”.
• Describe how the gain or loss on constructive retirement of
intercompany bond holdings is allocated between the
purchasing and issuing companies.
• 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.
• Determine the effect on the consolidated financial
statements when a subsidiary issues a stock dividend.
• Understand the difference in how stock dividends and cash
dividends issued by a subsidiary company affect the
consolidated financial statements.

2
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Learning Objectives
• Determine the impact on the investment account when a
subsidiary issues a stock dividend from preacquisition
earnings and from postacquisition earnings.
• Explain how the purchase price is allocated when the
subsidiary has both common and preferred stock
outstanding.
• Determine the controlling interest in income when the
parent company owns both common and preferred stock
of the subsidiary.

3
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Intercompany Bond Holdings
• An affiliate company may purchase bonds issued by another
affiliate directly from the issuing company or from outsiders after
the original issue.
• Because the bonds are held within the affiliated group, the
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.

LO 1 Constructive retirement of debt.


4
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Accounting for Bonds - A Review
Illustration: Three year bonds with a par value of $100,000 are
issued on Jan. 2, 2013, for $85,000. The bonds pay 7% interest each
December 31. Assume straight-line amortization of the discount.

7% Discount Carrying
Date Interest Amortized Amount
1/1/13 $ 85,000
12/31/13 $ 7,000 $ 5,000 * 90,000
12/31/14 7,000 5,000 95,000
12/31/15 7,000 5,000 100,000

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

LO 1 Constructive retirement of debt.


5
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Accounting for Bonds - A Review
Illustration - Issuing Company
Journal entries for 2013:

Jan. 2 Cash 85,000


Discount on Bonds Payable 15,000
Bonds Payable 100,000

Dec. 31 Interest Expense 7,000


Cash 7,000
Interest Expense 5,000
Discount on Bonds Payable 5,000

LO 1 Constructive retirement of debt.


6
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Accounting for Bonds - A Review
Illustration - Investor Company
Journal entries for 2013:

Jan. 2 Investment in Bonds 85,000


Cash 85,000

Dec. 31 Cash 7,000


Interest Revenue 7,000
Investment in Bonds 5,000
Interest Revenue 5,000

LO 1 Constructive retirement of debt.


7
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss on Intercompany
Bond Holdings
• The purchase of an affiliate’s bonds does not alter the
accounting on the books of the individual companies.
• 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.

LO 1 Constructive retirement of debt.


8
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss on Intercompany
Bond Holdings
• The constructive gain or loss on the bond retirement is
computed as the difference between the carrying value
of the liability and the purchase price of the bonds.
– 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 constructive
gain or loss recorded during the period on the books
of the individual companies.

LO 1 Constructive retirement of debt.


9
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss
Allocation of Constructive Gain or Loss
• Four 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.
LO 2 Allocating the constructive gain or10loss.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss
Computing the Constructive Gain or Loss
• On 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.

LO 2 Allocating the constructive gain or11loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss
Computing the Constructive Gain or Loss
If 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 Price
1 $ 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

LO 2 Allocating the constructive gain or12loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss
Computing the Constructive Gain or Loss - Combination 3
Issuing Co. Purchasing Co.
Book Value Par Value Purchase Price
3. 110,000 > 100,000 < 115,000

+ $10,000 - $15,000
Constructive gain Constructive loss

- $5,000
Net constructive loss

LO 2 Allocating the constructive gain or13loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Constructive Gain or Loss -
Computing the Constructive Gain or Loss - Combination 4
Issuing Co. Purchasing Co.
Book Value Par Value Purchase Price
4. 90,000 < 100,000 > 85,000

- $10,000 + $15,000
Constructive loss Constructive gain

+ $5,000
Net constructive gain

LO 2 Allocating the constructive gain or14loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Accounting for Intercompany Bonds
Illustrated
• Illustration: P Company acquired an 80% interest in S
Company for $1,200,000 on January 2, 2012, when the retained
earnings and common stock accounts of S Company were
$500,000 and $1,000,000, respectively. On December 31, 2015,
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, 2019, 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.

LO 2 Allocating the constructive gain or15loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Book Entry Related to Bond
Investment
Prepare the entry made by P Company to record the bond investment on
December 31, 2015:
Dec. 31 Investment in S Company Bonds 310,000
Cash 310,000

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.

LO 2 Allocating the constructive gain or16loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Book Entry Related to Bond
Investment
Compute the Constructive Gain or Loss
S Company P Company
Book Value Par Value Purchase Price
288,000 < 300,000 < 310,000

- $12,000 - $10,000
Constructive loss Constructive loss

On the books of the The constructive loss is


individual companies, - $22,000 recognized in the
the constructive loss is determination of
not recorded. Net constructive loss combined income.

LO 2 Allocating the constructive gain or17loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015 Cost Method
P S Eliminations Consolidated
Income Statement Company Company Debit Credit NCI Balances
Sales 3,104,000 2,200,000 5,304,000
(5)
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
(2)
Loss on constructive 10,000
(3)
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 Statement


Retained earnings, 1/1 1,650,000 700,000 700,000 (6) 160,000 (1) 1,810,000
Net income 296,000 125,000 38,000 - 22,600 360,400
Dividends declared (150,000) (20,000) 16,000 (5) (4,000) (150,000)
Retained earnings, 12/31 1,796,000 805,000 738,000 176,000 18,600 2,020,400

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

LO 2 Allocating the constructive gain or18loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015 Cost Method

P S Eliminations Consolidated
Balance Sheet Company Company Debit Credit (2) NCI Balances
Investment in S Co. bonds 310,000 10,000 (4) -
(1) 300,000 (6)
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 (4) 8,040,000
9% bonds payable 500,000 300,000 (3) 200,000
Discount on bonds payable (20,000) 12,000 (8,000)
Other liabilities 2,134,000 335,000 (6) 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 (6) 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

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

LO 2 Allocating the constructive gain or19loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015
Worksheet entries for 2015.
1. Investment in S Company Stock 160,000
Beginning Retained Earnings—P Company 160,000
To establish reciprocity, or convert to equity

Retained earnings balance—January 1, 2015 $ 700,000


Retained earnings balance—date of acquisition 500,000
Increase in retained earnings 200,000
Percentage interest held by P Company 80%
Amount to establish reciprocity $ 160,000

LO 2 Allocating the constructive gain or20loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015
Worksheet entries for 2015.
2. Loss on Constructive Retirement of Bonds 10,000
Investment in S Company Bonds 10,000
To recognize the constructive loss not recorded by P Company and adjust the bond
investment to par value.

3. Loss on Constructive Retirement of Bonds 12,000


Discount on Bonds Payable 12,000
To recognize the constructive loss not recorded by the subsidiary and adjust the
intercompany bonds to par value.

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.

LO 2 Allocating the constructive gain or21loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015
Worksheet entries for 2015.
4. Bonds Payable 300,000
Investment in S Company Bonds 300,000
To eliminate intercompany bond investment and liability.

5. Dividend Income 16,000


Dividends Declared—S Company 16,000
To eliminate intercompany dividends.
6. Beginning Retained Earnings—S Company 700,000
Common Stock—S Company 1,000,000
Investment in S Company Stock 1,360,000
Noncontrolling Interest in Equity 340,000
To eliminate investment account and create NCI.
LO 2 Allocating the constructive gain or22loss.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements Workpaper—
2015
Complete Equity
Method

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 80,400


Dividends Declared 16,000
Investment in S Company Stock 64,400
To eliminate the intercompany income and dividends.

LO 2 Allocating the constructive gain or23loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Complete
Consolidated Statements Workpaper —2015 Equity Method
P S Eliminations 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 (3) -
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 (1) 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 Statement
Retained earnings, 1/1 1,810,000 700,000 700,000 (4) 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 (3) 18,600 2,020,400

Balance Sheet
(1)
Investment in S Co. bonds 310,000 10,000 (2) -
300,000 (3)
Investment in S. Co. stock 1,424,400 64,400 (4) -
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 (2) 200,000
(1)
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 (4) 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 (4) 340,000 -
NCI in net assets 12/31 358,600 358,600
Total liab. & equity 7,154,400 2,620,000 2,102,400 2,102,400 8,040,000
24
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Year Subsequent to Acquisition of Bonds, Entries
on the Books of Affiliated Companies—2016

P Company’s Books
Entries on June 30 and December 31

Cash 13,500
Interest Revenue 13,500
To record receipt of interest ($300,000 x 9% x 6/12).

Interest Revenue 1,250


Investment in S Company Bonds 1,250
To amortize premium on outstanding bonds ($10,000/ 8 periods).

LO 2 Allocating the constructive gain or25loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Year Subsequent to Acquisition of Bonds, Entries
on the Books of Companies—2016

S Company’s Books
Entries on June 30 and December 31

Interest Expense 22,500


Cash 22,500
To record payment of interest ($500,000 x 9% x 6/12).

Interest Expense 2,500


Discount on Bonds Payable 2,500
To amortize discount on outstanding bonds ($20,000 / 8 periods).

LO 2 Allocating the constructive gain or26loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Cost Method
Worksheet entries for December 31, 2016.
1. Investment in S Company Stock 244,000
Beginning Retained Earnings—P Company 244,000

To establish reciprocity/convert to equity


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

2. Beginning Retained Earnings—P Company 10,000


Investment in S Company Bonds 10,000

To adjust beginning retained earnings for constructive loss (recorded in prior year as
workpaper entry only; see 2015 entry (2) and to adjust investment to par.

LO 2 Allocating the constructive gain or27loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Worksheet entries for December 31, 2016. Cost Method

3. Beginning Retained Earnings—P Company * 9,600


Beginning Noncontrolling Interest ** 2,400
Discount on Bonds Payable ($15,000 x 60%) 12,000

To adjust beginning retained earnings balances for unrecorded constructive loss at


beginning of the year (recorded in 2015 as workpaper entry only; see 2015 entry (3))
and adjust intercompany bonds to par value.

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

LO 2 Allocating the constructive gain or28loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Worksheet entries for December 31, 2016. Cost Method

4. Investment in S Company Bonds 2,500


Interest 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 2015).

LO 2 Allocating the constructive gain or29loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Worksheet entries for December 31, 2016. Cost Method

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


Interest 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 2015).

6. Interest Revenue * 27,000


Interest Expense 27,000

To eliminate intercompany interest.

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

LO 2 Allocating the constructive gain or30loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Worksheet entries for December 31, 2016. Cost Method

7. Bonds Payable ($500,000 x 60%) 300,000


Investment in S Company Bonds 300,000

To eliminate intercompany bond investment and bonds payable.

8. Dividend Income 48,000


Dividends Declared—S Company 48,000
To eliminate intercompany bond investment and bonds payable.

LO 2 Allocating the constructive gain or31loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidated Statements
Workpaper Entries
Cost Method
Worksheet entries for December 31, 2016.
9. Beginning Retained Earnings—S Company 805,000
Common Stock—S Company 1,000,000
Investment in S Company Stock 1,444,000
Noncontrolling Interest in Equity 361,000
To eliminate the investment account and recognize NCI in Net Assets.

LO 2 Allocating the constructive gain or32loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Cost Method

Consolidated Statements Workpaper—2016


P S Eliminations 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 (8) -
Interest income 24,500 27,000 (6) 2,500 (4) -
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 (5) 20,000
27,000 (6)
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 Statement
Retained earnings, 1/1 10,000 (2)
P Company 1,796,000 9,600 (3) 244,000 (1) 2,020,400
S Company 805,000 805,000 (9) -
Net income 454,000 140,000 75,000 32,500 28,600 522,900
Dividends declared (150,000) (60,000) 48,000 (1) (12,000) (150,000)
Retained earnings, 12/31 2,100,000 885,000 899,600 324,500 16,600 2,393,300

Balance Sheet
Investment in S Co. bonds 307,500 2,500 (4) 10,000 (2) -
300,000 (7)
Investment in S. Co. stock 1,200,000 244,000 (1) 1,444,000 (9) -
Other assets 5,812,500 2,690,000 8,502,500
Total assets 7,320,000 2,690,000 8,502,500
9% bonds payable 500,000 300,000 (7) 200,000
Discount on bonds payable (15,000) 3,000 (5) 12,000 (3) (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
(9)
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 -
(3) (9)
NCI in net assets 12/31 375,200 375,200
33
Total liab. & equity 7,320,000 2,690,000 2,451,500 2,451,500 8,502,500
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Interim Purchase of Intercompany
Bonds
Had the bonds been held during 2015, 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 2015, the original workpaper entries (2) and (3) for constructive
losses) are modified as follows:
2. Loss on Constructive Retirement Bonds 10,000
Interest Revenue 500
Investment in S Company Bonds 9,500
3. Loss on Constructive Retirement of Bonds 12,000
Interest Expense 600
Discount on Bonds Payable 11,400
LO 2 Allocating the constructive gain or34loss.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Interim Purchase of Intercompany
Bonds
• Notes:
– The consolidated income statement will still show a
total loss on the constructive retirement of $22,000.
– 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 2015.
– 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.

LO 2 Allocating the constructive gain or35loss.


Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary Company
• A subsidiary may issue stock dividends in the same class of
stock that is held by the parent company.
• 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 subsidiary.

LO 4 Stock dividends issued by a subsidiary.


36
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary Company
Illustration: Assume that P Company purchased 4,000 shares of S
Company’s $100 par value common stock on January 2, 2015, 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,
2015, the investment eliminating entry would be:

Capital Stock—S Company 500,000


1/1 Retained Earnings—S Company 200,000
Investment in S Company 560,000
Noncontrolling Interest in Equity 140,000

LO 4 Stock dividends issued by a subsidiary.


37
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary Company
Illustration: Now assume that S Company reports net income of
$50,000 and declares a 30% stock dividend (1,500 shares) on
December 31, 2015. S Company would record the dividend as follows
(par value):
Stock Dividend Declared (or R/E) 150,000
Capital Stock (1,500 shares $100) 150,000

The only entry made by P Company in 2015 is a memorandum


entry to record the receipt of 1,200 shares from S Company.

LO 4 Stock dividends issued by a subsidiary.


38
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Cost Method

Consolidated Statements Workpaper—2015


Consolidated Statement Workpaper December 31, 2015
P S Eliminations 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 Statement


Retained earnings, 1/1
P Company 460,000 (2) 460,000
S Company 200,000 200,000 -
Net income 240,000 50,000 - - (1) 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 Sheet (2)


Investment 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 (1) 900,000
S Company 650,000 120,000 (2) 30,000 -
500,000
Retained earnings 700,000 100,000 200,000 120,000 (2) (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
39
LO 4 Stock dividends issued by a subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary
Company
Worksheet Entries – Year Stock Dividends Are Declared
1. Capital Stock—S Company 120,000
Stock Dividends Declared—S Company 120,000
To reverse effects of stock dividend ($150,000 x 80%).

2. 1/1 Retained Earnings—S Company 200,000


Capital Stock—S Company 500,000
Investment in S Company 560,000
Noncontrolling Interest in Equity 140,000
To eliminate investment account and recognize noncontrolling interest.

LO 4 Stock dividends issued by a subsidiary.


40
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary
Company
Stock Dividends Issued from Postacquisition
Earnings
• If the stock dividend had been more than retained
earnings balance ($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 earned surplus
[retained earnings] arising since acquisition, by
means of a stock dividend or otherwise. This does not
require a transfer to capital surplus on consolidation.
LO 6 Subsidiary stock dividends issued from postacquisition earnings.
41
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Stock Dividends Issued by a Subsidiary
Company
Dividends from Preacquisition Earnings
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, 2015, 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, 2015, the subsidiary
declared and paid a cash dividend of $250,000.
LO 6 Subsidiary stock dividends issued from preacquisition earnings.
42
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Stock Dividends Issued by a Subsidiary
Company
Dividends from Preacquisition Earnings
Liquidating dividends are accounted for as a return of part of
the original investment.
P Company’s Books
Cash 200,000
Dividend Income ($200,000 x 80%) 160,000
Investment 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.

LO 6 Subsidiary stock dividends issued from preacquisition earnings.


43
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Stock Dividends Issued by a Subsidiary
Company
Dividends from Preacquisition Earnings
The December 31, 2015, eliminating entries are as follows:
1. Dividend Income 160,000
Dividends Declared—S Company 160,000
To eliminate intercompany dividends.

2. Investment in S Company 40,000


Dividends Declared—S Company 40,000
To reverse the liquidating dividend.

LO 6 Subsidiary stock dividends issued from preacquisition earnings.


44
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Stock Dividends Issued by a Subsidiary
Company
Dividends from Preacquisition Earnings
The December 31, 2015, eliminating entries are as follows:
3. Beginning Retained Earnings—S Co. 200,000
Capital Stock—S Company 500,000
Investment in S Company 560,000
Noncontrolling Interest in Equity 140,000
To eliminate investment account and create noncontrolling interest.

LO 6 Subsidiary stock dividends issued from preacquisition earnings.


45
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Subsidiary with Preferred and Common Stock
Outstanding
Determining Equity Interest of Each Class of Stockholders
• Subsidiary preferred shares, not held by the parent company,
are considered part of the noncontrolling interest.
• In consolidation, each class of stockholders has an interest in
the net assets of the firm, thus it is necessary to allocate:
– Subsidiary’s stockholders’ equity between preferred and
common stock interests.
– Operating results of the subsidiary to determine the interest
of the two classes of stockholders in the changes in the
retained earnings balance.
– The dividend preference of the preferred stock issue will
determine the amounts allocated to each class of
stockholders..
LO 7 Allocating the purchase price between common
and preferred stockholders. 46
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Consolidating with Preferred Stock
Outstanding
Illustration: Assume the following information concerning the capital
accounts of S Company as of January 2, 2015:
8%, $100 par value preferred stock, cumulative, nonparticipating,
dividends in arrears for 2014, call price is $103,5,000 shares
outstanding $ 500,000
Common stock, $10 par value 1,000,000
Other contributed capital-excess on issue of common stock
over par 305,000
Retained earnings 200,000
Total stockholders’ equity $2,005,000

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


47
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Consolidating with Preferred Stock
Outstanding
On January 2, 2015, 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:
P Company’s Books
Investment in S Co. Preferred stock 180,000
Investment in S Co. Common Stock 1,160,000
Cash 1,340,000

LO 7 Allocating the purchase price between common


and preferred stockholders. 48
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidating with Preferred Stock
Outstanding
Computation and Allocation of Difference Between Implied and Book Value
Acquired—Preferred Stock
Date of Acquisition - 1/2/ 2015 Parent NCI Total
30% 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
* 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
LO 7 Allocating the purchase price between common and preferred stockholders.
49
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Consolidating with Preferred Stock
Outstanding
Consolidated Statements Workpaper Entries—2015
Cost Method or Partial Equity Method
1a. Beginning Retained Earnings—S Co. 55,000
Preferred Stock—S Co. 500,000
Difference Between Implied and BV 45,000
Investment in S Co. Preferred Stock 180,000
Noncontrolling Interest in Equity 420,000
To eliminate the preferred stock investment account and recognize the
noncontrolling interest in equity.

LO 7 Allocating the purchase price between common


and preferred stockholders. 50
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidating with Preferred Stock
Outstanding
Consolidated Statements Workpaper Entries—2015
Cost Method or Partial Equity Method

1b. Other Contributed Capital—P Company 13,500


Noncontrolling 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.

LO 7 Allocating the purchase price between common


and preferred stockholders. 51
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.
Consolidating with Preferred Stock
Outstanding
Computation and Allocation of Difference Between Implied and Book
Value Acquired—Common Stock
Parent NCI Total
Date of Acquisition - 1/2/2015
80% 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

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

LO 7 Allocating the purchase price between common


and preferred stockholders. 52
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Consolidating with Preferred Stock
Outstanding
Consolidated Statements Workpaper Entries—2015
Cost Method or Partial Equity Method
2. Beginning Retained Earnings—S Co. 145,000
Common Stock—S Co. 1,000,000
Other Contributed Capital—S Co. 305,000
Investment in S Co. Common Stock 1,160,000
NCI in Equity 290,000
To eliminate the common stock investment account and recognize NCI.

LO 7 Allocating the purchase price between common


and preferred stockholders.
53
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Consolidating with Preferred Stock
Outstanding
Noncontrolling interest in the consolidated income for 2015 is
computed as follows:
Contribution
to Consolidated
Income NCI % NCI
Reported 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

LO 7 Allocating the purchase price between common


and preferred stockholders. 54
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Consolidating with Preferred Stock
Outstanding Cost Method Page 1
Consolidated Statement Workpaper December 31, 2015
P S Eliminations Consolidated
Income Statement Company Company Debit Credit NCI Balances
Net/consolidated income 800,000 200,000 1,000,000
Noncontrolling interest
in Dividend income
Preferred stock 28,000
Common stock 32,000 (60,000)
Net income 800,000 200,000 - - 60,000 940,000
Retained Earnings Statement
Retained earnings, 1/1
P Company 1,450,000 1,450,000
S Company (1a) -
Preferred stock 55,000 55,000 (2) -
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

55
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Consolidating with Preferred Stock
Outstanding
Consolidated Statement Workpaper December 31, 2015 Cost Method Page 2
P S Eliminations Consolidated
Balance Sheet
Investment 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
Total liab. & equity 6,750,000 2,805,000 2,095,000 2,095,000 8,215,000

56
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Consolidating with Preferred Stock
Outstanding
Consolidated Statement Workpaper December 31, 2015 Cost Method Page 2

P S Eliminations Consolidated
Company Company Debit Credit NCI Balances
Balance Sheet
Investment 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
Total liab. & equity 6,750,000 2,805,000 2,095,000 2,095,000 8,215,000

57
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