Slide 4 1 4 Consolidated Financial Statements After

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4 Consolidated Financial Statements After Acquisition Advanced Accounting, Fourth Edition Slide 4 -2

4 Consolidated Financial Statements After Acquisition Advanced Accounting, Fourth Edition Slide 4 -2

Learning Objectives Slide 4 -3 1. Describe the accounting treatment required under current GAAP

Learning Objectives Slide 4 -3 1. Describe the accounting treatment required under current GAAP for varying levels of influence or control by investors. 2. Prepare journal entries on the parent’s books to account for an investment using the cost method, the partial equity method, and the complete equity method. 3. Understand the use of the workpaper in preparing consolidated financial statements. 4. Prepare a schedule for the computation and allocation of the difference between implied and book values. 5. Prepare the workpaper eliminating entries for the year of acquisition (and subsequent years) for the cost and equity methods. 6. Describe two alternative methods to account for interim acquisitions of subsidiary stock at the end of the first year. 7. Explain how the consolidated statement of cash flows differs from a single firm’s statement of cash flows. 8. Understand how the reporting of an acquisition on the consolidated statement of cash flows differs when stock is issued rather than cash. 9. Describe some of the differences between U. S. GAAP and IFRS in accounting for equity investments.

Investments in Stock Investments in voting stock of other companies may be consolidated, or

Investments in Stock Investments in voting stock of other companies may be consolidated, or separately reported in the financial statements at cost, fair value, or equity. Slide 4 -4

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods § Generally

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods § Generally speaking, there are three levels of influence or control by an investor over an investee, which determine the appropriate accounting treatment. § There are no absolute percentage to distinguish between these three levels, but there are guidelines. § The three levels and the corresponding accounting treatment are summarized as presented in the next slide. § All these methods are methods to record investments after acquisition. The cost method is the most commonly used method in practice and the simplest. Slide 4 -5

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods Ownership Percentages

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods Ownership Percentages 0 -------20% ------ 50% ------- 100% Slide 4 -6 No significant influence Significant influence (no control) Investment valued using the “cost” method but with adjustments to fair value. Investment valued using the complete Equity Method Effective control Investment valued using (Cost, partial, Equity, complete Equity) Method (investment eliminated in Consolidation)

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods Consolidated financial

Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods Consolidated financial statements will be identical, regardless of method used. However, if the parent issues parent-only financial statements, the complete equity method should be used for investees over which the parent has either significant influence or effective control. Slide 4 -7 LO 1 Varying levels of ownership are accounted for differently.

Accounting for Investments by the Cost Method E 4 -1: Percy Company purchased 80%

Accounting for Investments by the Cost Method E 4 -1: Percy Company purchased 80% of the outstanding voting shares of Song Company at the beginning of 2009 for $387, 000. At the time of purchase, Song Company’s total stockholders’ equity amounted to $475, 000. Income and dividend distributions for Song Company from 2009 through 2010 are as follows: Required: Prepare journal entries for Percy Company from the date of purchase through 2011 to account for its investment in Song Company under each of the following assumptions: Slide 4 -8 LO 2 Journal entries for Parent using cost method.

Accounting for Investments by the Cost Method E 4 -1: A. Percy Company uses

Accounting for Investments by the Cost Method E 4 -1: A. Percy Company uses the cost method to record its investment. 2009 Investment in Song 387, 000 Cash 20, 000 Dividend income (. 8 x $25, 000) Slide 4 -9 20, 000 LO 2 Journal entries for Parent using cost method.

Accounting for Investments by the Cost Method E 4 -1: A. Percy Company uses

Accounting for Investments by the Cost Method E 4 -1: A. Percy Company uses the cost method to record its investment. 2010 Cash 40, 000 Dividend income (. 8 x $50, 000) 2011 Cash 28, 000 Investment in Song (. 8 x $35, 000) (Liquidating dividend) **Liquidating dividend= the cumulative dividends declared exceeds the cumulative income earned. Slide 4 -10 40, 000 28, 000

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the partial equity method to record its investment. 2009 Investment in Song 387, 000 Cash Investment in Song 387, 000 50, 800 Equity income (. 8 x $63, 500) Cash 50, 800 20, 000 Investment in Song (. 8 x $25, 000) Slide 4 -11 20, 000

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the partial equity method to record its investment. 2010 Investment in Song 42, 000 Equity income (. 8 x $52, 500) Cash 42, 000 40, 000 Investment in Song (. 8 x $50, 000) Slide 4 -12 40, 000 LO 2 Journal entries for Parent using partial equity method.

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the

Accounting for Investments by Partial Equity E 4 -1: B. Percy Company uses the partial equity method to record its investment. 2011 Equity loss (. 8 x $55, 000) 44, 000 Investment in Song Cash 44, 000 28, 000 Investment in Song (. 8 x $35, 000) Slide 4 -13 28, 000 LO 2 Journal entries for Parent using partial equity method.

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the complete equity method to record its investment. The difference between book value of equity acquired and the value implied by the purchase price was attributed solely to an excess of market over book values of depreciable assets, with a remaining life of 10 years. The complete equity method is usually required to report common stock investments in the 20% to 50% range, assuming the investor has the ability to exercise significant influence and does not have effective control over the investee. Slide 4 -14

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the complete equity method to record its investment. 2009 Investment in Song 387, 000 Cash Investment in Song 387, 000 50, 800 Equity income (. 8 x $63, 500) Cash 50, 800 20, 000 Investment in Song (. 8 x $25, 000) Slide 4 -15 20, 000 LO 2 Journal entries for Parent using complete equity method.

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the complete equity method to record its investment. A journal entry is required to adjust for depreciation related to the excess of market over book values of depreciable assets. Cost of investment (IV) Book value acquired ($475, 000 x 80%) Difference between Cost and Book value 2009 Equity income ($7, 000 / 10 yrs. ) Investment in Song Slide 4 -16 $387, 000 380, 000 $ 7, 000 700 LO 2 Journal entries for Parent using complete equity method.

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the complete equity method to record its investment. 2010 Investment in Song 42, 000 Equity income (. 8 x $52, 500) Cash 42, 000 40, 000 Investment in Song (. 8 x $50, 000) Equity income ($7, 000 / 10 yrs. ) Investment in Song Slide 4 -17 40, 000 700 LO 2 Journal entries for Parent using complete equity method.

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the

Accounting for Investments by Complete Equity E 4 -1: C. Percy Company uses the complete equity method to record its investment. 2011 Equity Loss (. 8 x $55, 000) 44, 000 Investment in Song Cash 44, 000 28, 000 Investment in Song (. 8 x $35, 000) Equity income ($7, 000 / 10) Investment in Song Slide 4 -18 28, 000 700 LO 2 Journal entries for Parent using complete equity method.

Consolidated Statements After Acquisition On the date of acquisition, the only relevant financial statement

Consolidated Statements After Acquisition On the date of acquisition, the only relevant financial statement is the consolidated balance sheet. After acquisition, a complete set of consolidated financial statements must be prepared for the affiliated group: Slide 4 -19 Ø Income statement, Ø Retained earnings statement, Ø Balance sheet, and Ø Statement of cash flows LO 3 Use of workpapers.

Consolidated Statements After Acquisition Year of Acquisition—Cost Method P 4 -8: On January 1,

Consolidated Statements After Acquisition Year of Acquisition—Cost Method P 4 -8: On January 1, 2010, Parker Company purchased 95% of the outstanding common stock of Sid Company for $160, 000. At that time, Sid’s stockholders’ equity consisted of common stock, $120, 000; other contributed capital, $10, 000; and retained earnings, $23, 000. Required: A. Prepare a consolidated statements workpaper on Dec. 31, 2010. B. Prepare a consolidated statements workpaper on Dec. 31, 2011. Slide 4 -20 LO 3 Use of workpapers.

Consolidated Statements After Acquisition P 4 -8: A. 2010 Year of Acquisition On December

Consolidated Statements After Acquisition P 4 -8: A. 2010 Year of Acquisition On December 31, 2010, the two companies’ trial balances were as follows at right: Required A. Prepare a consolidated statements workpaper on December 31, 2010. Slide 4 -21 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition P 4 -8: Begin the consolidating process by preparing a

Consolidated Statements After Acquisition P 4 -8: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows: Difference between implied and book values is established only at the date of acquisition. Slide 4 -22 LO 4 Preparing Computation and Allocation (CAD) Schedule.

Consolidated Statements After Acquisition Workpaper Observations 1. Each section of the workpaper represents one

Consolidated Statements After Acquisition Workpaper Observations 1. Each section of the workpaper represents one of three consolidated financial statements. 2. Elimination of the investment account (The investment entry) Common stock 120, 000 Other contributed capital 10, 000 Retained earnings, 1/1 23, 000 Difference between Implied and Book Noncontrolling interest in equity Investment in Sid Slide 4 -23 15, 421 8, 421 160, 000 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition Workpaper Observations 3. Allocation of the difference between implied and

Consolidated Statements After Acquisition Workpaper Observations 3. Allocation of the difference between implied and book value (the differential entry): Goodwill 15, 421 Difference between Implied and Book 4. Elimination of intercompany dividends (The dividends entry) Dividend income 19, 000 Dividends declared – Sid Company Slide 4 -24 15, 421 19, 000 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition P 4 -8: A. 2010 Slide 4 -25 Year of

Consolidated Statements After Acquisition P 4 -8: A. 2010 Slide 4 -25 Year of Acquisition LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition P 4 -8: A. 2010 Slide 4 -26 Year of

Consolidated Statements After Acquisition P 4 -8: A. 2010 Slide 4 -26 Year of Acquisition LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition Workpaper Observations 5. Noncontrolling interest in consolidated net income: Internally

Consolidated Statements After Acquisition Workpaper Observations 5. Noncontrolling interest in consolidated net income: Internally generated income of Sid Company Slide 4 -27 $26, 000 Noncontrolling percentage owned 5% Noncontrolling interest in income $ 1, 300 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition Workpaper Observations 6. Consolidated retained earnings: Parker Company’s retained earnings,

Consolidated Statements After Acquisition Workpaper Observations 6. Consolidated retained earnings: Parker Company’s retained earnings, 1/1 + Parker’s income 129, 000 - Dividends from Sid Company - 19, 000 + Parker’s percentage of Sid income (95%) Slide 4 -28 $ 40, 000 24, 700 - Parker’s dividends declared - 20, 000 Parker Company’s retained earnings, 12/31 $154, 700 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition Workpaper Observations 7. Total eliminations for all three sections are

Consolidated Statements After Acquisition Workpaper Observations 7. Total eliminations for all three sections are in balance. 8. To calculate the noncontrolling interest in net assets or equity at year-end, compute the following: NCI at Acquisition Date $ + NCI share of Sid income ($26, 000 x 5%) - NCI share of Sid dividends ($20, 000 x 5%) Noncontrolling Interest in Equity Slide 4 -29 8, 421 1, 300 -1, 000 $ 8, 721 LO 5 Workpapers eliminating entries.

Consolidated Statements After Acquisition After Year of Acquisition – Cost Method P 4 -8:

Consolidated Statements After Acquisition After Year of Acquisition – Cost Method P 4 -8: B. 2011 On December 31, 2011, the two companies’ trial balances were as follows at right: Required B. Prepare a consolidated statements workpaper on December 31, 2011. Slide 4 -30 LO 5 Workpapers eliminating entries after acquisition (cost method).

Consolidated Statements After Acquisition Workpaper Observations 1. Before elimination of the investment account, a

Consolidated Statements After Acquisition Workpaper Observations 1. Before elimination of the investment account, a workpaper entry is made to the investment account and Parker Company’s beginning retained earnings to recognize Parker’s share of the cumulative undistributed income or loss of Sid Company from the date of acquisition to the beginning of the current year as follows: Investment in Sid Company Retained earnings, 1/1 ($29, 000 – $23, 000 ) Slide 4 -31 X . 95 = $5, 700 Entry to establish Reciprocity LO 5 Workpapers eliminating entries after acquisition (cost method).

Consolidated Statements After Acquisition Workpaper Observations The following workpaper entries are also made: 2.

Consolidated Statements After Acquisition Workpaper Observations The following workpaper entries are also made: 2. Eliminate investment in Sid Company. 3. Eliminate intercompany dividends. 4. Allocate difference between cost and book value. 5. All (100%) of Sid’s revenues, expenses, assets, and liabilities are included in the consolidated totals. The noncontrolling interest’s share of income and net assets are shown as separate line items. Slide 4 -32 LO 5 Workpapers eliminating entries after acquisition (cost method).

Consolidated Statements After Acquisition P 4 -8: B. 2011 Slide 4 -33 After Year

Consolidated Statements After Acquisition P 4 -8: B. 2011 Slide 4 -33 After Year of Acquisition LO 5 Workpapers eliminating entries after acquisition (cost method).

Consolidated Statements After Acquisition P 4 -8: B. 2011 Slide 4 -34 After Year

Consolidated Statements After Acquisition P 4 -8: B. 2011 Slide 4 -34 After Year of Acquisition LO 5 Workpapers eliminating entries after acquisition (cost method).

Recording Investments – Equity Method Record the investment at cost and subsequently adjust the

Recording Investments – Equity Method Record the investment at cost and subsequently adjust the amount each period for Ø the investor’s proportionate share of the earnings (losses) and Ø dividends received by the investor. If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method. Slide 4 -35 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method Example: (Equity Method) On January 1, 2010, Pennington Corporation

Recording Investments – Equity Method Example: (Equity Method) On January 1, 2010, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180, 000. During the year, Edwards earned net income of $80, 000 and paid dividends of $20, 000. Instructions Prepare the journal entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2010. Slide 4 -36 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method Example: Prepare the entries for Pennington to record the

Recording Investments – Equity Method Example: Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2010. Investment in Stock 180, 000 Cash 180, 000 Investment in Stock 24, 000 Equity in subsidiary income ($80, 000 x 30%) Cash 6, 000 Investment in Stock ($20, 000 x 30%) Slide 4 -37 24, 000 6, 000 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method Investment Carried at Equity—Year of Acquisition P 4 -12:

Recording Investments – Equity Method Investment Carried at Equity—Year of Acquisition P 4 -12: On January 1, 2010, Parker Company purchased 90% of the outstanding common stock of Sid Company for $180, 000. At that time, Sid’s stockholders’ equity consisted of common stock, $120, 000; other contributed capital, $20, 000; and retained earnings, $25, 000. Assume that any difference between book value of equity and the value implied by the purchase price is attributable to land. Required: A. Prepare a consolidated statements workpaper on Dec. 31, 2010. B. Prepare a consolidated statements workpaper on Dec. 31, 2011. Slide 4 -38 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: Begin the consolidating process by preparing

Recording Investments – Equity Method P 4 -12: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows: Difference between implied and book values is established only at the date of acquisition. Slide 4 -39 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: A. 2010 Year of Acquisition On

Recording Investments – Equity Method P 4 -12: A. 2010 Year of Acquisition On December 31, 2010, the two companies’ trial balances were as follows: Required A. Prepare a consolidated statements workpaper on December 31, 2010. Slide 4 -40 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: A. 2010 Slide 4 -41 Year

Recording Investments – Equity Method P 4 -12: A. 2010 Slide 4 -41 Year of Acquisition LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: A. 2010 Slide 4 -42 Year

Recording Investments – Equity Method P 4 -12: A. 2010 Slide 4 -42 Year of Acquisition LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method Workpaper Observations The following workpaper entries were made: To

Recording Investments – Equity Method Workpaper Observations The following workpaper entries were made: To eliminate the account “equity in subsidiary income” and intercompany dividends. To eliminate the Investment account against subsidiary equity. To distribute the difference between implied and book value of equity acquired. Slide 4 -43 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method Investment Carried at Equity—After Year of Acquisition P 4

Recording Investments – Equity Method Investment Carried at Equity—After Year of Acquisition P 4 -12: B. 2011 On December 31, 2011, the two companies’ trial balances were as follows at right: Required B. Prepare a consolidated statements workpaper on December 31, 2011. Slide 4 -44 LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: B. 2011 Slide 4 -45 After

Recording Investments – Equity Method P 4 -12: B. 2011 Slide 4 -45 After Year of Acquisition LO 5 Workpaper eliminating entries (equity method).

Recording Investments – Equity Method P 4 -12: B. 2011 Slide 4 -46 After

Recording Investments – Equity Method P 4 -12: B. 2011 Slide 4 -46 After Year of Acquisition LO 5 Workpaper eliminating entries (equity method).

Interim Acquisitions of Subsidiary Stock Revenues and expenses of the acquired company are included

Interim Acquisitions of Subsidiary Stock Revenues and expenses of the acquired company are included with those of the acquiring company only from the date of acquisition forward. Two acceptable alternatives for presenting the subsidiary’s revenue and expense items in the consolidated income statement in the year of acquisition: Full-year reporting alternative. Partial-year reporting alternative. Slide 4 -47 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock Equity Method—Full-Year Reporting Alternative P 4 -16: Pillow Company

Interim Acquisitions of Subsidiary Stock Equity Method—Full-Year Reporting Alternative P 4 -16: Pillow Company purchased 90% of the common stock of Satin Company on May 1, 2009, for a cash payment of $474, 000. December 31, 2009, trial balances for Pillow and Satin were: Slide 4 -48 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -16: Satin Company declared a $60, 000

Interim Acquisitions of Subsidiary Stock P 4 -16: Satin Company declared a $60, 000 cash dividend on December 20, 2009, payable on January 10, 2010, to stockholders of record on December 31, 2009. Pillow Company recognized the dividend on its declaration date. Any difference between book value and the value implied by the purchase price relates to subsidiary land, included in property and equipment. Required: Prepare a consolidated statements workpaper at December 31, 2009, assuming that Satin Company uses the fullyear reporting alternative. Slide 4 -49 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -16: Computation and Allocation of Difference between

Interim Acquisitions of Subsidiary Stock P 4 -16: Computation and Allocation of Difference between Cost and Book Value Acquired: Slide 4 -50 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -16: Full-Year Reporting Alternative Slide 4 -51

Interim Acquisitions of Subsidiary Stock P 4 -16: Full-Year Reporting Alternative Slide 4 -51 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -16: Full-Year Reporting Alternative Slide 4 -52

Interim Acquisitions of Subsidiary Stock P 4 -16: Full-Year Reporting Alternative Slide 4 -52 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -17: (Data from P 4 -16) Partial-Year

Interim Acquisitions of Subsidiary Stock P 4 -17: (Data from P 4 -16) Partial-Year Reporting Alternative Slide 4 -53 LO 6 Two approaches for interim acquisitions.

Interim Acquisitions of Subsidiary Stock P 4 -17: (Data from P 4 -16) Partial-Year

Interim Acquisitions of Subsidiary Stock P 4 -17: (Data from P 4 -16) Partial-Year Reporting Alternative Slide 4 -54 LO 6 Two approaches for interim acquisitions.

Consolidated Statement of Cash Flows Peculiarities: 1. If the statement of cash flows starts

Consolidated Statement of Cash Flows Peculiarities: 1. If the statement of cash flows starts with consolidated net income, then the noncontrolling interest is already included and need not be added back. 2. Subsidiary dividends paid to the noncontrolling stockholders must be included with dividends paid by the parent company when calculating cash outflow from financing activities. 3. Subsidiary stock acquired directly from the subsidiary represents an intercompany cash transfer that does not affect the total cash balance of the consolidated group. Slide 4 -55 LO 7 Peculiarities of Consolidated Statement of Cash Flows.

Consolidated Statement of Cash Flows The preparation of the consolidated statement of cash flows

Consolidated Statement of Cash Flows The preparation of the consolidated statement of cash flows in the year of acquisition is complicated slightly because the comparative balance sheets at the beginning and end of the current year are dissimilar. 1. Any cash spent or received in the acquisition itself should be reflected in the Investing activities section. 2. Assets and liabilities of the subsidiary at the date of acquisition must be added to those of the parent at the beginning of the current year. Slide 4 -56 LO 8 Stock issued as Consideration in Statement of Cash Flows.

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4 -57 U. S. GAAP IFRS LO 9 Differences between U. S. GAAP and IFRS.

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4 -58 U. S. GAAP IFRS LO 9 Differences between U. S. GAAP and IFRS.

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4

Compare U. S. GAAP and IFRS Application of the Equity Method Issue Slide 4 -59 U. S. GAAP IFRS LO 9 Differences between U. S. GAAP and IFRS.

Two categories: Ø Three-division workpaper format used in this text. Ø Trial balance format.

Two categories: Ø Three-division workpaper format used in this text. Ø Trial balance format. ü Columns are provided for the trial balances, the elimination entries, and normally, each financial statement to be prepared, except for the statement of cash flows. Slide 4 -60

Two major topics require attention in addressing the treatment of deferred income tax consequences

Two major topics require attention in addressing the treatment of deferred income tax consequences when the affiliates each file separate income tax returns: 1. Undistributed subsidiary income (Appendix B of Chapter 4). 2. Elimination of unrealized intercompany profit (discussed in the appendices to Chapters 6 and 7). Slide 4 -61

When affiliated companies elect to file one consolidated return, the tax expense amount is

When affiliated companies elect to file one consolidated return, the tax expense amount is computed on the consolidated workpapers rather than on the individual books of the parent and subsidiary. The amount of tax expense attributed to each company is computed from combined income and allocated back to each company’s books. Slide 4 -62

When separate tax returns are filed, the parent company will include dividends received from

When separate tax returns are filed, the parent company will include dividends received from the subsidiary in its taxable income, while the subsidiary’s reported income is included in consolidated net income. Thus the difference between the subsidiary’s income and dividends paid represents a temporary difference because eventually this undistributed amount will be realized through future dividends or upon sale of the subsidiary. Slide 4 -63

Assume that the parent uses the cost method to account for the investment and

Assume that the parent uses the cost method to account for the investment and that both the parent and the subsidiary file separate tax returns. This means each company records a tax provision based on the items reported on its individual books. Tax consequences relating to undistributed income are not recorded on the books of the parent company when the investment in the subsidiary is recorded using the cost method. Slide 4 -64

If the undistributed income is not expected to be received as a future dividend

If the undistributed income is not expected to be received as a future dividend but is expected to be realized when the investment is sold, the undistributed income is taxed at the capital gains rate Slide 4 -65

If the equity method is used to account for the investment, there is a

If the equity method is used to account for the investment, there is a timing difference between books and tax on the books of the parent. Equity income is reported on the parent’s income statement while dividends are included on the tax return. Therefore, deferred taxes on the parent’s books must reflect the amount of undistributed income in the subsidiary. Slide 4 -66

Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation

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