Slide 8-1. Slide 8-2 Changes in Ownership Interest Advanced Accounting, Fourth Edition 88.

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Changes inChanges inOwnership InterestOwnership Interest

Advanced Accounting, Fourth Edition

8888

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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

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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.

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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.

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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)

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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.

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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


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.

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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.

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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

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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

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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$

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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

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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]

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On the workpaper, the investment is eliminated by the following entry:


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

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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.


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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.

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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.

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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).

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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.

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The correct consolidated amount of additional contributed

capital on is:

An adjustment is needed on the workpapers to reduce

additional contributed capital:

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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.

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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


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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.


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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.



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].

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To adjust the investment to fair value as of the date of acquisition, the gain on revaluation of the initial shares is computed as:


P Company’s Books


Gain on revaluation 1,500

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P Company will recognize its share of S Company income for 2009 as follows:



Equity in Subsidiary Income 58,500

[90% x ($185,000 - $120,000)]

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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.




(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

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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):


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.

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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:




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Loss of Control


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.

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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).

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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


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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:


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The gain or loss in net income attributable to P Company is

computed as follows:


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To record the sale of the shares, P Company makes the

following entry in its books on January 1, 2010.


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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).


Investment in S Company (60,000 x .90) 54,000

1/1 Retained Earnings-P Company 54,000

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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

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New Shares Issued above Existing Carrying

Value per Share


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.

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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:

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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:

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New Shares Issued at or below the Existing

Carrying Value per Share


Illustration: The shares are issued at their book value of

$17.50 per share (or $70,000), the computation is as

follows:

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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:

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Assume the new shares were issued at $14 per share (or

$56,000). The excess of book value over cost is computed as

follows:

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Journal entry by P Company to record the purchase of the new

shares is:

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Workpaper entries:

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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.

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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.

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