Chapter 7

Special Issues in Accounting

for an
Investment
in a
Subsidiary
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. Parent’s interest is a percent of total sub.
equity. There will be an excess as in any other
purchase.

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Block purchase:
Prior control
 Parent already has control and buys an additional block.
 Current practice views this as a separate investment with
its own D&D of excess and separate amortizations.
– values assigned are independent of D&D 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 D&D.

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Block purchase:
Control with later purchase
 Separate blocks with separate D&Ds, 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 D&D exists and is used.
– The prior investment will be maintained at cost if it is less
than a 20% interest. No D&D; it is done now, retroactively.
 Future: The cost of the first block may be “rolled” into
the second. One D&D 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 sub’s
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.

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Sale of entire investment:
Adjustments
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 investment:
Example
D&D 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 investment:
Example (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 investment:
Entries
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 investment:
Entries (continued)
Cost and Simple Equity (for current year)
Investment in Sub 24,000
Investment Income 24,000
Investment Inc (½ yr amort of excess) 5,000Investment
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 sale:
Control 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).

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Partial sale:
Control 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 stock:
Two 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 stock:
Example
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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Appendix:
Balance 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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Appendix:
Balance sheet only procedures (cont’d)
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

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