Peter Inc. Acquired 100% Of The Outstanding Common Stock Of
1 Peter Inc Acquired 100 Of The Outstanding Common Stock Of Simran
1) Peter Inc. acquired 100% of the outstanding Common Stock of Simran Inc. for $250,000 cash and 10,000 shares of its own common stock ($1 par value), which was trading at $5 per share at the acquisition date. Determine the acquisition cost and pass journal entries in the books of the parent company. 2) Parkin Corporation created Sunlight Corporation with a transfer of $800 cash. During Sunlight Corp.'s first year, it incurred a net loss of $150 and paid no dividends. In the second year, it generated a net income of $350 and paid dividends of $80. Pass journal entries for two years using the equity method and prepare the ‘Investment in Sunlight Corporation Account’ for each year, showing the ending balances. 3) Explain at least two points each of the different approaches or theories that serve as the basis for preparing consolidated financial statements.
Paper For Above instruction
The acquisition of a subsidiary by a parent company involves complex accounting processes that reflect the economic reality of the transaction. In this context, Peter Inc.'s complete acquisition of Simran Inc. and the subsequent accounting treatments provide a comprehensive illustration of consolidation principles and equity method applications. Additionally, understanding different theoretical approaches for preparing consolidated financial statements is crucial for financial reporting standards and regulatory compliance.
Part 1: Acquisition Cost and Journal Entries of Peter Inc. for the Acquisition of Simran Inc.
Peter Inc. acquired 100% of Simran Inc.'s outstanding common stock for a total consideration comprising cash and shares of its own stock. The consideration paid in cash was $250,000. The stock consideration involved issuing 10,000 shares at a trading price of $5 per share, resulting in a stock consideration of $50,000 (10,000 shares x $5). Therefore, the total acquisition cost, which is the sum of cash paid and the fair value of shares issued, amounts to $300,000 ($250,000 + $50,000).
The journal entry in the books of Peter Inc. to record the acquisition would be as follows:
- Debit Investment in Simran Inc. for $300,000
- Credit Cash for $250,000
- Credit Share Capital for $10,000 (for the issued shares with $1 par value)
- Credit Share Premium or Additional Paid-in Capital for $40,000 (the excess over par value, i.e., $50,000 minus $10,000 par value shares issued)
This entry reflects the total cost invested in Simran Inc., recognizing the fair value of consideration transferred.
Part 2: Equity Method Accounting for Parkin and Sunlight Corporation
Under the equity method, investments are initially recorded at cost, and the carrying amount is adjusted for the investor’s share of the investee’s income or loss, minus dividends received. For Parkin Corporation’s investment in Sunlight Corporation, the initial investment transfer of $800 is recorded as follows:
| Year | Journal Entry | Investment Account Balance |
|---|---|---|
| Year 1 |
Debit Investment in Sunlight Corporation for $800 |
$800 (initial) |
| Year 1 |
Adjust for net loss: Debit Loss and Credit Investment |
Balance remains at $800 (since loss reduces value, but in this case no additional entry is needed apart from recognition) |
| Year 2 |
Increase investment by the share of net income: Debit Investment and Credit Income |
$800 + ($350 - share of loss, if any). Since Sunlight's net income is $350, and there was a prior loss, net income increases the investment. Dividends paid reduce the investment. |
Specifically, the journal entries for each year are:
- Year 1: Investment recorded at initial transfer of $800.
- Year 1 net loss: Investment account decreased by investor’s share of loss (if any). Since the loss is $150, the investor’s share, assuming 100% ownership, is $150. Entry: Debit Loss $150, Credit Investment $150.
- Year 2 net income: Investment increased by $350. Entry: Debit Investment $350, Credit Income from Sunlight.
- Year 2 dividends of $80: Investment decreased by $80. Entry: Debit Dividends Receivable or Cash $80, Credit Investment $80.
At the end of each year, the ‘Investment in Sunlight Corporation’ account reflects the cumulative adjustments for income, loss, and dividends, showing the fair economic position of the investment.
Part 3: Approaches/Theories for Preparing Consolidated Financial Statements
Consolidated financial statements aim to present the financial position and results of a parent and its subsidiaries as a single economic entity. Different approaches or theories underpin the preparation of these statements, impacting methodology and disclosure. These include:
1. The Cost or Purchase Method
- Historical Cost Perspective: The method records the investment at its original cost, typically the consideration transferred during acquisition. Subsequent adjustments mainly involve impairment or cost allocations rather than fair value changes.
- Focus on Ownership Rights: This approach emphasizes the ownership stake acquired and the initial investment's historical value, providing stability in reporting.
2. The Equity Method
- Reflects Economic Reality: Adjustments are made for the investor’s share of the investee’s net income or loss, providing a more dynamic view of the investment’s value over time.
- Profit and Loss Linkage: This method links the investor’s financial results directly to the investee’s performance, emphasizing ongoing economic ties rather than just the acquisition cost.
3. The Fair Value or Market Value Approach
- Focus on Market Conditions: Investments are measured at fair value, reflecting current market conditions, which can be more relevant for certain types of investments like trading securities.
- Volatility and Transparency: Changes in fair value are recognized directly in earnings or comprehensive income, providing transparency on unrealized gains and losses.
4. The Consolidation Approach Based on Control
- Control-Based Standard: When the parent controls the subsidiary (more than 50% ownership), full consolidation is required, combining all assets, liabilities, income, and expenses.
- Reflects True Economic Power: This approach ensures the consolidated statements reflect the economic power exercised by the parent over the subsidiary.
In conclusion, these approaches serve different reporting needs and regulatory requirements. The choice among them depends on the ownership levels, strategic goals, and the nature of investments, impacting how financial information is consolidated and presented to stakeholders.
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