Dr. M.D.

Chase
Advanced Accounting 705-51Ca

Long Beach State University

Special Issues: Direct and Piecemeal Acquisition of S Stock
Page 1

SPECIAL ISSUES IN ACCOUNTING FOR THE INVESTMENT IN "S":

I. Direct Acquisitions:
When a Parent organizes a subsidiary and takes back all of the stock, there are no special accounting issues and cost is equal to bv.
Normal procedures apply.
When a Parent organizes a subsidiary and sells part of the stock into the open market, the price paid for the stock by outsiders is
deemed to reflect the underlying value of the stock and adjustments to cost must be made to reflect the market value.
A.
B.

"P" organizes "S" and provides equity funds in exchange for C/S: Cost=BV;
"P" organizes "S" and provides equity funds in exchange for C/S; Some of "S" C/S is sold to outsiders:
--if price paid by outsiders = "P"'s basis in "S" C/S then Cost = BV
--if price paid by outsiders < "P"'s basis in "S" C/S then Cost > BV and goodwill must be recognized by "P"
--if price paid by outsiders > "P"'s basis in "S" C/S then Cost < BV and normal analysis procedures must be followed;
--if cash is the only asset on the books of "S", a deferred credit must be recognized by "P"
For example:
--"P" forms "S" by investing $500,000 in return for 80% of "S"'s 10,000 shares of "S" $10 par common stock.
--if "S" sells the remaining 2,000 shares to outsiders for $20 per share, "P" would make the following analysis:
Cost........................................
$
500,000
Purchased BV:
Common stock: (10,000 x $10)........ $
100,000
PIC (8,000 x $52.50) + (2,000 x $10). 440,000
ownership interest (80%)(540,000)
432,000
Excess of cost over book value.........
68,000 ** Attributed to goodwill

"P"'s bookvalue is more than the book value indicated by the "arms-length" purchase by outsiders. When a purchaser pays LESS than the
indicated book value, goodwill is created.
--if "S" sells the remaining 2,000 shares to outsiders for $70 per share, "P" would make
The computation of PIC would look like this:
the following analysis:
Cost.....................................
$
500,000
PIC = $500,000/8,000 =
62.50
Purchased BV:
Less: par value
=
10.00
Common stock: (10,000 x $10)........... $
100,000
52.50
PIC (8,000 x $52.50) + (2,000 x $60)....
540,000
Ownership interest (80%)..........
512,000
Excess of cost over book value......
12,000 **
**allocated to noncurrent assets if available, attributed to deferred credit if only fair
market value accounts* exists (Fair market value accounts are those that must be valued at FMV (CA; Liabilities; MES))

"P" 's indicated bookvalue is less than the book value indicated by the "arms-length" purchase by outsiders. When a purchaser pays MORE
than the indicated book value, a bargain purchase is indicated and the valuation of non-current assets must be reduced.
II. Piecemeal Acquisitions:
A. General Rules:
Treat each purchase as a separate independent event just as would be done for purchases of separate, independent companies;
each purchase must be analyzed and accounted for separately; each investment must keep its underlying basis separate from
other acquisitions of the same company in order to insure proper accounting of gains and losses from future sales;
if the cost method is used, conversions are handled separately;
consolidation procedures go into effect only when the aggregate purchase exceeds 50% of the outstanding voting stock of the
investee company.