Question

Answer the following questions:

* Explain the terms pre-acquisition earnings and pre-acquisition dividends in your own word.

* How are pre-acquisition earnings accounted for by a parent under the equity method? How are they accounted for in the consolidated income statement?

* Assume that a subsidiary has 10,000 shares of stock outstanding, of which 8,000 shares owned by the parent. What equity method adjustment will be necessary on the parent books if the subsidiary sells 2,000 additional shares of its own stock to outside interest at book value? At an amount in excess of book value?

Please explain it in detail...

Answer 1

Q1.

Pre-acquisition earnings:

They are the reserves that exist in a susidiary company as on particular date when it is acquired by a Holding company. These Pre-acqusition earnings are considered while calculating goodwill.  Both the holding company and the minority shareholders will have proportionate share in such profits and reserves. The share of the minority shareholders in such profit and reserves will be added to the amount of minority interest. But the holding company’s proportionate share in such profits and reserve should be treated as capital profits and credited to Capital Reserve since the holding company cannot earn any revenue profits from its subsidiary before the shares are acquired in it. While preparing the consolidated balance sheet, this Capital Reserve should be shown on the liabilities side or if there is any Goodwill, it can be shown as a deduction from the Goodwill in the assets side.

pre-acquisition dividends:

Suppose XYZ Company purchased shares of ABC ltd in april 2020....and the company declared dividend on those shares related to the f.y 2010-20....that dividend will be received by XYZ Company because at the receipt of the dividend time the name on the Shares register is XYZ...this is pre accquisition dividend which will be deducted from the cost of the investment of XYZ company.

Q 2.

Pre-acquisition earnings will not be accounted by a parent company in Equity method of accounting because the Parent company’s proportionate share in such profits and reserve (Earnings) should be treated as capital profits and credited to Capital Reserve since the Parent company cannot earn any revenue profits from its subsidiary before the shares are acquired in it. While preparing the consolidated balance sheet, this Capital Reserve should be shown on the liabilities side or if there is any Goodwill, it can be shown as a deduction from the Goodwill in the assets side.

Q3. When Subsidiary sella its own stock  a nonoperational increase or decrease occurs in the company’s fair and book value. The transaction need not involve the parent, so the parent’s investment account does not automatically reflect the effect of this change.