Investment in Common Stock: Differential Method- Part 3

In part two, you saw that the differential is handed in two parts. Part of the differential is the difference between the fair market value of the net assets and the equity of the company. That accounted for $50,000 of the difference.

Goodwill is defined as the difference between:

·            The value of the company, based on the consideration paid for Hollywood Jeans. Based on the $310,000 paid for 80% of Hollywood Jeans, Hollywood has a value of $387,500.

·            The fair market value of the net assets. That total was $350,000.

Goodwill accounted for $37,500 of the difference.

The accounting entry in consolidation:

When you consolidate the financial statements of Hollywood Jeans and Basic Jeans, you make two journal entries to account for the differential. The first journal entry does four things:

1.     Eliminates the subsidiary’s (Hollywood’s) equity

2.     Eliminate Basic’s “Investment in Hollywood” account

3.     Eliminate the Non-Controlling Interest’s investment in Hollywood

4.     Balance (plug) the entry by eliminating the differential.

                                                        Debit                         Credit

Hollywood Equity                          $300,000

Differential                                    $87,500

   Investment in Hollywood                                                 $310,000 (Basic)

   Investment in Hollywood                                                 $77,500

                                                                                          (Non-controlling interest)

(To eliminate the Investment balances and Hollywood’s Equity account)

Next, you will credit the differential to eliminate it. The differential is a temporary account. It is an account that is always adjusted to zero. As a result, it is never posted to the financial statements.

To post a balanced entry, you’ll post debits to increase the asset accounts from their book value to their fair market value. In part two, you noted computer software and land assets that had fair market values above their book value. As mentioned in part two, the asset values for Hollywood will reflect fair market value in consolidation. Here’s the entry:

                                                        Debit                         Credit

Hollywood Asset                              $87,500

(Various accounts)

     Differential                                                                    $87,500

(To assign the differential to asset accounts)

Liability accounts may also have fair market values that differ from book value. If so, they would be included in the entry above. However, it’s easier to visualize asset fair market values- that’s why assets are used in this example.

You now know what a differential is, what components might make up the balance- and how to post journal entries to eliminate the differential balance.

I hope this video is helpful:

http://www.youtube.com/watch?v=cfZ568erLg4

Your comments are welcome! For live chats on some of the toughest accounting topics, go to my website listed below.

Thanks!

Ken Boyd

St. Louis Test Preparation

(cell) (314) 913-6529

(email) ken@stltest.net

(website) www.stltest.net

(you tube channel) kenboydstl

(blog) http://accountingaccidentally.blogspot.com/

(twitter) @StLouisTestPrep                         

Author/ Cost Accounting for Dummies (John Wiley and Sons) March 2013