Chapter 3: An Introduction to Consolidated Financial Statements

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy to accompany Advanced Accounting, 10th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn

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Intro to Consolidations: Objectives

1. Recognize the benefits and limitations of consolidated financial statements. 2. Understand the requirements for inclusion of a subsidiary in consolidated financial statements. 3. Apply the consolidation concepts to parent company recording of the investment in a subsidiary at the date of acquisition. 4. Allocate the excess of the fair value over the book value of the subsidiary at the date of acquisition.
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Objectives (continued)
5. Learn the concept of noncontrolling interest when the parent company acquires less than 100% of the subsidiary's outstanding common stock. 6. Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. 7. Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of elimination entries. 8. Apply the concepts underlying preparation of a consolidated income statement.
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An Introduction to Consolidated Financial Statements

1: Benefits & Limitations

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Business Acquisitions
FASB Statement 141R Business combinations occur Acquire controlling interest in voting stock More than 50% May have control through indirect ownership Consolidated financial statements Primarily for owners & creditors of parent Not for noncontrolling owners or subsidiary creditors
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An Introduction to Consolidated Financial Statements

2: Subsidiaries

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Who is a Subsidiary?
ARB No. 51 allowed broad discretion FASB Statement No. 94 Control based on share ownership FASB Statement No. 160 Financial control Subsidiaries, or affiliates, continue as separate legal entities and reporting to their controlling and noncontrolling interests.
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Consolidated Statements
Prepared by the parent company Parent discloses Consolidation policy, Reg. S-X Exceptions to consolidation, temporary control and inability to obtain control Fiscal year end Use parent's FYE, but May include subsidiary statements with FYE within 3 months of parent's FYE. Disclose intervening material events
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An Introduction to Consolidated Financial Statements

3: Parent Company Recording

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Penn Example: Acquisition Cost = Fair Value = Book Value

Skelly BV=FV Cash Other current assets Net plant assets Total Accounts payable Other liabilities Capital stock Retained earnings Total $10 15 40 $65 $15 10 30 10 $65 Penn acquires 100% of Skelly for $40, which equals the book value and fair values of the net assets acquired. Cost of acquisition Less 100% book value Excess of cost over book value $40 40 $0

To consolidate, eliminate Penn's Investment account and Skelly's capital stock and retained earnings.
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Balance sheets Cash Other curr. assets Net plant Investment in Skelly Total Accounts payable Other curr. liabilities Capital stock Retained earnings Total

Separate Penn Skelly $20 45 60 40 $165 $20 25 100 20 $165 $10 15 40 0 $65 $15 10 30 10 $65

Consolidated Penn & Sub. $30 60 100 0 $190 $35 35 100 20 $190
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An Introduction to Consolidated Financial Statements

4: Allocations at Acquisition Date

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Cost, Fair Value and Book Value

Acquisition cost, fair values of identifiable net assets and book values may differ. Allocate excess or deficiency of cost over book value and determine goodwill, if any. When BV = FV, excess is goodwill. Cost less BV = Excess to allocate Allocate first to FV-BV differences Remainder is goodwill (or bargain purchase)

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Example: BV FV but Cost = FV

Piper acquires 100% of Sandy for $310. Sandy BV FV BV = 100 + 145 = $245 Cash $40 $40 FV = 385 75 = $310
Receivables Inventory Plant, net Total Liabilities Capital stock Retained earnings Total 30 50 200 $75 100 145 $320 30 75 240 $75

Cost FV = $0 goodwill
Cost 100% BV Excess of cost over BV
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$320 $385

$310 245 $65

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Piper and Sandy (cont.)

Allocate to: Inventory 100%(+25) Plant 100%(+40) Total Amt Amort. 25 1st yr 40 10 yrs $65

Piper's elimination worksheet entry: Capital stock 100 Retained earnings 145 Inventory 25 Plant 40 Investment in Sandy
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Example: BV FV and Cost FV

Panda acquires 100% of Salty for $530. BV = 250 + 190 = $440 Salty BV FV Cash $100 $100 FV = 580 85 = $495
Receivables Inventory Plant, net Total Liabilities Capital stock Retained earnings Total 40 250 130 $80 250 190 $520 40 250 190 $85

Cost FV = $35 goodwill

Cost 100% BV (250+190) Excess of cost over BV
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$520 $580

$530 440 $90

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Panda and Salty (cont.)

Allocate to: Amt Amort. Plant 60 4 yrs Liabilities -5 5 yrs Goodwill 35 Total $90 Panda's elimination worksheet entry: Capital stock 250 Retained earnings 190 Plant 60 Goodwill 35 Liabilities Investment in Salty
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Example: BV FV and Cost FV

Printemps acquires 100% of Summer for $185. BV = 75 + 105 = $180 Summer BV FV FV = 250 - 40 = $210 Cash $10 $10
Receivables Inventory Plant, net Total Liabilities Capital stock Retained earnings Total 30 80 100 $40 75 105 $220
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30 90 120 $40

$220 $250

Cost 100% BV (75+105) Excess of cost over BV

$185 180 $5

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Printemps and Summer (cont.)

Allocate to: Inventory Plant, land Bargain purchase Total Amt 10 20 (25) $5 Amort. 1st yr Gain

Printemps records the acquisition of Summer assuming a cash purchase as follows. Note that the investment account is recorded at its fair value and the bargain purchase is treated immediately as a gain. Investment in Summer 210 Gain on Bargain purchase Cash
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Worksheet Elimination Entry

Unamortized excess equals $30 (gain is recognized) $10 for undervalued inventory $20 for undervalued land included in plant assets
Printemps' elimination worksheet entry: Capital stock Retained earnings Unamortized excess Investment in Summer Inventory Plant Unamortized excess
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75 105 30 210 10 20 30
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Cash Receivables Inventory Plant, net Investment in Summer Unamortized excess Total Liabilities Capital stock Retained earnings Total

Printemps BV $30 50 100 450 210

Summer Adjustments ConsolBV DR CR idated $10 $40 30 80 80 10 190 100 20 570 210 30 0 $880 $310 200 370 $880 240
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30 $840 $270 200 370 $840 $220 $40 75 105 $220

75 105 240

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An Introduction to Consolidated Financial Statements

5: Noncontrolling Interests

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Noncontrolling Interest
Parent owns less than 100% Noncontrolling interest represents the minority shareholders Part of stockholders' equity Measured at fair value, based on parent's acquisition price Parent pays $40,000 for an 85% interest Implied value of the full investee is 40,000/85% = $47,059. Minority share = 15%(47,059) = $7,059.
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Example: Noncontrolling Interests

Popo acquires 80% of Sine for $400 when Sine had capital stock of $200 and retained earnings of $175. Sine's assets and liabilities equaled their fair values except for buildings which are undervalued by $50. Buildings have a 10-year remaining life.
Cost of 80% of Sine Implied value of Sine (400/80%) Book value (200+175) Excess over book value $400 $500 375 $125 Allocate to: Building $50 Goodwill 75 Total $125
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Elimination Entry
Popo's elimination worksheet entry: Capital stock Retained earnings Building Goodwill Investment in Sine Noncontrolling interest 200 175 50 75 400 100

An unamortized excess account could have been used for the excess assigned to the building and goodwill.

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Cash Receivables Inventory Building, net Investment in Sine Goodwill Total Liabilities Capital stock Retained earnings Noncontrolling interest Total

Popo BV $50 130 80 300 400 $960 $150 250 560 $960

Sine Adjustments BV DR CR $10 50 100 240 50 400 75 $400 $25 200 200 175 175 100 $400 500 500
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Consolidated $60 180 180 590 0 75 $1,085 $175 250 560 100 $1,085

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An Introduction to Consolidated Financial Statements

6: Amortizations After Acquisition

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Unamortized Excess
Excess assigned to assets and liabilities are amortized according to the account
Balance sheet account Inventories and other current assets Buildings, equipment, patents, Land, copyrights Long term debt Amortization period Generally, 1st year Remaining life at business combination Not amortized Time to maturity Income statement account Cost of sales and other expense Depreciation and amortization expense Interest expense
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Piper and Sandy (cont.)

Cost 100% BV Excess $310 245 $65 Allocate to: Inventory Plant Total Amt Amort. 25 1st yr 40 10 yrs $65

Inventory Plant Total

Beginning Current Ending unamortized year's unamortized excess amortization excess 25 (25) 0 40 (4) 36 65 (29) 36
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Panda and Salty (cont.)

Cost 100% BV Excess $530 440 $90 Allocate to: Plant Liabilities Goodwill Total Amt 60 -5 35 $90 Amort. 4 yrs 5 yrs -

Plant Liabilities Goodwill Total

Beginning Current Ending unamortized year's unamortized excess amortization excess 60 (15) 45 (5) 1 (4) 35 0 35 90 14 76
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Printemps and Summer (cont.)

Cost 100% BV Excess $185 180 $5
Allocate to: Inventory Plant, land Bargain purchase Total Amt 10 20 (25) $5 Amort. 1st yr Gain

Inventory Land Total

Beginning Current Ending unamortized year's unamortized excess amortization excess 10 (10) 0 20 0 20 30 (10) 20
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An Introduction to Consolidated Financial Statements

7: Subsequent Balance Sheets

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Balance Sheets After Acquisition

In preparing a consolidated balance sheet Eliminate the parent's Investment in Subsidiary Eliminate the subsidiary's equity accounts (common stock, retained earnings, etc.) Adjust asset and liability accounts for any unamortized excess balance Record goodwill, if any Record Noncontrolling Interest, if any

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Popo and Sine (cont.)

Cost of 80% of Sine Implied value of Sine Book value Excess $400 $500 375 $125 Allocate to: Building $50 10 yrs Goodwill 75 Total $125

Building Goodwill Total

Beginning Current Ending unamortized year's unamortized excess amortization excess 50 (5) 45 75 0 75 125 (5) 120
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After 1 year: Cash Receivables Inventory Building, net Investment in Sine Total

Popo $40 110 90 280 404 $924

Sine $15 Liabilities 85 Capital stock 100 Retained earnings 235 $435 Total

Popo $100 250 574

Sine $50 200 185

$924

$435

Popo's elimination worksheet entry: Capital stock Retained earnings Unamortized excess Investment in Sine (80%) Noncontrolling interest (20%) Building Goodwill Unamortized excess
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200 185 120 404 101 45 75 120

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After 1 year: Cash Receivables Inventory Building, net Investment in Sine Goodwill
Unamortized excess

Popo BV $40 110 90 280 404

Sine BV $15 85 100 235

Adjustments DR CR

45 404 75
120 120

Consolidated $55 195 190 560 0 75 $1,075 $150 250 574 101 $1,075

Total $924 Liabilities $100 Capital stock 250 Retained earnings 574 Noncontrolling interest Total $924

$435 $50 200 185 $435

200 185 101

505 505
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Key Balance Sheet Items

Investment in Subsidiary does not exist on the consolidated balance sheet Equity on the consolidated balance sheet consists of the parent's equity plus the noncontrolling interest. Noncontrolling interest is proportional to the Investment in Subsidiary account when the equity method is used. $101 = $404 x .20/.80
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An Introduction to Consolidated Financial Statements

8: Consolidated Income Statements

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Comprehensive Example, Data

Pilot acquires 90% of Sand on 12/31/2009 for $4,333 when Sand's equity consists of $4,000 common stock, $1,000 other paid in capital, and $900 retained earnings. On that date Sand's inventories, land and buildings are understated by $100, $200, and $1,000, respectively and its equipment and notes payable are overstated by $300 and $100.

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Assignment and Amortization

Cost of 90% of Sand Implied value of Sand 10,200/.90 Book value (4000+1000+900) Excess over book value Inventory Land Building Equipment Note payable Goodwill Total $10,200 $11,333 5,900 $5,433 Unamortized excess 1/1/10 100 200 1,000 (300) 100 4,333 5,433

Allocate to: Inventory Land Building Equipment Note payable Goodwill Total Current amortization (100) 0 (25) 60 (100) 0 (165)

$100 1st yr 200 1,000 40 yrs (300) 5 yrs 100 1st yr 4,333 $5,433 Unamortized excess 12/31/10 0 200 975 (240) 0 4,333 5,268
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Pilot Sand Consol.* Sales $9,523.50 $2,200.00 $11,723.50 Income from Sand 571.50 $0.00 Cost of sales (4,000.00) (700.00) (4,800.00) Depreciation exp - bldg (200.00) (80.00) (305.00) Depreciation exp - equip (700.00) (360.00) (1,000.00) Other expense (1,800.00) (120.00) (1,920.00) Interest expense (300.00) (140.00) (540.00) Net income $3,095.00 $800.00 Total consolidated income $3,158.50 Noncontrolling interest 63.50 share Controlling interest share $3,095.00 * Cost of sales, building depreciation and interest expense are increased by $100, $25, and $100, and equipment depreciation is $60 lower than the sum of Pilot and Sand.
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Key Income Statement Items

The Income from Subsidiary account is eliminated. Current period amortizations are included in the appropriate expense accounts. Noncontrolling interest share of net income is proportional to the Income from Subsidiary under the equity method. $571.50 x .10/.90 = $63.50

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Push-Down Accounting
SEC requirement Subsidiary is substantially wholly-owned (approx. 90%) No publicly held debt or preferred stock Books of the subsidiary are adjusted Assets, including goodwill, and liabilities revalued based on acquisition price Retained earnings is replaced by Push-Down Capital which includes retained earnings and the valuation adjustments
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