Chapter 3: An Introduction to Consolidated Financial Statements

Chapter 3:An Introduction to Consolidated Financial Statements3-1Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hallto accompanyAdvanced Accounting, 11th editionby Beams, Anthony, Bettinghaus, and Smith1Intro to Consolidations: ObjectivesRecognize the benefits and limitations of consolidated financial statements.Understand the requirements for including a subsidiary in consolidated financial statements.Apply consolidation concepts to parent company recording of an investment in a subsidiary company at the date of acquisition.Record the fair value of the subsidiary at the date of acquisition.3-2Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallObjectives (continued)Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock.Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of elimination entries.Amortize the excess of the fair value over the book value in periods subsequent to the acquisition.Apply the concepts underlying preparation of a consolidated income statement.

3-3Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall1: Benefits & LimitationsAn Introduction to Consolidated Financial Statements3-4Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallBusiness AcquisitionsBusiness combinations through stock acquisitionsAcquire controlling interest in voting stockMore than 50%May have control through indirect ownershipBusiness combination occurs onceAcquisition of additional subsidiary stock is simply additional investment3-5Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallConsolidated StatementsPrimarily benefit the owners and creditors of the parent

Not primarily intended for the noncontrolling owners nor the subsidiarys creditors

Subsidiaries issue separate statements for the benefit of their owners and creditors3-6Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall2: SubsidiariesAn Introduction to Consolidated Financial Statements3-7Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallWho is a Subsidiary?A corporation becomes a subsidiary when another corporation acquires controlling interest in its outstanding voting stock.In a 100 percent acquisition, the investee continues to operate as a separate legal entity.Subsidiaries, or affiliates, continue as separate legal entities and prepare their own financial reports.3-8Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallSubsidiaries Are ConsolidatedCases where a subsidiary may be excluded from consolidation:Control doesnt rest with majority ownerJoint venturesAcquisitions of groups of assets that do not constitute a businessCombination between entities under common controlCombination of not-for-profit entities or acquisition of a for-profit company by a not-for-profit entity3-9Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallConsolidated StatementsPrepared by the parent companyParent disclosesConsolidation policy [SEC Reg. S-X, Rule 3A-03]Any exceptions to consolidationFiscal year-end for consolidated entity:Use parent's FYE, butMay include subsidiary statements with FYE within 3 months of parent's FYE.Disclose intervening material events3-10Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall3: Parent Company RecordingAn Introduction to Consolidated Financial Statements3-11Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPen Example: Acquisition Cost = Fair Value = Book ValuePen acquires 100% of Sel for $40, which equals the book value and fair values of the net assets acquired.Cost of acquisition$40Less 100% book value40Excess of cost over book value$0Sels Balance Sheet: BV=FVCash$10Other current assets15Plant assets, net40Total$65Accounts payable$15Other current liabilities10Capital stock30Retained earnings10Total $65To consolidate, eliminate Pen's Investment account and Sel's capital stock and retained earnings.3-12Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallBalance SheetsSeparateConsolidatedPenSelPen & Sub.Cash$20$10$30Other curr. assets451560Plant assets, net6040100Investment in Sel4000Total$165$65$190Accounts payable$20$15$35Other curr. liabilities251035Capital stock100 30100Retained earnings201020Total$165$65$1903-13Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall4: Fair Value at Acquisition DateAn Introduction to Consolidated Financial Statements3-14Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallCost, Fair Value, and Book ValueAcquisition 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 = FVCost > BV, excess is goodwillCost < BV, excess is a gain on the bargain purchase3-15Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallBV FV CostDifference between the book value of net assets (BV) and the fair value of identifiable net assets (FV) is assigned to the specific assets or liabilitiesE.g., undervalued or overvalued inventories, plant assetsUnrecorded assets (patents) or liabilities (existing contingencies)Difference between FV and Cost is goodwill or a gain on the bargain purchase3-16Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallExample: BV FV but Cost = FVPiper acquires 100% of Sandy for $310.

BV = 100 + 145 = $245FV = 385 75 = $310

Cost FV = $0 goodwillSandyBVFVCash$40 $40 Receivables3030Inventory5075Plant, net200240Total$320 $385 Liabilities$75 $75 Capital stock100Retained earnings145Total$320 Cost$310 100% Book value245Excess of cost over BV$65 3-17Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPiper and Sandy (cont.)Allocate to:AmtAmort.Inventory 100%(+25)251st yrPlant 100%(+40)4010 yrsTotal$65 Piper's elimination worksheet entry:Capital stock (-SE)100Retained earnings (-SE)145Inventory (+A)25Plant (+A)40Investment in Sandy (-A)3103-18Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallExample: BV FV and Cost FVPanda acquires 100% of Salty for $530.

BV = 250 + 190 = $440FV = 580 85 = $495

Cost FV = $35 goodwillSaltyBVFVCash$100 $100 Receivables4040Inventory250250Plant, net130190Total$520 $580 Liabilities$80 $85 Capital stock250Retained earnings190Total$520 Cost$530 100% Book value440Excess of cost over BV$90 3-19Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPanda and Salty (cont.)Panda's elimination worksheet entry:Capital stock (-SE)250Retained earnings (-SE)190Plant (+A)60Goodwill (+A)35Liabilities (+L)5Investment in Salty (-A)530Allocate to:AmountAmort.Plant604 yrsLiabilities-55 yrsGoodwill 35 Total$90 3-20Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallExample: BV FV and Cost FVPrint acquires 100% of Sum for $185.

BV = 75 + 105 = $180FV = 250 - 40 = $210

Cost FV = -$25: Gain on bargain purchaseCost$185 100% BV180Excess of cost over BV$5SumBVFVCash$10 $10 Receivables3030Inventory8090Plant, net100120Total$220 $250 Liabilities$40 $40 Capital stock75Retained earnings105Total$220 3-21Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPrint and Sum (cont.)Allocate to:AmtAmort.Inventory101st yrPlant, land20 - Bargain purchase(25)GainTotal$5Investment in Sum (+A)210 Gain on bargain purchase (R, +SE)25Cash (-A) 185Print records the acquisition of Sum 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.3-22Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallWorksheet Elimination EntryPrints elimination worksheet entry:Capital stock (-SE)75Retained earnings (-SE)105Unamortized excess (+A)30Investment in Sum (-A)210Inventory (+A)10Plant (+A)20Unamortized excess (-A)30Unamortized excess equals $30 $10 for undervalued inventory $20 for undervalued land included in plant assets3-23Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPrintSumAdjustmentsConsol-BVBVDRCRidatedCash$30 $10 $40 Receivables503080Inventory1008010190Plant, net45010020570Investment in Sum2102100Unamortized excess3030Total$840 $220 $880 Liabilities$270 $40 $310 Capital stock2007575200Retained earnings370105105370Total$840 $220 $880 2402403-24Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall5: Noncontrolling InterestsAn Introduction to Consolidated Financial Statements3-25Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallNoncontrolling InterestParent owns less than 100%Noncontrolling interest represents the minority shareholdersPart of stockholders' equityMeasured at fair value, based on parent's acquisition price

Parent pays $40,000 for an 85% interestImplied value of the full investee is $40,000/85% = $47,059.Minority share = 15%(47,059) = $7,059

3-26Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallExample: Noncontrolling InterestsPopo 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$400 Implied value of Sine (400/80%)$500 Book value (200+175)375Excess over book value$125 Allocate to:Building$50 Goodwill75Total$125 3-27Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallElimination EntryPopo's elimination worksheet entry:Capital stock (-SE)200Retained earnings (-SE)175Building (+A)50Goodwill (+A)75Investment in Sine (-A)400Noncontrolling interest (+SE)100An unamortized excess account could have been used for the excess assigned to the building and goodwill. 3-28Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPopoSineAdjustmentsConsol-BVBVDRCRidatedCash$50 $10 $60 Receivables13050180Inventory80100180Building, net30024050590Investment in Sine4004000Goodwill7575Total$960 $400 $1,085 Liabilities$150 $25 $175 Capital stock250200200250Retained earnings560175175560Noncontrolling interest100100Total$960 $400 $1,085 5005003-29Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall6: Subsequent Balance SheetsAn Introduction to Consolidated Financial Statements3-30Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallBalance Sheets After AcquisitionIn preparing a consolidated balance sheetEliminate the parent's Investment in SubsidiaryEliminate the subsidiary's equity accounts (common stock, retained earnings, etc.)Adjust asset and liability accounts for any unamortized excess balanceRecord goodwill, if anyRecord Noncontrolling Interest, if any

3-31Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPopo and Sine (cont.)Cost of 80% of Sine$400 Implied value of Sine$500 Book value375Excess$125 Allocate to:Building$50 10 yrsGoodwill75 - Total$125 Beginning unamortized excessCurrent year's amortizationEnding unamortized excessBuilding50(5)45Goodwill75075Total125(5)1203-32Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallAfter 1 year:PopoSineCash$40 $15 Receivables11085Inventory90100Building, net280235Investment in Sine404Total$924 $435 PopoSineLiabilities$100 $50 Capital stock250200Retained earnings574185Total$924 $435 Popo's elimination worksheet entry:Capital stock (-SE)200Retained earnings (-SE)185Unamortized excess (+A)120Investment in Sine (80%) (-A)404Noncontrolling interest (20%) (+SE)101Building (+A)45Goodwill (+A)75Unamortized excess (-A)1203-33Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallAfter 1 year:PopoSineAdjustmentsConsol-BVBVDRCRidatedCash$40 $15 $55 Receivables11085195Inventory90100190Building, net28023545560Investment in Sine4044040Goodwill7575Unamortized excess120120Total$924 $435 $1,075 Liabilities$100 $50 $150 Capital stock250200200250Retained earnings574185185574Noncontrolling interest101101Total$924 $435 $1,075 5055053-34Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallKey Balance Sheet ItemsInvestment in Subsidiary does not exist on the consolidated balance sheetEquity 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/.803-35Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall7: Amortizations After AcquisitionAn Introduction to Consolidated Financial Statements3-36Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallUnamortized ExcessExcess assigned to assets and liabilities are amortized according to the accountBalance sheet accountAmortization periodIncome statement accountInventories and other current assetsGenerally, 1st yearCost of sales and other expenseBuildings, equipment, patentsRemaining life at business combinationDepreciation and amortization expenseLand, copyrightsNot amortizedLong-term debtTime to maturityInterest expense3-37Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPiper and Sandy (cont.)Allocate to:AmtAmort.Inventory251st yrPlant4010 yrsTotal$65 Cost$310 100% BV245Excess$65 Beginning unamortized excessCurrent year's amortizationEnding unamortized excessInventory25(25)0Plant40(4)36Total65(29)363-38Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPanda and Salty (cont.)Beginning unamortized excessCurrent year's amortizationEnding unamortized excessPlant60(15)45Liabilities(5)1(4)Goodwill35035Total90(14)76Cost$530 100% BV440Excess$90 Allocate to:AmtAmort.Plant604 yrsLiabilities-55 yrsGoodwill 35 - Total$90 3-39Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPrint and Sum (cont.)Beginning unamortized excessCurrent year's amortizationEnding unamortized excessInventory10(10)0Land20020Total30(10)20Cost$185 100% BV180Excess$5Allocate to:AmtAmort.Inventory101st yrPlant, land20 - Bargain purchase(25)GainTotal$53-40Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall8: Consolidated Income StatementsAn Introduction to Consolidated Financial Statements3-41Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallComprehensive Example, DataPil acquires 90% of Sad on 12/31/2011 for $4,333 when Sad's equity consists of $4,000 common stock, $1,000 other paid in capital, and $900 retained earnings. On that date Sad'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. 3-42Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallCost of 90% of Sad$10,200 Implied value of Sad 10,200/.90$11,333 Book value (4000+1000+900)5,900Excess over book value$5,433 Unamortized excess 1/1/12Current amortizationUnamortized excess 12/31/12Inventory100(100)0Land2000200Building1,000(25)975Equipment(300)60(240)Note payable100(100)0Goodwill4,33304,333Total5,433(165)5,268Allocate to:Inventory$100 1st yrLand200 - Building1,00040 yrsEquipment(300)5 yrsNote payable1001st yrGoodwill4,333 -Total$5,433 3-43Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPilSadConsol.*Sales$9,523.50 $2,200.00 $11,723.50 Income from Sad571.50$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 share63.50 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 Pil and Sad.3-44Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallKey Income Statement ItemsThe 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= $63.503-45Copyright 2012 Pearson Education, Inc. Publishing as Prentice HallPush-Down AccountingSEC requirementSubsidiary is substantially wholly-owned (approx. 90%)No publicly held debt or preferred stockBooks of the subsidiary are adjustedAssets, including goodwill, and liabilities revalued based on acquisition priceRetained earnings is replaced by Push-Down Capital which includes retained earnings and the valuation adjustments3-46Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall3-47Copyright 2012 Pearson Education, Inc. 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