Chapter Two Consolidated Financial Statement on Date of Acqusitions

Chapter Two

Consolidated Financial Statement on Date of Business Combination

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Parent Company – Subsidiary RelationshipsIf the investor acquires a controlling interest in the

investee, a parent - subsidiary relationship established.

The investee becomes a subsidiary of the acquiring parent company (investor) but remains a separate legal entity.

A strict adherence to legal aspects of such business combination would require the issuance of separate financial statements for the parent company and for the subsidiary company.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in

Accounting and Finance)

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Parent Company – Subsidiary Relationships However, such strict adherence to legal form disregards

the substance of most parent-subsidiary relationships. A parent company and its subsidiaries are a single

economic entity. In recognition of this fact, consolidated financial

statements are issued to report the financial position and operating results of a parent company and its subsidiaries as though they comprised a single accounting entity.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in


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Nature of Consolidated Financial Statements Consolidated financial statements are similar to the

combined financial statements for a home office and its branches.

Assets, liabilities, revenue, and expenses of the parent company and its subsidiaries are totaled; inter-company transactions and balances are eliminated; and the final consolidated amounts are reported in the consolidated balance sheet, income statements, statement of stockholders’ equity, and statement of cash flows.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in


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Nature of Consolidated Financial StatementsA “pro forma ” presentation--it means “as if ” the parent and subsidiary were a SINGLE legal entity with one or more branches.

It is a LEGAL FICTIONAL PRESENTATION (an accounting mirage).Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in


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Consolidation Procedures: Primary Objectives To present on a combined basis

The detailed asset, liability, and net worth position represented by the parent company’s separate books, plus

The individual values of the subsidiary’s assets and liabilities acquired

Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)

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Consolidated Financial Statements Prepared from separate F/statements of

acquiring(parent) & acquired (subsidiaries) companies using consolidation worksheet procedure

Present assets & liabilities of two companies as if they were single accounting entity

Required whenever stock held by acquiring company gives it controlling interest in acquired company


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Consolidation Issues

Acquisition Price (at book value or more than book value)

Acquisition Timing (at beginning of year or during the year)

Percent of subsidiary acquired (100% or less than 100%)


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The Purpose of Consolidated Financial Statements The purpose of consolidated financial statements

is to present, primarily for the benefit of the owners and creditors of the parent company, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single economic entity.

Consolidated statements are intended primarily for the parent’s investors, rather than for the non-controlling stockholders and subsidiary creditors.


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Should All Subsidiaries Be Consolidated?

Consolidated financial statements provide much information that is not included in the separate statements of the parent, and are usually required for fair presentation of the financial position and results of operations for a group of affiliated companies.

The usual condition for consolidation is ownership of more than 50 percent of the voting stock of another company


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Under current GAAP, a subsidiary can be excluded from consolidation in some situations:

When control does not rest with the majority owner,

Control does not rest with the majority owner if the subsidiary is in legal reorganization or bankruptcy or is operating under severe foreign-exchange restrictions, or other governmentally-imposed uncertainties

Formation of joint ventures, Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in


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Under current GAAP , a subsidiary can be excluded from consolidation in some situations:

The acquisition of an asset or group of assets that does not constitute a business,

A combination between entities under common control, and

A combination between not-for-profit entities or the acquisition of a for-profit business by a not-for-profit entity.


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Consolidated Financial Statements Weaknesses

Diverse businesses are more difficult to interpret

Weak performers are more difficult to identify

Consolidations make it difficult to compare entities to industry standards

Financial ratios do not represent any particular part of the entity


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Parent Subsidiary

The Sub still prepares separate financial statements

Consolidated financial statements are prepared.

The parent does not prepare separate financial

statements

Consolidation of Financial Information

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The Meaning of Controlling InterestWhen one company owns, directly or indirectly, over 50% of outstanding voting shares of another company

Gives parent company ability to establish subsidiary’s operating and financial policies and to direct subsidiary’s economic activities as if they were the economic activities of one of their branches or divisions


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Criteria for ConsolidationPercentage of Outstanding Voting Stock Acquired

20% 50% 100%0%

1. Level of economic influence

Nominal “Significant influence” Control

2. Financial statement presentation

Investment AccountSeparate Financial Statements

ConsolidatedFinancial Statements

Company A Company A

Company Y

Company Z

Dir

ect

Ow

ners

hip

of

Co. Z

by

Co. A

owns shares in owns shares in

owns shares in

Indirect Ow

nership of Co. Z by Co. A

Company Z

Direct vs. Indirect Ownership

Consolidation: The 3 Considerations


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In buying real estate, the three most important considerations are “location, location, and location.”

In determining whether consolidation is appropriate, the three most important considerations are “control, control,and control.”

Control: It Means Having Power


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To hire and fire management.

To set management’s compensation.

To decide when to pay dividends.

Control: It Means Having Power


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To approve operating, capital, and R&D budgets.

To direct the use of the subsidiary’s assets.

To liquidate the subsidiary into a division if desired.

Consolidation of Wholly Owned Subsidiary on Date of Purchase-Type Business Combination

When the fiscal periods of the parent and its subsidiaries differ, we prepare consolidated statements for and as of the end of the parent’s fiscal period

The consolidated balance sheet is not merely a summation of account balances of the affiliates. We eliminate reciprocal accounts in the process of consolidation and combine only nonreciprocal accounts.

The capital stock that appears in a consolidated balance sheet is the capital stock of the parent, and the consolidated retained earnings are the retained earnings of the parent company.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in


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Consolidation of Wholly Owned Subsidiary on Date of Purchase-Type Business Combination

There is no a question of control for wholly owned subsidiary.


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Consolidated Balance Sheets: Use of Work papers Assets and liabilities are summed, regardless of

whether the parent owns 100% or a smaller controlling interest.

Non-controlling interests are reflected as a component of owners’ equity.Eliminations must be made to cancel the effects of transactions among the parent and its subsidiaries.A work paper is frequently used to summarize the effects of various additions and eliminations


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Consolidated Balance Sheets: Use of Work papers

Intercompany receivable (payable) Intercompany payable (receivable)AgainstAdvances to subsidiary

(from subsidiary)Advances from parent

(to parent)AgainstInterest revenue (interest expense)

Interest expense (interest revenue)Against

Dividend revenue (dividends declared)

Dividends declared (dividend revenue)Against

Management fee received from subsidiary Management fee paid to parentAgainstSales to subsidiary (purchases of inventory

from subsidiary)Purchases of inventory from parent (sales

to parent)Against

Parent’s Accounts Subsidiary’s AccountsInvestment in subsidiary Equity accounts Against

Intercompany Accounts to Be Eliminated

Use of Work papers: Investment Elimination It is necessary to eliminate the investment account of

the parent company against the related stockholders’ equity of the subsidiary to avoid double counting of these net assets.

When parent’s share of subsidiary’s equity is eliminated against the investment account, subsidiary’s net assets are substituted for the investment account in the consolidated balance sheet.


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Columns of Work papers

The first two columns provide information from the separate balance sheets of Parent and Subsidiary.

The third column records adjustments and eliminations, subdivided into debits and credits.

The last column presents the totals that will appear in the consolidated balance sheet.

We calculate amounts in the Consolidated Balance Sheet column by adding together amounts from the first two columns and then adding or subtracting the adjustments and eliminations, as appropriate


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Nature of working paper entries

Working paper entries are only work paper adjustments and eliminations and are not recorded in the accounts of the parent or subsidiary corporations . The entries will never be journalized or posted.

Their only purpose is to facilitate completion of the work papers to consolidate a parent and subsidiary at and for the period ended on a particular date


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Steps for Consolidation1. Record the financial information for both

Parent and Sub on the worksheet.

2. Remove the Investment in Sub balance.

3. Remove the Sub’s equity account balances.4. Adjust the identifiable assets acquired and

liabilities assumed to Fair Values.5. Allocate any remaining excess of

consideration transferred over Book Values to goodwill.

6. Combine all account balances.

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Documents

Chapter Two Consolidated Financial Statement on Date of Acqusitions