1. Chapter 5 Consolidation Subsequent To Acquisition (No Intercompany Profits)

2. © 2009 Clarence Byrd Inc.2 Classification of Problems Open Trial Balance (Requires more than just a Balance Sheet) Open Trial Balance (Requires more than just a Balance Sheet) Investment at CostInvestment at Cost Investment at EquityInvestment at Equity

3. © 2009 Clarence Byrd Inc.3 Classification of Problems Closed Trial Balance (Requires only a Balance Sheet) Closed Trial Balance (Requires only a Balance Sheet) Investment at Cost vs.Investment at Cost vs. Investment at EquityInvestment at Equity

4. © 2009 Clarence Byrd Inc.4 Classification of Problems Focus of this chapter is when investment is held at cost Focus of this chapter is when investment is held at cost Problems involving the equity method are given limited coverage in Chapter 7, which will not be covered in this course Problems involving the equity method are given limited coverage in Chapter 7, which will not be covered in this course

5. © 2009 Clarence Byrd Inc.5 Step A Procedures Step A-1 Procedure Eliminate 100 percent of the Investment In Subsidiary account. Step A-1 Procedure Eliminate 100 percent of the Investment In Subsidiary account. Step A-2 Procedure Eliminate 100 percent of all the balances in the subsidiary’s common shareholders’ equity that are present on the acquisition date. Step A-2 Procedure Eliminate 100 percent of all the balances in the subsidiary’s common shareholders’ equity that are present on the acquisition date. Step A-3 Procedure Allocate any debit or credit Differential to 100 percent of fair value change on the identifiable assets, liabilities and goodwill (Bargain Purchase Gain). Step A-3 Procedure Allocate any debit or credit Differential to 100 percent of fair value change on the identifiable assets, liabilities and goodwill (Bargain Purchase Gain). Step A-4 Procedure Record Non-Controlling interest at the time of acquisition. Depending on management’s choice, the amount to be recorded will be either the non- controlling interest’s share of the fair value of the subsidiary’s identifiable assets or, alternatively, the fair value of the non-controlling interest Step A-4 Procedure Record Non-Controlling interest at the time of acquisition. Depending on management’s choice, the amount to be recorded will be either the non- controlling interest’s share of the fair value of the subsidiary’s identifiable assets or, alternatively, the fair value of the non-controlling interest

6. © 2009 Clarence Byrd Inc.6 Step A Procedures Complete coverage in Chapter 4 Complete coverage in Chapter 4 Will be repeated unchanged in every problem Will be repeated unchanged in every problem

7. © 2009 Clarence Byrd Inc.7 Step B Procedures Chapter 4 Coverage Chapter 4 Coverage Step B-1 Procedure Eliminate 100 percent of all intercompany assets and liabilities.Step B-1 Procedure Eliminate 100 percent of all intercompany assets and liabilities. New In Chapter 5 New In Chapter 5 Realization of fair value changesRealization of fair value changes Goodwill impairmentGoodwill impairment Intercompany expenses and revenuesIntercompany expenses and revenues Intercompany dividendsIntercompany dividends

8. © 2009 Clarence Byrd Inc.8 Step C Distribution of subsidiary Retained Earnings since acquisition Distribution of subsidiary Retained Earnings since acquisition Introduced in this ChapterIntroduced in this Chapter Modified in Chapter 6Modified in Chapter 6

9. © 2009 Clarence Byrd Inc. 9 Step B(2) Realization of Fair Value Changes Basic Concept Basic Concept Acquisition amounts recorded in Step AAcquisition amounts recorded in Step A As assets are sold or used, the recorded fair value changes become realizedAs assets are sold or used, the recorded fair value changes become realized As the fair value changes become realized, the Step A amounts must be reduced, with the changes taken into incomeAs the fair value changes become realized, the Step A amounts must be reduced, with the changes taken into income

10. © 2009 Clarence Byrd Inc.10 Step B(2) – Current Assets On January 1, 2009, Par acquires 100 percent of the voting shares of Sub. Sub has Inventories with a carrying value of $550,000 and a fair value of $600,000. During the year ending December 31, 2009, the Inventories are sold, with Sub recording a Cost Of Goods Sold of $550,000.

11. © 2009 Clarence Byrd Inc.11 Step B(2) - Inventories Required Adjustment 2009 Required Adjustment 2009 Increases Cost Of Goods Sold and reverses the Step A debit of $50,000 Increases Cost Of Goods Sold and reverses the Step A debit of $50,000 Year Ending December 31, 2009 Cost Of Goods Sold $50,000 Inventories$50,000

12. © 2009 Clarence Byrd Inc.12 Step B(2) - Inventories Required adjustment 2010 Required adjustment 2010 This entry will be required in every subsequent year This entry will be required in every subsequent year Year Ending December 31, 2010 Retained Earnings $50,000 Inventories$50,000

13. © 2009 Clarence Byrd Inc.13 Step B(2) - Depreciable Assets On January 1, 2009, Par acquires 100 percent of the voting shares of Sub. Sub has a factory building with a carrying value of $810,000 and a fair value of $900,000. The building will be used for 3 years and retired on December 31, 2011 with no salvage value. It is subject to straight line amortization at the rate of $270,000 per year.

14. © 2009 Clarence Byrd Inc.14 Step B(2) - Depreciable Assets Required Adjustment 2009 Required Adjustment 2009 Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to $60,000. Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to $60,000. Year Ending December 31, 2009 Amortization Expense ($90,000 ÷ 3) $30,000 Building (Net) $30,000

15. © 2009 Clarence Byrd Inc.15 Step B(2) - Depreciable Assets Required adjustment 2010 Required adjustment 2010 Reduces the opening Retained Earnings to reflect the 2009 amortization. Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to $30,000. Reduces the opening Retained Earnings to reflect the 2009 amortization. Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to $30,000. Year Ending December 31, 2010 Retained Earnings (Opening) $30,000 Amortization Expense 30,000 Building (Net) $60,000

16. © 2009 Clarence Byrd Inc.16 Step B(2) - Depreciable Assets Required adjustment 2011 Required adjustment 2011 Reduces the opening Retained Earnings to reflect the 2009 and 2010 amortization. Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to Nil. Reduces the opening Retained Earnings to reflect the 2009 and 2010 amortization. Increases Amortization Expense from $270,000 ($810,000 ÷ 3) to $300,000 ($900,000 ÷ 3). Reduces the Step A allocation from $90,000 to Nil. Year Ending December 31, 2011 Retained Earnings (Opening) $60,000 Amortization Expense 30,000 Building (Net) $90,000

17. © 2009 Clarence Byrd Inc.17 Step B(2) Depreciable Assets Required adjustment 2012 Required adjustment 2012 This entry will be required in every subsequent year This entry will be required in every subsequent year Year Ending December 31, 2012 Retained Earnings $90,000 Building (Net) $90,000

18. © 2009 Clarence Byrd Inc.18 Step B(2) - Land On January 1, 2009, Par acquires 100 percent of the voting shares of Sub. Sub has Land with a carrying value of $450,000 and a fair value of $600,000. Sub sells this parcel of Land on December 31, 2012 for $700,000.

19. © 2009 Clarence Byrd Inc.19 Step B(2) - Land As Land does not depreciate, no entry is required in 2009, 2010, or 2011.

20. © 2009 Clarence Byrd Inc.20 Step B(2) - Land Sub’s entry when Land is sold Sub’s entry when Land is sold Year Ending December 31, 2012 Cash$700,000 Gain On Sale Of Land $250,000 Land450,000

21. © 2009 Clarence Byrd Inc.21 Step B(2) - Land Required Consolidation Adjustment Required Consolidation Adjustment Reduce gain to $100,000 ($700,000 - $600,000)Reduce gain to $100,000 ($700,000 - $600,000) Reverse the Step A allocation to LandReverse the Step A allocation to Land Year Ending December 31, 2012 Gain On Sale Of Land $150,000 Land$150,000

22. © 2009 Clarence Byrd Inc.22 Step B(3) – Goodwill Impairment Goodwill is no longer subject to amortization Goodwill is no longer subject to amortization Must be tested annually for impairment Must be tested annually for impairment If impaired: The Step A allocation must be adjusted and charged to income If impaired: The Step A allocation must be adjusted and charged to income

23. © 2009 Clarence Byrd Inc.23 Step B(4) – Intercompany Expenses and Revenues Must be eliminated for purposes of consolidation Must be eliminated for purposes of consolidation Unless an unrealized profit is involved, no change to income. More on this in Chapter 6. Unless an unrealized profit is involved, no change to income. More on this in Chapter 6.

24. © 2009 Clarence Byrd Inc.24 Step B(4) – Intercompany Expenses and Revenues During 2009, a subsidiary pays interest of $50,000 to its parent During 2009, a subsidiary pays interest of $50,000 to its parent Required adjustment: Required adjustment: Year Ending December 31, 2009 Interest Revenue (Parent’s) $50,000 Interest Expense (Subsidiary’s) $50,000

25. © 2009 Clarence Byrd Inc.25 Step B(5) – Intercompany Dividends Required Adjustments Required Adjustments Eliminate the Dividend Revenue recorded by the parentEliminate the Dividend Revenue recorded by the parent Eliminate 100 percent of the Dividends Declared by the subsidiaryEliminate 100 percent of the Dividends Declared by the subsidiary Statement Of Retained Earnings contains parent company approach income (doesn’t include minority share) Statement Of Retained Earnings contains parent company approach income (doesn’t include minority share) This means minority dividends cannot be shown in the Statement of Retained Earnings This means minority dividends cannot be shown in the Statement of Retained Earnings Minority share of dividends debited to the Non-Controlling Interest in the Balance SheetMinority share of dividends debited to the Non-Controlling Interest in the Balance Sheet

26. © 2009 Clarence Byrd Inc.26 Step C – Concepts Step A: Eliminate the non- controlling share of Retained Earnings At Acquisition Step A: Eliminate the non- controlling share of Retained Earnings At Acquisition Step B: Make adjustments to the balance of Retained Earnings since acquisition Step B: Make adjustments to the balance of Retained Earnings since acquisition Step C: Allocate the balance since acquisition to Non-Controlling Interest and consolidated Retained Earnings Step C: Allocate the balance since acquisition to Non-Controlling Interest and consolidated Retained Earnings

27. © 2009 Clarence Byrd Inc.27 Step C Schedule Beginning Balance Of Retained Earnings $1,200,000 Step A Elimination ( 800,000) Balance Since Acquisition $ 400,000 Step B Adjustments (Fair Value Changes and Goodwill Impairment) and Goodwill Impairment) ( 120,000) Balance To Be Distributed $ 280,000 To Non-Controlling Interest (20%) ( 56,000) To Consolidated Retained Earnings $ 224,000 *Numbers created for this example

28. © 2009 Clarence Byrd Inc.28 Step C Schedule This schedule will be modified in Chapter 6 to deal with unrealized intercompany profits This schedule will be modified in Chapter 6 to deal with unrealized intercompany profits

29. © 2009 Clarence Byrd Inc.29 Preparing The Statements General Approach General Approach Add parent and subsidiary figuresAdd parent and subsidiary figures Add or subtract the Step A and Step B and Step C adjustmentsAdd or subtract the Step A and Step B and Step C adjustments

30. © 2009 Clarence Byrd Inc.30 Definitional Calculations Useful for checking figures arrived at through statements Useful for checking figures arrived at through statements In problems or exams, this may be the only requirement In problems or exams, this may be the only requirement

31. © 2009 Clarence Byrd Inc.31 Consolidated Net Income – Definitional Calculation Parent Company Income $1,000,000 Less: Intercompany Dividends ( 60,000) Balance $ 940,000 Subsidiary Net income $220,000 Fair Value and Goodwill adjustments ( 125,000) $95,000 Consolidated Net Income Of The Enterprise $1,035,000 Non-Controlling interest (20%)(95,000) ( 19,000) Consolidated Net Income $1,016,000 *Numbers created for this example

32. © 2009 Clarence Byrd Inc.32 Consolidated Retained Earnings – Definitional Calculation Parent Company Closing Retained Earnings $3,500,000 Add: Parent’s Share Of Subsidiary Retained Earnings Since Acquisition adjusted for fair value and goodwill adjustments (Step B) Retained Earnings Since Acquisition adjusted for fair value and goodwill adjustments (Step B)440,000 Consolidated Retained Earnings $3,940,000 *Numbers created for this example

33. © 2009 Clarence Byrd Inc.33 Non-Controlling Interest Calculation - Balance Sheet Using the procedures Using the procedures Add: Step A AllocationAdd: Step A Allocation Subtract: non-controlling dividendsSubtract: non-controlling dividends Add: Non-controlling interest in incomeAdd: Non-controlling interest in income Add: Step C allocationAdd: Step C allocation Direct Calculation May Be Easier Direct Calculation May Be Easier If NCI on identifiable assets, multiply NCI percent times the subsidiary’s Shareholder’s Equity after Step B adjustments.If NCI on identifiable assets, multiply NCI percent times the subsidiary’s Shareholder’s Equity after Step B adjustments. Doesn’t work if NCI based on its fair value.Doesn’t work if NCI based on its fair value.

34. © 2009 Clarence Byrd Inc.34 Application of the Equity Method Paragraph 3051.08 Investment income as calculated by the equity method should be the amount necessary to increase or decrease the investor's income to that which would have been recognized if the results of the investee's operations had been consolidated with those of the investor. (August, 1978) Paragraph 3051.08 Investment income as calculated by the equity method should be the amount necessary to increase or decrease the investor's income to that which would have been recognized if the results of the investee's operations had been consolidated with those of the investor. (August, 1978) “One Line Consolidation”: “One Line Consolidation”: All consolidation adjustments are treated as adjustments of investment incomeAll consolidation adjustments are treated as adjustments of investment income No elimination of intercompany assets, liabilities, expenses, or revenuesNo elimination of intercompany assets, liabilities, expenses, or revenues

35. © 2009 Clarence Byrd Inc.35 Investment Income Under The Equity Method Reported Investment Income (All Sources) $200,000 Less: Intercompany Dividends ( 80,000) $120,000 Parent’s Equity In Subsidiary Net Income adjusted for fair value and goodwill adjustments for current year 105,000 Equity Method Investment Income $225,000 *Numbers created for this example

36. © 2009 Clarence Byrd Inc.36 Investment Account Balance Under The Equity Method Investment Cost $1,200,000 Investor’s Equity In Investee Retained Earnings Since Acquisition adjusted for fair value and goodwill adjustments 175,000 Equity Method Investment Account Balance $1,375,000 *Numbers created for this example

37. © 2009 Clarence Byrd Inc.37 Summary Of Consolidation Procedures Step A-1 Procedure Step A-1 Procedure Eliminate 100 percent of the Investment In Subsidiary account. Step A-2 Procedure Step A-2 Procedure Eliminate 100 percent of all the acquisition date balances in the subsidiary’s shareholders’ equity (includes both contributed capital and retained earnings). Step A-3 Procedure Step A-3 Procedure Allocate any debit or credit Differential to 100 percent of fair value changes on identifiable assets, liabilities and Goodwill (Bargain Purchase Gain). The amount allocated to Goodwill or Bargain Purchase Gain is dependent on the measurement used for the non-controlling interest. Step A-4 Procedure Step A-4 Procedure Record Non-Controlling interest at the time of acquisition. Depending on management’s choice, the amount to be recorded will be either the non-controlling interest’s share of the fair value of the subsidiary’s identifiable net assets or, alternatively, the fair value of the non-controlling interest.

38. © 2009 Clarence Byrd Inc.38 Summary Of Consolidation Procedures Step B-1 Procedure Step B-1 Procedure Eliminate 100 percent of all intercompany assets and liabilities. Step B-2 Procedure Step B-2 Procedure Give recognition to the post-acquisition realization of acquisition date fair value changes on assets and liabilities that have been used up or sold during the post-acquisition period. To the extent that this realization occurred in prior periods, recognition will require an adjustment of the opening retained earnings of the subsidiary. Alternatively, if the realization occurred in the current period, the adjustment will be to the subsidiary’s current period expenses, revenues, gains, or losses. Step B-3 Procedure Step B-3 Procedure Recognize current and cumulative goodwill impairment losses that have been measured since the acquisition of the subsidiary and the initial recognition of the goodwill balance. To the extent that the impairment took place during the current period, the measured amount will be charged to Goodwill Impairment Loss. To the extent that it occurred in prior periods, it will be charged to retained earnings.

39. © 2009 Clarence Byrd Inc.39 Summary Of Consolidation Procedures Step B-4 Procedure Step B-4 Procedure Eliminate 100 percent of all intercompany expenses and revenues. Step B-5 Procedure. Step B-5 Procedure Eliminate 100 percent of subsidiary dividends declared. The parent’s share of this amount will be deducted from the revenues of the parent company and the non-controlling interest’s share of this amount will be deducted from the Non-Controlling Interest in the Balance Sheet.

40. © 2009 Clarence Byrd Inc.40 Summary Of Consolidation Procedures Step C-1 Procedure Step C-1 Procedure Eliminate the subsidiary’s adjusted Retained Earnings since acquisition and allocate the appropriate amounts of this balance to the Non-Controlling interest in the Balance sheet and to Consolidated Retained Earnings.

41. © 2009 Clarence Byrd Inc.41 Summary Of Definitional Calculations Identifiable Assets And Liabilities Identifiable Assets And Liabilities The amount to be included in the consolidated Balance Sheet for any identifiable asset or liability is calculated as follows: 100 percent of the carrying value of the identifiable asset (liability) on the books of the parent company at the Balance Sheet date; plus 100 percent of the carrying value of the identifiable asset (liability) on the books of the subsidiary company at the Balance Sheet date; plus (minus) 100 percent of the acquisition date fair value increase (decrease) on the asset (liability); minus (plus) amortization or realization of the fair value increase (decrease) on the asset (liability) for the period since acquisition to the current Balance Sheet date.

42. © 2009 Clarence Byrd Inc.42 Summary Of Definitional Calculations Goodwill Goodwill The Goodwill to be recorded in the consolidated Balance Sheet is equal to: The sum of the consideration paid for the controlling interest and the value assigned to the acquisition date non-controlling interest; minus The acquisition date fair value of the subsidiary’s identifiable net assets

43. © 2009 Clarence Byrd Inc.43 Summary Of Definitional Calculations Non-Controlling Interest - Balance Sheet there are 2 alternatives: Non-Controlling Interest - Balance Sheet there are 2 alternatives: The Non-Controlling Interest can be based on the non-controlling shareholders’ percentage interest in the fair value of the identifiable net assets in the subsidiaryThe Non-Controlling Interest can be based on the non-controlling shareholders’ percentage interest in the fair value of the identifiable net assets in the subsidiary The Non-Controlling Interest can be based on the fair value of the non-controlling shareholders’ interest in the enterprise. The estimate of this value can be based on the fair value of the controlling interest as measured by the investment cost or, alternatively, through some form of separate measurementThe Non-Controlling Interest can be based on the fair value of the non-controlling shareholders’ interest in the enterprise. The estimate of this value can be based on the fair value of the controlling interest as measured by the investment cost or, alternatively, through some form of separate measurement

44. © 2009 Clarence Byrd Inc.44 Summary Of Definitional Calculations Contributed Capital. Contributed Capital The Contributed Capital to be recorded in the consolidated Balance Sheet is equal to the contributed capital from the single entity Balance Sheet of the parent company.

45. © 2009 Clarence Byrd Inc.45 Summary Of Definitional Calculations Retained Earnings Retained Earnings The Retained Earnings amount to be included in the consolidated Balance Sheet is calculated as follows: 100 percent of the Retained Earnings of the parent company; plus (minus) the parent company’s share of the subsidiary’s Retained Earnings (Deficit) since acquisition. The adjustments to this balance would be for the accumulated amounts of fair value changes that have been realized since the acquisition date through use or sale. In addition, if the acquisition date non- controlling interest has been recorded at fair value, the adjustments would include any goodwill impairment that has been recognized since acquisition. If the acquisition date non-controlling interest was measured on the basis of identifiable assets only, any goodwill impairment would be subtracted in full against the sum fo the first two items.

46. © 2009 Clarence Byrd Inc.46 Summary Of Definitional Calculations Revenue Revenue The amount of any revenue to be included in the consolidated Income Statement is calculated as follows: 100 percent of the amount reported in the parent company’s financial statements; plus 100 percent of the amount reported in the subsidiary’s financial statements; minus 100 percent of any intercompany amounts included in the parent or subsidiary figures Revenue Revenue The amount of any revenue to be included in the consolidated Income Statement is calculated as follows: 100 percent of the amount reported in the parent company’s financial statements; plus 100 percent of the amount reported in the subsidiary’s financial statements; minus 100 percent of any intercompany amounts included in the parent or subsidiary figures

47. © 2009 Clarence Byrd Inc.47 Summary Of Definitional Calculations Expense Expense The amount of any expense to be included in the consolidated Income Statement is calculated as follows: 100 percent of the amount reported in the parent company’s financial statements; plus 100 percent of the amount reported in the subsidiary’s financial statements; minus 100 percent of any intercompany amounts included in the parent or subsidiary figures; plus (minus) 100 percent of any fair value changes realized during the period through usage or sale of subsidiary assets.

48. © 2009 Clarence Byrd Inc.48 Summary Of Definitional Calculations Goodwill. Goodwill Impairment Loss If the required annual test of goodwill for impairment determines that any impairment has occurred during the current period, this amount will be recorded as a Goodwill Impairment Loss.

49. © 2009 Clarence Byrd Inc.49 Summary Of Definitional Calculations Consolidated Net Income Of The Enterprise Consolidated Net Income Of The Enterprise can be calculated as follows: 100 percent of the parent company’s Net Income, excluding dividends received from the subsidiary; plus (minus) 100 percent of the adjusted Net Income of the subsidiary. The adjustments are for 100 percent of the amounts charges to income for fair value changes realized during the period through use or sale. In addition, if the acquisition date non- controlling interest has been recorded at fair value, the adjustments would include any goodwill impairment that has been recognized during the period. If the acquisition date non-controlling interest was measured on the basis of identifiable assets only, any goodwill impairment recognized during the period would be subtracted in full against the sum of the first two items.

50. © 2009 Clarence Byrd Inc.50 Summary Of Definitional Calculations Non-Controlling Interest - Income Statement The non-controlling interest in the consolidated Income Statement is an amount equal to the non-controlling interest’s ownership percentage of the adjusted Net Income of the subsidiary. Non-Controlling Interest - Income Statement The non-controlling interest in the consolidated Income Statement is an amount equal to the non-controlling interest’s ownership percentage of the adjusted Net Income of the subsidiary. The adjustments are for 100 percent of the amounts charged to income for fair value changes realized during the period through use or sale. In addition if the acquisition date non-controlling interest has been recorded at fair value, the adjustments would include any goodwill impairment that has been recognized during the period The adjustments are for 100 percent of the amounts charged to income for fair value changes realized during the period through use or sale. In addition if the acquisition date non-controlling interest has been recorded at fair value, the adjustments would include any goodwill impairment that has been recognized during the period

51. © 2009 Clarence Byrd Inc.51 Summary Of Definitional Calculations Controlling Interest - Income Statement Controlling Interest - Income Statement The controlling interest in consolidated Net Income is simply the Consolidated Net Income Of The Enterprise, less the Non-Controlling Interest in that income. The controlling interest in consolidated Net Income is simply the Consolidated Net Income Of The Enterprise, less the Non-Controlling Interest in that income.

52. Homework Read Chapter 5 Read Chapter 5 Omit p193 to p205, dealing with consolidated cash flow statements and Step AcquisitionOmit p193 to p205, dealing with consolidated cash flow statements and Step Acquisition Do Problems 1 to 5 Do Problems 1 to 5 © 2008 Clarence Byrd Inc.52