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To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 3: An Introduction to Consolidated Financial Statements.

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Presentation on theme: "To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 3: An Introduction to Consolidated Financial Statements."— Presentation transcript:

1 to accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 3: An Introduction to Consolidated Financial Statements 3-1 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

2 Intro to Consolidations: Objectives 1.Recognize the benefits and limitations of consolidated financial statements. 2.Understand the requirements for including a subsidiary in consolidated financial statements. 3.Apply consolidation concepts to parent company recording of an investment in a subsidiary company at the date of acquisition. 4.Record the fair value of the subsidiary at the date of acquisition. 3-2 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

3 Objectives (continued) 5.Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. 6.Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of elimination entries. 7.Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. 8.Apply the concepts underlying preparation of a consolidated income statement. 3-3 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

4 1: BENEFITS & LIMITATIONS An Introduction to Consolidated Financial Statements 3-4 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

5 Business Acquisitions Business combinations through stock acquisitions  Acquire controlling interest in voting stock  More than 50%  May have control through indirect ownership Business combination occurs once  Acquisition of additional subsidiary stock is simply additional investment 3-5 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

6 Consolidated Statements  Primarily benefit the owners and creditors of the parent  Not primarily intended for the noncontrolling owners nor the subsidiary’s creditors  Subsidiaries issue separate statements for the benefit of their owners and creditors 3-6 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

7 2: SUBSIDIARIES An Introduction to Consolidated Financial Statements 3-7 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

8 Who 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. 3-8 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

9 Subsidiaries Are Consolidated Cases where a subsidiary may be excluded from consolidation:  Control doesn’t rest with majority owner  Joint ventures  Acquisitions of groups of assets that do not constitute a business  Combination between entities under common control  Combination of not-for-profit entities or acquisition of a for-profit company by a not-for-profit entity 3-9 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

10 Consolidated Statements Prepared by the parent company Parent discloses  Consolidation policy [SEC Reg. S-X, Rule 3A-03]  Any exceptions to consolidation Fiscal year-end for consolidated entity:  Use parent's FYE, but  May include subsidiary statements with FYE within 3 months of parent's FYE.  Disclose intervening material events 3-10 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

11 3: PARENT COMPANY RECORDING An Introduction to Consolidated Financial Statements 3-11 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

12 Pen Example: Acquisition Cost = Fair Value = Book Value Pen acquires 100% of Sel for $40, which equals the book value and fair values of the net assets acquired. Cost of acquisition$40 Less 100% book value40 Excess of cost over book value $0 Sel’s Balance Sheet: BV=FV Cash$10 Other current assets15 Plant assets, net40 Total$65 Accounts payable$15 Other current liabilities10 Capital stock30 Retained earnings10 Total$65 To consolidate, eliminate Pen's Investment account and Sel's capital stock and retained earnings Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

13 Balance SheetsSeparateConsolidated PenSelPen & Sub. Cash$20$10$30 Other curr. assets Plant assets, net Investment in Sel4000 Total$165$65$190 Accounts payable$20$15$35 Other curr. liabilities Capital stock Retained earnings Total$165$65$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

14 4: FAIR VALUE AT ACQUISITION DATE An Introduction to Consolidated Financial Statements 3-14 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

15 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  Cost > BV, excess is goodwill  Cost < BV, excess is a gain on the bargain purchase 3-15 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

16 BV ≠ FV ≠ Cost Difference between the book value of net assets (BV) and the fair value of identifiable net assets (FV) is assigned to the specific assets or liabilities  E.g., undervalued or overvalued inventories, plant assets  Unrecorded assets (patents) or liabilities (existing contingencies) Difference between FV and Cost is goodwill or a gain on the bargain purchase 3-16 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

17 Example: BV ≠ FV but Cost = FV Piper acquires 100% of Sandy for $310. BV = = $245 FV = 385 – 75 = $310 Cost – FV = $0 goodwill SandyBVFV Cash$40 Receivables30 Inventory5075 Plant, net Total$320$385 Liabilities$75 Capital stock100 Retained earnings145 Total$320 Cost$ % Book value245 Excess of cost over BV$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

18 Piper and Sandy (cont.) Allocate to:AmtAmort. Inventory 100%(+25)251st yr Plant 100%(+40)4010 yrs Total$65 Piper's elimination worksheet entry: Capital stock (-SE)100 Retained earnings (-SE)145 Inventory (+A)25 Plant (+A)40 Investment in Sandy (-A) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

19 Example: BV ≠ FV and Cost ≠ FV Panda acquires 100% of Salty for $530. BV = = $440 FV = 580 – 85 = $495 Cost – FV = $35 goodwill SaltyBVFV Cash$100 Receivables40 Inventory250 Plant, net Total$520$580 Liabilities$80$85 Capital stock250 Retained earnings190 Total$520 Cost$ % Book value440 Excess of cost over BV$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

20 Panda and Salty (cont.) Panda's elimination worksheet entry: Capital stock (-SE)250 Retained earnings (-SE)190 Plant (+A)60 Goodwill (+A)35 Liabilities (+L)5 Investment in Salty (-A)530 Allocate to:AmountAmort. Plant604 yrs Liabilities-55 yrs Goodwill35 Total$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

21 Example: BV ≠ FV and Cost ≠ FV Print acquires 100% of Sum for $185. BV = = $180 FV = = $210 Cost – FV = -$25: Gain on bargain purchase Cost$ % BV180 Excess of cost over BV$5 SumBVFV Cash$10 Receivables30 Inventory8090 Plant, net Total$220$250 Liabilities$40 Capital stock75 Retained earnings105 Total$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

22 Print and Sum (cont.) Allocate to:AmtAmort. Inventory101st yr Plant, land20 - Bargain purchase(25)Gain Total$5 Investment in Sum (+A)210 Gain on bargain purchase (R, +SE)25 Cash (-A) 185 Print 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

23 Worksheet Elimination Entry Print’s elimination worksheet entry: Capital stock (-SE)75 Retained earnings (-SE)105 Unamortized excess (+A)30 Investment in Sum (-A)210 Inventory (+A)10 Plant (+A)20 Unamortized excess (-A)30 Unamortized excess equals $30 $10 for undervalued inventory $20 for undervalued land included in plant assets 3-23 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

24 PrintSumAdjustmentsConsol- BV DRCR idated Cash$30$10 $40 Receivables Inventory Plant, net Investment in Sum210 0 Unamortized excess 30 Total$840$220 $880 Liabilities$270$40 $310 Capital stock Retained earnings Total$840$220 $ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

25 5: NONCONTROLLING INTERESTS An Introduction to Consolidated Financial Statements 3-25 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

26 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, Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

27 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$400 Implied value of Sine (400/80%) $500 Book value ( ) 375 Excess over book value$125 Allocate to: Building$50 Goodwill75 Total$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

28 Elimination Entry Popo's elimination worksheet entry: Capital stock (-SE)200 Retained earnings (-SE)175 Building (+A)50 Goodwill (+A)75 Investment in Sine (-A)400 Noncontrolling interest (+SE)100 An unamortized excess account could have been used for the excess assigned to the building and goodwill Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

29 PopoSineAdjustmentsConsol- BV DRCRidated Cash$50$10 $60 Receivables Inventory Building, net Investment in Sine400 0 Goodwill 75 Total$960$400 $1,085 Liabilities$150$25 $175 Capital stock Retained earnings Noncontrolling interest 100 Total$960$400 $1, Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

30 6: SUBSEQUENT BALANCE SHEETS An Introduction to Consolidated Financial Statements 3-30 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

31 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 3-31 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

32 Popo and Sine (cont.) Cost of 80% of Sine$400 Implied value of Sine$500 Book value375 Excess$125 Allocate to: Building$5010 yrs Goodwill75 - Total$125 Beginning unamortized excess Current year's amortization Ending unamortized excess Building50(5)45 Goodwill750 Total125(5) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

33 After 1 year:PopoSine Cash$40$15 Receivables11085 Inventory90100 Building, net Investment in Sine404 Total$924$435 PopoSine Liabilities$100$50 Capital stock Retained earnings Total$924$435 Popo's elimination worksheet entry: Capital stock (-SE)200 Retained earnings (-SE)185 Unamortized excess (+A)120 Investment in Sine (80%) (-A)404 Noncontrolling interest (20%) (+SE)101 Building (+A)45 Goodwill (+A)75 Unamortized excess (-A) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

34 After 1 year:PopoSineAdjustmentsConsol- BV DRCRidated Cash$40$15 $55 Receivables Inventory Building, net Investment in Sine404 0 Goodwill 75 Unamortized excess120 Total$924$435 $1,075 Liabilities$100$50 $150 Capital stock Retained earnings Noncontrolling interest 101 Total$924$435 $1, Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

35 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/ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

36 7: AMORTIZATIONS AFTER ACQUISITION An Introduction to Consolidated Financial Statements 3-36 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

37 Unamortized Excess Excess assigned to assets and liabilities are amortized according to the account Balance sheet account Amortization periodIncome statement account Inventories and other current assets Generally, 1 st yearCost of sales and other expense Buildings, equipment, patents Remaining life at business combination Depreciation and amortization expense Land, copyrightsNot amortized Long-term debtTime to maturityInterest expense 3-37 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

38 Piper and Sandy (cont.) Allocate to:AmtAmort. Inventory251st yr Plant4010 yrs Total$65 Cost$ % BV245 Excess$65 Beginning unamortized excess Current year's amortization Ending unamortized excess Inventory25(25)0 Plant40(4)36 Total65(29) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

39 Panda and Salty (cont.) Beginning unamortized excess Current year's amortization Ending unamortized excess Plant60(15)45 Liabilities(5)1(4) Goodwill350 Total90(14)76 Cost$ % BV440 Excess$90 Allocate to:AmtAmort. Plant604 yrs Liabilities-55 yrs Goodwill35 - Total$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

40 Print and Sum (cont.) Beginning unamortized excess Current year's amortization Ending unamortized excess Inventory10(10)0 Land200 Total30(10)20 Cost$ % BV180 Excess$5 Allocate to:AmtAmort. Inventory101st yr Plant, land20 - Bargain purchase(25)Gain Total$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

41 8: CONSOLIDATED INCOME STATEMENTS An Introduction to Consolidated Financial Statements 3-41 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

42 Comprehensive Example, Data Pil 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 $ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

43 Cost of 90% of Sad$10,200 Implied value of Sad 10,200/.90$11,333 Book value ( )5,900 Excess over book value$5,433 Unamortized excess 1/1/12 Current amortization Unamortized excess 12/31/12 Inventory100(100)0 Land2000 Building1,000(25)975 Equipment(300)60(240) Note payable100(100)0 Goodwill4,3330 Total5,433(165)5,268 Allocate to: Inventory$1001st yr Land200 - Building1,00040 yrs Equipment(300)5 yrs Note payable1001st yr Goodwill4,333 - Total$5, Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

44 PilSadConsol.* Sales$9,523.50$2,200.00$11, 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$3,095.00$ Total consolidated income$3, Noncontrolling interest share63.50 Controlling interest share$3, * 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

45 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. $ x.10/.90 = $ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

46 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 3-46 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

47 This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it is should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. ! All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall


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