1. An Introduction to Consolidated Financial Statements
Chapter 3:
An Introduction to Consolidated Financial Statements
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2. Intro to Consolidations: Objectives
Recognize 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.
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3. Objectives (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.
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4. 1: Benefits & Limitations
An Introduction to Consolidated Financial Statements
1: Benefits & Limitations
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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
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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
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An Introduction to Consolidated Financial Statements
2: Subsidiaries
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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.
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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
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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
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11. 3: Parent Company Recording
An Introduction to Consolidated Financial Statements
3: Parent Company Recording
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12. Pen Example: Acquisition Cost = Fair Value = Book Value
Sel’s Balance Sheet: BV=FV
Cash
$10
Other current assets 15
Plant assets, net 40
Total
$65
Accounts payable
$15
Other current liabilities 10
Capital stock 30
Retained earnings
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 value 40
Excess of cost over book value $0
To consolidate, eliminate Pen's Investment account and Sel's capital stock and retained earnings.
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13. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Balance Sheets
Separate
Consolidated
Pen
Sel
Pen & Sub.
Cash
$20
$10
$30
Other curr. assets 45 15 60
Plant assets, net 40
100
Investment in Sel
Total
$165
$65
$190
Accounts payable
$15
$35
Other curr. liabilities 25 10 35
Capital stock 30
Retained earnings 20
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14. 4: Fair Value at Acquisition Date
An Introduction to Consolidated Financial Statements
4: Fair Value at Acquisition Date
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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
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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
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17. Example: BV ≠ FV but Cost = FV
Piper acquires 100% of Sandy for $310. BV = = $245 FV = 385 – 75 = $310 Cost – FV = $0 goodwill
Sandy BV FV
Cash
$40
Receivables 30
Inventory 50 75
Plant, net
200
240
Total
$320
$385
Liabilities
$75
Capital stock
100
Retained earnings
145
Cost
$310
100% Book value
245
Excess of cost over BV
$65
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18. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Piper and Sandy (cont.)
Allocate to:
Amt
Amort.
Inventory 100%(+25) 25
1st yr
Plant 100%(+40) 40
10 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)
310
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19. Example: BV ≠ FV and Cost ≠ FV
Panda acquires 100% of Salty for $530. BV = = $440 FV = 580 – 85 = $495 Cost – FV = $35 goodwill
Salty BV FV
Cash
$100
Receivables 40
Inventory
250
Plant, net
130
190
Total
$520
$580
Liabilities
$80
$85
Capital stock
Retained earnings
Cost
$530
100% Book value
440
Excess of cost over BV
$90
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20. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Panda and Salty (cont.)
Allocate to:
Amount
Amort.
Plant 60
4 yrs
Liabilities -5
5 yrs
Goodwill 35
Total
$90
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
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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
Sum BV FV
Cash
$10
Receivables 30
Inventory 80 90
Plant, net
100
120
Total
$220
$250
Liabilities
$40
Capital stock 75
Retained earnings
105
Cost
$185
100% BV
180
Excess of cost over BV $5
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22. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Print and Sum (cont.)
Allocate to:
Amt
Amort.
Inventory 10
1st yr
Plant, land 20 -
Bargain purchase
(25)
Gain
Total $5
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.
Investment in Sum (+A)
210
Gain on bargain purchase (R, +SE) 25
Cash (-A)
185
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23. Worksheet Elimination Entry
Unamortized excess equals $30
$10 for undervalued inventory
$20 for undervalued land included in plant assets
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)
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24. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Print
Sum
Adjustments
Consol- BV DR CR
idated
Cash
$30
$10
$40
Receivables 50 30 80
Inventory
100 10
190
Plant, net
450 20
570
Investment in Sum
210
Unamortized excess
Total
$840
$220
$880
Liabilities
$270
$310
Capital stock
200 75
Retained earnings
370
105
240
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25. 5: Noncontrolling Interests
An Introduction to Consolidated Financial Statements
5: Noncontrolling Interests
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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) = $7,059
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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
Goodwill 75
Total
$125
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28. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
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.
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29. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Popo
Sine
Adjustments
Consol- BV DR CR
idated
Cash
$50
$10
$60
Receivables
130 50
180
Inventory 80
100
Building, net
300
240
590
Investment in Sine
400
Goodwill 75
Total
$960
$400
$1,085
Liabilities
$150
$25
$175
Capital stock
250
200
Retained earnings
560
175
Noncontrolling interest 
500
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30. 6: Subsequent Balance Sheets
An Introduction to Consolidated Financial Statements
6: Subsequent Balance Sheets
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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
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32. Popo and Sine (cont.) Cost of 80% of Sine $400 Implied value of Sine
$500
Book value
375
Excess
$125
Allocate to:
Building
$50
10 yrs
Goodwill 75 -
Total
$125
Beginning unamortized excess
Current year's amortization
Ending unamortized excess
Building 50
(5) 45
Goodwill 75
Total
125
120
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After 1 year:
Popo
Sine
Cash
$40
$15
Receivables
110 85
Inventory 90
100
Building, net
280
235
Investment in Sine
404
Total
$924
$435
Popo
Sine
Liabilities
$100
$50
Capital stock
250
200
Retained earnings
574
185
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)
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34. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
After 1 year:
Popo
Sine
Adjustments
Consol- BV DR CR
idated
Cash
$40
$15
$55
Receivables
110 85
195
Inventory 90
100
190
Building, net
280
235 45
560
Investment in Sine
404
Goodwill 75
Unamortized excess
120
Total
$924
$435
$1,075
Liabilities
$100
$50
$150
Capital stock
250
200
Retained earnings
574
185
Noncontrolling interest
101
505
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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/.80
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36. 7: Amortizations After Acquisition
An Introduction to Consolidated Financial Statements
7: Amortizations After Acquisition
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37. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Unamortized Excess
Excess assigned to assets and liabilities are amortized according to the account
Balance sheet account
Amortization period
Income statement account
Inventories and other current assets
Generally, 1st year
Cost of sales and other expense
Buildings, equipment, patents
Remaining life at business combination
Depreciation and amortization expense
Land, copyrights
Not amortized
Long-term debt
Time to maturity
Interest expense
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38. Piper and Sandy (cont.) Cost $310 100% BV 245 Excess $65 Allocate to:
Amt
Amort.
Inventory 25
1st yr
Plant 40
10 yrs
Total
$65
Beginning unamortized excess
Current year's amortization
Ending unamortized excess
Inventory 25
(25)
Plant 40
(4) 36
Total 65
(29)
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39. Panda and Salty (cont.) Cost $530 100% BV 440 Excess $90 Allocate to:
Amt
Amort.
Plant 60
4 yrs
Liabilities -5
5 yrs
Goodwill 35 -
Total
$90
Beginning unamortized excess
Current year's amortization
Ending unamortized excess
Plant 60
(15) 45
Liabilities
(5) 1
(4)
Goodwill 35
Total 90
(14) 76
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40. Print and Sum (cont.) Cost $185 100% BV 180 Excess $5
Allocate to:
Amt
Amort.
Inventory 10
1st yr
Plant, land 20 -
Bargain purchase
(25)
Gain
Total $5
Beginning unamortized excess
Current year's amortization
Ending unamortized excess
Inventory 10
(10)
Land 20
Total 30
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41. 8: Consolidated Income Statements
An Introduction to Consolidated Financial Statements
8: Consolidated Income Statements
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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 $100.
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43. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
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
Allocate to:
Inventory
$100
1st yr
Land
200 -
Building
1,000
40 yrs
Equipment
(300)
5 yrs
Note payable
100
Goodwill
4,333
Total
$5,433
Unamortized excess 1/1/12
Current amortization
Unamortized excess 12/31/12
Inventory
100
(100)
Land
200
Building
1,000
(25)
975
Equipment
(300) 60
(240)
Note payable
Goodwill
4,333
Total
5,433
(165)
5,268
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44. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall
Pil
Sad
Consol.*
Sales
$9,523.50
$2,200.00
$11,723.50
Income from Sad
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
(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 share
63.50
Controlling interest share
* 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.
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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
= $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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