1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Peter Secord Saint Mary’s University © 2003 McGraw-Hill Ryerson Limited

2. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 2 Chapter 9 Consolidated Cash Flows: Ownership Issues

3. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 3 Consolidated Cash Flows: Ownership Issues Chapter Outline –Consolidated cash flow statement –Ownership changes Purchase discrepancy Step acquisitions Reductions in parent shareholding –Subsidiary Preferred Shares –International View

4. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 4 Consolidated Cash Flows

5. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 5 Consolidated Cash Flows The cash flow statement is one of the primary financial statements required for companies which report under Canadian GAAP When a consolidated cash flow statement is prepared, it must include the operating, investing, and financing cash flows of the company, to the extent that these cash flows have taken place outside the corporate group The cash flow effects of intercorporate investments and divestitures must be reported as a part of this statement

6. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 6 Consolidated Cash Flows What items are unique to the preparation of consolidated cash flow statements? –What cash flow effect does the acquisition of an intercorporate investment have for the consolidated financial statements? –What special disclosures are required regarding the acquisition of an intercorporate investment? –What non cash items of revenue and expense lead to adjustments in the computation of consolidated cash flow from operations? –What are the effects of dividends paid by subsidiaries?

7. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 7 Consolidated Cash Flows What cash flow effect does the acquisition of an intercorporate investment have for the consolidated financial statements?

8. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 8 Consolidated Cash Flows What cash flow effect does the acquisition of an intercorporate investment have for the consolidated financial statements? –cash payments to acquire equity or debt instruments of other enterprises and interests in joint ventures must be disclosed in the consolidated cash flow statement

9. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 9 Consolidated Cash Flows What cash flow effect does the acquisition of an intercorporate investment have for the consolidated financial statements? –cash payments to acquire equity or debt instruments of other enterprises and interests in joint ventures must be disclosed in the consolidated cash flow statement –as the intercorporate investment is to be consolidated, the cash and cash equivalents of the subsidiary will be “netted” against the cash disbursement to acquire the investment

10. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 10 Consolidated Cash Flows What special disclosures are required regarding the acquisition of an intercorporate investment?

11. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 11 Consolidated Cash Flows What special disclosures are required regarding the acquisition of an intercorporate investment? –Among other things, these items must be disclosed: the cost of the purchase and the type and value of consideration paid condensed balance sheet disclosing the amount assigned to each major class of asset and liability of the acquired enterprise at the date of acquisition Typical disclosure is shown on the next 2 slides

12. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 12 Consolidated Cash Flows The cash used to acquire businesses during the year is shown net of the cash received as a result of the intercorporate investment Net cash flow effect of dispositions is also shown

13. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 13 Consolidated Cash Flows The cash flow effect should be readily discernable

14. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 14 Consolidated Cash Flows What non cash items of revenue and expense lead to adjustments in the computation of consolidated cash flow from operations?

15. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 15 Consolidated Cash Flows What non cash items of revenue and expense lead to adjustments in the computation of consolidated cash flow from operations? –Numerous non-cash items are determinants of consolidated income

16. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 16 Consolidated Cash Flows What non cash items of revenue and expense lead to adjustments in the computation of consolidated cash flow from operations? –Numerous non-cash items are determinants of consolidated income –These non cash items requiring adjustment to compute cash flow from operations include amortization of the purchase price discrepancy allocation to non-controlling interest in the income statement other items where the income effect differs from the cash flow amount - e.g. equity in earnings

17. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 17 Consolidated Cash Flows This represents typical annual report disclosure of operating cash flow effects associated with intercorporate investments

18. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 18 Consolidated Cash Flows What are the effects of dividends paid by subsidiaries?

19. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 19 Consolidated Cash Flows What are the effects of dividends paid by subsidiaries? –When the subsidiary pays a dividend to the parent, there is no change in the cash balance of the company and no disclosure is warranted

20. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 20 Consolidated Cash Flows What are the effects of dividends paid by subsidiaries? –When the subsidiary pays a dividend to the parent, there is no change in the cash balance of the company and no disclosure is warranted –When the subsidiary pays dividends to the external (non-controlling) shareholders, these dividends result in a cash outflow which is not otherwise reported in the consolidated statements Dividends paid by subsidiaries to non-controlling interests must be presented separately in the cash flow statement as cash flows used in financing activities

21. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 21 Changes in Ownership Interests

22. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 22 Changes in Ownership Interests Few inter-corporate investments consist of a single purchase held into perpetuity Acquisitions are made as opportunities arise and are sold as strategies change A systematic way of accounting for diverse acquisitions is needed Further, a systematic way of accounting for disposals is required, in order that a gain or loss may be computed

23. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 23 Step acquisitions Most share acquisitions are made not as a single purchase, but in “layers” The key to the accounting treatment is that the layers must be tracked separately, to the extent that there are purchase discrepancies arising with each layer, and for the computation of consolidated retained earnings For working papers and other supporting calculations, a columnar format is often the best approach

24. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 24 Step acquisitions Some step acquisitions are fully planned and scheduled

25. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 25 Step acquisitions The “layers” are tracked separately

26. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 26 Step acquisitions Whether an acquisition of a first small step, the consummation of control from significant influence, or the final stage of a 100% acquisition, step acquisitions are the norm.

27. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 27 Disposals of investments When an investment is sold, a gain or loss is computed as the difference between the proceeds received and the net book value of the investment The net book value of a portfolio investment is the original cost The net book value of an affiliate or a subsidiary is the book value computed under the equity method Purchase discrepancy is adjusted to remove investments sold (proportionately)

28. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 28 Disposals of investments Disposals of subsidiaries are generally accounted for as discontinued operations

29. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 29 Disposals of investments The earnings and earnings per share effect of discontinued operations is presented on the face of the income statement The cash flow effect is also shown separately

30. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 30 Issue of shares by subsidiary Issue of shares by a subsidiary is always accounted for as a partial disposal of the investment, as the percentage owned changes When the subsidiary issues shares, the interest of the parent is diluted Accordingly, when shares are issued, a gain or loss is computed by computing the difference between the proceeds received and the net book value of the “reduction” The net book value is computed under the equity method

31. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 31 Issue of shares by subsidiary When the net book value is computed under the equity method, the investment account is updated for all earnings since acquisition and all dividends paid (i.e. for the change in the subsidiary retained earnings), for amortization of the purchase price discrepancy, and for elimination of unrealized intercompany profits This “up to date” book value is used in all calculations necessary to determine the gain or loss on the issuance of shares by the subsidiary

32. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 32 The Investment Account Investment in Subsidiary Original Cost Income earned Dividends received P.D. Amortization Unrealized gains, net Balance

33. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 33 Issue of shares by subsidiary In this case, the subsidiary issued shares to the public, diluting ownership by the parent The gain is computed by comparing the parent’s share of proceeds received to the parent’s share of the subsidiary, based on the balance in the investment account This non-cash, non-taxable gain increases the carrying value of the investment

34. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 34 Issue of shares by subsidiary In this case, the Subsidiary (Loblaw) issued common shares in order to consummate the acquisition of a further subsidiary (Provigo) - the gain is recognized pursuant to the issuance of shares and resulting ownership change

35. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 35 Subsidiary Preferred Shares Corporations often have complex capital structures, with many categories of shares When there are preferred shares in the capital structure of the subsidiary, total shareholders’ equity of the subsidiary must be allocated among the interests of the various classes of shares on the basis of the applicable rights and preferences –Preferred shares owned by external shareholders are presented as part of non-controlling interest –All shares owned by the parent are eliminated

36. Chapter 9 © 2003 McGraw-Hill Ryerson Limited 36 International View In many jurisdictions, detailed requirements of accounting standards does not approach that of Canada, so (although treatments of these complex issues may be similar to that of Canada) there is likely to be wide diversity in practice and significant differences in disclosure will be found In some countries, and especially for large listed companies, however, the details of the disclosure to be found may exceed that found in Canadian financial statements