McGraw-Hill/Irwin© 2008 The McGraw-Hill Companies, Inc. All rights reserved. 5 Consolidation of Less-Than-Wholly-Owned Subsidiaries

5-2 Consolidation of Less-Than-Wholly- Owned Subsidiaries More than a consolidated balance sheet, however, is needed to provide a comprehensive picture of the consolidated entity’s activities following acquisition.

5-3 Consolidation of Less-Than-Wholly- Owned Subsidiaries The stockholders who own the shares of the subsidiary not held by the parent are referred to collectively as the noncontrolling interest or minority interest.

5-4 Consolidation of Less-Than-Wholly- Owned Subsidiaries When a subsidiary is less than wholly owned, the general approach to consolidation is the same as discussed in Chapter 4, but the consolidation procedures must be modified slightly to recognize the noncontrolling interest. Also, the computation of consolidated net income and retained earnings must allow for the claim of the noncontrolling interest.

5-5 Consolidated Net Income Consolidated net income is that portion of the enterprise’s total income that accrues to the parent company’s stockholders.

5-6 Consolidated Net Income Consolidated net income is computed by adding the parent’s proportionate share of the income of all subsidiaries, adjusted for any differential write-off or goodwill impairment, to the parent’s income from its own separate operations (parent’s net income less income from the subsidiaries included in net income).

5-7 Consolidated Net Income Consolidated net income is that portion of the enterprise’s total income that accrues to the parent company’s stockholders. Consolidated net income is computed by adding the parent’s proportionate share of the income of all subsidiaries, adjusted for any differential write-off or goodwill impairment, to the parent’s income from its own separate operations (parent’s net income less income from the subsidiaries included in net income).

5-8 Consolidated Net Income When a subsidiary is less than wholly owned, a portion of its income accrues to its noncontrolling shareholders and is excluded from consolidated net income. A subsidiary’s income available to common stockholders is divided between the parent and noncontrolling stockholders based on their relative common stock ownership of the subsidiary.

5-9 Consolidated Retained Earnings Consolidated retained earnings is that portion of the consolidated entity’s undistributed earnings accruing to the parent’s stockholders. It is calculated by adding the parent’s share of the subsidiary’s cumulative net income since acquisition to the parent’s retained earnings from its own operations (excluding any income from the subsidiary included in retained earnings).

5-10 PREPARATION OF CONSOLIDATED BALANCE SHEET IMMEDIATELY FOLLOWING ACQUISITION OF CONTROLLING OWNERSHIP The consolidation process for a majority-owned subsidiary is the same as for a wholly owned subsidiary except the claims of the noncontrolling or minority interest must be included.

5-11 CONSOLIDATION SUBSEQUENT TO ACQUISITION OF CONTROLLING OWNERSHIP Consolidation subsequent to acquisition involves the preparation of a complete set of consolidated financial statements, as discussed in Chapter 4.

5-12 Second Year of Ownership The equity-method and consolidation procedures employed during the second and subsequent years of ownership are the same as in the first year.

5-13 DISCONTINUANCE OF CONSOLIDATION A previously consolidated subsidiary is excluded from consolidation if it no longer meets the criteria for consolidation, usually because the parent can no longer exercise control over the subsidiary FASB Statement No. 154, “Accounting Changes and Error Corrections,” requires that the change in reporting entity be applied retrospectively to reflect the new entity.

5-14 TREATMENT OF OTHER COMPREHENSIVE INCOME FASB Statement No. 130, “Reporting Comprehensive Income” (FASB 130), established a new category for financial reporting, other comprehensive income, which includes all revenues, expenses, gains, and losses that under generally accepted accounting principles are excluded from net income.

5-15 TREATMENT OF OTHER COMPREHENSIVE INCOME FASB 130 permits several different options for reporting comprehensive income, but the consolidation process is the same regardless of the reporting format.

5-16 Modification of the Consolidation Workpaper When a parent or subsidiary has recorded other comprehensive income, the consolidation workpaper normally includes an additional section for other comprehensive income. When other comprehensive income is reported, the workpaper is prepared in the normal manner, with the additional section added to the bottom.

5-17 Subsidiary Valuation Accounts at Acquisition The consolidation treatment of a subsidiary’s various valuation accounts depends on the particular type of account.

5-18 Subsidiary Valuation Accounts at Acquisition A subsidiary’s accumulated depreciation on the date of acquisition theoretically should be eliminated in the preparation of consolidated financial statements. When fixed assets are acquired, whether in a business combination or otherwise, the seller’s accumulated depreciation on the assets is never transferred to the purchaser’s books.

5-19 Subsidiary Valuation Accounts at Acquisition Accounts receivable normally are valued in the balance sheet at net realizable value through the use of the allowance for uncollectible accounts to bring the full legal amount of the receivable down to the actual amount expected to be collected.

5-20 Subsidiary Valuation Accounts at Acquisition If a subsidiary is holding investment securities at the date of combination, those securities must be revalued to fair value. A valuation account associated with the subsidiary’s available-for-sale securities at the date of combination should be eliminated against the related accumulated unrealized gain or loss account.

5-21 Subsidiary Valuation Accounts at Acquisition A subsidiary may have long-term debt outstanding at the date of acquisition, and that debt must be valued at its fair value at the date of combination. If the fair value is different than the book value, the difference is recognized through a discount or premium account associated with the debt.

5-22 Negative Retained Earnings of Subsidiary at Acquisition A parent company may purchase a subsidiary with a negative or debit balance in its retained earnings account. An accumulated deficit of a subsidiary at acquisition causes no special problems in the consolidation process.

5-23 Other Stockholders’ Equity Accounts The discussion of consolidated statements up to this point has dealt with companies having stockholders’ equity consisting only of retained earnings and a single class of capital stock issued at par.

5-24 Subsidiary’s Disposal of Differential- Related Assets The disposal of an asset usually has income statement implications. If the asset is held by a subsidiary and is one to which a differential is assigned in the consolidation workpaper, both the parent’s equity-method income and consolidated net income are affected

5-25 Inventory Any inventory-related differential is assigned to inventory for as long as the subsidiary holds the inventory units. In the period in which the inventory units are sold, the inventory-related differential is assigned to Cost of Goods Sold.

5-26 Inventory When the subsidiary uses FIFO inventory costing, the inventory units on hand on the date of combination are viewed as being the first units sold after the combination. When the subsidiary uses LIFO inventory costing, the inventory units on the date of combination are viewed as remaining in the subsidiary’s inventory.

5-27 Changes Proposed by the FASB FASB has proposed significant changes in accounting for business combinations and the presentation of consolidated financial statements. In general, the criteria for when consolidated financial statements should be presented and which companies should be consolidated are the same as under current standards.

5-28 Changes Proposed by the FASB One of the most significant changes relates to the acquisition of less-than-wholly owned subsidiaries. The proposed standard on business combinations requires acquired companies, and all of their assets and liabilities, to be valued at their fair values at the date of combination, regardless of the percentage ownership acquired by the parent

5-29 Changes Proposed by the FASB Under the FASB’s proposal, goodwill would be computed as the difference between the fair value of the acquired company as a whole and the fair value of its net identifiable assets. This can be contrasted with the current approach of measuring goodwill as the difference between the purchase price of the acquired company and the fair value of the parent’s share of the acquired company’s net identifiable assets.

5-30 You Will Survive This Chapter !!! You can’t own yourself ! You can’t owe money to yourself ! You can’t make money selling to yourself !

McGraw-Hill/Irwin© 2008 The McGraw-Hill Companies, Inc. All rights reserved. 5 Consolidation of Less-Than-Wholly-Owned Subsidiaries End of Chapter