1. Chapter Four Consolidated Financial Statements and Outside Ownership Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. Noncontrolling Interest  Although most parent companies do possess 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock.  If the parent doesn’t own 100% of the company, WHO owns the rest of it?  Noncontrolling Shareholders  The ownership interests of the Noncontrolling Shareholders must be reflected in the consolidated financial statements. 4-2 LO 1 4-2

3. Noncontrolling Interest 4-3 The Parent, with controlling interest, must consolidate 100% of the Subsidiary’s financial information. The acquisition method requires that the subsidiary be valued at the acquisition-date fair value. The total acquired firm fair value in a partial acquisition is the sum of  The fair value of the controlling interest.  The fair value of the noncontrolling interest at the acquisition date. LO 2 4-3

4. Noncontrolling Interest Example Parker purchased 9,000 shares at $70 per share. The fair value of their consideration transferred is $630,000. The remaining 1,000 shares trade at $60 per share indicating that the fair value of the noncontrolling interest is $60,000. The total acquisition-date fair value of the sub is $690,000. Fair value of controlling interest : ($70 X 9,000 shares)............... $630,000 Fair value of noncontrolling interest ($60 X 1,000 shares)................. 60,000 Total fair value of sub.............. $690,000 4-4

5. Noncontrolling Interest Example The total acquisition-date fair value (amount paid) of Strong of $690,000 is greater than the fair value of the identifiable net assets acquired of $600,000 (10,000 shares x $60 per share). The difference is allocated to Goodwill. The parent first allocates goodwill to its controlling interest for the excess of the fair value of the parent’s equity interest over its share of the fair value of the net identifiable assets. ($600,000 X 90% = 540, 000). Goodwill allocated to the controlling and noncontrolling interests will not always be proportional to the percentages owned. LO3 4-5

6. Allocating Subsidiary’s Net Income The subsidiary’s net income (including excess acquisition-date fair- value amortizations) must be allocated to its owners - the parent and the noncontrolling interest - to properly measure their respective equity in the consolidated entity. On the Income Statement: An account called Noncontolling Interest in Subsidiary Net Income represents the noncontrolling shareholders’ share of the sub’s net income. This account is created during consolidation and reported in the worksheet entries. LO4 4-6

7. Noncontrolling Interests and Consolidations The consolidation process remains substantially unchanged with a noncontrolling interest.  Consolidate as though the Parent has 100% ownership. Then determine noncontrolling interest:  in the subsidiary at beginning of the current year.  In sub’s current year net income.  In sub’s current year dividend payments.  in the subsidiary as of the end of the year. LO 5 4-7

8. Consolidated Financial Statement Income Statement Noncontrolling interests in the equity of subsidiaries are reported in the owners’ equity section of the consolidated statement of financial position. The amount should be clearly identified, labeled, and distinguished from the parent’s controlling interest in its subsidiaries. Also consolidated net income (or loss) and each component of other comprehensive income must be allocated to the controlling and noncontrolling interests. LO 6 4-8

9. Noncontrolling Interest – Premium Paid If King had paid $11.00 for their shares, at a time when they were trading for $9.75, then the goodwill allocation would look like this: $11.00 x 80,000 shares $9.75 x 20,000 shares Acquisition-date FV LO 7 4-9

10. Effects of using the Initial Value Method The initial value method employs cash basis for income recognition. The parent recognizes dividend income rather than an equity income accrual. Parent does not accrue the percentage of the sub’s income earned in excess of dividends (the increase in subsidiary retained earnings). The parent does not record amortization expense, therefore it must include it in the consolidation process if proper totals are to be achieved. 4-10

11. Effects of using the Initial Value Method If the Parent used the Initial Value Method to account for the Sub after acquisition, Entry *C is used to convert to the Equity Method. The entry will combine the increase in the Sub’s Retained Earnings since acquisition X the parent’s percentage of ownership, and the parent’s share of amortization expense since acquisition. Entry D is not necessary. 4-11

12. Effects of using the Partial Equity Method Entry *C converts from the Partial Equity Method to the Equity Method, but only the adjustment for the parent’s share of amortization expense is necessary. If the Parent used the Partial Equity Method to account for the Subsidiary after acquisition, Entry *C is used to convert to the Equity Method. 4-12

13. Mid-Year Acquisitions When control of a Sub is acquired at a time subsequent to the beginning of the sub’s fiscal year:  The income statements are consolidated as usual  The Sub’s pre-acquisition revenues and expenses are excluded from the Parent’s consolidated statements (adjusted via EntryS)  Only a partial year’s amortization on excess fair value is taken. LO 8 4-13

14. Step Acquisitions When a Parent acquires a Subsidiary over time, or in “steps,” the date control is achieved is significant –  All previous values for the investment, prior to the date control is obtained, are remeasured to fair value as of the date of control.  If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. LO 9 4-14

15. Sales of Subsidiary Stock If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section. If the sale results in the loss of control, the parent recognizes any resulting gain or loss in consolidated net income. What is reported on the consolidated statements when a Parent sells some of its ownership in a Subsidiary? LO 10 4-15

16. Sales of Subsidiary Stock  If the parent retains any of its former sub’s shares, the investment should be remeasured to fair value on the date control is lost.  Any resulting gain or loss from the remeasurement should be recognized in the parent’s net income.  If it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase.  For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied. 4-16

17. Noncontrolling Interest – Int’l Accounting Standards IFRS permits fair value measurement, or the noncontrolling interest may be measured at a proportionate share of the Sub’s identifiable net asset fair value, which excludes goodwill. This option assumes that any goodwill created via acquisition applies solely to the controlling interest. U.S. GAAP requires fair value measurement. Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest which is adjusted for its share of subsidiary income and dividends subsequent to acquisition. US GAAP vs. IFRS 4-17