Chapter Four Consolidated Financial Statements and Outside Ownership Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objective 4-1 Understand that complete ownership is not a prerequisite for the formation of a business combination 4-2 Noncontrolling Interest Although most parent companies 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 4-3 Learning Objective 4-2 Describe the valuation principles underlying the acquisition method of accounting for the noncontrolling interest 4-4 Noncontrolling Interest 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 4-5 Noncontrolling Interest Example Assume Parker Corporation wants to acquire 90% of Strong Company Strong’s stock has been trading for around $60 per share Parker has to pay a premium for the shares needed to gain control If Parker pays $70 per share to induce enough stockholders to sell, how will the 10% of Strong that Parker does not own be recorded? 4-6 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 4-7 Learning Objective 4-3 Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests 4-8 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 4-9 Noncontrolling Interest Example Total acquisition-date fair value $690,000 Fair value of net identifiable net assets (600,000) Goodwill $ 90,000 Assign Goodwill: Controlling Noncontrolling Interest Fair value at acquisition date $630,000 Interest $60,000 Relative fair value of identifiable net assets acquired ($600,000 X 90%) (540,000) and ($600,000 X 10%) - ($60,000) Goodwill $90,000 $0 There is no excess goodwill to assign to the noncontrolling interest 4-10 Consolidated Financial Statement Balance Sheet 4-28 Learning Objective 4-7 Determine the effect on consolidated financial statements of a control premium paid by the parent 4-29 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: 4-30 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 4-31 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 4-32 Effects of using the Partial Equity Method 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 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 4-33 Learning Objective 4-8 Understand the impact on consolidated financial statements of a midyear acquisition 4-34 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 Entry S) Only a partial year’s amortization on excess fair value is taken 4-35 Learning Objective 4-9 Understand the impact on consolidated financial statements when a step acquisition has taken place 4-36 Step Acquisitions A step acquisition occurs when control is achieved in a series of equity acquisitions, as opposed to a single transaction As with all business combinations, the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained 4-37 Step Acquisitions If the parent held a noncontrolling interest in the acquired firm, the parent remeasures that interest to fair value and recognizes a gain or loss If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place The parent simply accounts for the additional subsidiary shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders 4-38 Learning Objective 4-10 Record the sale of a subsidiary (or a portion of its shares) 4-39 Sales of Subsidiary Stock What is reported on the consolidated statements when a Parent sells some of its ownership in a Subsidiary? 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 4-40 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 4-41 Noncontrolling Interest – International Accounting Standards US GAAP vs IFRS U.S GAAP requires fair value measurement IFRS permits fair value measurement, or the Thus, acquisition-date fair value provides a noncontrolling interest may be measured at a basis for reporting the noncontrolling interest proportionate share of the Sub’s identifiable net which is adjusted for its share of subsidiary asset fair value, which excludes goodwill This income and dividends subsequent to option assumes that any goodwill created via acquisition acquisition applies solely to the controlling interest 4-42 ... acquisition: Net income - Current year (2015) $90,000 Less: Dividends declared .(50,000) Increase in retained earnings (2015) $40,000 Prior years (2014)... 4-3 Learning Objective 4-2 Describe the valuation principles underlying the acquisition method of accounting for the noncontrolling interest 4-4 Noncontrolling Interest The Parent, with controlling