Chapter 3: An Introduction to Consolidated Financial Statements by Jeanne M David, Ph.D., Univ of Detroit Mercy to accompany Advanced Accounting, 10th edition by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn © Pearson Education, Inc publishing as Prentice Hal 3-1 Intro to Consolidations: Objectives Recognize the benefits and limitations of consolidated financial statements Understand the requirements for inclusion of a subsidiary in consolidated financial statements Apply the consolidation concepts to parent company recording of the investment in a subsidiary at the date of acquisition Allocate the excess of the fair value over the book value of the subsidiary at the date of acquisition © Pearson Education, Inc publishing as Prentice Hal 3-2 Objectives (continued) Learn the concept of noncontrolling interest when the parent company acquires less than 100% of the subsidiary's outstanding common stock Amortize the excess of the fair value over the book value in periods subsequent to the acquisition Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of elimination entries Apply the concepts underlying preparation of a consolidated income statement © Pearson Education, Inc publishing as Prentice Hal 3-3 An Introduction to Consolidated Financial Statements 1: Benefits & Limitations © Pearson Education, Inc publishing as Prentice Hal 3-4 Business Acquisitions • FASB Statement 141R • Business combinations occur – Acquire controlling interest in voting stock – More than 50% – May have control through indirect ownership • Consolidated financial statements – Primarily for owners & creditors of parent – Not for noncontrolling owners or subsidiary creditors © Pearson Education, Inc publishing as Prentice Hal 3-5 An Introduction to Consolidated Financial Statements 2: Subsidiaries © Pearson Education, Inc publishing as Prentice Hal 3-6 Who is a Subsidiary? • ARB No 51 allowed broad discretion • FASB Statement No 94 – Control based on share ownership • FASB Statement No 160 – Financial control • Subsidiaries, or affiliates, continue as separate legal entities and reporting to their controlling and noncontrolling interests © Pearson Education, Inc publishing as Prentice Hal 3-7 Consolidated Statements • Prepared by the parent company • Parent discloses – Consolidation policy, Reg S-X – Exceptions to consolidation, temporary control and inability to obtain control • Fiscal year end – Use parent's FYE, but – May include subsidiary statements with FYE within months of parent's FYE • Disclose intervening material events © Pearson Education, Inc publishing as Prentice Hal 3-8 An Introduction to Consolidated Financial Statements 3: Parent Company Recording © Pearson Education, Inc publishing as Prentice Hal 3-9 Penn Example: Acquisition Cost = Fair Value = Book Value Skelly BV=FV Cash Other current assets Net plant assets Total Accounts payable Other liabilities Capital stock Retained earnings Total $10 15 40 $65 $15 10 30 10 $65 Penn acquires 100% of Skelly 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 Penn's Investment account and Skelly's capital stock and retained earnings © Pearson Education, Inc publishing as Prentice Hal 3-10 Panda and Salty (cont.) Cost $530 100% BV 440 Excess $90 Plant Liabilities Goodwill Total Allocate to: Plant Liabilities Goodwill Total Amt 60 -5 35 $90 Amort yrs yrs - Beginning Current Ending unamortized year's unamortized excess amortization excess 60 (15) 45 (5) (4) 35 35 90 14 76 © Pearson Education, Inc publishing as Prentice Hal 3-30 Printemps and Summer (cont.) Cost 100% BV $185 180 Allocate to: Inventory Plant, land Bargain purchase Total Amt 10 20 (25) $5 Amort 1st yr Gain Excess $5 Inventory Land Total Beginning Current Ending unamortized year's unamortized excess amortization excess 10 (10) 20 20 30 (10) 20 © Pearson Education, Inc publishing as Prentice Hal 3-31 An Introduction to Consolidated Financial Statements 7: Subsequent Balance Sheets © Pearson Education, Inc publishing as Prentice Hal 3-32 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 © Pearson Education, Inc publishing as Prentice Hal 3-33 Popo and Sine (cont.) Cost of 80% of Sine Implied value of Sine Book value Excess Building Goodwill Total $400 $500 375 $125 Allocate to: Building $50 10 yrs Goodwill 75 Total $125 Beginning Current Ending unamortized year's unamortized excess amortization excess 50 (5) 45 75 75 125 (5) 120 © Pearson Education, Inc publishing as Prentice Hal 3-34 After year: Cash Receivables Inventory Building, net Investment in Sine Total Popo $40 110 90 280 404 $924 Sine $15 85 100 235 $435 Liabilities Capital stock Retained earnings Popo $100 250 574 Sine $50 200 185 Total $924 $435 Popo's elimination worksheet entry: Capital stock Retained earnings Unamortized excess Investment in Sine (80%) Noncontrolling interest (20%) Building Goodwill Unamortized excess © Pearson Education, Inc publishing as Prentice Hal 200 185 120 404 101 45 75 120 3-35 After year: Popo BV $40 110 90 280 404 Cash Receivables Inventory Building, net Investment in Sine Goodwill Sine BV $15 85 100 235 Unamortized excess 120 Total $924 Liabilities $100 Capital stock 250 Retained earnings 574 Noncontrolling interest Total $924 Adjustments DR CR 45 404 75 $435 $50 200 185 $435 120 200 185 101 505 © Pearson Education, Inc publishing as Prentice Hal Consolidated $55 195 190 560 75 $1,075 $150 250 574 101 $1,075 505 3-36 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 © Pearson Education, Inc publishing as Prentice Hal 3-37 An Introduction to Consolidated Financial Statements 8: Consolidated Income Statements © Pearson Education, Inc publishing as Prentice Hal 3-38 Comprehensive Example, Data Pilot acquires 90% of Sand on 12/31/2009 for $4,333 when Sand's equity consists of $4,000 common stock, $1,000 other paid in capital, and $900 retained earnings On that date Sand'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 © Pearson Education, Inc publishing as Prentice Hal 3-39 Assignment and Amortization Cost of 90% of Sand $10,200 Implied value of Sand 10,200/.90 $11,333 Book value (4000+1000+900) Excess over book value Inventory Land Building Equipment Note payable Goodwill Total 5,900 $5,433 Unamortized excess 1/1/10 100 200 1,000 (300) 100 4,333 5,433 Allocate to: Inventory Land Building Equipment Note payable Goodwill Total Current amortization (100) (25) 60 (100) (165) © Pearson Education, Inc publishing as Prentice Hal $100 1st yr 200 1,000 40 yrs (300) yrs 100 1st yr 4,333 $5,433 Unamortized excess 12/31/10 200 975 (240) 4,333 5,268 3-40 Pilot Sand Consol.* $9,523.50 $2,200.00 $11,723.50 571.50 $0.00 (4,000.00) (700.00) (4,800.00) (200.00) (80.00) (305.00) (700.00) (360.00) (1,000.00) (1,800.00) (120.00) (1,920.00) (300.00) (140.00) (540.00) $3,095.00 $800.00 $3,158.50 Sales Income from Sand Cost of sales Depreciation exp - bldg Depreciation exp - equip Other expense Interest expense Net income Total consolidated income Noncontrolling interest 63.50 share Controlling interest share $3,095.00 * 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 Pilot and Sand © Pearson Education, Inc publishing as Prentice Hal 3-41 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 $571.50 x 10/.90 = $63.50 © Pearson Education, Inc publishing as Prentice Hal 3-42 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 © Pearson Education, Inc publishing as Prentice Hal 3-43 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2009 Pearson Education, Inc Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice Hal 3-44 ... records the acquisition of Summer 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... stock Retained earnings Total © Pearson Education, Inc publishing as Prentice Hal 3-11 An Introduction to Consolidated Financial Statements 4: Allocations at Acquisition Date © Pearson Education,... Consolidated Financial Statements 6: Amortizations After Acquisition © Pearson Education, Inc publishing as Prentice Hal 3-27 Unamortized Excess Excess assigned to assets and liabilities are amortized