Consolidated financial statement in acquisitions at book value

Consolidated
financial statement:
Acquisition at
Book Value
Arthik Davianti

Menu:
One-line
consolidation
Working paper
Situations of
acquisition
Illustration

Equity Method – A One-line Consolidation
• The investment is reported in a single amount on one
line of the investor’s balance sheet
• Investment income is reported in a single amount on
one line of the investor’s income statement
• A parent-company/investor’s income and stockholders’
equity are the same – under a complete and correct
application of equity method, and the financial
statement of a parent and subsidiary are consolidated

Equity Investments at Acquisition (reminder)
• Investment cost in voting common stock of other
entities – measured by cash disbursed or the fair
value of other assets distributed or securities issued
• Direct cost charged against additional paid-in capital
• Expense other direct costs of acquisition

Equity Investments at Acquisition
Payne Co purchases 30% of Sloan Co’s outstanding voting
common stock on January 1 from existing stockholders for
$2,000,000 cash plus 200,000 shares of Payne Co $10 par
common stock with a market value of $15 per share. Additional
cash costs of the equity interest consist of $50,000 for
registration of the shares and $100,000 for consulting and
advisory fees.
Note:
Under a one-line consolidation, entry can be made without the
knowledge of book value or fair value of Sloan Co’s assets and
liabilities.

Equity Investments at Acquisition
January 1:
Investment in Sloan (+A) 5,000
Common stock (+SE) 2,000
Additional paid-in capital (+SE) 1,000
Cash (-A) 3,000
To record acquisition in Sloan Co
January 1:
Investment expense (E, -SE) 100
Additional paid-in capital (-SE) 50
Cash (-A) 150
To record additional direct costs

Worksheet (Working Paper) for
Consolidation
• Assignment schedule and allocation of the difference
between cost of investment and book value
• Important issues:
1. Ownership percentage in subsidiary (100% wholly-
owned or less than wholly)
2. Compare investment cost with net assets book
value – any purchase differential should be assign
to adjust assets and/or liabilities acquired

Difference between investment cost
and book value
Situation 1
Investment cost = subsidiary’s net assets book value;
and parent company acquires 100% or less than 100%
subsidiary’s common stock
Situation 2
Investment cost > subsidiary’s net assets book value;
Situation 3
Investment cost < subsidiary’s net assets book value;

Situation 1
Worksheet
at the Date of
Acquisition
(100% ownership)

Wholly-owned Subsidiary (100 Percent Ownership)
at Book Value
Peerless acquires all of Special
Food’s outstanding common
stock for $300,000 in 20X1,
equal with the fair value of
Special Food as a whole. Fair
value of Special Food’s
individual assets and liabilities
are equal with its book value.
The balance sheets show that
the total book value of the
shares acquired equals the
total stockholders’ equity of
Special Foods ($200,000 +
$100,000)
Peerless
Product
Special
Foods
Assets
Cash 350,000 50,000
Account receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and equipment 800,000 600,000
Accumulated depreciation (400,000) (300,000)
Total assets 1,100,000 500,000
Liabilities and stockholder's equity
Account payable 100,000 100,000
Bonds payable 200,000 100,000
Common stock 500,000 200,000
Retained earnings 300,000 100,000
Total liabilities and equity 1,100,000 500,000

Investment in Special Foods 300,000
Cash 300,000
To record purchase of Special Food stock
at Book Value
Peerless
Product
Special
Foods
Assets
Cash 50,000 50,000
Account receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and equipment 800,000 600,000
Accumulated depreciation (400,000) (300,000)
Investment in Special Food 300,000
Total assets 1,100,000 500,000
Account payable 100,000 100,000
Bonds payable 200,000 100,000
Common stock 500,000 200,000
Retained earnings 300,000 100,000
Total liabilities and equity 1,100,000 500,000
The separate financial
statements of Peerless and
Special Foods immediately
after the combination.

at Book Value – Investment Elimination Entry
Basic Elimination Entry
Total Common Retained
Book Value Stock Earnings
Original Book Value 300,000 200,000 100,000
= +
Common Stock 200,000
Retained Earnings 100000
Objective:
 Eliminate equity accounts of Sub
 Eliminate equity method accounts of Parent.
Book Value Calculations

at Book Value – Worksheet at date of acquisition
Peerless
Product
Special
Foods
Consolidated
Assets
Cash 50,000 50,000 100,000
Account receivable 75,000 50,000 125,000
Inventory 100,000 60,000 160,000
Investment in Special Food 300,000 300,000 0
Land 175,000 40,000 215,000
Buildings and equipment 800,000 600,000 1,400,000
Accumulated depreciation (400,000) (300,000) (700,000)
Total assets 1,100,000 500,000 0 300,000 1,300,000
Account payable 100,000 100,000 200,000
Bonds payable 200,000 100,000 300,000
Common stock 500,000 200,000 200,000 500,000
Retained earnings 300,000 100,000 100,000 300,000
Total liabilities and equity 1,100,000 500,000 300,000 0 1,300,000
Elimination Entries

at Book Value – Worksheet at date of acquisition
Peerless
Products
Special
Foods
Common stock, January 1, 20X1 500,000 200,000
Retained earnings, January, 20X1 300,000 100,000
20X1:
Separate operating income, Peerless
Net income, Special Foods
Dividends
140,000
60,000
50,000
30,000
20X2:
Separate operating income, Peerless
Net income, Special Foods
Dividends
160,000
60,000
75,000
40,000

at Book Value – Initial Year of Ownership
Parent Company Entries
Income from Special Foods 50,000
To record Peerless 100% share of Special Food’s 20X1 income
During 20X1, Peerless records operating earnings of $140,000,
excluding its income from investing in Special Foods, and
declares dividends of $60,000. Special Foods reports 20X1 net
income of $50,000 and declares dividends of $30,000.
Cash 50,000
To record Peerless 100% share of Special Food’s 20X1 dividend

+ Net Income 50,000 50,000
 Dividends (30,000) (30,000)
Ending Book Value 320,000 200,000 120,000
= +
Retained Earnings 100,000
Dividends Declared 30,000

Let’s do
the Working Sheet for 20X1

Illustration of Situation 1
Worksheet
Subsequent years (100%
ownership)

at Book Value – Second & Subsequent Years
After 2 years, Peerless’ separate income from its own operation
for 20X2 is $160,000, and its dividends total $60,000. Special
Foods reports net income of $75,000 in 20X2 and pays dividends
of $40,000.
Investment in Special Foods increases to $355,000 and reported
net income of Peerless totals $235,000 ($160,000 + $75,000).
Cash 40,000

+ Net Income 75,000 75,000
 Dividends (40,000) (40,000)
Ending Book Value 355,000 200,000 155,000
= +

Let’s do
the Working Sheet for 20X2

Concepts of
consolidated financial
statements

Consolidation: The Concept
•Parent creates or gains control of the subsidiary.
The result: a single legal entity.
P
S

Parent
Company
Sub CSub BSub A
80% 51% 21%
Review
How do we report the results of subsidiaries?
Consolidation
(plus the Equity Method)
Equity Method

Consolidated Financial Statements
Consolidated financial statements present the
financial position and results of operations for:
• a parent (controlling entity) and
• one or more subsidiaries (controlled entities)
• as if the individual entities actually were a single
company or entity.

Benefits of Consolidated Financial
Statements
• Presented primarily for those parties having a long-
run interest in the parent company:
• shareholders,
• long-term creditors, or
• other resource providers.
• Provide a means of obtaining a clear picture of the
total resources of the combined entity that are under
the parent's control.

Limitations of Consolidated Financial
Statements
• Results of individual companies not disclosed (hides
poor performance).
• Financial ratios are not necessarily representative of
any single company in the consolidation.
• Similar accounts of different companies may not be
entirely comparable.
• Information is lost any time data sets are aggregated.

Subsidiary Financial Statements
• Creditors, preferred stockholders, and noncontrolling
common stockholders of subsidiaries are most
interested in the separate financial statements of the
subsidiaries in which they have an interest.
• Because subsidiaries are legally separate from their
parents,
• the creditors and stockholders of a subsidiary generally have
no claim on the parent, and
• the stockholders of the subsidiary do not share in the profits
of the parent.

Concepts and Standards
Traditional view of control includes:
• Direct control that occurs when one company owns
a majority of another company’s common stock.
• Indirect control or pyramiding that occurs when a
company’s common stock is owned by one or more
other companies that are all under common control.

Ability to Exercise Control
• Sometimes, majority stockholders may not be
able to exercise control even though they
hold more than 50 percent of outstanding
voting stock.
• Subsidiary is in legal reorganization or bankruptcy
• Foreign country restricts remittance of subsidiary profits
to domestic parent company
• The unconsolidated subsidiary is reported as
an intercorporate investment.

P
X
Z
X Y
P
Z
0.80
0.60
0.90
0.40
0.70
0.30
Indirect Control

W X Y
P
Z
0.90
0.80
0.15
0.30
0.80
0.15

Noncontrolling Interest
• Only a controlling interest
is needed for the parent to
consolidate the
subsidiary—not 100%
interest.
• Shareholders of the
subsidiary other than the
parent are referred to as
“noncontrolling”
shareholders.
• Noncontrolling interest or
refers to the claim of these
shareholders on the
income and net assets of
the subsidiary.
Parent
Sub
>50%<50%
NCI

Noncontrolling Interest (NCI)
• What is a noncontrolling interest (NCI)?
• Voting shares not owned by the parent company
• NCI was formerly called the “Minority Interest”
Parent
Sub
>50%<50%
NCI
Two Issues:
(1) Should 100% of the
financial statements
be consolidated?
(2) Where to report
NCI in the financial
statements?

Issue 1:
Should 100% be Consolidated?
Proportional
Consolidation
Full
Consolidation
Percent
Consolidated?
Reports NCI
Amounts?
Complies with
US GAAP?
Relative
Complexity?
< 100% 100%
No Yes
No Yes
Easy Hard

Issue 1: Should 100% be Consolidated?
• Full consolidation required by US GAAP (100%)
• This means two special accounts appear in
consolidated statements:
• NCI in Net Income of Sub
• Like an “expense” in the consolidated income statement
• “Reported income that doesn’t belong to us.”
• NCI in Net Assets of Sub
• Equity of unrelated owners
• “Net assets on our balance sheet not belonging to us.”

Issue 2:
Where to report NCI in Net Assets?
• Old rules: Could report in in equity,
liabilities, or “no man’s land” between
liabilities and equity.
• New rules: Must report in equity
• FASB 160 makes clear that the noncontrolling
interest’s claim on net assets is an element of
equity, not a liability.

Noncontrolling Interest
• Computation of income to the
noncontrolling interest
• In uncomplicated situations, it is a simple
proportionate share of the subsidiary’s net income
• Presentation
• FASB 160 requires that
• the term “consolidated net income” be applied to the
income available to all stockholders,
• with the allocation of that income between the
controlling and noncontrolling stockholders shown.

Different Approaches to
Consolidation
• Theories that might serve as a basis for
preparing consolidated financial statements:
• Proprietary theory
• Parent company theory
• Entity theory
• With the issuance of FASB 141R, the FASB’s
approach to consolidation now focuses on
the entity theory.

Proprietary Theory
• Views the firm as an extension of its owners.
• Assets and liabilities of the firm are
considered to be those of the owners.
• Results in a pro rata consolidation where the
parent consolidates only its proportionate
share of a less-than-wholly owned subsidiary’s
assets, liabilities, revenues and expenses.

Parent Company Theory
• Recognizes that though the parent does not
have direct ownership or responsibility, it has
the ability to exercise effective control over all
of the subsidiary’s assets and liabilities, not
simply a proportionate share.
• Separate recognition is given, in the
consolidated financial statements, to the
noncontrolling interest’s claim on the net assets
and earnings of the subsidiary.

Entity Theory
• Focuses on the firm as a separate economic
entity, rather than on the ownership rights of
the shareholders.
• Emphasis is on the consolidated entity itself,
with the controlling and noncontrolling
shareholders viewed as two separate groups,
each having an equity in the consolidated
entity.

Comparison of Alternative Theories
• Proprietary approach – only the parent’s share
of a subsidiary’s assets and liability is included
in the consolidated BS based on fair value; the
parent’s share of goodwill is included.
• Parent company approach – all of the
subsidiary’s assets and liabilities in the
consolidated BS, only the parent’s share of fair
value increment and goodwill is included.
46

Comparison of Alternative Theories
• Entity approach – all subsidiary assets and
liabilities are included in the consolidated BS.
• All of the assets, liabilities, revenues, and
expenses of a less-than-wholly owned
subsidiary are included in the consolidated
financial statements, with no special treatment
accorded either the controlling or
noncontrolling interest.
47

Recognition of Subsidiary Net Assets

Recognition of Subsidiary Income

Comparison of Alternative Theories -
Illustration
P Company acquires 80% of the stock of S Company on
January 1, 20X1, for $96,000. On that date, S Company
has a total fair value of $120,000 and the 20%
noncontrolling interest has a fair value of $24,000. S
Company holds assets with a book value of $100,000
and fair value $120,000.
The $20,000 fair value increment relates entirely to S
Company’s buildings and equipment, with a remaining
live of 10 years (straight line depreciation. For the year
20X1, P Company reports $200,000 net income and S
Company reports $30,000 net.
50

51
Item Proprietary
Parent
Company
Entity
Value of subsidiary net assets
recognized at acquisition:
Book value:
$100,000 X 0.80 80,000$
$100,000 X 1.00 100,000$ 100,000$
Fair value increment:
$20,000 x 0.80 16,000$ 16,000$
$20,000 x 1.00 20,000$
Total net assets 96,000$ 116,000$ 120,000$
Amount of noncontroing interest
recognized at acquisition 20,000$ 24,000$
Amount of fair value increment
amortized (10 years) 1,600$ 1,600$ 2,000$
Consolidated net income 222,400$ 222,400$ 228,000$
Income assigned to noncontrolling
interest 6,000$ 5,600$

Worksheet
at the Date of Acquisition
(less than 100%
ownership)

Less than Wholly-owned Subsidiary
(less than 100 Percent) at Book Value
Peerless acquires 80% of Special Foods’ outstanding common stock
for $240,000, equal with 80% of fair value of Special Foods’ net
assets on January 1.
Because Peerless acquires only 80% of Special Foods common
stock, the Investment in Special Foods equals 80% of the total
stockholders’ equity of Special Foods ($200,000 + $100,000)
Cash 240,000
To record purchase of Special Food stock

Less than wholly-owned Subsidiary
(80 Percent Ownership) at Book Value –
Investment Elimination Entry
Retained Earnings 100000
NCI in NA of Special Foods 60,000
Investment
Account Common Retained
NCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000
=

Worksheet at date of acquisition
Peerless
Product
Special
Foods
Consolidated
Assets
Cash 110,000 50,000 160,000
Account receivable 75,000 50,000 125,000
Inventory 100,000 60,000 160,000
Investment in Special Food 240,000 240,000 0
Land 175,000 40,000 215,000
Buildings and equipment 800,000 600,000 1,400,000
Accumulated depreciation (400,000) (300,000) (700,000)
Total assets 1,100,000 500,000 0 240,000 1,360,000
Account payable 100,000 100,000 200,000
Bonds payable 200,000 100,000 300,000
Common stock 500,000 200,000 200,000 500,000
Retained earnings 300,000 100,000 100,000 300,000
NCI in NA of Special Foods 60,000 60,000
Total liabilities and equity 1,100,000 500,000 300,000 60,000 1,360,000
Elimination Entries

Initial Year of Ownership
During 20X1, Peerless records operating earnings of $140,000,
excluding its income from investing in Special Foods, and
declares dividends of $60,000. Special Foods reports 20X1 net
income of $50,000 and declares dividends of $30,000.
Cash 24,000

Investment
+ Net income 10,000 40,000 50,000
- Dividend (6,000) (24,000) (30,000)
Ending book value 64,000 256,000 200,000 120,000
=

NCI in NI of Special Foods 10,000

Worksheet
Subsequent years (less
100% ownership)

Second & Subsequent Years
Consolidation after 2 years, Peerless’ separate income from its
own operation for 20X2 is $160,000, and its dividends total
$60,000. Special Foods reports net income of $75,000 in 20X2 and
pays dividend of $40,000.
Peerless’ reported net income totals $220,000 ($160,000 from
separate operations + $60,000 from Special Foods).
Cash 32,000

Investment
+ Net income 15,000 60,000 75,000
- Dividend (6,000) (24,000) (30,000)
Ending book value 71,000 284,000 200,000 155,000
=

NCI in NI of Special Foods 15,000

UNTIL NEXT WEEK
GOD BLESS US ALL

Consolidated financial statement in acquisitions at book value

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