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Consolidated financial statement in acquisitions at book value

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Preparing consolidated financial statement on acquisitions at net assets' book value

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Consolidated financial statement in acquisitions at book value

  1. 1. Consolidated financial statement: Acquisition at Book Value Arthik Davianti
  2. 2. Menu: One-line consolidation Working paper Situations of acquisition Illustration
  3. 3. One-Line Consolidation
  4. 4. 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
  5. 5. 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
  6. 6. 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.
  7. 7. 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
  8. 8. Consolidation Worksheet
  9. 9. 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
  10. 10. Situations of Acquisition
  11. 11. 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; and parent company acquires 100% or less than 100% subsidiary’s common stock Situation 3 Investment cost < subsidiary’s net assets book value; and parent company acquires 100% or less than 100% subsidiary’s common stock
  12. 12. Situation 1 Worksheet at the Date of Acquisition (100% ownership)
  13. 13. 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
  14. 14. Investment in Special Foods 300,000 Cash 300,000 To record purchase of Special Food stock Wholly-owned Subsidiary (100 Percent Ownership) 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 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 The separate financial statements of Peerless and Special Foods immediately after the combination.
  15. 15. Wholly-owned Subsidiary (100 Percent Ownership) 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 Investment in Special Foods 300,000 Objective:  Eliminate equity accounts of Sub  Eliminate equity method accounts of Parent. Book Value Calculations
  16. 16. Wholly-owned Subsidiary (100 Percent Ownership) 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 Liabilities and stockholder's equity 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
  17. 17. Wholly-owned Subsidiary (100 Percent Ownership) 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
  18. 18. Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Parent Company Entries Investment in Special Foods 50,000 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 Investment in Special Foods 50,000 To record Peerless 100% share of Special Food’s 20X1 dividend
  19. 19. Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Basic Elimination Entry Total Common Retained Book Value Stock Earnings Original Book Value 300,000 200,000 100,000 + Net Income 50,000 50,000  Dividends (30,000) (30,000) Ending Book Value 320,000 200,000 120,000 = + Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 50,000 Dividends Declared 30,000 Investment in Special Foods 320,000
  20. 20. Let’s do the Working Sheet for 20X1
  21. 21. Illustration of Situation 1 Worksheet Subsequent years (100% ownership)
  22. 22. Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Second & Subsequent Years Parent Company Entries Investment in Special Foods 75,000 Income from Special Foods 75,000 To record Peerless 100% share of Special Food’s 20X2 income 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 Investment in Special Foods 40,000 To record Peerless 100% share of Special Food’s 20X2 dividend
  23. 23. Wholly-owned Subsidiary (100 Percent Ownership) at Book Value – Initial Year of Ownership Basic Elimination Entry Total Common Retained Book Value Stock Earnings Original Book Value 320,000 200,000 120,000 + Net Income 75,000 75,000  Dividends (40,000) (40,000) Ending Book Value 355,000 200,000 155,000 = + Common Stock 200,000 Retained Earnings 120,000 Income from Special Foods 75,000 Dividends Declared 40,000 Investment in Special Foods 355,000
  24. 24. Let’s do the Working Sheet for 20X2
  25. 25. Concepts of consolidated financial statements
  26. 26. Consolidation: The Concept •Parent creates or gains control of the subsidiary. The result: a single legal entity. P S
  27. 27. 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
  28. 28. 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.
  29. 29. 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.
  30. 30. 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.
  31. 31. 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.
  32. 32. 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.
  33. 33. Concepts and Standards 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.
  34. 34. Concepts and Standards P X Z X Y P Z 0.80 0.60 0.90 0.40 0.70 0.30 Indirect Control
  35. 35. Concepts and Standards W X Y P Z 0.90 0.80 0.15 0.30 0.80 0.15
  36. 36. 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
  37. 37. 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?
  38. 38. 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
  39. 39. 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.”
  40. 40. 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.
  41. 41. 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.
  42. 42. 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.
  43. 43. 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.
  44. 44. 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.
  45. 45. 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.
  46. 46. 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
  47. 47. 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
  48. 48. Recognition of Subsidiary Net Assets
  49. 49. Recognition of Subsidiary Income
  50. 50. 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. 51. 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$
  52. 52. Illustration of Situation 1 Worksheet at the Date of Acquisition (less than 100% ownership)
  53. 53. 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) Investment in Special Foods 240,000 Cash 240,000 To record purchase of Special Food stock
  54. 54. Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Investment Elimination Entry Basic Elimination Entry Common Stock 200,000 Retained Earnings 100000 Investment in Special Foods 240,000 NCI in NA of Special Foods 60,000 Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 =
  55. 55. Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – 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 Liabilities and stockholder's equity 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
  56. 56. Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Initial Year of Ownership Parent Company Entries Investment in Special Foods 40,000 Income from Special Foods 40,000 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 24,000 Investment in Special Foods 24,000 To record Peerless 100% share of Special Food’s 20X1 dividend
  57. 57. Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 60,000 240,000 200,000 100,000 + 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 = Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Initial Year of Ownership
  58. 58. Basic Elimination Entry Common Stock 200,000 Retained Earnings 100,000 Income from Special Foods 40,000 NCI in NI of Special Foods 10,000 Dividends Declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Initial Year of Ownership
  59. 59. Let’s do the Working Sheet for 20X1
  60. 60. Illustration of Situation 1 Worksheet Subsequent years (less 100% ownership)
  61. 61. Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Second & Subsequent Years Parent Company Entries Investment in Special Foods 60,000 Income from Special Foods 60,000 To record Peerless 100% share of Special Food’s 20X2 income 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 in Special Foods 32,000 To record Peerless 100% share of Special Food’s 20X2 dividend
  62. 62. Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Second & Subsequent Years Book Value Calculations Investment Account Common Retained NCI (20%) (80%) Stock Earnings Original book value 64,000 256,000 200,000 120,000 + 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 =
  63. 63. Basic Elimination Entry Common Stock 200,000 Retained Earnings 120,000 Income from Special Foods 60,000 NCI in NI of Special Foods 15,000 Dividends Declared 40,000 Investment in Special Foods 284,000 NCI in NA of Special Foods 71,000 Less than wholly-owned Subsidiary (80 Percent Ownership) at Book Value – Second & Subsequent Years
  64. 64. Let’s do the Working Sheet for 20X2
  65. 65. UNTIL NEXT WEEK GOD BLESS US ALL

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