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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

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Intro to Consolidations: Objectives


1. Recognize the benefits and limitations of
consolidated financial statements.
2. Understand the requirements for inclusion of a
subsidiary in consolidated financial statements.
3. Apply the consolidation concepts to parent
company recording of the investment in a
subsidiary at the date of acquisition.
4. Allocate the excess of the fair value over the book
value of the subsidiary at the date of acquisition.
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Objectives (continued)
5. Learn the concept of noncontrolling interest when
the parent company acquires less than 100% of the
subsidiary's outstanding common stock.
6. Amortize the excess of the fair value over the book
value in periods subsequent to the acquisition.
7. Prepare consolidated balance sheets subsequent
to the date of acquisition, including preparation of
elimination entries.
8. Apply the concepts underlying preparation of a
consolidated income statement.
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An Introduction to Consolidated Financial Statements

1: Benefits & Limitations

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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
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An Introduction to Consolidated Financial Statements

2: Subsidiaries

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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.
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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 3 months of parent's FYE.
Disclose intervening material events
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An Introduction to Consolidated Financial Statements

3: Parent Company Recording

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Penn Example: Acquisition Cost =


Fair Value = Book Value
Skelly BV=FV
Cash

$10

Other current assets

15

Net plant assets

40

Penn acquires 100% of Skelly for


$40, which equals the book value
and fair values of the net assets
acquired.

Total

$65

Cost of acquisition

$40

Accounts payable

$15

Less 100% book value

40
$0

Other liabilities

10

Excess of cost over book value

Capital stock

30

Retained earnings

10

To consolidate, eliminate Penn's


Investment account and Skelly's
capital stock and retained earnings.

Total

$65

Pearson Education, Inc. publishing as Prentice Hal

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Balance sheets
Cash

Separate

Consolidated

Penn Skelly

Penn & Sub.

$20

$10

$30

Other curr. assets

45

15

60

Net plant

60

40

100

Investment in Skelly

40

$165

$65

$190

$20

$15

$35

25

10

35

100

30

100

20

10

20

$165

$65

$190

Total
Accounts payable
Other curr. liabilities
Capital stock
Retained earnings
Total

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An Introduction to Consolidated Financial Statements

4: Allocations at Acquisition Date

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Cost, Fair Value and Book Value


Acquisition cost, fair values of identifiable net
assets and book values may differ.
Allocate excess or deficiency of cost over
book value and determine goodwill, if any.
When BV = FV, excess is goodwill.
Cost less BV = Excess to allocate
Allocate first to FV-BV differences
Remainder is goodwill (or bargain purchase)

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Example: BV FV but Cost = FV


Piper acquires 100% of Sandy for $310.
BV = 100 + 145 = $245
FV = 385 75 = $310
Cost FV = $0 goodwill

Sandy

BV

FV

$40

$40

Receivables

30

30

Inventory

50

75

Plant, net

200

240

Cash

Total

$320 $385

Liabilities

$75

Capital stock

100

Retained
earnings

145

Total

$320

$75

Cost

$310

100% BV

245

Excess of cost over BV

$65

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Piper and Sandy (cont.)


Allocate to:

Amt Amort.

Inventory 100%(+25)

25 1st yr

Plant 100%(+40)

40 10 yrs

Total

$65

Piper's elimination worksheet entry:


Capital stock
100
Retained earnings
145
Inventory
25
Plant
40
Investment in Sandy
Pearson Education, Inc. publishing as Prentice Hal

310
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Example: BV FV and Cost FV


Panda acquires 100% of Salty for $530.

Salty
Cash
Receivables

BV

FV

$100 $100
40

40

Inventory

250

250

Plant, net

130

190

Total

$520 $580

Liabilities

$80

Capital stock

250

Retained earnings

190

Total

BV = 250 + 190 = $440


FV = 580 85 = $495

$520

$85

Cost FV = $35 goodwill

Cost

$530

100% BV (250+190)

440

Excess of cost over BV

$90

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Panda and Salty (cont.)


Allocate to:

Amt Amort.

Plant

60 4 yrs

Liabilities

-5 5 yrs

Goodwill

35 -

Total
Panda's elimination worksheet $90
entry:
Capital stock

250

Retained earnings

190

Plant

60

Goodwill

35

Liabilities
Investment
Salty
Pearson
Education,in
Inc.
publishing as Prentice Hal

5
530
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Example: BV FV and Cost FV


Printemps acquires 100% of Summer for $185.
BV = 75 + 105 = $180
Summer
BV
FV
FV = 250 - 40 = $210
Cash
$10 $10
Receivables

30

30

Inventory

80

90

Plant, net

100

120

Total

$220 $250

Liabilities

$40

Capital stock
Retained earnings
Total

75
105

$40

Cost
100% BV (75+105)
Excess of cost over BV

$185
180
$5

$220

Pearson Education, Inc. publishing as Prentice Hal

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Printemps and Summer (cont.)


Allocate to:

Amt Amort.

Inventory

10 1st yr

Plant, land

20 -

Bargain purchase

(25) Gain

Total
$5
Printemps
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 in Summer
210

Gain on Bargain purchase


Cash
Pearson Education, Inc. publishing as Prentice Hal

25
185
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Worksheet Elimination Entry


Unamortized excess equals $30 (gain is recognized)
$10 for undervalued inventory
$20 for undervalued land included in plant
assets
Printemps' elimination worksheet entry:
Capital stock
Retained earnings
Unamortized excess

75
105
30

Investment in Summer

210

Inventory

10

Plant

20

Pearson
Education, Inc.
publishing as Prentice Hal
Unamortized
excess

3-20
30

Printemps

Summer Adjustments Consol-

BV

BV

$30

$10

$40

50

30

80

Inventory

100

80

10

190

Plant, net

450

100

20

570

Investment in
Summer

210

Cash
Receivables

DR

CR

210

Unamortized excess

30

idated

30

Total

$840

$220

$880

Liabilities

$270

$40

$310

Capital stock

200

75

75

200

Retained earnings

370

105

105

370

$840

$220

Total

$880
240

Pearson Education, Inc. publishing as Prentice Hal

240

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An Introduction to Consolidated Financial Statements

5: Noncontrolling Interests

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Noncontrolling Interest
Parent owns less than 100%
Noncontrolling interest represents the
minority shareholders
Part of stockholders' equity
Measured at fair value, based on parent's
acquisition price
Parent pays $40,000 for an 85% interest
Implied value of the full investee is
40,000/85% = $47,059.
Minority share = 15%(47,059) = $7,059.
Pearson Education, Inc. publishing as Prentice Hal

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Example: Noncontrolling Interests


Popo acquires 80% of Sine for $400 when Sine had
capital stock of $200 and retained earnings of
$175. Sine's assets and liabilities equaled their fair
values except for buildings which are undervalued
by $50. Buildings have a 10-year remaining life.
Cost of 80% of Sine

$400

Allocate to:

Implied value of Sine (400/80%)

$500

Building

$50

Book value (200+175)

375

Goodwill

75

Excess over book value

$125

Total

Pearson Education, Inc. publishing as Prentice Hal

$125
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Elimination Entry
Popo's elimination worksheet entry:
Capital stock

200

Retained earnings

175

Building

50

Goodwill

75

Investment in Sine

400

Noncontrolling interest
100
An unamortized excess account could have been used for the
excess assigned to the building and goodwill.

Pearson Education, Inc. publishing as Prentice Hal

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Popo

Sine Adjustments

BV

BV

Cash

$50

$10

$60

Receivables

130

50

180

80

100

180

Building, net

300

240

Investment in Sine

400

Inventory

DR

CR

Consol-

50

590
400

Goodwill

idated

75

0
75

Total

$960

$400

$1,085

Liabilities

$150

$25

$175

Capital stock

250

200

200

250

Retained earnings

560

175

175

560

Noncontrolling interest
Total

100
$960

$400

Pearson Education, Inc. publishing as Prentice Hal


500

100
$1,085

500

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An Introduction to Consolidated Financial Statements

6: Amortizations After Acquisition

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Unamortized Excess
Excess assigned to assets and liabilities are
amortized according to the account
Balance sheet
account

Amortization
period

Income statement
account

Inventories and
Generally, 1st year
other current assets

Cost of sales and


other expense

Buildings,
equipment,
patents,

Remaining life at
business
combination

Depreciation and
amortization
expense

Land, copyrights

Not amortized

Long term debt

Time to maturity

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Interest expense

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Piper and Sandy (cont.)


Cost

$310

Allocate to:

Amt Amort.

100% BV

245

Inventory

25 1st yr

Excess

$65

Plant

40 10 yrs

Total

$65

Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
Inventory

25

(25)

Plant

40

(4)

36

Total

65

(29)

36

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Panda and Salty (cont.)


Cost

$530

Allocate to:

Amt Amort.

100% BV

440

Plant

60 4 yrs

Excess

$90

Liabilities

-5 5 yrs

Goodwill

35 -

$90Ending
BeginningTotal Current
unamortized
year's
unamortized
excess
amortization
excess
Plant

60

(15)

45

Liabilities

(5)

(4)

Goodwill

35

35

Total

90

14

76

Pearson Education, Inc. publishing as Prentice Hal

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Printemps and Summer (cont.)


Cost
100% BV
Excess

Allocate to:

$185
180
$5

Amt Amort.

Inventory

10 1st yr

Plant, land

20 -

Bargain purchase
Total

(25) Gain
$5

Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
Inventory

10

(10)

Land

20

20

Total

30

(10)

20

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An Introduction to Consolidated Financial Statements

7: Subsequent Balance Sheets

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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

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Popo and Sine (cont.)


Cost of 80% of Sine

$400

Allocate to:

Implied value of Sine

$500

Building

375

Goodwill

Book value
Excess

$125

Total

$50 10 yrs
75 $125

Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
Building

50

(5)

45

Goodwill

75

75

Total

125

(5)

120

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After 1 year:

Popo

Cash

$40

Receivables

110

Inventory

90

Building, net

280

Investment in Sine

404

Sine

Popo

Sine

$15 Liabilities

$100

$50

250

200

574

185

$924

$435

85 Capital stock
100 Retained earnings
235

Total

$924 $435 Total


Popo's elimination worksheet
entry:

Capital stock

200

Retained earnings

185

Unamortized excess

120

Investment in Sine (80%)

404

Noncontrolling interest (20%)

101

Building

45

Goodwill

75

Pearson Education, Inc. publishing as Prentice Hal

Unamortized excess

3-35
120

After 1 year:

Popo

Sine

BV

BV

Cash

$40

$15

$55

Receivables

110

85

195

90

100

190

Building, net

280

235

Investment in Sine

404

Inventory

Adjustments
DR

CR

45
75

Unamortized excess

120

idated

560
404

Goodwill

Consol-

0
75

120

Total

$924

$435

$1,075

Liabilities

$100

$50

$150

Capital stock

250

200

200

250

Retained earnings

574

185

185

574

Noncontrolling
interest
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Inc. publishing as Prentice Hal

101

101
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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
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An Introduction to Consolidated Financial Statements

8: Consolidated Income Statements

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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.

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Assignment and
Amortization
Cost of 90% of Sand

Allocate to:
Inventory
$10,200

Implied value of Sand


10,200/.90

$11,333

Book value (4000+1000+900)


Excess over book value

5,900

Land

$100 1st yr
200 -

Building

1,000 40 yrs

Equipment

(300) 5 yrs

Note payable

Goodwill
$5,433
Unamortized
Current
Total
excess 1/1/10
amortization

100 1st yr
4,333 Unamortized
$5,433
excess 12/31/10

Inventory

100

(100)

Land

200

200

Building

1,000

(25)

975

Equipment

(300)

60

(240)

100

(100)

Goodwill

4,333

4,333

Total

5,433

(165)

5,268

Note payable

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Pilot
Sales
Income from Sand
Cost of sales

Sand

Consol.*

$9,523.50

$2,200.00 $11,723.50

571.50

$0.00

(4,000.00)

(700.00)

(4,800.00)

Depreciation exp - bldg

(200.00)

(80.00)

(305.00)

Depreciation exp - equip

(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

Other expense
Interest expense
Net income
Total consolidated income

$3,158.50

Noncontrolling interest
share
63.50
* Cost of sales, building depreciation and interest expense are
Controlling
increased interest
by $100,share
$25, and $100, and equipment $3,095.00
depreciation is $60 lower than the sum of Pilot and Sand.
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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

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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

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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

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