Understanding Consolidated Financial Statements

An Introduction to Consolidated Financial Statements Chapter 3
3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
3-1
Learning Objective 1 Recognize the benefits and limitations of consolidated financial statements.
3-2
Business Combinations Consummated Through Stock Acquisitions

Business combination One or more companies become subsidiaries of a common parent corporation.
3-3
The Reporting Entity

Parent Parent Financial Financial Statements Statements _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ Subsidiary Subsidiary Financial Financial Statements Statements _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____
Consolidated Consolidated Financial Financial Statements Statements _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____
3-4
The Reporting Entity

A parent company may acquire a subsidiary in a very different industry from its own as a means of diversifying its overall business risk. There are also legal reasons for maintaining separate identities.
3-5
The Parent-Subsidiary Relationship

Parent Company Owns more than 50% of another company Affiliate
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The Parent-Subsidiary Relationship
Parent Company 90% ownership Subsidiary A 80% ownership Subsidiary B

3-7
Learning Objective 2 Understand the requirements for inclusion of a subsidiary in consolidated financial statements.
3-8
Consolidation Policy
Consolidated financial statements provide information that is not included in the separate statements of the parent corporation.
3-9
A subsidiary can be excluded from consolidation in only two situations: 1 2 Control is likely to be temporary. Control does not rest with the majority owner.
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Consolidation policy is usually presented under the following headings:
Principles of consolidation
Basis of consolidation
3 - 11
Parent and Subsidiary with Different Fiscal Periods

Consolidated statements are prepared for and as of the end of the parents fiscal period. If the difference does not exceed three months it is acceptable to use the subsidiarys statements with disclosure.
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Learning Objective 3 Apply the consolidations concepts to parent company recording of the investment in a subsidiary company at the date of acquisition.
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Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

Assets
Current assets Cash Other current assets Total current assets Plant assets Less: Accum. depr. Total plant assets Investment in Skelly Total assets Penn $ 20,000 45,000 $ 65,000 $ 75,000 15,000 $ 60,000 40,000 $165,000 Skelly $10,000 15,000 $25,000 $45,000 5,000 $40,000 0 $65,000 Consolidated $ 30,000 60,000 $ 90,000 $120,000 20,000 $100,000 0 $190,000
3 - 14

Liabilities
Penn Skelly $15,000 10,000 $25,000 $30,000 10,000 $40,000 $65,000 Consolidated $ 35,000 35,000 $ 70,000 $100,000 20,000 $120,000 $190,000
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Current liabilities Accounts payable $ 20,000 Other current liabilities 25,000 Total current liabilities $ 45,000 Stockholders equity Capital stock $100,000 Retained earnings 20,000 Total stockholders equity $120,000 Total liabilities and stockholders equity $165,000
Learning Objective 4 Allocate the excess of the investment cost over the book value of the subsidiary at the date of acquisition.
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Parent Acquires 100% of Subsidiary with Goodwill

Penn purchased all the stock of Skelly for $50,000. Skelly stockholders equity is $40,000. What is the consolidating (eliminating) entry?
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Parent Acquires 100% of Subsidiary with Goodwill

Capital Stock 30,000 Retained Earnings 10,000 Goodwill 10,000 Investment in Skelly 50,000 To eliminate reciprocal investment and equity accounts and to assign the excess of investment cost over book value acquired to goodwill
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Learning Objective 5 Prepare a consolidated balance sheet at the date of acquisition, including preparation of eliminating entries.
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Assets

Penn Skelly $ 10,000 45,000 $ 55,000 $ 75,000 15,000 $ 60,000 50,000 $165,000 $10,000 15,000 $25,000 $45,000 5,000 $40,000 $65,000
Consolidated $ 20,000 60,000 $ 80,000 $120,000 20,000 $100,000 10,000 $190,000

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Current assets Cash Other current assets Total current assets Plant assets Less: Accum. depr. Total plant assets Investment in Skelly Goodwill Total assets

Liabilities
Penn Skelly $15,000 10,000 $25,000 $30,000 10,000 $40,000 $65,000 Consolidated $ 35,000 35,000 $ 70,000 $100,000 20,000 $120,000 $190,000
3 - 21
Current liabilities Accounts payable $ 20,000 Other current liabilities 25,000 Total current liabilities $ 45,000 Stockholders equity Capital stock $100,000 Retained earnings 20,000 Total stockholders equity $120,000 Total liabilities and stockholders equity $165,000
Learning Objective 6 Learn the concept of minority interest when the parent company acquires less than 100% of the subsidiarys outstanding common stock.
3 - 22

Assets
Current assets Cash Other current assets Total current assets Plant assets Less: Accum. depr. Total plant assets Investment in Skelly Goodwill Total assets Penn $ 10,000 45,000 $ 55,000 $ 75,000 15,000 $ 60,000 50,000 $165,000 Skelly $10,000 15,000 $25,000 $45,000 5,000 $40,000 $65,000 Consolidated $ 20,000 60,000 $ 80,000 $120,000 20,000 $100,000 14,000 $194,000
3 - 23
Liabilities

Penn Skelly $15,000 10,000 $25,000 $30,000 10,000 $40,000 $65,000 Consolidated $ 35,000 35,000 $ 70,000 $ 4,000 $100,000 20,000 $120,000 $194,000
3 - 24
Current liabilities Accounts payable $ 20,000 Other current liabilities 25,000 Total current liabilities $ 45,000 Minority interest Stockholders equity Capital stock $100,000 Retained earnings 20,000 Total stockholders equity $120,000 Total liabilities and stockholders equity $165,000
Minority Interest
Minority interest in subsidiaries is generally shown in a single amount in the liability section of the consolidated balance sheet. The alternatives are to include the minority interest in consolidated stockholders equity or to place it in a separate minority interest section.
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Minority Interest
The interest of minority stockholders represents equity investments in the consolidated net assets by stockholders of the company affiliated with the parent.
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Learning Objective 7 Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of eliminating entries.
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Consolidated Balance Sheet After Acquisition

1. Penn acquired a 90% interest in Skelly on January 1 for $50,000 when Skellys stockholders equity was $40,000. 2. The accounts payable of Skelly includes $5,000 owed to Penn. 3. During the year, Skelly had income of $20,000 and declared $10,000 dividends.
3 - 28

What is the balance in the investment in Skellys account at December 31? Original investment January 1 + 90% of Skellys net income 90% of Skellys dividends Investment account balance $50,000 18,000 9,000 $59,000
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Capital Stock 30,000 Retained Earnings 20,000 Goodwill 14,000 Investment in Skelly 59,000 Minority Interest 5,000 To eliminate reciprocal investment and equity balances, record goodwill, and enter the minority interest
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Dividends Payable 9,000 Dividends Receivable 9,000 To eliminate reciprocal dividends receivable and payable Accounts Payable 5,000 Accounts Receivable 5,000 To eliminate intercompany receivable and accounts payable
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Effect of Allocation on Consolidated Balance Sheet at Acquisition

The separate books of the affiliated companies do not record cost/book value differentials in acquisitions that create parent-subsidiary relationships. Working paper procedures are used to adjust subsidiary book values to reflect the cost/book differentials.
3 - 32

The adjusted amounts appear in the consolidated balance sheet. The amount of the adjustment to individual assets and liabilities is determined using an investment cost-allocation schedule.
3 - 33

On Dec. 3, 2003, Pilot purchases 90% of Sand Corporations outstanding common stock for $5,000,000 cash plus 100,000 shares of $10 stock with a market value of $5,000,000. Additional costs are $300,000. $200,000 is recorded as cost of the investment.
3 - 34

Sand Corporation (000) Assets Cash Net receivables Inventories Other current assets Land Building, net Equipment, net Total assets Book Value Fair Value $ 200 300 500 400 600 4,000 2,000 $8,000 $ 200 300 600 400 800 5,000 1,700 $9,000
3 - 35

Sand Corporation (000) Liabilities Accounts payable Notes payable Common stock Paid-in capital Retained earnings Total liabilities and stockholders equity Book Value Fair Value $ 700 1,400 4,000 1,000 900 $8,000
3 - 36
$ 700 1,300
Assignment of Excess Cost over Underlying Equity

Investment in Sand 10,000 Common Stock 1,000 Additional Paid-in Capital 4,000 Cash 5,000 To record 90% acquisition of Sand Corporation
3 - 37
Assignment of Excess Cost over Underlying Equity

Investment in Sand 200 Additional Paid-in Capital 100 Cash 300 To record additional costs of combining with Sand
3 - 38
Allocation of Excess Cost over Underlying Equity
Investment in Sand Book value of interest acquired $5,900,000 90% = Excess of cost over BV
$10,200,000 (5,310,000) $ 4,890,000
3 - 39
Allocation of Excess Cost over Underlying Equity

Fair Book Excess 90% = Value Value Allocated
Inventories 600 Land 800 Building net 5,000 Equipment, net 1,700 Notes payable 1,300 Total allocated Remainder to goodwill Total
500 600 4,000 2,000 1,400
90 180 900 (270) 90 990 3,900 4,890

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Consolidated Working Papers December 31, 2003

Account Title Pilot Cash 1,300 Receivables, net 700 Inventories 900 Other current assets 600 Land 1,200 Building, net 8,000 Equipment, net 7,000 Investment in Sand 10,200 Goodwill Unamortized excess Total assets 29,900 Sand 200 300 500 b 400 600 b 4,000 b 2,000 Adjustments and Eliminations Dr. Cr. 90 180 900 Consolidated Balance Sheet 1,500 1,000 1,490 1,000 1,980 12,900 b 270 8,730 a 10,200 3,900 b 4,890 32,500
3 - 41
b 3,900 a 4,890 8,000

Account Title Pilot Accounts payable 2,000 Notes payable 3,700 Common stock 11,000 Other paid-in capital 8,900 Retained earnings 4,300 Minority interest Total liabilities and stockholders equity Sand 700 1,400 4,000 1,000 900 Adjustments and Eliminations Dr. Cr. b 90 a 4,000 a 1,000 a 900 a 590 Consolidated Balance Sheet 2,700 5,010 11,000 8,900 4,300 590
29,900
8,000
32,500
3 - 42
Learning Objective 8 Apply the concepts underlying preparation of a consolidated income statement.
3 - 43
Consolidated Income Statement
The difference between a consolidated and an unconsolidated income statement of the parent company lies in the detail presented rather than the net income amount.
3 - 44
Learning Objective 9 Amortize the excess of the investment cost over the book value in periods subsequent to the acquisition.
3 - 45
Effect of Amortization on Consolidated Balance Sheet after Acquisition

Income for 2004: Sands net income Pilots income (excluding income from Sand)
$ 800,000 $2,523,500
3 - 46
Dividends Paid: Sand Pilot
$ 300,000 $1,500,000
3 - 47

Amortization of excess: Undervalued inventories sold in 2004 Undervalued land still held Undervalued building (45 years useful life) Overvalued equipment (5 years useful life) Overvalued notes payable retired in 2004 Goodwill (no amortization)
3 - 48

Account Title Cash Receivables, net Inventories Other current assets Land Building, net Equipment, net Investment in Sand Goodwill Unamortized excess Total assets Pilot Sand 253.5 100 540 200 1,300 600 800 500 1,200 600 b 180 9,500 3,800 b 880 8,000 1,800 10,504 b 3,900 a 4,744 32,097.5 7,600 Adjustments and Eliminations Dr. Cr. Consolidated Balance Sheet 353.5 740 1,900 1,300 1,980 12,900 b 216 8,730 a 10,504 3,900 b 4,744 33,937.5
3 - 49

Account Title Pilot Accounts payable 2,300 Notes payable 4,000 Common stock 11,000 Other paid-in capital 8,900 Retained earnings 5,897.5 Minority interest Total liabilities and stockholders equity Sand 1,200 Adjustments and Eliminations Dr. Cr. Consolidated Balance Sheet 3,500 4,000 11,000 8,900 5,897.5 640
4,000 a 4,000 1,000 a 1,000 1,400 a 1,400 a 640
32,097.5 7,600
33,937.5
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End of Chapter 3
3 - 51

Understanding Consolidated Financial Statements

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Understanding Consolidated Financial Statements

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An Introduction to Consolidated Financial Statements Chapter 3

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Business Combinations Consummated Through Stock Acquisitions

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Reporting Entity

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Reporting Entity

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Parent-Subsidiary Relationship

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

The Parent-Subsidiary Relationship

Parent Company 90% ownership Subsidiary A 80% ownership Subsidiary B

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Parent and Subsidiary with Different Fiscal Periods

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Parent Acquires 100% of Subsidiary with Goodwill

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Parent Acquires 100% of Subsidiary with Goodwill

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

Consolidated $ 20,000 60,000 $ 80,000 $120,000 20,000 $100,000 10,000 $190,000

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet at Date of Acquisition (100% at Book Value)

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet After Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet After Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet After Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Consolidated Balance Sheet After Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Effect of Allocation on Consolidated Balance Sheet at Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Effect of Allocation on Consolidated Balance Sheet at Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Effect of Allocation on Consolidated Balance Sheet at Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Effect of Allocation on Consolidated Balance Sheet at Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Effect of Allocation on Consolidated Balance Sheet at Acquisition

3 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn