Consolidated Statement of Financial Position on the Date of
Acquisition
LEARNING OBJECI!ES
• Know the criteria for consolidation of a subsidiary
• Understand the Parent Company approach and the Economic Unit
approach of consolidation
• Prepare a worksheet for a Consolidated Statement of Financial
Position for affiliated companies
immediately after acquisition
The concept of consolidation
A consolidated financial statement for a parent company and its
subsidiaries is a financial
statement prepared by combining the individual statements of the
affiliated companies As you will see! a
number of ad"ustments! called elimination entries! are required
immediately prior to combining the
accounts #he need to make ad"ustments to the accounts before
consolidating means that the most efficient
way to prepare consolidated financial statements is with the use of
a consolidated statements worksheet $n
this chapter you will learn how to prepare a worksheet for a
consolidated statement of financial position
immediately after acquisition of a subsidiary company by a parent
company $n subsequent chapters! you
will learn how to prepare a full set of statements %$ncome
Statement! Statement of &etained 'arnings!
Statement of Financial Position! and Statement of Cash Flows( in
the years subsequent to the acquisition
Consolidated statements worksheets are off the books in the
sense that none of the accounting
work involved in their preparation! including the elimination
entries, is entered into the "ournals and
ledger of either the parent company or the subsidiary companies
&ecall from Chapter )! however! that the
parent company does record entries to account for its
investment in the subsidiary using either the cost
method or the equity method $n order to contrast the difference
between cost or equity method
ad"ustments %on the parent company books( with elimination entries
%on the consolidated worksheet only(!
this book shows all elimination entries in a
shaded format
#he purpose of consolidated financial statements is to show the
financial position and results of
operations of separate! but affiliated companies! as if they were a
single company #his approach is in
accordance with the economic entity concept Under the economic
entity concept! *AAP requires a
single set of financial statements be prepared for each economic
entity +hen an entity consists of more
than one corporation! consolidated financial statements are
required Consolidated financial statements
,
present the financial position and results of operations of
the economic entity that consists of two or more
legal entities #hese separate legal entities! the parent company
and the subsidiaries! continue to e-ist
separately #herefore it would not be appropriate for the financial
activities of the parent and subsidiaries
to be actually combined into a single set of accounting records
Figure , illustrates the relationship
between a Parent Company and its Subsidiaries
Insert Figure 1 about here
.istorically! a consolidated statements worksheet was done by hand
on one or more accountant/s
worksheets 0epending on the particular approach used! a worksheet
to consolidate one parent company
and one subsidiary requires a worksheet of si- or more columns!
resulting in the need to use a foldout
worksheet 1 what is usually called ,) column or ,2 column working
paper +ith the advent of the personal
computer %PC(! it is more efficient to prepare these worksheets
using a PC spreadsheet +hile the
mathematics of consolidated statements worksheets are not comple-!
the need to post elimination entries
makes the PC spreadsheet a very efficient way of preparing
consolidated financial statements
3earning the theory and practice of consolidated financial
statements is a very important sub"ect in
financial accounting because the practice is so common #he vast
ma"ority of publicly traded companies!
as well as many closely held companies have subsidiaries As was
observed in Chapter ,! there are several
reasons for these affiliations 4usiness corporations with
international operations normally will form
separate subsidiary companies for each country or geographic region
in which they have substantial
operations #his approach to organi5ing the business is dictated by
legal considerations! ta-ation! and the
natural effect of cultural diversity on business practices!
production and distribution! and product mi- For
e-ample! the pharmaceutical manufacturer 6ohnson 7 6ohnson has
about ,89 operating companies
worldwide, Subsidiaries will also often be established for
diversified companies or for lines of business!
which form an essential component of corporate activity but are
functionally unrelated to the core business
A common e-ample of this type of situation is the e-istence of
finance type subsidiaries :any
manufacturers of durable goods %automobiles! appliances! and farm
equipment( have finance subsidiaries
that provide financial services to consumers or dealers Another
e-ample is the ownership by retailing
)
whose operations complement the operations of the parent company!
which will often be in another
industry FAS4 Statement ;2 requires that all ma"ority owned
subsidiaries be consolidated! including those
whose principal business is financial services #he footnote
disclosures shown below for the Ford :otor
Company indicate how significant the financial services segment can
be $n ,;;<! Ford :otor Company/s
financial services segment! consisting principally of a subsidiary
%Ford Credit( earned =)!8;, million as
compared with =)!>,< million from automotive sales
Reporting of Manufacturing and Financial er!ices Income
Automotive ,;;< ,;;> ,;;2 Financial Services ,;;< ,;;>
,;;2
Sales? &evenues? United States =8<!92@ =8!@89
=8!8>; United States =))!@; =),!@ =,8!>< 'urope
)8!99< )<!,) ))!<) 'urope !82) !,22 )!< All
Bther ,2!;<; ,9!2;2 ,9!8>> All Bther )!<>8 )!,,2
,!<,9
#otal =,,@!;< ;
=,,9!2; <
#otal =)@!;<@ =)<!<2, =),!9)
Bperating income? et income? United States =)!@99 =)!29;
=2!,, United States =)!),< =,!8,@ =,!,,; 'urope %2;8( )9
<,, 'urope )<@ ), ),@ All Bther ), @>) ,!9@2 All
Bther 98 22 @
#otal =)!>,< =!)@, =>!@)< #otal =)!8;, =)!9@
=,!;>
ource" #nnual report of the Ford Motor Company for 1$$%&
Consolidation policy – the criteria for consolidation
As the above discussion demonstrates! there are many different
reasons for corporate affiliations
and many different types of affiliated companies $n addition! a
subsidiary need not be ,99D owned
$ndeed! one of the advantages of the stock
ac'uisition business combination is that control of a
subsidiary
can be achieved with less than ,99D ownership! whereas a
merger cannot normally be accomplished with
much less than complete ownership Prior to ,;@8! *AAP required a
subsidiary to becontrolled and to
have economically homogeneous operations in order to be
consolidated Control was generally
interpreted to mean ownership of more than >9D of the voting
common stock of the subsidiary unless other
circumstances indicated that it was controlled by another entity!
such as a bankruptcy trustee #he concept
carried as investments in the consolidated financial statements #he
result of this approach was that the
consolidated financial statements would not report any of the
assets and liabilities of these unconsolidated
subsidiaries but would simply show a single account for the
investment in the common stock #he income
statement of the consolidated entity would report a single line in
the income statement for these subsidiaries
as well 1 e'uity in the income of unconsolidated subsidiaries
#he problem with the above approach was that it results in less
than optimal disclosure!
particularly in the statement of financial position A brief
discussion of the relationship between a
manufacturing or retailing parent company and its financial
services subsidiary is illustrative Bne purpose
of a financial services subsidiary is to make loans to consumers or
dealers who purchase the products of the
parent company #he operating profit of such a subsidiary
results from its fees for servicing the loans to its
customers and from the interest it charges on those loans #he
subsidiary can also leverage its investment
and increase profitability by borrowing 0epending on the level of
risk it chooses to take! some portion of
the subsidiary/s debt will be long term debt #he subsidiary/s
principal business is financing the parent
company/s sales! either by direct loans to the customer or by
purchasing the receivables of the parent
company in accordance with a factoring arrangement #he
transactions! which finance the sales of the
parent company! allow the parent company to report its sales
as essentially cash sales #he parent company
also avoids the need to borrow money to finance its sales! which
function being done by the subsidiary
#he financial reporting problem that arises is that the parent/s
financial statements will not show either the
receivable from the lending transactions or the related long term
debt if the subsidiary is unconsolidated
As mentioned earlier! prior to ,;@8! *AAP did not allow
consolidation of this type of subsidiary! giving
rise to a reporting problem that became known as off balance sheet
financing
E$n ,;@8 the FAS4 issued FAS4 Statement o ;2! Consolidation of All
:a"orityGBwned
SubsidiariesH! which was designed to provide financial statement
users with more complete information
about the financial position of consolidated entities) FAS4
Statement o ;2 requires consolidation of all
ma"orityGowned subsidiaries unless control is deemed temporary or
control does not rest with the parent
company A subsidiary in the process of being sold or spunGoff is an
e-ample of a temporarily controlled
subsidiary Bther conditions may result in control being transferred
from the parent company to another
) Statement of Financial Accounting Standards o ;2!
Consolidation of All Majority-Owned Subsidiaries %Stamford!
C#? Financial Accounting Standards 4oard! ,;@8(
2
entity For e-ample! the courtGappointed trustee would normally
control a subsidiary in bankruptcy $n
addition! a subsidiary domiciled in another country may be
controlled by the government of that country
under certain conditions #he imposition of capital repatriation
restrictions by the local government is
generally grounds for nonconsolidation Unconsolidated subsidiaries
are accounted for by the equity
method and reported in the consolidated financial statements as
investments .owever! the e-istence of
conditions which give rise to uncertainty regarding the reali5ation
of the investment in the subsidiary
require use of the cost method &efer to Figure )G, in Chapter )
for a flow chart of the decision process for
accounting for passive! substantial influence! and controlled
investments in common stock
Consolidation of Finance Company ubsidiaries
#he following data taken from the annual report of the (eneral
Electric Company illustrate the potential
impact of finance company subsidiaries on a consolidated statement
of financial position?
*eneral 'lectric Company and Consolidated Affiliates
*eneral 'lectric Company Separate
)otal #ssets %millions of US=( *+- *. */..
)otal 0iabilities
ource" ,;;8 annual report of *eneral 'lectric Company
$n ,;;<! the FAS4 issued a proposed statement of financial
accounting standards that would
change the definition of control Under this proposal! control
of a subsidiary may be presumed even if the
subsidiary is not ma"ority owned #he proposed standard does not
specify an e-act percentage which
allows the presumption of control but does require consideration of
the circumstances of the investment
prior to making a decision regarding the choice of accounting
method for the investment For e-ample!
control may be present if a parent company owns a maority of the
common stock !oted in the most
recent stockholders/ meeting Bther issues which affect the decision
to consolidate include the presence or
absence of another large minority investor! the ability to affect
the election of a ma"ority of directors! and
the ability to influence ma"or policy decisions of the
investee
Proposed Statement of Financial Accounting Standards!
Consolidated Financial Statements: Policy and
Procedures %Stamford! C#? Financial Accounting Standards
4oard! ,;;>(
>
All companies must disclose consolidation policy in footnotes to
financial statements if subsidiary
operations materially affect the financial statements2 #his
disclosure is frequently the first of the
accounting policies footnotes Figure ) shows an e-amples from two
recent corporate annual reports
Place figure / about here
Interpreti!e e2ercise" Following FAS4 ;2 criteria! a 2;D owned
finance affiliate would not be consolidated #he criteria for
consolidation in the ,;;< FAS4 e-posure draft would require
consolidation of a 2;D owned affiliate if the 2;D holding were
sufficient to e-ercise control over corporate policy +hy might a
company create a financing affiliate and retain only a minority
interest in its common stockI
Consolidation theory
&ecall that a merger transaction accounted for by the purchase
method of accounting %Chapter ,(
requires the assets and liabilities of the merged company be
recorded at fair market value on the books of
the acquiring entity #he purchase method of accounting also
requires reporting the assets and liabilities of
a subsidiary in the consolidated financial statements on the date
of acquisition at fair market value +hen
the subsidiary is less than ,99D owned! a question arises regarding
the values to be assigned to
consolidated subsidiary assets and liabilities whose book values
and fair market values differ on the
acquisition date #wo alternative practices e-ist Currently! the
most common practice is to follow what is
called the parent company approach Under the parent company
approach the assets and liabilities of
the subsidiary are consolidated at an amount equal to their book
value plus the controlling interest share of
the amount by which fair market value e-ceeds book value on the
date of acquisition For e-ample! assume
an @9D owned subsidiary had buildings with a book value of =,99!999
and a fair market value of =)99!999
on the acquisition date #he consolidated statement of financial
position as of the date of acquisition would
report these buildings at =,@9!999 %historical book value plus @9D
of the costGbook value differential(!
following the parent company approach #he argument in favor of this
approach is that the acquisition
transaction by the parent company involves only the controlling
interest share of the fair market value 1
book value differential +hile this argument may be valid on
strict technical grounds! it is not consistent
with economic reality
<
#he ,;;> FAS4 draft e-posure opinion>! Consolidated Financial
Statements: Policy and
Procedures! recommended that the parent company
approach to preparation of consolidated financial
statements be prohibited $n its place! only the economic unit
approach would be permitted Under the
economic unit approach! subsidiary assets and liabilities would be
consolidated at the same values for
both wholly owned and less than ,99D owned subsidiaries Under
this approach! all subsidiary assets and
liabilities would be consolidated at fair market value on the date
of acquisition $n the above e-ample!
subsidiary buildings with a book value of =,99!999 and a fair
market value of =)99!999 on the acquisition
date would be consolidated at =)99!999 #he e-istence of a
noncontrolling interest would not affect asset
valuation #his approach is consistent with the move toward fair
market value recognition that permeates
all recent FAS4 Standards! notably those concerned with investments
%FAS4 Statements ,,> 7 ,)2( and
contributions %FAS4 Statement ,,<(< #he illustrations
that follow in this and later chapters follow the
economic unit approach
parent company approach as compared with the economic unit
approach
Parent company
L
CI3 - '-cess of F:M over 4M of Subsidiary net assets
Economic unit
L
13 of '-cess of F:M over 4M of subsidiary net assets
+here? C$D controlling interest percent F:M fair market value 4M
book value
> Ibid < Statement of Financial Accounting
Standards o ,,>! Accounting for Certain In!estments in Debt
and
"#uity Securities Statement of Financial Accounting Standards
o ,)2! Accounting for Certain
In!estments by $eld by %ot-for-Profit Organi&ations
Statement of Financial Accounting Standards o
,,<! Accounting for Contributions 'ecei!ed and Made
%Stamford! C#? Financial Accounting Standards 4oard!
,;;>G,;;<(
8
Proportional consolidation 4 a hybrid approach to in!estment
reporting
A third alternative approach is theoretically possible and
sometimes used in unusual circumstances!
particularly where companies wish to adopt a compromise
approach that falls between the equity method
and consolidation #his approach! called proportional
consolidation consolidates only the controlling
interest share of the investee/s assets and liabilities8
Proportional consolidation is a generally accepted
practice in the petroleum industry for e-ploration and
production ventures $n order to diversify risks!
e-ploration efforts are often conducted as "oint ventures where no
company owns a ma"ority interest in the
venture For e-ample! assume a 29D owned investee had buildings with
a book value of =,99!999 and a
fair market value of =)99!999 on the acquisition date Proportional
consolidation would report these assets
at a value of =@9!999 %=)99!999 - 29D( in the consolidated
financial statements Figure ) shows a footnote
from the ,;;< annual report of the Bccidental Petroleum
Corporation describing its use of proportional
consolidation Proportional consolidation may seem intuitively
appealing at first glance! but this approach
should not be used for controlled subsidiaries 4oth the parent
company and the economic unit
approaches to consolidation provide more complete information for
the statement user #hese approaches
show subsidiary assets and liabilities at appro-imately full value
on the date of acquisition and also present
an equity account for the noncontrolling interest in the
consolidated statement of financial position
Concept 'uestion and reflection" +hat are some of the ways that
fair market value of business assets can be determinedI
Consolidated Statement of Financial Position at the date of
Acquisition
135o6ned subsidiaries 4 cost and book !alue e'ual
#he procedures for consolidation of purchase method subsidiaries
begins with an allocation
schedule #his schedule is identical to the schedule used for
applying the equity method of accounting as
illustrated in Chapter ) #he allocation schedule is prepared as of
the date of acquisition and supports the
consolidation procedures used in all future years e-t! a worksheet
for consolidated financial statements
@
is prepared $n simple illustrations the consolidated statements
worksheet may seem unnecessary because
of the small number of ad"ustments required .owever! we will see
that more comple- consolidation
situations are much easier to analy5e using a worksheet than would
be the case in attempting to prepare the
statements in a less formal way
As an illustration! assume that on 6anuary ,! ,;-9 3ogan Company
acquires ,99D of Kelly
Company common stock for a cash price of =,99!999 in a business
combination accounted for by the
purchase method Bn the date of acquisition Kelly Company
capital consists of >9!999 shares of =, par
value common stock outstanding and a retained earnings balance of
>9!999 #here are no direct acquisition
costs and Kelly/ assets have book values appro-imately equal to
fair market values on the date of
acquisition #he "ournal entry to record this acquisition on the
books of 3ogan is?
1/1/x0 Investment in Kelly Company 100,000
Cash 100,000
An allocation schedule for the acquisition of Kelly by 3ogan is as
follows?
Cost of Kelly Stock 100,000$
Stockholders' equity of Kelly
Retained earnings 50,000
Excess of cost over book value -$
$n this simple e-ample a consolidated balance sheet for Kelly and
3ogan on 6anuary ,! l;-9 is
prepared by combining the accounts of the two companies after
making one worksheet elimination entry
#his entry requires that we eliminate both the $nvestment in Kelly
account and the stockholders/ equity
accounts of Kelly #o illustrate how this elimination entry is made
refer toE2hibit +51! which shows the
worksheet for the Consolidated Statement of Financial Position
Assume that the assets! liabilities! and
stockholders/ equity of 3ogan and Kelly immediately after the
acquisition of the Kelly common stock by
3ogan on 6anuary ,! ,;-9 are as illustrated in the first two
columns of the worksheet shown in E2hibit +51
;
worksheet and e-tending the balances of the assets and liabilities
across the worksheet to the consolidated
column $n general "ournal form entry %,( is as follows?
1/1/x0 Common stock, Kelly 50,000
Retained earnings, Kelly 50,000
Investment in Kelly 100,000
E2hibit +51 shows how the consolidated statements worksheet
transforms two separate financial
statements into a single financial statement 'ntry %,( accomplishes
two ob"ectives First! it eliminates the
account $nvestment in KellyH! which is replaced by the individual
assets and liabilities of Kelly in the
consolidated statement Second! the entry eliminates the
stockholders/ equity accounts of Kelly Since
3ogan owns all of Kelly Company common! from a consolidated
viewpoint Kelly Company common stock
is essentially treasury stock Since *AAP requires reporting
treasury stock as temporarily retired!
subsidiary stock is eliminated in a consolidation )he concept that
dri!es all consolidation procedures is
that consolidated financial statements should sho6 only the results
of transactions 6ith outsiders
#he effects on the accounts of transactions between the parent
company and its subsidiaries or between
subsidiaries should always be eliminated
0ess than 13 o6ned subsidiaries 4 cost and book !alue e'ual
Assume that 3ogan acquired only an @9D interest in the common stock
of Kelly $f the price paid
for Kelly common is equal to the book value of the net assets of
Kelly! the price paid by 3ogan would be
=@9!999
$n order to prepare a consolidated statement of financial position!
an allocation schedule is first prepared?
Cost of Kelly Stock 80,000$
Stockholders' equity of Kelly
Retained earnings 50,000
Excess of cost over book value -$
,9
$f the subsidiary is less than ,99D owned! a noncontrolling
interest in the equity of the
consolidated companies e-ists $n order to show this noncontrolling
interest in the consolidated statement
of financial position! the entry to eliminate the $nvestment in
Kelly and Kelly/s equity accounts is altered
slightly?
Retained earnings , Kelly 50,000
Noncontrolling interest 20,000
#he entry eliminates ,99D of the stockholder/s equity of Kelly and
the account $nvestment in
KellyH #he noncontrolling interest equity account is equal to the
noncontrolling interest percentage %)9D(
multiplied times Kelly stockholders/ equity %=,99!999( #he
noncontrolling interest account is a new
account! created by this entry #herefore! the noncontrolling
interest is shown in the consolidated
statements but does not appear in separate statements of either the
parent company or its subsidiaries #he
worksheet for the consolidated statement of financial position is
shown in E2hibit +5/
Place E2hibit +5/ about here 7see E2cel Files8
13 o6ned subsidiaries 4 cost greater than book !alue
+hen the cost of a subsidiary investment e-ceeds the underlying
book value of the subsidiary/s
net assets as of the date of acquisition! additional elimination
entries are required #he purchase method of
accounting for business combinations requires that a consolidated
balance sheet show the assets of the
subsidiary in the financial statements at the fair market value as
of the date of acquisition Subsidiary
assets should not be consolidated at book value if fair market
value and book value are different on the
acquisition date As in the previous illustrations! the first step
in preparing a worksheet for consolidated
financial statements is to construct an allocation schedule based
on the acquisition data As an e-ample
assume that Picardi Company acquires Sanche5 Company on 6anuary ,!
,;-9 in a purchase method
business combination whereby Picardi pays =,>9!999 for all
of the outstanding common stock of Sanche5
Company $n addition! Picardi incurs =,9!999 in direct acquisition
costs in the form of consulting fees
$mmediately prior to the acquisition! Sanche5 had assets and
liabilities with book and fair market values on
6anuary ,! ,;-9 as shown in E2hibit +5+&
,,
January 1, 19x0
Cash $15,000 $15,000
Common s tock, Sanchez $5 par 50,000
Additional paid in Capital 20,000
Retained earnings, Sanchez 50,000
$157,500
+hen the cost of an investment in a subsidiary company is not equal
to the underlying book value
of the subsidiary/s net assets! the assets and liabilities of the
subsidiary must be ad"usted in the consolidated
statements to fair market value Accordingly! an allocation schedule
is required #his schedule is prepared
in same manner as for an investee to be merged or for an investee
accounted for by the equity method #he
allocation schedule for the acquisition of the Sanche5 $nvestment
by Picardi is shown in E2hibit +5- #his
schedule also provides all the necessary data needed for the
elimination entries in the worksheet for a
consolidated statement of financial position
,)
Stockholders' equity of Sanchez
Additional paid in Capital 20,000
Retained earnings 50,000
Excess of cost over book value 40,000$
Allocation:
Excess of cost over book value 40,000$
Using the data in the allocation schedule the following elimination
entries are required for the
consolidation of Picardi and Sanche5 as of 6anuary ,! ,;-9 #he
first entry eliminates the stockholders/
equity accounts of the subsidiary and Picardi/s account! $nvestment
in Sanche5H #he difference between
these two accounts is the e2cess of cost o!er book !alue that
must be assigned to other subsidiary accounts
in the consolidation #he e-cess of cost over book value in the
allocation schedule represents the total
amount of additional net upward valuations that must be made in the
subsidiary/s net assets upon
consolidation For purpose of convenience and illustration this
allocation is made in a second entry Jou
will see that the two entries may be easily combined into a single
compound entry .owever! we will
continue to illustrate this process in separate entries for reasons
of clarity #he second entry eliminates the
e-cess of cost over book value and ad"usts the remaining assets and
liabilities of the subsidiary in
,
Additional paid in Capital, Sanchez 20,000
Retained earnings, Sanchez 50,000
Investment in Sanchez 160,000
Excess of cost over book value 40,000
#he separate financial statements of the two companies! the
elimination entries! and the consolidated totals
for the statement of financial position on 6anuary ,! ,;-9 are
shown in E2hibit +5.
Place E2hibit +5. about here 4 see E2cel files&
0ess than 13 o6ned subsidiaries 4 cost greater than book
!alue
+hen a subsidiary with undervalued net assets is acquired in a
transaction where less than ,99D
of its outstanding voting common stock is acquired! the
noncontrolling interest is affected@ E2hibit +5%
shows an allocation schedule for the Picardi 1 Sanche5
consolidation assuming that Picardi pays the same
price as in E2hibit +5-! but acquires only a ;9D interest in
the voting common stock of Sanche5 4ecause
Picardi acquires only a ;9D interest! the e-cess of cost over book
value increases to =>)!999 #he
allocation section of the schedule is also affected by the
e-istence of a ,9D noncontrolling interest in the
subsidiary Any ad"ustment in the identifiable net assets of the
subsidiary will now change the amount of
the noncontrolling interest $n this e-ample! the building is
undervalued by =>!999 and the equipment is
undervalued by =,9!999 +hen these are ad"usted upward on the
consolidated statements worksheet! the
noncontrolling interest must be increased by ,9D of the total of
these two ad"ustments! or =,!>99 %=,>!999
- ,9D( )he remaining amount of the e2cess of cost o!er book !alue
of *+9,. is assumed to be
applicable to unidentifiable assets 4 good6ill& Furthermore,
this good6ill is deemed to be solely
@ #here are several ways this scenario may be handled in the
consolidated statements worksheet According to the parent
company approach! only that portion of cost book value
differentials applicable to the controlling interest should be
reflected in the consolidated statements .owever! the action
required by the economic unit approach is to ad"ust subsidiary
identifiable net assets to ,99D of fair market value as of the date
of acquisition All illustrations in this book follow theeconomic
unit approach
,2
applicable to the controlling interest ! thus no further ad"ustment
is needed to the noncontrolling interest
account;
Place E2hibit +5% about here 4 see E2cel files
Using the data in the allocation schedule the following elimination
entries are required for the
consolidation of Picardi and Sanche5 as of 6anuary ,! ,;-9 #he
first entry eliminates the stockholders/
equity accounts of the subsidiary! the parent/s account $nvestment
in Sanche5H! and establishes a
noncontrolling interest equal to the subsidiary stockholder/s
equity multiplied by the noncontrolling interest
%,9D( #he difference between these three amounts is the e-cess of
cost over book value! which will be a
debit amount when the price paid for the investment e-ceeds the
fair value of the subsidiary net assets on
the date of acquisition #he second entry assigns the e-cess of cost
over book value to the appropriate
accounts in accordance with the allocation schedule #hus the
buildings account and the equipment
account are increased by =>!999 and =,9!999 respectively
resulting in these items being reported at fair
market value on the date of acquisition #he noncontrolling interest
account initially set up in the first entry
is increased by =,!>99 to reflect the increased carrying values
of the identifiable assets! and the remaining
amount of the e-cess of cost over book value is recorded as
goodwill %applicable to the controlling
interest(
Additional paid in Capital, Sanchez 20,000
Retained earnings, Sanchez 50,000
Investment in Sanchez 160,000
Noncontrolling interest 1,500
N%Sanche5 equity of =,)9!999 O ,9D(
,>
#he separate financial statements of Picardi and Sanche5! the
elimination entries! and the consolidated
totals for the statement of financial position on 6anuary ,! ,;-9
are shown in E2hibit +5:
Place E2hibit +5: about here 4 see E2cel files
Financial statement disclosure of noncontrolling interest
+hen a noncontrolling interest e-ists as a result of a less than
,99D owned subsidiary! a question
arises regarding the appropriate classification of the
noncontrolling interest account in the consolidated
statement of financial position #hree potential classifications
e-ist #he noncontrolling interest could
potentially be shown as a liability! as an element of
stockholders/ equity! or in a separate section between
the liability and stockholders/ equity sections in the consolidated
statement of financial position $n an
e-posure draft issued on Bctober ,<! ,;;> the FAS4 gave
strong endorsement for inclusion of
noncontrolling interest in the stockholders/ equity section,9
oncontrolling interest does not meet the
definition of a liability in FAS4 Concepts Statement o < thus it
seems clear that this alternative is not
appropriate,, #he other alternative! showing the
noncontrolling interest in the statement of financial
position between the liability and stockholders/ equity
section! is the most common disclosure under
current practice #he FAS4 carefully considered this alternative and
concluded that the definition of
stockholders/ equity is broad enough to include noncontrolling
interests even though! from a strict technical
standpoint! the subsidiary shareholders that make up the
noncontrolling interest are not shareholders of the
parent company #he FAS4 further concluded that there was no
compelling reasonH to establish a separate
section in the Consolidated Statement of Financial Position for
noncontrolling interests,) #hus! the
appropriate disclosure of noncontrolling interests from a
conceptual perspective is to include this account
as a separate element of stockholders/ equity
Comprehensi!e illustration
Assume that Prospect Company acquires ;9D of the voting common
stock of Sunshine Company
for =);9!999 on 6anuary ,! ,;-9! and also incurs an additional
=,9!999 of direct acquisition costs #he
statement of financial position of Sunshine Company and the fair
market values of its assets and liabilities
,9 Proposed Statement of Financial Accounting Standards!
Consolidated Financial Statements: Policy and
Procedures %Stamford! C#? Financial Accounting Standards
4oard! ,;;>(! pars ))! ,9,G,98 ,, Statement of Financial
Accounting Concepts o <! "lements of Financial
Statements %Stanford! C#? Financial Accounting Standards
4oard! ,;@>( ,) Proposed Statement of Financial Accounting
Standards! Consolidated Financial Statements: Policy and
Procedures %Stamford! C#? Financial Accounting Standards
4oard! ,;;>(! par ,9<
,<
as of 6anuary ,! ,;-9 is shown in E2hibit +59 4ased on this
information! an allocation schedule necessary
to prepare a consolidated statement of financial position for both
Prospect Company and Sunshine
Company is shown in E2hibit +5$
Place E2hibits +59 and +5$ about here 4 see E2cel files
#he allocation schedule shows an e-cess of cost over book value of
=,)2!>99 #his is the amount
by which the net assets of Sunshine must be increased in
total in the consolidation elimination entries #he
allocation section of the schedule provides the necessary detail to
make these entries ote that the
inventory! land! and building accounts are all undervalued #hus
these accounts will be debited in the
elimination entries #he equipment! however! is o!er!alued by *1.,!
and will have to be decreased in
value by an elimination entry Since a decrease in an asset account
must be accomplished with a credit!
this overvaluation is shown in the allocation schedule as a
negative number ote also that the longGterm
debt is o!er!alued by *1, $n the consolidations worksheet! an
elimination entry will be needed which
includes a debit to this account for =,9!999! because longGterm
debt has a credit balance Accordingly! the
allocation schedule shows the overvaluation of longGterm debt as a
positive number In effect, the
allocation schedule sho6s the elimination entry debits as positi!e
amounts and the elimination entry
credits as negati!e amounts
$n addition to the investment in subsidiary account and the
subsidiary stockholders/ equity! other
accounts may require elimination as well An important category of
these is intercompany debts $f any of
the companies involved in a consolidation has obligations to any of
the other companies! intercompany
debt e-ists For e-ample! assume Sunshine Company owes Prospect
Company =8!999 #his intercompany
debt would be shown on the books of Sunshine as an account payable
and on the books of Prospect as an
account receivable either of these amounts may be included in the
financial statements because! from a
consolidated perspective! neither the payable nor the receivable
involves an e-ternal entity
As in the previous illustrations! the noncontrolling interest must
be increased by the
noncontrolling interest percent multiplied by the net increase in
the identifiable assets of the subsidiary
#he residual number in the allocation schedule is the goodwill!
which is only applicable to the controlling
interest shareholders #he required elimination entries for this
consolidation! including the entries based on
the allocation schedule in E2hibit +5$ and the intercompany
account payable are as follows?
,8
Additional paid in Capital, Sunshine 25,000
Common stock, Sunshine 100,000
Retained earnings, Sunshine 70,000
Investment in Sunshine 300,000
1/1/x0 Accounts payable 7,000
Accounts receivable 7,000
#he first entry eliminates the stockholders/ equity of Sunshine and
the parent company/s account!
investment in Sunshine #his entry also establishes a =,;!>99
noncontrolling interest account equal to the
noncontrolling interest percent %,9D( of Sunshine Company
stockholders/ equity #he debit difference
between these three amounts is equal to the e-cess of cost
over book value in the allocation schedule
%E2hibit +5$( #he second entry eliminates the unallocated
differential by assigning it to the assets and
liabilities of the subsidiary based upon the allocation schedule
#he third entry eliminates the intercompany
account receivable and account payable #he separate financial
statements of the two companies! the
elimination entries! and the consolidated totals are shown in
E2hibit +51 ote that the debit in entry
three is posted to the current liabilitiesH account because no
separate account for accounts payable appears
in the consolidated statement of financial position
Place E2hibit +51 about here 4 see E2cel files
ummary
• Know the criteria for consolidation of a subsidiary
• Understand the Parent company approach and the Economic unit
approach of consolidation
• Prepare a worksheet for a Consolidated Statement of Financial
Position for affiliated companies
immediately after acquisition
,@
Consolidated financial statements are based on the theory that the
primary focus of financial reporting
is the economic entity #c'uisitions5of5 stock business combinations
create economic entities
composed of more than one ;usiness Corporation #ccordingly the
financial statements of the
parent company and its subsidiaries are consolidated for
reporting purposes $mmediately after
acquisition of a subsidiary by a parent company a consolidated
statement of financial position may be
prepared #his chapter illustrates that the most efficient way
of preparing this financial statement is with
the use of a worksheet where the separate financial statements of
the companies to be consolidated are
combined #his worksheet allows the elimination entries to be posted
to the financial statement elements
prior to their final consolidation #he worksheet is easily
prepared with the use of computeri5ed
spreadsheet software! although it also may be done manually #he
worksheet for consolidated financial
statements is off the books because the elimination
entries and the subsidiary accounts are never entered in
the parent company/s ledger
Current FAS4 standards require that all ma"orityGowned subsidiary
companies be consolidated! unless
control does not rest with the parent company #here is also a
proposed FAS4 standard! in e-posure draft
form! that would require consolidation of a subsidiary that was
deemed controlled! even where the parent
company does not own a ma"ority interest in the subsidiary/s common
stock For e-ample! control might
be achieved if the parent company owns more than >9D of
the shares voted at the annual meeting
#wo alternative theories may serve as a basis for determining the
reported value of subsidiary company
assets in consolidated financial statements Under the parent
company approach! the assets and liabilities
of the subsidiary are consolidated at an amount equal to their book
value plus or minus the controlling
interest share of the difference between book value and fair market
value Under the economic unit
approach! subsidiary assets and liabilities are consolidated at
fair market value for both ,99D owned and
less than ,99D owned subsidiaries #he parent company
approach is currently the prevalent practice
.owever! the FAS4 has proposed %in the ,;;> e-posure draft( that
the economic unit approach be
followed for all consolidations )here is no difference bet6een the
economic unit approach and the
parent company approach for 135o6ned subsidiaries
A consolidated statement of financial position is based upon an
allocation schedule that assigns the
,;
schedule also serves as the basis for the elimination entries that
eliminate the reciprocal accounts in the
consolidated financial statements At the date of acquisition! the
principle reciprocal accounts are the
investment in the subsidiary on the books of the parent company and
the stockholders/ equity accounts of
the subsidiary $n situations where there is an e-cess of cost over
book value! goodwill may be recorded in
the consolidation process
$n years subsequent to the date of acquisition! consolidated
financial statements must also be
prepared $n these later years! a full set of statements 1 an
income statement! a retained earnings statement!
a statement of financial position! and a cash flow statement 1 must
all be prepared #he allocation
schedule prepared as of the date of acquisition serves as a basis
for this financial statement as well $n
addition! the method of accounting used to account for the
investment in the subsidiary common stock will
affect the consolidation procedures #hese procedures will be
illustrated and discussed in the following
chapter
Appendix
LEARNING OBJECI!E
• Prepare a consolidation as of the date of acquisition for a
bargain purchase situation
;argain purchase ac'uisitions of a 13 interest
As was illustrated in Chapter ,! a business combination may occur
under bargain purchase
conditions! whereby the price paid for the investment in the
subsidiary is less than the fair market value of
the net identifiable assets of the investee A bargain purchase may
occur because the subsidiary has not
e-hibited a record of past operating performance sufficient to
"ustify an acquisition price equal to or greater
than the appraised value of its identifiable net assets $n a
bargain purchase! an allocation schedule is
prepared to determine the amount of the differential %either
an e-cess of cost over book value or an e-cess
of book value over cost( #he allocation section of the schedule is
prepared in the same manner as previous
illustrations! e-cept that the residual figure for goodwill will be
a negative number 1 indicating negative
goodwill As was illustrated for the asset acquisition scenarios in
the appendi- to Chapter ,! negative
goodwill should be further allocated to the longGterm assets of the
subsidiary other than investment in
)9
marketable securities, For subsidiaries to be consolidated!
this allocation is done on the worksheet for
consolidated statements
As an e-ample! assume that the Picardi 1 Sanche5 consolidation
%E2hibits +5+ and +5-( involves
the payment of =,99!999 %including direct acquisitions costs( for a
,99D interest in the voting common
stock of Sanche5 4ased on the bookQfair market data in E2hibit
+5+ this price is */, less than the
book !alue of anche< net assets and *+., less than the fair
market !alue of those assets E2hibit
+511 presents an allocation schedule suitable for developing a
consolidated statement of financial position
for Picardi and Sanche5 under these conditions Since the price paid
for the subsidiary is less than the book
value of the subsidiary/s net assets! the differential is an e2cess
of book !alue o!er cost and is shown in
E2hibit +511 as a negati!e number #he allocation section
increases the carrying value of the buildings by
=>!999 and the equipment by =,9!999! which are undervalued by
these amounts respectively #hese
allocations are the same as the previous scenarios $n this case!
however! the residual amount of goodwill
is a negative =>!999! the amount necessary for the total of the
goodwill %a negati!e *+.,( and the
undervaluations of the buildings and equipment %a positi!e *1.,( to
equal =)9!999 According to AP4
Bpinion ,<,2! negative goodwill must be assigned to long term
assets other than marketable securities in
accordance with their relative market values #he last portion of
the schedule uses the fair market values of
Sanche5 longGterm assets to allocate the negative goodwill to all
of the longGterm assets including the land!
which did not have a bookQfair market value differential
Place E2hibit +511 about here 4 see E2cel files
E2hibit +511 provides the information necessary to make three
elimination entries that are posted
on the consolidated statement worksheet #hese entries are shown
below?
),
Retained earnings, Sanchez 50,000
Investment in Sanchez 100,000
Buildings 5,000
Equipment 10,000
Land 4,866
Buildings 17,329
Equipment 12,805
#he first entry eliminates the stockholders/ equity accounts of
Sanche5! the $nvestment in Sanche5
account! and establishes an e2cess of book !alue o!er
cost account equal to the difference between the
Sanche5 stockholders/ equity and the investment account $n this
case! this amount is a credit of */,
#he second entry eliminates this e2cess of book !alue o!er
cost and ad"usts the undervalued assets and
liabilities of the subsidiary in accordance with the allocation
schedule #he residual figure in this second
entry is always goodwill $f the goodwill is positive! as in
previous illustrations! no other entries are
required $f the goodwill is negative %indicated by a credit
balance(! as in this case! it is eliminated in a
third entry using the relative market value allocation shown in
E2hibit +511 #he separate statements of the
two companies! the elimination entries! and the consolidated totals
for this scenario are shown in E2hibit +5
1/
;argain purchase ac'uisitions of less than a 13 interest
A final series of illustrations shows a bargain purchase scenario
where a noncontrolling interest
e-ists Assume for e-ample that Picardi acquires ;9D of the
outstanding voting common stock of Sanche5
for a price of =,99!999! including direct acquisition costs 4ook
and fair market value of Sanche5 net
assets are the same as in the previous illustrations #he allocation
schedule for a consolidated statement of
financial position is shown in E2hibit +51+ $n this case the
=,99!999 purchase price is =@!999 less than
))
represents the net amount of required writeGdowns in Sanche5 net
assets in the consolidated statement of
financial position #he allocation section of the E2hibit
+51+ increases the building by its =>!999
undervaluation! the undervalued equipment by =,9!999! and increases
the noncontrolling interest by
*1,. to reflect the increased carrying !alues of these t6o
identifiable assets #hese revaluations
increase the e-cess of book value over cost to =),!>99 an amount
recorded as negative goodwill %applicable
to the controlling interest( Finally this resulting negative
goodwill is allocated to the longGterm assets of
the subsidiary in the same manner as the previous
illustration
Place E2hibit +51+ about here 4 see E2cel files
#he required elimination entries based on E2hibit +51+ are
shown below?
1/1/x0 Common stock, Sanchez 50,000
Paid in Capital, Sanchez 20,000
Retained earnings, Sanchez 50,000
Investment in Sanchez 100,000
Negative goodwill 21,500
Noncontrolling interest 1,500
#he first entry eliminates the stockholders/ equity accounts of
Sanche5! establishes a
noncontrolling interest account equal to the noncontrolling
interest percentage %,9D( multiplied by total
subsidiary equity! and eliminates the account! $nvestment in
Sanche5 #he residual figure in this entry is
the e-cess of book value over cost! an =@!999 credit #he second
entry ad"usts the buildings and equipment
to fair market value on the acquisition date! eliminates the e-cess
of book value over cost from the first
entry! and increases the noncontrolling interest by the
noncontrolling interest percentage %,9D( multiplied
)
and equipment( #he relative market value allocation calculations
are shown in E2hibit +51+ A worksheet
for a consolidated statement of financial position! showing
beginning unconsolidated balances for the two
companies! consolidation elimination entries! and consolidated
totals in shown in E2hibit +51-
Place E2hibit +51- about here 4 see E2cel files
ummary
#he following learning ob"ective was stated at the beginning of the
appendi-
• Prepare a consolidation as of the date of acquisition for a
bargain purchase situation
$n a bargain purchase! an allocation schedule is prepared to
determine the amount of the
differential %either an e-cess of cost over book value or an e-cess
of book value over cost( #he allocation
section of the schedule is prepared in the same manner as in the
case of an e-cess of cost over book value!
e-cept that the residual figure for goodwill will be a negative
number 1 indicating negative goodwill As
was illustrated for the asset acquisition scenarios in the appendi-
to Chapter ,! negative goodwill must be
further allocated to the longGterm assets of the subsidiary other
than investment in marketable securities
#his allocation is done using the relative market values of the
assets to which it is allocated A relative
market value ratio %&:Mratio( is first computed for each
applicable longGterm asset by dividing the
individual market values by the total market value of all
applicable longGterm assets #he amount of
negative goodwill assigned to each longGterm asset is determined by
multiplying negative goodwill by the
&:M ratios Finally a worksheet entry is made eliminating the
negative goodwill and reducing the
applicable longGterm assets by the results of the allocation
'ssentially this process adds one elimination
entry to the consolidation analysis 1 elimination of the negative
goodwill
)2