Chapter 3 an Introduction to Consolidated Financial Statements - Std

Chapter 3 An Introduction to Consolidated Financial Statements

Intro to Consolidations: Objectives 1. Recogni Recognize ze the the benefi benefits ts and and limitat limitation ions s of conso consolid lidated ated financial statements. 2. Understand the requirements requireme nts for including a subsidiary in consolidated financial statements. 3. Apply consolidation concepts to parent company recording of an investment in a subsidiary company at the date of acquisition 4. Record the fair value of the subsidiary at the date of acquisition -

Intro to Consolidations: Objectives 1. Recogni Recognize ze the the benefi benefits ts and and limitat limitation ions s of conso consolid lidated ated financial statements. 2. Understand the requirements requireme nts for including a subsidiary in consolidated financial statements. 3. Apply consolidation concepts to parent company recording of an investment in a subsidiary company at the date of acquisition 4. Record the fair value of the subsidiary at the date of acquisition -

Objectives (continued) 5. Learn Learn the the conce concept pt of of nonc noncon ontr trol olli ling ng int intere erest st when when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. 6. Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries.

7. Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. 8. Apply the concepts underlying preparation of a consolidated income statement.

An Introduction to Consolidated Financial Statements

1: BENEFITS & LIMITATIONS A BUSINESS COMBINATION UNDER GAAP INCLUDES COMBINATIONS IN WHICH ONE OR MORE COMPANIES BECOME SUBSIDIARIES OF A PARENT CORPORATION. A. A CORPORATION THAT HOLDS A MAJORITY INTEREST (OVER 50%) OF THE VOTING STOCK OF ANOTHER CORPORATION IS REFERRED TO AS THE PARENT COMPANY. B. THE INTEREST NOT HELD BY THE PARENT COMPANY IS REFERRED TO AS THE NONCONTROLLING INTEREST.

Business Acquisitions Business combinations through stock acquisitions

 –  Acquire controlling interest in voting stock   –  More than 50%  –  May have control through indirect ownership Business combination occurs once

 –  Acquisition of additional subsidiary stock is simply additional investment

Consolidated Statements

 – Primarily benefit the owners and creditors of the parent

 – Not primarily intended for the noncontrolling owners nor the subsidiary s creditors ’

 – Subsidiaries issue separate statements for the benefit of their owners and creditors

- GAAP states that the acquisition of additional shares of a subsidiary is recorded by an increase in the investment account and a reduction of the noncontrolling interest.

- The parent company and subsidiary exist as separate legal entities and maintain separate accounting records.

- Consolidated financial statements are prepared by the parent company for all the companies under the control of a single management team to reflect a single reporting entity with multiple divisions. - The purpose of consolidated financial statements is to present fairly, primarily for the benefit of the owners and creditors of the parent company, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single entity.

- The subsidiary will continue to report the results of its separate operations to its noncontrolling stockholders. - The consolidated entity (the reporting entity) has no transactions and it does not maintain a ledger. The financial statements of the separate legal entities are combined only for external reporting purposes.

PARENT AND SUBSIDIARY WITH DIFFERENT FISCAL PERIODS A Consolidated statements are prepared for and as of the end of the parent company’s fiscal period, but May include subsidiary statements with FYE within 3 months of parent's FYE.

CONSOLIDATED FINANCIAL STATEMENTS A. A set of consolidated financial statements includes a consolidated balance sheet, a consolidated income statement and retained earnings statement, and a consolidated statement of cash flows. B. The consolidated balance sheet, income statement, and retained earnings statement are prepared by combining the separate financial statements of the parent company and the subsidiary. •

C. The consolidated cash flow statement, however, is prepared from the consolidated financial statements for two consecutive years.

•

•

•

THE CONSOLIDATED BALANCE SHEET The investment in subsidiary account on the parent company balance sheet and the stockholders’ equity accounts on the subsidiary’s balance sheet are reciprocal, both representing the net assets of the subsidiary. The reciprocal investment in subsidiary on the parent’s balance sheet and subsidiary stockholders’ equity accounts are eliminated in consolidation (and are replaced by the individual assets and liabilities of the subsidiary).

* A one-line consolidation (the investment account) is replaced by details about individual assets and liabilities controlled by a single management group. * Non-reciprocal accounts are combined. * Reciprocal accounts are often eliminated * The capital stock and retained earnings amounts that appear in the consolidated balance sheet are those of the parent company.

* Unimpaired cost-book value differentials are added to (or subtracted from) the asset and liability accounts that will appear in the consolidated balance sheet. Goodwill from the investment, which does not appear in the separate company statements, is added to the asset listing. * Intercompany balances are eliminated.

An Introduction to Consolidated Financial Statements

2: SUBSIDIARIES

Who is a Subsidiary?  –  A corporation becomes a subsidiary when another corporation acquires controlling interest in its outstanding voting stock.

 –  In a 100 percent acquisition, the investee continues to operate as a separate legal entity.

 –  Subsidiaries, or affiliates, continue as separate legal entities and prepare their own financial reports.

CONSOLIDATION POLICY: Under current GAAP, consolidation is required for all corporations that are over 50% owned except (Cases where a subsidiary may be excluded from consolidation):

When Subsidiaries are excluded from Consolidated? Cases where a subsidiary may be excluded from consolidation:

 –  Control doesn t rest with majority owner  –  Joint ventures  –  Acquisitions of groups of assets that do not ’

constitute a business

 –  Combination between entities under common control

 –  Combination of not-for-profit entities or acquisition of a for-profit company by a not-forprofit entity

An Introduction to Consolidated Financial Statements

3: CONSOLIDATED BALANCE SHEET AT DATE OF ACQUISITON

Pen Example: Acquisition Cost = Fair Value = Book Value Sel’s Balance Sheet: BV=FV

Cash

$10

Other current assets

15

Plant assets, net

40

Total

$65

Accounts payable

$15

Other current liabilities

10

Capital stock

30

Retained earnings

10

Total

$65

Pen acquires 100% of Sel for $40, which equals the book value and fair values of the net assets acquired.

Cost of acquisition

$40

Less 100% book value

40

Excess of cost over book value

$0

To consolidate, eliminate Pen's Investment account and Sel's capital stock and retained earnings.

Balance Sheets

Separate

Consolidated

Pen

Sel

Pen & Sub.

$20

$10

$30

Other curr. assets

45

15

60

Plant assets, net

60

40

100

Investment in Sel

40

0

0

$165

$65

$190

$20

$15

$35

25

10

35

100

30

100

20

10

20

$165

$65

$190

Cash

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

An Introduction to Consolidated Financial Statements

4: FAIR VALUE AT ACQUISITION DATE

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 • •

Cost > BV, excess is goodwill Cost < BV, excess is a gain on the bargain purchase

BV ≠ FV ≠ Cost Difference between the book value of net assets (BV) and the fair value of identifiable net assets (FV) is assigned to the specific assets or liabilities – –

E.g., undervalued or overvalued inventories, plant assets Unrecorded assets (patents) or liabilities (existing contingencies)

Difference between FV and Cost is goodwill or a gain on the bargain purchase

Example: BV ≠ FV but Cost = FV Piper acquires 100% of Sandy for $310. Sandy

BV

FV

$40

$40

Receivables

30

30

Inventory

50

75

Plant, net

200

240

Cash

goodwill

Total

$320 $385

Liabilities

$75

Capital stock

100

Retained earnings

145

Total

$320

$75

BV = 100 + 145 = $245 FV = 385 – 75 = $310

Cost – FV = $0 Cost

$310

100% Book value

245

Excess of cost over BV

$65

Piper and Sandy (cont.) Allocate to: Inventory 100%(+25) Plant 100%(+40)

Amt Amort. 25 1st yr 40 10 yrs

Total

$65

Piper's elimination worksheet entry: Capital stock (-SE)

100

Retained earnings (-SE)

145

Inventory (+A)

25

Plant (+A)

40

Investment in Sandy (-A)

310

Example: BV ≠ FV and Cost ≠ FV Panda acquires 100% of Salty for $530. Salty

BV

FV

$100

$100

40

40

Inventory

250

250

Plant, net

130

190

$520

$580

Liabilities

$80

$85

Capital stock

250

Cash Receivables

Total

Retained earnings Total

190 $520

BV = 250 + 190 = $440 FV = 580 – 85 = $495 Cost – FV = $35 goodwill

Cost

$530

100% Book value

440

Excess of cost over BV

$90

Panda and Salty (cont.) Allocate to:

Amount Amort.

Plant

60 4 yrs

Liabilities

-5 5 yrs

Goodwill

35

Total

$90

Panda's elimination worksheet entry: Capital stock (-SE)

250

Retained earnings (-SE)

190

Plant (+A)

60

Goodwill (+A)

35

Liabilities (+L) Investment in Salty (-A)

5 530

Example: BV ≠ FV and Cost ≠ FV Print acquires 100% of Sum for $185. Sum

BV

FV

Cash

$10

$10

Receivables

30

30

Inventory

80

90

Plant, net

100

120

$220

$250

$40

$40

Total

Liabilities Capital stock Retained earnings Total

75 105

BV = 75 + 105 = $180 FV = 250 - 40 = $210

Cost – FV = -$25: Gain on bargain purchase Cost 100% BV Excess of cost over BV

$220

$185 180 $5

Print and Sum (cont.) Allocate to:

Amt Amort.

Inventory

10 1st yr

Plant, land

20

Bargain purchase

-

(25) Gain

Total

$5

Print records the acquisition of Sum 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 Sum (+A) Gain on bargain purchase (R, +SE) Cash (-A)

210 25 185

Worksheet Elimination Entry Unamortized excess equals $30 • $10 for undervalued inventory • $20 for undervalued land included in plant assets Print’s elimination worksheet entry: Capital stock (-SE) Retained earnings (-SE) Unamortized excess (+A)

75 105 30

Investment in Sum (-A)

210

Inventory (+A)

10

Plant (+A)

20

Unamortized excess (-A)

30

Print

Sum

BV

BV

$30

$10

$40

50

30

80

Inventory

100

80

10

190

Plant, net

450

100

20

570

Investment in Sum

210

Cash Receivables

DR

30

Consolidated

CR

210

Unamortized excess Total

Adjustments

0

30

$840

$220

$880

$270

$40

$310

Capital stock

200

75

75

200

Retained earnings

370

105

105

370

$840

$220

Liabilities

Total

$880 240

240

An Introduction to Consolidated Financial Statements

5: NONCONTROLLING INTERESTS

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

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

Book value (200+175)

375

Excess over book value

$125

Goodwill Total

$50 75 $125

Elimination Entry Popo's elimination worksheet entry: Capital stock (-SE)

200

Retained earnings (-SE)

175

Building (+A)

50

Goodwill (+A)

75

Investment in Sine (-A)

400

Noncontrolling interest (+SE)

100

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

Popo

Sine

BV

BV

Cash

$50

$10

$60

Receivables

130

50

180

80

100

180

Building, net

300

240

Investment in Sine

400

Inventory

DR

Consolidated

CR

50

590 400

Goodwill Total

Adjustments

75

0 75

$960

$400

$1,085

$150

$25

$175

Capital stock

250

200

200

250

Retained earnings

560

175

175

560

Liabilities

Noncontrolling interest Total

100 $960

$400

100 $1,085

500

500

An Introduction to Consolidated Financial Statements

6: CONSOLIDATED BALANCE SHEETS AFTER ACQUISITION

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

Popo and Sine (cont.)

Cost of 80% of Sine Implied value of Sine Book value Excess

$400 $500 375 $125

Allocate to: Building Goodwill Total

$50 10 yrs 75

-

$125

Current year's amortization

Building

Beginning unamortized excess 50

(5)

Ending unamortized excess 45

Goodwill

75

0

75

125

(5)

120

Total

After 1 year: Cash Receivables Inventory Building, net Investment in Sine Total

Popo $40 110 90 280 404 $924

Sine $15 Liabilities 85 Capital stock 100 Retained earnings 235 $435 Total

Popo's elimination worksheet entry: Capital stock (-SE) Retained earnings (-SE) Unamortized excess (+A) Investment in Sine (80%) (-A)

Popo $100 250 574

$924 $435

200 185 120 404

Noncontrolling interest (20%) (+SE)

101

Building (+A)

45

Goodwill (+A)

75

Unamortized excess (-A) Assume that Sine’s net income 5

thousands (80% * 5 = 4) +Investment

Sine $50 200 185

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

DR

45

560

75

Unamortized excess

120

Consolidated

CR

404

Goodwill Total

Adjustments

0 75

120

$924

$435

$1,075

$100

$50

$150

Capital stock

250

200

200

250

Retained earnings

574

185

185

574

Liabilities

Noncontrolling interest Total

101 $924

$435

101 $1,075

505 505

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

An Introduction to Consolidated Financial Statements

7: AMORTIZATIONS AFTER ACQUISITION

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

Amortization period

Inventories and other current assets Buildings, equipment, patents

Generally, 1st year

Land, copyrights

Not amortized

Long-term debt

Time to maturity

Remaining life at business combination

Income statement account Cost of sales and other expense Depreciation and amortization expense

Interest expense

Piper and Sandy (cont.) Cost

$310

100% BV

245

Excess

$65

Allocate to: Inventory Plant

Amt Amort. 25 1st yr 40 10 yrs

Total

$65

Beginning unamortized excess 25

Current year's amortization (25)

Ending unamortized excess 0

Plant

40

(4)

36

Total

65

(29)

36

Inventory

Panda and Salty (cont.) Cost

$530

100% BV

440

Excess

$90

Allocate to: Plant

Amt Amort. 60 4 yrs

Liabilities Goodwill Total

-5 5 yrs 35 $90

Beginning unamortized excess 60

Current year's amortization (15)

Ending unamortized excess 45

Liabilities

(5)

1

(4)

Goodwill

35

0

35

Total

90

(14)

76

Plant

Print and Sum (cont.) Cost 100% BV Excess

Allocate to: Inventory Plant, land Bargain purchase Total

$185 180 $5

Amt Amort. 10 1st yr 20 (25) Gain $5

Beginning unamortize d excess 10

Current year's amortization (10)

Ending unamortized excess 0

Land

20

0

20

Total

30

(10)

20

Inventory

An Introduction to Consolidated Financial Statements

8: CONSOLIDATED INCOME STATEMENTS

Comprehensive Example, Data Pil acquires 90% of Sad on 12/31/2011 for $10,200 when Sad's equity consists of $4,000 common stock, $1,000 other paid in capital, and $900 retained earnings. On that date Sad'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.

Cost of 90% of Sad

$10,200

Implied value of Sad 10,200/.90

$11,333

Book value (4000+1000+900)

5,900

Excess over book value

$5,433

Allocate to: Inventory Land Building Equipment Note payable Goodwill Total

$100 200 1,000 (300) 100 4,333 $5,433

1st yr 40 yrs 5 yrs 1st yr -

Unamortized excess 1/1/12

Current amortization

Inventory

100

(100)

Unamortized excess 12/31/12 0

Land

200

0

200

Building

1,000

(25)

975

Equipment

(300)

60

(240)

100

(100)

0

Goodwill

4,333

0

4,333

Total

5,433

(165)

5,268

Note payable

Sales Income from Sad Cost of sales

Consol.*

$9,523.50

$2,200.00

$11,723.50

571.50

$0.00 (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

Interest expense Net income Total consolidated income

•

Sad

(4,000.00)

Other expense

•

Pil

$3,158.50

Noncontrolling interest share

63.50

Controlling interest share

$3,095.00

Cost of sales, building depreciation, and interest expense are increased by $100, $25, and $100, and equipment depreciation is $60 lower than the sum of Pil and Sad. Sad's income $ 635