Chapter 3: An Introduction to Consolidated Financial Statements
Transcript of Chapter 3: An Introduction to Consolidated Financial Statements
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Chapter 3: An Introduction to Consolidated Financial Statementsby Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompanyAdvanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
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Intro to Consolidations: Objectives1. 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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1: Benefits & Limitations1: Benefits & LimitationsAn Introduction to Consolidated Financial Statements
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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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2: Subsidiaries2: SubsidiariesAn Introduction to Consolidated Financial Statements
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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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3: Parent Company Recording3: Parent Company RecordingAn Introduction to Consolidated Financial Statements
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Penn Example: Acquisition Cost = Fair Value = Book Value
Penn acquires 100% of Skelly for $40, which equals the book value and fair values of the net assets acquired.
Cost of acquisition $40Less 100% book value 40Excess of cost over book value $0
Skelly BV=FVCash $10Other current assets 15Net plant assets 40Total $65Accounts payable $15Other liabilities 10Capital stock 30Retained earnings 10Total $65 To consolidate, eliminate Penn's
Investment account and Skelly's capital stock and retained earnings.
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Balance sheets Separate ConsolidatedPenn Skelly Penn & Sub.
Cash $20 $10 $30Other curr. assets 45 15 60Net plant 60 40 100Investment in Skelly 40 0 0Total $165 $65 $190Accounts payable $20 $15 $35Other curr. liabilities 25 10 35Capital stock 100 30 100Retained earnings 20 10 20Total $165 $65 $190
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4: Allocations at Acquisition Date4: Allocations at Acquisition DateAn Introduction to Consolidated Financial Statements
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Cost, Fair Value and Book ValueAcquisition 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 = FVPiper acquires 100% of Sandy for $310.
BV = 100 + 145 = $245FV = 385 – 75 = $310
Cost – FV = $0 goodwill
Sandy BV FVCash $40 $40 Receivables 30 30Inventory 50 75Plant, net 200 240Total $320 $385 Liabilities $75 $75
Capital stock 100Retained earnings 145
Total $320
Cost $310 100% BV 245Excess of cost over BV $65
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Piper and Sandy (cont.)Allocate to: Amt Amort.Inventory 100%(+25) 25 1st yrPlant 100%(+40) 40 10 yrsTotal $65
Piper's elimination worksheet entry:Capital stock 100Retained earnings 145Inventory 25Plant 40
Investment in Sandy 310
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Example: BV ≠ FV and Cost ≠ FVPanda acquires 100% of Salty for $530.
BV = 250 + 190 = $440FV = 580 – 85 = $495
Cost – FV = $35 goodwill
Salty BV FVCash $100 $100 Receivables 40 40Inventory 250 250Plant, net 130 190Total $520 $580 Liabilities $80 $85 Capital stock 250 Retained earnings 190 Total $520
Cost $530 100% BV (250+190) 440Excess of cost over BV $90
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Panda and Salty (cont.)
Panda's elimination worksheet entry:Capital stock 250Retained earnings 190Plant 60Goodwill 35
Liabilities 5Investment in Salty 530
Allocate to: Amt Amort.Plant 60 4 yrsLiabilities -5 5 yrsGoodwill 35 - Total $90
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Example: BV ≠ FV and Cost ≠ FVPrintemps acquires 100% of Summer for $185.
BV = 75 + 105 = $180FV = 250 - 40 = $210
Cost $185 100% BV (75+105) 180Excess of cost over BV $5
Summer BV FVCash $10 $10 Receivables 30 30Inventory 80 90Plant, net 100 120Total $220 $250 Liabilities $40 $40 Capital stock 75 Retained earnings 105 Total $220
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Printemps and Summer (cont.)Allocate to: Amt Amort.Inventory 10 1st yrPlant, land 20 - Bargain purchase (25) GainTotal $5
Investment in Summer 210 Gain on Bargain purchase 25
Cash 185
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.
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Worksheet Elimination Entry
Printemps' elimination worksheet entry:Capital stock 75Retained earnings 105Unamortized excess 30
Investment in Summer 210Inventory 10Plant 20
Unamortized excess 30
Unamortized excess equals $30 (gain is recognized)• $10 for undervalued inventory• $20 for undervalued land included in plant assets
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Printemps Summer Adjustments Consol- BV BV DR CR idated
Cash $30 $10 $40 Receivables 50 30 80Inventory 100 80 10 190Plant, net 450 100 20 570Investment in Summer 210 210 0Unamortized excess 30 30 Total $840 $220 $880 Liabilities $270 $40 $310 Capital stock 200 75 75 200Retained earnings 370 105 105 370Total $840 $220 $880 240 240
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5: Noncontrolling Interests5: Noncontrolling InterestsAn Introduction to Consolidated Financial Statements
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Noncontrolling InterestParent 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.
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Example: Noncontrolling InterestsPopo 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 Implied value of Sine (400/80%) $500 Book value (200+175) 375Excess over book value $125
Allocate to:Building $50 Goodwill 75Total $125
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Elimination EntryPopo's elimination worksheet entry:Capital stock 200Retained earnings 175Building 50Goodwill 75
Investment in Sine 400Noncontrolling interest 100
An unamortized excess account could have been used for the excess assigned to the building and goodwill.
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Popo Sine Adjustments Consol- BV BV DR CR idated
Cash $50 $10 $60 Receivables 130 50 180Inventory 80 100 180Building, net 300 240 50 590Investment in Sine 400 400 0Goodwill 75 75Total $960 $400 $1,085 Liabilities $150 $25 $175 Capital stock 250 200 200 250Retained earnings 560 175 175 560Noncontrolling interest 100 100Total $960 $400 $1,085 500 500
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6: Amortizations After Acquisition6: Amortizations After AcquisitionAn Introduction to Consolidated Financial Statements
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Unamortized ExcessExcess assigned to assets and liabilities are
amortized according to the account
Balance sheet account
Amortization period
Income statement account
Inventories and other current assets
Generally, 1st year Cost of sales and other expense
Buildings, equipment, patents,
Remaining life at business combination
Depreciation and amortization expense
Land, copyrights Not amortizedLong term debt Time to maturity Interest expense
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Piper and Sandy (cont.)Allocate to: Amt Amort.Inventory 25 1st yrPlant 40 10 yrsTotal $65
Cost $310 100% BV 245Excess $65
Beginning unamortized
excess
Current year's
amortization
Ending unamortized
excessInventory 25 (25) 0Plant 40 (4) 36Total 65 (29) 36
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Panda and Salty (cont.)
Beginning unamortized
excess
Current year's
amortization
Ending unamortized
excessPlant 60 (15) 45Liabilities (5) 1 (4)Goodwill 35 0 35Total 90 14 76
Cost $530 100% BV 440Excess $90
Allocate to: Amt Amort.Plant 60 4 yrsLiabilities -5 5 yrsGoodwill 35 - Total $90
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Printemps and Summer (cont.)
Beginning unamortized
excess
Current year's
amortization
Ending unamortized
excessInventory 10 (10) 0Land 20 0 20Total 30 (10) 20
Cost $185 100% BV 180Excess $5
Allocate to: Amt Amort.Inventory 10 1st yrPlant, land 20 - Bargain purchase (25) GainTotal $5
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7: Subsequent Balance Sheets7: Subsequent Balance SheetsAn Introduction to Consolidated Financial Statements
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Balance Sheets After AcquisitionIn 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
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Popo and Sine (cont.)Cost of 80% of Sine $400 Implied value of Sine $500 Book value 375Excess $125
Allocate to:Building $50 10 yrsGoodwill 75 - Total $125
Beginning unamortized
excess
Current year's
amortization
Ending unamortized
excessBuilding 50 (5) 45Goodwill 75 0 75Total 125 (5) 120
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After 1 year: Popo SineCash $40 $15 Receivables 110 85Inventory 90 100Building, net 280 235Investment in Sine 404 Total $924 $435
Popo SineLiabilities $100 $50 Capital stock 250 200Retained earnings 574 185
Total $924 $435 Popo's elimination worksheet entry:Capital stock 200Retained earnings 185Unamortized excess 120
Investment in Sine (80%) 404Noncontrolling interest (20%) 101
Building 45Goodwill 75
Unamortized excess 120
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After 1 year: Popo Sine Adjustments Consol- BV BV DR CR idated
Cash $40 $15 $55 Receivables 110 85 195Inventory 90 100 190Building, net 280 235 45 560Investment in Sine 404 404 0Goodwill 75 75Unamortized excess 120 120Total $924 $435 $1,075 Liabilities $100 $50 $150 Capital stock 250 200 200 250Retained earnings 574 185 185 574Noncontrolling interest 101 101Total $924 $435 $1,075 505 505
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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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8: Consolidated Income Statements8: Consolidated Income StatementsAn Introduction to Consolidated Financial Statements
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Comprehensive Example, DataPilot 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 AmortizationCost of 90% of Sand $10,200 Implied value of Sand 10,200/.90 $11,333 Book value (4000+1000+900) 5,900Excess over book value $5,433
Unamortized excess 1/1/10
Current amortization
Unamortized excess 12/31/10
Inventory 100 (100) 0Land 200 0 200Building 1,000 (25) 975Equipment (300) 60 (240)Note payable 100 (100) 0Goodwill 4,333 0 4,333Total 5,433 (165) 5,268
Allocate to:Inventory $100 1st yrLand 200 - Building 1,000 40 yrsEquipment (300) 5 yrsNote payable 100 1st yrGoodwill 4,333 -Total $5,433
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Pilot Sand Consol.*Sales $9,523.50 $2,200.00 $11,723.50 Income from Sand 571.50 $0.00 Cost of sales (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)Other expense (1,800.00) (120.00) (1,920.00)Interest expense (300.00) (140.00) (540.00)Net income $3,095.00 $800.00 Total consolidated income $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 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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