Chapter 3: An Introduction to
Consolidated Financial Statements
3-1
Intro to Consolidations: Objectives
1. Recognize the benefits and limitations of
consolidated financial statements.
2. Understand the requirements for inclusion of a
subsidiary in consolidated financial statements.
3. Apply the consolidation concepts to parent
company recording of the investment in a
subsidiary at the date of acquisition.
4. Allocate the excess of the fair value over the
book value of the subsidiary at the date of
acquisition.
3-2
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.
3-3
An Introduction to Consolidated Financial Statements
1: Benefits & Limitations
3-4
Business Acquisitions
• 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
3-5
An Introduction to Consolidated Financial Statements
2: Subsidiaries
3-6
Who is a Subsidiary?
• 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.
3-7
3-8
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
3-9
An Introduction to Consolidated Financial Statements
3: Parent Company Recording
3-10
Penn Example: Acquisition Cost =
Fair Value = Book Value
Skelly BV=FV
Cash
Other current assets
Net plant assets
Total
Accounts payable
Other liabilities
Capital stock
Retained earnings
Total
$10
15
40
$65
$15
10
30
10
$65
Penn acquires 100% of Skelly for
$40, which equals the book value
and fair values of the net assets
acquired.
Cost of acquisition
Less 100% book value
Excess of cost over book value
$40
40
$0
To consolidate, eliminate Penn's
Investment account and Skelly's
capital stock and retained
earnings.
3-11
Balance sheets
Separate
Consolidated
Penn Skelly Penn & Sub.
$20
$10
$30
Cash
Other curr. assets
45
Net plant
60
Investment in Skelly
40
Total
$165
Accounts payable
$20
Other curr. liabilities
25
Capital stock
100
Retained earnings
20
Total
$165
15
40
0
60
100
0
$65
$15
10
30
$190
$35
35
100
10
$65
20
$190
3-12
An Introduction to Consolidated Financial Statements
4: Allocations at Acquisition Date
3-13
Cost, Fair Value and Book Value
Acquisition cost, fair values of identifiable net
assets and book values may differ.
– Allocate excess or deficiency of cost over
book value and determine goodwill, if any.
– When BV = FV, excess is goodwill.
Cost less BV = Excess to allocate
– Allocate first to FV-BV differences
– Remainder is goodwill (or bargain purchase)
3-14
Example: BV ≠ FV but Cost = FV
Piper acquires 100% of Sandy for $310.
Sandy
BV
FV
BV = 100 + 145 = $245
Cash
$40 $40
FV = 385 – 75 = $310
Receivables
30
30
Inventory
50
75
Plant, net
200
240
Total
$320 $385
Liabilities
$75
Capital stock
100
Retained earnings
145
Total
Cost – FV = $0 goodwill
$75
Cost
100% BV
Excess of cost over BV
$310
245
$65
$320
3-15
Piper and Sandy (cont.)
Allocate to:
Inventory 100%(+25)
Plant 100%(+40)
Total
Amt Amort.
25 1st yr
40 10 yrs
$65
Piper's elimination worksheet entry:
Capital stock
100
Retained earnings
145
Inventory
25
Plant
40
Investment in Sandy
310
3-16
Example: BV ≠ FV and Cost ≠ FV
Panda acquires 100% of Salty for $530.
BV = 250 + 190 = $440
Salty
BV
FV
Cash
$100 $100
FV = 580 – 85 = $495
Receivables
40
40
Inventory
250
250
Plant, net
130
190
Total
$520 $580
Liabilities
$80
Capital stock
250
Retained earnings
190
Total
Cost – FV = $35 goodwill
$520
$85
Cost
100% BV (250+190)
Excess of cost over BV
$530
440
$90
3-17
Panda and Salty (cont.)
Allocate to:
Plant
Liabilities
Goodwill
Total
Amt
60
-5
35
$90
Amort.
4 yrs
5 yrs
-
Panda's elimination worksheet entry:
Capital stock
Retained earnings
Plant
Goodwill
Liabilities
Investment in Salty
250
190
60
35
5
530
3-18
Example: BV ≠ FV and Cost ≠ FV
Printemps acquires 100% of Summer for $185.
BV = 75 + 105 = $180
Summer
BV
FV
FV = 250 - 40 = $210
Cash
$10 $10
Receivables
30
30
Inventory
80
90
Plant, net
100
120
Total
Liabilities
Capital stock
Retained earnings
Total
$220 $250
$40
75
105
$40 Cost
100% BV (75+105)
Excess of cost over BV
$185
180
$5
$220
3-19
Printemps and Summer (cont.)
Allocate to:
Inventory
Plant, land
Bargain purchase
Total
Amt
10
20
(25)
$5
Amort.
1st yr
Gain
Printemps records the acquisition of Summer assuming a cash
purchase as follows. Note that the investment account is
recorded at its fair value and the bargain purchase is treated
immediately as a gain.
Investment in Summer
Gain on Bargain purchase
Cash
210
25
185
3-20
Worksheet Elimination Entry
Unamortized excess equals $30 (gain is recognized)
• $10 for undervalued inventory
• $20 for undervalued land included in plant
assets
Printemps' elimination worksheet entry:
Capital stock
Retained earnings
Inventory
Plant
Investment in Summer
75
105
10
20
210
3-21
Cash
Receivables
Inventory
Plant, net
Investment in
Summer
Total
Liabilities
Capital stock
Retained earnings
Total
Printemps
BV
$30
50
100
450
Summer Adjustments ConsolBV DR
CR
idated
$10
$40
30
80
80
10
190
100
20
570
210
$840
$270
200
370
$840
210
$220
$40
75
105
$220
$880
$310
200
370
$880
75
105
210
0
210
3-22
An Introduction to Consolidated Financial Statements
5: Noncontrolling Interests
3-23
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.
3-24
Example: Noncontrolling Interests
Koç acquires 80% of Migros for $400 when
Migros had capital stock of $200 and retained
earnings of $175. Migros'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 Migros
Implied value of Migros(400/80%)
Book value (200+175)
Excess over book value
$400
$500
375
$125
Allocate to:
Building
$50
Goodwill
75
Total
$125
3-25
Elimination Entry
Koç's elimination worksheet entry:
Capital stock
Retained earnings
Building
Goodwill
Investment in Migros
Noncontrolling interest
200
175
50
75
400
100
An unamortized excess account could have been used for the
excess assigned to the building and goodwill.
3-26
Cash
Receivables
Inventory
Building, net
Investment in Migros
Goodwill
Total
Liabilities
Capital stock
Retained earnings
Noncontrolling interest
Total
Koç Migros Adjustments
BV
BV DR
CR
$50
$10
130
50
80
100
300
240
50
400
400
75
$960
$400
$150
$25
250
200 200
560
175 175
100
$960
$400
500 500
Consolidated
$60
180
180
590
0
75
$1,085
$175
250
560
100
$1,085
3-27
An Introduction to Consolidated Financial Statements
6: Amortizations After Acquisition
3-28
Unamortized Excess
Excess assigned to assets and liabilities are
amortized according to the account
Balance sheet
account
Inventories and
other current assets
Buildings,
equipment,
patents,
Land, copyrights
Long term debt
Amortization
period
Generally, 1st year
Remaining life at
business
combination
Not amortized
Time to maturity
Income statement
account
Cost of sales and
other expense
Depreciation and
amortization
expense
Interest expense
3-29
Piper and Sandy (cont.)
Cost
100% BV
Excess
Inventory
Plant
Total
$310
245
$65
Allocate to:
Inventory
Plant
Total
Amt Amort.
25 1st yr
40 10 yrs
$65
Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
25
(25)
0
40
(4)
36
65
(29)
36
3-30
Panda and Salty (cont.)
Cost
100% BV
Excess
Plant
Liabilities
Goodwill
Total
$530
440
$90
Allocate to:
Plant
Liabilities
Goodwill
Total
Amt
60
-5
35
$90
Amort.
4 yrs
5 yrs
-
Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
60
(15)
45
(5)
1
(4)
35
0
35
90
14
76
3-31
Printemps and Summer (cont.)
Cost
100% BV
Excess
Inventory
Land
Total
$185
180
$5
Allocate to:
Inventory
Plant, land
Bargain purchase
Total
Amt
10
20
(25)
$5
Amort.
1st yr
Gain
Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
10
(10)
0
20
0
20
30
(10)
20
3-32
An Introduction to Consolidated Financial Statements
7: Subsequent Balance Sheets
3-33
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
3-34
Koç and Migros (cont.)
Cost of 80% of Sine
Implied value of Sine
Book value
Excess
Building
Goodwill
Total
$400
$500
375
$125
Allocate to:
Building
$50 10 yrs
Goodwill
75 Total
$125
Beginning
Current
Ending
unamortized
year's
unamortized
excess
amortization
excess
50
(5)
45
75
0
75
125
(5)
120
3-35
After 1 year:
Cash
Receivables
Inventory
Building, net
Investment in Migros
Total
Koç Migros
$40
$15 Liabilities
110
85 Capital stock
90
100 Retained earnings
280
235
404
$924
$435 Total
Koç's elimination worksheet entry:
Capital stock
Retained earnings
Unamortized excess
Investment in Migros (80%)
Noncontrolling interest (20%)
Building
Goodwill
Unamortized excess
Koç Migros
$100
$50
250
200
574
185
$924
$435
200
185
120
404
101
45
75
120
3-36
After 1 year:
Cash
Receivables
Inventory
Building, net
Investment in Sine
Goodwill
Popo
BV
$40
110
90
280
404
Sine
BV
$15
85
100
235
45
404
75
Unamortized excess
Total
$924
Liabilities
$100
Capital stock
250
Retained earnings
574
Noncontrolling interest
Total
$924
Adjustments
DR CR
120
$435
$50
200
185
120
200
185
101
$435
505
Consolidated
$55
195
190
560
0
75
$1,075
$150
250
574
101
$1,075
505
3-37
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
3-38
An Introduction to Consolidated Financial Statements
8: Consolidated Income Statements
3-39
Comprehensive Example, Data
Pilot acquires 90% of Sand on 12/31/2009 for
$10,200 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.
3-40
Assignment and
Amortization
Cost of 90% of Sand
$10,200
Implied value of Sand 10,200/.90 $11,333
Book value (4000+1000+900)
Excess over book value
Inventory
Land
Building
Equipment
Note payable
Goodwill
Total
5,900
$5,433
Unamortized
excess 1/1/10
100
200
1,000
(300)
100
4,333
5,433
Allocate to:
Inventory
Land
Building
Equipment
Note payable
Goodwill
Total
Current
amortization
(100)
0
(25)
60
(100)
0
(165)
$100
200
1,000
(300)
100
4,333
$5,433
1st yr
40 yrs
5 yrs
1st yr
-
Unamortized
excess 12/31/10
0
200
975
(240)
0
4,333
5,268
3-41
Pilot
Sand
$9,523.50 $2,200.00
571.50
(4,000.00) (700.00)
(200.00)
(80.00)
(700.00) (360.00)
(1,800.00) (120.00)
(300.00) (140.00)
$3,095.00
$800.00
Consol.*
$11,723.50
$0.00
(4,800.00)
(305.00)
(1,000.00)
(1,920.00)
(540.00)
Sales
Income from Sand
Cost of sales
Depreciation exp - bldg
Depreciation exp - equip
Other expense
Interest expense
Net income
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.
3-42
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
3-43