An Introduction to Consolidated
Financial Statements
Chapter 3
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Learning Objective 1
Recognize the benefits and
limitations of consolidated
financial statements.
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Business Combinations Consummated
Through Stock Acquisitions
Business combination
One or more companies
become subsidiaries of a
common parent corporation.
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The Reporting Entity
Parent
Financial
Statements
_____ _____
_____ _____
_____ _____
_____ _____
Subsidiary
Financial
Statements
_____ _____
_____ _____
_____ _____
_____ _____
Consolidated
Financial
Statements
_____ _____
_____ _____
_____ _____
_____ _____
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The Reporting Entity
A parent company may acquire a
subsidiary in a very different industry
from its own as a means of diversifying
its overall business risk.
There are also legal reasons for
maintaining separate identities.
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The Parent-Subsidiary Relationship
Parent Company
Owns more than 50%
of another company
Affiliate
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The Parent-Subsidiary Relationship
Parent Company
90%
ownership
Subsidiary A
80%
ownership
Subsidiary B
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Learning Objective 2
Understand the requirements for
inclusion of a subsidiary in
consolidated financial statements.
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3-8
Consolidation Policy
Consolidated financial statements provide
information that is not included in the separate
statements of the parent corporation.
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3-9
Consolidation Policy
A subsidiary can be excluded from
consolidation in only two situations:
1
Control is likely to be temporary.
2
Control does not rest with the
majority owner.
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Consolidation Policy
Consolidation policy is usually presented
under the following headings:
Principles of
consolidation
Basis of
consolidation
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Parent and Subsidiary with
Different Fiscal Periods
Consolidated statements are prepared for and
as of the end of the parent’s fiscal period.
If the difference does not exceed three months…
it is acceptable to use the subsidiary’s
statements with disclosure.
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Learning Objective 3
Apply the consolidations concepts
to parent company recording of
the investment in a subsidiary
company at the date of acquisition.
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Assets
Current assets
Cash
Other current assets
Total current assets
Plant assets
Less: Accum. depr.
Total plant assets
Investment in Skelly
Total assets
Penn
Skelly
$ 20,000
45,000
$ 65,000
$ 75,000
15,000
$ 60,000
40,000
$165,000
$10,000
15,000
$25,000
$45,000
5,000
$40,000
0
$65,000
Consolidated
$ 30,000
60,000
$ 90,000
$120,000
20,000
$100,000
0
$190,000
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Liabilities
Penn
Current liabilities
Accounts payable
$ 20,000
Other current liabilities
25,000
Total current liabilities $ 45,000
Stockholders’ equity
Capital stock
$100,000
Retained earnings
20,000
Total stockholders’ equity $120,000
Total liabilities and
stockholders’ equity
$165,000
Skelly
Consolidated
$15,000
10,000
$25,000
$ 35,000
35,000
$ 70,000
$30,000
10,000
$40,000
$100,000
20,000
$120,000
$65,000
$190,000
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Learning Objective 4
Allocate the excess of the
investment cost over the
book value of the subsidiary
at the date of acquisition.
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Parent Acquires 100% of
Subsidiary with Goodwill
Penn purchased all the stock of Skelly for $50,000.
Skelly stockholder’s equity is $40,000.
What is the consolidating (eliminating) entry?
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Parent Acquires 100% of
Subsidiary with Goodwill
Capital Stock
30,000
Retained Earnings
10,000
Goodwill
10,000
Investment in Skelly
50,000
To eliminate reciprocal investment and equity
accounts and to assign the excess of investment
cost over book value acquired to goodwill
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Learning Objective 5
Prepare a consolidated balance
sheet at the date of acquisition,
including preparation
of eliminating entries.
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Assets
Current assets
Cash
Other current assets
Total current assets
Plant assets
Less: Accum. depr.
Total plant assets
Investment in Skelly
Goodwill
Total assets
Penn
Skelly
$ 10,000
45,000
$ 55,000
$ 75,000
15,000
$ 60,000
50,000
$10,000
15,000
$25,000
$45,000
5,000
$40,000
$ 20,000
60,000
$ 80,000
$120,000
20,000
$100,000
$65,000
10,000
$190,000
$165,000
Consolidated
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Liabilities
Penn
Current liabilities
Accounts payable
$ 20,000
Other current liabilities
25,000
Total current liabilities $ 45,000
Stockholders’ equity
Capital stock
$100,000
Retained earnings
20,000
Total stockholders’ equity $120,000
Total liabilities and
stockholders’ equity
$165,000
Skelly
Consolidated
$15,000
10,000
$25,000
$ 35,000
35,000
$ 70,000
$30,000
10,000
$40,000
$100,000
20,000
$120,000
$65,000
$190,000
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Learning Objective 6
Learn the concept of minority
interest when the parent
company acquires less than
100% of the subsidiary’s
outstanding common stock.
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Assets
Current assets
Cash
Other current assets
Total current assets
Plant assets
Less: Accum. depr.
Total plant assets
Investment in Skelly
Goodwill
Total assets
Penn
Skelly
$ 10,000
45,000
$ 55,000
$ 75,000
15,000
$ 60,000
50,000
$10,000
15,000
$25,000
$45,000
5,000
$40,000
$ 20,000
60,000
$ 80,000
$120,000
20,000
$100,000
$65,000
14,000
$194,000
$165,000
Consolidated
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Consolidated Balance Sheet at Date
of Acquisition (100% at Book Value)
Liabilities
Penn
Current liabilities
Accounts payable
$ 20,000
Other current liabilities
25,000
Total current liabilities $ 45,000
Minority interest
Stockholders’ equity
Capital stock
$100,000
Retained earnings
20,000
Total stockholders’ equity $120,000
Total liabilities and
stockholders’ equity
$165,000
Skelly
Consolidated
$15,000
10,000
$25,000
$ 35,000
35,000
$ 70,000
$ 4,000
$30,000
10,000
$40,000
$100,000
20,000
$120,000
$65,000
$194,000
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Minority Interest
Minority interest in subsidiaries is generally
shown in a single amount in the liability section
of the consolidated balance sheet.
The alternatives are to include the minority interest
in consolidated stockholders’ equity or to place it
in a separate minority interest section.
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Minority Interest
The interest of minority
stockholders represents
equity investments in the
consolidated net assets by
stockholders of the company
affiliated with the parent.
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Learning Objective 7
Prepare consolidated balance
sheets subsequent to the date
of acquisition, including
preparation of eliminating entries.
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Consolidated Balance Sheet
After Acquisition
1. Penn acquired a 90% interest in Skelly on
January 1 for $50,000 when Skelly’s
stockholders’ equity was $40,000.
2. The accounts payable of Skelly includes
$5,000 owed to Penn.
3. During the year, Skelly had income of
$20,000 and declared $10,000 dividends.
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Consolidated Balance Sheet
After Acquisition
What is the balance in the investment in
Skelly’s account at December 31?
Original investment January 1
+ 90% of Skelly’s net income
– 90% of Skelly’s dividends
Investment account balance
$50,000
18,000
– 9,000
$59,000
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Consolidated Balance Sheet
After Acquisition
Capital Stock
30,000
Retained Earnings
20,000
Goodwill
14,000
Investment in Skelly
59,000
Minority Interest
5,000
To eliminate reciprocal investment and
equity balances, record goodwill, and
enter the minority interest
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Consolidated Balance Sheet
After Acquisition
Dividends Payable
9,000
Dividends Receivable
9,000
To eliminate reciprocal dividends
receivable and payable
Accounts Payable
5,000
Accounts Receivable
5,000
To eliminate intercompany receivable
and accounts payable
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Effect of Allocation on Consolidated
Balance Sheet at Acquisition
The separate books of the affiliated
companies do not record cost/book
value differentials in acquisitions that
create parent-subsidiary relationships.
Working paper procedures are used
to adjust subsidiary book values to
reflect the cost/book differentials.
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Effect of Allocation on Consolidated
Balance Sheet at Acquisition
The adjusted amounts appear in the
consolidated balance sheet.
The amount of the adjustment to
individual assets and liabilities is
determined using an investment
cost-allocation schedule.
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Effect of Allocation on Consolidated
Balance Sheet at Acquisition
On Dec. 3, 2003, Pilot purchases 90% of Sand
Corporation’s outstanding common stock for
$5,000,000 cash plus 100,000 shares of $10
stock with a market value of $5,000,000.
Additional costs are $300,000.
$200,000 is recorded as cost of the investment.
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Effect of Allocation on Consolidated
Balance Sheet at Acquisition
Sand Corporation (000)
Assets
Cash
Net receivables
Inventories
Other current assets
Land
Building, net
Equipment, net
Total assets
Book Value Fair Value
$ 200
300
500
400
600
4,000
2,000
$8,000
$ 200
300
600
400
800
5,000
1,700
$9,000
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Effect of Allocation on Consolidated
Balance Sheet at Acquisition
Sand Corporation (000)
Liabilities
Accounts payable
Notes payable
Common stock
Paid-in capital
Retained earnings
Total liabilities and
stockholders’ equity
Book Value Fair Value
$ 700
1,400
4,000
1,000
900
$ 700
1,300
$8,000
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Assignment of Excess Cost
over Underlying Equity
Investment in Sand
10,000
Common Stock
1,000
Additional Paid-in Capital
4,000
Cash
5,000
To record 90% acquisition of Sand Corporation
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Assignment of Excess Cost
over Underlying Equity
Investment in Sand
200
Additional Paid-in Capital
100
Cash
300
To record additional costs of combining with
Sand
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Allocation of Excess Cost
over Underlying Equity
Investment in Sand
Book value of interest acquired
$5,900,000 × 90% =
Excess of cost over BV
$10,200,000
(5,310,000)
$ 4,890,000
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Allocation of Excess Cost
over Underlying Equity
Fair
Book
Excess
× 90% =
–
Value
Value
Allocated
Inventories
600
Land
800
Building net
5,000
Equipment, net
1,700
Notes payable
1,300
Total allocated
Remainder to goodwill
Total
500
600
4,000
2,000
1,400
90
180
900
(270)
90
990
3,900
4,890
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Consolidated Working Papers
December 31, 2003
Account Title
Cash
Receivables, net
Inventories
Other current assets
Land
Building, net
Equipment, net
Investment in Sand
Goodwill
Unamortized excess
Pilot
1,300
700
900
600
1,200
8,000
7,000
10,200
Total assets
29,900
Adjustments and
Eliminations
Dr.
Cr.
Sand
200
300
500 b
400
600 b
4,000 b
2,000
90
180
900
b 3,900
a 4,890
8,000
Consolidated
Balance
Sheet
1,500
1,000
1,490
1,000
1,980
12,900
b
270
8,730
a 10,200
3,900
b 4,890
32,500
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Consolidated Working Papers
December 31, 2003
Account Title
Pilot
Accounts payable
2,000
Notes payable
3,700
Common stock
11,000
Other paid-in capital 8,900
Retained earnings
4,300
Sand
700
1,400
4,000
1,000
900
Minority interest
Total liabilities and
stockholders’ equity
Adjustments and
Eliminations
Dr.
Cr.
b
90
a 4,000
a 1,000
a 900
a
29,900
8,000
590
Consolidated
Balance
Sheet
2,700
5,010
11,000
8,900
4,300
590
32,500
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Learning Objective 8
Apply the concepts underlying
preparation of a consolidated
income statement.
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Consolidated Income Statement
The difference between a consolidated and
an unconsolidated income statement of the
parent company lies in the detail presented
rather than the net income amount.
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Learning Objective 9
Amortize the excess of the
investment cost over the book
value in periods subsequent
to the acquisition.
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Effect of Amortization on Consolidated
Balance Sheet after Acquisition
Income for 2004:
Sand’s net income
Pilot’s income
(excluding income from Sand)
$ 800,000
$2,523,500
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Effect of Amortization on Consolidated
Balance Sheet after Acquisition
Dividends Paid:
Sand
Pilot
$ 300,000
$1,500,000
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Effect of Amortization on Consolidated
Balance Sheet after Acquisition
Amortization of excess:
Undervalued inventories sold in 2004
Undervalued land still held
Undervalued building (45 years useful life)
Overvalued equipment (5 years useful life)
Overvalued notes payable retired in 2004
Goodwill (no amortization)
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Consolidated Working Papers
December 31, 2004
Adjustments and
Eliminations
Dr.
Cr.
Account Title
Cash
Receivables, net
Inventories
Other current assets
Land
Building, net
Equipment, net
Investment in Sand
Goodwill
Unamortized excess
Pilot Sand
253.5 100
540
200
1,300
600
800
500
1,200
600 b 180
9,500 3,800 b 880
8,000 1,800
10,504
b 3,900
a 4,744
Total assets
32,097.5 7,600
Consolidated
Balance
Sheet
353.5
740
1,900
1,300
1,980
12,900
b
216
8,730
a 10,504
3,900
b 4,744
33,937.5
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Consolidated Working Papers
December 31, 2004
Adjustments and
Eliminations
Dr.
Cr.
Account Title
Pilot Sand
Accounts payable
2,300 1,200
Notes payable
4,000
Common stock
11,000 4,000 a 4,000
Other paid-in capital 8,900 1,000 a 1,000
Retained earnings
5,897.5 1,400 a 1,400
Minority interest
Total liabilities and
stockholders’ equity
a
32,097.5 7,600
640
Consolidated
Balance
Sheet
3,500
4,000
11,000
8,900
5,897.5
640
33,937.5
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End of Chapter 3
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