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Session 23

Session 23. Consolidation. Consolidation Methods. Equity Method Full/Global Consolidation Proportional Consolidation. Full Consolidation (example A owns 80% of B). Assets: A B A+B Net fixed assets 420 150 570 Investments 80 -- 0 Inventories 200 50 250 Receivables 100 30 130

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Session 23

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  1. Session 23 Consolidation

  2. Consolidation Methods • Equity Method • Full/Global Consolidation • Proportional Consolidation

  3. Full Consolidation (example A owns 80% of B) • Assets: A B A+B • Net fixed assets 420 150 570 • Investments 80 -- 0 • Inventories 200 50 250 • Receivables 100 30 130 • Cash 50 20 70 850 2501020

  4. Full Consolidation (example) • Equity A B A+B • Common Stock 400 100 400 • Retained Earnings 200 50 240 • Net Income 100 20 116 700 170756 • Minority Interest • - - 34 • Liabilities • Debt 100 50 150 • Payables 50 30 80 150 80230

  5. Full Consolidation (example) • Revenues A B A+B • Sales 950 300 1250 • Interest revenue 50 -- 50 1000 300 1300 • Expenses • COGS 400 100 500 • Services 200 50 250 • Employees 200 50 250 • Depreciation 100 80 180 900 280 1180 • Net income (consol.) 100 20 120 • Net income (min.int.) 4 • Net income (A) 116

  6. Full Consolidation (explanations) • Assets • Consolidating the Assets was easy, since there were no internal operations between the firms. That is none of the receivables of A were payables of B (and vice versa) and none of the debt of B was loaned by A (and vice versa). Therefore, all Assets were added to each other to deliver the consolidated Assets of the Group, with one exception! • The investments of A in B had to be excluded from the consolidation. Ask yourself how much investments does the group hold? Can you claim that internal investments count for that item? That’s why we exclude the 80 of investments of A in B. With the argument that the Group doesn’t really have any investments in outside assets. • Notice that in the Assets side we are consolidating Assets from A and from B disregarding the fact that A only owns 80% of B. All considerations on how much the shareholders of A can claim of the Assets of B is only made in the Equity side of the Balance Sheet. That should not be a surprise to you! Remember that the Assets are everything that is on the table, the other side of the Balance Sheet is exactly where we think about who these assets belong to and who can claim them… The argument here is that the shareholders of A do in fact completely control B and therefore do control all Assets of B, even if they cannot claim them all.

  7. Full Consolidation (explanations) • Equity • Common Stock 400 • only account for the Common Stock of A, when you consolidate. 80% of the common stock of B was what was originally acquired by A for 80. Therefore, as you exclude the investments in the Assets side, you also need to exclude this 80. Now the total common stock of B was 100, not 80, so where do the remaining 20 end up? (see below) • Retained Earnings 240 • The retained earnings of B are accumulated earnings by the firm since it was created. Only 80% of these earnings belong to A, the rest shows up below... • Net Income 116 • For the net income, the best way is to look at the income statement and understand that of this income, only 80% belongs to A and the rest is for the minority interests. • Minority Interest 34 • This value is whatever was not considered above as equity belonging to the shareholders of A. In other words, this is the part of B that CANNOT BE CLAIMED by A or its shareholders. It is equal to 20% of the Common Stock of B (20) + 20% of the retained earnings of B (10) + 20% of the net income of B (4). • Liabilities • The Liabilities consolidation is easy since we assume that there were no Internal Operations between A and B. No money was owed by A to B or vice versa.

  8. Full Consolidation (explanations) • Income Statement • Two notes on the income statement full consolidation: • First, none of the Sales of A were done to B and vice versa. Otherwise, we would need to exclude internal Sales and corresponding internal COGS. • Second, as we mentioned for the net income, only 80% of this net income can be claimed by A and its shareholders. 20% belongs to the minority shareholders of B.

  9. Goodwill • Difference between Accounting value and Finance Value of subsidiaries. • Represents the anticipation of future profits of the subsidiary by the controlling firm. • Needs to be amortized over time, preferably at the same rate as these profits are being generated. • Example.

  10. Proportional Consolidation (example A owns 50% of B) • Assets: A B A+B • Net fixed assets 420 150 495 • Investments 50 -- 0 • Inventories 230 50 255 • Receivables 100 30 115 • Cash 50 20 60 850 250925

  11. Proportional Consolidation (example) • Equity A B A+B • Common Stock 400 100 400 • Retained Earnings 200 50 225 • Net Income 100 20 110 700 170735 • Liabilities • Debt 100 50 125 • Payables 50 30 65 150 80190

  12. Proportional Consolidation (example) • Revenues A B A+B • Sales 950 300 1100 • Interest revenue 50 -- 50 1000 3001150 • Expenses • COGS 400 100 450 • Services 200 50 225 • Employees 200 50 225 • Depreciation 100 80 140 900 280 1040 • Net income 100 20 110

  13. Proportional Consolidation (explanations) • Assets (similar arguments to the full consolidation) • Consolidating the Assets was still easy, since there were no internal operations between the firms. However, now we only consider 50% of the Assets of B as being part of the group, see below why. • The investments of A in B had to be excluded from the consolidation again. Exactly the same argument as the one in full consolidation. • This is where the proportional consolidation becomes tricky. Now we don’t disregarding the fact that A only owns 50% of B. Now we only count on the assets proportional to the share of A in B. The argument now is that there is another shareholder of B (say V, as in Victor ), and he is now as relevant as we are, when it comes to making decisions and controlling B. V is also consolidating with B and he is also doing it proportionally. This will have consequences on the other side of the Balance Sheet. Now the part referring to his claims will no longer show up as a separate item in the other side, cause already took V’s claims into account, when we only considered half of B’s Assets.

  14. Proportional Consolidation (explanations) • Equity • Common Stock 400 • Exactly the same argument as in full consolidation. Only account for the common stock of A and exclude common stock of B. The 50 we excluded in the investments’ assets is excluded here again. However, we are excluding more than 50, we exclude all common stock of B, all 100. The remaining 50 are the part of common stock that can be claimed by V, like before with the 20. The difference to the full consolidation is that those 20 were showing up as a separate item as minority interests, and now they don’t show up here. Why? • Retained Earnings 225 • Same argument as before in the full consolidation. We can only claim half the retained earnings of B. The rest belongs to V. • Net Income 110 • Same as retained earnings and same as full consolidation only half the net income of B is ours. • Minority Interest 0 • There are no Minority Interests here. V is not even a minority shareholder this time. We already took care of his claims by only considering that we only control half the Assets of B. • Liabilities • The same argument we used for the Assets, holds for the Liabilities. Only half the responsibilities are ours. If V wants to have half the assets, he has to step up to his responsibilities too…

  15. Proportional Consolidation (explanations) • Income Statement • Again, no internal operations here. This makes our life easier when consolidating the income statement. • However, now we only half the revenues and half the costs as ours. The rest is V’s.

  16. Equity Method • As the investment is made in the participated firm, the investment is recorded at cost. • Afterwards, at the end of each accounting period, the value of the investment is updated to include a share of the income generated in the participated firm. • This share is proportional to the share of equity held by the controlling firm.

  17. Equity Method (example A owns 30% of B) • Assets: A B A* • Net fixed assets 420 150 420 • Investments 30 -- 36 • Inventories 250 50 250 • Receivables 100 30 100 • Cash 50 20 50 850 250856

  18. Equity Method (example) • Equity A B A* • Common Stock 400 100 400 • Retained Earnings 200 50 200 • Net Income 100 20 106 700 170706 • Liabilities • Debt 100 50 100 • Payables 50 30 50 150 80150

  19. Equity Method(explanations) • We aren’t really consolidating. All we did was to claim that 30% of the net income of B was ours and revalue our investments accordingly…

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