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An Introduction to Consolidated Financial Statements

An Introduction to Consolidated Financial Statements. Chapter 3. Learning Objective 1. Recognize the benefits and limitations of consolidated financial statements. Business Combinations Consummated Through Stock Acquisitions. Business combination. One or more companies

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An Introduction to Consolidated Financial Statements

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  1. An Introduction to ConsolidatedFinancial Statements Chapter 3

  2. Learning Objective 1 Recognize the benefits and limitations of consolidated financial statements.

  3. Business Combinations ConsummatedThrough Stock Acquisitions Business combination One or more companies become subsidiaries of a common parent corporation.

  4. The Reporting Entity Parent Financial Statements _____ _____ _____ _____ _____ _____ _____ _____ Subsidiary Financial Statements _____ _____ _____ _____ _____ _____ _____ _____ Consolidated Financial Statements _____ _____ _____ _____ _____ _____ _____ _____

  5. 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.

  6. The Parent-Subsidiary Relationship Parent Company Owns more than 50% of another company Affiliate

  7. 90% ownership 80% ownership Subsidiary A Subsidiary B The Parent-Subsidiary Relationship Parent Company

  8. Learning Objective 2 Understand the requirements for inclusion of a subsidiary in consolidated financial statements.

  9. Consolidation Policy Consolidated financial statements provide information that is not included in the separate statements of the parent corporation.

  10. 1 Control is likely to be temporary. 2 Control does not rest with the majority owner. Consolidation Policy A subsidiary can be excluded from consolidation in only two situations:

  11. Consolidation Policy Consolidation policy is usually presented under the following headings: Principles of consolidation Basis of consolidation

  12. Parent and Subsidiary withDifferent 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.

  13. Learning Objective 3 Apply the consolidations concepts to parent company recording of the investment in a subsidiary company at the date of acquisition.

  14. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash $ 20,000 $10,000 $ 30,000 Other current assets 45,000 15,000 60,000 Total current assets $ 65,000 $25,000 $ 90,000 Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets $ 60,000 $40,000 $100,000 Investment in Skelly 40,000 0 0 Total assets $165,000 $65,000 $190,000

  15. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities $ 45,000 $25,000 $ 70,000 Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity $120,000 $40,000 $120,000 Total liabilities and stockholders’ equity $165,000 $65,000 $190,000

  16. Learning Objective 4 Allocate the excess of the investment cost over the book value of the subsidiary at the date of acquisition.

  17. Parent Acquires 100% ofSubsidiary 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?

  18. Parent Acquires 100% ofSubsidiary 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

  19. Learning Objective 5 Prepare a consolidated balance sheet at the date of acquisition, including preparation of eliminating entries.

  20. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash $ 10,000 $10,000 $ 20,000 Other current assets 45,000 15,000 60,000 Total current assets $ 55,000 $25,000 $ 80,000 Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets $ 60,000 $40,000 $100,000 Investment in Skelly 50,000 Goodwill 10,000 Total assets $165,000 $65,000 $190,000

  21. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities $ 45,000 $25,000 $ 70,000 Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity $120,000 $40,000 $120,000 Total liabilities and stockholders’ equity $165,000 $65,000 $190,000

  22. Learning Objective 6 Learn the concept of minority interest when the parent company acquires less than 100% of the subsidiary’s outstanding common stock.

  23. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash $ 10,000 $10,000 $ 20,000 Other current assets 45,000 15,000 60,000 Total current assets $ 55,000 $25,000 $ 80,000 Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets $ 60,000 $40,000 $100,000 Investment in Skelly 50,000 Goodwill 14,000 Total assets $165,000 $65,000 $194,000

  24. Consolidated Balance Sheet at Dateof Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities $ 45,000 $25,000 $ 70,000 Minority interest $ 4,000 Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity $120,000 $40,000 $120,000 Total liabilities and stockholders’ equity $165,000 $65,000 $194,000

  25. 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.

  26. Minority Interest The interest of minority stockholders represents equity investments in the consolidated net assets by stockholders of the company affiliated with the parent.

  27. Learning Objective 7 Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of eliminating entries.

  28. Consolidated Balance SheetAfter Acquisition Assumptions 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.

  29. Consolidated Balance SheetAfter Acquisition What is the balance in the investment in Skelly’s account at December 31? Original investment January 1 $50,000 + 90% of Skelly’s net income 18,000 – 90% of Skelly’s dividends – 9,000 Investment account balance $59,000

  30. Consolidated Balance SheetAfter 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

  31. Consolidated Balance SheetAfter 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

  32. Effect of Allocation on ConsolidatedBalance 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.

  33. Effect of Allocation on ConsolidatedBalance 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.

  34. Effect of Allocation on ConsolidatedBalance 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.

  35. Effect of Allocation on ConsolidatedBalance Sheet at Acquisition Sand Corporation (000) Book Value Fair Value Assets Cash $ 200 $ 200 Net receivables 300 300 Inventories 500 600 Other current assets 400 400 Land 600 800 Building, net 4,000 5,000 Equipment, net 2,000 1,700 Total assets $8,000 $9,000

  36. Effect of Allocation on ConsolidatedBalance Sheet at Acquisition Sand Corporation (000) Book Value Fair Value Liabilities Accounts payable $ 700 $ 700 Notes payable 1,400 1,300 Common stock 4,000 Paid-in capital 1,000 Retained earnings 900 Total liabilities and stockholders’ equity $8,000

  37. Assignment of Excess Costover 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

  38. Assignment of Excess Costover Underlying Equity Investment in Sand 200 Additional Paid-in Capital 100 Cash 300 To record additional costs of combining with Sand

  39. Allocation of Excess Costover Underlying Equity Investment in Sand $10,200,000 Book value of interest acquired $5,900,000 ×90% = (5,310,000) Excess of cost over BV $ 4,890,000

  40. Allocation of Excess Costover Underlying Equity Fair Value – Book Value × 90% = Excess Allocated Inventories 600 500 90 Land 800 600 180 Building net 5,000 4,000 900 Equipment, net 1,700 2,000 (270) Notes payable 1,300 1,400 90 Total allocated 990 Remainder to goodwill 3,900 Total 4,890

  41. Consolidated Working PapersDecember 31, 2003 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet Cash Receivables, net Inventories Other current assets Land Building, net Equipment, net Investment in Sand Goodwill Unamortized excess Total assets 1,300 700 900 600 1,200 8,000 7,000 10,200 29,900 200 300 500 400 600 4,000 2,000 8,000 b 90 b 180 b 900 b 3,900 a 4,890 b 270 a 10,200 b 4,890 1,500 1,000 1,490 1,000 1,980 12,900 8,730 3,900 32,500

  42. Consolidated Working PapersDecember 31, 2003 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet Accounts payable Notes payable Common stock Other paid-in capital Retained earnings Minority interest Total liabilities and stockholders’ equity 2,000 3,700 11,000 8,900 4,300 29,900 700 1,400 4,000 1,000 900 8,000 b 90 a 4,000 a 1,000 a 900 a 590 2,700 5,010 11,000 8,900 4,300 590 32,500

  43. Learning Objective 8 Apply the concepts underlying preparation of a consolidated income statement.

  44. 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.

  45. Learning Objective 9 Amortize the excess of the investment cost over the book value in periods subsequent to the acquisition.

  46. Effect of Amortization on ConsolidatedBalance Sheet after Acquisition Income for 2004: Sand’s net income $ 800,000 Pilot’s income (excluding income from Sand) $2,523,500

  47. Effect of Amortization on ConsolidatedBalance Sheet after Acquisition Dividends Paid: Sand $ 300,000 Pilot $1,500,000

  48. Effect of Amortization on ConsolidatedBalance 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)

  49. Consolidated Working PapersDecember 31, 2004 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet Cash Receivables, net Inventories Other current assets Land Building, net Equipment, net Investment in Sand Goodwill Unamortized excess Total assets 253.5 540 1,300 800 1,200 9,500 8,000 10,504 32,097.5 100 200 600 500 600 3,800 1,800 7,600 b 180 b 880 b 3,900 a 4,744 b 216 a 10,504 b 4,744 353.5 740 1,900 1,300 1,980 12,900 8,730 3,900 33,937.5

  50. Consolidated Working PapersDecember 31, 2004 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet Accounts payable Notes payable Common stock Other paid-in capital Retained earnings Minority interest Total liabilities and stockholders’ equity 2,300 4,000 11,000 8,900 5,897.5 32,097.5 1,200 4,000 1,000 1,400 7,600 a 4,000 a 1,000 a 1,400 a 640 3,500 4,000 11,000 8,900 5,897.5 640 33,937.5

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