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Chapter 3:

An Introduction to
Consolidated
Financial
Statements
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education,
Inc. Publishing as Prentice Hall

3-1

Intro to Consolidations: Objectives


1. Recognize the benefits and limitations of
consolidated financial statements.
2. Understand the requirements for including a
subsidiary in consolidated financial
statements.
3. Apply consolidation concepts to parent
company recording of an investment in a
subsidiary company at the date of
acquisition.
4. Record the fair value of the subsidiary at the
date of acquisition.
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3-2

Objectives (continued)
5. Learn the concept of noncontrolling interest
when a parent company acquires less than 100
percent of a subsidiary's outstanding common
stock.
6. Prepare consolidated balance sheets
subsequent to the acquisition date, including
preparation of elimination entries.
7. Amortize the excess of the fair value over the
book value in periods subsequent to the
acquisition.
8. Apply the concepts underlying preparation of a
consolidated income statement.
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An Introduction to Consolidated Financial


Statements

1: BENEFITS & LIMITATIONS

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Business Acquisitions
Business combinations through stock
acquisitions
Acquire controlling interest in voting stock
More than 50%
May have control through indirect ownership
Business combination occurs once
Acquisition of additional subsidiary stock is simply
additional investment

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Consolidated Statements
Primarily benefit the owners and creditors of the
parent
Not primarily intended for the noncontrolling
owners nor the subsidiarys creditors
Subsidiaries issue separate statements for the
benefit of their owners and creditors

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An Introduction to Consolidated Financial


Statements

2: SUBSIDIARIES

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Who is a Subsidiary?
A corporation becomes a subsidiary when another
corporation acquires controlling interest in its
outstanding voting stock.
In a 100 percent acquisition, the investee continues
to operate as a separate legal entity.
Subsidiaries, or affiliates, continue as separate
legal entities and prepare their own financial
reports.

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Subsidiaries Are Consolidated


Cases where a subsidiary may be excluded
from consolidation:
Control doesnt rest with majority owner
Joint ventures
Acquisitions of groups of assets that do not
constitute a business
Combination between entities under common
control
Combination of not-for-profit entities or acquisition
of a for-profit company by a not-for-profit entity
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Consolidated Statements
Prepared by the parent company
Parent discloses
Consolidation policy [SEC Reg. S-X, Rule 3A-03]
Any exceptions to consolidation
Fiscal year-end for consolidated entity:
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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An Introduction to Consolidated Financial


Statements

3: PARENT COMPANY
RECORDING

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Pen Example: Acquisition Cost = Fair


Value = Book Value
Sels Balance Sheet: BV=FV
Cash
$10
Other current assets
15
Plant assets, net
40
Total
$65
Accounts payable
$15
Other current liabilities
10
Capital stock
30
Retained earnings
10
Total
$65

Pen acquires 100% of Sel 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 Pen's


Investment account and Sel's
capital stock and retained
earnings.

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Balance
Sheets
Cash
Other curr.
assets
Plant assets, net
Investment in
Sel
Total
Accounts
payable
Other curr.
liabilities

Consolida
Separate
ted
Pen Sel Pen & Sub.
$20 $10
$30
45

15

60

60

40

100

40

$16
5

$65

$190

$20

$15

$35

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10

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35

An Introduction to Consolidated Financial


Statements

4: FAIR VALUE AT
ACQUISITION DATE

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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
Cost > BV, excess is goodwill
Cost < BV, excess is a gain on the bargain
purchase

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BV FV Cost
Difference between the book value of net
assets (BV) and the fair value of identifiable net
assets (FV) is assigned to the specific assets
or liabilities
E.g., undervalued or overvalued inventories, plant
assets
Unrecorded assets (patents) or liabilities (existing
contingencies)
Difference between FV and Cost is goodwill or
a gain on the bargain purchase
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Example: BV FV but Cost = FV


Piper acquires 100% of Sandy for $310.
Sandy
BV
FV
BV = 100 + 145 = $245
FV = 385 75 = $310
Cash
$40 $40
Receivables
30 goodwill
30
Cost FV = $0
Inventory
50
75
Plant, net
200 240
Cost
$310
Total
$320 $385
100% Book value
245
Liabilities
$75 $75
Excess of cost over BV
$65
Capital stock
100
Retained earnings
Total

145
$320
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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 (-SE)
Retained earnings (-SE)
Inventory (+A)
Plant (+A)
Investment in Sandy
(-A)Pearson Education,
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100
145
25
40
3103-18

Example: BV FV and Cost FV


Panda acquires 100% of Salty for $530.
BV = 250 + 190 = $440
FV = 580 85 = $495
Salty
BV

FV

$10
0

$10
0

40

40

Inventory

250

250

Plant, net

130

190

Total

$52 $58
0
0

Liabilities

$80

Cash
Receivables

$85

Capital stock

250

Retained
earnings

190

Cost FV = $35 goodwill

Cost
100% Book value
Excess of cost over BV

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$52

$530
440
$90

3-19

Panda and Salty (cont.)


Allocate to:
Amount Amort.
Plant
60 4 yrs
Liabilities
-5 5 yrs
Goodwill
35
Total
$90
Panda's elimination worksheet entry:
Capital stock (-SE)
250
Retained earnings (-SE)
190
Plant (+A)
60
Goodwill (+A)
35
Liabilities (+L)
Investment in Salty (-A)
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530
3-20

Example: BV FV and Cost FV


Print acquires 100% of Sum for $185.
Sum

BV

FV

Cash

$10

$10

Receivables

30

30

Inventory

80

90

Plant, net

100

120

$220

$250

$40

$40

Total
Liabilities
Capital stock
Retained earnings
Total

75
105
$220

BV = 75 + 105 = $180
FV = 250 - 40 = $210
Cost FV = -$25:
Gain on bargain purchase
Cost
100% BV
Excess of cost over BV

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$185
180
$5
3-21

Print and Sum (cont.)


Allocate to:
Amt Amort.
Inventory
10 1st yr
Plant, land
20 Bargain purchase
(25) Gain
Total the acquisition of Sum assuming
$5 a cash purchase
Print records
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 Sum (+A)
210
Gain on bargain purchase (R, +SE)
Cash (-A)

25
185

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Worksheet Elimination Entry


Unamortized excess equals $30
$10 for undervalued inventory
$20 for undervalued land included in plant assets
Prints elimination worksheet entry:
Capital stock (-SE)
Retained earnings (-SE)
Unamortized excess (+A)
Investment in Sum (-A)
Inventory (+A)
Plant (+A)
Unamortized excessCopyright
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75
105
30
210
10
20
30

3-23

Cash
Receivables
Inventory
Plant, net
Investment in Sum
Unamortized excess
Total
Liabilities
Capital stock
Retained earnings
Total

Print
BV
$30
50
100
450
210
$840
$270
200
370
$840

Sum Adjustments
BV
DR
CR
$10
30
80
10
100
20
210
30
30
$220
$40
75
75
105 105
$220
240
240

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Consolidated
$40
80
190
570
0
$880
$310
200
370
$880

An Introduction to Consolidated Financial


Statements

5: NONCONTROLLING
INTERESTS

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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
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Example: Noncontrolling Interests


Popo 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
Implied value of Sine (400/80%)
Book value (200+175)
Excess over book value

$400
$500
375
$125

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Allocate to:
Building
Goodwill
Total

$50
75
$125
3-27

Elimination Entry
Popo's elimination worksheet entry:
Capital stock (-SE)
200
Retained earnings (-SE)
175
Building (+A)
50
Goodwill (+A)
75
Investment in Sine (-A)
400
Noncontrolling interest (+SE)
100
An unamortized excess account could have been
used for the excess assigned to the building and
goodwill.
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Cash
Receivables
Inventory
Building, net
Investment in Sine
Goodwill
Total
Liabilities
Capital stock
Retained earnings
Noncontrolling interest
Total

Popo
BV
$50
130
80
300
400

Sine Adjustments
BV
DR
CR
$10
50
100
240
50
400
75
$960
$400
$150
$25
250
200
200
560
175
175
100
$960
$400
500 3-29500
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Consolidated
$60
180
180
590
0
75
$1,085
$175
250
560
100
$1,085

An Introduction to Consolidated Financial


Statements

6: SUBSEQUENT BALANCE
SHEETS

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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

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Popo and Sine (cont.)


Cost of 80% of Sine
Implied value of Sine
Book value
Excess

Building
Goodwill
Total

$400
$500
375
$125

Beginning
unamortized
excess
50
75
125

Allocate to:
Building
$50 10 yrs
Goodwill
75 Total
$125
Current year's
amortization
(5)
0
(5)

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Ending
unamortized
excess
45
75
120
3-32

After 1 year:

Popo

Cash

$40

Receivables

110

Inventory

90

Building, net

280

Investment in Sine

404

Total

$924

Sine

Popo

Sine

$15 Liabilities
85 Capital stock

$100

$50

250

200

574

185

$924

$435

100 Retained earnings


235
$435

Total
Popo's elimination worksheet
entry:
Capital stock (-SE)
Retained earnings (-SE)
Unamortized excess (+A)
Investment in Sine (80%) (-A)
Noncontrolling interest (20%) (+SE)
Building (+A)
Goodwill (+A)
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200
185
120
404
101
45
75
3-33

120

After 1 year:
Cash
Receivables
Inventory
Building, net
Investment in Sine
Goodwill
Unamortized excess
Total
Liabilities
Capital stock
Retained earnings
Noncontrolling interest
Total

Popo
BV
$40
110
90
280
404

Sine
BV
$15
85
100
235

Adjustments
DR
CR

45
404
75
120

$924
$100
250
574

$435
$50
200
185

120

200
185
101

$924

$435

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Consolidated
$55
195
190
560
0
75

3-34

$1,075
$150
250
574
101
$1,075

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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An Introduction to Consolidated Financial


Statements

7: AMORTIZATIONS AFTER
ACQUISITION

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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

Amortization period Income statement


account
Generally, 1st year
Cost of sales and
other expense
Remaining life at
Depreciation and
business combination amortization expense

Land, copyrights
Long-term debt

Not amortized
Time to maturity
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Interest expense
3-37

Piper and Sandy (cont.)


Cost
100% BV
Excess

Inventory
Plant
Total

$310
245
$65

Allocate to:
Inventory
Plant
Total

Beginning
unamortized
excess
25
40
65

Current year's
amortization
(25)
(4)
(29)

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Amt Amort.
25 1st yr
40 10 yrs
$65
Ending
unamortized
excess
0
36
36
3-38

Panda and Salty (cont.)


Cost
100% BV
Excess

Plant
Liabilities
Goodwill
Total

Allocate to:
Plant
Liabilities
Goodwill
Total
Beginning
Current year's
unamortized
amortization
excess
60
(15)
(5)
1
35
0
90
(14)
$530
440
$90

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Amt Amort.
60 4 yrs
-5 5 yrs
35 $90
Ending
unamortized
excess
45
(4)
35
76
3-39

Print and Sum (cont.)


Cost
100% BV
Excess

$185
180
$5

Allocate to:

Amt Amort.

Inventory

10 1st yr

Plant, land

20 -

Bargain purchase
Total

Inventory
Land
Total

Beginning
unamortized
excess
10
20
30

(25) Gain
$5

Current year's
amortization
(10)
0
(10)

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Ending
unamortized
excess
0
20
20
3-40

An Introduction to Consolidated Financial


Statements

8: CONSOLIDATED INCOME
STATEMENTS

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Comprehensive Example, Data


Pil acquires 90% of Sad on 12/31/2011 for
$4,333 when Sad's equity consists of $4,000
common stock, $1,000 other paid in capital,
and $900 retained earnings. On that date
Sad'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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Cost of 90% of Sad

$10,200

Allocate to:

Implied value of Sad 10,200/.90

$11,333

Inventory

Book value (4000+1000+900)


Excess over book value

5,900
$5,433

$100 1st yr

Land

200 -

Building

1,000 40 yrs

Equipment

(300) 5 yrs

Note payable

100 1st yr

Unamortize
d excess
1/1/12

Goodwill
Current
Total
amortizatio
n

4,333 Unamortize
$5,433
d excess
12/31/12

Inventory

100

(100)

Land

200

200

Building

1,000

(25)

975

Equipment

(300)

60

(240)

100

(100)

4,333

5,433

(165)

Note payable
Goodwill
Total

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4,333
5,268

Pil
Sad
$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 Sad
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
* Cost of sales,
building
are
Controlling
interest
share depreciation, and interest expense
$3,095.00
increased by $100, $25, and $100, and equipment
depreciation is $60 lower than the sum of Pil and Sad.
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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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