1

Chapter Two
Consolidated Financial Statement on Date of Business
Combination

Parent Company Subsidiary

Relationships
If the investor acquires a controlling interest in the
investee,
a
parent
subsidiary relationship
established.
The investee becomes a subsidiary of the acquiring
parent company (investor) but remains a separate legal
entity.
A strict adherence to legal aspects of such business
combination would require the issuance of separate
financial statements for the parent company and for the
subsidiary company.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Parent Company Subsidiary

Relationships
However, such strict adherence to legal form disregards
the substance of most parent-subsidiary relationships.
A parent company and its subsidiaries are a single
economic entity.
In
recognition of this fact, consolidated financial
statements are issued to report the financial position and
operating results of a parent company and its
subsidiaries as though they comprised a single
accounting entity.

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Nature of Consolidated Financial

Statements
Consolidated financial statements are similar to the
combined financial statements for a home office and its
branches.
Assets, liabilities, revenue, and expenses of the parent
company and its subsidiaries are totaled; inter-company
transactions and balances are eliminated; and the final
consolidated
amounts
are
reported
in
the
consolidated
balance
sheet,
income
statements,
statement of stockholders equity, and statement of cash
flows.

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Nature of Consolidated Financial

Statements

A pro forma presentation--it means

as if the parent and subsidiary were a
SINGLE legal entity with one or more
branches.

It
is
a
LEGAL
FICTIONAL
PRESENTATION (an accounting mirage).
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidation Procedures: Primary

Objectives

To present on a combined basis

The detailed asset, liability, and net

worth position represented by the
parent companys separate books, plus
The
individual
values
of
the
subsidiarys
assets
and
liabilities
acquired
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidated Financial Statements

7

Prepared from separate F/statements of

acquiring(parent) & acquired (subsidiaries)
companies using consolidation worksheet
procedure
Present assets & liabilities of two companies
as if they were single accounting entity
Required whenever stock held by acquiring
company gives it controlling interest in
acquired company

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidation Issues
8

Acquisition Price (at book value or

more than book value)
Acquisition Timing (at beginning of
year or during the
year)
Percent of subsidiary acquired (100%
or less than 100%)
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

The Purpose of Consolidated Financial

Statements
The purpose of consolidated financial statements is
to present, primarily for the benefit of the owners
and creditors of the parent company, the results of
operations and the financial position of a parent
and all its subsidiaries as if the consolidated group
were a single economic entity.
Consolidated statements are intended primarily for
the parents investors, rather than for the noncontrolling stockholders and subsidiary creditors.

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Should All Subsidiaries Be

Consolidated?

10

Consolidated financial statements provide

much information that is not included in the
separate statements of the parent, and are
usually required for fair presentation of the
financial position and results of operations for a
group of affiliated companies.
The
usual condition for consolidation is
ownership of more than 50 percent of the
voting stock of another company

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Should All Subsidiaries Be

Consolidated?

11

Under current GAAP, a subsidiary can be excluded

from consolidation in some situations:
When control does not rest with the majority
owner,
Control does not rest with the majority owner
if the subsidiary is in legal reorganization or
bankruptcy or is operating under severe
foreign-exchange restrictions, or other
governmentally-imposed uncertainties
Formation of joint ventures,
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Should All Subsidiaries Be

Consolidated?

12

Under current GAAP , a subsidiary can be excluded

from consolidation in some situations:
The

acquisition of an asset or group of

assets that does not constitute a business,
A combination between entities under
common control, and
A combination between not-for-profit
entities or the acquisition of a for-profit
business by a not-for-profit entity.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidated Financial Statements

Weaknesses

13

Diverse businesses are more difficult to

interpret
Weak performers are more difficult to
identify
Consolidations
make
it
difficult
to
compare entities to industry standards
Financial
ratios do not represent any
particular part of the entity

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

2-14

Consolidation of Financial
Information

Parent

The parent does not

prepare separate financial
statements

Subsidiary

Consolidated financial
statements are prepared.

The Sub still prepares

separate financial statements

The Meaning of Controlling Interest

15

When one company owns, directly or

indirectly, over 50% of outstanding
voting shares of another company
Gives
parent
company
ability
to
establish subsidiarys operating and
financial
policies
and
to
direct
subsidiarys economic activities as if
they were the economic activities of one
of their branches or divisions

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Criteria for Consolidation

Percentage of Outstanding Voting Stock Acquired
0%

20%

50%

100%

1. Level of economic influence

Nominal

Significant influence

Control

2. Financial statement presentation

Investment Account
Separate Financial Statements

Consolidated
Financial Statements

Company A

Company A

owns shares in

owns shares in

Company Z

Company Y
owns shares in

Company Z

Indirect Ownership of
Co. Z by Co. A

Direct Ownership of
Co. Z by Co. A

Direct vs. Indirect

Ownership

Consolidation: The 3 Considerations

18

In buying real estate, the three most

important considerations are location,
location, and location.

In determining whether consolidation is

appropriate, the three most important
considerations are control, control,
and control.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Control: It Means Having Power

19

To hire and fire management.

To set managements compensation.

To decide when to pay dividends.

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Control: It Means Having Power

20

To approve operating, capital, and R&D budgets.

To direct the use of the subsidiarys assets.

To liquidate the subsidiary into a division if

desired.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidation of Wholly Owned Subsidiary on

Date of Purchase-Type Business Combination
21

When the fiscal periods of the parent and its

subsidiaries differ, we prepare consolidated statements
for and as of the end of the parents fiscal period
The consolidated balance sheet is not merely a
summation of account balances of the affiliates. We
eliminate reciprocal accounts in the process of
consolidation and combine only nonreciprocal accounts.
The capital stock that appears in a consolidated
balance sheet is the capital stock of the parent, and the
consolidated retained earnings are the retained
earnings of the parent company.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidation of Wholly Owned Subsidiary on

Date of Purchase-Type Business Combination
22

There is no a question of control for wholly owned

subsidiary.

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

23

Consolidated Balance Sheets: Use of Work

papers

Assets and liabilities are summed, regardless of

whether the parent owns 100% or a smaller
controlling interest.
Non-controlling interests are reflected as a component
of owners equity.
Eliminations must be made to cancel the effects of
transactions among the parent and its subsidiaries.
A work paper is frequently used to summarize the
effects of various additions and eliminations
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Consolidated Balance Sheets: Use of Work papers

Intercompany Accounts to Be
Eliminated
Parents
Accounts
Subsidiarys Accounts
Investment in subsidiary

Against

Equity accounts

Intercompany receivable (payable)

Against

Intercompany payable (receivable)

Advances to subsidiary
(from subsidiary)

Against

Advances from parent

(to parent)

Interest revenue
(interest expense)

Against

Interest expense
(interest revenue)

Dividend revenue
(dividends declared)

Against

Dividends declared
(dividend revenue)

Management fee received from subsidiary

Against

Management fee paid to parent

Sales to subsidiary (purchases of inventory

from subsidiary)

Against

Purchases of inventory from parent (sales

to parent)

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Use of Work papers: Investment

Elimination
It is necessary to eliminate the investment account
of the parent company against the related
stockholders equity of the subsidiary to avoid
double counting of these net assets.

When parents share of subsidiarys equity is

eliminated
against
the
investment
account,
subsidiarys net assets are substituted for the
investment account in the consolidated balance
sheet.
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Columns of Work papers

26

The

first two columns provide information from the

separate balance sheets of Parent and Subsidiary.
The third column records adjustments and
eliminations, subdivided into debits and credits.
The last column presents the totals that will appear
in the consolidated balance sheet.
We calculate amounts in the Consolidated Balance
Sheet column by adding together amounts from the
first two columns and then adding or subtracting the
adjustments and eliminations, as appropriate
Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

Nature of working paper entries

27

Working paper entries are only work paper

adjustments and eliminations and are not recorded
in the accounts of the parent or subsidiary
corporations . The entries will never be journalized
or posted.
Their only purpose is to facilitate completion of the
work papers to consolidate a parent and subsidiary
at and for the period ended on a particular date

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

2-28

Steps for Consolidation

1.
1. Record
Record the
the financial
financial information
information for
for both
both
Parent
Parent and
and Sub
Sub on
on the
the worksheet.
worksheet.
2.
2. Remove
Remove the
the Investment
Investment in
in Sub
Sub balance
balance. .
3.
3. Remove
Remove the
the Subs
Subs equity
equity account
account balances.
balances.
4.
4. Adjust
Adjust the
the identifiable
identifiable assets
assets acquired
acquired and
and
liabilities
liabilities assumed
assumed to
to Fair
Fair Values.
Values.
5.
5. Allocate
Allocate any
any remaining
remaining excess
excess of
of
consideration
consideration transferred
transferred over
over Book
Book Values
Values to
to
goodwill.
goodwill.
6.
6. Combine
Combine all
all account
account balances.
balances.

29

Consolidated Balance Sheets: Use of Work

papers

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)

30

Consolidated Balance Sheets: Use of Work

papers

Ch 2 Consolidated F/Statement on Date of Business Combination

By Tekalign N (M.Sc in
Accounting and Finance)