an introduction to consolidated financial statements

3 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

An Introduction to ConsolidatedFinancial 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 companiesbecome subsidiaries of a

common parent corporation.


The Reporting Entity

SubsidiaryFinancialStatements_____ __________ __________ __________ _____

SubsidiaryFinancialStatements_____ __________ __________ __________ _____

ConsolidatedFinancialStatements_____ __________ __________ __________ _____

ConsolidatedFinancialStatements_____ __________ __________ __________ _____

ParentFinancialStatements_____ __________ __________ __________ _____

ParentFinancialStatements_____ __________ __________ __________ _____


The Reporting Entity

A parent company may acquire asubsidiary in a very different industry

from its own as a means of diversifyingits overall business risk.

There are also legal reasons for maintaining separate identities.


The Parent-Subsidiary Relationship

Parent Company

Owns more than 50%of another company

Affiliate


The Parent-Subsidiary Relationship

Parent Company

Subsidiary A

90%ownership

Subsidiary B

80%ownership



Understand the requirements for

inclusion of a subsidiary in

consolidated financial statements.


Consolidation Policy

Consolidated financial statements provideinformation that is not included in the separate

statements of the parent corporation.



A subsidiary can be excluded fromconsolidation in only two situations:

1 Control is likely to be temporary.

2Control does not rest with the

majority owner.



Consolidation policy is usually presentedunder the following headings:

Principles ofconsolidation

Basis ofconsolidation


Parent and Subsidiary withDifferent Fiscal Periods

Consolidated statements are prepared for andas of the end of the parent’s fiscal period.

If the difference does not exceed three months…

it is acceptable to use the subsidiary’sstatements with disclosure.



Apply the consolidations concepts

to parent company recording of

the investment in a subsidiary

company at the date of acquisition.


Consolidated Balance Sheet at Dateof Acquisition (100% at Book

Value)Assets Penn Skelly ConsolidatedCurrent assets Cash $ 20,000 $10,000 $ 30,000 Other current assets 45,000 15,000 60,000Total current assets $ 65,000 $25,000 $ 90,000Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000Total plant assets $ 60,000 $40,000 $100,000Investment in Skelly 40,000 0 0Total assets $165,000 $65,000 $190,000



Value)Liabilities Penn Skelly ConsolidatedCurrent liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000Total current liabilities $ 45,000 $25,000 $ 70,000Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000Total stockholders’ equity$120,000 $40,000 $120,000Total liabilities and stockholders’ equity $165,000 $65,000 $190,000



Allocate the excess of the

investment cost over the

book value of the subsidiary

at the date of acquisition.


Parent Acquires 100% ofSubsidiary with Goodwill

Penn purchased all the stock of Skelly for $50,000.

What is the consolidating (eliminating) entry?

Skelly stockholder’s equity is $40,000.


Parent Acquires 100% ofSubsidiary with Goodwill

Capital Stock 30,000Retained Earnings 10,000Goodwill 10,000

Investment in Skelly 50,000To eliminate reciprocal investment and equityaccounts and to assign the excess of investmentcost over book value acquired to goodwill



Prepare a consolidated balance

sheet at the date of acquisition,

including preparation

of eliminating entries.



Value)Assets Penn Skelly ConsolidatedCurrent assets Cash $ 10,000 $10,000 $ 20,000 Other current assets 45,000 15,000 60,000Total current assets $ 55,000 $25,000 $ 80,000Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000Total plant assets $ 60,000 $40,000 $100,000Investment in Skelly 50,000Goodwill 10,000Total assets $165,000 $65,000 $190,000



Value)Liabilities Penn Skelly ConsolidatedCurrent liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000Total current liabilities $ 45,000 $25,000 $ 70,000Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000Total stockholders’ equity$120,000 $40,000 $120,000Total liabilities and stockholders’ equity $165,000 $65,000 $190,000



Learn the concept of minority

interest when the parent

company acquires less than

100% of the subsidiary’s

outstanding common stock.



Value)Assets Penn Skelly ConsolidatedCurrent assets Cash $ 10,000 $10,000 $ 20,000 Other current assets 45,000 15,000 60,000Total current assets $ 55,000 $25,000 $ 80,000Plant assets $ 75,000 $45,000 $120,000 Less: Accum. depr. 15,000 5,000 20,000Total plant assets $ 60,000 $40,000 $100,000Investment in Skelly 50,000Goodwill 14,000Total assets $165,000 $65,000 $194,000



Value)Liabilities Penn Skelly ConsolidatedCurrent liabilities Accounts payable $ 20,000 $15,000 $ 35,000 Other current liabilities 25,000 10,000 35,000Total current liabilities $ 45,000 $25,000 $ 70,000Minority interest $ 4,000Stockholders’ equity Capital stock $100,000 $30,000 $100,000 Retained earnings 20,000 10,000 20,000Total stockholders’ equity$120,000 $40,000 $120,000Total liabilities andstockholders’ equity $165,000 $65,000 $194,000


Minority Interest

Minority interest in subsidiaries is generallyshown in a single amount in the liability section

of the consolidated balance sheet.

The alternatives are to include the minority interestin consolidated stockholders’ equity or to place it

in a separate minority interest section.


Minority Interest

The interest of minoritystockholders represents

equity investments in theconsolidated net assets by

stockholders of the companyaffiliated with the parent.



Prepare consolidated balance

sheets subsequent to the date

of acquisition, including

preparation of eliminating entries.


Consolidated Balance SheetAfter 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.



What is the balance in the investment inSkelly’s account at December 31?

Original investment January 1 $50,000+ 90% of Skelly’s net income 18,000

– 90% of Skelly’s dividends – 9,000Investment account balance $59,000



Capital Stock 30,000Retained Earnings 20,000Goodwill 14,000

Investment in Skelly 59,000Minority Interest 5,000

To eliminate reciprocal investment andequity balances, record goodwill, andenter the minority interest



Dividends Payable 9,000Dividends Receivable 9,000

To eliminate reciprocal dividendsreceivable and payable

Accounts Payable 5,000Accounts Receivable 5,000

To eliminate intercompany receivableand accounts payable


The separate books of the affiliatedcompanies do not record cost/book

value differentials in acquisitions thatcreate parent-subsidiary relationships.

Working paper procedures are usedto adjust subsidiary book values toreflect the cost/book differentials.

Effect of Allocation on Consolidated

Balance Sheet at Acquisition


The adjusted amounts appear in theconsolidated balance sheet.

The amount of the adjustment toindividual assets and liabilities isdetermined using an investment

cost-allocation schedule.






On Dec. 3, 2003, Pilot purchases 90% of SandCorporation’s outstanding common stock for$5,000,000 cash plus 100,000 shares of $10stock with a market value of $5,000,000.

Additional costs are $300,000.

$200,000 is recorded as cost of the investment.




AssetsCash $ 200 $ 200Net receivables 300 300Inventories 500 600Other current assets 400 400Land 600 800Building, net 4,000 5,000Equipment, net 2,000 1,700

Total assets $8,000 $9,000

Sand Corporation (000) Book Value Fair Value




LiabilitiesAccounts payable $ 700 $ 700Notes payable 1,400 1,300

Common stock 4,000Paid-in capital 1,000Retained earnings 900Total liabilities and stockholders’ equity $8,000

Sand Corporation (000) Book Value Fair Value


Investment in Sand 10,000Common Stock 1,000Additional Paid-in Capital 4,000Cash 5,000

To record 90% acquisition of Sand Corporation

Assignment of Excess Costover Underlying Equity


Investment in Sand 200Additional Paid-in Capital 100

Cash 300To record additional costs of combining withSand

Assignment of Excess Costover Underlying Equity


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

Allocation of Excess Costover Underlying Equity


Allocation of Excess Costover Underlying Equity

Inventories 600 500 90Land 800 600 180Building net 5,000 4,000 900Equipment, net 1,700 2,000 (270)Notes payable 1,300 1,400 90Total allocated 990Remainder to goodwill 3,900Total 4,890

FairValue

BookValue

× 90% = ExcessAllocated–


CashReceivables, netInventoriesOther current assetsLandBuilding, netEquipment, netInvestment in SandGoodwillUnamortized excess

Total assets

1,300 700 900 600 1,200 8,000 7,00010,200

29,900

200 300 500 400 600 4,000 2,000

8,000

b 90

b 180b 900

b 3,900a 4,890

b 270a 10,200

b 4,890

1,500 1,000 1,490 1,000 1,980 12,900 8,730

3,900

32,500

Consolidated Working PapersDecember 31, 2003

Adjustments and Consolidated Eliminations Balance

Account Title Pilot Sand Dr. Cr. Sheet


Accounts payableNotes payableCommon stockOther paid-in capitalRetained earnings

Minority interest

Total liabilities andstockholders’ 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 4,000a 1,000a 900

a 590

2,700 5,010 11,000 8,900 4,300

590

32,500






Apply the concepts underlying

preparation of a consolidated

income statement.


Consolidated Income Statement

The difference between a consolidated andan unconsolidated income statement of theparent company lies in the detail presented

rather than the net income amount.



Amortize the excess of the

investment cost over the book

value in periods subsequent

to the acquisition.


Effect of Amortization on Consolidated

Balance Sheet after Acquisition

Income for 2004:Sand’s net income $ 800,000Pilot’s income(excluding income from Sand) $2,523,500




Dividends Paid:Sand $ 300,000Pilot $1,500,000




Amortization of excess:Undervalued inventories sold in 2004

Undervalued land still heldUndervalued building (45 years useful life)Overvalued equipment (5 years useful life)Overvalued notes payable retired in 2004

Goodwill (no amortization)


CashReceivables, netInventoriesOther current assetsLandBuilding, netEquipment, netInvestment in SandGoodwillUnamortized excess

Total assets

253.5 540 1,300 800 1,200 9,500 8,000 10,504

32,097.5

100 200 600 500 6003,8001,800

7,600

b 180b 880

b 3,900a 4,744

b 216a 10,504

b 4,744

353.5 740 1,900 1,300 1,980 12,900 8,730

3,900

33,937.5





Accounts payableNotes payableCommon stockOther paid-in capitalRetained earnings

Minority interest

Total liabilities andstockholders’ equity

2,300 4,000 11,000 8,900 5,897.5

32,097.5

1,200

4,0001,0001,400

7,600

a 4,000a 1,000a 1,400

a 640

3,500 4,000 11,000 8,900 5,897.5

640

33,937.5





End of Chapter 3

an introduction to consolidated financial statements

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