chapter 4 - consolidated financial statements and outside ownership

7/25/2019 Chapter 4 - Consolidated Financial Statements and Outside Ownership

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CONSOLIDATED

FINANCIAL STATEMENTS

AND OUTSIDEOWNERSHIP

CHAPTER FOUR

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OUTSIDE OWNERSHIP

When a parent doest not hold 100% of the ownership,

the remaining outside owners are collectively referred

to as a non-controlling interest or minority interest.

A number of reasons exist for one company to hold lessthan 100% ownership of a subsidiary !arent could not have sufficient resources available to

obtain all of the outstanding stoc".

A few stoc"holders of the subsidiary could have elected toretain their ownership, perhaps in hope of getting a better

price in future.

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OUTSIDE OWNERSHIP

#he laws of some countries prohibit outsiders from

maintaining complete control of domestic business

enterprise, this is for the case of foreign subsidiaries.

A parent maintain some percentage of nativeownership with the purpose to establish better relations

with a subsidiary$s employee, customers and local

government.

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CONSOLIDATIONS INVOLVE

NONCONTROLLING INTEREST

When a noncontrolling interest outside ownerships&remains after a business combination, difficulty ariseconcerning #he appropriate consolidation values to assign to the

subsidiary$s assets and liabilities. #he method of valuing and disclosing the presence of the

other owners. 'n previous chapters, we were assuming total

ownership exist and the subsidiary$s assets andliabilities are always consolidated based on fair valueat the date of ac(uisition with any excess assigned togoodwill.

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)owever, when a company ac(uires less than

100% of a subsidiary, several different method

exist to calculate the consolidated values of the

ac(uired accounts. *xample 1 Assume +mall ompany posses net

asset with the following value

oo" value 110,000

/air value of identifiable net assets ex. oodwill& 10,000

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*xample 1 ig ompany purchase 2,000 20%& of the 10,000

outstanding voting stoc" shares of +mall for 30 per share. #herefore, the fair value for +mall as a whole is 300,000

10,000 x 30&

4ow, (uestion arise on What amounts should the parent report for the ac(uired

subsidiary$s assets and liabilities when ac(uired less than

100%. )ow does the valuation for these ac(uired net assets affect

the amount reported for the noncontrolling interest5

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#he first method re(uired that +mall ompany$sentire 300,000 fair value should serve as thevaluation basis for both the parent and the

noncontrolling interest share of the subsidiary netassets. ecause they views that management has

effectively controls100% of the net assets

ac(uired. #his method is referred to as the economic unit

concept.

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#he second method simply values the

noncontrolling interest and its share of the

subsidiary net assets at 6ero.

#his approach reflects the strict interpretation ofthe cost principle by incorporating only the

percentage ac(uired by the parent.

And this method as referred to as the proportionateconsolidation concept.

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#he third method continue reflect the cost principle 3nd

method&, but also assigns a value to the noncontrolling

interest shares.

ecause the parent only purchased 20% of thesubsidiary$s shares, only this percentage of the

subsidiary$s net assets are valued at the parent$s cost.

#he noncontrolling interest, 0% of the net assets

remains at the subsidiary$s former boo" value andcarry over.

#his approach view as the parent company concept.

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NONCONTROLLING INTEREST:

THE ECONOMIC UNIT CONCEPT

#he 3007 /A+ *xposure 8raft were adopting this

concept.

Where a controlled company must always be

consolidated as a whole regardless of the parent$s levelof ownership.

ecause it gives the best view of the assets and

liabilities that have come under the control of the

parent company.

As previous example, ig ac(uire +mall, the 30 price

share paid by ig for its 2,000 shares is assumed to be

e(uivalent to the value of all 10,00 of +mall$s.

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#herefore, all subsidiary$s assets and liabilities are

included at their fair values with any excess

assigned to goodwill.

/air value of +mall purchase price& 300,000/air value of +mall$s net assets 10,000

/air value not assigned 9 oodwill 20,000

4oncontrolling interest 0% of 300,000& :0,000

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*ven +mall$s outside owners do not possess an

e(uity interest in the parent company, the :0,000

balance is presented within the consolidated

stoc"holder$s e(uity section. #he outside parties own a component part of the

resulting business combination, thus their interest is

viewed as an ownership balance to be reportedwithin the consolidated balance sheet.

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/or income statement, parent company will

recogni6es 100% of the subsidiary$s revenue and

expenses balances.

#he ob;ective of reporting subsidiary as aninseparable unit within the consolidated entity.

And, also effectively reports the income generated

by the net assets under the control of the parentcompany.

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/or ig ac(uisition of +mall, 100% of the

subsidiary revenue and expenses are included in the

consolidated figure.

)owever, since parent only own 20% of +mall, a0% claim to subsidiary$s earnings must be

deducted separately in recognition of the

noncontrolling interest.

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THE PROPORTIONATE CONSOLIDATION CONCEPT

#his approach assumes that ultimate ob;ective of

consolidated financial statements is to serve as a

report to stoc"holders of the parent company.

#he value utili6ed for consolidation reflect theparent$s payment attributed to each asset and

liability.

*.g. +mall owns land with a boo" value of


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#herefore, under this approach, only >?,000 of

goodwill is recogni6ed.

!urchase price @10,000 x 20%& x 30 1>0,000

/air value of +mall$s net assets 10,000 x 20%& ?1,000

ost excess of fair value 9 oodwill >?,000

4oncontrolling interest 0

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A uni(ue feature of proportionate consolidation is the

reporting of the noncontrolling interest, where

consolidated statements totally ignore these outside

owners. ecause this theory hold that the presence of a

noncontrolling interest is irrelevant to the stoc"holders

of the parent company.

'n other words, an outside owner of a subsidiary has nocapital invested in the parent company and the parent

has no legal obligation to this outside ownership.

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/or income statement reporting, ta"en ig as

example, ig will only include 20% of each of the

subsidiary$s revenue and expenses accounts in the

consolidated balances.

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THE PARENT COMPAN CONCEPT

#his approach is viewed as hybrid mixture& methodbecause it incorporates the assumptions of economicunit concept and proportionate consolidation )olding control of a subsidiary provides the parent an

inseparable interest in that company= and #he parent company primarily produces consolidated

financial statements for the benefit of its stoc"holders.

#he subsidiary$s boo" value and the purchase price the

parent paid are viewed as separate elements that can beaccounted for individually within the consolidationprocess.

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/or ig ompany example

!urchase price @10,000 x 20%& x 30 1>0,000

oo" value of +mall 100%& 110,000

Bess Cecognition of noncontrolling interest 0%& ,000& 22,000ost in excess of boo" value :,000

Allocation on fair value excess boo" value@10,000 - 110,000& x 20% 1>,000&

oodwill >?,000

4oncontrolling interest 110,000 x 0%& ,000

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#he subsidiary$s boo" value is consolidated in total

whereas any cost in excess of boo" value is

assumed to be a parent company expenditure

appropriately allocated based on fair values. /or the income statement, the entire amount of

each subsidiary revenue and expenses account is

included in the total and the outside ownership

share of the subsidiary$s net income is identified

with the noncontrolling interest.

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THANK YOU

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TUTORIAL !UESTIONS

1. 8efine the term noncontrolling interest.

3. Airway orporation ac(uires

chapter 4 - consolidated financial statements and outside ownership

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