Consolidated financial statement: an intro

Consolidated financial statement: Acquisition at Book ValueArthik Davianti

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One-line consolidationWorking paperSituations of acquisitionIllustration

One-Line Consolidation

Equity Method A One-line ConsolidationThe investment is reported in a single amount on one line of the investors balance sheetInvestment income is reported in a single amount on one line of the investors income statement A parent-company/investors income and stockholders equity are the same under a complete and correct application of equity method, and the financial statement of a parent and subsidiary are consolidated

Equity Investments at Acquisition (reminder)Investment cost in voting common stock of other entities measured by cash disbursed or the fair value of other assets distributed or securities issuedDirect cost charged against additional paid-in capitalExpense other direct costs of acquisition

Equity Investments at AcquisitionPayne Co purchases 30% of Sloan Cos outstanding voting common stock on January 1 from existing stockholders for $2,000,000 cash plus 200,000 shares of Payne Co $10 par common stock with a market value of $15 per share. Additional cash costs of the equity interest consist of $50,000 for registration of the shares and $100,000 for consulting and advisory fees.

Note:Under a one-line consolidation, entry can be made without the knowledge of book value or fair value of Sloan Cos assets and liabilities.

Equity Investments at AcquisitionJanuary 1:Investment in Sloan (+A)5,000 Common stock (+SE)2,000 Additional paid-in capital (+SE)1,000 Cash (-A)3,000 To record acquisition in Sloan CoJanuary 1:Investment expense (E, -SE) 100Additional paid-in capital (-SE) 50 Cash (-A) 150 To record additional direct costs

Consolidation Worksheet

Worksheet (Working Paper) for ConsolidationAssignment schedule and allocation of the difference between cost of investment and book valueImportant issues:Ownership percentage in subsidiary (100% wholly-owned or less than wholly)Compare investment cost with net assets book value any purchase differential should be assign to adjust assets and/or liabilities acquired

Situations of Acquisition

Difference between investment cost and book value Situation 1Investment cost = subsidiarys net assets book value; and parent company acquires 100% or less than 100% subsidiarys common stock Situation 2Investment cost > subsidiarys net assets book value; and parent company acquires 100% or less than 100% subsidiarys common stock Situation 3Investment cost < subsidiarys net assets book value; and parent company acquires 100% or less than 100% subsidiarys common stock

Situation 1Worksheet

at the Date of Acquisition(100% ownership)

Wholly-owned Subsidiary (100 Percent Ownership) at Book ValuePeerless acquires all of Special Foods outstanding common stock for $300,000 in 20X1, equal with the fair value of Special Food as a whole. Fair value of Special Foods individual assets and liabilities are equal with its book value.

The balance sheets show that the total book value of the shares acquired equals the total stockholders equity of Special Foods ($200,000 + $100,000)

Investment in Special Foods300,000 Cash300,000 To record purchase of Special Food stockWholly-owned Subsidiary (100 Percent Ownership) at Book Value

The separate financial statements of Peerless and Special Foods immediately after the combination.

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Investment Elimination EntryBasic Elimination EntryTotalCommonRetainedBook ValueStockEarningsOriginal Book Value300,000200,000100,000=+Common Stock200,000Retained Earnings100000Investment in Special Foods300,000

Objective:Eliminate equity accounts of SubEliminate equity method accounts of Parent.Book Value Calculations

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Worksheet at date of acquisition

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Worksheet at date of acquisitionPeerless ProductsSpecial FoodsCommon stock, January 1, 20X1500,000200,000Retained earnings, January, 20X1300,000100,00020X1: Separate operating income, Peerless Net income, Special Foods Dividends140,000

60,00050,00030,00020X2: Separate operating income, Peerless Net income, Special Foods Dividends160,000

60,00075,00040,000

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Initial Year of OwnershipParent Company EntriesInvestment in Special Foods50,000Income from Special Foods50,000To record Peerless 100% share of Special Foods 20X1 incomeDuring 20X1, Peerless records operating earnings of $140,000, excluding its income from investing in Special Foods, and declares dividends of $60,000. Special Foods reports 20X1 net income of $50,000 and declares dividends of $30,000.Cash50,000Investment in Special Foods50,000To record Peerless 100% share of Special Foods 20X1 dividend

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Initial Year of OwnershipBasic Elimination EntryTotalCommonRetainedBook ValueStockEarningsOriginal Book Value300,000200,000100,000+ Net Income50,00050,000Dividends(30,000)(30,000)Ending Book Value320,000200,000120,000=+Common Stock200,000Retained Earnings100,000Income from Special Foods50,000Dividends Declared30,000Investment in Special Foods320,000

Lets do the Working Sheet for 20X1

Illustration of Situation 1Worksheet

Subsequent years (100% ownership)

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Second & Subsequent YearsParent Company EntriesInvestment in Special Foods75,000Income from Special Foods75,000To record Peerless 100% share of Special Foods 20X2 incomeAfter 2 years, Peerless separate income from its own operation for 20X2 is $160,000, and its dividends total $60,000. Special Foods reports net income of $75,000 in 20X2 and pays dividends of $40,000. Investment in Special Foods increases to $355,000 and reported net income of Peerless totals $235,000 ($160,000 + $75,000).Cash40,000Investment in Special Foods40,000To record Peerless 100% share of Special Foods 20X2 dividend

Wholly-owned Subsidiary (100 Percent Ownership) at Book Value Initial Year of OwnershipBasic Elimination EntryTotalCommonRetainedBook ValueStockEarningsOriginal Book Value320,000200,000120,000+ Net Income75,00075,000Dividends(40,000)(40,000)Ending Book Value355,000200,000155,000=+Common Stock200,000Retained Earnings120,000Income from Special Foods75,000Dividends Declared40,000Investment in Special Foods355,000

Lets do the Working Sheet for 20X2

Concepts of consolidated financial statements

Consolidation: The ConceptParent creates or gains control of the subsidiary.The result: a single legal entity.PS

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ParentCompanySub CSub BSub A

80%51%21%ReviewHow do we report the results of subsidiaries?Consolidation(plus the Equity Method)Equity Method

Consolidated Financial StatementsConsolidated financial statements present the financial position and results of operations for: a parent (controlling entity) and one or more subsidiaries (controlled entities) as if the individual entities actually were a single company or entity.

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Benefits of Consolidated FinancialStatementsPresented primarily for those parties having a long-run interest in the parent company:shareholders, long-term creditors, or other resource providers.Provide a means of obtaining a clear picture of the total resources of the combined entity that are under the parent's control.

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Limitations of Consolidated Financial StatementsResults of individual companies not disclosed (hides poor performance). Financial ratios are not necessarily representative of any single company in the consolidation.Similar accounts of different companies may not be entirely comparable.Information is lost any time data sets are aggregated.

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Subsidiary Financial StatementsCreditors, preferred stockholders, and noncontrolling common stockholders of subsidiaries are most interested in the separate financial statements of the subsidiaries in which they have an interest.Because subsidiaries are legally separate from their parents,the creditors and stockholders of a subsidiary generally have no claim on the parent, and the stockholders of the subsidiary do not share in the profits of the parent.

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Concepts and StandardsTraditional view of control includes:

Direct control that occurs when one company owns a majority of another companys common stock. Indirect control or pyramiding that occurs when a companys common stock is owned by one or more other companies that are all under common control.

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Concepts and StandardsAbility to Exercise ControlSometimes, majority stockholders may not be able to exercise control even though they hold more than 50 percent of outstanding voting stock. Subsidiary is in legal reorganization or bankruptcyForeign country restricts remittance of subsidiary profits to domestic parent companyThe unconsolidated subsidiary is reported as an intercorporate investment.

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Concepts and StandardsPXZXYPZ0.800.600.900.400.700.30Indirect Control

Concepts and StandardsWXYPZ0.900.800.150.300.800.15

Noncontrolling InterestOnly a controlling interest is needed for the parent to consolidate the subsidiarynot 100% interest.Shareholders of the subsidiary other than the parent are referred to as noncontrolling shareholders.Noncontrolling interest or refers to the claim of these shareholders on the income and net assets of the subsidiary.ParentSub>50%

50%