Consolidated Financial Statements and Outside Ownership

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Agenda for Chapter 4

· Consolidated Financial Statements and Outside Ownership

– When parent company holds less than 100% ownership Reading Assignments:http://studiestime.com/

Learning Objectives

1. Understand that complete ownership is not a prerequisite for the formation of a business combination.2. Describe the valuation principles underlying the

acquisition method of accounting for the noncontrolling interest.

3. Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests.

4. Demonstrate the computation and allocation of consolidated net income in the presence of a noncontrolling interest.

Learning Objectives

5. Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest.

6. Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements.

7. Determine the effect on consolidated financial statements of a control premium paid by the parent.

Learning Objectives

8. Understand the impact on consolidated financial statements of a midyear acquisition.

9. Understand the impact on consolidated financial statements when a step acquisition has taken place.

10. Record the sale of a subsidiary (or a portion of its share).

Learning Objective 1

Understand that complete ownership is not a prerequisite for the formation of a business combination.

Consolidation General Rule

WHEN DO WE CONSOLIDATE?

• When one company is able to control the decision making process of another entity!!

• You don’t need complete ownership of the stock of the other company to control it..

Learning Objective 2

Describe the valuation principles underlying the acquisition method of accounting for the noncontrolling interest.

Noncontrolling Interest Definition

• Noncontrolling (Minority) interest is the ownership interests in the subsidiary that are held by owners other than the parent.

Noncontrolling Interest Reasons

• A number of reasons exist for one company to hold less than 100% ownership of a subsidiary. Some examples:– Can still have control with 51% and it cost less

than acquiring 100%– Takeover bids jack up share– Prohibited by foreign laws– Retain relationship with local investors / native

ownership

Valuation Issues

• We must assign values to the noncontrolling interest’s share of the subsidiary’s assets and liabilities.

• We must value and disclose the presence of the other owners.

• KEY: Fair Market Value– Acquisition method uses fair value– Fair value helps investors and creditors assess the

success of the combination.

Noncontrolling Interest Accounting Implications

• The interests of the noncontrolling (non-parent stockholders must be reflected in the consolidated financial statements.

• The existence of noncontrolling investors requires the establishment of two new accounts:– Noncontrolling (Minority) Interest BALANCE SHEET– Noncontrolling (Minority) Interest in Subsidiary Net

Income (Noncontrolling Interest’s share of Subsidiary’s Net Income) INCOME STATEMENT

Assume parent acquires 70% of subsidiary’s shares outstanding on the acquisition date:

What values are used on the Consolidated Balance Sheet on the Date of Acquisition??

Acquisition Method Noncontrolling Interest

• If a noncontrolling interest is present then measuring fair value can create some complications.– We still measure the assets and liabilities at FMV– We measure the noncontrolling interest at FMV– We still measure Goodwill or a gain from a bargain

purchase.• We have to measure the FMV of the controlling and

noncontrolling interest separately.– Is it worth more to be in control?– The fair value of the entity is the total of the fair value of

both interests.

Acquisition Method Noncontrolling Interest

• If the Fair Value of the entity is greater than the fair value of the net identifiable assets, what do we have?– Goodwill

• If the Fair Value of the entity is less than the fair value of the net identifiable assets, what do we have?– A bargain purchase and a gain

Acquisition Method Noncontrolling Interest

Acquisition date fair value of the acquired firm required independent valuations for:1. The fair value of the controlling interest

- Fair value of consideration transferred.2. The fair value of the noncontrolling interest

- Readily available market trading activity surrounding the acquisition if available

- Otherwise use one of the following:- comparable investments - discounted future cash flows- FV of noncontrolling interest at acquisition may be the consideration paid by parent if there was no control premium.

Noncontrolling Interest

Fair Value Evidenced by Market Trades Example 1

Big Bird Company acquired 90% of the 20,000 outstanding shares of Sally Company.

To induce a sufficient number of shareholders to sell, Big Bird ended up paying

$35/share, despite the fact that the shares had been trading in the $29 to $31 range. (18,000 x 35 = $630,000)

During the weeks following the acquisition, the 10% noncontrollinginterest in Sally Company continues to trade in the $29 to $31 range. (approx

$30 average trading price x 2,000 shares = $60,000) The identifiable assets and liabilities at Sally Company are valued at$600,000 at acquisition date.

What is the FV of the controlling and noncontrolling interest? What is Goodwill?

1. Determine the fair value of Sally Company @ acquisition date

630,000$60,000$

Totalacquisition-datefairvalueofSally Company 690,000$

FairvalueofcontrollinginterestFairvalueofnoncontrollinginterest

2. Calculate goodwill

690,000$600,000$

Goodwill 90,000$Fairvalueofnetidentifiableassets/liabilitiesacquiredTotalacquisition-datefairvalueofSally Company

Learning Objective 3

Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests.

Noncontrolling Interest Allocation of Goodwill

Goodwill is first allocated to the controlling interest for the excess of the fair value of the parent’s equity interest over its share of the fair value of the net identifiable assets.

Any remaining goodwill is then attributed to the noncontrolling interest.

Bottom line:Goodwill allocated to controlling and

noncontrolling interest will NOT always beproportional to the % owned.

3. Allocate goodwill to controlling and noncontrolling interest

For Controlling Interest• Fair Value at Acquisition date $630,000• Fair Value of assets/liabilities acquired 540,000• Goodwill Allocated to Controlling Interest $ 90,000

For Non-ControllingInterest• Fair Value at Acquisition date $ 60,000• Fair Value of assets/liabilities acquired 60,000• Goodwill Allocated to Non-Controlling Interest 0

$600,000 FV of identifiable net assets * 90% = $540,000$600,000 FV of identifiable net assets * 10% = $60,000

Scenerio 2 - Fair Value is Implied by Parent’s Consideration Transferred

• Sometimes when a large percentage of the voting stock is purchased, the consideration paid by the parent may actually reflect the fair value for both the controlling and noncontrolling interest.– The remaining shares may not be actively traded.

Noncontrolling Interest Fair Value is Implied by Parent’s Consideration Transferred Example 2

Big Bird Company acquired 90% of the 20,000 outstanding shares ofSally Company. The remaining 1,000 noncontrolling interest shares are not activelytraded. There was no compelling evidence that the $35 acquisition price wasnot representative of all of Sally’s 20,000 shares. The identifiable assets and liabilities at Sally Company are valued at$600,000 at acquisition date.

1. Determine the fair value of Sally Company @ acquisition date

630,000$70,000$

Totalacquisition-datefairvalueofSally Company 700,000$

FairvalueofcontrollinginterestFairvalueofnoncontrollinginterest

2. Calculate goodwill

700,000$600,000$

Goodwill 100,000$Fairvalueofnetidentifiableassets/liabilitiesacquiredTotalacquisition-datefairvalueof Sal

lyCompany

3. Allocate goodwill to controlling and noncontrolling interest

LO 4

• Demonstrate the computation and allocation of consolidated net income in the presence of a noncontrolling interest.

Noncontrolling Interest Allocation of Net Income

• Assume parent acquires 70% of subsidiary’s shares outstanding on the acquisition date. A year later,

Noncontrolling Interest Allocation of Net Income (Cont’d)

• On the income statement:

Concept of IncomeSubsidiary’s adjusted net income = Subsidiary’s reported net income Less: Annual excess amortization

Subsidiary’s adjusted net income is split

Controlling interest’s share of Subsidiary’s net income

Noncontrolling interest’s share of Subsidiary’s net income

Concept of IncomeConsolidated net income = Parent’s own net income (not including investment income from Subsidiary) Plus: Subsidiary’s adjusted net income (per the prior slide). Net income to the controlling interest =Consolidated net income Less: Noncontrolling interest’s share of Subsidiary’s net income or

Parent’s own net income Plus: Controlling interest’s share of Subsidiary’s netincome

Noncontrolling Interest Big Bird company acquired 70% of the 10,000 outstanding shares of Sally

Company on January 1, 2015. During 2015, Sally reported revenues of $280,000 and expenses of $200,000.

Big Bird reported revenues of $900,000, not including any income from Sally, and expenses of $400,000.

Assume the annual excess fair value amortization results from increasing

Sally’s acquisition date book values to fair values is $30,000 for the first year.

Please calculate for 2015, (1) controlling interest (Big Bird)’s share of Sally’s net

income , (2) noncontrolling interest’s share of Sally’s net income, (3) consolidated net income, and (4) net income to controlling interest (Big Bird)

1. Determine subsidiary's net income

2. Allocate subsidiary's net income to controlling and noncontrolling interest

$50,000 x .7 = $35,000$50,000 x .3 = $15,000

3. Consolidated net income

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4. Net income to controlling interest

LO 5

• Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest.

What are the four noncontrolling interest numbers?

• Noncontrolling interest in the subsidiary as of the beginning of the current year.

• Net income attributable to the noncontrolling interest.

• Subsidiary dividends attributable to the noncontrolling interest.

• Noncontrolling interest as of the end of the year (found by combining the three balances above).

Noncontrolling Interest Consolidation Example

CookieMonster Company acquired 80% of Yummy Company’s 100,000 outstanding voting shares on January 1, 2015, for $9.75/share. (9.75 x 80,000 = $780,000)

The 20% noncontrolling interest shares traded both before and after

the acquisition date at an average of $9.75/share. (9.75 x 20,000 = $195,000)

Additional Data is on the next slide…….

Basic Consolidation Information

Book Values @ January 1, 2015 Fair Values @ January 1, 2015 DifferencesCurrent assets 440,000$ 440,000 - Trademarks (indefinite) 260,000 320,000 60,000 Patented Technology (20-year life) 480,000 600,000 120,000 Equipment (10-year life) 110,000 100,000 (10,000) Long-term liabilities (550,000) (510,000) 40,000

Net Assets 740,000 950,000 210,000

Common Stock (230,000) Retained earnings, 1/1/15 (510,000)

Yummy

Company

Questions?????

Q1: Please calculate Yummy’s total fair value at January 1, 2015.

Q2a: Please calculate goodwill and allocate goodwill

between controlling and noncontrolling interest. Q2b: Please prepare excess cost over book value

allocation schedule and calculate annual excess amortization/depreciation.

1. Determine the fair value of Yummy Company @ acquisition date

Q1: Please calculate Yummy’s total fair value at January 1, 2015.

780,000$195,000$975,000$Yummy totalfairvalueat January1,2015

ConsiderationtransferredbyCookie MonsterNoncontrollinginterestfairvalue

2a. Allocate goodwill to controlling and noncontrolling interest

Q2a: Please calculate goodwill and allocate goodwill between controlling and noncontrolling interest.

$950,000 FV of identifiable net assets x 80% = $760,000$950,000 FV of identifiable net assets x 20% = $190,000

ControllingInterest Total$ 780,000 $ 975,000

760,000$ 950,000$

20,000$ 25,000$Goodwill 5,000$

RelativefairvalueoFYummysidentifiablenetassets 190,000$Fairvalueatacquisitiondate

NoncontrollingInterest$ 195,000

Basic Consolidation Information

YummyBook Values @ January 1, 2015 Fair Values @ January 1, 2015 Differences

Current assets 440,000$ 440,000 - Trademarks (indefinite) 260,000 320,000 60,000 Patented Technology (20-year life) 480,000 600,000 120,000 Equipment (10-year life) 110,000 100,000 (10,000) Long-term liabilities (550,000) (510,000) 40,000

Net Assets 740,000 950,000 210,000

Common Stock (230,000) Retained earnings, 1/1/15 (510,000)

Company

2b. Prepare allocation schedule and calculate annual excess amortization

Yummy975,000$

' acquisition-date book value 740,000$ Excess of fair value over book value 235,000$

Remaining AnnualExcessAllocations made to specific accounts: Life Amort. /Depre.

60,000 Indefinite -120,000 20 6,000 (10,000) 10 (1,000) 40,000 210,000$ 8 5,000

10,000 Goodwill 25,000$

Trademarks (indefinite life)Patented Technology (20-year life)Equipment (10-year life)Long-term liabilities (8 years to maturity)

Acquisition-DateFairValueAllocationSchedule' acquisition-date fair value

Noncontrolling Interest Consolidation Example (Cont’d)

In 2015 and 2016, Yummy Company reported net incomes of$70,000 and $90,000, respectively. Q3: Please allocate Yummy’s net income between Controlling

Interest and Non-Controlling Interest.Allocation of Yummy's Net Income

Yummy's RevenuesYummy's ExpensesYummy's Net IncomeLess: Excess Acquisitions Date Fair Value AmortizationYummy's Net Income Adjusted for Excess Amortization

3. Allocate Yummy's net income between controlling and noncontrolling interest in 2015

Yummy's Net Income in 2015 70,000 Annual Excess Amortization (10,000) Yummy's Net Income Adjusted 60,000 2015 Split of Yummy's Adjusted Net Income: Non Controlling Interest Share (20%) 12,000

Controlling Interest Share (80%) 48,000

How do we allocate Yummy's net income between controlling and noncontrolling interest in 2016?

Yummy's Net Income in 2016 90,000

Annual Excess Amortization (10,000)

Yummy's Net Income Adjusted 80,000

2016 Split of Yummy's Adjusted Net Income:

Non Controlling Interest Share 16,000

Controlling Interest Share 64,000

Formulas to MemorizeEquity Method When Noncontrolling Interest Present

In 2015, Yummy Company reported net income of $70,000 and distributed no dividend. In 2016, Yummy Company reported net income of $90,000 and distributed dividend of $50,000.

CookieMonster’s Investment in Yummy Company @ 12/31/2016= Fair value of the consideration transferred at acquisition $780,000 + earnings accrued(CI) ((70,000+90,000)*.8) + 128,000– cash dividends (CI) (50,000 * .8) - 40,000- annual excess amortization expenses (CI) = - 16,000 Investment In Yummy 12/31/2016 $852,000

Formulas to Memorize

CookieMonster’s Equity in Yummy’s earnings @ 12/31/2016= Earnings accrued during 2016 (CI) $72,000- annual excess amortization expense in 2016 (CI) = 8,000Equity in Yummy Earnings $64,000 Noncontrolling Interest Share in Yummy’s earnings @ 12/31/2016 =Earnings accrued during 2016 (NCI) $18,000 - annual excess amortization expense in 2016 (NCI) - $2,000 Noncontrolling Interest in Yummy’s Earnings $16,000

Formulas to Memorize

Non controlling interest in Yummy Company @ 12/31/2016 =Fair value at acquisition $195,000 + earnings accrued(NCI) (70,000 + 90,000 = 160,000 X 20%) + 32,000– cash dividends (NCI) = (50,000 X 20%) – 10,000 - annual excess amortization expenses (NCI) ) – 4,000Noncontrolling interest in Yummy $213,000

Consolidating entries• Still “SAIDE”• Add a column for the noncontrolling interest• Entries S & A recognize the noncontrolling interest BOY

balance and sub’s information at 100%.• I,and D are just the parent and are recognized at

ownership % (less than 100%).• E recognizes current income effects from excess

acquisition date fair-value allocations.• NEW: Then add dividends paid and sub’s net income for

noncontrolling interest

Basic Consolidation InformationYummy Company

In 2015, Yummy Company reported net income of $70,000 and distributed no dividend. In 2016, Yummy Company reported net income of $90,000 and distributed dividend of $50,000.

$740,000 BV @ 1/1/15 .8 x 740,000 = 592,000 CI , .2 x 740,000 = 148,000 NCI

Book Values @ January 1, 2015 Fair Values @ January 1, 2015 DifferencesCurrent assets 440,000$ 440,000 - Trademarks (indefinite) 260,000 320,000 60,000 Patented Technology (20-year life) 480,000 600,000 120,000 Equipment (10-year life) 110,000 100,000 (10,000) Long-term liabilities (550,000) (510,000) 40,000

Net Assets 740,000 950,000 210,000

Common Stock (230,000) Retained earnings, 1/1/15 (510,000)

Entry S Calculation

Entry “S” – 12/31/16Common Stock (Yummy) 230,000Retained earnings 1/1 580,000* Investment in Yummy (80%) 648,000** NCI in Yummy 1/1 (20%) 162,000

*510,000 R/E 1/1/15 **592,000 BV at purchase 70,000 NI 2015 56,000 NI (70,000) x 80% 580,000 R/E 12/31/15 648,000 Investment Bal.

Noncontrolling InterestBV at Purchase 148,000NI (70,000 X .2) 14,000NCI in Yummy 162,000

2b. Prepare allocation schedule and calculate annual excess amortization

975,000$ acquisition-date book value 740,000$

Excess of fair value over book value 235,000$ Remaining AnnualExcess

Allocations made to specific accounts: Life Amort. /Depre.60,000 Indefinite -

120,000 20 6,000 (10,000) 10 (1,000) 40,000 210,000$ 8 5,000

10,000 Goodwill 25,000$

Trademarks (indefinite life)Patented Technology (20-year life)Equipment (10-year life)Long-term liabilities (8 years to maturity)

Acquisition-DateFairValueAllocationSchedule acquisition-date fair value

Account Unamortized BalanceTrademark (60,000-0) 60,000Patented Technology (120,000 – 6) 114,000Equipment (10,000-1) (9,000)Long-term Liabilities (40,000-5) 35,000Goodwill (25,000 – 0) 25,000

Worksheet for Entry A

Entry “A” – 12/31/16

Trademark 60,000Patent 114,000Liabilities 35,000Goodwill 25,000

Equipment 9,000Investment in Yummy (80%) 180,000NCI in Yummy 1/1 (20%) 45,000

Entry “I” - 12/31/16

Equity in Yummy’s income 64,000 Investment in Yummy 64,000

90,000 NI 2016(10,000) annual excess amort80,000 adj NI 2016.8 x 80,000 = 64,000

Entry “D” – 12/31/16

Investment in Yummy 40,000Dividends Paid 40,000

$50,000 x .8 = 40,000

Entry “E” – 12/31/16

Amortization expense 6,000Interest expense 5,000Equipment 1,000

Depreciation expense 1,000Patent 6,000Long-term liabilities 5,000

NonControlling Interest Column

NCI (Non-controlling interest) Columnar Adjustments

• Then add non-controlling interest in sub’s net income

• Subtract dividends paid

BOY balance (S&A) 207,000 (162,000+45,000)Add: subs NI 16,000 ((90,000 X .2) – 2,000)Less: div. pd (10,000) (50,000 X .2) NCI year $ 213,000

Cookie Monster Yummy Noncontrollin g Controlling Accounts Company Company Interest InterestRevenues (910,000) (430,000) (1,340,000) Cost of Goods Sold 344,000 200,000 544,000 Depreciation Expense 60,000 20,000 E 1,000 79,000 Amortization expense 100,000 75,000 E 6,000 181,000 Interest expense 70,000 45,000 E 5,000 120,000 Equity in Yummy NI (64,000) - I 64,000 - Separate company income (400,000) (90,000)

Consolidated Net Income (416,000) Noncontrolling interes in Yummy Income (16,000) 16,000 Net Income to Controlling Interest (400,000)

- Retained Earnings 1/1 (860,000) (580,000) S 580,000 (860,000) Net Income (above) (400,000) (90,000) (400,000) Dividends Paid 60,000 50,000 D 40,000 10,000 60,000 Retained Earnings 12/31 (1,200,000) (620,000) (1,200,000)

- Current Assets 726,000 445,000 1,171,000 Trademarks 304,000 295,000 A 60,000 659,000 Patented Technology 880,000 540,000 A 114,000 E 6,000 1,528,000 Equipment (net) 390,000 160,000 E 1,000 A 9,000 542,000 Investment in Yummy Co. 852,000 - D 40,000 S 648,000 -

A 180,000 I 64,000

Goodwill - - A 25,000 25,000 Total Assets 3,152,000 1,440,000 3,925,000

- Long-term Liabilities (1,082,000) (590,000) A 35,000 E 5,000 (1,642,000) Common Stock (870,000) (230,000) S 230,000 (870,000)

- -

Noncontrolling interest in Yummy 1/1 S 162,000 A 45,000 (207,000)

Noncontrolling interest in Yummy 12/31 (213,000) (213,000) Retained Earnings 12/31 (1,200,000) (620,000) (1,200,000) Total Liabilities and Equities (3,152,000) (1,440,000) (3,925,000)

Consolidated Entries

LO 6

• Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements.

Consolidated Income Statement

Noncontrolling Interest Consolidated Income Statement

Consolidated income statement requires aseparate line to represent noncontrollinginterest’s share of subsidiary’s net income.Net income to controlling interest= Parent’s NI

Consolidated Statement of Changes in Owners’ Equity

Noncontrolling Interest Consolidated Statement of RE

Under equity method, the parent’sstatement of RE is always the same asconsolidated statement of RE, even when noncontrolling ownership present.

Consolidated Balance Sheet

LO 7

• Determine the effect on consolidated financial statements of a control premium paid by the parent.

Partial Acquisition With Control Premium

• The identifiable assets are all revalued to FMV.• The goodwill may not be split in proportion to

the ownership.– Controlling interest may have paid a higher price

than the stock is trading at.– Remember that more goodwill may be allocated

to the controlling interest!

How does this effect the consolidation?

• May have to make two entries for entry A (A1 and A2).– A1 writes the identifiable assets up to FMV

• The Investment and NCI are split in proportion to the ownership for this entry.

– A2 is to write up the Goodwill• The Investment and NCI are not split in proportion to

the ownership.• Split the goodwill based upon how much is going to the

controlling interest. The NCI gets the balance.

Problem 28

LO 8

• Understand the impact on consolidated financial statements of a midyear acquisition.

How do we handle a mid-year acquisition?

• Only post acquisition subsidiary revenues and expenses are consolidated.

• Consolidated revenues and expenses do not include the subsidiary’s current year preacquisition revenues and expenses.

Problem 26

LO 9

• Understand the impact on consolidated financial statements when a step acquisition has taken place.

Step Acquisitions

• The parent obtains control of the subsidiary by making several separate purchase over time.

• When control is achieved all assets and liabilities are revalued to FMV– Including the ones obtained before control was achieved!!– A gain or a loss may be recognized.

• The FMV of the acquired company is the FMV of the prior investments, the consideration transferred for the current investment, and the FMV of the noncontrolling interest.

Step Acquisitions

• If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place.

• If additional shares are acquired after the parent already has control then the difference between the fair value of the consideration transferred and the underlying subsidiary valuation is an adjustment to Additional Paid-In-Capital.

Problem 25

Problem 41

LO 10

• Record the sale of a subsidiary (or a portion of its share).

What happens when the parent sells share.

• It eliminates a portion of the investment account. – If the equity method was not used the parent’s investment

balance is adjusted to recognize any income or amortization that was previously omitted. The resulting balance is compared to the amount received for the stock. An adjustment is made.

• If control is maintained the adjustment is made to paid in capital.• If control is not maintained a gain or loss is recognized.

– Shares held after the sale will be reported using consolidation, the equity method, or the fair-value method.

• It depends on the influence retained by the parent…

Summary Consolidation when Noncontrolling Interest Present

· Control does not require total ownership. Ownership ofsubsidiary stock retained by outside, unrelated parties is callednoncontrolling (minority) interest. · An equity account must be created on consolidated balancesheet to represent noncontrolling interest. · An income account must be created on consolidated incomestatement to represent noncontrolling interest in subsidiary netincome. · Consolidated statement of retained earnings should be the sameas parent’s statement of retained earnings, if equity method isapplied.