Consolidated Financial Statements

1
Chapter 6

• Consolidated Financial Statements
• Subsequent to Acquisition Date
• Cost Method

2
Learning Objectives

• To prepare consolidated financial statements when
  the parent uses the COST METHOD of accounting
• Balance sheet
• Income Statement
• Statement of Retained earnings
• We will look
• Year of Acquisition
• One year after acquisition
• Two years after acquisition

3
Learning Objectives

• To describe the preparation of consolidated
  statements when the subsidiary is acquired on a
  date other than the fiscal year-end, or when the
  subsidiary has discontinued operations or
  extraordinary items
• Chapter deals with COST METHOD (most popular)

4
Consolidation background

• Parent maintains its set of books because it is a
  separate legal entity.
• Parent makes journal entries related to its
  investment
• Upon consolidation, we are looking at the parent
  and sub together as a combined entity so we must
  eliminate these entries

5
Method of Accounting for an Investment in a
Subsidiary

• Parents journal entries (cost method)
• When parent buys sub, it records an one-time
  investment
• Investment in sub xxx
• Cash xxx
• This investment is always shown on the parents
  balance sheet so we must remove it when we
  consolidate
• Parent makes one entry each year to record
  dividends received from sub
• Cash xxx
• Dividend revenue xxx
• We must remove the dividend revenue because it is
  not external

6
Consolidation background

• Other issues
• We must add goodwill to the balance sheet
• We must recalculate the Retained Earnings balance

7
Consolidation from the Cost Method

• Bookss approach to consolidation from the cost
  method is simply to update the investment account
  and to compute income as if the equity method had
  been used, instead of the cost method
• As equity method income is exactly equal to
  consolidated income, this approach is certainly
  valid, and provides useful check digits for
  preparation of consolidated statements
• This approach involves filling in the gaps in the
  investment account for the subsidiary

8
Steps in consolidation

• Add statements together and make adjustments
• Separate calculations and Checkpoints
• Calculate consolidated net income
• Calculate non-controlling interest (balance
  sheet)
• Calculate non-controlling interest (income
  statement)
• Calculate consolidated retained earnings

a
9
100 owned sub

• Example P purchases 100 of S on Jan 1, 2001 for
  19M. Ss common stock is 10M and Retained
  Earnings is 6M. Inventory of S has a FMV that is
  2000 greater than BV. All other assets and
  liabilities have FMV equal to their BV.

b
10
100 owned sub

• Balance sheet at date of acquisition
• Exhibit 5.2

11
100 owned sub

• Balance sheet and income statement at the end of
  year 1
• Additional information
• S reports a net income of 7300 and pays
  dividends of 2500
• The inventory purchased with the company was sold
  during the year
• An impairment test on Goodwill on Dec 31 showed a
  50 loss
• The parent uses the cost method of accounting

c
12
Example year 2

• At the end of year 2, net income from the sub was
  10,000, the subsidiary declared dividends of
  3000 and goodwill has a value of 870. Prepare
  the consolidated financial statements.

d
13
100 subsidiary

• Calculation of consolidated statements
• (notes on board)
• Date of acquisition p. 217
• Year 1 parent/sub statements Exhibit 6.2
• Year 1 consolidated statements Exhibit 6.3
• Year 2 parent/sub statements Exhibit 6.4
• Year 2 consolidated statements Exhibit 6.5

14
80 subsidiary

• P purchases 80 of S on Jan 1, 2001 for 15,200.
  Ss common stock is 10M and Retained Earnings is
  6M. Inventory of S has a FMV that is 2000
  greater than BV. All other assets and liabilities
  have FMV equal to their BV.

15
80 owned sub

• Recall issues with lt 100 ownership
• NON-CONTROLLING INTEREST
• Non-controlling interest on B/S
• Subs equity at acquisition x 20 any
  additions from I/S
• (shown between liabilities and equity)
• Non-controlling interest on I/S (like an expense)
• Subs net income x 20
• (use net income before extraordinary items and
  discontinued operations)

16
80 owned sub

• All else is the same as if 100 owned
• Parents investment in sub on B/S needs to be
  removed
• Parents dividend revenues need to be removed
• Goodwill needs to be added to B/S
• Goodwill impairment loss needs to be added to I/S

17
80 owned sub

• Balance sheet and income statement at the end of
  year 1
• Additional information
• S reports a net income of 7300 and pays
  dividends of 2500
• The inventory purchased with the company was sold
  during the year
• An impairment test on Goodwill on Dec 31 showed a
  40 loss
• The parent uses the cost method of accounting

e
18
80 subsidiary

• Calculation of consolidated statements
• (notes on board)
• Date of acquisition p. 224
• Year 1 parent/sub statements Exhibit 6.7
• Year 1 consolidated statements Exhibit 6.8
• Year 2 parent/sub statements Exhibit 6.9
• Year 2 consolidated statements Exhibit 6.10

19
80 owned sub

• Balance sheet and income statement at the end of
  Year 2
• Additional information on the example
• In year 2, S reports earnings of 10M and pays a
  dividend of 3M.
• An impairment test on goodwill shows it has a
  fair value of 696 therefore there is a 64 loss.

f
20
Subsidiary acquired during year

• If sub is not acquired on year-end date
• Earnings and amortization are recorded only for
  the period since the date of acquisition

21
Subsidiary acquired during year

• For the users of the financial statements
• Since results of operations are reflected only
  from the date of acquisition, it is desirable to
  provide supplemental information, on a proforma
  basis showing the results of operations as though
  the companies had combined at the beginning of
  the fiscal period, in order to assist users of
  financial statements in their assessment of the
  potential effect of the acquisition on earnings
• It may also be desirable to provide, in the year
  immediately following the year of acquisition,
  supplemental information in order to provide a
  full year's comparative figures for the
  combination

22
Subsidiary with discontinued operations

• Discontinued operations are the operations of a
  business segment that has been sold, abandoned,
  shut down or otherwise disposed of, or that is
  the subject of a formal plan of disposal.
• A business segment is a component of an entity,
  the activities of which represent a line of
  business significant to the entity as a whole.

23
Subsidiary with discontinued operations

• When a subsidiary is to be disposed of, and is
  significant, it should be accounted for as a
  discontinued operation
• When a subsidiary to the reporting entity has a
  significant discontinued operation, separate
  disclosure is also necessary
• This is based on the requirement that
  non-controlling interest is based on earnings
  before such items, and that these items are
  material on the basis of their nature, not their
  amount

24
Subsidiary with discontinued operations

• The Handbook describes the presentation of items
  such as these as follows
• In calculating consolidated net income, a
  deduction is made in the amount of any
  non-controlling interests proportion of the
  subsidiary companys income or loss before
  discontinued operations and extraordinary items
  reported by a subsidiary are disclosed as such in
  the consolidated income statement if the items
  represent discontinued operations or are
  extraordinary to the parent 1600.66

25
Exhibit 6.11