2. 3 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn An Introduction to Consolidated Financial Statements Chapter 3

3. 3 - 2 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 1 Recognize the benefits and limitations of consolidated financial statements.

4. 3 - 3 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Business Combinations Consummated Through Stock Acquisitions Business combination One or more companies become subsidiaries of a common parent corporation.

5. 3 - 4 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Reporting Entity Subsidiary Financial Statements _____ Consolidated Financial Statements _____ Parent Financial Statements _____

6. 3 - 5 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Reporting Entity A parent company may acquire a subsidiary in a very different industry from its own as a means of diversifying its overall business risk. There are also legal reasons for maintaining separate identities.

7. 3 - 6 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Parent-Subsidiary Relationship Parent Company Owns more than 50% of another company Affiliate

8. 3 - 7 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Parent-Subsidiary Relationship Parent Company Subsidiary A 90% ownership Subsidiary B 80% ownership

9. 3 - 8 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 2 Understand the requirements for inclusion of a subsidiary in consolidated financial statements.

10. 3 - 9 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidation Policy Consolidated financial statements provide information that is not included in the separate statements of the parent corporation.

11. 3 - 10 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidation Policy A subsidiary can be excluded from consolidation in only two situations: 1 Control is likely to be temporary. 2 Control does not rest with the majority owner.

12. 3 - 11 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidation Policy Consolidation policy is usually presented under the following headings: Principles of consolidation Basis of consolidation

13. 3 - 12 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Parent and Subsidiary with Different Fiscal Periods Consolidated statements are prepared for and as of the end of the parent’s fiscal period. If the difference does not exceed three months… it is acceptable to use the subsidiary’s statements with disclosure.

14. 3 - 13 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 3 Apply the consolidations concepts to parent company recording of the investment in a subsidiary company at the date of acquisition.

15. 3 - 14 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash$ 20,000$10,000$ 30,000 Other current assets 45,000 15,000 60,000 Total current assets$ 65,000$25,000$ 90,000 Plant assets$ 75,000$45,000$120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets$ 60,000$40,000$100,000 Investment in Skelly 40,000 0 0 Total assets$165,000$65,000$190,000

16. 3 - 15 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable$ 20,000$15,000$ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities$ 45,000$25,000$ 70,000 Stockholders’ equity Capital stock$100,000$30,000$100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity$120,000$40,000$120,000 Total liabilities and stockholders’ equity$165,000$65,000$190,000

17. 3 - 16 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 4 Allocate the excess of the investment cost over the book value of the subsidiary at the date of acquisition.

18. 3 - 17 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Parent Acquires 100% of Subsidiary 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.

19. 3 - 18 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Parent Acquires 100% of Subsidiary with Goodwill Capital Stock30,000 Retained Earnings10,000 Goodwill10,000 Investment in Skelly50,000 To eliminate reciprocal investment and equity accounts and to assign the excess of investment cost over book value acquired to goodwill

20. 3 - 19 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 5 Prepare a consolidated balance sheet at the date of acquisition, including preparation of eliminating entries.

21. 3 - 20 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash$ 10,000$10,000$ 20,000 Other current assets 45,000 15,000 60,000 Total current assets$ 55,000$25,000$ 80,000 Plant assets$ 75,000$45,000$120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets$ 60,000$40,000$100,000 Investment in Skelly 50,000 Goodwill 10,000 Total assets$165,000$65,000$190,000

22. 3 - 21 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable$ 20,000$15,000$ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities$ 45,000$25,000$ 70,000 Stockholders’ equity Capital stock$100,000$30,000$100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity$120,000$40,000$120,000 Total liabilities and stockholders’ equity$165,000$65,000$190,000

23. 3 - 22 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 6 Learn the concept of minority interest when the parent company acquires less than 100% of the subsidiary’s outstanding common stock.

24. 3 - 23 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Assets Penn Skelly Consolidated Current assets Cash$ 10,000$10,000$ 20,000 Other current assets 45,000 15,000 60,000 Total current assets$ 55,000$25,000$ 80,000 Plant assets$ 75,000$45,000$120,000 Less: Accum. depr. 15,000 5,000 20,000 Total plant assets$ 60,000$40,000$100,000 Investment in Skelly 50,000 Goodwill 14,000 Total assets$165,000$65,000$194,000

25. 3 - 24 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet at Date of Acquisition (100% at Book Value) Liabilities Penn Skelly Consolidated Current liabilities Accounts payable$ 20,000$15,000$ 35,000 Other current liabilities 25,000 10,000 35,000 Total current liabilities$ 45,000$25,000$ 70,000 Minority interest$ 4,000 Stockholders’ equity Capital stock$100,000$30,000$100,000 Retained earnings 20,000 10,000 20,000 Total stockholders’ equity$120,000$40,000$120,000 Total liabilities and stockholders’ equity$165,000$65,000$194,000

26. 3 - 25 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Minority Interest Minority interest in subsidiaries is generally shown in a single amount in the liability section of the consolidated balance sheet. The alternatives are to include the minority interest in consolidated stockholders’ equity or to place it in a separate minority interest section.

27. 3 - 26 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Minority Interest The interest of minority stockholders represents equity investments in the consolidated net assets by stockholders of the company affiliated with the parent.

28. 3 - 27 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 7 Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of eliminating entries.

29. 3 - 28 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet After 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.

30. 3 - 29 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet After Acquisition What is the balance in the investment in Skelly’s account at December 31? Original investment January 1$50,000 + 90% of Skelly’s net income 18,000 – 90% of Skelly’s dividends– 9,000 Investment account balance$59,000

31. 3 - 30 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet After Acquisition Capital Stock30,000 Retained Earnings20,000 Goodwill14,000 Investment in Skelly59,000 Minority Interest 5,000 To eliminate reciprocal investment and equity balances, record goodwill, and enter the minority interest

32. 3 - 31 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Balance Sheet After Acquisition Dividends Payable9,000 Dividends Receivable9,000 To eliminate reciprocal dividends receivable and payable Accounts Payable5,000 Accounts Receivable5,000 To eliminate intercompany receivable and accounts payable

33. 3 - 32 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The separate books of the affiliated companies do not record cost/book value differentials in acquisitions that create parent-subsidiary relationships. Working paper procedures are used to adjust subsidiary book values to reflect the cost/book differentials. Effect of Allocation on Consolidated Balance Sheet at Acquisition

34. 3 - 33 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The adjusted amounts appear in the consolidated balance sheet. The amount of the adjustment to individual assets and liabilities is determined using an investment cost-allocation schedule. Effect of Allocation on Consolidated Balance Sheet at Acquisition

35. 3 - 34 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Allocation on Consolidated Balance Sheet at Acquisition On Dec. 3, 2003, Pilot purchases 90% of Sand Corporation’s outstanding common stock for $5,000,000 cash plus 100,000 shares of $10 stock with a market value of $5,000,000. Additional costs are $300,000. $200,000 is recorded as cost of the investment.

36. 3 - 35 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Allocation on Consolidated Balance Sheet at Acquisition Assets Cash$ 200$ 200 Net receivables 300 300 Inventories 500 600 Other current assets 400 400 Land 600 800 Building, net 4,000 5,000 Equipment, net 2,000 1,700 Total assets$8,000$9,000 Sand Corporation (000) Book Value Fair Value

37. 3 - 36 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Allocation on Consolidated Balance Sheet at Acquisition Liabilities Accounts payable$ 700 $ 700 Notes payable 1,400 1,300 Common stock 4,000 Paid-in capital 1,000 Retained earnings 900 Total liabilities and stockholders’ equity$8,000 Sand Corporation (000) Book Value Fair Value

38. 3 - 37 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Investment in Sand10,000 Common Stock1,000 Additional Paid-in Capital4,000 Cash5,000 To record 90% acquisition of Sand Corporation Assignment of Excess Cost over Underlying Equity

39. 3 - 38 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Investment in Sand200 Additional Paid-in Capital100 Cash300 To record additional costs of combining with Sand Assignment of Excess Cost over Underlying Equity

40. 3 - 39 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Investment in Sand$10,200,000 Book value of interest acquired $5,900,000 × 90% = (5,310,000) Excess of cost over BV$ 4,890,000 Allocation of Excess Cost over Underlying Equity

41. 3 - 40 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Allocation of Excess Cost over Underlying Equity Inventories 600 500 90 Land 800 600 180 Building net5,0004,000 900 Equipment, net1,7002,000 (270) Notes payable1,3001,400 90 Total allocated 990 Remainder to goodwill3,900 Total4,890 Fair Value Book Value × 90% = Excess Allocated –

42. 3 - 41 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Cash Receivables, net Inventories Other current assets Land Building, net Equipment, net Investment in Sand Goodwill Unamortized excess Total assets 1,300 700 900 600 1,200 8,000 7,000 10,200 29,900 200 300 500 400 600 4,000 2,000 8,000 b 90 b 180 b 900 b 3,900 a 4,890 b 270 a 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 Papers December 31, 2003 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet

43. 3 - 42 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Accounts payable Notes payable Common stock Other paid-in capital Retained earnings Minority interest Total liabilities and stockholders’ 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 4,000 a 1,000 a 900 a 590 2,700 5,010 11,000 8,900 4,300 590 32,500 Consolidated Working Papers December 31, 2003 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet

44. 3 - 43 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 8 Apply the concepts underlying preparation of a consolidated income statement.

45. 3 - 44 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidated Income Statement The difference between a consolidated and an unconsolidated income statement of the parent company lies in the detail presented rather than the net income amount.

46. 3 - 45 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 9 Amortize the excess of the investment cost over the book value in periods subsequent to the acquisition.

47. 3 - 46 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Amortization on Consolidated Balance Sheet after Acquisition Income for 2004: Sand’s net income$ 800,000 Pilot’s income (excluding income from Sand)$2,523,500

48. 3 - 47 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Amortization on Consolidated Balance Sheet after Acquisition Dividends Paid: Sand$ 300,000 Pilot$1,500,000

49. 3 - 48 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Effect of Amortization on Consolidated Balance Sheet after Acquisition Amortization of excess: Undervalued inventories sold in 2004 Undervalued land still held Undervalued building (45 years useful life) Overvalued equipment (5 years useful life) Overvalued notes payable retired in 2004 Goodwill (no amortization)

50. 3 - 49 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Cash Receivables, net Inventories Other current assets Land Building, net Equipment, net Investment in Sand Goodwill Unamortized excess Total assets 253.5 540 1,300 800 1,200 9,500 8,000 10,504 32,097.5 100 200 600 500 600 3,800 1,800 7,600 b 180 b 880 b 3,900 a 4,744 b 216 a 10,504 b 4,744 353.5 740 1,900 1,300 1,980 12,900 8,730 3,900 33,937.5 Consolidated Working Papers December 31, 2004 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet

51. 3 - 50 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Accounts payable Notes payable Common stock Other paid-in capital Retained earnings Minority interest Total liabilities and stockholders’ equity 2,300 4,000 11,000 8,900 5,897.5 32,097.5 1,200 4,000 1,000 1,400 7,600 a 4,000 a 1,000 a 1,400 a 640 3,500 4,000 11,000 8,900 5,897.5 640 33,937.5 Consolidated Working Papers December 31, 2004 Adjustments and Consolidated Eliminations Balance Account Title Pilot Sand Dr. Cr. Sheet

52. 3 - 51 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn End of Chapter 3