© Pearson Education, Inc. publishing as Prentice Hall3-1 Chapter 3: An Introduction to Consolidated Financial Statements by Jeanne M. David, Ph.D., Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn

© Pearson Education, Inc. publishing as Prentice Hall3-2 Intro to Consolidations: Objectives 1.Recognize the benefits and limitations of consolidated financial statements. 2.Understand the requirements for inclusion of a subsidiary in consolidated financial statements. 3.Apply the consolidation concepts to parent company recording of the investment in a subsidiary at the date of acquisition. 4.Allocate the excess of the fair value over the book value of the subsidiary at the date of acquisition.

© Pearson Education, Inc. publishing as Prentice Hall3-3 Objectives (continued) 5.Learn the concept of noncontrolling interest when the parent company acquires less than 100% of the subsidiary's outstanding common stock. 6.Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. 7.Prepare consolidated balance sheets subsequent to the date of acquisition, including preparation of elimination entries. 8.Apply the concepts underlying preparation of a consolidated income statement.

© Pearson Education, Inc. publishing as Prentice Hall3-4 1: Benefits & Limitations An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-5 Business Acquisitions FASB Statement 141R Business combinations occur –Acquire controlling interest in voting stock –More than 50% –May have control through indirect ownership Consolidated financial statements –Primarily for owners & creditors of parent –Not for noncontrolling owners or subsidiary creditors

© Pearson Education, Inc. publishing as Prentice Hall3-6 2: Subsidiaries An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-7 Who is a Subsidiary? ARB No. 51 allowed broad discretion FASB Statement No. 94 –Control based on share ownership FASB Statement No. 160 –Financial control Subsidiaries, or affiliates, continue as separate legal entities and reporting to their controlling and noncontrolling interests.

© Pearson Education, Inc. publishing as Prentice Hall3-8 Consolidated Statements Prepared by the parent company Parent discloses –Consolidation policy, Reg. S-X –Exceptions to consolidation, temporary control and inability to obtain control Fiscal year end –Use parent's FYE, but –May include subsidiary statements with FYE within 3 months of parent's FYE. Disclose intervening material events

© Pearson Education, Inc. publishing as Prentice Hall3-9 3: Parent Company Recording An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-10 Penn Example: Acquisition Cost = Fair Value = Book Value Penn acquires 100% of Skelly for $40, which equals the book value and fair values of the net assets acquired. Cost of acquisition$40 Less 100% book value40 Excess of cost over book value$0 Skelly BV=FV Cash$10 Other current assets15 Net plant assets40 Total$65 Accounts payable$15 Other liabilities10 Capital stock30 Retained earnings10 Total$65 To consolidate, eliminate Penn's Investment account and Skelly's capital stock and retained earnings.

© Pearson Education, Inc. publishing as Prentice Hall3-11 Balance sheetsSeparateConsolidated PennSkellyPenn & Sub. Cash$20$10$30 Other curr. assets Net plant Investment in Skelly4000 Total$165$65$190 Accounts payable$20$15$35 Other curr. liabilities Capital stock Retained earnings Total$165$65$190

© Pearson Education, Inc. publishing as Prentice Hall3-12 4: Allocations at Acquisition Date An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-13 Cost, Fair Value and Book Value Acquisition cost, fair values of identifiable net assets and book values may differ. –Allocate excess or deficiency of cost over book value and determine goodwill, if any. –When BV = FV, excess is goodwill. Cost less BV = Excess to allocate –Allocate first to FV-BV differences –Remainder is goodwill (or bargain purchase)

© Pearson Education, Inc. publishing as Prentice Hall3-14 Example: BV ≠ FV but Cost = FV Piper acquires 100% of Sandy for $310. BV = = $245 FV = 385 – 75 = $310 Cost – FV = $0 goodwill SandyBVFV Cash$40 Receivables30 Inventory5075 Plant, net Total$320$385 Liabilities$75 Capital stock100 Retained earnings145 Total$320 Cost$ % BV245 Excess of cost over BV$65

© Pearson Education, Inc. publishing as Prentice Hall3-15 Piper and Sandy (cont.) Allocate to:AmtAmort. Inventory 100%(+25)251st yr Plant 100%(+40)4010 yrs Total$65 Piper's elimination worksheet entry: Capital stock100 Retained earnings145 Inventory25 Plant40 Investment in Sandy310

© Pearson Education, Inc. publishing as Prentice Hall3-16 Example: BV ≠ FV and Cost ≠ FV Panda acquires 100% of Salty for $530. BV = = $440 FV = 580 – 85 = $495 Cost – FV = $35 goodwill SaltyBVFV Cash$100 Receivables40 Inventory250 Plant, net Total$520$580 Liabilities$80$85 Capital stock250 Retained earnings190 Total$520 Cost$ % BV ( )440 Excess of cost over BV$90

© Pearson Education, Inc. publishing as Prentice Hall3-17 Panda and Salty (cont.) Panda's elimination worksheet entry: Capital stock250 Retained earnings190 Plant60 Goodwill35 Liabilities5 Investment in Salty530 Allocate to:AmtAmort. Plant604 yrs Liabilities-55 yrs Goodwill35 - Total$90

© Pearson Education, Inc. publishing as Prentice Hall3-18 Example: BV ≠ FV and Cost ≠ FV Printemps acquires 100% of Summer for $185. BV = = $180 FV = = $210 Cost$ % BV (75+105)180 Excess of cost over BV$5 SummerBVFV Cash$10 Receivables30 Inventory8090 Plant, net Total$220$250 Liabilities$40 Capital stock75 Retained earnings105 Total$220

© Pearson Education, Inc. publishing as Prentice Hall3-19 Printemps and Summer (cont.) Allocate to:AmtAmort. Inventory101st yr Plant, land20 - Bargain purchase(25)Gain Total$5 Investment in Summer210 Gain on Bargain purchase25 Cash 185 Printemps records the acquisition of Summer assuming a cash purchase as follows. Note that the investment account is recorded at its fair value and the bargain purchase is treated immediately as a gain.

© Pearson Education, Inc. publishing as Prentice Hall3-20 Worksheet Elimination Entry Printemps' elimination worksheet entry: Capital stock75 Retained earnings105 Unamortized excess30 Investment in Summer210 Inventory10 Plant20 Unamortized excess30 Unamortized excess equals $30 (gain is recognized) $10 for undervalued inventory $20 for undervalued land included in plant assets

© Pearson Education, Inc. publishing as Prentice Hall3-21 PrintempsSummerAdjustmentsConsol- BV DRCRidated Cash$30$10 $40 Receivables Inventory Plant, net Investment in Summer210 0 Unamortized excess 30 Total$840$220 $880 Liabilities$270$40 $310 Capital stock Retained earnings Total$840$220 $

© Pearson Education, Inc. publishing as Prentice Hall3-22 5: Noncontrolling Interests An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-23 Noncontrolling Interest Parent owns less than 100% –Noncontrolling interest represents the minority shareholders –Part of stockholders' equity –Measured at fair value, based on parent's acquisition price Parent pays $40,000 for an 85% interest –Implied value of the full investee is 40,000/85% = $47,059. –Minority share = 15%(47,059) = $7,059.

© Pearson Education, Inc. publishing as Prentice Hall3-24 Example: Noncontrolling Interests Popo acquires 80% of Sine for $400 when Sine had capital stock of $200 and retained earnings of $175. Sine's assets and liabilities equaled their fair values except for buildings which are undervalued by $50. Buildings have a 10-year remaining life. Cost of 80% of Sine$400 Implied value of Sine (400/80%)$500 Book value ( )375 Excess over book value$125 Allocate to: Building$50 Goodwill75 Total$125

© Pearson Education, Inc. publishing as Prentice Hall3-25 Elimination Entry Popo's elimination worksheet entry: Capital stock200 Retained earnings175 Building50 Goodwill75 Investment in Sine400 Noncontrolling interest100 An unamortized excess account could have been used for the excess assigned to the building and goodwill.

© Pearson Education, Inc. publishing as Prentice Hall3-26 PopoSineAdjustmentsConsol- BV DRCRidated Cash$50$10 $60 Receivables Inventory Building, net Investment in Sine400 0 Goodwill 75 Total$960$400 $1,085 Liabilities$150$25 $175 Capital stock Retained earnings Noncontrolling interest 100 Total$960$400 $1,

© Pearson Education, Inc. publishing as Prentice Hall3-27 6: Amortizations After Acquisition An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-28 Unamortized Excess Excess assigned to assets and liabilities are amortized according to the account Balance sheet account Amortization period Income statement account Inventories and other current assets Generally, 1 st yearCost of sales and other expense Buildings, equipment, patents, Remaining life at business combination Depreciation and amortization expense Land, copyrightsNot amortized Long term debtTime to maturityInterest expense

© Pearson Education, Inc. publishing as Prentice Hall3-29 Piper and Sandy (cont.) Allocate to:AmtAmort. Inventory251st yr Plant4010 yrs Total$65 Cost$ % BV245 Excess$65 Beginning unamortized excess Current year's amortization Ending unamortized excess Inventory25(25)0 Plant40(4)36 Total65(29)36

© Pearson Education, Inc. publishing as Prentice Hall3-30 Panda and Salty (cont.) Beginning unamortized excess Current year's amortization Ending unamortized excess Plant60(15)45 Liabilities(5)1(4) Goodwill350 Total Cost$ % BV440 Excess$90 Allocate to:AmtAmort. Plant604 yrs Liabilities-55 yrs Goodwill35 - Total$90

© Pearson Education, Inc. publishing as Prentice Hall3-31 Printemps and Summer (cont.) Beginning unamortized excess Current year's amortization Ending unamortized excess Inventory10(10)0 Land200 Total30(10)20 Cost$ % BV180 Excess$5 Allocate to:AmtAmort. Inventory101st yr Plant, land20 - Bargain purchase(25)Gain Total$5

© Pearson Education, Inc. publishing as Prentice Hall3-32 7: Subsequent Balance Sheets An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-33 Balance Sheets After Acquisition In preparing a consolidated balance sheet –Eliminate the parent's Investment in Subsidiary –Eliminate the subsidiary's equity accounts (common stock, retained earnings, etc.) –Adjust asset and liability accounts for any unamortized excess balance –Record goodwill, if any –Record Noncontrolling Interest, if any

© Pearson Education, Inc. publishing as Prentice Hall3-34 Popo and Sine (cont.) Cost of 80% of Sine$400 Implied value of Sine$500 Book value375 Excess$125 Allocate to: Building$5010 yrs Goodwill75 - Total$125 Beginning unamortized excess Current year's amortization Ending unamortized excess Building50(5)45 Goodwill750 Total125(5)120

© Pearson Education, Inc. publishing as Prentice Hall3-35 After 1 year:PopoSine Cash$40$15 Receivables11085 Inventory90100 Building, net Investment in Sine404 Total$924$435 PopoSine Liabilities$100$50 Capital stock Retained earnings Total$924$435 Popo's elimination worksheet entry: Capital stock200 Retained earnings185 Unamortized excess120 Investment in Sine (80%)404 Noncontrolling interest (20%)101 Building45 Goodwill75 Unamortized excess120

© Pearson Education, Inc. publishing as Prentice Hall3-36 After 1 year:PopoSineAdjustmentsConsol- BV DRCRidated Cash$40$15 $55 Receivables Inventory Building, net Investment in Sine404 0 Goodwill 75 Unamortized excess120 Total$924$435 $1,075 Liabilities$100$50 $150 Capital stock Retained earnings Noncontrolling interest 101 Total$924$435 $1,

© Pearson Education, Inc. publishing as Prentice Hall3-37 Key Balance Sheet Items Investment in Subsidiary does not exist on the consolidated balance sheet Equity on the consolidated balance sheet consists of the parent's equity plus the noncontrolling interest. Noncontrolling interest is proportional to the Investment in Subsidiary account when the equity method is used. $101 = $404 x.20/.80

© Pearson Education, Inc. publishing as Prentice Hall3-38 8: Consolidated Income Statements An Introduction to Consolidated Financial Statements

© Pearson Education, Inc. publishing as Prentice Hall3-39 Comprehensive Example, Data Pilot acquires 90% of Sand on 12/31/2009 for $4,333 when Sand's equity consists of $4,000 common stock, $1,000 other paid in capital, and $900 retained earnings. On that date Sand's inventories, land and buildings are understated by $100, $200, and $1,000, respectively and its equipment and notes payable are overstated by $300 and $100.

© Pearson Education, Inc. publishing as Prentice Hall3-40 Assignment and Amortization Cost of 90% of Sand$10,200 Implied value of Sand 10,200/.90$11,333 Book value ( )5,900 Excess over book value$5,433 Unamortized excess 1/1/10 Current amortization Unamortized excess 12/31/10 Inventory100(100)0 Land2000 Building1,000(25)975 Equipment(300)60(240) Note payable100(100)0 Goodwill4,3330 Total5,433(165)5,268 Allocate to: Inventory$1001st yr Land200 - Building1,00040 yrs Equipment(300)5 yrs Note payable1001st yr Goodwill4,333 - Total$5,433

© Pearson Education, Inc. publishing as Prentice Hall3-41 PilotSandConsol.* Sales$9,523.50$2,200.00$11, Income from Sand571.50$0.00 Cost of sales(4,000.00)(700.00)(4,800.00) Depreciation exp - bldg(200.00)(80.00)(305.00) Depreciation exp - equip(700.00)(360.00)(1,000.00) Other expense(1,800.00)(120.00)(1,920.00) Interest expense(300.00)(140.00)(540.00) Net income$3,095.00$ Total consolidated income$3, Noncontrolling interest share63.50 Controlling interest share$3, * Cost of sales, building depreciation and interest expense are increased by $100, $25, and $100, and equipment depreciation is $60 lower than the sum of Pilot and Sand.

© Pearson Education, Inc. publishing as Prentice Hall3-42 Key Income Statement Items The Income from Subsidiary account is eliminated. Current period amortizations are included in the appropriate expense accounts. Noncontrolling interest share of net income is proportional to the Income from Subsidiary under the equity method. $ x.10/.90 = $63.50

© Pearson Education, Inc. publishing as Prentice Hall3-43 Push-Down Accounting SEC requirement –Subsidiary is substantially wholly-owned (approx. 90%) –No publicly held debt or preferred stock Books of the subsidiary are adjusted –Assets, including goodwill, and liabilities revalued based on acquisition price –Retained earnings is replaced by Push-Down Capital which includes retained earnings and the valuation adjustments

© Pearson Education, Inc. publishing as Prentice Hall3-44 Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.