Chapter 4 Consolidated Balance Sheet At Acquisition

© 2008 Clarence Byrd Inc.2 The Objective Of Consolidation Parent Sub A Sub B Parent And Subs As If One Entity

© 2008 Clarence Byrd Inc.3 User Needs Creditors Creditors Consolidated Entity ≠ Legal Entity Consolidated Entity ≠ Legal Entity Creditors must look to single entity parent or subsidiary Creditors must look to single entity parent or subsidiary

© 2008 Clarence Byrd Inc.4 User Needs Taxation Authorities Taxation Authorities U.S. has consolidated tax return U.S. has consolidated tax return In Canada – the single legal entities must file In Canada – the single legal entities must file

© 2008 Clarence Byrd Inc.5 User Needs Non-Controlling Shareholders Non-Controlling Shareholders Must look to single entity statements to evaluate their investment Must look to single entity statements to evaluate their investment

© 2008 Clarence Byrd Inc.6 User Needs Majority Shareholders Majority Shareholders The major users of consolidated financial statements The major users of consolidated financial statements

© 2008 Clarence Byrd Inc.7 Consolidation Policy

© 2008 Clarence Byrd Inc.8 Terminology The “correct” term is “Non-Controlling Interest” The “correct” term is “Non-Controlling Interest” Control may not required holding a majority share of voting shares. Control may not required holding a majority share of voting shares. Consolidation is still required Consolidation is still required “Minority Interest” is still widely used “Minority Interest” is still widely used In most cases, control requires a majority of the voting shares In most cases, control requires a majority of the voting shares In these situations, Minority Interest is an appropriate description of the Non-Controlling Interest In these situations, Minority Interest is an appropriate description of the Non-Controlling Interest

© 2008 Clarence Byrd Inc.9 Conceptual Alternatives In Consolidation Controlling Interest Non-Controlling Interest What Is The Nature Of This Interest?

© 2008 Clarence Byrd Inc.10 Conceptual Alternatives In Consolidation Proprietary Approach Proprietary Approach The Non-Controlling Interest is not part of the consolidated entity The Non-Controlling Interest is not part of the consolidated entity Like proportionate consolidation Like proportionate consolidation

© 2008 Clarence Byrd Inc.11 Proprietary Approach Procedures Assets: Only the parent’s share of fair values Assets: Only the parent’s share of fair values Non-controlling interest Non-controlling interest In assets: None disclosed In assets: None disclosed In income: None disclosed In income: None disclosed Unrealized Profits: Eliminate parent’s share Unrealized Profits: Eliminate parent’s share

© 2008 Clarence Byrd Inc.12 Conceptual Alternatives In Consolidation Parent Company Approach Parent Company Approach The Non-Controlling Interest is a debt-like interest in the consolidated entity The Non-Controlling Interest is a debt-like interest in the consolidated entity Current CICA approach (for the most part) Current CICA approach (for the most part)

© 2008 Clarence Byrd Inc.13 Parent Company Approach Procedures Assets: Includes subsidiary carrying values, plus the parent’s share of fair value changes Assets: Includes subsidiary carrying values, plus the parent’s share of fair value changes Non-controlling interest Non-controlling interest In assets: With the liabilities In assets: With the liabilities In income: Deducted in the determination of income (like interest) In income: Deducted in the determination of income (like interest) Unrealized Profits: Eliminate parent’s share Unrealized Profits: Eliminate parent’s share

© 2008 Clarence Byrd Inc.14 Conceptual Alternatives In Consolidation Entity Approach Entity Approach The Non-Controlling Interest is an equity interest in the consolidated entity The Non-Controlling Interest is an equity interest in the consolidated entity The IFRS approach The IFRS approach

© 2008 Clarence Byrd Inc.15 Entity Approach Procedures Assets: Includes 100 percent of subsidiary fair values Assets: Includes 100 percent of subsidiary fair values Non-controlling interest Non-controlling interest In assets: With shareholders’ equity In assets: With shareholders’ equity In income: Shown as distribution of income (like preferred dividends) In income: Shown as distribution of income (like preferred dividends) Unrealized Profits: Eliminate 100 percent (upstream and downstream) Unrealized Profits: Eliminate 100 percent (upstream and downstream)

© 2008 Clarence Byrd Inc.16 Why Study? Aids in understanding the current rules and their inconsistencies Aids in understanding the current rules and their inconsistencies Will assist with the changeover to IFRSs (going to entity approach) Will assist with the changeover to IFRSs (going to entity approach) For Students: It can be examinable For Students: It can be examinable Conceptual Alternatives In Consolidation

© 2008 Clarence Byrd Inc.17 Conceptual Alternatives Asset Value Example Asset Value Example Parco owns 65 percent of the voting shares of Subco. Parco has Land with a carrying value of $1,000,000. Subco has Land with a carrying value of $500,000 and a fair value of $700,000.

© 2008 Clarence Byrd Inc.18 Proprietary Approach Solution Parco’s Carrying Value $1,000, Percent Of Subco’s Fair Value [(65%)($700,000)] [(65%)($700,000)]455,000 Consolidated Land $1,455,000

© 2008 Clarence Byrd Inc.19 Parent Company Approach Solution Parco’s Carrying Value $1,000,000 Subco’s Carrying Value 500, Percent Of Subco’s Fair Value Change [(65%)($700,000 - $500,000)] [(65%)($700,000 - $500,000)]130,000 Consolidated Land $1,630,000

© 2008 Clarence Byrd Inc.20 Entity Approach Solution Parco’s Carrying Value $1,000, Percent Of Subco’s Fair Value 700,000 Consolidated Land $1,700,000

© 2008 Clarence Byrd Inc.21 Evaluation Proprietary Proprietary Does not reflect the economic entity which is made up of 100 percent of both companies’ assets Does not reflect the economic entity which is made up of 100 percent of both companies’ assets Parent Company Parent Company Non-controlling interest has none of the characteristics of debt Non-controlling interest has none of the characteristics of debt Entity Entity Reflects properly the nature of the non-controlling interest Reflects properly the nature of the non-controlling interest Used in IFRSs (Current and Proposed) Used in IFRSs (Current and Proposed)

© 2008 Clarence Byrd Inc.22 Procedural Approaches Every text has a different approach Every text has a different approach Everyone who has ever taught the subject believes that they have a better way Everyone who has ever taught the subject believes that they have a better way Difficult to move between alternatives Difficult to move between alternatives

© 2008 Clarence Byrd Inc.23 Procedural Approaches Work Sheets Work Sheets A mechanistic approach that is easy to use, provided a proper format is provided A mechanistic approach that is easy to use, provided a proper format is provided Provides no understanding of the underlying concepts Provides no understanding of the underlying concepts In our view: Consolidations for “Dummies” In our view: Consolidations for “Dummies”

© 2008 Clarence Byrd Inc.24 Procedural Alternatives Direct Calculations Of Required Balances Direct Calculations Of Required Balances The most efficient approach The most efficient approach Requires complete understanding of concepts Requires complete understanding of concepts Consolidations for the “gifted” Consolidations for the “gifted”

© 2008 Clarence Byrd Inc.25 Procedural Alternatives Journal Entries into direct calculations Journal Entries into direct calculations Stresses an understanding of concepts Stresses an understanding of concepts Provides for movement towards direct calculations of required balances Provides for movement towards direct calculations of required balances Is not dependent on the format of the problem Is not dependent on the format of the problem Supported by a large quantity of problem material in this text Supported by a large quantity of problem material in this text

© 2008 Clarence Byrd Inc.26 General Approach Eliminate the investment account against the subsidiary Shareholders’ Equity at acquisition Allocate the excess of the investment cost over the carrying values of the subsidiary assets to fair value changes and goodwill Establish the Non-Controlling Interest At Acquisition

© 2008 Clarence Byrd Inc.27 General Approach Various adjustments and eliminations

© 2008 Clarence Byrd Inc.28 General Approach Allocate the subsidiary’s Retained Earnings since acquisition To Controlling Interest To Non-Controlling Interest

© 2008 Clarence Byrd Inc.29 Investment Analysis Schedule Investment Cost $1,000,000 Subsidiary Shareholders’ Equity ( 800,000) Differential (Excess Of Cost Over Book Value) $ 200,000 Fair Value Increase On Assets ( 20,000) Fair Value Decrease On Assets 30,000 Fair Value Increase On Liabilities 40,000 Fair Value Decrease On Liabilities ( 50,000) Goodwill$200,000 This type of analysis is required in almost every consolidation problem. The basic rules are as shown in this example. The numbers were created for this example.

© 2008 Clarence Byrd Inc.30 Example – Consolidation At Acquisition Parco purchases 70 percent of the outstanding voting shares of Subco for cash of $735,000. Subco’s assets have a fair value of $1,400,000. ParcoSubco Assets$3,500,000$1,200,000 Liabilities$1,300,000 $ 500,000 Shareholders’ Equity Common Stock Common Stock900,000200,000 Retained Earnings Retained Earnings1,300,000500,000 Total Equities $3,500,000$1,200,000

© 2008 Clarence Byrd Inc.31 Example – Investment Analysis Schedule 70%100% Investment Cost $735,000$1,050,000 Book Value ( 490,000) ( 700,000) Differential$245,000 $ 350,000 Fair Value Increase On Assets ( 140,000) ( 200,000) Goodwill$105,000$150,000

© 2008 Clarence Byrd Inc.32 Proprietary Approach Assets [$3,500,000 - $735,000 + (70%)($1,200,000 + $200,000)] (70%)($1,200,000 + $200,000)]$3,745,000 Goodwill105,000 Total Assets $3,850,000 Liabilities [$1,300,000 + (70%)($500,000)] $1,650,000 Shareholders’ Equity Common Stock (Parco’s) Common Stock (Parco’s)900,000 Retained Earnings (Parco’s) Retained Earnings (Parco’s)1,300,000 Total Equities $3,850,000 Consolidated Balance Sheet

© 2008 Clarence Byrd Inc.33 Parent Company Approach Assets [$3,500,000 - $735,000 + (100%)($1,200,000) + (70%)($200,000)] + (100%)($1,200,000) + (70%)($200,000)]$4,105,000 Goodwill105,000 Total Assets $4,210,000 Liabilities Regular [$1,300,000 + (100%)($500,000)] Regular [$1,300,000 + (100%)($500,000)]$1,800,000 Non-Controlling Interest [(30%)($700,000)] Non-Controlling Interest [(30%)($700,000)]210,000 Total Liabilities $2,010,000 Shareholders’ Equity Common Stock (Parco’s) Common Stock (Parco’s)900,000 Retained Earnings (Parco’s) Retained Earnings (Parco’s)1,300,000 Total Equities $4,210,000 Consolidated Balance Sheet

© 2008 Clarence Byrd Inc.34 Entity Approach Assets [$3,500,000 - $735,000 + (100%)($1,200,000 + $200,000)] (100%)($1,200,000 + $200,000)]$4,165,000 Goodwill150,000 Total Assets $4,315,000 Liabilities [$1,300,000 + (100%)($500,000)] $1,800,000 Shareholders’ Equity Non-Controlling Interest [(30%)($1,050,000)] Non-Controlling Interest [(30%)($1,050,000)]315,000 Common Stock (Parco’s) Common Stock (Parco’s)900,000 Retained Earnings (Parco’s) Retained Earnings (Parco’s)1,300,000 Total Equities $4,315,000 Consolidated Balance Sheet

© 2008 Clarence Byrd Inc.35 International Convergence IFRS No. 3 and IAS No. 27 IFRS No. 3 and IAS No. 27 Require 100 percent of the fair values of identifiable assets Require 100 percent of the fair values of identifiable assets Require treating the non- controlling interest as part of shareholders’ equity Require treating the non- controlling interest as part of shareholders’ equity Like entity approach except no 100 percent of goodwill Like entity approach except no 100 percent of goodwill Current proposals will record 100 percent of goodwill Current proposals will record 100 percent of goodwill

© 2008 Clarence Byrd Inc.36 Consolidated Balance Sheet IFRS No. 3 and IAS No. 27 Assets [$3,500,000 - $735,000 + (100%)($1,200,000 + $200,000)] (100%)($1,200,000 + $200,000)]$4,165,000 Goodwill105,000 Total Assets $4,270,000 Liabilities [$1,300,000 + (100%)($500,000)] $1,800,000 Shareholders’ Equity Non-Controlling Interest [(30%)($700,000 + $200,000)] Non-Controlling Interest [(30%)($700,000 + $200,000)]270,000 Common Stock (Parco’s) Common Stock (Parco’s)900,000 Retained Earnings (Parco’s) Retained Earnings (Parco’s)1,300,000 Total Equities $4,270,000

© 2008 Clarence Byrd Inc.37 Summary Of Chapter 4 Procedures Step A-1 Procedure Eliminate 100 percent of the Investment In Subsidiary account. Step A-1 Procedure Eliminate 100 percent of the Investment In Subsidiary account. Step A-2 Procedure Eliminate 100 percent of all the acquisition date balances in the subsidiary’s common shareholders’ equity (includes both contributed capital and retained earnings). Step A-2 Procedure Eliminate 100 percent of all the acquisition date balances in the subsidiary’s common shareholders’ equity (includes both contributed capital and retained earnings). Step A-3 Procedure Allocate any debit or credit Differential that is present at acquisition to the investor’s share of fair value changes on identifiable assets, fair value changes on identifiable liabilities, and positive or negative goodwill. Step A-3 Procedure Allocate any debit or credit Differential that is present at acquisition to the investor’s share of fair value changes on identifiable assets, fair value changes on identifiable liabilities, and positive or negative goodwill. Step A-4 Procedure Allocate to a Non-Controlling Interest account in the consolidated Balance Sheet, the non-controlling interest’s share of the at acquisition book value of the common shareholders’ equity of the subsidiary (includes both contributed capital and retained earnings). Step A-4 Procedure Allocate to a Non-Controlling Interest account in the consolidated Balance Sheet, the non-controlling interest’s share of the at acquisition book value of the common shareholders’ equity of the subsidiary (includes both contributed capital and retained earnings). Step B-1 Procedure Eliminate 100 percent of all intercompany assets and liabilities. Step B-1 Procedure Eliminate 100 percent of all intercompany assets and liabilities.

© 2008 Clarence Byrd Inc.38 Definitional Calculations Identifiable Assets And Liabilities The amount to be included in the consolidated Balance Sheet for any identifiable asset or liability is calculated as follows: Identifiable Assets And Liabilities The amount to be included in the consolidated Balance Sheet for any identifiable asset or liability is calculated as follows: 100 percent of the carrying value of the identifiable asset (liability) on the books of the parent company at the Balance Sheet date; plus 100 percent of the carrying value of the identifiable asset (liability) on the books of the parent company at the Balance Sheet date; plus 100 percent of the carrying value of the identifiable asset (liability) on the books of the subsidiary company at the Balance Sheet date; plus (minus) 100 percent of the carrying value of the identifiable asset (liability) on the books of the subsidiary company at the Balance Sheet date; plus (minus) the parent company’s share of the fair value increase (decrease) on the asset (liability) (i.e., the parent company’s share of the difference between the fair value of the subsidiary’s asset or liability at time of acquisition and the carrying value of that asset or liability at the time of acquisition). the parent company’s share of the fair value increase (decrease) on the asset (liability) (i.e., the parent company’s share of the difference between the fair value of the subsidiary’s asset or liability at time of acquisition and the carrying value of that asset or liability at the time of acquisition).

© 2008 Clarence Byrd Inc.39 Definitional Calculations Goodwill The Goodwill to be recorded in the consolidated balance sheet is equal to the excess of the cost of the investment over the parent company’s share of the fair values of the subsidiary’s net identifiable assets as at the time of acquisition. Goodwill The Goodwill to be recorded in the consolidated balance sheet is equal to the excess of the cost of the investment over the parent company’s share of the fair values of the subsidiary’s net identifiable assets as at the time of acquisition. Non-Controlling Interest - Balance Sheet The Non- Controlling Interest to be recorded in the consolidated Balance Sheet is an amount equal to the non-controlling interest’s ownership percentage of the book value of the subsidiary’s common stock equity at the Balance Sheet date. It will also include any preferred stock equity of the subsidiary that is outstanding. Non-Controlling Interest - Balance Sheet The Non- Controlling Interest to be recorded in the consolidated Balance Sheet is an amount equal to the non-controlling interest’s ownership percentage of the book value of the subsidiary’s common stock equity at the Balance Sheet date. It will also include any preferred stock equity of the subsidiary that is outstanding.

© 2008 Clarence Byrd Inc.40 Definitional Calculations Contributed Capital The Contributed Capital to be recorded in the consolidated Balance Sheet is equal to the contributed capital from the single entity Balance Sheet of the parent company. Contributed Capital The Contributed Capital to be recorded in the consolidated Balance Sheet is equal to the contributed capital from the single entity Balance Sheet of the parent company. Retained Earnings Consolidated Retained Earnings will be equal to the Retained Earnings balance that is included in the Balance Sheet of the parent company. Retained Earnings Consolidated Retained Earnings will be equal to the Retained Earnings balance that is included in the Balance Sheet of the parent company.

© 2008 Clarence Byrd Inc.41