Consolidated Financial Statements and Outside Ownership Chapter Four Consolidated Financial Statements and Outside Ownership Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Noncontrolling Interest Learning Objective 4-1: Understand that complete ownership is not a prerequisite for the formation of a business combination. Although most parent companies do possess 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock. If the parent doesn’t own 100% of the company, WHO owns the rest of it? Noncontrolling Shareholders The ownership interests of the Noncontrolling Shareholders must be reflected in the consolidated financial statements. Although most parent companies do possess 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock. The remaining outside owners are collectively referred to as a noncontrolling interest, which replaces the traditional term minority interest. 2

Noncontrolling Interest Learning Objective 4-2: Describe the valuation principles underlying the acquisition method of accounting for the noncontrolling interest. The Parent, with controlling interest, must consolidate 100% of the Subsidiary’s financial information valued at the acquisition- date fair value. The total acquired firm fair value in a partial acquisition is the sum of The fair value of the controlling interest. The fair value of the noncontrolling interest at the acquisition date. The Parent, with controlling interest, must consolidate 100% of the Subsidiary’s financial information. The acquisition method requires that the subsidiary be valued at the acquisition-date fair value. The total acquired firm fair value in a partial acquisition is the sum of The fair value of the controlling interest. The fair value of the noncontrolling interest at the acquisition date. 2

Noncontrolling Interest Example Learning Objective 4-3: Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests. If the total acquisition-date fair value (amount paid) of a subsidiary is greater than the fair value of the identifiable net assets acquired, the difference is allocated to Goodwill. The parent first allocates goodwill to its 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. Goodwill allocated to the controlling and noncontrolling interests will not always be proportional to the percentages owned. acquisition-date goodwill should be apportioned across the controlling and noncontrolling interests. The parent first allocates goodwill to its 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. As a result, goodwill allocated to the controlling and noncontrolling interests will not always be proportional to the percentages owned.

Allocating Subsidiary’s Net Income Learning Objective 4-4: Understand the computation and allocation of consolidated net income in the presence of a noncontrolling interest. The subsidiary’s net income (including excess acquisition-date fair-value amortizations) must be allocated to its owners - the parent and the noncontrolling interest - to properly measure their respective equity in the consolidated entity. The subsidiary’s net income (including excess acquisition-date fair-value amortizations) must be allocated to its owners - the parent and the noncontrolling interest - to properly measure their respective equity in the consolidated entity. We will assume in all cases that the relative ownership percentages of the parent and noncontrolling interest represent an appropriate basis for attributing all elements (including excess acquisition-date fair-value amortizations for identifiable assets and liabilities) of a subsidiary’s income across the ownership groups. Including the excess fair-value amortizations is based on the assumption that the noncontrolling interest represents equity in the subsidiary’s net assets as remeasured on the acquisition date. 5

Allocating Subsidiary’s Net Income Assume that the relative ownership percentages of the parent and noncontrolling interest represent an appropriate basis for attributing all elements (including excess acquisition-date fair-value amortizations for identifiable assets and liabilities) of a subsidiary’s income across the ownership groups. Including the excess fair-value amortizations is based on the assumption that the noncontrolling interest represents equity in the subsidiary’s net assets as remeasured on the acquisition date. The subsidiary’s net income (including excess acquisition-date fair-value amortizations) must be allocated to its owners - the parent and the noncontrolling interest - to properly measure their respective equity in the consolidated entity. We will assume in all cases that the relative ownership percentages of the parent and noncontrolling interest represent an appropriate basis for attributing all elements (including excess acquisition-date fair-value amortizations for identifiable assets and liabilities) of a subsidiary’s income across the ownership groups. Including the excess fair-value amortizations is based on the assumption that the noncontrolling interest represents equity in the subsidiary’s net assets as remeasured on the acquisition date. 5

Noncontrolling Interests and Consolidations Learning Objective 4-5: Identify and calculate the four noncontrolling interest figures that must be included in the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest. Noncontrolling interest In subsidiary at beginning of the current year. In subsidiary’s current year net income. In subsidiary’s current year dividend payments. In subsidiary as of the end of the year. The process remains substantially unchanged. The parent must determine and enter these figures when in the worksheet. The presence of a noncontrolling interest does not dramatically alter the consolidation procedures presented in Chapter 3. The unamortized balance of the acquisition-date fair-value allocation must still be computed and included within the consolidated totals. Excess fair-value amortization expenses of these allocations are recognized each year as appropriate. Reciprocal balances are eliminated. Beyond these basic steps, the measurement and recognition of four noncontrolling interest balances add a new dimension to the process of consolidating financial information.The consolidation process remains substantially unchanged with a noncontrolling interest. Consolidate as though the Parent has 100% ownership. Then determine noncontrolling interest: in the subsidiary at beginning of the current year. In sub’s current year net income. In sub’s current year dividend payments. in the subsidiary as of the end of the year.

Consolidated Financial Statement Learning Objective 4-6: Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements. Consolidated net income is computed at the combined entity level and allocated to the noncontrolling and controlling interests. The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders. Consolidated net income is computed at the combined entity level as $416,000 and then allocated to the noncontrolling and controlling interests. The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders.4 Finally, note the placement of the noncontrolling interest in the subsidiary’s equity squarely in the consolidated owners’ equity section.

Consolidated Financial Statement Each component of other comprehensive income is allocated to the controlling and noncontrolling interest. The statement of changes in owners’ equity would also provide an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests. Note the placement of the noncontrolling interest in the subsidiary’s equity in the consolidated owners’ equity section. Consolidated net income is computed at the combined entity level as $416,000 and then allocated to the noncontrolling and controlling interests. The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders.4 Finally, note the placement of the noncontrolling interest in the subsidiary’s equity squarely in the consolidated owners’ equity section.

Consolidated Financial Statement Income Statement, Owners’ Equity 22

Consolidated Financial Statement Balance Sheet 23

Noncontrolling Interest – Premium Paid Learning Objective 4-7: Determine the effect on consolidated financial statements of a control premium paid by the parent. If King paid $11.00 for the subsidiary’s shares, when they were trading for $9.75, then the goodwill allocation would look like this: If King had paid $11.00 for their shares, at a time when they were trading for $9.75, then the goodwill allocation would be $125,000.

Mid-Year Acquisitions Learning Objective 4-8: Understand the impact on consolidated financial statements of a midyear acquisition. When control of a Sub is acquired at a time subsequent to the beginning of the sub’s fiscal year: The income statements are consolidated as usual The Sub’s pre-acquisition revenues and expenses are excluded from the Parent’s consolidated statements (adjusted via Entry S) Only partial year’s amortization on excess fair value is taken. When control of a Sub is acquired at a time subsequent to the beginning of the sub’s fiscal year: The income statements are consolidated as usual The Sub’s pre-acquisition revenues and expenses are excluded from the Parent’s consolidated statements (adjusted via Entry S) Only a partial year’s amortization on excess fair value is taken. 32

Step Acquisitions Learning Objective 4-9: Understand the impact on consolidated financial statements when a step acquisition has taken place. A step acquisition occurs when control is achieved in a series of equity acquisitions, as opposed to a single transaction. As with all business combinations, the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained. A step acquisition occurs when control is achieved in a series of equity acquisitions, as opposed to a single transaction. As with all business combinations, the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained. The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained. 31

Step Acquisitions The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained. If the parent held a noncontrolling interest in the acquired firm, the interest is remeasured to fair value and a gain or loss is recognized. If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. The parent accounts for the additional shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders. If the parent previously held a noncontrolling interest in the acquired firm, the parent remeasures that interest to fair value and recognizes a gain or loss. If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. The parent simply accounts for the additional subsidiary shares acquired as an equity transaction—consistent with any transactions with other owners, as opposed to outsiders. 31

Sales of Subsidiary Stock Learning Objective 4-10: Record the sale of a subsidiary (or a portion of its shares). If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section. If the sale results in the loss of control, the parent recognizes any resulting gain or loss in consolidated net income. What is reported on the consolidated statements when a Parent sells some of its ownership in a Subsidiary? If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section. If the sale results in the loss of control, the parent recognizes any resulting gain or loss in consolidated net income.

Sales of Subsidiary Stock If the parent retains any of its former sub’s shares, the investment should be remeasured to fair value on the date control is lost. Any resulting gain or loss from the remeasurement should be recognized in the parent’s net income. If it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase. For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied. If the parent retains any of its former sub’s shares, the investment should be remeasured to fair value on the date control is lost. Any resulting gain or loss from the remeasurement should be recognized in the parent’s net income. If it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase. For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied.

Noncontrolling Interest – International Accounting Standards US GAAP vs. IFRS U.S. GAAP requires fair value measurement. Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest which is adjusted for its share of subsidiary income and dividends subsequent to acquisition. IFRS permits fair value measurement, or the noncontrolling interest may be measured at a proportionate share of the Sub’s identifiable net asset fair value, which excludes goodwill. This option assumes that any goodwill created via acquisition applies solely to the controlling interest. US GAAP vs IFRS U.S. GAAP requires fair value measurement. Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest which is adjusted for its share of subsidiary income and dividends subsequent to acquisition. IFRS permits fair value measurement, or the noncontrolling interest may be measured at a proportionate share of the Sub’s identifiable net asset fair value, which excludes goodwill. This option assumes that any goodwill created via acquisition applies solely to the controlling interest.