© The McGraw-Hill Companies, Inc., 2004 Slide 4-1 McGraw-Hill/Irwin Chapter Four Consolidated Financial Statements and Outside Ownership

© The McGraw-Hill Companies, Inc., 2004 Slide 4-2 McGraw-Hill/Irwin ? Noncontrolling Interest Noncontrolling Interest is the amount of the acquired company’s stock that is not acquired by the parent. The interests of the noncontrolling (non- parent) stockholders must be reflected in the consolidated financial statements.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-3 McGraw-Hill/Irwin ? Noncontrolling Interest The existence of noncontrolling investors requires the establishment of two new accounts: Noncontrolling Interest Noncontrolling Interest in Subsidiary Net Income

© The McGraw-Hill Companies, Inc., 2004 Slide 4-4 McGraw-Hill/Irwin Noncontrolling Interest 3 approaches are defined for defining noncontrolling interest: Economic Unit Concept Proportionate Consolidation Concept Parent Company Concept Assume that Expo,Inc. acquires 70% of Nent Co. for $10 million cash. How do we account for the 30% of Nent Co. that Expo does not own? Assume that Expo,Inc. acquires 70% of Nent Co. for $10 million cash. How do we account for the 30% of Nent Co. that Expo does not own?

© The McGraw-Hill Companies, Inc., 2004 Slide 4-5 McGraw-Hill/Irwin Recommended by the FASB. Noncontrolling Interest is a % of the sub’s implied value. Noncontrolling Interest in Sub Net Income is a % of the sub’s net income less amortization of purchase price allocations. The sub is viewed as an indivisible unit within the business combination. Economic Unit Concept

© The McGraw-Hill Companies, Inc., 2004 Slide 4-6 McGraw-Hill/Irwin Little evidence exists to suggest widespread use of this method. Only the portion of the sub’s assets that are acquired by the parent are consolidated. Noncontrolling Interest is not reported under this method. This method has been used where control exists, but less than 50% of the sub has been acquired. Proportionate Consolidation Concept

© The McGraw-Hill Companies, Inc., 2004 Slide 4-7 McGraw-Hill/Irwin Noncontrolling Interest is a % of the sub’s book value at the balance sheet date. Noncontrolling Interest in Sub Net Income is a % of the sub’s net income. Noncontrolling Interest may appear in the equity section or between the equity section and the liability section. Parent Company Concept #1 practice in use. Considered to be the most common method in practice.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-8 McGraw-Hill/Irwin Parent Company Concept #1 practice in use. This concept includes the entire book value of each of the subsidiary’s accounts within the consolidated statements. (Consistent with Economic Unit Concept) However, only the parent’s share of the difference between FMV and book value in included in the consolidated statements. (Consistent with Proportionate Consolidation Concept) This concept includes the entire book value of each of the subsidiary’s accounts within the consolidated statements. (Consistent with Economic Unit Concept) However, only the parent’s share of the difference between FMV and book value in included in the consolidated statements. (Consistent with Proportionate Consolidation Concept)

© The McGraw-Hill Companies, Inc., 2004 Slide 4-9 McGraw-Hill/Irwin Accounting for Noncontrolling Interest On the Balance Sheet: A credit balance account called Noncontrolling Interest is set up to recognize the noncontrolling stockholders’ investment in the subsidiary. The account usually appears in the equity section of the Consolidated Balance Sheet. Or it may be placed in a separate section between equity and non-current liabilities On the Balance Sheet: A credit balance account called Noncontrolling Interest is set up to recognize the noncontrolling stockholders’ investment in the subsidiary. The account usually appears in the equity section of the Consolidated Balance Sheet. Or it may be placed in a separate section between equity and non-current liabilities

© The McGraw-Hill Companies, Inc., 2004 Slide 4-10 McGraw-Hill/Irwin Accounting for Noncontrolling Interest On the Income Statement: An account called Noncontolling Interest in Subsidiary Net Income is set up to recognize the noncontrolling shareholders’ share of the sub’s net income. The account appears on the Income Statement. On the Income Statement: An account called Noncontolling Interest in Subsidiary Net Income is set up to recognize the noncontrolling shareholders’ share of the sub’s net income. The account appears on the Income Statement.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-11 McGraw-Hill/Irwin Let’s look at an example using the Parent Company Concept. Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-12 McGraw-Hill/Irwin On 1/1/05, Jumbo purchases 80% of Li’l Bit for $800,000 cash. Noncontrolling Interest Example Note, that Li’l Bit owns an internally developed patent valued at $220,000, with an expected useful life of 10 years.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-13 McGraw-Hill/Irwin Record the initial investment on Jumbo’s books. Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-14 McGraw-Hill/Irwin Goodwill computation: This computation will be needed again when the consolidation is done in years subsequent to the year of acquisition. Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-15 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-16 McGraw-Hill/Irwin As of the date of acquisition, the balances for each company are entered into the worksheet. Next, enter the consolidation entries on the worksheet.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-17 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-18 McGraw-Hill/Irwin This is 20% of Li’l Bit’s BV at date of acquisition.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-19 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-20 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-21 McGraw-Hill/Irwin This will be the sum of all the amounts in the Noncontrolling Interest column.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-22 McGraw-Hill/Irwin Let’s do the consolidation at the end of Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-23 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-24 McGraw-Hill/Irwin First, update Jumbo’s numbers for the equity method entries.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-25 McGraw-Hill/Irwin Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-26 McGraw-Hill/Irwin $60,000 dividends were paid to Jumbo by Li’l Bit during the year. Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-27 McGraw-Hill/Irwin FMV adjustment and intangible amortization is computed as follows: Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-28 McGraw-Hill/Irwin Assume that the building has a remaining useful life of 10 years, the equipment has a remaining useful life of 4 years, and the patent has a remaining useful life of 10 years. Amortization computation: Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-29 McGraw-Hill/Irwin Amortization computation: Noncontrolling Interest Example

© The McGraw-Hill Companies, Inc., 2004 Slide 4-30 McGraw-Hill/Irwin Note Jumbo’s updated numbers. This is based on 80% of Li’l Bit’s income less $20.8 in Amortization Expense

© The McGraw-Hill Companies, Inc., 2004 Slide 4-31 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-32 McGraw-Hill/Irwin This is 20% of Li’l Bit’s BV at date of acquisition.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-33 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-34 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-35 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-36 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-37 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-38 McGraw-Hill/Irwin This is the 80% of Li’l Bit’s dividends that went to Jumbo.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-39 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-40 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-41 McGraw-Hill/Irwin These numbers are computed and entered into the Noncontrolling Interest column.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-42 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2004 Slide 4-43 McGraw-Hill/Irwin Effects Created by Using the Cost Method Prepare Entry *C to convert from the Cost Method to the Equity Method Combine: 1.The increase in the sub’s BV since acquisition x the parent’s ownership % 2.Total amortization for the same period. Prepare Entry *C to convert from the Cost Method to the Equity Method Combine: 1.The increase in the sub’s BV since acquisition x the parent’s ownership % 2.Total amortization for the same period.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-44 McGraw-Hill/Irwin Effects Created by Using the Cost Method Change Entry I to eliminate the Dividend Income Change Entry I to eliminate the Dividend Income DO NOT use Entry D DO NOT use Entry D Change Entry I to eliminate the Dividend Income Change Entry I to eliminate the Dividend Income DO NOT use Entry D DO NOT use Entry D

© The McGraw-Hill Companies, Inc., 2004 Slide 4-45 McGraw-Hill/Irwin Effects Created by Using the Partial Equity Method Perform Entry *C. Only the adjustment for the amortization expense is necessary. Perform Entry *C. Only the adjustment for the amortization expense is necessary.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-46 McGraw-Hill/Irwin Step Acquisitions Companies often acquire controlling interest in other companies a piece at a time; i.e. “in steps”. Under the Parent Company Concept, each investment is viewed as a separate purchase, with its own cost allocations and amortization. Companies often acquire controlling interest in other companies a piece at a time; i.e. “in steps”. Under the Parent Company Concept, each investment is viewed as a separate purchase, with its own cost allocations and amortization.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-47 McGraw-Hill/Irwin Preacquisition Income 1. When control of a sub is acquired at a time subsequent to the beginning of the sub’s fiscal year, the income statement accounts are consolidated as if the acquisition was made at the beginning of the period. 2. A line-item is included (as a deduction) in the income statement for the parent’s share of the sub’s current year income prior to the date of acquisition. (which effectively belongs to the former shareholders) 3. The dividends paid to these former shareholders are then eliminated. 1. When control of a sub is acquired at a time subsequent to the beginning of the sub’s fiscal year, the income statement accounts are consolidated as if the acquisition was made at the beginning of the period. 2. A line-item is included (as a deduction) in the income statement for the parent’s share of the sub’s current year income prior to the date of acquisition. (which effectively belongs to the former shareholders) 3. The dividends paid to these former shareholders are then eliminated.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-48 McGraw-Hill/Irwin Preacquisition Income Steps 2 & 3 are done via the following “S” in SAIDE entry: Dr. Pre Acquisition Income Cr. Dividends paid (of subsidiary) Cr. Investment in Subsidiary Steps 2 & 3 are done via the following “S” in SAIDE entry: Dr. Pre Acquisition Income Cr. Dividends paid (of subsidiary) Cr. Investment in Subsidiary

© The McGraw-Hill Companies, Inc., 2004 Slide 4-49 McGraw-Hill/Irwin Preacquisition Income (Cont’d) 4. The determination of goodwill and the computation of excess FMV over BV is based on the subsidiary’s BV at the time of acquisition. 5. The current year’s amortization is based only on the period for which the parent had its ownership in the subsidiary. E.g. the last 3 months of the year. 4. The determination of goodwill and the computation of excess FMV over BV is based on the subsidiary’s BV at the time of acquisition. 5. The current year’s amortization is based only on the period for which the parent had its ownership in the subsidiary. E.g. the last 3 months of the year.

© The McGraw-Hill Companies, Inc., 2004 Slide 4-50 McGraw-Hill/Irwin Ten cups of this stuff and I still don’t get it! End of Chapter 4