1. Chapter Four Consolidated Financial Statements and Outside Ownership Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. Learning Objective 4-1 4-2 Understand that business combinations can occur with less than complete ownership. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

3. Noncontrolling Interest in a Subsidiary  Although most parent companies have 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock.  If the parent doesn’t own 100 percent of the company, outside owners are referred to as a noncontrolling interest.  How should the ownership interests of the noncontrolling interest be reflected in the consolidated financial statements? 4-3 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

4. Learning Objective 4-2 4-4 Describe the concepts and valuation principles underlying the acquisition method of accounting for the noncontrolling interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5. Consolidated Financial Reporting in the Presence of a Noncontrolling Interest 4-5  The parent, with controlling interest, must consolidate 100 percent of its subsidiary’s financial information as a single economic unit.  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 two components at the acquisition date:  The fair value of the controlling interest.  The fair value of the noncontrolling interest at the acquisition date. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

6. Noncontrolling Interest Example 4-6  Assume Parker Corporation wants to acquire 90 percent of Strong Company. Strong’s stock has been trading for around $60 per share.  Parker offered all of Strong’s shareholders a premium price for up to 90 percent of the outstanding shares, even though the shares are trading in the $59 to $61 range.  The fair value of Strong is measured as the sum of the respective fair values of the controlling and noncontrolling interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

7. Parker purchased 9,000 shares at $70 per share. The fair value of their consideration transferred is $630,000. The remaining 1,000 shares trade at $60 per share, indicating that the fair value of the noncontrolling interest is $60,000. The total acquisition-date fair value of the subsidiary is $690,000. Fair value of controlling interest ($70 × 9,000 shares)............... $630,000 Fair value of noncontrolling interest ($60 × 1,000 shares)................. 60,000 Total fair value of subsidiary...... $690,000 Noncontrolling Interest—Measuring Fair Value Example 4-7 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

8. Learning Objective 4-3 4-8 Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9. Allocating Acquired Goodwill to the Controlling and Noncontrolling Interests  To report ownership equity in consolidated financial statements, acquisition-date goodwill is apportioned across controlling and noncontrolling interests.  The parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest over its share of the fair value of the net assets.  Total acquisition-date fair value (amount paid) of Strong, $690,000, is greater than the fair value of the identifiable net assets acquired of $600,000 (10,000 shares × $60 per share). The difference, $90,000, is allocated to Goodwill. 4-9 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

10. The parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest, $630,000, over its share of the fair value of the identifiable net assets ($600,000 × 90% = 540,000). Any remaining goodwill is then attributed to the noncontrolling interest. All of the acquisition goodwill is allocated to the controlling interest as follows: Allocating Acquired Goodwill Example 4-10 Controlling Noncontrolling Interest Interest Total Fair value at acquisition date..... $630,000 $60,000 $690,000 Relative fair value of identifiable net assets acquired (90% and 10% of $600,000)............. 540,000 $60,000 600,000 Goodwill....................... $90,000 $-0- $90,000 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

11. Noncontrolling Interest Goodwill Example 4-11 No excess goodwill is assigned to the noncontrolling interest. Allocated goodwill will not always be proportional to the percentages owned. Controlling Noncontrolling Interest Interest Fair value at acquisition date..... $630,000 $60,000 Relative fair value of identifiable net assets acquired (90% and 10% of $600,000)............. 540,000 $60,000 Goodwill....................... $90,000 $-0- Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

12. Noncontrolling Interest Additional Issues  If the noncontrolling interest’s proportionate share of subsidiary’s fair values exceeds its total fair value, the excess reduces goodwill recognized by the parent.  If the total fair value of the acquired firm is less than the collective sum of its identifiable net assets:  A bargain purchase occurs.  Parent recognizes the entire gain in current income.  No gain is ever allocated to the noncontrolling interest.  If the price per share paid by the parent equals the noncontrolling interest per share fair value, goodwill is recognized proportionately across the two ownership groups. 4-12 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

13. Learning Objective 4-4 4-13 Demonstrate the computation and allocation of consolidated net income in the presence of a noncontrolling interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

14. Consolidated Net Income 4-14  To reflect the economic unit concept, consolidated net income includes 100 percent of both the parent’s and the subsidiary’s net income, adjusted for excess acquisition-date fair value over book value amortizations.  Once consolidated net income is determined, it is allocated to the parent company and the noncontrolling interests.  Noncontrolling interests’ ownership pertains only to the subsidiary; its share of consolidated net income is limited to a share of the adjusted subsidiary’s net income. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

15. Noncontrolling Interest in Subsidiary Net Income 4-15 Parker acquires 90 percent of Strong Company. Current year consolidated net income equals $108,000 including $10,000 of annual acquisition-date excess fair-value amortization. If Strong reports revenues of $280,000 and expenses of $160,000 (internal book values), the noncontrolling interest share of Strong’s income can be computed as follows: Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

16. Accounting for Noncontrolling Interest in Subsidiary Net Income 4-16  The $11,000 noncontrolling interest share of adjusted subsidiary net income is equivalent to the noncontrolling interest share of consolidated net income, which is then subtracted from consolidated net income to determine the parent’s interest in consolidated net income.  The noncontrolling shareholders’ portion of consolidated net income is limited to their 10 percent share of adjusted subsidiary income. They own a 10 percent interest in the subsidiary company but no ownership in the parent firm. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

17. Learning Objective 4-5 4-17 Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

18. Partial Ownership Consolidations— Acquisition Method 4-18  The acquisition method incorporates 100 percent of the subsidiary’s assets and liabilities at their acquisition-date fair values in the consolidated financial statements.  Subsequent to acquisition, changes in current fair values for assets and liabilities are not recognized.  Subsidiary assets acquired and liabilities assumed are reflected in future consolidated financial statements using acquisition-date fair values net of subsequent amortizations (or reduced for impairment). Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

19. Noncontrolling Interest and Consolidations 4-19 The consolidation is substantially unchanged with the presence of a noncontrolling interest. The parent company must determine and enter each of these figures when constructing a worksheet:  Noncontrolling interest in subsidiary at beginning of current year.  Net income attributable to noncontrolling interest.  Subsidiary dividends attributable to noncontrolling interest.  Noncontrolling interest as of the end of the year (three balances above combined). Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

20. Partial Acquisition with No Control Premium Example 4-20 Assume that King Co. acquires 80 percent of Pawn Co.’s 100,000 outstanding voting shares on January 1, 2017, for $9.75 per share or a total of $780,000 cash consideration.  The shares are trading at an average of $9.75 per share before and after the acquisition.  The total fair value of Pawn to be used initially in consolidation is: Consideration transferred by King ($9.75 × 80,000 shares)................ $780,000 Noncontrolling interest fair value ($9.75 × 20,000 shares)................. 195,000 Pawn’s total fair value on Jan. 1, 2017... $975,000 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

21. Noncontrolling Interest—Excess Fair-Value Allocations Example 4-21 EXHIBIT 4.3 Excess Fair-Value Allocations Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

22. Noncontrolling Interest—Changes in Retained Earnings Example 4-22 To complete the information needed for this combination, assume that Pawn Company reports the following changes in retained earnings since King’s acquisition: Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

23. Noncontrolling Interest—Worksheet Process Example 4-23  King uses the equity method to account for Pawn subsequent to acquisition. The consolidation process is substantially the same as consolidation without a noncontrolling interest.  Consolidation, worksheet Entries S (expanded), A, I, D, and E are prepared.  A column will be added to the worksheet to record the noncontrolling interest in the subsidiary. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

24. Noncontrolling Interest—Separate Financial Records Example 4-24 EXHIBIT 4.5 Separate Financial Records Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

25. Noncontrolling Interest—Example Worksheet 4-25 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

26. Noncontrolling Interest—Example Consolidation Entries S and A 4-26 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

27. Noncontrolling Interest—Example Consolidation Entries I, D, and E 4-27 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

28. Learning Objective 4-6 4-28 Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

29. Consolidated Financial Statements— Income Statement and Balance Sheet 4-29  Consolidated net income is computed at the combined entity level and allocated to the noncontrolling and controlling interests.  Identifiable assets acquired and liabilities assumed are adjusted to their full individual fair values at the acquisition date. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

30. Consolidated Financial Statements— Statement of Changes in Owners’ Equity 4-30  The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders.  Note the placement of the noncontrolling interest in the subsidiary’s equity in the consolidated owners’ equity section.  If appropriate, each component of other comprehensive income is allocated to the controlling and noncontrolling interests.  The statement of changes in owners’ equity provides an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

31. Consolidated Statements—Income Statement and Statement of Changes in Owners’ Equity 4-31 EXHIBIT 4.7 Consolidated Statements with Noncontrolling Interest—Acquisition Method Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

32. Consolidated Statements—Balance Sheet 4-32 EXHIBIT 4.7 Consolidated Statements with Noncontrolling Interest—Acquisition Method Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

33. Learning Objective 4-7 4-33 Determine the effect on consolidated financial statements of a control premium paid by the parent. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

34. Partial Acquisition with Control Premium 4-34 Assume that to acquire sufficient shares to gain control of Pawn, King pays a control premium of $1.25 ($11 − $9.75) for a total of $880,000 cash consideration for its 80 percent interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

35. Effects of Using the Initial Value Method 4-35 The initial value method ignores two accrual-based adjustments: 1)The parent does not accrue the percentage of subsidiary net income earned in past years in excess of dividends. 2)The parent does not record amortization expense under the initial value method. Entry *C is added to the worksheet to convert the previously recorded balances to the equity method. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

36. Entry *C is used to convert to the equity method. Combine: 1)The increase (since acquisition) in the subsidiary’s retained earnings during past years (net income less dividends) times the parent’s ownership percentage. 2)The parent’s percentage of total amortization expense for these same past years. Entry (I) removes both intra-entity dividend income and subsidiary dividends to the parent. (Entry D is unnecessary.) Conversion to Equity Method from Initial Value Method (Entry *C) 4-36 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

37. Partial Equity Method 4-37  If the parent used the partial equity method to account for the subsidiary after acquisition, Entry *C is used to convert to the equity method.  In this case, only the amortization expense for the prior years must be included.  Under the partial equity method, the parent accrues its share of reported subsidiary income, but it does not recognize any acquisition-date excess fair value amortization expenses. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

38. Learning Objective 4-8 4-38 Understand the impact on consolidated financial statements of a midyear acquisition. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

39. Midyear Acquisitions When control of a subsidiary is acquired at a midyear date:  New parent must compute the subsidiary’s book value as of acquisition date to determine excess total fair value over book value allocations.  Excess amortization expenses, any equity accrual, and dividend distributions are recognized for a period of less than a year.  Because only net income earned by the subsidiary after the acquisition date accrues to the new owners, it is appropriate to include only postacquisition revenues and expenses in consolidated totals. 4-39 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

40. Learning Objective 4-9 4-40 Understand the impact on consolidated financial statements when a step acquisition has taken place. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

41. Control Achieved in Steps— Acquisition Method  A step acquisition occurs when control is achieved in a series of equity acquisitions.  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. 4-41 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

42. Postacquisition Control Achieved in Steps  If the parent previously held a noncontrolling interest in the acquired firm, the parent remeasures its 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 accounts for additional subsidiary shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders. 4-42 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

43. Learning Objective 4-10 4-43 Record the sale of a subsidiary (or a portion of its shares). Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

44. Parent Company Sales of Subsidiary Stock—Acquisition Method The accounting effect from selling subsidiary shares depends on whether the parent continues to maintain control after the sale.  If the sale results in the loss of control, parent recognizes any resulting gain or loss in consolidated net income.  If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section.  The parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital. 4-44 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

45. Parent Company Sales of Subsidiary Stock—Less Than Entire Investment  If the former parent retains any of its former subsidiary’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. 4-45 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

46. Noncontrolling Interest—U.S. GAAP 4-46  Accounting and reporting for business combinations between U.S. and international standards has converged with FASB ASC Topic 805 and IFRS 3R, each of which carries the title “Business Combinations” and ASC Topic 810: “Consolidation.”  U.S. GAAP requires fair value measurement. Acquisition-date fair value provides a basis for reporting noncontrolling interest, which is adjusted for its share of subsidiary income and dividends subsequent to acquisition. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

47. Noncontrolling Interest—International Financial Reporting Standards 4-47  IFRS 3R allows an option for reporting the noncontrolling interest for each business combination.  It may be measured either at its acquisition-date fair value, which can include goodwill, or at a proportionate share of the subsidiary’s identifiable net asset fair value, which excludes goodwill.  This option assumes that any goodwill created via acquisition applies solely to the controlling interest. Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.