Chapter 4
CONSOLIDATION TECHNIQUES AND PROCEDURES
Comprehensive Chapter Outline
CONSOLIDATION WORKING PAPERS ARE TOOLS USED TO ASSEMBLE AND
ORGANIZE THE INFORMATION REQUIRED FOR THE PREPARATION OF
CONSOLIDATED FINANCIAL STATEMENTS FOR A PARENT COMPANY AND
ITS SUBSIDIARIES.
A
All data presented in the consolidated financial statements can be determined
independently from the working papers.
B
Working paper entries do not affect the general ledger accounts of either the parent
company or its subsidiaries.
THIS BOOK USES THE FOLLOWING WORKING PAPER TECHNIQUES FOR
CONSOLIDATING THE FINANCIAL STATEMENTS OF A PARENT COMPANY
AND ITS SUBSIDIARY:
A
The financial statements of the parent company and subsidiary appear in the first two
columns of the working papers, followed by debit and credit columns for the adjusting
and eliminating entries. The final column shows the consolidated financial statements.
B
Some accounts are adjusted or eliminated and other accounts are added before the
separate financial statement columns are combined into consolidated amounts.
C
Only account balances may be adjusted or eliminated.
D
Parent company and subsidiary net income (income statement) and ending retained
earnings (retained earnings statement) balances are not accounts and are not subject to
adjustment or elimination.
E
1
Consolidated net income consists of consolidated revenues less consolidated
expenses.
2
Consolidated retained earnings consists of beginning consolidated retained
earnings plus consolidated net income less parent company dividends.
All nominal accounts are assumed to be open and to permit adjustment.
PROCEDURES FOR PREPARING CONSOLIDATION WORKING PAPERS:
A
Determine the parent company’s method of accounting for its subsidiary.
B
Copy the separate company financial statements of the parent and subsidiary in the first
two columns of the working papers.
C
Enter consolidation working paper entries in the adjustments and eliminations columns
in the following sequence:
1
D
Adjust for errors or omissions in the separate company financial statements.
2
Eliminate intercompany profits and losses.
3
Eliminate income and dividends from the subsidiary and adjust the investment
in subsidiary to its beginning-of-the-period balance.
4
Record the adjustment to record the minority’s interest in subsidiary’s earnings
(minority interest expense) and dividends.
5
Eliminate reciprocal investment in subsidiary and subsidiary equity balances,
enter beginning of the period minority interest, and enter unamortized cost-book
value differentials.
6
Amortize cost-book value differentials.
7
Eliminate other reciprocal balances (intercompany receivables and payables, for
example).
Add the separate company accounts plus or minus any related amounts from the
adjustments and eliminations column and enter the sum in the consolidated statement
column.
E
Calculate consolidated net income as consolidated revenues less consolidated expenses
and less minority interest expense and carry consolidated net income to the consolidated
retained earnings statement.
F
Calculate consolidated retained earnings and carry that amount to the consolidated
balance sheet.
G
Sum the consolidated balance sheet assets and equities.
H
Under the equity method, parent company net income equals consolidated net income
and parent company retained earnings equals consolidated retained earnings.
A CONSOLIDATED STATEMENT OF CASH FLOWS IS PREPARED FROM
THE CONSOLIDATED BALANCE SHEETS AND THE CONSOLIDATED INCOME
STATEMENT USING THE SAME GENERAL PROCEDURES AS USED FOR
SEPARATE COMPANY STATEMENTS OF CASH FLOWS.
A
B
C
Both the direct and indirect methods for preparing the cash flows from operating
activities section of the statement are permitted.
1
The cash flows from investing activities and the cash flows from financing activities
sections are the same under the direct and indirect methods.
2
The direct method is preferred by the FASB.
3
Items not involving cash are explained in notes or schedules to the cash flow
statement.
The indirect method begins with consolidated net income. Items not providing or using
cash are adjusted to arrive at net cash flows from operations.
1
Minority interest expense is an increase in the cash flow from operating
activities.
2
Minority interest dividends decrease cash flow from financing activities.
3
The net amount of income less dividends received from equity investees (i.e., the
change in the investment account) is deducted from net income in the cash flow
from operating activities section of the cash flow statement. If dividends
received are greater than income from equity investees, the net amount is an
addition to net income.
a
Income from equity investees increases income without increasing cash
because the increase is reflected in the investment account.
b
Dividends received from equity investees increase cash without affecting
income because the dividends are reflected in the investment account.
The direct method begins with cash received from customers and investment income.
Cash paid to suppliers, employees, and so on is offset against cash received to arrive
at net cash flows from operating activities.
1
Consolidated income statement items involving cash flows are converted from
the accrual to the cash basis.
2
Dividends received from equity investees are reported directly as cash flows
from operating activities.
3
A schedule reconciling consolidated net income to operating cash flows is
required.
APPENDIX: THE TRIAL BALANCE WORKING PAPER FORMAT CONSOLIDATES
THE ADJUSTED TRIAL BALANCES OF THE PARENT COMPANY AND ITS
SUBSIDIARIES.
A
B
The adjustments and eliminations are the same for the financial statement and the trial
balance working paper approaches.
1
Only actual accounts are adjusted.
2
Beginning retained earnings appears in the trial balances and can be adjusted.
Debit accounts are listed first and totaled. Credit items are listed next and totaled.
1
The separate adjusted trial balances of the parent company and subsidiary are
presented in the first two columns, followed by the adjustment and elimination
columns.
2
Separate columns for the income statement, retained earnings statement, and
balance sheet follow.