Electronic
Presentations
in Microsoft®
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Prepared by
James Myers,
C.A.
University of
Toronto
© 2010 McGraw-Hill
Ryerson Limited
Chapter 8, Slide 1
© 2010 McGraw-Hill Ryerson Limited
Chapter 8
Consolidated Cash Flows
and
Ownership Issues
Chapter 8, Slide 2
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
1.
2.
3.
Prepare a consolidated cash flow statement by
applying concepts learned in prior courses and unique
consolidation concepts discussed here
Prepare consolidated financial statements in situations
where the parent’s ownership has increased (step
purchase)
Prepare consolidated financial statements after the
parent’s ownership has decreased
Chapter 8, Slide 3
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
4.
5.
Prepare consolidated financial statements in situations
where the subsidiary has preferred shares in its capital
structure
Calculate consolidated net income and non-controlling
interest in situations where a parent has direct and
indirect control over a number of subsidiary companies
Chapter 8, Slide 4
© 2010 McGraw-Hill Ryerson Limited
Consolidated Cash Flow Statement

The consolidated cash flow statement must include the
operating, investing, and financing cash flows of the
corporate group, to the extent that these cash flows have
taken place with parties outside of the combined group
and not within the group

Instead of combining the separate company cash flow
statements of the parent and subsidiary which contain
intercompany transactions, it is more practical to prepare
the consolidated cash flow statement by using
comparative year-end consolidated balance sheets and
income statements
LO 1
Chapter 8, Slide 5
© 2010 McGraw-Hill Ryerson Limited
Consolidated Cash Flow Statements

The following items arising from business combinations
must be adjusted on the consolidated cash flow
statement:




LO 1
The cash, if any, paid for the acquisition of a subsidiary is
presented net of the subsidiary’s cash acquired at that date
The acquisition differential is amortized in the consolidated
income statement but does not affect cash flows
Non-controlling interest in the consolidated income statement is
an allocation of the entity’s net income and does not affect cash
flows
Dividends paid by subsidiaries to the parent company do not
change the combined entity’s cash. Dividends paid by
subsidiaries to non-controlling shareholders are disclosed
separately from dividends paid by the parent to its shareholders.
Chapter 8, Slide 6
© 2010 McGraw-Hill Ryerson Limited
Consolidated Cash Flow Statements

In the period that a subsidiary is acquired:

Cash paid to acquire the subsidiary, less cash held by the
subsidiary, is netted and disclosed on one line under “Investing
Activities” on the cash flow statement as:
“Acquisition of subsidiary, less cash acquired in acquisition”

LO 1
Details are disclosed in the notes to the financial statements
including condensed balance sheet of acquired subsidiary
disclosing the amount assigned to each major class of non-cash
assets and liabilities of the acquired enterprise at the date of
acquisition
Chapter 8, Slide 7
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes





Few intercorporate investments consist of a single
purchase
Investments are acquired as opportunities arise (“block
acquisitions” or “step purchases”) and are sold directly to
third parties as strategies change
Subsidiaries may sell additional shares to the public,
indirectly reducing the parent’s ownership percentage
How do we account for acquisitions made in multiple
stages or steps?
How do we account for a direct or indirect reduction in
the parent’s investment in a subsidiary? What effect do
these have on non-controlling interest?
LO 2, 3
Chapter 8, Slide 8
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Increases


Available-for-sale investments (without significant
influence) are recorded at the price paid for the shares
and are adjusted to fair value through Other
Comprehensive Income at the end of each reporting
period
After the first increase in ownership (“block acquisition”
or “step purchase”) that results in significant influence,
the equity method of accounting is used which requires
an Acquisition Differential (AD) to be calculated and
allocated based on fair values at the date that significant
influence is obtained

LO 2
For this calculation, the amount paid equals the carrying value of
previous purchases + cost of the current purchase
Chapter 8, Slide 9
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Increases

For each subsequent increase of significant influence
that does not result in control, determine a separate AD
based on the cost paid for the additional proportion of
shares acquired


LO 2
Do not revalue previous purchases while using equity accounting
The AD amortization schedule is expanded by adding columns
to track separately the amortization and unamortized balance of
the AD arising from each step acquisition – for example:
Chapter 8, Slide 10
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Increases

When control is obtained, IFRS 3 requires the
investment account to be adjusted to fair value on that
date




LO 2
The resulting gain or loss, together with any amounts previously
reflected in Other Comprehensive Income for the investment, are
recorded in income, and,
Replace any previous purchase price allocations with a new
purchase price allocation calculated on the date of the business
combination reflecting 100% of the subsidiary’s fair value and
any non-controlling interests, and
Begin to consolidate, and
Do not subsequently adjust the investment account to fair value
Chapter 8, Slide 11
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Increases

For additional acquisitions that occur after control has
been obtained:


LO 2
Do not calculate a separate purchase price allocation
Instead, treat the acquisition as a transfer of equity from noncontrolling interest to the parent with the following calculation:
Balance sheet non-controlling interest amount prior to the
acquisition
x portion sold to the parent
= Transfer from NCI to parent
If the cost of the step acquisition is greater than amount of the
transfer from NCI, the difference is debited to consolidated
retained earnings
Chapter 8, Slide 12
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Increases



Shares repurchased and cancelled by the subsidiary,
which results in the increase of the parent’s ownership,
are recorded in the same manner as direct acquisitions
by the parent after control has been obtained
Numerous small purchases within a short period of time
(days or weeks) can be treated as one single purchase
Consolidated retained earnings should recognize the
parent’s interest in the subsidiary’s income, and
amortization of the acquisition differential, for each
separate period as the parent’s interest increases
LO 2
Chapter 8, Slide 13
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Decreases

Under either a direct or indirect decrease in ownership,
the parent’s portion of unamortized AD must be reduced
by the percentage of its investment that the parent has
disposed of, and transferred to the NCI’s share of
unamortized AD


LO 3
Direct decrease: parent sells shares that it owns in subsidiary to
third parties
Indirect decrease: subsidiary issues additional new shares and
sells them to third parties, thereby diluting the parent’s
ownership
Chapter 8, Slide 14
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Decreases

A gain or loss is computed as the difference between:
(i) the proceeds received either directly from third
parties, or indirectly as the parent’s share of the
proceeds received by the subsidiary, and
(ii) the net book value of the investment before the
decrease computed under the equity method


LO 3
reflecting parent’s share of subsidiary earnings less dividends
received from the subsidiary, amortization of acquisition
differential, and elimination of unrealized upstream and
downstream profits
If the parent has used the cost method to account for its
investment in subsidiary, the investment account must first be
recomputed using the equity method
Chapter 8, Slide 15
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Decreases

As long as the parent retains control after the decrease,
it is treated as a transfer between owners which does not
affect net income, therefore record any gain or loss in
consolidated retained earnings



LO 3
The subsidiary’s net assets are not revalued when the parent
sells a portion of its investment
Proceeds of disposal of subsidiary shares should be reported in
investing activities on the consolidated cash flow statement
Balance sheet NCI increases with each decrease in the parent’s
holding – see example on next slide
Chapter 8, Slide 16
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Decreases

Example of reallocation from controlling interest to noncontrolling interest (parent selling 9% of its shareholding
in the subsidiary):
LO 3
Chapter 8, Slide 17
© 2010 McGraw-Hill Ryerson Limited
Ownership Changes - Decreases

When the subsidiary issues new shares to third
parties and dilutes the parent’s ownership, the
gain or loss is computed based on:
Share issuance proceeds received by subsidiary
x Parent’s new ownership %
= Portion of proceeds attributable to parent
- Investment in subsidiary balance pre-dilution x %
reduction in parent’s ownership
= Gain (loss)
LO 3
Chapter 8, Slide 18
© 2010 McGraw-Hill Ryerson Limited
Subsidiary with Preferred Shares Outstanding


Corporations often have complex capital structures, with
many categories of shares
When there are preferred shares in the capital structure
of the subsidiary, total shareholders’ equity of the
subsidiary must be allocated among the interests of the
various classes of shares on the basis of their respective
rights and preferences


LO 4
Preferred shares owned by external shareholders are presented
as part of non-controlling interest
All common and preferred shares owned by the parent are
eliminated
Chapter 8, Slide 19
© 2010 McGraw-Hill Ryerson Limited
Subsidiary with Preferred Shares Outstanding

Preferred shareholders have a non-controlling claim on:





Preferred share capital
Preferred dividends (as a claim on current income of the
subsidiary)
Preferred dividends in arrears, if the preferred shares have
cumulative dividend rights
Redemption premiums, if the preferred shares are redeemable
for greater than their cost
These non-controlling claims of preferred shareholders
are “reserved”, or set aside, in NCI by reducing equity
available to the common shareholders
LO 4
Chapter 8, Slide 20
© 2010 McGraw-Hill Ryerson Limited
Subsidiary with Preferred Shares Outstanding

Example:



LO 4
P bought 80% of S common shares for $500,000 on Jan. 1, Yr. 1
S net income for Year 1 = $120,000 and S paid $10,000 of
dividends to its common shareholders in Year 1. There were no
intercompany transactions during the year.
On Jan. 1, Year 1 the book values of S’s assets and liabilities
equalled their fair values, and S’s equity consisted of:
$80,000 Preferred Shares: 10,000, 10%, cumulative,
stated value $8, redeemable at $9
$50,000 Common shares: 50,000
$400,000 Retained earnings
Preferred share dividends were 2 years in arrears on Jan. 1, Yr. 1
Chapter 8, Slide 21
© 2010 McGraw-Hill Ryerson Limited
Subsidiary with Preferred Shares Outstanding
Calculation of Acquisition Differential and NCI (B/S) at acquisition:
Cost
$500K/80%
$625,000
NBV of S common shares:
Common shares
$ 50,000
Retained earnings
$400,000
Less: Pref. share redemption premium
($ 10,000)
Less: Pref. share dividend arrears
($ 16,000)
$424,000
AD
$201,000
Allocate to FVI’s
$
Goodwill
$201,000
NCI (B/S) = (424 x 20%) + 80 + 10 + 16 = $190.8
LO 4
Chapter 8, Slide 22
© 2010 McGraw-Hill Ryerson Limited
Subsidiary with Preferred Shares Outstanding
Calculation of Year 1 consolidated net income and NCI (I/S):
= Parent net income – common share dividends received by Parent
from subsidiary
+ S Net income
$120,000
Allocate to pref. shareholders*
Amortize acquisition differential
Available to common shareholders
Parent ownership
($8,000)
$112,000
x 80%
$ 89,600
NCI (I/S) = ($112,000 x 20%) + $8,000
$30,400
*Pref. shareholder allocation = 10% dividend x $80,000 for Year 1
LO 4
Chapter 8, Slide 23
© 2010 McGraw-Hill Ryerson Limited
Indirect Shareholdings

The following diagrams illustrate both direct and indirect
holdings

In this first diagram, each of B and C are subsidiaries of A
through direct control:
B
A
C
LO 5
Chapter 8, Slide 24
© 2010 McGraw-Hill Ryerson Limited
Indirect Shareholdings

The second example, below, illustrates indirect control


G is a subsidiary of F, and F in turn is a subsidiary of E
Because E can control the voting shares of G through its control of F,
G is also a subsidiary of E
E
LO 5
90%
F
70%
G
Chapter 8, Slide 25
© 2010 McGraw-Hill Ryerson Limited
Indirect Shareholdings

In the third example, below, K is a subsidiary of J through direct
control.

L is also a subsidiary of J though indirect control, because 55% of
its voting shares are controlled directly or indirectly by J, even
though only 43% [25% + (60% x 30%)] of L’s net income will flow to
J under the equity method of accounting
K
J
30%
L
LO 5
Chapter 8, Slide 26
© 2010 McGraw-Hill Ryerson Limited
Indirect Shareholdings

To prepare consolidated financial statements when there
are indirect shareholdings in subsidiaries, the equity
method of accounting must be used by the parent for
each subsidiary investment



If the cost method has been used to record investment in
subsidiaries, it must first be adjusted to the equity method
Allocate the equity-accounted net income of each
company up to its owner(s) starting with the lowest
company in the corporate chain
The unallocated income of all the subsidiaries represents
non-controlling interest in income – see example on next
slide
LO 5
Chapter 8, Slide 27
© 2010 McGraw-Hill Ryerson Limited
Indirect Shareholdings

Example: Parent owns 80% of Subone and 45% of Subtwo.
Subone owns 25% of Subtwo, giving Parent indirect control of
Subtwo. Allocate net income from right to left in this chart:
LO 5
Chapter 8, Slide 28
© 2010 McGraw-Hill Ryerson Limited