Electronic
Presentations
in Microsoft®
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Prepared by
James Myers,
C.A.
University of
Toronto
© 2010 McGraw-Hill
Ryerson Limited
Chapter 4, Slide 1
© 2010 McGraw-Hill Ryerson Limited
Chapter 4
Consolidated Statements
on
Date of Acquisition
Chapter 4, Slide 2
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
1.
2.
3.
4.
5.
6.
Calculate and allocate the acquisition differential
Explain the concept of negative goodwill and describe
how it should be treated when it arises in a business
combination
Prepare a consolidated balance sheet, using working
paper & direct approaches
Describe the concept of push-down accounting
Explain the differences between the four consolidation
theories, and apply these theories by preparing a
consolidated balance sheet on acquisition date
Account for contingent consideration based on its
classification as a liability or equity
Chapter 4, Slide 3
© 2010 McGraw-Hill Ryerson Limited
Consolidated Financial Statements



IAS 27 specifies the accounting principles
involved in the preparation of consolidated
financial statements
Consolidated financial statements consist of a
balance sheet, a statement of comprehensive
income, a statement of changes in equity, a
cash flow statement, and the accompanying
notes
We will now focus on the preparation of the
consolidated balance sheet on the date that
control is obtained by the parent company, using
the acquisition method
LO 3
Chapter 4, Slide 4
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

The facts below are the basis of the following
illustrations:



We will examine P Ltd. and S Ltd. Both companies have a June
30 fiscal year-end.
The balance sheets of the two companies on June 29, Year 1 are
shown in Exhibit 4.1.
P pays $90,000 to acquire 100% of S on June 30, Year 1. P
records in its books:
Dr investment in S
$90,000
Cr cash


LO 3
$90,000
The calculation and allocation of acquisition differential is in
Exhibit 4.2.
Exhibit 4.3 shows the consolidated balance sheet of P on June
30, Year 1, using the working paper approach; Exhibit 4.4 shows
the same balance sheet using the direct approach.
Chapter 4, Slide 5
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.1
LO 3
Chapter 4, Slide 6
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.2
LO 3
Chapter 4, Slide 7
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date


Working Paper Approach – Use of the working paper
ensures that the debit and credit adjustments balance
each other.
The working paper in Exhibit 4.3 reflects two
consolidation adjusting entries:



To eliminate the parent’s share of the subsidiary’s shareholders’
equity accounts and the parent’s investment account; and
To allocate the acquisition differential to the identifiable assets
and liabilities of the subsidiary and record goodwill.
These entries are made only on the working paper, not
in the accounting records of P or S.
LO 3
Chapter 4, Slide 8
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.3
LO 3
Chapter 4, Slide 9
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date


Direct Approach - An alternative to the worksheet
method of preparing consolidated financial statements in
Exhibit 4.3 is the Direct Approach, preparing the
statements directly without the use of a working paper.
See Exhibit 4.4 next slide.
The basic process in the direct approach on the
acquisition date is as follows:
Book value + Book value +(-) Acquisition = Consolidated
(parent)
(subsidiary)
differential
balance

Note that the investment account, acquisition differential,
and shareholders’ equity accounts of the subsidiary are
eliminated by simply ignoring or omitting them.
LO 3
Chapter 4, Slide 10
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.4
LO 3
Chapter 4, Slide 11
© 2010 McGraw-Hill Ryerson Limited
Consolidation on Acquisition Date
Income Statement in Year of Acquisition
 Under the acquisition method, only the net
income earned by the subsidiary after the date
of acquisition is included in consolidated net
income. In the above example, P’s financial
statements for June 30, Year 1 would include a
consolidated balance sheet and net income,
changes in equity, and cash flows from P’s
separate entity financial statements
LO 3
Chapter 4, Slide 12
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date
Push-down Accounting
 Not permitted under IFRS but may be in the future.
Permitted by GAAP for private enterprises, with
disclosures required in the first year of application
 Under CICA Handbook Section 1625 push-down
accounting was permitted when the parent owned 90%
or more of a subsidiary. In these cases the parent could
revalue the subsidiary’s assets and liabilities based on
the parent’s acquisition cost, simplifying the process of
preparing consolidated financial statements
LO 4
Chapter 4, Slide 13
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date
Subsidiary Formed by Parent
 When a parent company starts a subsidiary, the
preparation of the consolidated balance sheet
on the date of formation of the subsidiary
requires only the elimination of the parent’s
investment against the subsidiary’s share capital
since the subsidiary would have no retained
earnings on formation
LO 3
Chapter 4, Slide 14
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date
Negative Goodwill
 The parent company gains control of
subsidiary’s assets and liabilities at a price that
is less than the fair values assigned to those
assets and liabilities


Often described as a bargain purchase, this can occur
when share prices are depressed or subsidiary has
had recent operating losses
IFRS 3 requires that negative goodwill be
reduced to zero by first reducing any goodwill on
the subsidiary’s books, then recognizing any
remaining negative goodwill as a gain
LO 2
Chapter 4, Slide 15
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

Illustration 2 – Negative Goodwill:




LO 2
On June 30, Year 1 P Ltd. purchased 100% of the
shares of S. Ltd. for $75,000 cash. The book value of
S’s identifiable net assets is $70,000 and the
acquisition differential is $5,000 on that date
$7,000 of the $5,000 acquisition differential is
allocated to the net assets of S, leaving $2,000
negative goodwill
The calculation and amortization of the acquisition
differential is shown in Exhibit 4.5 next slide
The consolidated balance sheet is shown in Exhibit
4.6 on the following slide
Chapter 4, Slide 16
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.5
LO 2
Chapter 4, Slide 17
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.6
LO 2
Chapter 4, Slide 18
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

Negative Acquisition Differential:



LO 1
Not the same as negative goodwill
Results when the parent’s interest in the book values
of the subsidiary’s net assets exceed acquisition cost
Could result in negative goodwill if the fair values of
the subsidiary’s net assets also exceed acquisition
cost, otherwise will result in positive goodwill
Chapter 4, Slide 19
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

Subsidiary with Goodwill:



LO 1
Any goodwill on balance sheet of subsidiary on
acquisition date is not carried forward to the
consolidated balance sheet
That goodwill resulted from a past transaction in which
the subsidiary was the acquirer in a business
combination, reflecting outdated fair values of the
entity it acquired
The parent’s acquisition differential is now calculated
as if the goodwill had been written off by the
subsidiary and replaced instead by the updated fair
values and goodwill of the entity the subsidiary
previously acquired
Chapter 4, Slide 20
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

Illustration 3 – Subsidiary with Goodwill:




LO 1
On June 30, Year 1 P Ltd. purchased 100% of the
shares of S. Ltd. for $75,000 cash. The fair value of
S’s identifiable net assets – which excludes goodwill is $67,000 on that date.
The balance sheets of both companies is shown in
Exhibit 4.8 next slide.
The calculation and amortization of the acquisition
differential is shown in Exhibit 4.9 in the following
slide.
The consolidated balance sheet is shown in Exhibit
4.10 in the second following slide.
Chapter 4, Slide 21
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.9
LO 1
Chapter 4, Slide 22
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.10
LO 3
Chapter 4, Slide 23
© 2010 McGraw-Hill Ryerson Limited
The Consolidated Balance Sheet on Acquisition Date

Consolidation of Non-wholly Owned Subsidiaries:



LO 3
The shares not owned by the parent are owned by the other
shareholders, referred to as the “non-controlling shareholders”.
The value of shares held by the non-controlling shareholders
appears on the balance sheet as “non-controlling interest” (NCI).
Four theories address the following questions:
 How should the portion of the subsidiary’s net assets not
owned by the parent be valued on the consolidated financial
statements?
 How should NCI be valued?
 How should NCI be presented?
Chapter 4, Slide 24
© 2010 McGraw-Hill Ryerson Limited
Conceptual Alternatives
The four theories are:








Proprietary Theory
Entity Theory
Parent Company Theory
Parent Company Extension
Parent Company Theory was GAAP in Canada to January 1,
2011 or sooner upon earlier adoption of IFRS 3
On January 1, 2011 the Entity Theory replaces Parent
Company Theory as the preferred method of consolidating
subsidiaries
The Parent Company Extension Theory is also acceptable
after January 1, 2011 or sooner
Proprietary Theory is presently used for consolidating joint
ventures but may be discontinued soon
LO 5
Chapter 4, Slide 25
© 2010 McGraw-Hill Ryerson Limited
The Proprietary Theory



Views the consolidated entity from the
standpoint of the shareholders of the parent
company
Therefore the consolidated statements do not
reflect the equity of the non-controlling
shareholders
Not permitted under GAAP for consolidation of
parent and subsidiary, however is used to report
joint venture investments where there is no
control relationship
LO 5
Chapter 4, Slide 26
© 2010 McGraw-Hill Ryerson Limited
The Proprietary Theory


The consolidated balance sheet consists of the
historical values of the parent’s assets and
liabilities plus the parent’s share of the fair
values of the subsidiary’s assets and liabilities
Goodwill is therefore based only on the cost paid
by the parent for the acquisition, and does not
include any portion attributable to the noncontrolling shareholders
LO 5
Chapter 4, Slide 27
© 2010 McGraw-Hill Ryerson Limited
The Entity Theory




Views the consolidated entity as having two distinct
groups of shareholders – the controlling and noncontrolling shareholders
The basis of GAAP for consolidation beginning January
1, 2011 or upon earlier adoption of IFRS 3
The consolidated balance sheet reflects full fair values of
subsidiary’s net assets and goodwill as if the parent had
acquired 100% instead of the lesser amount actually
acquired
For the balance sheet to reflect full fair value of the
subsidiary, the price per share paid by the parent is
effectively extrapolated to the shares not acquired, to
establish an implied fair value for the entire company.
LO 5
Chapter 4, Slide 28
© 2010 McGraw-Hill Ryerson Limited
The Entity Theory




As parent’s holding moves further away from 100%, or as parent
acquires control through a series of small purchases, straight-line
extrapolation loses validity
If the subsidiary was a public company and its shares were actively
traded prior to acquisition, an alternative approach to valuing the
non-controlling interest would be to multiply the number of noncontrolling shares by the acquisition date trading price
Another alternative approach for valuing non-controlling interests
would be to perform an independent business valuation using
valuation techniques, which could be costly
The entity theory results in the following:



LO 5
Assets acquired and liabilities assumed are valued at their total fair value
at the date of acquisition
Non-controlling interest is valued on the basis of the market value of the
company acquired, not the underlying book value as in the parent
company theory.
NCI is presented in consolidated equity based on fair values of
subsidiary’s net assets and goodwill.
Chapter 4, Slide 29
© 2010 McGraw-Hill Ryerson Limited
The Entity Theory

Illustration of entity theory:


LO 5
P Ltd. acquires 80% of S Ltd. on June 30, Year 1 for
$72,000 paid in cash
The following two slides Exhibits 4.14 and 4.15 reflect
the calculation and allocation of acquisition differential,
non-controlling interest, and consolidated balance
sheet of P Ltd.
Chapter 4, Slide 30
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.14
LO 5
Chapter 4, Slide 31
© 2010 McGraw-Hill Ryerson Limited
Exhibit 4.15
LO 5
Chapter 4, Slide 32
© 2010 McGraw-Hill Ryerson Limited
The Parent Company Theory




Similar to the proprietary theory the Parent Company
theory focuses on the parent’s shareholders
Required by GAAP prior to January 1, 2011 or before
earlier adoption of IFRS 3
The fair values of the assets and liabilities acquired in
the consolidation are reflected in the consolidated
statements, but only to the extent of the parent’s
proportionate interest acquired. The non-controlling
shareholders’ portion is reflected at book values
Accordingly, the value of subsidiary’s assets and
liabilities reflected on the consolidated balance sheet is a
hybrid: book value for non-controlling interest portion and
fair value for the parent’s share
LO 5
Chapter 4, Slide 33
© 2010 McGraw-Hill Ryerson Limited
The Parent Company Theory


Requires that fair values be recognized only to the extent
of the proportion evidenced by the parent’s purchase.
That is, with a 90% purchase of a subsidiary, book value
is reflected for each asset and liability of the subsidiary,
plus the parent’s fair value increment based on 90% of
the difference between fair and book values.
Consolidated balance sheet is the sum of the:




Book value of Parent Company's Net Assets
Book value of Subsidiary Company Net Assets, and
Difference between fair value and book value of Subsidiary’s
assets and liabilities, only for the percentage acquired by the
parent. (The non-controlling portion remains at historical cost)
NCI is reflected as a liability
LO 5
Chapter 4, Slide 34
© 2010 McGraw-Hill Ryerson Limited
Parent Company Extension Theory



Addresses concern about goodwill valuation
under the entity theory
Reflects both parent’s and non-controlling
interest’s share of identifiable net assets at full
fair values.
However only parent’s share of subsidiary’s
goodwill is reflected on consolidated balance
sheet.
LO 5
Chapter 4, Slide 35
© 2010 McGraw-Hill Ryerson Limited
Parent Company Extension Theory

NCI is calculated as follows:
Book values of S Ltd.’s net assets
Assets
Liabilities
$100,000
(30,000)
70,000
Excess of fair value over book value
for identifiable net assets (Ex. 4.14) 7,000
Fair value of identifiable net assets
77,000
non-controlling ownership %
20%
non-controlling interest
$15,400

LO 5
NCI is reflected in equity
Chapter 4, Slide 36
© 2010 McGraw-Hill Ryerson Limited
Contingent Consideration


What happens when a portion of the total cost of
the acquisition is variable depending on future
events, so the eventual total cost is not known
with certainty at the date of acquisition of the
subsidiary?
IFRS 3 requires the contingent consideration to
be recorded at fair value at the acquisition date
as part of the acquisition cost, using
assumptions, probabilities, and other valuation
techniques which can be subjective and require
significant amounts of judgment
LO 6
Chapter 4, Slide 37
© 2010 McGraw-Hill Ryerson Limited
Contingent Consideration

Classify contingent consideration as either liability or
equity depending on its nature.
 If payable in cash or another asset, record as liability.
Revalue liability after acquisition date as
circumstances change



LO 6
Record revaluation adjustment in earnings if revaluation arose
as a result of events occurring after acquisition; or
Adjust the purchase price if revaluation arose as a result of
new information about facts and circumstances that existed as
at the date of acquisition
If payable in additional shares of the parent, record as
equity. Do not revalue contingent consideration
classified as equity.
Chapter 4, Slide 38
© 2010 McGraw-Hill Ryerson Limited
Contingent Consideration

Contingent consideration disclosures:






LO 6
Amount of contingent consideration recognized on acquisition
date
Description of the contingency and basis for determining payment
Range of potential payments (undiscounted), or the reasons why
a range cannot be estimated
If applicable, the presence of an unlimited maximum payment
Each period until the contingency is settled, changes in the
amounts recognized for contingent consideration, changes in the
range of outcomes (undiscounted), and the reasons for the
changes.
The valuation techniques used to measure contingent
consideration.
Chapter 4, Slide 39
© 2010 McGraw-Hill Ryerson Limited