4
Consolidation of Wholly Owned Subsidiaries
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc. All rights reserved.
1-2
Consolidation Procedures
• The starting point for preparing consolidated
financial statements is the books of the separate
consolidating companies.
• The consolidated entity has no books of its own.
• The consolidation workpaper provides a
mechanism for combining accounts of the
separate companies and for adjusting the
combined balances to the amounts that would
be reported if all consolidating companies were
actually a single company.
1-3
Nature of Eliminating Entries
• Eliminating entries are used in the consolidation
workpaper to adjust the totals of the individual account
balances of the separate consolidating companies to
reflect the amounts that would appear if all the legally
separate companies were actually a single company.
• They do not affect the books of the separate companies.
• Some eliminating entries are required at the end of one
period but not at the end of subsequent periods.
1-4
Full Ownership Purchased at Book
Value
• The purchase price of $300,000 is equal to the book
value of the shares acquired. This ownership situation
can be characterized as follows:
• Investment cost
$300,000
• Book value 1/1/X1 Common stock $200,000
• 100% Retained earnings
100,000
• Peerless’ s share 100% (300,000)
• Difference between cost and book value
$ -0-
1-5
Entry to record the purchase on
Parents books
Parent records the stock acquisition on its books
with the following entry:
Investment in Subsidiary
Cash
300,000
300,000
1-6
Investment Elimination Entry
An eliminating entry in the workpaper is one
needed to eliminate the Investment account and
the subsidiary’s stockholders’ equity accounts.
(You cannot own yourself)
Common Stock—Subsidary 200,000
Retained Earnings
Investment in Subsidiary
100,000
300,000
4-7
Example: 80% Owned @ Book Value
• Assume all of the same facts in the previous
example except that Parent purchases 80% of
Sub for $240,000.
• NOTE: $240,000 is 80% of the $300,000 total
book value of Sub. The remaining 20% of the
total book value of Sub, that is $60,000, will be
referred to as the noncontrolling interest.
4-8
Example: 80% Owned @ Book Value
_______________________________________________________________________________________________________________________________________________________________
Investment Cost
Book Value:
Common Stock-Sub
Retained Earnings-Sub
Parent’s share 100%
Differential
$240,000
$200,000
100,000
$300,000
x 0.80 (240,000)
$
-0==============
4-9
Example: 80% Owned @ Book Value
• Parent records the stock acquisition as follows:
Investment in Subsidiary
Cash
$240,000
$240,000
• There is no entry by Sub with respect to the
acquisition.
4-10
Example: 80% Owned @ Book Value
The following elimination entry is needed:
Common Stock—Sub
$200,000
Retained Earnings—Sub
100,000
Investment in Sub Stock
$240,000
Noncontrolling Interest
*60,000
*60,000 = (200,000 + 100,000)(1.00 - 0.80)
4-11
Example: Debit Differential
• Assume all of the same facts in the previous
example except that Parent purchases 80% of
Sub for $250,000.
• NOTE: $250,000 is greater than $240,000 by
$10,000. Unless stated or implied otherwise,
this $10,000 represents goodwill. Since there
are no differences between fair and book value
at the individual account level, the $10,000 debit
differential “must be” goodwill.
4-12
Example: Debit Differential
_______________________________________________________________________________________________________________________________________________________________
Investment Cost
Book Value:
Common Stock-Sub
Retained Earnings-Sub
Parent’s share 100%
Debit Differential
$250,000
$200,000
100,000
$300,000
x 0.80 (240,000)
$10,000
==============
4-13
Example: Debit Differential
• Parent records the stock acquisition as follows:
Investment in Sub Stock
Cash
$250,000
$250,000
4-14
Example: Debit Difference
The following elimination entry is needed:
Common Stock—Sub
$200,000
Retained Earnings—Sub
100,000
Goodwill
10,000
Investment in Sub Stock
$250,000
Noncontrolling Interest
*60,000
*60,000 = (200,000 + 100,000)(1.00 - 0.80)
4-15
Example: Debit Differential
• In the previous example, the debit differential
was solely attributed to goodwill. In other cases,
the debit differential could have been attributed
to multiple items.
• For example, the net debit differential could be
allocated as follows: goodwill $9,000; land
$4,000; and, equipment ($3,000).
4-16
Example: Debit Differential
• For “audit trail” purposes, two elimination entries
are used when multiple differential items exist.
• The first elimination is the same as the previous
example except that the term differential is
used in lieu of the term goodwill.
• The second elimination entry allocates the
differential to the various items giving rise to the
differential—in this example: goodwill $9,000;
land $4,000; and, equipment ($3,000).
4-17
Debit Differential—Elimination Entries
• Common Stock—Sub
$200,000
Retained Earnings—Sub
100,000
Differential
10,000
Investment in Sub Stock
$250,000
Noncontrolling Interest
60,000
• Land
Goodwill
Equipment
Differential
$4,000
9,000
$3,000
10,000
4-18
Credit Differential
• A negative differential occurs when one
company acquires the stock of another company
for less than book value.
• This “negative goodwill,” indicates that the net
assets of the subsidiary are worth less together
than if they were sold individually.
4-19
Unallocated Credit Differential
• Whenever an unallocated credit differential
exists, the FASB requires that this negative
goodwill be allocated proportionately against
non-current assets.
• If non-current assets are exhausted and
negative goodwill remains, an extraordinary gain
would be recognized.
1-20
Full Ownership Purchased at More
than Book Value
• When one company purchases another, there is
no reason to expect that the purchase price
necessarily will be equal to the acquired stock’s
book value.
The process used to prepare the consolidated
balance sheet is complicated only slightly when
100 percent of a company’s stock is purchased
at a price different from its book value.
1-21
Reason for a differential: Excess of Fair
Value over Book Value of Net Assets
• In many cases, the fair value of an acquired
company’s net assets exceeds the book value.
• Revaluing the assets and liabilities on the
subsidiary’s books generally is the simplest
approach if all of the subsidiary’s common stock
is acquired.
1-22
Reason for a differential: Existence
of Goodwill
• If a company purchases a subsidiary at a price
in excess of the total of the fair values of the
subsidiary’s net identifiable assets, the
additional amount generally is considered to be
a payment for the excess earning power of the
acquired company, referred to as goodwill .
1-23
Reason for a differential: Bargain
Purchase
• Numerous cases of companies with common
stock trading in the market at prices less than
book value.
• Often the companies are singled out as prime
acquisition targets.
• The existence of “negative goodwill,” indicating
that the subsidiary’s net assets are worth less as
a going concern than if they were sold
individually.
1-24
CONSOLIDATION SUBSEQUENT
TO ACQUISITION
• A full set of Consolidated financials is needed to
provide a complete picture of the consolidated
entities activities after acquisition.
• Consolidated financial statements are prepared
in the same order as for the parent or the
subsidiary.
1-25
Consolidated Net Income
• All revenues and expenses of the individual
consolidating companies arising from
transactions with nonaffiliated companies are
included in the consolidated income statement.
• The amount reported as consolidated net
income is that part of the total enterprise’s
income that is assigned to the parent company’s
shareholders.
1-26
Consolidated Net Income
• Consolidated net income is computed by adding
the parent’s proportionate share of the income of
all subsidiaries, adjusted for any differential
write-off or goodwill impairment, to the parent’s
income from its own separate operations
(parent’s net income less investment income
from the subsidiaries under either the cost or
equity method).
1-27
Consolidated Retained Earnings
• Consolidated retained earnings must be
measured on a basis consistent with that used in
determining consolidated net income.
• Consolidated retained earnings is that portion
of the consolidated enterprise’s undistributed
earnings accruing to the parent company
shareholders.
1-28
CONSOLIDATION SUBSEQUENT TO
ACQUISITION— 100 PERCENT OWNERSHIP
PURCHASED AT BOOK VALUE
• Each of the consolidated financial statements is
prepared as if it is taken from a single set of
books that is being used to account for the
overall consolidated entity.
• As in the preparation of the consolidated
balance sheet, the consolidation process starts
with the data recorded on the books of the
individual consolidating companies.
1-29
Consolidation Workpaper—Year of
Combination
• After all appropriate entries, including year-end
adjustments, have been made on the books a
consolidation workpaper is prepared.
• Then all amounts that reflect intercorporate
transactions or ownership are eliminated in the
consolidation process.
1-30
Consolidation Workpaper—Year of
Combination
• Book entries affect balances on the books and
the amounts that are carried to the consolidation
workpaper; workpaper eliminating entries affect
only those balances carried to the consolidated
financial statements in the period.
1-31
Second and Subsequent Years of
Ownership
• The consolidation procedures employed at the
end of the second and subsequent years are
basically the same as those used at the end of
the first year.
• Adjusted trial balance data of the individual
companies are used as the starting point each
time consolidated statements are prepared
because no separate books are kept for the
consolidated entity.
1-32
Second and Subsequent Years of
Ownership
• An additional check is needed in each period
following acquisition to ensure that the beginning
balance of consolidated retained earnings
shown in the completed workpaper equals the
balance reported at the end of the prior period.
1-33
100 PERCENT OWNERSHIP PURCHASED
AT MORE THAN BOOK VALUE
• The excess of the purchase price over the book
value of the net identifiable assets purchased
must be allocated to those assets and liabilities
acquired, including any purchased goodwill.
1-34
100 PERCENT OWNERSHIP PURCHASED
AT MORE THAN BOOK VALUE
• In consolidation, the purchase differential is
assigned to the appropriate asset and liability
balances, and consolidated income is adjusted
for the amounts expiring during the period by
assigning them to the related expense items
(e.g., depreciation expense).
1-35
INTERCOMPANY RECEIVABLES AND
PAYABLES
• All forms of intercompany receivables and
payables need to be eliminated when
consolidated financial statements are prepared.
• From a single-company viewpoint, a company
cannot owe itself money.
1-36
INTERCOMPANY RECEIVABLES AND
PAYABLES
• When consolidated financial statements are
prepared, the following elimination entry is
needed in the consolidation workpaper:
Accounts Payable 1,000
Accounts Receivable 1,000
Eliminate intercompany receivable/payable.
• If no eliminating entry is made, both the
consolidated assets and liabilities are overstated
by an equal amount.
4-37
Push-Down Accounting
• The term Push-Down Accounting refers to the
practice of revaluing the assets and liabilities of
a purchased subsidiary directly on the books of
that subsidiary at the date of acquisition.
• If this practice is followed, the revaluations are
recorded once on the books of the purchased
subsidiary at the date of acquisition and,
therefore, are not made in the consolidation
workpapers each time consolidated statements