Concepts of Consolid. Statements - 1
2-1
Concepts of Consolidated Financial
Statements
Parent
Subsidiary
Consolidated
financial statements
are prepared.
Concepts of Consolid. Statements - 2
CONSOLIDATED
FINANCIAL STATEMENTS
“Economic Substance Over Legal Form”
 Conditions for consolidation
– Majority control
• Parent company owns more than 50% of voting stock
• Intent is long-term control
• ALL majority owned subsidiaries MUST be consolidated
(SFAS No. 94 - October 1987)
– Effective control by majority shareholders
• Not in bankruptcy or reorganization
• Not in restricted foreign environment
Concepts of Consolid. Statements - 3
CONSOLIDATED STATEMENTS
General Concepts
 Same GAAP as separate statements
 Only external transactions
 Specific consolidation mechanics
depend on Parent’s accounting for
investment in subsidiary
Concepts of Consolid. Statements - 4
CONSOLIDATED STATEMENTS
Other Issues
 Classification of “noncontrolling”
(minority) interest
 Elimination of intercompany items
– Receivables and payables
– Profits on intercompany sales
 Mechanics of consolidation
Concepts of Consolid. Statements - 5
LIMITATIONS OF
CONSOLIDATED STATEMENTS
 Limited relevance for certain users
– Minority stockholders
– Separate creditors
– Regulatory authorities (related to
subsidiary)
 Consolidation of highly diversified
companies
 Difficult financial analysis
Concepts of Consolid. Statements - 6
3-6
Consolidation - The Effects of the
Passage of Time
The parent can account
for its investment in
one of three ways:
 Equity Method
 Cost Method
 Partial Equity
Let’s briefly
compare the
three methods
Concepts of Consolid. Statements - 7
3-7
Method
Equity
Cost
Partial
Equity
Investment Account
Income Account
Income accrued as
Continually adjusted earned; amortization
to reflect ownership
and other
of acquired company.
adjustments are
recognized.
Cash received
Remains at initially
recorded as dividend
recorded cost.
Income.
Adjusted only for
Income accrued as
accrued income and
earned; no other
dividends received
adjustments
from acquired
recognized.
company.
Concepts of Consolid. Statements - 8
3-8
Method
Advantages
Equity
Acquiring company totals give a true
representation of consolidation figures
Cost
Easy to apply: measures cash flows
Partial
Equity
Usually gives balances approximating
consolidation figures, but is easier to
apply than equity method
3-9
Concepts of Consolid. Statements - 9
Before the consolidation balances can
be determined, the Parent’s investment
account must be adjusted to reflect
application of the Equity method.
Record the Investment in Sub on the
acquisition date.
Recognize the receipt of dividends from
the sub.
Recognize a share of the sub’s income
(loss).
FMV adjustments and other intangible
assets.
Concepts of Consolid. Statements - 10
CONSOLIDATION MECHANICS
 Consolidation workpapers
– No “set of books” for consolidated entity
– Each party maintains their own books
 Eliminating entries
– Necessary to eliminate “intercompany
items”
– Appear only on consolidation workpapers
Concepts of Consolid. Statements - 11
CONSOLIDATION MECHANICS
Parent Co.
Other
Assets
(BOOK)
Subsidiary Co.
+
Other
Assets
(FMV)
Consolidated Entity
=
Other
Assets
Invest.
In S
(ELIMIN)
Liab.
(BOOK)
Stk.
Equity
+
Liab.
(FMV)
=
Liab.
Stk.
Equity
(ELIMIN)
Stk.
Equity
Consolid – Other. Issues - 12
INVESTMENT ELIMINATION
 Investment account (Parent’s books) vs.
Stockholders’ equity (Subsidiary’s books)
 Treatment of the differential
– Cost of the investment
– FMV of subsidiary’s net assets
– Book value of subsidiary’s net assets
Consolid – Other. Issues - 13
INVESTMENT ELIMINATION
Continued
 Positive differential (Cost vs. Book value)
– Errors or omissions on subsidiary’s books
– Excess of FMV over book value of subsidiary’s net
assets
– Existence of goodwill
 Negative differential (Cost vs. Book value)
– Errors or omissions on subsidiary’s books
– Excess of book value over FMV of subsidiary’s net
assets
– Bargain purchase or “negative goodwill”
Consolid – Other. Issues - 14
INVESTMENT ELIMINATION
Continued
Treatment of noncontrolling interest
Cost vs. Equity methods on Parent’s books
Intercompany receivables and payables
Valuation accounts at acquisition
– Accumulated depreciation
– Allowance for change in FMV of investment securities
– Allowance for uncollectible accounts
– Discount or premium on bonds payable
 Negative Retained earnings of subsidiary at acquisition
 Other stockholders’ equity accounts
– Accounts accruing to common stock




3-15
Concepts of Consolid. Statements - 15
Subsequent Consolidation Worksheet Entries
5 basic entries are posted to the worksheet.
The Sub’s equity accounts are eliminated.
Other intangible assets are recorded and the
Sub’s assets are adjusted to FV.
The Equity in Sub Income account is
eliminated.
The Sub’s dividends are eliminated.
Amortization Expense is recorded for the FMV
adjustments and other intangible assets
associated with the consolidated entity.
Consolid – Other. Issues - 16
ELIMINATING ENTRIES
First Subsequent Period
(Equity Method)
 Impact of current equity method entries
– Ignore any impairment of goodwill
 Assignment of income to noncontrolling interest
 Investment account – Stockholders’ equity of subsidiary
–
–
–
–
–
Including identification of noncontrolling interest
Identification of differential
Allocation of differential
Depreciation/amortization of appropriate differentials
Impairment of goodwill
Consolid – Other. Issues - 17
ELIMINATING ENTRIES
Further Subsequent Period
(Equity Method)
 Impact of current equity method entries
– Ignore impairment of goodwill
 Assignment of income to noncontrolling interest
 Investment account – Stockholders’ equity of subsidiary
–
–
–
–
Retained earnings of subsidiary at BEGINNING of current year
Including identification of noncontrolling interest
Identification of REMAINING differential
Allocation of REMAINING differential
• Including appropriate valuation accounts
– Depreciation/amortization of appropriate differentials
– Impairment of goodwill
3-18
Concepts of Consolid. Statements - 18
Applying the Cost Method
If the COST METHOD is used by the parent
company to account for the investment, then the
consolidation entries will change only slightly.
Remember . . .
1. No adjustments are recorded in the
Investment account for current year
operations, dividends paid by the subsidiary,
or amortization of purchase price allocations.
2. Dividends received from the subsidiary are
recorded as Dividend Revenue.
Concepts of Consolid. Statements - 19
3-19
Consolidation Entries
Cost Method
Adjust Investment in Sub to equity method as of the
beginning of the period
This would be necessary for periods after the year of
the Investment in the Sub.
This entry is NOT REQUIRED under the Equity Method
CONSOLIDATION RECORD
Date
Description
Investment in Subsidiary
Retained earnings (Parent)
Page
Debit
##
Credit
$$$
$$$
Concepts of Consolid. Statements - 20
3-20
Consolidation Entries
Cost Method
Eliminate the sub’s equity balances as of the
beginning of the period.
This entry is the same under both the Equity Method and
the Cost Method.
CONSOLIDATION RECORD
Date
Description
Common Stock - Subsidiary
APIC - Subsidiary
R/E-Beg.(Subsidiary)
Investment in Subsidiary
Page
Debit
##
Credit
$$$
$$$
$$$
$$$
Concepts of Consolid. Statements - 21
3-21
Consolidation Entries
Cost
Method
Adjust sub’s
assets
and liabilities to FV.
Set up the Goodwill account and the other
intangible assets. This is part of the elimination
of the Investment in Subsidiary account.
This entry is the same under both the Equity Method and the
Cost Method.
CONSOLIDATION RECORD
Date
Description
Asset #1
Asset #2
Asset #3
Investment in Subsidiary
Page
Debit
##
Credit
$$$
$$$
$$$
$$$
Concepts of Consolid. Statements - 22
3-22
Consolidation Entries
Cost Method
This entry is different under the Cost Method.
Eliminate the Parent’s Dividend Income
account.
Also, eliminate the Sub’s Dividends Paid
account.
CONSOLIDATION RECORD
Date
Description
Dividend Income
Dividends Paid
Page
Debit
##
Credit
$$$
$$$
Concepts of Consolid. Statements - 23
3-23
SFAS No. 142 - Goodwill and Other
Intangible Assets
For fiscal periods
beginning AFTER
December 15, 2001,
goodwill is no longer
amortized.
The “nonamortization”
rule is applied to both
previously recognized
and newly acquired
goodwill.
Any unamortized
goodwill arising
from pre-SFAS 142
combinations is
carried on the
books as a
permanent asset
(subject to
impairment).
Concepts of Consolid. Statements - 24
3-24
SFAS No. 142 - Goodwill and Other
Intangible Assets
Generally, once goodwill has been recorded, the
value will remain unchanged.
Two circumstances exist that
will result in adjusting the amount
of goodwill on the consolidated balance sheet.
Sale of all or part of the
related subsidiary.
A determination that goodwill
has experienced a permanent
impairment of value.
Any impairment in the value
of goodwill should be reported
as an extraordinary item.
Concepts of Consolid. Statements - 25
3-25
Goodwill Impairment Test
 Step 1
– Compare fair value of
REPORTING UNIT to
carrying value of the
REPORTING UNIT
 Step 2
– Compare fair value of
GOODWILL to carrying
value of GOODWILL
 (SEE HANDOUT)