Advanced Financial Accounting I
ADMS 4520 – Winter 2012 – Patrice Gelinas
Lecture 8 Part 1 – Consolidated Cash Flows and Ownership Issues – Mar 2
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
- The following items arising from business combinations must be adjusted on the
consolidated cash flow statement:
o The cash, if any, paid for the acquisition of a subsidiary is presented net of
the subsidiary’s cash acquired at that date
o The acquisition differential is amortized in the consolidated income
statement but does not affect cash flows
o Non-controlling interest in the consolidated income statement is an
allocation of the entity’s net income and does not affect cash flows
o 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.
- In the period that a subsidiary is acquired:
o 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”
o 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
Ownership Changes
- Few inter-corporate 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?
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
o For this calculation, the amount paid equals the carrying value of previous
purchases + cost of the current purchase
- 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
o Do not revalue previous purchases while using equity accounting
o 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
- When control is obtained, IFRS 3 requires the investment account to be adjusted to
fair value on that date
o The resulting gain or loss, together with any amounts previously reflected in
Other Comprehensive Income for the investment, are recorded in income,
and,
o 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
o Begin to consolidate, and
o Do not subsequently adjust the investment account to fair value
- For additional acquisitions that occur after control has been obtained:
o Do not calculate a separate purchase price allocation
o Instead, treat the acquisition as a transfer of equity from non-controlling
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
- 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
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
o Direct decrease: parent sells shares that it owns in subsidiary to third parties
o Indirect decrease: subsidiary issues additional new shares and sells them to
third parties, thereby diluting the parent’s ownership
- 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
o 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
o 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
- 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
o The subsidiary’s net assets are not revalued when the parent sells a portion
of its investment
o Proceeds of disposal of subsidiary shares should be reported in investing
activities on the consolidated cash flow statement
- When the subsidiary issues new shares to third parties and dilutes the parent’s
ownership, the gain or loss is computed based on:
o 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)
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
o Preferred shares owned by external shareholders are presented as part of
non-controlling interest
o All common and preferred shares owned by the parent are eliminated
- Preferred shareholders have a non-controlling claim on:
o Preferred share capital
o Preferred dividends (as a claim on current income of the subsidiary)
o Preferred dividends in arrears, if the preferred shares have cumulative
dividend rights
-
o 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
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
o 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