Advanced accounting, 5th edition international student version ch03

33
Consolidated Financial
Statements—Date of Acquisition

Advanced Accounting, Fifth Edition
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3-1


Learning
Learning Objectives
Objectives

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3-2

1.

Understand the concept of control as used in reference to consolidations.

2.

Explain the role of a noncontrolling interest in business combinations.

3.

Describe the reasons why a company acquires a subsidiary rather than its
net assets.

4.

Describe the valuation and classification of accounts in consolidated
financial statements.

5.

List the requirements for inclusion of a subsidiary in consolidated financial
statements.

6.

Discuss the limitations of consolidated financial statements.

7.

Record the investment in the subsidiary on the parent’s books at the date
of acquisition.

8.

Prepare the consolidated workpapers and eliminating entries at the date of
acquisition.

9.

Compute and allocate the difference between implied value and book value
of the acquired firm’s equity.

10.

Discuss some of the similarities and differences between U.S. GAAP and

IFRS with respect to the preparation of consolidated financial statements at
the date of acquisition.


Stock
Stock Acquisition
Acquisition
Chapter Focus - Accounting for Stock
Acquisitions
When one company controls another company
through direct or indirect ownership of its voting stock.
Acquiring company referred to as the parent.

Acquired company referred to as the subsidiary.
Other shareholders considered noncontrolling
interest.
Parent records interest in subsidiary as an investment.
If a subsidiary owns a controlling interest in one or more
other companies, a chain of ownership is forged by which
the parent company controls other companies.
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LO 2 Noncontrolling interest (NCI).


Definitions
Definitions of
of Subsidiary
Subsidiary and

and Control
Control
The Securities and Exchange Commission
defines a subsidiary as an affiliate controlled by
another entity, directly or indirectly, through one or
more intermediaries.
Control means the possession, direct or indirect, of
the power to direct management and policies of
another entity, whether through the ownership of
voting shares, by contract, or otherwise.

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LO 1 Meaning of control.


Definitions
Definitions of
of Subsidiary
Subsidiary and
and Control
Control
Control using U.S. GAAP:
the direct or indirect ability to determine the
direction of management and policies
through

ownership, contract, or otherwise

FASB ASC paragraph 810-10-15-8 states:
the usual condition for a controlling financial
interest is ownership of a majority voting
interest

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LO 1 Meaning of control.


Definitions
Definitions of
of Subsidiary
Subsidiary and
and Control
Control
However, application of the majority voting interest
requirement may not identify the party with a
controlling financial interest because the controlling
financial interest may be achieved through
arrangements that do not involve voting interests.
The first step in determining whether the financial
statements should be consolidated is to determine
if the reporting entity has a variable interest in
another entity, referred to as a potential variable
interest entity (VIE).
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LO 1 Meaning of control.


Definitions
Definitions of
of Control
Control

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LO 1 Meaning of control.


Requirements
Requirements for
for the
the Inclusion
Inclusion of
of
Subsidiaries
Subsidiaries in
in the
the Consolidated
Consolidated
Financial
Financial Statements
Statements

Purpose of consolidated statements - to present

the operating results and the financial position of a
parent and all its subsidiaries as if they are one
economic entity.
Circumstances when majority-owned subsidiaries
should be excluded from the consolidated
statements:
1. Control does not rest with the majority owner.

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3-8

2. Subsidiary operates under governmentally imposed
uncertainty so severe as to raise significant doubt
LO 5 Requirements regarding consolidation of subsidiaries.
about the parent’s control.


Reasons
Reasons For
For Subsidiary
Subsidiary Companies
Companies
Advantages to acquiring a controlling interest in
another company.
1. Stock acquisition is relatively simple.
2. Control of subsidiary can be accomplished with a
smaller investment.
3. Separate legal existence of affiliates provides an
element of protection of the parent’s assets.

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LO 3 Acquiring assets or stock.


Consolidated
Consolidated Financial
Financial Statements
Statements
Statements prepared for a parent company and its
subsidiaries are called consolidated financial
statements.
Ignore legal aspects of separate entities, focus on
economic entity under “control” of management.
Substance rather than form.
Not substitute for statements prepared by separate
subsidiaries, which may be used by:

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

Creditors



Noncontrolling stockholders



Regulatory agencies
LO 4 Valuation and classification of subsidiary assets and


Investments
Investments at
at the
the Date
Date of
of Acquisition
Acquisition
Recording Investments at Cost (Parent’s
Books)
Stock investment is recorded at cost as measured by
fair value of the consideration given or consideration
received, whichever is more clearly evident.
Consideration given may include cash, other assets,
debt securities, stock of the acquiring company.

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LO 7 Recording of investment at acquisition.


Investments
Investments at
at the

the Date
Date of
of Acquisition
Acquisition
E3-2: On January 1, 2011, Polo Company purchased
100% of the common stock of Save Company by issuing
40,000 shares of its (Polo’s) $10 par value common stock
with a market price of $17.50 per share. Polo incurred
cash expenses of $20,000 for registering and issuing the
common stock. The stockholders’ equity section of the
two company’s balance sheets on December 31, 2010,
were:
Polo
Save
Common stock, $10 par value

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$350,000 $320,000

Other contributed capital

590,000

175,000

Retained earnings

380,000

205,000

LO 7 Recording of investment at acquisition.


Investments
Investments at
at the
the Date
Date of
of Acquisition
Acquisition
E3-2: Prepare the journal entry on the books of Polo
Company to record the purchase of the common stock of
Save Company and related expenses.
Investment in Save (40,000 x $17.50)

700,000

Common Stock

400,000

Other Contributed Capital
Other Contributed Capital
Cash

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300,000
20,000
20,000

LO 7 Recording of investment at acquisition.


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers
Assets and liabilities are summed, regardless of
whether the parent owns 100% or a smaller
controlling interest.
Noncontrolling interests (NCI) are reflected as a
component of owners’ equity.
Eliminations must be made to cancel the effects of
transactions among the parent and its subsidiaries.
A workpaper is frequently used to summarize the
effects of various additions and eliminations.

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LO 8 Preparing consolidated statements using a workpaper.

Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

Intercompany Accounts to Be Eliminated
Subsidiary’s
Parent’s Accounts
Accounts

Investment in subsidiary

Against

Equity accounts

Intercompany receivable (payable)

Against

Intercompany payable (receivable)

Advances to subsidiary (from
subsidiary)

Against

Advances from parent (to parent)

Interest revenue (interest expense)

Against

Interest expense (interest revenue)

Dividend revenue (dividends
declared)

Against

Dividends declared (dividend
revenue)

Management fee received from
subsidiary

Against

Management fee paid to parent

Sales to subsidiary (purchases of
inventory from subsidiary)

Against

Purchases of inventory from parent
(sales to parent)

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LO 8 Preparing consolidated statements using a workpaper.


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers
Investment Elimination
It is necessary to eliminate the investment account of
the parent company against the related stockholders’
equity of the subsidiary to avoid double counting of
these net assets.
When parent’s share of subsidiary’s equity is
eliminated against the investment account,
subsidiary’s net assets are substituted for the
investment account in the consolidated balance
sheet.
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LO 8 Investment is eliminated for consolidated statements.


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers
Investment Elimination
“Computation and Allocation of Difference between
Implied Value and Book Value”
Step 1: Determine percentage of stock acquired.
Step 2: Divide purchase price by the percentage
acquired to calculate the implied value of the
subsidiary.
Step 3: Difference between step 2 and book value of
subsidiary’s equity must be allocated to adjust the
underlying assets and liabilities of the acquired
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3-17

company.

LO 9 Computing and allocating the
difference between implied and

Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

The prior steps lead to the following possible cases:
Case 1. The implied value (IV) of the subsidiary is equal to the book
value of the subsidiary’s equity (IV = BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s
stock.
Case 2. The implied value of the subsidiary exceeds the book value of
the subsidiary’s equity (IV > BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s
stock.
Case 3. The implied value of the subsidiary is less than the book value of
the subsidiary’s equity (IV < BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or

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3-18

LO less
9 Computing

allocating
the
b. The parent company acquires
than 100%and
of the
subsidiary’s
difference between implied and
stock.


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

Case 1(a): Implied Value of Subsidiary Is Equal to
Book Value of Subsidiary Company’s Equity (IV BV)—
100% of Stock Acquired.

Illustration: Assume that on January 1, 2013, P
Company acquired all the outstanding stock (10,000
shares) of S Company for cash of $160,000. What
journal entry would P Company make to record the
shares of S Company acquired?
Investment in S Company
$160,000

Cash

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$160,000

LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

Case 1(a): The balance sheets of both companies
immediately after the acquisition of shares is as follows:

Balance Sheet
Cash
Other current assets
Plant and equipment
Land
Investment in Sill
Total assets

P Company S Company
$ 40,000 $ 40,000
280,000
100,000
240,000
80,000
80,000
40,000
160,000
$ 800,000 $ 260,000

Liabilities
Common stock
Other Contributed capital
Retained earnings
Total Liab. and Equity

$ 120,000
400,000
80,000
200,000
$ 800,000

$ 100,000
100,000
20,000
40,000
$ 260,000

Implied value =
Book value
Price paid
% acquired

100%

Implied value
160,000
Book value
Difference

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$160,000

160,000
$0

LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of

Workpapers
Workpapers

Case 1(a): The workpaper to consolidate the balance
sheets for P and S on Jan. 1, 2013, date of acquisition, is
presented below:
Eliminations
Consolidated

Balance Sheet
Cash
Other current assets
Plant and equipment
Land
Investment in Sill
Total assets

P Company S Company
$ 40,000 $ 40,000
280,000
100,000
240,000
80,000
80,000
40,000
160,000
$ 800,000 $ 260,000

Liabilities
Common stock

Other Contributed capital
Retained earnings
Total Liab. and Equity

$ 120,000
400,000
80,000
200,000
$ 800,000

$ 100,000
100,000
20,000
40,000
$ 260,000

Debit

Credit

Balances
$
80,000
380,000
320,000
120,000
160,000
$ 1,060,000
$

$

220,000
500,000
100,000
240,000
1,060,000

Adjusting and eliminating entries are made on the workpaper
for the preparation of consolidated statements.
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LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

Case 1(a): The workpaper to consolidate the balance
sheets for P and S on Jan. 1, 2013, date of acquisition, is
presented below:
Eliminations

Consolidated

Balance Sheet
Cash
Other current assets
Plant and equipment
Land
Investment in Sill
Total assets

P Company S Company
$ 40,000 $ 40,000
280,000
100,000
240,000
80,000
80,000
40,000
160,000
$ 800,000 $ 260,000

Liabilities
Common stock
Other Contributed capital
Retained earnings
Total Liab. and Equity

$ 120,000
400,000
80,000

200,000
$ 800,000

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Solution on
notes page

$ 100,000
100,000
20,000
40,000
$ 260,000

Debit

Credit

160,000

Balances
$
80,000
380,000
320,000
120,000
$
900,000
$

100,000
20,000
40,000
$ 160,000

$ 160,000

$

220,000
400,000
80,000
200,000
900,000

LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers
Workpapers

Case 1(a): The workpaper entry to eliminate S

Company’s stockholders’ equity against the investment
account is:
Common stock (S)

100,000

Other contributed capital (S)

20,000

Retained earnings (S)

40,000

Investment in S Company

160,000

This is a workpaper-only entry.

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LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:

Sheets: Use
Use of
of
Workpapers
Workpapers
Case 1(a): Note the following on the workpaper.

1. The investment account and related subsidiary’s
stockholders’ equity have been eliminated and the
subsidiary’s net assets substituted for the
investment account.
2. Consolidated assets and liabilities consist of the
sum of the parent and subsidiary assets and
liabilities in each classification.
3. Consolidated stockholders’ equity is the same as
the parent company’s stockholders’ equity.
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LO 9 Computing and allocating the
difference between implied and


Consolidated
Consolidated Balance
Balance Sheets:
Sheets: Use
Use of
of
Workpapers

Workpapers

Case 1(b): Parent’s Cost of Investment Is Equal to Book
Value of Subsidiary’s Stock Acquired (IV=BV) - Partial
Ownership.

Illustration: Assume that on January 1, 2013, P
Company acquired 90% (9,000 shares) of the stock of S
Company for $144,000. What journal entry would P
Company make to record the shares of S Company
acquired?
Investment in S Company
$144,000
Cash

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$144,000

LO 9 Computing and allocating the
difference between implied and