CHAPTER TWO

BUSINESS COMBINATION: CONSOLIDATION

OF FINANCIAL INFORMATION
2.1. The Reporting entities and consolidated financial
statements
2.2. Consolidation of Financial Information on the
date of Acquisition
2.3. Consolidation of Financial Information:
Subsquent to the date of Acquisition
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 created by
which the parent company controls other companies.
Meaning of Control

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.

Criteria/Requirement

for consolidation
5

 Control: The power to govern the entities financial and

operating policies so as to obtain benefits from its activities.
 Traditional view of control includes:
 Investor’s direct or indirect ownership of more than 50% of

an investee’s outstanding common stock.

Direct control that occurs when one company owns a
majority of another company’s common stock.
 Indirect control or pyramiding that occurs when a

company’s common stock is owned by one or more other

companies that are all under common control.
 Emphasizes objectively determined legal form or ownership
 Limitations of the Traditional View of Control
 Inability to exercise control even with majority ownership
may occur when:
 Subsidiary is in legal reorganization or bankruptcy
 Foreign country restricts remittance of subsidiary profits to
domestic parent company
 Ability to exercise control even with less than 50% or
minority ownership may occur when:
 Remaining common stock is scattered among a large
number of shareholders who do not attend shareholders
meetings or give proxies
 Individuals comprising management of the investor
company own a substantial number of shares of common
stock of the investee or successfully solicit proxies from
the investee’s other shareholders.
 Revised (proposed new) Meaning of Controlling Interest
 Parent’s non-shared decision making ability that
enables it to guide the ongoing activities of its
subsidiary and to use that power to increase the benefits
that it derives and limits the losses that it suffers from
the activities of that subsidiary.
 Objectively determined legal form (majority ownership
of an investee’s outstanding common stock) was to be
replaced by subjectively determined economic
substance as the basis (prerequisite) for consolidation.
 Differences in Fiscal Periods
 Difference in the fiscal periods of a parent and subsidiary
should not preclude consolidation.
 Often the fiscal period of the subsidiary is changed to
coincide with that of the parent.
 Another alternative is to adjust the financial statement data
of the subsidiary each period to place the data on a basis
consistent with the fiscal period of the parent.
Consolidation:
Consolidation:The
The Concept
Concept

 A method of reporting the financial affairs of

parent company and its subsidiaries as a single
operating economic entity or unit.
 A “pro forma” presentation--it means “as if” the
parent and subsidiary were a single legal entity
with one or more branches, i.e. 2-1=1.
  Produces single set financial statements for group
of companies which are economically related but
legally separate (the overall economic entity is the
group of companies).
 No formal group accounts just consolidated
working papers and statements.

12
 Artificial construct of the accounting profession
because there is no legal entity that corresponds to the
consolidated entity. It does not existence as a legal
entity or it is a Legal Fictional Presentation (or an
accounting mirage).

P
 Parent creates or gains control of the subsidiary.
 The result: a single reporting entity.
S
Alternative Reporting Approaches: There are two
possible reporting approaches:
• An aggregated, “unlayered” reporting format, i.e.
Consolidation and
• A disaggregated, “layered” reporting format, i.e.
Segment Reporting
Consolidated Financial 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.
16

Not substitute for statements prepared by separate

subsidiaries, which may be used by:
 Creditors

 Noncontrolling stockholders
 Regulatory agencies
Consolidated financial statements present the financial
position and results of operations for
 a parent (controlling entity) and
 one or more subsidiaries (controlled entities)
 as if the individual entities actually were a single
company or entity.
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.
2. Ownership is temporary
3. Subsidiary operates under governmentally imposed uncertainty
so severe as to raise significant doubt about the parent’s control.
A parent that has been consolidating a subsidiary in
its financial statements should exclude that company
from future consolidation if the parent can no longer
exercise control over it. Control might be lost for a
number of reasons, such as

(1) the parent sells some or all of its interest in the

subsidiary,
(2) the subsidiary issues additional common stock,
(3) the parent enters into an agreement to relinquish
control, or
(4) the subsidiary comes under the control of the
government or other regulator.
How do we report the results of subsidiaries/Associate/Investe

Parent
Company

80% 51% 21% 14%

Sub A Sub B Associate c Investee D

Consolidation Equity Method Fair value

(plus the Equity Method)
Benefits of Consolidated Financial Statements
 Presented primarily for those parties having a long-run
interest in the parent company:
 shareholders,
 long-term creditors, or
 other resource providers.
 Provide a means of obtaining a clear picture of the
total resources of the combined entity that are under
the parent's control.
Limitations of Consolidated Financial Statements

 Results of individual companies not disclosed (hides poor

performance).
 Little information of value in consolidated statements because they contain
insufficient detail about the individual subsidiaries.
 Financial ratios are not necessarily representative of any single
company in the consolidation.
 Similar accounts of different companies may not be entirely
comparable.
 Highly diversified companies operating across several industries, often the
result of mergers and acquisitions, are difficult to analyze or compare.
 Information is lost any time data sets are aggregated.
 Subsidiary Financial Statements
 Creditors, preferred stockholders, and noncontrolling
common stockholders of subsidiaries are most
interested in the separate financial statements of the
subsidiaries in which they have an interest.
 Because subsidiaries are legally separate from their
parents,
 the creditors and stockholders of a subsidiary
generally have no claim on the parent, and
 the stockholders of the subsidiary do not share in the
profits of the parent.
Noncontrolling Interest
 Only a controlling interest is needed for the parent to
consolidate the subsidiary—not 100% interest.
 Shareholders of the subsidiary other than the parent are
referred to as “noncontrolling” shareholders.
 Noncontrolling interest refers to the claim of these
shareholders on the income and net assets of the
subsidiary.
25

 Voting shares not owned by the parent company

 NCI was formerly called the “Minority Interest”

NCI Parent

<50% >50%

Sub
Two Issues:
(1) Should 100% of the financial statements be
consolidated?
(2) Where & at what value to report NCI in the
financial statements? (Disclosure & Valuation
of NCI)
NCI Parent
<50% >50%

Sub
Consolidated Financial Statements

Investments at the Date of 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.
E 5-1: 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 $350,000 $320,000

Other contributed capital 590,000 175,000
Retained earnings 380,000 205,000
Required: 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 300,000

Other Contributed Capital 20,000

Cash 20,000
Consolidated Balance Sheets: Use
of 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.
3 Steps in Consolidation Procedures
1. Combine like items of assets, liabilities, equity, income,
expenses and cash flows of the parent with those of its
subsidiaries;
2. Offset (eliminate):
the carrying amount of the parent’s investment in each
subsidiary; and the parent’s portion of equity of each
subsidiary;
3. Eliminate in full intragroup assets and liabilities, equity,
income, expenses and cash flows relating to transactions
Intercompany Accounts to Be Eliminated
Subsidiary’s
Parent’s Accounts
Accounts
Again
Investment in subsidiary Equity accounts
st
Intercompany receivable Again Intercompany payable
(payable) st (receivable)
Advances to subsidiary (from Again Advances from parent (to
subsidiary) st parent)
Interest revenue (interest Again Interest expense (interest
expense) st revenue)
Dividend revenue (dividends Again Dividends declared (dividend
declared) st revenue)
Management fee received from Again Management fee paid to
subsidiary st parent

Sales to subsidiary (purchases Again Purchases of inventory from

of inventory from subsidiary) st parent (sales to parent)
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.
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
company.
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
b. The parent company acquires less than 100% of the
subsidiary’s stock.
 Case 4. The implied value of the subsidiary is less than
the fair value of the subsidiary’s equity (IV < FV)-
Partially owned
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 $160,000
 Case 1(a): The balance sheets of both companies
immediately after the acquisition of shares is as
follows:
Implied value =
Balance Sheet P Company S Company Book value
Cash $ 40,000 $ 40,000
Other current assets 280,000 100,000
Plant and equipment 240,000 80,000
Land 80,000 40,000
Price paid $160,000
Investment in Sill 160,000
Total assets $ 800,000 $ 260,000
% acquired 100%

Liabilities $ 120,000 $ 100,000

Implied value 160,000
Common stock 400,000 100,000
Other Contributed capital 80,000 20,000 Book value 160,000
Retained earnings 200,000 40,000
Total Liab. and Equity $ 800,000 $ 260,000 Difference $0
 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 P Company S Company Debit Credit Balances
Cash $ 40,000 $ 40,000 $ 80,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 120,000
Investment in Sill 160,000 160,000
Total assets $ 800,000 $ 260,000 $ 1,060,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 500,000
Other Contributed capital 80,000 20,000 100,000
Retained earnings 200,000 40,000 240,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 1,060,000

Adjusting and eliminating entries are made on the

workpaper for the preparation of consolidated
statements.
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 P Company S Company Debit Credit Balances
Cash $ 40,000 $ 40,000 $ 80,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 120,000
Investment in Sill 160,000 160,000 -
Total assets $ 800,000 $ 260,000 $ 900,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 200,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 160,000 $ 160,000 $ 900,000
Solution
on notes
page
Case 1(a): The workpaper entry to eliminate S
Company’s stockholders’ equity against the
investment account is:

Common stock (S)

Other contributed capital (S) 20,000
100,000
Retained earnings (S) 40,000
Investment in S Company 160,000

This is a workpaper-only entry.

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.
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 $144,000
 Case 1(b): The balance sheets of both
companies immediately after the acquisition of
Implied value =
shares
Balance Sheet is as follows:
P Company S Company Book value
Cash $ 56,000 $ 40,000
Other current assets 280,000 100,000
Plant and equipment 240,000 80,000
Land 80,000 40,000 Price paid $144,000
Investment in Sill 144,000
Total assets $ 800,000 $ 260,000 % acquired 90%
Liabilities $ 120,000 $ 100,000 Implied value 160,000
Common stock 400,000 100,000
Other Contributed capital 80,000 20,000 Book value 160,000
Retained earnings 200,000 40,000
Noncontrolling interest Difference $0
Total Liab. and Equity $ 800,000 $ 260,000
Case 1(b): Computation and Allocation of
Difference between Implied and Book Values:
90% 10%
Parent Noncontrolling Total
Share Share Value
Purchase price and implied value $ 144,000 $ 16,000 $ 160,000
Less: Book value of equity acquired:
Common stock 90,000 10,000 100,000
Other contributed capital 18,000 2,000 20,000
Retained earnings 36,000 4,000 40,000
Total book value $ 144,000 $ 16,000 $ 160,000

Difference between implied and book value $ - $ - $ -

 Case 1(b): 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 P Company S Company Debit Credit Balances
Cash $ 56,000 $ 40,000 $ 96,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 120,000
Investment in Sill 144,000 144,000
Total assets $ 800,000 $ 260,000 $ 1,060,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 500,000
Other Contributed capital 80,000 20,000 100,000
Retained earnings 200,000 40,000 240,000
Noncontrolling interest -
Total Liab. and Equity $ 800,000 $ 260,000 $ 1,060,000
Solution
on notes
page
 Case 1(b): 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 P Company S Company Debit Credit Balances
Cash $ 56,000 $ 40,000 $ 96,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 120,000
Investment in Sill 144,000 144,000 -
Total assets $ 800,000 $ 260,000 $ 916,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 200,000
Noncontrolling interest 16,000 16,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 160,000 $ 160,000 $ 916,000
Case 1(b): 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 144,000
Noncontrolling interest in equity 16,000
(establish the NCI)
Case 2(b): Implied Value Exceeds Book Value
of Subsidiary Company’s Equity (IV>BV)—
Partial Ownership.

Illustration: Assume that on January 1, 2013,

P Company acquired 80% (8,000 shares) of the
stock of S Company for $148,000. What journal
entry would P Company make to record the
shares of S Company acquired?

Investment in S Company $148,000

Cash $148,000
 Case 2(b): The balance sheets of both
companies immediately after the acquisition of
shares is as follows:
Balance Sheet P Company S Company Implied value =
Cash $ 52,000 $ 40,000 Book value
Other current assets 280,000 100,000
Plant and equipment 240,000 80,000
Land 80,000 40,000 Price paid
Investment in Sill 148,000
Difference (IV>BV)
Total assets $ 800,000 $ 260,000 $148,000
Liabilities $ 120,000 $ 100,000 % acquired
Common stock 400,000 100,000
Other Contributed capital 80,000 20,000
Retained earnings 200,000 40,000
80%
Noncontrolling interest
Total Liab. and Equity $ 800,000 $ 260,000
Implied value

185,000
 Case 2(b): Computation and Allocation of
Difference between Implied and Book Values:
80% 20%
Parent Noncontrolling Total
Share Share Value
Purchase price and implied value $ 148,000 $ 37,000 $ 185,000
Less: Book value of equity acquired:
Common stock 80,000 20,000 100,000
Other contributed capital 16,000 4,000 20,000
Retained earnings 32,000 8,000 40,000
Total book value $ 128,000 $ 32,000 $ 160,000

Difference between implied and book value $ 20,000 $ 5,000 $ 25,000

Land revaluation (mark to market) (20,000) (5,000) (25,000)
Balance $ - $ - $ -

We assume the entire difference is

attributable to land with a current value
higher than historical cost.
 Case 2(b): 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 P Company S Company Debit Credit Balances
Cash $ 52,000 $ 40,000 $ 92,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 25,000 145,000
Investment in Sill 148,000 148,000 -
Difference (IV>BV) 25,000 25,000 -
Total assets $ 800,000 $ 260,000 $ 937,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 200,000
Noncontrolling interest 37,000 37,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 210,000 $ 210,000 $ 937,000
 Case 2(b): The workpaper (elimination) entries
are as follows:
# Common stock (S) 100,000
1 Other contributed capital (S) 20,000
Retained earnings (S) 40,000
Difference between IV and BV 25,000
Investment in S Company 148,000
Noncontrolling interest in equity 37,000

# Land 25,000
2 Difference between IV and BV 25,000
 Case 2(b1): Computation and Allocation of
Difference between Implied and Book Values:
80% 20%
Parent Noncontrolling Total
Share Share Value
Purchase price and implied value $ 148,000 $ 37,000 $ 185,000
Less: Book value of equity acquired:
Common stock 80,000 20,000 100,000
Other contributed capital 16,000 4,000 20,000
Retained earnings 32,000 8,000 40,000
Total book value $ 128,000 $ 32,000 $ 160,000

Difference between implied and book value $ 20,000 $ 5,000 $ 25,000

Land revaluation (mark to market) (20,000) (5,000) (25,000)
Balance $ - $ - $ -

We assume the difference is attributable to

land with a current value higher than
historical cost by $10,000 and the
 Case 2(b1): 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 P Company S Company Debit Credit Balances
Cash $ 52,000 $ 40,000 $ 92,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 10,000 130,000
Goodwill 15,000 15,000
Investment in Sill 148,000 148,000 -
Difference (IV>BV) 25,000 25,000 -
Total assets $ 800,000 $ 260,000 $ 937,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 200,000
Noncontrolling interest 37,000 37,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 210,000 $ 210,000 $ 937,000
 Case 2(b): The workpaper (elimination) entries
are as follows:
# Common stock (S) 100,000
1 Other contributed capital (S) 20,000

Retained earnings (S) 40,000

Difference between IV and BV 25,000
Investment in S Company 148,000
Noncontrolling interest in equity 37,000

# Land 10,000
2
Goodwill 15,000
Difference between IV and BV 25,000
Case 2(b): Reasons an Acquiring Company May
Pay More Than Book Value.

1. Fair value of specific tangible or intangible

assets of the subsidiary may exceed its
recorded value because of appreciation.
2. Excess payment may indicate existence of
goodwill.
3. Liabilities, generally long-term, may be
overvalued.
4. A variety of market factors may affect the
price paid.
Case 3(b): Implied Value of Subsidiary is Less
Than Book Value (IV<BV)—Partial Ownership.
Illustration: Assume that on January 1, 2013,
P Company acquired 80% (8,000 shares) of the
stock of S Company for $120,000. What journal
entry would P Company make to record the
shares of S Company acquired?
Investment in S Company $120,000

Cash $120,000
 Case 3(b): The balance sheets of both
companies immediately after the acquisition of
shares is as follows:
Balance Sheet P Company S Company
Implied value =
Cash $ 80,000 $ 40,000
Other current assets 280,000 100,000 Book value
Plant and equipment 240,000 80,000
Land 80,000 40,000
Investment in Sill 120,000 Price paid
Difference (IV<BV)
Total assets $ 800,000 $ 260,000
$120,000
Liabilities $ 120,000 $ 100,000
Common stock 400,000 100,000
% acquired 80%
Other Contributed capital 80,000 20,000
Retained earnings 200,000 40,000
Implied value150,000
Noncontrolling interest
Total Liab. and Equity $ 800,000 $ 260,000
Book value

160,000
 Case 3(b): Computation and Allocation of
Difference between Implied and Book Values:
80% 20%
Parent Noncontrolling Total
Share Share Value
Purchase price and implied value $ 120,000 $ 30,000 $ 150,000
Less: Book value of equity acquired:
Common stock 80,000 20,000 100,000
Other contributed capital 16,000 4,000 20,000
Retained earnings 32,000 8,000 40,000
Total book value $ 128,000 $ 32,000 $ 160,000

Difference between implied and book value $ (8,000) $ (2,000) $ (10,000)

Plant & equipment (mark to market) 8,000 2,000 10,000
Balance $ - $ - $ -

Assume the difference is attributable to

land, in this case an overvaluation of
$10,000.
 Case 3(b): 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 P Company S Company Debit Credit Balances
Cash $ 80,000 $ 40,000 $ 120,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 320,000
Land 80,000 40,000 10,000 110,000
Investment in Sill 120,000 120,000 -
Difference (IV>BV) 10,000 10,000 -
Total assets $ 800,000 $ 260,000 $ 930,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 200,000
Noncontrolling interest 30,000 30,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 170,000 $ 170,000 $ 930,000
 Case 3(b): The workpaper (elimination) entries
are as follows:
# Common stock (S) 100,000
1 Other contributed capital (S)20,000

Retained earnings (S) 40,000

Difference between IV and BV 10,000
Investment in S Company 120,000
Noncontrolling interest in equity 30,000

# Difference between IV and BV 10,000

2 Lan 10,000
Case 3(b1): Implied Value of Subsidiary is
Less Than Book Value (IV<BV)—Partial
Ownership.
Illustration: Assume that on January 1, 2013,
P Company acquired 80% (8,000 shares) of the
stock of S Company for $120,000. What journal
entry would P Company make to record the
shares of S Company acquired?
Investment in S Company $120,000
Cash $120,000
 Case 3(b1): The balance sheets of both
companies immediately after the acquisition of
shares is as follows:
Balance Sheet P Company S Company
Cash $ 80,000 $ 40,000 Implied value =
Other current assets 280,000 100,000 Book value
Plant and equipment 240,000 80,000
Land 80,000 40,000
Investment in Sill 120,000 Price paid
Difference (IV<BV)
Total assets $ 800,000 $ 260,000
$120,000
Liabilities $ 120,000 $ 100,000 % acquired
Common stock 400,000 100,000
Other Contributed capital 80,000 20,000
Retained earnings 200,000 40,000 80%
Noncontrolling interest
Total Liab. and Equity $ 800,000 $ 260,000 Implied value

150,000
 Case 3(b1): Computation and Allocation of
Difference between Implied and Book Values:
80% 20%
Parent Noncontrolling Total
Share Share Value
Purchase price and implied value $ 120,000 $ 30,000 $ 150,000
Less: Book value of equity acquired:
Common stock 80,000 20,000 100,000
Other contributed capital 16,000 4,000 20,000
Retained earnings 32,000 8,000 40,000
Total book value $ 128,000 $ 32,000 $ 160,000

Difference between implied and book value $ (8,000) $ (2,000) $ (10,000)

Plant & equipment (mark to market) & Gain-bargain 8,000 2,000 10,000
Balance $ - $ - $ -

Assume the difference is attributable to

plant and equipment, in this case an
overvaluation of $5,000 and gain on
 Case 3(b1): 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 P Company S Company Debit Credit Balances
Cash $ 80,000 $ 40,000 $ 120,000
Other current assets 280,000 100,000 380,000
Plant and equipment 240,000 80,000 5,000 315,000
Land 80,000 40,000 120,000
Investment in Sill 120,000 120,000 -
Difference (IV>BV) 10,000 10,000 -
Total assets $ 800,000 $ 260,000 $ 935,000

Liabilities $ 120,000 $ 100,000 $ 220,000

Common stock 400,000 100,000 100,000 400,000
Other Contributed capital 80,000 20,000 20,000 80,000
Retained earnings 200,000 40,000 40,000 4,000 204,000
Noncontrolling interest 31,000 31,000
Total Liab. and Equity $ 800,000 $ 260,000 $ 170,000 $ 170,000 $ 935,000
 Case 3(b1): The work paper (elimination) entries
are as follows:
# Common stock (S) 100,000
1 Other contributed capital (S)20,000

Retained earnings (S) 40,000

Difference between IV and BV 10,000
Investment in S Company 120,000
Noncontrolling interest Equity 30,000

# Difference between IV and BV 10,000

2 Plant and equipment 5,000
Retained Earnings-P 4,000
Noncontrolling interest in equity 1,000
Other Intercompany Balance Sheet
Eliminations
 Intercompany accounts receivable, notes
receivable, and interest receivable, for example,
must be eliminated against the reciprocal
accounts payable, notes payable, and interest
payable.
 The full amount of all intercompany receivables
and payables is eliminated without regard to the
percentage of control held by the parent
company.
Investments
Investments in
in Stock
Stock

Investments in voting stock may be consolidated,

or separately reported at
fair value, or
equity.
 Summary

P Company & Subsidiary/ P & S Companies

Consolidated Balance Sheet
1-Jan-13
Assets
Cash $ 120,000
Other current assets 380,000
Plant and equipment 315,000
Land 120,000
Total Assets $ 935,000

Liabilities
Liabilities $ 220,000
Stockholders' Equity
Common stock 400,000
Other Contributed capital 80,000
Retained earnings 204,000
Noncontrolling interest 31,000
Total Liabilities & Equity 935,000
 Summary
               

P Company S Company P Company & S Company

Consolidated
   
   

Various Various Assets

  Assets  
Purchase Various
Premium Assets

     

Invetsment Reclassified
  in S    
  Eliminated  

  Liabilities  

Liabilities Stockholders'
  Equity  
  Stockholders'   Liabilities  
Equity
Stockholders' NCI
  Equity  
   

Reclassified
   
 Summary
The EQUITY method gives rise to a ONE LINE
CONSOLIDATION THEORY.
ALWAY S
Consolidated Net Income = Parent’s Net Income

Consolidated Retained = Parent’s Retained

Earnings Earnings

Consolidated = Parent’s Stockholders’

Stockholders’ Equity Equity
(if 100% Subsidiary)
Ex.1: Consolidated balance sheet at date of acquisition-
Wholly owned subsidiary (100%)

 On May 31, 2010 Amex Corporation acquired all of 10,000

shares of Luck’s outstanding common stock by paying Br
400,000 cash and issuing 20,000 shares of Br 15 par
common stock having a market value of Br 40 per share
to Luck’s stockholders. In addition, Br 300,000 is
contingent up on the achievement of Br 1,000,000 profit
margin in the next annual period. The fair value of
contingent consideration was Br 100,000.
 Separate balance sheets of Amex Corporation and Luck
Company on May 31, 2010, together with current fair
values of Luck’s identifiable net assets are given on the
next slide:
 Amex corporation and Luck Company
Separate Balance sheets (Prior to business
combination)
  Luck Company

  Amex Book values Fair Values

Corporation

Assets
Cash Br 1,600,000 Br 20,000 Br 20,000

Accounts Receivable (net) 1,400,000 260,000 260,000

Inventories 2,800,000 220,000 280,000

Plant assets (net) 5,000,000 900,000 1,100,000
Patent _ -- 300,000

Customer contracts _ _ 200,000

Total assets 10,800,000 1,400,000 2,160,000

Required:
a. Prepare journal entries for Amex Corporation to record the
business combination with Luck Company on May 31, 2010.
b. Prepare consolidated balance sheet of Amex Corporation and
subsidiary on May 31, 2010
Ex.2: Consolidated balance sheet at date
of acquisition-Partially owned subsidiary

Assume Amex Corporation acquired 9,000 (90%) shares

of Luck Company by paying Br 1,260,000 cash (Br 140
per share) to lucks stock holders.
Separate balance sheets of Amex Corporation and Luck
Company on May 31, 2010, together with current fair
values of Luck’s identifiable net assets are as follows.
 Amex corporation and Luck Company
  Separate Balance sheets (Prior to business Luck Company
combination)
  Amex Book Fair Values
Corporation values

Assets
Cash Br 1,600,000 Br 20,000 Br 20,000

Accounts Receivable (net) 1,400,000 260,000 260,000

Inventories 2,800,000 220,000 280,000

Plant assets (net) 5,000,000 900,000 1,100,000

Patent _ _ 300,000
Required:
a. Prepare journal entries for Amex Corporation to record the
business combination with Luck Company on May 31, 2010
b. Prepare consolidated balance sheet of Amex Corporation
and subsidiary on May 31, 2010
2.3. Consolidation of Financial Information: Subsequent to
the Date of Acquisition

Consolidation – The Effects of the Passage of Time

1. The passage of time creates complexities for internal record keeping and
the balance of the investment account & Income from the subsidiary
varies due to the accounting method used.

2. The parent can use;

1. Equity method of accounting

3. A worksheet and consolidation entries are used to eliminate the investment

account and record the subsidiary’s assets and liabilities to create a single
set of financial statements for the combined business entity.
 Equity Method on Parent’s Books
Investment in subsidiary (balance sheet account)
Historical cost of investment Share of reported losses of
subsidiary

Share of reported earnings of Dividends received from subsidiary

subsidiary
Amortization of excess value of
identifiable assets of subsidiary

Earnings of subsidiaries (income statement account)

Share of reported losses of subsidiary Share of reported earnings of
subsidiary
Amortization of excess value of
identifiable assets of subsidiary
Accounting
Accounting for
for Investments
Investments by
by the
the
Equity
Equity Method
Method
Percy Company purchased 80% of the outstanding voting
shares of Song Company at the beginning of 2009 for
$387,000. At the time of purchase, Song Company’s total
stockholders’ equity amounted to $475,000. Income and
dividend distributions for Song Company from 2009
2009
through 2010 are as follows: 2010 2011
Net income (loss) $ 63,500 $ 52,500 $ (55,000)
Dividend distribution 25,000 50,000 35,000
Percy Company uses the equity method to record its
investment. The difference between book value of equity
acquired and the value implied by the purchase price
was attributed solely to an excess of market over
book values of depreciable assets, with a remaining
life of 10 years.
Required: Prepare journal entries for Percy Company
from the date of purchase through 2011 to account for
its investment in Song Company under each of the
following assumptions:
Percy Company uses the equity method to record its
investment. 2009 2010 2011
Net income (loss) $ 63,500 $ 52,500 $ (55,000)
Dividend distribution 25,000 50,000 35,000

2009 Investment in Song 387,000

Cash 387,000

Investment in Song 50,800

Equity income (.8 x $63,500) 50,800

Cash 20,000
Investment in Song (.8 x $25,00)
20,000
Percy Company uses the equity method to record its
investment.

A journal entry is required to adjust for

depreciation related to the excess of market over
book values of depreciable assets.
Cost of investment

$387,000
Book value acquired ($475,000 x 80%)

2009 Equity
380,000income ($7,000 / 10 yrs.)700
Difference between
Investment Cost and
in Song Book value
700
$ 7,000
Percy Company uses the equity method to record its
investment.
2009 2010 2011
Net income (loss) $ 63,500 $ 52,500 $ (55,000)
Dividend distribution 25,000 50,000 35,000

201 Investment in Song 42,000

0 Equity income (.8 x $52,500) 42,000

Cash 40,000
Investment in Song (.8 x $50,000)
40,000
Equity income ($7,000 / 10 yrs.)700
Investment in Song 700
Percy Company uses the equity method to record its
investment.
2009 2010 2011
Net income (loss) $ 63,500 $ 52,500 $ (55,000)
Dividend distribution 25,000 50,000 35,000

201 Equity Loss (.8 x $55,000) 44,000

1 Investment in Song 44,000

Cash 28,000
Investment in Song (.8 x $35,000) 28,000

Equity income ($7,000 / 10)

Investment in Song 700
700
Consolidated
Consolidated Statements
Statements After
After Acquisition
Acquisition

On the date of acquisition, the only relevant financial

statement is the consolidated balance sheet.
After acquisition, a complete set of consolidated
financial statements must be prepared for the
affiliated group:
 Income statement,
 Retained earnings statement,
 Balance sheet, and
 Statement of cash flows
 Equity Method

Record the investment at cost and subsequently

adjust the amount each period for
 the investor’s proportionate share of the
earnings (losses) and
 dividends received by the investor.

If investor’s share of investee’s losses

exceeds the carrying amount of the
investment, the investor ordinarily should
discontinue applying the equity method.
Investment Carried at Equity—Year of
Acquisition
On January 1, 2010, Parker Company purchased
90% of the outstanding common stock of Sid
Company for $180,000. At that time, Sid’s
stockholders’ equity consisted of common stock,
$120,000; other contributed capital, $20,000; and
retained earnings, $25,000. Assume that any
difference between book value of equity and the
value implied by the purchase price is attributable to
land.
Required: Prepare a consolidated statements
workpaper on Dec. 31,2010.
 Begin the consolidating process by preparing a
Computation and Allocation Schedule, as follows:
90% 10% 100%
Parent NCI Total
Share Share Value
Purchase price and implied value $ 180,000 $ 20,000 $ 200,000

Less: Book value of equity acquired:

Common stock 108,000 12,000 120,000
Other contributed capital 18,000 2,000 20,000
Retained earings 22,500 2,500 25,000
Total book value 148,500 16,500 165,000

Difference between implied and book value 31,500 3,500 35,000

Allocated to land (31,500) (3,500) (35,000)
Balance $ - $ - $ -
Difference between implied and
book values is established only at
the date of acquisition.
 2010 Year of Acquisition
Parker Sid
Cash $ 65,000 $ 35,000
Accounts receivable 40,000 30,000
Inventory 25,000 15,000
Investment in Sid 184,500 -
On December 31, Plant and equipment 110,000 85,000
2010, the two Land 48,500 45,000
companies’ trial Dividends declared 20,000 15,000
Cost of goods sold 150,000 60,000
balances were as
Operating expenses 35,000 15,000
follows: Total debits $ 678,000 $ 300,000
Required A.
Prepare a Accounts payable $ 20,000 $ 15,000
Other liabilities 15,000 25,000
consolidated Common stock 200,000 120,000
statements Other contributed capital 70,000 20,000
workpaper on Retained earnings 55,000 25,000
December 31, 2010. Sales 300,000 95,000
Equity in subsidiary income 18,000 -
Total credits $ 678,000 $ 300,000
 A. 2010 Year of Acquisition
Eliminations Consolidated
Income Statement Parker Sid Debit Credit NCI Balances
Sales $ 300,000 $ 95,000 $ 395,000
Equity in subsidiary income 18,000 18,000 -
Total revenue 318,000 95,000 395,000
Cost of goods sold 150,000 60,000 210,000
Other expenses 35,000 15,000 50,000
Total cost and expense 185,000 75,000 260,000
Net income 133,000 20,000 135,000
Noncontrolling interest 2,000 (2,000)
Net income $ 133,000 $ 20,000 $ 18,000 $ - $ 2,000 $ 133,000

Retained Earnings Statement

Retained earnings, 1/1/10 55,000 25,000 25,000 55,000
Net income 133,000 20,000 18,000 2,000 133,000
Dividends declared (20,000) (15,000) 13,500 (1,500) (20,000)
Retained earnings, 12/31/10 $ 168,000 $ 30,000 $ 43,000 $ 13,500 $ 500 $ 168,000
 A. 2010 Year of Acquisition
Eliminations Consolidated
Balance Sheet Parker Sid Debit Credit NCI Balances
Cash $ 65,000 $ 35,000 $ 100,000
Accounts receivable 40,000 30,000 70,000
Inventory 25,000 15,000 40,000
Investment in Sid 184,500 - 4,500 -
180,000
Difference (cost & book) 35,000 35,000 -
Plant and equipment 110,000 85,000 195,000
Land 48,500 45,000 35,000 128,500
Total assets $ 473,000 $ 210,000 $ 533,500

Accounts payable $ 20,000 $ 15,000 $ 35,000

Other liabilities 15,000 25,000 40,000
Common stock 200,000 120,000 120,000 200,000
Other contributed capital 70,000 20,000 20,000 70,000
Retained earnings 168,000 30,000 43,000 13,500 500 168,000
Noncontrolling interest 1/1 20,000 20,000
Noncontrolling interest 12/31 $ 20,500 20,500
Total liabilities & equity $ 473,000 $ 210,000 $ 253,000 $ 253,000 $ 533,500
 Workpaper Observations
Workpaper entries were made:
To eliminate the account “equity in subsidiary income” and
intercompany dividends.
Toeliminate the Investment account against subsidiary
equity.
Todistribute the difference between implied and book value
of equity acquired.
 Consolidated
Consolidated Statement
Statement of
of Cash
Cash Flows
Flows
Peculiarities:
1. If the statement of cash flows starts with consolidated
net income, then the noncontrolling interest is already
included and need not be added back.
2. Subsidiary dividends paid to the noncontrolling
stockholders must be included with dividends paid by
the parent company when calculating cash outflow from
financing activities.
3. Subsidiary stock acquired directly from the subsidiary
represents an intercompany cash transfer that does not
affect the total cash balance of the consolidated group.
The preparation of the consolidated statement of cash
flows in the year of acquisition is complicated slightly
because the comparative balance sheets at the
beginning and end of the current year are dissimilar.
1. Any cash spent or received in the acquisition itself
should be reflected in the Investing activities
section.
2. Assets and liabilities of the subsidiary at the date
of acquisition must be added to those of the
parent at the beginning of the current year.
Exercise 1

Assume that ABC Company obtains all of the

outstanding common stock of XYZ Company on
January 1, 2011. ABC acquires all of XYZ’s stock
for Br 900,000 in cash. The following are assets
and liabilities of the subsidiary at book value and
fair value on the date of combination.
   Book Fair Values
values

Assets

Cash Br 100,000 Br 100,000

Inventory 200,000 220,000

Trademarks (indefinite life) 100,000 180,000

Patented technology (10-year life) 200,000 300,000

Building (20- years life) 180,000 150,000

 Assume that XYZ earns income of Br
200,000 during the year and pays Br 30,000
cash dividend on May 1. In addition Assume
ABC used equity method.
Required:
1. Record the necessary entries
2. Prepare consolidated financial
statement at the end of the year;
December 31, 2011
 Assume the following are financial statements for the
parent and the subsidiary at the end of the accounting
period December 31, 2011.
 ABC COMPANY AND XYZ COMPANY
Financial Statements
For Year Ending December 31, 2011

ABC XYZ
Company Company

Income Statement    

Revenues 1,000,000 500,000

-Cost of goods sold 500,000 200,000

-Amortization expense 100,000 25,000

-Depreciation expense 80,000 75,000

+Equity in subsidiary earnings 191,500 –0–

Net income 511,500 200,000

   
Statement of Retained Earnings
 ABC XYZ
Company  
Balance Sheet

Company  

Cash 800,000 270,000

Inventory 236,000 200,000

Investment in XYZ Company (at

1,061,500 –0–
equity)

Trademarks 600,000 100,000

Patented technology 300,000 200,000

180,000
Building 200,000

Total assets 3,197,500 950,000

  ABC XYZ Consolidation Consolidated
Accounts Compan Company entries Totals

y
 

Debit Credit

Income statement  
   
Revenues 1,000,000 500,000

-Cost of goods sold 500,000 200,000

-Amortization expense 100,000 25,000

-Depreciation expense 80,000 75,000

 Statement of retained earnings

0
Retained earnings, 1/1/11 800,000 200,000

+Net income (above) 511,500 200,000

-Dividends paid 100,000 30,000

=Retained earnings, 12/31/11 1,211,500 370,000

Balance sheet

Cash 800,000 270,000

Inventory 236,000 200,000

Investment in XYZ Company 1,061,500 –0–

Trademarks 600,000 100,000

 Exercise 2
Assume that ABC Company acquires 80 percent of XYZ
Company’s 120,000 outstanding voting shares on January 1,
2011, for Br 8 per share or a total of Br 768,000 cash
consideration. Further assume that the 20 percent non-
controlling interest shares traded both before and after the
acquisition date at an average of Br 8 per share. The
following are assets and liabilities of XYZ at book values
and fair values;
   Book values Fair Values
Assets
Cash Br 100,000 Br 100,000

Inventory 200,000 220,000

Trademarks (indefinite life) 100,000 180,000
Patented technology (10-year life) 200,000 300,000
Building (20- years life) 180,000 150,000

Liabilities (80,000) (90,000)

Net assets 700,000 860,000

Common Stock 400,000  

Additional Paid-in Capital 100,000  

Assume the subsidiary earned net income of Br
200,000 during the period and paid cash dividend
of Br 30,000. Assume ABC used equity method.
Required:
1. Record the necessary entries on the book of
ABC
2. Prepare consolidated financial statement
at the end of the year; December 31,
2011
 Assume the following are separate financial
statements for the parent and the subsidiary at the
end of the accounting period
  
ABC COMPANY AND XYZ COMPANY
Financial Statements
For Year Ending December 31, 2011
ABC XYZ
Company Company

Income Statement    
Revenues 1,000,000 500,000
-Cost of goods sold 500,000 200,000
-Amortization expense 100,000 25,000
-Depreciation expense 80,000 75,000
+Equity in subsidiary earnings 153,200 –0–
Net income 473,200 200,000
     
Statement of Retained Earnings    

Retained earnings, 1/1/11 800,000 200,000

Net income (above) 473,200 200,000
Dividends paid 100,000 30,000
Retained earnings, 12/31/11 1,173,200 370,000
     
Balance Sheet    

Cash 800,000 270,000

Inventory 262,000 200,000

Investment in XYZ Company (at equity) 897,200 –0–

Trademarks 700,000 100,000

Patented technology 300,000 200,000

180,000
Building 200,000

Total assets 3,159,200 950,000

Liabilities 86,000 80,000

Common stock 900,000 400,000

Additional paid-in capital 1,000,000 100,000

Retained earnings, 12/31/11 (above) 1,173,200 370,000

Total liabilities and equity 3,159,200 950,000

   ABC XYZ Consolidation Non- Consolidated
Accounts Company Company Entries controlli Totals
  ng
interest
Credit
Debit

Income statement

Revenues 1,000,000 500,000

-Cost of goods sold 500,000 200,000

-Amortization expense 100,000 25,000

-Depreciation expense 80,000 75,000

+Equity in subsidiary earnings. 153,200 –0–

 Statement of retained earnings

Non- Consolidated
controllin total
Dr. Cr. g interest

800,000
Retained earnings, 1/1/11 800,000 200,000

473,200
+Net income (above) 473,200 200,000

100,000
-Dividends paid 100,000 30,000

     
Retained 1,173,200
1,173,200 370,000
earnings,12/31/11
 Balance sheet Dr. Cr.
Cash 800,000 270,000  
Inventory 262,000 200,000
Investment in XYZ Company 897,200 –0–
Trademarks 700,000 100,000
Patented technology 300,000 200,000
Building 200,000 180,000
Goodwill    
Total assets 3,159,200 950,000
Liabilities 86,000 80,000
Common stock 900,000 400,000
Additional paid-in capital 1,000,000 100,000
Noncontrolling interest Jan 1/11
   
 
Noncontrolling interest 12/31/11      
Retained earnings, 12/31/11 (above) 1,173,200 370,000  
Total liabilities and equity 3,159,200 950,000
Don’t’ forget to
prepare
financial
statements
following the
appropriate
format!