Chapter 3: An Introduction to

Consolidated Financial Statements

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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 Intro to Consolidations: Objectives
1. Recognize the benefits and limitations of
consolidated financial statements.
2. Understand the requirements for inclusion of a
subsidiary in consolidated financial statements.
3. Apply the consolidation concepts to parent
company recording of the investment in a
subsidiary at the date of acquisition.
4. Allocate the excess of the fair value over the
book value of the subsidiary at the date of
acquisition.
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Objectives (continued)
5. Learn the concept of noncontrolling interest when
the parent company acquires less than 100% of the
subsidiary's outstanding common stock.
6. Amortize the excess of the fair value over the
book value in periods subsequent to the
acquisition.
7. Prepare consolidated balance sheets subsequent
to the date of acquisition, including preparation of
elimination entries.
8. Apply the concepts underlying preparation of a
consolidated income statement.
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An Introduction to Consolidated Financial Statements
1: Benefits & Limitations

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 Business Acquisitions
• FASB Statement 141R
• Business combinations occur
– Acquire controlling interest in voting stock
– More than 50%
– May have control through indirect ownership
• Consolidated financial statements
– Primarily for owners & creditors of parent
– Not for noncontrolling owners or subsidiary
creditors

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An Introduction to Consolidated Financial Statements
2: Subsidiaries

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 Who is a Subsidiary?
• ARB No. 51 allowed broad discretion
• FASB Statement No. 94
– Control based on share ownership
• FASB Statement No. 160
– Financial control

• Subsidiaries, or affiliates, continue as separate

legal entities and reporting to their controlling and
noncontrolling interests.

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 Consolidated Statements
• Prepared by the parent company
• Parent discloses
– Consolidation policy, Reg. S-X
– Exceptions to consolidation, temporary
control and inability to obtain control
• Fiscal year end
– Use parent's FYE, but
– May include subsidiary statements with FYE
within 3 months of parent's FYE.
• Disclose intervening material events
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An Introduction to Consolidated Financial Statements
3: Parent Company Recording

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 Penn Example: Acquisition Cost =
Fair Value = Book Value
Skelly BV=FV
Cash $10 Penn acquires 100% of Skelly for
Other current assets 15 $40, which equals the book value
Net plant assets 40 and fair values of the net assets
Total $65 acquired.
Accounts payable $15
Other liabilities 10 Cost of acquisition $40
Capital stock 30 Less 100% book value 40
Retained earnings 10
Excess of cost over book value $0
Total $65
To consolidate, eliminate Penn's
Investment account and Skelly's
capital stock and retained
earnings.
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 Balance sheets Separate Consolidated
Penn Skelly Penn & Sub.
Cash $20 $10 $30
Other curr. assets 45 15 60
Net plant 60 40 100
Investment in Skelly 40 0 0
Total $165 $65 $190
Accounts payable $20 $15 $35
Other curr. liabilities 25 10 35
Capital stock 100 30 100
Retained earnings 20 10 20
Total $165 $65 $190

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An Introduction to Consolidated Financial Statements
4: Allocations at Acquisition Date

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 Cost, Fair Value and Book Value
Acquisition cost, fair values of identifiable net
assets and book values may differ.
– Allocate excess or deficiency of cost over
book value and determine goodwill, if any.
– When BV = FV, excess is goodwill.
Cost less BV = Excess to allocate
– Allocate first to FV-BV differences
– Remainder is goodwill (or bargain purchase)

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 Example: BV ≠ FV but Cost = FV
Piper acquires 100% of Sandy for $310.
Sandy BV FV BV = 100 + 145 = $245
Cash $40 $40
FV = 385 – 75 = $310
Receivables 30 30
Inventory 50 75
Plant, net 200 240 Cost – FV = $0 goodwill
Total $320 $385
Liabilities $75 $75
Capital stock 100 Cost $310
Retained 100% BV 245
earnings 145 Excess of cost over BV $65
Total $320

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 Piper and Sandy (cont.)
Allocate to: Amt Amort.
Inventory 100%(+25) 25 1st yr
Plant 100%(+40) 40 10 yrs
Total $65

Piper's elimination worksheet entry:

Capital stock 100
Retained earnings 145
Inventory 25
Plant 40
Investment in Sandy 310
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 Example: BV ≠ FV and Cost ≠ FV
Panda acquires 100% of Salty for $530.
Salty BV FV BV = 250 + 190 = $440
Cash $100 $100 FV = 580 – 85 = $495
Receivables 40 40
Inventory 250 250 Cost – FV = $35 goodwill
Plant, net 130 190
Total $520 $580
Liabilities $80 $85 Cost $530
Capital stock 250   100% BV (250+190) 440
Retained earnings 190  
Excess of cost over BV $90
Total $520  

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 Panda and Salty (cont.)
Allocate to: Amt Amort.
Plant 60 4 yrs
Liabilities -5 5 yrs
Goodwill 35 -
Total $90
Panda's elimination worksheet entry:
Capital stock 250
Retained earnings 190
Plant 60
Goodwill 35
Liabilities 5
Investment in Salty 530
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 Example: BV ≠ FV and Cost ≠ FV
Printemps acquires 100% of Summer for $185.
Summer BV FV BV = 75 + 105 = $180
Cash $10 $10 FV = 250 - 40 = $210
Receivables 30 30
Inventory 80 90
Plant, net 100 120
Total $220 $250
Liabilities $40 $40
Cost $185
Capital stock 75   100% BV (75+105) 180
Retained earnings 105   Excess of cost over BV $5
Total $220  
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 Printemps and Summer (cont.)
Allocate to: Amt Amort.
Inventory 10 1st yr
Plant, land 20 -
Bargain purchase (25) Gain
Total $5
Printemps records the acquisition of Summer assuming a cash
purchase as follows. Note that the investment account is
recorded at its fair value and the bargain purchase is treated
immediately as a gain.
Investment in Summer 210
Gain on Bargain purchase 25
Cash 185
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 Worksheet Elimination Entry
Unamortized excess equals $30 (gain is recognized)
• $10 for undervalued inventory
• $20 for undervalued land included in plant assets

Printemps' elimination worksheet entry:

Capital stock 75
Retained earnings 105
Unamortized excess 30
Investment in Summer 210
Inventory 10
Plant 20
Unamortized excess 30
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   Printemps Summer Adjustments Consol-
  BV BV DR CR idated
Cash $30 $10     $40
Receivables 50 30     80
Inventory 100 80 10   190
Plant, net 450 100 20   570
Investment in
Summer 210     210 0
Unamortized excess     30 30  
Total $840 $220     $880
Liabilities $270 $40     $310
Capital stock 200 75 75   200
Retained earnings 370 105 105   370
Total $840 $220     $880
      240 240  

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An Introduction to Consolidated Financial Statements
5: Noncontrolling Interests

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 Noncontrolling Interest
Parent owns less than 100%
– Noncontrolling interest represents the
minority shareholders
– Part of stockholders' equity
– Measured at fair value, based on parent's
acquisition price

• Parent pays $40,000 for an 85% interest

– Implied value of the full investee is
40,000/85% = $47,059.
– Minority share = 15%(47,059) = $7,059.
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 Example: Noncontrolling Interests
Popo acquires 80% of Sine for $400 when Sine
had capital stock of $200 and retained earnings
of $175. Sine's assets and liabilities equaled
their fair values except for buildings which are
undervalued by $50. Buildings have a 10-year
remaining life.
Cost of 80% of Sine $400 Allocate to:
Implied value of Sine (400/80%) $500 Building $50
Book value (200+175) 375 Goodwill 75
Excess over book value $125 Total $125

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 Elimination Entry
Popo's elimination worksheet entry:
Capital stock 200
Retained earnings 175
Building 50
Goodwill 75
Investment in Sine 400
Noncontrolling interest 100

An unamortized excess account could have been used for the

excess assigned to the building and goodwill.

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   Popo Sine Adjustments Consol-
  BV BV DR CR idated
Cash $50 $10     $60
Receivables 130 50     180
Inventory 80 100     180
Building, net 300 240 50   590
Investment in Sine 400     400 0
Goodwill     75   75
Total $960 $400     $1,085
Liabilities $150 $25     $175
Capital stock 250 200 200   250
Retained earnings 560 175 175   560
Noncontrolling interest        100 100
Total $960 $400     $1,085
      500 500  
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An Introduction to Consolidated Financial Statements
6: Amortizations After Acquisition

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 Unamortized Excess
Excess assigned to assets and liabilities are
amortized according to the account
Balance sheet Amortization Income statement
account period account
Inventories and Generally, 1st year Cost of sales and
other current assets other expense
Buildings, Remaining life at Depreciation and
equipment, business amortization
patents, combination expense
Land, copyrights Not amortized
Long term debt Time to maturity Interest expense
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 Piper and Sandy (cont.)
Cost $310 Allocate to: Amt Amort.
100% BV 245 Inventory 25 1st yr
Excess $65 Plant 40 10 yrs
Total $65

Beginning Current Ending

unamortized year's unamortized
excess amortization excess
Inventory 25 (25) 0
Plant 40 (4) 36
Total 65 (29) 36

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 Panda and Salty (cont.)
Cost $530 Allocate to: Amt Amort.
100% BV 440 Plant 60 4 yrs
Liabilities -5 5 yrs
Excess $90
Goodwill 35 -
Total $90
Beginning Current Ending
unamortized year's unamortized
excess amortization excess
Plant 60 (15) 45
Liabilities (5) 1 (4)
Goodwill 35 0 35
Total 90 14 76
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 Printemps and Summer (cont.)
Cost $185 Allocate to: Amt Amort.
Inventory 10 1st yr
100% BV 180
Plant, land 20 -
Excess $5 Bargain purchase (25) Gain
Total $5

Beginning Current Ending

unamortized year's unamortized
excess amortization excess
Inventory 10 (10) 0
Land 20 0 20
Total 30 (10) 20

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An Introduction to Consolidated Financial Statements
7: Subsequent Balance Sheets

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 Balance Sheets After Acquisition
In preparing a consolidated balance sheet
– Eliminate the parent's Investment in
Subsidiary
– Eliminate the subsidiary's equity accounts
(common stock, retained earnings, etc.)
– Adjust asset and liability accounts for any
unamortized excess balance
– Record goodwill, if any
– Record Noncontrolling Interest, if any

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 Popo and Sine (cont.)
Cost of 80% of Sine $400 Allocate to:
Implied value of Sine $500 Building $50 10 yrs
Book value 375 Goodwill 75 -
Excess $125 Total $125

Beginning Current Ending

unamortized year's unamortized
excess amortization excess
Building 50 (5) 45
Goodwill 75 0 75
Total 125 (5) 120

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After 1 year: Popo Sine Popo Sine
Cash $40 $15 Liabilities $100 $50
Receivables 110 85 Capital stock 250 200
Inventory 90 100 Retained earnings 574 185
Building, net 280 235
Investment in Sine 404  
Total $924 $435 Total $924 $435

Popo's elimination worksheet entry:

Capital stock 200
Retained earnings 185
Unamortized excess 120
Investment in Sine (80%) 404
Noncontrolling interest (20%) 101
Building 45
Goodwill 75
Unamortized excess 120

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After 1 year: Popo Sine Adjustments Consol-
  BV BV DR CR idated
Cash $40 $15     $55
Receivables 110 85     195
Inventory 90 100     190
Building, net 280 235 45   560
Investment in Sine 404     404 0
Goodwill     75   75
Unamortized excess 120 120
Total $924 $435     $1,075
Liabilities $100 $50     $150
Capital stock 250 200 200   250
Retained earnings 574 185 185   574
Noncontrolling interest     101 101
Total $924 $435     $1,075
      505 505  

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 Key Balance Sheet Items
• Investment in Subsidiary does not exist on the
consolidated balance sheet
• Equity on the consolidated balance sheet
consists of the parent's equity plus the
noncontrolling interest.
• Noncontrolling interest is proportional to the
Investment in Subsidiary account when the
equity method is used.
$101 = $404 x .20/.80

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An Introduction to Consolidated Financial Statements
8: Consolidated Income Statements

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 Comprehensive Example, Data
Pilot acquires 90% of Sand on 12/31/2009 for
$4,333 when Sand's equity consists of $4,000
common stock, $1,000 other paid in capital, and
$900 retained earnings. On that date Sand's
inventories, land and buildings are understated
by $100, $200, and $1,000, respectively and its
equipment and notes payable are overstated by
$300 and $100.

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Assignment and Allocate to:
Amortization Inventory
Land
$100
200
1st yr
-
Cost of 90% of Sand $10,200 Building 1,000 40 yrs
Implied value of Sand Equipment (300) 5 yrs
10,200/.90 $11,333 Note payable 100 1st yr
Book value (4000+1000+900) 5,900 Goodwill 4,333 -
Total $5,433
Excess over book value $5,433
Unamortized Current Unamortized
excess 1/1/10 amortization excess 12/31/10
Inventory 100 (100) 0
Land 200 0 200
Building 1,000 (25) 975
Equipment (300) 60 (240)
Note payable 100 (100) 0
Goodwill 4,333 0 4,333
Total 5,433 (165) 5,268
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 Pilot Sand Consol.*
Sales $9,523.50 $2,200.00 $11,723.50
Income from Sand 571.50 $0.00
Cost of sales (4,000.00) (700.00) (4,800.00)
Depreciation exp - bldg (200.00) (80.00) (305.00)
Depreciation exp - equip (700.00) (360.00) (1,000.00)
Other expense (1,800.00) (120.00) (1,920.00)
Interest expense (300.00) (140.00) (540.00)
Net income $3,095.00 $800.00
Total consolidated income $3,158.50
Noncontrolling interest
share 63.50
Controlling interest share $3,095.00

* Cost of sales, building depreciation and interest expense are

increased by $100, $25, and $100, and equipment
depreciation is $60 lower than the sum of Pilot and Sand.
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 Key Income Statement Items
• The Income from Subsidiary account is
eliminated.
• Current period amortizations are included in
the appropriate expense accounts.
• Noncontrolling interest share of net income is
proportional to the Income from Subsidiary
under the equity method.
$571.50 x .10/.90
= $63.50

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 Push-Down Accounting
• SEC requirement
– Subsidiary is substantially wholly-owned
(approx. 90%)
– No publicly held debt or preferred stock
• Books of the subsidiary are adjusted
– Assets, including goodwill, and liabilities
revalued based on acquisition price
– Retained earnings is replaced by Push-Down
Capital which includes retained earnings and
the valuation adjustments
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