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An Introduction to Consolidated Financial Statements

Chapter 3

AN INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS

A BUSINESS COMBINATION UNDER GAAP INCLUDES COMBINATIONS IN WHICH ONE OR MORE COMPANIES BECOME SUBSIDIARIES OF A PARENT CORPORATION.

A A corporation that holds a majority interest (over 50%) of the voting stock of another corporation is referred to as the parent company.

B The interest not held by the parent company is referred to as the noncontrolling interest.

C A corporation whose outstanding voting stock is over 50% owned by another corporation is a subsidiary of that corporation.

D GAAP states that the acquisition of additional shares of a subsidiary is recorded by an increase in the investment account and a reduction of the noncontrolling interest, based on the carrying amount of the noncontrolling interest at the additional acquisition date. APIC is adjusted for any difference between the price and the carrying amount.

E The parent company and subsidiary exist as separate legal entities and maintain separate accounting records. However, each reporting period their separate accounting records are combined into one set of consolidated financial statements for reporting the financial position and results of operations of a consolidated reporting entity.

1 Consolidated financial statements are prepared for all the companies under the control of a single management team to reflect a single reporting entity with multiple divisions.

2 The purpose of consolidated financial statements is to present fairly, primarily for the benefit of the owners and creditors of the parent company, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single entity.

3 The subsidiary will continue to report the results of its separate operations to its noncontrolling stockholders.

4 The consolidated entity (the reporting entity) has no transactions and it does not maintain a ledger. The financial statements of the separate legal entities are combined only for external reporting purposes.


CONSOLIDATION POLICY

A Under current GAAP, consolidation is required for all corporations that are over 50% owned except:

  • Where control does not rest with the majority ownership
  • Formation of joint ventures
  • The acquisition of an asset or group of assets that does not constitute

a business

  • A combination of entities under common control
  • A combination between not-for-profit entities or the acquisition of a for-profit

business by a not-for-profit entity

DISCLOSURE OF CONSOLIDATION POLICIES

  • the reporting period that includes a business combination
  • a business combination that occurs after the reporting period but

before the financial statements are issued

  • provisional amounts related to business combinations
  • adjustments related to business combinations

PARENT AND SUBSIDIARY WITH DIFFERENT FISCAL PERIODS

A Consolidated statements are prepared for and as of the end of the parent company’s fiscal period.

CONSOLIDATED FINANCIAL STATEMENTS

A A set of consolidated financial statements includes a consolidated balance sheet, a consolidated income statement and retained earnings statement, and a consolidated statement of cash flows.

B The consolidated balance sheet, income statement, and retained earnings statement are prepared by combining the separate financial statements of the parent company and the subsidiary.

C The consolidated cash flow statement, however, is prepared from the consolidated financial statements for two consecutive years.


THE CONSOLIDATED BALANCE SHEET

A The investment in subsidiary account on the parent company balance sheet and the stockholders’ equity accounts on the subsidiary’s balance sheet are reciprocal, both representing the net assets of the subsidiary.

  • The reciprocal investment in subsidiary on the parent’s balance sheet and subsidiary stockholders’ equity accounts are eliminated in consolidation (and are replaced by the individual assets and liabilities of the subsidiary).

a A one-line consolidation (the investment account) as discussed in Chapter 2 is replaced by details about individual assets and liabilities controlled by a single management group.

2 Non-reciprocal accounts are combined.

3 Reciprocal accounts are often eliminated.

B The capital stock and retained earnings amounts that appear in the consolidated balance sheet are those of the parent company.

C Unimpared cost-book value differentials are added to (or subtracted from) the asset and liability accounts that will appear in the consolidated balance sheet. Goodwill from the investment, which does not appear in the separate company statements, is added to the asset listing.

D Intercompany balances are eliminated.

E 100% of the assets and liabilities of the parent company and subsidiary are shown in the consolidated balance sheet, and any noncontrolling interest in the subsidiary’s net assets is reported separately in the liability or the stockholders’ equity section.

1 Noncontrolling interest is computed as the noncontrolling interest ownership percentage times the subsidiary equity at the balance sheet date.

  • Classification of noncontrolling interest:

a GAAP requires that noncontrolling interest appear as a separate component of stockholders’ equity.

b Income attributable to the noncontrolling interest is deducted from consolidated net income.


ASSIGNING EXCESS TO IDENTIFIABLE NET ASSETS AND GOODWILL

A Before the balance sheets of the parent and subsidiary can be combined, differences between the book values and fair values must be assigned to over-valued or under-valued identifiable assets.

B Fair value-book value differentials are not recorded on the books of the parent company or its subsidiary, and therefore they must be entered in the working papers to adjust the subsidiary’s book values to the new cost basis for consolidated statement purposes.

1 The amounts assigned to identifiable assets and liabilities are for the fair value and book value difference because the price paid by the parent company/investor implies an investment price for 100% of the investment.

2 The noncontrolling interest's share of the subsidiary’s assets and liabilities are adjusted based on the price paid by the parent for the percentage owned by the parent.

3 The asset and liability amounts that appear in the consolidated balance sheet are determined by combining the separate parent company and subsidiary financial statement amounts (book value) with the debit and credit amounts entered in the adjustment and elimination columns.

  • If several asset and liability accounts are affected by cost-book value differentials, the use of an “unamortized excess” account simplifies the process of entering the cost-book value differentials in the working papers. The unamortized excess account does not affect the consolidated financial statements because it has equal debit and credit entries in the adjustment and elimination columns.

CONSOLIDATED INCOME STATEMENT

A Under GAAP consolidated net income is the net income of the consolidated group. The consolidated income statement must clearly separate income attributable to the controlling and noncontrolling interests.

B Under the equity method, the parent company’s income statement shows revenues and expenses of the parent company and investment income from the subsidiary.

C In contrast, the consolidated income statement shows the total revenues and expenses of the parent company and subsidiary (adjusted for amortization of the fair value-book value differentials) and an allocation as noted above.

D The objective of a consolidated income statement is to show the income of a parent company and its subsidiaries as if there were a single entity.

PUSH-DOWN ACCOUNTING

A Push-down accounting is the process of recording the effects of the purchase price assignment directly on the books of the subsidiary.

B Push-down accounting affects the subsidiary’s separate books and financial statements, but it does not alter consolidated financial statement amounts.

1 Cost-book value differentials are recorded on the books of the subsidiary (i.e., pushed down to the subsidiary’s accounts). At the acquisition date:

a The parent company records its investment as usual.

b The subsidiary makes an entry on its own books to record the new asset bases, including goodwill, and reclassifies retained earnings to push-down capital.

2 The balance sheets of the parent company and subsidiary are consolidated by eliminating the investment in subsidiary account against the subsidiary’s capital stock and push-down capital.

C The SEC requires push-down accounting for SEC filings when a subsidiary is substantially wholly owned (90%) and has no public debt or preferred stock outstanding.

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