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CHAPTER 3
AN INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS
Business Combinations Consummated Through Stock Acquisitions
-

-

Once a parent-subsidiary relationship is established, the purchase of additional subsidiary
stock is not a business combination  increase controlling interest = making additional
investment
...


The Reporting Entity
-

-

When an investment in voting stock creates a parent-subsidiary relationship, the
purchasing entity (P) and the entity acquired (S) continue to function as separate entities
and maintain accounting records on separate basis  consolidated FS
Why maintaining separate legal entities?
1
...
Limited legal liability  if lawsuit against a subsidiary results in a significant loss,
the parent cannot be held accountable for more than the loss of its investment

The Parent-Subsidiary Relationship
Percy Company
(Parent)
90% ownership

80% ownership

San Del Corp

Saltz Corp

(Subsidiary)

(Subsidiary)

Percy Company as Parent and has significant influence :
-uses equity method for reporting
-able to elect subsidiary directors and control subsidiary decisions
San Del Corp
...
)
-report results of its own operation to noncontrolling interest

By: Anita Eva Erdina

Consolidation Policy
Under GAAP, a subsidiary can be excluded from consolidation in some situations:
1
...
Formation of joint ventures
3
...
Combination between entities under common control
5
...
The reporting period that includes a business combinations
a
...
Information about goodwill or bargain purchase gain
c
...
Details about specific assets, liabilities, and any noncontrolling interest
e
...
Information about transactions accounted for separately from business
combination
g
...
A business combination that occurs after the reporting period but before the
financial statements are issued
3
...
Adjustments related to business combinations
 Parent and Subsidiary with Different Fiscal Period
Prepare consolidated statements for and as of the end of parent’s fiscal period
...



-

-

Parent Acquires 100% of Subsidiary at Book Value
Pen acquires 100% of Sel Corp at its book value and fair value of $40,000 in an acquisition on
January 1, 2011
100%
Investment cost :
$40,000

By: Anita Eva Erdina

Book Value: 40,000
Excess cost over BV = Investment cost – 100%
Book Value
$40,000 - $40,000 = 0

To consolidate, eliminate
Pen's Investment account
and Sel's capital stock and
retained earnings
...
Capital Stock—Sel (-SE)
30
Retained Earnings—Sel (-SE)
10
Goodwill (+A)
10
Investment in Sel (-A)
50
To eliminate the reciprocal investment and equity accounts and to assign the excess
of investment cost over book value to goodwill
**Acquisition cost, fair values of identifiable net assets and book values may differ
...

When BV = FV
Cost > BV, excess is goodwill
Cost < BV, excess is a gain on the bargain purchase

By: Anita Eva Erdina

**Difference between the book value of net assets (BV) and the fair value of identifiable net
assets (FV) is assigned to the specific assets or liabilities
- E
...
, undervalued or overvalued inventories, plant assets
- Unrecorded assets (patents) or liabilities (existing contingencies)
Difference between FV and Cost is goodwill or a gain on the bargain purchase

Parent Acquires 90% of Subsidiary—With Goodwill
Pen acquires 90% of Sel’s outstanding stock for $45,000
90%

Investment cost :
$45,000

Book Value: 40,000
Implied fair value
$45,000/90% = $50,000
$50,000 - $40,000 = $10,000 (goodwill)

*there is $5000 (10% x $50,000) of noncontrolling interest
The elimination journal for 90% ownership :
a
...
4
9
41
75
(20)
54
186
...
4
$186
...
Pen acquired a 90% interest in Sel for $45,000 on January 1, 2011, when Sel’s
stockholders’ equity at book value was $40,000
...
The accounts payable of Sel includes $5,000 owed to Pen
...
During 2011 Sel had income of $20,000 and declared $10,000 in dividends
...
Capital stock—Sel (-SE)
30
Retained earnings—Sel (-SE)
20
Goodwill (+A)
10
Investment in Sel (-A)
54
Noncontrolling interest (+SE)
6
To eliminate reciprocal investment and equity balances, record goodwill, and
enter the noncontrolling interest (10%x$60,000)
b
...
Accounts payable (-L)
Other current assets (-A)

5
5

To eliminate intercompany accounts receivable and accounts payable

By: Anita Eva Erdina

ASSIGNING EXCESS TO IDENTIFIABLE NET ASSETS AND GOODWILL
Effect of Assignment on Consolidated Balance Sheet at Acquisition
On December 31, 2011 Pil purchase 90% of Sad Corporation’s outstanding voting common
stock directly from Sad Corporation’s stockholders for $5,200,000 cash plus 100,000 shares of
Pil Corporation $10 par common stock with a market value of $5,000,000
...
Pil pays these additional costs in cash
...

How to record the acquisition of 90% interest
Investment in Sad
Common Stock
Additional PIC
Cash

10,200,000
1,000,000 ($100,000x$10)
4,000,000 ($5,000,000-$1,000,000)
5,200,000

The investment expense will be recorded as follow:
Investment expense
Cash

200,000
200,000

If the underlying book value of Sad Corp is $5,900,000, and the excess of fair value over book
value are assigned to identifiable net assets and goodwill, the entry would be:
Intitial computation:
FV 90% interest
Implied FV
BV of Sad NA
Total excess FV over BV

10,200
11,333
(5,900)
5,433

Allocation Schedule
FV
Inventories
600
Land
800
Buildings
5000
Equipment
1700
Notes payable
1300
Total allocated to identifiable net assets
Total allocated to goodwill

By: Anita Eva Erdina

BV
500
600
4000
2000
1400

Excess Allocated
100
200
1000
(300)
100
1100
4333

Elimination journal:
a
...
Inventories
100
Land
200
Buildings
1,000
Goodwill
4,333
Notes Payable
100
Equipment
Unamortized excess

300
5,433

Effect of Amortization on Consolidation Balance Sheet After Acquisition
The effect of amortizing $5,433,000 excess on December 31, 2012, consolidated balance
sheet is based on the following assumptions:
Income for 2012
Sad’s net income
Pil’s income excluding income from Sad

800,000
2,523,500

Dividends paid in 2012
Sad
Pil

300,000
1,500,000

Amortization of excess
Undervalued inventories—sold in 2012
Undervalued land—still held by Sad: no amortization
Undervalued buildings—useful life 40 years from Jan 1, 2012
Overvalued equipment—useful life 5 years from Jan 1,2012
Overvalued notes payable—retired in 2012
Goodwill—no amortization
How to calculate Income from Sad 2012
90% of Sad reported NI (90%x800,000)
(+)Pil’s 90% share of amortization on overvalued equip
(300,000/5 years)x90%
(-)Amortization of Pil’s share of excess allocated to
Inventories (100,000 x 90%)
90,000

By: Anita Eva Erdina

720,000
54,000

Land
Buildings ((1,000,000/40)x90%)
Notes payable (100,000x90%)
Income from Sad

22,500
90,000

Alternatively:
Sad’s net income
+ Amortization of overvalued equip
- Amortization excess allocated to:
Inventories
100,000
Land
Building
25,000
Notes payable
100,000
Sad’s adjusted net income
90% of Sad’s adjusted net income

(202,500)
571,500

800,000
60,000 300,000/5 years

(225,000)
635,000
571,500

We can also verify the noncontrolling interest at December 31, 2012:
Noncontrolling interest at December 31,2011
1,133,000
+10% of Sad’s 2012 net income
80,000
-10% of 2012 amortization
(16,500)
-10% of 2012 dividends
(30,000)
Noncontrolling interest at December 31, 2012
1,166,500
Thus, the elimination journal would be
a
...
Land
200
Buildings
975
Goodwill
4,333
Equipment
Unamortized excess

By: Anita Eva Erdina

4,000
1,000
1,400
5,268
10,501
...
5

240
5,268

Where are the numbers come from:

Inventories
Land
Buildings-net
Equipment-net
Notes payable
Goodwill

Unamortized Excess
December 31, 2011
100
200
1000
(300)
100
4333
5433

Initial cost—December 31, 2011
90% of Sad’s 2012 NI
90% of Sad’s 2012 dividends
Amortization of FV over BV (90%x165,500)
Balance—December 31, 2102

By: Anita Eva Erdina

Amortization

Unamortized Excess
December 31,2012
100
25
(60)
100
165

10,200,000
720,000
(270,000)
(148,500)
10,501,500

200
975
(240)
4333
5268



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