Consolidated Financial Statements—Date of Acquisition - PowerPoint Presentation

1. Consolidated Financial Statements—Date of Acquisition1

2. Learning ObjectivesUnderstand the concept of control as used in reference to consolidations.Explain the role of a noncontrolling interest in business combinations.Describe the reasons why a company acquires a subsidiary rather than its net assets.Describe the valuation and classification of accounts in consolidated financial statements.List the requirements for inclusion of a subsidiary in consolidated financial statements.2

3. Learning ObjectivesDiscuss the limitations of consolidated financial statements.Record the investment in the subsidiary on the parent’s books at the date of acquisition.Prepare the consolidated workpapers and eliminating entries at the date of acquisition.Compute and allocate the difference between implied value and book value of the acquired firm’s equity.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.3

4. Stock AcquisitionsChapter Focus - Accounting for Stock AcquisitionsWhen one company controls another company through direct or indirect ownership of some or all 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.4LO 2 Noncontrolling interest (NCI).

5. Definitions of Subsidiary and ControlThe 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.5LO 1 Meaning of control.

6. Definitions of Subsidiary and ControlSubsidiary:A parent company (and/or the parent’s other subsidiaries) owns a controlling financial interest in another company.Control:Both the IASB and the FASB have indicated their opinion that the definition of control should not be limited to the common presumption in practice of a 50% cutoff but should instead include an indirect ability to control another entity’s assets.The usual condition for a controlling financial interest is ownership of a majority voting interest. [FASB ASC paragraph 810-10-15-8]6LO 1 Meaning of control.

7. Definitions of Subsidiary and ControlControl (continued):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).7LO 1 Meaning of control.

8. Definitions of Control8LO 1 Meaning of control.

9. Requirements for the Inclusion of Subsidiaries in the Consolidated Financial StatementsPurpose 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:Control does not rest with the majority owner.Subsidiary operates under governmentally imposed uncertainty so severe as to raise significant doubt about the parent’s control.9LO 5 Requirements regarding consolidation of subsidiaries.

10. Reasons For Subsidiary CompaniesAdvantages to acquiring a controlling interest in the voting stock of another company rather than its assets or all of its voting stock.Stock acquisition is relatively simple.Control of subsidiary can be accomplished with a smaller investment.Separate legal existence of affiliates provides an element of protection of the parent’s assets.10LO 3 Acquiring assets or stock.

11. Consolidated Financial StatementsStatements prepared for a parent company and its subsidiaries are called consolidated financial statements.Ignore legal aspects of separate entities, but focus instead, on economic entity under “control” of management.Focus on substance rather than form.Not substitutes for statements prepared by separate subsidiaries, which may be used by:CreditorsNoncontrolling stockholdersRegulatory agencies.11LO 4 Valuation and classification of subsidiary assets and liabilities.

12. Consolidated Financial StatementsPurpose of consolidated financial statements:To present, primarily for the benefit of the owners and creditors of the parent, the results of operations and the financial positions of a parent company and all of its subsidiariesAs if the consolidated group were a single economic entity.12LO 4 Valuation and classification of subsidiary assets and liabilities.

13. Investments at the Date of AcquisitionRecording 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, or a combination of these items.Both the direct costs of acquiring the stock and the indirect costs relating to acquisitions (such as costs of maintaining an acquisitions department) should be expensed as incurred.13LO 7 Recording of investment at acquisition.

14. E3-2: On January 1, 2014, 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 companies’ balance sheets on December 31, 2013, were:Common stock, $10 par value $350,000 $320,000Other contributed capital 590,000 175,000Retained earnings 380,000 205,000PoloSaveInvestments at the Date of Acquisition14LO 7 Recording of investment at acquisition.

15. 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 300,000Other Contributed Capital 20,000 Cash 20,000Investments at the Date of Acquisition15LO 7 Recording of investment at acquisition.Stock registration and issuance costs reduce Other Contributed Capital

16. Consolidated Balance Sheets: Use of WorkpapersAssets and liabilities are summed in their entirety, 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.16LO 8 Preparing consolidated statements using a workpaper.

17. Consolidated Balance Sheets: Use of Workpapers17LO 8 Preparing consolidated statements using a workpaper.Intercompany receivable (payable)Intercompany payable (receivable)AgainstAdvances to subsidiary (from subsidiary)Advances from parent (to parent)AgainstInterest revenue (interest expense)Interest expense (interest revenue)AgainstDividend revenue (dividends declared)Dividends declared (dividend revenue)AgainstManagement fee received from subsidiaryManagement fee paid to parentAgainstSales to subsidiary (purchases of inventory from subsidiary)Purchases of inventory from parent (sales to parent)AgainstParent’s AccountsSubsidiary’s AccountsInvestment in subsidiaryEquity accountsAgainstIntercompany Accounts to Be Eliminated

18. Consolidated Balance Sheets: Use of WorkpapersInvestment EliminationIt 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.18LO 8 Investment is eliminated for consolidated statements.

19. Consolidated Balance Sheets: Use of WorkpapersInvestment EliminationComputation and Allocation of Difference between Implied Value and Book Value (CAD)Step 1: Determine percentage of stock acquired.Step 2: Divide purchase price by the percentage acquired* to calculate the implied value of the subsidiary. * If 100%, the implied value will equal the purchase price.Step 3: Difference between Step 2 and book value of subsidiary’s equity must be allocated to adjust the underlying assets and/or liabilities of the acquired company.19LO 9 Computing and allocating the difference between implied and book value (CAD).

20. Consolidated Balance Sheets: Use of WorkpapersThe 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.20LO 9 Computing and allocating the difference between implied and book value (CAD).

21. Case 1(a): Implied Value of Subsidiary Is Equal to Book Value of Subsidiary Company’s Equity (IV = BV) - 100% of Stock Acquired.Consolidated Balance Sheets: Use of Workpapers21LO 9 Computing and allocating the difference between implied and book value (CAD).Illustration: Assume that on January 1, 2015, 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

22. Case 1(a): The balance sheets of both companies immediately after the acquisition of shares is as follows:Consolidated Balance Sheets: Use of Workpapers22LO 9 Computing and allocating the difference between implied and book value (CAD).Price paid $160,000% acquired 100%Implied value 160,000Book value 160,000Difference $0Implied value = Book value

23. Case 1(a): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:Consolidated Balance Sheets: Use of Workpapers23LO 9 Computing and allocating the difference between implied and book value (CAD).Adjusting and eliminating entries are made on the workpaper for the preparation of consolidated statements.

24. Consolidated Balance Sheets: Use of Workpapers24LO 9 Computing and allocating the difference between implied and book value (CAD).Case 1(a): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:

25. Case 1(a): The workpaper entry to eliminate S Company’s stockholders’ equity against the investment account is:Consolidated Balance Sheets: Use of Workpapers25LO 9 Computing and allocating the difference between implied and book value (CAD).Common Stock (S) 100,000Other Contributed Capital (S) 20,000Retained Earnings (S) 40,000 Investment in S Company 160,000This is a workpaper-only entry.

26. Consolidated Balance Sheets: Use of WorkpapersCase 1(a): Note the following on the workpaper.Investment account and related subsidiary’s stockholders’ equity have been eliminated .Subsidiary’s net assets have been substituted for the investment account.Consolidated assets and liabilities consist of the sum of the parent and subsidiary assets and liabilities in each classification.Consolidated stockholders’ equity is the same as the parent company’s stockholders’ equity.Consolidated balance sheet is that of the economic entity.26LO 9 Computing and allocating the difference between implied and book value (CAD).

27. Case 1(b): Parent’s Cost of Investment Is Equal to Book Value of Subsidiary’s Stock Acquired (IV=BV) - Partial Ownership.Consolidated Balance Sheets: Use of Workpapers27LO 9 Computing and allocating the difference between implied and book value (CAD).Illustration: Assume that on January 1, 2015, 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

28. Consolidated Balance Sheets: Use of Workpapers28LO 9 Computing and allocating the difference between implied and book value (CAD).Case 1(b): The balance sheets of both companies immediately after the acquisition of shares is as follows:Price paid $144,000% acquired 90%Implied value 160,000Book value 160,000Difference $0Implied value = Book value

29. Consolidated Balance Sheets: Use of Workpapers29LO 9 Computing and allocating the difference between implied and book value (CAD).Case 1(b): Computation and Allocation of Difference between Implied and Book Values:

30. Consolidated Balance Sheets: Use of Workpapers30LO 9 Computing and allocating the difference between implied and book value (CAD).Case 1(b): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:Solution on notes page

31. Consolidated Balance Sheets: Use of Workpapers31LO 9 Computing and allocating the difference between implied and book value (CAD).Case 1(b): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:

32. Case 1(b): The workpaper entry to eliminate S Company’s stockholders’ equity against the investment account is:Consolidated Balance Sheets: Use of Workpapers32LO 9 Computing and allocating the difference between implied and book value (CAD).Common Stock (S) 100,000Other Contributed Capital (S) 20,000Retained Earnings (S) 40,000 Investment in S Company 144,000 Noncontrolling Interest in Equity 16,000 (establish the NCI)

33. Case 2(b): Implied Value Exceeds Book Value of Subsidiary Company’s Equity (IV>BV) - Partial Ownership.Consolidated Balance Sheets: Use of Workpapers33LO 9 Computing and allocating the difference between implied and book value (CAD).Illustration: Assume that on January 1, 2015, 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

34. Consolidated Balance Sheets: Use of Workpapers34LO 9 Computing and allocating the difference between implied and book value (CAD).Case 2(b): The balance sheets of both companies immediately after the acquisition of shares is as follows:Price paid $148,000% acquired 80%Implied value 185,000Book value 160,000Difference $25,000Implied value = Book value

35. Consolidated Balance Sheets: Use of Workpapers35LO 9 Computing and allocating the difference between implied and book value (CAD).Case 2(b): Computation and Allocation of Difference between Implied and Book Values:We assume the entire difference is attributable to land with a current value higher than historical cost.

36. Consolidated Balance Sheets: Use of Workpapers36LO 9 Computing and allocating the difference between implied and book value (CAD).Case 2(b): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:

37. Case 2(b): The workpaper (elimination) entries are as follows:Consolidated Balance Sheets: Use of Workpapers37LO 9 Computing and allocating the difference between implied and book value (CAD).Common Stock (S) 100,000Other Contributed Capital (S) 20,000Retained Earnings (S) 40,000Difference between IV and BV 25,000 Investment in S Company 148,000 Noncontrolling Interest in Equity 37,000#1Land 25,000 Difference between IV and BV 25,000#2

38. Consolidated Balance Sheets: Use of WorkpapersCase 2(b) Reasons an Acquiring Company May Pay More Than Book Value:Fair value of specific tangible or intangible assets of the subsidiary may exceed the recorded value because of appreciation.Excess payment may indicate existence of goodwill.Liabilities, generally long-term, may be overvalued.A variety of market factors may affect the price paid.38LO 9 Computing and allocating the difference between implied and book value (CAD).

39. Case 3(b): Implied Value of Subsidiary is Less Than Book Value (IV<BV) - Partial Ownership.Consolidated Balance Sheets: Use of Workpapers39LO 9 Computing and allocating the difference between implied and book value (CAD).Illustration: Assume that on January 1, 2015, 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

40. Consolidated Balance Sheets: Use of Workpapers40LO 9 Computing and allocating the difference between implied and book value (CAD).Case 3(b): The balance sheets of both companies immediately after the acquisition of shares is as follows:Price paid $120,000% acquired 80%Implied value 150,000Book value 160,000Difference $10,000Implied value = Book value

41. Consolidated Balance Sheets: Use of Workpapers41LO 9 Computing and allocating the difference between implied and book value (CAD).Case 3(b): Computation and Allocation of Difference between Implied and Book Values:Assume the difference is attributable to plant and equipment, in this case an overvaluation of $10,000.

42. Consolidated Balance Sheets: Use of Workpapers42LO 9 Computing and allocating the difference between implied and book value (CAD).Case 3(b): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015, date of acquisition, is presented below:

43. Case 3(b): The workpaper (elimination) entries are as follows:Consolidated Balance Sheets: Use of Workpapers43LO 9 Computing and allocating the difference between implied and book value (CAD).Common Stock (S) 100,000Other Contributed Capital (S) 20,000Retained Earnings (S) 40,000 Difference between IV and BV 10,000 Investment in S Company 120,000 Noncontrolling Interest in Equity 30,000#1Difference between IV and BV 10,000 Plant and Equipment 10,000#2

44. Consolidated Balance Sheets: Use of WorkpapersReview QuestionThe noncontrolling interest in the subsidiary is reported as:AssetLiabilityEquityExpense44LO 9 Computing and allocating the difference between implied and book value (CAD).

45. Consolidated Balance Sheets: Use of WorkpapersSubsidiary Treasury Stock HoldingsA subsidiary may hold some of its own shares as treasury stock at the time the parent company acquires its interest.Because the treasury stock account represents a contra stockholders’ equity account, it must be eliminated by a credit when the investment account and subsidiary company’s equity accounts are eliminated on the workpaper.45LO 9 Computing and allocating the difference between implied and book value (CAD).

46. Consolidated Balance Sheets: Use of WorkpapersOther Intercompany Balance Sheet EliminationsIntercompany accounts receivable, notes receivable, and interest receivable, for example, must be eliminated against the reciprocal accounts payable, notes payable, and interest payable.Eliminations must also be made for all types of intercompany accruals for such items as rent and other services.The full amount of all intercompany receivables and payables is eliminated without regard to the percentage of control held by the parent company.46LO 9 Computing and allocating the difference between implied and book value (CAD).

47. Consolidated Balance Sheets: Use of WorkpapersAdjusting Entries Prior to Eliminating EntriesAt times, workpaper adjustments to accounting data may be needed before appropriate eliminating entries can be accomplished. The need for adjustments generally arises because of in-transit items when only one of the affiliates has recorded the effect of an intercompany transaction.Enter these adjusting entries on worksheet eliminations columns orAdjust the subsidiary’s statements prior to their entry on the workpaper.47LO 9 Computing and allocating the difference between implied and book value (CAD).

48. Consolidated Balance Sheets: Use of WorkpapersReview QuestionWhich of the following adjustments do not occur in the consolidating process?Elimination of parent’s retained earningsElimination of intra-company balancesAllocations of difference between implied and book valuesElimination of the investment account48LO 9 Computing and allocating the difference between implied and book value (CAD).

49. LO 6 Limitations of consolidated statements.Limitations of Consolidated StatementsConsolidated statements may have limited usefulness for noncontrolling stockholders, subsidiary creditors, and some regulatory agencies. For Example:Little information of value in consolidated statements because they contain insufficient detail about the individual subsidiaries.Highly diversified companies operating across several industries, often the result of mergers and acquisitions, are difficult to analyze or compare.49

50. IFRS Versus U.S. GAAP50LO 10 Similarities and differences between U.S. GAAP and IFRS.

51. IFRS Versus U.S. GAAP51LO 10 Similarities and differences between U.S. GAAP and IFRS.

52. IFRS Versus U.S. GAAP52LO 10 Similarities and differences between U.S. GAAP and IFRS.