ch03 (1).ppt

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Consolidated Financial
Statements—Date of Acquisition
Advanced Accounting, Fifth Edition
3

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1. Understand the concept of control as used in reference to consolidations.
2. Explain the role of a noncontrolling interest in business combinations.
3. Describe the reasons why a company acquires a subsidiary rather than its net
assets.
4. Describe the valuation and classification of accounts in consolidated financial
statements.
5. List the requirements for inclusion of a subsidiary in consolidated financial
statements.
6. Discuss the limitations of consolidated financial statements.
7. Record the investment in the subsidiary on the parent’s books at the date of
acquisition.
8. Prepare the consolidated workpapers and eliminating entries at the date of
acquisition.
9. Compute and allocate the difference between implied value and book value of the
acquired firm’s equity.
10. 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.
Learning Objectives

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Chapter Focus - Accounting for Stock Acquisitions
When one company controls another company through
direct or indirect ownership of its voting stock.
Stock Acquisition
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.
LO 2 Noncontrolling interest (NCI).

4
The 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.
Definitions of Subsidiary and Control
LO 1 Meaning of control.

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Control using U.S. GAAP:
the direct or indirect ability to determine the
direction of management and policies through
ownership, contract, or otherwise
FASB ASC paragraph 810-10-15-8 states:
the usual condition for a controlling financial
interest is ownership of a majority voting
interest

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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).

7
Definitions of Control

8
Requirements for the Inclusion of Subsidiaries
in the Consolidated Financial Statements
LO 5 Requirements regarding consolidation of subsidiaries.
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. Subsidiary operates under governmentally imposed
uncertainty so severe as to raise significant doubt about
the parent’s control.

9
Advantages to acquiring a controlling interest in
another company.
Reasons For Subsidiary Companies
1. Stock acquisition is relatively simple.
2. Control of subsidiary can be accomplished with a smaller
investment.
3. Separate legal existence of affiliates provides an
element of protection of the parent’s assets.
LO 3 Acquiring assets or stock.

10
Statements prepared for a parent company and its
subsidiaries are called consolidated financial
statements.
Consolidated Financial Statements
Ignore legal aspects of separate entities, focus on
economic entity under “control” of management.
Substance rather than form.
Not substitute for statements prepared by separate
subsidiaries, which may be used by:
 Creditors
 Noncontrolling stockholders
 Regulatory agencies
LO 4 Valuation and classification of subsidiary assets and liabilities.

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Investments at the Date of Acquisition
LO 7 Recording of investment at 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.

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E3-2: 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:
Common stock, $10 par value $350,000 $320,000
Other contributed capital 590,000 175,000
Retained earnings 380,000 205,000
Polo Save

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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 300,000
Other Contributed Capital 20,000
Cash 20,000

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Assets and liabilities are summed, regardless of
whether the parent owns 100% or a smaller controlling
interest.
Consolidated Balance Sheets: Use of Workpapers
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.
LO 8 Preparing consolidated statements using a workpaper.

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LO 8 Preparing consolidated statements using a workpaper.
Intercompany receivable (payable) Intercompany payable (receivable)
Against
Advances to subsidiary (from subsidiary) Advances from parent (to parent)
Against
Interest revenue (interest expense) Interest expense (interest revenue)
Against
Dividend revenue (dividends declared) Dividends declared (dividend revenue)
Against
Management fee received from
subsidiary
Management fee paid to parent
Against
Sales to subsidiary (purchases of
inventory from subsidiary)
Purchases of inventory from parent
(sales to parent)
Against
Parent’s Accounts Subsidiary’s Accounts
Investment in subsidiary Equity accounts
Against
Intercompany Accounts to Be Eliminated

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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.
LO 8 Investment is eliminated for consolidated statements.

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Investment Elimination
LO 9 Computing and allocating the difference
between implied and book value (CAD).
“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.

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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
Case 3. The implied value of the subsidiary is less than the book value of the
subsidiary’s equity (IV < BV), and

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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

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Balance Sheet P Company S Company
Cash 40,000
$ 40,000
$
Other current assets 280,000 100,000
Plant and equipment 240,000 80,000
Land 80,000 40,000
Investment in Sill 160,000
Total assets 800,000
$ 260,000
$
Liabilities 120,000
$ 100,000
$
Common stock 400,000 100,000
Other Contributed capital 80,000 20,000
Total Liab. and Equity 800,000
$ 260,000
$
Case 1(a): The balance sheets of both companies immediately
after the acquisition of shares is as follows:
Price paid $160,000
% acquired 100%
Implied value 160,000
Book value 160,000
Difference $0
Implied value =
Book value

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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 -
$ 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
$ 260,000
$ 160,000
$ 160,000
$ 900,000
$
Eliminations
Case 1(a): The workpaper to consolidate the balance sheets for
P and S on Jan. 1, 2013, date of acquisition, is presented below:
Solution on
notes page
Adjusting and eliminating entries are made on the workpaper for the
preparation of consolidated statements.

23
Case 1(a): 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 160,000
This is a workpaper-only entry.

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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.

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Case 1(b): Parent’s Cost of Investment Is Equal to Book Value of
Subsidiary’s Stock Acquired (IV=BV) - Partial Ownership.
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?
Cash $144,000

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Cash 56,000
$ 40,000
$
Land 80,000 40,000
$ 260,000
$
Liabilities 120,000
$ 100,000
$
Common stock 400,000 100,000
Noncontrolling interest
$ 260,000
$
Case 1(b): The balance sheets of both companies immediately
Price paid $144,000
% acquired 90%
Book value 160,000
Difference $0
Implied value =
Book value

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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): Computation and Allocation of Difference between
Implied and Book Values:

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Consolidated
Cash 56,000
$ 40,000
$ 96,000
$
Land 80,000 40,000 120,000
Investment in Sill 144,000 144,000
$ 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
Noncontrolling interest -
$ 260,000
$ 1,060,000
$
Eliminations
Case 1(b): The workpaper to consolidate the balance sheets for
Solution on
notes page

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Consolidated
Cash 56,000
$ 40,000
$ 96,000
$
Land 80,000 40,000 120,000
$ 260,000
$ 916,000
$
Liabilities 120,000
$ 100,000
$ 220,000
$
Common stock 400,000 100,000 100,000 400,000
Noncontrolling interest 16,000 16,000
$ 260,000
$ 160,000
$ 160,000
$ 916,000
$
Eliminations

30
Case 1(b): The workpaper entry to eliminate S Company’s
stockholders’ equity against the investment account is:
Noncontrolling interest in equity 16,000
(establish the NCI)

31
Case 2(b): Implied Value Exceeds Book Value of Subsidiary
Company’s Equity (IV>BV)—Partial Ownership.
Cash $148,000

32
Cash 52,000
$ 40,000
$
Land 80,000 40,000
Difference (IV>BV)
$ 260,000
$
Liabilities 120,000
$ 100,000
$
Common stock 400,000 100,000
$ 260,000
$
Price paid $148,000
% acquired 80%
Book value 160,000
Difference $25,000
Implied value =
Book value

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80% 20%
Share Share Value
$ 37,000
$ 185,000
$
Common stock 80,000 20,000 100,000
$ 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.

34
Consolidated
Cash 52,000
$ 40,000
$ 92,000
$
Land 80,000 40,000 25,000 145,000
Difference (IV>BV) 25,000 25,000 -
$ 260,000
$ 937,000
$
Liabilities 120,000
$ 100,000
$ 220,000
$
Common stock 400,000 100,000 100,000 400,000
$ 260,000
$ 210,000
$ 210,000
$ 937,000
$
Eliminations

35
Case 2(b): The workpaper (elimination) entries are as follows:
Difference between IV and BV 25,000
#1
Land 25,000
#2

36
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.

37
Cash 52,000
$ 40,000
$
Land 80,000 40,000
Difference (IV>BV)
$ 260,000
$
Liabilities 120,000
$ 100,000
$
Common stock 400,000 100,000
$ 260,000
$
Price paid $148,000
% acquired 80%
Book value 160,000
Difference $25,000
Implied value =
Book value

38
80% 20%
Share Share Value
$ 37,000
$ 185,000
$
Common stock 80,000 20,000 100,000
$ 32,000
$ 160,000
$
Difference between implied and book value 20,000
$ 5,000
$ 25,000
$
Land revaluation (mark to market) (16,000)
$ (4,000)
$ (20,000)
$
Goodwill (4,000) (1,000) (5,000)
Balance -
$ -
$ -
$
We assume the entire difference is attributable to
land $20,000 and the rest is for Goodwill

39
Consolidated
Cash 52,000
$ 40,000
$ 92,000
$
Land 80,000 40,000 20,000 140,000
Goodwill 5,000 5,000
$ 260,000
$ 937,000
$
Liabilities 120,000
$ 100,000
$ 220,000
$
Common stock 400,000 100,000 100,000 400,000
$ 260,000
$ 210,000
$ 210,000
$ 937,000
$
Eliminations

40
#1
Land 20,000
#2
Goodwill 5,000

41
Case 3(b): Implied Value of Subsidiary is Less Than Book
Value (IV<BV)—Partial Ownership.
Cash $120,000

42
Cash 80,000
$ 40,000
$
Land 80,000 40,000
Difference (IV<BV)
$ 260,000
$
Liabilities 120,000
$ 100,000
$
Common stock 400,000 100,000
$ 260,000
$
Price paid $120,000
% acquired 80%
Book value 160,000
Difference $10,000
Implied value =
Book value

43
80% 20%
Share Share Value
$ 30,000
$ 150,000
$
Common stock 80,000 20,000 100,000
$ 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 plant and
equipment, in this case an overvaluation of $10,000.

44
Consolidated
Cash 80,000
$ 40,000
$ 120,000
$
Plant and equipment 240,000 80,000 10,000 310,000
Land 80,000 40,000 120,000
$ 260,000
$ 930,000
$
Liabilities 120,000
$ 100,000
$ 220,000
$
Common stock 400,000 100,000 100,000 400,000
$ 260,000
$ 170,000
$ 170,000
$ 930,000
$
Eliminations

45
#1
Plant and equipment 10,000
#2

46
The noncontrolling interest in the subsidiary is
reported as:
a. Asset
b. Liability
c. Equity
d. Expense
Review Question

47
Subsidiary Treasury Stock Holdings
A 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.

48
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.

49
Adjusting Entries Prior to Eliminating Entries
At times, workpaper adjustments to accounting data
may be needed before appropriate eliminating entries
can be accomplished.
Make on workpaper in eliminations columns or
Adjust the subsidiary’s statements prior to their
entry on the workpaper.

50
Which of the following adjustments do not occur in the
consolidating process?
a. Elimination of parent’s retained earnings
b. Elimination of intra-company balances
c. Allocations of difference between implied and book
values
d. Elimination of the investment account
Review Question

51
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.
LO 6 Limitations of consolidated statements.
Limitations of Consolidated Statements

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

53

54

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Deferred Taxes on the Date of Acquisition
APPENDIX A
If a purchase acquisition is tax-free to the seller
 Tax bases of the acquired assets and liabilities are
carried forward at historical book values.
 Assets and liabilities of the acquired company are
recorded on the consolidated books at adjusted fair
value.
Under current guidelines, the tax effects of the difference
between consolidated book values and the tax bases must be
recorded as deferred tax liabilities or assets.

56
Illustration: Suppose that Purchasing Company acquires
90% of Selling Company by issuing stock valued at $800,000.
The only difference between book value and fair value relates
to depreciable plant and equipment. Plant and equipment has a
market value of $400,000 and a book value of $250,000. All
other book values approximate market values. Assume that the
combination qualifies as a nontaxable exchange. On the date of
acquisition, Selling Company’s book value of equity is $600,000,
which includes $150,000 of common stock and $450,000 of
retained earnings. Assume a 30% tax rate. Consider the
following Computation and Allocation Schedule with and without
considering deferred taxes.

57

58

59
The workpaper entry to eliminate the investment account is
as follows:
Entries for allocation with and without deferred taxes.

60
FASB has issued guidance for the consolidation of special-
purpose entities (SPEs) through Interpretation No. 46(R)
“Consolidation of Variable Interest Entities” and SFAS No. 167,
“Amendments to FASB Interpretation No. 46(R)[ASC 810–10–
30].”
An enterprise shall consolidate a variable interest entity (VIE)
when that enterprise has a variable interest (or combination of
variable interests) that provides the enterprise with a
controlling financial interest on the basis of the certain
provisions (listed below).
FASB Statement No. 167 requires ongoing reassessments of
whether an enterprise is the primary beneficiary of a variable
interest entity.
Consolidation of Variable Interest Entities
APPENDIX B

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Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
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to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.
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