Chapter 3

Chapter 3
An Introduction
to Consolidated
Financial
Statements
Intro to Consolidations: Objectives

1. Recognize the benefits and limitations of
consolidated financial statements.
2. Understand the requirements for including a
subsidiary in consolidated financial statements.
3. Apply consolidation concepts to parent company
recording of an investment in a subsidiary
company at the date of acquisition.
4. Record the fair value of the subsidiary at the date
of acquisition.
Pearson Education Limited 2015
3-2
Objectives (continued)
5. Learn the concept of noncontrolling interest
when a parent company acquires less than 100
percent of a subsidiary's outstanding common
stock.
6. Prepare consolidated balance sheets
subsequent to the acquisition date, including
preparation of eliminating entries.
7. Amortize the excess of the fair value over the
book value in periods subsequent to the
acquisition.
8. Apply the concepts underlying preparation of a
consolidated income statement.
3-3
An Introduction to Consolidated Financial Statements
1: BENEFITS &
LIMITATIONS
3-4
Business Acquisitions
Business combinations through stock
acquisitions
Acquire controlling interest in voting stock
More than 50%
May have control through indirect ownership
Business combination occurs once

Acquisition of additional subsidiary stock is
simply additional investment
3-5
Consolidated Statements
Primarily benefit the owners and creditors of the
parent
Not primarily intended for the noncontrolling
owners nor the subsidiarys creditors
Subsidiaries issue separate statements for the
benefit of their owners and creditors
3-6
2: SUBSIDIARIES
3-7
Who is a Subsidiary?
A corporation becomes a subsidiary when
another corporation acquires controlling interest
in its outstanding voting stock.
In a 100 percent acquisition, the investee
continues to operate as a separate legal entity.
Subsidiaries, or affiliates, continue as separate
legal entities and prepare their own financial
reports.
3-8
Subsidiaries Are Consolidated

Cases where a subsidiary may be excluded
from consolidation:
Control doesnt rest with majority owner
Joint ventures
Acquisitions of groups of assets that do not
constitute a business
Combination between entities under common
control
Combination of not-for-profit entities or
acquisition of a for-profit company by a not-forprofit entity
3-9
Consolidated Statements
Prepared by the parent company
Parent discloses
Consolidation policy [SEC Reg. S-X, Rule 3A-03]
Any exceptions to consolidation
Fiscal year-end for consolidated entity:

Use parent's FYE, but
May include subsidiary statements with FYE
within 3 months of parent's FYE.
Disclose intervening material events
3-10
3: CONSOLIDATED
BALANCE SHEET AT DATE
OF ACQUISITON
3-11
Pen Example: Acquisition Cost = Fair

Value = Book Value
Sels Balance Sheet: BV=FV
Cash
$10
Other current assets
15
Plant assets, net
40
Total
$65
Accounts payable
$15
Other current liabilities
10
Capital stock
30
Retained earnings
10
Total
$65
Pen acquires 100% of Sel for $40,

which equals the book value and fair
values of the net assets acquired.
Cost of acquisition
$40
Less 100% book value
40
Excess of cost over book value
$0
To consolidate, eliminate Pen's

Investment account and Sel's capital
stock and retained earnings.
3-12
Balance Sheets
Separate
Consolidated
Pen
Sel
Pen & Sub.
$20
$10
$30
Other curr. assets
45
15
60
Plant assets, net
60
40
100
Investment in Sel
40
$165
$65
$190
$20
$15
$35
25
10
35
30
100
20
10
20
$165
$65
$190
Cash
Total
Accounts payable
Other curr. liabilities
Capital stock
Retained earnings
Total
100
3-13
4: FAIR VALUE AT
ACQUISITION DATE
3-14
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
Cost > BV, excess is goodwill
Cost < BV, excess is a gain on the bargain purchase
3-15
BV FV Cost
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.g., 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
3-16
Example: BV FV but Cost = FV

Piper acquires 100% of Sandy for $310.
Sandy
BV = 100 +BV145FV = $245 FV = 385 75

Cash
$40
$40
$310
Receivables
30
30
Inventory
50
75
Plant, net
Total
Liabilities
Cost240
FV = $0 goodwill
200
$320 $385
$75
Capital stock
100
Retained earnings
145
Total
$75
Cost
100% Book value
Excess of cost over BV
$310
245
$65
$320
3-17
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 (-SE)
100
Retained earnings (-SE)
145
Inventory (+A)
25
Plant (+A)
40
Investment in Sandy (-A)
310
3-18
Example: BV FV and Cost FV

Panda acquires 100% of Salty for $530.
Salty
BV
FV
130
190
$520
$58
0
$80
$85
BV = 250
+ 190
= $440
$100
$100
FV = 580
85 40 = $495
Receivables
40
Cost FV = $35 goodwill
Inventory
250
250
Cash
Plant, net
Total
Liabilities
Capital stock
250
Retained earnings
190
Total
Cost
100% Book value
Excess of cost over
BV
$530
440
$90
$520
3-19
Panda and Salty (cont.)

Allocate to:
Amount Amort.
Plant
60 4 yrs
Liabilities
-5 5 yrs
Goodwill
35
Total
$90
Panda's elimination worksheet entry:

Capital stock (-SE)
250
190
Plant (+A)
60
Goodwill (+A)
35
Liabilities (+L)
Investment in Salty (-A)
5
530
3-20
Example: BV FV and Cost FV

Print acquires 100% of Sum for $185.
Sum
Cash
BV
$10
FV
$10
Receivables
30
30
Inventory
80
90
Plant, net
100
120
Total
Liabilities
Capital stock
Retained
earnings
Total
$220
$40
75
105
$220
$250
BV = 75 + 105 = $180
FV = 250 - 40 = $210
Cost FV = -$25:
Gain on bargain purchase
$40
Cost
100% BV
Excess of cost over
BV
$185
180
$5
3-21
Print and Sum (cont.)

Allocate to:
Amt Amort.
Inventory
10 1st yr
Plant, land
20
Bargain purchase
(25) Gain
Total
$5
Print records the acquisition of Sum 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 Sum (+A)
Gain on bargain purchase (R, +SE)
Cash (-A)
210
25
185
3-22
Worksheet Elimination Entry

Unamortized excess equals $30
$10 for undervalued inventory
$20 for undervalued land included in plant assets
Prints elimination worksheet entry:
Capital stock (-SE)
Unamortized excess (+A)
75
105
30
Investment in Sum (-A)
210
Inventory (+A)
10
Plant (+A)
20
Unamortized excess (-A)

30
3-23
Cash
Receivables
Print
Sum
BV
BV
$30
Adjustments
DR
Consolidated
CR
$10
$40
50
30
80
Inventory
100
80
10
190
Plant, net
450
100
20
570
Investment in Sum
210
210
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
3-24
5: NONCONTROLLING
INTERESTS
3-25
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
3-26
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
Implied value of Sine

(400/80%)
$500
Book value (200+175)

Excess over book value
375
$125
Allocate to:
Building
Goodwill
Total
$50
75
$125
3-27
Elimination Entry
Popo's elimination worksheet entry:
Capital stock (-SE)
200
175
Building (+A)
50
Goodwill (+A)
75
Investment in Sine (-A)
400
Noncontrolling interest (+SE)
100
An unamortized excess account could have been used

for the excess assigned to the building and goodwill.
3-28
Cash
Receivables
Popo
Sine
BV
BV
$50
Adjustments
DR
Consolidated
CR
$10
$60
130
50
180
80
100
180
Building, net
300
240
Investment in Sine
400
Inventory
50
590
400
Goodwill
75
0
75
Total
$960
$400
$1,085
Liabilities
$150
$25
$175
Capital stock
250
200
200
250
Retained earnings
560
175
175
560
Noncontrolling interest
Total
100
$960
$400
$1,085
500
100
500
3-29
6: CONSOLIDATED
BALANCE SHEETS AFTER
ACQUISITION
3-30
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
3-31
Popo and Sine (cont.)
Cost of 80% of Sine
$400
Allocate to:
Implied value of Sine
$500
Building
Book value
Excess
375
$125
Goodwill
Total
$50
10 yrs
75
$125
Beginning
unamortized
excess
Current year's
amortization
Ending
unamortized
excess
Building
50
(5)
45
Goodwill
75
75
125
(5)
120
Total
3-32
After 1 year:
Cash
Receivables
Inventory
Popo
Sine
$40
$15
110
90
Building, net
280
Investment in Sine
404
Total
$924
Liabilities
85 Capital stock
100 Retained earnings
235
$435
Popo's elimination worksheetTotal

entry:
Capital stock (-SE)
Unamortized excess (+A)
Popo
Sine
$100
$50
250
574
200From 175
185Subsid m
Increase
How pare
Dr invest
$924 $435
Cr income
200
Deduct a
185
so becom
120
Investment in Sine (80%) (-A)
404
Noncontrolling interest (20%) (+SE)
101
Building (+A)
45
Goodwill (+A)
75
Unamortized excess (-A)

120
3-33
After 1 year:
Cash
Receivables
Popo
Sine
BV
BV
$40
Adjustments
DR
Consolidated
CR
$15
$55
110
85
195
90
100
190
Building, net
280
235
Investment in Sine
404
Inventory
45
560
404
Goodwill
75
Unamortized excess
120
0
75
120
Total
$924
$435
$1,075
Liabilities
$100
$50
$150
Capital stock
250
200
200
250
Retained earnings
574
185
185
574
Noncontrolling interest
Total
101
$924
$435
101
$1,075
505 505
3-34
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
3-35
7: AMORTIZATIONS AFTER
ACQUISITION
3-36
Unamortized Excess
Excess assigned to assets and liabilities are
amortized according to the account
Balance sheet
account
Amortization
period
Income
statement
account
Inventories and
other current
assets
Generally, 1st year
Cost of sales and

other expense
Buildings,
equipment,
patents
Remaining life at
business
combination
Depreciation and
amortization
expense
Land, copyrights
Not amortized
Long-term debt
Time to maturity
Interest expense
3-37
Piper and Sandy (cont.)

Cost
100% BV
Excess
$310
245
$65
Allocate to:
Amt Amort.
Inventory
25 1st yr
Plant
40 10 yrs
Total
$65
Beginning
unamortized
excess
Current year's
amortization
Ending
unamortized
excess
Inventory
25
(25)
Plant
40
(4)
36
Total
65
(29)
36
3-38
Panda and Salty (cont.)

Cost
100% BV
Excess
$530
440
$90
Allocate to:
Amt Amort.
Plant
60 4 yrs
Liabilities
-5 5 yrs
Goodwill
35
Total
$90
Beginning
unamortized
excess
Current year's
amortization
Ending
unamortized
excess
Plant
60
(15)
45
Liabilities
(5)
(4)
Goodwill
35
35
Total
90
(14)
76
3-39
Print and Sum (cont.)

Cost
100% BV
Excess
$185
Allocate to:
Amt Amort.
180
Inventory
10 1st yr
$5
Plant, land
20
Bargain purchase
Total
(25) Gain
$5
Beginning
unamortized
excess
Current year's
amortization
Ending
unamortized
excess
Inventory
10
(10)
Land
20
20
Total
30
(10)
20
3-40
8: CONSOLIDATED
INCOME STATEMENTS
3-41
Comprehensive Example, Data

Pil acquires 90% of Sad on 12/31/2011 for
$10,200 when Sad's equity consists of $4,000
common stock, $1,000 other paid in capital,
and $900 retained earnings. On that date
Sad'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.
3-42
Cost of 90% of Sad
$10,200
Implied value of Sad

10,200/.90
$11,333
Book value
(4000+1000+900)
5,900
Excess over book value
$5,433
Allocate to:
Inventory
Land
$100
200
1st yr
-
Building
1,000 40 yrs
Equipment
(300) 5 yrs
Note payable
100 1st yr
Goodwill
4,333
Unamortized
excess 1/1/12
Total
Current
amortization
$5,433
Unamortized
excess 12/31/12
Inventory
100
(100)
Land
200
200
Building
1,000
(25)
975
Equipment
(300)
60
(240)
100
(100)
Goodwill
4,333
4,333
Total
5,433
(165)
5,268
Note payable
3-43
Pil
Sales
Income from Sad
Cost of sales
$9,523.50
Sad
$2,200.00
Consol.*
$11,723.50
571.50
Amortize of inventroy 100 more
$0.00
(4,000.00)
(700.00)
Depreciation exp - bldg
(200.00)
(80.00)
(305.00)
Depreciation exp - equip
(700.00)
(360.00)
(1,000.00)
(1,800.00)
(120.00)
(1,920.00)
(300.00)
(140.00)
(540.00)
Other expense
Interest expense
Net income
Total consolidated income
$3,095.00
(4,800.00)
Building 25 adj
$800.00
$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 Pil and Sad.
3-44
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
3-45

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Chapter 3

Intro to Consolidations: Objectives

Pearson Education Limited 2015

An Introduction to Consolidated Financial Statements

Pearson Education Limited 2015

Business combination occurs once

Pearson Education Limited 2015

Pearson Education Limited 2015

An Introduction to Consolidated Financial Statements

Pearson Education Limited 2015

Pearson Education Limited 2015

Subsidiaries Are Consolidated

Fiscal year-end for consolidated entity:

Pearson Education Limited 2015

An Introduction to Consolidated Financial Statements

Pearson Education Limited 2015

Pen Example: Acquisition Cost = Fair

Other current assets

Plant assets, net

Other current liabilities

Pearson Education Limited 2015

Pen acquires 100% of Sel for $40,

Less 100% book value

Excess of cost over book value

To consolidate, eliminate Pen's

Pen & Sub.

Other curr. assets

Plant assets, net

Pearson Education Limited 2015

An Introduction to Consolidated Financial Statements

Pearson Education Limited 2015

Cost, Fair Value, and Book Value

Pearson Education Limited 2015

Difference between FV and Cost is goodwill or

Example: BV FV but Cost = FV

BV = 100 +BV145FV = $245 FV = 385 75

Pearson Education Limited 2015

Piper and Sandy (cont.)

Piper's elimination worksheet entry:

Retained earnings (-SE)

Investment in Sandy (-A)

Pearson Education Limited 2015

Example: BV FV and Cost FV

Panda and Salty (cont.)

Panda's elimination worksheet entry:

Retained earnings (-SE)

Example: BV FV and Cost FV

Pearson Education Limited 2015

Print and Sum (cont.)

Print records the acquisition of Sum assuming a cash

Worksheet Elimination Entry

Investment in Sum (-A)

Unamortized excess (-A)

Pearson Education Limited 2015

An Introduction to Consolidated Financial Statements

Pearson Education Limited 2015

Parent pays $40,000 for an 85% interest

Example: Noncontrolling Interests

Implied value of Sine

Book value (200+175)

Retained earnings (-SE)

Investment in Sine (-A)

Noncontrolling interest (+SE)

An unamortized excess account could have been used