Consolidated Financial Statements Part 1

CONSOLIDATED FINANCIAL STATEMENTS AND OUTSIDE OWNERSHIP Chapter Outline I. Outside ownership may be present within any business combination A. Complete ownership of a subsidiary is not a prerequisite for consolidation—only enough voting shares need be owned so that the acquiring company has the ability to control the decision-making process of the acquired company B. Any ownership retained in a subsidiary corporation by a party unrelated to the acquiring company is termed a noncontrolling interest II. Valuation of subsidiary assets and liabilities poses a problem when a noncontrolling interest is present follows the acquisition method (Economic Unit Concept) SFAS 141R and SFAS 160 1. The accounting emphasis is placed on the entire entity that results from the business combination as measured by the sum of the acquisition-date fair values of the controlling and noncontrolling interests. 2. Valuation of subsidiary accounts is based on the acquisition-date fair value of the company (frequently determined by the consideration transferred and the fair value of the noncontrolling interest); specific subsidiary assets and liabilities are consolidated at their fair values 3. The noncontrolling interest balance is reported as a component of stockholders' equity III. Consolidations involving a noncontrolling interest—subsequent to the date of acquisition A. According to the parent company concept, all noncontrolling interest amounts are calculated in reference to the book value of the subsidiary company B. Only four noncontrolling interest figures are determined for reporting purposes 1. Beginning of year balance 2. Interest in subsidiary’s current income 3. Dividends paid during the period 4. End of year balance C. Noncontrolling interest balances are accumulated in a separate column in the consolidation worksheet 1. The beginning of year figure is recorded on the worksheet as a component of Entries S and A 2. The noncontrolling interest's share of the subsidiary's income is established by a columnar entry that simultaneously reports the balance in both the consolidated income statement and the noncontrolling interest column 3. Dividends paid to these outside owners are reflected by extending the subsidiary's Dividends Paid balance (after eliminating intercompany transfers) into the noncontrolling interest column as a reduction 4. The end of year noncontrolling interest total is the summation of the three items above and is reported (in this book) between consolidated liabilities and stockholders' equity IV. Step acquisitions A. An acquiring company may make several different purchases of a subsidiary's stock in order to gain control B. Upon attaining control, all of the parent’s previous investments in the subsidiary are adjusted to fair value and a gain or loss recognized as appropriate C. Upon attaining control, the valuation basis for the subsidiary is established at its total fair value (the sum of the fair values of the controlling and noncontrolling interests) Vl. Sales of subsidiary stock A. The proper book value must be established within the parent's Investment account so that the sales transaction can be correctly recorded B. The investment balance is adjusted as if the equity method had been applied during the entire period of ownership C. If only a portion of the shares are being sold, the book value of the investment account must be reduced based on either a FIFO or a weighted-average cost flow assumption D. If the parent maintains control, any difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as an adjustment to additional paid-in capital. E. If the parent loses control with the sale of the subsidiary shares, the difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as a gain or loss. F. Any interest retained by the parent company should be accounted for by either consolidation, the equity method, or the fair value method depending on the influence remaining after the sale. Learning Objectives Upon completion of Chapter Four, "Consolidated Financial Statements and Outside Ownership," students should be able to fulfill each of the following learning objectives: 1. Realize that complete ownership is not a prerequisite for the formation of a business combination. 2. Understand the meaning of the term "noncontrolling interest.” 3. Explain the rationale underlying the acquisition method for accounting for the noncontrolling interest. 4. Identify appropriate balance sheet placements for the components of the noncontrolling interest in consolidated financial statements. 5. Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and be able to enter each balance on a consolidation worksheet. 6. Carry out a consolidation when a step acquisition has taken place. 7. Record the sale of a subsidiary (or a portion of its shares) when the parent has been applying either the Initial value method, the equity method, or the partial equity method. 8. Select an appropriate method by which to account for any shares remaining after the sale of a portion of an investment in a subsidiary company. Answers to Questions 1. "Noncontrolling interest" refers to an equity interest that is held in a member of a business combination by an unrelated (outside) party. 2. a. Acquisition method = $220,000 (fair value) b. Purchase method = $208,000 (all of the book value plus 80 percent of the $60,000 difference between fair value and book value) 3. A control premium is the portion of an acquisition price (above currently traded market values) paid by a parent company to induce shareholders to sell a sufficient number of shares to obtain control. The extra payment typically becomes part of the goodwill acquired in the acquisition attributable to the parent company. 4. In practice, noncontrolling interest figures will appear in various locations within consolidated financial statements. The end of year balance can be found in the liability section, in the stockholders' equity section, or between these two. The noncontrolling interest's share of net income can be shown as a reduction on either the income statement or the statement of retained earnings. Based on current practice, this textbook reports the ending balance between consolidated liabilities and stockholders' equity with the income allocation shown as a reduction on the income statement. 5. The ending noncontrolling interest can be determined on a consolidation worksheet by adding the components found in the noncontrolling interest column: the beginning balance plus allocation of current year net income less dividends paid to these outside owners. The ending balance can also be determined (at this point in the exploration of consolidated financial statements) by multiplying the outside ownership percentage by the subsidiary's ending book value. In subsequent chapters, this calculation must be altered because of various adjustments made within the consolidation process. 6. Allsports should remove the pre-acquisition revenues and expenses from the consolidated totals. These amounts have been earned (incurred) prior to ownership by Allsports and therefore should not be reported as earnings for the current parent company owners. 7. In previous years, Tree has appropriately utilized the market-value method in accounting for its investment in Limb. Now, following a second acquisition, consolidation has become applicable. These two methods are not considered to be comparable. Therefore, at the point in time that Tree begins to produce consolidated statements, all previous financial reports must be restated as if the equity method had been applied since the date of the first acquisition. This handling presents the reader of the financial statements with figures that are more comparable from year to year. 8. When a company sells a portion of an investment, a gain or loss is recognized based on the difference between the proceeds received and the book value of the investment (on the portion sold). The correct book value is determined based upon the consistent application of the equity method. Thus, if either the Initial value method or the partial equity method has been used, Duke must first restate the account to the equity method before recording the sales transaction. This same method is also applied to the operations of the current period occurring prior to the time of sale. 9. Unless control is surrendered, the acquisition method views the sale of subsidiary's stock as a treasury stock transaction. Thus, no gain or loss can be recognized. 10. The accounting method choice for the remaining shares depends upon the current relationship between the two firms. If Duke retains control, consolidation is still required. However, if the parent now can only significantly influence the decision-making process, the equity method is applied. A third possibility is Duke may have lost the power to exercise even significant influence. The market-value method then is appropriate. Answers to Problems 1. D The acquisition method consolidates assets at fair value at acquisition date regardless of the parent’s percentage ownership. 2. D In consolidating the subsidiary's figures, all intercompany balances must be eliminated in their entirety for external reporting purposes. Even though the subsidiary is less than fully owned, the parent nonetheless controls it. 3. C An asset acquired in a business combination is initially valued at 100% acquisition-date fair value and subsequently amortized its useful life. Patent fair value at January 1, 2009 .............................................. Amortization for 2 years (10 year life) ........................................... Patent reported amount December 31, 2010 ................................ 4. A Plaster building .............................................................................. Turner building acquisition-date fair value $300,000 Amortization for 3 years (10-year life) (90,000) Consolidated buildings ................................................................. $45,000 (9,000) $36,000 $510,000 210,000 $720,000 -ORPlaster building .............................................................................. $510,000 Turner building 12/31/11 $182,000 Excess acquisition-date fair value allocation 40,000 Excess amortization for 3 years (10-year life) (12,000) 210,000 Consolidated buildings ................................................................. $720,000 5. C Hygille expense .............................................................................. $621,000 Nuyt expenses ................................................................................ 714,000 Excess fair value amortization (70,000 ÷ 10 yrs) .......................... 7,000 Consolidated expenses ................................................................. $1,342,000 6. B Combined revenues ....................................................................... $1,100,000 Combined expenses ...................................................................... (700,000) Excess acquisition-date fair value amortization .......................... (15,000) Consolidated net income ............................................................... $385,000 Less: noncontrolling interest ($85,000 × 40%) ............................. (34,000) Consolidated net income to controlling interest ......................... $351,000 7. C 8. B 9. A Amie, Inc. Fair value at January 1, 2007: 30% previously owned fair value (30,000 shares × $5) ................ 60% new shares acquired (60,000 shares × $6) ............................ 10% NCI fair value (10,000 shares × $5) ........................................ Acquisition-date fair value ............................................................. Net assets' fair value ...................................................................... Goodwill ......................................................................................... $150,000 360,000 50,000 $560,000 500,000 $60,000 11. A Fair value of noncontrolling interest on April 1 ........................... 30% of net income for 9 months (¾ year × $240,000 × 30%) ....... Noncontrolling interest December 31 ........................................... $165,000 54,000 $219,000 10. C 12. B Combined revenues ....................................................................... $1,300,000 Combined expenses ...................................................................... (800,000) Trademark amortization ................................................................. (6,000) Patented technology amortization ................................................ (8,000) Consolidated net income ............................................................... $486,000 13. C Subsidiary income ($100,000 – $14,000 excess amortizations) .. Noncontrolling interest percentage .............................................. Noncontrolling interest in subsidiary income .............................. $86,000 40% $34,400 Fair value of noncontrolling interest at acquisition date ............ 40% change in Scott book value since acquisition ..................... Excess fair value amortization ($14,000 × 40%) ........................... 40% current year income ............................................................... Noncontrolling interest at end of year .......................................... $180,000 52,000 (5,600) 34,400 $260,800 14. A Michael trademark balance ............................................................ Scott trademark balance ................................................................ Excess fair value ............................................................................ Two years amortization (10-year life) ............................................ Consolidated trademarks .............................................................. $260,000 200,000 60,000 (12,000) $508,000 15. A Acquisition-date fair value ($60,000 ÷ 80%) .................................. Strand's book value ...................................................................... Fair value in excess of book value ............................................... $75,000 (50,000) $25,000 Excess assigned to inventory (60%) ................................$15,000 Excess assigned to goodwill (40%) .................................$10,000 Park current assets ........................................................................ Strand current assets..................................................................... Excess inventory fair value ........................................................... Consolidated current assets ......................................................... $70,000 20,000 15,000 $105,000 16. D Park noncurrent assets .................................................................. Strand noncurrent assets .............................................................. Excess fair value to goodwill ........................................................ Consolidated noncurrent assets ................................................... $90,000 40,000 10,000 $140,000 17. B Add the two book values and include 10% (the $6,000 current portion) of the loan taken out by Park to acquire Strand. 18. B Add the two book values and include 90% (the $54,000 noncurrent portion) of the loan taken out by Polk to acquire Strand. 19. C Park stockholders' equity .............................................................. Noncontrolling interest at fair value (20% × $75,000) .................. Total stockholders' equity ............................................................. 20. $80,000 15,000 $95,000 (15 minutes) (Compute consolidated income and noncontrolling interests) 2009 Harrison income ............................................................ $220,000 Starr income .................................................................. 70,000 Excess fair value amortization ..................................... (8,000) Consolidated net income .............................................. $282,000 2010 $260,000 90,000 (8,000) $342,000 Starr fair value ................................................................................ $1,200,000 Fair value of consideration transferred ........................................ 1,125,000 Noncontrolling interest fair value ................................................. $75,000 Noncontrolling interest fair value January 1, 2009 (above) .......... 2009 income to NCI ([$70,000 – $8,000] × 10%)................................ 2009 dividends to NCI ................................................................... Noncontrolling interest reported value December 31, 2009 ........ 2010 income to NCI ([$90,000 – $8,000] × 10%)................................ 2010 dividends to NCI ................................................................... Noncontrolling interest reported value December 31, 2010 $75,000 6,200 (3,000) 78,200 8,200 (3,000) $83,400 21. (40 minutes) (Several valuation and income determination questions for a business combination involving a noncontrolling interest.) a. Business combinations are recorded generally at the fair value of the consideration transferred by the acquiring firm plus the acquisition-date fair value of the noncontrolling interest. Patterson’s consideration transferred ($31.25 × 80,000 shares) ......... $2,500,000 Noncontrolling interest fair value ($30.00 × 20,000 shares) ................ $600,000 Soriano’s total fair value 1/1/09 .......................................................... $3,100,000 b. Each identifiable asset acquired and liability assumed in a business combination should initially be reported at its acquisition-date fair value. c. In periods subsequent to acquisition, the subsidiary’s assets and liabilities are reported at their acquisition-date fair values adjusted for amortization and depreciation. Except for certain financial items, they are not continually adjusted for changing fair values. d. Soriano’s total fair value 1/1/09 .......................................................... $3,100,000 Soriano’s net assets book value ........................................................ 1,290,000 Excess acquisition-date fair value over book value.......................... $1,810,000 Adjustments from book to fair values ................................................ Buildings and equipment .................................... (250,000) Trademarks........................................................... 200,000 Patented technology ............................................ 1,060,000 Unpatented technology ....................................... 600,000 1,610,000 Goodwill ......................................................................................... $ 200,000 e. Combined revenues ............................................................................ $4,400,000 Combined expenses ............................................................................ (2,350,000) Building and equipment excess depreciation ................................... 50,000 Trademark excess amortization ......................................................... (20,000) Patented technology amortization ..................................................... (265,000) Unpatented technology amortization ................................................. (200,000) Consolidated net income .................................................................... $1,615,000 To noncontrolling interest: Soriano’s revenues ........................................................................ $1,400,000 Soriano’s expenses........................................................................ (600,000) Total excess amortization expenses (above) ............................... (435,000) Soriano’s adjusted net income...................................................... $365,000 Noncontrolling interest percentage ownership ........................... 20% Noncontrolling interest share of consolidated net income ......... $73,000 To controlling interest: Consolidated net income ............................................................... $1,615,000 Noncontrolling interest share of consolidated net income ......... (73,000) Controlling interest share of consolidated net income ............... $1,542,000 -ORPatterson’s revenues ..................................................................... $3,000,000 Patterson’s expenses..................................................................... 1,750,000 Patterson’s separate net income................................................... $1,250,000 Patterson’s share of Soriano’s adjusted net income (80% × $365,000) .................................................................. 292,000 Controlling interest share of consolidated net income ............... $1,542,000 f. Fair value of noncontrolling interest January 1, 2009....................... 2009 income ......................................................................................... Dividends (20% × $30,000) .................................................................. Noncontrolling interest December 31, 2009....................................... $600,000 73,000 (6,000) $ 667,000 g. If Soriano’s acquisition-date total fair value was $2,250,000, then a bargain purchase has occurred. Soriano’s total fair value 1/1/09 .......................................................... $2,250,000 Collective fair values of Soriano’s net assets ................................... $2,300,000 Bargain purchase ................................................................................ $50,000 The acquisition method requires that the subsidiary assets acquired and liabilities assumed be recognized at their acquisition date fair values regardless of the assessed fair value. Therefore, none of Soriano’s identifiable assets and liabilities would change as a result of the assessed fair value. When a bargain purchase occurs, however, no goodwill is recognized. 22. (20 Minutes) (Determine consolidated income balances, includes a mid-year acquisition) a. Acquisition-date total fair value ......................... $594,000 Book value of net assets ..................................... (400,000) Fair value in excess of book value .................... $194,000 Annual Excess Excess fair value assigned to Life Amortizations Patent ......................................................... 140,000 5 years $28,000 Land ......................................................... 10,000 Buildings ....................................................... 30,000 10 years 3,000 Goodwill ........................................................ 14,000 Total ......................................................... -0$31,000 Consolidated figures following January 1 acquisition date: Combined revenues ........................................................................... $1,500,000 Combined expenses ............................................................................ (1,031,000) Consolidated net income .................................................................... 469,000 NCI in Sawyer’s income ([200,000 – 31,000] × 30%) ............................. (50,700) Controlling interest in consolidated net income .............................. $418,300 b. Consolidated figures following April 1 acquisition date: Combined revenues (1) ....................................................................... $1,350,000 Combined expenses (2) ....................................................................... (923,250) Consolidated net income ................................................................... $426,750 Noncontrolling interest in subsidiary income (3) .............................. (38,025) Controlling interest in consolidated net income .............................. $388,725 (1) $900,000 Parker revenues plus $450,000 of post-acquisition Sawyer revenues (2) $600,000 Parker expenses plus $300,000 of post-acquisition Sawyer expenses plus $23,250 amortization expenses for 9 months (3) ($200,000 – 31,000) adjusted subsidiary income × 30% × ¾ year