Chapter Two
Consolidated Financial Statement on Date of Business Combination
1
Parent Company – Subsidiary RelationshipsIf the investor acquires a controlling interest in the
investee, a parent - subsidiary relationship established.
The investee becomes a subsidiary of the acquiring parent company (investor) but remains a separate legal entity.
A strict adherence to legal aspects of such business combination would require the issuance of separate financial statements for the parent company and for the subsidiary company.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
2
Parent Company – Subsidiary Relationships However, such strict adherence to legal form disregards
the substance of most parent-subsidiary relationships. A parent company and its subsidiaries are a single
economic entity. In recognition of this fact, consolidated financial
statements are issued to report the financial position and operating results of a parent company and its subsidiaries as though they comprised a single accounting entity.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
3
Nature of Consolidated Financial Statements Consolidated financial statements are similar to the
combined financial statements for a home office and its branches.
Assets, liabilities, revenue, and expenses of the parent company and its subsidiaries are totaled; inter-company transactions and balances are eliminated; and the final consolidated amounts are reported in the consolidated balance sheet, income statements, statement of stockholders’ equity, and statement of cash flows.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
4
Nature of Consolidated Financial StatementsA “pro forma ” presentation--it means “as if ” the parent and subsidiary were a SINGLE legal entity with one or more branches.
It is a LEGAL FICTIONAL PRESENTATION (an accounting mirage).Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
5
Consolidation Procedures: Primary Objectives To present on a combined basis
The detailed asset, liability, and net worth position represented by the parent company’s separate books, plus
The individual values of the subsidiary’s assets and liabilities acquired
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
6
Consolidated Financial Statements Prepared from separate F/statements of
acquiring(parent) & acquired (subsidiaries) companies using consolidation worksheet procedure
Present assets & liabilities of two companies as if they were single accounting entity
Required whenever stock held by acquiring company gives it controlling interest in acquired company
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
7
Consolidation Issues
Acquisition Price (at book value or more than book value)
Acquisition Timing (at beginning of year or during the year)
Percent of subsidiary acquired (100% or less than 100%)
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
8
The Purpose of Consolidated Financial Statements The purpose of consolidated financial statements
is to present, primarily for the benefit of the owners and creditors of the parent company, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single economic entity.
Consolidated statements are intended primarily for the parent’s investors, rather than for the non-controlling stockholders and subsidiary creditors.
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
9
Should All Subsidiaries Be Consolidated?
Consolidated financial statements provide much information that is not included in the separate statements of the parent, and are usually required for fair presentation of the financial position and results of operations for a group of affiliated companies.
The usual condition for consolidation is ownership of more than 50 percent of the voting stock of another company
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
10
Should All Subsidiaries Be Consolidated?
Under current GAAP, a subsidiary can be excluded from consolidation in some situations:
When control does not rest with the majority owner,
Control does not rest with the majority owner if the subsidiary is in legal reorganization or bankruptcy or is operating under severe foreign-exchange restrictions, or other governmentally-imposed uncertainties
Formation of joint ventures, Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
11
Should All Subsidiaries Be Consolidated?
Under current GAAP , a subsidiary can be excluded from consolidation in some situations:
The acquisition of an asset or group of assets that does not constitute a business,
A combination between entities under common control, and
A combination between not-for-profit entities or the acquisition of a for-profit business by a not-for-profit entity.
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
12
Consolidated Financial Statements Weaknesses
Diverse businesses are more difficult to interpret
Weak performers are more difficult to identify
Consolidations make it difficult to compare entities to industry standards
Financial ratios do not represent any particular part of the entity
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
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Parent Subsidiary
The Sub still prepares separate financial statements
Consolidated financial statements are prepared.
The parent does not prepare separate financial
statements
Consolidation of Financial Information
2-14
The Meaning of Controlling InterestWhen one company owns, directly or indirectly, over 50% of outstanding voting shares of another company
Gives parent company ability to establish subsidiary’s operating and financial policies and to direct subsidiary’s economic activities as if they were the economic activities of one of their branches or divisions
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
15
Criteria for ConsolidationPercentage of Outstanding Voting Stock Acquired
20% 50% 100%0%
1. Level of economic influence
Nominal “Significant influence” Control
2. Financial statement presentation
Investment AccountSeparate Financial Statements
ConsolidatedFinancial Statements
Company A Company A
Company Y
Company Z
Dir
ect
Ow
ners
hip
of
Co. Z
by
Co. A
owns shares in owns shares in
owns shares in
Indirect Ow
nership of Co. Z by Co. A
Company Z
Direct vs. Indirect Ownership
Consolidation: The 3 Considerations
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
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In buying real estate, the three most important considerations are “location, location, and location.”
In determining whether consolidation is appropriate, the three most important considerations are “control, control,and control.”
Control: It Means Having Power
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
19
To hire and fire management.
To set management’s compensation.
To decide when to pay dividends.
Control: It Means Having Power
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
20
To approve operating, capital, and R&D budgets.
To direct the use of the subsidiary’s assets.
To liquidate the subsidiary into a division if desired.
Consolidation of Wholly Owned Subsidiary on Date of Purchase-Type Business Combination
When the fiscal periods of the parent and its subsidiaries differ, we prepare consolidated statements for and as of the end of the parent’s fiscal period
The consolidated balance sheet is not merely a summation of account balances of the affiliates. We eliminate reciprocal accounts in the process of consolidation and combine only nonreciprocal accounts.
The capital stock that appears in a consolidated balance sheet is the capital stock of the parent, and the consolidated retained earnings are the retained earnings of the parent company.Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in
Accounting and Finance)
21
Consolidation of Wholly Owned Subsidiary on Date of Purchase-Type Business Combination
There is no a question of control for wholly owned subsidiary.
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
22
Consolidated Balance Sheets: Use of Work papers Assets and liabilities are summed, regardless of
whether the parent owns 100% or a smaller controlling interest.
Non-controlling interests 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 work paper is frequently used to summarize the effects of various additions and eliminations
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
23
Consolidated Balance Sheets: Use of Work papers
Intercompany receivable (payable) Intercompany payable (receivable)AgainstAdvances to subsidiary
(from subsidiary)Advances from parent
(to parent)AgainstInterest 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 parentAgainstSales to subsidiary (purchases of inventory
from subsidiary)Purchases of inventory from parent (sales
to parent)Against
Parent’s Accounts Subsidiary’s AccountsInvestment in subsidiary Equity accounts Against
Intercompany Accounts to Be Eliminated
Use of Work papers: 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.
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
25
Columns of Work papers
The first two columns provide information from the separate balance sheets of Parent and Subsidiary.
The third column records adjustments and eliminations, subdivided into debits and credits.
The last column presents the totals that will appear in the consolidated balance sheet.
We calculate amounts in the Consolidated Balance Sheet column by adding together amounts from the first two columns and then adding or subtracting the adjustments and eliminations, as appropriate
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
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Nature of working paper entries
Working paper entries are only work paper adjustments and eliminations and are not recorded in the accounts of the parent or subsidiary corporations . The entries will never be journalized or posted.
Their only purpose is to facilitate completion of the work papers to consolidate a parent and subsidiary at and for the period ended on a particular date
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
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Steps for Consolidation1. Record the financial information for both
Parent and Sub on the worksheet.
2. Remove the Investment in Sub balance.
3. Remove the Sub’s equity account balances.4. Adjust the identifiable assets acquired and
liabilities assumed to Fair Values.5. Allocate any remaining excess of
consideration transferred over Book Values to goodwill.
6. Combine all account balances.
2-28
Consolidated Balance Sheets: Use of Work papers
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
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Consolidated Balance Sheets: Use of Work papers
Ch 2 Consolidated F/Statement on Date of Business Combination By Tekalign N (M.Sc in Accounting and Finance)
30