4

Consolidation of Wholly Owned Subsidiaries

McGraw-Hill/Irwin 2008 The McGraw-Hill Companies, Inc. All rights reserved.

 1-2

Consolidation Procedures

The starting point for preparing consolidated

financial statements is the books of the separate
consolidating companies.
The consolidated entity has no books of its own.
The consolidation workpaper provides a
mechanism for combining accounts of the
separate companies and for adjusting the
combined balances to the amounts that would
be reported if all consolidating companies were
actually a single company.
 1-3

Nature of Eliminating Entries

Eliminating entries are used in the consolidation

workpaper to adjust the totals of the individual account
balances of the separate consolidating companies to
reflect the amounts that would appear if all the legally
separate companies were actually a single company.

They do not affect the books of the separate companies.

Some eliminating entries are required at the end of one

period but not at the end of subsequent periods.
 1-4

Full Ownership Purchased at Book

Value

The purchase price of $300,000 is equal to the book

value of the shares acquired. This ownership situation
can be characterized as follows:
Investment cost $300,000
Book value 1/1/X1 Common stock $200,000
100% Retained earnings 100,000

Peerless s share 100% (300,000)

Difference between cost and book value $ -0-
 1-5

Entry to record the purchase on

Parents books
Parent records the stock acquisition on its books
with the following entry:

Investment in Subsidiary 300,000

Cash 300,000
 1-6

Investment Elimination Entry

An eliminating entry in the workpaper is one

needed to eliminate the Investment account and
the subsidiarys stockholders equity accounts.
(You cannot own yourself)

Common StockSubsidary 200,000

Retained Earnings 100,000
Investment in Subsidiary 300,000
 4-7

Example: 80% Owned @ Book Value

Assume all of the same facts in the previous

example except that Parent purchases 80% of
Sub for $240,000.

NOTE: $240,000 is 80% of the $300,000 total

book value of Sub. The remaining 20% of the
total book value of Sub, that is $60,000, will be
referred to as the noncontrolling interest.
 4-8

Example: 80% Owned @ Book Value

_______________________________________________________________________________________________________________________________________________________________

Investment Cost $240,000

Book Value:
Common Stock-Sub $200,000
Retained Earnings-Sub 100,000
$300,000
Parents share 100% x 0.80 (240,000)
Differential $ -0-
==============
 4-9

Example: 80% Owned @ Book Value

Parent records the stock acquisition as follows:

Investment in Subsidiary $240,000
Cash $240,000
There is no entry by Sub with respect to the
acquisition.
 4-10

Example: 80% Owned @ Book Value

The following elimination entry is needed:

Common StockSub $200,000
Retained EarningsSub 100,000
Investment in Sub Stock $240,000
Noncontrolling Interest *60,000
*60,000 = (200,000 + 100,000)(1.00 - 0.80)
 4-11

Example: Debit Differential

Assume all of the same facts in the previous

example except that Parent purchases 80% of
Sub for $250,000.
NOTE: $250,000 is greater than $240,000 by
$10,000. Unless stated or implied otherwise,
this $10,000 represents goodwill. Since there
are no differences between fair and book value
at the individual account level, the $10,000 debit
differential must be goodwill.
 4-12

Example: Debit Differential

_______________________________________________________________________________________________________________________________________________________________

Investment Cost $250,000

Book Value:
Common Stock-Sub $200,000
Retained Earnings-Sub 100,000
$300,000
Parents share 100% x 0.80 (240,000)
Debit Differential $10,000
==============
 4-13

Example: Debit Differential

Parent records the stock acquisition as follows:

Investment in Sub Stock $250,000
Cash $250,000
 4-14

Example: Debit Difference

The following elimination entry is needed:

Common StockSub $200,000
Retained EarningsSub 100,000
Goodwill 10,000
Investment in Sub Stock $250,000
Noncontrolling Interest *60,000
*60,000 = (200,000 + 100,000)(1.00 - 0.80)
 4-15

Example: Debit Differential

In the previous example, the debit differential

was solely attributed to goodwill. In other cases,
the debit differential could have been attributed
to multiple items.
For example, the net debit differential could be
allocated as follows: goodwill $9,000; land
$4,000; and, equipment ($3,000).
 4-16

Example: Debit Differential

For audit trail purposes, two elimination entries

are used when multiple differential items exist.

The first elimination is the same as the previous

example except that the term differential is
used in lieu of the term goodwill.

The second elimination entry allocates the

differential to the various items giving rise to the
differentialin this example: goodwill $9,000;
land $4,000; and, equipment ($3,000).
 4-17

Debit DifferentialElimination Entries

Common StockSub $200,000

Retained EarningsSub 100,000
Differential 10,000
Investment in Sub Stock $250,000
Noncontrolling Interest 60,000
Land $4,000
Goodwill 9,000
Equipment $3,000
Differential 10,000
 4-18

Credit Differential

A negative differential occurs when one

company acquires the stock of another company
for less than book value.

This negative goodwill, indicates that the net

assets of the subsidiary are worth less together
than if they were sold individually.
 4-19

Unallocated Credit Differential

Whenever an unallocated credit differential

exists, the FASB requires that this negative
goodwill be allocated proportionately against
non-current assets.

If non-current assets are exhausted and

negative goodwill remains, an extraordinary gain
would be recognized.
 1-20

Full Ownership Purchased at More

than Book Value
When one company purchases another, there is
no reason to expect that the purchase price
necessarily will be equal to the acquired stocks
book value.

The process used to prepare the consolidated

balance sheet is complicated only slightly when
100 percent of a companys stock is purchased
at a price different from its book value.
 1-21

Reason for a differential: Excess of Fair

Value over Book Value of Net Assets

In many cases, the fair value of an acquired

companys net assets exceeds the book value.
Revaluing the assets and liabilities on the
subsidiarys books generally is the simplest
approach if all of the subsidiarys common stock
is acquired.
 1-22

Reason for a differential: Existence

of Goodwill

If a company purchases a subsidiary at a price

in excess of the total of the fair values of the
subsidiarys net identifiable assets, the
additional amount generally is considered to be
a payment for the excess earning power of the
acquired company, referred to as goodwill .
 1-23

Reason for a differential: Bargain

Purchase
Numerous cases of companies with common
stock trading in the market at prices less than
book value.
Often the companies are singled out as prime
acquisition targets.
The existence of negative goodwill, indicating
that the subsidiarys net assets are worth less as
a going concern than if they were sold
individually.
 1-24

CONSOLIDATION SUBSEQUENT
TO ACQUISITION
A full set of Consolidated financials is needed to
provide a complete picture of the consolidated
entities activities after acquisition.
Consolidated financial statements are prepared
in the same order as for the parent or the
subsidiary.
 1-25

Consolidated Net Income

All revenues and expenses of the individual

consolidating companies arising from
transactions with nonaffiliated companies are
included in the consolidated income statement.
The amount reported as consolidated net
income is that part of the total enterprises
income that is assigned to the parent companys
shareholders.
 1-26

Consolidated Net Income

Consolidated net income is computed by adding

the parents proportionate share of the income of
all subsidiaries, adjusted for any differential
write-off or goodwill impairment, to the parents
income from its own separate operations
(parents net income less investment income
from the subsidiaries under either the cost or
equity method).
 1-27

Consolidated Retained Earnings

Consolidated retained earnings must be

measured on a basis consistent with that used in
determining consolidated net income.
Consolidated retained earnings is that portion
of the consolidated enterprises undistributed
earnings accruing to the parent company
shareholders.
 1-28

CONSOLIDATION SUBSEQUENT TO
ACQUISITION 100 PERCENT OWNERSHIP
PURCHASED AT BOOK VALUE
Each of the consolidated financial statements is
prepared as if it is taken from a single set of
books that is being used to account for the
overall consolidated entity.
As in the preparation of the consolidated
balance sheet, the consolidation process starts
with the data recorded on the books of the
individual consolidating companies.
 1-29

Consolidation WorkpaperYear of
Combination

After all appropriate entries, including year-end

adjustments, have been made on the books a
consolidation workpaper is prepared.
Then all amounts that reflect intercorporate
transactions or ownership are eliminated in the
consolidation process.
 1-30

Consolidation WorkpaperYear of
Combination

Book entries affect balances on the books and

the amounts that are carried to the consolidation
workpaper; workpaper eliminating entries affect
only those balances carried to the consolidated
financial statements in the period.
 1-31

Second and Subsequent Years of

Ownership

The consolidation procedures employed at the

end of the second and subsequent years are
basically the same as those used at the end of
the first year.
Adjusted trial balance data of the individual
companies are used as the starting point each
time consolidated statements are prepared
because no separate books are kept for the
consolidated entity.
 1-32

Second and Subsequent Years of

Ownership

An additional check is needed in each period

following acquisition to ensure that the beginning
balance of consolidated retained earnings
shown in the completed workpaper equals the
balance reported at the end of the prior period.
 1-33

100 PERCENT OWNERSHIP PURCHASED

AT MORE THAN BOOK VALUE

The excess of the purchase price over the book

value of the net identifiable assets purchased
must be allocated to those assets and liabilities
acquired, including any purchased goodwill.
 1-34

100 PERCENT OWNERSHIP PURCHASED

AT MORE THAN BOOK VALUE

In consolidation, the purchase differential is

assigned to the appropriate asset and liability
balances, and consolidated income is adjusted
for the amounts expiring during the period by
assigning them to the related expense items
(e.g., depreciation expense).
 1-35

INTERCOMPANY RECEIVABLES AND

PAYABLES

All forms of intercompany receivables and

payables need to be eliminated when
consolidated financial statements are prepared.
From a single-company viewpoint, a company
cannot owe itself money.
 1-36

INTERCOMPANY RECEIVABLES AND

PAYABLES

When consolidated financial statements are

prepared, the following elimination entry is
needed in the consolidation workpaper:
Accounts Payable 1,000
Accounts Receivable 1,000
Eliminate intercompany receivable/payable.
If no eliminating entry is made, both the
consolidated assets and liabilities are overstated
by an equal amount.
 4-37

Push-Down Accounting

The term Push-Down Accounting refers to the

practice of revaluing the assets and liabilities of
a purchased subsidiary directly on the books of
that subsidiary at the date of acquisition.

If this practice is followed, the revaluations are

recorded once on the books of the purchased
subsidiary at the date of acquisition and,
therefore, are not made in the consolidation
workpapers each time consolidated statements