NON-PROFIT ACCOUNTING HW
SKKL
Hoyle_Chapter_04.pptx.pptxChapter Four
Consolidated Financial Statements and Outside Ownership
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 4-1
4-2
Understand that business combinations can occur with less than complete ownership.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-1: Understand that business combinations can occur with less than complete ownership.
Noncontrolling Interest in a Subsidiary
Although most parent companies have 100 percent ownership of their subsidiaries, a significant number establish control with a lesser amount of stock.
If the parent doesn’t own 100 percent of the company, outside owners are referred to as a noncontrolling interest.
How should the ownership interests of the noncontrolling interest be reflected in the consolidated financial statements?
4-3
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
2
Although most parent companies own 100 percent of their subsidiaries, a significant number, such as Walmart, establish control with a lesser amount of stock. The remaining outside owners are collectively referred to as a noncontrolling interest, which replaces the traditional term minority interest. The presence of these other stockholders poses a number of reporting questions for the accountant. Whenever less than 100 percent of a subsidiary’s voting stock is held, how should the subsidiary’s accounts be valued within consolidated financial statements? How should the presence of these additional owners be acknowledged?
Learning Objective 4-2
4-4
Describe the concepts and valuation principles underlying the acquisition method of accounting for the noncontrolling interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-2: Describe the concepts and valuation principles underlying the acquisition method of accounting for the noncontrolling interest.
Consolidated Financial Reporting in the Presence of a Noncontrolling Interest
4-5
The parent, with controlling interest, must consolidate 100 percent of its subsidiary’s financial information as a single economic unit.
The acquisition method requires that the subsidiary be valued at the acquisition-date fair value.
The total acquired firm fair value in a partial acquisition is the sum of two components at the acquisition date:
The fair value of the controlling interest.
The fair value of the noncontrolling interest at the acquisition date.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
2
When a parent company acquires a controlling ownership interest with less than 100 percent of a subsidiary’s voting shares, it must account for the noncontrolling shareholders’ interest in its consolidated financial statements.
The acquisition method involves both the economic unit concept and fair value. First, the economic unit concept views the parent and subsidiary companies as a single economic unit for financial reporting purposes. A controlled company must always be consolidated as a whole regardless of the parent’s level of ownership. When a parent controls a subsidiary through a 70 percent ownership, the parent must consolidate 100 percent of the subsidiary’s (and the parent’s) assets and liabilities in order to reflect the single economic unit. The consolidated balance sheet then provides an owners’ equity amount for the noncontrolling owners’ interest—a recognition that the parent does not own 100 percent of the subsidiary’s assets and liabilities.
The acquisition method also captures the subsidiary’s acquisition-date fair values as the relevant attribute for reporting the financial effects of the business combination—including the noncontrolling interest. Fair values also provide for managerial accountability to investors and creditors for assessing the success or failure of the combination. In contrast, the parent’s assets and liabilities remain at their previous carrying amounts.
The total acquired firm fair value in the presence of a partial acquisition is the sum of two components at the acquisition date:
The fair value of the controlling interest.
The fair value of the noncontrolling interest.
Noncontrolling Interest Example
4-6
Assume Parker Corporation wants to acquire 90 percent of Strong Company. Strong’s stock has been trading for around $60 per share.
Parker offered all of Strong’s shareholders a premium price for up to 90 percent of the outstanding shares, even though the shares are trading in the $59 to $61 range.
The fair value of Strong is measured as the sum of the respective fair values of the controlling and noncontrolling interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Assume that Parker Corporation wished to acquire 9,000 of the 10,000 outstanding equity shares of Strong Company and projected substantial synergies from the proposed acquisition. Parker estimated that a 100 percent acquisition was not needed to extract these synergies. Also, Parker projected that financing more than a 90 percent acquisition would be too costly.
Parker then offered all of Strong’s shareholders a premium price for up to 90 percent of the outstanding shares. To induce a sufficient number of shareholders to sell, Parker needed to offer $70 per share, even though the shares had been trading in the $59 to $61 range. During the weeks following the acquisition, the 10 percent noncontrolling interest in Strong Company continues to trade in the $59 to $61 range.
In this case, the $70 per share price paid by Parker does not appear representative of the fair value of all the shares of Strong Company. The fact that the noncontrolling interest shares continue to trade around $60 per share indicates a $60,000 fair value for the 1,000 shares not owned by Parker. Therefore, the valuation of the noncontrolling interest is best evidenced by the traded fair value of Strong’s shares, not the price paid by Parker.
The $70 share price paid by Parker nonetheless represents a negotiated value for the 9,000 shares. In the absence of any evidence to the contrary, these shares owned by Parker have a fair value of $630,000 incorporating the additional value Parker expects to extract from synergies with Strong. Thus the fair value of Strong is measured as the sum of the respective fair values of the controlling and noncontrolling interests.
Parker purchased 9,000 shares at $70 per share. The fair value of their consideration transferred is $630,000.
The remaining 1,000 shares trade at $60 per share, indicating that the fair value of the noncontrolling interest is $60,000. The total acquisition-date fair value of the subsidiary is $690,000.
Fair value of controlling interest
($70 × 9,000 shares) . . . . . . . . . . . . . . . $630,000
Fair value of noncontrolling interest
($60 × 1,000 shares) . . . . . . . . . . . . . . . . . 60,000
Total fair value of subsidiary . . . . . . $690,000
Noncontrolling Interest—Measuring Fair Value Example
4-7
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The $70 share price paid by Parker represents a negotiated value for the 9,000 shares. In the absence of any evidence to the contrary, these shares owned by Parker have a fair value of $630,000 incorporating the additional value Parker expects to extract from synergies with Strong. Thus the fair value of Strong is measured as the sum of the respective fair values of the controlling and noncontrolling interests as follows:
Fair value of controlling interest ($70 × 9,000 shares) . . . . . . . . . . . . . . . $630,000
Fair value of noncontrolling interest ($60 × 1,000 shares) . . . . . . . . . . . . . . 60,000
Acquisition-date fair value of Strong Company . . . . . . . . . . . . . . . . . . . . . $690,000
Learning Objective 4-3
4-8
Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-3: Allocate goodwill acquired in a business combination across the controlling and noncontrolling interests.
Allocating Acquired Goodwill to the Controlling and Noncontrolling Interests
To report ownership equity in consolidated financial statements, acquisition-date goodwill is apportioned across controlling and noncontrolling interests.
The parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest over its share of the fair value of the net assets.
Total acquisition-date fair value (amount paid) of Strong, $690,000, is greater than the fair value of the identifiable net assets acquired of $600,000 (10,000 shares × $60 per share). The difference, $90,000, is allocated to Goodwill.
4-9
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
To properly report ownership equity in consolidated financial statements, acquisition-date goodwill should be apportioned across the controlling and noncontrolling interests. The parent first allocates goodwill to its controlling interest for the excess of the fair value of the parent’s equity interest over its share of the fair value of the identifiable net assets.
The total acquisition-date fair value (amount paid) of Strong is $690,000. At the acquisition date, Parker assessed the total fair value of Strong’s identifiable net assets at $600,000. Therefore, goodwill, $90,000, is the excess of the acquisition-date fair value of the firm as a whole over the sum of the fair values of the identifiable net assets.
The parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest, $630,000, over its share of the fair value of the identifiable net assets ($600,000 × 90% = 540,000). Any remaining goodwill is then attributed to the noncontrolling interest.
All of the acquisition goodwill is allocated to the controlling interest as follows:
Allocating Acquired Goodwill Example
4-10
Controlling Noncontrolling
Interest Interest Total
Fair value at acquisition date . . . . . $630,000 $60,000 $690,000
Relative fair value of identifiable net
assets acquired (90% and 10% of $600,000) . . . . . . . . . . . . . 540,000 $60,000 600,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . $90,000 $-0- $90,000
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
To properly report ownership equity in consolidated financial statements, acquisition-date goodwill should be apportioned across the controlling and noncontrolling interests. The parent first allocates goodwill to its controlling interest for the excess of the fair value of the parent’s equity interest over its share of the fair value of the identifiable net assets. Any remaining goodwill is then attributed to the noncontrolling interest.
Noncontrolling Interest Goodwill Example
4-11
No excess goodwill is assigned to the noncontrolling interest. Allocated goodwill will not always be proportional to the percentages owned.
Controlling Noncontrolling
Interest Interest
Fair value at acquisition date . . . . . $630,000 $60,000
Relative fair value of identifiable net
assets acquired (90% and 10% of $600,000) . . . . . . . . . . . . . 540,000 $60,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . $90,000 $-0-
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
As a result, the allocated goodwill will not always be proportional to the percentages owned. Continuing the Parker and Strong example, all of the acquisition goodwill is allocated to the controlling interest as follows:
Total acquisition-date fair value . . . . . . . . . . $690,000
Fair value of net identifiable net assets . . . . . (600,000)
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
Controlling Noncontrolling
Interest Interest
Fair value at acquisition date . . . . . $630,000 $60,000
Relative fair value of identifiable net
assets acquired (90% and 10% of $600,000) . . . . . . . . . . . . . 540,000 $60,000
Goodwill . . . . . . . . . . . . . . . . . . . . $90,000 $-0-
There is no excess goodwill to assign to the noncontrolling interest.
Noncontrolling Interest Additional Issues
If the noncontrolling interest’s proportionate share of subsidiary’s fair values exceeds its total fair value, the excess reduces goodwill recognized by the parent.
If the total fair value of the acquired firm is less than the collective sum of its identifiable net assets:
A bargain purchase occurs.
Parent recognizes the entire gain in current income.
No gain is ever allocated to the noncontrolling interest.
If the price per share paid by the parent equals the noncontrolling interest per share fair value, goodwill is recognized proportionately across the two ownership groups.
4-12
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
In the unlikely event that the noncontrolling interest’s proportionate share of the subsidiary’s net asset fair values exceeds its total fair value, such an excess would serve to reduce the goodwill recognized by the parent.
If the total fair value of the acquired firm is less than the collective sum of its identifiable net assets, a bargain purchase occurs. In such rare combinations, the parent recognizes the entire gain on bargain purchase in current income. In no case is any amount of the gain allocated to the noncontrolling interest.
In other cases, especially when a large percentage of the acquiree’s voting stock is purchased, the consideration paid by the parent may be reflective of the acquiree’s total fair value. Note that in this case, because the price per share paid by the parent equals the noncontrolling interest per share fair value, goodwill is recognized proportionately across the two ownership groups.
Learning Objective 4-4
4-13
Demonstrate the computation and allocation of consolidated net income in the presence of a noncontrolling interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-4: Demonstrate the computation and allocation of consolidated net income in the presence of a noncontrolling interest.
Consolidated Net Income
4-14
To reflect the economic unit concept, consolidated net income includes 100 percent of both the parent’s and the subsidiary’s net income, adjusted for excess acquisition-date fair value over book value amortizations.
Once consolidated net income is determined, it is allocated to the parent company and the noncontrolling interests.
Noncontrolling interests’ ownership pertains only to the subsidiary; its share of consolidated net income is limited to a share of the adjusted subsidiary’s net income.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
5
Consolidated net income measures the results of operations for the combined entity. Reflecting the economic unit concept, consolidated net income includes 100 percent of the parent’s net income and 100 percent of the subsidiary’s net income, adjusted for excess acquisition-date fair value over book value amortizations. Once consolidated net income is determined, it is then allocated to the parent company and the noncontrolling interests. Because the noncontrolling interests’ ownership pertains only to the subsidiary, their share of consolidated net income is limited to a share of the subsidiary’s net income adjusted for acquisition-date excess fair-value amortizations.
Noncontrolling Interest in Subsidiary Net Income
4-15
Parker acquires 90 percent of Strong Company. Current year consolidated net income equals $108,000 including $10,000 of annual acquisition-date excess fair-value amortization. If Strong reports revenues of $280,000 and expenses of $160,000 (internal book values), the noncontrolling interest share of Strong’s income can be computed as follows:
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
5
Assume that Parker acquires 90 percent of Strong Company. Further assume that current year consolidated net income equals $108,000 including $10,000 of annual acquisition-date excess fair-value amortization. If Strong reports revenues of $280,000 and expenses of $160,000 based on its internal book values, then the noncontrolling interest share of Strong’s income can be computed as shown.
Accounting for Noncontrolling Interest in Subsidiary Net Income
4-16
The $11,000 noncontrolling interest share of adjusted subsidiary net income is equivalent to the noncontrolling interest share of consolidated net income, which is then subtracted from consolidated net income to determine the parent’s interest in consolidated net income.
The noncontrolling shareholders’ portion of consolidated net income is limited to their 10 percent share of adjusted subsidiary income. They own a 10 percent interest in the subsidiary company but no ownership in the parent firm.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
5
The $11,000 noncontrolling interest share of adjusted subsidiary net income is equivalent to the noncontrolling interest share of consolidated net income. This figure is then simply subtracted from the combined entity’s consolidated net income to derive the parent’s interest in consolidated net income.
Note that the noncontrolling shareholders’ portion of consolidated net income is limited to their 10 percent share of the adjusted subsidiary income. These shareholders own a 10 percent interest in the subsidiary company but no ownership in the parent firm.
Learning Objective 4-5
4-17
Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-5: Identify and calculate the four noncontrolling interest figures that must be included within the consolidation process and prepare a consolidation worksheet in the presence of a noncontrolling interest.
Partial Ownership Consolidations—Acquisition Method
4-18
The acquisition method incorporates 100 percent of the subsidiary’s assets and liabilities at their acquisition-date fair values in the consolidated financial statements.
Subsequent to acquisition, changes in current fair values for assets and liabilities are not recognized.
Subsidiary assets acquired and liabilities assumed are reflected in future consolidated financial statements using acquisition-date fair values net of subsequent amortizations (or reduced for impairment).
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The acquisition method focuses on incorporating in the consolidated financial statements 100 percent of the subsidiary’s assets and liabilities at their acquisition-date fair values. Note that subsequent to acquisition, changes in current fair values for assets and liabilities are not recognized. Instead, the subsidiary assets acquired and liabilities assumed are reflected in future consolidated financial statements using their acquisition-date fair values net of subsequent excess fair-value amortizations (or possibly reduced for impairment).
Noncontrolling Interest and Consolidations
4-19
The consolidation is substantially unchanged with the presence of a noncontrolling interest.
The parent company must determine and enter each of these figures when constructing a worksheet:
Noncontrolling interest in subsidiary at beginning of current year.
Net income attributable to noncontrolling interest.
Subsidiary dividends attributable to noncontrolling interest.
Noncontrolling interest as of the end of the year (three balances above combined).
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The presence of a noncontrolling interest does not dramatically alter the consolidation procedures presented in Chapter 3. The unamortized balance of the acquisition-date fair-value allocation must still be computed and included within the consolidated totals. Excess fair-value amortization expenses of these allocations are recognized each year as appropriate. Reciprocal balances are eliminated. Beyond these basic steps, the measurement and recognition of four noncontrolling interest balances add a new dimension to the process of consolidating financial information. The parent company must determine and then enter each of these figures when constructing a worksheet:
Noncontrolling interest in the subsidiary as of the beginning of the current year.
Net income attributable to the noncontrolling interest.
Subsidiary dividends attributable to the noncontrolling interest.
Noncontrolling interest as of the end of the year (found by combining the three balances above).
Partial Acquisition with No Control Premium Example
4-20
Assume that King Co. acquires 80 percent of Pawn Co.’s 100,000 outstanding voting shares on January 1, 2017, for $9.75 per share or a total of $780,000 cash consideration.
The shares are trading at an average of $9.75 per share before and after the acquisition.
The total fair value of Pawn to be used initially in consolidation is:
Consideration transferred by King ($9.75 × 80,000 shares) . . . . . . . . . . . . . . . . $780,000
Noncontrolling interest fair value ($9.75 × 20,000 shares) . . . . . . . . . . . . . . . . . 195,000
Pawn’s total fair value on Jan. 1, 2017 . . . $975,000
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Assume that King Company acquires 80 percent of Pawn Company’s 100,000 outstanding voting shares on January 1, 2017, for $9.75 per share or a total of $780,000 cash consideration. Further assume that the 20 percent noncontrolling interest shares traded both before and after the acquisition date at an average of $9.75 per share. The total fair value of Pawn to be used initially in consolidation is $975,000.
Noncontrolling Interest—Excess Fair-Value Allocations Example
4-21
EXHIBIT 4.3 Excess Fair-Value Allocations
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Exhibit 4.3 shows first that all identifiable assets acquired and liabilities assumed are adjusted to their full individual fair values at the acquisition date. The noncontrolling interest will share proportionately in these fair-value adjustments. The exhibit also shows that any excess fair value not attributable to Pawn’s identifiable net assets is assigned to goodwill. Because the controlling and noncontrolling interests’ acquisition-date fair values are identical at $9.75 per share, the resulting goodwill is allocated proportionately across these ownership interests.
Noncontrolling Interest—Changes in Retained Earnings Example
4-22
To complete the information needed for this combination, assume that Pawn Company reports the following changes in retained earnings since King’s acquisition:
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
To complete the information needed for this combination, assume that Pawn Company reports the following changes in retained earnings since King’s acquisition:
Current year (2018)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
Less: Dividends declared . . . . . . . . . . . . . . . . . . . (50,000)
Increase in retained earnings . . . . . . . . . . . . . . . . $40,000
Prior years (only 2017 in this illustration):
Increase in retained earnings . . . . . . . . . . . . . . . . . . $70,000
Noncontrolling Interest—Worksheet Process Example
4-23
King uses the equity method to account for Pawn subsequent to acquisition. The consolidation process is substantially the same as consolidation without a noncontrolling interest.
Consolidation, worksheet Entries S (expanded), A, I, D, and E are prepared.
A column will be added to the worksheet to record the noncontrolling interest in the subsidiary.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Assuming that King Company applies the equity method, the Investment in Pawn Company account as of December 31, 2018, can be constructed as shown in Exhibit 4.4. Note that the $852,000 balance is computed based on applying King’s 80 percent ownership to Pawn’s income (less amortization) and dividends. Although 100 percent of the subsidiary’s assets, liabilities, revenues, and expenses will be combined in consolidation, the internal accounting for King’s investment in Pawn is based on its 80 percent ownership. This technique facilitates worksheet adjustments that allocate various amounts to the noncontrolling interest. Exhibit 4.5 presents the separate financial statements for these two companies as of December 31, 2018, and the year then ended, based on the information provided.
The worksheet still includes elimination of the subsidiary’s stockholders’ equity accounts (Entry S) although, as explained next, this entry is expanded to record the beginning noncontrolling interest for the year. The second worksheet entry (Entry A) recognizes the excess acquisition-date fair-value allocations at January 1 after one year of amortization with an additional adjustment to the beginning noncontrolling interest. Intra-entity income and dividends are removed also (Entries I and D) while current-year excess amortization expenses are recognized (Entry E). The differences from the Chapter 3 illustrations relate exclusively to the recognition of the three components of the noncontrolling interest. In addition, a separate Noncontrolling Interest column is added to the worksheet to accumulate these components to form the year-end figure to be reported on the consolidated balance sheet.
Noncontrolling Interest—Separate Financial Records Example
4-24
EXHIBIT 4.5 Separate Financial Records
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
19
Noncontrolling Interest—Example Worksheet
4-25
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The consolidated totals for King and Pawn also can be determined by means of a worksheet as shown in Exhibit 4.6.
Noncontrolling Interest—Example Consolidation Entries S and A
4-26
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
21
The worksheet still includes elimination of the subsidiary’s stockholders’ equity accounts (Entry S) although, as explained next, this entry is expanded to record the beginning noncontrolling interest for the year. The second worksheet entry (Entry A) recognizes the excess acquisition-date fair-value allocations at January 1 after one year of amortization with an additional adjustment to the beginning noncontrolling interest.
Noncontrolling Interest—Example Consolidation Entries I, D, and E
4-27
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Intra-entity income and dividends are removed also (Entries I and D) while current-year excess amortization expenses are recognized (Entry E).
Learning Objective 4-6
4-28
Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-6: Identify appropriate placements for the components of the noncontrolling interest in consolidated financial statements.
Consolidated Financial Statements—Income Statement and Balance Sheet
4-29
Consolidated net income is computed at the combined entity level and allocated to the noncontrolling and controlling interests.
Identifiable assets acquired and liabilities assumed are adjusted to their full individual fair values at the acquisition date.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Having successfully consolidated the information for King and Pawn, the resulting financial statements for these two companies are produced in Exhibit 4.7. These figures are taken from the consolidation worksheet.
Exhibit 4.7 shows first the consolidated income statement. Consolidated net income is computed at the combined entity level as $416,000 and then allocated to the noncontrolling and controlling interests.
In keeping with the acquisition method’s requirement that identifiable assets acquired and liabilities assumed be adjusted to fair value, King allocates Pawn’s total fair value. Note that the identifiable assets acquired and liabilities assumed are again adjusted to their full individual fair values at the acquisition date. Only the amount designated as goodwill is changed to $125,000 from $25,000 in the original fair-value allocation example as shown in Exhibit 4.3. In this case, King allocates $120,000 of the $125,000 total goodwill amount to its own interest.
Consolidated Financial Statements—Statement of Changes in Owners’ Equity
4-30
The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders.
Note the placement of the noncontrolling interest in the subsidiary’s equity in the consolidated owners’ equity section.
If appropriate, each component of other comprehensive income is allocated to the controlling and noncontrolling interests.
The statement of changes in owners’ equity provides an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The statement of changes in owners’ equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders. Finally, note the placement of the noncontrolling interest in the subsidiary’s equity squarely in the consolidated owners’ equity section. If appropriate, each component of other comprehensive income is allocated to the controlling and noncontrolling interests. The statement of changes in owners’ equity would also provide an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests.
Consolidated Statements—Income Statement and Statement of Changes in Owners’ Equity
4-31
EXHIBIT 4.7 Consolidated Statements with Noncontrolling Interest—Acquisition Method
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
22
Consolidated Statements—Balance Sheet
4-32
EXHIBIT 4.7 Consolidated Statements with Noncontrolling Interest—Acquisition Method
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
23
Learning Objective 4-7
4-33
Determine the effect on consolidated financial statements of a control premium paid by the parent.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-7: Determine the effect on consolidated financial statements of a control premium paid by the parent.
Partial Acquisition with Control Premium
4-34
Assume that to acquire sufficient shares to gain control of Pawn, King pays a control premium of $1.25 ($11 − $9.75) for a total of $880,000 cash consideration for its 80 percent interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Again assume that King Company acquires 80 percent of Pawn Company’s 100,000 outstanding voting shares on January 1, 2017. We also again assume that Pawn’s shares traded before the acquisition date at an average of $9.75 per share. In this scenario, however, we assume that to acquire sufficient shares to gain control, King pays $11 per share or a total of $880,000 cash consideration for its 80 percent interest. King thus pays a control premium of $1.25 ($11 − $9.75) per share to acquire Pawn. King anticipates that synergies with Pawn will create additional value for King’s shareholders. Finally, following the acquisition, the remaining 20 percent noncontrolling interest shares continue to trade at $9.75.
Effects of Using the Initial Value Method
4-35
The initial value method ignores two accrual-based adjustments:
The parent does not accrue the percentage of subsidiary net income earned in past years in excess of dividends.
The parent does not record amortization expense under the initial value method.
Entry *C is added to the worksheet to convert the previously recorded balances to the equity method.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The initial value method ignores two accrual-based adjustments. First, the parent recognizes dividend income rather than an equity income accrual. Thus, the parent does not accrue the percentage of the subsidiary’s net income earned in past years in excess of dividends (the increase in subsidiary retained earnings). Second, the parent does not record amortization expense under the initial value method and therefore must include it in the consolidation process if proper totals are to be achieved. Because neither of these figures is recognized in applying the initial value method, an Entry *C is added to the worksheet to convert the previously recorded balances to the equity method. The parent’s beginning Retained Earnings is affected by this adjustment as well as the Investment in Subsidiary account. The exact amount is computed as follows.
Entry *C is used to convert to the equity method. Combine:
The increase (since acquisition) in the subsidiary’s retained earnings during past years (net income less dividends) times the parent’s ownership percentage.
The parent’s percentage of total amortization expense for these same past years.
Entry (I) removes both intra-entity dividend income and subsidiary dividends to the parent. (Entry D is unnecessary.)
Conversion to Equity Method from Initial Value Method (Entry *C)
4-36
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
To convert to the equity method from the initial value method (Entry *C), combine:
The increase (since acquisition) in the subsidiary’s retained earnings during past years (net income less dividends) times the parent’s ownership percentage.
The parent’s percentage of total amortization expense for these same past years.
The parent’s use of the initial value method requires an additional procedural change. Under this method, the parent recognizes income when its subsidiary declares a dividend. Entry (I) removes both intra-entity dividend income and subsidiary dividends to the parent. Thus, when the initial value method is used, Entry D is unnecessary.
Partial Equity Method
4-37
If the parent used the partial equity method to account for the subsidiary after acquisition, Entry *C is used to convert to the equity method.
In this case, only the amortization expense for the prior years must be included.
Under the partial equity method, the parent accrues its share of reported subsidiary income, but it does not recognize any acquisition-date excess fair value amortization expenses.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
If the parent used the partial equity method to account for the subsidiary after acquisition, Entry *C is needed to convert the parent’s retained earnings as of January 1 to the equity method. In this case, however, only the amortization expense for the prior years must be included. Recall that under the partial equity method, although the parent accrues its share of reported subsidiary income, it does not recognize any acquisition-date excess fair value amortization expenses.
Learning Objective 4-8
4-38
Understand the impact on consolidated financial statements of a midyear acquisition.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-8: Understand the impact on consolidated financial statements of a midyear acquisition.
Midyear Acquisitions
When control of a subsidiary is acquired at a midyear date:
New parent must compute the subsidiary’s book value as of acquisition date to determine excess total fair value over book value allocations.
Excess amortization expenses, any equity accrual, and dividend distributions are recognized for a period of less than a year.
Because only net income earned by the subsidiary after the acquisition date accrues to the new owners, it is appropriate to include only postacquisition revenues and expenses in consolidated totals.
4-39
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
32
When a company gains control at a midyear date, a few obvious changes are needed. The new parent must compute the subsidiary’s book value as of that date to determine excess total fair value over book value allocations (e.g., intangibles). Excess amortization expenses as well as any equity accrual and dividend distributions are recognized for a period of less than a year. Finally, because only net income earned by the subsidiary after the acquisition date accrues to the new owners, it is appropriate to include only postacquisition revenues and expenses in consolidated totals.
Learning Objective 4-9
4-40
Understand the impact on consolidated financial statements when a step acquisition has taken place.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-9: Understand the impact on consolidated financial statements when a step acquisition has taken place.
Control Achieved in Steps—Acquisition Method
A step acquisition occurs when control is achieved in a series of equity acquisitions.
The acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained.
The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained.
4-41
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
31
A step acquisition occurs when control is achieved in a series of equity acquisitions, as opposed to a single transaction. As with all business combinations, the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained. The acquisition of a controlling interest is considered an important economic, and therefore measurement, event. Consequently, the parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained.
Postacquisition Control Achieved in Steps
If the parent previously held a noncontrolling interest in the acquired firm, the parent remeasures its interest to fair value and recognizes a gain or loss.
If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place.
The parent accounts for additional subsidiary shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders.
4-42
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
31
If the parent previously held a noncontrolling interest in the acquired firm, the parent remeasures that interest to fair value and recognizes a gain or loss. If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. The parent simply accounts for the additional subsidiary shares acquired as an equity transaction—consistent with any transactions with other owners, as opposed to outsiders. Next we present an example of consolidated reporting when the parent obtains a controlling interest in a series of steps. Then, we present an example of a parent’s post-control acquisition of its subsidiary’s shares.
Learning Objective 4-10
4-43
Record the sale of a subsidiary (or a portion of its shares).
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO 4-10: Record the sale of a subsidiary (or a portion of its shares).
Parent Company Sales of Subsidiary Stock—Acquisition Method
The accounting effect from selling subsidiary shares depends on whether the parent continues to maintain control after the sale.
If the sale results in the loss of control, parent recognizes any resulting gain or loss in consolidated net income.
If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section.
The parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital.
4-44
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The accounting effect from selling subsidiary shares depends on whether the parent continues to maintain control after the sale. If the sale of the parent’s ownership interest results in the loss of control of a subsidiary, it recognizes any resulting gain or loss in consolidated net income.
If the parent sells some subsidiary shares but retains control, it recognizes no gains or losses on the sale. Under the acquisition method, as long as control remains with the parent, transactions in the stock of the subsidiary are considered to be transactions in the equity of the consolidated entity. Because such transactions are considered to occur with owners, the parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital.
Parent Company Sales of Subsidiary Stock—Less Than Entire Investment
If the former parent retains any of its former subsidiary’s shares, the investment should be remeasured to fair value on the date control is lost.
Any resulting gain or loss from the remeasurement should be recognized in the parent’s net income.
If it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase.
For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied.
4-45
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
If the former parent retains any of its former subsidiary’s shares, the investment should be remeasured to fair value on the date control is lost. Any resulting gain or loss from the remeasurement should be recognized in the parent’s net income.
If the parent sells less than the entire investment, it must select an appropriate cost-flow assumption when it has made more than one purchase. In the sale of securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied.
Noncontrolling Interest—U.S. GAAP
4-46
Accounting and reporting for business combinations between U.S. and international standards has converged with FASB ASC Topic 805 and IFRS 3R, each of which carries the title “Business Combinations” and ASC Topic 810: “Consolidation.”
U.S. GAAP requires fair value measurement. Acquisition-date fair value provides a basis for reporting noncontrolling interest, which is adjusted for its share of subsidiary income and dividends subsequent to acquisition.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The accounting and reporting for business combinations between U.S. and international standards has largely converged with FASB ASC Topic 805 and IFRS 3R, each of which carries the title “Business Combinations,” and ASC Topic 810: “Consolidation.”
U.S. GAAP requires a fair-value measurement attribute, consistent with the overall valuation principles for business combinations. Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest, which is adjusted for its share of subsidiary income and dividends subsequent to acquisition.
Noncontrolling Interest—International Financial Reporting Standards
4-47
IFRS 3R allows an option for reporting the noncontrolling interest for each business combination.
It may be measured either at its acquisition-date fair value, which can include goodwill, or at a proportionate share of the subsidiary’s identifiable net asset fair value, which excludes goodwill.
This option assumes that any goodwill created via acquisition applies solely to the controlling interest.
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
In contrast, IFRS 3R allows an option for reporting the noncontrolling interest for each business combination. Under IFRS, the noncontrolling interest may be measured either at its acquisition-date fair value, which can include goodwill, or at a proportionate share of the acquiree’s identifiable net asset fair value, which excludes goodwill. The IFRS proportionate-share option effectively assumes that any goodwill created through the business combination applies solely to the controlling interest.
