ACCT6381

Advanced Accounting

Week 3
Consolidated Financial Statement – Date of
Acquisition
Consolidated Financial Statements—Date of
Acquisition

2
 Learning Objectives
• Understand the concept of control as used in reference to
consolidations.
• Explain the role of a noncontrolling interest in business combinations.
• Describe the reasons why a company acquires a subsidiary rather than
its net assets.
• Describe the valuation and classification of accounts in consolidated
financial statements.
• List the requirements for inclusion of a subsidiary in consolidated
financial statements.

3
 Learning Objectives
• Discuss the limitations of consolidated financial statements.
• Record the investment in the subsidiary on the parent’s books at the
date of acquisition.
• Prepare the consolidated workpapers and eliminating entries at the
date of acquisition.
• Compute and allocate the difference between implied value and book
value of the acquired firm’s equity.
• Discuss some of the similarities and differences between U.S. GAAP and
IFRS with respect to the preparation of consolidated financial
statements at the date of acquisition.
4
 Stock Acquisitions
Chapter Focus - Accounting for Stock Acquisitions
• When one company controls another company through direct or
indirect ownership of some or all of its voting stock.
• Acquiring company referred to as the parent.
• Acquired company referred to as the subsidiary.
• Other shareholders considered noncontrolling interest.
• Parent records interest in subsidiary as an investment.
• If a subsidiary owns a controlling interest in one or more other companies, a
chain of ownership is forged by which the parent company controls other
companies.

LO 2 Noncontrolling interest (NCI). 5

 Definitions of Subsidiary and
Control
• The Securities and Exchange Commission defines a subsidiary as an
affiliate controlled by another entity, directly or indirectly, through
one or more intermediaries.
• Control means the possession, direct or indirect, of the power to direct
management and policies of another entity, whether through the ownership
of voting shares, by contract, or otherwise.

LO 1 Meaning of control. 6
 Definitions of Subsidiary and
Control
Subsidiary:
•A parent company (and/or the parent’s other subsidiaries)
owns a controlling financial interest in another company.
Control:
Both the IASB and the FASB have indicated their opinion
that the definition of control should not be limited to
the common presumption in practice of a 50% cutoff
but should instead include an indirect ability to control
another entity’s assets.
•The usual condition for a controlling financial interest is ownership of a
majority voting interest. [FASB ASC paragraph 810-10-15-8]

LO 1 Meaning of control. 7
 Definitions of Subsidiary and
Control
Control (continued):
• However, application of the majority voting interest requirement may
not identify the party with a controlling financial interest because the
controlling financial interest may be achieved through arrangements
that do not involve voting interests.
• The first step in determining whether the financial statements should
be consolidated is to determine if the reporting entity has a variable
interest in another entity, referred to as a potential variable interest
entity (VIE).

LO 1 Meaning of control. 8
Definitions of Control

LO 1 Meaning of control. 9
 Requirements for the Inclusion of Subsidiaries in the
Consolidated Financial Statements

Purpose of consolidated statements - to present the operating results

and the financial position of a parent and all its subsidiaries as if they
are one economic entity.

Circumstances when majority-owned subsidiaries should be excluded

from the consolidated statements:
• Control does not rest with the majority owner.
• Subsidiary operates under governmentally imposed uncertainty so severe as
to raise significant doubt about the parent’s control.

LO 5 Requirements regarding consolidation of subsidiaries. 10

 Reasons For Subsidiary Companies
Advantages to acquiring a controlling interest in the voting stock of another
company rather than its assets or all of its voting stock.
• Stock acquisition is relatively simple.
• Control of subsidiary can be accomplished with a smaller investment.
• Separate legal existence of affiliates provides an element of protection of the
parent’s assets.

LO 3 Acquiring assets or stock. 11

 Consolidated Financial Statements
Statements prepared for a parent company and its subsidiaries are called
consolidated financial statements.
• Ignore legal aspects of separate entities, but focus instead, on economic
entity under “control” of management.
• Focus on substance rather than form.
• Not substitutes for statements prepared by separate subsidiaries, which may
be used by:
• Creditors
• Noncontrolling stockholders
• Regulatory agencies.

LO 4 Valuation and classification of subsidiary assets and liabilities. 12

 Consolidated Financial Statements
Purpose of consolidated financial statements:
• To present, primarily for the benefit of the owners and creditors of the parent,
the results of operations and the financial positions of a parent company and
all of its subsidiaries
• As if the consolidated group were a single economic entity.

LO 4 Valuation and classification of subsidiary assets and liabilities. 13

 Investments at the Date of
Acquisition
Recording Investments at Cost (Parent’s Books)
• Stock investment is recorded at cost as measured by fair value of the
consideration given or consideration received, whichever is more
clearly evident.
• Consideration given may include cash, other assets, debt securities, stock of
the acquiring company, or a combination of these items.
Both the direct costs of acquiring the stock and the indirect costs
relating to acquisitions (such as costs of maintaining an acquisitions
department) should be expensed as incurred.

LO 7 Recording of investment at acquisition. 14

 Investments at the Date of
Acquisition
E3-2: On January 1, 2014, Polo Company purchased 100% of the
common stock of Save Company by issuing 40,000 shares of its (Polo’s)
$10 par value common stock with a market price of $17.50 per share.
Polo incurred cash expenses of $20,000 for registering and issuing the
common stock. The stockholders’ equity section of the two companies’
balance sheets on December 31, 2013, were:

Polo Save
Common stock, $10 par value $350,000 $320,000
Other contributed capital 590,000 175,000
Retained earnings 380,000 205,000

LO 7 Recording of investment at acquisition. 15

 Investments at the Date of
Acquisition
E3-2: Prepare the journal entry on the books of Polo Company to
record the purchase of the common stock of Save Company and related
expenses.
Investment in Save (40,000 x $17.50) 700,000
Common Stock 400,000
Other Contributed Capital 300,000

Other Contributed Capital 20,000

Cash 20,000

Stock registration and issuance costs

reduce Other Contributed Capital

LO 7 Recording of investment at acquisition. 16

 Consolidated Balance Sheets: Use of
Workpapers
Assets and liabilities are summed in their entirety, regardless of
whether the parent owns 100% or a smaller controlling interest.
• Noncontrolling interests (NCI) 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 workpaper is frequently used to summarize the effects of various additions
and eliminations.

LO 8 Preparing consolidated statements using a workpaper. 17

 Consolidated Balance Sheets: Use of
Workpapers
Intercompany Accounts to Be Eliminated
Parent’s Accounts Subsidiary’s Accounts
Investment in subsidiary Against Equity accounts

Intercompany receivable (payable) Against Intercompany payable (receivable)

Advances to subsidiary (from subsidiary) Against Advances from parent (to parent)

Interest revenue (interest expense) Against Interest expense (interest revenue)

Dividend revenue (dividends declared) Against Dividends declared (dividend revenue)

Management fee received from subsidiary Against Management fee paid to parent

Sales to subsidiary (purchases of inventory Purchases of inventory from parent (sales to

Against
from subsidiary) parent)

LO 8 Preparing consolidated statements using a workpaper. 18

 Consolidated Balance Sheets: Use of
Workpapers
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.

LO 8 Investment is eliminated for consolidated statements. 19

 Consolidated Balance Sheets: Use of
Workpapers
Investment Elimination
• Computation and Allocation of Difference between Implied Value and
Book Value (CAD)
• Step 1: Determine percentage of stock acquired.
• Step 2: Divide purchase price by the percentage acquired* to calculate the
implied value of the subsidiary.
* If 100%, the implied value will equal the purchase price.
• Step 3: Difference between Step 2 and book value of subsidiary’s equity must
be allocated to adjust the underlying assets and/or liabilities of the acquired
company.

LO 9 Computing and allocating the difference between

20
implied and book value (CAD).
 Consolidated Balance Sheets: Use of
Workpapers
The prior steps lead to the following possible cases:
Case 1. The implied value (IV) of the subsidiary is equal to the book value of the subsidiary’s equity (IV =
BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s stock.
Case 2. The implied value of the subsidiary exceeds the book value of the subsidiary’s equity (IV > BV),
and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s stock.
Case 3. The implied value of the subsidiary is less than the book value of the subsidiary’s equity (IV <
BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s stock.
LO 9 Computing and allocating the difference between
21
implied and book value (CAD).
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): Implied Value of Subsidiary Is Equal to Book Value of
Subsidiary Company’s Equity (IV = BV) - 100% of Stock Acquired.

Illustration: Assume that on January 1, 2015, P Company acquired all

the outstanding stock (10,000 shares) of S Company for cash of
$160,000. What journal entry would P Company make to record the
shares of S Company acquired?

Investment in S Company $160,000

Cash $160,000

LO 9 Computing and allocating the difference between

22
implied and book value (CAD).
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): The balance sheets of both companies immediately after the
acquisition of shares is as follows:
Implied value = Book
value
Price paid $160,000
% acquired 100%
Implied value 160,000
Book value 160,000
Difference $0

LO 9 Computing and allocating the difference between

23
implied and book value (CAD).
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): The workpaper to consolidate the balance sheets for P and S on
Jan. 1, 2015, date of acquisition, is presented below:

Adjusting and eliminating entries are made on the workpaper for the preparation
of consolidated statements.
LO 9 Computing and allocating the difference between
implied and book value (CAD). 24
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): The workpaper to consolidate the balance sheets for P and S on
Jan. 1, 2015, date of acquisition, is presented below:

LO 9 Computing and allocating the difference between

implied and book value (CAD). 25
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): The workpaper entry to eliminate S Company’s stockholders’
equity against the investment account is:
Common Stock (S) 100,000
Other Contributed Capital (S) 20,000
Retained Earnings (S) 40,000
Investment in S Company 160,000

This is a workpaper-only entry.

LO 9 Computing and allocating the difference between

implied and book value (CAD). 26
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(a): Note the following on the workpaper.
• Investment account and related subsidiary’s stockholders’ equity have
been eliminated .
• Subsidiary’s net assets have been substituted for the investment account.
• Consolidated assets and liabilities consist of the sum of the parent and
subsidiary assets and liabilities in each classification.
• Consolidated stockholders’ equity is the same as the parent company’s
stockholders’ equity.
• Consolidated balance sheet is that of the economic entity.
LO 9 Computing and allocating the difference between
implied and book value (CAD). 27
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): Parent’s Cost of Investment Is Equal to Book Value of
Subsidiary’s Stock Acquired (IV=BV) - Partial Ownership.
Illustration: Assume that on January 1, 2015, P Company acquired
90% (9,000 shares) of the stock of S Company for $144,000. What
journal entry would P Company make to record the shares of S
Company acquired?

Investment in S Company $144,000

Cash $144,000

LO 9 Computing and allocating the difference between

implied and book value (CAD).
28
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): The balance sheets of both companies immediately after the
acquisition of shares is as follows:
Implied value = Book
value
Price paid $144,000
% acquired 90%
Implied value 160,000
Book value 160,000
Difference $0

LO 9 Computing and allocating the difference between

implied and book value (CAD). 29
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): Computation and Allocation of Difference between Implied
and Book Values:

LO 9 Computing and allocating the difference between

implied and book value (CAD). 30
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): The workpaper to consolidate the balance sheets for P and S on
Jan. 1, 2015, date of acquisition, is presented below:

Solution on LO 9 Computing and allocating the difference between

notes page implied and book value (CAD). 31
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): The workpaper to consolidate the balance sheets for P and S on Jan. 1, 2015,
date of acquisition, is presented below:

LO 9 Computing and allocating the difference between

implied and book value (CAD). 32
 Consolidated Balance Sheets: Use of
Workpapers
Case 1(b): The workpaper entry to eliminate S Company’s stockholders’
equity against the investment account is:
Common Stock (S) 100,000
Other Contributed Capital (S) 20,000
Retained Earnings (S) 40,000
Investment in S Company 144,000
Noncontrolling Interest in Equity 16,000
(establish the NCI)

LO 9 Computing and allocating the difference between

implied and book value (CAD). 33
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b): Implied Value Exceeds Book Value of Subsidiary
Company’s Equity (IV>BV) - Partial Ownership.
Illustration: Assume that on January 1, 2015, P Company acquired
80% (8,000 shares) of the stock of S Company for $148,000. What
journal entry would P Company make to record the shares of S
Company acquired?

Investment in S Company $148,000

Cash $148,000

LO 9 Computing and allocating the difference between

implied and book value (CAD). 34
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b): The balance sheets of both companies immediately after the
acquisition of shares is as follows:

Implied value = Book

value
Price paid $148,000
% acquired 80%
Implied value 185,000
Book value 160,000
Difference $25,000

LO 9 Computing and allocating the difference between

implied and book value (CAD). 35
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b): Computation and Allocation of Difference between Implied
and Book Values:

We assume the entire difference is attributable to land with a

current value higher than historical cost.
LO 9 Computing and allocating the difference between implied and book value (CAD).
36
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b): The workpaper to consolidate the balance sheets for P and S on
Jan. 1, 2015, date of acquisition, is presented below:

LO 9 Computing and allocating the difference between implied and book value (CAD). 37
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b): The workpaper (elimination) entries are as follows:
#1 Common Stock (S) 100,000
Other Contributed Capital (S) 20,000
Retained Earnings (S) 40,000
Difference between IV and BV 25,000
Investment in S Company 148,000
Noncontrolling Interest in Equity 37,000

#2 Land 25,000
Difference between IV and BV 25,000
LO 9 Computing and allocating the difference between
implied and book value (CAD). 38
 Consolidated Balance Sheets: Use of
Workpapers
Case 2(b) Reasons an Acquiring Company May Pay More Than Book
Value:
1) Fair value of specific tangible or intangible assets of the subsidiary may
exceed the recorded value because of appreciation.
2) Excess payment may indicate existence of goodwill.
3) Liabilities, generally long-term, may be overvalued.
4) A variety of market factors may affect the price paid.

LO 9 Computing and allocating the difference between

implied and book value (CAD). 39
 Consolidated Balance Sheets: Use of
Workpapers
Case 3(b): Implied Value of Subsidiary is Less Than Book Value
(IV<BV) - Partial Ownership.
Illustration: Assume that on January 1, 2015, P Company acquired
80% (8,000 shares) of the stock of S Company for $120,000. What
journal entry would P Company make to record the shares of S
Company acquired?

Investment in S Company $120,000

Cash $120,000

LO 9 Computing and allocating the difference between

implied and book value (CAD). 40
 Consolidated Balance Sheets: Use of
Workpapers
Case 3(b): The balance sheets of both companies immediately after the
acquisition of shares is as follows:

Implied value = Book

value
Price paid $120,000
% acquired 80%
Implied value 150,000
Book value 160,000
Difference $10,000

LO 9 Computing and allocating the difference between

implied and book value (CAD). 41
 Consolidated Balance Sheets: Use of
Workpapers
Case 3(b): Computation and Allocation of Difference between Implied
and Book Values:

Assume the difference is attributable to plant and equipment,

in this case an overvaluation of $10,000.
LO 9 Computing and allocating the difference between implied and book value (CAD).
42
 Consolidated Balance Sheets: Use of
Workpapers
Case 3(b): The workpaper to consolidate the balance sheets for P and S on
Jan. 1, 2015, date of acquisition, is presented below:

LO 9 Computing and allocating the difference between implied and book value (CAD).
43
 Consolidated Balance Sheets: Use of
Workpapers
Case 3(b): The workpaper (elimination) entries are as follows:
#1 Common Stock (S) 100,000
Other Contributed Capital (S) 20,000
Retained Earnings (S) 40,000
Difference between IV and BV 10,000
Investment in S Company 120,000
Noncontrolling Interest in Equity 30,000

#2 Difference between IV and BV 10,000

Plant and Equipment 10,000
LO 9 Computing and allocating the difference between
implied and book value (CAD). 44
 Consolidated Balance Sheets: Use of
Workpapers
Review Question
The noncontrolling interest in the subsidiary is reported
as:
a) Asset
b) Liability
c) Equity
d) Expense

LO 9 Computing and allocating the difference between

implied and book value (CAD). 45
 Consolidated Balance Sheets: Use of
Workpapers
Subsidiary Treasury Stock Holdings
• A subsidiary may hold some of its own shares as treasury stock at the
time the parent company acquires its interest.
• Because the treasury stock account represents a contra stockholders’
equity account, it must be eliminated by a credit when the investment
account and subsidiary company’s equity accounts are eliminated on
the workpaper.

LO 9 Computing and allocating the difference between

implied and book value (CAD). 46
 Consolidated Balance Sheets: Use of
Workpapers
Other Intercompany Balance Sheet Eliminations
• Intercompany accounts receivable, notes receivable, and interest
receivable, for example, must be eliminated against the reciprocal
accounts payable, notes payable, and interest payable.
• Eliminations must also be made for all types of intercompany accruals
for such items as rent and other services.
• The full amount of all intercompany receivables and payables is
eliminated without regard to the percentage of control held by the
parent company.
LO 9 Computing and allocating the difference between
implied and book value (CAD). 47
 Consolidated Balance Sheets: Use of
Workpapers
Adjusting Entries Prior to Eliminating Entries
• At times, workpaper adjustments to accounting data may be needed
before appropriate eliminating entries can be accomplished. The
need for adjustments generally arises because of in-transit items
when only one of the affiliates has recorded the effect of an
intercompany transaction.
• Enter these adjusting entries on worksheet eliminations columns or
• Adjust the subsidiary’s statements prior to their entry on the workpaper.

LO 9 Computing and allocating the difference between

implied and book value (CAD). 48
 Consolidated Balance Sheets: Use of
Workpapers
Review Question
Which of the following adjustments do not occur in the
consolidating process?
a) Elimination of intra-company balances
b) Elimination of parent’s retained earnings
c) Allocations of difference between implied and book values
d) Elimination of the investment account

LO 9 Computing and allocating the difference between

implied and book value (CAD).
49
 Limitations of Consolidated
Statements
Consolidated statements may have limited usefulness for
noncontrolling stockholders, subsidiary creditors, and some regulatory
agencies.

For Example:
• Little information of value in consolidated statements because they contain
insufficient detail about the individual subsidiaries.
• Highly diversified companies operating across several industries, often the
result of mergers and acquisitions, are difficult to analyze or compare.

LO 6 Limitations of consolidated statements. 50

IFRS Versus U.S. GAAP

LO 10 Similarities and differences between U.S. GAAP and IFRS.

51
IFRS Versus U.S. GAAP

LO 10 Similarities and differences between U.S. GAAP and IFRS.

52
IFRS Versus U.S. GAAP

LO 10 Similarities and differences between U.S. GAAP and IFRS.

53
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