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.
• Because the consolidated entity has no books,
all amounts in the consolidated financial
statements originate on the books of the parent
or a subsidiary or in the consolidation
workpaper.
 1-3

Consolidation Procedures

• The term subsidiary has been defined as “an

entity . . . in which another entity known as its
parent holds a controlling financial interest.”
 1-4

Consolidation Workpapers

• The consolidation workpaper provides a

mechanism for efficiently combining the
accounts of the separate companies involved in
the consolidation and for adjusting the combined
balances to the amounts that would be reported
if all consolidating companies were actually a
single company.
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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.
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Nature of Eliminating Entries

• Eliminating entries appear only in the

consolidating workpapers and 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.
 1-7

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
—Special Foods $200,000
• 100% Retained earnings—Special Foods 100,000
$300,000
• Peerless’ s share 1.00 (300,000)
• Difference between cost and book value $ -0-
 1-8

Full Ownership Purchased at Book

Value
Peerless records the stock acquisition on its
books with the following entry on the date of
combination:
January 1, 20X1
Investment in Special Foods Stock 300,000
Cash 300,000
Record purchase of Special Foods stock.
 1-9

Investment Elimination Entry

The only eliminating entry in the workpaper is

one needed to eliminate the Investment in
Special Foods Stock account and the
subsidiary’s stockholders’ equity accounts.

Common Stock—Special Foods 200,000

Retained Earnings 100,000
Inv in Special Foods Stock 300,000
Eliminate investment balance.
 1-10

Full Ownership Purchased at More

than Book Value

• A company’s stock price is influenced by many

factors, including net asset values, enterprise
earning power, and general market conditions.
• When one company purchases another, there is
no reason to expect that the purchase price
necessarily will be equal to the acquired stock’s
book value.
 1-11

Full Ownership Purchased at More

than Book Value

• The process used to prepare the consolidated

balance sheet is complicated only slightly when
100 percent of a company’s stock is purchased
at a price different from its book value.
 1-12

Treatment of a Positive Differential

• There are several reasons that the purchase

price of a company’s stock might exceed the
stock’s book value:
1. Errors or omissions on the books of the
subsidiary.
2. Excess of fair value over the book value of the
subsidiary’s net identifiable assets.
3. Existence of goodwill.
 1-13

Excess of Fair Value over Book Value of

Subsidiary’s Net Identifiable Assets

• The fair value of a company’s assets is an

important factor in the overall determination of
the company’s purchase price.
• In many cases, the fair value of an acquired
company’s net assets exceeds the book value.
• Revaluing the assets and liabilities on the
subsidiary’s books generally is the simplest
approach if all of the subsidiary’s common stock
is acquired.
 1-14

Existence of Goodwill

• If a company purchases a subsidiary at a price

in excess of the total of the fair values of the
subsidiary’s 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 .
 1-15

Existence of Goodwill

• In the past, some companies have included in

goodwill the portion of the purchase price related
to certain identifiable intangible assets.
• This treatment is not acceptable.
 1-16

Full Ownership Purchased at Less

than Book Value

• 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.
 1-17

Full Ownership Purchased at Less

than Book Value

• Differential may include:

• 1. Errors or omissions on the books of the
subsidiary.
• 2. Excess of book value over the fair value of the
subsidiary’s net identifiable assets.
• 3. Diminution of previously recorded goodwill.
• 4. Bargain purchase.
 1-18

Bargain Purchase

• The existence of “negative goodwill,” indicating

that the subsidiary’s net assets are worth less as
a going concern than if they were sold
individually.
 1-19

Illustration of Treatment of Credit

Differential
• Peerless purchases all of Special Foods’ stock for
$260,000. The resulting ownership situation is as follows:
Investment cost $260,000
Book value
Common stock—Special Foods $200,000
Retained earnings—Special Foods 100,000
$300,000
S Peerless’s share 1.00 (300,000)
Differential (credit) $ (40,000)
 1-20

CONSOLIDATION SUBSEQUENT
TO ACQUISITION
• More than a consolidated balance sheet,
however, is needed to provide a comprehensive
picture of the consolidated entity’s activities
following acquisition.
• The approach followed to prepare a complete
set of consolidated financial statements
subsequent to a business combination is quite
similar to that used to prepare a consolidated
balance sheet as of the date of combination.
 1-21

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 enterprise’s
income that is assigned to the parent company’s
shareholders.
 1-22

Consolidated Net Income

• Consolidated net income is computed by adding

the parent’s proportionate share of the income of
all subsidiaries, adjusted for any differential
write-off or goodwill impairment, to the parent’s
income from its own separate operations
(parent’s net income less investment income
from the subsidiaries under either the cost or
equity method).
 1-23

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 enterprise’s undistributed
earnings accruing to the parent company
shareholders.
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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.
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Consolidation Workpaper—Year 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.
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Consolidation Workpaper—Year 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.
 1-27

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.
 1-28

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.
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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.
 1-30

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).
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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.
 1-32

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.
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PUSH-DOWN ACCOUNTING

• The term push-down accounting refers to the

practice of revaluing the assets and liabilities of
a purchased subsidiary directly on that
subsidiary’s books at the date of acquisition.
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PUSH-DOWN ACCOUNTING

• Those who favor push-down accounting argue

that the change in the subsidiary’s ownership in
an acquisition is reason for adopting a new basis
of accounting for the subsidiary’s assets and
liabilities, and this new basis of accounting
should be reflected directly on the subsidiary’s
books.
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PUSH-DOWN ACCOUNTING

• SEC Staff Accounting Bulletin No. 54 requires

push-down accounting whenever a business
combination results in the acquired subsidiary
becoming substantially wholly owned.
• The revaluation of assets and liabilities on a
subsidiary’s books involves making an entry to
debit or credit each asset and liability account to
be revalued, with the balancing entry to a
revaluation capital account.
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You Will Survive This Chapter !!!

Now this is Advanced Accounting !!!

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End of Chapter

Consolidation of Wholly Owned Subsidiaries

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