5

Consolidation of Less-Than-Wholly-Owned Subsidiaries

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

 5-2

Consolidation of Less-Than-Wholly-
Owned Subsidiaries

• More than a consolidated balance sheet,

however, is needed to provide a
comprehensive picture of the consolidated
entity’s activities following acquisition.
 5-3

Consolidation of Less-Than-Wholly-
Owned Subsidiaries

• The stockholders who own the shares of the

subsidiary not held by the parent are referred to
collectively as the noncontrolling interest or
minority interest .
 5-4

Consolidation of Less-Than-Wholly-
Owned Subsidiaries

• When a subsidiary is less than wholly owned,

the general approach to consolidation is the
same as discussed in Chapter 4, but the
consolidation procedures must be modified
slightly to recognize the noncontrolling interest.
• Also, the computation of consolidated net
income and retained earnings must allow for the
claim of the noncontrolling interest.
 5-5

Consolidated Net Income

• Consolidated net income is that portion of the

enterprise’s total income that accrues to the
parent company’s stockholders.
 5-6

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 income from the
subsidiaries included in net income).
 5-7

Consolidated Net Income

• Consolidated net income is that portion of the
enterprise’s total income that accrues to the
parent company’s stockholders.
• 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 income from the
subsidiaries included in net income).
 5-8

Consolidated Net Income

• When a subsidiary is less than wholly owned, a
portion of its income accrues to its noncontrolling
shareholders and is excluded from consolidated
net income.
• A subsidiary’s income available to common
stockholders is divided between the parent and
noncontrolling stockholders based on their
relative common stock ownership of the
subsidiary.
 5-9

Consolidated Retained Earnings

• Consolidated retained earnings is that portion
of the consolidated entity’s undistributed
earnings accruing to the parent’s stockholders.
• It is calculated by adding the parent’s share of
the subsidiary’s cumulative net income since
acquisition to the parent’s retained earnings from
its own operations (excluding any income from
the subsidiary included in retained earnings).
 5-10

PREPARATION OF CONSOLIDATED BALANCE

SHEET IMMEDIATELY FOLLOWING
ACQUISITION OF CONTROLLING OWNERSHIP

• The consolidation process for a majority-owned

subsidiary is the same as for a wholly owned
subsidiary except the claims of the
noncontrolling or minority interest must be
included.
 5-11

CONSOLIDATION SUBSEQUENT TO
ACQUISITION OF CONTROLLING OWNERSHIP

• Consolidation subsequent to acquisition involves

the preparation of a complete set of consolidated
financial statements, as discussed in Chapter 4.
 5-12

Second Year of Ownership

• The equity-method and consolidation

procedures employed during the second and
subsequent years of ownership are the same as
in the first year.
 5-13

DISCONTINUANCE OF
CONSOLIDATION

• A previously consolidated subsidiary is excluded

from consolidation if it no longer meets the
criteria for consolidation, usually because the
parent can no longer exercise control over the
subsidiary
• FASB Statement No. 154 , “Accounting
Changes and Error Corrections,” requires that
the change in reporting entity be applied
retrospectively to reflect the new entity.
 5-14

TREATMENT OF OTHER
COMPREHENSIVE INCOME
• FASB Statement No. 130 , “Reporting
Comprehensive Income” (FASB 130),
established a new category for financial
reporting, other comprehensive income, which
includes all revenues, expenses, gains, and
losses that under generally accepted accounting
principles are excluded from net income.
 5-15

TREATMENT OF OTHER
COMPREHENSIVE INCOME

• FASB 130 permits several different options for

reporting comprehensive income, but the
consolidation process is the same regardless of
the reporting format.
 5-16

Modification of the Consolidation

Workpaper

• When a parent or subsidiary has recorded other

comprehensive income, the consolidation
workpaper normally includes an additional
section for other comprehensive income.
• When other comprehensive income is reported,
the workpaper is prepared in the normal manner,
with the additional section added to the bottom.
 5-17

Subsidiary Valuation Accounts at

Acquisition

• The consolidation treatment of a subsidiary’s

various valuation accounts depends on the
particular type of account.
 5-18

Subsidiary Valuation Accounts at

Acquisition

• A subsidiary’s accumulated depreciation on the

date of acquisition theoretically should be
eliminated in the preparation of consolidated
financial statements.
• When fixed assets are acquired, whether in a
business combination or otherwise, the seller’s
accumulated depreciation on the assets is never
transferred to the purchaser’s books.
 5-19

Subsidiary Valuation Accounts at

Acquisition

• Accounts receivable normally are valued in the

balance sheet at net realizable value through the
use of the allowance for uncollectible accounts
to bring the full legal amount of the receivable
down to the actual amount expected to be
collected.
 5-20

Subsidiary Valuation Accounts at

Acquisition

• If a subsidiary is holding investment securities at

the date of combination, those securities must
be revalued to fair value.
• A valuation account associated with the
subsidiary’s available-for-sale securities at the
date of combination should be eliminated
against the related accumulated unrealized gain
or loss account.
 5-21

Subsidiary Valuation Accounts at

Acquisition

• A subsidiary may have long-term debt

outstanding at the date of acquisition, and that
debt must be valued at its fair value at the date
of combination. If the fair value is different than
the book value, the difference is recognized
through a discount or premium account
associated with the debt.
 5-22

Negative Retained Earnings of Subsidiary

at Acquisition

• A parent company may purchase a subsidiary

with a negative or debit balance in its retained
earnings account.
• An accumulated deficit of a subsidiary at
acquisition causes no special problems in the
consolidation process.
 5-23

Other Stockholders’ Equity Accounts

• The discussion of consolidated statements up to

this point has dealt with companies having
stockholders’ equity consisting only of retained
earnings and a single class of capital stock
issued at par.
 5-24

Subsidiary’s Disposal of Differential-

Related Assets

• The disposal of an asset usually has income

statement implications.
• If the asset is held by a subsidiary and is one to
which a differential is assigned in the
consolidation workpaper, both the parent’s
equity-method income and consolidated net
income are affected
 5-25

Inventory

• Any inventory-related differential is assigned to

inventory for as long as the subsidiary holds the
inventory units. In the period in which the
inventory units are sold, the inventory-related
differential is assigned to Cost of Goods Sold.
 5-26

Inventory

• When the subsidiary uses FIFO inventory

costing, the inventory units on hand on the date
of combination are viewed as being the first units
sold after the combination.
• When the subsidiary uses LIFO inventory
costing, the inventory units on the date of
combination are viewed as remaining in the
subsidiary’s inventory.
 5-27

Changes Proposed by the FASB

• FASB has proposed significant changes in

accounting for business combinations and the
presentation of consolidated financial
statements.
• In general, the criteria for when consolidated
financial statements should be presented and
which companies should be consolidated are the
same as under current standards.
 5-28

Changes Proposed by the FASB

• One of the most significant changes relates to

the acquisition of less-than-wholly owned
subsidiaries.
• The proposed standard on business
combinations requires acquired companies, and
all of their assets and liabilities, to be valued at
their fair values at the date of combination,
regardless of the percentage ownership
acquired by the parent
 5-29

Changes Proposed by the FASB

• Under the FASB’s proposal, goodwill would be
computed as the difference between the fair
value of the acquired company as a whole and
the fair value of its net identifiable assets.
• This can be contrasted with the current
approach of measuring goodwill as the
difference between the purchase price of the
acquired company and the fair value of the
parent’s share of the acquired company’s net
identifiable assets.
 5-30

You Will Survive This Chapter !!!

• You can’t own yourself !

• You can’t owe money to yourself !

• You can’t make money selling to yourself !

 5

End of Chapter

Consolidation of Less-Than-Wholly-Owned Subsidiaries

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