Chapter 4 Consolidation Techniques and Procedures by Jeanne

Chapter 4: Consolidation Techniques and Procedures by Jeanne M. David, Ph. D. , Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn © Pearson Education, Inc. publishing as Prentice Hall 4 -1

Consolidation Techniques: Objectives 1. Prepare consolidation working papers for the year of acquisition when the parent company uses the full equity method to account for its invesment in a subsidiary. 2. Prepare consolidation working papers for the year subsequent to acquisition. 3. Locate errors in preparing consolidation working papers. 4. Allocate excess fair value over book value to include identifiable net assets. © Pearson Education, Inc. publishing as Prentice Hall 4 -2

Objectives (continued) 5. Apply concepts to prepare a consolidated statement of cash flows. 6. Appendix: Understand the alternative trial balance consolidation working paper format. © Pearson Education, Inc. publishing as Prentice Hall 4 -3

Consolidation Techniques and Procedures 1: Acquisition-Year Working Papers © Pearson Education, Inc. publishing as Prentice Hall 4 -4

Preparing the Worksheet • Statements are entered onto the worksheet: – Income statement – Statement of retained earnings – Balance sheet • Columns needed: – Parent – Subsidiary – DR and CR columns for elimination entries – Consolidated © Pearson Education, Inc. publishing as Prentice Hall 4 -5

Completing the Worksheet • Enter Parent and Sub. amounts at 100% of book value. (Even if parent owns less) • Enter elimination entries into the DR and CR columns. (Check totals) • Consolidated expenses, dividends and assets: – Add parent, subsidiary, plus DR, less CR • Consolidated revenues, liabilities and equity (other than ending retained earnings): – Add parent, subsidiary, less DR, plus CR • Income, ending retained earnings and all subtotals and totals: – Compute directly in consolidated column. © Pearson Education, Inc. publishing as Prentice Hall 4 -6

Working Paper Entries 1. Adjust for errors & omissions 2. Eliminate intercompany profits and losses 3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance 4. Record noncontrolling interest in sub's earnings & dividends 5. Eliminate reciprocal Investment & sub's equity balances 6. Amortize fair value/book value differentials 7. Eliminate other reciprocal balances © Pearson Education, Inc. publishing as Prentice Hall 4 -7

Example: Prep & Snap Data Prep pays $88 for 80% of Snap on 1/1/2009 when Snap's equity consisted of $60 capital stock and $30 retained earnings. All excess was due to unrecorded patents with a 10 -year life. Snap's income and dividends follow: Net income Dividends 2009 $25 $15 © Pearson Education, Inc. publishing as Prentice Hall 2010 $30 $15 4 -8

Analysis Cost of 80% of Snap Implied value of Snap ($88/. 80) Book value (60+30) Excess Patent s Unamort. Bal. on 1/1/2009 Amortizati on $20 $88 $110 90 $20 Allocated to: Patents Amt Amort. $20 10 yrs Amortizati on in 2009 Unamort. Bal. on 12/31/2009 in 2010 Unamort. Bal. on 12/31/2010 $2 $18 $2 $16 Use these amounts in 2009 worksheet for 2010 worksheet for amortization expense and patents. © Pearson Education, Inc. publishing as Prentice Hall 4 -9

Income & Dividend Calculations 2009: Snap's net income Amortization Adjusted income Dividends 2010: Snap's net income Amortization Adjusted income Dividends $25 Prep's 80% share $18. 4 (2) $12. 0 $23 NCI 20% share $4. 6 $15 $3. 0 80% share $30 Prep's$22. 4 (2) $12. 0 $28 NCI 20% share $5. 6 $15 $3. 0 © Pearson Education, Inc. publishing as Prentice Hall 4 -10

Prep's 2009 Worksheet Entries 1. Adjust for errors & omissions none 2. Eliminate intercompany profits and losses none 3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance Income from Snap (I. S. ) Dividends (St. RE) Investment in Snap (B. S. ) © Pearson Education, Inc. publishing as Prentice Hall 18. 4 12. 0 6. 4 4 -11

Prep 2009: Entries (2 of 3) 4. Record noncontrolling interest in sub's earnings & dividends Noncontrolling interest share (I. S. ) 4. 6 Dividends (St. RE) 3. 0 Noncontrolling interest (B. S. ) 1. 6 5. Eliminate reciprocal Investment & sub's equity balances Capital stock (B. S. ) 60 Retained earnings (St. RE, beg. ) 30 Patents (B. S. ) 20 Investment in Snap (B. S. ) 88 Noncontrolling interest (B. S. ) 22 © Pearson Education, Inc. publishing as Prentice Hall 4 -12

Prep 2009: Entries (3 of 3) 6. Amortize fair value/book value differentials Amortization Expense (I. S. ) Patents (B. S. ) 2 2 7. Eliminate other reciprocal balances none Note that in last chapter, all worksheet entries were prepared for the balance sheet. Here worksheet entries are prepared for the income statement, statement of retained earnings and balance sheet. © Pearson Education, Inc. publishing as Prentice Hall 4 -13

Prep's 2009 Worksheet Year ended 12/31/2009 Income statement: Revenues Income from Snap Expenses Noncontrolling interest share Net income/ Controlling share Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends Ending retained earnings © Pearson Education, Inc. publishing as Prentice Hall Prep Snap 250. 0 65. 0 18. 4 (200. 0) (40. 0) 68. 4 25. 0 30. 0 68. 4 25. 0 (30. 0) (15. 0) 43. 4 40. 0 DR 18. 4 2. 0 4. 6 30. 0 CR Consol 315. 0 0. 0 (242. 0) (4. 6) 68. 4 5. 0 68. 4 12. 0 (30. 0) 3. 0 43. 4 4 -14

Balance sheet, 12/31/2009: Cash Other current assets Investment in Snap Plant & equipment, net Patents Total Liabilities Capital stock Retained earnings Noncontrolling interest, Jan. 1 Noncontrolling interest, Dec. 31 Total © Pearson Education, Inc. publishing as Prentice Hall Prep Snap DR 39. 0 10. 0 90. 0 50. 0 94. 4 250. 0 70. 0 20. 0 473. 4 130. 0 80. 0 30. 0 350. 0 60. 0 43. 4 40. 0 473. 4 130. 0 CR Consol 49. 0 140. 0 6. 4 0. 0 88. 0 320. 0 2. 0 18. 0 527. 0 110. 0 350. 0 43. 4 22. 0 1. 6 23. 6 527. 0 4 -15

A Look at the Income Statement Year ended 12/31/2009 Income statement: Revenues Income from Snap Expenses Noncontrolling interest share Net income/ Controlling share Prep Snap 250. 0 65. 0 18. 4 (200. 0) (40. 0) 68. 4 25. 0 DR 18. 4 2. 0 4. 6 CR Consol 315. 0 0. 0 (242. 0) (4. 6) 68. 4 • Income from Snap is eliminated. • Expenses are adjusted for 2009 amortization - $2 on patents • Noncontrolling interest is proportional to Prep's Income from Snap since Prep uses the equity method. $18. 4 x. 20/. 80 = $4. 6 © Pearson Education, Inc. publishing as Prentice Hall 4 -16

A Look at Retained Earnings Year ended 12/31/2009 Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends Ending retained earnings Prep Snap 5. 0 30. 0 68. 4 25. 0 (30. 0) (15. 0) 43. 4 40. 0 DR CR Consol 30. 0 5. 0 68. 4 12. 0 (30. 0) 3. 0 43. 4 • Beginning retained earnings of Snap is eliminated. • All of Snap's dividends are eliminated. • Net income is not calculated across the line, but taken from the consolidated income statement. • Ending retained earnings is calculated in the consolidated column. © Pearson Education, Inc. publishing as Prentice Hall 4 -17

A Look at Assets Balance sheet: Cash Other current assets Investment in Snap Plant & equipment, net Patents Total Prep Snap DR CR Consol 39. 0 10. 0 49. 0 90. 0 50. 0 140. 0 94. 4 6. 4 0. 0 88. 0 250. 0 70. 0 320. 0 2. 0 18. 0 473. 4 130. 0 527. 0 • Investment in Snap is eliminated. • Patents at the start of 2009 were $20, and current amortization is $2; they are $18 at the end of 2009. • The total is calculated in the consolidated column. © Pearson Education, Inc. publishing as Prentice Hall 4 -18

A Look at Liabilities & Equity Balance sheet: Prep Liabilities 80. 0 Capital stock 350. 0 Retained earnings 43. 4 Noncontrolling interest, Jan. 1 Noncontrolling interest, Dec. 31 Total 473. 4 Snap 30. 0 60. 0 40. 0 130. 0 DR CR Consol 110. 0 60. 0 350. 0 43. 4 22. 0 1. 6 23. 6 527. 0 • Snap's capital stock is eliminated. • Retained earnings are not calculated across the row; they are taken from the statement of retained earnings. • Noncontrolling interest at year-end is proportional to Prep's Investment in Snap account. $94. 4 x. 20/. 80 = $23. 6 © Pearson Education, Inc. publishing as Prentice Hall 4 -19

Consolidation Techniques and Procedures 2: Working Papers in Subsequent Years © Pearson Education, Inc. publishing as Prentice Hall 4 -20

Analysis, for 2010 Cost of 80% of Snap Implied value of Snap ($88/. 80) Book value (60+30) Excess Patent s Unamort. Bal. Amortizati on on 1/1/2009 $20 $88 $110 90 $20 Allocated to: Patents Amt Amort. $20 10 yrs Amortizatio n in 2009 Unamort. Bal. on 12/31/2009 in 2010 Unamort. Bal. on 12/31/2010 $2 $18 $2 $16 Use these amounts in 2009 worksheet for amortization expense and patents. © Pearson Education, Inc. publishing as Prentice Hall Use these amounts in 2010 worksheet for amortization expense and patents. 4 -21

Income & Dividend Calculations 2009: Snap's net income Amortization Adjusted income Dividends 2010: Snap's net income Amortization Adjusted income Dividends $25 Prep's 80% share $18. 4 (2) $12. 0 $23 NCI 20% share $4. 6 $15 $3. 0 $30 Prep's 80% share $22. 4 (2) $12. 0 $28 NCI 20% share $5. 6 $15 $3. 0 © Pearson Education, Inc. publishing as Prentice Hall 4 -22

Prep's Worksheet Entries for 2010 1. Adjust for errors & omissions none 2. Eliminate intercompany profits and losses none 3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance Income from Snap (I. S. ) Dividends (St. RE) Investment in Snap (B. S. ) © Pearson Education, Inc. publishing as Prentice Hall 22. 4 12. 0 10. 4 4 -23

Prep 2010: Entries (2 of 3) 4. Record noncontrolling interest in sub's earnings & dividends Noncontrolling interest share (I. S. ) 5. 6 Dividends (St. RE) 3. 0 Noncontrolling interest (B. S. ) 2. 6 5. Eliminate reciprocal Investment & sub's equity balances Capital stock (B. S. ) 60 Retained earnings (St. RE, beg. ) 40 Patents (B. S. ) 18 Investment in Snap (B. S. ) 94. 4 Noncontrolling interest (B. S. ) 23. 6 © Pearson Education, Inc. publishing as Prentice Hall 4 -24

Eliminating Investment in Snap • Entry 5 eliminates the Investment in Snap and establishes the Noncontrolling Interest as of the beginning of the current year. Implied value of Snap at acquisition $88/. 80 Add the increase in retained earnings from acquisition to the beginning of the current year $40 at 1/1/2010 minus $30 at 1/1/2009 Less amortization for all prior periods $2 patent amortization for 2009 Adjusted value of Snap at 1/1/2010 $110 10 (2) $118 • Investment in Snap (80% x $118) = $94. 4 • Noncontrolling interest (20% x $118) = $23. 6 Verify the $118 from the entry (60 + 40 + 18). © Pearson Education, Inc. publishing as Prentice Hall 4 -25

Prep 2010: Entries (3 of 3) 6. Amortize fair value/book value differentials Amortization Expense (I. S. ) Patents (B. S. ) 2 2 7. Eliminate other reciprocal balances Note payable – Prep (B. S. ) Note receivable – Snap (B. S. ) © Pearson Education, Inc. publishing as Prentice Hall 10 4 -26

Prep's 2010 Worksheet Year ended 12/31/2010 Income statement: Revenues Income from Snap Expenses Noncontrolling interest share Net income/ Controlling share Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends Ending retained earnings © Pearson Education, Inc. publishing as Prentice Hall Prep Snap 300. 0 75. 0 22. 4 (244. 0) (45. 0) 78. 4 30. 0 43. 4 40. 0 78. 4 30. 0 (45. 0) (15. 0) 76. 8 55. 0 DR 22. 4 2. 0 5. 6 40. 0 CR Consol 375. 0 0. 0 (291. 0) (5. 6) 78. 4 43. 4 78. 4 12. 0 (45. 0) 3. 0 76. 8 4 -27

Balance sheet, 12/31/2010: Cash Note receivable – Snap Other current assets Investment in Snap Plant & equipment, net Patents Total Note payable – Prep Liabilities Capital stock Retained earnings Noncontrolling interest, Jan. 1 Noncontrolling interest, Dec. 31 Total © Pearson Education, Inc. publishing as Prentice Hall Prep Snap DR 45. 0 20. 0 10. 0 97. 0 70. 0 104. 8 240. 0 60. 0 18. 0 496. 8 150. 0 10. 0 70. 0 25. 0 350. 0 60. 0 76. 8 55. 0 496. 8 150. 0 CR Consol 65. 0 10. 0 167. 0 10. 4 0. 0 94. 4 300. 0 2. 0 16. 0 548. 0 95. 0 350. 0 76. 8 23. 6 2. 6 26. 2 548. 0 4 -28

Consolidation Techniques and Procedures 3: Locating Errors in Working Papers © Pearson Education, Inc. publishing as Prentice Hall 4 -29

Errors Most errors show up when the consolidated balance sheet does not balance. Common omissions: – Noncontrolling interest share (income) – Goodwill – Noncontrolling interest (equity) Check equality of DR and CR adjustments. Verify totals for parent and subsidiary statements. Re-calculate the consolidated amounts. © Pearson Education, Inc. publishing as Prentice Hall 4 -30

Consolidation Techniques and Procedures 4: Allocating Excess of Fair Value over Book Value © Pearson Education, Inc. publishing as Prentice Hall 4 -31

Example with Excess Allocated Pate pays $360 for 90% of Solo on 12/31/2009 when Solo's equity consisted of $200 capital stock and $50 retained earnings. Inventory (sold in 2010), land buildings (20 years) were undervalued by $10, $30, and $80, respectively. Equipment (10 years) was overvalued by $20. Solo's income and dividends for 2010 were $60 and $20. At year-end, Solo has dividends payable of $10 which Pate has not yet recorded. There is $20 cash in transit from Solo to Pate for the note. © Pearson Education, Inc. publishing as Prentice Hall 4 -32

Analysis at Acquisition Cost of 90% of Solo Implied value of Snap ($360/. 90) Book value (200+50) Excess $360 $400 250 $150 Noncontrolling interest, 10%(400) $40 Allocated to: Inventories Land Building Equipment Goodwill Unamort. Bal. Amortization Unamort. Bal. 12/31/2009 * in 2010 * on 12/31/2010 Inventories $10 ($10) $0 Land 30 0 30 Building 80 (4) 76 Equipment (20) 2 (18) Goodwill 50 0 50 $150 ($12) $138 © Pearson Education, Inc. publishing as Prentice Hall Amt $10 30 80 (20) 50 150 Amort 1 st yr - 20 yrs 10 yrs * Use the 12/31/2009 and 2010 amortization in worksheet entries for 2010. 4 -33

Solo's Income & Dividend Solo's net income Amortization Adjusted Solo's dividends 2010 $60 ($12) Pate's 90% share $43. 2 $18. 0 $48 $20 NCI 10% share $4. 8 $2. 0 © Pearson Education, Inc. publishing as Prentice Hall 4 -34

Pate's Worksheet Entries 1. Adjust for errors & omissions Dividends receivable (B. S. ) Investment in Solo (B. S. ) Cash (B. S. ) 9. 0 20. 0 Note receivable (B. S. ) 20. 0 2. Eliminate intercompany profits and losses none 3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance Income from Solo (I. S. ) Dividends (St. RE) Investment in Solo (B. S. ) © Pearson Education, Inc. publishing as Prentice Hall 43. 2 18. 0 25. 2 4 -35

Pate: Entries (2 of 4) 4. Record noncontrolling interest in sub's earnings & dividends Noncontrolling interest share (I. S. ) 4. 8 Dividends (St. RE) 2. 0 Noncontrolling interest (B. S. ) 2. 8 5. Eliminate reciprocal Investment & sub's equity balances Capital stock (B. S. ) 200 Retained earnings (St. RE, beg. ) 50 Unamortized excess 150 Investment in Solo (B. S. ) 360 Noncontrolling interest (B. S. ) 40 © Pearson Education, Inc. publishing as Prentice Hall 4 -36

Pate: Entries (3 of 4) Allocate the unamortized excess according to beginning of year balances. Inventory Land Building, net Goodwill Equipment, net Unamortized excess © Pearson Education, Inc. publishing as Prentice Hall 10 30 80 50 20 150 4 -37

Pate: Entries (4 of 4) 6. Amortize fair value/book value differentials Cost of sales Inventory 10 Operating (depreciation) expense 4 Buildings, net 4 Equipment, net 2 Operating (depreciation) expense 2 7. Eliminate other reciprocal balances Dividends payable (B. S. ) Dividends receivable (B. S. ) © Pearson Education, Inc. publishing as Prentice Hall 9. 0 4 -38

Pate's 2010 Worksheet Year ended 12/31/2010 Income statement: Revenues Income from Snap Cost of goods sold Operating expenses Noncontrolling interest share Net income/ Controlling share Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends Ending retained earnings © Pearson Education, Inc. publishing as Prentice Hall Pate Solo 900. 0 300. 0 43. 2 (600. 0) (150. 0) (190. 0) (90. 0) 153. 2 60. 0 120. 0 50. 0 153. 2 60. 0 (100. 0) (20. 0) 173. 2 90. 0 DR 43. 2 10. 0 4. 8 50. 0 CR 2. 0 18. 0 2. 0 Consol 1, 200. 0 (760. 0) (282. 0) (4. 8) 153. 2 120. 0 153. 2 (100. 0) 173. 2 4 -39

Balance sheet, 12/31/2010: Cash Accounts receivable, net Note receivable - solo Inventories Land Building, net Equipment, net Investment in Solo Dividends receivable Goodwill Unamortized excess Total Accounts payable Dividends payable Capital stock Retained earnings Noncontrolling interest, Jan. 1 Noncontrolling interest, Dec. 31 Total © Pearson Education, Inc. publishing as Prentice Hall Prep 13. 0 76. 0 20. 0 90. 0 60. 0 190. 0 150. 0 394. 2 993. 2 120. 0 700. 0 173. 2 993. 2 Snap DR CR 15. 0 20. 0 25. 0 20. 0 60. 0 10. 0 30. 0 110. 0 80. 0 4. 0 120. 0 9. 0 25. 2 360. 0 9. 0 50. 0 150. 0 360. 0 10. 0 9. 0 200. 0 90. 0 40. 0 2. 8 360. 0 Consol 48. 0 101. 0 0. 0 150. 0 120. 0 376. 0 252. 0 0. 0 50. 0 1, 097. 0 180. 0 1. 0 700. 0 173. 2 42. 8 1, 097. 0 4 -40

Consolidation Techniques and Procedures 5: Consolidated Statement of Cash Flows © Pearson Education, Inc. publishing as Prentice Hall 4 -41

Consolidated Cash Flows The consolidated statement of cash flows is prepared from – Consolidated balance sheets, beginning & ending – Consolidated income statement – Other information Procedure similar to an "unconsolidated" statement of cash flows Look at items specific to companies with – Subsidiaries – Equity investments © Pearson Education, Inc. publishing as Prentice Hall 4 -42

Investing & Financing Cash Flows • Investing cash flows: – Include cash acquisition and/or disposition of subsidiaries – Include cash acquisition and/or disposition of equity investees • Financing cash flows: – Include cash dividends paid to noncontrolling interests © Pearson Education, Inc. publishing as Prentice Hall 4 -43

Operating Cash Flows • Direct method: – Include cash dividends received from equity investees (not equity method income) • Indirect method: – Starting with consolidated net income to the controlling interest share, ADD the noncontrolling interest share – Deduct the excess of equity method income over cash dividends received from equity investees © Pearson Education, Inc. publishing as Prentice Hall 4 -44

Consolidation Techniques and Procedures 6: Appendix – Trial Balance Format © Pearson Education, Inc. publishing as Prentice Hall 4 -45

Alternative Worksheet Format • Worksheet format presented earlier used the basic financial statements • Alternative uses the ADJUSTED trial balances of the parent and subsidiary. • Columns on worksheet: – Parent and subsidiary adjusted trial balances, – DR and CR adjustments, – Income statement, – Statement of retained earnings, and – Balance sheet columns. © Pearson Education, Inc. publishing as Prentice Hall 4 -46

Completing the Worksheet 1. Enter worksheet elimination entries into the DR and CR columns. 2. Add accounts as needed (e. g. , noncontrolling interest, goodwill, noncontrolling interest share). 3. Carry consolidated balances to income statement, retained earnings, or balance sheet columns, as appropriate. 4. Move consolidated net income, or controlling interest share, to retained earnings. 5. Move ending retained earnings to the balance sheet. © Pearson Education, Inc. publishing as Prentice Hall 4 -47

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall © Pearson Education, Inc. publishing as Prentice Hall 4 -48