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Department of Accounting and Information Systems

MBA 2nd Semester
AIS: 5201 Advanced Financial Accounting
Course Teacher: Md. Shahbub Alam, Lecturer, Dept. of AIS, I.U, Kushtia.

Chapter-04
The Reporting Entity and the Consolidation of Less-than-Wholly-Owned
Subsidiaries with No Differential
Contents: Limitations of Consolidated Financial Statements, Subsidiary Financial Statements,
Consolidated Financial Statements: Concepts and Standards, Non-controlling Interest, The
Effect of a Non-controlling Interest, Consolidated Balance Sheet with a Less-Than Wholly-
Owned Subsidiary, Consolidation Subsequent to Acquisition—80 Percent Ownership Acquired
at Book Value, Combined Financial Statements, Special-Purpose and Variable Interest Entities.

1. Consolidated Financial Statements

Consolidated financial statements are the combined financial statements of a parent company
and its subsidiaries. Consolidated financial statements present an aggregated look at the
financial position of a parent company and its subsidiaries, and they provide a picture of the
overall health of an entire group of companies as opposed to one company's standalone
position.

2. What is the basic idea underlying the preparation of consolidated financial

statements?
The basic idea underlying the preparation of consolidated financial statements is the notion that
the consolidated financial statements present the financial position and the results of operations
of a parent and its subsidiaries as if the related companies actually were a single company.

3. How might consolidated statements help an investor assess the desirability of

purchasing shares of the parent company?
Without consolidated statements it is often very difficult for an investor to gain an
understanding of the total resources controlled by a company. A consolidated balance sheet
provides a much better picture of both the total assets under the control of the parent company
and the financing used in providing those resources. Similarly, the consolidated income
statement provides a better picture of the total revenue generated and the costs incurred in
generating the revenue. Estimates of future profit potential and the ability to meet anticipated
funds flows often can be more easily assessed by analyzing the consolidated statements.
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4. Limitations of Consolidated Financial Statements

Some of the more important limitations of consolidated financial statements are:
1. The masking of poor performance: Because the operating results and financial position of
individual companies included in the consolidation are not disclosed, the poor performance or
financial position of one or more companies may be hidden by the good performance and
financial position of others.
2. Limited availability of resources: Not all of the consolidated retained earnings balance is
necessarily available for dividends of the parent because a portion may represent the parent’s
share of undistributed subsidiary earnings. Similarly, because the consolidated statements
include the subsidiary’s assets, not all assets shown are available for dividend distributions of
the parent company.

3. Unrepresentative combined financial ratios: Because financial ratios based on the

consolidated statements are calculated on aggregated information, they are not necessarily
representative of any single company in the consolidation, including the parent.

4. A lack of uniformity: Similar accounts of different companies that are combined in the
consolidation may not be entirely comparable. For example, the length of operating cycles of
different companies may vary, causing receivables of similar length to be classified differently.

5. The lack of detailed disclosures: Additional information about individual companies or

groups of companies included in the consolidation often is necessary for a fair presentation;
such additional disclosures may require voluminous footnotes.

5. Subsidiary Financial Statements

Some financial statement users may be interested in the separate financial statements of
individual subsidiaries, either instead of or in addition to consolidated financial statements.
Although the parent company’s management is concerned with the entire consolidated entity
as well as individual subsidiaries, the creditors, preferred stockholders, and non controlling
common stockholders of subsidiary companies are most interested in the separate financial
statements of the subsidiaries in which they have an interest. Because subsidiaries are legally
separate from their parents, a subsidiary’s creditors and stockholders generally have no claim
on the parent and the subsidiary’s stockholders do not share in the parent’s profits unless the
parent has provided guarantees or entered into other arrangements for the benefit of the
subsidiaries. Therefore, consolidated financial statements usually are of little use to those
interested in obtaining information about the assets, capital, or income of individual
subsidiaries.

6. Consolidated Financial Statements: Concepts and Standards (Understand and

explain how direct and indirect control influence the consolidation of a subsidiary)
Consolidated financial statements are intended to provide a meaningful representation of the
overall financial position and activities of a single economic entity comprising a number of
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related companies. Under current standards, subsidiaries must be consolidated unless the parent
is precluded from exercising control. When it is not appropriate to consolidate a subsidiary, it
is reported as an intercompany investment (ASC 810-10-10, 15, 25). Under current standards,
subsidiaries must be consolidated unless the parent is precluded from exercising control. When
it is not appropriate to consolidate a subsidiary, it is reported as an inter corporate investment.

Traditional View of Control

Over the years, the concept of control has been the single most important criterion for
determining when an individual subsidiary should be consolidated. ASC 810-10-10-10
indicates that consolidated financial statements normally are appropriate for a group of
companies when one company “has a controlling financial interest in the other companies.” It
also states that “the usual condition for a controlling financial interest is ownership of a
majority voting interest. . . .” In practice, control has been determined by the proportion of
voting shares of a company’s stock owned directly or indirectly by another company. This
criterion was formalized by ASC 810-10-15, which requires consolidation of all majority-
owned subsidiaries unless the parent is unable to exercise control.

Indirect Control
The traditional view of control includes both direct and indirect control. Direct control
typically occurs when one company owns a majority of another company’s common stock.

Indirect control or pyramiding occurs when a company’s common stock is owned by one or
more other companies that are all under common control. In each of the following examples, P
Company controls Z Company. However, in each case, P Company does not own a direct
interest in Z. Instead, P controls Z indirectly through the ownership of other companies.
P----------X-----------Z
80% 60%

Ability to Exercise Control

Under certain circumstances, a subsidiary’s majority stockholders may not be able to exercise
control even though they hold more than 50 percent of its outstanding voting stock. This might
occur, for instance, if the subsidiary was in legal reorganization or in bankruptcy; although the
parent might hold majority ownership, control would rest with the courts or a court-appointed
trustee. Similarly, if the subsidiary were located in a foreign country and that country had
placed restrictions on the subsidiary that prevented the remittance of profits or assets back to
the parent company, consolidation of that subsidiary would not be appropriate because of the
parent’s inability to control important aspects of the subsidiary’s operations.

Differences in Fiscal Periods

A difference in the fiscal periods of a parent and subsidiary should not preclude consolidation
of that subsidiary. Often the subsidiary’s fiscal period, if different from the parent’s, is changed
to coincide with that of the parent. Another alternative is to adjust the financial statement data
of the subsidiary each period to place the data on a basis consistent with the parent’s fiscal
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period. Both the Securities and Exchange Commission and current accounting standards permit
the consolidation of a subsidiary’s financial statements without adjusting the fiscal period of
the subsidiary if that period does not differ from the parent’s by more than three months and if
recognition is given to intervening events that have a material effect on financial position or
results of operations.

7. What must be done if the fiscal periods of the parent and its subsidiary are not
the same?
A-While it is not considered appropriate to consolidate if the fiscal periods of the parent and
subsidiary differ by more than 3 months, a difference in time periods cannot be used as a means
of avoiding consolidation. The fiscal period of one of the companies must be adjusted to fall
within an acceptable time period and consolidated statement prepared.

8. Non-controlling Interest

A parent company does not always own 100 percent of a subsidiary’s outstanding common
stock. The parent may have acquired less than 100 percent of a company’s stock in a business
combination, or it may originally have held 100 percent but sold or awarded some shares to
others. For the parent to consolidate the subsidiary, only a controlling interest is needed. Those
shareholders of the subsidiary other than the parent are referred to as “non controlling” or
“minority” shareholders. The claim of these shareholders on the income and net assets of the
subsidiary is referred to as the non controlling interest or the minority interest. whenever
the acquired company is less-than-wholly-owned, we will frequently refer to the non
controlling interest shareholders as the “NCI shareholders (Non-controlling interest).” The NCI
shareholders clearly have a claim on the subsidiary’s assets and earnings through their stock
ownership. Because 100 percent of a subsidiary’s assets, liabilities, and earnings is included in
the consolidated financial statements, regardless of the parent’s percentage ownership, the NCI
shareholders’ claim on these items must be reported.

9. Computation and Presentation of Non-controlling Interest (Follow text book page

106-107, required for mathematical purpose)

10. The Effect of a Non-controlling Interest (Follow text book page 107-110, required
for mathematical purpose)

11. Consolidated Balance Sheet with a Less-Than Wholly-Owned Subsidiary(Follow

text book page 110-113, required for mathematical purpose)

12. Consolidation Subsequent to Acquisition—80 Percent Ownership Acquired at

Book Value(Follow text book page 113-119, required for mathematical purpose)
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13. Combined Financial Statements

Financial statements are sometimes prepared for a group of companies when no one company
in the group owns a majority of the common stock of any other company in the group. Financial
statements that include a group of related companies without including the parent company or
other owner are referred to as combined financial statements.

Combined financial statements are commonly prepared when an individual, rather than a
corporation, owns or controls a number of companies and wishes to include them all in a single
set of financial statements. In some cases, a parent company may prepare financial statements
that include only its subsidiaries, not the parent. In other cases, a parent may prepare financial
statements for its subsidiaries by operating group, with all the subsidiaries engaged in a
particular type of operation, or those located in a particular geographical region, reported
together.

14. Special-Purpose and Variable Interest Entities (Understand and explain rules
related to the consolidation of variable interest entities).
A variable interest entity (VIE) is a legal structure used for business purposes, usually
a corporation, trust, or partnership, that either (1) does not have equity investors that have
voting rights and share in all of the entity’s profits and losses or (2) has equity investors
that do not provide sufficient financial resources to support the entity’s activities. In a
variable interest entity, specific agreements may limit the extent to which the equity
investors, if any, share in the entity’s profits or losses, and the agreements may limit the
control that equity investors have over the entity’s activities. For the equity investment to
be considered sufficient financial support for the entity’s activities (condition 2), it must be
able to absorb the entity’s expected future losses. A total equity investment that is less than
10 percent of the entity’s total assets is, in general, considered to be insufficient by itself to
allow the entity to finance its activities, and an investment of more than 10 percent might
be needed, depending on the circumstances.

(For more detailed follow text book page 120-123)

Practical Problem and Solution

E3-5 Solution:
a. 4,70,000=4,70,000-44,000(Cash Outlay)+44,000(Investment).
b. 6,16,000=4,70,000-44,000(Investment)+1,90,000.
c. 4,05,000=2,70,000+1,35,000
d. 2,11,000
Acquisition price----------------------44,000
/ Percent purchase--------------------80%
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Total fair value of Bristol co. Na-55,000

NCI of Bristol co………………………………11,000
Guild co. stock holders’ equity………………..2, 00,000
Total consolidated stockholders equity……….2, 11,000

E3-6 Solution:
a. 6, 31,500=5, 10,000+1, 21,500(Investment).
b. 8, 60,000=5, 10,000+3, 50,000.
c. 6,56,500=(3,20,000+1,21,500)+2,15,000
d. 2,03,500
Acquisition price--------------------1, 21,500
/ Percent purchase--------------------90%
Total fair value of Bristol co. Na-1, 35,000
NCI of Bristol co………………………………13,500
Guild co. stock holders’ equity………………..1, 90,000
Total consolidated stockholders equity………..2, 03,500

E3-17 Solution:
Equity Method Entries on Banner Crops Books
Investment in Dwyer Co…….1, 36,000
Cash………………………………1, 36,000
(Record the initial investment in Dwyer co.)
Book value calculations:

Ending Book Value at Acquisition = NCI 20%+ Banner Crop.80%=Common stock+ Retained
earnings
=34,000+136,000=90,000+80,000.
SO, Goodwill=0, Identifiable excess=0, 80% Book Value=1, 36,000.
1, 36,000 is initial investment in Dwyer Co.
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Basic Consolidation Entry:

Common stock 90,000
Retained earnings 80,000
Investment in Dwyer Co 1, 36,000
NCI in NA Dwyer Co. 34,000

Balance Sheet Banner Dwyer Consolidation Consolidation

Crop Co. Entries
Dr. Cr
Cash 74,000 20,000 94,000
Account Receivable 1,20,000 70,000 1,90,000
Inventory 1,80,000 90,000 2,70,000
Fixed Assets (Net) 3,50,000 2,40,000 5,90,000
Investment in Dwyer Co. 1,36,000 1,36,000
Total Assets 8,60,000 4,20,000 0 1,36,000 11,44,000
Accounts Payable 65,000 30,000 95,000
Notes Payable 3,50,000 2,20,000 5,70,000
Common Stock 1,50,000 90,000 90,000 1,50,000
Retained Earnings 2,95,000 80,000 80,000 2,95,000
NCI in NA Dwyer Co 34,000
Total liabilities and 8,60,000 4,20,000 1,70,000 34,000 11,44,000
Equities

Banner Corporation and Its Subsidiary

Consolidated Balance Sheet
December 31, 20X8

Cash(74,000+20,000)……………………………………………………94,000
Account Receivable(1,20,000+70,000)…………………………….…1,90,000
Inventory(1,80,000+90,000)…………………………………………..2.70,000
Fixed Assets (Net) (3,50,000+2,40,000)………………………………5,90,000
Total Assets…………………………………………………………..11,44,000

Accounts Payable(65,000+30,000)………………………………….….95,000
Notes Payable(3,50,000+2,20,000)………………………………….5,70,000
Common Stock……………………………………………………….1,50,000
Retained Earnings…………………………………………………….2,95,000
Total liabilities and Equities…………………….....……………….11,44,000
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3-18 Solution:
a. Net identifiable assets: 7,20,0,000 = 520,000 + 2, 00,000
b. Non-controlling interest: 50,000 = 200,000 x .25

P3-24 Solution:
Consolidated net income $164,300
Income of subsidiary ($15,200 / .40) (38,000)
Income from Tally's operations $126,300

P3-24 Solution:
a. The investment balance reported by Roof will be $192,000.
b. Total assets will increase by $310,000.
c. Total liabilities will increase by $95,000.
d. The amount of goodwill for the entity as a whole will be $25,000
[($192,000 + $48,000) - ($310,000 - $95,000)].
e. Non-controlling interest will be reported at $48,000 ($240,000 x .20).

P3-24 Solution:
a. 57,000=(1,20,000-25,000)x.60
b. 81,000=(1,20,000-25,000)+40,000-54,000
c. 48,800= (1, 20,000-25,000)+27,000-73,200.

Home Task-E3-7, 8, P3-33.