Chapter Four

Consolidated
Financial
Statements and
Outside
Ownership

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 Learning Objective 4-1

Understand that complete

ownership is not a prerequisite
for the formation of a business
combination.

4-2
 Noncontrolling Interest

 Although most parent companies do possess 100

percent ownership of their subsidiaries, a significant
number establish control with a lesser amount of stock.
 If the parent doesn’t own 100% of the company, WHO
owns the rest of it?
 Noncontrolling Shareholders
 The ownership interests of the Noncontrolling
Shareholders must be reflected in the consolidated
financial statements.

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 Learning Objective 4-2

Describe the valuation principles

underlying the acquisition
method of accounting for the
noncontrolling interest.

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 Noncontrolling Interest

The Parent, with controlling interest, must consolidate

100% of the Subsidiary’s financial information.
The acquisition method requires that the subsidiary be
valued at the acquisition-date fair value.
The total acquired firm fair value in a partial acquisition is
the sum of
 The fair value of the controlling interest.
 The fair value of the noncontrolling interest
at the acquisition date.

4-5
 Noncontrolling Interest Example

Assume Parker Corporation wants to acquire 90% of

Strong Company. Strong’s stock has been trading for
around $60 per share.
Parker has to pay a premium for the shares needed to
gain control.
If Parker pays $70 per share to induce enough
stockholders to sell, how will the 10% of Strong that
Parker does not own be recorded?

4-6
 Noncontrolling Interest Example

Parker purchased 9,000 shares at $70 per share. The fair

value of their consideration transferred is $630,000.
The remaining 1,000 shares trade at $60 per share indicating
that the fair value of the noncontrolling interest is $60,000.
The total acquisition-date fair value of the sub is $690,000.
Fair value of controlling interest :
($70 X 9,000 shares) . . . . . . . . . . . . . . . $630,000
Fair value of noncontrolling interest
($60 X 1,000 shares) . . . . . . . . . . . . . . . . . 60,000
Total fair value of sub. . . . . . . . . . . . . . $690,000

4-7
 Learning Objective 4-3

Allocate goodwill acquired in

a business combination across
the controlling and noncontrolling
interests.

4-8
Noncontrolling Interest Example

The total acquisition-date fair value (amount paid) of Strong of

$690,000 is greater than the fair value of the identifiable net
assets acquired of $600,000 (10,000 shares x $60 per share). The
difference is allocated to Goodwill.
The parent first allocates goodwill to its controlling interest for
the excess of the fair value of the parent’s equity interest over its
share of the fair value of the net identifiable assets. ($600,000 X
90% = 540, 000).
Goodwill allocated to the controlling and noncontrolling
interests will not always be proportional to the percentages
owned.

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 Noncontrolling Interest Example
Total acquisition-date fair value . . . . . . . . . . $690,000
Fair value of net identifiable net assets . . . . . (600,000)
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000

Assign Goodwill: Controlling Noncontrolling

Interest Interest
Fair value at acquisition date . . . . . $630,000 $60,000
Relative fair value of identifiable net
assets acquired ($600,000 X 90%). . (540,000) ----------
and ($600,000 X 10%) . . . . . . . . . . . . . --------- ($60,000)
Goodwill . . . . . . . . . . . . . . . . . . . . . . . $90,000 $0
There is no excess goodwill to assign to the noncontrolling
interest.
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Noncontrolling Interest - Example

If the shares were not actively traded, the $70 per

share consideration transferred by Parker would
be considered the best measure of fair value of
Strong, and the fair value of the noncontrolling
interest would be estimated at $70,000.

Fair value of controlling interest ($70 X 9,000 shares) . $630,000

Fair value of noncontrolling interest ($70 X 1,000 shares). 70,000
Total fair value of Strong Company . . . . . . . . . . . . . . . . $700,000

4-11
 Noncontrolling Interest - Example

Because the price per share paid by the parent

equals the noncontrolling interest per share fair
value, goodwill is recognized proportionately
across the two ownership groups.

Assign Goodwill: Controlling Noncontrolling

Interest Interest
Fair value at acquisition date . . . . . $630,000 $70,000
Relative fair value of identifiable net
assets acquired ($600,000 X 90%). . (540,000) ----------
and ($600,000 X 10%) . . . . . . . . . . . . . --------- ($60,000)
Goodwill . . . . . . . . . . . . . . . . . . . . . . . $90,000 $10,000

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 Learning Objective 4-4

Understand the computation

and allocation of consolidated
net income in the presence of a
noncontrolling interest.

4-13
 Allocating Subsidiary’s Net Income
The subsidiary’s net income (including excess acquisition-date
fair-value amortizations) must be allocated to its owners - the
parent and the noncontrolling interest - to properly measure
their respective equity in the consolidated entity.
Assume that the relative ownership percentages of the parent and
noncontrolling interest represent an appropriate basis for
attributing all elements (including excess acquisition-date fair-
value amortizations for identifiable assets and liabilities) of a
subsidiary’s income across the ownership groups.
Including the excess fair-value amortizations is based on the
assumption that the noncontrolling interest represents equity in the
subsidiary’s net assets as remeasured on the acquisition date.

4-14
 Noncontrolling Interest - Example
Strong earns $80,000 in the first year and there is a $30,000
annual excess fair value amortization.

The $5,000 noncontrolling interest in the sub’s net income is

subtracted from the combined entity’s consolidated net income
to derive parent’s interest in consolidated net income.
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 Learning Objective 4-5

Identify and calculate the four

noncontrolling interest figures
that must be included within
the consolidation process and
prepare a consolidation worksheet
in the presence of a noncontrolling
interest.
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 Noncontrolling Interests and Consolidations

The consolidation process remains substantially unchanged

with a noncontrolling interest. The parent company must
determine and then enter each of these figures when
constructing a worksheet:

Noncontrolling interest:
 In subsidiary at beginning of the current year.
 In subsidiary’s current year net income.
 In subsidiary’s current year dividend payments.
 In subsidiary as of the end of the year.
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Noncontrolling Interest - Example

Assume that King Co. acquires 80% of Pawn Co’s

100,000 outstanding voting shares on January 1, 2014,
for $9.75 per share or a total of $780,000 cash.
The shares are trading at an average of $9.75 per
share before and after the acquisition.
The total fair value of Pawn to be used initially in
consolidation is:

Consideration transferred by King. . . . . . $780,000

Noncontrolling interest fair value . . . . . . . .195,000
Pawn’s total fair value on Jan. 1, 2014 . . . $975,000

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 Noncontrolling Interest -
Excess Fair Value Allocations

4-19
 Noncontrolling Interest - Example

To complete the information needed for this combination,

assume that Pawn Company reports the following changes in
retained earnings since King’s acquisition:

Pawn Company changes in retained earnings since acquisition:

Net income - Current year (2015) . . . . . . . . . . . . $90,000
Less: Dividends declared. . . . . . . . . . . . . . . . . . . . .(50,000)
Increase in retained earnings (2015) . . . . . . . . . . $40,000
Prior years (2014) Increase in retained earnings. $70,000

4-20
 Noncontrolling Interest -
Worksheet Example

King uses the Equity Method to account for Pawn

subsequent to acquisition. The consolidation process is
substantially the same.

At each consolidation, worksheet entries S, A, I, D, and E

are prepare AND…

A column will be added to the worksheet to record the

noncontrolling interest in the subsidiary.

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Noncontrolling Interest -
Worksheet Example

4-22
Noncontrolling Interest –
Worksheet Example

4-23
Noncontrolling Interest –
Worksheet Example

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 Learning Objective 4-6

Identify appropriate placements

for the components of the
noncontrolling interest in
consolidated financial statements.

4-25
 Consolidated Financial Statement

1. Consolidated net income is computed at the combined entity

level and allocated to the noncontrolling and controlling
interests. The statement of changes in owners’ equity provides
details of the ownership changes for the year for both the
controlling and noncontrolling interest shareholders.
2. If appropriate, each component of other comprehensive income
is allocataed to the controlling and noncontrolling interest. The
statement of changes in owners’ equity would also provide an
allocation of accumulated other comprehensive income elements
across the controlling and noncontrolling interests.
3. Note the placement of the noncontrolling interest in the
subsidiary’s equity in the consolidated owners’ equity section.

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 Consolidated Financial Statement
Income Statement, Owners’ Equity

4-27
Consolidated Financial Statement
Balance Sheet

4-28
 Learning Objective 4-7

Determine the effect on consolidated

financial statements of a control
premium paid by the parent.

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 Noncontrolling Interest –
Premium Paid

If King had paid $11.00 for their shares, at a time

when they were trading for $9.75, then the goodwill
allocation would look like this:

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 Effects of using the
Initial Value Method

The initial value method employs cash basis for income

recognition.
The parent recognizes dividend income rather than an equity
income accrual.
Parent does not accrue the percentage of the sub’s income
earned in excess of dividends (the increase in subsidiary
retained earnings).
The parent does not record amortization expense, therefore it
must include it in the consolidation process if proper totals are
to be achieved.

4-31
 Effects of using the
Initial Value Method

If the Parent used the Initial Value Method to account for

the Sub after acquisition, Entry *C is used to convert to
the Equity Method.
The entry will combine the increase in the Sub’s Retained
Earnings since acquisition X the parent’s percentage of
ownership, and the parent’s share of amortization
expense since acquisition.
Entry D is not necessary.

4-32
 Effects of using the
Partial Equity Method

If the Parent used the Partial Equity Method

to account for the Subsidiary after
acquisition, Entry *C is used to convert to
the Equity Method.

Entry *C converts from the Partial Equity

Method to the Equity Method, but only the
adjustment for the parent’s share of
amortization expense is necessary.

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 Learning Objective 4-8

Understand the impact on

consolidated financial statements
of a midyear acquisition.

4-34
 Mid-Year Acquisitions

When control of a Sub is acquired at a time

subsequent to the beginning of the sub’s fiscal
year:
 The income statements are consolidated as usual
 The Sub’s pre-acquisition revenues and expenses are
excluded from the Parent’s consolidated statements
(adjusted via Entry S)
 Only a partial year’s amortization on excess fair value
is taken.

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 Learning Objective 4-9

Understand the impact on

consolidated financial statements
when a step acquisition
has taken place.

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 Step Acquisitions

A step acquisition occurs when control is achieved in

a series of equity acquisitions, as opposed to a single
transaction. As with all business combinations, the
acquisition method measures the acquired firm
(including the noncontrolling interest) at fair value
at the date control is obtained.
The parent utilizes a single uniform valuation basis
for all subsidiary assets acquired and liabilities
assumed—fair value at the date control is obtained.

4-37
 Step Acquisitions

If the parent held a noncontrolling interest in the

acquired firm, the parent remeasures that interest to
fair value and recognizes a gain or loss.
If after obtaining control, the parent increases its
ownership interest in the subsidiary, no further
remeasurement takes place. The parent simply
accounts for the additional subsidiary shares
acquired as an equity transaction—consistent with
transactions with other owners, as opposed to
outsiders.
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 Learning Objective 4-10

Record the sale of a subsidiary

(or a portion of its shares).

4-39
 Sales of Subsidiary Stock

What is reported on the consolidated statements

when a Parent sells some of its ownership in a
Subsidiary?

If the parent maintains control, it recognizes no

gains or losses – the sale is shown in the equity
section.
If the sale results in the loss of control, the parent
recognizes any resulting gain or loss in consolidated
net income.
4-40
 Sales of Subsidiary Stock

 If the parent retains any of its former sub’s shares, the

investment should be remeasured to fair value on the date
control is lost.
 Any resulting gain or loss from the remeasurement should be
recognized in the parent’s net income.
 If it sells less than the entire investment, parent must select a
cost-flow assumption if it has made more than one purchase.
 For securities, the use of specific identification based on serial
numbers is acceptable, although averaging or FIFO
assumptions often are applied.

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 Noncontrolling Interest –
International Accounting Standards
US GAAP vs.
U.S. GAAP requires fair
value measurement.
Thus, acquisition-date fair
value provides a basis for
reporting the
noncontrolling interest
which is adjusted for its
share of subsidiary income
and dividends subsequent
to acquisition.
IFRS
IFRS permits fair value
measurement, or the
noncontrolling interest may
be measured at a
proportionate share of the
Sub’s identifiable net asset
fair value, which excludes
goodwill. This option
assumes that any goodwill
created via acquisition
applies solely to the
controlling interest.
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