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Chapter 4

Consolidation
Techniques and
Procedures
Consolidation Techniques:
Objectives

1. Prepare consolidation workpaper for the


year of acquisition when the parent uses
the complete equity method to account for
its investment in a subsidiary.
2. Prepare a consolidation workpaper for the
years subsequent to acquisition.
3. Locate errors in a consolidation workpaper.
4. Record fair values to identifiable net assets
acquired.

© Pearson Education Limited 2015 4-2


Objectives (continued)

5. Prepare a consolidated statement of cash


flows.
6. (Students) Create an electronic
spreadsheet to prepare a consolidation
workpaper
7. Appendix: Understand the alternative trial
balance consolidation workpaper format.

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Consolidation Techniques and Procedures

1: ACQUISITION-YEAR
WORKPAPER

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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

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Completing the Worksheet (1 of 2)

1. Enter Parent and Sub. amounts at 100% of


book value. (Even if parent owns less)
2. Enter elimination entries into the DR and
CR columns. (Check totals)
3. For consolidated revenues, liabilities, and
equity (other than ending retained
earnings):
– Add parent, subsidiary, less DR, plus CR
4. For consolidated assets:
– Add parent, subsidiary, plus DR, less CR

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Completing the Worksheet (2 of 2)

5. For income, ending retained earnings and


all subtotals and totals:
– Compute directly in consolidated column.

Note:
– The total consolidated assets should equal the
total consolidated liabilities and equity.
– Expenses on the income statement and dividends
on the statement of retained earnings are
generally shown as negative numbers. So
compute the consolidated amounts as you would
for revenues.
© Pearson Education Limited 2015 4-7
Workpaper 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 differentials
7. Eliminate other reciprocal balances

© Pearson Education Limited 2015 4-8


Example: Pep & Sap Data

Pep pays $176 for 80% of Sap on 1/1/2011


when Sap's equity consisted of $120 capital
stock and $60 retained earnings. All excess
was due to unrecorded patents with a 10-
year life.

Sap's income and dividends follow:


2011 2012
Net income $50 $60
Dividends $30 $30

© Pearson Education Limited 2015 4-9


Analysis

Cost of 80% of Sap $176 Allocated to: Amt Amort.


Implied value of Sap Patents $40 10 yrs
($176/.80) $220
Book value (120+60) 180
Excess $40

Unamort.
Unamort. Bal. Amortization Bal. Amortization Unamort. Bal.
on
on 1/1/2011 in 2011 12/31/2011 in 2012 on 12/31/2012
Patents $40 $4 $36 $4 $32

Use these amounts Use these amounts in


in 2011 worksheet 2012 worksheet for
for amortization amortization expense
expense and and patents.
patents.

© Pearson Education Limited 2015 4-10


Income & Dividend Calculations
2011:
Sap's net income $50 Pep's 80% share
Amortization (4) $36.8
Adjusted income $46 $24.0 NCI 20% share
$9.2
Dividends $30 $6.0

2012:
Sap's net income $60 Pep's 80% share
Amortization (4) $44.8
Adjusted income $56 $24.0
NCI 20% share
$11.2
Dividends $30 $6.0

© Pearson Education Limited 2015 4-11


Pep's 2011 Worksheet Entries (1 of 3)

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 Sap (-R, -SE) 36.8

Dividends (+SE) 24.0

Investment in Sap (-A) 12.8

© Pearson Education Limited 2015 4-12


Pep 2011: Entries (2 of 3)

4. Record noncontrolling interest in sub.'s earnings &


dividends
Noncontrolling interest share (-SE) 9.2
Dividends (+SE) 6.0
Noncontrolling interest (+SE) 3.2
5. Eliminate reciprocal Investment & sub.'s equity
balances
Capital stock, Sap (-SE) 120
Retained earnings, Sap (beginning) (-SE) 60
Patents (+A) 40
Investment in Sap (-A) 176
Noncontrolling interest (+SE) 44

© Pearson Education Limited 2015 4-13


Pep 2011: Entries (3 of 3)

6. Amortize fair value/book value differentials


Amortization Expense (E, -SE) 4
Patents (-A) 4

7. Eliminate other reciprocal balances


• none

Note that in the 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 Limited 2015 4-14


Pep's 2011 Worksheet

Year ended 12/31/2011c Pep Sap DR CR Consol


Income statement:          
Revenues 500.0 130.0     630.0
Income from Sap 36.8   36.8   0.0
Expenses (400.0) (80.0) 4.0   (484.0)
Noncontrolling interest share     9.2   (9.2)
Net income/ Controlling
share 136.8 50.0     136.8
Statement of retained
earnings:          
Beginning retained earnings 10.0 60.0 60.0   10.0
Add net income 136.8 50.0     136.8
Deduct dividends (60.0) (30.0)   24.0 (60.0)
        6.0  
Ending retained earnings 86.8 80.0 86.8

© Pearson Education Limited 2015 4-15


Balance sheet, 12/31/2011: Pep Sap DR CR Consol
Cash 78.0 20.0     98.0
Other current assets 180.0 100.0     280.0
Investment in Sap 188.8     12.8 0.0
        176.0  
Plant & equipment, net 500.0 140.0     680.0
Patents     40.0 4.0 36.0
Total 946.8 260.0     1,054.0
Liabilities 160.0 60.0     220.0
Capital stock 700.0 120.0 120.0   700.0
Retained earnings 86.8 80.0     86.8
Noncontrolling interest, Jan.1       44.0  
Noncontrolling interest, Dec. 31       3.2 47.2
Total 946.8 260.0     1,054.0

© Pearson Education Limited 2015 4-16


A Look at the Income Statement

Year ended 12/31/2011c Pep Sap DR CR Consol


Income statement:          
Revenues 500.0 130.0     630.0
Income from Sap 36.8   36.8   0.0
Expenses (400.0) (80.0) 4.0   (484.0)
Noncontrolling interest share     9.2   (9.2)
Net income/ Controlling
share 136.8 50.0     136.8
• Income from Sap is eliminated.
• Expenses are adjusted for 2011 amortization, - $4
on patents
• Noncontrolling interest is proportional to Pep's
Income from Sap since Pep uses the equity
method.
 $36.8 x .20/.80 = $9.2

© Pearson Education Limited 2015 4-17


A Look at Retained Earnings
Year ended 12/31/2011c Pep Sap DR CR Consol
Statement of retained
earnings:          
Beginning retained earnings 10.0 60.0 60.0   10.0
Add net income 136.8 50.0     136.8
Deduct dividends (60.0) (30.0)   24.0 (60.0)
        6.0  
Ending retained earnings 86.8 80.0 86.8

• Beginning retained earnings of Sap is eliminated.


• All of Sap'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 Limited 2015 4-18


A Look at Assets
– Investment in Sap is eliminated.
– Patents at the start of 2011 were $20, and current
amortization is $2; they are $18 at the end of 2011.
– The total is calculated in the consolidated column.

Balance sheet, 12/31/2011: Pep Sap DR CR Consol


Cash 78.0 20.0     98.0
Other current assets 180.0 100.0     280.0
Investment in Sap 188.8     12.8 0.0
        176.0  
Plant & equipment, net 500.0 140.0     680.0
Patents     40.0 4.0 36.0
Total 946.8 360.0     1,054.0

© Pearson Education Limited 2015 4-19


A Look at Liabilities & Equity
– Sap'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
Pep's Investment in Sap account.
• $94.4 x .20/.80 = $23.6

Balance sheet, 12/31/2011: Pep Sap DR CR Consol


Liabilities 160.0 60.0     220.0
Capital stock 700.0 120.0 120.0   700.0
Retained earnings 86.8 80.0     86.8
Noncontrolling interest, Jan.1       44.0  
Noncontrolling interest, Dec. 31       3.2 47.2
Total 946.8 260.0     1,054.0

© Pearson Education Limited 2015 4-20


Consolidation Techniques and Procedures

2: WORKPAPERS IN
SUBSEQUENT YEARS

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Analysis, for 2012

Cost of 80% of Sap $176 Allocated to: Amt Amort.


Implied value of Sap ($88/.80) $220 Patents $40 10 yrs
Book value (120+60) 180
Excess $40

Unamort. Amortization Unamort. Bal. Amortization Unamort.


Bal. Bal.
on in 2011 on 12/31/2011 in 2012 on
1/1/2011 12/31/2012
Patents $40 $4 $36 $24 $32

Use these amounts in Use these amounts


2011 worksheet for in 2012 worksheet
amortization expense for amortization
and patents. expense and
patents.

© Pearson Education Limited 2015 4-22


Income & Dividend Calculations

2011:
Sap's net income $50 Pep's 80% share
Amortization (4) $36.8
Adjusted income $46 $24.0 NCI 20% share
$9.2
Dividends $30 $6.0

2012:
Sap's net income $60 Pep's 80% share
Amortization (4) $44.8
Adjusted income $56 $24.0 NCI 20% share
$11.2
Dividends $30 $6.0

© Pearson Education Limited 2015 4-23


Pep's Worksheet Entries for 2012 (1
of 3)
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 Sap (-R, -SE) 44.8

Dividends (+SE) 24.0

Investment in Sap (-A) 20.8

© Pearson Education Limited 2015 4-24


Pep 2012: Entries (2 of 3)

4. Record noncontrolling interest in sub.'s earnings &


dividends
Noncontrolling interest share (-SE) 11.2
Dividends (+SE) 6.0
Noncontrolling interest (+SE) 5.2
5. Eliminate reciprocal Investment & sub.'s equity
balances
Capital stock, Sap (-SE) 120
Retained earnings, Sap (beginning) (-SE) 80
Patents (+A) 36
Investment in Sap (-A) 188.8
Noncontrolling interest (+SE) 47.2

© Pearson Education Limited 2015 4-25


Eliminating Investment in Sap

Entry 5 eliminates the Investment in Sap and establishes the


Noncontrolling Interest as of the beginning of the current year.

Implied value of Sap at acquisition $176/.80 $220


Add the increase in retained earnings from 20
acquisition to the beginning of the current year
$80 at 1/1/2012 minus $60 at 1/1/2011

Less amortization for all prior periods (4)


$4 patent amortization for 2011
Adjusted value of Sap at 1/1/2012 $236

– Investment in Sap (80% x $236) = $188.8


– Noncontrolling interest (20% x $236) = $47.2
– Verify the $236 from the debits in Entry 5 (120 + 80 + 36).

© Pearson Education Limited 2015 4-26


Pep 2012: Entries (3 of 3)

6. Amortize fair value differentials

Amortization Expense (E, -SE) 4

Patents (-A) 4

7. Eliminate other reciprocal balances

Note payable – Pep (-L) 20

Note receivable – Sap (-A) 20

© Pearson Education Limited 2015 4-27


Pep's 2011 Worksheet

Year ended 12/31/2011 Pep Sap DR CR Consol


Income statement:          
Revenues 600.0 150.0     750.0
Income from Sap 44.8   44.8   0.0
Expenses (488.0) (90.0) 4.0   (582.0)
Noncontrolling interest share     11.2   (11.2)
Net income/ Controlling share 156.8 60.0     156.8
Statement of retained earnings:          
Beginning retained earnings 86.8 80.0 80.0   86.8
Add net income 156.8 60.0     156.8
Deduct dividends (90.0) (30.0)   24.0 (90.0)
        6.0  
Ending retained earnings 153.6 110.0 153.6

© Pearson Education Limited 2015 4-28


Balance sheet, 12/31/2012: Pep Sap DR CR Consol

Cash 90.0 40.0     130.0

Note receivable – Sap 20.0 20.0 0.0

Other current assets 194.0 140.0     334.0

Investment in Sap 209.6     20.8 0.0

        188.8  

Plant & equipment, net 480.0 120.0     600.0

Patents     36.0 4.0 32.0

Total 993.6 300.0     1,096.0

Note payable – Pep 20.0 20.0

Liabilities 140.0 50.0     190.0

Capital stock 790.0 120.0 120.0   700.0

Retained earnings 153.6 110.0     153.6

Noncontrolling interest, Jan.1       47.2  

Noncontrolling interest, Dec. 31       5.2 52.4

Total 993.6 300.0     1,096.0

© Pearson Education Limited 2015 4-29


Consolidation Techniques and Procedures

3: ERRORS IN THE
WORKPAPERS

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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 Limited 2015 4-31


Consolidation Techniques and Procedures

4: ASSIGNING FAIR VALUE

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Example with Excess Allocated

Pat pays $360 for 90% of Sol on 12/31/2011


when Sol's equity consisted of $200 capital stock
and $50 retained earnings. Inventory (sold in
2011), land, and buildings (20 years) were
undervalued by $10, $30, and $80, respectively.
Equipment (10 years) was overvalued by $20.
Sol's income and dividends for 2012 were $60
and $20.
At year-end, Sol has dividends payable of $10
which Pat has not yet recorded. There is $20 cash
in transit from Sol to Pat for the note.

© Pearson Education Limited 2015 4-33


Analysis at Acquisition
$36 Allocated to: Amt Amort
Cost of 90% of Sol 0 Inventories $10 1st yr
Implied value of Sap ($360/.90) $400 Land 30 -
Book value (200+50) 250 Building 80 20 yrs
$15 Equipment (20) 10 yrs
Excess 0
Goodwill 50 -
  150  
Noncontrolling interest,
10%(400) $40

  Unamort. Bal. Amortization Unamort. Bal.


  12/31/2011 * in 2012 * on 12/31/2012
* Use the
Inventories $10 ($10) $0
12/31/2011
Land 30 0 30
and 2012
amortization
Building 80 (4) 76
in worksheet
Equipment (20) 2 (18)
entries for
Goodwill 50 0 50
2012.
  $150 ($12) $138

© Pearson Education Limited 2015 4-34


Sol's Income & Dividend

  2012
Sol's net income $60
Pat's 90% share
Amortization ($12) $43.2
Adjusted $18.0
income $48
   
Sol's dividends $20

NCI 10% share


$4.8
$2.0

© Pearson Education Limited 2015 4-35


Pat's Worksheet Entries (1 of 4)
1. Adjust for errors & omissions

Dividends receivable (+A) 9.0


Investment in Sol (-A) 9.0
Cash (+A) 20.0
Note receivable, Sol (-A) 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 Sol (-R, -SE) 43.2


Dividends (+SE) 18.0
Investment in Sol (-A) 25.2

© Pearson Education Limited 2015 4-36


Pat: Entries (2 of 4)

4. Record noncontrolling interest in sub.'s earnings &


dividends
Noncontrolling interest share (-SE) 4.8
Dividends (+SE) 2.0
Noncontrolling interest (+SE) 2.8

5a. Eliminate reciprocal Investment & sub.'s equity


balances (with unamortized excess)
Capital stock (-SE) 200
Retained earnings, Sol (beginning) (-SE) 50
Unamortized excess (+A) 150
Investment in Sol (-A) 360
Noncontrolling interest (+SE) 40

© Pearson Education Limited 2015 4-37


Pat: Entries (3 of 4)

5b. Allocate the unamortized excess


according to beginning-of-year balances.
Cost of Goods Sold (-SE) 10

Land (+A) 30

Building, net (+A) 80

Goodwill (+A) 50

Equipment, net (-A) 20

Unamortized excess (-A) 150

© Pearson Education Limited 2015 4-38


Pat: Entries (4 of 4)

6. Amortize fair value/book value differentials

Operating (depreciation) expense (E, -SE) 4


Buildings, net (-A) 4
Equipment, net (-A) 2
Operating (depreciation) expense (-E, 2
SE)

7. Eliminate other reciprocal balances

Dividends payable (-L) 9.0


Dividends receivable (-A) 9.0

© Pearson Education Limited 2015 4-39


Pat's 2012 Worksheet
Year ended 12/31/2012 Pat Sol DR CR Consol
Income statement:          
Revenues 900.0 300.0     1,200.0
Income from Sol 43.2   43.2   0.0
Cost of goods sold (600.0) (150.0) 10.0   (760.0)
Operating expenses (190.0) (90.0) 4.0 2.0 (282.0)
Noncontrolling interest share     4.8   (4.8)
Net income/ Controlling 153.2 60.0     153.2
share
Statement of retained          
earnings:
Beginning retained earnings 120.0 50.0 50.0   120.0
Add net income 153.2 60.0     153.2
Deduct dividends (100.0) (20.0)   18.0 (100.0)
        2.0  
Ending retained earnings 173.2 90.0     173.2

© Pearson Education Limited 2015 4-40


Balance sheet, 12/31/2012: Pat Sol DR CR Consol
Cash 13.0 15.0 20.0   48.0
Accounts receivable, net 76.0 25.0     101.0
Note receivable – Sol 20.0     20.0 0.0
Inventories 90.0 60.0 10.0 10.0 150.0
Land 60.0 30.0 30.0   120.0
Building, net 190.0 110.0 80.0 4.0 376.0
Equipment, net 150.0 120.0 2.0 20.0 252.0
Investment in Sol 394.2     9.0 0.0
        25.2  
        360.0  
Dividends receivable     9.0 9.0 0.0
Goodwill     50.0   50.0
Unamortized excess     150.0 150.0 0.0
Total 993.2 360.0     1,097.0
Accounts payable 120.0 60.0     180.0
Dividends payable   10.0 9.0   1.0
Capital stock 700.0 200.0 200.0   700.0
Retained earnings 173.2 90.0     173.2
Noncontrolling interest, Jan.1       40.0  
Noncontrolling interest, Dec. 31       2.8 42.8
Total 993.2 360.0     1,097.0

© Pearson Education Limited 2015 4-41


Consolidation Techniques and Procedures

5: CONSOLIDATED
STATEMENT OF CASH
FLOWS

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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 Limited 2015 4-43


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 Limited 2015 4-44


Operating Cash Flows

Direct method:
– Include cash dividends received from equity
investees (not equity method income)
Indirect method:
– Start with controlling share of net income
– Add the noncontrolling interest share
– Deduct the excess of equity method income over
cash dividends received from equity investees

© Pearson Education Limited 2015 4-45


Consolidation Techniques and Procedures

7: APPENDIX – TRIAL
BALANCE FORMAT

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Alternative (Trial Balance)
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 Limited 2015 4-47


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 controlling share of income to the retained
earnings column.
5. Move ending retained earnings to the balance
sheet column.

© Pearson Education Limited 2015 4-48

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