CHAPTER THREE

CONSOLIDATED FINANCIAL
STATEMENT: SUBSEQUENT
TO THE DATE OF BUSINESS
COMBINATION
PREPARED BY: HASSEN
MUSTEFA
 3.1. INTRODUCTION
• Subsequent to date of a business combination the parent
company accounts for operating results of subsidiary.
• That is it accounts for:
1. Net income or net loss, and
2. Dividends declared and paid by subsidiary
• In addition, a number of intercompany transactions and
event that frequently occur in a Parent- Subsidiary
relationship shall be recorded.
• All the three basic financial statements must be
consolidated for accounting periods subsequent to the
date of purchase type business combination.
3.2. METHOD OF ACCOUNTING
FOR CFS
A parent company may choose the Equity
Method or the Fair Value Method to
account for the operating results of
consolidated purchased subsidiaries.
 1. EQUITY METHOD

• The Parent company records its share of

subsidiary’s net income or net loss, adjusted for
depreciation and amortization of differences
between current fair values and carrying
amounts of a purchased subsidiary’s net asset
on the date of business combination, as well as
its share of dividends declared by subsidiary.
• Proponents claim that equity method stresses
the economic substance of the parent-
subsidiary relationship. 4
 Cont.…

• Proponents of the method maintain that the

method is consistent with the accrual basis of
accounting.
• Dividends declared by a subsidiary do not
constitute revenue to the parent company.
• It recognizes increases or decreases in the
carrying amount of the parent company’s
investment in the subsidiary
• When they are realized by the subsidiary as net
income or net loss, not when they are paid by the
subsidiary as dividends
 SAMPLE EQUITY METHOD

Initial Investment---Investment in S……………………….XX

Cash/other
assets………………………….XX
 Net Income ---------Investment in S………………………...XX
Income from
S……………………..….XX

 Net Loss -------------Loss from S…………………….……...XX

Investment in S………………….
…...XX

 Dividend ------------Dividend receivable/ cash….…...XX

Investment in S…………..…….
6
…...XX
 2. FAIR VALUE METHOD
• Parent company accounts for the operations
of a subsidiary only to the extent that
dividends are declared by the subsidiary.
• Net income or net loss of the subsidiary is
not recognized by the parent company.
• Supporters of the method contend that the
method appropriately recognizes the legal
form of parent – subsidiary relationship.

7
 Cont.…
• Dividends declared by subsidiary are
recognized as revenue by the parent
company.
• The general accounting and reporting rule for
these investments is to value the securities at
fair value and record gains and losses in
PROFIT OR LOSS.
 SAMPLE FAIR VALUE METHOD

Initial Investment---Investment in S…………….….XX

Cash/other assets…………….…..XX
 Net Income --------- NO JOURNAL ENTRY
 Net Loss ------------ NO JOURNAL ENTRY
 Dividend ------------Dividend receivable/ cash…..……...XX
Dividend income………….
……….…...XX
Fair value adjustment:
Increase In Fair Value: Investment In S………………….Xx
Gain From Fair Value
Adjustment…………..Xx
Decrease In Fair Value: Loss From Fair Value 9
 EXAMPLE
• Arthur Company invested Br 400,000.00
for a 80% interest in ARBE Company on
January 1, 2019. At December 31, 2019,
ARBE reported a Net Income of Br
300,000.00 and also on December 21, 2019
it declared a dividend of Br 100,000.00. At
December 31, 2019, the Fair Value of
Arthur’s 80% Share Was Br 600,000.

10
 ELIMINATIONS AND
ADJUSTMENTS FOR EQUITY
METHOD
The items that must be included in the
elimination are:
1. Three components of the subsidiary’s
stockholders’ equity are reciprocal to
the parent company’s Investment
Ledger Account.
2. The subsidiary’s beginning-of-year
retained earnings amount is
 Cont..
3. The debits to the subsidiary’s plant assets,
patent, and goodwill bring into the
consolidated balance sheet the un-amortized
differences between current fair values and
carrying amounts of the subsidiary’s assets on
the date of the business combination.
4. The amount of the parent company’s inter-
company investment income is an element of
the balance of the parent’s Investment Ledger
Account.
 CONT…
5. Subsidiary’s dividends are an offset to
the subsidiary’s retained earnings.
6. The balance of the parent company’s
Investment Ledger Account is net of the
dividends received from the subsidiary.
7. The elimination of the subsidiary’s
beginning-of-year retained earnings makes
beginning-of-year consolidated retained
earnings identical to the end-of-previous-
 SUMMARY OF ELIMINATION AND
ADJUSTMENT ENTRIES
1. The basic elimination entry:
Common Stock (S) XX
Additional Paid-in Capital (S) XX
Retained Earnings, Beginning Balance (S) XX
Income from Sub XX
Investment in Sub BV
Dividends Declared XX

2. The excess value reclassification entry:

Asset 1 XX
Asset 2 XX
Goodwill XX
Investment in Sub Excess
 SUMMARY OF ELIMINATION AND
ADJUSTMENT ENTRIES
3. The amortized excess value reclassification entry:
Cost of Sales XX
Other Expenses XX
Income from Sub XX
This entry reclassifies the equity method amortization of cost
in excess of book from Income from Sub to the appropriate
expense accounts where the costs would have been had the
sub used FMV instead of BV.

4. The accumulated depreciation elimination entry:

Accumulated Depreciation XX
Buildings and Equipment XX
 EXAMPLE 1
Pan Corp. purchased 100% of the voting interest of Sen on
Jan. 1, 2010 for Br 750,000 Cash.
Sen Corporation’s Statement of Financial Position
 CONT…
Fair Value of Assets of Sen at Jan. 1, 2010
Inventory Br 105,000 Building Br 220,000 EEL of 10
Years
Other Current 100,000 Machin 40,000 EEL of 10
Asset ery Years
Land 160,000
Additional Information
1. Pan uses the Equity Method of Accounting.

2. Sen’s Dec. 31, 2010, Net Income and Dividend Payments

were Br 140,000 and Br 100,000, Respectively.
3. Sen’s Inventory was sold during 2010.
 Cont..
January 1, 2010: Investment in Sen……750,000
Cash………………………………….750,000
Goodwill Calculation
 Goodwill = Acquisition Cost – Fair Value of Net Identifiable Asset(FVNIA)

FVNIA = Fair Value of Assets – Fair Value of Liabilities

FVNIA = (105,000 + 100,000 + 160,000 + 220,000 + 40,000) - (100,000)

= Br 625,000 – Br 100,000= Br 525,000

 Goodwill = Br 750,000 – Br 525,000 = Br 225,000

 Cont.…
Elimination and Adjustment Entry for Jan. 1/ 2010
Common Stock…………………………………………………………..300,000
Retained Earning………………………………………………………..200,000
Inventory………………………………………………………………………
5,000
Land…………..
………………………………………………………………….10,000
Building…………………………………………………………………………
20,000

Goodwill……………………………………………………………………….225,000
Investment in
Starr……………………………………………….750,000
Machinery………………….……..
……………………………..……….10,000
 Cont..
Dec. 31, 2010
Sen: Dividend Declared………..100,000

Cash……………………………….100,000
Pan: 1. Investment in Sen……..….140,000
Income from Sen……………140,000
2. Cash……………………………100,000
Investment in Sen……….100,000
 Cont..
Adjustments for Previously increased or decreased assets
Jan. 1/ 2010 Expensed Dec. 31/2010

Inventor Increased By CGS= 5,000 (B/C Inventory 0

y 5,000 was sold )
Land Increased By Zero (B/C Land is 10,000
10,000 Undepreciated Asset)
Building Increased By 20,000/10 = 2,000 18,000
20,000
Machiner Decreased By 10,000/10 = 1,000 9,000
y 10,000
Total Expense Increased by 6,000 = (5,000+2,000-1000)
 Cont..
After the adjustment total expenses of Sen increased
by 6,000. So, the following adjustment will be made
at Dec. 31/2010:
Income from Sen………….6,000
Investment
Investment in Sen
in Sen………….6,000
Income from Sen
Br 750,000 Br 100,000
Br 6,000 Br 140,000
140,000 6,000
Br 134,000
Br 890,000 Br 106,000
Br 784,000
 Cont.…
Elimination and Adjustment Entry for Dec. 31/ 2010
Common Stock…………………………………………………………..300,000
Retained Earning………………………………………………………..200,000
Cost of Goods Sold…………………………………………………………5,000
Land…………..………………………………………………………………….10,000
Building…………………………………………………………………………18,000
Income from Sen…………………………………………………….…..134,000
Operating Expenses………………………………………………………..1,000
Goodwill……………………………………………………………………….225,000
Investment in
Starr……………………………………………….784,000
Machinery………………….……..……………………………..
……….9,000
Dividend
Declared………………………………………………..…100,000
 Example 2
1. Assume that Starr Company had net income of
Br 60,000 for the year ended December 31, 2003,
and dividends of Br 24,000 are declared on
December 20, 2003.
2. Adjustments
Cont.…
CONT…
 Cont..

STARR:
Dec. 20, 2003: Dividend Declared………..24,000
Dividend
Payable………………………….24,000
PALM:
Dec. 20, 2003: Dividend Receivable………………24,000
Investment in Starr……….24,000

Dec. 31, 2003: Investment. in Starr……..….60,000

Income from Starr……………60,000
 Cont..
Adjustments for Previously increased or decreased assets
Dec. 31/ Expensed Dec. 31/2003
2002
Inventor Increased By CGS= 25,000 (B/C Inventory 0
y 25,000 was sold )
Land Increased By Zero (B/C Land is Undepreciated 15,000
15,000 Asset)
Building Increased By 30,000/10 = 3,000 27,000
30,000
Machiner Increased By 20,000/10 = 2,000 18,000
Patent Increased By 5,000/5 = 1,000 4,000
y 20,000
5,000
Goodwill Increased By 0 (No Impairment of Goodwill) 15,000
15,000
Total Expense Increased by 31,000 = (25,000+3,000+2,000+1,000)
Cost of Goods Sold is Br 25,000 and Operating Expense is Br 6,000

Total Plant Asset Increased By 60,000 =

(15,000+27,000+18,000)
 Cont..
After the adjustment total expenses of Starr
increased by 31,000. So, Its Net Income Decreased
by 31,000. The following adjustment will be made at
Dec. 31/2003:
Income from Starr………….31,000
Investment in Starr………….31,000
Investment in Sen Income from Sen
Br 500,000 Br 24,000
Br 31,000 Br 60,000
60,000 31,000
Br 560,000 Br 55,000 Br 29,000
Br 505,000
 Cont.…
Elimination and Adjustment Entry for Dec. 31/ 2003
Common Stock…………………………………………………………..200,000
Retained Earning………………………………………………………..132,000
Additional Paid In Capital-In Excess of Capital…………...58,000
Dividend Payable………………………………………………………….24,000
Cost of Goods Sold………………………………………………………25,000
Plant Asset……………………………………………………………………60,000
Patent……………………………………………………………………………..4,000
Income from Starr…………………………………………………….…29,000
Operating Expenses………………………………………………………..6,000
Goodwill………………………………………………………………………….15,000
Investment in
Starr……………………………………………….505,000
Dividend
Declared………………………………………………..…..24,000
Dividend Receivable………………………………………….
………24.000
Cont…
CONT…
 Example 3
1. Assume that on December 5, 2004 Sage
Company declared dividend of Br 1 per Share
Payable on December 19, 2004 and net
income of Sage for the year was Br 90,000.
2. Adjustments
Cont..
Cont..
 Cont..

SAGE:
Dec. 5, 2004: Dividend Declared………..40,000
Dividend
Payable………………………….40,000

Dec. 19, 2004: Dividend Payable…………………40,000

Cash…………………………………………….40,000
 Cont..

PALM:

Dec. 05, 2003: Dividend Receivable..(40,000 0.95)……38,000

Investment in Sage……….38,000

Dec. 19, 2003: Cash……………………38,000

Dividend Receivable…………………38,000

Dec. 31, 2003: Investment in Sage..(90,000 0.95)……..….85,500

Income from Sage……………
85,500
NCI’s Share of Dividend is Br 2,000
NCI’s Share of Net Income is Br 4,500
 Cont..
Adjustments for Previously increased or decreased assets
Dec. 31/ Expensed Dec. 31/2004
2003
Inventor Increased By CGS= 26,000 (B/C Inventory 0
y 26,000 was sold )
Land Increased By Zero (B/C Land is Undepreciated 60,000
60,000 Asset)
Building Increased By 80,000/20 = 4,000 76,000
80,000
Machiner Increased By 50,000/5 = 10,000 40,000
y 50,000
Leasehold Increased By 30,000/6 = 5,000 25,000
30,000
Goodwill Increased By 0 (No Impairment of Goodwill) 185,000
185,000
Total Expense Increased by 45,000 = (26,000+4,000+10,000+5,000)
Cost of Goods Sold is Br 26,000 and Operating Expense is Br 19,000
Total Plant Asset Increased By 176,000 =
 Cont..
After the adjustment total expenses of Starr
increased by 45,000. So, Its Net Income Decreased
by 45,000. The following adjustment will be made at
Dec. 31/2003:
Income from Sage…(45,000 0.95)….42,750
Investment in Sage………….42,750
NCI’s Share of Additional Expense is Br 2,250
Investment in Sage Income from Starr
Br 1,330,000 Br 38,000
85,500 42,750 Br 42,750 Br 85,500
Br 1,415,500 Br 80,750
Br 42,750
Br 1, 334,750
 Cont..

Non Controlling Interest NCI’s Share of Sage’s Net

Income
Br 2,000 Br 70,000 Br 2,250 Br 4,500
2,250 4,500
Br 2,250
Br 4,250 Br 74,500

Br 70,250
 Cont.…
Elimination and Adjustment Entry for Dec. 31/ 2003
Common Stock…………………………………………………………..400,000
Retained Earning……………………………………………………….334,000
Additional Paid In Capital-In Excess of Capital………….235,000
Cost of Goods Sold………………………………………………………26,000
Plant Asset………………………………………………………………….176,000
Leasehold….………………………………………………………………….25,000
Income from Starr…………………………………………………….…42,750
NCI’s Share of Sage’s Net Income………………………………….2,250
Operating Expenses……………………………………………………….19,000
Goodwill………………………………………………………………………..185,000
Investment in Sage.
…………………………………………….1,334,750
Non Controlling
Interest………………………………………….70,250
Dividend Declared…………………………………………..…..
…..40,000
Cont…
Cont…
 SUMMARY OF CFS
• In effect, the elimination of the inter-company investment
income comprises a reclassification of the inter-company
investment income to the adjusted components of the
subsidiary’s net income in the consolidated income statement.
• The increases in the subsidiary’s cost of goods sold and
operating expenses, in effect, reclassify the comparable
decrease in the parent company’s Investment ledger account
under the equity method of accounting.
• The inter-company receivable and payable, placed in adjacent
columns on the same line, are offset without a formal
elimination.
• The elimination cancels all inter-company transactions and
balances not dealt with by the offset described above.
 Cont..
• The elimination cancels the subsidiary’s retained
earnings balance at the beginning-of-year, so that
each of the three basic financial statements may be
consolidated in turn.
• The first-in, first-out method is used by subsidiary
to account for inventories; thus the difference
attributable to subsidiary’s beginning inventories is
allocated to cost of goods sold for the year ended.
• Income tax effects of the elimination’s increase in
subsidiary’s expenses are not included in the
elimination.
 Cont..
• One of the effects of the elimination is to reduce
the differences between the current fair values
and the carrying amounts of the subsidiary’s net
assets, except land and goodwill, on the
business combination date.
• The parent company’s use of the equity method
of accounting results in the equalities described
below:
• Parent Company Net Income = Consolidated
Net Income
 Cont..

• Parent Company Retained Earnings =

Consolidated Retained Earnings
• Despite the equalities, consolidated
financial statements are superior to
parent company financial statements
for the presentation of financial position
and operating results of parent and
subsidiary companies.