INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS

This chapter introduces combining the separate accounting records of the parent and
subsidiary into a more meaningful set of consolidated financial statements.
A corporation that owns more than 50 percent of the voting stock of another corporation
controls that corporation through its stock ownership, and a parent–subsidiary relationship
exists. When parent–subsidiary relationships exist, the companies are affiliated.

Exhibit below illustrates an affiliation structure with two subsidiaries. For illustration, Percy
Company owning 90 percent of the voting stock of San Del Corporation and 80 percent of the
voting stock of Saltz Corporation.

Percy Company owns 90 percent of the voting stock of San Del, and stockholders outside the
affiliation structure own the other 10 percent. These outside stockholders are the
noncontrolling stockholders, and their interest is referred to as a noncontrolling interest.
Outside stockholders have a 20 percent noncontrolling interest in Saltz Corporation.

Percy Company and its subsidiaries are separate legal entities that maintain separate
accounting records. In its separate records, Percy Company uses the equity method described
in Chapter 2 to account for its investments in San Del and Saltz Corporations.

Consolidated balance sheet at date of acquisition

Parent Acquires 100 percent of Subsidiary at Book Value
Pop Corporation acquires 100 percent of Son Corporation at its book value and fair value of
$80,000 in an acquisition on January 1, 2016. Exhibit 3-2 shows the balance sheets prepared
immediately after the investment.
Pop’s “Investment in Son” appears in the separate balance sheet of Pop, but not in the
consolidated balance sheet for Pop and Subsidiary. When preparing the balance sheet, we
eliminate the Investment in Son account (Pop’s books) and the stockholders’ equity accounts
(Son’s books) because they are reciprocal—both representing the net assets of Son at January
1, 2016.

We combine the nonreciprocal accounts of Pop and Sun and include them in the consolidated
balance sheet of Pop Corporation and Subsidiary. Note that the consolidated balance sheet is
not merely a summation of account balances of the affiliates. We eliminate reciprocal accounts
in the process of consolidation and combine only nonreciprocal accounts.

The capital stock that appears in a consolidated balance sheet is the capital stock of the parent,
and the consolidated retained earnings are the retained earnings of the parent company.

Parent Acquires 100 percent of Subsidiary—With Goodwill

Pop acquires all of Son’s stock for $100,000, there will be a $20,000 excess of investment cost
over book value acquired ($100,000 investment cost less $80,000 stockholders’ equity of Son).
The $20,000 appears in the consolidated balance sheet at acquisition as an asset of $20,000.

In the absence of evidence that identifiable net assets are undervalued, this asset is assumed to
be goodwill. Exhibit 3-3 illustrates procedures for preparing a consolidated balance sheet for
Pop Corporation, assuming that Pop pays $100,000 for the outstanding stock of Son.
The elimination entry is reproduced in general journal form for convenient reference:

Parent Acquires 90 percent of Subsidiary—With Goodwill

Pop paid $90,000 for a 90 percent interest. This implies that the total fair value of Son is
$100,000 ($90,000/90 percent).

In this case, the excess of total fair value over book value of Son’s net identifiable assets and
liabilities is $20,000, and there is a noncontrolling interest of $10,000 (10 percent of the
$100,000 fair value of Son’s equity). The $20,000 excess of fair value over book value is
goodwill. The workpapers in Exhibit 3-4 illustrate procedures for preparing the consolidated
balance sheet for Pop and Son under the 90 percent ownership assumption
Workpaper entry a eliminates the reciprocal accounts of Pop and Son and recognizes goodwill
and the noncontrolling interest in Son at the date of acquisition:
Consolidated balance sheets after acquisition

The balance sheets of Pop and Son Corporations at December 31, 2016, one year after
acquisition, contain the following (in thousands):

Assumptions
1. Pop acquired a 90 percent interest in Son for $90,000 on January 1, 2016, when Son’s
stockholders’ equity at book value was $80,000 (see Exhibit 3-4).
2. The accounts payable of Son include $10,000 owed to Pop.
3. During 2016 Son had income of $40,000 and declared $20,000 in dividends.

Exhibit 3-5 presents consolidated balance sheet workpapers reflecting this information. We
determine the balance in the Investment in Son account at December 31, 2016, using the
equity method of accounting.

Calculations of the December 31, 2016, investment account balance are as follows:
The workpaper entries necessary to consolidate the balance sheets of Pop and Son are
reproduced in general journal form for convenient reference:
Assigning excess to identifiable net assets and goodwill

Effect of assignment on consolidated balance sheet at acquisition

On December 31, 2016, Pam purchases 90 percent of Sun Corporation’s outstanding voting
common stock directly from Sun Corporation’s stockholders for $5,200,000 cash plus 100,000
shares of Pam Corporation $10 par common stock with a market value of $5,000,000.
Additional costs of combination are $200,000. Pam pays these additional costs in cash. Pam and
Sun must continue to operate as parent company and subsidiary because 10 percent of Sun’s
shares are outstanding and held by noncontrolling stockholders. We expense the $200,000
costs in recording the investment.

Comparative book value and fair value information for Pam and Sun immediately before the
acquisition on December 31, 2016, appear in Exhibit 3-6.
Pam records the acquisition on its books with the following journal entries in thousands:

The schedule in Exhibit 3-7 illustrates the adjustment necessary to consolidate the balance
sheets of Pam and Sun at December 31, 2016.

We incorporate the excess fair value over book value as determined in Exhibit 3-7 into a
consolidated balance sheet through workpaper procedures. Exhibit 3-8 illustrates these
procedures for Pam and Sun as of the date of acquisition.
The consolidated balance sheet workpapers show two workpaper entries for the consolidation.
Entry a in general journal form follows:
Effect Of Amortization On Consolidated Balance Sheet After Acquisition

The effect of amortizing the $5,433,000 excess on the December 31, 2017, consolidated
balance
sheet is based on the following assumptions about the operations of Pam and Sun during 2017
and about the relevant amortization periods of the assets and liabilities to which we allocate
the excess in Exhibit 3-7. These assumptions are as follows:

At December 31, 2017, Pam’s Investment in Sun account has a balance of $10,501,500,
consisting
of the original $10,200,000 cost, increased by $571,500 investment income from Sun and
decreased by $270,000 dividends received from Sun. Pam’s income from Sun for 2017 is
calculated under a one-line consolidation as follows (in thousands):
Pam’s net income for 2017 is $3,095,000, consisting of income from its own operations of
$2,523,500, plus $571,500 income from Sun. Sun’s stockholders equity increased $500,000
during 2017, from $5,900,000 to $6,400,000. Pam’s retained earnings increased $1,795,000,
from $4,100,000 at December 31, 2016, to $5,895,000 at December 31, 2017. Pam’s retained
earnings decreased from $4,300,000 to $4,100,000 at the acquisition date due to the expensing
of the costs of the combination. We reflect this information in a consolidated balance sheet
workpaper for Pam and Subsidiary at December 31, 2017, in Exhibit 3-9.

We reproduce the workpaper entries as follows:

The differences in the adjustments and eliminations in Exhibit 3-8 and Exhibit 3-9 result from
changes that occurred between December 31, 2016, acquisition, and December 31, 2017, when
the investment had been held for one year. The following schedule provides the basis for the
workpaper entries that appear in Exhibit 3-9 (in thousands).

The following summarizes the transactions recorded by Pam in its Investment in Sun account
(in thousands):
Consolidated Income Statement

Consolidated income statements, like consolidated balance sheets, are more than summations
of the income accounts of the affiliates. A summation of all income statement items for Pam
and Sun would result in a combined income figure of $3,895,000, whereas consolidated net
income is only $3,158,500. The $736,500 difference between these two amounts lies in the
investment income of $571,500 and the $165,000 amortization.