Unit 2

Consolidated Financial Statements: as of Date of Acquisition

DEFINITION OF SUBSIDIARY AND CONTROL

An investor, regardless of the nature of its involvement with an entity (the investee), determines
whether it is a parent by assessing whether it controls the investee. An investor controls an
investee when it is exposed, or has rights, to variable returns from its involvement with the
investee and has the ability to affect those returns through its power over the investee. Thus, an
investor controls an investee if and only if the investor has all of the following:

 power over the investee;

 exposure, or rights, to variable returns from its involvement with the investee; and
 the ability to use its power over the investee to affect the amount of the investor‘s returns.

Although not a defined term, IFRS 10 uses the term ‗investor‘ to refer to a reporting entity that
potentially controls one or more other entities, and ‗investee‘ to refer to an entity that is, or may
potentially be, the subsidiary of a reporting entity. Ownership of a debt or equity interest may be
a key factor in determining whether an investor has control. However, it is also possible for a
party to be an investor and potentially control an investee, without having an equity or debt
interest in that investee. An investor has to consider all facts and circumstances when assessing
whether it controls an investee. Only one party, if any, can control an investee.

However, IFRS 10 notes that two or more investors collectively can control an investee. To
control an investee collectively, investors must act together to direct the relevant activities. In
such cases, because no investor can direct the activities without the co-operation of the others, no
investor individually controls the investee.

Parent and Subsidiary with Different Fiscal Periods

When the fiscal periods of the parent and its subsidiaries differ, we prepare consolidated
statements for and as of the end of the parent‘s fiscal period. If the difference in fiscal periods is
not in excess of three months, it usually is acceptable to use the subsidiary‘s statements for its
fiscal year for consolidation purposes, with disclosure of the effect of intervening events which
materially affect the financial position or results of operations. Otherwise, the statements of the
subsidiary should be adjusted so that they correspond as closely as possible to the fiscal period of
the parent company.

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CONSOLIDATION PROCEDURES

Consolidated Financial Statements

When an investor acquires sufficient voting shares to obtain control over the investee, a parent
subsidiary relationship is established. The investor is the parent, and the investee is the
subsidiary. Usually, the two (or more) companies involved continue as separate legal entities,
with each maintaining separate accounting records and producing separate financial statements.

However, the two entities now operate as a family of companies. In effect, they operate or have
the ability to operate as one economic entity. Users of the parent‘s financial statements would
generally prefer to get one financial statement for the entire family rather than obtain separate
statements for each company in the family. Therefore, it is not surprising that IFRSs require the
preparation of consolidated financial statements to present the financial position and financial
performance for the family as a whole.

The accounting principles involved in the preparation of consolidated financial statements are
found in IFRS 10. In the material that follows in this and later chapters, the preparation of
consolidated statements will follow this standard‘s requirements. Consolidated statements consist
of a balance sheet, a statement of comprehensive income, a statement of changes in equity, a
cash flow statement, and the accompanying notes.

We will illustrate the preparation of the consolidated balance sheet on the date that control is
obtained by the parent company. Consolidation of other financial statements will be illustrated in
later chapters.

The following definitions are provided in IFRS 10:

a. Consolidated financial statements: The financial statements of a group in which
the assets, liabilities, equity, income, expenses, and cash flows of the parent and
its subsidiaries are presented as those of a single economic entity
b. Group: A parent and its subsidiaries
c. Parent: An entity that controls one or more entities
d. Subsidiary: An entity that is controlled by another entity
e. Non-controlling interest: Equity in a subsidiary not attributable, directly or
indirectly, to a parent

When a parent company has control over one or more subsidiaries, it has the right to benefit
economically from the subsidiaries‘ resources and, at the same time, is exposed to the related
risks involved. Consolidated financial statements reflect a group of economic resources that are
under the common control of the parent company, even though these resources are owned
separately by the parent and the subsidiary companies.

2
Consolidation Process
The consolidation process adds together the financial statements of two or more legally separate
companies, creating a single set of financial statements. Topic 4 and 5 discuss the specific
procedures used to produce consolidated financial statements in considerable detail. An
understanding of the procedures is important because they facilitate the accurate and efficient
preparation of consolidated statements. However, the focus should continue to be on the end
product—the financial statements. The procedures are intended to produce financial statements
that appear as if the consolidated companies are actually a single company.

The separate financial statements of the companies involved serve as the starting point each time
consolidated statements are prepared. These separate statements are added together, after some
adjustments and eliminations, to generate consolidated financial statements. The adjustments and
eliminations relate to intercompany transactions and holdings. Although the individual
companies within a consolidated entity may legitimately report sales and receivables or payables
to one another, the consolidated entity as a whole must report transactions only with parties
outside the consolidated entity and receivables from or payables to external parties. Thus, the
adjustments and eliminations required as part of the consolidation process aim at ensuring that
the consolidated financial statements are presented as if they were the statements of a single
enterprise.

Consolidation Procedure
We begin preparing consolidated financial statements with the books of the individual companies
that are to be consolidated. Because the consolidated entity has no books, all amounts in the
consolidated financial statements originate on the books of the parent or a subsidiary or in the
consolidation worksheet. A parent company may hold all or less than all of a corporate
subsidiary‘s common stock, but at least majority ownership is normally required for the
presentation of consolidated financial statements.

We start with basic consolidation procedures applied to the preparation of a consolidated balance
sheet immediately following the establishment of a parent–subsidiary relationship, either through
creation or acquisition of the subsidiary. Then we introduce the use of a simple consolidation
worksheet for the balance sheet only in the next sections of this chapter. But generally, IFRS 10
lays out the basic procedures for preparing consolidated financial statements. The financial
statements of a parent and its subsidiaries are combined on a line-by-line basis by adding
together like items of assets, liabilities, equity, income and expenses.

The following steps are then taken, in order that the consolidated financial statements should
show financial information about the group as if it was a single entity.

a. The carrying amount of the parent's investment in each subsidiary and the parent's
portion of equity of each subsidiary are eliminated or cancelled

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 b. Non-controlling interests in the net income of consolidated subsidiaries are adjusted
against group income, to arrive at the net income attributable to the owners of the parent
c. Non-controlling interests in the net assets of consolidated subsidiaries should be
presented separately in the consolidated statement of financial position

Other matters to be dealt with include the following.

a. Goodwill on consolidation should be dealt with according to IFRS 3
b. Dividends paid by a subsidiary must be accounted for

IFRS 10 states that all intragroup balances and transactions, and the resulting unrealized profits,
should be eliminated in full. Unrealized losses resulting from intragroup transactions should
also be eliminated unless cost can be recovered. This will be explained later in this chapter.

The preparation of a consolidated statement of financial position, in a very simple form, consists
of two procedures.
a. Take the individual accounts of the parent company and each subsidiary and cancel out
items which appear as an asset in one company and a liability in another.
b. Add together all the uncancelled assets and liabilities throughout the group.

Items requiring cancellation may include the following.

(a) The asset 'shares in subsidiary companies' which appears in the parent company's accounts
will be matched with the liability 'share capital' in the subsidiaries' accounts.
(b) There may be intra-group trading within the group. For example, S Co may sell goods on
credit to P Co. P Co would then be a receivable in the accounts of S Co, while S Co would be a
payable in the accounts of P Co.

Consolidation Worksheets
The consolidation worksheet provides a mechanism for efficiently combining the accounts of
the separate companies involved in the consolidation and for adjusting the combined balances to
the amounts that would be reported if all consolidating companies were actually a single
company. When consolidated financial statements are prepared, the account balances are taken
from the separate books of the parent and each subsidiary and placed in the consolidation
worksheet. The consolidated statements are prepared, after adjustments and eliminations, from
the amounts in the consolidation worksheet.

Worksheet Format
In practice, companies use several different worksheet formats for preparing consolidated
financial statements. One of the most widely used formats is the three-part worksheet, consisting
of one part for each of three financial statements: (1) the income statement, (2) the statement of
retained earnings, and (3) the balance sheet (Statement of financial position). In recent years, the
retained earnings statement has been dropped by many companies in favor of the statement of

4
changes in stockholders‘ equity. Nevertheless, the information normally found in a retained
earnings statement is included in the statement of stockholders‘ equity, along with additional
information, and so the three-part worksheet still provides a useful format. The following table
presents the format for the comprehensive three part consolidation worksheet. Specifically, the
table illustrates the basic form of a consolidation worksheet.

Format for Consolidation Worksheet

Elimination
Items Consolidated
Parent Subsidiary Debit Credit

Income Statement
Revenues
Expenses

Net Income
Statement of Retained Earnings
Beginning Retained Earnings
Add: Net Income
Less: Dividends

Ending Retained Earnings

Statement of Financial Position
Assets

Total Assets
Liabilities

Equity
Common Stock
Retained Earnings
Total Liabilities & Equity

The titles of the accounts of the consolidating companies are listed in the first column of the
worksheet. The account balances from the books or trial balances of the individual companies
are listed in the next set of columns, with a separate column for each company included in the
consolidation. Entries are made in the columns labeled Elimination Entries to adjust or eliminate
balances so that the resulting amounts are those that would appear in the financial statements if
all the consolidating companies actually formed a single company. The balances in the last
column are obtained by summing all amounts algebraically across the worksheet by account.
These are the balances that appear in the consolidated financial statements.

5
The top portion of the worksheet is used in preparing the consolidated income statement. All
income statement accounts are listed in the order they normally appear in an income statement.
When the income statement portion of the worksheet is completed, a total for each column is
entered at the bottom of the income statement portion of the worksheet. The bottom line in this
part of the worksheet shows the parent‘s net income, the subsidiary‘s net income, the totals of the
debit and credit eliminations for this section of the worksheet, and consolidated net income. The
entire bottom line is carried down to the ―net income‖ line in the retained earnings statement
portion of the worksheet immediately below the income statement.

The retained earnings statement section of the worksheet is in the same format as a retained
earnings statement, or the retained earnings section of a statement of stockholders‘ equity. Net
income and the other column totals from the bottom line of the income statement portion of the
worksheet are brought down from the income statement above. Similarly, the final line in the
retained earnings statement section of the worksheet is carried down in its entirety to the retained
earnings line in the balance sheet section. The bottom portion of the worksheet reflects the
balance sheet amounts at the end of the period. (Optionally, accounts can be separated and listed
with debits first and then credits.) The retained earnings amounts appearing in the balance sheet
section of the worksheet are the totals carried forward from the bottom line of the retained
earnings statement section.

Nature of Elimination Entries

Elimination entries are used in the consolidation worksheet to adjust the totals of the individual
account balances of the separate consolidating companies to reflect the amounts that would
appear if the legally separate companies were actually a single company. Elimination entries
appear only in the consolidation worksheet and do not affect the books of the separate
companies. These worksheet entries are sometimes called ―elimination‖ entries or simply
―consolidation‖ entries.

For the most part, companies that are to be consolidated record their transactions during the
period without regard to the consolidated entity. Transactions with related companies tend to be
recorded in the same manner as those with unrelated parties, although intercompany transactions
may be recorded in separate accounts or other records may be kept to facilitate the later
elimination of intercompany transactions. Each of the consolidating companies also prepares its
adjusting and closing entries at the end of the period in the normal manner. The resulting
balances are entered in the consolidation worksheet and combined to arrive at the consolidated
totals.

Elimination entries are used in the worksheet to increase or decrease the combined totals for
individual accounts so that only transactions with external parties are reflected in the

6
consolidated amounts. Some elimination entries are required at the end of one period but not at
the end of subsequent periods. For example, a loan from a parent to a subsidiary in December
20X1, repaid in February 20X2, requires an entry to eliminate the intercompany receivable and
payable on December 31, 20X1, but not at the end of 20X2.

Some other elimination entries need to be placed in the consolidation worksheets each time
consolidated statements are prepared for a period of years. For example, if a parent company
sells land to a subsidiary for $5,000 above the original cost to the parent, a worksheet entry is
needed to reduce the basis of the land by $5,000 each time consolidated statements are prepared
for as long as an affiliate (an affiliated company) holds the land. (An affiliated company is one
that is related to the company in question. For example, two corporations controlled by the same
parent company would be considered affiliates.)

It is important to remember that because elimination entries are not made on the books of any
company, they do not carry over from period to period.

DEFINITION AND PRESENTATION OF NON-CONTROLLING INTERESTS

The definition of non-controlling interest

IFRS 10 defines a non-controlling interest as ‗equity in a subsidiary not attributable, directly or
indirectly, to a parent.‘ The principle underlying accounting for non-controlling interests is that
all residual economic interest holders of any part of the consolidated entity have an equity
interest in that consolidated entity.
This principle applies regardless of the decision-making ability of that interest holder and where
in the group that interest is held. Therefore, any equity instruments issued by a subsidiary that are
not owned by the parent are non-controlling interests.

Presentation of non-controlling interests

IFRS 10 requires non-controlling interests to be presented in the consolidated statement of
financial position within equity, separately from the equity of the owners of the parent Profit or
loss and each component of other comprehensive income are attributed to the owners of the
parent and to the non-controlling interests. IFRS 3 allows two alternative ways of calculating
non-controlling interest in the group statement of financial position. Non-controlling interest can
be valued at:

a. Its proportionate share of the fair value of the subsidiary's net assets; or
b. Full (or fair) value (usually based on the market value of the shares held by the non-
controlling interest).

7
CONSOLIDATED STATEMENT OF FINANCIAL POSITION: WHOLLY OWNED
SUBSIDIARY

The simplest consolidation setting occurs when the financial statements of related companies are
consolidated immediately after a parent–subsidiary relationship is established through a business
combination or the creation of a new subsidiary. We present a series of examples to illustrate the
preparation of a consolidated balance sheet. Consolidation procedures are the same whether a
subsidiary is created or acquired.

Example 1: Consolidated Balance Sheet Immediately following Acquisition of full

ownership
P Corporation acquires all of S company‘s outstanding stock on January 1, 20X1, by paying
$350,000 cash. Assume the fair value of S company‘s land is determined to be $40,000 more
than its book value and all other assets and liabilities have fair value equal to their book values.
Balance sheet of P Corporation and S Company as of January 1, 20x1, immediately before
combination

Balance Sheets of P Corporation and S company,

January 1, 20X1, Immediately before Combination
P S
Assets
Cash $350,000 $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000

Required:
A. Record acquisition of S Company‘s stock on the books of the acquiring Company.
B. Prepare the balance sheet of P and S as of January 1, 20X1 immediately after
combination.
C. Prepare working papers for consolidated balance sheet as of date of combination.
D. Prepare consolidated balance sheet as of January 1, 20X1.

8
Solution
A. Refer the class illustration for the journal entry.
B. The following shows the balance sheet of P & S

Balance Sheets of P Corporation and S company,

January 1, 20X1, Immediately After Combination
P S
Assets
Cash $ ------ $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Investment in S Stock 350,000
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000

C. Refer the class discussions for Elimination Entries to complete the working paper.
Workpaper for Consolidated Balance Sheet, January 1, 20X1, Date of Combination;

Eliminations
Items P Corp. S Comp. Consolidated
Debit Credit
Cash - 50,000 50,000
Accounts Receivable 75,000 50,000 125,000
Inventory 100,000 60,000 160,000
Land 175,000 40,000 40,000 (2) 255,000
Building and Equipment 800,000 600,000 1,400,000
Investment in S Stock 350,000 - 350,000 (1)
Goodwill - - 10,000 (2) 10,000
Differential - - 50,000 (1) 50,000 (2) -
Debits 1,500,000 800,000 2,000,000

Accumulated Depreciation 400,000 300,000 700,000

Accounts Payable 100,000 100,000 200,000
Bonds Payable 200,000 100,000 300,000
Common Stock 500,000 200,000 200,000 (1) 500,000
Retained Earnings, from above 300,000 100,000 100,000 (1) 300,000
Credits 1,500,000 800,000 400,000 400,000 2,000,000

9
The first two columns provide information from the separate balance sheets of P and S. The third
column records adjustments and eliminations, subdivided into debits and credits. The last column
presents the totals that will appear in the consolidated balance sheet. We calculate amounts in the
Consolidated Balance Sheet column by adding together amounts from the first two columns and
then adding or subtracting the adjustments and eliminations, as appropriate. This basic
workpaper format is used throughout the discussions of acquisitions and preparation of
consolidated financial statements.

P‘s ―Investment in S‖ appears in the separate balance sheet of P, but not in the consolidated
balance sheet for P and Subsidiary. When preparing the balance sheet, we eliminate the
Investment in S account (P‘s books) and the stockholders‘ equity accounts (S‘s books) because
they are reciprocal—both representing the net assets of S at January 1, 20X1. We combine the
nonreciprocal accounts of P and S and include them in the consolidated balance sheet of P
Corporation and Subsidiary.

The elimination entry is reproduced in general journal form as illustrated in the class. These
Entries are only workpaper adjustments and eliminations and are not recorded in the accounts of
the parent or subsidiary corporations. The entries will never be journalized or posted. Their only
purpose is to facilitate completion of the workpapers to consolidate a parent and subsidiary at
and for the period ended on a particular date. In this book, workpaper entries are shaded in blue
to avoid confusing them with actual journal entries that are recorded in the accounts of the parent
and subsidiary companies.

In future periods, the difference between the investment account balance and the subsidiary
equity will decline if, and only if, goodwill is written down due to impairment.

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.

D. The consolidated balance sheet is prepared directly from the last column of the
consolidation workpaper.

10
 P Corporation and Subsidiary
Consolidated Balance Sheet
January 1, 20X1
Assets Liabilities
Cash $50,000 Accounts Payable $200,000
Accounts Receivable 125,000 Bonds Payable 300,000
Inventory 160,000
Land 255,000 Stockholders’ Equity
Building & Equipment 1,400,000 Common Stock 500,000
Accumulated Depreciation (700,000) Retained Earnings 300,000
Goodwill 10,000
Total Assets $1,300,000 Total Liability & Equity $1,300,000

CONSOLIDATED STATEMENT OF FINANCIAL POSITION: PARTIALLY OWNED

SUBSIDIARY

Example 2: Consolidated Balance Sheet Immediately following Acquisition of controlling

interest
P Corporation acquires 80% of S company‘s outstanding stock on January 1, 20X1, by paying
$280,000 cash. Assume the fair value of S company‘s land is determined to be $40,000 more
than its book value and all other assets and liabilities have fair value equal to their book values.
Balance sheet of P Corporation and S Company as of January 1, 20x1, immediately before
combination

Balance Sheets of P Corporation and S company,

January 1, 20X1, Immediately before Combination
P S
Assets
Cash $350,000 $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000

11
Required:

A. Record acquisition of S Company‘s stock on the books of the acquiring Company.

B. Prepare the balance sheet of P and S as of January 1, 20X1 immediately after
combination.
C. Prepare working papers for consolidated balance sheet as of date of combination.
D. Prepare consolidated balance sheet as of January 1, 20X1.

Solution

The consolidation process for a less-than-wholly-owned subsidiary with a differential is the same
as the process for a wholly owned subsidiary with a differential except that the claims of the
noncontrolling interest must be considered.

A. Refer the class illustration for the journal entry.

B. The following shows the balance sheet of P & S

Balance Sheets of P Corporation and S company,

January 1, 20X1, Immediately After Combination
P S
Assets
Cash $ 70,000 $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Investment in S Stock 280,000
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000

C. Refer the class discussions for Elimination Entries to complete the working paper.

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Workpaper for Consolidated Balance Sheet, January 1, 20X1, Date of Combination;

S Comp. Eliminations Consolidat

Items P Corp.
(80%) Debit Credit ed

Cash 70,000 50,000 120,000

Accounts Receivable 75,000 50,000 125,000
Inventory 100,000 60,000 160,000
Land 175,000 40,000 40,000 (2) 255,000
Building and Equipment 800,000 600,000 1,400,000
Investment in S Stock 280,000 - 280,000 (1)
Goodwill - - 10,000 (2) 10,000
Differential - - 50,000 (1) 50,000 (2) -
Debits 1,500,000 800,000 2,070,000
Accumulated Depreciation 400,000 300,000 700,000
Accounts Payable 100,000 100,000 200,000
Bonds Payable 200,000 100,000 300,000
Common Stock 500,000 200,000 200,000 (1) 500,000
Retained Earnings, from above 300,000 100,000 100,000 (1) 300,000
Non-Controlling Interest - - 70,000 (1) 70,000
Credits 1,500,000 800,000 400,000 400,000 2,070,000

Essentially, the acquisition method uses the entity theory of consolidations. Under the acquisition
method, all assets and liabilities of the subsidiary are reported using 100 percent of fair values at
the combination date, based on the price paid by the parent for its controlling interest, even when
the parent acquires less than a 100 percent interest. Thus, both the controlling and noncontrolling
interests will be reported based on fair values at the acquisition date.
D. The consolidated balance sheet is prepared directly from the last column of the
consolidation workpaper.

P Corporation and Subsidiary

Consolidated Balance Sheet
January 1, 20X1
Assets Liabilities
Cash $120,000 Accounts Payable $200,000
Accounts Receivable 125,000 Bonds Payable 300,000
Inventory 160,000
Land 255,000 Stockholders’ Equity
Building & Equipment 1,400,000 Common Stock 500,000
Accumulated Depreciation (700,000) Retained Earnings 300,000
Goodwill 10,000 Non-Controlling Interest 70,000
Total Assets $1,370,000 Total Liability & Equity $1,370,000

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Non-controlling Interest

We include all assets and liabilities of the subsidiary in the consolidated balance sheet and record
the noncontrolling interest‘s share of subsidiary net assets based on fair values separately in
stockholders‘ equity.
Historically, practice varied with respect to classification. The noncontrolling interest in
subsidiaries was generally shown in a single amount in the liability section of the consolidated
balance sheet, frequently under the heading of noncurrent liabilities. Conceptually, the
classification of noncontrolling stockholder interests as liabilities was inconsistent because the
interests of noncontrolling stockholders represent equity investments in the subsidiary net assets
by stockholders outside the affiliation structure.

Generally;-
 A noncontrolling interest in a subsidiary should be displayed and labeled in the
consolidated balance sheet as a separate component of equity.

 Income attributable to the noncontrolling interest is not an expense or a loss but a

deduction from consolidated net income to compute income attributable to the controlling
interest.

 Both components of consolidated net income (net income attributable to noncontrolling

interest and net income attributable to controlling interest) should be disclosed on the
face of the consolidated income statement.

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Part II: Multiple-Choice Questions
Select the correct answer for each of the following questions.
1. Noncontrolling interest, as it appears in a consolidated balance sheet, refers to:
A. Owners of less than 50 percent of the parent company‘s stock
B. Parent‘s interest in subsidiary companies
C. Interest expense on subsidiary‘s bonds payable
D. Equity in the subsidiary‘s net assets held by stockholders other than the parent
2. Goodwill represents the excess of the sum of the fair value of the (1) consideration given, (2)
shares already owned, and (3) the noncontrolling interest over the
A. Sum of the fair values assigned to identifiable assets acquired less liabilities assumed.
B. Sum of the fair values assigned to tangible assets acquired less liabilities assumed.
C. Sum of the fair values assigned to intangible assets acquired less liabilities assumed.
D. Book value of an acquired company.
3. The retained earnings that appear on the consolidated balance sheet of a parent company and
its 60 percent owned subsidiary are:
A. The parent company‘s retained earnings plus 100 percent of the subsidiary‘s retained
earnings
B. The parent company‘s retained earnings plus 60 percent of the subsidiary‘s retained
earnings
C. The parent company‘s retained earnings
D. Pooled retained earnings
4. On January 1, 20X1, Rolan Corporation issued 10,000 shares of common stock in exchange
for all of Sandin Corporation‘s outstanding stock. Condensed balance sheets of Rolan and
Sandin immediately before the combination follow:

Rolan Sandin
Total Assets $1,000,000 $500,000
Liabilities $ 300,000 $150,000
Common Stock ($10 par) 200,000 100,000
Retained Earnings 500,000 250,000
Total Liabilities & Equities $1,000,000 $500,000

Rolan‘s common stock had a market price of $60 per share on January 1, 20X1. The market
price of Sandin‘s stock was not readily determinable. The fair value of Sandin‘s net identifiable
assets was determined to be $570,000. Rolan‘s investment in Sandin‘s stock will be stated in
Rolan‘s balance sheet immediately after the combination in the amount of
A. $350,000.
B. $500,000.
C. $570,000.
D. $600,000.

15
Exercise 1
Balance sheet of P Corporation and S Company as of January 1, 20x1, immediately before
combination
Balance Sheets of P Corporation and S company,
January 1, 20X1, Immediately before Combination
P S
Assets
Cash $350,000 $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000

Assume that the acquisition-date book values and fair values of Special Foods‘ assets and
liabilities are as shown.

16
Assume that P Corporation acquires all of S company‘s capital stock for $400,000 on January 1,
20X1, by issuing $100,000 of 9 percent bonds, with a fair value of $100,000, and paying cash of
$300,000.

Required:
A. Record acquisition of S Company‘s stock on the books of the acquiring Company.
B. Prepare the balance sheet of P and S as of January 1, 20X1 immediately after
combination.
C. Prepare working papers for consolidated balance sheet as of date of combination.
D. Prepare consolidated balance sheet as of January 1, 20X1.

Exercise 2

Par Corporation acquired 70 percent of the outstanding common stock of Set Corporation on
January 1, 2011, for $350,000 cash. Immediately after this acquisition the balance sheet
information for the two companies was as follows (in thousands):
Set
Par Book Value Book Value Fair
Value
Assets
Cash $ 70 $ 40 $ 40
Receivables—net 160 60 60
Inventories 140 60 100
Land 200 100 120
Buildings—net 220 140 180
Equipment—net 160 80 60
Investment in Set 350 — —
Total assets $1,300 $480 $560
Liabilities and Stockholders’ Equity
Accounts payable $ 180 $160 $160
Other liabilities 20 100 80
Capital stock, $20 par 1,000 200
Retained earnings 100 20
Total equities $1,300 $480

Required:
1. Prepare a schedule to allocate the difference between the fair value of the investment in Set
and the book value of the interest to identifiable and unidentifiable net assets.

2. Prepare a consolidated balance sheet for Par Corporation and Subsidiary at January 1, 2011.

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Appendix

DEFINITION AND PRESENTATION OF NON-CONTROLLING INTERESTS

The definition of non-controlling interest

IFRS 10 defines a non-controlling interest as ‗equity in a subsidiary not attributable, directly or
indirectly, to a parent.‘ The principle underlying accounting for non-controlling interests is that
all residual economic interest holders of any part of the consolidated entity have an equity
interest in that consolidated entity.
This principle applies regardless of the decision-making ability of that interest holder and where
in the group that interest is held. Therefore, any equity instruments issued by a subsidiary that are
not owned by the parent are non-controlling interests.

Presentation of non-controlling interests

IFRS 10 requires non-controlling interests to be presented in the consolidated statement of
financial position within equity, separately from the equity of the owners of the parent Profit or
loss and each component of other comprehensive income are attributed to the owners of the
parent and to the non-controlling interests. IFRS 3 allows two alternative ways of calculating
non-controlling interest in the group statement of financial position. Non-controlling interest can
be valued at:
c. Its proportionate share of the fair value of the subsidiary's net assets; or
d. Full (or fair) value (usually based on the market value of the shares held by the non-
controlling interest).

Example: Measurement and Presentation of Non-Controlling Interest

Assume that on June 30, Year 1, S Ltd. had 10,000 shares outstanding and P Ltd. purchases
8,000 shares (80%) of S Ltd. for a total cost of $72,000. P Ltd. obtains control over S Ltd. No
additional transactions take place on this date.

P Ltd.‘s journal entry to record this purchase is as follows:

Investment in S Ltd……………………… 72,000

Cash…………………………………. 72,000

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The balance sheets of P Ltd. and S Ltd. just prior to this purchase on June 30, Year 1, were
shown below:

Statement of Financial Position (Balance Sheet)

At June 29, Year 1
P Ltd. S Ltd.
Carrying amount Carrying amount Fair value
Cash $100,000 $ 12,000 $ 12,000
Accounts receivable 90,000 7,000 7,000
Inventory 130,000 20,000 22,000
Plant 280,000 50,000 59,000
Patent — 11,000 10,000
Total Assets $600,000 $100,000 $110,000
Current liabilities $ 60,000 $ 8,000 $ 8,000
Long-term debt 180,000 22,000 25,000
Total liabilities 240,000 30,000 $ 33,000
Common shares 200,000 40,000
Retained earnings 160,000 30,000
Total Liabilities and
Shareholders’ Equity $600,000 $100,000

Required:
1. How should NCI be measured on the consolidated financial statements?
2. How should NCI be presented on the consolidated financial statements?

Solution:
The following acceptable approaches have developed over time and have been proposed as
solutions to measure and present NCI in the consolidated financial statements for non–wholly
owned subsidiaries:

Case 1-1: Fair Value of Non-controlling Interest as Evidenced by Market Trades

For example, assume that P Ltd. wished to acquire 8,000 of S Ltd.‘s shares in order to obtain
substantial synergies from the proposed acquisition. P Ltd. estimated that a 100% acquisition
was not needed to extract these synergies. Also, P Ltd. projected that financing more than an
80% acquisition would be too costly. P Ltd. then offered all of S Ltd.‘s shareholders a premium

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price for up to 80% of the outstanding shares. To induce a sufficient number of shareholders to
sell, P Ltd. needed to offer $9 per share, even though the shares had been trading in the $7.65 to
$7.85 range. During the weeks following the acquisition, the 20% non-controlling interest shares
in S Ltd. continued to trade in the $7.65 to $7.85 range.

In this case, the $9 per share paid by P Ltd. does not appear representative of the fair value of all
the shares of S Ltd. The fact that the non-controlling interest shares continued to trade around
$7.75 per share indicates a fair value for the 2,000 shares not owned by P Ltd of $15,500 (7.75 *
2,000 shares). Therefore, the valuation of the non-controlling interest is best evidenced by the
trading price of S Ltd.‘s shares, not the price paid by P Ltd.

The $9 share price paid by P Ltd. nonetheless represents a negotiated value for the 8,000 shares.
In the absence of any evidence to the contrary, P Ltd.‘s shares have a fair value of $72,000
incorporating the additional value P Ltd. expects to extract from synergies with S Ltd. Thus, the
fair value of S Ltd. as a whole is measured as the sum of the respective fair values of the
controlling and non-controlling interests as follows:

Fair value of controlling interest ($9 * 8,000 shares)………………………. $72,000

Fair value of non-controlling interest ($7.75 * 2,000 shares)………………. 15,500
Total acquisition-date fair value of S Ltd…………………………………... $87,500

At the acquisition date, P Ltd. assessed the total fair value of S Ltd.‘s identifiable net assets at
$77,000, as indicated in the example above. Therefore, we compute goodwill as the excess of the
total fair value of the firm over the fair values of the identifiable net assets as follows:

Total acquisition-date fair value of S Ltd……………………… $87,500

Fair value of identifiable net assets acquired…………………... (77,000)
Goodwill………………………………………………………...$10,500
To provide a basis for potential future allocations of goodwill impairment charges, acquisition-
date goodwill should be apportioned across the controlling and non-controlling interests. 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 identifiable net assets. Any

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remaining goodwill is then attributed to the non-controlling interest. As a result, goodwill

allocated to the controlling and non-controlling interests will not always be proportional to the
percentages owned. Continuing with our example, the acquisition goodwill is allocated as
follows:
Controlling NCI Total
Interest
Fair value at acquisition date $72,000 $15,500 $87,500
Relative fair value of identifiable net assets
acquired (80% and 20%) 61,600 15,400 77,000
Goodwill $10,400 $ 100 $10,500

Case 1-2: Fair Value of Non-controlling Interest Implied by Parent’s Consideration

Transferred
In some cases, the price paid by the parent on a per share basis may reflect what would have
been paid on a per share basis for 100% of the subsidiary‘s shares. This is true in the following
situations:
1. The parent acquired a large percentage of the acquiree‘s voting stock.
2. The parent‘s offer to buy shares was based on the value of the subsidiary as a whole.
3. The trading price of the acquiree‘s share just before and just after the business
combination was similar to the price paid by the parent.
4. The non-controlling shareholders could use their minority shareholder rights to
demand the same price per share that was paid to the other shareholders.

Therefore, if there was no compelling evidence that the $9 acquisition price was not
representative of all of S Ltd.‘s 10,000 shares, then it appears reasonable to estimate the fair
value of the 20% non-controlling interest using the price paid by P Ltd. The total fair value of S
Ltd. is then estimated at $90,000 and allocated as follows:
Fair value of controlling interest ($9 * 8,000 shares)……………… $72,000
Fair value of non-controlling interest ($9 * 2,000 shares) ………… 18,000
Total acquisition-date fair value of S Ltd…………………………. $90,000

Alternatively, the total fair value can be calculated using basic math by simply dividing the
amount paid of $72,000 by the percentage ownership, 80% or 0.8, to get $90,000. Goodwill for
the subsidiary as a whole would be valued at $13,000, as indicated below.

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CALCULATION OF ACQUISITION DIFFERENTIAL

Cost of 80% investment in S Ltd. $72,000
Implied value of 100% investment in S Ltd.
(72,000 / 80%) $90,000
Carrying amount of S Ltd.‘s net assets
Assets $100,000
Liabilities (30,000) 70,000
Implied acquisition differential 20,000
Allocated: (FV - CA) * 100%
Inventory + 2,000 * 100% = + 2,000a
Plant + 9,000 * 100% = + 9,000b
Patent - 1,000 * 100% = - 1,000c
10,000
Long-term debt + 3,000 * 100% = + 3,000d 7,000
Balance—goodwill $13,000 e
CALCULATION OF NCI
Implied value of 100% investment in S Ltd. $90,000
NCI ownership 20%
$18,000 (f)

P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1

Cash (100,000- 72,000*+12,000) $ 40,000

Accounts receivable (90,000 + 7,000) 97,000
Inventory (130,000 + 20,000 + [a] 2,000) 152,000
Plant (280,000 + 50,000 + [b] 9,000) 339,000
Patent (0 + 11,000- [c] 1,000) 10,000
Goodwill (0 + 0 + [e] 13,000) 13,000
$651,000
Current liabilities (60,000 + 8,000) $ 68,000
Long-term debt (180,000 + 22,000 + [d] 3,000) 205,000
Total liabilities 273,000
Shareholders‘ equity
Controlling interest
Common shares 200,000
Retained earnings 160,000
360,000
Non-controlling interest [5f] 18,000 378,000
$651,000
*
Cash paid by P Ltd. to acquire S Ltd.
The above illustrates the preparation of the consolidated balance sheet using the direct approach.

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The working paper used to prepare the consolidated balance sheet under this theory is shown in
the next section examples.

Case 2: Non Controlling Interest Based on the Fair Values of the Identifiable Net Assets of
the Subsidiary.

Under parent company extension theory, NCI is recognized in shareholders‘ equity in the
consolidated balance sheet, similar to entity theory (Case1-1 and Case1-2 approaches). Its
amount is based on the fair values of the identifiable net assets of the subsidiary; it excludes any
value pertaining to the subsidiary‘s goodwill. NCI is calculated as follows:

Carrying amount of S Ltd.‘s net assets

Assets……………………………………………………………. $100,000
Liabilities………………………………………………………… (30,000)
70,000
Excess of fair value over carrying amount for identifiable net assets…… 7,000
Fair value of identifiable net assets ……………………………………… 77,000
Non-controlling ownership percentage ………………………………….. 20%
Non-controlling interest ………………………………………………….. $ 15,400

The consolidated balance sheet is prepared by combining, on an item-by-item basis, the carrying
amount of the parent with the fair value of the subsidiary‘s identifiable net assets plus the
parent‘s share of the subsidiary‘s goodwill. The following table shows the preparation of the
consolidated balance sheet under parent company extension theory.

Either entity theory or parent company extension theory can be used under IFRSs. It is an
accounting policy choice. However, IFRS 3 does not use the term parent company extension
theory. It simply states the following: For each business combination, the acquirer shall measure
any non-controlling interest in the acquiree either at fair value or at the non-controlling interest‘s
proportionate share of the acquiree‘s identifiable net assets.

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P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1

Cash (100,000- 72,000*+12,000) $ 40,000

Accounts receivable (90,000 + 7,000) 97,000
Inventory (130,000 + 20,000 + 2,000) 152,000
Plant (280,000 + 50,000 + 9,000) 339,000
Patent (0 + 11,000- 1,000) 10,000
Goodwill (0 + 0 + 10,400) 10,400
$648,400
Current liabilities (60,000 + 8,000) $ 68,000
Long-term debt (180,000 + 22,000 + 3,000) 205,000
Total liabilities 273,000
Shareholders‘ equity
Controlling interest
Common shares 200,000
Retained earnings 160,000
360,000
Non-controlling interest 15,400 375,400
$648,400
*
Cash paid by P Ltd. to acquire S Ltd.

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