Chapter 4 IMSM 13th Ed - Lecture notes Chap 4 PDF

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

PCHAPTER 4 CONSOLIDATED FINANCIAL STATEMENTS AND OUTSIDE OWNERSHIP Chapter Outline I.

Outside ownership may be present within any consolidated entity. A. Complete ownership of a subsidiary is not a prerequisite for consolidation—only enough voting shares need be owned so that the acquiring company has the ability to control the decision-making process of the acquired company. B. Any ownership interest in a subsidiary company by a party unrelated to the acquiring company is termed a noncontrolling interest.

II.

Valuation of subsidiary assets and liabilities poses a challenge when a noncontrolling interest is present. A. The accounting emphasis (economic unit concept) is placed on the entire entity that results from the business combination when control has been obtained. The parent company that controls its subsidiary must consolidate 100% of subsidiary assets, liabilities, revenues, and expense are consolidated even when its ownership is less than 100%. B. The consolidated valuation basis for a newly acquired subsidiary is the acquisition-date fair value of the company (most frequently determined by the consideration transferred and the fair value of the noncontrolling interest); specific subsidiary assets and liabilities are measured at their acquisition-date fair values. C. The noncontrolling interest balance is reported in the parent’s consolidated financial statements as a component of stockholders' equity.

III.

Consolidations involving a noncontrolling interest—subsequent to the date of acquisition A. Four noncontrolling interest figures are determined for reporting purposes 1. Beginning of year balance sheet amount 2. Net income attributable to noncontrolling interest 3. Dividends declared by subsidiary during the period attributable to the noncontrolling interest 4. End of year balance sheet amount 4-1 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e B. Noncontrolling interest balances are accumulated in a separate column in the consolidation worksheet 1. The beginning of year figure is entered on the worksheet as a component of Entries S and A 2. The net income attributable to the noncontrolling interest is established by a columnar entry that simultaneously reports the balance in both the consolidated income statement and the noncontrolling interest column 3. Dividends declared to these outside owners are reflected by extending the subsidiary's Dividends declared balance (after eliminating intra-entity transfers) into the noncontrolling interest column as a reduction 4. The end of year noncontrolling interest total is the summation of the three items above and is reported in stockholders' equity.

IV.

Step acquisitions A. An acquiring company may make several different purchases of a subsidiary's stock in order to gain control B. Upon attaining control, all of the parent’s previous investments in the subsidiary are adjusted to fair value and a gain or loss recognized as appropriate C. Upon attaining control, the valuation basis for the subsidiary is established at its total fair value (the sum of the fair values of the controlling and noncontrolling interests) D. Post-control subsidiary stock acquisitions by the parent are considered transactions with current owners of the consolidated entity. Thus such post-control stock acquisitions neither result in gains or losses nor provide a basis for subsidiary asset remeasurement to fair value. The difference between the sale proceeds and the carrying value of the shares sold (equity method) is recorded as an adjustment to the parent’s additional paid in capital.

V.

Sales of subsidiary stock A. The proper book value must be established within the parent's Investment account so that the sales transaction can be correctly recorded B. The investment balance is adjusted as if the equity method had been applied during the entire period of ownership C. If only a portion of the shares are being sold, the book value of the investment account is reduced using either a FIFO or a weighted-average cost flow assumption 4-2

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

D. If the parent maintains control, any difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as an adjustment to additional paid-in capital. E. If the parent loses control with the sale of the subsidiary shares, the difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as a gain or loss. F. Any interest retained by the parent company should be accounted for by either consolidation, the equity method, or the fair value method depending on the influence remaining after the sale.

Answer to Discussion Question:

Do you think the FASB made the correct decision in requiring consolidated financial statements to recognize all subsidiary’s assets and liabilities at fair value regardless of the percentage ownership acquired by the parent?

As the quotes from the five accounting professionals illustrate, the decision to require the revaluation of 100% of a newly controlled subsidiary’s assets and liabilities—regardless of percentage ownership —was not without some controversy. Students can use the quotes to discuss cost-benefit issues, relevance of capturing the underlying economics, use of hypothetical transactions in financial reporting, potential for abuse, etc. The requirement to value all acquisition date subsidiary assets at 100% fair value thus provides a useful vehicle for the class to discuss the many issues surrounding standard setters’ decisions.

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Answer to Discussion Question: DOES GAAP UNDERVALUE POST-CONTROL STOCK ACQUISITIONS?

From the Berkshire Hathaway 2012 annual 10-K report:

We have owned a controlling interest in Marmon Holdings, Inc. (“Marmon”) since 2008. In the fourth quarter of 2012, pursuant to the terms of the 2008 Marmon acquisition agreement, we acquired an additional 10% of the outstanding shares of Marmon held by noncontrolling interests for aggregate consideration of approximately $1.4 billion. Approximately $800 million of the consideration was paid in the fourth quarter of 2012, and the remainder is payable in March 2013. In the fourth quarter of 2010, we acquired 16.6% of Marmon’s outstanding common stock for approximately $1.5 billion. As a result of these acquisitions, our ownership interest in Marmon has increased to approximately 90%.

These purchases were accounted for as acquisitions of noncontrolling interests. The differences between the consideration paid or payable and the carrying amounts of the noncontrolling interests acquired were recorded as reductions in Berkshire’s shareholders equity of approximately $700 million in 2012 and $614 million in 2010. We are contractually required to acquire substantially all of the remaining noncontrolling interests of Marmon no later than March 31, 2014, for an amount that will be based on Marmon’s future operating results.

On the date control is established, the new subsidiary’s valuation basis is established. Subsequent acquisitions of any remaining portions of the noncontrolling interests do not establish a new valuation basis for the subsidiary. In the Berkshire case, the new valuation basis for Marmon was established in 2008 when its 64% control was acquired. Berkshire then increases Marmon’s consolidated carrying amount as Marmon earns income, not by subsequent purchases of Marmon’s noncontrolling shares.

Berkshire’s payments for its post-control equity acquisitions (16% and 10%) were in excess of Marmon’s proportionate carrying amounts. Because these transactions were with owners (not outside parties), no gain or loss is recorded. Berkshire reduces its paid-in capital the for excess of the purchase price over the carrying amount. The accounting is similar to retirement of stock for a payment in excess of the company’s proportionate carrying amount.

Mr.Buffett may be correct that the current market value of Marmon is $4.6 bilion more that its carrying amount. However, GAAP does not, in general, record unrealized increases in a firm’s market value as increases in reported asset amounts. 4-4 Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Answers to Questions 1.

"Noncontrolling interest" refers to an equity interest that is held in a member of a consolidated entity by an unrelated (outside) party.

2.

Acquisition method = $220,000 (fair value)

3.

A control premium is the portion of an acquisition price (above currently traded market values) paid by a parent company to induce shareholders to sell a sufficient number of shares to obtain control. The extra payment typically becomes part of the goodwill acquired in the acquisition attributable to the parent company.

4.

Current accounting standards require the noncontrolling interest to appear in the stockholders' equity section. The noncontrolling interest's share of the subsidiary’s net income is shown as an allocated component of consolidated net income.

5.

The ending noncontrolling interest is determined on a consolidation worksheet by adding the four components found in the noncontrolling interest column: (1) the beginning balance of the subsidiary’s book value, (2) the noncontrolling interest share of the adusted acquisition-date excess fair over book value allocation, (3) its share of current year net income, (4) less dividends declared to these outside owners.

6.

Allsports should remove the pre-acquisition revenues and expenses from the consolidated totals. These amounts are attributable to prior ownership and therefore should are not earnings for the current parent company owners.

7.

Following the second acquisition, consolidation is appropriate. Once Tree gains control, the 10% previous ownership is included at fair value as part of the total consideration transferred by Tree in the acquisition.

8.

When a company sells a portion of an investment, it must remove the carrying value of that portion from its investment account. The carrying value is based upon application of the equity method. Thus, if either the initial value method or the partial equity method has been used, Duke must first restate the account to the equity method before recording the sales transaction. The same method is applied to the operations of the current period occurring prior to the time of sale.

9.

Unless control is surrendered, the acquisition method views the sale of subsidiary's stock as a transaction with its owners. Thus, no gain or loss is recognized. The difference between the sale proceeds and the carrying value of the shares sold (equity method) is accounted for as an adjustment to the parent’s additional paid in capital.

10.

The accounting method choice for the remaining shares depends upon the current relationship between the two firms. If Duke retains control, consolidation is still required. However, if the parent now can only significantly influence the decision-making process, the 4-5

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e equity method is applied. A third possibility is Duke may have lost the power to exercise even significant influence. The fair value method then is appropriate.

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Answers to Problems

1. C

2. A At the date control is obtained, the parent consolidates subsidiary assets at fair value ($549,000 in this case) regardless of the parent’s percentage ownership.

3. D In consolidating the subsidiary's figures, all intra-entity balances must be eliminated in their entirety for external reporting purposes. Even though the subsidiary is less than fully owned, the parent nonetheless controls it.

4. B An asset acquired in a business combination is initially valued at 100% acquisition-date fair value and subsequently amortized its useful life. Patent fair value at January 1, 2017................................................

$45,000

Amortization for 2 years (9 year remaining life)............................

(10,000)

Patent reported amount December 31, 2018..................................

$35,000

5. C

6. B Combined revenues......................................................................... Combined expenses......................................................................... Excess acquisition-date fair value amortization............................ Consolidated net income.................................................................

$1,100,000 (700,000) (15,000) $385,000

Less: noncontrolling interest share ($85,000 × 40%)....................

(34,000)

Consolidated net income to Chamberlain Corporation................

$351,000

7. C Consideration transferred by Pride.................................................

$540,000

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Noncontrolling interest fair value....................................................

60,000

Star acquisition-date fair value........................................................

$600,000

Star book value..................................................................................

420,000

Excess fair over book value.............................................................

$180,000

Amort. to equipment (8 year remaining life)............................

$ 80,000

$10,000

to customer list (4 year remaining life)........................

100,000

25,000 $35,000

Combined revenues..........................................................................

$783,000

Combined expenses......................................................

$545,000

Excess fair value amortization.....................................

35,000

580,000

Consolidated net income.................................................................

$203,000

8. A Under the equity method, consolidated RE = parent’s RE.

9. B

10. A Amie, Inc. fair value at July 1, 2018: 30% previously owned fair value (30,000 shares × $5) ................

$150,000

60% new shares acquired (60,000 shares × $6)............................

360,000

10% NCI fair value (10,000 shares × $5).........................................

50,000

Acquisition-date fair value...............................................................

$560,000

Net assets' fair value.........................................................................

500,000

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Goodwill ............................................................................................

$ 60,000

11. C

12. B Fair value of 30% noncontrolling interest on April 1.....................

$165,000

30% of net income for remainder of year ($240,000 × 30%).........

72,000

Noncontrolling interest December 31.............................................

$237,000

13. C Proceeds of $80,000 less $64,000 (⅓ × $192,000) book value = $16,000 Control is maintained so excess proceeds go to APIC.

14. B Combined revenues..........................................................................

$1,300,000

Combined expenses.........................................................................

(800,000)

Trademark amortization....................................................................

(6,000)

Patented technology amortization..................................................

(8,000)

Consolidated net income ................................................................

$ 486,000

15. C Subsidiary net income ($100,000 – $14,000 excess amortizations)............................... Noncontrolling interest percentage................................................

$86,000 40%

Net income attributable to noncontrolling interest.......................

$34,400

Acquisition-date fair value of noncontrolling interest..................

$200,000

40% change in previous year Solar book value............................. ($430,000 – $400,000) × 40%...................................................... 40% of excess fair value amortization—year one..........................

12,000 (5,600)

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Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, 13e

Net income attributable to noncontrolling interest (above).........

34,400

Noncontrolling interest at end of year............................................

$240,800

16. A West trademark balance...................................................................

$260,000

Solar trademark balance..................................................................

200,000

Acquisition-date fair value allocation.............................................

60,000

Excess fair value amortization for two years.................................

(12,000)

Consolidated t...