COURSE NAME: ACCOUNTING FOR BUSINESS COMBINATIONS

MODULE 3: CONSOLIDATED FINANCIAL STATEMENT – SUBSEQUENT TO DATE OF

ACQUISITION
INTRODUCTION
After the parent acquires subsidiary, it will commence its operations as a legal entity. Each of
the individual entity (the parent and the subsidiaries), will prepares its own set of financial
statements after reporting period passes.
However, for external reporting purposes, the parent company is required to prepare
consolidated financial statements. In this module, the main objective is to able to prepares a
complete set of financial statements from the parent company’s perspective. The consolidation
process is similar to the previous module, but with additional steps with regards to the
preparation of income statement and retained earnings.

COMPARISON OF COST AND EQUITY METHOD

In accounting for investment in subsidiary the default method is the cost method. This is in
contrast to investment in associate which uses equity method. However, the PFRS does not
prescribe which method will be used therefore either cost or equity method is allowed in the
standard.
At this point it is important to distinguish both methods for you to appreciate the intricate
procedures in consolidation process. After this comparison, we will demonstrate the
consolidation process under cost method then followed by equity method.
Let’s have a simple example. Suppose that on year 20x9, P Company acquires 100% of S
Company for P500,000. The net income of S Company for the year is P100,000 and dividends
declared and paid by S Company is P10,000. Finally, there is a P5,000 adjustment in the
depreciation for the year in order to reflect fair value of the equipment at the date of
acquisition. The following are entries to be made by P Company in its books under both
methods:

1
As illustrated above, under cost method the only entries are the cost of investment and the
receipt of cash dividends, which is recorded as dividend income. In equity method, P Company
records its share in net income of subsidiary which result to increase in the cost of investment
and recognizing investment income. The cash dividend received from subsidiary is recorded as
reduction of investment. The same effect with regards to the adjustment in depreciation.
While there are difference as mentioned above between cost and equity method, the objective
is still the consolidated financial statements of subsidiary into parent. Thus, the consolidated
balances will be the same under both method as illustrated below.
Demonstration Problem (Cost Method):
On January 1, 2009, Father Company acquired an 80 percent interest in Sun Company for P425,000. The
acquisition-date fair value of the 20 percent noncontrolling interest’s ownership shares was P102,500.
Also as of that date, Sun reported total stockholders’ equity of P400,000: P100,000 in common stock
and P300,000 in retained earnings. In setting the acquisition price, Father appraised four accounts at
values different from the balances reported within Sun’s financial records.

Buildings (8-year life) . . . . . . . . . . . . . . . . . . . . . Undervalued by P20,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Undervalued by P50,000
Equipment (5-year life) . . . . . . . . . . . . . . . . . . . Undervalued by P12,500
Royalty agreement (20-year life) . . . . . . . . . . . . Not recorded, valued at P30,000

As of December 31, 2013, the trial balances of these two companies are as follows:

Accounts Father Co Sun Co

Debits
Current assets P605,000 P280,000
Investment in Sun Co 425,000 --
Land 200,000 300,000
Buildings (net) 640,000 290,000

2
Equipment (net) 380,000 160,000
Expenses 550,000 190,000
Dividends 90,000 20,000
Total debits P2,890,000 P1,240,000

Credits
Liabilities P910,000 P300,000
Common stock 480,000 100,000
Retained earnings, 1/1/13 704,000 480,000
Revenues 780,000 360,000
Dividend income 16,000 --
Total credits P2,890,000 P1,240,000

Included in these figures is a P20,000 debt that Sun owes to the parent company. No goodwill
impairments have occurred since the Sun Company acquisition

Required:

a. Determine consolidated totals for Father Company and Sun Company for the year 2013.

b. Prepare worksheet entries to consolidate the trial balances of Father Company and Sun Company for
the year 2013.

c. Assume instead that the acquisition-date fair value of the noncontrolling interest was P112,500. What
balances in the December 31, 2013, consolidated statements would change?

Suggested Answer:
The consolidation process begins with the allocation of the subsidiary’s acquisition date fair
values as shown above. Note that the consolidation process takes place several years after the
acquisition date. The determination and allocation of excess (D & A) schedule is shown below.

3
The price paid is indicated in the cost of investment is P425,000. This is for the 80% interest in
the subsidiary. The fair value of the non-controlling interest is given at P102,500, thus the total
fair value of subsidiary is P527,500. The result is goodwill which is allocated entirely for the
parent company.
An additional schedule called amortization of excess schedule is shown below.

The question is why such amortization is prepared? This is the properly reflect assets of the
subsidiary at fair value in the consolidated financial statements. Take a look at building account.
As reported by subsidiary, it reflects its cost at P290,000. However, the building account should
reflect its acquisition date fair value of P310,000, since the building is undervalued by P20,000.
If we do not reflect it in its fair value, the depreciation expense will be understated which
necessitates adjustment. The same thing for equipment and royalties which is the reason
behind the amortization schedule.
The D & A schedule and the amortization of excess schedule will serve as a guide in formulating
working paper entries as shown below:

4
The second and third entries are similar to the previous module, which is the eliminate
stockholders’ equity of subsidiary to prevent double counting and to recognize goodwill and fair
value of assets acquired.
Let’s look at the first entry. The entry represents adjustment in the beginning balance of
retained earnings of parent company due to the effects of cost method. Remember under cost
method, the only recorded income in the books of parent is the dividend income. The share in
the net income of the subsidiary was not recorded in the parent’s books. The effect is that the
retained earnings of parent will be understated, thus necessitating adjustment.
The amount of adjustment is computed below:

In other textbooks, this is referred to as conversion from cost to equity method. In the
consolidated financial statements, the retained earnings should reflect not only the net income

5
of parent from its own operations, but also the net income of subsidiary. This is not reflected
under cost method.
Let’s now proceed with the other working paper entries:

These are additional working paper entries made to facilitate consolidation process subsequent
to acquisition. First let’s examine entries E1 and E2.
E1 represents adjustments to depreciation for the current year and E2 represents adjustments
to depreciation for the prior years since the date of acquisition. These adjustments will be
made until the end of the remaining useful life of the asset involved.
Entry I eliminates the dividend income recorded by the parent company. This represent 90%
share in the dividends declared and paid by the subsidiary. The 10% represent 10% share of
NCI, thus a debit to NCI is necessary.
Entry P eliminates the intercompany receivables and payables that occurred between the
parent and the subsidiary.
Entry NCI represents share of NCI in the net income of the subsidiary. It is computed as follows:

6
The net income of subsidiary is adjusted for depreciation (amortization of excess) for the
current year, as it is the subsidiary that records the understated depreciation. The net income
of parent company amounting to P246,000 includes the dividend income record by the parent
in its books. This should be excluded in the consolidation process, thus adjustment of dividend
income against parent’s net income. The consolidated net income of P393,500 is determined by
adding the adjusted net income of parent and subsidiary (P230,000 + P163,500).
The shares of both NCI and parent company is based on the adjusted net income. The share of
parent and then the adjusted net income of parent is added to arrive at net income attributable
to parent. Both of these are required disclosures in the consolidated income statement of the
combined company.
Next to be computed is the ending balance of retained earnings and non-controlling interest. It
is determined as follows:

7
The undistributed income is computed as follows:

The computation of undistributed income is the same when it comes to the share of parent
company. This is also the basis of first working paper entry which adjusts the beginning retained
earnings of parent company. Note that only the retained earnings of parent company is
included in the computation for consolidation purposes. The share of NCI is based on adjusted
net increase in retained earnings which is then multiplied by its interest.
Next is the determination of consolidated balances for assets, liabilities and the rest of
accounts. The general guide is the balances of parent and subsidiary as added, taking account
of the adjustment in the working paper entries. The following shows the computation of
consolidated balances.
[]