CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

CONSOLIDATED FINANCIAL STATEMENTS: ON DATE OF BUSINESS

COMBINATION
Parent Company – Subsidiary Relationships:

▪ When the investor acquires a controlling interest in the investee, a parent -

subsidiary relationship establishes.
▪ The investee becomes a subsidiary of the acquiring parent company
(investor) but remains a separate legal entity

▪ A parent company and its subsidiaries are a single economic entity. In

recognition of this fact, consolidated financial statements are issued to
report the financial position and operating results of a parent company and
its subsidiaries as though they comprised a single accounting entity.

Nature of Consolidated Financial Statements:

▪ Similar to the combined financial statements for a home office and its
branches.
▪ Assets, liabilities, revenue, and expenses of the parent company and its
subsidiaries are totaled; inter-company transactions and balances are
eliminated; and the final consolidated amounts are reported in the balance
sheet, income statements, statement of stockholders’ equity, and statement
of cash flows.

The Meaning of Controlling Interest:

▪ Traditionally, an investor’s direct or indirect ownership of more than 50%

of an investee’s outstanding common stock has been required to evidence
the controlling interest underlying a parent – subsidiary relationship.
▪ However, even though such a common stock ownership exists, other
circumstances may negate the parent company’s actual control of the
subsidiary.
▪ A foreign subsidiary in a country having severe production, monitory or
income tax restrictions may be subject to the authority of the foreign country
rather than of the parent company

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

Consolidation of Wholly Owned Subsidiary on Date of Business Combination:

Example 1:

On December 31, 2002, P company issued 10,000 shares of its $10 par common
stock (current fair value $50 a share) to stockholders of S company for all the
outstanding $5 par common stock of S.
Out of pocket costs of the business combination paid by P on December 31, 2002
consisted of the followings:
Finder’s & legal fees relating to business combination $50,000
Costs associated with SEC Registration $35,000
The S company was to continue its corporate existence as a wholly owned
subsidiary of P Corporation.
The income tax rate for each company was 40%
Financial statements of P Corporation and S Company for the year ended
December 31, 2002, prior to consummation of the business combination,
followings
P CORPORATION AND S COMPANY
Separate Financial Statements ( prior to business combination)
For Year Ended December 31, 2002

P Corp. S Comp
Income Statements
Revenue:
Net Sales $990,000 $600,000
Interest Revenue 10,000
Total Revenue $1,000,000 $600,000
Costs and Expenses:
Cost of Goods Sold $635,000 $410,000
Operating Expenses 158,333 73,333
Interest Expense 50,000 30,000
Income Taxes Expense 62,667 34,667
Total Costs and Expenses $906,000 $548,000
Net Income $94,000 $52,000

Statements of Retained Earnings

Retained Earnings, begineing of year $65,000 $100,000
Add: Net Income 94,000 52,000
Subtotals $159,000 $152,000
Less: Dividends 25,000 20,000
Retained Earnings, end of year $134,000 $132,000

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

P CORPORATION AND S COMPANY

Separate Financial Statements ( prior to business combination)
For Year Ended December 31, 2002

P Corp. S Comp
Balance Sheets
Assets
Cash $100,000 $40,000
Inventories $150,000 $110,000
Other Current Assets 110,000 $70,000
Receivable from S Company $25,000
Plant Assets (Net) $450,000 $300,000
Patent (Net) $20,000
Total Assets 835,000 540,000

Liabilities and Stockholders' Equity

Payables to P Corp. $25,000
Income Taxes Payable 26,000 10,000
Other Liabilities $325,000 $115,000
Common Stock, $10 par 300,000
Common Stock, $5 par $200,000
Additional Paid-In Capital 50,000 58,000
Retained Earnings $134,000 $132,000
Total Liabilities & Stockholders' Equity 835,000 540,000

On December 31 2002, the current fair values of S company’s identifiable assets

and liabilities were the same as their carrying amounts, except for the Inventories,
Plant Assets (net) and Patent (net). They were as

Assets Current Fair Value as or 31/12/2002

Inventories $ 135,000

Plant Assets (net) $ 365,000

Paten (net) $ 25,000

Instructions:

1- Prepare the journal entries for the business combinations on

31/12/2002?
2- Prepare the consolidated balance sheet without a working paper on
31/12/2002?

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

1-Because S was to continue as a separate corporation and generally accepted

accounting principles do not sanction write-ups of assets of a going concern.

S did not prepare journal entries for the business combination.

P recorded the combination as a purchase on December 31, 2002, with following

journal entries.

Investment in S Company Common Stock (10,000 x 50) 500,000

Common Stock (10,000 x $10) $100,000
Paid-In-Capital in Excess of Par $400,000
To record Issuance of 10,000 shares of common stock for all the
outstanding common stock of S company in a business
Combination

Merger Expense 85,000

Cash 85,000

2-

▪ The business combination involves parent-subsidiary relationship, so

the theory reflects that an acquisition of the combinee’s net assets by
the combinor is involved.
▪ A consolidated balance sheet is the only consolidated financial
statement issued by P Corp on December 31, 2002.
▪ The parent company’s investment account and the subsidiary’s
stockholders’ equity accounts do not appear in the consolidated
balance sheet because they are essentially reciprocal accounts.
▪ The parent company’s assets and liabilities are reflected at carrying
amounts, and the subsidiary (combinee) assets and liabilities are
reflected at current fair values, in the consolidated balance sheet.
▪ Inter-company accounts are excluded from the consolidated balance
sheet.

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

Notes Regarding S Company (Subsidiary)

Assets Current Fair Value as or 31/12/2016

BV FMV

Inventories $110,000 $ 135,000

Plant Assets (net) $300,000 $ 365,000

Patent (net) $20,000 $ 25,000

NFMV = FMVA – FMVL =

[40,000+135,000+70,000+365,000+25,000-10,000+115,000+25,000]= 485,000

GW = CP – NFMV = 500,000 – 485,000 = 15,000

General Notes :

*Cash for P= Cash 31/12 – Merger Expenses =

$100,000 – $85,000 = $15,000

#A/R from S Eliminated 25,000

# A/P from P Eliminated 25,000

# Common Stock of S Eliminated 200,000

#Additional paid-in-capital of S Eliminated

# RE of S Eliminated

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

P CORPORATION AND S COMPANY

Consolidated Balance Sheet

Assets
Current Assets
Cash ($15,000+$40,000) $55,000
Inventories ($150,000+ $135,000) 285,000
Other ($110,000 + $ 70,000) 180,000
Total Current Assets $520,000
Plant Assets (net) ($450,000 + $365,000) 815,000
Intangible Assets:
Patent (net) ($0 + $25,000) 25,000
Goodwill (500000-485000) 15,000 40,000
Total Assets 1,375,000

Liabilities and Stockholders' Equity

Liabilities :
Income taxes payable ($26,000 +$10,000) $36,000
Other ($325,000 + $115,000) 440,000
Total Liabilities $476,000
Stockholders' Equity:
Common Stock, $ 10 par (300000+100000 $400,000
Additional paid-in-capital (50000+400000) 450,000
Retained Earnings (134000-85000) 49,000 899,000
Total Liabilities and Stockholders' Equity $1,375,000
Working Paper for Consolidated Balance Sheet:

The preparation of consolidated balance sheet on the date of a business

combination usually requires the use of a working paper for consolidated
balance sheet.

Developing the Eliminations:

The following features of the working paper for consolidated balance sheet
on the date of the business combination should be emphasized:

1- The elimination is not entered in either the parent company’s or the

subsidiary’s accounting records; it is only a part of the working paper for
preparation of the consolidated balance sheet.

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

2- The elimination is used to reflect differences between current fair values

and carrying amounts of the subsidiary’s identifiable net assets because
the subsidiary did not write up its assets to current fair values on the date of
the business combination.
3- The respective corporations are identified in the working paper elimination.
4- The consolidated paid-in capital amounts are those of the parent company
only. Subsidiaries’ paid-in capital amounts always are eliminated in the
process of consolidation.
5- Consolidated retained earnings on the date of a business combination
include only the retained earnings of the parent company.
6- The amounts in the consolidated column of the working paper for
consolidated balance sheet reflect the financial position of a single economic
entity comprising two legal entities, with all inter-company balances of the
two entities eliminated.

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 CONSOLIDATED FINANCIAL STATEMENTS (Topic 4)

Example 2:

The same information in example 1

Instructions:

1- Prepare the journal entries for the business combinations on 31/12/2002?

2- Prepare a working paper at 31/12/2002?

PALM CORPORATION AND SUBSIDIARY

Working Paper for Consolidated Balance Sheet
December 31, 2002
Palm Star
Corporation Company Eliminations Consolidated
Assets Dr Cr

Cash (100000-85000) 15,000 40,000 55,000

Inventories 150,000 110,000 25,000 285,000
Other current assets 110,000 70,000 180,000
Receivable from Star Company 25,000 0 25,000 1 0
Plant assets (net) 450,000 300,000 65,000 815,000
Patent (net) 0 20,000 5,000 25,000
Investment in Star Company 500,000 500,000 0
Goodwill 15,000 15,000
Total Assets 1,250,000 540,000 1,375,000
Liabilities & Stockholders’ Equity

Payable to Palm Corporation 0 25,000 25,000 1 0

Income Tax Payable 26,000 10,000 36,000
Other Liabilities 325,000 115,000 440,000
Common Stock 400,000 200,000 200,000 400,000
Additional Paid in capital 450,000 58,000 58,000 450,000
Retained earnings (134000-85000) 49,000 132,000 132,000 49,000
Total Liabilities & Stockholders’ Equity 1,250,000 540,000 525,000 525,000 1,375,000

Plam Corporation & Subsidiary

Working Paper Elimination
December 31,2005

Inventories 25,000
Plant assets 65,000
Patent 5,000
Goodwill 15,000
A/P 25,000
Common Stock 200,000
Additional Paid in capital 58,000
R.E 132,000
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A/R 25,000
Investment in Star Company 500,000