Chapter 10
Consolidated Financial Statements: Special Problems
HIGHLIGHTS OF THE CHAPTER
1.If a parent company acquires all or part of the minority interest in a subsidiary, purchase accounting (including recognition of goodwill) is applied to the acquisition. This standard holds true even though the business combination had been accounted for as a pooling (when pooling was permitted).
2.If a parent company disposes of a portion of its common stockholdings in a subsidiary, a gain or loss is recognized in the parent’s accounting records and in the consolidated income statement. The gain or loss is measured as the difference between the cash or current fair value of consideration received by the parent and the carrying amount of the subsidiary common stock sold. The gain or loss is not an extraordinary item. For accounting periods subsequent to the date of the parent company’s disposal of a portion of its subsidiary common stockholdings, the minority interest in the subsidiary’s net income and net assets is larger than prior to the disposal.
3.If a subsidiary issues additional shares of common stock to the public, thus increasing the minority interest in the net income and net assets of the subsidiary, the parent company generally recognizes a gain or loss. A gain results if the price per share for the subsidiary’s common stock issued to the public exceeded the carrying amount per share of the parent company’s investment in the subsidiary. A loss to the parent company results from the converse situation. The parent company’s gain or loss generally is displayed as a nonoperating item in both the consolidated income statement and the parent’s income statement.
4.A subsidiary’s issuance of additional shares of common stock to the parent company also results in a nonoperating gain or loss to the parent company if an existing minority interest in net assets of the subsidiary is changed by the subsidiary’s common stock issuance.
5.Some combinees in a business combination have preferred stock as well as common stock outstanding. If the parent company acquires less than 100% of the subsidiary’s preferred stock, the preferences associated with the preferred stock must be considered in the measurement of the minority interest in net income and net assets of the subsidiary.
6.Preferred stock of a subsidiary does not enter into the measurement of goodwill acquired in a business combination because the preferred stock substantively may be considered debt rather than equity of the subsidiary. Thus, the amount paid by the parent company for the subsidiary’s common stock is the measure of the amount of goodwill acquired in a business combination.
7.The call price of a subsidiary’s preferred stock is used in the measurement of both the cost of the parent company’s investment in the preferred stock and the minority interest of preferred stockholders in the net assets of the subsidiary on the date of the business combination. The call price is both the preferred stockholders’ maximum claim on the subsidiary’s net assets and the amount that the subsidiary would pay to retire the preferred stock.
8.Dividends received by a parent company on its investment in a subsidiary’s preferred stock are recognized as intercompany revenue under the cost method of accounting. If a subsidiary passes dividends on cumulative preferred stock owned by the parent company, the parent accrues the passed dividends under the equity method of accounting. Minority preferred stockholders’ dividends are included in the measurement of minority interest in net income of the subsidiary.
9.The amount of consolidated retained earnings is not affected by a subsidiary’s stock dividends. All accumulated earnings of the consolidated group not distributed to the parent company’s stockholders or capitalized by the parent company are included in consolidated retained earnings.
10.Treasury stock of a subsidiary on the date of a business combination is treated as retired stock in the consolidated financial statements. A working paper elimination is prepared to reflect the “retirement” of the treasury stock by the par or stated value method. Comparable treatment is accorded to treasury stock acquired by the subsidiary from minority stockholders subsequent to the date of a business combination. In addition, goodwill is recognized if the cost of the acquired treasury stock exceeds the carrying amount of the relevant minority interest in net assets.
11.Indirect shareholdings exist if a subsidiary and the parent company jointly own a controlling interest in another subsidiary, or a subsidiary is itself the parent company of its own subsidiary. Accountants who prepare working papers for consolidated financial statements for parent–subsidiary relationships involving indirect shareholdings must follow carefully the common stock ownership percentages and apply the equity method of accounting for the indirectly owned subsidiary’s operating results accordingly.
12.Reciprocal shareholdings involve subsidiary ownership of the parent company’s common stock. Reciprocal shareholdings are in substance treasury stock to the consolidated entity; thus, working paper eliminations (in journal entry format) such as the following are appropriate for reciprocal shareholdings.
Treasury StockParent / XXXInvestment in Parent Company Common StockSubsidiary / XXX
To transfer subsidiary’s investment in parent company’s common stock to treasury stock category.
Intercompany Dividend RevenueSubsidiary / XXX
Dividends DeclaredParent / XXX
To eliminate parent company dividends received by subsidiary.