Chapter 2: Consolidation of Financial Information

Chapter 2: Consolidation of Financial Information

I.What are consolidated financial statements?

Financial statements that present the combined financial data of more than one company are called consolidated financial statements.

II.What key factor determines why consolidated financial statements must be prepared?

Whenever one company gains control over another company, the financial data of the individual companies must be combined into consolidated financial statements. For practical purposes, control is said to exist when one company owns more than 50% of another company's voting stock.

Summarize the reporting of equity investments by briefly describing the reporting required under each of the following ownership percentages.

A.Less than 20% owned:

Trading securities are reported at fair value. Increases or decreases in fair value are reported in the income statement. Securities available for sale are reported at fair value. Increases or decreases in fair value are reported in comprehensive income and included in stockholders' equity as accumulated other comprehensive income.

B.20% to 50% owned:

Investments are accounted for by the equity method.

C.More than 50% owned:

Financial statements are consolidated. The investment account is not reported in balance sheets, but instead the combined assets and liabilities of the corporations are reported.

III.Factors important to the consolidation process.

A.Number of companies remaining after the business combination:

1.Briefly describe the accounting treatment required for a business combination that results in the continuation of only one company (one company survives while the other company is eliminated).

The dissolved company's financial records are closed. All general ledger account balances are combined in the financial records of the surviving company. The surviving company's accounts are adjusted to include the balances of the dissolved company.

2.Briefly describe the accounting treatment required for a business combination that results in the continuation of more than one company (both companies survive after the combination).

Each company continues to maintain its own financial records. Only the financial statements data are combined, periodically, usually through the use of worksheets, whenever financial statements are prepared.

B.Accounting treatment of the business combination, i.e., the investment in one company by another. Accounting for business combinations has changed significantly during the last several years.

1.Identify the only acceptable way to account for business combinations occurring after 2008.

SFAS 141R requires that the acquisition method be used to account for all business combinations occurring on or after December 15, 2008.

2.Identify the only acceptable way to account for business combinations occurring during the 2002-2008 time period. See text page 61.

SFAS 141 required that the purchase method be used to account for all business combinations occurring after June 30, 2001.

3.Identify the two acceptable ways to account for business combinations occurring before 2002. See text page 65.

APB 16, issued in 1970,allowed the use of the (1) purchase method and (2) pooling of interests method to account for all business combinations occurring after October 31, 1970.

4.Identify the fundamental characteristic ofa business combination to be accounted for by the acquisition method:

A change in ownership. Acquisitions result in a clear break in ownership because the previous owners of the acquired company are eliminated. A common characteristic of acquisitions is the exchange of cash for the voting shares of the acquired company.

5.Identify the fundamental characteristic of a business combination to be accounted for by the pooling of interests method:

A continuation of ownership. Pooling of interests do not result in a clear break in ownership because the previous owners of the acquired company continue to own part of the resulting company. The common characteristic of pooling of interests is the exchange of voting shares of the acquiring company for voting shares of the acquired company.

IV.The consolidation process: considering the number of companies that can remain after a business combination (one or more) and the ways in which the combination may be accounted for (acquisition, purchase, or pooling of interests), results in the following six possibilities for the consolidation process.

1.) one company remains: the business combination is recorded as an acquisition

2.) more than one company remains: the business combination is recorded as an acquisition

3.)one company remains: the business combination is recorded as a purchase

4.)more than one company remains: the business combination is recorded as a purchase

5.)one company remains: the business combination is recorded as a pooling of interests

6.)more than one company remains: the business combination is recorded as a pooling of interests

A.One company remains: the business combination is accounted for by the acquisition method:

1.At the date of acquisition, when only one company remains, the acquisition method consolidates the book values of the acquiring company's assets and liabilities with the fair values of the acquired company's assets and liabilities. Any payment in excess of the fair value of net assets acquired is recorded as goodwill.

Only the acquired company's dividends, revenues, and expenses that occur after the acquisition affect the combined accounts and, thus the financial statements, of the combined companies.

Since only one company remains, the resulting financial statements are consolidated financial statements. No additional consideration must be given to the consolidation process.

More than one company remains: the business combination is accounted for by the acquisition method:

When more than one company remains after the acquisition, information for consolidated financial statements is generated outside of the general ledger, often in the form of worksheets.

Assume that the Lowell Corporation acquired the Boston Corporation on December 31, 2009 by paying $48,000 cash for 100% of the Boston Corporation's common stock. After acquisition, both corporations continue to operate. The following information is available.

Accounts / Lowell
Book Value
12/31/09 / Boston
Book Value
12/31/09 / Boston
Fair Value
12/31/09
Cash / $50,000 / $7,000 / $7,000
Accounts Receivable / 35,000 / 10,000 / 10,000
Land / 25,000 / 5,000 / 6,000
Buildings / 50,000 / 18,000 / 20,000
Equipment / 200,000 / 40,000 / 43,000
Accounts Payable / 15,000 / 3,000 / 3,000
Bonds Payable / 220,000 / 40,000 / 42,000
Common Stock, $1 par / 5,000 / 3,000
Additional Paid-in Capital, Com. St. / 14,000 / 4,000
Retained Earnings, 1/1/09 / 88,000 / 22,000
Dividends (2009) / 22,000 / 0
Revenues (2009) / 200,000 / 50,000
Expenses (2009) / 160,000 / 42,000

Show how the Lowell Corporation would be affected by the acquisition.

Total
Resources / = / Sources of
Borrowed
Resources / + / Sources of
Owner
Invested
Resources / + / Sources of Management
Generated
Resources
Assets / = / Liabilities / + / Stockholders’ Equity
Total
Resources / = / Sources of
Borrowed
Resources / + / Sources of
Owner
Invested
Resources / + / Sources of Management
Generated
Resources
Assets / = / Liabilities / + / Stockholders’ Equity
+ $48,000
Investment in
Boston Corp.
- $48,000
Cash

Prepare the journal entry to record the Lowell Corporation’s acquisition of the Boston Corporation.

Posting
Date / Item / Ref. / Debits / Credits
Dec. 31
Boston Corp. Combination
Posting
Date / Item / Ref. / Debits / Credits
Dec. 31 / Investment in Boston Corporation / 48,000
Cash / 48,000
Boston Corp. Combination

Complete the Lowell Corporation's account balances after the acquisition.

Accounts / Lowell
Corporation
12/31/09
Cash
Accounts Receivable / 35,000
Land / 25,000
Buildings
Equipment / 200,000
Goodwill / 0
Accounts Payable / 15,000
Bonds Payable
Common Stock, $1 par / 5,000
Additional Paid-in Capital, Com. St. / 14,000
Retained Earnings, 1/1/09
Dividends (2009)
Revenues (2009)
Expenses (2009)
Accounts / Lowell
Corporation
12/31/09
Cash / $2,000
Accounts Receivable / 35,000
Investment in Boston Corp. / 48,000
Land / 25,000
Buildings / 50,000
Equipment / 200,000
Goodwill / 0
Accounts Payable / 15,000
Bonds Payable / 220,000
Common Stock, $1 par / 5,000
Additional Paid-in Capital, Com. St. / 14,000
Retained Earnings, 1/1/09 / 88,000
Dividends (2009) / 22,000
Revenues (2009) / 200,000
Expenses (2009) / 160,000

To consolidate the financial data of the Lowell Corporation and the Boston Corporation, the Lowell Corporation would make use of a worksheet, as shown below. The data in the first two numerical columns were obtained directly from the accounting records of each company. The debits and credits columns will be used to adjust each individual company's data to reflect the results of the combination. The last column contains the consolidated financial data.

Without entering any amounts in the debits and credits columns of the worksheet, complete the Consolidated Totals 12/31/09 column to determine the proper balances to be reported in the Lowell Corporation’s consolidated financial statements. Be careful. Some of the consolidated balances will not be obtained by simply adding the Lowell Corporation and Boston Corporation book values.

Accounts / Lowell
Book
Value
12/31/09 / Boston
Book
Value
12/31/09 / Debits / Credits / Consolidated
Totals
12/31/09
Income Statement
Revenues / $200,000 / $50,000
Expenses / 160,000 / 42,000
Net Income / $40,000 / $8,000
St. of Retained Earn.
R/E, 1/1/09 / $88,000 / $22,000
Plus: Net Income / 40,000 / 8,000
Less: Dividends / 22,000 / 0
R/E, 12/31/09 / $106,000 / $30,000 / $106,000
Balance Sheet
Cash / $2,000 / $7,000
Accounts Receivable / 35,000 / 10,000
Investment in Boston Corp. / 48,000 / 0
Land / 25,000 / 5,000
Buildings / 50,000 / 18,000
Equipment / 200,000 / 40,000
Goodwill / 0 / 0
Total assets / $360,000 / $80,000
Accounts Payable / 15,000 / 3,000
Bonds Payable / 220,000 / 40,000
Common Stock, $1 par / 5,000 / 3,000
Add. Paid-in Cap., Com. St. / 14,000 / 4,000
R/E, 12/31/09 / 106,000 / 30,000
Total Liab. & St. Eq. / $360,000 / $80,000 / $405,000
Accounts / Lowell
Book
Value
12/31/09 / Boston
Book
Value
12/31/09 / Debits / Credits / Consolidated
Totals
12/31/09
Income Statement
Revenues / $200,000 / $50,000 / (1) 50,000 / $200,000
Expenses / 160,000 / 42,000 / (1) 42,000 / 160,000
Net Income / $40,000 / $8,000 / $40,000
St. of Retained Earn.
R/E, 1/1/09 / $88,000 / $22,000 / (S) 30,000 / (1) 8,000 / $88,000
Plus: Net Income / 40,000 / 8,000 / 40,000
Less: Dividends / 22,000 / 0 / 22,000
R/E, 12/31/09 / $106,000 / $30,000 / $106,000
Balance Sheet
Cash / $2,000 / $7,000 / $9,000
Accounts Receivable / 35,000 / 10,000 / 45,000
Investment in Boston Corp. / 48,000 / 0 / (S) 37,000 / 0
(A) 11,000
Land / 25,000 / 5,000 / (A) 1,000 / 31,000
Buildings / 50,000 / 18,000 / (A) 2,000 / 70,000
Equipment / 200,000 / 40,000 / (A) 3,000 / 243,000
Goodwill / 0 / 0 / (A) 7,000 / 7,000
Total assets / $360,000 / $80,000 / $405,000
Accounts Payable / 15,000 / 3,000 / 18,000
Bonds Payable / 220,000 / 40,000 / (A) 2,000 / 262,000
Common Stock, $1 par / 5,000 / 3,000 / (S) 3,000 / 5,000
Add. Paid-in Cap., Com. St. / 14,000 / 4,000 / (S) 4,000 / 14,000
R/E, 12/31/09 / 106,000 / 30,000 / 106,000
Total Liab. & St. Eq. / $360,000 / $80,000 / $100,000 / $100,000 / $405,000

Income statement: Only the acquired company's revenues and expenses that occur after the acquisition affect the income statement of the combined companies. Since the acquisition took place on December 31, 2009, only the Lowell Corporation’s revenues and expenses would be included in the consolidated income statement. None of the Boston Corporation’s revenues and expenses would be included in the consolidated income statement.

Statement of retained earnings: Only the acquired company’s net income and dividends that occur after the acquisition affect the statement of retained earnings of the combined companies.

Since the acquisition took place on December 31, 2009, only the Lowell Corporation’s net income and dividends would be included in the consolidated statement of retained earnings. None of the Boston Corporation’s net income or dividends would be included in the consolidated statement of retained earnings. Similarly, since the Boston Corporation’s beginning retained earnings balance (1/1/09) includes its income and dividends for periods prior to the date of acquisition (12/31/09), the Boston Corporation’s beginning retained earnings balance would not be included in the beginning retained earnings balance reported in the consolidated statement of retained earnings

Balance sheet: The acquisition method consolidates the book values of the acquiring company's assets and liabilities with the fair values of the acquired company's assets and liabilities. Any payment in excess of the fair value of net assets acquired is recorded as goodwill. So, the consolidated balances for assets and liabilities would be the book values of the Lowell Corporation plus the fair values of the Boston Corporation. In essence, the Lowell Corporation’s Investment in Boston Corporation balance is replaced by the individual assets and liabilities of the Boston Corporation.

Accounts / Lowell
Book Value
12/31/09 / Boston
Fair Value
12/31/09 / Consolidated
Totals
12/31/09
Cash / $2,000 / $7,000 / $9,000
Accounts Receivable / 35,000 / 10,000 / 45,000
Investment in Boston Corporation / 48,000 / 0
Land / 25,000 / 6,000 / 31,000
Buildings / 50,000 / 20,000 / 70,000
Equipment / 200,000 / 43,000 / 243,000
Accounts Payable / 15,000 / 3,000 / 18,000
Bonds Payable / 220,000 / 42,000 / 262,000
Fair value of net assets / 41,000
Goodwill (excess) / 7,000 / 7,000
Net assets acquired (investment) / 48,000

The common stock and additional paid-in capital consolidated balances would report only the Lowell Corporation balances since the Boston Corporation stock is all being held by the Lowell Corporation.

Once you have completed the Consolidated Totals 12/31/09 column of the worksheet, develop the series of adjustments necessary to arrive at the proper consolidated balances and enter your adjustments into the debits and credits columns on page 5.

In order to consolidate the financial data of the Lowell Corporation and the Boston Corporation, the following three adjustments were required. Briefly describe the (S) stockholders’ equity and (A) allocations adjustments.

(1)Eliminate acquired company revenues and expenses prior to the date of the combination. Remember, an acquisition represents a break in ownership. Thus, the operation of the acquired company before the acquisition does not affect the operations of the new company. Note: this adjustment is not presented in the text.

(S) Stockholders' equity adjustment.

Eliminate the book value of the acquired company's stockholders' equity accounts by reducing common stock, additional paid-in capital, retained earnings, and the investment in Boston Corporation. Remember, anacquisition results in a break in ownership. The previous owners of the acquired company have been eliminated.

(A) Allocations adjustment.

Allocate the amount of the acquisition price in excess of the book value of net assets acquired to the acquired assets. This adjustment may increase some specific assets and liabilities, recognize goodwill, and will reduce the investment in Boston Corporation.

It is important to note that the result of the consolidation worksheet is a set of consolidated financial statements that would be identical to the set of financial statements the Lowell Corporation would have prepared if it had acquired the Boston Corporation and the Boston Corporation had been eliminated!

C.One company remains: the business combination is accounted for as a pooling of interests:

At the date of acquisition, when only one company remains, the pooling of interests method consolidates the book values of the acquiring company's accounts with the book values of the acquired company's accounts, with one exception. The acquiring company's stock issued in the acquisition increases its common stock account by the par value of shares issued while total contributed capital for the acquisition is limited to the total contributed capital of the acquired company.

Both the acquiring company's and the acquired company's revenues and expenses that occurred at any time during the fiscal year affect the combined accounts and, thus the financial statements of the combined companies.

Since only one company remains, the resulting financial statements are consolidated financial statements. No additional consideration must be given to the consolidation process.

D.More than one company remains: the business combination is accounted for as a pooling of interests:

When more than one company remains after the pooling of interests, information for consolidated financial statements is generated outside of the general ledger, often in the form of worksheets. The dollar amounts reported on the consolidated financial statements will be the same no matter how many companies remain after the pooling of interests.

Instead of the December 31, 2009 acquisition date used previously in part IV.B., assume that the Lowell Corporation acquired the Boston Corporation on December 31, 2000 by issuing 1,000 shares of its $1 par common stock for 100% of the Boston Corporation's common stock. The market price per share of the Lowell Corporation common stock was $48. After acquisition, both corporations continue to operate.

Note: Try not to get too frustrated with the following few pages. This material is not covered in the text, so you will have to use your imagination. If you get too frustrated, stop and wait until we discuss the material in class.

Show how the Lowell Corporation would be affected by the pooling of interests.

In the pooling of interests method the Investment in Boston Corporation account is recorded at the book value of the Boston Corporation's net assets as of January 1, 2000, the beginning of the fiscal year, not December 31, 2000, the date of acquisition. The acquiring company's common stock increases by the par value of shares issued while total contributed capital for the acquisition is limited to the total contributed capital of the acquired company. Retained earnings increases by the book value of the acquired company’s retained earnings at the beginning of the fiscal year.

Prepare the journal entry to record the Lowell Corporation’s pooling of interests.

Posting
Date / Item / Ref. / Debits / Credits
Dec. 31
Boston Corp. Combination
Posting
Date / Item / Ref. / Debits / Credits
Dec. 31 / Investment in Boston Corporation / 29,000
Common Stock / 1,000
Additional Paid-in Capital, Com. St. / 6,000
Retained Earnings / 22,000
Boston Corp. Combination

Complete the Lowell Corporation's account balances after the pooling of interests.

Accounts / Lowell
Corporation
12/31/00
Cash / $50,000
Accounts Receivable / 35,000
Investment in Boston Corp. / 29,000
Land
Buildings / 50,000
Equipment / 200,000
Goodwill
Accounts Payable / 15,000
Bonds Payable
Common Stock, $1 par
Additional Paid-in Capital, Com. St.
Retained Earnings, 1/1/00
Dividends (2000)
Revenues (2000)
Expenses (2000)
Accounts / Lowell
Corporation
12/31/00
Cash / $50,000
Accounts Receivable / 35,000
Investment in Boston Corp. / 29,000
Land / 25,000
Buildings / 50,000
Equipment / 200,000
Goodwill / 0
Accounts Payable / 15,000
Bonds Payable / 220,000
Common Stock, $1 par / 6,000
Additional Paid-in Capital, Com. St. / 20,000
Retained Earnings, 1/1/00 / 110,000
Dividends (2000) / 22,000
Revenues (2000) / 200,000
Expenses (2000) / 160,000

To consolidate the financial data of the Lowell Corporation and the Boston Corporation, the Lowell Corporation would make use of a worksheet, as shown on the following page. The data in the first two numerical columns were obtained directly from the accounting records of each company. The debits and credits columns will be used to adjust each individual company's data to reflect the results of the combination. The last column contains the consolidated financial data.

Without entering any amounts in the debits and credits columns of the worksheet, complete the Consolidated Totals 12/31/00 column to determine the proper balances to be reported in the Lowell Corporation’s consolidated financial statements. Be careful. Some of the consolidated balances will not be obtained by simply adding the Lowell Corporation and Boston Corporation book values.