Chapter five

Consolidated Financial Statements

5.1. Introduction
Consolidated financial statements are similar to the combined financial statements described in
chapter 2 for a home office and its branches. Assets, liabilities, revenues, and expenses of the
parent company and its subsidiaries are totaled; inter-company transactions and balances are
eliminate; and the final consolidated amounts are reported in the consolidated balance sheet,
income statement, stockholders, equity, and statement of cash flows.
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.

Definition A parent is an enterprise that has one or more subsidiaries.

Definition A subsidiary is an enterprise that is controlled by another enterprise (known as

the parent).

Definition Control is the power to govern the financial and operating policies of an
enterprise so as to obtain benefits from its activities.

This state of affairs requires a parent company generally to produce consolidated financial
statements showing the position and results of the whole group.

An investor’s direct and 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.

5.2. Consolidation of Wholly Owned Subsidiary on Date of Purchase-type Business

Combination
There is no question of control of a wholly owned subsidiary. Thus, to illustrate consolidated
financial statements for a parent company and a wholly owned purchased subsidiary, assume that
on December 31, 1999 palm corporation issued 10,000 shares of its $10 par common stock
(current fair value $45 per share) to stockholders of Starr company for all outstanding $5 par
common stock of star. There was no contingent consideration. Out-of-pocket costs of business
combination paid by palm for finder’s and legal fees on December 31, 1999 amount $50,000.
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Assume also that the business combination qualified for purchase accounting because required
conditions for pooling accounting were not met, both companies had a December 31, 1999 fiscal
year and used the same accounting principles and procedures.
The balance sheets of Palm Corporation and star company for the year ended December 31, 1999
follow:
Assets palm corporation star company
Cash $ 100,000 $40,000
Inventories 150,000 110,000
Other current assets 110,000 70,000
Receivable from star company 25,000
Plant assets (net). 450,000 300,000
Patent (net) ________ 20,000
Total assets $ 835,000 540,000
Liabilities and stockholders’ equity
Payable to palm corporation $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 31,199, current fair values of star company’s identifiable assets and liabilities
were the same as their carrying amounts, except for the three assets listed below.
Current fair values
December 31, 1999.
Inventories $135,000
Plant assets (net). 365,000
Patent (net) 25,000
Required:

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 1. Prepare the necessary journal entries for the business combination as a purchase
accounting method?
2. Prepare the consolidated balance sheet at 31 December 1999?
Answer
Palm Corporation recorded the combination as a purchase on December 31, 1999, with the
following journal entries:
1. Investment in star common stock (10,000 x $ 45) 450,000
Common stock (100,000 x $ 10 100,000
Paid-in capital in excess of par 350,000
To record issuance of 10,000 shares of common stock for all the outstanding common stock of
star in a purchase type business combination.
Investment in star company common stock...............................50,000
Cash ..............................................................................50,000
To record out-of-pocket costs of business combination with star company
After the forgoing journal entries have been posted, the affected ledger accounts of Palm
Corporation are as follows:
__________________Cash____________________
Balance forward $ 100,000 50,000 out-of-pocket
Costs of business combination
Balance 50,000
Investment in star company common stock
$ 450,000 issuance of common stock
50,000 direct out-of-pocket costs of
business combination
500,000 balance.
Common stock__________________
300,000 balance forward, 100,000 issuance of common stock in business
Combination
__________________________
400,000 balance

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Paid-in capital in excess of par__________________________
$ 50,000 balance forward
350,000 issuance common stock in business combination

400,000 balance.
2. Now we can prepare the following consolidated balance sheet.
Consolidated balance sheet
December 31, 1999
Assets
Cash ($ 50,000 + 40,000) $ 90,000
Inventories ($ 150,000 + 135,000) 285,000
Other current asset ($ 110,000 + 70,000) 180,000
Plant assets (net) ($ 450,000 + 365,000) 815,000
Patent (net) (0 + $ 25,000) 25,000
Goodwill (net) 15,000
Total assets $ 1,410,000
Liabilities and stockholders’ equity
Income-tax payable ($ 26,000 + 10,000) $ 36,000
Other liabilities ($ 325,000 + 115,000) 440,000
Common stock, $10 par 400,000
Additional paid-in capital. 400,000
Retained earnings 134,000
Total liabilities and stockholder’s equity - - 1,410,000
The following are significant aspects of the foregoing consolidated balance sheet.
1. The first amounts in the computations of consolidated assets and liabilities (except goodwill)
are the parent company’s carrying amounts; the second amounts are the subsidiary’s current
fair values.
2. Inter-company accounts (parent’s investment, subsidiary’s stockholders’ equity, and inter-
company receivable/payable) are excluded from the consolidated balance sheet.
3. goodwill in the consolidated balance sheet is the cost of the parent company’s investment ($
500,000) minus the current fair value of the subsidiary’s identifiable net assets ($ 485,000);

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 or $ 15,000. The $ 485,000 current fair value of the subsidiary’s identifiable net assets is
computed as follows: $ 40,000 + 135,000 + 70,000 + 365,000 + 25,000 – 25,000 – 10,000 –
115,000 = $ 485,000.
5.3. Consolidation of Partially Owned Subsidiary on Date of Purchase-type of
Business Combination
The consolidation of a parent company and its partially owned subsidiary differs from the
consolidation of a wholly owned subsidiary in one major respect-the recognition of minority
interest. Minority interest is a term applied to the claims of stockholders other than the parent
company (the controlling interest) to the net income or losses and net assets of the subsidiary.
The minority interest in the subsidiary’s net income or losses is displayed in the consolidated
income statement, and the minority interest in the subsidiary’s assets is displayed in the
consolidated balance sheet.
Example
On December 31, 1999, Post Corporation issued 57,000 shares of its $1 par common stock
(current fair value $ 20 a share) to the stockholders of sage company in exchange for 38,000 of
the 40,000 outstanding shares of sage’s $ 10 par common stock in a purchase type business
combination. Thus, post acquired a 95% interest (38,000/ 40,000 = 0.95) in sage, which became
post’s subsidiary. There was no contingent consideration. Out-of-pocket costs of combination
paid in cash by post on December 31, 1999 for finder and legal fees amount $ 52,250.
The balance sheets of Post Corporation and sage company for their fiscal year ended December
31, 1999, prior to the business combination, were as follows. There were no inter-company
transactions to the combination.
Assets post corporation sage company
Cash $ 200,000 $ 100,000
Inventories 800,000 500,000
Other current assets 550,000 215,000
Plant assets (net) 3,500,000 1,100,000
Goodwill (net) 100,000 _________
Total assets $ 5,150,000 1,915,000
Liabilities and stockholders’ equity
Income taxes payable $ 100,000 $ 16,000

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 Other liabilities 2,450,000 930,000
Common stock, $ 1 par 1,000,000
Common stock, 10 par. 400,000
Additional paid-in capital. 550,000 235,000
Retained earnings 1050,000 334,000
Total liabilities and Stockholders’ equity 5,150,000 1,915,000
The December 31, 1999 current fair values of sage company’s identifiable assets and liabilities
were the same as their carrying amounts, except for the following assets:
Current fair values
December 31, 1999
Inventories $ 526,000
Plant assets 1,290,000
Leasehold 30,000
Required
1. Prepare the necessary journal entries for the combination?
2. Prepare consolidated financial statement?
Answers
1. Post recorded the combination with sage as a purchase by means of the following journal
entries:
Investment in sage company common stock (57,000 x $ 20) ..................$ 1,140,000
Common stock (57,000 x $ 1) .........................57,000
Paid-in capital-in-excess of par..................1,083,000
Investment in sage company common stock................52,250
Cash.....................................................52,250

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2. Consolidated balance sheet of post
December 31, 1999.
Assets
Cash (200,000-52,250+100,000) $ 247,750
Inventories (800,000+526,000) 1, 326,000
Other current assets (550,000+215,000) 765,000
Plant asset (3,500,000+1,290,000) 4,790,000
Leasehold (0+30,000) 30,000
Good will (net) (100,000+38,000) 138,000
Total asset 7,296,750
Liabilities and stockholders’ equity
Income taxes payable. (100,000+16,000) $ 116,000
Other current liabilities (2,450,000+930,0000) 3,380,000
Minority interest in net assets of subsidiary 60,750
Common stock, $ 1 par (1,000,000+57,000) 1,057,000
Additional paid-in capital (550,000+1,083,000) 1,633,000
Retained earnings (parent) 1,050,000
Total liabilities and stockholders’ equity 7,296,750
Workings
1. Shareholding in sage company.
Parent (post). 95%
Minority 5%
100%
2. Goodwill.
Cost of Post Corporation’s 95% interest in
Sage company $ 1,192,250
Less: current fair value of sage company’s identifiable
Net assets acquired by
Post ($ 1,215,000 x 0.95) 1,154,250
Good will acquired by post $38,000

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 3. Minority interest.
Current fair value of sage company’s
Identifiable net assets 1,215,000
Minority interest share x0.05
Minority interest in sage company’s
Identifiable net assets $60,750

Note
Consolidated financial statements are intended to provide information about a group of legal
entities-a parent and it’s subsidiaries-operating as a single entity. The assets, liabilities,
revenues, expenses, gains and losses of the various component entities under the control of the
parent are combined in the consolidated financial statements. For partially owned subsidiaries,
minority interests should be included in the consolidated financial statements to reflect financial
statements to reflect the claims of minority stockholders’ in components of a consolidated
enterprise.
5.4. Consolidated Financial Statement: Subsequent to data of acquisition:
Accounting for the parent’s investment
For external reporting, consolidation of a subsidiary becomes necessary whenever control exists.
For monitoring the activities of its subsidiaries, the parent can use the cost method or the equity
method for internal record-keeping.
1. Cost Method (initial value method)
This method uses the cash basis for income recognition. Dividends received by the parent from
the subsidiary are recognized as income. No recognition is given to the income or loss of the
subsidiary. The investment balance remains permanently on the parent’s financial records at the
initial fair value assigned at the acquisition date except for the declaration of dividends by the
subsidiary in excess of post combination net income constitute. Because dividend paid in excess
of net income reduces the carrying amount of the parent company’s investment in the subsidiary.
The cost method might be selected:
 If the parent does not require an accrual based income measure of subsidiary
performance. For example, the parent may wish to assess subsidiary performance on its
ability to generate cash flows, on revenues generated, or some other non income basis.

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  Also, some firms may find the cost method’s ease of application attractive.
2. Equity Method
The equity method embraces full accrual accounting in maintaining the investment account and
related income over time. In the equity method of accounting, the parent company recognizes its
share of the subsidiary’s net income or net loss, adjusted for depreciation and amortization of
differences between current fair values and carrying amounts of a purchased subsidiary’s net
assets on the data of the business combination, as well as its share of dividends declared by the
subsidiary.
Illustration
Assume that P Company acquired 90% of the outstanding voting stock of S Company at the
beginning of Year 1 for $800,000. Income (loss) of S Company and dividends declared by S
Company during the next three years are listed below. During the third year, the firm pays a
liquidating dividend (i.e., the cumulative dividends declared exceeds the cumulative income
earned).
Income Dividends Cumulative Income over
Year (Loss) Declared (paid) (under) Cumulative Dividends
1 $90,000 $30,000 $60,000
2 (20,000) 30,000 10,000
3 10,000 30,000 (10,000)
Required: record the necessary journal entries by using cost and equity methods
Cost method
Year 1—P’s Books
Investment in S Company..... 800,000
Cash ..................................800,000
(To record the initial investment)
Cash...................... ......27,000
Dividend Income............ 27,000
(To record dividends received (0.9*$30,000))
Year 2—P’s Books
Cash.............................. 27,000
Dividend Income .............27,000
(To record dividends received (0.9*$30,000))

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Year 3—P’s Books
Cash......................... 27,000
Dividend Income................ 18,000
Investment in S Company.... 9,000
(To record dividends received, $9,000(10.000*.9) of which represents a return of investment)
Equity method
Year 1—P’s Books
Investment in S Company........... 800,000
Cash......................................... 800,000
(To record the initial investment)
Investment in S Company.................. 81,000
Equity in Subsidiary Income .9($90,000)......... 81,000
(To record P’s share of subsidiary income)
Cash ..................................27,000
Investment in S Company............. 27,000
(To record dividends received .9 ($30,000))
Note: The entries to record equity in subsidiary income and dividends received may be combined
into one entry, if desired.
Year 2—P’s Books
Equity in Subsidiary Loss............... 18,000
Investment in S Company ............18,000
(To record equity in subsidiary loss .9($20,000))
Cash.................................... 27,000
Investment in S Company ..............27,000
(To record dividends received .9($30,000))
Year 3—P’s Books
Investment in S Company ....................9,000
Equity in Subsidiary Income ................9,000
(To record equity in subsidiary income .9($10,000))
Cash .................................. 27,000
Investment in S Company ......27,000
(To record dividends received .9($30,000))

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5.4.1. Wholly owned subsidiary
As a basis for this illustration, assume that Parrot Company obtains all of the outstanding
common stock of Sun Company on January 1, 1998. Parrot acquires this stock for $760,000 in
cash but pays an additional $40,000 in direct combination costs. Because cash is paid, the
purchase method is applicable; a pooling of interests requires that the business combination be
created only through the exchange of voting common stock.
The book values as well as the appraised values of sun’s accounts are as follows:
Fair market Value, Jan.
Book value Jan. 1, 1998
1, 1998
Current assets $320,000 $320,000
Land 200,000 250,00
Buildings (10 years life) 320,000 400,000
Equipment (5 years life) 180,000 150,000
Liabilities 420,000 420,000
Common stock, $40 par value 200,000
Additional paid in capital 20,000
Retained earnings, Jan. 1, 1998 380,000

The financial statement of parrot and Sun Company at 31, December 1998 were:
Parrot Company Sun Company
Income Statement
Revenues $1,500,000 $400,000
Expenses (900,000) (300,000)
Equity in subsidiary earnings 93,000 -0-
Net Income 693,000 100,000
Balance Sheet
Current assets $1,040,000 $400,000
Investment in sun company (at equity) 853,000 -0-
Land 600,000 200,000
Building (net) 370,000 288,000
Equipment (net) 250,000 220,00
Total assets 3,113,000 1,108,000
Liabilities 980,000 448,000
Common stock 600,000 200,000
Additional paid-in capital 120,000 20,000
Retained earnings; 12/31/98 1,413,000 440,000
Total liabilities and equities 3,113,000 1,108,000

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 a. Prepare the consolidated financial statement as of 31, December 1998? Goodwill is
amortized over a 20-year period using the straight line method.
b. Record the necessary entries by using equity method
Answers
Good will
Cost of investment ($760,000 + 40,000) $800,000
Less: Current fair value of net assets of Sun Company
at the acquisition date (1,120,000-420,000) $700,000
Goodwill $100,000
A consolidation of the two sets of financial information is relatively uncomplicated task.
Understanding the origin of each reported figure is the first step in gaining knowledge of this
process.
Amortization expenses
Additional depreciation for buildings
80,000 / 10 years $ 8,000
Decrease in depreciation for equipment 30,000 / 5 years (6,000)
Goodwill 100,000 / 20 years 5,000
Total $ 7,000
a. Parrot Company and Sun Company
Consolidated income statement
For year ended December 31, 1998.

Revenues (1,500,000+400,000)…………………. $ 1,900,000

Expenses (900,000+300,000+7,000) …………. (1, 207,000)
Net income………………………........................... 693,000

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 Consolidated balance sheet
December 31, 1998.
Current assets (1,040,000+400,000) $ 1,440,000
Land (600,000+250,000) 850,000
Buildings (net) (370,000+360,000) 730,000
Equipment (net) (250,000+220,000-30,000+6,000) 446,000
Goodwill (100,000-5,000) 95,000
Total assets 3,561,000
Liabilities ( 980,000+448,000) 1,428,000
Common stock (parent) 600,000
Additional paid-in capital (parent) 120,000
Retained earnings, 12/31/98 (parent) 1,413,000
Total liabilities and equities 3,561,000
b. For recording the necessary entries by using equity method
Investment in Sun company common stock..........800,000
Cash .......................................................................800,000
(To record initial investment)
Investment in Sun company common stock..........100,000
Equity in subsidiary earning ..................................100,000
(To record the income from subsidiary)
Equity in subsidiary earning .....................................7,000
Investment in Sun company common stock.................7,000
(to record amortizations)
- Equity in subsidiary earnings = $ 0 – The investment income recorded by the parent is
eliminated so that the subsidiary’s revenues and expenses can be included in the consolidated
totals.
Note: - summary of consolidated total subsequent to acquisition – purchase method.
- Current revenues: Parent revenues are included subsidiary revenues are included but only
for the period since acquisition.
- Current expenses: Parent expenses are included subsidiary expenses are included but only
for the period since the acquisition amortization expense is included.

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- Investment (or dividend): Income recognized by the parent is eliminated so that the balance
is not included in consolidated figures.
- Retained earnings, beginning balance: parent balance is included. Subsidiary balance sine
the acquisition is included.
- Assets and liabilities: Parent balances are included. Subsidiary balances are included
intercompany receivable /payable balances are eliminated.
- Goodwill: Remaining unamortized balance is included.
- Investment in subsidiary: asset account recorded by parent is eliminated so that the balance
is not included in consolidated figures.
- Capital stock and additional paid-in capital: Parent balance only is included although
they will have been adjusted at date of purchase if stock was issue.
5.4.2. Partially owned subsidiary
The consolidation of parent company and its partially owned subsidiary differs from the
consolidation of a wholly owned subsidiary in one major respect the recognition of minority
interest. Minority interest is a term applied to the claims of stock holders other than the parent
company to the net income or losses and net assets of the subsidiary. The minority interest in the
subsidiary’s net income or losses is displayed in the consolidated income statement, and the
minority interest in the subsidiary’s net assets is displayed in the consolidated balance sheet.
Illustration
Assume that on January 1, 19x1, Palm Company acquired 75% of the outstanding common
stock of Starr Company as at a total cost of $450,000. Each of Starr’s assets and liabilities has a
current value equal to its book value. The balance sheet of Starr at the acquisition date is as
follows.

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 Balance sheet, Jan. 1, 19x1
Current assets $1,200,000
Non – current assets (net) 1,000,000
2,200,000
Liabilities 1,600,000
Common stock 100,000
Additional paid-in capital 200,000
Retained earnings $300,000
2,100,000
Palm Company’s and Starr Company’s financial statement as of December 31, 19x1 (one year
after the acquisition date) are as follows:
Palm Company Starr Company
($000) ($000)

Income statement (19x2)

Sales $8,500 $900

Cost of goods sold (5,500) (400)

Expenses (2,400) (320)

Income from subsidiary (135) -

Net income $735 180
Balance sheet
Current assets $2,545 $1440
Investment in Starr 450
Non – current assets (net) 5160 960
Total asset 8155 2,400
Liabilities $2800 $1720
Common stock 1,000 100
Additional paid – in capital 2,000 200
Retained earnings 2355 380
Total L&E 8155 2,400
Divided declared paid 380 100

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a. Prepare consolidated financial statements and b) make the necessary entries?
a. For preparing consolidated financial statements follow the following steps:-
b. Step-1 Ownership interest percentage in Starr Company
Palm 75%
Minority 25%
Step-2 Goodwill
Cost of investment $450,000
Less: Share of net assets
Of Starr at the acquisition date 600,000
Palm’s share x 75% 450,000
Goodwill -0-
Step–3
Retained earnings
Palm Company $2,355,000
Starr Company 75% (380,000-300,000) 60,000
2,415,000
Step-4 minority interest
Net assets of Starr at the balance sheet date $680,000
Minority share x25%
170,000
Step-5 Consolidated financial statements
Consolidated income statement
Year ended Dec. 31, 19x1
Sales (8,500+900) $9,400
Cost of goods sold (5,500+400) (5,900)
Expenses (2,400+320) (2720)
780
Minority interest (25% x 180) 45
Profit attributed to palm 735
Divided paid by palm 380
Amount added to retained earnings 355

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 Consolidated balance sheet of palm and subsidiary
Dec. 31, 19x2
Asset
Current assets (2,545+1440) $3985
Non – current assets (net) (5160+960) 6120
Total asset 10105
Liability and share holders equity
Liabilities (2,800+1720) $4520
Minority interest 170
Common stock (parent) 1,000
Additional paid-in capital (parent) 2,000
Retained earnings 2415
Total liability & S. holders equity 10105
b. Journal entries on the books of palm by using equity method
Investment in Sttar company common stock........450,000
Cash.................................................................450,000
To record initial investment
Investment in Sttar company common stock (180,000*.75)........135,000
Equity in subsidiary income.........................................135,000
To record 75% net income of starr company
Cash.........................................................................................75,000
Investment in Sttar company common stock (100,000*.75)........75,000
(To record dividend received from Starr Company)

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