Herauf10e PPT Ch04

CHAPTER 4:
Consolidation of
Non-Wholly
Owned
Subsidiaries
Prepared by
Shannon Butler, CPA, CA
© 2022 McGraw Hill Limited Carleton University
Learning Objectives, Part 1
LO1 Define non-controlling interest and explain how it

is measured on the consolidated balance sheet.
LO2 Prepare a consolidated balance sheet using the

fair value enterprise method.
LO3 Prepare a consolidated balance sheet using

the identifiable net assets method.
LO4 Explain the concept of negative goodwill and

describe how it should be treated when it arises
in a business combination.
© 2022 McGraw Hill Limited 2

Learning Objectives, Part 2
LO5 Account for contingent consideration based

on its classification as a liability or equity.
LO6 Analyze and interpret financial statements

involving consolidation of non-wholly
owned subsidiaries.
LO7 (Appendix 4A) Prepare a consolidated balance

sheet using the working paper approach.

Non-Wholly
Owned Subsidiaries, Part 1
 When the parent acquires less than 100% of the shares, the
parent’s own assets and liabilities and the parent’s share of
the subsidiary’s assets and liabilities will be measured at
carrying value and fair value, respectively, on the
consolidated balance.
 The following example, Exhibit 4.1, will form the basis of

many of the illustrations that will be used in this chapter.

Exhibit 4.1
BALANCE SHEET
At June 29, Year 1
P Ltd. S Ltd.
Carrying
Carrying Amount Fair Value
Amount
Cash $100,000 $ 12,000 $ 12,000
Accounts receivable 90,000 7,000 7,000
Inventory 130,000 20,000 22,000
Plant 280,000 50,000 59,000
Patent 11,000 10,000
Total assets $600,000 $100,000 $110,000
Current liabilities $ 60,000 $ 8,000 $ 8,000
Long-term debt 180,000 22,000 25,000
Total liabilities 240,000 30,000 $ 33,000
Common shares 200,000 40,000
Retained earnings 160,000 30,000
Total liabilities and shareholders’ equity $600,000 $100,000

Non-Wholly
 The shares not acquired by the parent are owned by the other
shareholders, referred to as the “non-controlling shareholders”.
 The value of shares held by the non-controlling shareholders
appears on the balance sheet as “non-controlling interest” (NCI)

Non-Wholly
 Three questions arise when preparing consolidated financial
statements for less-than-100% subsidiaries:
1. How should the portion of the subsidiaries net assets not acquired
by the parent be valued on the consolidated financial statements?
2. How should NCI be measured?
3. How should NCI be presented?

Non-Wholly
 Four theories propose a solution to preparing consolidated
financial statements for non-wholly subsidiaries.
• Proportionate consolidation method
• Parent Company method
• Identifiable net asset (INA) method
• Fair value enterprise (FVE) method

Non-Wholly
 The proportionate consolidation method used to be called the
proprietary theory.
 The INA method used to be called the parent company

extension theory and is sometimes referred to as the partial
goodwill method.
 The FVE method used to be called the entity theory and is

sometimes referred to as the full goodwill method.

Non-Wholly
 Each of the methods has been or is currently required by GAAP
in specified situations. The following table indicates the current
status and effective usage dates for these four methods:
Method Status
Proportionate Current GAAP for consolidating certain types of joint arrangements; was an option
consolidation under GAAP prior to 2013 when consolidating joint ventures.
Parent company Was GAAP for consolidating subsidiaries prior to January 1, 2011.
INA An acceptable option for consolidating subsidiaries after January 1, 2011.
FVE An acceptable option for consolidating subsidiaries after January 1, 2011.

Consolidation Methods for Valuation
of Subsidiary
Portion of Subsidiary Presented on Consolidated Financial Statements
Proportionate Identifiable Net
Parent Company Fair Value
Consolidation Assets
Method Enterprise Method
Method Method
Parent NCI Parent NCI Parent NCI Parent NCI
Carrying
amount of
subsidiary’s
net assets
Fair value
excess
Goodwill
The parent’s portion of the subsidiary’s value is fully represented under all methods. The NCI’s
share varies under the four methods.

Consolidation Methods
 We will illustrate the preparation of consolidated financial
statements under these methods using the following example:
 We will examine P Ltd. And S Ltd. Both companies have a
June 30 fiscal year-end. On June 30, Year 1, S Ltd. had
10,000 shares outstanding and P Ltd. purchased 8,000 shares
(80%) of S Ltd. for a total cost of $72,000. P Ltd.’s journal
entry to record this purchase is as follows:
Dr investment in S Ltd. $72,000

Cr Cash $72,000

Proportionate Consolidation Method,
Part 1
 Views the consolidated entity from the standpoint
of the shareholders of the parent company.
 Therefore the consolidated statements do not

reflect the equity of the non-controlling shareholders.
 The consolidated balance sheet on the date of acquisition

reflects only the parent’s share of the assets and liabilities of
the subsidiary, based on their fair values, and the resultant
goodwill from the combination.

Proportionate Consolidation Method,
Part 2
 Proportionate consolidation focuses solely on the parent’s
percentage interest in the subsidiary.
 Proportionate consolidation is not used in practice to

consolidate a parent and its subsidiaries. However, it is
used to report certain types of joint arrangements.

The Parent Company Method
 Similar to the proportionate consolidation method the

parent company method focuses on the parent company but
gives some recognition to NCI.
 Since the parent company method is no longer used in

practice, it will not be illustrated in this textbook.

Fair Value Enterprise (FVE) Method,
Part 1
 Views the consolidated entity as having two distinct groups
of shareholders – the controlling and non-controlling
shareholders.
 The fair value enterprise method gives equal attention to the
controlling and non-controlling shareholders.
 The trading price of the subsidiary’s shares or shares of a
comparable company in an active market is probably the
most accurate reflection of the value of the NCI.

Part 2
 An investor typically pays a premium over the trading price
of a company’s shares when acquiring sufficient shares to
obtain control of the company.
 Discounted cash flow analysis could be used to estimate the

fair value of the subsidiary.

Part 3
Example 1: Fair value of NCI as evidenced by market
trades.
 P Ltd. acquires 80% of S Ltd. (8,000 of S Ltd’s shares) for

$72,000 by paying $9 per share.
 S Ltd. shares are trading for $7.75 per share at

acquisition date.

Part 4
 Acquisition date FV is as follows:
FV of controlling interest ($9 x 8,000 shares)
$72,000
FV of NCI ($7.75 x 2,000 shares) 15,500
Total FV of S Ltd. at acquisition date $87,500
 The next slide will show the calculation of acquisition differential

(exhibit 4.5)
 The goodwill component as a % of total value for the controlling

interest is much higher than NCI when a parent pays a premium
to obtain control. See Chapter 5 self-study for an example.
Part 5
CALCULATION OF ACQUISITION DIFFERENTIAL
(FVE method—Example 1)
Parent NCI Total
80% 20% 100%
Percentage of S Ltd.
$ 72,000 $15,500 $87,500
Fair value at date of acquisition
Carrying amount of S Ltd.’s net assets:
Assets
$100,000
Liabilities
(30,000)
70,000 56,000 14,000 70,000
Acquisition differential 16,000 1,500 17,500
Fair value excess: FV − CA
Inventory 2,000
Plant 9,000
Patent (1,000)
10,000
Long-term debt −3,000
7,000 5,600 1,400 7,000
Balance—goodwill $ 10,400 $ 100 $10,500

Part 6
Example 2: Fair value of NCI Implied by parent’s
consideration paid.
 P Ltd. Acquires 80% of S Ltd. on June 30, Year 1 for $72,000
paid in cash.
 The following two slides Exhibit 4.6 and 4.7 reflect the
calculation and allocation of acquisition differential, non-
controlling interest, and consolidated balance sheet of P Ltd.

Exhibit 4.6
Exhibit 4.6
CALCULATION OF ACQUISITION DIFFERENTIAL
(FVE method—Example 2)
Cost of 80% investment in
$72,000
S Ltd.
Implied value of 100% investment in S Ltd. ($72,000 ÷ 80%) $90,000
Assets $100,000
Liabilities (30,000)
70,000
Implied acquisition differential 20,000

Allocated: (FV − CA) × 100%
Inventory + 2,000 × 100% = + 2,000 (a)
Plant + 9,000 × 100% = + 9,000 (b)
Patent − 1,000 × 100% = − 1,000 (c)
10,000
Long-term debt −3,000 × 100% = −3,000 7,000 (d)
Balance—goodwill $13,000 (e)
Calculation of NCI
Implied value of 100% investment in S Ltd. $90,000
NCI ownership 20%
$18,000 (f)

Exhibit 4.7
Exhibit 4.7, Part 1
ILLUSTRATION OF THE DIRECT APPROACH
(FVE method)
P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1
Cash (100,000 − 72,000* + 12,000) $ 40,000
Accounts receivable (90,000 + 7,000) 97,000
Inventory (130,000 + 20,000 + [6a] 2,000) 152,000
Plant (280,000 + 50,000 + [6b] 9,000) 339,000
Patent (0 + 11,000 − [6c] 1,000) 10,000
Goodwill (0 + 0 + [6e] 13,000) 13,000
$651,000
*Cash paid by P Ltd. to acquire S Ltd.

Exhibit 4.7
Exhibit 4.7, Part 2
(FVE method)
P LTD.
At June 30, Year 1
Current liabilities (60,000 + 8,000) $ 68,000
Long-term debt (180,000 + 22,000 + [6d] 3,000) 205,000
Total liabilities 273,000
Shareholders’ equity:
Controlling interest:
Common shares 200,000
Retained earnings 160,000
360,000
Non-controlling interest [6f] 18,000 378,000
$651,000

Part 7
 Sometimes, it is appropriate to measure NCI using the price per
share paid by the parent to obtain control.
 The implied value assumes that the parent’s acquisition cost
can be extrapolated linearly to determine the total value of the
subsidiary.
 NCI could be valued using business valuation techniques, but
this is a costly exercise.
 In this text, we will assume a linear relationship to calculate the
value of NCI except when we are given the market price of the
subsidiary’s shares help by the non-controlling shareholders.

Identifiable Net Assets Method, Part
1
 Addresses concern about goodwill valuation under the fair
value enterprise method.
 Reflects both parent’s and non-controlling interest’s share of
identifiable net assets at full fair values.
 However only parent’s share of subsidiary’s goodwill is
reflected on consolidated balance sheet.

Identifiable Net Assets Method, Part
2
 NCI is calculated as follows:
Carrying amount of S Ltd’s net assets:
Assets $100,000
70,000
Excess of fair value over carrying amount
for identifiable net assets (Exhibit 4.5) 7,000
Fair value of identifiable net assets 77,000
Non-controlling ownership % 20%
Non-controlling interest $15,400
 NCI is based on the fair value of identifiable assets and

liabilities.
 See Exhibit 4.8 for Consolidated Balance Sheet
Bargain Purchases, Part 1
 Negative goodwill results when the total consideration

(purchase price) is less than the fair value of identifiable net
assets.
 Often described as a bargain purchase, this can occur when share
prices are depressed or subsidiary has had recent operating losses.

 IFRS 3 requires that negative goodwill be reduced to zero by

first reducing any goodwill on the subsidiary’s books, then
recognizing any remaining negative goodwill as a gain.
 Since negative goodwill is very rare, the parent should check

the valuations of the identifiable net assets before recording a
gain on bargain purchase.

Illustration - Negative Goodwill:

 On June 30, year 1 P Ltd. Purchased 100% of the
shares of S Ltd. For $72,000 cash. The carrying amount of
S’s identifiable net assets is $70,000 and the acquisition
differential is $2,000 on that date.
 $7,000 of the $2,000 acquisition differential is allocated to
the net assets of S, leaving $5,000 negative goodwill.
 The calculation and amortization of the acquisition
differential is shown in Exhibit 4.9 on the next slide.

Exhibit 4.9
CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL
(Negative goodwill, wholly owned subsidiary)
Cost of investment in S Ltd. $ 72,000
Assets 100,000
Liabilities (30,000) 70,000
Acquisition differential 2,000
Allocated: (FV − CA)
Inventory + 2,000
Plant + 9,000
Patent − 1,000
10,000
Long-term debt − 3,000 7,000
Balance—“negative goodwill” (gain on bargain purchase) $ (5,000)
The negative goodwill is recognized as a gain on bargain purchase

Negative Acquisition Differential
 Not the same as negative goodwill.
 Results when the parent’s interest in the book values of the

subsidiary’s net assets exceed acquisition cost.
 Could result in negative goodwill if the fair values of the

subsidiary’s net assets also exceed acquisition cost,
otherwise will result in positive goodwill.

Subsidiary with Goodwill, Part 1
 Any goodwill on the balance sheet of subsidiary on
acquisition date is not carried forward to the consolidated balance
sheet.
 That goodwill resulted from a past transaction in which
the subsidiary was the acquirer in a business combination,
reflecting outdated fair values of entity it acquired.
 The parent’s acquisition differential is now calculated as
if the goodwill has been written off by the subsidiary and replaced
instead by the updated fair values and goodwill of the entity the
subsidiary previously acquired.

Subsidiary with Goodwill, Part 2
Example:
 On June 30, Year 1 P Ltd. purchased 80% of the shares of S Ltd. For
$62,000 cash. The fair value of S’s
identifiable net assets – which includes goodwill is $67,000 on that
date.
 The balance sheets of both companies is shown in Exhibit 4.12 on the

next slide.
 The calculation and amortization of the acquisition

differential is shown in Exhibit 4.13 in the following slide.
 The consolidated balance sheet is shown in Exhibit 4.14 in the second

following slide.
Exhibit
Exhibit 4.12
4.12
BALANCE SHEET
At June 29, Year 1
P Ltd. S Ltd.
Fair
Carrying Amount Carrying Amount
Value
Cash $100,000 $ 12,000 $12,000
Accounts receivable 90,000 7,000 7,000
Inventory 130,000 20,000 22,000
Plant 280,000 50,000 59,000
Goodwill 11,000
$600,000 $100,000
Current liabilities $ 60,000 $ 8,000 8,000
Long-term debt 180,000 22,000 25,000
Common shares 200,000 40,000
Retained earnings 160,000 30,000
$600,000 $100,000

Exhibit
Exhibit 4.13, 4.
Part 1
CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL
(Subsidiary with goodwill)
Cost of 80% investment in
$62,000
S Ltd.
Implied value of 100% investment in
(62,000/0.80) $77,500
S Ltd.
Carrying amount of net assets of S Ltd.
Assets $ 100,000
70,000
Deduct old goodwill of
11,000 (a)
S Ltd.
Adjusted net assets 59,000
Acquisition differential 18,500
Allocated: (FV − CA)
Inventory +$2,000 (b)
Plant +9,000 (c)
11,000

Exhibit
Exhibit 4.13, 4.
Part 2
Long-term debt −3,000 8,000 (d)

Balance—goodwill $10,500 (e)
Calculation of NCI
Implied value of 100% investment in S
$77,500
Ltd.
NCI ownership 20%
$15,500 (f)
The subsidiary’s goodwill was revalued at the date of acquisition. It is now worth $10,500, based on the recent
price paid by the parent.

Exhibit 4.14
(Subsidiary with goodwill)
P LTD.
At June 30, Year 1
Cash (100,000 − 62,000* + 12,000) $ 50,000
Accounts receivable (90,000 + 7,000) 97,000
Inventory (130,000 + 20,000 + [13b] 2,000) 152,000
Plant (280,000 + 50,000 + [13c] 9,000) 339,000
Goodwill (0 + 11,000 − [13a] 11,000 + [13e] 10,500) 10,500
$648,500
Current liabilities (60,000 + 8,000) $ 68,000
Long-term debt (180,000 + 22,000 + [13d] 3,000) 205,000
Common shares 200,000
Retained earnings 160,000
Non-controlling interest [13f] 15,500
$648,500

Contingent Consideration, Part 1
 What happens when a portion of the total cost of the
acquisition is variable depending on future events, so the
eventual total cost is not known with certainty at the date of
acquisition of the subsidiary?
 IFRS 3 requires the contingent consideration to be

recorded at fair value at the acquisition date as part
of the acquisition cost, using assumptions, probabilities, and
other valuation techniques which can be subjective and
require significant amount of judgment.

 Classify contingent consideration as either liability or equity
depending on its nature.
 If payable in cash or another asset, record as liability.
Revalue liability after acquisition date as circumstances change.
 Record revaluation adjustment in earnings if revaluation arose as a
result of events occurring after acquisition; or
 Adjust the purchase price if revaluation arose as a result of new
information about facts and circumstances that exists as at the date of
acquisition.
 If payable in additional shares of the parent, record as equity. Do
not revalue contingent consideration classified as equity.

 Disclosure Requirements:
 IFRS 3, paragraph B64, requires that a reporting entity disclose
the following for each business combination in which the acquirer
holds less than 100% of the equity interests in the acquiree at the
acquisition date:
a) The amount of the NCI in the acquiree recognized at the acquisition
date and the measurement basis for that amount.
b) For each NCI in an acquiree measured at fair value, the valuation
techniques and key model inputs used for determining that value.

Analysis and Interpretation
of Financial Statements
 The key ratios are different under different
reporting methods.
 The value and classification of NCI is significantly different

under the three methods.
 The classification of non-controlling interest has a big impact

on the debt-to-equity ratio.
 See Exhibit 4.16 for impact on current and debt-

to-equity ratios.

Consolidation of Non-Wholly
Appendix 4A
 Working Paper Approach - Use of the working paper ensures
that the debit and credit adjustments balance each other.
 The working paper in Exhibit A4.1 (refer to exhibit in text for
example) reflects three consolidated adjusting entries:
1. Establishes the NCI on the consolidated balance sheet and
adds this additional value to the investment account, which
then includes both the parent’s and NCI proportionate interest
in the subsidiary.

Appendix 4A
 The working paper in Exhibit A4.1 (refer to exhibit in text for

example) reflects three consolidated adjusting entries continued:
2. Eliminates the investment account and the subsidiary’s
shareholders’ equity accounts with the difference established
as the acquisition differential.
3. Allocates the acquisition differential to revalue the
identifiable net assets of the subsidiary to fair value, and
establishes the resulting goodwill.

Appendix 4A
 Worksheet entries are made only in the working
paper; they are not entered into the accounting
records of P Ltd. Or S Ltd.
 Exhibit A4.2 shows the preparation of the consolidated balance
sheet when P Ltd. Acquires 80% of the common shares of S Ltd.
For $60,000
• results in negative goodwill, reported as a gain.
 Exhibit A4.3 show the preparation of the consolidated balance
sheet when S Ltd. has goodwill on its own balance sheet.

Herauf10e PPT Ch04

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Herauf10e PPT Ch04

Uploaded by

Copyright:

Available Formats

CHAPTER 4:

LO1 Define non-controlling interest and explain how it

LO2 Prepare a consolidated balance sheet using the

LO3 Prepare a consolidated balance sheet using

LO4 Explain the concept of negative goodwill and

© 2022 McGraw Hill Limited 2

LO5 Account for contingent consideration based

LO6 Analyze and interpret financial statements

LO7 (Appendix 4A) Prepare a consolidated balance

© 2022 McGraw Hill Limited 3

 The following example, Exhibit 4.1, will form the basis of

© 2022 McGraw Hill Limited 4

© 2022 McGraw Hill Limited 5

© 2022 McGraw Hill Limited 6

© 2022 McGraw Hill Limited 7

© 2022 McGraw Hill Limited 8

 The INA method used to be called the parent company

 The FVE method used to be called the entity theory and is

© 2022 McGraw Hill Limited 9

© 2022 McGraw Hill Limited 10

© 2022 McGraw Hill Limited 11

Dr investment in S Ltd. $72,000

© 2022 McGraw Hill Limited 12

 Therefore the consolidated statements do not

 The consolidated balance sheet on the date of acquisition

© 2022 McGraw Hill Limited 13

 Proportionate consolidation is not used in practice to

© 2022 McGraw Hill Limited 14

 Similar to the proportionate consolidation method the

 Since the parent company method is no longer used in

© 2022 McGraw Hill Limited 15

© 2022 McGraw Hill Limited 16

 Discounted cash flow analysis could be used to estimate the

© 2022 McGraw Hill Limited 17

 P Ltd. acquires 80% of S Ltd. (8,000 of S Ltd’s shares) for

 S Ltd. shares are trading for $7.75 per share at

© 2022 McGraw Hill Limited 18

 The next slide will show the calculation of acquisition differential

 The goodwill component as a % of total value for the controlling

Acquisition differential 16,000 1,500 17,500

Fair value excess: FV − CA

Long-term debt −3,000

7,000 5,600 1,400 7,000

Balance—goodwill $ 10,400 $ 100 $10,500

© 2022 McGraw Hill Limited 20

© 2022 McGraw Hill Limited 21

Implied value of 100% investment in S Ltd. ($72,000 ÷ 80%) $90,000

Carrying amount of S Ltd.’s net assets:

Implied acquisition differential 20,000

Implied value of 100% investment in S Ltd. $90,000

NCI ownership 20%

© 2022 McGraw Hill Limited 22

Cash (100,000 − 72,000* + 12,000) $ 40,000

Accounts receivable (90,000 + 7,000) 97,000

Inventory (130,000 + 20,000 + [6a] 2,000) 152,000

Plant (280,000 + 50,000 + [6b] 9,000) 339,000

Patent (0 + 11,000 − [6c] 1,000) 10,000

Goodwill (0 + 0 + [6e] 13,000) 13,000

*Cash paid by P Ltd. to acquire S Ltd.

© 2022 McGraw Hill Limited 23

Current liabilities (60,000 + 8,000) $ 68,000

Long-term debt (180,000 + 22,000 + [6d] 3,000) 205,000

Total liabilities 273,000