CHAPTER -2-

CONSOLIDATION OF
FINANCIAL STATEMENTS ON
DATE OF BUSINESS
COMBINATION
Consolidated financial statement is combination of parent company’s
financial statement and subsidiary’s financial statement.
Parent: An entity that controls one or more entities
Subsidiary: An entity that is controlled by another entity

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Consolidation of Wholly Owned Subsidiary on Date of
Business Combination
assume that on December 31, 2020, Palm Corporation issued
10,000 shares of its Br. 10 par common stock (current fair
value Br. 45 a share) to stockholders of Starr Company for
all the outstanding Br. 5 par common stock of Starr. Out-of-
pocket costs of the business combination paid by Palm on
December 31, 2020, consisted of the following:
Finder's and legal fees relating to business combination Br. 50,000
Costs associated with registration 35,000
Br85,000
Total out-of-pocket costs of business combination

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Assume also that Starr Company was to continue its corporate
existence as a wholly owned subsidiary of Palm Corporation
PALM CORPORATION AND STARR COMPANY
Separate Financial Statements (prior to business combination)
For Year Ended December 31, 2020

PALM CORPORATION AND STARR COMPANY

Income Statements (prior to business combination)
For Year Ended December 31, 2020

Palm Corporation Starr Company

Revenue:
Net sales Br. 990,000 Br. 600,000
Interest revenue 10,000 -
Total revenue Br. 1,000,000 Br. 600,000
Costs and expenses:
Cost of goods sold Br. 635,000 Br. 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 Br. 906,000 Br. 548,000
Net income Br. 94,000 Br. 52,000
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 PALM CORPORATION AND STARR COMPANY
Statements of Retained Earnings (prior to business combination)
For Year Ended December 31, 2020

Palm Starr Company

Corporation

Retained earnings, beginning of year Br. 65,000 Br. 100,000

Add: Net income 94,000 52,000

Subtotals Br. 159,000 Br. 152,000

Less: Dividends 25,000 20,000

Retained earnings, end of year Br. 134,000 Br. 132,000

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 PALM CORPORATION AND STARR COMPANY
Balance Sheets (prior to business combination)
December 31, 2020

Palm Corporation Starr Company

Assets
Cash Br. 100,000 Br. 40,000
Inventories 150,000 110,000
Other current assets 110,000 70,000
Receivable from Starr Company 25,000 ----
Plant assets (net) 450,000 300,000
Patent (net) ---- 20,000
Total assets Br. 835,000 Br. 540,000

Liabilities and Stockholders' Equity

Payables to Palm Corporation ---- Br. 25,000
Income taxes payable Br. 26,000 10,000
Other liabilities 325,000 115,000
Common stock, Br10 par 300,000 ----
Common stock, Br5 par ---- 200,000
Additional paid-in capital 50,000 58,000
Retained earnings 134,000 132,000
Total liabilities and stockholders' equity Br. 835,000 Br. 540,000
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The December 31, 2020, current fair values of Starr 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, 2020
Inventories Br. 135,000

Plant assets (net) 365,000

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 PALM CORPORATION (COMBINOR)
Journal Entries
December 31, 2020
Investment in Star Company Common Stock (10,000 x Br. 45) ……………………… 450,000
Common Stock (10,000 x Br. 10)………………………………………………….. 100,000
Paid-in Capital in Excess of par …………………………………………………… 350,000
To record the issuance of 10,000 shares of common stock for all the outstanding common stock
of Starr Company in a business combination.

Investment is star company common stock ………………………………………… 50,000

Paid-in Capital in Excess Par…………………………………………………………… 35,000

Cash…………………………………………………………………………… 85,000

To record payment of out-of-pocket costs of business combination with Starr Company.

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Palm company’s accounts affected after business combination

Cash
Date
Explanation Debit Credit Balance
2020

Dec. 31
Balance forward 100,000 dr
31
Out-of-pocket costs of 85,000 15,000 dr
business combination

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 Investment in Starr Company Common Stock
Date
Explanation Debit Credit Balance
2020

Dec. 31
Issuance of common stock in 450,000 450,000 dr
business combination
31
Direct out-of-pocket costs of 50,000 500,000 dr
business combination

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 Common Stock, Br10 Par
Date
Explanation Debit Credit Balance

2020

Dec. 31
Balance forward 300,000 cr

31
Issuance of common stock in 100,000 400,000 cr
business combination

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 Paid-in Capital in Excess of Par
Date
Explanation Debit Credit Balance
2020

Dec. 31
Balance forward 50,000 cr
31
Issuance of common stock in business combination 350,000 400,000 cr

31
Costs of issuing common stock in business 365,000 cr
combination 35,000

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 Preparation of Consolidated Balance
Consolidated balance sheet is the only consolidated financial
statement issued by parent company on date of business combination.
Preparation of a consolidated balance sheet for a parent company and
its wholly owned subsidiary may be accomplished without the use of a
supporting working paper.
The parent company's investment account and the subsidiary's
stockholder's equity accounts do not appear in the consolidated
balance sheet
The parent company (combinor) 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
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Format of Working Paper for Consolidated Balance Sheet for Wholly Owned Subsidiary on Date of Business Combination

Working Paper for Consolidated

PALMBalance
CORPORATION Sheet
AND SUBSIDIARY
Working Paper for Consolidated Balance Sheet
December 31, 2020

Eliminations
Palm Corporation Starr Company Increase
(Decrease) Consolidated

Assets
Cash 15,000 40,000 55,000
Inventories 150,000 110,000 25,000 285,000
Other current assets 110,000 70,000 180,000

Intercompany receivable (payable) 25,000 (25,000) 0

Investment in Starr Company Common Stock 500,000 (500,000) 0

Plant assets (net) 450,000 300,000 65,000 815,000

Patent (net) 20 000 5,000 25,000
Goodwill 15,000 15,000
Total assets 1,250,000 515,000 (390,000) 1,375,000

Liabilities and Stockholders' Equity

Income taxes payable 26,000 10,000 36,000
Other liabilities 325,000 115,000 440,000
Common stock, Br10 par 400,000 400,000
Common stock, Br5 par 200,000 200,000 0
Additional paid-in capital 365,000 58,000 58,000 365,000
Retained earnings 134,000 132,000 132,000 134,000
Total liabilities and stockholders' equity 1,250,000 515,000 390,000 1,375,000
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A. Record the elimination entry
B. Complete the above working paper

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P company and S company have the ff B/sheet

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•Company P acquired 100% of Company S in a
stock acquisition by issuing 4,000 shares of
common stock with a par value of $35 and a
market value of $50; the market values of the
identifiable net assets of Company S are equal to
their book values.
Required: Record all necessary journal entries

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 Date of Acquisition
100% Investment
At Book Value

Company Company _ Eliminations _

P S _ _Debit __ Credit _ Consolidated
Cash 70,000 25,000 95,000
Receivables 85,000 75,000 160,000
Inventory 45,000 30,000 75,000
Investment in S 200,000 (1) 200,000
Plant and Equipment 315,000 80,000 395,000
Land 60,000 40,000 _ _ 100,000
775,000 250,000 200,000 825,000

Liabilities 75,000 50,000 125,000

Common Stock
Company P 490,000 490,000
Company S 100,000 (1) 100,000
Paid-in Capital
Company P 115,000 115,000
Company S 35,000 (1) 35,000
Retained Earnings
Company P 95,000 95,000
Company S _ _ _65,000 (1) 65,000 _ _
775,000 250,000 200,000 200,000 825,000

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• Company P acquired 100% of Company S in a
stock acquisition by issuing 4,800 shares of
common stock with a par value of $35 and a
market value of $50; the market values of the
identifiable net assets of Company S are equal
to their book values.
Record all necessary journal entries

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 NON–WHOLLY OWNED SUBSIDIARIES

• If parent company purchased less than 100% net asset of

subsidiary, the subsidiary is known as partially owned
subsidiary
• The shares not acquired by the parent are owned by other
shareholders, who are referred to as the non-controlling
shareholders.
• The value of the shares attributed to the non-controlling
shareholders, when presented on the consolidated financial
statements, is referred to as non-controlling interests,
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abbreviated as NCI.
Three questions arise when preparing consolidated
financial statements for less-than-100%-owned
subsidiaries:
1. How should the portion of the subsidiary’s assets and
liabilities that was not acquired by the parent be
measured on the consolidated financial statements?
2. How should NCI be measured on the consolidated
financial statements?
3. How should NCI be presented on the consolidated
financial statements?
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The following theories have developed over time
and have been proposed as solutions to preparing
consolidated financial statements for non–wholly
owned subsidiaries:
• Proprietary theory
• Parent company theory
• Parent company extension theory
• Entity theory
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• The chart on preceding slide highlights the
differences between the four theories.
• The left side for each theory shows the portion
of the subsidiary owned by the parent while
the right side shows the portion owned by the
NCI.
• The shaded area represents the values brought
onto the consolidated financial statements.
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• On June 30, Year 1, P Ltd. obtains control over
S Ltd. by paying cash to the shareholders of S
Ltd. for a portion of that company’s
outstanding common shares. No additional
transactions take place on this date.
Immediately after the share acquisition, P Ltd.
prepares a consolidated balance sheet.

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Assume that on June 30, Year 1, S Ltd. had 10,000
shares outstanding and P Ltd. purchases 8,000
shares (80%) of S Ltd. for a total cost of $72,000.

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Proprietary Theory
• Proprietary theory views the consolidated entity from
the standpoint of the shareholders of the parent
company.
• The consolidated statements do not acknowledge or
show 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. 29
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NB: Proprietary theory is not used in practice to
consolidate a parent and its subsidiaries.
However, it is used to report certain types of
joint arrangements.

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Parent Company Theory
• Parent company theory is similar to proprietary
theory in that the focus of the consolidated
statements is directed toward the shareholders
of the parent company.
• However, NCI is recognized and reflected as a
liability in the consolidated balance sheet; its
amount is based on the carrying amounts of the
net assets of the subsidiary.
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• The consolidated balance sheet is prepared by
combining, on an item-by-item basis, the
carrying amount of the parent with 100% of the
carrying amount of the subsidiary plus the
parent’s share of the acquisition differential.
• Under this theory, the parent’s share of the
subsidiary is measured at fair value, whereas the
NCI’s share is based on the subsidiary’s carrying
amount on the consolidated balance sheet.
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Entity Theory
• Entity theory views the consolidated entity as
having two distinct groups of shareholders the
controlling shareholders and the non-
controlling shareholders.
• NCI is presented as a separate component of
shareholders’ equity on the consolidated
balance sheet.
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• In acquiring a controlling interest, a parent company
becomes responsible for managing all the subsidiary’s
assets and liabilities, even though it may own only a partial
interest.
• If a parent can control the business activities of its
subsidiary, it directly follows that the parent is accountable
to its investors and creditors for all of the subsidiary’s assets
and liabilities.
• Assets and liabilities of subsidiary should be measured at
full fair value at the date of acquisition.
• NCI is shown in shareholders’ equity.
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• Parent Company Extension Theory
• Parent company extension theory was invented to
address the concerns about goodwill valuation under
entity theory. Given that many people feel that goodwill
for the subsidiary, as a whole, is very difficult to
measure when the parent does not purchase 100% of the
subsidiary, they did not support the use of entity theory.
• However, there is much support for valuing the
subsidiary’s identifiable assets and liabilities at their full
fair value on the consolidated statements at the time of
acquisition.
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• Since the total value of the subsidiary’s goodwill
is not reasonably measurable, the NCI’s portion
of the subsidiary’s goodwill is not measured and
not brought onto the consolidated statements.
• Under parent company extension theory, NCI is
recognized in shareholders’ equity in the
consolidated balance sheet, similar to entity
theory.

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• NCI is calculated as follows:
Assets $100,000

Liabilities
(30,000)
70,000
Excess of fair value over carrying amount for identifiable net assets

Fair value of identifiable net assets 7,000

77,000

Non-controlling ownership percentage

20%
Non-controlling interest $ 15,400
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• The consolidated balance sheet is prepared by
combining, on an item-by-item basis, the
carrying amount of the parent with the fair
value of the subsidiary’s identifiable net assets
plus the parent’s share of the subsidiary’s
goodwill.

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 Exercise
• On January 1, Year 5, FLA Company issued 6,300
ordinary shares to purchase 9,000 ordinary shares of
MES Company. Prior to the acquisition, FLA had
180,000 and MES had 10,000 ordinary shares
outstanding, which were trading at $5 and $3 per
share, respectively. The following information has
been assembled for these two companies just prior to
the acquisition:
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• On December 31, Year 1, P Company
purchased 80% of the outstanding shares of S
Company for $6,960 cash. The statements of
financial position of the two companies
immediately after the acquisition transaction
appear below.

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END OF CHAPTER 2

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