Chapter 10

Additional
Consolidation
Reporting Issues
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
 General Overview

 This chapter discusses the following

general financial reporting topics as they
relate to consolidated financial
statements:
1. The consolidated statement of cash flows
2. Consolidation following an interim acquisition
3. Consolidation tax considerations
4. Consolidated earnings per share

10-2
Learning Objective 10-1

Prepare a consolidated
statement of cash flows.

10-3
 Consolidated Statement of Cash Flows

 A consolidated statement of cash flows is

similar to a statement of cash flows
prepared for a single-corporate entity and
is prepared in basically the same manner.
 Preparation
 Typically prepared after the consolidated
income statement, retained earnings statement,
and balance sheet.
 Prepared from the information in the other three
statements.
10-4
 Consolidated Statement of Cash Flows

 Preparation
 Requires only a few adjustments (such as those
for depreciation and amortization resulting from
the write-off of a differential) beyond those used
in preparing a cash flow statement for an
individual company.
 All transfers between affiliates should be
eliminated.
 Noncontrolling interest typically does not cause
any special problems.

10-5
Consolidated Statement of Cash Flows for the Year
Ended December 31, 20X2 (Figure10–2)

10-6
 Consolidated Statement of Cash Flows

 Consolidated cash flow statement—direct

method
 Nearly all major companies use the indirect
method.
 Critics have argued that the direct method is less
confusing and more useful.

10-7
 Consolidated Statement of Cash Flows

 The only section affected by the difference

in approaches is the operating activities
section.
 Under the indirect approach, the operating
activities section starts with net income and, to
derive cash provided by operating activities,
adjusts for all items affecting cash and net
income differently.
 Under the direct approach, the operating
activities section of the statement shows the
actual cash flows.
10-8
 Consolidated Statement of Cash Flows

 Direct approach: As an example, the only cash

flows related to operations are
Cash Flows from Operating Activities:
Cash Received from Customers $615,000)
Cash Paid to Suppliers (510,000)
Net Cash Provided by Operating Activities $105,000)

 The remainder of the cash flow statement is the

same under both approaches except that a
separate reconciliation of operating cash flows
and net income is required under the direct
approach.
10-9
 Practice Quiz Question #1
Which of the following statements is true?
a. After the consolidated income statement
and balance sheet have been prepared, the
statement of cash flows is calculated in the
same way as for a single company.
b. The preparation of a consolidated
statement of cash flows requires
procedures that are unique to consolidated
companies.
c. A consolidated statement of cash flows is
not required under U.S. GAAP.
d. The consolidated statement of cash flows is
calculated from the subsidiary’s financial
statements alone. 10-10
 Practice Quiz Question #1 Solution
Which of the following statements is true?
a. After the consolidated income statement
and balance sheet have been prepared, the
statement of cash flows is calculated in the
same way as for a single company.
b. The preparation of a consolidated
statement of cash flows requires
procedures that are unique to consolidated
companies.
c. A consolidated statement of cash flows is
not required under U.S. GAAP.
d. The consolidated statement of cash flows is
calculated from the subsidiary’s financial
statements alone. 10-11
Learning Objective 10-2

Make calculations and

record journal and
worksheet entries related to
an interim acquisition.

10-12
 Consolidation Following an Interim Acquisition

 When a subsidiary is acquired during a

fiscal period, the results of the
subsidiary’s operations are included in
the consolidated statements only for the
portion of the year that the stock is owned
by the parent.

10-13
 Consolidation Following an Interim Acquisition:
Illustration
Peanut purchases 75% of Snoopy’s outstanding common stock on July 1,
20X1 for an amount equal to 75% of the book value of Snoopy’s net assets.
Prior to the acquisition, Snoopy had earned net income of $35,000 and
declared $8,000 of dividends. The income and dividends for the year are
summarized in the following table:

1/1 to 6/30 7/1 to 12/31

Sales 125,000 250,000
Less: COGS 50,000 110,000
Less: Depreciation Expense 25,000 50,000
Less: Other Expenses 15,000 30,000
Net Income 35,000 60,000

Dividends 8,000 20,000

10-14
 Consolidation Following an Interim Acquisition:
Illustration

Parent Company Entries

Peanut records the purchase of Snoopy stock with the following entry:

July 1, 20X1
Investment in Snoopy Stock 320,250
Cash 320,250
Record purchase of Snoopy stock.

During the second half of 20X1, Peanut records its share of Snoopy's income and
dividends under the equity method:

Investment in Snoopy Stock 45, 000

Income from Snoopy 45, 000
Record equity-method income: $60,000 x 0.75.

Cash 15,000
Investment in Snoopy Stock 15,000
Record dividends from Snoopy: $20,000 x 0.75. 10-15
 Consolidation Following an Interim Acquisition:
Illustration
Pre-acquisition income and dividend elimination entry:
Sales 125,000  Close pre-acquisition sales to RE
COGS 50,000  Close pre-acquisition COGS to RE
Depreciation Expense 25,000  Close pre-acquisition depr. exp. To RE
Other Expense 15,000  Close pre-acquisition other expenses to RE
Dividends Declared 8,000  Close pre-acquisition dividends to RE
Retained Earnings 27,000  Pre-acquisition net increase in RE

After making this worksheet entry to close the pre-acquisition earnings and
dividends to the Retained Earnings account, the beginning balance in Retained
Earnings as of the date of acquisition is $117,000.

Retained Earnings
90,000 Balance 1/1/20X1

27,000
117,000 Balance 6/30/20X1
10-16
 Consolidation Following an Interim Acquisition:
Illustration
Based on this acquisition date beginning balance, we calculate the post-acquisition
changes in book value as follows:
Book Value Calculations:
NCI Peanut Common Retained
25% + 75% = Stock + Earnings
July 1, 20X1, balances 106,750) 320,250) 250,000 177,000)
+ Net Income 15,000) 45,000) 60,000)
 Dividends (5,000) (15,000) (20,000)
December 31, 20X1, balances 116,750) 350,250) 250,000 217,000)

This leads to the basic elimination entry, following the normal procedure (but based
on post-acquisition earnings and dividends):
Basic Elimination Entry
Common Stock 250,000  Original amount invested (100%)
Retained Earnings 177,000  Beginning balance in RE
Income from Snoopy 45,000  Peanut's share of reported NI
NCI in NI of Snoopy 15,000  NCI’s share of reported NI
Dividends Declared 20,000  100% of Sub’s dividends declared
Investment in Snoopy 350,250  Net amount of BV left in inv. acct.
NCI in NA of Snoopy 116,750  NCI’s share of net book value
10-17
 Consolidation Following an Interim Acquisition:
Illustration
The following T-accounts illustrate how the basic elimination entry zeros out the balances in the
Investment in Snoopy and Income from Snoopy accounts:

Investment in Snoopy Income from Snoopy

Acquisition 320,250
75% Net Income 45,000 45,000 75% Net Income
15,000 75% Dividends

Balance 12/31/X1 350,250 45,000 Balance 12/31/X1

350,250 Basic 45,000

0 0

Again, we include the normal accumulated depreciation elimination entry based on the balance
in accumulated depreciation on Snoopy’s books on the acquisition date. Assume that this
amount is 65,000 on the acquisition date.

Optional accumulated depreciation elimination entry:

Accumulated Depreciation 65,000
Building and Equipment 65,000
10-18
Learning Objective 10-3

Make basic calculations and

journal entries related to
income taxes in the
consolidated financial
statements.

10-19
 Consolidation Income Tax Issues

 A parent company and its subsidiaries

may file a consolidated income tax return,
or they may choose to file separate
returns.
 For a subsidiary to be eligible to be included in a
consolidated tax return, at least 80 percent of its
stock must be held by the parent company or
another company included in the consolidated
return.

10-20
 Consolidation Income Tax Issues

 Filing a consolidated return: advantages

 The losses of one company may be offset against
the profits of another.
 Dividends and other transfers between the
affiliated companies are not taxed.
 May make it possible to avoid limits on the use of
certain items such as foreign tax credits and
charitable contributions.

10-21
 Consolidation Income Tax Issues

 Filing a consolidated return: limitations

 Once an election is made to include a subsidiary
in the consolidated return, the company cannot
file separate tax returns in the future unless it
receives IRS approval.
 The subsidiary’s tax year also must be brought
into conformity with the parent’s tax year.
 Can become quite difficult when numerous
companies are involved and complex ownership
arrangements exist.

10-22
 Consolidation Income Tax Issues

 Allocation of tax expense when a

consolidated return is filed
 Portrays the companies included in the return as
if they were actually a single legal entity.
 All intercorporate transfers of goods and
services and intercompany dividends are
eliminated and a single income tax figure is
assessed

10-23
 Consolidation Income Tax Issues

 Allocation of tax expense when a

consolidated return is filed
 Because only a single income tax amount is
determined, income tax expense must be
assigned to the individual companies.
 The method of tax allocation can affect the
amounts reported in the income statements of
both the separate companies and the
consolidated entity.

10-24
 Consolidation Income Tax Issues

 Allocation of tax expense when a

consolidated return is filed
 When a subsidiary is less than 100 percent
owned, tax expense assigned to the subsidiary
reduces proportionately the income assigned to
the parent and the noncontrolling interest.
 The more tax expense assigned to the subsidiary,
the less is assigned to the parent; the income
attributed to the controlling interest then
becomes greater.

10-25
 Consolidation Income Tax Issues

 Unrealized profits when a consolidated

return is filed
 Intercompany transfers are eliminated in
computing both consolidated net income and
taxable income.
 Because profits are taxed in the same period
they are recognized for financial reporting
purposes, no temporary differences arise, and no
additional tax accruals are needed in preparing
the consolidated financial statements.

10-26
 Consolidation Income Tax Issues

 Unrealized profits when separate returns

are filed
 The companies are taxed individually on the
profits from intercompany sales.
 No consideration is given to whether the
intercompany profits are realized from a
consolidated viewpoint.

10-27
 Consolidation Income Tax Issues

 Unrealized profits when separate returns

are filed
 The tax expense on the unrealized intercompany
profit must be eliminated when the unrealized
intercompany profit is eliminated in preparing
consolidated financial statements.
 This difference in timing of the tax expense
recognition results in the recording of deferred
income taxes.

10-28
 Consolidation Income Tax Issues

Assume that Peanut acquired 75% of Snoopy’s

common stock. Peanut acquired the stock when the
book value of Snoopy’s common stock was
$250,000 and retained earnings were $150,000.
During the year, Snoopy reports pre-tax income of
$60,000 and declares $20,000 of dividends. In
addition, during 20X1 Snoopy sold inventory
costing $75,000 to Peanut for $100,000. $60,000 of
this inventory was resold by year end. Assume the
two companies file separate a tax returns for 20X1.
Both Peanut and Snoopy are subject to a 40% tax
rate.
10-29
 Consolidation Income Tax Issues
Snoopy sells inventory costing $75,000 to Peanut Products for $100,000, and
resold $60,000 of this inventory before year-end. Assume 40 percent tax rate.
Total = Re-sold + Ending Inventory
Sales 100,000 60,000 40,000
COGS 75,000 45,000 30,000
Gross Profit 25,000 15,000 10,000
Gross Profit % 25%
Sales 100,000
Cost of Goods Sold 90,000
Inventory 10,000
Eliminate intercompany upstream sale of inventory.
With a 40 percent income tax rate, the following eliminating entry adjusts income tax expense of
the consolidated entity downward by $4,000 ($10,000 x 0.40) to reflect the reduction of reported
profits:

Deferred Tax Asset 4,000

Income Tax Expense 4,000
Eliminate tax expense on unrealized intercompany profit. 10-30
 Unrealized Profit in Separate Tax Return
Illustrated
If Peanut accounts for its investment in Snoopy using the fully adjusted equity method, Peanut
would make the following journal entries on its books:

Investment in Snoopy 27,000

Income from Snoopy 27,000
Record Peanut’s 75 percent share of Snoopy’s 20X1 reported income.
Cash 15,000
Investment in Snoopy 15,000
Record Peanut’s 75 percent share of Snoopy’s 20X1 dividend.
Peanut also defers its 75% share of the unrealized profit on intercompany upstream sales (net of
taxes). Thus, the $10,000 of unrealized profit ($40,000  $30,000) net of 40% taxes is $6,000
($10,000 x 0.60). Thus, the deferral of Peanut's relative share of the unrealized gross profit is
$4,500 ($6,000 x 0.75).

Income from Snoopy 4,500

Investment in Snoopy 4,500
Eliminate unrealized gross profit on inventory purchases from Snoopy.

In order to prepare the basic elimination entry, we first analyze the book value of Snoopy's equity
accounts and the related 75% share belonging to Peanut and the 25% share belonging to the NCI
shareholders:
10-31
 Unrealized Profit in Separate Tax Return
Illustrated
Book Value Calculations:
NCI Peanut Common Retained
25% + 75% = Stock + Earnings
Original book value 100,000) 300,000) 250,000 150,000)
+ Net Income 9,000) 27,000) 36,000)
 Dividends (5,000) (15,000) (20,000)
Ending book value 104,000) 312,000) 250,000 166,000)

We note that the book value calculations form the basis for the basic elimination entry, but
Peanut's share of income and its investment account must be adjusted for the equity-method
entry previously made for $4,500. In addition, the NCI share of income and net assets is adjusted
for the 25% share of the unrealized gross profit (net of 40 percent taxes).

Basic Elimination Entry

Common Stock 250,000  Original amount invested (100%)
Retained Earnings 150,000  Beginning balance in RE
Income from Snoopy 22,500  Peanut's % of NI – 75% of Def. GP (net of tax)
NCI in NI of Snoopy 7,500  NCI % of NI – 25% of Def. GP (net of tax)
Dividends Declared 20,000  100% of Sub’s dividends declared
Investment in Snoopy 307,500  Net BV – 75% of Def. GP (net of tax)
NCI in NA of Snoopy 102,500  NCI % of BV – 25% of Def. GP (net of tax)
10-32
 Subsequent Profit Realization When Separate
Returns Are Filed
If income taxes were ignored, the following eliminating entry would be used
in preparing consolidated statements as of December 31, 20X2, assuming
that Snoopy had $10,000 of unrealized inventory profit on its books on
January 1, 20X2, and the inventory was resold in 20X2:

Investment in Snoopy 7,500

NCI in NA of Snoopy 2,500
Cost of Goods Sold 10,000
Eliminate beginning inventory profit.

On the other hand, if the 40 percent tax rate is considered, the eliminating
entry would be modified as follows:

Investment in Snoopy 4,500

NCI in NA of Snoopy 1,500
Income Tax Expense 4,000
Cost of Goods Sold 10,000

10-33
Learning Objective 10-4

Make calculations related to

consolidated earnings per
share.

10-34
 Consolidated Earnings Per Share

 Basic consolidated EPS is calculated by

deducting income to the noncontrolling interest
and any preferred dividend requirement of the
parent company from consolidated net income
 The resulting amount is then divided by the weighted-
average number of the parent’s common shares
outstanding during the period.
 While consolidated net income is viewed from an entity
perspective, consolidated earnings per share follows a
parent company approach and clearly is aimed at the
stockholders of the parent company.

10-35
 Consolidated Earnings Per Share

 Computation of diluted consolidated

earnings per share

10-36
 Consolidated Earnings Per Share

 Diluted consolidated earnings per share

 The parent’s share of consolidated net income
normally is the starting point in the computation
of diluted consolidated EPS.
 It then is adjusted for the effects of parent and
subsidiary dilutive securities.

10-37
Practice Quiz Question #2

Consolidated EPS is calculated:

a. as the sum of the subsidiary’s and the
parent’s individual EPS numbers.
b. by adding the subsidiary’s and the parent’s
net income numbers and dividing by the
subsidiary’s shares owned by the parent.
c. by deducting the NCI in net income and
preferred dividends from consolidated net
income and dividing by the parent’s
weighted-average shares.
d. as the parent’s net income divided by the
combined weighted shares outstanding of
the parent and subsidiary.
10-38
Practice Quiz Question #2 Solution

Consolidated EPS is calculated:

a. as the sum of the subsidiary’s and the
parent’s individual EPS numbers.
b. by adding the subsidiary’s and the parent’s
net income numbers and dividing by the
subsidiary’s shares owned by the parent.
c. by deducting the NCI in net income and
preferred dividends from consolidated net
income and dividing by the parent’s
weighted-average shares.
d. as the parent’s net income divided by the
combined weighted shares outstanding of
the parent and subsidiary.
10-39
Conclusion

The End

10-40