Hoyle Chap 4 Yoel 12e Students

Chapter Four

Consolidated Financial Statements and

Outside Ownership

Noncontrolling Interest

If the parent doesn’t own 100% of the company, WHO owns the rest of it?

Noncontrolling (Minority) Shareholder

The ownership interests of the Noncontrolling Shareholders must be reflected in the consolidated financial statements.

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Noncontrolling Interest

1. Noncontrolling Interest

2. Noncontrolling Interest in Subsidiary Net Income

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The Parent has control and is responsible for all of the Subsidiary’s assets and liabilities, so we will still consolidate 100% of the Subsidiary’s financial information. However…

The existence of noncontrolling investors requires two new accounts:

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Noncontrolling Interest - Example

• Parker Corporation wants to acquire 90% of Strong Company.

• Strong’s stock has been trading for $60 per share.

• If Parker has to pay $70 per share to induce enough stockholders to sell, how do we account for the 10% of Strong that Parker does not own?

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• In this case, the Controlling Investor had to pay a premium for the shares they need to gain control.

• How do we value this premium, and how do we value the noncontrolling interest?

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If Parker purchased 9,000 shares at this price, then the fair value of their consideration transferred is $630,000. The remaining 1,000 shares of Strong have a fair value of $60,000.

This gives a total acquisition-date fair value of Strong Company of $690,000.

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The total acquisition-date fair value of Strong of $690,000 is greater than the fair value of the identifiable net assets acquired of $600,000 (10,000 shares x $60 per share).

The difference is allocated to Goodwill.

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• If the shares were not actively traded, then the consideration transferred by Parker would be considered the best measure of fair value of Strong.

• And we would estimate the fair value of the noncontrolling interest at $70,000.

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Recording Noncontrolling Interest

On the Balance Sheet: A credit balance account called Noncontrolling

Interest represents the noncontrolling stockholders’ investment.

This account appears in the equity section of the Consolidated Balance Sheet as required by SFAS 160.

Prior to SFAS 160 an option existed to report it in the

liability section, or as a “mezzanine” item between the two sections.

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Recording Noncontrolling Interest

On the Income Statement: An account called Noncontolling Interest in

Subsidiary Net Income represents the noncontrolling shareholders’ share of the sub’s net income.

This account is created in consolidation and reported in the worksheet entries, similar to the balance sheet account for the noncontrolling interest.

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Let’s take our original example one step further. Parker owns 90% of Strong.

Strong earns $80,000 in the first year Parker has control.

$30,000 of annual excess fair value amortization results from increasing Strong’s acquisition-date book values to fair value.

Noncontrolling Interest - Example4-11

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Noncontrolling Interest in Strong Company Net IncomeRevenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $280,000Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000Subsidiary Strong net income . . . . . . . . . . . . . . . . 80,000Excess acquisition-date fair-value amortization. . . 30,000Net income adjusted for excess amortizations. . . $ 50,000Noncontrolling interest percentage . . . . . . . . . . . . . . 10%Noncontrolling interest in Strong net income. . . . . $ 5,000

Note: The noncontrolling shareholders have a 10% interest in the subsidiary company, but no interest in the parent firm.

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Noncontrolling Interests and Consolidations

The consolidation process remains substantially unchanged with a noncontrolling interest.

Consolidate as though the Parent has 100% ownership, and then determine the noncontrolling interest in:

The subsidiary as of the beginning of the current year.

The subsidiary’s current year net income.

The subsidiary’s dividend payments.

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Noncontrolling Interest -Worksheet Example

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Assume that King Co. acquires 80% of Pawn Co’s 100,000 outstanding voting shares on January 1, 2011, for $9.75 per share or a total of $780,000 cash.

Further assume that the 20% noncontrolling interest shares trade before and after the acquisition at an average of $9.75 per share.

The total fair value of Pawn to be used initially in consolidation is thus as follows:

Consideration transferred by King. . . . . . . . . . . $780,000Noncontrolling interest fair value . . . . . . . . . . . . 195,000Pawn’s total fair value at January 1, 2011 . . . $975,000

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Noncontrolling Interest - Worksheet Example

Note: Comparing the total fair value based on the stock value of $975,000 to the fair value of identifiable net assets shown above, it appears Pawn has goodwill valued at $25,000.

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Exhibit 4.2: Subsidiary Accounts – Date of Acquisition

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Exhibit 4.3: Excess Fair Value Allocations

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Exhibit 4.4: Equity Method Investment Balance

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Exhibit 4.5: Separate Financial Records


• King uses the Equity Method to account for Pawn subsequent to acquisition.

• The consolidation process is substantially the same.

• At each consolidation, we will prepare the worksheet with the entries we referenced as S, A, I, D, and E, AND…

• We will add a column to our worksheet where we will record the noncontrolling interest in the subsidiary.

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Consolidated Financial Statement Balance Sheet 4-25

Noncontrolling Interest – Premium Paid

If King had paid $11.00 for their shares, at a time when they were trading for $9.75, then the goodwill allocation would look like this:

$11.00 x 80,000 shares$9.75 x 20,000 shares

Acquisition-date FV

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Effects of using the Initial Value Method

Add Entry *C to convert from the Initial Value Method to the Equity Method by combining: the increase in the Sub’s Retained Earnings since

acquisition x the parent’s ownership %, and the parent’s share of amortization expense since

acquisition.

Entry D will not be necessary.

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What if the Parent used the Initial Value Method to account for the Subsidiary after acquisition?

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Effects of using the Partial Equity Method

Add Entry *C to convert from the Partial Equity Method to the Equity Method, but only the adjustment for the parent’s share of amortization expense is necessary.

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What if the Parent used the Partial Equity Method to account for the Subsidiary after acquisition?

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Mid-Year Acquisitions

When control of a Sub is acquired at a time subsequent to the beginning of the sub’s fiscal year:

The income statements are consolidated as usual, and

The Sub’s pre-acquisition revenues and expenses are excluded from the Parent’s consolidated statements (adjusted via Entry S), and

Only a partial year’s amortization on excess fair value is taken.

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Problem 33:

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Problem 33:

Step Acquisitions

When a Parent acquires a Subsidiary over time, or in “steps,” the date control is achieved is significant –

All previous values for the investment, prior to the date control is obtained, are remeasured to fair value as of the date of control.

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Amie, Inc., has 100,000 shares of $ 2 par value stock outstanding.

Prairie Corporation acquired 30,000 of Amie’s shares on January 1, 2009, for $ 120,000 when Amie’s net assets had a total fair value of $ 350,000.

On July 1, 2013, Prairie agreed to buy an additional 60,000 shares of Amie from a single stockholder for $ 6 per share.

Although Amie’s shares were selling in the $ 5 range around July 1, 2013, Prairie forecasted that obtaining control of Amie would produce significant revenue synergies to justify the premium price paid.

If Amie’s net identifiable assets had a fair value of $ 500,000 at July 1, 2013, how much goodwill should Prairie report in its postcombination consolidated balance sheet?

Problem 10:

Sales of Subsidiary Stock

If the parent maintains control, it recognizes no gains or losses – the sale is shown in the equity section.

If the sale results in the loss of control, the parent recognizes any resulting gain or loss in net income.

What is reported on the consolidated statements when a Parent sells some of its ownership in a Subsidiary?

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Noncontrolling Interest – International Accounting Standards

• IFRS permits fair value measurement, or the noncontrolling interest may be measured at a proportionate share of the Sub’s identifiable net asset fair value, which excludes goodwill.

• This option assumes that any goodwill created via acquisition applies solely to the controlling interest.

• U.S. GAAP requires fair value measurement.

• Thus, acquisition-date fair value provides a basis for reporting the noncontrolling interest;

• which is adjusted for its share of subsidiary income and dividends subsequent to acquisition.

US GAAP vs IFRS

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Noncontrolling Interest – The Legacy Purchase Method

• Under the purchase method, when less than 100% was purchased, only the parent’s percentage was adjusted to fair value.

• Therefore, the valuation principle for the noncontrolling interest under the purchase method was simply its share of the subsidiary’s book value.

• The consolidation worksheet entries must be adjusted accordingly.

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Summary

Control does not require 100% ownership. The minority ownership by outside, unrelated parties is called noncontrolling interest.

Noncontrolling interest is recognized as a credit balance on the balance sheet, and as a separate line on the income statement.

If a mid-year acquisition occurs, pre-acquisition revenues and expenses of the subsidiary are excluded from consolidated results.

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Possible Criticisms FASB advocates that a noncontrolling interest be

accounted for as equity, even though the outside parties do not hold a direct interest in the parent company.

Others believe that “mezzanine” recognition of a credit balance, that is neither liability nor equity, is the appropriate accounting for a noncontrolling interest.

Finally, there are those who think liability section reporting is best.

WHAT DO YOU THINK???

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Hoyle Chap 4 Yoel 12e Students

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