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© The McGraw
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Chapter Four

Consolidated
Financial
Statements
and Outside
Ownership

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?

Noncontrolling Interest


Noncontrolling (Minority)
interest

is the amount of
the acquired company’s
stock that is not held by
the parent.


The interests of the
noncontrolling (non
-
parent) stockholders
must be reflected in the
consolidated financial
statements.

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Noncontrolling Interest

The existence of
noncontrolling investors
requires the establishment
of two new accounts:


Noncontrolling Interest


Noncontrolling Interest in
Subsidiary Net Income

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Noncontrolling Interest

3 approaches for defining
noncontrolling interest:


Economic Unit Concept


Proportionate Consolidation Concept


Parent Company Concept

Assume that Expo,Inc. acquires 70%
of Nent Co. for $10 million cash.

How do we account for the 30% of
Nent Co. that Expo does not own?

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Recommended by the FASB.

Noncontrolling Interest is a % of the
sub’s implied value.

Noncontrolling Interest in Sub Net
Income is a % of the sub’s net income
less amortization of purchase price
allocations.

The sub is viewed as an indivisible unit
within the business combination.

Economic Unit Concept

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Little evidence exists to suggest
widespread use of this method.

Only the portion of the sub’s assets that
are acquired by the parent are
consolidated.

Noncontrolling Interest is not reported
under this method.

This method has been used where
control exists, but less than 50% of the
sub has been acquired.

Proportionate Consolidation
Concept

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Considered to be the most common
method in practice.

Noncontrolling Interest
is a % of the
sub’s book value at the balance sheet
date.

Noncontrolling Interest in Sub Net
Income is a % of the sub’s net income.

Noncontrolling Interest may appear in the
equity section or between the equity
section and the liability section.

Parent Company Concept

#1 practice
in use.

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Accounting for

Noncontrolling Interest

On the Balance Sheet:


A credit balance account called
Noncontrolling Interest

is set up
to recognize the noncontrolling
stockholders’ investment in the
subsidiary.


The account usually appears in
the equity section of the
Consolidated Balance Sheet, but
is also sometimes reported in the
liability section or as a
“mezzanine” item between the two
sections.

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Proposed Reporting Change

2005 FASB Exposure Drafts would:



Require noncontrolling interests be
accounted for and reported as equity


Require that this account would be
disclosed separately from the parent
shareholders’ equity

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Accounting for

Noncontrolling Interest

On the Income Statement:


An account called
Noncontolling Interest in
Subsidiary Net Income

is
set up to recognize the
noncontrolling
shareholders’ share of the
sub’s net income.


The account appears on the
Income Statement.

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Let’s look at an
example using
the Parent
Company
Concept.

Noncontrolling Interest

Example

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On 1/1/08,
Jumbo
purchases
80% of Li’l
Bit for
$800,000
cash.

Noncontrolling Interest

Example

Note that Li’l Bit owns an internally developed patent
valued at $220,000, with an expected useful life of 10
years.

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Record the initial investment on
Jumbo’s books.

Noncontrolling Interest

Example

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Goodwill computation:

This computation
will be needed
again when the
consolidation is
done in years
subsequent to the
year of
acquisition.

Noncontrolling Interest

Example

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As of the date
of acquisition,
the balances
for each
company are
entered into the
worksheet.

Next, enter the
consolidation
entries on the
worksheet.

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This is 20% of
Li’l Bit’s BV at
date of
acquisition.

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This will be the
sum of all the
amounts in the
Noncontrolling
Interest column.

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Let’s do the
consolidation
at the end of
2008.

Noncontrolling Interest

Example

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First, update Jumbo’s
numbers for the
equity method entries.

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Noncontrolling Interest

Example

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$60,000 dividends were paid
to Jumbo by Li’l Bit during
the year.

Noncontrolling Interest

Example

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FMV adjustment and intangible
amortization is computed as follows:

Noncontrolling Interest

Example

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Assume that the
building has a
remaining useful
life of 10 years,
the equipment
has a remaining
useful life of 4
years, and the
patent has a
remaining useful
life of 10 years.

Amortization computation:

Noncontrolling Interest

Example

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Amortization computation:

Noncontrolling Interest

Example

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Note Jumbo’s
updated
numbers.

This is based on
80% of Li’l Bit’s
income less $20.8
in Amortization
Expense

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This is 20% of
Li’l Bit’s BV at
date of
acquisition.

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This is the
80% of Li’l
Bit’s dividends
that went to
Jumbo.

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These numbers
are computed
and entered into
the
Noncontrolling
Interest column.

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Effects Created by Using the Cost
Method

Prepare Entry *C to convert
from the Cost Method to
the Equity Method


Combine:

1.
The increase in the sub’s BV
since acquisition x the
parent’s ownership %

2.
Total amortization for the
same period.

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Effects Created by Using the Cost
Method


Change Entry I to
eliminate the Dividend
Income



DO NOT use Entry D


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Effects Created by Using the
Partial Equity Method

Perform Entry *C.

Only the
adjustment for
the amortization
expense is
necessary.

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Step Acquisitions


Companies often acquire
controlling interest in other
companies a piece at a
time; i.e. “in steps”.


Under the Parent Company
Concept, each investment
is viewed as a separate
purchase, with its own cost
allocations and
amortization.

© The McGraw
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Preacquisition Income


When control of a sub is acquired
at a time subsequent to the
beginning of the sub’s fiscal year,
the income statement accounts
are consolidated as if the
acquisition was made at the
beginning of the period.


A line
-
item is included in the
income statement for the parent’s
share of the sub’s income prior to
the date of acquisition.

© The McGraw
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Summary


Control does not require total
ownership. Ownership of subsidiary
stock retained by outside, unrelated
parties is called noncontrolling
(minority) interest



Three reporting alternatives:


Proportionate consolidation


Economic unit


Parent company (most popular)

© The McGraw
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Possible Criticisms


FASB is currently advocating that noncontrolling
interest be accounted for as an equity item. Some
critics deem this inappropriate because the outside
parties do not hold a direct interest in the parent
company. They advocate non
-
reporting.


Others believe that “mezzanine” recognition of a
fourth balance sheet classification that shows a credit
balance, but is neither liability nor equity, is the
appropriate method of disclosing noncontrolling
interest.


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


WHAT DO YOU THINK?????

© The McGraw
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Ten cups of
this stuff
and I still
don’t get it!

End of Chapter 4