If an investor corporation acquires a controlling interest in the outstanding common stock of an investee corporation that is not liquidated, the investee becomes a subsidiary of the investor parent company.
Consolidated financial statements are issued to report the financial position and operating results of a parent company and its subsidiaries as a single economic entity, despite the fact that the affiliated companies are separate legal entities.
In the preparation of consolidated financial statements, assets, liabilities, revenue, and expenses of the parent company and its subsidiaries are totaled; intercompany transactions and balances are eliminated; and the final consolidated amounts are reported in the consolidated balance sheet, income statement, statement of stockholders' equity, and statement of cash flows.
In the past, a wide range of consolidation practices existed among major corporations in the United States. Many companies excluded from consolidation foreign subsidiaries and domestic finance-related subsidiaries such as insurance companies and banks. However, the Financial Accounting Standards Board has issued a Statement requiring the consolidation of all subsidiaries that are controlled.
The traditional concept of a parent company's controlling financial interest in a subsidiary has been ownership of more than 50% of the subsidiary's voting common stock. However, a parent company may not actually control a subsidiary that is in court-supervised liquidation or reorganization, or a subsidiary in a highly restrictive foreign country.
In 1999, the FASB proposed to redefine control as a parent company's nonshared decision-making ability that enables it to increase the benefits it derives and limit the losses it suffers from the subsidiary's activities. Subsequently, the FASB "shelved" the proposal, leaving the problem of variable interest entities unresolved.
In a business combination resulting in a parent company—wholly owned subsidiary relationship, the subsidiary prepares no journal entries associated with the combination. The parent company's journal entry to record such a business combination includes a debit to the Investment in Subsidiary Common Stock ledger account for the amount of cash or the current fair value of securities issued to effect the combination. The Investment in Subsidiary Common Stock ledger account also is debited with the direct out-of-pocket costs of the business combination.
Accountants generally use a working paper for consolidated balance sheet and working paper eliminations to facilitate the preparation of a consolidated balance sheet on the date of a business combination. A consolidated income statement, a consolidated statement of stockholders' equity, and a consolidated statement of cash flows are not appropriate for the accounting period ended on the date of a business combination, because the combining companies were separate economic as well as legal entities prior to the combination.
Working paper eliminations are working paper entries only; they are not entered in the accounting records of either the parent company or the subsidiaries. Working paper eliminations on the date of a business combination include differences between current fair values and carrying amounts of the subsidiary's identifiable assets and liabilities because a subsidiary prepares no journal entries for a business combination.
The consolidated paid-in capital amounts in a consolidated balance sheet are those of the parent company only. Subsidiaries' paid-in capital amounts always are eliminated in consolidation. In addition, consolidated retained earnings on the date of a business combination includes the retained earnings of the parent company only.
The consolidated balance sheet for a parent company and a partially owned subsidiary on the date of a business combination includes the minority interest of the subsidiary's stockholders other than the parent company in the net assets of the subsidiary.
The economic unit concept and the parent company concept of consolidated financial statements have different approaches to the display of minority interest in the consolidated financial statements. In the economic unit concept, the minority interest in the subsidiary's net assets is displayed in the stockholders' equity section of the consolidated balance sheet, and the minority interest in the subsidiary's net income is displayed as a subdivision of total consolidated income in the consolidated income statement.
In the parent company concept, the minority interest in net assets of the subsidiary is displayed as a liability in the consolidated balance sheet, and the minority interest in the subsidiary's net income is displayed as an expense in the consolidated income statement.
In the opinion of the author, the economic unit concept of displaying minority interest in consolidated financial statements emphasizes the legal aspects of the separate corporate entities making up the consolidated entity. Because a proposed Statement of the FASB mandates its use, the economic unit concept has been adopted by the author in the textbook chapters dealing with consolidated financial statements.
Three methods have been advanced with respect to the valuation of the minority interest in net assets of subsidiary (and goodwill) in the consolidated balance sheet of a parent company and its partially owned subsidiary. The three methods are summarized as follows:
All identifiable assets and liabilities of a partially owned subsidiary are valued on a single basis—current fair value—and only the goodwill of the subsidiary acquired by the parent company is displayed in the consolidated balance sheet. This method is consistent with accounting for business combinations and is widely used.
Current fair values are assigned to a partially owned subsidiary's net assets (including goodwill) only to the extent of the parent company's ownership interest in the net assets. The minority interest is based upon the carrying amounts of the subsidiary's net assets. This method is not consistent with accounting for business combinations.
Same as in a, except that minority interest in the consolidated balance sheet includes the minority's share of the implicit current fair value of the subsidiary's total goodwill.
To illustrate the three methods described in paragraph 15, assume that Parent Corporation acquired 80% of the common stock of Sub Company for $800,000, and that data for Sub Company on the date of the business combination were as follows:
Carrying amount of net assets
$ 600,000
Current fair value of identifiable net assets
900,000
Current fair value of total net assets, including goodwill ($800,000 ÷ 0.80)
1,000,000
The minority interest and goodwill in the consolidated balance sheet for Parent Corporation and subsidiary on the date of the business combination are computed under each method described in paragraph 15 as follows:
Minority interest in net assets of subsidiary
Goodwill
a. Minority interest ($900,000 x 0.20)
$180,000
Goodwill [$800,000 — ($900,000 x 0.80)]
$80,000
b. Minority interest ($600,000 x 0.20)
120,000
Goodwill [$800,000 — ($900,000 x 0.80)]
$80,000
c. Minority interest ($1,000,000 x 0.20)
200,000
Goodwill ($1,000,000 — $900,000)
$100,000
The minority interest in the subsidiary's net assets and the goodwill as computed in paragraph 16 are not recognized in the accounting records of either the parent company or the subsidiary. They are included in the consolidated balance sheet by means of a working paper elimination. The following working paper elimination (in journal entry format) for Parent Corporation and subsidiary on the date of the business combination illustrates this. (In the illustration, which incorporates the method described in part a of paragraph 15, amounts not in boldface are assumed.)
Common Stock— Sub
350,000
Additional Paid-in Capital— Sub
100,000
Retained Earnings— Sub
150,000
Various Identifiable Assets— Sub
300,000
Goodwill — Parent
80,000
Investment in Sub Common Stock— Parent
800,000
Minority Interest in Net Assets of Subsidiary
180,000
To eliminate intercompany investment and equity accounts of subsidiary on date of business combination; to allocate excess of cost over carrying amount of identifiable assets acquired, with remainder to goodwill; and to establish minority interest in net assets of subsidiary on date of combination.
If a business combination that results in a parent company—subsidiary relationship involves a bargain-purchase excess, the excess of current fair values of the subsidiary's identifiable net assets over the cost of the parent company's investment is applied pro rata to reduce the amounts initially assigned to specified assets. The proration is accomplished in a working paper elimination.
A description of the consolidation policy reflected in consolidated financial statements is included in the "Summary of Significant Accounting Policies" required by APB Opinion No. 22, "Disclosure of Accounting Policies."
Consolidated financial statements are useful primarily to stockholders and prospective investors in the common stock of the parent company. Creditors of all consolidated corporations and minority stockholders of subsidiaries find only limited use for consolidated financial statements because such statements do not show the financial position, operating results, or cash flows of individual corporations comprising the consolidated group. In addition, consolidated financial statements of a highly diversified corporate group are impossible to categorize into a single operating segment or product classification.
The SEC has authorized push-down accounting, for valuations based on parent company investment cost, in the separate financial statements for certain subsidiaries of companies subject to the SEC's authority.
