After studying this chapter, you should be able to do the following:

1. Explain the basic differences between the four theories of consolidation.
2. Prepare a consolidated balance sheet using the entity theory.
3. Prepare a consolidated balance sheet using the parent company extension theory.
4. Explain the concept of negative goodwill and describe how it should be treated when it arises in a business combination.
5. Account for contingent consideration based on its classification as a liability or equity.
6. Analyze and interpret financial statements involving consolidation of non-wholly owned subsidiaries.
7. Identify some of the differences between IFRS and ASPE involving consolidation of non-wholly owned subsidiaries.
8. Prepare a consolidated balance sheet using the working paper approach.

Consolidated financial statements present the financial position and operating results of a group of companies under common control as if they constitute a single entity. When one company gains control over another company, it becomes a parent company and GAAP requires it to present consolidated statements for external reporting purposes. The preparation involves eliminating the parent’s investment account and the parent’s share of the subsidiary’s shareholders’ equity accounts, revaluing the net assets of the subsidiary to fair value, and establishing the non-controlling interest (NCI) in the fair value of the subsidiary’s net assets. Either the entity method or the parent company extension method must be used when consolidating non–wholly owned subsidiaries.

When the purchase price is less than the fair value of identifiable net assets, the negative goodwill is used to eliminate any goodwill reported on the subsidiaries’ separate-entity financial statements. Any remaining negative goodwill is reported as a gain on purchase of the consolidated income statement.

A working paper can be used to prepare the consolidated statements, and is necessary if there are a large number of subsidiaries to consolidate. A computerized spreadsheet is particularly useful in this situation. When there are only one or two subsidiaries, the direct approach is by far the fastest way to arrive at the desired results.

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.

Each of the theories has been or is currently required by GAAP. The following table indicates the current status and effective usage dates for these four theories:

These four theories differ in the valuation of the NCI and how much of the subsidiary’s value pertaining to the NCI is brought onto the consolidated financial statements. The parent’s portion of the subsidiary’s value is fully represented under all theories. The NCI’s share varies under the four theories. The chart on page 152 of the text illustrates the differences between the four theories.

The proprietary theory focuses solely on the parent’s percentage interest in the subsidiary. Only the parent’s share of the fair values of the subsidiary is brought onto the consolidated balance sheet. The acquisition differential consists of the investment in subsidiary ownership percentage of the fair value excess plus the parent’s share of the goodwill. NCI is not recognized under the proprietary theory.

The parent company theory focuses on the parent company but gives some recognition to NCI. On consolidation, 100 percent of the subsidiary’s book values plus the parent’s share of the fair value excess are brought onto the consolidated balance sheet. NCI is presented as a liability.

In parent company extension theory, all of the subsidiary’s value except for the NCI’s share of goodwill is brought onto the consolidated balance sheet. NCI is based on the fair value of identifiable assets and liabilities. On consolidation, 100 percent of the subsidiary’s fair values of identifiable assets and liabilities plus the parent’s share of the subsidiary’s goodwill are brought onto the consolidated balance sheet. NCI is presented in shareholders’ equity.

The entity theory gives equal attention to the controlling and non-controlling shareholders. The acquisition differential consists of 100 percent of the fair value excess plus the implied value of total goodwill. Goodwill is the difference between the total value of the subsidiary and the amount assigned to identifiable assets and liabilities. On consolidation, 100 percent of the subsidiary’s fair values are brought on to the consolidated balance sheet. NCI is presented as a separate component in shareholders’ equity.

The terms of a business combination may require an additional cash payment, or an additional share issue contingent on some specified future event. The accounting for contingent consideration is contained in IFRS 3. Contingent consideration should be valued at fair value at the date of acquisition. The range of potential payment for contingent consideration should be disclosed. The expected value incorporates the probability of payments being made. The additional consideration compensates for the loss in value for shares originally issued as consideration for the purchase.

The contingent consideration will be classified as either a liability or equity depending on its nature. If the contingent consideration will be paid in the form of cash or another asset, it will be classified as a liability. Changes in contingent consideration classified as a liability are reported in net income. The likelihood of having to make an additional payment should be reassessed and the liability revalued, if necessary, at the end of each reporting period. If issuing additional shares will satisfy the contingent consideration, it will be classified as equity. Changes in contingent consideration classified as equity are reported as adjustments to equity. After the initial recognition, the contingent consideration classified as equity will not be re-measured.

ASPE Differences
As mentioned in Chapter 3, private companies can either consolidate their subsidiaries or report their investments in subsidiaries under the cost method or the equity method, or at fair value if they would otherwise have chosen the cost method and the equity securities of the investee are quoted in an active market.

A number of methods can be used to prepare consolidation working papers at the date of acquisition. All methods must result in identical consolidated amounts. Our approach is to prepare adjusting entries to eliminate the investment account, establish non-controlling interest, and allocate the acquisition differential to appropriate accounts. The entries are supported by the same calculations and schedules used under the direct approach. These worksheet entries establish the appropriate account balances for the consolidated balance sheet.