Consolidated Financial Statements

Question 1

How is the ending balance of NCI Equity calculated if you have the beginning balance of NCI Equity and the current year performance of S?

Answer 1

The beginning balance of NCI Equity is rolled forward by adjusting for the NCI Percentage of the following:

1. Add S’s current year net income
2. Deduct S’s current year dividends
3. Deduct current year impairment loss
4. Deduct current year depreciation or amortization of the acquisition premium

Question 2

Define “consolidated financial statement.”

Answer 2

Consolidated financial statements present the financial information of two or more separate legal entities, usually a parent company and one or more of its subsidiaries, as though they were a single economic entity.

Question 3

What is the requirement and justification for the use of consolidated financial statements?

Answer 3

Consolidated financial statements are required when one entity has effective control of another entity. Because the entities are under common control, GAAP require that consolidated financial statements be the primary form of financial reporting for the affiliated entities. In form the entities may be separate legal entities, because of the common control, in substance they are a single economic entity. The financial statements should be presented as a single economic entity.

Question 4

What are the possible accounting methods a parent can use to carry on its books an investment in a subsidiary that will be consolidated?

Answer 4

The parent can use:
* Cost Method
* Equity Method
* Any other method it chooses
Whatever method it uses, the investment account will be eliminated on the consolidated worksheet. (Only the cost and equity methods have been used on prior exams).

Question 5

What are the kinds of information needed to prepare consolidated financial statements?

Answer 5

• Financial statements/adjusted trial balances of affiliated entities
• Data as of date of acquisition, including:
  1. Book values of subsidiary’s assets and liabilities
  2. Fair values of subsidiary’s assets and liabilities
  3. Fair value of noncontrolling interest, if any
  4. Fair value of precombination equity interest, if any
• Intercompany transaction data and balances

Question 6

When a parent uses the equity method to carry on its books an investment in a subsidiary that it will consolidate, what entries does the parent make on its books related to the subsidiary?

Answer 6

Adjusts on its books the carrying value of its investment in the subsidiary to reflect:

• The parent’s share of the subsidiary’s income or loss.
• The parent’s share of dividends declared by the subsidiary.
• The amortization/depreciation of the difference between the fair market value of identifiable assets (but not goodwill) and the book value of those assets.

Question 7

What does the investment eliminating entry on the consolidating worksheet accomplish?

Answer 7

1. It eliminates the investment account (in the subsidiary) brought on to the worksheet by the parent against the shareholders equity accounts (of the subsidiary) brought on to the worksheet by the subsidiary.
2. In the process, it adjusts the subsidiary’s identifiable assets and liabilities to fair value at the date of acquisition and recognizes goodwill, if any.

Question 8

List the methods a parent may use to carry investment in subsidiary to be consolidated.

Answer 8

• Cost
• Equity
• Any other method it chooses

Question 9

Identify the general kinds of eliminating entries made in the consolidating process.

Answer 9

• Investment eliminating entry (Always)
• Intercompany receivables/payables elimination(s)
• Intercompany revenues/expenses elimination(s)
• Intercompany profit elimination(s)

Question 10

When a parent uses the cost method to carry on it s books an investment in a subsidiary that it will consolidate, what is the purpose of the reciprocity entry made on the consolidating worksheet?

Answer 10

The reciprocity entry adjusts the parent’s investment account for changes in the subsidiary’s retained earnings since the business combination up to the beginning of the period being consolidated that have not been recognized in the parent’s investment account because it is using the cost method of accounting.

Question 11

Where is the consolidating process carried out?

Answer 11

On a consolidating worksheet, not on the books of any entity.

Question 12

What is the basic sequence of steps in the consolidating process?

Answer 12

1. Record trial balances on consolidating worksheet.
2. Record adjusting entries, if any.
3. Record eliminating entries.
4. Complete consolidating worksheet.
5. Prepare consolidated financial statements.

Question 13

List some examples of intercompany amounts to be eliminated during a consolidation.

Answer 13

• Receivables/payables
• Interest
• Dividends
• Bonds

Question 14

What will be the difference(s) in the consolidated statements resulting from the parent using the cost method or the equity method to account for an investment in a subsidiary to be consolidated?

Answer 14

There will be no difference in the final consolidated statements based on which method the parent uses to account for its investment in a subsidiary. The consolidated statements will be the same regardless of which method is used; only the consolidating process will be different.

Question 15

What steps should be followed to make adjusting entries to help derive the consolidated financial statements?

Answer 15

1. Determine if any transactions are in transit between the affiliated entities.
2. Record an entry on the consolidating worksheet to treat in-transit transactions as though they were completed.

Question 16

Under U.S. GAAP, what process must be followed to determine if an entity should be consolidated?

Answer 16

First, it must be determined if the entity is a variable-interest entity (VIE).

• If it is, the reporting entity must determine if it is the primary beneficiary of the VIE and, if so, consolidate the VIE.
• If the entity is not a VIE, the reporting entity must determine if ht has controlling voting interest in the entity. If so, and nothing prevents the exercise of that control, the reporting entity (parent) must consolidate the entity (subsidiary).

Question 17

When a parent uses the cost method to carry on its books an investment in a subsidiary that it will consolidate, what entries does the parent make on its books related to the subsidiary?

Answer 17

After recording the investment in the subsidiary on its books, in normal circumstances, the parent will only recognize its share of the subsidiary’s dividends declared/paid as dividend income. It will not recognize on its books its share of the subsidiary’s reported net income/loss, nor will it adjust its investment account for the subsidiary’s income/loss or dividends.

Question 18

How does a parent company record a subsidiary?

Answer 18

As an investment.

Question 19

How is an in-transit intercompany transaction handled?

Answer 19

Make an adjusting entry on the consolidating worksheet to complete the transaction as though it had been received by the receiving company.

Question 20

What is the effect on consolidated values when the fair values of a subsidiary’s identifiable assets are less than the subsidiary’s book values for those assets at the date of a business combination?

Answer 20

On the consolidating worksheet:

• The identifiable assets are written down to fair value at the date of the business combination.
• Any depreciation/amortization expense on those assets taken by the subsidiary will be reduced on the consolidating worksheet to an amount based on the lower fair values.

Question 21

Where will a noncontrolling interest account show in consolidated financial statements?

Answer 21

On the consolidated balance sheet as a separate item within shareholders’ equity.

Question 22

How is NCI Equity calculated if you have information about S’s net book value (NBV) and the acquisition premium?

Answer 22

NCI Equity is calculated by:

1. Adding any acquisition premium (revaluations of identifiable assets including goodwill) to S’s (NBV),
2. Deducting any depreciation of amortization of the acquisition premium since the date of acquisition, and
3. Multiplying S’s adjusted NBV by the NCI percentage ownership

Question 23

What is the amount at which any noncontrolling interest is recognized in the eliminating entry at the date of business combination?

Answer 23

Fair value of noncontrolling interest percentage claim to consolidated net assets attributable to the subsidiary. This would include its claim to the subsidiary’s net assets at fair value and any goodwill recognized in the combination.

Question 24

What is the effect on an investment in subsidiary account when the parent accounts for its investment using the equity method?

Answer 24

The carrying amount of the investment would change with changes in the equity accounts of the subsidiary, including:

• Increasing with reported subsidiary profits/decreasing with reported subsidiary losses.
• Decreasing with the payment of dividends by the subsidiary.
• Decreasing for “depreciation/amortization? of the excess of fair value over book value at the date of investment.

Question 25

Where does the noncontrolling interests in a subsidiary’s income/loss and assets/liabilities get reported in consolidated financial statements?

Answer 25

• Noncontrolling interest in a subsidiary’s net income or net loss gets reported as a separate line item in the consolidated income statement.
• Noncontrolling interest in a subsidiary’s assets and liabilities gets reported as a separate line item in shareholders’ equity in the consolidated balance sheet.

Question 26

What amount of intercompany inventory sales and intercompany inventory purchases must be eliminated?

Answer 26

The full amount (100%) of intercompany inventory sales and intercompany inventory purchases must be eliminated (against each other) on the consolidating worksheet, even if the sale was at no profit to the selling affiliate.

Question 27

What determines the amount of any net gain or loss resulting from bonds becoming intercompany?

Answer 27

The sum or difference between the premium or discount on the bond investment (of the buying affiliate) and the premium or discount on the bonds payable (of the issuing affiliate).

Gain would result from eliminating:

• Premium on bond payable OR
• Discount on investment

Loss would result from eliminating:

• Discount on bond payable OR
• Premium on investment

Question 28

What is a majority-owned subsidiary that is not consolidated called and how is it accounted for?

Answer 28

A majority-owned subsidiary that is not consolidated is an unconsolidated subsidiary and would be accounted for as an investment asset by the parent, using either fair value or the equity method of accounting.

Question 29

What amount of intercompany revenues and expenses must be eliminated on the consolidating worksheet?

Answer 29

The full amount (100%) of revenues and expenses that resulted from intercompany transactions must be eliminated, even if the transaction did not result in a profit to the “selling” affiliate.

Question 30

List the main types of intercompany transactions and intercompany balances.

Answer 30

• Receivables/payables
• Revenues/expenses
• Inventory
• Fixed assets
• Bonds

Question 31

If not eliminated, what effect will the intercompany sale of a fixed asset at a loss have on the reported value of the fixed asset for consolidated statement purposes?

Answer 31

Unless the appropriate eliminating entry is made, the intercompany sale of a fixed asset at a loss will result in an understatement of the value of the fixed asset on consolidated financial statements.

Question 32

What amount of intercompany receivables and payables must be eliminated on the consolidating worksheet?

Answer 32

The full amount (100%) of receivables and payables that resulted from intercompany transactions must be eliminated on the consolidating worksheet.

Question 33

What are the differences between when a 100%-owned subsidiary sells goods for a profit to a parent and when a less-than-100%-owned subsidiary sells goods for a profit to a parent?

Answer 33

In both cases, the full amounts of the intercompany sales and purchases have to be reversed. The full amount of profit in ending inventory has to be eliminated (by reducing profit and reducing inventory carrying valued). When the subsidiary is 100% owned, the parent (and parent shareholders) absorb the entire effect of the reductions. When the subsidiary is less than 100% owned, the reductions (in profit and asset value) are allocated between the parent and noncontrolling interest based on percentage ownership…

Question 34

What are the differences between a legal merger or legal consolidation and a legal acquisition that determine whether or not consolidated statements will be required?

Answer 34

In a legal merger or legal consolidation only one entity exists after the combination; therefore, there is no need for a consolidation statement. In a legal acquisition, two separate legal entities survive, but under common control. Their financial statements must be consolidated.

Question 35

What are two objective differences between U.S. GAAP and IFRS in determining control?

Answer 35

1. Under U.S. GAAP, only outstanding voting rights are used to measure control. Under IFRS, securities currently exercisable or convertible into voting rights are used in assessing control.
2. Under U.S. GAAP, only if an entity has more than 50% voting ownership can it have control.. Under IFRS, an entity may have control even when it does not have more than 50% voting control.

Question 36

What is an intercompany inventory transaction?

Answer 36

When one affiliated entity sells goods to be resold (merchandise inventory) or used (raw materials inventory) by the buying affiliate, and intercompany inventory transaction has occurred.

Question 37

What effect does an intercompany sale of a fixed asset by a less-than-100%-owned subsidiary to a parent have on the consolidated financial statements that is different from the sale by a parent to a subsidiary or by a 100%-owned subsidiary to a parent?

Answer 37

In all cases the full amount of any intercompany gain or loss will be eliminated; however, if the sale is less-than-100%-owned subsidiary, the gain or loss (and subsequent elimination adjustments of depreciation expense) will be allocated on the worksheet between the parent and the noncontrolling interest in proportion to their ownership percentages.

Question 38

What is the entry on the consolidating worksheet to eliminate intercompany inventory profit that is in ending inventory?

Answer 38

DR: Cost of Goods Sold (or Inventory) - I/S
CR: Ending Inventory - B/S

The entry eliminates the profit brought on the worksheet by the selling affiliate and reduces the ending inventory brought on the worksheet by the buying affiliate to cost from an outsider.

Question 39

When are consolidated statements required?

Answer 39

Under two major circumstances:

1. When a firm is the primary beneficiary of a variable-interest entity (VIE), the VIE must be consolidated with the primary beneficiary.
2. When a firm has a majority owned (>50% of voting stock) subsidiary, the subsidiary must be consolidated with its parent unless the parent lacks actual effective operating or financial control.

Question 40

When do intercompany bonds exist?

Answer 40

When one affiliate owns (as an investment) the bonds issued by another affiliate (a liability).

Question 41

What is the entry to eliminate intercompany inventory sales and intercompany inventory purchases on the consolidating worksheet?

Answer 41

DR: Intercompany sales
CR: Purchase (Inventory)

The entry would be for the full amount of intercompany sales/purchases during the period.

Question 42

What eliminating entry would be required for consolidating purposes immediately following an intercompany bond purchase that involved a discount on bonds payable and a premium on bond investment?

Answer 42

DR: Bonds Payable at face amount
Loss on Constructive Retirement - sum of Premium on B/I + Discount on B/P
CR: Investment in I/C Bonds at face amt
CR: Premium on I/C Bond Investment - for full amount
CR: Discount on I/C Bonds Payable - for I/C amount

Question 43

How does the gain or loss on constructive retirement of intercompany bonds get recognized on the books of the separate affiliated companies?

Answer 43

The gain or loss on constructive retirement of intercompany bonds get recognized on the books of the separate affiliated companies through the amortization on their separate books of the premium(s) and/or discount(s) on the bond investment and/or the bonds payable.

Question 44

If not eliminated, what effect will the intercompany sale of a fixed asset at a gain have on the reported value of the fixed asset for consolidated statement purposes?

Answer 44

Unless the appropriate eliminating entry is made, the intercompany sale of a fixed asset at a gain will result in an overstatement of the value of the fixed asset on consolidated financial statements.

Question 45

What are the only types of transactions recognized for consolidation?

Answer 45

Transactions with non-affiliates