Accounting 401 Consolidation Theories The first of the consolidation theories to be discussed below is the one we have been

using for this semester. It is also the theory that is being applied by companies on a day-to-day basis. The other theories are interesting, but to date none of these other theories has replaced the Parent Company Concept. The FASB is looking into the issue of whether or not one particular theory should be applied by all companies, and, if so, what theory that should be. 1. Parent Company Concept a. Consolidation is based on parents interest in the fair market value of subsidiarys net assets on the date of the purchase combination. b. The parents long-term investment account is assumed to include a proportionate share of the fair market value of subsidiarys net assets. c. Minority interest in subsidiary net assets is calculated using the book value of subsidiarys net assets and is reported as a non-current liability on the consolidated balance sheet. d. Goodwill is calculated as the difference between the investment cost and proportionate share of subsidiarys net identifiable assets at fair market value on the date of the purchase combination. e. Consolidated working paper entries include an adjustment to subsidiarys net assets at book value of parents share of the difference between fair market value and book value. Entity (Economic Unit Concept)/Full Goodwill Method a. Consolidation is based on the fair market value of subsidiarys net assets on the date of the purchase combination. b. Emphasizes control of the entire consolidated enterprise. Thus, consolidated financial statements are intended to provide information about the parent company and its subsidiaries as if they were a single entity. c. Goodwill is calculated using an implied entity approach. Goodwill is derived from the total fair value of the subsidiary inferred from the price paid by the parent for its fractional interest in the subsidiary. d. Minority interest in subsidiary net assets reflects the minority share of the total fair value of subsidiarys equity. Minority interest is reported as part of consolidated stockholders equity. e. In consolidated working papers, subsidiarys net assets at book value are adjusted to their full fair market value without considering the parents percentage interest in the subsidiary.

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Entity (Economic Unit Concept)/Purchased Goodwill Method a. Consolidation is based on the fair market value of subsidiarys net assets on the date of the purchase business combination. b. Emphasizes control of the entire consolidated enterprise. c. Goodwill is calculated in the same way as the parent company concept. That is, goodwill is the difference between the investment cost and the parents share of the subsidiarys net identifiable assets at fair market value. d. Minority interest reflects the minority share of subsidiarys net identifiable assets at fair market value. This represents a major difference from the parent company concept. Minority interest is reported as either a non-current liability or is shown between non-current liabilities and stockholders equity. The latter is often the case for the reporting of minority interest no matter which of the theories is followed. e. In consolidated working papers, subsidiarys net assets at book value are adjusted to their full fair market value without considering the parents percentage interest in the subsidiary. Proportionate Consolidation (Often referred to as the Pro Rata Method) a. Consolidation is based on the parents interest in the fair market value of subsidiarys net assets on the date of the purchase business combination. b. Minority interest in subsidiary net assets is not reported on the consolidated balance sheet. c. Goodwill is determined in the same was as shown under parent company theory. d. In consolidated working papers, combine the financial information of the parent with certain proportionate consolidation elimination entries, or use a process that is similar to what is used for the other theories.

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Illustration: Given information: Parent acquired an 80% interest in a subsidiary. Cost of parents investment in the sub is $1,600. Book value of subsidiarys net assets on the date of the combination is $900, consisting of the following: Assets $1,500 Liabilities 600 Fair market value of subsidiarys net assets on the date of the combination is $1,500, consisting of the following: Assets $2,100 Liabilities 600 Separate financial information on the date of the combination, follows: Assets Investment in Subsidiary Goodwill Total assets Liabilities Minority interest Stockholders equity Total Parent $1,400 1,600 $3,000 $ 900 2,100 $3,000 Subsidiary $1,500 -___ $1,500 $ 600 900 $1,500

Lets complete consolidated working papers assuming each one of the following consolidation theories: 1. Parent company theory 2. Economic unit concept/full goodwill 3. Economic unit concept/purchased goodwill 4. Pro rata method As an additional requirement, lets consider how the push-down concept might work for the above data. 1. Consolidated working papers Parent company theory Consolidated working paper entry: Stockholders equity Subsidiary Assets Subsidiary Goodwill Investment in Subsidiary Minority interest 900 480 400 1,600 180

Adjustment to Assets Subsidiary determined as follows: (Assets at fair value Assets at book value) x .80 = (2,100 1,500) x .80 = 480 Goodwill = Cost (.80) (Fair value of net assets) = $1,600 (.80) (1,500) = $400 2. Consolidated working papers Economic unit concept/full goodwill Consolidated working paper entry: Stockholders equity Subsidiary Assets Subsidiary Goodwill Investment in Subsidiary Minority interest 900 600 500 1,600 400

Adjustment to Assets Subsidiary is made for the full difference. Goodwill is implied goodwill which is determined as follows: Investment cost/.80 = $1,600/.80 = $2,000 This is referred to as the full entity value Full entity value Fair market value of all net assets = Goodwill Goodwill = $2,000 -1,500 = $500 Minority interest = $2,000 x .20 = $400 3. Consolidated working papers Economic unit concept/purchased goodwill Consolidated working paper entry: Stockholders equity Subsidiary Assets Subsidiary Goodwill Investment in Subsidiary Minority interest 900 600 400 1,600 300

Adjustment to Assets Subsidiary is for the full difference. Goodwill is calculated just as it was for the Parent company theory. Minority interest = (.20) (Fair market value of Subsidiarys net assets) = (.20) (1,500) = 300 4. Consolidated working papers Pro rata method Stockholders equity Subsidiary Assets Subsidiary Liabilities Subsidiary Goodwill Investment in Subsidiary 900 180 120 400 1,600

Adjustment to Assets Subsidiary calculated as follows;

(Fair market value of assets) (.80) Book value of assets = 1,680 1,500 = 180 Adjustment to liabilities = (600) (.80) 600 = (120) Goodwill is calculated just as it was for the parent company theory. Note that no minority interest is reported under this theory. Push-down theory: The subsidiary would make the following entry on their books: Assets 480 Goodwill 400 Push-Down Capital 880 The Push-Down Capital account becomes part of the subsidiarys stockholders equity and therefore, will be eliminated in consolidation. Consolidated working paper entry: Stockholders equity Subsidiary Push-Down Capital Investment in Subsidiary Minority interest 900 880 1,600 180

Note that both the asset adjustment and goodwill are booked by the subsidiary. This means that we do not have to do those things in the consolidated working papers.