US: Consolidation Techniques and Procedures

Consolidation Techniques and Procedures

1. If a parent in accounting for its subsidiary amortizes patents on its separate books, why do we include an adjustment for patents amortization in the consolidation workpaper?

Under the equity method, a parent amortizes patents from its subsidiary investments by adjusting its subsidiary investment and income accounts. Since patents and patent amortization accounts are not recorded on the parent’s books, they are created for consolidated statement purposes through workpaper entries.

2. How is noncontrolling interest share entered in consolidation workpapers?

Noncontrolling interest share is entered in the consolidation workpapers by preparing a workpaper adjusting entry in which noncontrolling interest share is debited and noncontrolling interest is credited. The noncontrolling interest share (debit) is carried to the consolidated income statement as a deduction, and the credit to noncontrolling interest for noncontrolling interest share is added to the beginning noncontrolling interest. The noncontrolling interest share is calculated based on the subsidiary’s reported net income adjusted to reflect fair value through the amortization of the excess of fair value over book value. This is the approach illustrated throughout this text.

3. How are the workpaper procedures for the investment in subsidiary, income from subsidiary, and subsidiary’s stockholders’ equity accounts alike?

Workpaper procedures for the investment in subsidiary, income from subsidiary, and subsidiary equity accounts are alike in regard to the objectives of consolidation. Regardless of the configuration of the workpaper entries, the final result of adjustments for these items is to eliminate them through workpaper entries. In other words, the investment in subsidiary, income from subsidiary, and the capital stock, additional paid-in capital, retained earnings, and other stockholders’ equity accounts of the subsidiary never appear in consolidated financial statements.

4. If a parent uses the equity method but does not amortize the difference between fair value and book value on its separate books, its net income and retained earnings will not equal its share of consolidated net income and consolidated retained earnings. How does this affect consolidation workpaper procedures?

When the parent does not amortize fair value/book value differentials on its separate books, the parent’s income from subsidiary and investment in subsidiary accounts are overstated in the year of acquisition. In subsequent years, the income from the subsidiary, investment in subsidiary, and parent’s beginning retained earnings will be overstated. The error may be corrected in the workpapers with the following entries:

5. Are workpaper adjustments and eliminations entered on the parent’s books? The subsidiary’s books? Explain.

Workpaper adjustments are not normally entered in the general ledger of the parent or any other entity. They are used in the preparation of consolidated financial statements for a conceptual entity for which there are no formal accounting records. An exception occurs when the adjusting entries involve the correction of an error. For example, if a parent does not record a dividend from a subsidiary. Then the workpaper entry is recorded in the parent’s separate books.

6. The financial statement and trial balance workpaper approaches illustrated in the chapter generate comparable information, so why learn both approaches?

Workpapers are tools of the accountant that facilitate the consolidation of parent and subsidiary financial statements. Given the tools available, the accountant should select those that are most convenient in the circumstances. If financial statements are to be consolidated, the financial statement approach is the appropriate tool. The trial balance approach is most convenient when the data are presented in the form of a trial balance. The accountant needs to be familiar with both approaches to perform the work as efficiently as possible.

7. In what way do the adjustment and elimination entries for consolidation workpapers differ for the financial statement and trial balance approaches?

Workpaper adjustment and elimination entries as illustrated in this text are exactly the same when the trial balance approach is used as when the financial statement approach is used.

8. When is it necessary to adjust the parent’s retained earnings account in the preparation of consolidation workpapers? In answering this question, explain the relationship between parent retained earnings and consolidated retained earnings.

The retained earnings of the parent will equal consolidated retained earnings if the equity method of accounting has been correctly applied. In consolidating the financial statements of affiliated companies, the beginning retained earnings of the parent are used as beginning consolidated retained earnings. If the equity method has not been correctly applied, parent beginning retained earnings will not equal beginning consolidated retained earnings. In this case, retained earnings of the parent are adjusted to a correct equity basis in order to establish the correct amount of beginning consolidated retained earnings. Thus, workpaper adjustments to beginning retained earnings of the parent are needed whenever the beginning retained earnings of the parent do not correctly reflect the equity method.

9. What approach would you use to check the accuracy of the consolidated retained earnings and noncontrolling interest amounts that appear in the balance sheet section of completed consolidation workpapers?

The noncontroling interest that appears in the consolidated balance sheet can be checked by first adjusting the equity of the subsidiary on the consolidated balance sheet date to fair value (i.e., adjusting for any unamortized excess of fair value over book value) and then multiplying by the noncontrolling interest percentage. Consolidated retained earnings at a balance sheet date can be checked by comparing the amount with the parent’s retained earnings on the same date. If consolidated retained earnings and parent retained earnings are not equal, either consolidated retained earnings have been computed incorrectly, or parent retained earnings do not reflect a correct equity method of accounting.

10. Explain why noncontrolling interest share is added to the controlling share of consolidated net income in determining cash flows from operating activities.

Consolidated assets and liabilities are reported for all equity holders—noncontrolling as well as controlling. Therefore, the change in net cash from operations for a period results from noncontrolling interest share and controlling interest share.

11. Controlling share of consolidated net income is a measurement of income to the stockholders of the parent, but does a change in cash as reflected in a statement of cash flows also relate to other stockholders of the parent?

No. It relates to all interests in the consolidated entity. This difference is one of many inconsistencies in the concepts underlying consolidated financial statements. Consider, for example, the error that could result from dividing cash provided by operations by outstanding parent shares to compute cash flow per share.