Accounting 401Consolidation 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 Concepta. Consolidation is based on parent’s interest in the fair market value of

subsidiary’s net assets on the date of the purchase combination.b. The parent’s long-term investment account is assumed to include a

proportionate share of the fair market value of subsidiary’s net assets.c. Minority interest in subsidiary net assets is calculated using the book value of

subsidiary’s 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 subsidiary’s net identifiable assets at fair market value on the date of the purchase combination.

e. Consolidated working paper entries include an adjustment to subsidiary’s net assets at book value of parent’s share of the difference between fair market value and book value.

2. Entity (Economic Unit Concept)/Full Goodwill Methoda. Consolidation is based on the fair market value of subsidiary’s 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 subsidiary’s equity. Minority interest is reported as part of consolidated stockholders’ equity.

e. In consolidated working papers, subsidiary’s net assets at book value are adjusted to their full fair market value without considering the parent’s percentage interest in the subsidiary.

3. Entity (Economic Unit Concept)/Purchased Goodwill Methoda. Consolidation is based on the fair market value of subsidiary’s 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 parent’s share of the subsidiary’s net identifiable assets at fair market value.

d. Minority interest reflects the minority share of subsidiary’s 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, subsidiary’s net assets at book value are adjusted to their full fair market value without considering the parent’s percentage interest in the subsidiary.

4. Proportionate Consolidation (Often referred to as the Pro Rata Method)a. Consolidation is based on the parent’s interest in the fair market value of

subsidiary’s 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.

Illustration:

Given information:Parent acquired an 80% interest in a subsidiary.Cost of parent’s investment in the sub is $1,600. Book value of subsidiary’s net assets on the date of the combination is $900, consisting of the following:

Assets $1,500Liabilities 600

Fair market value of subsidiary’s net assets on the date of the combination is $1,500, consisting of the following:

Assets $2,100Liabilities 600

Separate financial information on the date of the combination, follows:

Parent SubsidiaryAssets $1,400 $1,500Investment in Subsidiary 1,600 -Goodwill - -___Total assets $3,000 $1,500

Liabilities $ 900 $ 600Minority interest - -Stockholders’ equity 2,100 900Total $3,000 $1,500

Let’s complete consolidated working papers assuming each one of the following consolidation theories:

1. Parent company theory2. Economic unit concept/full goodwill3. Economic unit concept/purchased goodwill4. Pro rata method

As an additional requirement, let’s 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 900Assets – Subsidiary 480Goodwill 400 Investment in Subsidiary 1,600 Minority interest 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 900Assets – Subsidiary 600Goodwill 500 Investment in Subsidiary 1,600 Minority interest 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 valueFull entity value – Fair market value of all net assets = GoodwillGoodwill = $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 900Assets – Subsidiary 600Goodwill 400 Investment in Subsidiary 1,600 Minority interest 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 Subsidiary’s net assets) = (.20) (1,500) = 300

4. Consolidated working papers – Pro rata method

Stockholders’ equity – Subsidiary 900Assets – Subsidiary 180Liabilities – Subsidiary 120Goodwill 400 Investment in Subsidiary 1,600

Adjustment to Assets – Subsidiary calculated as follows;

(Fair market value of assets) (.80) – Book value of assets = 1,680 – 1,500 = 180Adjustment 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 subsidiary’s stockholders’ equity and therefore, will be eliminated in consolidation.

Consolidated working paper entry:

Stockholders’ equity – Subsidiary 900Push-Down Capital 880 Investment in Subsidiary 1,600 Minority interest 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.