CHAPTER 4:

Consolidation of Non-Wholly
Owned Subsidiaries

Garabedian
Some slides © 2019 McGraw-Hill Education
 Non-Wholly
Owned Subsidiaries
 When the parent acquires less than 100% of the shares,
 the parent’s own A+L will be measured at carrying value
 the subsidiary’s A+L will be measured at fair value

 The shares not acquired by the parent are owned by the other
shareholders, referred to as the “non-controlling shareholders”.
The value of shares held by the non-controlling shareholders
appears on the balance sheet as “non-controlling interest” (NCI)

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 Exhibit 4.1
BALANCE SHEET
At June 29, Year 1
P Ltd. S Ltd.
Carrying
Carrying Amount Fair Value
Amount
Cash $100,000 $ 12,000 $ 12,000
Accounts receivable 90,000 7,000 7,000
Inventory 130,000 20,000 22,000
Plant 280,000 50,000 59,000
Patent 11,000 10,000
Total assets $600,000 $100,000 $110,000
Current liabilities $ 60,000 $ 8,000 $ 8,000
Long-term debt 180,000 22,000 25,000
Total liabilities 240,000 30,000 $ 33,000
Common shares 200,000 40,000
Retained earnings 160,000 30,000
Total liabilities and shareholders’ equity $600,000 $100,000

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 Non-Wholly
Owned Subsidiaries
 Three questions arise when preparing consolidated financial
statements for less-than-100% subsidiaries:
1. How should the portion of the subsidiaries net assets not acquired
by the parent be valued on the consolidated financial statements?
2. How should NCI be measured?
3. How should NCI be presented?

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 Non-Wholly
Owned Subsidiaries
 Four theories propose a solution to preparing consolidated
financial statements for non-wholly subsidiaries.
• Proportionate consolidation method
• Parent Company method
• Identifiable net asset (INA) method (also called parent company
extension theory)
• Fair value enterprise (FVE) method (also called entity theory)

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 Non-Wholly
Owned Subsidiaries
 Each of the methods has been or is currently required by GAAP
in specified situations. The following table indicates the current
status and effective usage dates for these four methods:

Method Status
Proportionate Current GAAP for consolidating certain types of joint arrangements; was an
consolidation option under GAAP prior to 2013 when consolidating joint ventures.
Parent company Was GAAP for consolidating subsidiaries prior to January 1, 2011.
INA An acceptable option after January 1, 2011.
FVE An acceptable option after January 1, 2011.

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THE ACQUISITION METHOD, continued

Assume Parent owns 80% of Subsidiary

Proprietary Parent Identifiable Fair Value

(Proportion Company Net Assets Enterprise
ate) Method Method

Subsidiary 80% FMV 100% NBV 100% FMV 100% FMV

Net Asset + 80% FVI except for including
Values GW – NCI G/W –
record only 100% GW
parent’s
80% GW
portion

NBV = net book value FMV = fair market value

FVI = fair value increment = (FMV – NBV)
 Consolidation Methods
 We will illustrate the preparation of consolidated financial
statements under these methods using the following example:
 We will examine P Ltd. And S Ltd. Both companies have a
June 30 fiscal year-end. On June 30, Year 1, S Ltd. had
10,000 shares outstanding and P Ltd. purchased 8,000 shares
(80%) of S Ltd. for a total cost of $72,000. P Ltd.’s journal
entry to record this purchase is as follows:

Dr investment in S Ltd. $72,000

Cr Cash $72,000

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Fair Value Enterprise (FVE) Method
 Views the consolidated entity as having two distinct groups
of shareholders: controlling & non-controlling shareholders.
 The trading price of the subsidiary’s shares (or shares of a
comparable company) in an active market is probably the
most accurate reflection of the value of the NCI.
 An investor typically pays a premium over the trading price
of a company’s shares when acquiring sufficient shares to
obtain control of the company.
 Discounted cash flow analysis could be used to estimate the
fair value of the subsidiary.

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Fair Value Enterprise (FVE) Method
Example 1: Fair value of NCI as evidenced by market trades.

 P Ltd. acquires 80% of S Ltd. (8,000 of S Ltd’s shares) for

$72,000 by paying $9 per share.

 S Ltd. shares are trading for $7.75 per share at

acquisition date.

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 Fair Value Enterprise (FVE) Method
Acquisition date FV is as follows:

FV of controlling interest ($9 x 8,000 shares) $72,000

FV of NCI ($7.75 x 2,000 shares) 15,500
Total FV of S Ltd. at acquisition date $87,500

The goodwill component as a % of total value for the controlling interest is

much higher than NCI when a parent pays a premium to obtain control.

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 CALCULATION OF ACQUISITION DIFFERENTIAL

Fair Value Enterprise (FVE) Method

(FVE method—Example 1)

Parent NCI Total

80% 20% 100%
Percentage of S Ltd. $ 72,000 $15,500 $87,500
Fair value at date of acquisition
Carrying amount of S Ltd.’s net assets:
Assets $100,000
Liabilities (30,000)

70,000 56,000 14,000 70,000

Acquisition differential 16,000 1,500 17,500

Fair value excess: FV − CA

Inventory 2,000

Plant 9,000
Patent (1,000)
10,000
Long-term debt −3,000
7,000 5,600 1,400 7,000
Balance—goodwill $ 10,400 $ 100 $10,500

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 Fair Value Enterprise (FVE) Method
Fair value of NCI Implied by parent’s consideration paid.

Is there a linear
relationship?

E.g. If goodwill for a

purchase of 80% of G/W
the company is
$200 goodwill for
100% of the company
is $250 ?
% of S Co purchased

Bus 420 D1 Chapter 4

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Fair Value Enterprise (FVE) Method
Example 2: Fair value of NCI Implied by parent’s
consideration paid.
 P Ltd. Acquires 80% of S Ltd. on June 30, Year 1 for $72,000
paid in cash.

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 Exhibit 4.6
Cost of 80% investment in S Ltd.
Exhibit 4.6
CALCULATION OF ACQUISITION DIFFERENTIAL
(FVE method—Example 2)

$72,000
Implied value of 100% investment in S Ltd. ($72,000 ÷ 80%) $90,000
Carrying amount of S Ltd.’s net assets:

Assets $100,000

Liabilities (30,000)

70,000

Implied acquisition differential 20,000

Allocated: (FV − CA) × 100%
Inventory + 2,000 (a)
Plant + 9,000 (b)
Patent − 1,000 (c)
10,000 (d)
Long-term debt −3,000 7,000 (e)
Balance—goodwill $13,000

Calculation of NCI

Implied value of 100% investment in S Ltd. $90,000

NCI ownership 20%

$18,000 (f)

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 Exhibit 4.7
Exhibit 4.7
(FVE method)
P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1

Cash (100,000 − 72,000* + 12,000) $ 40,000

Accounts receivable (90,000 + 7,000) 97,000

Inventory (130,000 + 20,000 + [6a] 2,000) 152,000

Plant (280,000 + 50,000 + [6b] 9,000) 339,000

Patent (0 + 11,000 − [6c] 1,000) 10,000

Goodwill (0 + 0 + [6e] 13,000) 13,000

$651,000
*Cash paid by P Ltd. to acquire S Ltd.

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 Exhibit 4.7 continued
Exhibit 4.7
(FVE method)
P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1

Current liabilities (60,000 + 8,000) $ 68,000

Long-term debt (180,000 + 22,000 + [6d] 3,000) 205,000

Total liabilities 273,000

Shareholders’ equity:

Controlling interest:

Common shares 200,000

Retained earnings 160,000

360,000

Non-controlling interest [6f] 18,000 378,000

$651,000
*Cash paid by P Ltd. to acquire S Ltd.

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Fair Value Enterprise (FVE) Method
 The implied value assumes that the parent’s acquisition cost
can be extrapolated linearly to determine the total value of the
subsidiary.

 NCI could be valued using business valuation techniques, but

this is a costly exercise.

 In this text, we will assume a linear relationship to calculate

the value of NCI except when we are given the market price of
the subsidiary’s shares help by the non-controlling
shareholders.
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 Identifiable Net Assets Method

 Addresses concern about goodwill valuation under the fair

value enterprise method.
 Reflects both parent’s and non-controlling interest’s share of
identifiable net assets at full fair values.
 Only parent’s share of subsidiary’s goodwill is reflected
on consolidated balance sheet.

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 Identifiable Net Assets Method
 NCI is calculated as follows:
Carrying amount of S Ltd’s net assets:
Assets $100,000
Liabilities (30,000)
70,000
Excess of fair value over carrying amount
for identifiable net assets (Exhibit 4.5) 7,000
Fair value of identifiable net assets 77,000
Non-controlling ownership % 20%
Non-controlling interest $15,400

 NCI is based on the fair value of identifiable assets and

liabilities.
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 Summary
GW NCI
FVE (Exhibit 4.7) 13,000 18,000
Less 20% GW (2,600) (2,600)
INA (slide 20) 10,400 15,400

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In-Class Problem
Problem 4-1

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 Bargain Purchases
 When the total consideration (purchase price) < fair value of
identifiable net assets => Negative goodwill
 Often described as a bargain purchase, this can occur when share
prices are depressed or subsidiary has had recent operating losses.

 IFRS 3 requires that negative goodwill be reduced to zero by

first reducing any goodwill on the subsidiary’s books, then
recognizing any remaining negative goodwill as a gain.

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 Bargain Purchases

Illustration - Negative Goodwill:

 On June 30, year 1 P Ltd. Purchased 100% of the
shares of S Ltd. For $72,000 cash. The carrying amount of
S’s identifiable net assets is $70,000 and the acquisition
differential is $2,000 on that date.
 $7,000 of the $2,000 acquisition differential is allocated to
the net assets of S, leaving $5,000 negative goodwill.

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 Exhibit 4.9
CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL
(Negative goodwill, wholly owned subsidiary)
Cost of investment in S Ltd. $ 72,000

Carrying amount of S Ltd.’s net assets:

Assets 100,000

Liabilities (30,000) 70,000

Acquisition differential 2,000

Allocated: (FV − CA)

Inventory + 2,000

Plant + 9,000

Patent − 1,000

10,000

Long-term debt − 3,000 7,000

Balance—“negative goodwill” (gain on bargain purchase) $ (5,000)

The negative goodwill is recognized as a gain on bargain purchase

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In-Class Problem
Problem 4-6

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 Subsidiary with Goodwill
 Any goodwill on the balance sheet of subsidiary on
acquisition date is not carried forward to the consolidated balance
sheet.
 The parent’s acquisition differential is calculated as
if the goodwill has been written off by the subsidiary and replaced
instead by the updated fair values and goodwill of the entity the
subsidiary previously acquired.

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 Subsidiary with Goodwill
Example:
 On June 30, Year 1 P Ltd. purchased 80% of the shares of S Ltd.
For $62,000 cash. The fair value of S’s
identifiable net assets – which includes goodwill is $67,000 on
that date.

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 Exhibit
Exhibit 4.12
4.12
BALANCE SHEET
At June 29, Year 1
P Ltd. S Ltd.
Fair
Carrying Amount Carrying Amount
Value
Cash $100,000 $ 12,000 $12,000

Accounts receivable 90,000 7,000 7,000

Inventory 130,000 20,000 22,000

Plant 280,000 50,000 59,000

Goodwill 11,000

$600,000 $100,000

Current liabilities $ 60,000 $ 8,000 8,000

Long-term debt 180,000 22,000 25,000

Common shares 200,000 40,000

Retained earnings 160,000 30,000

$600,000 $100,000
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 Exhibit 4.13
Exhibit 4.
CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL
(Subsidiary with goodwill)

Cost of 80% investment in S Ltd. $62,000

Implied value of 100% investment in S
(62,000/0.80) $77,500
Ltd.
Carrying amount of net assets of S Ltd.
Assets $ 100,000
Liabilities (30,000)
70,000
Deduct old goodwill of S Ltd. 11,000 (a)

Adjusted net assets 59,000

Acquisition differential 18,500
Allocated: (FV − CA)
Inventory +$2,000 (b)

Plant +9,000 (c)

11,000

Long-term debt −3,000 8,000 (d)

Balance—goodwill $10,500 (e)30
 ExhibitExhibit 4.
4.13 continued
Calculation of NCI
Implied value of 100% investment in S Ltd. $77,500
NCI ownership 20%
$15,500 (f)

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 Exhibit 4.14
(Subsidiary with goodwill)
P LTD.
CONSOLIDATED BALANCE SHEET
At June 30, Year 1

Cash (100,000 − 62,000* + 12,000) $ 50,000

Accounts receivable (90,000 + 7,000) 97,000

Inventory (130,000 + 20,000 + [b] 2,000) 152,000

Plant (280,000 + 50,000 + [13c] 9,000) 339,000

Goodwill (0 + 11,000 − [a] 11,000 + [e] 10,500) 10,500

$648,500

Current liabilities (60,000 + 8,000) $ 68,000

Long-term debt (180,000 + 22,000 + [d] 3,000) 205,000

Common shares 200,000

Retained earnings 160,000

Non-controlling interest [f] 15,500

$648,500
*Cash paid by P Ltd. to acquire S Ltd.
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 Contingent Consideration

 What happens when a portion of the total cost of the

acquisition is variable depending on future events, so the
eventual total cost is not known with certainty at the date of
acquisition of the subsidiary?

 IFRS 3 requires the contingent consideration to be

recorded at fair value at the acquisition date as part
of the acquisition cost, using assumptions, probabilities, and
other valuation techniques which can be subjective and
require significant amount of judgment.

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 Contingent Consideration
Classify contingent consideration as either liability or equity:
 If payable in cash or another asset, record as liability.
Revalue liability after acquisition date as circumstances change.
 Record revaluation adjustment in earnings if revaluation arose as
a result of events occurring after acquisition; or
 Adjust the purchase price if revaluation arose as a result of new
information about facts and circumstances that exists as at the date
of acquisition.
 If payable in additional shares of the parent, record as equity.
Do not revalue contingent consideration classified as equity.

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 Contingent Consideration

 Disclosure Requirements:
 IFRS 3, paragraph B64, requires that a reporting entity disclose
the following for each business combination in which the acquirer
holds less than 100% of the equity interests in the acquiree at the
acquisition date:
a) The amount of the NCI in the acquiree recognized at the acquisition
date and the measurement basis for that amount.
b) For each NCI in an acquiree measured at fair value, the valuation
techniques and key model inputs used for determining that value.

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 Analysis and Interpretation
of Financial Statements
 The value of NCI is significantly different under the FVE &
INA methods.

 The classification of non-controlling interest has a big

impact on the debt-to-equity ratio.

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 In-Class Problem
Problem 4-4
HINT :

Cost of investment $328,000

($288,000 + $40,000 for contingent consideration)

GW= $ 78,500

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