Chapter

4
Consolidation of Non-Wholly Owned Subsidiaries

LEARNING OBJECTIVES
After studying this chapter, you should be able to do the following:
1. Define non-controlling interest and explain how it is measured on the consolidated balance sheet.
2. Prepare a consolidated balance sheet using the entity theory.
3. Prepare a consolidated balance sheet using the parent company extension theory.
4. Explain the concept of negative goodwill and describe how it should be treated when it arises in a
business combination.
5. Account for contingent consideration based on its classification as a liability or equity.
6. Analyze and interpret financial statements involving consolidation of non-wholly owned
subsidiaries.
7. Prepare a consolidated balance sheet using the working paper approach.

WHAT YOU REALLY NEED TO KNOW

Consolidated financial statements present the financial position and operating results of a group of
companies under common control as if they constitute a single entity. When one company gains control over
another company, it becomes a parent company and GAAP requires it to present consolidated statements
for external reporting purposes. The preparation involves eliminating the parents investment account and
the parents share of the subsidiarys shareholders equity accounts, revaluing the net assets of the
subsidiary to fair value, and establishing the non-controlling interest (NCI) in the fair value of the
subsidiarys net assets. Either the entity method or the parent company extension method must be used
when consolidating nonwholly owned subsidiaries.
When the purchase price is less than the fair value of identifiable net assets, the negative goodwill is used to
eliminate any goodwill reported on the subsidiaries separate-entity financial statements. Any remaining
negative goodwill is reported as a gain on purchase by the acquirer on the consolidated income statement.
A working paper can be used to prepare the consolidated statements, and is necessary if there are a large
number of subsidiaries to consolidate. A computerized spreadsheet is particularly useful in this situation.
When there are only one or two subsidiaries, the direct approach is by far the fastest way to arrive at the
desired results.
The following theories have developed over time and have been proposed as solutions to preparing
consolidated financial statements for nonwholly owned subsidiaries:
Proprietary theory.
Parent company theory.
Parent company extension theory.
Entity theory.

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Each of the theories has been or is currently required by GAAP. The following table indicates the current
status and effective usage dates for these four theories:
Method
Proprietary theory
Parent company theory
Parent company extension
theory
Entity theory

Status
Present GAAP for consolidating certain types of joint
arrangements; was an option under GAAP prior to 2013
when consolidating joint ventures.
Was GAAP for consolidating subsidiaries prior to January 1,
2011.
An acceptable method for consolidating subsidiaries after
January 1, 2011.
An acceptable method for consolidating subsidiaries after
January 1, 2011.

These four theories differ in the valuation of the NCI and how much of the subsidiarys value pertaining to
the NCI is brought onto the consolidated financial statements. The parents portion of the subsidiarys value
is fully represented under all theories. The NCIs share varies under the four theories. The chart in Exhibit
4.2 of the text illustrates the differences between the four theories.
The proprietary theory focuses solely on the parents percentage interest in the subsidiary. Only the
parents share of the fair values of the subsidiary is brought onto the consolidated balance sheet. The
acquisition differential consists of the investment in subsidiary ownership percentage of the fair value
excess plus the parents share of the goodwill. NCI is not recognized under the proprietary theory.
The parent company theory focuses on the parent company but gives some recognition to NCI. On
consolidation, 100% of the subsidiarys book values plus the parents share of the fair value excess are
brought onto the consolidated balance sheet. NCI is presented as a liability.
In parent company extension theory, all of the subsidiarys value except for the NCIs share of goodwill
is brought onto the consolidated balance sheet. NCI is based on the fair value of identifiable assets and
liabilities. On consolidation, 100% of the subsidiarys fair values of identifiable assets and liabilities plus
the parents share of the subsidiarys goodwill are brought onto the consolidated balance sheet. NCI is
presented in shareholders equity. This is sometimes referred to as the net identifiable assets method, or the
partial goodwill method.
The entity theory gives equal attention to the controlling and non-controlling shareholders. The acquisition
differential consists of 100% of the fair value excess plus the implied value of total goodwill. Goodwill is
the difference between the total value of the subsidiary and the amount assigned to identifiable assets and
liabilities. On consolidation, 100% of the subsidiarys fair values are brought on to the consolidated
balance sheet. NCI is presented as a separate component in shareholders equity. This is sometimes referred
to as the fair value of the subsidiary method, or the full goodwill method.
When the total consideration given is less than the fair value of the subsidiarys identifiable net assets, a
gain on bargain purchase is reported on the consolidated income statement. To record a gain on a purchase
of any asset may seem very strange. It goes against the long-standing tradition of recording assets at cost
and recording gains only when realized. However, it is consistent with the general trend in financial
reporting to use fair value more and more often to report assets and liabilities. The gain is recorded on the
consolidated income statement and ends up in consolidated retained earnings at the date of acquisition.
However, IFRS 3 states that a gain on a bargain purchase can only be recognized by the acquirer. Any
difference between the value assigned to the non-controlling interest and the non-controlling interests share
of the fair value of the subsidiarys identifiable net assets is attributed to the parent and is included in the
overall gain on bargain purchase at the date of acquisition.

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2016 McGraw-Hill Education. All rights reserved.

When a subsidiary has goodwill on its separate-entity balance sheet, this goodwill is eliminated on
consolidation and replaced by the goodwill inherent in the parents purchase of the subsidiary.
The terms of a business combination may require an additional cash payment, or an additional share issue
contingent on some specified future event. The accounting for contingent consideration is contained in
IFRS 3. Contingent consideration should be valued at fair value at the date of acquisition. The range of
potential payment for contingent consideration should be disclosed. The expected value incorporates the
probability of payments being made. The additional consideration compensates for the loss in value for
shares originally issued as consideration for the purchase.
The contingent consideration will be classified as either a liability or equity depending on its nature. If the
contingent consideration will be paid in the form of cash or another asset, it will be classified as a liability.
Changes in contingent consideration classified as a liability are reported in net income. The likelihood of
having to make an additional payment should be reassessed and the liability revalued, if necessary, at the
end of each reporting period. If issuing additional shares will satisfy the contingent consideration, it will be
classified as equity. Changes in contingent consideration classified as equity are reported as adjustments to
equity. After the initial recognition, the contingent consideration classified as equity will not be remeasured.
ASPE Differences
As mentioned in Chapter 3, private companies can either consolidate their subsidiaries or report their
investments in subsidiaries under the cost method or the equity method, or at fair value if they would
otherwise have chosen the cost method and the equity securities of the investee are quoted in an active
market.
Appendix 4A: Working Paper Approach for Consolidation of Non-Wholly Owned Subsidiaries
A number of methods can be used to prepare consolidation working papers at the date of acquisition. All
methods must result in identical consolidated amounts. Our approach is to prepare adjusting entries to
eliminate the investment account, establish non-controlling interest, and allocate the acquisition differential
to appropriate accounts. The entries are supported by the same calculations and schedules used under the
direct approach. These worksheet entries establish the appropriate account balances for the consolidated
balance sheet.

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2016 McGraw-Hill Education. All rights reserved.