CHAPTER TEN : ADDITIONAL CONSOLIDATION

REPORTING ISSUES

This chapter discusses the following general financial reporting topics as they
relate to consolidated financial statements:

1. the consolidated statement of cash flow

2. consolidation following an interim acquisition
3. consolidation income tax issues
4. consolidated earnings per share

1. CONSOLIDATED STATEMENT OF CASH FLOW

A consolidated statement of cash flows is similar to a statement of cash flows
prepared for a single-corporate entity and is prepared in basically the same manner.

Preparation of a consolidated cash flow statement

A consolidated statement of cash flows is typically prepared after the consolidated
income statement, retained earnings statement, and statement of financial position.
The consolidated cash flow statement is prepared from the information in the three
statements. When an indirect approach is used in preparing the statement, with
consolidated net income as the starting point, consolidated net income must be
adjusted for all items that affect consolidated net income and the cash of the
consolidated entity differently.

Income assigned to the noncontrolling interest is added back to consolidated net

income in the consolidated statement of cash flows to derive the cash flow from
operating activities. Receipts from and payments to noncontrolling shareholders
usually are included in the consolidated cash flow statement as cash flows related
to financing activities.

Consolidated Cash Flow Statement-Direct Method

Although nearly all major companies use the indirect method of presenting a cash
flow statement, authoritative bodies have generally expressed a preference for the
direct method even though they have not required its use.
2. CONSOLIDATION FOLLOWING AN INTERIM ACQUISITION
When one company purchases another company’s share-capital ordinary, the
subsidiary is viewed as being part of the consolidated entity only from the time the
stock is acquired. Consequently, when a subsidiary is acquired during a fiscal period
rather than at the beginning or end, the results of the subsidiary’s operations are
included in the consolidated statement only for the portion of the year that the stock
is owned by the parent. The subsidiary’s revenues, expenses, gains and losses for
the portion of the fiscal period prior to the time at which the parent acquired its
controlling financial interest in the subsidiary must be excluded from the
consolidated financial statement.

3. CONSOLIDATION INCOME TAX ISSUES

A parent company and its subsidiaries must file separate returns. They are not
allowed to file a consolidated income tax return.

The profit from an intercompany sale is taxed when the intercompany transfer
occurs, without waiting for confirmation through sale to a nonaffiliated. For
consolidated financial reporting purposes, however, unrealized intercompany
profits must be eliminated. While the separate company may pay income taxes on
the unrealized intercompany profit, the tax expense must be eliminated when the
unrealized intercompany profit is eliminated in the preparation of consolidated
financial statement. The difference in the timing of the income tax expense
recognition on results in the recording of deferred income taxes.

4. CONSOLIDATED EARNINGS PER SHARE

Consolidated earnings per shared is calculated largely in the same way as
for a single company. The numerator of the basic EPS computation is based on
earnings available to the holders of the parent’s share-capital ordinary, and the
denominator is the weighted-average number of the parent’s common shares
outstanding during the period. Diluted consolidated EPS assumes both the parent’s
and subsidiary’s dilutive securities are converted, and special adjustments to
consolidated net income may be needed to reflect the effect of the assumed
conversion on the amount of subsidiary income to include in the EPS numerator.
CONCLUSION
in addition to an income statement, statement of financial position, and statement
of retained earnings, a full set of consolidated financial statement must include a
consolidated statement of cash flows. The consolidated statement of cash flows is
prepared from the other three consolidated statements in the same way as the
statement of cash flows is prepared for a single company. However, certain
additional adjustments are needed. For example, income assigned to the
noncontrolling interest reduces consolidated net income but does not use cash; it
therefore must be added back to net income in deriving cash generated from
operating activities. Also dividends to noncontrolling shareholders must be
included as a financing use of cash because they do require the use of cash even
thogh they are not viewed as dividends of the consolidated entity.

When a subsidiary is purchased at an interim date during the year, the consolidation
procedures must ensure that the subsidiary’s operating results are included in the
consolidated financial statements for only that portion of the year during which the
parent held a controlling financial interest in the subsidiary. All of subsidiary’s
revenues, expenses, gains and losses for the portion of the year prior to the
subsidiary’s entry in to the consolidated entity must be excluded, along with its
dividends declared before acquisition.

Financial reporting issues related to income taxes arise in consolidation involves

the income tax effect of intercorporate transactions. Income tax expense is
recognized in the consolidated income statement when the associated transaction is
recognized by the consolidated entity, not necessarily when it is reported by an
individual company. If an intercompany gain or loss is included in an individual
company’s tax return in a different period from the one in which it is included in
the consolidated income statement, deffered income taxes should be recognized on
the temporary difference.
Consolidated earnings per share is calculated largely in the same way as for a single
company. The numerator of the basic EPS computation is based on earnings
available to the holders of the parent’s share-capital ordinary, and the denominator
is the weighted-average number of the parent’s common shares outstanding during
the period. Diluted consolidated EPS assumes both the parent’s and subsidiary’s
dilutive securities are converted, and special adjustments to consolidated net
income may be needed to reflect the effect of the assumed conversion on the amount
of subsidiary income to include in the EPS numerator.
KEY TERMS
Consolidated earnings per shared deffered income taxes
Consolidated income tax return statement of cash flows
Preacquisition subsidiary income temporary differences