 Hello, and welcome to the session in which you would look at consolidated financial statement. And at this point, we're going to go ahead and prepare the consolidated financial statement. We've been looking at journal entries, eliminating journal entries. Now we're going to look at the full picture. So I'm going to break the session into basically two parts. The first part, we're going to look at completed consolidated financial statements. I'm going to show you what it looks like, the ideas behind them. Then we will work a simulation that's going to show us how we end up preparing those consolidated financial statements. So let's go ahead and get started. But before we do so, I would also like to remind you, this lecture is designed for CPA candidate. This lecture is designed for CPA candidate. If you want more advanced explanation about this topic, go to farhatlectures.com and subscribe to my advanced accounting course. As a matter of fact, if you are a subscriber, you have access to my advanced accounting. So this is a summary, a review. But if you want more, again, I will be inviting you throughout this session. Every time I say if you want more about this, go to my advanced accounting. And the reason I say this because advanced accounting students, they learn a little bit more in the college course versus CPA candidate who are preparing for the exam. Let's go ahead and get started. When two corporations having a parent-sub relationship, they continue to exist as separate legal entities. What does that mean? We have the parent that keep their books separately and we have the sub, two totally independent companies. And only the parent or the acquirer prepare a consolidated financial statement. Then at some point, they're going to have to prepare consolidated financial statement, which would include the parent plus the sub equal to the consolidated. But each one of them will keep everything separately. So in this session, I'm going to show you first the consolidated, I'm going to show you how we end up with the consolidated. Starting with the consolidated balance sheet, we will include 100% of the assets and liabilities of the parent and the sub. Hold on a second. What if we own 95%, what if we only own 70%? It does not matter. We include 100% after eliminating all the intercompany transaction. So what happened to the remaining, the part that we don't own? Well that's fine. The equity section of the consolidated balance sheet include only the parent, equity, with an additional line representing the non-controlling interests. So the non-controlling interests, which are the 30% or the 20% that decided not to sell their stock, their interests will be represented in a line and a separate line on the equity section called non-controlling interest NCI, or it used to be called minority interest. And you need to understand how we create NCI, what changes NCI, which we cover this in a prior session. So the equity of the subsidiary is eliminated when consolidating. So nothing from the equity of the subsidiary will appear on the consolidated financial statement. So let's take a look at this illustration. Basically practically there is no adjustments. We have the parent, separate books. We have the sub, no adjustments. We have the investment. The investment account will have to be eliminated because when we purchase the sub, we create the investment account. When we consolidate, we have to remove because we're consolidating the assets and the liabilities. We cannot keep the assets and the liabilities and keep the investment because what we paid for the company is for the asset and the liabilities. If we're adding the assets and the liabilities, we cannot keep the investment. Therefore we have to remove the investment. So we're going to credit the investment and the credit is against the equity section of the sub. So we add up all the property, plant and equipment and notice here we're keeping it simple, no adjustments, which will work an adjustment shortly. Again we add all the liabilities and we're keeping it simple, no adjustments and simply put the investment is eliminated against the equity section. So we have to eliminate the common stock of the sub, additional paid in capital of the sub to retain earnings of the sub. And notice in this example, we eliminated all the equity section of the sub and it appears in this example, we don't own 100% of this company we created an NCI. We don't have to worry about how we did it. The point I'm trying to show you is when you debit investment, when investment goes down, when you debit investment, you have to bring down against that investment, common stock, additional paid in capital and retained earnings. And if you did not own 100%, you remove NCI. This is assuming you paid exactly the book value of the sub. Otherwise, we're going to work another example where we paid little bit more than the identifiable net asset. But this is basically what a balance sheet would look like. So in the consolidated balance sheet we can see that the parent investment in the sub and the sub equity are eliminated while the non-controlling interests NCI are reported as a separate line. To basically we want to keep track of those NCI. Consolidated income statement. In the year of acquisition, the consolidated income statement would include again 100% of revenues and expenses. Well, what if we only own 90% of the company or 55% of the company? Well, it does not matter. We're going to show the NCI on a separate line. So 100% of revenues and expenses along with revenues and expenses of the sub company. So we combine both the sub and the parent 100%. The total consolidated net income should be segregated between net income attributed to the non-controlling interests. We have an NCI net income and we have net income contributed to the parent company. So simply put, let's assume we own 80% of a company. We have the parent and the sub. They consolidate everything 100%. Then notice here there is a line it says, there is a line here it says net income, let me highlight it in yellow, net income attributed to the non-controlling interests and we subtract that amount. We subtract that amount to back out because we consolidated 100%, although we don't own 100% to back it out. So we keep track of NCI separately and you have to know how to do this. We work this in a prior session. The consolidated comprehensive income same concept. If we have any NCI, we have to keep track of NCI separately. Now the best way to illustrate all these concepts is to actually look at a complete simulation. This is a long simulation. Most likely you will not see something like this on the exam. Most likely you will see bits and pieces. Maybe you will see a smaller version of it, but you will see many multiple choice questions that you can answer by understanding this simulation. Before we look at the simulation, I would like to remind you one more time. If you're not a subscriber to go to farhatlectures.com, subscribe. I can help you understand this material. I can help you improve your knowledge, improve your confidence so you can pass the CPA exam. Let's go ahead and get started. On November 2nd, year one, Farhat Company announced its decision to acquire 100% of the common stock of Brian Company by issuing 62,500 shares of its $20 power value common stock. The acquisition occurred on January 1st, year one, I'm sorry, year two, when the fair market value of the common stock was $50. We really don't care about the announcement date. The transaction took place January 1st, year two. And how much did we pay for this company? How much did Farhat pay for the company? Farhat issued 62,500 shares, the share is worth $50. So if we take $62,500 times $50, they paid for the company 3,125,000. Just copy this down, paid this much. On the acquisition date, the net book value of Brian Net asset was $575, that's their net book value, while the fair value amounted to $825. So notice here, from a book value perspective, $825 minus $575. We have something inflated, $825 minus $575, not inflated. That's, we have something that's worth more than its book value. Well, it says the only difference between the book value and the fair value is attributed to a land. Okay, so this $250 belong to a land, make a note of it. That has appreciated in value. Moreover, Brian had in-process R&D of 150 that will be amortized. What does that mean? If you are giving this piece of information, it means there's, we have to add 150,000 in a new asset called in-process R&D. Because when the company, when Brian company was conducting this R&D, they had to expense it. Since we are buying the company, it's in-process R&D. And we are told here we're gonna be amortizing it. It means the R&D is successful, we bought it. It means it's somehow we, we know it's successful. Therefore, we're gonna amortize it over five years. So that's another asset. So we're gonna add the land as a new asset. We're gonna add in-process R&D as a new asset. Make a note of those. For year two, Brian recorded net income of 437,500 and paid cash dividend of 187. This is year two, this is year two. So the subsidiary made a profit and paid a dividend. Make a note of these numbers. On December 31st, year two, the equity section of Brian company included common stock of 1,250,000, a pick of 500,000 and retained earning of 625. Hold on a second. So this was the retained earning at the end of year two. So this is 625 here. This is year two, sorry, this is year two. So what was retained earning year one? We're gonna have to find out what was retained earnings at the beginning of the year or at the end of year one, January 1st, year two, which is the beginning of year two or the end of year one. On the other hand, the equity section of far had included common stock of 6,250,000, a pick of 1,250,000 and retained earnings of 3,750,000. The first thing we're gonna do, based on this information, prepare the journal entry to record the acquisition. Well, that's easy. We're already gonna figure out the acquisition cost, 3,150,000, we're gonna debit investment for that amount, 3,125,000, 3,125,000, credit common stock, the number of shares times the par value and credit additional paid in capital, 1,875,000. Now bear in mind when we consolidate, we're gonna have to eliminate the investment account. The investment account is eliminated because we purchased the assets and liabilities of the company. We purchased the net asset, which is the equity of the company. We cannot keep both. We have to eliminate the investment against the equity to keep the assets and the liabilities and the consolidated financial statements. And we'll see in the example, prepare the acquisition date eliminating entry. Now the acquisition date eliminating entry, it means when we purchase this company, when far had purchase Brian, there's an eliminating entry that's gonna eliminate the sub equity because we cannot have the sub equity. We cannot have the sub equity and we have to see how we process this entry because we have to add more assets to our books. So when preparing the eliminating entry, the equity section of the sub should be fully eliminated. We should notice the sub have to be gone. The sub equity has to be gone because we paid for it. Therefore to prepare the eliminating entry, we should determine the amount of the equity section of Brian on that date, which is again, now we're gonna go back and figure out January 1st equity because we're eliminating on the acquisition date. On December 31st year two, the equity section amounted which we were giving this, 2,375, 1,254 common stock, half a million of APEC and retained earning of 625. Remember what I told you, we are giving retained earning at 625. This is December 31st year two, but we purchased the company January 1st year two. So we have to go back and find out what was retained earning at the beginning of the year. So we don't know what retained earning was the beginning of the year. We know that we had net income minus dividends. So we added net income minus the dividend gave us ending retained earnings. What do we have to do now? Well, we were told what was net income. We were told what was dividend. Now we have to go backward. We have to take the ending retained earning, add the dividend, subtract the income. We come up with beginning retained earnings. So we were told that ending retained earning was 625. We were told on the prior slide that we paid cash dividend of 187,500. If we paid it, now we have to add it to go backward. We're going backward and net income, since we added net income, now we have to subtract net income of 437,500. Therefore the beginning retained earning X was 375,000. So this is the retained earning at the acquisition date, 375. It was not giving. We had to back out into it to be careful what date is retained earning given to you. Now, as a result, the total equity of the subsidiary on the acquisition date amounted to 2,125,000. An account computed as follow, common stock, APIC, and paid and retained earning is 375, what we just calculated. So the 2,125,000 represent the value of Brian's net asset. Remember, the value of Brian's net asset is 2,125,000. Remember that we paid 3,000,000. How much did we pay? We paid for this company, we paid 3,125,000. So we paid, notice, we paid 3,125,000 for a company that's worth 2,125,000 for their net asset. So we paid an additional $1 million an additional above their net asset. We already know, we were told in the problem earlier that the land was overstated by 250. Well, that's fine. So this explained 250 of the million that's gonna left us with 750. Well, we were also told that we have an in-process R&D that we need to capitalize of 150. Well, that explains 150 of the 750 that keeps us with $600,000. There is no explanation for this. Well, if there is no explanation and we paid extra, we're gonna call the 600,000 goodwill. So therefore what's gonna happen, 250 goes to the land of that excess amount, 150 goes to process R&D and what's left 600,000 goes to goodwill. Now let's prepare the eliminating entry. We're gonna debit common stock for the sub. Debit paid in capital, debit retained earnings, the beginning retained earnings. This is for the sub, gone. We're gonna have to debit land. We have to add the land to the consolidated. We have to add the intangible, the R&D. We have to add the goodwill and we eliminate it against the investment which is 3,125,000. Assume that Fahad accounts for the investment in Brian using the equity method, prepare the year and eliminating entry. Let's take a look at the equity method. Given that Fahad uses the equity method to internally account for its investment, the value would look something like this. The acquisition date of the investment was 3,125,000. This is what we paid for under the equity method. We increase it by the net income. We reduce it by the dividend. Therefore, ending investment using the equity method is 3,375,000. How do we process this entry? We're gonna debit common stock. Debit paid in capital, debit retained earnings. Now retained earnings will be retained earnings at December 31st, year two retained earnings, which is different then. So 6,25 is different than the beginning retained earnings of 3,75. Why? Because now net income and dividend is reflected in the retained earnings. The rest is the same and the difference will go to the investment account. So simply put, if you notice here, the difference between those two went to retained earnings and the difference is accounted for in the investment. So this is the equity method. And hopefully you should be very familiar with the equity method. Now what we're gonna do, we're gonna look at series of eliminating entries to just bring all of this together, starting with an inventory intercompany transaction. During the year, Farhat sold merchandise inventory with a cost of 1.5 million to Brian for 1,650. So notice here we have an intercompany profit of 1.50. Brian sold 40% of these merchandise to an external party, okay? With a profit margin of 25%. So what do we have to do now? Well, this is an intercompany transaction, intercompany sale, intercompany cost of goods sold, intercompany profit. We have to eliminate this. So the elimination of intercompany sales and cost of goods sold is pretty straightforward. It consists of debiting sales and crediting cost of goods sold. However, the profit is separated between the profit on the goods sold to third parties, which should be eliminated from cost of goods sold. Remember this 1.50, some of it already sold because we sold 40%. And the profit on the goods is still available in inventory. Remember if we sold 40, we still have 60. So 40 and 60, so 60 of this is 90,000. So we still have 90,000 in inventory and we sold 60. So we have to reduce the 60 and we have to reduce the 90. Why? Because those are inflated figures. This is part of the intercompany profit. So 60,000 is cost of goods sold to a third party. So the eliminating entry would look something like this. We have to obviously debit sales because we sold to a sub. Simply put, when the parent sold, they debited account receivable 1,650 credited sales, 1,650 debited cost of goods sold, 1.5 million credited inventory, 1.5 million. So we have to eliminate the sales. We have to eliminate this cost of goods sold. The remaining is 1.50. We have to also eliminate this profit. Now, if they did not sell anything, let's assume Brian did not sell anything to an outside party. All we have to do is reduce inventory 1.50. Why? Because inventory is inflated. Once we reduce inventory, it increase our cost of goods sold and it will solve the problem for the consolidation. But since 40% of it sold and 60% remaining, we're gonna eliminate, we're gonna reduce cost of goods sold to external party. So the sub has an inflated cost of goods sold of 60,000 because this 1.50 is profit. And now they counted it as cost of goods sold. Well, we have to reduce cost of goods sold and they still have 90,000 of the 1.50. Again, 60,000 was inflated cost of goods sold. The remaining is 90,000 and that's inflated inventory. What do we do with that inflated inventory? We also reduce the inflated inventory. Notice we reduce sales, we reduce cost of goods sold, intercompany cost of goods sold, external company cost of goods sold and we reduce inventory by 90,000. Basically what we are doing, we are going back and treating as if the sale between the sub and the parent company was never achieved. Now also, let's assume they still have an intercompany account receivable and payable of 400,000. That's easy, we debit the accounts payable and we credit the receivable to eliminate any intercompany payable and receivable. Let's assume also on December 31st, year two, Brian acquired bonds from the market for 512, these bonds were issued by Farhat for 450 on December 29th. The same year, the bonds had a face value of 375. So they were issued at a premium. Simply put, what Farhat did, they debited cash 450 credited bonds payable 375 and they have a premium of 75,000. This is what the parent company did. Yes, the parent company, so they issued a bond. Well, the sub purchased a bond and they purchased it for, they purchased it for 412,500. So they purchased it less than the book value. So we have a gain. So, but when they purchased it, the bond and the premium has to be gone. So we're gonna debit the bond. We have to debit the bond to remove the bond. We have to debit the premium to remove the premium. Debit the bond, debit the premium, remove the bond because now the bond is basically retired because it's an intercompany transaction. Now also the investment account, Brian paid 412,500, that's an intercompany investment. It also has to be eliminated. And there's again, why there's again? Because the bond has a book value of 450. We did not amortize anything in this bond to keep it simple. And Brian paid 412,500. We have a gain of 37,500. Now bear in mind that sometime they might give you, the bond was purchased a year or two later. So you have to amortize some of the premium. Not likely on the CPA exam, but if you don't wanna take any chances, again, Farhat lectures on my advanced accounting, I do work those scenarios. Let's also assume that Farhat acquired, Brian acquired land from Farhat for 300,000. The land has a cost of 262. So Brian purchased a piece of land that's good and they paid 300,000. Well, if they paid 300,000 to Farhat, Farhat will have a gain, but that gain an intercompany gain. What is the gain if my math is right, 37,500? Well, that gain has to be gone. Now Brian has an asset, a land that's worth 300,000, but it should be reported at 262,500. We have a land that has to go down as well by 37,500 inflated land. So we have to debit the gain and credit the land. Now, if I'm going a little bit too fast, please go to the CPA review session and I explain those transactions much, much more in details, but this is just I'm processing these transactions as a review to get you to the full picture to show you how all these entries eventually fit on the financial statements, on the consolidated financial statements for that matter. On January 1st, Brian paid 150,000 to purchase an asset from Farhat. The book value was 105. Well, if they paid Farhat 150 for something that's worth 105, you know that Farhat will have a $45,000 gain. That gain is an intercompany gain will need to be eliminated. Farhat acquired the machine at the beginning of the year for 126. So they paid 126, now it's reported at 150. Again, we're gonna have to reduce the machine by the difference, which is 24,000. Farhat was using the straight line method, assume in six years. So we're gonna take 126 divided by six and that's gonna give us the depreciation with no salvage value. And Brian kept on accounting for this the same way. So they bought this a year later, January 1st, year two. Well, first we have a $45,000 gain computed as the difference between 105, 150 and 105. We need to eliminate this. Also, the asset and accumulated depreciation should be adjusted to the original balances and the selling company books. Simply put, we have to go back and bring the asset back to its original value and bring the accumulated depreciation to its original value, original means on the company's selling books. Well, Brian also, since they bought the company, Brian recorded depreciation expense and we'll see how do, how do we bring it back. Brian also recorded depreciation expense for the acquired asset. And what did Brian said? Brian said, I'm gonna keep the life the same which is six years, one year went by, we still have five years to go. So Brian's gonna take 150 what they paid for the asset on their books divided by five and they're gonna depreciate the asset for 30,000. However, the depreciation on the books for the parent company was 126 divided by six which is 21,000. In other words, depreciation expense is overstated by 9,000. We also have to fix that. So let's take a look at the journal entries to fix all of those. One, the gain. We have to debit the gain to eliminate the gain. So that gain is gone. We have to credit the machine for 24,000 because when Brian bought the machine, Brian is recording the machine at 150, right? It needs to be reduced by 24, Y24 to bring it back on the consolidated to 126. Also we have to credit accumulated depreciation by 21,000. Why do we do this? What does this number represent? It represents year one depreciation. When FAR had sold this machine, they debited because you had to debit accumulated depreciation as part of the entry. Accumulated depreciation is debited. You debited accumulated depreciation. Now you credit accumulated depreciation to bring back the accumulated depreciation. So this is to bring back the asset to its original value. Also remember I told you we have 9,000 of depreciation overstated. Now we debit accumulated depreciation and credit depreciation expense because 9,000 between the two companies because Brian reporting 30,000 of depreciation which is not correct, it has to be 21. So when we consolidate, we reduce depreciation expense and we reduce accumulated depreciation by 9,000. So the net depreciation on the consolidated is only 21. One more thing to take care of. In addition to the listed eliminating entries, FAR had to record an amortization of the research and development for year two. Remember the research and development asset? We added an asset of 150 and we said we're gonna amortize it over five years. So each year we'll take $30,000, we debit amortization expense of 30, credit R&D, credit in process R&D which is an asset of 30,000. Why do we do that? Because now we are amortizing this in process R&D. Now let's take a look at the consolidated financial statement. Let's see how all these numbers fit in the big picture. So this is the parent numbers, this is the sub Brian and those are given. Now these are the eliminating entries. Remember we reduce sales by 1,650. So we'll take the parent plus the sub minus the adjustment will give us the consolidated sales. Cost of goods sold for the parent plus cost of goods sold for Brian. And remember we had an adjustment for cost of goods sold. We reduced cost of goods sold. Why did we have to do that? Remember we reduced cost of goods sold. 1.5 million was an internal cost of goods sold for the inventory transaction. Then we eliminated an additional 60,000 of cost of goods sold for the external sale. Therefore the internal cost of goods, the internal basically the eliminated cost of goods sold is 1,560 will need to be eliminated. Sales minus cost of goods sold give us consolidated gross profit operating expenses. We have to adjust it by in total of 21,000. Why 21,000? Let's take a look at this. Would reduce depreciation expense by nine. We increase amortization by 30. The net is 21,000. Therefore we increase depreciation operating expenses in total by 21,000. Equity and earnings. We cannot keep any equity in earnings because this is intercompany equity. We have to eliminate this. Interest income, no adjustment. Interest expense, parent plus sub no adjustment. Gain on fixed asset. Well that needs to be eliminated because the gains those were intercompany gain of 82,500. Remember we sold the land. We had a gain of 37,500. We sold the machine again of 45. We need to eliminate this. There's no intercompany gain. Also when we bought back the bond we had a gain of 37,500. Now this is an actual gain. We'll need to be reported of 37,500. So all in all the consolidated net income is 619. Well for this company since we own 100% we don't need to subtract any NCI net income. Therefore that's the consolidated net income, 619. If we own less than 100% we would have had to deduct some portion for the NCI. Statement of retained earnings. We have the retained earnings of the parent. We have the retained earnings of Brian. Again, we cannot show any equity for Brian. Therefore we have to eliminate this and what's left is the retained earning of the parent. Net income of the parent plus net income of the sub minus the adjustment of 593 will give us consolidated net income 619 that we just saw earlier. The dividend is 100% eliminated. What's left is zero. And this is the ending retained earnings, the consolidated ending retained earnings. Now let's take a look at the balance sheet. Again, the balance sheet, the same concept. We're gonna take the parent plus the sub and if there's any adjustment to take care of the adjustment. And in this example as I told you we're gonna look at the adjustments. We did not make any adjustment to cash. Parent plus sub equal to 1.6 million consolidated cash. Account receivable, parent plus sub and remember we reduce account receivable intercompany account receivable by 400,000. We also reduce intercompany payable by 400,000. So those were the debits and the credits. Inventory, we reduced inventory by 90,000. Parent plus sub and remember we had to reduce the inflated inventory by 90,000. Investment in bond, far hat plus the sub minus the investment in bonds because we had to remove the investment in the bonds that the sub made. Fixed asset, parent plus sub and 176,500. Where is this coming from? I made a note. It's worth noting that 175 is computed as follow. The balance sheet adjustment of 250, adjustment to accumulated depreciation net this is the nine minus 21 and we deducted the land 37,500 and we deducted 24,000 to reduce the land and reduce the machine. We went over all these transactions and the eliminating entries. Therefore the net is 175. There was no R&D. Now we had to add R&D in the consolidated. There was no goodwill. We had to add goodwill to the consolidated. Accounts payable, we reduced it by 4,000. Bonds payable, we reduced it by 450 when we eliminated the, when we eliminate the investment and bonds. This is total liabilities. Common stock, again, we don't show, we don't show the sub, test has to be gone. So we don't show a pick, it has to be gone and retained earning is coming from the previous slide on the retained earning, a retained earning when we compute it. Therefore, common stock is the company's common stock. The parent company common stock, additional paid in capital is the parent company additional paid in capital and retained earning is the consolidated retained earning, which is this amount here, 3,594,000. So I hope this makes sense. Now, if you want more examples like this one, including NCI, because I kept NCI out because I don't want to complicate things for you. But if you want more, go to farhatlectures.com and you should go to farhatlectures.com, work multiple choice, look at additional resources that's gonna help you. Consolidation is an extremely important topic on the CPA exam. You don't want to walk into that exam room, pro-metric center without being 100% confident. Study hard, good luck, you can do it. Consolidation is not as bad as you think as long as you understand it. There will be easy points for you and stay safe.