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A balance sheet consolidation is the process of combining the balance sheet of a parent company with all of its subsidiary companies into one single consolidated balance sheet. The consolidated balance sheet presents the financial position of this single economic entity.
There are 8 steps in the balance sheet consolidation process. These are the same steps taken in the income statement consolidation process. So, if you’ve already done these as part of preparing a consolidated income statement, you do not need to redo them.
Goodwill is technically defined as an intangible asset that represents the future economic benefits stemming from a business combination. It is essentially the difference between what the acquiring company paid for the acquired company and the fair value of that acquired company at the time of acquisition.
A bargain purchase is the inverse. A bargain purchase in a business combination arises from the acquiring company paying less than the fair value of the acquired company.
Here’s how to calculate goodwill or a bargain purchase. There are 3 steps.
There are two methods available to make this determination, market capitalization and purchase price. The market capitalization method only makes sense if there is an active market price for the acquired company’s shares.
In the market capitalization method, you multiply the subsidiary’s number of shares by the market price of the subsidiary’s share on the acquisition date.
Fair Value = Number of Shares X Market Share Price
In the purchase price method, which is commonly used for small business acquisitions, fair value is equal to the purchase price paid for the subsidiary divided by the percent of the subsidiary that the parent company now owns.
Fair Value = Purchase Price of Investment in Subsidiary / Ownership %
The fair value of the net assets acquired is the difference between the fair value of the acquired assets and the liabilities assumed.
Fair Value of Net Assets = Fair Value of Assets – Fair Value of Liabilities
Net assets are of course the same as equity. So, this can also be calculated as common stock, additional paid-in-capital and retained earnings
Fair Value of Net Assets = Common Stock + Additional Paid-in-Capital + Retained Earnings
Goodwill or bargain purchase is equal to the difference between the fair value of the company and the fair value of the company’s identifiable net assets.
| Goodwill | |
| Fair Value of Company | XXX |
| Less: Fair Value of Company’s Net Assets | XXX |
| Equals: Goodwill | XXX |
| Bargain Purchase | |
| Fair Value of Company’s Net Assets | XXX |
| Less: Fair Value of Company | XXX |
| Equals: Bargain Purchase | XXX |
Inter-company transactions are transactions between the parent company and its subsidiary. As they are now treated as the same economic entity, these transactions need to be eliminated to avoid double counting. To be clear, all inter-company transactions need to be eliminated during the preparation of consolidated financial statements regardless of the ownership percentage of the parent company in the subsidiary.
The elimination process itself involves reversing the effects of inter-company transactions like sales, purchases, dividends, interest payments and so forth. The following section covers the most common inter-company transaction types.
Big Dog Company acquired a controlling interest in Little Dog Company, and is now preparing its consolidated balance sheet. Prior to acquiring Little Dog Company, Big Dog Company purchased inventory from Cat Company for $2,500.
| Inventory | $2,500 | |
| Cash | $2,500 |
This inventory was subsequently sold to Little Dog Company for $5,000. The following two journal entries record this event in Big Dog Company’s books.
| Accounts Receivable (Little Dog) | $5,000 | |
| Sales | $5,000 |
| Cost of Sales | $2,500 | |
| Inventory | $2,500 |
This purchase of inventory from Big Dog Company was recorded in Little Dog Company’s books like this:
| Inventory | $5,000 | |
| Accounts Payable (Big Dog) | $5,000 |
Little Dog Company sold this inventory to their customer Rabbit Company for $10,000. Little Dog Company recorded this event in the following two journal entries.
| Accounts Receivable (Rabbit) | $10,000 | |
| Sales | $10,000 |
| Cost of Sales | $5,000 | |
| Inventory | $5,000 |
The initial purchase by Big Dog Company of inventory for $2,500 from Cat Company, and the ultimate sale of this inventory by Little Dog Company to Rabbit Company for $10,000 are true transactions. These two should not be eliminated, because they are transactions with external third-parties.
All of the other transactions are now inter-company transactions and need to be eliminated in the consolidated financial statements. Here’s how. First eliminate the Sales and Cost of Sales.
| Sales | $5,000 | |
| Cost of Sales | $5,000 |
Next eliminate the accounts payable and accounts receivable between Big Dog and Little Dog.
| Accounts Payable (Big Dog) | $5,000 | |
| Accounts Receivable (Little Dog) | $5,000 |
All of the inventory was sold by Little Dog. It has been automatically eliminated, and there is now no unrealized profit in the books. So, after elimination, we are left with the following transactions.
The initial inventory purchase:
Inventory $2,500 Cash $2,500
The true cost of sales and credit to inventory:
Cost of Sales $2,500 Inventory $2,500
And the final sale:
Accounts Receivable (Rabbit) $10,000 Sales $10,000
Take this same scenario, but instead now not all of the inventory has been sold. Little Dog Company only sold $4,000 of the inventory to Rabbit Company for $8,000.
| Accounts Receivable (Rabbit) | $8,000 | |
| Sales | $8,000 |
| Cost of Sales | $4,000 | |
| Inventory | $4,000 |
Just as before, the initial purchase of inventory by Big Dog Company from Cat Company, and the final sale by Little Dog Company to Rabbit Company are kept. As before, the inter-company accounts receivable and accounts payable transactions are also eliminated by reversing them.
| Accounts Payable (Big Dog) | $5,000 | |
| Accounts Receivable (Little Dog) | $5,000 |
The inter-company sale of $5,000 also needs to be eliminated as before. When all the inventory had been sold, there was a cleanly matching $5,000 cost of sales to be eliminated as well. Now, however, Little Dog has only sold 80% of the inventory purchased from Big Dog. Therefore, the true cost of sales is $2,000 ($2,500 X 80%).
The combined books reflect a cost of sales of $6,500 with $2,500 from Big Dog and $4,000 from Little Dog. The $4,500 difference between the true cost of sales, $2,000, and the double counted cost of sales, $6,500, is what in this version needs to be eliminated not $5,000 as before.
In this version, the true cost of the remaining inventory is $500 ($2,500 X 20%) from Big Dog’s initial purchase of it. This same inventory, however, is in Little Dog’s books valued at $1,000 ($5,000 X 20%). This gives us an unrealized profit of $500 ($1,000 – $500) that needs to be eliminated. We fix overstated sales, cost of sales and inventory with the following journal entry.
| Sales | $5,000 | |
| Cost of Sales | $4,500 | |
| Inventory | $500 |
The net effect of this on the balance sheet is to reduce both Retained Earnings (profit) and Inventory by $500 each.
Eliminating inter-company sales of PP&E involve reversing the sale and any related gains or losses in the books of the parent and subsidiary companies. Then, any depreciation adjustments made in either the parent or the subsidiary are reconciled and adjusted to reflect the eliminated inter-company transaction.
Suppose Big Dog Company sold a ball throwing machine with an original cost of $15,000 and Accumulated Depreciation of $7,000 to Little Dog Company for $10,000. Since the book value on Big Dog’s books was $8,000 ($15,000 – $7,000), Big Dog recorded a gain of $2,000 ($10,000 – $8,000).
| Cash | $10,000 | |
| Accumulated Depreciation | $7,000 | |
| Asset (Ball Machine) | $15,000 | |
| Gain on Disposal | $2,000 |
On Little Dog’s books, the ball machine purchase was recorded like this:
| Asset (Ball Machine) | $10,000 | |
| Cash | $10,000 |
Later that year, Big Dog acquires Little Dog and is preparing its consolidated balance sheet at the end of the year. The ball machine asset is on Little Dog’s books at a value of $10,000. That needs restored to its original Big Dog value of $15,000. The Gain on Disposal needs to be reversed, and the Accumulated Depreciation needs to be restored back to $70,000 as well.
| Asset (Ball Machine) | $5,000 | |
| Gain on Disposal (RE) | $2,000 | |
| Accumulated Depreciation | $7,000 |
Big Dog was depreciation the ball machine over 10 years using the straight-line method, and so would have recorded an annual depreciation of $1,500 had it not sold the machine to Little Dog. Little Dog was depreciating the ball machine over 5 years using the straight-line method and so recorded $2,000 of depreciation. So, depreciation was overcharged by $500. The fix is this journal entry.
| Accumulated Depreciation | $500 | |
| Depreciation Expense (RE) | $500 |
When there are inter-company bond sales, double-counting effects need to be eliminated. Suppose that Big Dog Company purchased a $10,000 bond from Little Dog Company the year prior to acquiring Little Dog. In Big Dog’s books we would have a journal entry like this one.
| Investment in Bonds | $10,000 | |
| Cash | $10,000 |
While in Little Dog’s books, we would find a journal entry like this one.
| Cash | $10,000 | |
| Bonds Payable | $10,000 |
As can be seen from these two journal entries, the inter-company cash transfer is already eliminated. The Investment in Bonds and Bonds Payable need to be eliminated, which we accomplish with this journal entry.
| Bonds Payable | $10,000 | |
| Investment in Bonds | $10,000 |
Similarly, the interest revenue received by Big Dog and the interest expense of Little Dog would also need to be eliminated. This would need to be done for both accrued and already received interest payments and receipts.
| Interest Income | $1,000 | |
| Interest Expense | $1,000 |
If a subsidiary company has already paid dividends to a parent company, these would affect the subsidiary’s retained earnings and the parent’s investment in the subsidiary account. These accounts are eliminated at the time of consolidation. However, if declared dividends are not yet paid by the subsidiary to the parent, then these would need to be eliminated as in the following journal entry.
| Dividends Payable | $1,000 | |
| Dividends Receivable | $1,000 |
In this step, we want to determine the post-acquisition profit, which is any increase in fair value between the acquisition date and the consolidation date. Calculating post-acquisition profits involves four steps.
The fair value of the subsidiary’s net assets at the acquisition date is the sum of its common stock, additional paid-in-capital and retained earnings. Of course, this is also the same as the difference between assets and liabilities.
| Fair Value of Net Assets at Acquisition | |
| Common Stock (At Acquisition) | XXX |
| Add: Additional Paid-in-Capital (At Acquisition) | XXX |
| Add: Retained Earnings (At Acquisition) | XXX |
| Equals: Fair Value of Net Assets (At Acquisition) | XXX |
Repeat these same calculations for the consolidation date.
| Fair Value of Net Assets at Consolidation | |
| Common Stock (At Consolidation) | XXX |
| Add: Additional Paid-in-Capital (At Consolidation) | XXX |
| Add: Retained Earnings (At Consolidation) | XXX |
| Equals: Fair Value of Net Assets (At Consolidation) | XXX |
The increase in fair value is the difference between the fair value of net assets at consolidation and fair value of net assets at acquisition.
| Fair Value Increase | |
| Fair Value of Net Assets (At Consolidation) | XXX |
| Less: Fair Value of Net Assets (At Acquisition) | XXX |
| Equals: Increase in Fair Value of Net Assets | XXX |
If the subsidiary company had any unrealized profits in inventory at the acquisition date, these profits should be subtracted from any increase in fair value. As well, any dividends received by the parent company from the subsidiary should be added to the increase in fair value.
| Post-Acquisition Profit | |
| Increase in Fair Value of Net Assets | XXX |
| Add: Dividend Paid by Subsidiary | XXX |
| Less: Unrealized Profit in Inventory | XXX |
| Equals: Post-Acquisition Profit | XXX |
The parent company’s retained earnings at consolidation are the sum of the parent company’s current retained earnings and the parent company’s share of post-acquisition profit minus any dividend’s paid by the parent to the subsidiary. The parent company’s share of post-acquisition profit is determined by the post-acquisition ownership percentage that the parent company holds of the subsidiary company.
| Parent Company’s Retained Earnings (At Consolidation) | |
| Parent Company’s Retained Earnings | XXX |
| Add: Parent Share of Subsidiary’s Post-Acquisition Profit | XXX |
| Less: Dividends Paid by Parent to Subsidiary | XXX |
| Equals: Parent Company’s Retained Earnings (At Consolidation) | XXX |
Non-controlling interest (NCI) is oftentimes referred to as minority interest. A minority interest equals the percentage of a subsidiary company’s equity that is not owned by the parent company.
In a consolidated balance sheet, the minority interest is reported in the equity section as the non-controlling interest. The non-controlling interest holders have an ownership stake in equity, but they do not have a controlling interest in the subsidiary company. There are two steps to calculate the non-controlling interest.
There are two methods for determining the fair value of the non-controlling interest at the acquisition date. In the market capitalization method, you multiply the number of shares of non-controlling interest by the market price of the subsidiary’s shares at the acquisition date.
Fair Value of NCI = Number of Shares of NCI X Market Share Price
In the purchase price method, which is commonly used for small business acquisitions, fair value of the non-controlling interest is equal to the purchase price paid for the subsidiary divided by the percent of the subsidiary that the parent company now owns multiplied by the non-controlling interest percentage.
Fair Value of NCI = (Purchase Price of Investment in Subsidiary / Ownership %) X NCI
At consolidation, the non-controlling interest is the non-controlling interest at acquisition plus the non-controlling interest’s share in the subsidiary’s post-acquisition net income minus the non-controlling interest’s share of the subsidiary’s post-acquisition dividend.
| Non-Controlling Interest (At Consolidation) | |
| Non-Controlling Interest at Acquisition | XXX |
| Add: NCI’s Share of Subsidiary’s Post-Acquisition Net Income | XXX |
| Less: NCI’s Share of Dividends Paid by Subsidiary | XXX |
| Equals: Non-Controlling Interest (At Consolidation) | XXX |
Similarly, the parent company’s investment in the subsidiary is its investment at the acquisition plus its share of the subsidiary’s post-acquisition net income minus the parent company’s share of the subsidiary’s post-acquisition dividend.
| Parent Investment in Subsidiary (At Consolidation) | |
| Investment in Subsidiary at Acquisition | XXX |
| Add: Parent’s Share of Subsidiary’s Post-Acquisition Net Income | XXX |
| Less: Parent’s Share of Dividends Paid by Subsidiary | XXX |
| Equals: Investment in Subsidiary (At Consolidation) | XXX |
The consolidation journal entry needs to accomplish these six goals:
This is accomplished with the following journal entry.
| Common Stock (Subsidiary) | Book Value | |
| Additional Paid-in-Capital (Subsidiary) | Book Value | |
| Retained Earnings (Subsidiary) | Book Value – Unrealized Profit | |
| Goodwill | Calculated Above | |
| Non-Controlling Interest | Calculated Above | |
| Investment in Subsidiary | Calculated Above |
| Consolidated Balance Sheet | |
|---|---|
| As of Dec 31, XXXX | |
| Assets | |
| Current Assets | |
| Cash | Parent + Subsidiary |
| Accounts Receivable | Parent + Subsidiary – Elimination |
| Inventory | Parent + Subsidiary – Elimination |
| Non-Current Assets | |
| PP&E | Parent + Subsidiary – Elimination |
| Investment | Parent + Subsidiary – Elimination |
| Goodwill | Calculated Above |
| Liabilities | |
| Current Liabilities | |
| Accounts Payable | Parent + Subsidiary – Elimination |
| Accrued Liabilities | Parent + Subsidiary – Elimination |
| Non-Current Liabilities | |
| Bonds Payable | Parent + Subsidiary – Elimination |
| Equity | |
| Common Stock | Parent |
| Additional Paid-in-Capital | Parent |
| Retained Earnings | Calculated Above |
| Non-Controlling Interest | Calculated Above |
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