B4002 - Chapter 08

Consolidated Cash Flows and Changes in Ownership

Consolidated Cash Flow Statement

• PS are part of NCI
• Instead of combining the separate company cash flow statements of the parent and subsidiary which contain intercompany transactions, it is more practical to prepare the consolidated cash flow statement by using comparative YE consolidated BS and IS
• We will assume that cash flows from operations are presented using the indirect method where the net income is adjusted for the effects of non-cash items, changes in working capital items, and for gains and losses associated with investing and financing cash flows
  • Examples of non-cash items: depreciation, amortization
• Under the indirect method, we start with net income and show the adjustments to convert it to a cash basis
• The change in cash can be determined by analyzing the change in non-cash items during the period
• Dividends paid by subsidiaries to the parent company do not change the consolidated entity’s cash
  • Dividends paid by the parent to its shareholders, and dividends paid by the subsidiaries to noncontrolling shareholders, reduce the cash of the consolidated entity
• A change in the parent’s ownership percentage during the year requires a careful analysis to determine its effect on consolidated assets, liabilities, and equities
• Special disclosures are required in the cash flow statement in the year that a subsidiary is acquired
• The components of the acquisition differential are reported on the consolidated BS
• The assets and liabilities of the subsidiary are added to the consolidated BS
• The investment account is replaced by the underlying assets and liabilities in the consolidation process
• Only the net change in cash is presented on the consolidated cash flow statement
• The details of the changes in non-cash items are disclosed in the notes to the consolidated cash flow statement

Changes in Parent’s Ownership Interest

• A parent’s ownership interest will change for any of the following reasons:
  • The parent buys additional shares of the subsidiary
  • The parent sells some of the shares of the subsidiary
  • The subsidiary issues additional CS to the public, and the parent does not maintain its previous ownership percentage
  • The subsidiary repurchases some of its CS from the NCI
• The parent’s percentage of ownership can change when the parent buys or sells shares of the subsidiary or when they subsidiary issues or repurchases shares
• Any time the parent’s percentage of ownership …
  • Increases, we will account for the transaction as a purchase
  • Decreases we will account for the transaction as a sale

Ownership Changes – Increases

• FV investments (without significant influence) are recorded at the price paid for the shares and are adjusted to FV through net income or OCI at the end of each reporting period
• After the first increase in ownership (“block acquisition” or “step purchase”) that results in significant influence, the equity method of accounting is used which requires an acquisition differential (AD) to be calculated and allocated based on FV at the date that significant influence is obtained
• For this calculation, the amount paid = the CV of previous purchases + cost of the current purchase
• For each subsequent increase of significant influence that does not result in control, determine a separate AD based on the cost paid for the additional proportion of shares acquired
  • Do not revalue previous purchases while using equity accounting
  • The AD amortization schedule is expanded by adding columns to track separately the amortization and unamortized balance of the AD arising from each step acquisition

• When control is obtained, IFRS 3 requires the investment account to be adjusted to FV on that date
  • The resulting gain or loss, together with any amount previously reflected in OCI for the investment, are in income
  • Replace any previous AD with a new AD calculated on the date of the business combination reflecting 100% of the subsidiary’s FV and any NCI
  • Begin to consolidate
  • Do not subsequently adjust the investment account to FV
• For additional acquisitions that occur after control has been obtained:
  • Do not calculate a separate AD
  • Instead, treat the acquisition as a transfer of equity from NCI to the parent with the following calculation: BS NCI amount prior to the acquisition*portion sold to the parent = transfer from NCI to parent
• If the cost of the step acquisition is > than amount of the transfer from NCI, the difference is debited to consolidated RE
• Numerous small purchases within a short period of time (days or weeks) can be treated as one single purchase
• Shares repurchased and cancelled by the subsidiary, which results in the increase of the parent’s ownership, are recorded in the same manner as direct acquisitions by the parent after control has been obtained
• Consolidated RE should recognize the parent’s interest in the sub’s income, and amortization of the AD, for each separate period as the parent’s interest increases

Ownership Changes – Decreases

• Under either a direct or indirect decrease in ownership, the parent’s portion of unamortized AD must be reduced by the percentage of its investment that the parent has disposed of, and transferred to the NCI’s share of unamortized AD
  • Direct decrease: parent sells shares that it owns in subsidiary to third party
  • Indirect decrease: subsidiary issues additional new shares and sells them to third parties, thereby diluting the parent’s ownership
• A gain or loss is computed as the difference between …
  • (1) The proceeds received either directly from third parties, or indirectly as the parent’s share of the proceeds received by the subsidiary
  • (2) The NBV of the investment before the decrease computed under the equity method
    • Reflecting parent’s share of the subsidiary earnings less dividends received from the subsidiary, amortization of AD, and elimination of unrealized upstream and downstream profits
    • If the parent has used the cost method to account for its investment in subsidiary, the investment account must first be recomputed using the equity method
• As long as the parent retains control after the decrease, it is treated as a transfer between owners which does not affect net income, therefore record any gain or loss in consolidated RE
  • The subsidiary’s net assets are not revalued when the parent sells a portion of its investment
  • Proceeds of disposal of subsidiary shares should be reported in investing activities on the consolidated cash flow statement
  • BS NCI increases with each decrease in the parent’s holding

Example of reallocation from controlling interest to NCI (parent selling 9% of its shareholding in the sub):

• When the sub issues new shares to third parties and dilutes the parent’s ownership, the gain or loss is computed based on: share issuance proceeds received by sub*parent’s new ownership % = portion of proceeds attributable to parent less investment in sub balance pre-dilution*% reduction in parent’s ownership = gain(loss)
• The parent’s percentage interest decreases when the subsidiary issues additional shares and the parent does not purchase any of the additional shares
• Gains (losses) on transactions with shareholders are not reported in net income
• The investment account comprises the parent’s share of the subsidiary’s equity plus the undepleted AD
• The undepleted AD is not revalued when the parent’s percentage ownership changes as long as the parent still has control

Consolidated Cash Flow Analysis

• NCI can be reconciled to the sub’s shareholders’ equity and the undepleted AD at any point in time
• The excess of proceeds over the value of the transfer of equity to the NCI is recorded directly to RE or contributed surplus

Subsidiary with Preferred Shares Outstanding

• Corporations often have complex capital structures, with many categories of shares
• When there are PS in the capital structure of the sub, total shareholders’ equity of the sub must be allocated among the interests of the various classes of shares on the basis of their respective rights and preferences
  • PS owned by external shareholders are presented as part of NCI
  • All CS and PS owned by the parent are eliminated
• Preferred shareholders have a non-controlling claim on:
  • (1) PS capital
  • (2) Preferred dividends (as a claim on current income of the sub)
  • (3) Preferred dividends in arrears if the PS have cumulative dividend rights
  • (4) Redemption premiums if the PS are redeemable for greater than cost
• These non-controlling claims of preferred shareholders are “reserved”, or set aside, in NCI by reducing equity available to the common shareholders

Calculation of AD and NCI at acquisition:

NCI = (424*20%)+80+10+16 = $190 Common shareholders value = (424*20%) 80 = what the PS are worth 10 = 16 =

Calculation of Year 1 consolidated net income and NCI:

Indirect Shareholdings

• The following diagrams illustrate both direct and indirect holdings:

Image 1

Image 2

Image 3

• • (1) Each of B and C are subs of A through direct control
  • (2) G is a sub of F, but F is a sub of E
    • E can control the voting shares of G through its control of F, G is also a sub of E
  • (3) K is a sub of J through direct control
    • L is also a sub of J through indirect control, because 55% of its voting shares are controlled directly or indirectly by J
    • Even though only 43% (25%*[60%*30%]) of L’s net income will flow to J under the equity method of accounting
• To prepare consolidated FS when there are indirect shareholdings in subsidiaries, the equity method of accounting must be used by the parent for each subsidiary investment
• If the cost method has been used to record investment in subsidiaries it must first be adjusted to the equity method
• Allocate the equity-accounted net income of each company up to its owner(s) starting with the lowest company in the corporate chain
• The unallocated income of all the subsidiaries represents NCI in income

Analysis and Interpretation of Financial Statements

• Note: refer to exhibit 8.9
• The separate-entity net income and return-on-equity ratio under the cost and equity methods are different
• The separate-entity net income and retained earnings under the equity method are equal to consolidated net income attributable to the shareholders of Parco and consolidated retained earnings, respectively
• The separate entity return on equity under the equity method is equal to the consolidated return on equity for the shareholders of Parco
• The solvency position looks worst on the consolidated financial statements because the subsidiary’s debt is included on the consolidated financial statements
  • This increases the debt-to-equity ratio