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Preparing Consolidated Statements of Cash Flows

Preparing Consolidated Statements

A Company has to publish a Statement of Cash Flow along with the Income Statement and Balance Sheet. The cash acquisition of a controlling interest in a company is considered an investing activity and would appear as a cash outflow in the cash flows from the investing activities section of the statement of cash flows. It is also necessary to explain the total increase in consolidated assets and the addition of the NCI to the consolidated balance sheet. This is a result of the requirement that the statement of cash flows disclose investing and financing activities that affect the company’s financial position even though they do not impact cash.

Net income is the largest source of cash, but in calculating net income some noncash expenses are deducted. These noncash expenses such as depreciation and amortization of capitalized software and other intangibles do not require a cash payment. Within the cash flow statement net income is subsequently adjusted to align with cash flows by “adding back” noncash expenses such as depreciation and amortization. In a similar manner, an adjustment must be made for deferred taxes. The change in deferred taxes represents the difference between the tax expenses on the income statement and what was actually paid to the taxing authorities.

The second section of cash from operating activities presents the year-to-year changes in operating assets and liabilities. Eg. Accounts receivables, inventories and so on.

Preparing Consolidated Statements of Cash Flows

Let us look at a small example:

Assets

Amount

Liabilities

Amount

Cash and cash equivalents

50000

Long term liabilities

150000

Inventory

60000

Common Stock

200000

Equipment

190000

Retained Earnings

350000

Building

400000

Total Assets

700000

Total

700000

Assume the fair values of the equipment and building are $250000 and $425000 respectively and any remaining excess of cost is attributed to goodwill. The estimated remaining life of the equipment in 5 years and of the building is 10 years.

The following value analysis schedule and D&D schedule were prepared:

Value Analysis Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Company Fair Value

$675000

$540000

$135000

Fair value of net assets excluding goodwill

635000

508000

127000

Goodwill

40000

32000

8000

Based on the above information, the following D&D schedule is prepared:

Determination And Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair Value of Subsidiary

$675000

$540000

$135000

Less book value of interest acquired:

Common Stock

$200000

Retained Earnings

350000

Total Stockholders’ equity

$550000

$550000

$550000

Interest acquired

80%

20%

Book Value

$440000

$110000

Excess of fair value over book value

125000

100000

25000

Adjustment of Identifiable Accounts:

Adjustment

Amortization per year

Life

Worksheet Key

Equipment (250000 – 1900000)

60000

12000

5

Debit D1

Building (425000 –400000)

25000

2500

10

Debit D2

Goodwill (675000 —635000)

40000

Debit D3

Total

125000

The effect of the purchase on the balance sheet accounts of the consolidated company would be as follows:

Debit

Credit

Cash (540000 – 50000 subsidiary cash)

490000

Inventory

60000

Equipment (190000 book value + 60000 excess)

250000

Building (400000 bookvalue + 60000 excess)

425000

Goodwill

40000

Long term liabilities

150000

Non controlling interest (20% * 550000 subsidiary equity + 25000 NCI adjustment)

135000

Total

775000

775000

The disclosure of the purchase on the statement of cash flows would be summarized as:

Under the heading “Cash Flows from investing activities”

Payment for the purchase of Company S, net of cash acquired $149000

In the supplemental schedule of noncash financing and investing activity:

Company P acquired 80% of the common stock of Company S for $540000. In conjunction with the acquisition, liabilities were assumed and an NCI was created as follows:

Adjusted value of assets acquired ($700000 book value + $125000 excess)$825000

Cash paid for common stock540000

Balance (noncash)$285000 Liabilities assumed$150000 Noncontrolling interest$135000

Noncash acquisition of Controlling Interest

Suppose that instead of paying cash for its controlling interest, Company P issued 10000 sharesof its $10 par stockfor the controlling interest. Further we assume the shares had a market value of $54 each. Since the acquisition price is the same (#540000), the determination and distribution of excess schedule would not change. The analysis of balance sheet account changes would be as follows:

Debit

Credit

Cash ($50000 subsidiary cash)

50000

Inventory

60000

Equipment ($190000 book value + $60000 excess)

250000

Building ($400000 book value + $25000 )

425000

Goodwill

40000

Long term Liabilities

150000

Noncontrolling interest (20% * $555000, subsidiary equity + $25000 NCI adjustment)

135000

Common stock ($10 par), Company P

100000

Paid-in capital in excess of par, Company P

440000

Total

825000

825000

A business combination will have ramifications on the statements of cash flows prepared in subsequent periods. An acquisition may create amortizations of excess deductions (non cash items) that need to be adjusted. In addition, there may be changes resulting from additional purchases of subsidiary shares and/or dividend payments by the subsidiary. Intercompany bonds and nonconsolidated investments also need to be considered for their impact.

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This article is in continuation with our previous articles on Finance which include CAPM Model, Merger & Acquisitions, Corporate Finance, Capital Structure, Bond Valuation

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