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Chapter 13: Problem 10

Which of the following items would differ on a firm's financial statements before and after consolidation of its subsidiaries? Explain your answers. a. Total assets b. Total liabilities c. shareholders' equity d. Sales e. Expenses f. Net inc

Short Answer

Expert verified
The reported Total assets, Total liabilities, Sales and Expenses would typically increase after consolidation as they would include those of both parent company and its subsidiaries. Shareholders' equity might remain the same as the parent company's stake in its subsidiaries is already accounted for. Net income may not differ greatly, but elimination of inter-company transactions might cause some differences.

Step by step solution

01

Understanding Consolidation

The process of consolidation involves combining the financial statements of the parent company and its subsidiaries into one. The purpose of consolidation is to provide a comprehensive picture of the entire business group, which includes the parent and its subsidiaries.
02

Assessing Total assets

The total assets reported on consolidated financial statements will typically increase, as they now include the combined assets of both the parent company and its subsidiaries.
03

Assessing Total liabilities

Total liabilities on consolidated financial statements would also increase because it will include the liabilities of both the parent company and its subsidiaries.
04

Assessing Shareholders' equity

The shareholders' equity on consolidated financial statements could possibly stay the same. This is because the ownership stake of the parent company in its subsidiaries is already reported as an investment in its financial statements, so consolidating may not necessarily increase shareholders' equity.
05

Assessing Sales

Sales on consolidated financial statements would generally increase because it will include sales from both the parent company and its subsidiaries.
06

Assessing Expenses

Expenses on consolidated financial statements would also generally increase, because they would include the expenses of both the parent company and its subsidiaries.
07

Assessing Net income

The net income on consolidated financial statements may not differ greatly, as it will include the combined net incomes of the parent company and its subsidiaries. However, inter-company transactions and dealings would be eliminated during consolidation, so this may result in some differences in net income.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Total Assets
When considering total assets on a financial statement, it's essential to understand how consolidation affects these figures. Consolidation means combining the financial statements of a parent company with its subsidiaries.
This process results in a comprehensive financial picture of all entities involved.

Upon consolidation, the total assets of the combined entities generally increase. This is because both the parent company's and subsidiaries' assets are combined into a single report.
  • This includes physical assets such as buildings and machinery.
  • Besides tangible assets, it also includes intangible assets like patents and trademarks.
  • The value of investments held by the parent company in its subsidiaries will also be reflected in total assets, although such investments are adjusted or eliminated to avoid double-counting.
In summary, total assets on consolidated financial statements provide a holistic view of a business's resources.
Shareholders' Equity
Shareholders' equity in financial statements can be a bit tricky when it comes to consolidation.
It represents the ownership interests of shareholders in a company and includes elements such as common stock and retained earnings.

Upon consolidation, one might expect shareholders' equity to change drastically. However, quite often it does not increase as significantly as total assets do because the ownership stake in subsidiaries is already accounted for.
  • The investment the parent company makes in its subsidiaries is initially reflected as an asset 鈥� thus, when consolidated, it is adjusted so that it does not unfairly inflate shareholders' equity.
  • Moreover, any transactions between the parent and its subsidiaries are eliminated during consolidation to ensure financial statements express an accurate equity position.
This means that while assets and liabilities may see a more noticeable change, shareholders鈥� equity remains relatively stable after consolidation.
Net Income
Net income is another key component of financial statements that may be affected by the consolidation of subsidiaries. Simply put, it is the profit a company makes after all expenses and taxes have been accounted for.
Consolidation brings together the net incomes of both the parent and its subsidiaries into a unified figure.

However, there are notable nuances to consider:
  • Inter-company transactions 鈥� such as sales between the parent and subsidiaries 鈥� are eliminated. This ensures that net income reflects only external business transactions, preventing any artificial inflation.
  • Because of these eliminations and adjustments, net income on consolidated financial statements might not change significantly.
  • Occasionally, these inter-company dealing adjustments can result in some differences, but they're typically minor.
Ultimately, after consolidation, net income should provide a realistic earning measure for the entire business group.

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Most popular questions from this chapter

Describe what is meant by consolidated financial statements. In what circumstances should a parent company's financial statements be prepared on a consolidated basis?

Consolidation is mainly a process of adding together the financial statement elements of a parent and its controlled subsidiaries with certain necessary adjustments. Discuss why the following items may require adjustments in preparing a consolidated balance sheet: a. Investment in a subsidiary (on the parent's balance sheet) b. Shareholders' equity (on the subsidiary's balance sheet) c. Accounts receivable d. Accounts payable e. Inventory f. Goodwill g. Property, plant, and equipment

Assume that a foreign subsidiary of a U.S. firm acquired a parcel of land in 1998 and that each year thereafter the functional currency of the foreign subsidiary continues to weaken against the U.S. dollar. Describe how the carrying value of the land would change on successive translated balance sheets of the foreign subsidiary. Is the result sensible? What remedy could be suggested?

Distinguish between spot rates and forward rates of foreign currency exchange. Which rate would a U.S. firm use in order to report its balance sheet accounts receivable in foreign currencies?

Cabot Corporation, a producer of specialty chemicals and materials, reported the following accounting policies for intercorporate investments: Principles of Consolidation:The Consolidated Financial Statements include the accounts of Cabot Corporation and majority-owned and controlled domestic and foreign subsidiaries. Investments in majority-owned affiliates where control is temporary and investments in 20 to 50 percent-owned affiliates are accounted for on the equity method. All significant intercompany transactions have been eliminated. a. Cabot noted only"majority-owned and controlled" subsidiaries are included in the consolidation. Is it possible that majority ownership (greater than 50 percent in a subsidiary would not constitute control? Discuss. b. Why are subsidiaries that are less than 100 percent-owned included in the consolidation? c. Cabot used the equity method to account for investments in 20 - to 50 percentowned affiliates. Explain how consolidation of these affiliates would affect Cabot's reported total assets, total liabilities, shareholders' equity, and net income d. Cabot stated that all significant intercompany transactions were eliminated. Provide several examples of intercompany transactions that require elimination in order to consolidate affiliated firms.
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