Forecast Financials & Pro Forma Statements: How do I prepare a consolidated worksheet using the parent company concept?

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Problem Description
Main, Inc. is contemplating a tender offer to acquire 80 percent of Subsidiary Corporation's
common stock. Subsidiary's shares are currently quoted on the New York Stock Exchange at $85
per share. In order to have a reasonable chance of the tender offer attracting 80 percent of
Subsidiary's stock, Main believes it will have to offer at least $105 per share. If the tender offer is
made and is successful, the purchase will be consummated on January 1, 2004.
A typical part of the planning of a proposed business combination is the preparation of projected
or pro forma consolidated financial statements. As a member of Main's accounting group, you
have been asked to prepare the pro forma 2004 consolidated financial statements for Main and
Subsidiary assuming that 80 percent of Subsidiary's stock is acquired at a price of $105 per
share. To support your computations, Dave Johnson, the chairperson of Main's acquisitions
committee, has provided you with the projected 2004 financial statements for Subsidiary. (The
projected financial statements for Subsidiary and several other companies were prepared earlier
for the acquisition committee's use in targeting a company for acquisition.) The projected financial
statements for Subsidiary for 2004 and Main's actual 2003 financial statements are presented in
table 1.

Assumptions
Mr. Johnson has asked you to use the following assumptions to project Main's 2004 financial
statements:
• Sales will increase by 10 percent in 2004.
• All sales will be on account.
• Accounts receivable will be 5 percent lower on December 31, 2004, than on
December 31, 2003.
• Cost of goods sold will increase by 9 percent in 2004.
• All purchases of merchandise will be on account.
• Accounts payable are expected to be $50,500 on December 31, 2004.
• Inventory will be 3 percent higher on December 31, 2004, than on December 31,
2003.
• Straight-line depreciation is used for all fixed assets.
• No fixed assets will be disposed of during 2004. The annual depreciation on existing
assets is $40,000 per year.
• Equipment will be purchased on January 1, 2004, for $48,000 cash. The equipment
will have an estimated life of 10 years with no salvage value.
• Operating expenses, other than depreciation, will increase by 14 percent in 2004.
• All operating expenses, other than depreciation, will be paid in cash.
• Main's income tax rate is 40 percent, and taxes are paid in cash in four equal
payments. Payments will be made on the 15th of April, June, September, and
December. For simplicity, assume taxable income equals financial reporting income
before taxes.
• Main will continue the $2.50 per share annual cash dividend on its common stock.
• Main will finance the acquisition by issuing $170,000 of 6 percent non-convertible
bonds at par on January 1, 2004. The bonds would first pay interest on July 1, 2004,
and would pay interest semi-annually thereafter each January 1 and July 1 until
maturity on January 1, 2014.
• The acquisition will be accounted for as a purchase and Main will account for the
investment using the equity method. Although most of the legal work related to the
acquisition will be handled by Main's staff attorney, direct costs to prepare and
process the tender offer will total $2,000 and will be paid in cash by Main in 2004.

As of January 1, 2004, all of Subsidiary's assets and liabilities are fairly valued except for
machinery with a book value of $8,000, an estimated fair value of $9,500, and a 5-year remaining
useful life. Assume that straight-line depreciation is used to amortize any revaluation increment.
No transactions between these companies occurred prior to 2004. Regardless of whether they
combine, Main plans to buy $50,000 of merchandise from Subsidiary in 2004 and will have
$3,600 of these purchases remaining in inventory on December 31, 2004. In addition, Subsidiary
is expected to buy $2,400 of merchandise from Main in 2004 and to have $495 of these
purchases in inventory on December 31, 2004. Main and Subsidiary price their products to yield a
65 percent and 80 percent markup on cost, respectively.

Main intends to use three financial yardsticks to determine the financial attractiveness of the
combination. First, Main wishes to acquire Subsidiary Corporation only if 2004 consolidated
earnings per share will be at least as high as the earnings per share Main would report if no
combination takes place. Second, Main will consider the proposed combination unattractive if it
will cause the consolidated current ratio to fall below 2 to 1. Third, return on average
stockholders' equity must remain above 20 percent for the combined entity.

If the financial yardsticks described above and the non-financial aspects of the combination are
appealing, then the tender offer will be made. On the other hand, if these objectives are not met,
the acquisition will either be restructured or abandoned.

Required
1. Forecast the separate financial statements of Main, Inc. Using Ms. Franklin's assumptions and
Main's 2003 financial statements, prepare pro forma 2004 financial statements for Main, Inc.,
assuming that the acquisition is not attempted. Support your statements with appropriate work
papers and journal entries. Pro forma financial statements include Statement of Operation;
Statement of Retained Earnings, Balance Sheet and Cash Flow Statement.

2. Adjust the separate financial statements of Main, Inc. to reflect the proposed acquisition. Adjust
Main's pro forma 2004 financial statements prepared in #1 to reflect the proposed acquisition
(i.e., adjust Main's forecasted financial statements for bond issuance, stock purchase, income
from subsidiary, etc.). Support your statements with appropriate work papers and journal entries.
Pro forma financial statements include Statement of Operation; Statement of Retained Earnings,
Balance Sheet and Cash Flow Statement.

3. Prepare pro forma consolidated worksheet. Prepare a pro forma consolidation
worksheet for Main, Inc. and its proposed subsidiary as of December 31, 2004. Use the
adjusted pro forma 2004 financial statements of Main, Inc. prepared in #2 and the
projected 2004 financial statements of Subsidiary Corporation in table 1. Show all
consolidation adjusting entries including minority interest entries.

4. Perform ratio analysis. Compute earnings per share for (1) the separate financial
statements of Main, Inc. prepared in #1 and (2) the consolidated financial statements
contained in the pro forma consolidation worksheet prepared in #3. Also, calculate current
ratio and return on average stockholders' equity for the consolidated financial statements.
Table 1
Main , Inc Actual Financial Statements for 2003 and
Subsidiary Corporation Projected Financial Statements for 2004

Subsidiary
Main 2003 2004
Actual Projected

Sales $ 800,000 $ 100,000
Cost of Goods Sold (485,000) (55,000)
Operating Expenses (219,000) (10,000)
Income before Taxes 96,000 35,000
Income Tax Expense (38,400) (14,000)
Net Income $ 57,600 $ 21,000

Retained Earnings January 1 $ 23,000 $ 14,500
Add Net Income 57,600 21,000
Deduct Dividends (38,000) (7,000)
Retained Earnings December 31 $ 42,600 $ 28,500

Cash $ 36,200 $ 19,500
Accounts Receivable 39,000 13,000
Inventory 26,000 12,000
Property, Plant and Equipment 673,000 213,000
Accumulated Depreciation (490,000) (28,000)
Total Assets 284,200 229,500

Accounts Payable 44,600 21,000
Common Stock* 190,000 150,000
Paid-in Capital in Excess of Par 7,000 30,000
Retained Earnings 42,600 28,500
Total Liabilities & Equities $ 284,200 $ 229,500
*Main: $12.50 par value. Subsidiary: $75 par value

Main Company
Projected Income Statement
For the year ended December 31, 2004

Subsidiary
Main 2003 2004 Main 2004
Actual Projected Projected

Sales $ 800,000 $ 100,000 $ 880,000
Cost of Goods Sold (485,000) (55,000) (528,650)
Operating Expenses (219,000) (10,000) (248,860)
Interest Expense (10,200)
Income from subsidiary 15,085
Income before Taxes 96,000 35,000 107,375
Income Tax Expense (38,400) (14,000) (42,950)
Net Income $ 57,600 $ 21,000 $ 64,425

Main Company
Projected Statement of Retained Earnings
As of December 31, 2004

Subsidiary
Main 2003 2004 Main 2004
Actual Projected Projected
Retained Earnings January 1 $ 23,000 $ 14,500 $ 42,600
Add Net Income 57,600 21,000 64,425
Deduct Dividends (38,000) (7,000) (38,000)
Retained Earnings December 31 $ 42,600 $ 28,500 $ 69,025

Main Company
Projected Balance Sheet
As of December 31, 2004

Subsidiary
Main 2003 2004 Main 2004
Actual Projected Projected
Cash $ 36,200 $ 19,500 $ 62,110
Accounts Receivable 39,000 13,000 37,050
Inventory 26,000 12,000 26,780
Investment in Subsidiary 179,485

Property, Plant and Equipment 673,000 213,000 721,000
Accumulated Depreciation (490,000) (28,000) (534,800)
Total Assets $ 284,200 $ 229,500 $ 491,625

Accounts Payable $ 44,600 $ 21,000 $ 50,500
Interest Payable 5,100
Bonds Payable 170,000
Common Stock* 190,000 150,000 190,000
Paid-in Capital in Excess of Par 7,000 30,000 7,000
Retained Earnings 42,600 28,500 69,025
Total Liabilities & Equities $ 284,200 $ 229,500 $ 491,625
Main Company
Projected Statement of Cash Flows
For the Year Ended December 31, 2004

Cash from operating activities
Net Income before tax $ 107,375
Add: Depreciation 44,800
Interest expense 10,200
Decrease in A/R 1,950
Increase in A/R 5,900
Increase in Interest Payable 5,100
Less: Investment income (15,085)
Increase in Inventory (780)
Income tax expense (42,950)
Cash from operating activities $ 116,510

Cash from Investing activities
Purchase of Equipment (48,000)
Investment in Subsidiary (170,000)
Cash from Investing Activities (218,000)

Cash from Financing activities
6% bonds issued 170,000
Dividend paid (38,000)
Dividend recd from investment 5,600
Interest paid (10,200)
Cash from Financing Activities 127,400
Changes in cash 25,910
Add: Opening balance 36,200
Closing cash balance $ 62,110

2004 Projected Schedules
Investment Acquisition
Cash Paid $ 168,000
Direct Acquisition Costs 2,000
Cost of Acquisition $ 170,000

Investment in Subsidiary
Investment in Subsidiary 1/1/04 $ 170,000
Deduct Dividends (5,600)
Add Income Accrual 2004 16,800
Deduct Amortization (240)
Deduct Unrealized Intercompany gain (1,280)
Deduct Unrealized Intercompany gain (195)
Investment in Subsidiary 12/31/04 $ 179,485
Item:
Machinery $ 8,000
Book Value 8,000
Fair Value 9,500
Difference $ 1,500
% Ownership 80%
Remaining Life 5
Amortization $ 240

Inventory Sales - Upstream 2004
Gross profit $ 1,600
Ownership % 80%
Unrealized Intercompany Gain $ 1,280

Inventory Sales - Downstream 2004
Gross profit $ 195
Ownership % 100%
Unrealized Intercompany Gain $ 195

Equity Income 2004
Annual Amortization $ -
Income from Subsidiary 16,800
Unrealized Intercompany Gain (1,475)
Equity Income 2004 $ 15,325

Purchases Schedule
1/1/2004 Beginning Inventory $ 26,000
Purchases 529,430
COGS (528,650)
12/31/04 End Inventory $ 26,780

Accounts Payable Schedule
Accounts Payable Beg Bal $ 44,600
Inventory Purchase 529,430
Payments (523,530)
Ending Balance $ 50,500

Accounts Receivable Schedule
Accounts Receivable beg bal $ 39,000
Sales 880,000
Cash Receipts (881,950)
Ending Balance $ 37,050
MAIN COMPANY AND SUBSIDIARY COMPANY
Consolidation Worksheet
For Year Ending December 31, 2009

Main Subsidiary Consolidation Entries Consolidated
Accounts Company Company Debit Credit Totals
Revenues $ (880,000) $ (100,000) $ (980,000)
Costs of goods sold 528,650 55,000 583,650
Depreciation expense 248,860 10,000 258,860
Interest Expense 10,200 - 10,200
Income from subsidiary (15,085) - (15,085)
Income Tax Expense 42,950 14,000 56,950
Noncontrolling Interest -
Net income $ (64,425) $ (21,000) $ (85,425)

Retained Earnings January 1 (42,600) (14,500) 14,500 $ (42,600)
Net income (64,425) (21,000) 21,000 $ (64,425)
Dividends paid 38,000 7,000 7,000 $ 38,000
Retained Earnings December $
31 (69,025) $ (28,500) $ (69,025)

Cash $ 62,110 $ 19,500 $ 81,610
Accounts Receivable 37,050 13,000 $ 50,050
Inventory 26,780 12,000 $ 38,780
Investment in Subsidiary 179,485 $ 179,485
$ -
Property, Plant and Equipment 721,000 213,000 $ 934,000
Accumulated Depreciation (534,800) (28,000) $ (562,800)
Total assets $ 491,625 $ 229,500 $ 721,125

Accounts Payable (50,500) (21,000) (71,500)
Interest Payable (5,100) - (5,100)
Bonds Payable (170,000) - (170,000)
Common Stock* (190,000) (150,000) (340,000)
Paid-in Capital in Excess of Par (7,000) (30,000) (37,000)
Retained Earnings (69,025) (28,500) (97,525)
Total liabilities and equity $ (491,625) $ (229,500) $ (721,125)

Parentheses indicate a credit balance.