Accounting Practices Related to Financial Statements, Account Liquidation and Journalizing

Solution Preview

Consolidated financial Statements
The main purpose of a company is to grow financially, so most often in practice companies will purchase other companies. This is a form of investment and allows a company to extend its services and products to existing and new clientele, and also allows a company to grow geographically [more branches]. So then a company will purchase equity of another existing company, and depending on the amount of equity purchased the purchasing company can either own substantially enough shares to control the purchased company or have significant influence within that company or just own shares and have no control over the specific company.

If company-A purchases enough shares to control company-B [51% +], then company-A is called the 'Parent' and company-B is called the 'subsidiary' and any other remaining investors are called "Non-Controlling Interest".
Purchasing shares from a company means that one is acquiring the equity of that company, and according to the accounting equation - we know that Assets = Equity + Liabilities, thus Equity = Assets - Liabilities. So essentially when Company-A invests in Company-B, it is acquiring the equity of that company which is in essences the Assets - Liabilities of that company.

Unit 3 and Unit 5
The purpose of consolidating financial statements of a Group of companies (collection of parents and subsidiaries) is to express to the owners of the parent company how well or bad the company is doing. When consolidating financial statements a parent cannot include its investment in its subsidiary within the consolidated financial statements of the group, because it will be double counting figures. Think about it this way, A invests in B - so now A and B are essentially one entity because they form a group of companies. So now, A cannot include its investment in B within its consolidated financial statements because then it will be showing an investment within its self, and companies cannot invest in within themselves. So the investment gets eliminated through the pro forma journals.
Here is an example of a pro forma journal that eliminates an investment in subsidiary.
Ordinary Shares XXXXX
Retained Earnings XXXXX
Revaluation Surplus XXXXX
Investment in subsidiary XXXX
Non-controlling interest XXXX

So as you can see elimination journals are the inverse of the original journal - they eliminate transactions. (This principle also applies to Intra group transactions)

When an asset is under or over valued at date of acquisition then necessary adjustments have to be made to reflect the true value of the companies' assets. If A purchases B at a price more than what it is worth (after values have been adjusted and are fairly presented) then the residual is called "Goodwill" and if A purchases B at less than what it's worth then the deficit is called "Gain on Bargain purchase". If either of the two elements stated above exist then they shall be presented on the consolidated statements.

Intra group ...