FASB Statement No. 95, “Statement of Cash Flows,” mandates that companies include a statement of cash flows among their financial statements. The consolidated statement of cash flows is not prepared from the individual cash flow statements of the separate companies. Instead, the income statements and balance sheets are first brought together on the worksheet. The cash flows statement is then based on the resulting consolidated figures.
Thus, this statement is not actually produced by consolidation but is created from numbers generated by that process. However, preparing a consolidated statement of cash flows does introduce several accounting issues. Its preparation involves properly handling of any excess amortizations, intercompany transactions, subsidiary dividends, and several other acquisition-year cash flows.
A worksheet adjustment (Entry E) includes in the consolidation process the amortizations of acquisition-date excess fair-value allocations. These expenses do not appear on either set of individual records but in the consolidated income statement. As a noncash decrease in income, this expense, under the indirect approach, is added back to consolidated net income to arrive at cash flows from operations. If the business combination uses the direct approach, it omits the balance because this expense does not affect the amount of cash.
As this text previously discussed, a significant volume of transfers between the related companies composing a business combination often occurs. The resulting effects of this intercompany activity is eliminated on the worksheet so that the consolidated statements reflect only transactions with outside parties. Likewise, the consolidated statement of cash flows does not include the impact of these transfers.
Intercompany sales and purchases do not change the amount of cash held by the business combination when viewed as a whole. Because the statement of cash flows is derived from the consolidated balance sheet and income statement, the impact of all transfers is already removed. Therefore, no special adjustments are needed to properly present cash flows. The worksheet entries produce correct balances for the consolidated statement of cash flows.
The cash outflow from dividends paid by a subsidiary only leaves the consolidated entity when paid to the non-controlling interest. Thus dividends paid by a subsidiary to its parent do not appear as financing outflows. However, subsidiary dividends paid to the non-controlling interest are a component of cash outflows from financing activities.
In the year of a business acquisition, the consolidated cash flow statement must properly reflect several additional considerations.
For many business combinations, the following issues frequently are present:
i. Cash purchases of businesses are an investing activity. The net cash outflow (cash paid less subsidiary cash acquired) is reported as the amount paid in a business acquisition.
ii. For intraperiod acquisitions, SFAS No. 95 requires that any adjustments from changes in operating balance sheet accounts (Accounts Receivable, Inventory, Accounts Payable, etc.) reflect the amounts acquired in the combination. Therefore, any changes in operating assets and liabilities are reported net of effects of acquired businesses in computing the adjustments to convert consolidated net income to operating cash flows. Use of the direct approach of presenting operating cash flows also reports the separate computations of cash collected from customers and cash paid for inventory net of effects of any acquired businesses.
iii. Any adjustments arising from the subsidiary’s revenues or expenses (e.g., depreciation, amortization) must reflect only post-acquisition amounts. Closing the subsidiary’s books at the date of acquisition facilitates the determination of the appropriate post-acquisition subsidiary effects on the consolidated entity’s cash flows.
Assume that on July 1, 2009, Pinto Company acquires 90 percent of Salida Company’s outstanding stock for $774,000 in cash. At the acquisition date, the 10 percent non-controlling interest has a fair value of $86,000. Exhibit 6.6 shows book and fair values of Salida’s assets and liabilities and Pinto’s acquisition-date fair-value allocation schedule.
At the end of 2009, the following comparative balance sheets and consolidated income statement are available:
Additional Information:
i. The consolidated income statement totals include Salida’s post-acquisition revenues and expenses.
ii. During 2009, Pinto paid $50,000 in dividends. On August 1, 2009, Salida paid a $25,000 dividend.
iii. During 2009, Pinto issued $504,000 in long-term debt at par value.
iv. No asset purchases or dispositions occurred during 2009 other than Pinto’s purchase of Salida.
In preparing the consolidated statement of cash flows, note that each adjustment derives from the consolidated income statement or changes from Pinto’s January 1, 2009, balance sheet to the consolidated balance sheet at December 31, 2009.
Depreciation and Amortization:
These expenses do not represent current operating cash outflows and thus are added back to convert accrual basis income to cash provided by operating activities.
Increase in Accounts Receivable, Inventory, and Accounts Payable (Net of Acquisition):
SFAS No. 95 requires that changes in balance sheet accounts affecting operating cash flows reflect amounts acquired in business acquisitions.
In this case, note that the changes in Accounts Receivable, Inventory, and Accounts Payable are computed as follows:
Acquisition of Salida Company:
The Investing Activities section of the cash flow statement shows increases and decreases in assets purchased or sold involving cash.
The cash outflow from the acquisition of Salida Company is determined as follows:
Note here that although Pinto acquires only 90 percent of Salida, 100 percent of Salida’s cash is offset against the purchase price in determining the investing cash outflow. Ownership divisions between the non-controlling and controlling interests do not affect reporting for the entity’s investing cash flows.
Issue of Long-Term Debt:
Pinto Company’s issuance of long-term debt represents a cash inflow from financing activities.
The dividends paid to Pinto Company owners ($50,000) combined with the dividends paid to the non-controlling interest ($2,500) represent cash outflows from financing activities.
Based on the consolidated totals from the comparative balance sheets and the consolidated income statement, the following consolidated statement of cash flows is then prepared. Pinto chooses to use the indirect method of reporting cash flows from operating activities.
