Accounting theory and practice, Volume 2 (of 3)

by Roy B. Kester

The Setting Up of the Consolidated Balance Sheet

With this explanation of purpose and function of the consolidated balance sheet, it is purposed now to draw attention to some of the problems met in drawing up such a statement. The first essential condition to facilitate the consolidation of the balance sheets of the various subsidiaries with that of the holding company is that standardized methods of accounting resulting in a similar classification of accounts and presentation of results be used by all the subsidiaries. The consolidated statement is then merely a combination of the values of similar items in all the balance sheets to determine the valuation at which the consolidated items shall appear.

On the balance sheets of the various companies certain accounts will appear which represent intercompany relationships. Thus, on that of the holding company appear the securities which are represented on the statements of the subsidiaries by their net assets. In other words, the securities of the holding company are assets represented by the proprietorship items of the various subsidiaries. Sometimes on the consolidated balance sheet both items are shown. This results, of course, in an almost exact duplication of items inasmuch as the holding company’s securities are a statement of the net asset values of the subsidiaries. The better method of presentation, however, seems to be the elimination of the securities of the holding company against the proprietorship items of the subsidiaries. It may frequently happen that the values of these two items to be eliminated are not the same. This will always be the case if the holding company values its securities either above or below the par of the capital stocks of the subsidiaries, plus any surplus belonging to the subsidiary at date of purchase by the holding company.

It is to be presumed that the values at which the securities are held on the books of the holding company represent the latter’s estimate of the value of its interests in the various subsidiaries. If this value is more than the net worth of the subsidiary as shown by its capital stock outstanding and surplus at the time of purchase by the holding company, the difference between the value at which the securities are carried by the holding company and the net worth of the subsidiary must represent the value placed by the holding company on the good-will of the subsidiary. This good-will does not appear, of course, on the books of the subsidiary. Hence, in consolidating the balance sheet of the subsidiary with that of the holding company, it is necessary to set up the asset good-will and thus increase the net worth of the subsidiary to the point where it can be exactly canceled against the value of the securities on the balance sheet of the holding company. If, however, the value of the securities on the holding company’s books is less than the net worth of the subsidiary, that condition indicates that in the opinion of the holding company the assets of the subsidiary as carried on the subsidiary’s books are overvalued. In this case it becomes necessary, upon consolidation, to set up a depreciation reserve under suitable title.

The effect of this, so far as the eliminations on the consolidated balance sheet are concerned, is merely to set up under the title Depreciation Reserve the portion of the subsidiary’s capital stock—or capital stock and surplus—not canceled by the amount at which the holding company carries on its books the value of its interest in the subsidiary. Instead of carrying this difference in values under the title Depreciation Reserve, it is sometimes shown as Capital Surplus. This is merely another way of saying that the portion of the subsidiary’s capital stock not canceled by the holding company’s investment in the subsidiary is simply carried on the consolidated balance sheet under another name. Another method of handling this uncanceled amount is to carry it into the consolidated balance sheet as a credit to Good-Will account, and so secure a reduction in the value at which this intangible asset is shown in the balance sheet of the allied companies. This may sometimes result in reducing the value of good-will to a negligible figure, or in writing it off the books entirely, or even in showing it with a credit balance. There is little to choose between the methods; the author prefers the use of the depreciation reserve. The balance sheets of all of the subsidiaries are in this way consolidated with the balance sheet of the holding company.

On the consolidated balance sheet as at the date of the purchase of the various subsidiaries, there will not therefore be shown any item of surplus, inasmuch as the items of surplus on the balance sheets of the various subsidiaries have been eliminated together with their capital stock items against the securities on the balance sheet of the holding company. This is as it should be. Surplus account properly used should represent only profits reserved from operation. The holding company cannot, therefore, previous to its operation, show any item of surplus even though the subsidiary companies have accumulated profits which they, of course, are entirely right in showing under the title Surplus.

A distinction must be made here between what is termed “contributed” surplus and “operating” surplus. Any corporation, the holding company included, may at the time of its organization have some portion of its capital represented by contributed or capital surplus. It has been pointed out that this may arise either through subscription to its stock at a premium, or by a later donation of stock by its stockholders which, when sold, may be recorded as working capital surplus or contributed surplus. It is not possible, however, for any corporation, previous to its operation, to show as a balance sheet item an operating surplus from which it might be possible to declare dividends.

Showing of Intercompany Accounts

At the time of consolidation, intercompany accounts of various sorts will also appear. The holding company may have made advances of cash to some of the subsidiaries. These will be shown on the books of the holding company as open account claims against the subsidiaries, while on the books of the subsidiaries they appear as increases among the assets—usually cash or other current items—offset by open liability claims in favor of the holding company. The account receivable on the holding company’s books should be eliminated against the account payable on the books of the subsidiary. Similarly, there may be numerous inter-subsidiary accounts which may be eliminated, the ones against the others. The need for a very careful classification of accounts receivable in order to separate the claims against trade debtors from those against allied companies should be emphasized when it is desirable to consolidate balance sheets on which these various classes of accounts receivable appear.

Showing of Notes Discounted