by 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.
Amortizations:
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.
Intercompany Transactions:
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.
Subsidiary Dividends Paid:
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.
Acquisition Year Cash Flow Adjustments:
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:
- 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.
- 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.
- 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.
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.
Acquisition of Salida Company:
The Investing Activities section of the cash flow statement shows increases and decreases in assets purchased or sold involving cash.
Consolidation Includes
Adjustments to offset the net effect of intercompany sales and transfers are required, because consolidation rolls all results into one and no accounting rule allows a company to sell or transfer goods or services to itself. For consolidation rules to apply, your company must own the majority of the outstanding stock, membership interests or limited partner interests in a business. If your company has voting control but not ownership control, meaning your company directs what another business does but does not own 50.1 percent or more, then you exclude that business from the consolidation.
