A Company has to publish a Statement of Cash Flow along with the Income Statement and Balance Sheet. The cash acquisition of a controlling interest in a company is considered an investing activity and would appear as a cash outflow in the cash flows from the investing activities section of the statement of cash flows. It is also necessary to explain the total increase in consolidated assets and the addition of the NCI to the consolidated balance sheet. This is a result of the requirement that the statement of cash flows disclose investing and financing activities that affect the company’s financial position even though they do not impact cash.
Net income is the largest source of cash, but in calculating net income some noncash expenses are deducted. These noncash expenses such as depreciation and amortization of capitalized software and other intangibles do not require a cash payment. Within the cash flow statement net income is subsequently adjusted to align with cash flows by “adding back” noncash expenses such as depreciation and amortization. In a similar manner, an adjustment must be made for deferred taxes. The change in deferred taxes represents the difference between the tax expenses on the income statement and what was actually paid to the taxing authorities.
The second section of cash from operating activities presents the year-to-year changes in operating assets and liabilities. Eg. Accounts receivables, inventories and so on.
Let us look at a small example:
| Assets | Amount | Liabilities | Amount |
| Cash and cash equivalents | 50000 | Long term liabilities | 150000 |
| Inventory | 60000 | Common Stock | 200000 |
| Equipment | 190000 | Retained Earnings | 350000 |
| Building | 400000 | | |
| Total Assets | 700000 | Total | 700000 |
Assume the fair values of the equipment and building are $250000 and $425000 respectively and any remaining excess of cost is attributed to goodwill. The estimated remaining life of the equipment in 5 years and of the building is 10 years.
The following value analysis schedule and D&D schedule were prepared:
| Value Analysis Schedule | Company Implied Fair Value | Parent Price (80%) | NCI Value (20%) |
| Company Fair Value | $675000 | $540000 | $135000 |
| Fair value of net assets excluding goodwill | 635000 | 508000 | 127000 |
| Goodwill | 40000 | 32000 | 8000 |
Based on the above information, the following D&D schedule is prepared:
Determination And Distribution of Excess Schedule
| | Company Implied Fair Value | Parent Price (80%) | NCI Value (20%) | ||
| Fair Value of Subsidiary | $675000 | $540000 | $135000 | ||
| Less book value of interest acquired: | | | | ||
| Common Stock | $200000 | | | ||
| Retained Earnings | 350000 | | | ||
| Total Stockholders’ equity | $550000 | $550000 | $550000 | ||
| Interest acquired | | 80% | 20% | ||
| Book Value | | $440000 | $110000 | ||
| Excess of fair value over book value | 125000 | 100000 | 25000 | ||
| Adjustment of Identifiable Accounts: | Adjustment | Amortization per year | Life | Worksheet Key | |
| Equipment (250000 – 1900000) | 60000 | 12000 | 5 | Debit D1 | |
| Building (425000 –400000) | 25000 | 2500 | 10 | Debit D2 | |
| Goodwill (675000 —635000) | 40000 | | | Debit D3 | |
| Total | 125000 | | | | |
The effect of the purchase on the balance sheet accounts of the consolidated company would be as follows:
| | Debit | Credit |
| Cash (540000 – 50000 subsidiary cash) | | 490000 |
| Inventory | 60000 | |
| Equipment (190000 book value + 60000 excess) | 250000 | |
| Building (400000 bookvalue + 60000 excess) | 425000 | |
| Goodwill | 40000 | |
| Long term liabilities | | 150000 |
| Non controlling interest (20% * 550000 subsidiary equity + 25000 NCI adjustment) | | 135000 |
| Total | 775000 | 775000 |
The disclosure of the purchase on the statement of cash flows would be summarized as:
Under the heading “Cash Flows from investing activities”
Payment for the purchase of Company S, net of cash acquired $149000
In the supplemental schedule of noncash financing and investing activity:
Company P acquired 80% of the common stock of Company S for $540000. In conjunction with the acquisition, liabilities were assumed and an NCI was created as follows:
Adjusted value of assets acquired ($700000 book value + $125000 excess) $825000
Cash paid for common stock 540000
Balance (noncash) $285000 Liabilities assumed $150000 Noncontrolling interest $135000
Noncash acquisition of Controlling Interest
Suppose that instead of paying cash for its controlling interest, Company P issued 10000 shares of its $10 par stock for the controlling interest. Further we assume the shares had a market value of $54 each. Since the acquisition price is the same (#540000), the determination and distribution of excess schedule would not change. The analysis of balance sheet account changes would be as follows:
| | Debit | Credit |
| Cash ($50000 subsidiary cash) | 50000 | |
| Inventory | 60000 | |
| Equipment ($190000 book value + $60000 excess) | 250000 | |
| Building ($400000 book value + $25000 ) | 425000 | |
| Goodwill | 40000 | |
| Long term Liabilities | | 150000 |
| Noncontrolling interest (20% * $555000, subsidiary equity + $25000 NCI adjustment) | | 135000 |
| Common stock ($10 par), Company P | | 100000 |
| Paid-in capital in excess of par, Company P | | 440000 |
| Total | 825000 | 825000 |
A business combination will have ramifications on the statements of cash flows prepared in subsequent periods. An acquisition may create amortizations of excess deductions (non cash items) that need to be adjusted. In addition, there may be changes resulting from additional purchases of subsidiary shares and/or dividend payments by the subsidiary. Intercompany bonds and nonconsolidated investments also need to be considered for their impact.
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This article is in continuation with our previous articles on Finance which include CAPM Model, Merger & Acquisitions, Corporate Finance, Capital Structure, Bond Valuation
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