Download Advanced Accounting by Hoyle et al, 6th Edition

Chapter Two
Consolidation
of Financial
Information
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
2-2
Business Combinations
A business combination refers
to a transaction or other event
in which an acquirer obtains
control
over one or more businesses.
There are five types of
combinations that are required
to prepare consolidated
statements.
2-3
Statutory Merger (Through
Asset Acquisition)
Investor acquires assets (and
often liabilities) of the Investee
Investee dissolves and goes out of
business
Investee’s books are permanently
closed and the Investor’s books are
adjusted at the acquisition date for
the newly acquired accounts
One entity survives and moves
forward
2-4
Statutory Merger (Through
Capital Stock Acquisition)
Investor acquires all stock of
the Investee, and then transfers
assets and liabilities of the
Investee to its own books.
Investee dissolves as a separate
company but often remains as a
division of the Investor.
One entity survives and moves
forward
2-5
Statutory Consolidation
A newly created company
receives all assets or stock of the
original companies.
Original companies dissolve,
but often remain as divisions of
the new company.
2-6
Acquisition of Majority of Shares
Investor acquires the majority of
voting stock of another company,
and is able to control their
decisions.
Investor records the investment
in the stock of the Investee.
Investee remains in existence as a
separate company, but as a
subsidiary of the Investor, or
parent company.
2-7
Control Through Ownership of
Variable Interests
Sponsoring Firm creates a Special
Purpose Entity (SPE) intended to engage
in a specific activity
Investor may be different than the
Sponsoring Firm
SPE is a separate legal entity whose
risks and rewards may flow to
Sponsoring Firm instead of to the equity
investors.
Control is established by
agreement, not ownership.
2-8
The Acquisition Method –
EFFECTIVE IN 2009

Used when there is a change in
ownership, resulting in control of one
enterprise by another
 Requires accounting for the fair value of
the acquired business as a whole by
recognizing and measuring:
 Consideration transferred
 The fair value of each
asset acquired and
liability assumed
 Effectively converged with
International Standards
2-9
Acquisition Method
(Continued…)
What must be determined at
the date of acquisition?
The “Fair Value” of assets and
liabilities acquired, including the value
of purchased In-Process Research
and Development (and ignoring
equity accounts)
 The value of consideration transferred
 The fair value of any contingent
consideration given, based on risk
and probability of payment

2-10
Acquisition Method –
(Continued…)
But what if the consideration transferred
does NOT EQUAL the Fair Value of the
Assets acquired??
If the Consideration is MORE than the
Fair Value of the Assets acquired, the
difference is attributed to GOODWILL
If the Consideration is LESS than the
Fair Value of the Assets acquired, we
got a BARGAIN!! And we will record a
GAIN on the acquisition!!
2-11
Acquisition Method – Related
Costs of Business Combinations

Direct Costs of the acquisition
(attorneys, appraisers, accountants,
investment bankers, etc.) are NOT part
of the fair value received, and so are
immediately expensed
 Indirect or Internal Costs of acquisition
(secretarial and management time) are
expensed as incurred.
 Costs to register and issue
securities related to the
acquisition reduce their fair value
2-12
Acquisition Method –
No Dissolution
If the acquired company doesn’t dissolve,
but continues as a separate entity:

Separate records for each company are still
maintained.

The acquired company is reported on the
Parent’s books (Investment in Subsidiary
account).

The adjusted balances for Parent and
Subsidiary are consolidated using a
worksheet only (no formal
journal entries!)
2-13
The Consolidation Worksheet
1. Parent prepares the allocation of the FV,
including calculation of gain or goodwill.
2. The financial information for Parent and
Sub are recorded in the first two columns of
the worksheet (with Sub’s prior revenue
and expense already closed).
3. Remove the Sub’s equity account balances.
4. Remove the Investment in Sub balance.
5. Allocate Sub’s Fair Values, including any
excess of cost over Book Value to
identifiable assets or goodwill.
6. Combine all account balances.
2-14
Purchase Price Allocations –
Additional Issues
Intangibles are assets that:
 Lack physical substance (excluding
financial instruments)
 Arise from contractual or other legal rights
 Can be sold or otherwise separated from
the acquired enterprise
Note: If there was goodwill
already recorded in the acquired
company’s accounts, it is ignored
in the allocation of the purchase
price.
2-15
Purchase Price Allocations Additional Issues
In-Process R&D
 IPR&D is capitalized as an intangible
asset
 Determination of fair value is critical

IPR&D is considered to have an
indefinite life, and is reviewed for
impairment.
 Ongoing R&D is expensed
as incurred.
2-16
Legacy Methods – Purchase and
Pooling of Interests Methods
Since the ACQUISITION
METHOD is applied only
to business combinations
occurring in 2009 and
after, the two prior
methods are still in use.

2002 to 2008: PURCHASE METHOD

Prior to 2002: PURCHASE METHOD
or the POOLING OF
INTERESTS METHOD
2-17
Purchase Method – Differences
from the Acquisition Method

Valuation basis is “cost”
 The value of the consideration
transferred,
 PLUS the direct costs of the acquisition,
 IGNORING any indirect costs of the
acquisition,
 IGNORING any contingent payments.

The total cost of the acquisition is
allocated proportionately to the net
assets based on their fair values,
with any excess going to goodwill.
2-18
Pooling of Interests –
Historical Review





The larger company records an
Investment in Sub account.
Consolidation is done on a
worksheet only, eliminating Investment
account and Sub’s equity accounts.
The remaining Book Values of the
combining companies are simply added
together.
No goodwill is recorded.
Revenues and expenses are combined
retrospectively, and prospectively.