CONSOLIDATION OF FINANCIAL INFORMATION

Chapter 02 – Consolidation of Financial Information – Hoyle, Schaefer, Doupnik, Fundamentals 7e 2-1 Copyright © 2018 McGraw-Hill Education. All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.

CHAPTER 2

CONSOLIDATION OF FINANCIAL INFORMATION

Accounting standards for business combination are found in FASB ASC Topic 805, “Business Combinations” and Topic 810, “Consolidation.” These standards require the acquisition method which emphasizes acquisition-date fair values for recording all combinations.In this chapter, we first provide coverage of expansion through corporate takeovers and an overview of the consolidation process. Then we present the acquisition method of accounting for business combinations followed by limited coverage of the purchase method and pooling of interests provided in the Appendix 2A and pushdown accounting in Appendix 2B.Chapter Outline

• Business combinations and the consolidation process
• A business combination is the formation of a single economic entity, an event that

occurs whenever one company gains control over another

• Business combinations can be created in several different ways
• Statutory merger—only one of the original companies remains in business as a

legally incorporated enterprise.

• Assets and liabilities can be acquired with the seller then dissolving itself as a

corporation.

• All of the capital stock of a company can be acquired with the assets and

liabilities then transferred to the buyer followed by the seller’s dissolution.

• Statutory consolidation—assets or capital stock of two or more companies are

transferred to a newly formed corporation

• Acquisition by one company of a controlling interest in the voting stock of a

second. Dissolution does not take place; both parties retain their separate legal incorporation.

• Financial information from the members of a business combination must be

consolidated into a single set of financial statements representing the entire economic entity.

• If the acquired company is legally dissolved, a permanent consolidation is

produced on the date of acquisition by entering all account balances into the financial records of the surviving company.

• If separate incorporation is maintained, consolidation is periodically simulated

whenever financial statements are to be prepared. This process is carried out through the use of worksheets and consolidation entries. Consolidation worksheet entries are used to adjust and eliminate subsidiary company accounts. Entry “S” eliminates the equity accounts of the subsidiary. Entry “A” allocates exess payment amounts to identifiable assets and liabilities based on the fair value of the subsidiary accounts. (Consolidation journal entries are never recorded in the books of either company, they are worksheet entries only.) Fundamentals of Advanced Accounting 8th Edition Hoyle Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Chapter 02 – Consolidation of Financial Information – Hoyle, Schaefer, Doupnik, Fundamentals 7e 2-2 Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.II. The Acquisition Method

• The acquisition method replaced the purchase method. For combinations resulting in

complete ownership, it is distinguished by four characteristics.

• All assets acquired and liabilities assumed in the combination are recognized and

measured at their individual fair values (with few exceptions).

• The fair value of the consideration transferred provides a starting point for valuing

and recording a business combination.

• The consideration transferred includes cash, securities, and contingent

performance obligations.

• Direct combination costs are expensed as incurred.
• Stock issuance costs are recorded as a reduction in paid-in capital.
• The fair value of any noncontrolling interest also adds to the valuation of the

acquired firm and is covered beginning in Chapter 4 of the text.

• Any excess of the fair value of the consideration transferred over the net amount

assigned to the individual assets acquired and liabilities assumed is recognized by the acquirer as goodwill.

• Any excess of the net amount assigned to the individual assets acquired and

liabilities assumed over the fair value of the consideration transferred is recognized by the acquirer as a “gain on bargain purchase.”

• In-process research and development acquired in a business combination is

recognized as an asset at its acquisition-date fair value.III. Convergence between U.S. GAAP and IAS IFRS 3 – nearly identical to U.S. GAAP because of joint efforts

APPENDIX 2A:

• The Purchase Method
• The purchase method was applicable for business combinations occurring for fiscal

years beginning prior to December 15, 2008. It was distinguished by three characteristics.

• One company was clearly in a dominant role as the purchasing party
• A bargained exchange transaction took place to obtain control over the second

company.

• A historical cost figure was determined based on the acquisition price paid.
• The cost of the acquisition included any direct combination costs.
• Stock issuance costs were recorded as a reduction in paid-in capital and are

not considered to be a component of the acquisition price.

• Purchase method procedures
• The assets and liabilities acquired were measured by the buyer at fair value as of

the date of acquisition.

• Any portion of the payment made in excess of the fair value of these assets and

liabilities was attributed to an intangible asset commonly referred to as goodwill.

• If the price paid was below the fair value of the assets and liabilities, the acquired

company accounts were still measured at fair value except that certain noncurrent asset values were reduced by the excess cost. If these values were not great enough to absorb the entire reduction, an extraordinary gain was recognized.

Chapter 02 – Consolidation of Financial Information – Hoyle, Schaefer, Doupnik, Fundamentals 7e 2-3 Copyright © 2018 McGraw-Hill Education. All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.II. The Pooling of Interest Method (prohibited for combinations after June 2002)

• A pooling of interests reflected united ownership of two companies through the

exchange of equity securities. The characteristics of a pooling are fundamentally different from either the purchase or acquisition methods.

• Neither party was truly viewed as an acquiring company.
• Precise cost figures from the exchange of securities were difficult to ascertain.
• The transaction affected the stockholders rather than the companies.
• Pooling of interests accounting
• Because of the nature of a pooling, an acquisition price was not relevant.
• Since no acquisition price was computed, all direct costs of creating the

combination were expensed immediately.

• No new goodwill was recognized from the combination. Similarly, no valuation

adjustments were recorded for any of the subsidiary assets or liabilities.

• The book values of the two companies were simply brought together to produce

consolidated financial statements. A pooling was viewed as a uniting of the owners rather than the two companies.

• The results of operations reported by both parties were combined on a retroactive

basis as if the companies had always been together.

• Controversy historically surrounded the pooling of interests method.
• Cost figures indicated by the exchange transaction were ignored.
• Income balances previously reported were combined on a retrospective basis.
• Reported net income was usually higher in subsequent years than in a

purchase because the lack of valuation adjustments reduced amortization.

APPENDIX 2B: Pushdown Accounting

• Pushdown accounting is the application of the parent’s acquisition-date valuations for the

subsidiary’s standalone financial statements. A newly acquired entity may elect the option to apply pushdown accounting in the reporting period immediately following the acquisition. The rationale is that the acquisition-date fair values for the subsidiary’s assets and liabilities are more representationally faithful and relevant to users of the subsidiary’s financial statements.II. When push-down accounting is elected,

• The subsidiary revalues its assets and liabilities based on the acquisition-date fair value

allocations. The subsidiary then recognizes periodic amortization expense on those allocations with definite lives. Therefore, the subsidiary’s recorded income equals its impact on consolidated earnings (except in the presence of a bargain purchase gain).

• Any goodwill from the combination is reported in the acquired entity’s separate financial

statements. In the case of a bargain purchase gain, pushdown accounting recognize an adjustment to its additional paid-in capital, not as a gain in its income statement.

• the subsidiary’s retained earnings are revalued to zero recognizing the new reporting

entity as of the parent’s acquisition date.III. The parent uses no special procedures when push-down accounting is being applied.However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary.

Chapter 02 – Consolidation of Financial Information – Hoyle, Schaefer, Doupnik, Fundamentals 7e 2-4 Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Answers to Questions

• A business combination is the process of forming a single economic entity by the uniting

of two or more organizations under common ownership. The term also refers to the entity that results from this process.

• (1) A statutory merger is created whenever two or more companies come together to

form a business combination and only one remains in existence as an identifiable entity.This arrangement is often instituted by the acquisition of substantially all of an enterprise’s assets. (2) A statutory merger can also be produced by the acquisition of a company’s capital stock. This transaction is labeled a statutory merger if the acquired company transfers its assets and liabilities to the buyer and then legally dissolves as a corporation. (3) A statutory consolidation results when two or more companies transfer all of their assets or capital stock to a newly formed corporation. The original companies are being “consolidated” into the new entity. (4) A business combination is also formed whenever one company gains control over another through the acquisition of outstanding voting stock. Both companies retain their separate legal identities although the common ownership indicates that only a single economic entity exists.

• Consolidated financial statements represent accounting information gathered from two or

more separate companies. This data, although accumulated individually by the organizations, is brought together (or consolidated) to describe the single economic entity created by the business combination.

• Companies that form a business combination will often retain their separate legal

identities as well as their individual accounting systems. In such cases, internal financial data continues to be accumulated by each organization. Separate financial reports may be required for outside shareholders (a noncontrolling interest), the government, debt holders, etc. This information may also be utilized in corporate evaluations and other decision making. However, the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity. The purpose of a worksheet is to organize and structure this process.The worksheet allows for a simulated consolidation to be carried out on a regular, periodic basis without affecting the financial records of the various component companies.

• Several situations can occur in which the fair value of the 50,000 shares being issued

might be difficult to ascertain. These examples include:

 The shares may be newly issued (if Jones has just been created) so that no accurate value has yet been established;  Jones may be a closely held corporation so that no fair value is available for its shares;  The number of newly issued shares (especially if the amount is large in comparison to the quantity of previously outstanding shares) may cause the price of the stock to fluctuate widely so that no accurate fair value can be determined during a reasonable period of time;  Jones’ stock may have historically experienced drastic swings in price. Thus, a quoted figure at any specific point in time may not be an adequate or representative value for long-term accounting purposes.

• For combinations resulting in complete ownership, the acquisition method allocates the

fair value of the consideration transferred to the separately recognized assets acquired and liabilities assumed based on their individual fair values.

• The revenues and expenses (both current and past) of the parent are included within

reported figures. However, the revenues and expenses of the subsidiary are