Chapter Three

Consolidations – Subsequent to

the Date of Acquisition

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Consolidation – The Effects of the Passage of Time

Learning Objective 3-1:Recognize the complexities in preparing consolidated financial reports that emerge from the passage of time.

The passage of time creates complexities for internal record keeping and the balance of the investment account varies due to the accounting method used.

A worksheet and consolidation entries are used to eliminate the investment account and record the subsidiary’s assets and liabilities to create a single set of financial statements for the combined business entity.

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Investment Accounting by Acquiring Company

The acquiring company selects one of three methods :

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Equity Method Initial Value Method Partial Equity Method

Learning Objective 3-2: Identify and describe the various methods available to a parent company in order to maintain its investment in subsidiary account in its internal records.

An asset account, investment account, and an income account is created for each subsidiary owned.

Investment Accounting by Acquiring Company

Comparison of internal reporting of investment methods.

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Method Investment Income Account

Equity Continually adjusted to reflect ownership of acquired company.

Income accrued as earned; amortization and other adjustments are recognized.

Initial Value Remains at Initially-Recorded cost

Dividends declared recorded as Dividend Income

Partial Equity Adjusted only for accrued income and dividends declared by acquired company.

Income accrued as earned; no other adjustments recognized.

During the year, the parent will adjust its investment account for the Subsidiary under application of the equity method. The original investment, recorded at the date of acquisition, is adjusted for:

Subsequent Consolidation – Equity Method

1. FMV adjustments and other intangible assets,2. The parent’s share of the sub’s income (loss), 3. The receipt of dividends from the sub.

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Learning Objective 3-3a:Prepare consolidated financial statements subsequent to acquisition when the parent has applied the equity method in its internal records.

Subsequent Consolidation – Allocating FMV

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FV of consideration transferred by Parrot Company. $ 800,000Net Book Value of Sun Company. . . . . . . . . . . . . . . . . . .(600,000)

Excess of fair value over book value . . . . . . . . . . 200,000Allocation to specific accounts based on fair values:Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 20,000Patented technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,000Equipment (overvalued) . . . . . . . . . . . . . . . . . . . . . . . . . (30,000) 120,000Excess FV not specifically identified—goodwill. . . . . . $ 80,000

PARROT COMPANY100 Percent Acquisition of Sun Company

Allocation of Acquisition-Date Subsidiary Fair ValueJanuary 1, 2014

Recording Net Income and Dividends

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Assume subsidiary, Sun Company, earns income of $100,000 in 2014 and pays a $40,0000 cash dividend on August 1, 2014.

Subsequent Consolidation - Worksheet Entries

S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the book value component within the parent’s investment account.

A) Recognizes the unamortized Allocations as of the beginning of the current year associated with the adjustments to fair value.

I) Eliminates the subsidiary Income accrued by the parent.

D) Eliminates the subsidiary Dividends.

E) Recognizes excess amortization Expenses for the current period on the allocations from the original adjustments to fair value.

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For the first year, the parent prepares five entries on the workpapers to consolidate the two companies.

Applying the Initial Value Method

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Learning Objective 3-3b:Prepare consolidated financial statements subsequent to acquisition when the parent has applied the initial value method for internal record-keeping.

Application of either method changes the balances recorded by the parent over time, but neither affect any of the final consolidated balances reported.

Just three parent’s accounts vary because of the method applied:• Investment account.• Income recognized from the subsidiary.

• Parent’s retained earnings (periods after year of combination).

Consolidation Entries – Partial Equity Method

Learning Objective 3-3c:

Prepare consolidated financial statements subsequent to acquisition when the parent has applied the partial equity method in its internal records.

For the Partial Equity Method, entry S, A, D, and entry E are the same as the Equity Method.

Entry I is different using Partial Equity Method: It eliminates the Parent’s equity in the sub’s income and reduces the investment account.

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Consolidation Entries – Other than Equity Method

Entries S, A, and E are the same for all three methods.

The parent’s record-keeping is limited to two periodic journal entries: annual accrual of subsidiary income and receipt of dividends.

So, the Investment and Income account balances differ for the other methods, and so will the worksheet Entries I and D.

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Investment Accounting by Acquiring Company

Learning Objective 3-4:

Understand that a parent’s internal accounting method for its subsidiary investments has no effect on the resulting consolidated financial statements.

The selection of a particular method does not affect the totals ultimately reported for the combined companies.

The internal accounting method used does require distinct procedures for consolidation of the financial information from the separate organizations.

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Goodwill and Other Intangible Assets (ASC Topic 350)

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Learning Objective 3-5: Discuss the rationale for the goodwill impairment testing approach.

FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of impairment of intangibles acquired in a business combination.

In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.

Goodwill and Other Intangible Assets (ASC Topic 350)

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Once goodwill has been recorded, the value will remain unchanged until:

1. All or part of the related subsidiary is sold, or

2. There has been a permanent decline in value in which case we test for impairment and record an impairment loss if the item is impaired.

Learning Objective 3-6: Describe the procedures for conducting a goodwill impairment test.

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Stop

Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test - Step One

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Stop

Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test -Step Two

Comparison of U.S. GAAP and International Accounting Standards

Under US GAAP: Goodwill is allocated to reporting units, usually operating segments, expected to benefit from it.A two-step process is used to test for impairment.If the carrying amount of goodwill is more than its implied value, an impairment loss is recognized.

IFRS Under IAS 36: Goodwill is allocated to cash-generating units – at a level much lower than an operating segment.A one-step process is used to test for impairment.Goodwill is reduced for any excess carrying value, down to zero, and then other assets are reduced pro-rata.

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Other Intangibles

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All identified intangible assets with finite lives should be amortized over their economic useful life that reflects the pattern of decline in the economic usefulness of the asset.

Intangible assets with indefinite lives (extends beyond the foreseeable future) are tested for impairment on an annual basis. An entity has the option to first perform qualitative assessments to determine whether “it is more likely than not” the asset is impaired.

Contingent Consideration in Business Combinations

Learning Objective 3-7: Understand the accounting and reporting for contingent consideration subsequent to a business acquisition.

If part of the consideration to be transferred in an acquisition is contingent on a future event:

The acquiring firm estimates the fair value of a cash contingency and records a liability equal to the present value of the future payment.

The liability will continue to be measured at fair value with adjustments recognized in income.

Contingent stock payments are reported as a component of stockholders’ equity, and are not remeasured at fair value.

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Push Down Accounting

Learning Objective 3-8: Understand, in general, the requirements of push-down accounting and its appropriate use.

Method permits acquired subsidiary to record fair value allocations and subsequent amortization in its accounting records.

SEC requires push-down accounting for separate subsidiary statements if no substantial outside ownership exists. Generally limited for external reporting, also used internally.

Method simplifies the consolidation process and provides better information for internal evaluation.

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