Chap 2 consolidated of financial information

8/2/2019 Chap 2 consolidated of financial information

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Chapter Two

Consolidationof FinancialInformation

McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.


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Business Combinations

A business combination refers

to a transaction or other event

in which an acquirer obtains

controlover one or more businesses.

There are five types of

combinations that are requiredto prepare consolidated

statements.

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Statutory Merger (ThroughAsset Acquisition)

Investor acquires assets (and

often liabilities) of the Investee

Investee dissolves and goes out of

businessInvestees books are permanently

closedand the Investors books are

adjusted at the acquisition date forthe newly acquired accounts

One entity survives and moves

forward

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Statutory Merger (ThroughCapital Stock Acquisition)

Investor acquires all stock ofthe 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

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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.

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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 aseparate company, but as a

subsidiary of the Investor, or

parent company.

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Control Through Ownership ofVariable Interests

Sponsoring Firm creates a SpecialPurpose Entity (SPE) intended to engage

in a specific activity

Investor may be different than theSponsoring 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.

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The Acquisition MethodEFFECTIVE IN 2009

Used when there is a change inownership, resulting in control of oneenterprise by another

Requires accounting for the fair value of

the acquired business as a whole byrecognizing and measuring:

Consideration transferred

The fair value of eachasset acquired andliability assumed

Effectively converged withInternational Standards

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Acquisition Method(Continued)

What must be determined atthe date of acquisition?

The Fair Value of assets andliabilities acquired, including the valueof purchased In-Process Researchand Development (and ignoring

equity accounts) The value of consideration transferred

The fair value of any contingentconsideration given, based on risk

and probability of payment

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Acquisition Method(Continued)

But what if the consideration transferreddoes NOT EQUAL the Fair Value of theAssets acquired??

If the Consideration is LESS than theFair Value of the Assets acquired, wegot a BARGAIN!! And we will record a

GAIN on the acquisition!!

If the Consideration is MORE than theFair Value of the Assets acquired, thedifference is attributed to GOODWILL

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Acquisition Method RelatedCosts of Business Combinations

Direct Costs of the acquisition(attorneys, appraisers, accountants,investment bankers, etc.) are NOT partof 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 theacquisition reduce their fair value

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Acquisition MethodNo Dissolution

If the acquired company doesnt dissolve,but continues as a separate entity:

Separate records for each company are stillmaintained.

The acquired company is reported on theParents books (Investment in Subsidiaryaccount).

The adjusted balances for Parent andSubsidiary are consolidatedusing aworksheet only (no formaljournal entries!)

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The Consolidation Worksheet2-13

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 Subs prior revenueand expense already closed).

3. Remove the Subs equity account balances.

4. Remove the Investment in Sub balance.

5. Allocate Subs Fair Values, including any

excess of cost over Book Value to

identifiable assets or goodwill.

6. Combine all account balances.


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Purchase Price AllocationsAdditional Issues

Intangibles are assets that: Lack physical substance (excluding

financial instruments)

Arise from contractual or other legal rights

Can be sold or otherwise separated fromthe acquired enterprise

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Note: If there was goodwillalready recorded in the acquiredcompanys accounts, it is ignored

in the allocation of the purchaseprice.


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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 anindefinite life, and is reviewed forimpairment.

Ongoing R&D is expensedas incurred.

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Legacy Methods Purchase andPooling of Interests Methods

2002 to 2008: PURCHASE METHOD

Prior to 2002: PURCHASE METHOD

or the POOLING OF

INTERESTS METHOD

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Since the ACQUISITIONMETHOD is applied onlyto business combinationsoccurring in 2009 and

after, the two priormethods are still in use.


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Purchase Method Differencesfrom the Acquisition Method

Valuation basis is costThe value of the consideration

transferred,

PLUS the direct costs of the acquisition,

IGNORING any indirect costs of theacquisition,

IGNORING any contingent payments.

The total cost of the acquisition isallocated proportionately to the netassets based on their fair values,with any excess going to goodwill.

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The larger company records anInvestment in Sub account.

Consolidation is done on aworksheet only, eliminating Investment

account and Subs equity accounts.

The remaining Book Values of thecombining companies are simply added

together. No goodwill is recorded.

Revenues and expenses are combinedretrospectively, and prospectively.

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Pooling of InterestsHistorical Review

Chap 2 consolidated of financial information

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