SUBJECT: Accounting 15

DESCIPTIVE TITLE: Accounting for Business Combination

Instructor: Alfredo R. Cabiso

This course covers essential issues on financial accounting and reporting in Business
Combinations. It covers accounting on Mergers and Consolidation.
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The materials in this learning module are from the following:
1. Main reference Textbook: Advanced Financial Accounting: 2021 edition by
Antonio Dayag.
2. Other references:
 Advanced Financial Accounting Volume 2: by Pedro Guerrero & Jose
Peralta
 CPA Reviewer in Practical Accounting 2: by Antonio Dayag
 CPA Reviewer in Practical Accounting 2: by Pedro Guerrero & Jose Peralta

LESSON No. 3
BUSINESS COMBINATION-3
Consolidated Financial Statements- Subsequent to Date of Acquisition

Learning Objectives:
The students should be able:
 To understand the accounting for investment in subsidiaries using the cost model and
the equity method
 To prepare separate and consolidated financial statement subsequent to date of
acquisition

Consolidated Statements subsequent to Date of Acquisition

The preparation of consolidated financial statements after acquisition is not materially different
in concept from preparing them at the acquisition data in the sence that reciprocal accounts are
eliminated and remaining balances are combine.

The process is more complex, however, because time has elapsed and business activity has
taken place between the date of acquisition and the date of consolidated statement preparation.
On the date of acquisition, the only relevant financial statement is the consolidated balance
sheet; after acquisition, a complete set of consolidated financial statements – statement of
comprehensive income and retained earnings statement.

Separate Financial Statements

A parent will usually produce its own single company financial statements and these should be
prepared in accordance with PAS 27, Separate Financial Statements. In these statements,
investment in subsidiaries, associates and joint ventures included in the consolidated financial
statements should be either:

1. At cost
2. In accordance with PFRS 9 (Fair Value Option), or
3. Using the equity method as described in PAS 28

Although there appears to be significant differences between cost model, equity method and fair
value option/method, the main difference is timing.

Pro-Forma Entries/Comparison – Accounting for Subsidiaries, Associates and Joint Ventrures in

the books of the Acquirer/Investor.
Cost Model Equity Method Fair Value Option
Cost of investment Investment- xx Investment- xx Investment- xx
Various credits xx Various credits xx Various credits xx
Results of
operations:
a. Net income of No entry Inv. In Sub - xx No entry
subsidiary Investment income -xx
 b. Cash dividend of Cash/div. rec. -xx Cash/div. rec. -xx Cash/div. rec. -xx
subsidiary Div. Inc. xx Inv. In Sub Inv. income
xx xx
c. Amortization of No entry Inv. Income - xx No entry( no special
allocated excess Inv. In sub. treatment is accorded
xx for the allocated
excess)
d. Impairment of No entry Inv. Income - xx No entry
Page | 2 goodwill Inv. In sub.
xx

The First Method: Cost Model (formerly Cost method or Initial Value Method)
The cost model (method) of accounting for inter-corporate investments is consistent with
historical cost basis for most other assets.
Under the Cost model:
1. is subject to the usual criticisms leveled against historical cost, in particular questions arise
as to the relevance of reporting the purchase price of an investment acquired some years
earlier.
2. The cost model (method) does conform more closely to the traditional accounting
accounting and legal views of the realization of income in that the subsidiaries earnings are
not available to the parent until transferred as dividens.
3. is the most common method used in practice by parent companies, simple to use during the
accounting period and avoids the risk of incorrect adjustments.

Typically, the correct income of the subsidiary is not knpwn until after the end of the
accounting period. Awainting its determination would delay the parent’s company closing
procedures.

It should be noted than for purposes of preparing consolidated statements, companies that use
the Cost Model should convert to Equity Method.

When the Cost model is used, the investment in subsidiary account is retained at its original
cost of acquisition balance. No adjustments are made to the account for income as it is earned
by the subsidiary. Income on the investment is limited to dividends received from the
subsidiary.

The cost model is acceptable for subsidiaries that are to be consolidated because in the
consolidation process, the investment account is eliminated entirely.
Results of operations: Cost model – dividends declare/paid

The Second method: Equity Method

The equity method of accounting is essentially accrual accounting for equity investments that
enable the investor to exercise significant influence over the investee.

Results of operations: Equity Method – Net Income. Dividends declared/paid, amortization of

allocated excess and impairment of goodwill, intercompany profit in inventory and unrealized
gain or losses on intercompany sales of property and equipment.

Under this method:

Record the investments at cost, adjust for earnings, losses, dividends declared/paid,
amortization of allocated excess (over-undervaluation) and goodwill impairment, if any.
The investor reports its share of the investees earnings as investment income and its share of
the investee’sl losses as investment loss
Increase the investment account for investment income and decrease it for investment losses,
Dividends received from investees are disinvestments under the equity method and they are
recorded as decreases in the investment account.
Investment income under the equity method reflects the investor’s share of the net income of
the investee, and the investment account reflects the investor’s share of the investee’s net
assets.

Although the equity methd is not a substitute for consolidation, the income reported by a parent
in its separate income statement under the equity method of accounting is generally the same
as the parent’s share of (or controlling interest in ) consolidated net income reported in
 consolidated financial statements for a parent and its subsidiary. This is the same with the
reported net income determined under the equity method.

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 The equity method of accounting is often called aa one-line consolidation. The name carries
about because the investment is reported in a single amount on one line of the investor’s
balance sheet, and investment income is reported in a signle amount on one line of the
investor’s income statement (except when the investee has extraordinary or other “below-the-
line” items that require separate disclosure.

Page | 4 Illustrative Problems

Comprehensive problems found in chapter 3 of the text book “Advanced Financial Accounting”
2021 Edition by Antonio C. Dayag will illustrate the accounting as discussed above. Solutions
in excel format follow.