2 0 2 2

Accounting for Business

Combinations &
Consolidated Statement

○ D r. P e n g F e i
○ E-mail: pengfei@btbu.edu.cn
 Learning Objectives

• Discuss the goodwill impairment test, including its

frequency, the steps laid out in the new standard, and
some of the implementation problems.
• Explain how acquisition expenses are reported.
• Understand the concept of control as used in reference
to consolidations.
• Explain the role of a noncontrolling interest in business
combinations.
• Describe the reasons why a company acquires a
subsidiary rather than its net assets.
 Learning Objectives

• List the requirements for inclusion of a subsidiary in consolidated

financial statements.
• Discuss the limitations of consolidated financial statements.
• Prepare the consolidated workpapers and eliminating entries at
the date of acquisition.
Asset Acquisitions

Vs

StockAcquisitions
 Explanation and Illustration of
Acquisition Accounting
Four steps in the accounting for a business combination:
1) Identify the acquirer.
2) Determine the acquisition date.
3) Measure the fair value of the acquiree.
4) Measure and recognize the assets acquired and liabilities
assumed.

LO 6 Valuation of acquired assets and liabilities assumed.

 Explanation and Illustration of
Acquisition Accounting
Value of Assets and Liabilities Acquired
• Identifiable assets acquired (including intangibles other than
goodwill) and liabilities assumed should be recorded at their fair
values at the date of acquisition.

• Any excess of total cost over the sum of amounts assigned to

identifiable assets and liabilities is recorded as goodwill. Goodwill
should not be amortized but should be adjusted downward only
when it is impaired (discussed earlier).

LO 6 Valuation of acquired assets and liabilities assumed.

 Accounting Standards on Business
Combinations: Background
Goodwill Impairment Test
• For public companies, goodwill is no longer amortized.
– Goodwill of each reporting unit is tested for impairment
on an annual basis.
• Private companies can elect an alternative model: amortize
goodwill over a period not to exceed 10 years and utilize a
simplified impairment model.

Issued January 2014

LO 3 Goodwill impairment assessment.

 Accounting Standards on Business
Combinations: Background
Goodwill Impairment Test
All goodwill must be assigned to a reporting unit.
Reporting Unit is the level at which management reviews and
assesses the operating segment’s performance
Eg: business lines; product division
（1）Have economic character different from other components
（2）At the level at which goodwill benefits are realized
（3）Discrete financial information is available
.

LO 3 Goodwill impairment assessment.

 Accounting Standards on Business
Combinations: Background
Goodwill Impairment Test
Qualitative assessment to determine Whether it is more likely
than not that the fair value of a reporting unit is less than its
carrying amount, including goodwill.
--macroeconomic conditions;
--industry considerations;
--loss of key personnel

LO 3 Goodwill impairment assessment.

 Perspective on Business Combinations

• Treatment of Acquisition Expenses

• Direct expenses incurred in the combination include finder’s
fees, as well as advisory, legal, accounting, valuation, and other
professional or consulting fees.
• Indirect, ongoing costs include the cost to maintain a mergers and
acquisitions department, as well as other general administrative
costs such as managerial or secretarial time and overhead that are
allocated to the merger but would have existed in its absence
 Perspective on Business Combinations

Treatment of Acquisition Expenses

– Both direct and indirect costs are expensed
– The cost of issuing securities is excluded from the
consideration.
• Security issuance costs are assigned to the valuation of
the security, thus reducing the additional contributed
capital for stock issues or adjusting the premium or
discount on bond issues.

LO 4 Reporting acquisition expenses.

 Explanation and Illustration of Acquisition
Accounting
Bargain Purchase
• When the fair values of identifiable net assets (assets less
liabilities) exceeds the total cost of the acquired company, the
acquisition is a bargain.
– In the past, FASB required that most long-lived assets be
written down on a pro rata basis before recognizing any
gain.

LO 6 Valuation of acquired assets and liabilities assumed.

 Explanation and Illustration of Acquisition
Accounting
Bargain Acquisition
• When the price paid to acquire another firm is lower than the fair
value of identifiable net assets (assets minus liabilities), the
acquisition is referred to as a bargain.
– Any previously recorded goodwill on the seller’s books is
eliminated (and no new goodwill recorded).

LO 6 Valuation of acquired assets and liabilities assumed.

Asset Acquisitions

Vs

StockAcquisitions
 Terminology and Types of Combinations

• Asset acquisition, a firm must acquire 100% of the assets of the

other firm.
• Only acquiring or new company survives
• The books of the acquired company are closed out. Its asset and
liability are transferred to the books of acquirer
• Stock acquisition, control may be obtained by purchasing 50%
or more of the voting common stock (or possibly less) .
• The acquired company and its books remain intact and
consolidated financial statements are prepared.
 When one company controls another
company through direct or indirect
ownership of some or all of its voting stock.
Parent GROUP
P Company

a. Acquiring company referred to as the

80%
parent.
S Company b. Acquired company referred to as the
subsidiary.
Subsidiary
c. Other shareholders considered non
controlling interest.
Controlling interest
Noncontrolling interest
 Definitions of Subsidiary and Control

• The Securities and Exchange Commission defines a

subsidiary as an affiliate controlled by another entity, directly or
indirectly, through one or more intermediaries.
– Control means the possession, direct or indirect, of the power
to direct management and policies of another entity, whether
through the ownership of voting shares, by contract, or
otherwise.

LO 1 Meaning of control.
 Direct ownership

P Company P Company

80% 70% 80% 90%

S1 S2 S3
S Company
Company Company Company

Assumption：P have the control over S if P owns over 50% of the S’ voting stock,
vice verse.
 Indirect ownership

P Company P Company

80%
80% 40%

S1 Company
S1 S2
60% Company Company
20%

S2 Company *usually by step acquisition

P and S1 are persons acting in concert

 Indirect ownership

P Company P Company

60%
15% 40% 15%

S1 Company
S1 S2
40% Company Company
60%

S2 Company

Are S1 and S2 the subsidiaries of P?

 Definitions of Subsidiary and Control

Control (continued):
• However, application of the majority voting interest requirement
may not identify the party with a controlling financial interest
because the controlling financial interest may be achieved
through arrangements that do not involve voting interests.
• (VIE).

LO 1 Meaning of control.
Definitions of Control

LO 1 Meaning of control.
Definitions of Subsidiary and Control

P Company

80% 30% 55%

30% 20%
S1 S2 S3
Company Company Company

Are S1, S2 and S3 the subsidiaries of P?

If so, what’s the Noncontrolling interest of S2?

Definitions of Subsidiary and Control

P Company

80% 20% 35%

20% 55%
S1 S2 S3
Company Company Company

Are S1, S2 and S3 the subsidiaries of P?

If so, what’s the Noncontrolling interest of S2?

 Requirements for the Inclusion of Subsidiaries
in the Consolidated Financial Statements
Purpose of consolidated statements - to present the operating
results and the financial position of a parent and all its subsidiaries
as if they are one economic entity.
Circumstances when majority-owned subsidiaries should be
excluded from the consolidated statements:
– Control does not rest with the majority owner.（bankrupty）
– Subsidiary operates under governmentally imposed
uncertainty so severe as to raise significant doubt about the
parent’s control.

LO 5 Requirements regarding consolidation of subsidiaries.

 Reasons For Stock Acquisitions

Advantages to acquiring a controlling interest in the voting stock of

another company rather than its assets or all of its voting stock.
– Stock acquisition is relatively simple.
– Control of subsidiary can be accomplished with a smaller
investment.
– Separate legal existence of affiliates provides an element of
protection of the parent’s assets.

LO 3 Acquiring assets or stock.

 Investments at the Date of Acquisition

Recording Investments at Cost (Parent’s Books)

• Stock investment is recorded at cost as measured by fair value of
the consideration given or consideration received, whichever is
more clearly evident.
– Consideration given may include cash, other assets, debt
securities, stock of the acquiring company, or a combination
of these items.
➢ Both the direct costs of acquiring the stock and the indirect costs
relating to acquisitions (such as costs of maintaining an acquisitions
department) should be expensed as incurred.

LO 7 Recording of investment at acquisition.

 Consolidated Financial Statements

Statements prepared for a parent company and its subsidiaries are

called consolidated financial statements.
– Ignore legal aspects of separate entities, but focus instead, on
economic entity under “control” of management.
– Focus on substance rather than form.
– Not substitutes for statements prepared by separate
subsidiaries, which may be used by:
• Creditors
• Noncontrolling stockholders
• Regulatory agencies.

LO 4 Valuation and classification of subsidiary assets and liabilities.

 Consolidated Balance Sheets: Use of
Workpapers
Assets and liabilities are summed in their entirety, regardless of
whether the parent owns 100% or a smaller controlling interest.
– Noncontrolling interests (NCI) are reflected as a component
of owners’ equity.
– Eliminations must be made to cancel the effects of
transactions among the parent and its subsidiaries.
– A workpaper is frequently used to summarize the effects of
various additions and eliminations.

LO 8 Preparing consolidated statements using a workpaper.

 Consolidated Balance Sheets: Use of
Workpapers
Investment Elimination
• It is necessary to eliminate the investment account of the parent
company against the related stockholders’ equity of the subsidiary
to avoid double counting of these net assets.
• When parent’s share of subsidiary’s equity is eliminated against
the investment account, subsidiary’s net assets are substituted for
the investment account in the consolidated balance sheet.

LO 8 Preparing consolidated statements using a workpaper.

Consolidated Workpaper

Items P S Summed Elimination Consoli

dated
Dr. Cr.

cash 140 200 340 340

Investment in s 160 160 160 0

Total assets 300 200 500 160 340

Common stock 300 200 500 200 300

NCI 40 40

Total Liabilities 300 200 500 160 340

and Equity

LO 7 Recording of investment at acquisition.

 Consolidated Balance Sheets: Use of
Workpapers
Intercompany Accounts to Be Elimin

Parent’s Accounts Subsidiary’s Accounts

Investment in
Investment in subsidiary
subsidiary Against
Against Equity accounts
accounts

Intercompany receivable
Intercompany receivable(payable)
(payable) Against
Against Intercompany payable
Intercompany payable(receivable)
(receivable)

Advances to
Advances tosubsidiary
subsidiary(from
(fromsubsidiary)
subsidiary) Against
Against Advances from
Advances from parent
parent(to
(toparent)
parent)

Interest revenue
Interest revenue(interest
(interestexpense)
expense) Against Interest expense (interest revenue)

Dividend revenue (dividendsdeclared)

revenue (dividends declared) Against Dividends declared (dividend revenue)

Managementfee
Management feereceived
receivedfrom
fromsubsidiary
subsidiary Against Management fee paid to parent

Sales
Salesto
tosubsidiary
subsidiary(purchases
(purchasesofofinventory
inventory Purchases of inventory from parent (sales
Against
from subsidiary) to parent)

LO 8 Preparing consolidated statements using a workpaper.

Thank Yo u !