Accounting for Stock Acquisitions

When one company controls another company through direct or indirect

ownership of its voting stock.

 Acquiring company referred to as the parent.

 Acquired company referred to as the subsidiary.
 Other shareholders considered noncontrolling interest.
 Parent records interest in subsidiary as an investment.

If a subsidiary owns a controlling interest in one or more other companies, a

chain of ownership is forged by which the parent company controls other
companies.

‫إلمحاسبة عن رشإء إألسهم‬

‫إلت لها‬ ‫ر‬ ‫ر‬ ‫إلشكات يف رشكة أخرى من خالل إلملكية‬ ‫عندما تتحكم ؤحدى ر‬
‫غي إلمباشة ألسهمها ي‬
‫إلمباشة أو ر‬
.‫حق إلتصويت‬
.‫إلشكة إألم‬‫إلشكة إلمستحوذة إلمشار ؤليها باسم ر‬
‫• ر‬
‫إلشكة إلمقتناة ويشار ؤليها باسم ر‬
.‫إلشكة إلتابعة‬ ‫• ر‬
.‫غي مسيطرة‬ ‫إعتي مساهمون آخرون مصلحة ر‬ ‫• ر‬
.‫•تسجيل إألم لحصتها يف رشكة تابعة كاستثمار‬
‫ؤذإ كانت رشكة تابعة تمتلك حصة مسيطرة ف وإحدة أو ر‬
‫أكي من ر‬
‫ يتم تشكيل سلسلة‬، ‫إلشكات إألخرى‬ ‫ي‬
.‫إلشكة إألم عىل رشكات أخرى‬ ‫ملكية تسيطر من خاللها ر‬

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.

‫ بشكل‬، ‫إلشكة إلتابعة عىل أنها رشكة تابعة يتحكم فيها كيان آخر‬
‫تعرف لجنة إألورإق إلمالية وإلبورصات ر‬
‫ من خالل وسيط وإحد أو ر‬، ‫مباش‬
‫أكي‬ ‫غي ر‬ ‫ر‬
‫مباش أو ر‬.
‫غي ر‬
‫ سوإء من خالل ملكية‬، ‫مباشة ؤلدإرة وسياسات كيان آخر‬ ‫إلسيطرة تعت إمتالك سلطة ر‬
‫مباشة أو ر‬ ‫ي‬
.‫غي ذلك‬
‫ أو ر‬، ‫ أو بموجب عقد‬، ‫إلت لها حق إلتصويت‬
‫إألسهم ي‬

1 | Page
The FASB has defined control as the “ability of an entity to direct the policies and
management that guide the ongoing activities of another entity so as to increase
its benefits and limit its losses from that other entity’s activities.”

The FASB stressed the need to prepare consolidated financial statements

whenever control exists, even in the absence of a majority ownership.

‫إلت‬ ّ
‫معايي إلمحاسبة إلمالية إلسيطرة عىل أنها "قدرة إلكيان عىل توجيه إلسياسات وإؤلدإرة ي‬
‫ر‬ ‫عرف مجلس‬
."‫توجه إألنشطة إلجارية لكيان آخر لزيادة منافعه وإلحد من خسائره من أنشطة ذلك إلكيان إآلخر‬

، ‫معايي إلمحاسبة إلمالية عىل إلحاجة ؤىل ؤعدإد بيانات مالية موحدة مت وجدت سيطرة‬
‫ر‬ ‫شدد مجلس‬
.‫حت يف حالة عدم وجود ملكية إألغلبية‬

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:

1. Control does not rest with the majority owner.

2. Subsidiary operates under governmentally imposed uncertainty so

severe as to raise significant doubt about the parent’s control.

Advantages to acquiring a controlling interest in another company.

1. Stock acquisition is relatively simple.
2. Control of subsidiary can be accomplished with a smaller
investment.
3. Separate legal existence of affiliates provides an element of
protection of the parent’s assets.

2 | Page
Statements prepared for a parent company and its subsidiaries are
called consolidated financial statements.

 Ignore legal aspects of separate entities, focus on economic entity

under “control” of management.
 Substance rather than form.
 Not substitute for statements prepared by separate subsidiaries,
which may be used by:
o Creditors
o Noncontrolling stockholders
o Regulatory agencies
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.

3 | Page
E3-2: On January 1, 2011, Polo Company purchased 100% of the
common stock of Save Company by issuing 40,000 shares of its (Polo’s)
$10 par value common stock with a market price of $17.50 per share.
Polo incurred cash expenses of $20,000 for registering and issuing the
common stock. The stockholders’ equity section of the two company’s
balance sheets on December 31, 2010, were:
Common stock, $10 par value $350,000 $320,000
Other contributed capital 590,000 175,000
Retained earnings 380,000 205,000

Required
Prepare the journal entry on the books of Polo Company to record the
purchase of the common stock of Save Company and related expenses.
Solution
Investment in Save (40,000 x $17.50) 700,000
Common Stock 400,000
Other Contributed Capital 300,000
Other Contributed Capital 20,000
Cash 20,000

Assets and liabilities are summed, regardless of whether the parent

owns 100% or a smaller controlling interest.

 Noncontrolling interests are reflected as a component of owners’

equity.

4 | Page
  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.

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.

5 | Page
“Computation and Allocation of Difference between Implied Value and
Book Value”
1. Determine percentage of stock acquired.
2. Divide purchase price by the percentage acquired to calculate the
implied value of the subsidiary.
3. Difference between step 2 and book value of subsidiary’s equity
must be allocated to adjust the underlying assets and liabilities of
the acquired company.

The prior steps lead to the following possible cases:

Case 1. The implied value (IV) of the subsidiary is equal to the book
value of the subsidiary’s equity (IV = BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s
stock.
Case 2. The implied value of the subsidiary exceeds the book value of
the subsidiary’s equity (IV > BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s
stock.
Case 3. The implied value of the subsidiary is less than the book value
of the subsidiary’s equity (IV < BV), and
a. The parent company acquires 100% of the subsidiary’s stock; or
b. The parent company acquires less than 100% of the subsidiary’s
stock.

6 | Page
Case 1(a): Implied Value of Subsidiary Is Equal to Book Value of
Subsidiary Company’s Equity (IV BV)—100% of Stock Acquired.
Illustration: Assume that on January 1, 2010, P Company acquired all
the outstanding stock (10,000 shares) of S Company for cash of
$160,000. What journal entry would P Company make to record the
shares of S Company acquired?
Investment in S Company $160,000
Cash $160,000

7 | Page
Case 1(a): The workpaper entry to eliminate S Company’s
stockholders’ equity against the investment account is:

Common stock (S) 100,000

Other contributed capital (S) 20,000
Retained earnings (S) 40,000
Investment in S Company 160,000

This is a workpaper-only entry.

Case 1(a): Note the following on the workpaper.

8 | Page
 1. The investment account and related subsidiary’s
stockholders’ equity have been eliminated and
the subsidiary’s net assets substituted for the
investment account.
2. Consolidated assets and liabilities consist of
the sum of the parent and subsidiary assets and
liabilities in each classification.
3. Consolidated stockholders’ equity is the same as
the parent company’s equity.
Case 1(b): Parent’s Cost of Investment Is Equal to
Book Value of Subsidiary’s Stock Acquired (IV=BV) -
Partial Ownership.

Illustration: Assume that on January 1, 2010, P

Company acquired 90% (9,000 shares) of the stock
of S Company for $144,000. What journal entry
would P Company make to record the shares of S
Company acquired?

Investment in S Company $144,000

Cash $144,000

9 | Page
10 | Page