Chapter Two

Consolidation of
Financial
Information

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 Business Combinations

Parent & subsidiaries

➢ Most companies, whether large or small, have

ownership in other companies.
➢ FASB Accounting Standards Codification (ASC)
Business Combinations (Topic 805) and
Consolidation (Topic 810) provide guidance using
the “acquisition method”.
➢ The acquisition method embraces the fair value
measurement for measuring and assessing business
activity. consolidation method

Acquisition method

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 Business Combinations

➢ Consolidated financial statements are defined as

financial statements that show the holding company
and its subsidiaries as one company.
➢ The holding company owns subsidiaries through one
of the following ways:
▪ Obtain a majority of the shares, thereby a majority of the
votes in the subsidiaries.
▪ Governance contracts.
▪ Finance leases.

▪ Other agreements with shareholders in case of having low

shares in those companies.
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 Reasons Firms Combine

➢ Vertical integration
➢ Cost savings
➢ Quick entry into new markets
➢ Economies of scale
➢ More attractive financing opportunities
➢ Diversification of business risk
➢ Business Expansion
➢ Increasingly competitive environment
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Recent Notable Business Combinations

2-5
 The Consolidation Process

“There is a presumption that consolidated statements

are more meaningful.. and that they are usually
necessary for a fair presentation when one of the
companies in the group… has a controlling financial
interest..” FASB ASC (810-10-10-1)

➢ Consolidated financial statements provide more meaningful

information than separate statements.
➢ Consolidated financial statements more fairly present the
activities of the consolidated companies.
➢ Yet, consolidated companies may retain their legal identities
as separate corporations.
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 Business Combinations

A business combination . . .
➢ refers to a transaction or other event in which an
acquirer obtains control over one or more businesses.
➢ is formed by a wide variety of transactions or events
with various formats.
➢ can differ widely in legal form.
➢ unites two or more enterprises into a single economic
entity that require consolidated financial statements.

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Business Combinations

2-8
 FASB Control Model

The FASB provides guidance and defines control when

accounting for business combinations with this control
model:
➢ The FASB ASC Glossary, in addition to majority share
ownership, further describes control as the direct or
indirect ability to determine the direction of management
and policies through ownership, contract, or otherwise.
➢ The FASB continues its effort to develop comprehensive
guidance for consolidation of all entities, including entities
controlled by voting interests.

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Consolidation of Financial Information

Parent’s Subsidiaries’
financial data financial data
brought together

To report the financial position, results of operations,

and cash flows for the combined entity.

Reciprocal accounts and intra-entity transactions

are adjusted or eliminated to. . .

Prepare a single set of consolidated financial statements.

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 What is to be consolidated?

If dissolution occurs: after transfer of assets & liabilities strry end

All appropriate account balances are physically

consolidated in the financial records of the
survivor.
-> have to consolidate statements

If separate incorporation maintained:

Only the Financial statement information (on work
papers, not the actual records) is consolidated.

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 When does consolidation occur?

If dissolution occurs:
Permanent consolidation occurs at the
combination date.

If separate incorporation maintained:

The consolidation process is carried out at
regular intervals whenever financial
statements are to be prepared.

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 How does consolidation affect the
accounting records?
If dissolution occurs:
Dissolved company’s records are closed out.
Surviving company’s accounts are adjusted to
include appropriate balances of the dissolved
company. ->
is
there consolidation
no in future
the

If separate incorporation is maintained:

Each company continues to retain its own records.
Worksheets facilitate the periodic consolidation
process without disturbing individual accounting
systems.

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 The Acquisition Method

The acquisition method embraces the fair value in

measuring the acquirer’s interest in the acquired
business.
Applying the acquisition method involves recognizing
and measuring:
➢ the consideration transferred for the acquired
business and any non-controlling interest.
➢ separately identified assets acquired and liabilities
assumed.
➢ goodwill, or a gain from a bargain purchase.
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 LO 5
Fair Value

➢ Fair value is defined as the price that would be received to sell an

asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
➢ The Market Approach – The market approach estimates fair
values using other market transactions involving similar
assets or liabilities.
➢ The Income Approach – The income approach relies on
multiperiod estimates of future cash flows projected to be
generated by an asset.
➢ The Cost Approach – estimates fair values by reference to the
current cost of replacing an asset with another of comparable
economic utility.

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 Acquisition Method

What if the consideration transferred does NOT

EQUAL the fair value of the assets acquired?

If the consideration is MORE than the

Fair Value of the Assets acquired, the
difference is attributed to GOODWILL

If the consideration is LESS than the

Fair Value of the Assets acquired, we
got a BARGAIN and a GAIN is
recorded.
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Acquisition Method Example
Purchase Price = Fair Value
Basic Consolidation Information

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 Acquisition Method Example
Purchase Price = Fair Value

If dissolution occurs:

On December 31, 2018, BigNet Company acquired all the

assets and liabilities of Smallport Company by paying
$2,550,000 ($550,000 in cash and 20,000 non-issued shares,
par value of $10 and market value of $100).
Assuming that Smallport Company is legally dissolved,
and the purchase price paid by BigNet Company
represents the fair value.

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 Consideration Transferred =
Net Identified Asset Fair Values

Dissolution of Subsidiary

2-19
 Acquisition Method Example
Purchase Price > Fair Value

If dissolution occurs:
On December 31, 2018, BigNet Company acquired all the
assets and liabilities of Smallport Company by paying
$3,000,000 ($1,000,000 in cash and 20,000 non-issued
shares, par value of $10 and market value of $100).
Assuming that Smallport Company is legally dissolved,
and the purchase price paid by BigNet Company is greater
than the fair value.

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Consideration Transferred Exceeds
Net Identified Asset Fair Values

Dissolution of Subsidiary

2-21
 Acquisition Method Example
Purchase Price < Fair Value

If dissolution occurs:
On December 31, 2018, BigNet Company acquired all the
assets and liabilities of Smallport Company by paying
$2,000,000 (20,000 non-issued shares, par value of $10 and
market value of $100).
Assuming that Smallport Company is legally dissolved,
the purchase price paid by BigNet Company is less than
the fair value.

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Consideration Transferred Is Less Than
Net Identified Asset Fair Values

Dissolution of Subsidiary

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 Related Costs of Business Combinations

➢ Direct Costs of the acquisition (attorneys,

appraisers, accountants, investment bankers, etc.)
are NOT part of the fair value received, and are
immediately expensed.
➢ Indirect or Internal Costs of acquisition (secretarial
and management time) are period costs expensed as
incurred.
➢ Costs to register and issue securities related to the
acquisition reduce their fair value. This reduces the
additional paid-in capital.
2-24
 1) Direct costs

Direct costs x X

cash XX

wai
ring
2) Indirect cost +

Bed clothes
(red)
Indirect cost xf

x x
Cash

Gain
of issuing stocks
3)
-> cost
Additional paid-in capital x4

cash XX
 Acquisition Method -
Subsidiary Is Not Dissolved

Separate Incorporation Maintained

➢Dissolution does not occur.
➢Consolidation process is similar to previous example.
➢Fair value is the basis for initial consolidation of
subsidiary’s net assets.
➢Subsidiary is a legally incorporated separate entity.
➢Each company maintains independent record-keeping
➢Consolidation of financial information is simulated.
➢Acquiring company does not physically record the
transaction.
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 The Consolidation Worksheet

Consolidation worksheet entries (adjustments and eliminations)

are entered on the worksheet only.
Steps in the process:
1. Prior to constructing a worksheet, the parent prepares a
formal allocation of the acquisition date fair value similar to
the equity method procedures.
2. Financial information for Parent and Sub is recorded in the
first two columns of the worksheet (with subsidiary prior
revenue and expense already closed).

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 The Consolidation Worksheet
continued. . .

3. Remove the subsidiary equity account balances.

4. Remove the Investment in Sub balance.
5. Allocate subsidiary Fair Values, including any excess of cost
over Book Value to identifiable assets or goodwill.
6. Combine all account balances and extend into the
Consolidated totals column.
7. Subtract consolidated expenses from revenues to arrive at net
income.

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 Acquisition Method –
Consolidation Workpaper Example
BigNet Company acquired all the assets and liabilities of
Smallport Company through the issuance of 26,000 non -
issued shares; The par value of the share is $10 and its
market value is $100. Smallport Company is a wholly
owned subsidiary of BigNet Company but it is considered a
separate legal entity with separate accounting information
systems. additional information: apart of purchase
price
but it contingent

-
a

BigNet Company will pay an additional $83,200 to the viability

former owners of Smallport Company only if Smallport

Company earns more than $300,000 in revenue next year.
BigNet Company has estimated the present value of the
probability of achieving this item at an expected value of
$20,000. BigNet Company paid $ 40,000 to a third party to
facilitate the acquisition process. 2-28
 Acquisition Method –
Consolidation Workpaper Example
Basic Consolidation Information

2-29
 Acquisition Method –
Consolidation Workpaper Example
The value of issued shares $2,600,000
Contingent performance liability 20,000
Fair value of the purchase price $2,620,000

The $40,000 paid to a third party to facilitate the

acquisition process will not be considered as part of the
purchase price but as a separate expense.
Investment in Smallport Company 2,620,000
Contingent performance liability 20,000
Common stock (26000 10)
x par value &
260,000
FU
Additional paid-in capital (26000x (100 -

10) 2,340,000
↳ par
cost
extra
treatment
Professional services expenses 40,000
Cash 3disput
40,000
2-30
same
.
 Acquisition Method –
Consolidation Workpaper Example

1. Prior to constructing a worksheet, the parent prepares a

formal allocation of the acquisition date fair value similar to
the equity method procedures.

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 Acquisition Method –
Consolidation Workpaper Example

2. Financial information for Parent and Sub is recorded in

the first two columns of the worksheet (with subsidiary
prior revenue and expense already closed).

A Gain Log in ener 2-32

Dr
 Consolidation Entries
Accounts Bignet Smallport Consolidated Totals
Debits Credits
Income Statement wedit

I
~

Revenues debit
-
no bracs
(1,000,000) Increase by 40,000
bracs
Expenses wedits -

840,000 * Professional services expenses

Net income (160,000) ↑

-> consolidation at date ofarquisition
Statement of Retained Earnings Cash decreased by 40,000

↳
Retained earnings, 1/1 (870,000) Professional services expenses
Net income (above) (160,000)* -> Net Income

Dividends declared 110,000 consolidate

Parent has no
right to

re or profits before
date of acquis
Retained earnings, 12/31 (920,000) -

itich
Balance Sheet
Current assets 1,060,000* 300,000 Investment in Smallport
Investment in Smallport Company 2,620,000 Company

Computers and equipment 1,300,000 400,000

Capitalized software 500,000 100,000
Customer contracts Contingent performance liability
Goodwill

Total assets 5,480,000 800,000 Common stock:

Increase by 260,000
Notes payable (300,000) (200,000)
Contingent performance liability (20,000) *
Additional paid-in capital
Common stock (1,860,000)* (100,000) Increase by 2,340,000
Additional paid-in capital (2,380,000)* (20,000)
Retained earnings, 12/31 (above) (920,000) (480,000)
Retained earnings decreased by
Total liabilities and equities (5,480,000) (800,000) Professional services expenses
 Acquisition Method –
Consolidation Workpaper Example

3. Remove the subsidiary equity account balances.

4. Remove the Investment in subsidiary balance.

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 Consolidation Entries
Accounts Bignet Smallport Consolidated Totals
Debits Credits
Income Statement
Revenues (1,000,000)
Expenses 840,000 *

Net income (160,000)

Statement of Retained Earnings
Retained earnings, 1/1 (870,000)
Net income (above) (160,000)*
Dividends declared (110,000)

Retained earnings, 12/31 (920,000)

Balance Sheet
Current assets 1,060,000* 300,000
Investment in Smallport Company 2,620,000 (S) 600,000

Computers and equipment 1,300,000 400,000

Capitalized software 500,000 100,000
Customer contracts
Goodwill

Total assets 5,480,000 800,000

Notes payable (300,000) (200,000)

Contingent performance liability (20,000) *
Common stock (1,860,000)* (100,000) (S) 100,000
Additional paid-in capital (2,380,000)* (20,000) (S) 20,000
Retained earnings, 12/31 (above) (920,000) (480,000) (S) 480,000

Total liabilities and equities (5,480,000) (800,000)

 Acquisition Method –
Consolidation Workpaper Example

5. Allocate subsidiary Fair Values, including any excess of

cost over Book Value to identifiable assets or goodwill.

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 Consolidation Entries
Accounts Bignet Smallport Consolidated Totals
Debits Credits
Income Statement
Revenues (1,000,000)
Expenses 840,000 *

Net income (160,000)

Statement of Retained Earnings
Retained earnings, 1/1 (870,000)
Net income (above) (160,000)*
Dividends declared (110,000)

Retained earnings, 12/31 (920,000)

Balance Sheet
Current assets 1,060,000* 300,000
Investment in Smallport Company 2,620,000 (S) 600,000
(A) 2,020,000
Computers and equipment 1,300,000 400,000 ) A( 200,000
Capitalized software 500,000 100,000 ) A( 1,100,000
Customer contracts ) A( 700,000
Goodwill ) A( 70,000

Total assets 5,480,000 800,000

Notes payable (300,000) (200,000) (A) 50,000

Contingent performance liability (20,000) *
Common stock (1,860,000)* (100,000) (S) 100,000
Additional paid-in capital (2,380,000)* (20,000) (S) 20,000
Retained earnings, 12/31 (above) (920,000) (480,000) (S) 480,000

Total liabilities and equities (5,480,000) (800,000) 2,670,000 2,670,000

 Acquisition Method –
Consolidation Workpaper Example

6. Combine all account balances and extend into the

Consolidated totals column.

7. Subtract consolidated expenses from revenues to arrive at

net income.

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 Consolidation Entries
Accounts Bignet Smallport Consolidated Totals
Debits Credits
Income Statement
Revenues (1,000,000) ) 1,000,000(
Expenses 840,000 * 840,000

Net income (160,000) (160,000)

Statement of Retained Earnings
Retained earnings, 1/1 (870,000) ) 870,000(
Net income (above) (160,000)* ) 160,000(
Dividends declared (110,000) 110,000

Retained earnings, 12/31 (920,000) (920,000)

Balance Sheet
Current assets 1,060,000* 300,000 1,360,000
Investment in Smallport Company 2,620,000 (S) 600,000
(A) 2,020,000
Computers and equipment 1,300,000 400,000 ) A( 200,000 1,900,000
Capitalized software 500,000 100,000 ) A( 1,100,000 1,700,000
Customer contracts ) A( 700,000 700,000
Goodwill ) A( 70,000 70,000

Total assets 5,480,000 800,000 5,730,000

Notes payable (300,000) (200,000) (A) 50,000 ) 550,000(
Contingent performance liability (20,000) * ) 20,000(
Common stock (1,860,000)* (100,000) (S) 100,000 ) 1,860,000(
Additional paid-in capital (2,380,000)* (20,000) (S) 20,000 ) 2,380,000(
Retained earnings, 12/31 (above) (920,000) (480,000) (S) 480,000 ) 920,000(

Total liabilities and equities (5,480,000) (800,000) 2,670,000 2,670,000 (5,730,000)

 Acquisition Date Fair-Value Allocations –
Additional Issues
Intangibles are assets that:
➢ Lack physical substance (excluding financial instruments)
➢ Arise from contractual or other legal rights (most intangibles
in business combinations meet the contractual-legal criterion).
➢ Is capable of being sold or otherwise separated from the
acquired enterprise
Preexisting goodwill recorded in the acquired company’s accounts
is ignored in the allocation of the purchase price.
IPR&D that has reached technological feasibility is capitalized as
an intangible asset at fair value with an indefinite life that is
reviewed for impairment.
Ongoing R&D is expensed as incurred.

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 Legacy Methods – Purchase and Pooling
of Interests Methods

Since the ACQUISITION METHOD is applied to

business combinations occurring in 2009 and after,
the two prior methods are still in use.

➢ 2002 to 2008: Purchase Method

➢ Prior to 2002: Purchase Method

Or The Pooling Of Interests Method

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