Chapter Two CONSOLIDATION AT THE DATE OF ACQUISITION

1
Chapter Two CONSOLIDATION AT THE DATE OF
ACQUISITION
2
Consolidated Financial Statements

• Required since Accounting Research Bulletin (ARB)
  No. 51 (1959)
• Allowed exclusions for a variety of reasons
• Statement of Financial Accounting Standards No.
  94, Consolidation of All Majority-Owned
  Subsidiaries eliminated the exclusions except
• When control is temporary
• When control does not reside with the majority
  owner

3
Consolidated Financial Statements Weaknesses

• Diverse businesses are more difficult to
  interpret
• Weak performers are more difficult to identify
• Consolidations make it difficult to compare
  entities to industry standards
• Financial ratios do not represent any particular
  part of the entity

4
Purchase Method

• Investment account is recorded at the market
  value given
• Investment account represents ownership
  percentage of subsidiarys underlying assets and
  liabilities acquired

5
Consolidation Procedures Primary Objectives

• To present on a combined basis
• The detailed asset, liability, and net worth
  position represented by the parent companys
  separate books, plus
• The individual values of the subsidiarys assets
  and liabilities acquired

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Consolidation Issues

• Acquisition Price (at book value or more than
  book value)
• Acquisition Timing (at beginning of year or
  during the year)
• Percent of subsidiary acquired (100 or less than
  100)

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Worksheet Procedures

• Worksheet eliminations are not posted
• Parent investment account and subsidiary equity
  accounts exactly offset when
• 100 of subsidiary stock is acquired,
• and
• Price paid equals subsidiarys book values

8
Investment Account and Subsidiary Equity
Elimination

• Investment account eliminated because
• subsidiarys individual assets and liabilities
  are included instead
• Subsidiary equity eliminated because
• parents net worth includes the investment in
  subsidiary value
• Consolidated statements are prepared for Parent
  Company stockholders

9
Acquisition Price Equals Book Value

• Market value of subsidiary assets and liabilities
  equals book values
• Investment account balance exactly equals sum of
  Subsidiary equity accounts
• Subsidiary equity may include Preacquisition
  Earnings if acquisition is during year

10
Acquisition Price Equals Book Value

• Consolidated revenues, expenses, assets, and
  liabilities are found by summing parent and
  subsidiary book value amounts

11
Acquisition Price Equals Book Value

• Worksheet Elimination
• Common Stock 1,000
• Add Paid-in Cap 750
• Retained Earnings 250
• Invest in Sterling 2,000
• Investment credit equals subsidiary equity
  accounts debited in acquisition at book value case

12
Acquisition Price Exceeds Book Value

• Market value of subsidiarys assets and
  liabilities acquired become book value to
  consolidated entity
• Purchase price for 100
• Less book value acquired
• Purchase Differential

13
Acquisition Price Exceeds Book Value

• Purchase differential is first allocated to
  identifiable individual assets and liabilities
  having market greater than book value
• Any remaining purchase differential is either
  positive or negative goodwill

14
Reasons Negative Goodwill Exists

• Something inherent that reduces overall company
  value such as rates of return below market
  expectations or pending litigation
• Estimation error on market value appraisals

15
Acquisition Price Exceeds Book Value (contd)

• Example (Illustration 4)
• Purchase price - book value purchase
  differential
• 2,400,000 - 2,000,000 400,000
• Allocation Inventory 130
• (Illustration 3) P, P, and E 350
• (000s omitted) Patents (200)
• Bonds Payable (105) 175
• Goodwill (400 175) 225

16
Acquisition Price Exceeds Book Value

• Worksheet Elimination 4 (000s omitted)
• Common Stock 1,000
• Add Paid-in Cap 750 2,000 BV
• Retained Earnings 250
• Inventory 130
• Prop, Plant, and Equip 350 MVgtBV
• Goodwill 225 400
• Patents 200
• Discount on Bonds Pybl 105
• Investment in Sterling 2,400

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Acquisition at Beginning of Year

• Worksheet includes only the balance sheet
• Only time when a worksheet elimination of
  Retained Earnings is made directly to the
  balance sheet account

18
Acquisition of Less Than 100

• For a business combination to exist, control of
  the subsidiary must be achieved
• Subsidiary stockholders not in control are called
  noncontrolling interest

19
Acquisition of Less Than 100

• Theories of consolidation
• Proportionate consolidation concept
• Parent company concept (current GAAP)
• Economic unit concept

20
Acquisition of Less Than 100

• Proponents of all three consolidation concepts
  agree that the parents ownership share of the
  following should be included in the consolidated
  financial statements
• Revenues and Expenses
• Assets and Liabilities, including goodwill paid
  to acquire the subsidiary

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Proportionate Consolidation Concept

• Ownership is essential to recognition in the
  consolidated financial statements
• Consolidated statements prepared only for parent
  company stockholders
• Noncontrolling interest is not disclosed
• Eliminate noncontrolling interest share of
  subsidiary accounts in consolidation worksheet

22
Parent Company Concept

• Ownership and control are essential to
  recognition in consolidated financial statements
• Subsidiary assets and liabilities recognized as a
  hybrid of
• Market values for the percentage acquired by the
  parent company
• book values for the percentage not acquired

23
Parent Company Concept

• Asset and liability market value recognition
  based on verifiable transaction for the part
  acquired
• Noncontrolling interest should be disclosed in a
  separate category between liabilities and owners
  equity

24
Parent Company Concept

• Consolidated income statement should include all
  revenues and expenses
• Subtract income to noncontrolling interest to
  determine consolidated net income

25
Economic Unit Concept

• Control is essential to recognition in the
  consolidated financial statements
• Full market value of subsidiary assets and
  liabilities included on consolidated balance
  sheet
• All of subsidiarys revenues and expenses are
  included on the consolidated income statement

26
Economic Unit Concept

• Consolidated net income is calculated and then
  divided between parent company and noncontrolling
  interest
• Noncontrolling interest is disclosed in the
  equity section of the consolidated balance sheet
• Two approaches to recognizing goodwill full
  goodwill and purchased goodwill

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Economic Unit Concept Full Goodwill

• Total goodwill is imputed and recorded
• Example parent identifies goodwill of 60,000 in
  a 75 acquisition.
• Total goodwill is imputed
• .75(total goodwill) 60,000
• total goodwill 60,000/.75
• total goodwill 80,000

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Economic Unit Concept Purchased Goodwill

• Only parents goodwill is recognized on the
  consolidated balance sheet
• Argues that estimation of noncontrolling interest
  portion of goodwill is too unreliable
• FASB proposal chooses full goodwill approach

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Acquisition of Less Than 100

• Purchase differential recognized on the
  consolidated balance sheet is full imputed market
  value of subsidiary net assets including goodwill

30
Acquisition of Less Than 100

• Noncontrolling Interest is created in equity
  section of consolidated balance sheet
• Noncontrolling interest ALWAYS equals subsidiary
  imputed market value X noncontrolling interest
  percentage

31
Acquisition of Less Than 100 During the Year

• Both subsidiary preacquisition earnings, and
  current year dividends prior to acquisition are
  eliminated because they reduce subsidiary equity
  and have not been closed to Retained Earnings
• This procedure is same for 100 and less than
  100 ownership

32
Noncontrolling Interest Recognition (000s
omitted)

• (From Illustration 12)
• Common Stock 1,000
• Add Paid-in Cap 750 2,000 BV
• Retained Earnings 160 Preacquisition
  Earnings 90
• Purchase Differentials 400
• 2,400 MV Investment in Sterling 2,160
• Noncontrolling Interest 240
• Dividends (if any) XX

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Consolidated Financial Statements - Strength

• Includes detailed reporting of significant
  revenue and expenses, assets and liabilities,
  cash receipts and payments

34
Purchase and Pooling of Interests

• Fundamental difference assumption regarding
  ownership
• Purchase method
• Assumes there is a change in ownership
• Arms length transaction for market value
• Change in ownership may result in asset and
  liability revaluation

35
Purchase and Pooling of Interests

• Pooling of interests method
• Uniting of ownership interests
• No acquisition for market value assumed
• Assets and liabilities accounted for at book value

36
Purchase and Pooling of Interests

• Pooling of interests method
• Pooling of interests method was discontinued in
  2001
• Existing combinations that used pooling were
  grandfathered

37
Using a Separate Accumulated Depreciation Account

• Special procedures are necessary to
  consolidate when depreciable fixed assets are
  not reported net of accumulated depreciation
• View asset as if newly purchased at market
  value

38
Using a Separate Accumulated Depreciation Account

• In worksheet elimination
• Eliminate existing balance in
• Accumulated Depreciation
• Adjust historical cost to market

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Push-Down Accounting

• Securities and Exchange Commission requirement
  for some subsidiaries when
• Subsidiary issues separate statements
• Large percentage owned by parent
• Subsidiarys net assets must be reported based on
  market values estimated as a result of the
  acquisition