Focus on: Consolidated Statements—Module 18

BUSINESS COMBINATIONS/ACQUISITIONS

Consolidation is required whenever the acquirer has control over another entity.

• Acquirer is the entity that obtains control of one or more businesses in the business combination
• Ownership of majority of voting stock generally indicates control
• Consolidation is required even if control situation is temporary
• Consolidation is not appropriate when a majority shareholder doesn’t have effective control:
  • Company is in bankruptcy or reorganization
  • Foreign exchange controls limit power to keep control of subsidiary assets
• All consolidations are accounted for as acquisitions
  • The acquirer shall recognize goodwill, the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and any residual goodwill
  • Recognize separately
    • Acquisition-related costs
    • Assets acquired and liabilities assumed arising from contractual contingencies
    • Bargain purchase (fair value of assets acquired > amount paid) recognized as gain
    • Fair values of research and development assets
    • Changes in the value of acquirer deferred tax benefits

Accounting for an Acquisition

Combination—Records Combined

* Credit common stock for par value of shares issued and credit additional paid-in capital (APIC) for difference between fair value and par value of shares issued.

Combination—Records Not Combined

Earnings

Consolidated net income:

Retained Earnings—Year of Combination

CONSOLIDATIONS

Eliminate the Investment

Example 1—Date of Combination—No Goodwill or Minority Interest

Example 2—Date of Combination—No Goodwill or Minority Interest

Example 3—Date of Combination—Goodwill and Minority Interest

Calculating goodwill—Four steps

Additional entries—after date of acquisition

• Debit cost of sales instead of inventory for fair market value (FMV) adjustment
• Recognize depreciation on excess of fair value over carrying value of depreciable assets
• Recognize impairment of goodwill (if FMV of goodwill is less than carrying amount)

Eliminating Entries

Intercompany Sales of Inventory

Eliminate gross amount of intercompany sales

Eliminate intercompany profit included in ending inventory

Eliminate unpaid portion of intercompany sales

Intercompany Sales of Property, Plant, and Equipment

Eliminate intercompany gain or loss

Adjust depreciation

Intercompany Bond Holdings

Eliminate intercompany investment in bonds

Variable Interest Entities (VIEs)

Also known as special-purpose entities

Control is achieved based on contractual, ownership, or other pecuniary interests

Primary beneficiary—The entity that has controlling financial interest in the VIE and must consolidate it. This must be reassessed every year.

Both conditions must exist for control:

Qualitative approach used to determine control when power is shared among unrelated parties, which could lead to none of the entities consolidating the VIE

Kick-outs rights—The ability to remove the reporting entity who has the power to direct the VIE’s significant activities

Participating rights—The ability to block the reporting entity with the power to direct the VIE’s significant activities

Push-Down Accounting

The method used to prepare the separate financial statements for significant, very large subsidiaries that are either wholly owned or substantially owned (> 90%)

SEC requires (for publicly traded companies) a one-time adjustment under the acquisition method to revalue the subsidiary’s assets and liabilities to fair value

The entry is made directly on the books to the subsidiary

Has no effect on the presentation of the consolidated financial statements or separate parent financial statements

The subsidiary’s financial statements would be recorded at fair value rather than historical cost

IFRS Business Combinations

• Focus is on the concept of the power to control, with control being the parent’s ability to govern the financial and operating policies of an entity to obtain benefits. Control is presumed to exist if parent owns more than 50% of the votes, and potential voting rights must be considered.
• Special-purpose entities
  • IFRS: Consolidated when the substance of the relationship indicates that an entity controls the SPE
• Consolidated financial statements required except when parent is a wholly owned subsidiary
• Equity method Investments must use equity method (i.e., no fair value option)
• Joint ventures can use either equity method or proportionate consolidation method
• Push-down accounting not allowed