Slide
2-1
Chapter Two
Consolidation
of Financial
Information
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-2
Why do Firms Combine?






McGraw-Hill/Irwin
Vertical integration.
Cost savings.
Quick access to new
markets.
Economies of scale.
More attractive
financing opportunities.
Diversification of
business risk.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-3
The Consolidation Process
The consolidation of financial information into a
single set of statements becomes necessary
whenever a single economic entity is created by
the business combination of two or more
companies. - - ARB No. 51
Why Consolidated Statements?
 They are presumed to be more meaningful
that separate statements.
 They are considered necessary for a fair
presentation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-4
Business Combinations
A business combination
occurs when an enterprise
acquires net assets that
constitute a business or equity
interests of one or more other
enterprises and obtains
control over that enterprise or
enterprises. - - SFAS No. 141
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-5
Business Combinations
Type of
Combination
Statutory merger
through asset
acquisition
Statutory merger
through capital
stock acquisition
Statutory
consolidation
through capital
stock or asset
acquisition.
Exh.
2-2
Action of Acquiring
Company
Acquires assets &
often liabilities.
Action of Acquired
Company
Dissolves & goes out of
business
Acquires all stock and
then transfers assets
& liabilities to its own
books
Newly created to
receive assets or
capital stock of
original companies
Dissolves as a separate
corporation, often
remaining as a division of
the acquiring company
Both original companies
may dissolve while
remaining as separate
divisions of newly created
company.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-6
Business Combinations – Cont.
Type of
Action of Acquiring
Combination
Company
Acquisition of more Acquires sotck that is
than 50% of the
recorded as an
voting stock.
investment. Controls
decision making of
acquired company.
Control though
A sponsoring firm
ownership of
creates an entity variable interests.
often referred to as
Risks and rewards an SPE - to engage in
often flow to a
a specific activity.
sponsoring firm
rather than the
equity holders.
McGraw-Hill/Irwin
Exh.
2-2
Action of Acquired
Company
Remains in existence as
legal corporation, although
now a subsidiary of the
acquiring company.
Remains in existence as a
separate legal entity - often
a trust or partnership.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-7
Consolidation of Financial
Information
Parent
Subsidiary
The parent does not
Consolidated
The Sub still prepares
prepare separate financial statements
separate financial
financial statements
are prepared.
statements
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-8
GAAP Accounting Methods
Level of
Influence
Method of Accounting
No Influence Fair Value Method (SFAS 115)
Significant
Equity Method (APB 18 and
Influence
SFAS 142)
Purchase Method (ARB 51,
Control
SFAS 141, & SFAS 142)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-9
Purchase Method – SFAS 141

Used when when
there is a change in
ownership that
If the acquisition is
results in control of
made by issuing
one enterprise by
stock, the cost of
another enterprise.
the acquisition is
equal to the
 The appropriate
MARKET VALUE of
valuation basis for
the stock issued.
any purchase
transaction is “cost”.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-10
Purchase Method Situations

Dissolution of the
acquired company:
 Cost = FMV
 Cost > FMV
 Cost < FMV

McGraw-Hill/Irwin
Separate
incorporation is
maintained.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-11
Purchase Method - Dissolution
Cost = FMV



Ignore the Equity and Nominal
accounts of the acquired
company.
Determine FMV of the acquired
company’s assets and liabilities.
Prepare a journal entry to
 recognize cost of the acquisition
 incorporate the FMV of acquired
company’s assets and liabilities
into acquiring company’s books.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-12
Purchase Method - Dissolution
Cost = FMV
On 1/1/04, Large acquired 100% of Tiny
for $300,000 cash.
Tiny's
Account
Book Value
Cash
$
22,000
Accounts Receivable
20,000
Inventory
35,000
Land
25,000
Buildings
90,000
Equipment
35,000
Tiny's
FMV
$
22,000
20,000
35,000
50,000
130,000
43,000
Prepare the entry to record Large’s
purchase.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-13
Purchase Method - Dissolution
Cost = FMV
Tiny’s fair market value was $300,000 which is
equal to the price paid by Large. Record the
purchased assets at their market value.
GENERAL JOURNAL
Date
Description
1-Jan Cash
Accounts Receivable
Inventory
Land
Buildings
Equipment
Cash
McGraw-Hill/Irwin
Page
Debit
##
Credit
22,000
20,000
35,000
50,000
130,000
43,000
300,000
© The McGraw-Hill Companies, Inc., 2004
Slide
2-14
Purchase Method - Dissolution
Cost > FMV

At date of acquisition:
 Acquired company should
prepare a Balance Sheet as of
the date of acquisition.
 Acquired company’s income
prior to acquisition is irrelevant
to the acquiring company.


McGraw-Hill/Irwin
FMV of acquired company’s
assets and liabilities is added
to acquiring company’s
books.
Difference between Cost and
FMV is allocated to
identifiable intangible assets
and to goodwill.
Note: Goodwill
should be viewed
as a residual
amount
remaining after
all other
identifiable and
separable
intangible assets
have been
identified.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-15
Purchase Method - Dissolution
Cost > FMV
On 1/1/04, Huge acquires 100% of Small
for $250,000 cash.
Small's
Small's
Account
Book Value
FMV
Cash
$
7,000 $
7,000
Accounts Receivable
11,000
11,000
Inventory
23,000
23,000
Land
10,000
40,000
Buildings & Equipment
77,000
145,000
Accounts Payable
9,000
9,000
Small has no identifiable, separable intangible
assets.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-16
Purchase Method - Dissolution
Cost > FMV
Huge's %
Huge's Cost
Small's BV
Difference
Asset FMV Adjustment
Land
Bldg & Equip.
100% $
100%
100%
Remainder Allocated to Goodwill
Small's
Amounts
119,000
Huge's
Share
$
250,000
119,000
131,000
30,000
68,000
30,000
68,000
$
33,000
Goodwill will be recorded as an intangible asset
on Huge’s books, but will not be amortized.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-17
Purchase Method - Dissolution
Cost > FMV
Prepare Large’s journal entry for this
acquisition. Remember to record the
$33,000 of Goodwill.
GENERAL JOURNAL
Date
Description
1-Jan Cash
Accounts Receivable
Inventory
Land
Buildings
Goodwill
Accounts Payable
Cash
McGraw-Hill/Irwin
Page
Debit
##
Credit
7,000
11,000
23,000
40,000
145,000
33,000
9,000
250,000
© The McGraw-Hill Companies, Inc., 2004
Slide
2-18
Purchase Method - Dissolution
Cost < FMV

When FMV exceeds cost, we
have a Bargain Purchase.
 Current assets and liabilities
should be consolidated at
their FMV.
 Non-current assets should
be recorded at a value
between FMV and BV.
 i.e. each non-current asset’s
(including in-process R&D)
FMV should be reduced by a
proportionate share of the
excess of FMV over cost.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-19
Purchase Method - Dissolution
Cost < FMV
In the event that the difference is
substantial enough to eliminate all
the non-current asset balances of
the acquired company . . .
. . . The remainder is to be
reported as an extraordinary gain
(SFAS 141)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-20
Let’s see what happens
when the acquired company
is not dissolved.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-21
Purchase Method
No Dissolution

The acquired company
continues as a separate entity.
 The acquisition shows up on the
Parent’s books in the Investment
in Subsidiary account.
McGraw-Hill/Irwin

Separate records for each
company are still maintained.

The adjusted balances for the
Parent and the Subsidiary are
consolidated using a
worksheet.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-22
Steps for Consolidation
1. Record the financial information for
both Parent and Sub on the worksheet.
2. Remove the Investment in Sub balance.
3. Remove the Sub’s equity account
balances.
4. Adjust the Sub’s net assets to FMV.
5. Allocate any excess of cost over BV to
identifiable, separable intangible assets
or goodwill.
6. Combine all account balances.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-23
No Dissolution
Example
On 1/1/05, Huge acquires 100% of Small
for $250,000 cash.
Account
Cash
Current Assets
Land
Buildings & Equipment
Accounts Payable
Common Stock
Retained Earnings
Small's
Small's
Book Value
FMV
$
7,000 $
7,000
34,000
34,000
10,000
40,000
77,000
145,000
9,000
9,000
90,000
90,000
29,000
29,000
Small holds a trademark that is valued at
$25,000.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-24
At 1/1/05
Account
Cash
A/R
Invest in Small
CONSOLIDATION WORKSHEET
HUGE
Small
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
A/P
Common Stock
(42,000)
(280,000)
(9,000)
(90,000)
PIC
R/E (Beg.)
(60,000)
(136,000)
(29,000)
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
-
Cons.
Balance
CR
1. Record the
balances for
each company
in the
worksheet.
$
-
$
-
$
-
© The McGraw-Hill Companies, Inc., 2004
Slide
2-25
At 1/1/05
Account
Cash
A/R
Invest in Small
CONSOLIDATION WORKSHEET
HUGE
Small
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
CR
250,000
A/P
Common Stock
(42,000)
(280,000)
(9,000)
(90,000)
PIC
R/E (Beg.)
(60,000)
(136,000)
(29,000)
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
Cons.
Balance
-
2. Remove the
investment
account from
the worksheet.
$
-
$ 250,000
$
-
© The McGraw-Hill Companies, Inc., 2004
Slide
2-26
At 1/1/05
Account
Cash
A/R
Invest in Small
CONSOLIDATION WORKSHEET
HUGE
Small
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
(42,000)
(280,000)
(9,000)
(90,000)
90,000
PIC
R/E (Beg.)
(60,000)
(136,000)
(29,000)
29,000
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
CR
3. Remove the
subsidiary’s
250,000
equity account
balances.
A/P
Common Stock
-
Cons.
Balance
$ 119,000
Let’s look at
the
computation
of Goodwill.
$ 250,000
$
-
© The McGraw-Hill Companies, Inc., 2004
Slide
2-27
Goodwill Computation for Huge’s
Acquisition of Small
Small's
Amounts
Huge's
Share
$ 250,000
100% $ 119,000
119,000
Huge's %
Huge's Cost
Small's BV
Difference
Asset FMV Adj.
Land
Building
Trademark
Goodwill
McGraw-Hill/Irwin
We use these numbers
for steps #4 & #5.
100%
100%
100%
131,000
30,000
68,000
25,000
(30,000)
(68,000)
(25,000)
$
8,000
© The McGraw-Hill Companies, Inc., 2004
Slide
2-28
At 1/1/05
Account
Cash
A/R
Invest in Small
CONSOLIDATION WORKSHEET
HUGE
Small
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
CR
250,000
A/P
Common Stock
(42,000)
(280,000)
(9,000)
(90,000)
PIC
R/E (Beg.)
(60,000)
(136,000)
(29,000)
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
Cons.
Balance
-
30,000
68,000
4. Adjust the
subsidiary’s
90,000
balances to
FMV.
29,000
$ 217,000
$ 250,000
$
-
© The McGraw-Hill Companies, Inc., 2004
Slide
2-29
At 1/1/05
Account
Cash
A/R
Invest in Small
CONSOLIDATION WORKSHEET
HUGE
Small
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
CR
250,000
30,000
68,000
8,000
25,000
A/P
Common Stock
(42,000)
(280,000)
(9,000)
(90,000)
PIC
R/E (Beg.)
(60,000)
(136,000)
(29,000)
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
Cons.
Balance
-
90,000
5. Record the
trademark and
29,000
the Goodwill.
$ 250,000
$ 250,000
$
-
© The McGraw-Hill Companies, Inc., 2004
Slide
2-30
At 1/1/05
Account
Cash
Current Assets
Invest in Small
CONSOLIDATION WORKSHEET
6. Add the balances
HUGE
Small
Cons.
across
theCR
page. Balance
BV
BV
DR
$
20,000
97,000
250,000
$ 7,000
34,000
Land
Bldg. & Equip
100,000
125,000
10,000
77,000
Accum. Depr.
Goodwill
Trademark
(30,000)
250,000
A/P
Common Stock
(42,000)
(280,000)
PIC
R/E (Beg.)
(60,000)
(136,000)
Revenues
Expenses
Total
(1,300,000)
1,256,000
$
- $
McGraw-Hill/Irwin
$
(9,000)
(90,000)
(29,000)
-
27,000
131,000
-
30,000
68,000
140,000
270,000
8,000
25,000
(30,000)
8,000
25,000
90,000
(51,000)
(280,000)
29,000
(60,000)
(136,000)
$ 250,000
(1,300,000)
1,256,000
$
-
$ 250,000
© The McGraw-Hill Companies, Inc., 2004
Slide
2-31
Purchase Price Allocations Additional Issues

Consolidation Costs
 Legal Fees, Direct Costs
of Combination
 Increase the Investment in
Subsidiary account.

Stock Issuance Costs
 Broker Fees, Registration
Fees, etc.
 Decrease the Parent’s
Paid-In Capital account.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-32
Purchase Price Allocations Additional Issues, SFAS No. 141

Intangibles
 Current and noncurrent assets
that lack physical substance.
 Do not include financial
instruments.

When should an Intangible
be recognized?
 Does it arise from contractual
or other legal rights?
 Can it be sold or otherwise
separated from the acquired
enterprise?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-33
Purchase Price Allocations Additional Issues, SFAS No. 141
Exh.
2-7
Intangible Asset Examples






McGraw-Hill/Irwin
Customer Base
Trademarked Brand
Names
Customer Routes
Effective Advertising
Programs
Covenants
Rights (broadcasting,
development, use,
etc.)






Databases
Technological knowhow
Patents & Copyrights
Strong labor relations
Assembled, trained
workforce
Favorable government
relations
© The McGraw-Hill Companies, Inc., 2004
Slide
2-34
Purchase Price Allocations Additional Issues, SFAS No. 141

In-Process R&D
 Should be expensed immediately
upon acquisition, unless there
are alternative future uses.
• Dr. R&D Expense
• Cr. Investment in Investee
 It could also be written-off via
consolidation entries

IPR&D that has reached
technological feasibility, can
be “capitalized”.
 Determination of fair value is
critical.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-35
Unconsolidated Subsidiaries
When can a Parent exclude a 50%
owned subsidiary from consolidation?
When control does not
actually rest with the 50%
owners.
SFAS No. 94
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-36
Pooling of Interests
Historically, many business
combinations have been
accounted for as “Pooling
of Interests.”
In its SFAS 141, “Business
Combinations”, the FASB
states that all business
combinations should be
accounted for using the
“Purchase Method”.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-37
Pooling of Interests
According to SFAS No. 141, the
purchase method is to be
applied prospectively.
Past poolings of interests are
left intact by SFAS No. 141.
Therefore, it is important to
understand how to account
for PAST poolings.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-38
Historical Review of Pooling of
Interests. Read the book for details!
In a pooling, one
company obtained
essentially “all” of the
other company’s
stock.
The transaction
involved the
exchange of common
stock. No exchange
of cash was allowed.
McGraw-Hill/Irwin




The ownership interests of
two, or more, companies
were combined into one
new company.
No single company was
dominant.
Precise cost figures were
difficult to obtain.
To use pooling of
interests, 12 strict criteria
had to be met.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-39
Historical Review of Pooling of
Interests
The Book Values of the two
combining companies were
joined. No Goodwill was
recorded.
Revenues and expenses were
combined retroactively for the
two companies. This created
superior earnings, hence its
preference.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-40
Historical Review of Pooling of
Interests

If both companies
continued to exist, an
Investment in Sub
account was recorded on
one company’s books
(usually the larger).
 No Goodwill was
recorded.
 Both companies were
combined at BV.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
2-41
Historical Review of Pooling of
Interests



McGraw-Hill/Irwin
Prior Period Adjustments were
made to account for
differences in the ways the two
companies accounted for
income.
A journal entry was recorded
to recognize the Investment in
Subsidiary.
The BV’s for both companies
were entered on a
consolidation worksheet.
© The McGraw-Hill Companies, Inc., 2004
Slide
2-42
Continued Accounting for Pooling
of Interests

The Investment in Sub
account must be
eliminated.
 Also eliminate the Sub’s
Equity accounts to
prevent double-counting.
 They have already been
included in the original
Investment in Sub entry.

Add together the BV’s of
the remaining accounts.
THE END OF CHAPTER 2
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004