Admas University Lecture Note
CHAPTER FIVE
5. CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION
5.1 Introduction
Consolidation accounting is analyzed at the date that a combination is created. This chapter carries
this process one step further by examining the consolidation procedures that must be followed in
subsequent periods whenever separate incorporation of the subsidiary is maintained. Despite
complexities created by the passage of time, the basic objective of all consolidations remains the
same: to combine asset, liability, revenue, expense, and equity accounts of a parent and its
subsidiaries.
The time factor introduces additional complications into the consolidation process. For internal
record-keeping purposes, the parent must select and apply an accounting method to monitor the
relationship between the two companies. The investment balance recorded by the parent varies over
time as a result of the method chosen, as does the income subsequently recognized.
These differences affect the periodic consolidation process but not the figures to be reported by the
combined entity. Regardless of the amount, the parent’s investment account is eliminated on the
worksheet so that the subsidiary’s actual assets and liabilities can be consolidated.
The preparation of consolidated financial statements at the date the acquirer company (parent)
acquires more than 50% of the stock of the acquired company (subsidiary) is not different when
preparing consolidated financial statements subsequent to acquisition, except for the fact that there
are transactions between the parent and the subsidiary occurred after the acquisition date, which
were already recorded in their books.
5.2 Investment Accounting by the Acquiring Company
For a parent company’s external financial reporting, consolidation of a subsidiary becomes
necessary whenever control exists. Three methods have emerged as the most prominent:
a. Equity method
b. Initial value method
c. Partial equity method.
At the acquisition date, each investment accounting method (equity, initial value, and partial
equity) begins with an identical value recorded in an investment account. Typically the fair value of
the consideration transferred by the parent will serve as the recorded valuation basis on the parent’s
books.
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Subsequent to the acquisition date, the three methods produce different account balances for the
parent’s investment in subsidiary, income recognized from the subsidiary’s activities and retained
earnings accounts. Importantly, the selection of a particular method does not affect the totals
ultimately reported for the combined companies. However, the parent’s choice of an internal
accounting method does lead to distinct procedures for consolidating the financial information from
the separate organizations.
a. The Equity Method
The equity method embraces full accrual accounting in maintaining the investment account and
related income over time. Under the equity method, the acquiring company accrues income when
the subsidiary earns it. To match the additional fair value recorded in the combination against
income, amortization expense stemming from the original excess fair value allocations is
recognized through periodic adjusting entries. Unrealized gains on intra-entity transactions are
deferred; dividends paid by the subsidiary serve to reduce the investment balance. The equity
method creates a parallel between the parent’s investment accounts and changes in the underlying
equity of the acquired company. When the parent has complete ownership, equity method earnings
from the subsidiary, combined with the parent’s other income sources, create a total income figure
reflective of the entire combined business entity. Consequently, the equity method often is referred
to as a single-line consolidation. The equity method is used to value a company's investment in
another company when it holds significant influence over the company it is investing in.
The threshold for "significant influence" is commonly a 20-50% ownership.
Under the equity method, the investment is initially recorded at historical cost, and adjustments are
made to the value based on the investor's percentage ownership in net income, loss, and dividend
payouts.
A number of circumstances indicate an investor’s ability to exercise significant influence over
the operating and financial policies of an investee, including the following:

Board of directors representation

Policy-making participation

Intra-entity transactions that are material

Intra-entity management personnel interchange

Technological dependence

Proportion of ownership by the investor in comparison to that of other investors
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b. The Initial Value Method (formerly known as the cost method)
Subsequent to acquisition, the initial value method uses the cash basis for income recognition.
Dividends received by the parent from the subsidiary are recognized as income. No recognition is
given to the income earned by the subsidiary. The investment balance remains permanently on the
parent’s financial records at the initial fair value assigned at the acquisition date.
c. The Partial Equity Method
A third method available to the acquiring company is a partial application of the equity method.
Under this approach, the parent recognizes the reported income accruing from the subsidiary.
Dividends that are collected reduce the investment balance. However, no other equity adjustments
(amortization or deferral of unrealized gains) are recorded. Thus, in many cases, earnings figures on
the parent’s books approximate consolidated totals but without the effort associated with a full
application of the equity method.
The method adopted affects only the acquiring company’s separate financial records. No changes
are created in either the subsidiary’s accounts or the consolidated totals.
Because specific worksheet procedures differ based on the investment method utilized by the
parent, the consolidation process subsequent to the date of combination will be introduced twice.
Each acquiring company must decide for itself the appropriate approach in recording the operations
of its subsidiaries.
Method
Equity
Investment account
Income account
Advantages
Continually adjusted to
Income accrued as
Acquiring company totals give a
reflect ownership of
earned; amortization
true representation of
acquired company
and other adjustments
consolidation figures.
are recognized.
Initial
Remains at acquisition-date
value(Cost) value assigned.
Cash received
It is easy to apply; it measures
recorded as Dividend
cash flows.
Income.
Adjusted only for accrued
Income accrued as
It usually gives balance
Partial
income and dividends
earned; no other
approximating consolidation
Equity
received from acquired
adjustments
figures, but it is easier to apply
company.
recognized.
than equity method.
Investment Recorded by the Equity Method
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CONSOLIDATED FINANCIAL STATEMENTS FOR WHOLLY OWNED SUBSIDIARY
Example: assume that Parrot Company obtains all of the outstanding common stock of Sun
Company on January 1, 2010. Parrot acquires this stock for $800,000 in cash and 100 Percent
Acquisition of Sun Company.
The book values as well as the appraised fair values of Sun’s accounts follow:
Book value
Fair value
Difference
Current assets
$ 320,000
$ 320,000
–0–
Trademarks (indefinite life)
200,000
220,000
20,000
Patented technology (10-year life)
320,000
450,000
130,000
Equipment (5-year life)
180,000
150,000
(30,000)
Liabilities
(420,000)
(420,000)
–0–
Net book value
$ 600,000
$ 720,000
Common stock—$40 par value
$(200,000)
Additional paid-in capital
(20,000)
Retained earnings, 1/1/10
(380,000)
$120,000
Assume that Sun earns income of $100,000 during the year and pays a $40,000 cash dividend on
August 1
Parrot considers the economic life of Sun’s trademarks as extending beyond the foreseeable future
and thus having an indefinite life. Such assets are not amortized but are subject to periodic
impairment testing. For the definite lived assets acquired in the combination (patented technology
and equipment), we assume that straight-line amortization with no salvage value is appropriate.
Application of the Equity Method
Required
1. passes a necessary journal entry
2. Compute Good will
3. Prepare excess amortization schedule and record the journal entry
Solution
1. Journal entries
Parrot’s Financial Records
1/1/10 Investment in Sun Company . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
To record the acquisition of Sun Company
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8/1/10 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Investment in Sun Company . . . . . . . . . . . . . . . . . . . . 40,000
To record receipt of cash dividend from subsidiary under the equity method
12/31/10 Investment in Sun Company . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Equity in Subsidiary Earnings . . . . . . . . . . . . . . . . . . . . 100,000
To accrue income earned by 100 percent owned subsidiary.
2. Compute Good will
Compute goodwill of $80,000 must be recognized for consolidation purposes.
Good Will= Price paid or amounts of consideration – CFV of net Asset
GW= 800, 000-720,000
Goodwill……………………………….Br 80,000
The fair value of Sun’s Equipment account was $30,000 less than book value. Therefore, instead of
attributing an additional amount to this asset, the $30,000 allocation actually reflects a fair-value
reduction. As such, the amortization shown blow relating to Equipment is not an additional expense
but an expense reduction.
3. Prepare excess amortization schedule and record the journal entry

Annual Excess Amortization
ARROT COMPANY
Excess Amortization Schedule—Allocation of Acquisition-Date Fair Values
Account
Allocation
Life
Annual Excess Amortizations
Trademarks
$ 20,000
Indefinite
–0–
Patented technology
130,000
10 years
$13,000
Equipment
(30,000)
5 years
(6,000)
Indefinite
–0–
Goodwill
80,000
$7,000*
*Total excess amortizations will be $7,000 annually for five years until the equipment allocation is
fully removed. At the end of each asset’s life, future amortizations will change.
12/31/10 Equity in Subsidiary Earnings . . . . . . . . . . . . . . . . . . . . . . . . . 7,000
Investment in Sun Company . . . . . . . . . . . . . . . . . . . . 7,000
To recognize amortizations on allocations made in acquisition of subsidiary
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Example Separate Records—Equity Method Applied
PARROTCOMPANYANDSUNCOMPANY
Financial Statements
For Year Ending December31,2010
Parrot
Sun
Income Statement
Revenues... ... ... ... ... ... ... ... ... ... ... ... ... ... .
Cost of goods sold..................................
Amortization expense................................
Depreciation expense................................
Equity in subsidiary earnings..........................
Net income.....................................
$(1,500,000)
700,000
120,000
80,000
(93,000)
$(693,000)
$(400,000)
250,000
20,000
30,000
–0–
$(100,000)
Statement of Retained Earnings
Retainedearnings,1/1/10..............................
Net income (above).................................
Dividends paid.....................................
Retainedearnings,12/31/10.......................
$(840,000)
(693,000)
120,000
$(1,413,000)
$(380,000)
(100,000)
40,000
$(440,000)
Balance Sheet
Current assets. . .. . . . . . .. . . . . . .. . . . . .. . . .. . . .. .
Investment in Sun Company (at equity)..............
Trademarks.... ... .... ... .... ... ... .... ... .... ... ...
Patented technology..................................
Equipment (net).....................................
Total assets ......................................
$1,040,000
853,000
600,000
370,000
250,000
$3,113,000
$ 400,000
–0–
200,000
288,000
220,000
$1,108,000
Liabilities..........................................
Common stock......................................
Additional paid-in capital............................
Retainedearnings,12/31/10(above)....................
Total liabilities and equity. .. . .. .. .. .. .. .. . .. .. .. ..
$(980,000)
(600,000)
(120,000)
(1,413,000)
$(3,113,000)
$(448,000)
(200,000)
(20,000)
(440,000)
$(1,108,000)
1. Prepare consolidated financial statements subsequent to acquisition when the parent has
applied the equity method in its internal records.
2. Prepare consolidation entries
Solution
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Equity Method
Accounts
Income Statement
Revenues
Cost of goods sold
Amortization expense
Depreciation expense
Equity in subsidiary earnings
Net income
Statement of Retained Earnings
Retainedearnings,1/1/13
Net income(above)
Dividends paid
Retainedearnings,12/31/13
Balance Sheet
Current assets
Investment in Sun Company
Trademarks
Patented technology
Equipment(net)
Goodwill
Total assets
Liabilities
Common stock
Additional paid-in capital
Retainedearnings,12/31/13(above)
Total liabilities and equities
PARROT COMPANY AND SUN COMPANY
Consolidated Worksheet
For Year Ending December 31, 2010
Parrot
Sun Company Consolidation Entries
Company
Debit
Credit
Consolidated
Totals
(1,500,000)
700,000
120,000
80,000
(93,000)
(400,000)
250,000
20,000
30,000
–0–
(693,000)
(100,000)
(840,000)
(693,000)
120,000
(380,000)
(100,000)
40,000
(1,413,000)
(440,000)
(1,413,000)
1,040,000
853,000
600,000
370,000
250,000
–0–
400,000
–0–
200,000
288,000
220,000
–0–
1,440,000
–0–
820,000
775,000
446,000
80,000
3,113,000
1,108,000
3,561,000
(448,000)
(200,000) 200,000
(20,000) 20,000
(440,000)
(1,428,000)
(600,000)
(120,000)
(1413,000)
(980,000)
(600,000)
(120,000)
(1,413,000)
(3113,000)
(1108,000)
E) 13,000
E) 6,000
I)93,000
(1,900,000)
950,000
153,000
104,000
–0–
(693,000)
S)380,000
D)40,000
853000
20,000
130,000
6,000
80,000
942,000
13,000
30,000
942,000
(840000)
(693,000)
120,000
(3,561,000)
Determination of Consolidated Totals
Within this procedure, several important guidelines must be followed:
• Sun’s assets and liabilities are adjusted to reflect the allocations originating from their acquisitiondate fair values.
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• Because of the passage of time, the income effects (e.g., amortizations) of these allocations must
also be recognized within the consolidation process.
• Any reciprocal or intra-entity accounts must be offset. If, for example, one of the companies
owes money to the other, the receivable and the payable balances have no connection with an
outside party. Both should be eliminated for external reporting purposes. When the companies are
viewed as a single entity, the receivable and the payable are intra-entity balances to be removed.
Consolidated amounts
 Revenues _ $1,900,000. The revenues of the parent and the subsidiary are added together.
 Cost of goods sold_ $950,000. The cost of goods sold of the parent and subsidiary are added
together.
 Amortization expense= $153,000. The balances of the parent and of the subsidiary are
combined along with the additional amortization from the recognition of the excess fair value
over book value attributed to the subsidiary’s patented technology.
 Depreciation
expense=
$104,000.
The
depreciation
expenses
of
the
parent
and
subsidiaryareaddedtogetheralongwiththe$6,000 reduction in equipment depreciation
 Equity in subsidiary earnings= 0. The investment income recorded by the parent is eliminated
so that the subsidiary’s revenues and expenses can be included in the consolidated totals.
 Net income=$693,000. Consolidated revenues less consolidated expenses.
 Retained earnings, 1/1/10= $840,000. The parent figures only because the subsidiary was not
owned prior to that date.
Dividends paid=$120,000.The parent company balance only because the subsidiary’s dividends
were paid intra-entity to the parent, not to an outside party.
 Retained earnings,12/31/10=$1,413,000.Consolidated retained earnings as of the be-ginning of
the year plus consolidated net income less consolidated dividends paid.
 Current assets=$1,440,000.The parent’s book value plus the subsidiary’s book value.
 Investment in Sun Company = —0—. The asset recorded by the parent is eliminated so that the
subsidiary’s assets and liabilities can be included in the consolidated totals.
 Trademarks=$820,000.The parent’s book value plus the subsidiary’s book value plus the
$20,000 acquisition-date fair value allocation.
 Patented technology=$775,000.The parent’s book value plus the subsidiary’s book value plus the
$130,000 acquisition-date fair value allocation less current year amortization of$13,000.
 Equipment=$446,000.The parent’s book value plus the subsidiary’s book value less the
$30,000 fair value reduction allocation plus the current year expense reductionof$6,000.
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 Goodwill=$80,000.Goodwill is not amortized.
 Total assets=$3,561,000.A vertical summation of consolidated assets.
 Liabilities=$1,428,000.The parent’s book value plus the subsidiary’s book value.
 Common stock=$600,000.The parent’s book value. Subsidiary shares are no longer
outstanding.
 Additional paid-in capital= $120,000. The parent’s book value. Subsidiary shares are no longer
outstanding.
 Retainedearnings,12/31/10=$1,413,000. Computed previously.
 Totalliabilitiesandequities=$3,561,000.Averticalsummationofconsolidatedliabilities an equities.
Consolidation Worksheet
For Parrot and Sun, only five consolidation entries are needed to arrive at the same figures
previously derived for this business combination.
Consolidation entries:
(S) Elimination of Sun’s stockholders’ equity January 1 balances and the book value portion of the
investment account.
(A) Allocation of Sun’s acquisition-date excess fair values over book values.
(I) Elimination of parent’s equity in subsidiary earnings accrual
(D) Elimination of intra-entity dividend payment.
(E) Recognition of current year excess fair-value amortization and depreciation expenses.
Consolidation Entry S
Common Stock (Sun Company).........................
200,000
Additional Paid-In Capital (Sun Company)................
20,000
RetainedEarnings,1/1/10(Sun Company)................
380,000
Investment in Sun Company.....................
600,000
Elimination of Sun’s stockholders’ equity January 1balances and the book value portion of the
investment account
Note “Entry S” used in this example refers to the elimination of Sun’s beginning Stockholders’
Equity
Consolidation Entry A
Trademarks............................................
Patented technology............................
Goodwill.............................................
Equipment.......................................
Investment in Sun Company......................
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20,000
130,000
80,000
30,000
200,000
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Admas University Lecture Note
Allocation of Sun’s acquisition-date excess fair values over book values
Note This entry is labeled “Entry A” to indicate that it represents the Allocations made in
connection with the excess of the subsidiary’s fair values over its book values.
Consolidation Entry I
Equity in Subsidiary Earnings.. . . .. . .. . . .. . . .. . .. . . .. . ..
93,000
Investment in Sun Company......................
93,000
Elimination of parent’s equity in subsidiary earnings accrual
“Entry I” (for Income) removes the subsidiary income recognized by Parrot during the year
Consolidation Entry D
Investment in Sun Company............................
40,000
Dividends Paid..................................
40,000
Elimination of intra-entity dividend payment
Entry D” (for Dividends) is designed to offset the impact of this transaction by removing the
subsidiary’s Dividends Paid account.
Consolidation Entry E
Amortization Expense...............................
13,000
Equipment........................................
6,000
Patented Technology............................
13,000
Depreciation Expense............................
6,000
Recognition of current year excess fair-value amortization and depreciation expenses
“Entry E” (for Expense) now records the current year expense attributed to each of the specific
account allocations
Thus, the worksheet entries necessary for consolidation when the parent has applied the equity
method are as follows:
 Entry S; eliminates the subsidiary’s stockholders’ equity accounts as of the beginning of the
current year along with the equivalent book value component within the parent’s investment
account.
 Entry A; Recognizes the amortized allocations as of the beginning of the current year
associated with the original adjustments to fair value.
 Entry I; Eliminates the impact of intra-entity subsidiary income accrued by the parent.
 Entry D; Eliminates the impact of intra-entity subsidiary dividends.
 Entry E; Recognizes excess amortization expenses for the current period on the allocations
from the original adjustments to fair value.
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Based on the Example Above
a) Prepare consolidated financial statements subsequent to acquisition when the parent has
applied the initial value method in its internal records
b) Prepare consolidated financial statements subsequent to acquisition when the parent has
applied the partial equity method in its internal records
In reality, just three of the parent’s accounts actually vary because of the method applied:
1. The investment account.
2. The income recognized from the subsidiary.
3. The parent’s retained earnings (in periods after the initial year of the combination).
Solution
Prepare consolidated financial statements subsequent to acquisition when the parent has
applied the initial value method in its internal records
Initial Value Method
Accounts
Income Statement
Revenues
Cost of goods sold
Amortization expense
Depreciation expense
Dividend income
PARROT COMPANY AND SUN COMPANY
Consolidated Worksheet
For Year Ending December 31, 2010
Parrot
Sun Company Consolidation Entries
Company
Debit
Credit
Consolidated
Totals
(1,500,000)
700,000
120,000
80,000
40,000*
(400,000)
250,000
20,000
30,000
Net income
(640,000)
(100,000)
Statement of Retained Earnings
Retainedearnings,1/1/13
Net income(above)
Dividends paid
(840,000)
(640,000)
120,000
(380,000)
(100,000)
40,000
(1,360,000)
(440,000)
(1,413,000)
1,040,000
800,000*
600,000
400,000
–0–
200,000
1,440,000
–0–
820,000
Retainedearnings,12/31/13
Balance Sheet
Current assets
Investment in Sun Company
Trademarks
Advanced Financial Accounting –II
E) 13,000
E) 6,000
(1,900,000)
950,000
153,000
104,000
40,000*
(693,000)
S)380,000
D)40,000
800,000*
20,000
by Lemessa N
(840000)
(693,000)
120,000
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Patented technology
Equipment(net)
Goodwill
Total assets
Liabilities
Common stock
Additional paid-in capital
Retainedearnings,12/31/13(above)
Total liabilities and equities
370,000
250,000
–0–
288,000
220,000
–0–
130,000
6,000
80,000
13,000
30,000
3060,000
1,108,000
3,561,000
(980,000)
(600,000)
(120,000)
(1,360,000)
(448,000)
(200,000)
(20,000)
(440,000)
200,000
20,000
(1,428,000)
(600,000)
(120,000)
(1413,000)
(3060,000)
(1108,000)
942,000
942,000
775,000
446,000
80,000
(3,561,000)
Note: Parentheses indicate a credit balance.
*Boxed items highlight differences with consolidation in Equity Method Consolidation entries:
(S) Elimination of Sun’s stockholders’ equity January 1 balances and the book value portion of the
investment account.
(A) Allocation of Sun’s acquisition-date excess fair values over book values.
(I) Elimination of intra-entity dividend income and dividend paid by Sun
(E) Recognition of current year excess fair-value amortization and depreciation expenses.
Note: Consolidation entry (D) is not needed when the parent applies the initial value method
because entry (I) eliminates the intra-entity dividend
Prepare consolidated financial statements subsequent to acquisition when the parent has applied
the partial equity method in its internal records
PARROT COMPANY AND SUN COMPANY
Partial Equity Method
Consolidated Worksheet
For Year Ending December 31, 2010
Accounts
Income Statement
Revenues
Cost of goods sold
Amortization expense
Depreciation expense
Equity in subsidiary
Parrot
Sun Company Consolidation Entries
Company
Debit
Credit
(1,500,000)
700,000
120,000
80,000
100,000*
(400,000)
250,000
20,000
30,000
Net income
(700,000)
(100,000)
Statement of Retained Earnings
Retainedearnings,1/1/13
Net income(above)
Dividends paid
(840,000)
(700,000)
120,000
(380,000)
(100,000)
40,000
Advanced Financial Accounting –II
E) 13,000
E) 6,000
Consolidated
Totals
(1,900,000)
950,000
153,000
104,000
100,000*
(693,000)
S)380,000
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D)40,000
(840000)
(693,000)
120,000
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Retainedearnings,12/31/13
Balance Sheet
Current assets
Investment in Sun Company
Trademarks
Patented technology
Equipment(net)
Goodwill
Total assets
Liabilities
Common stock
Additional paid-in capital
Retainedearnings,12/31/13(above)
Total liabilities and equities
(1,420,000)
(440,000)
(1,413,000)
1,040,000
860,000*
600,000
370,000
250,000
–0–
400,000
–0–
200,000
288,000
220,000
–0–
1,440,000
–0–
820,000
775,000
446,000
80,000
3,120,000
1,108,000
3,561,000
(980,000)
(600,000)
(120,000)
(1,420,000)
(448,000)
(200,000)
(20,000)
(440,000)
200,000
20,000
(1,428,000)
(600,000)
(120,000)
(1413,000)
(3,120,000)
(1108,000)
942,000
860,000*
20,000
130,000
6,000
80,000
13,000
30,000
942,000
(3,561,000)
Note: Parentheses indicate a credit balance.
*Boxed items highlight differences with consolidation in Equity Consolidation entries:
(S) Elimination of Sun’s stockholders’ equity January 1 balances and the book value portion of the
investment account.
(A) Allocation of Sun’s acquisition-date excess fair values over book values.
(I) Elimination of parent’s equity in subsidiary earnings accrual
(D) Elimination of intra-entity dividend payment.
(E) Recognition of current year excess fair-value amortization and depreciation expenses
Capital stock and additional Parent balances only are included although they will have paid-in
capital been adjusted at acquisition date if stock was issued
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