Slide

2-1

Chapter Two

Consolidation
of Financial
Information

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Slide
2-2

Why do Firms Combine?

Vertical
Verticalintegration.
integration.

Cost
Costsavings.
savings.

Quick
Quickaccess
accessto
tonew
new

markets.
markets.

Economies
Economiesof
ofscale.
scale.

More
Moreattractive
attractive
financing
financingopportunities.
opportunities.

Diversification
Diversification of
of
business
businessrisk.
risk.

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Slide
2-3

The Consolidation Process

The
The consolidation
consolidation of
of financial
financial information
information into
into aa
single
single set
set of
of statements
statements becomes
becomes necessary
necessary
whenever
whenever aa single
single economic
economic entity
entity isis created
created by
by
the
the business
business combination
combination of
of two
two or
or more
more
companies.
companies. -- --ARB
ARB No.
No. 51
51
Why Consolidated Statements?
They are presumed to be more meaningful

that separate statements.

They are considered necessary for a fair
presentation.
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Slide
2-4

Business Combinations
AAbusiness
business combination
combination
occurs
occurs when
when an
an enterprise
enterprise
acquires
acquires net
net assets
assets that
that
constitute
constitute aa business
business or
or equity
equity
interests
interests of
of one
one or
or more
moreother
other
enterprises
enterprises and
and obtains
obtains
control
control over
over that
that enterprise
enterprise or
or
enterprises.
enterprises. -- -- SFAS
SFAS No.
No. 141
141

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Slide
2-5

Business Combinations

Exh.
2-2

Continue
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Slide
2-6

Business Combinations Cont.

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Exh.
2-2

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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
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Slide
2-8

GAAP Accounting Methods

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Slide
2-9

Purchase Method SFAS 141

Used

when when
there is a change in
ownership that
IfIf the
theacquisition
acquisitionis
is
results in control of
made
by
issuing
made
by
issuing
one enterprise by
stock,
stock, the
thecost
costof
of
another enterprise.
the
theacquisition
acquisitionis
is
equal
The appropriate
equalto
tothe
the
MARKET
MARKETVALUE
VALUEof
of
valuation basis for
the
stock
issued.
the
stock
issued.
any purchase
transaction is cost.
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Slide
2-10

Purchase Method Situations

Dissolution
Dissolution of
of the
the

acquired
acquired company:
company:

Cost
Cost == FMV
FMV

Cost
Cost >> FMV
FMV

Cost
Cost << FMV
FMV

Separate
Separate

incorporation
incorporation is
is
maintained.
maintained.

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Slide
2-11

Purchase Method - Dissolution

Cost = FMV

Ignore the Equity and Nominal

accounts of the acquired
company.
Determine FMV of the acquired
companys assets and liabilities.
Prepare a journal entry to
recognize cost of the acquisition
incorporate the FMV of acquired

companys assets and liabilities

into acquiring companys books.

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Slide
2-12

Purchase Method - Dissolution

Cost = FMV
On 1/1/04, Large acquired 100% of Tiny
for $300,000 cash.

Prepare the entry to record Larges

purchase.
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Slide
2-13

Purchase Method - Dissolution

Cost = FMV
Tinys fair market value was $300,000 which is
equal to the price paid by Large. Record the
purchased assets at their market value.

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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 companys income
prior to acquisition is irrelevant
to the acquiring company.

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FMV of acquired companys

assets and liabilities is added
to acquiring companys books.
Difference between Cost and
FMV is allocated to identifiable
intangible assets and to
goodwill.

Note:
Note:Goodwill
Goodwill
should
shouldbe
beviewed
viewed
as
asaaresidual
residual
amount
amount
remaining
remainingafter
after
all
allother
other
identifiable
identifiableand
and
separable
separable
intangible
intangibleassets
assets
have
havebeen
been
identified.
identified.

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Slide
2-15

Purchase Method - Dissolution

Cost > FMV
On 1/1/04, Huge acquires 100% of Small
for $250,000 cash.

Small has no identifiable, separable intangible

assets.
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Slide
2-16

Purchase Method - Dissolution

Cost > FMV

Goodwill will be recorded as an intangible asset

on Huges books, but will not be amortized.
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Slide
2-17

Purchase Method - Dissolution

Cost > FMV
Prepare Larges journal entry for this
acquisition. Remember to record the
$33,000 of Goodwill.

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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 assets

(including in-process R&D)

FMV should be reduced by a
proportionate share of the
excess of FMV over cost.

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Slide
2-19

Purchase Method - Dissolution

Cost < FMV
In
In the
the event
event that
that the
the difference
difference is
is
substantial
substantial enough
enough to
to eliminate
eliminate all
all
the
the non-current
non-current asset
asset balances
balances of
of
the
the acquired
acquired company
company .. .. ..
.. .. .. The
The remainder
remainder is
is to
to be
be
reported
reported as
as an
an extraordinary
extraordinary gain
gain
(SFAS
(SFAS 141)
141)

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Slide
2-20

Lets see what happens

when the acquired company
is not dissolved.

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Slide
2-21

Purchase Method
No Dissolution

The
Theacquired
acquired company
company

continues
continuesas
as aaseparate
separate entity.
entity.

The
Theacquisition
acquisitionshows
showsup
upon
onthe
the

Parents
Parentsbooks
booksin
inthe
theInvestment
Investment
in
inSubsidiary
Subsidiaryaccount.
account.

Separate
Separaterecords
recordsfor
foreach
each

company
companyare
arestill
stillmaintained.
maintained.

The
Theadjusted
adjusted balances
balancesfor
forthe
the
Parent
Parent and
and the
theSubsidiary
Subsidiaryare
are
consolidated
consolidated using
using aa
worksheet.
worksheet.

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Slide
2-22

Steps for Consolidation

1.
1. Record
Record the
thefinancial
financial information
informationfor
for
both
bothParent
Parentand
andSub
Sub on
on the
theworksheet.
worksheet.
2.
2. Remove
Removethe
theInvestment
Investment in
in Sub
Sub balance.
balance.
3.
3. Remove
Remove the
theSubs
Subsequity
equityaccount
account
balances.
balances.
4.
4. Adjust
Adjustthe
the Subs
Subsnet
netassets
assets to
to FMV.
FMV.
5.
5. Allocate
Allocateany
anyexcess
excessof
of cost
costover
overBV
BVto
to
identifiable,
identifiable,separable
separableintangible
intangibleassets
assets
or
or goodwill.
goodwill.
6.
6. Combine
Combineall
allaccount
accountbalances.
balances.

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Slide
2-23

No Dissolution
Example
On 1/1/05, Huge acquires 100% of Small
for $250,000 cash.

Small holds a trademark that is valued at

$25,000.
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Slide
2-24

1.
1. Record
Record the
the
balances
balancesfor
for
each
eachcompany
company
in
inthe
the
worksheet.
worksheet.

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Slide
2-25

2.
2. Remove
Removethe
the
investment
investment
account
accountfrom
from
the
the worksheet.
worksheet.

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Slide
2-26

3.
3. Remove
Remove the
the
subsidiarys
subsidiarys
equity
equityaccount
account
balances.
balances.
Lets
Letslook
lookat
at
the
the
computation
computation
of
of Goodwill.
Goodwill.

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Slide
2-27

Goodwill Computation for Huges

Acquisition of Small

Weuse
usethese
thesenumbers
numbers
We
forsteps
steps#4
#4 &&#5.
#5.
for

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Slide
2-28

4.
4. Adjust
Adjustthe
the
subsidiarys
subsidiarys
balances
balancesto
to
FMV.
FMV.

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Slide
2-29

5.
5. Record
Record the
the
trademark
trademarkand
and
the
theGoodwill.
Goodwill.

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Slide
2-30

McGraw-Hill/Irwin

6.
6. Add
Addthe
thebalances
balances
across
acrossthe
thepage.
page.

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Slide
2-31

Purchase Price Allocations Additional Issues

Consolidation
ConsolidationCosts
Costs

Legal
LegalFees,
Fees,Direct
DirectCosts
Costs
of
ofCombination
Combination

Increase
Increasethe
theInvestment
Investmentin
in

Subsidiary
Subsidiaryaccount.
account.

Stock
StockIssuance
IssuanceCosts
Costs

Broker
BrokerFees,
Fees,Registration
Registration
Fees,
Fees,etc.
etc.

Decrease
Decreasethe
theParents
Parents

Paid-In
Paid-InCapital
Capitalaccount.
account.

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Slide
2-32

Purchase Price Allocations Additional Issues, SFAS No. 141

Intangibles
Intangibles

Current
Current and
and noncurrent
noncurrent assets
assets

that
that lack
lack physical
physicalsubstance.
substance.

Do
Donot
not include
includefinancial
financial
instruments.
instruments.

When
When should
should an
an Intangible
Intangible

be
be recognized?
recognized?

Does
Doesitit arise
arisefrom
fromcontractual
contractual

or
orother
otherlegal
legal rights?
rights?

Can
Canititbe
besold
soldor
or otherwise
otherwise
separated
separatedfrom
fromthe
theacquired
acquired
enterprise?
enterprise?
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Slide
2-33

Purchase Price Allocations Additional Issues, SFAS No. 141

Exh.
2-7

Intangible Asset Examples

Customer
CustomerBase
Base
Trademarked
TrademarkedBrand
Brand
Names
Names

Customer
CustomerRoutes
Routes

Effective
EffectiveAdvertising
Advertising
Programs
Programs

Covenants
Covenants

Rights
Rights(broadcasting,
(broadcasting,
development,
development,use,
use,
etc.)
etc.)

McGraw-Hill/Irwin

Databases
Databases
Technological
Technologicalknowknowhow
how

Patents
Patents&&Copyrights
Copyrights

Strong
Stronglabor
laborrelations
relations

Assembled,
Assembled,trained
trained
workforce
workforce

Favorable
Favorablegovernment
government
relations
relations

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Slide
2-34

Purchase Price Allocations Additional Issues, SFAS No. 141

In-Process
In-Process R&D
R&D

Should
Shouldbe
beexpensed
expensedimmediately
immediately
upon
uponacquisition,
acquisition,unless
unlessthere
there
are
arealternative
alternativefuture
futureuses.
uses.
Dr.
Dr.R&D
R&DExpense
Expense

Cr.
Cr.Investment
Investmentin
inInvestee
Investee

ItItcould
couldalso
alsobe
bewritten-off
written-offvia
via
consolidation
consolidationentries
entries

IPR&D
IPR&Dthat
thathas
hasreached
reached

technological
technologicalfeasibility,
feasibility,can
can
be
be capitalized.
capitalized.

Determination
Determinationof
offair
fairvalue
valueis
is

critical.
critical.

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Slide
2-35

Unconsolidated Subsidiaries
W h e n c a n a P a r e n t e x c lu d e a 5 0 %
o w n e d s u b s id ia r y fr o m c o n s o lid a tio n ?

W h e n c o n tro l d o e s n o t
a c t u a ll y r e s t w i t h th e 5 0 %
o w n e rs.

SFAS N o. 94
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Slide
2-36

Pooling of Interests
Historically,
Historically,many
many business
business
combinations
combinations have
have been
been
accounted
accounted for
for as
as Pooling
Pooling
of
of Interests.
Interests.
In
In its
its SFAS
SFAS 141,
141, Business
Business
Combinations,
Combinations, the
the FASB
FASB
states
states that
that all
all business
business
combinations
combinations should
should be
be
accounted
accounted for
for using
using the
the
Purchase
Method
Purchase Method.
Method.
Method

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Slide
2-37

Pooling of Interests
According
Accordingto
toSFAS
SFASNo.
No.141,
141,the
the
purchase
purchasemethod
method is
isto
tobe
be
applied
appliedprospectively.
prospectively.
Past
Past poolings
poolingsof
ofinterests
interests are
are
left
left intact
intact by
bySFAS
SFASNo.
No.141.
141.
Therefore,
Therefore,itit is
isimportant
importantto
to
understand
understandhow
how to
toaccount
account
for
forPAST
PASTpoolings.
poolings.

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Slide
2-38

Historical Review of Pooling of

Interests. Read the book for details!
In
Inaapooling,
pooling,one
one
company
companyobtained
obtained
essentially
essentiallyall
allof
ofthe
the
other
othercompanys
companys
stock.
stock.
The
Thetransaction
transaction
involved
involvedthe
the
exchange
exchangeof
ofcommon
common
stock.
stock. No
Noexchange
exchange
of
of cash
cashwas
wasallowed.
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.

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Slide
2-39

Historical Review of Pooling of

Interests

The
TheBook
Book Values
Valuesof
ofthe
thetwo
two
combining
combiningcompanies
companies were
were
joined.
joined. No
NoGoodwill
Goodwillwas
was
recorded.
recorded.

Revenues
Revenuesand
andexpenses
expenseswere
were
combined
combinedretroactively
retroactivelyfor
for the
the
two
two companies.
companies. This
Thiscreated
created
superior
superiorearnings,
earnings,hence
henceits
its
preference.
preference.

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Slide
2-40

Historical Review of Pooling of

Interests

IfIf both
both companies
companies

continued
continued to
to exist,
exist, an
an
Investment
Investment in
in Sub
Sub
account
account was
was recorded
recorded on
on
one
one companys
companys books
books
(usually
(usually the
the larger).
larger).

No
No Goodwill
Goodwill was
was
recorded.
recorded.

Both
Both companies
companies were
were
combined
combined at
at BV.
BV.
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Slide
2-41

Historical Review of Pooling of

Interests

Prior
PriorPeriod
PeriodAdjustments
Adjustmentswere
were

made
madeto
to account
account for
for
differences
differences in
in the
the ways
ways the
thetwo
two
companies
companiesaccounted
accountedfor
for
income.
income.

A
Ajournal
journalentry
entrywas
wasrecorded
recorded
to
torecognize
recognizethe
the Investment
Investmentin
in
Subsidiary.
Subsidiary.

The
TheBVs
BVsfor
for both
both companies
companies
were
wereentered
enteredon
onaa
consolidation
consolidationworksheet.
worksheet.

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Slide
2-42

Continued Accounting for Pooling

of Interests
The

Investment in Sub
account must be
eliminated.
Also eliminate the Subs

Equity accounts to
prevent double-counting.
They have already been
included in the original
Investment in Sub entry.
Add

together the BVs of

the remaining accounts.

THE END OF CHAPTER 2

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