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2-1
Chapter Two
Consolidation
of Financial
Information
McGraw-Hill/Irwin
Slide
2-2
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.
McGraw-Hill/Irwin
Slide
2-3
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
McGraw-Hill/Irwin
Slide
2-5
Business Combinations
Exh.
2-2
Continue
McGraw-Hill/Irwin
Slide
2-6
McGraw-Hill/Irwin
Exh.
2-2
Slide
2-7
Consolidation of Financial
Information
Parent
Subsidiary
Slide
2-8
McGraw-Hill/Irwin
Slide
2-9
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.
McGraw-Hill/Irwin
Slide
2-10
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.
McGraw-Hill/Irwin
Slide
2-11
McGraw-Hill/Irwin
Slide
2-12
Slide
2-13
McGraw-Hill/Irwin
Slide
2-14
At date of acquisition:
Acquired company should
McGraw-Hill/Irwin
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.
Slide
2-15
Slide
2-16
Slide
2-17
McGraw-Hill/Irwin
Slide
2-18
McGraw-Hill/Irwin
Slide
2-19
McGraw-Hill/Irwin
Slide
2-20
McGraw-Hill/Irwin
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.
McGraw-Hill/Irwin
Slide
2-22
McGraw-Hill/Irwin
Slide
2-23
No Dissolution
Example
On 1/1/05, Huge acquires 100% of Small
for $250,000 cash.
Slide
2-24
1.
1. Record
Record the
the
balances
balancesfor
for
each
eachcompany
company
in
inthe
the
worksheet.
worksheet.
McGraw-Hill/Irwin
Slide
2-25
2.
2. Remove
Removethe
the
investment
investment
account
accountfrom
from
the
the worksheet.
worksheet.
McGraw-Hill/Irwin
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.
McGraw-Hill/Irwin
Slide
2-27
Weuse
usethese
thesenumbers
numbers
We
forsteps
steps#4
#4 &.
#5.
for
McGraw-Hill/Irwin
Slide
2-28
4.
4. Adjust
Adjustthe
the
subsidiarys
subsidiarys
balances
balancesto
to
FMV.
FMV.
McGraw-Hill/Irwin
Slide
2-29
5.
5. Record
Record the
the
trademark
trademarkand
and
the
theGoodwill.
Goodwill.
McGraw-Hill/Irwin
Slide
2-30
McGraw-Hill/Irwin
6.
6. Add
Addthe
thebalances
balances
across
acrossthe
thepage.
page.
Slide
2-31
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.
McGraw-Hill/Irwin
Slide
2-32
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?
McGraw-Hill/Irwin
Slide
2-33
Exh.
2-7
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
Slide
2-34
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.
McGraw-Hill/Irwin
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
McGraw-Hill/Irwin
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
McGraw-Hill/Irwin
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.
McGraw-Hill/Irwin
Slide
2-38
McGraw-Hill/Irwin
Slide
2-39
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.
McGraw-Hill/Irwin
Slide
2-40
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.
McGraw-Hill/Irwin
Slide
2-41
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.
McGraw-Hill/Irwin
Slide
2-42
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