Business Combinations

& Consolidations
MAROOF H. SABRI
CPA

1
 Contents
1. When to Consolidate and When not to?
2. Acquisition Method
3. Intercompany Entries
4. Consolidation Working Paper
5. Combined Financial Statements and how do they differ from Consolidated Financial
Statements
6. Adjustments in Detail

2
Consolidated Financial Statements
Consolidated Financial Statements:
Mean one set of financial statements is presented for both Parent and Subsidiaries
Are more meaningful that Separate Financial Statements
Necessary for Fair representation of an Entity as a whole
Emphasize substance over form
Economic substance is preferred over legal relationships
Can not be represented by using of Equity Method instead of Consolidated Financial Statements

3
Consolidated Financial Statements -
Limitations
Some stakeholders remain uniformed of subsidiaries financial statements:
Non Controlling interest Shareholders
Creditors of Subsidiaries
Distortion of Results
Offsetting of financial performance of one subsidiary against another one
Unreliable Analysis
Due to aggregation and non availability of separate financial statements
(Segment reporting does provide some information but not equivalent to separate Financial
statements)
Retained Earnings
Only Parents retained earnings are presented, no separation of individual subsidiaries retained
earnings

4
When to Consolidate?
Ownership Significant Influence Method Consolidate?
Less than 20% No Cost Method Do not Consolidate
Less than 50% Yes Equity Method Do not Consolidate
More than 50% Yes Consolidation Consolidate

5
 Cost Method
Investor owns < 20% of Investee, with NO Significant Influence
If Significant Influence Use Equity Method
Liquidated Dividends Reduce Investment

6
Cost Method Balance Sheet
Presentation
Balance Sheet

Presented as Investment:
Trading Securities (or)
Cost + Unrealized Gains- Unrealized Losses
Liquidating Dividends
Available for Sales Securities
Cost + Unrealized Gains- Unrealized Losses
Liquidating Dividends

7
Cost Method Income Statement
Treatment
Unrealized Gains - Income
Trading
Cash Dividends - Income
Securities

Unrealized Gains Other

Available for Comprehensive Income
Sales Securities Cash Dividends - Income

8
Equity Method
Typically 20 to 50% Ownership
If ownership less than 20% BUT significant influence exists

9
Equity Method Balance Sheet
Presentation
Presented in Investment Account

Cost of Investment
+ % of Net Income of Investee
- % of Cash Dividends distributed by Investee
- FV Adjustment Depreciation
= Investment to be Reported in Balance Sheet

Fair Value (FV) Adjustement is the difference between Fair Value and Book Value of Investee
FV Adjustments of PPE are subject to Depreciation, excluding Land

10
Equity Method Income Statement
Treatment
Results of Operations f Investees are recorded as Income of Investee times % Holding
Dividends distributed DO NOT affect Income statement since they affect Investment account
on balance sheet
Fair Value Adjustments and Depreciation are recorded in income statement

11
Consolidation
BUSINESS COMBINATIONS AND CONSOLIDATIONS

12
When to Consolidate?
When a Parent-Subsidiary Relationship is formed, Consolidated Financial Statements are
used, treating both subsidiary and parent company as one entity
If Ownership is more than 50% - Investor is Parent of Investee Company
More than 50% Ownership means Control of Subsidiary Consolidated FS are needed
Presenting Consolidated Financial Statements is more meaningful and required by GAAP
Do not Consolidate if Parent doesnt have control of subsidiary even though holding more
than 50% of ownership
Bankruptcy
Legal Reorganization

13
Accounting Standards
IFRS 3 (2008) resulted from a joint project with the US Financial Accounting Standards Board
(FASB) and replaced IFRS 3 (2004). FASB issued a similar standard in December 2007 (SFAS
141(R)). The revisions result in a high degree of convergence between IFRSs and US GAAP in
the accounting for business combinations, although some potentially significant differences
remain.
For More details on IFRS 3, please visit below link:
https://www.iasplus.com/en-us/standards/international/ifrs-en-us/ifrs3

14
Acquisition Method
Acquisition Method is used for Business Combination by both US GAAP and IFRS
Two Main Principles applied while using Acquisition Method:
1. Recognition Principle All Subsidiarys assets and liabilities are recognized
2. Measurement Principle Measure all recognized assets and liabilities at Acquisition Date Fair
value.

15
Acquisition Method
Investment is Valued at Fair Value of Consideration given or received whichever is more
clearly evident
Investment by Acquirer can be through any of below:
Cash
Issuance of Shares
Issuance of Debt Securities

16
Acquisition Method Treatment of
Costs
Accounting treatment of different Costs involved in Acquisition
method are:
Direct and Indirect Costs expensed out
If Acquisition is done by issuing new shares - Stock Issuance costs reduce
the Paid-in-Capital
If Acquisition is done by issuing debt securities (Bonds) Debt Issuance
Costs are Capitalized and Amortized

17
Acquisition Method Recording of
Investment
Accounting for Acquisition begins at date of acquisition
Acquirer adjusts its financial statements with below entries
Debit Investment in Subsidiary
Credit Cash (If cash is paid) OR
Credit Common Stock (at Par)
Credit Additional Paid in Capital (Fair Value of common stock less Par Value of Common Stock)
Above entries are done in Acquirers Financial Statements at date of Acquisition
What is Acquisition Price?
Acquisition price is the consideration given or received and always equal to Investment in Subsidiary
After making above Entries, Consolidation Entries are done

18
Acquisition Method Adjustments
After recording Investment in Subsidiaries, below adjustments are made during consolidation:
1. Eliminate Equity of Subsidiary
2. Eliminate Investment in Subsidiary
3. Create Non Controlling Interest if subsidiary is not acquired 100%
4. Adjust the Balance Sheet of Subsidiary to Fair Value
5. Record Identifiable Intangible Assets of Subsidiary at Fair Value
6. Calculate and create good will or record gain otherwise

A comprehensive example is provided in end of this presentation

In next slides, a brief overview of Acquisition Method presented
All these adjustments are explained in detail in last section of this presentation

19
Acquisition Method Adjustments
1. Eliminate Equity of Subsidiary
Adjustments are made on the Consolidating working papers
All the equity accounts of subsidiary are debited (or credited if they have debit balances) at date of acquisition with pre-
acquisition account balances
Consolidated Equity is Parents equity plus any Non Controlling Interest
Non Controlling Interest will be discussed later

2. Eliminate Investment in Subsidiary

On consolidated working paper, Investment in Subsidiary account of Parent is eliminated

20
Acquisition Method Adjustments
3. Create Non Controlling Interest
Since whole of subsidiarys Pre-Acquisition equity is eliminated, a Non Controlling Interest (NCI) is created.
NCI is not created for fully owned subsidiaries
NCI is created during Consolidation through Elimination Entry
On Financial Statements
NCI is presented separate from parents equity in Consolidated Equity section.
NCI Is calculated by multiplying Fair Value of Subsidiary x Non Controlling percentage
NCI must be recognized as a line item and deducted, calculated by multiplying Subsidiarys Income with NCI percentage
Comprehensive income attributable to NCI is shown separately on Consolidated statement of comprehensive income
A reconciliation for NCI at beginning and end of period is also shown on Consolidated Statement of Changes in Equity

21
Acquisition Method Adjustments
4. Adjust the Balance Sheet of Subsidiary to Fair Value
All balance sheet accounts are adjusted to Fair value
This adjustment is a must and has nothing to do with Acquisition price
This adjustment is needed for full fair value of assets and liabilities of subsidiary even if its a
partial ownership
Accomplished through elimination journal entry on consolidation workpaper

5. Record Identifiable Intangible Assets of Subsidiary at Fair Value

Parent records all Identifiable Intangible Assets of subsidiary even if they are acquired initially at
zero cost.

22
Acquisition Method Adjustments
6. Calculate and create good will or record gain otherwise

Good will = Excess of Acquisition cost plus non controlling interest over the Fair Value of Net Assets of
Subsidiary
Good will is debited on Consolidated Financial Statements
In case if the resultant figure is negative, recognize a gain

23
Acquisition Method Adjustments
Elimination Entry is summarized as below:

Debit All Equity Accounts of Subsidiary (Common stock, Additional paid up capital, retained earnings etc)
Credit Investment in Subsidiary
Credit Non Controlling Interest
Debit Fair Value adjustments to Balance Sheet accounts(or Credit if its lower than Book Value)
Debit Identifiable intangible Assets at Fair Value
Debit Good will (Or Credit Gain)

24
Acquisition Method Adjustments
Fair Value of Subsidiary = Acquisition Price + FV Non Controlling Interest

Good Will = Fair Value of subsidiary Fair Value of Subsidiarys Net Assets

Fair Value Adjustments = Fair Value of Subsidiarys Net Assets Fair Value of Subsidiarys Book value

25
 Elimination of Intercompany
Transactions
During preparation of Consolidated Financial Statements all Intercompany transactions are
eliminated.
1. Intercompany payables and receivables are eliminated 100%
2. Intercompany Sales and Purchases are eliminated 100%
3. Intercompany Fixed Assets transactions, Eliminate Gain on Sale/Depreciation Expenses
4. Gain and Loss on Intercompany sales of Land is unrecognized and recognized in case of
subsequent sales to third party outside of parent subsidiary group.
5. Interest Income and Interest Expenses are removed if the borrowings are from one another.
6. Intercompany inventory adjustment Remove the element of profit recognized in one
company if there is an inventory held by other company on balance sheet date
7. If debt of one company is acquired by another company, Gain/loss is recognized in the
consolidated financial statements through elimination entry

26
Consolidation Comprehensive
Example
Please refer to the case study handed over to you
Use the spreadsheet and prepare consolidated financial statements

27
Combined Financial Statements
What are combined Financial Statements
Why they are needed
How do they Differ from Consolidated FS

28
 Combined Financial Statements
1. Combined Financial Statements are prepared when there is no parent subsidiary
relationship but the companies are related to each other through
1. Common Control
2. Companies under same management
3. An individual owns many companies
4. Many unconsolidated subsidiaries are combined for example foreign subsidiaries

29
 Combined Financial Statements
1. When different companies are combined:
1. Since there is no parent-subisidiary relationship, capital stock and retained earnings are added up
instead of elimination
2. Income statement is added across all subsidiaries
3. Intercompany balances and transactions are eliminated
4. Non Controlling interest is calculated and presented in the same way as in Consolidated Financial
Statements

30
Reach the author at
Mhs_pk@Hotmail.com

31