Chapter Three

Consolidations Subsequent to
the Date of
Acquisition

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

LO 1

Consolidation The Effects

of the Passage of Time
The passage of time creates complexities for
internal record keeping and the balance of the
investment account varies due to the
accounting method used.
A worksheet and consolidation entries are used
to eliminate the investment account and record
the subsidiarys assets and liabilities to create a
single set of financial statements for the
combined business entity.

3-2

Investment Accounting by
Acquiring Company

LO 2

For each subsidiary owned, there is an asset, the

investment account, and an income account to
record the earnings on the investment.
The acquiring company selects one of these
three methods to account for its investment:

Equity Method
Initial Value Method
Partial Equity Method
3-3

Investment Accounting by
Acquiring Company
Comparison of internal reporting of investment
methods.
Method

Investment

Income Account

Equity

Continually adjusted to
reflect ownership of
acquired company.

Income accrued as
earned; amortization
and other adjustments
are recognized.

Initial Value

Remains at InitiallyRecorded cost

Cash received is
recorded as Dividend
Income

Partial Equity

Adjusted only for

accrued income and
dividends received from
acquired company.

Income accrued as
earned; no other
adjustments recognized.

3-4

Investment Accounting by
Acquiring Company
What is the advantage of each?
Equity Method: The acquiring company totals give a
true representation of consolidation figures.
Initial Value (or Cost) Method: It is easy to apply and
gives a good measurement of cash flows generated by
the investment.
Partial Equity Method: Usually gives balances
approximating consolidation figures, but is easier to
apply than equity method
3-5

Investment Accounting by
Acquiring Company

LO 3

A parents choice

of internal accounting method

for subsidiary investments has no effect on the
resulting consolidated financial statements.

The

selection of a particular method does not

affect the totals ultimately reported for the
combined companies.

The

internal accounting method used does

require distinct procedures for consolidation of
the financial information from the separate
organizations.
3-6

Subsequent Consolidation
Equity Method

LO 4a

During the year, the parent will adjust its

investment account for the Subsidiary under
application of the equity method. The original
investment, recorded at the date of acquisition, is
adjusted for:
FMV adjustments and other intangible assets,
2. The parents share of the subs income (loss),
3. The receipt of dividends from the sub.
1.

3-7

Subsequent Consolidation Equity Method Example

Parrot Company obtains all of the outstanding common stock of Sun
Company on January 1, 2012. Parrot acquires this stock for $800,000 in
cash. Sun Companys balances are shown below.

Book Values
1/1/12
Current assets . . . . . . . . . . . . . . . . . . $320,000
Trademarks (indefinite life) . . . . . . . . 200,000
Patented technology (10-year life) . . . 320,000
Equipment (5-year life) . . . . . . . . . . . 180,000
Liabilities . . . . . . . . . . . . . . . . . . . . . . .(420,000)
Net book value . . . . . . . . . . . . . . . . . . $600,000
Common stock$40 par value . . . .$(200,000)
Additional paid-in capital . . . . . . . . . . (20,000)
Retained earnings, 1/1/12 . . . . . . . . . .(380,000)

Fair Values
1/1/12
$ 320,000
220,000
450,000
150,000
(420,000)
$ 720,000

Difference
0
20,000
130,000
(30,000)
0
$120,000

3-8

Subsequent Consolidation Equity Method Example

PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2012
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company. . . . . . . . . . . . . . . . . . .(600,000)
Excess of fair value over book value . . . . . . . . . .
200,000
Allocation to specific accounts based on fair values:
Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 20,000
Patented technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,000
Equipment (overvalued) . . . . . . . . . . . . . . . . . . . . . . . . . (30,000)
120,000
Excess FV not specifically identifiedgoodwill. . . . . . $ 80,000
3-9

Subsequent Consolidation Equity Method Example

Amortization computation:
Account
Trademarks
Patented technology
Equipment
Goodwill

Allocation
$ 20,000
130,000
(30,000)
80,000

Useful
Life
Indefinite
10 years
5 years
Indefinite

Annual
Amortization
0
$13,000
(6,000)
0
$ 7,000

Amortization will be $7,000 annually for five

years until the equipment fair value reduction
is fully removed.
3-10

Subsequent Consolidation Equity Method Example

Assume Sun Company earns income of $100,000 in 2012
and pays a $40,0000 cash dividend on August 1, 2012.

1/1/12

Investment in Sun Company . . . . . 800,000

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
To record the acquisition of Sun Company.
8/1/12
Cash . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Investment in Sun Company. . . . . . . . . 40,000
To record receipt of cash dividend from subsidiary
under the equity method.
12/31/12 Investment in Sun Company. . . . 100,000
Equity in Subsidiary Earnings . . . . . . 100,000
To accrue income earned by 100% owned subsidiary.
12/31/12 Equity in Subsidiary Earnings . . . . 7,000
Investment in Sun Company . . . . . . . . . 7,000
To recognize amortizations on allocations made in acquisition of sub.
3-11

Subsequent Consolidation Worksheet Entries

For the first year, the parent prepares five entries on
the workpapers to consolidate the two companies.
S) Eliminates the subsidiarys Stockholders equity account
beginning balances and the book value component within the
parents investment account.
A) Recognizes the unamortized Allocations as of the beginning of
the current year associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period
on the allocations from the original adjustments to fair value.

3-12

Subsequent Consolidation
Equity Method Example Entry S
Common Stock (Sun Company). . . .200,000
APIC (Sun Company) . . . . . . . . . . . . 20,000
R/E, 1/1/1 (Sun Company) . . . . . . . . 380,000
Investment in Sun Company . . . . . . . . 600,000

Note: If this is the first year of the investment,

and the investment was made at a time
other than the beginning of the fiscal year,
then pre-acquisition income of the sub
must be accounted for in the retained earnings
balance.
3-13

Subsequent Consolidation
Equity Method Example Entry A
Trademarks . . . . . . . . . . . . . . .20,000
Patented technology . . . . . . . 130,000
Goodwill . . . . . . . . . . . . . . . . . .80,000
Equipment . . . . . . . . . . . . . . . . . . . 30,000
Investment in Sun Company . . . .200,000

Note: In the first year, FV adjustments are

calculated in the allocation computation. In
subsequent years, FV adjustments must be
reduced by any depreciation taken in prior
consolidations.
3-14

Subsequent Consolidation Equity

Method Example Entries I & D
Equity in Subsidiary Earnings . . .93,000
Investment in Sun Company. . . . . . . 93,000
Note: Entry I above removes Suns income recognized
by Parrot during the year so Suns revenue and
expense accounts (and current amortization
expense) can be brought into the consolidated
totals.
Investment in Sun Company . . . . 40,000
Dividends Paid . . . . . . . . . . . . . . . . 40,000
Note: Entry D above removes the intra-entity transfer
of cash for the dividends distributed to Parrot
from Sun.

3-15

Subsequent Consolidation Equity

Method Example Entry E
Amortization Expense . . . . . . . . . 13,000
Equipment . . . . . . . . . . . . . . . . . . . .6,000
Patented Technology . . . . . . . . . . . . . . . . . . . 13,000
Depreciation Expense . . . . . . . . . . . . . . . . . . . 6,000
Note : that depreciation expense is reduced for the
tangible asset equipment (fair value was less
than book value). Patented Technology
amortization expense was recognized for the
year.
3-16

LO 4b

Applying the Initial Value Method

If the Initial Value Method is used by the parent to
account for the investment in the first year, the
consolidation entries will change slightly.
The parent will record the subs activity differently
under this method, so the accounts will differ from the
Equity Method.
1. No adjustments are recorded in the Investment
account for current year income, dividends paid
by the subsidiary, or amortization of purchase
price allocations.
2. Dividends received from the subsidiary are
recorded as Dividend Revenue.
3-17

Consolidation Entries Initial Value Method

Two entries for the initial value method are
different than those for the equity method.
Entry S is the same as the Equity Method.
Entry A is the same as the Equity Method.
Entry I is different using Initial Value Method: It
eliminates the Parents Dividend Income account
and the Subs Dividends Paid account.
There is no Entry D.
Entry E is the same as the Equity Method.
3-18

LO 4c

Consolidation Entries
Partial Equity Method
The same two entries differ for the Partial Equity
Method .
Entry S is the same as the Equity Method.
Entry A is the same as the Equity Method.
Entry I is different using Partial Equity Method:
It
eliminates the Parents equity in the subs income and
reduces the investment account.
Entry D eliminates the dividend income account.
Entry E is the same as the Equity Method.

3-19

Consolidation Entries
Other than Equity Method

Remember . . .
Entries S, A, and E are the same for all
three methods.
The parents record-keeping is limited to
two periodic journal entries:
annual accrual of subsidiary income and
receipt of dividends.

So, the Investment and Income account

balances differ for the other methods, and
so will the worksheet Entries I and D.
3-20

Consolidation Entries
Subsequent Years

Neither the Initial Value or Partial Equity Method provides a fullaccrual-based measure of the subsidiary activities on the parents
income.

The initial value method uses the cash basis for income
recognition.

The partial equity method only partially accrues subsidiary

income.
A new worksheet adjustment is needed to convert the parents
beginning of the year retained earnings balance to a full-accrual
basis.

3-21

Consolidation Entries
Subsequent Years

For consolidation purposes, the beginning retained

earnings account must be increased (Initial Value
Method) or decreased (Partial Equity Method) to
create the same effect as the equity method.

Entry *C. The C refers to the Conversion being made

to equity method (full accrual) totals. The asterisk
indicates that this entry relates solely to transactions
of prior periods.

Entry *C should be recorded before other worksheet

entries to align the beginning balances for the year.
3-22

Other Consolidation Entries

In addition to the Entries S, A, I, D, E, and
*C, intercompany debt (payables and/or
receivables) must be eliminated in entry P.
No matter which method the Parent chooses
to record the Subs activity, the consolidated
totals are always the same!
This is because all the entries that were made
during the year are eliminated regardless of
the method used or the amount!
3-23

LO 5

Goodwill and Other Intangible

Assets (ASC Topic 350)
FASB ASC Topic 350, Intangibles-Goodwill
and Other, provides accounting standards for
reporting income statement effects of either
amortization or impairment of intangibles
acquired in a business combination.
In accounting for goodwill subsequent to the
acquisition date, GAAP requires an
impairment approach rather than
amortization.
3-24

LO 6

Goodwill and Other Intangible

Assets (ASC Topic 350)
Once goodwill has been recorded, the value will
remain unchanged until:
1.All

or part of the related subsidiary is sold,

2.There

has been a permanent decline in

value
in which case we test for impairment and record
an impairment loss if the item is impaired.

3-25

Goodwill Impairment
Two-Step Test
Step 1
Fair value (with allocated goodwill) is compared to
the carrying value (including goodwill) of the
consolidated entitys reporting unit.
Does fair value of the reporting unit exceed
carrying value?

Goodwill is NOT
impaired. No further
testing is required.

A second step must be

taken to test for
impairment.
3-26

Determination of Implied
Fair Value of Goodwill
The implied value of goodwill is calculated
similar to the initial determination of goodwill
in a business combination.
1.
2.

3.

Allocate the fair value of the reporting unit

to all its identifiable assets and liabilities.
Subtract the fair value of the net assets
from the fair value of the reporting unit.
The excess is implied goodwill.
Compare the resulting implied goodwill
to the recorded goodwill on the books.
3-27

Goodwill Impairment
Two-Step Test
Implied value of the related goodwill can be
determined using quoted market prices, similar
businesses, or present value of future cash flows.
Step 2
Is implied goodwill less than recorded goodwill?

Goodwill is NOT
impaired. No
further testing is
required.

An impairment loss is
recorded for the excess
carrying value over
implied fair value.
3-28

Goodwill Impairment Test Example

On January 1, 2013, Newcall Corporation was
formed to consolidate operations of three
companies in a deal valued at $2.9 billion.
Each of the three former firms is considered an
operating segment and will be maintained as a
subsidiary of Newcall.
One firm comprises two divisions, and the other
two firms are treated as independent reporting
units.
Newcall recognized $221 million as goodwill at the
merger date and allocated this entire/amount to its
reporting units.
3-29

Goodwill Impairment Test Example

Newcalls
Reporting Units
DSM Wired
DSM Wireless
Rocketel
Visiontalk

Goodwill
$ 22,000,000
155,000,000
38,000,000
6,000,000

Acquisition Fair Value

January 1, 2013
$950,000,000
748,000,000
492,000,000
710,000,000

Newcall tests for goodwill impairment of DSM

Wireless. The implied fair value of goodwill is
compared to its carrying value using the
following allocation of the fair value of DSM
Wireless at year end
3-30

Goodwill Impairment Test Example

DSM Wireless Dec. 31, 2013, fair value $600,000,000
Fair values of DSM Wireless net assets at Dec. 31, 2013:
Current asset
$ 50,000,000
Property
125,000,000
Equipment
265,000,000
Subscriber list
140,000,000
Patented technology
185,000,000
Current liabilities
(44,000,000)
Long-term debt
(125,000,000)
Value assigned to identifiable net assets
596,000,000
Value assigned to goodwill
4,000,000
Carrying value before impairment
155,000,000
Impairment loss
$151,000,000

3-31

Goodwill Impairment Test Example

Goodwill is now valued at $4,000,000.

Newcall

reports a $151,000,000 a separate line item

goodwill impairment loss in the operating section of
its consolidated income statement.

Additional disclosures required:

(1) the facts and circumstances leading to the
impairment
(2) the method used to determine fair value of the
associated reporting unit.

The

reported values for all of DSM Wireless

remaining assets and liabilities do not change.
3-32

Comparison of U.S. GAAP and

International Accounting Standards
Under US GAAP:
Goodwill is allocated to
reporting units, usually
operating segments, expected
to benefit from it.
A two-step process is used to
test for impairment.
If the carrying amount of
goodwill is more than its
implied value, an impairment
loss is recognized.

IFRS Under IAS 36:

Goodwill is allocated to cashgenerating units at a level much
lower than an operating segment.
A one-step process is used to test
for impairment.
Goodwill is reduced for any
excess carrying value, down to
zero, and then other assets are
reduced pro-rata.

3-33

Other Intangibles
All identified intangible assets should be amortized
over their economic useful life unless such life is
considered indefinite - that extends beyond the
foreseeable future.
Intangible assets with indefinite lives are not
amortized. They are tested for impairment on an
annual basis. The assets carrying value is compared
to its fair value. If fair value is less than carrying
value, the intangible asset is considered impaired
and an impairment loss is recognized. The assets
carrying value is reduced accordingly.
3-34

LO 7

Contingent Consideration
in Business Combinations
If part of the consideration to be transferred in
an acquisition is contingent on a future event:
The

acquiring firm estimates the fair value of a

cash contingency and records a liability equal
to the present value of the future payment.

The

liability will continue to be measured at

fair value with adjustments recognized in
income.
Contingent

stock payments are reported as a

component of stockholders equity, and are not
remeasured at fair value.
3-35

LO 8

Push Down Accounting

Push-down accounting permits an acquired subsidiary
to record fair value allocations and subsequent
amortization in its accounting records.
SEC requires push-down accounting for separate
subsidiary statements when no substantial outside
ownership exists.
Generally limited for external reporting, but
increasingly popular internally.
Simplifies the consolidation process.
Provides better information for internal evaluation.
3-36

Summary
Procedures used to consolidate financial information
for a business combination are affected by the
passage of time and the method applied by the
parent in accounting for the subsidiary.
Three methods are used to account for a subsidiary:
Initial Value, Partial Equity, and Equity methods.
Fair value is assigned to net assets of the acquired
company and any excess purchase price is assigned
to goodwill.
Goodwill must be periodically tested for impairment.

3-37