Chapter Three

Consolidations
Subsequent to the
Date of Acquisition
1

Consolidation
The Effects of the Passage of Time

So, what happens AFTER the date of

acquisition?

As time passes, the investment

account changes, and the
consolidation process becomes
more complex.

Consolidation
The Effects of the Passage of Time
3

There are three methods the parent

can use to account for its investment:
1.
2.
3.

Equity Method
Initial Value Method
Partial Equity Method

Consolidation
The Effects of the Passage of Time

For each subsidiary owned, there is an:

1. ASSET ACCOUNT (the INVESTMENT account
that represents the value of the investment); and an

2. INCOME ACCOUNT (the account that represents

the earnings on the investment).

Lets compare the three methods and how

they affect these two accounts.
4

Investment Accounting
Method

Investment Account

Income Account

Equity

Continually adjusted to Income accrued as

reflect ownership of
earned; amortization
acquired company.
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.
5

Investment Accounting
6

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

Investment Accounting
by the Acquiring Company

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.

3-7

Subsequent Consolidation - Equity Method

8

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:

1. FMV adjustments and other intangible

assets,
2. The parents share of the subs income
(loss), and
3. The receipt of dividends from the sub.

Subsequent Consolidation Equity Method Example

Parrot Company obtains all of the outstanding common stock of
Sun Company on January 1, 2010. Parrot acquires this stock for
$800,000 in cash. Sun Companys balances are shown below.
Book Values
Fair Values
1/1/10
1/1/10
Difference
Current assets . . . . . . . . . . . . . . . . . . .$ 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
$120,000
Common stock$40 par value . . . . .$(200,000)
Additional paid-in capital . . . . . . . . . . . (20,000)
Retained earnings, 1/1/10 . . . . . . . . . . (380,000)
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Subsequent Consolidation Equity Method Example

PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2010
FV of consideration transferred by Parrot Company. . $ 800,000
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
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Subsequent Consolidation Equity Method Example

Amortization computation:
Useful
Annual
Account
Allocation Life
Amortization
Trademarks
$ 20,000 Indefinite
0
Patented technology 130,000 10 years
$13,000
Equipment
(30,000) 5 years
(6,000)
Goodwill
80,000 Indefinite
0
$ 7,000

Amortization will be $7,000 annually for the first

five years, until the equipment allocation is fully
removed.

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Subsequent Consolidation Equity Method Example

Parrot Company will record an entry at

the date of acquisition, but what
happens after that?
Lets assume Sun Company earns income of
$100,000 in 2010 and pays a $40,0000 cash
dividend on August 1, 2010.

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Subsequent Consolidation Equity Method Example

1/1/10 Investment in Sun Company . . . . . 800,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
To record the acquisition of Sun Company.
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% owned subsidiary.
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.

13

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Subsequent Consolidation
Worksheet Entries

After the parent companys books are

updated under the equity method,
how do we consolidate the two
companies?

We will prepare FIVE different entries

for the consolidation worksheet!
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Subsequent Consolidation - Worksheet

Entries

15

S)
A)
A)
I)
I)
D)
E)
E)
F)

The Subs equity accounts are eliminated.

Other intangible assets are recorded and
the Subs assets are adjusted to FV.
The Equity in Sub Income account is
eliminated.
The Subs dividends are eliminated.
Amortization Expense is recorded for the
FMV adjustments and other intangible
assets that were recorded in consolidation.

Exhibit 3.4:

16

Exhibit 3.5:

17

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Subsequent Consolidation
Equity Method Example Entry S
Common Stock (Sun Company). . . . 200,000
APIC (Sun Company) . . . . . . . . . . . . 20,000
R/E, 1/1/10 (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 preacquisition income of the sub must be accounted
for in the retained earnings balance.

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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, the FV adjustments for this
entry are calculated in the allocation computation. In
subsequent years, the FV adjustments must be
reduced by any depreciation taken in prior
consolidations.
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Subsequent Consolidation
Equity MethodExample Entry I&D

Equity in Subsidiary Earnings . . .93,000

Investment in Sun Company. . . . . . . 93,000

Investment in Sun Company . . . . 40,000

Dividends Paid . . . . . . . . . . . . . . . . 40,000

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Subsequent Consolidation
Equity Method Example Entry E
Amortization Expense . . . . . . . . . 13,000
Equipment . . . . . . . . . . . . . . . . . . . 6,000
Patented Technology . . . . . . . . . . . . . . . . . . . 13,000
Depreciation Expense . . . . . . . . . . . . . . . . . . . 6,000

Remember: Do not amortize land or goodwill!

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Applying the Initial Value Method

If the Initial Value Method is used by the parent
company to account for the investment, then the
consolidation entries will change only slightly.
Remember . . . The PARENT will record the subs
activity differently under this method, so the Parents
accounts will differ from the Equity Method.

1. No adjustments are recorded in the Investment

account for current year operations, dividends paid
by the subsidiary, or amortization of purchase price
allocations.
2. Dividends received from the subsidiary are recorded
as Dividend Revenue.
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Consolidation Entries Initial Value Method

23

Entry S:
Eliminate the subs equity balances as of the
beginning of the period.
This entry is the same under the Equity
Method and the Initial Value Method.

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Consolidation Entries
Initial Value Method

24

Entry A:
Adjust subs assets and liabilities to FV, and
set up the intangible asset accounts.
This entry is the same under the Equity
Method and the Initial Value Method.

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Consolidation Entries
Initial Value Method

25

Entry I:
This entry is different under the Initial Value
Method.
Eliminate the Parents Dividend Income account
and the Subs Dividends Paid account.

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Consolidation Entries
Initial Value Method

26

Entry D:
Under the Initial Value Method we DO
NOT make an Entry D. (was done as
part of the income adjustment)

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Consolidation Entries Initial Value Method

27

Entry E:
Record the amortization of the purchase
price allocations.
This entry is the same under the Equity
Method and the Initial Value Method.

Exhibit 3.9:

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Consolidation Entries
Partial Equity Method

29

If the Parent uses the Partial Equity Method,

what will change from the previous two
methods?
Remember, the Parents record-keeping is limited to
two periodic journal entries:
1) the annual accrual of subsidiary income and
2) the receipt of dividends.

So, the Investment and Income account

balances will differ from the other methods,
and so will worksheet Entries I and D.

Exhibit
3.10:

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Other Consolidation Entries

31

In addition to the Entries S, A, I, D, & E,

we will also eliminate intercompany
payables or receivables. (entry P)
AND, if control acquired is less than
100%, an additional adjustment must be
made (see Chapter 4).

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Consolidation Entries
ALL METHODS

32

No matter which method the Parent

chooses to record the Subs activity, the
consolidated totals are always the SAME!

This is because we are eliminating all the

entries that we made during the year,
regardless of the method used, and
regardless of the amount!

Consolidation Entries
Subsequent Years
33

Neither the Initial Value or Partial Equity Method

provides a full-accrual-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.

Consolidation Entries
Subsequent Years
34

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.

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Goodwill and Other Intangible Assets (ASC

Topic 350)

AFTER December 15,

2001, goodwill is no
longer amortized.
This applies to both
previously recognized
and newly acquired
goodwill.

Unamortized
goodwill left from
prior combinations
is carried on the
books as a
permanent asset
(subject to
impairment review).
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Goodwill and Other Intangible Assets (ASC

Topic 350)

Generally, once goodwill has been recorded, the

value will remain unchanged.

We will adjust goodwill on the consolidated

balance sheet if:
1. We sell all or part of the related subsidiary, or
2. We determine that there has been a
permanent decline in value (in which case we
record the impairment as an extraordinary
item).
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Goodwill Impairment
Two-Step Test

37

Step 1
Is the fair value of the Reporting Unit less
than its carrying value?

If NO, then Goodwill is NOT impaired, and

there is no further testing required.

If YES, go to Step 2

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Goodwill Impairment
Two-Step Test

38

Step 2
Is the fair value of Goodwill less than
its carrying value?
If NO, then Goodwill is NOT impaired,
and there is no further testing required.
If YES, then an extraordinary
impairment loss is recorded.

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Goodwill Impairment Test

39

There are three

complexities.

How is the acquisition value assigned to

the Reporting Unit?
How is the fair value of the Reporting Unit
determined?
How is the implied fair value of goodwill
determined?

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Assignment of Acquisition Value

to the Reporting Unit

40

Goodwill must be assigned to a

related REPORTING UNIT.
A Reporting Unit can be
A component of an operating segment
A segment of an enterprise
The entire enterprise

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Periodic Determination of the

Fair Value of a Reporting Unit

41

Fair Value can be based on:

Market price, if the reporting unit is
publicly traded, or
Market price of comparable businesses, or
Business valuation techniques using PV.

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Determination of the
Implied Fair Value of Goodwill

42

The implied fair value of Goodwill is calculated

in a similar manner as the determination of
goodwill in a business combination.
Allocate the purchase price to all identifiable
assets and liabilities of the reporting unit.
Compare the resulting implied goodwill to the
goodwill on the books.
If implied goodwill is less than recorded
goodwill, impairment has occurred.

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International Accounting Standards

43

How does goodwill treatment compare to

International Accounting Standards?
Under US GAAP:

Goodwill is allocated to
Reporting Units, usually
operating segments.

A two-step process is used

to test for impairment.

If the carrying amount of

goodwill is more than its
implied value, an
extraordinary loss is
recognized.

Under IAS:
Goodwill is allocated to cashgenerating units at a level
that cannot be larger 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.

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Acquisition Method Accounting for

Contingent Consideration

44

What if part of the consideration to be

transferred is contingent on a future event?
Then the acquiring firm must estimate the fair
value of the contingent portion and record a
liability and/or APIC in consolidation.
An example of the fair value estimation could
be the following:
The amount of the payment, times
The likelihood it will be paid, times,
A factor for the time value of money
(represented as

Contingent Consideration
in Business Combinations
45

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
re-measured at fair value.

Similar to accounting for stock

appreciation rights

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Push Down Accounting

46

Push-down accounting permits an acquired subsidiary

to record fair value allocations and subsequent
amortization in the subsidiary accounting records.

Current vs. prior shareholders book value

SEC requires push-down accounting for separate

subsidiary statements when no substantial outside
ownership exists.

In general: required when more than 95% ownership; objected when less
than 80%

Generally limited for external reporting, but

increasingly popular internally.

Simplifies the consolidation process.

Provides better information for internal evaluation.

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Summary
47

The Parents method of accounting for the investment

in the subsidiary affect the consolidation procedures.
Methods include:

Equity
Initial Value
Partial Equity

Key worksheet entries include:

Income Recognition
Allocation of Values
Amortization
Elimination of reciprocal balances

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Possible Criticisms
48

Some critics contend that the

purchase of an entity effectively
creates a new entity and, therefore,
valuation changes should be pushed
down to the subsidiarys records.

Goodwill impairment is controversial

as some argue that it is difficult to
objectively measure and can lead to
financial statement manipulation.
WHAT DO YOU THINK ???

Problem 26 (in 11th edition; 28 in 12th edition):

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Problem 29:

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