1. Chapter Two Consolidation of Financial Information Business Combination vOne firm acquires an equity interest in and control over another firm. Consolidation of Financial Statements vUsing the purchase method, not the pooling method.

2. Reasons for Combinations vrevenue growth veconomies of scale vcost savings from eliminating duplicate processes vdominance in product or service markets vquick expansion into new markets

3. Types of Business Combinations vStatutory merger vBig Co. acquires the net assets or all of the capital stock of Small Co., and vSmall Co. dissolves vStatutory consolidation vLittle Co. and Tiny Co. transfer assets or stock to newly formed Large Co. vLittle Co. and Tiny Co. dissolve vCombination without dissolution

4. Special Purpose Entities vcreated by sponsoring firm vlimited, well-defined set of activities vsponsoring firm exercises control through contractual arrangements vcontractual firm owns little or no voting stock vadvantage: off-balance-sheet financing vFASB Interpretation 46 (2003): controlling financial interest requires consolidation (see Chapter 6)

5. CONSOLIDATING FINANCIAL INFORMATION vCombine accounts. vEliminate reciprocal accounts and intercompany transactions. Statutory Merger or Consolidation vOne consolidation at time of combination. vAll accounts brought together permanently.

6. 12/31/02 A/R100 Equipment1,200 Building500 Goodwill270 A/P120 Common Stock200 Additional Paid in Capital1,700 Cash50 Purchase Price Equals or Exceeds Fair Market Value of Net Assets Plug figure, if needed Includes legal costs of combination Recorded at fair values

7. Purchase Price Is Less Than Fair Market Value vReduce non-current accounts by proportionate share of the difference. vproportional to fair market value vRecord current accounts at fair market value. Purchase Price Is Substantially Less Than Fair Market Value vReduce non-current accounts to zero. vRecord remaining difference as extraordinary gain.

8. Combination without Dissolution vNo permanent consolidation of accounts. vConsolidation process each time financial statements are prepared. vWorksheet is used 12/31/02 Investment in Small Co,1,950 Common Stock200 Additional Paid in Capital1,700 Cash50 Individual assets / liabilities are not recorded.

9. Consol. Totals DebitsCredits Consol. Entries Curr Assets Invst - Small Equipment R/E, 12/31 Total Building Goodwill Total Bal. Sheet A/P Com Stock Add Pd-in Big Co. $ 800 1,950 4,800 (2,560) $(10,850) 3,300 0 $10,850 $ (470) (800) (7,020) Small Co. $ 100 0 1,100 (430) $ (1,550) 350 0 $ 1,550 $ (120) (300) (700)

10. vConsolidation should also include:  Income Statement  Statement of Retained Earnings vInclude only those revenues and expenses of the subsidiary that occur after the merger. Combination without Dissolution (cont.)

11. INTANGIBLE ASSETS FROM COMBINATIONS vRecognize other intangibles acquired in the business combination if:  intangibles arise from contractual / legal rights, or  intangibles can be sold or otherwise separated vPrecision vs. representational faithfulness Goodwill vs. Other Intangibles

12. vWritten off immediately unless they have an alternative future use.  Common criterion: capitalize only if technologically feasible. vWrite-off:  worksheet adjustment, or  recorded in the books of the parent vWrite-off abuses vContinued discussion In-Process Research & Development Assets

13. UNCONSOLIDATED SUBSIDIARIES vOnly one exception to consolidation requirement:  Majority ownership does not provide control.  legal reorganization  restrictions by foreign governments vRescinded exceptions:  Control is temporary (Stmt 94 superceded)  Business operations differ significantly (ARB 51 superceded)