1. Chapter Three Consolidations - Subsequent to the Date of Acquisition Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. 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 subsidiary’s assets and liabilities to create a single set of financial statements for the combined business entity. LO 1 3-2

3. Investment Accounting by Acquiring Company The acquiring company selects one of these three methods to account for its investment: LO 2  Equity Method  Initial Value Method  Partial Equity Method For each subsidiary owned, there is an asset, the investment account, and an income account to record the earnings on the investment. 3-3

4. Investment Accounting by Acquiring Company Comparison of internal reporting of investment methods. MethodInvestmentIncome Account EquityContinually adjusted to reflect ownership of acquired company. Income accrued as earned; amortization and other adjustments are recognized. Initial ValueRemains at Initially- Recorded cost Cash received is recorded as Dividend Income Partial EquityAdjusted only for accrued income and dividends received from acquired company. Income accrued as earned; no other adjustments recognized. 3-4

5. Investment Accounting by Acquiring Company A parent’s 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. LO 3 3-5

6. 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: Subsequent Consolidation – Equity Method 1.FMV adjustments and other intangible assets, 2.The parent’s share of the sub’s income (loss), 3.The receipt of dividends from the sub. LO 4a 3-6

7. 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 sub’s 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. LO 4b 3-7

8. 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 Parent’s Dividend Income account and the Sub’s Dividends Paid account. There is no Entry D. Entry E is the same as the Equity Method. 3-8

9. 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 Parent’s equity in the sub’s income and reduces the investment account. Entry D eliminates the dividend income account. Entry E is the same as the Equity Method. LO 4c 3-9

10. Consolidation Entries – Subsequent Years  Neither the Initial Value or Partial Equity Method provides a full-accrual-based measure of the subsidiary activities on the parent’s 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 parent’s beginning of the year retained earnings balance to a full-accrual basis. 3-10

11. 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. 3-11

12. 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 Sub’s 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! 3-12

13. 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. LO 5 3-13

14. 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 the impairment as an impairment loss if the item is impaired. LO 6 3-14

15. 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. LO 7 3-15

16. 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. LO 8 3-16