Chapter Two Consolidation of Financial Information McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Two

Consolidation of Financial

Information

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

2-2

Reasons Firms Combine

Vertical integration Cost savings Quick entry into new markets Economies of scale More attractive financing opportunities Diversification of business risk Business Expansion Increasingly competitive environment

LO 1

2-3

Business Combinations

Separate organizations tied together through common control under common management are combined into a single entity.

FASB Accounting Standards Codification (ASC) Business Combinations (Topic 805) and

Consolidation (Topic 810) provide guidance using the “acquisition method”.

The acquisition method embraces a fair value measurement attribute that reflects the FASB’s increasing emphasis on fair value for measuring and assessing business activity.

2-4

The Consolidation Process

Consolidated financial statements provide more meaningful information than separate statements.

Consolidated financial statements more fairly present the activities of the consolidated companies.

Consolidated companies may retain their legal identities as separate corporations.

“There is a presumption that consolidated statements are more meaningful.. and that they are usually necessary for a fair presentation when one of the companies in the group… has a controlling financial interest..” FASB ASC (810-10-10-1)

“There is a presumption that consolidated statements are more meaningful.. and that they are usually necessary for a fair presentation when one of the companies in the group… has a controlling financial interest..” FASB ASC (810-10-10-1)

LO 2

Subsidiaries’ financial data

Prepare a single set of consolidated financial statements.

Parent’s financial data

Consolidation of Financial Information

2-5

To report the financial position, results of operations, and cash flows for the combined entity.

Reciprocal accounts and intra-entity transactions are adjusted or eliminated to. . .

brought together

2-5

Business Combinations

Business combinations . . .

Can be achieved through transactions or events in which an acquirer obtains control over one or more businesses.

Create single economic entities.

Can be formed by a variety of events but can differ widely in legal form.

Require consolidated financial statements.

Business combinations . . .

Can be achieved through transactions or events in which an acquirer obtains control over one or more businesses.

Create single economic entities.

Can be formed by a variety of events but can differ widely in legal form.

Require consolidated financial statements.

LO 3

2-6

Business Combinations

2-7

2-8

The Acquisition Method

Used to account for business combinations.

Requires recognizing and measuring at fair value: Consideration transferred for the acquired

business Noncontrolling interest Separately identified assets and liabilities Goodwill or gain from a bargain purchase Any contingent considerations.

LO 4

2-9

Fair Value

Asset valuations established using… The Market Approach – fair value can be

estimated referencing similar market trades.

The Income Approach – fair value can be estimated using the discounted future cash flows of the asset.

The Cost Approach – estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.

LO 5

2-10

How does consolidation affect the accounting records?

If dissolution occurs:Dissolved company’s records are closed out.Surviving company’s accounts are adjusted to include all balances of the dissolved company.

If separate incorporation is maintained:Each company continues to retain its own records.

worksheets facilitates the periodic

consolidation process without disturbing

individual accounting systems.

2-11

Acquisition Method

What if the consideration transferred does NOT EQUAL the Fair Value of the Assets acquired?

If the consideration is LESS than the Fair Value of the Assets acquired, we got a BARGAIN!! And we will record a GAIN on the acquisition!!

If the consideration is MORE than the Fair Value of the Assets acquired, the difference is attributed to GOODWILL

LO 6

2-12

Related Costs of Business Combinations

Direct Costs of the acquisition (attorneys, appraisers, accountants, investment bankers, etc.) are NOT part of the fair value received, and are immediately expensed.

Indirect or Internal Costs of acquisition (secretarial and management time) are period costs expensed as incurred.

Costs to register and issue securities related to the acquisition reduce their fair value.

2-13

Acquisition Method

Separate Incorporation MaintainedDissolution does not occur.

Consolidation process is similar to previous example.

Fair value is the basis for initial consolidation of subsidiary’s net assets.

Subsidiary is a legally incorporated separate entity.

Consolidation of financial information is simulated.

Acquiring company does not physically record the transaction.

LO 7

2-14

Acquisition Method – Consolidation Workpaper Example

2-15

Acquisition Date Fair-Value Allocations – Additional Issues

Intangibles are assets that: Lack physical substance (excluding financial

instruments) Arise from contractual or other legal rights Can be sold or otherwise separated from the acquired

enterprise

Preexisting goodwill recorded in the acquired company’s accounts is ignored in the allocation of the purchase price.

IPR&D that has reached technological feasibility is capitalized as an intangible asset at fair value with an indefinite life that is reviewed for impairment.

Ongoing R&D is expensed as incurred.

LO 8

2-16

Legacy Methods – Purchase and Pooling of Interests Methods

The acquisition method is applied to businesscombinations beginning in 2009, but previousaccounting methods used are still in effect today.

2002 to 2008: Purchase MethodValuation basis was “cost” Purchase cost allocated proportionately to net assets

based on their fair values, excess to goodwill.

Prior to 2002: Purchase Method Or The Pooling Of Interests Method Only used when a company acquired all of another company’s stock – using its own stock as consideration (no cash!)

LO 9