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B. The Acquisition Method for Business Combinations

B. The Acquisition Method for Business Combinations

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(a) The entity that retains the largest portion of voting rights is usually the acquirer.

(b) The acquirer may also be determined by identifying the company that retains more individuals on

its governing body or in its senior management.

(c) If the business was acquired by exchanging equity interests, the acquirer is usually the entity that

pays a premium over the fair value of the equity interests of the other firm.

(d) The acquirer may also be determined by identifying the entity that is significantly larger in size,

mea­sured by its assets, revenues, or earnings.

3. Acquisition date identification.

a. Acquisition date identification is the second step in a business combination.

b. The acquisition date is important for two reasons:

(1) The acquisition date is the date when the identifiable assets and the liabilities of the acquiree are mea­

sured at fair values, and

(2) The acquirer recognizes net income of the acquiree only after the date of acquisition.

c. Acquisition date determination:

(1) The date on which the acquirer obtains control over the acquiree. Usually, the date on which the ac­

quirer transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree.

(a) However, it is possible that the acquirer could obtain control either before or after the closing date

when the consideration is transferred. In that case, the facts and circumstances should be examined

to determine the date at which control was acquired.

4. Recognition and Measurement.

a. Recognition and measurement of identifiable assets, liabilities and noncontrolling interest is the third step in

a business combination.

b. On the acquisition date, the identifiable assets acquired, the liabilities assumed, and any noncontrolling

inter­est (previously referred to as minority interest) are measured at fair value. The acquirer also recognizes

assets that were not previously recognized on the acquiree’s books if the assets are identifiable.









(1) An asset is an identifiable asset if it arises from a contractual or legal right, or if it is separable.

(2) An asset is separable if it can be separated or divided from the entity and sold, transferred, licensed,

rented, or exchanged.







c. At the acquisition date, the acquirer must classify the assets acquired and liabilities assumed so that GAAP

can be applied.







(1) Examples of items that must be classified include trading, available-for-sale, and held-to-maturity

securi­ties, derivatives, and embedded derivative instruments.

(2) Leases, however, are classified as either an operating or a capital lease based upon their contractual

terms at the inception of the contracts.























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(a) Therefore, if the lease was a capital lease for the acquiree, then it is classified as a capital lease on

the books of the acquirer.

(b) Similarly, if the lease was an operating lease on the books of the acquiree, then the lease continues

to be an operating lease on the books of the acquirer.

(c) An exception to this rule occurs when a lease contract is modified. If a lease contract is modified at

the date of acquisition, the new terms of the modified contract are used to classify the lease.

d. On the date of acquisition, the acquirer should recognize any newly identified intangible assets of the ac­

quiree that meet the contractual-legal or separability criteria. Examples of items that meet the contractuallegal or separability criteria include the following items:

(1) Marketing-related intangibles, such as trademarks, trade names, service marks, certification marks,

news­paper mastheads, internet domain names, and noncompetition agreements.

(2) Customer-related intangibles, such as customer lists, order or production backlog, customer contracts,

and noncontractual customer relationships.

(3) Artistic-related intangible assets, such as plays, operas, ballets, books, magazines, newspapers, literary

works, musical works, pictures, photographs, videos, motion pictures, films, music videos, and

television programs.



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(4) Contract-based intangibles, such as licensing, royalty, advertising, construction, management, lease,

or fran­chise agreements. Other examples include construction permits, operating and broadcast rights,

supply or service contracts, employment contracts, and drilling, water, air, and timber cutting rights.

(5) Technology-based intangibles, such as patented technology, computer software and mask works, unpat­

ented technology, and databases. Another example is trade secrets, such as secret formulas, processes,

and recipes.

(6) Items that do not meet the contractual-legal or separability criteria may not be recognized as assets.

(a) Nonqualifying assets include the value of an assembled workforce, intellectual capital, and

potential con­tracts.

5. Recognize goodwill

a. Goodwill recognition is the fourth step in a business combination.

b. At the date of acquisition, the assets and liabilities of the acquiree are measured at fair value.

(1) If the acquirer has previously held equity interests in the acquiree, these shares are revalued to fair value

at acquisition date.

(2) Any noncontrolling interest is also valued at fair value at acquisition date.

(3) After the assets, liabilities, previously held interests, and noncontrolling interest are valued at fair value,

the goodwill or gain from a bargain purchase is calculated, as illustrated below.

















Fair value of consideration transferred (cost to the acquirer)

Plus: Fair value of previously held equity interests in acquiree

Plus: Fair value of noncontrolling interest

Less: Fair value of net identifiable assets

Goodwill or gain from bargain purchase



(4) If the fair value of net identifiable assets is less than the aggregate of the consideration transferred, plus

the acquisition date fair value of previously held interests, plus the fair value of noncontrolling interest,

goodwill is recognized.



(a)

Goodwill is defined as “an asset representing the future economic benefits that arises from other

as­sets acquired in a business combination that are not individually identified and separately recog­

nized.”



(b) Although an intangible asset is defined as an asset that lacks physical substance for purposes of

busi­ness combinations, goodwill is not considered an intangible asset. Instead, goodwill is

classified sepa­rately, and the accounting rules for goodwill apply.

























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(5) If the fair value of net identifiable assets exceeds the aggregate of the consideration transferred, plus the

ac­quisition date fair value of previously held interests, plus the fair value of the noncontrolling interest,

then a bargain purchase occurs. A gain is recognized by the acquirer in the current period for the

bargain purchase.

c. The consideration transferred is measured at fair value at the acquisition date.

(1) Consideration may include assets transferred, liabilities incurred, and equity interests issued by the ac­

quirer.

(2) If the fair values of the acquirer’s assets or liabilities transferred are different from their carrying values,

the acquirer should recognize a gain or loss on the assets transferred in earnings of the current period.

(3) However, if the acquirer retains control of the transferred assets or liabilities, then the assets and

liabilities are measured at their carrying amounts immediately before the acquisition date.

(4) If the acquirer transfers contingent consideration, then the fair value of the contingent consideration is

in­cluded as part of the consideration paid for the acquiree. Measurement of contingent consideration is

discussed later in this module.

6. Step acquisition.

a. Sometimes the acquirer obtains control through a step acquisition, wherein the acquirer invests in less than

50% of the voting shares of the acquiree, and at a later date, acquires enough shares to obtain voting control.

b. Depending upon the percentage of ownership previously acquired, the acquirer may have accounted for

shares of stock using the cost adjusted for fair value method, the equity method, or the fair value option.



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c. In a step acquisition, the acquisition date fair value of the previously held shares is also included in the

acquisi­tion cost. If the fair values of the previously held shares at the acquisition date are not equal to their

carrying values, a gain or loss is recognized in the current period.

d. If the acquirer had previously recognized any changes in fair value of the securities in other comprehensive

in­come, then the amounts recognized in other comprehensive income should be reclassified and included as

a gain or loss on the income statement in the current period.

7. Noncontrolling interest.

a. Noncontrolling interest is measured by using the active market prices on the acquisition date for the equity

shares not held by the acquirer.

NOTE: The fair values of the acquirer’s investment and the noncontrolling interest may not be the same on a

per-share basis.





























b. Noncontrolling interest should be classified as equity in the statement of financial position of the consoli­

dated financial statements. On the statement of earnings, consolidated net income is adjusted to disclose the

net income or loss attributed to the noncontrolling interest. Comprehensive income is also adjusted to in­

clude the comprehensive income attributed to the noncontrolling interest.

8. Acquisition-related costs

a. Acquisition-related costs for a business acquisition are normally treated as an expense in the period in which

the costs are incurred or the services are received.

b. Acquisition-related costs may include finder’s, advisory, legal, accounting, valuation, consulting and other

profes­sional fees. They also include general administrative costs.

c. Although the costs of registering and issuing debt and equity securities are considered part of acquisition

costs, these costs are not expensed in the period of the acquisition, but are recognized in accordance with

other GAAP.

(1) Costs of registering and issuing common stock are normally netted against the proceeds of the stock and

re­duce the paid-in capital in excess of par account.

(2) Bond issue costs are treated as a deferred charge and amortized on a straight-line basis over the life of

the bond.

C. Consolidated Financial Statements







1. An acquisition of more than 50% of the outstanding voting stock will normally result in control and require the

preparation of consolidated financial statements.









a. The complete consolidation process is presented in the next section of this module.

b. The investment account will be eliminated in the consolidation working papers and will be replaced with the

specific assets and liabilities of the investee corporation.

c. Consolidation is generally required for investments of more than 50% of the outstanding voting stock except

when the control is not held by the majority owner, Examples of noncontrol include

















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(1) This difference can be attributed to the acquirer paying a premium to obtain control of the acquiree, or

to a noncontrolling interest discount due to lack of control.

(2) This difference should be ignored, and the noncontrolling interest should be valued by multiplying the

ac­tive market price on the acquisition date times the number of shares held by the noncontrolling parties.



(1) The investee is in legal reorganization or bankruptcy.

(2) The investee operates in a foreign country, which has severe restrictions on the financial transactions of

its business firms or is subject to material political or economic uncertainty that casts significant doubt

on the parent’s ability to control the subsidiary.

(a) In these limited cases, the investment will be reported as a long-term investment in an

unconsolidated subsidiary on the investor’s balance sheet.

(b) The cost method is used unless the acquirer qualifies to use the equity method or elects to use the

fair value option for reporting financial assets. As you recall from Module 16 on investments, the

equity method is used in cases where the investor has significant influence over the investee.



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2. Variable interest entities

a. In certain instances, control over an entity may be achieved through arrangements that do not involve

owner­ship or voting interests.

b. Special rules apply to variable interest entities (VIEs, also referred to as special-purpose entities) in which

con­trol is achieved based on contractual, ownership, or other pecuniary interests that change with changes in

the entity’s net asset value.

c. The initial determination of whether a legal entity is a VIE is made on the date the reporting entity becomes

in­volved with the legal entity.







(1) The status of a VIE is reconsidered if certain events occur such as a change in the legal entity’s

contractual ar­rangements or characteristics, a change in the equity investment by investors, or changes

in facts and circumstances that change the power from voting rights or similar rights to direct the

activities of the VIE.







d. If an entity has a controlling financial interest in the VIE, the entity is considered the primary beneficiary

of the VIE. A primary beneficiary is required to consolidate the VIE in its financial statements.













































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(1) An entity has a controlling financial interest in a VIE if both of the following conditions exist:

(a) The entity has the power to direct the activities of a VIE that most significantly impact the VIE’s

eco­nomic performance.

(b) The entity has the obligation to absorb losses of the VIE that could potentially be significant

to the VIE, or has the right to receive benefits from the VIE that could potentially be significant to

the VIE.

(2) A qualitative approach is used to determine if the entity has the power to control the VIE.

(a) If power is shared among unrelated parties and consent of the other parties is required to direct the

activi­ties of the VIE, then no one party has the power to direct the activities of the VIE. In such

cases where power is shared, none of the parties is required to consolidate the VIE.

1] If power is shared by unrelated parties and the nature of the activities directed by each party is

not the same, then the entities must identify which party has the power to direct the activities

that most significantly affect the VIE’s economic performance.

2] If the party that has the power to direct the economic performance is also obligated to absorb the

losses or receive the benefits, that entity is the primary beneficiary and must consolidate

the VIE.

(b) An entity should determine whether it is the primary beneficiary on the date it becomes involved

with a VIE. The reporting entity must also reassess whether it is the primary beneficiary throughout

its in­volvement with the VIE.

(c) Kick-out rights are the ability to remove the reporting entity who has the power to direct the

activities that most significantly impact the VIE’s economic performance.

(d) Participating rights are the ability to block the actions of a reporting entity with power to direct the

activi­ties of the VIE.

(e) Kick-out and participating rights will not affect an entity from being considered the primary benefi­

ciary unless those rights are held by a single equity holder who has the ability to exercise those rights.

e. Additional disclosures are required for entities that have interests in VIEs.

(1) The primary beneficiary that is required to consolidate the VIE must present separately on the face of

the statement of financial position the assets of the VIE that can be used only to settle obligations

of the con­solidated VIE and the liabilities of the VIE for which creditors do not have recourse to the

general credit of the primary beneficiary. Disclosures in the notes to financial statements by the primary

beneficiary that consolidates the VIE are

(a) The carrying amounts and classification of the VIE’s assets and liabilities that are consolidated, as

well as qualitative information about the assets and restrictions on the assets.

(b) Lack of recourse if creditors have no recourse to the general credit of the primary beneficiary.

(c) Terms of arrangements.



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(2) A reporting entity that is not the primary beneficiary is not required to consolidate the VIE, but must

dis­close the following:

(a) The carrying amounts and classification of the assets and liabilities that relate to the reporting

entity’s variable interest in the VIE.

(b) The maximum exposure to loss from involvement with the VIE.

(c) A comparison of the carrying amounts of assets and liabilities and the maximum exposure to loss,

to­gether with supporting information explaining the differences in amounts.

(d) Information about any liquidity arrangements, guarantees, or other commitments by third parties

that may affect the fair value or risk of the interest in the VIE.

(e) If applicable, significant factors considered and judgments in determining that the power to direct

the ac­tivities of the VIE is shared.

(3) All entities with interests in VIEs (both primary beneficiaries and other holders of variable interests in

VIEs that are not required to consolidate) must disclose the following:

(a) The methodology for determining whether the reporting entity is the primary beneficiary of a VIE.

(b) If facts and circumstances regarding consolidation of VIE have changed.

(c) Whether the reporting entity has provided financial or other support to the VIE that was not con­

tractually required during the periods presented.

(d) Qualitative and quantitative information about the reporting entity’s involvement with the VIE, in­

cluding nature, purpose, size, and activities of the VIE, and how the VIE is financed.







3. The concept of consolidated statements is that the resources of two or more companies are under the control of

the parent company.









a. Consolidated statements are prepared as if the group of legal entities were one economic entity group.

b. Consolidated statements are presumed to be more meaningful for management, owners, and creditors of the

ac­quirer company and they are required for fair presentation of the financially related companies.

c. Individual company statements should continue to be prepared for noncontrolling ownership and creditors

of the acquiree companies.









4. The accounting principles used to record and report events for a single legal entity are also applicable to a con­

solidated economic entity of two or more companies.







a. The concept of the reporting entity is expanded to include more than one company, but all other accounting

principles are applied in the same way as for an individual company.

b. The consolidation process eliminates reciprocal items that are shown on both the acquirer’s and acquiree’s

books. These eliminations are necessary to avoid double counting the same items, which would misstate the

financials of the combined economic entity.











5. Consolidated financial statements are prepared from worksheets, which begin with the trial balances of the ac­

quirer and acquiree companies.







a. Eliminating worksheet entries are made to reflect the two separate companies’ results of operations and fi­

nancial position as one combined economic entity.

b. The entire consolidation process takes place only on a worksheet; no consolidation elimination entries are

ever recorded on either the parent’s or subsidiary’s books.

















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6. Consolidated balance sheets are typically prepared at the date of combination to determine the initial financial

po­sition of the economic entity.

a. Any intercompany accounts between the acquirer and acquiree must be eliminated against each other.

b. The “Investment in acquiree’s stock” account from the acquirer’s books will be eliminated against the re­

ciprocal accounts of the acquiree’s stockholders’ equity.

c. The remaining accounts are then combined to prepare the consolidated balance sheet.

7. The preparation of consolidated statements after the date of combination becomes a little more complex be­

cause the acquirer and acquiree income statements may include reciprocal intercompany accounts, which must

be eliminated.



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8. The next section of the module will present an example of the preparation of a consolidated balance sheet at the

date of combination for the acquisition method. You should carefully review the date of combination consolida­

tion process before proceeding to the preparation of consolidation statements subsequent to combination.

NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 15







D. Pelican Corp. and Swan Corp.—Acquisition of Swan, 100% Acquisition

A presentation of the date of combination entries for the acquisition method will be made first for a 100% acqui­

sition. This problem will be expanded to present the method for preparing the income statement, statement of re­

tained earnings, and balance sheet at year-end for a 100% acquisition. The example will then be modified to apply

the accounting for less than a 100% acquisition with noncontrolling interest.



EXAMPLE

On January 1, year 2, Pelican Corporation acquired Swan Corporation by acquiring all of Swan’s out­standing

stock by issuing 16,000 shares of Pelican $1 par value common stock, with a fair value of $10 per share. The bal­

ance sheets for Pelican and Swan immediately before the acquisition are shown below.

Pelican Company and Swan Company

BALANCE SHEETS 1/1/Y2

(Immediately before combination)

Assets



Pelican Corp.



Swan Corp.



$ 30,000



$ 24,000



35,000



9,000



Inventories



23,000



16,000



Equipment



240,000



60,000



Accumulated depreciation



(40,000)



(10,000)



Cash

Accounts receivable



Patents

Total assets



--



12,000



$288,000



$111,000



$ 6,000



$ 7,000



Liabilities and Equity

Accounts payable

Bonds payable

Capital stock ($10 par)

Additional paid-in capital

Retained earnings

Total liabilities and equity



80,000



--



120,000



60,000



20,000



10,000



62,000



34,000



$288,000



$111,000



Additional Information:

1. At the time of the acquisition, it was determined that Swan had a client list with a fair value of $5,000, and a

trade­mark with a fair value of $14,000. The client list has a remaining life of five years, and the trademark has

a re­maining life of ten years.

2. The fair values of Swan’s assets and liabilities on the date of the acquisition are shown below.

3. The existing equipment of Swan will be depreciated over its remaining useful life of four years.

4. The patent on Swan’s books will be depreciated over a remaining life of six years.



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Swan Corporation

BALANCE SHEETS 1/1/Y2

(Immediately before combination)

Assets



Book value



Cash



$ 24,000



Accounts receivable

Inventories

Equipment

Less: Accumulated depreciation



Fair value



Difference between BV and FV



24,000



$



--



9,000



9,000



--



16,000



17,000



1,000



60,000



72,000



12,000



(10,000)



(12,000)*



(2,000)



12,000



15,000



3,000



--



5,000



5,000

14,000



Patents

Client list

Trademark



--



14,000



Total assets



$111,000



$144,000



$



$



Liabilities and Equity

Accounts payable



7,000



Bonds payable



--



Capital stock ($10 par)



60,000



Additional paid-in capital



10,000



Retained earnings

Total liabilities and equity



7,000



--



--



34,000

$111,000



* When the asset is revalued and increased by 20% ($60,000 × 20% = $12,000), there is also a corresponding increase in the

ac­cumulated depreciation account ($10,000 × 20% = $2,000).



NOTE: Although there are no previously held interests or noncontrolling interest in this

example, these items are shown in the following formulas for completeness.

The entry to record the investment in Swan is

Investment in Swan



160,000



  Common stock (Pelican)



 16,000



  Additional paid-in capital



144,000



To record the issuance of 16,000 shares of Pelican’s $1 par value stock with a fair value of $10 per share to

acquire Swan Corp.

Goodwill should be calculated using a three-step process.

Step 1: Compute the difference between (1) the aggregate of acquisition cost, the fair value of previously held

shares, and the fair value of noncontrolling interest and (2) the book value of Swan’s net assets:

Acquisition cost



$160,000



Plus: Fair value of previously held shares



--



Plus: Fair value of noncontrolling interest



--



Less: Book value of Swan ($111,000 assets – $7,000 liabilities)

Differential



104,000

$ 56,000



This differential can be attributed to assets written up to fair value, newly identified intangible assets, and

goodwill.



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Step 2: Compute the fair value of net identifiable assets.

Book value ($111,000 assets – $7,000 liability)



$104,000



Plus: Asset write-ups ($1,000 + $12,000 – $2,000 + $3,000)



14,000



Plus: Newly identified Intangibles ($5,000 + $14,000)



19,000



Fair value of net identifiable assets



$137,000



Step 3: Compute goodwill.

Acquisition cost



$160,000



Plus: Fair value of previously held shares



--



Plus: Fair value of noncontrolling interest



--



Less: Fair value of net identifiable assets



(137,000)



Goodwill



$ 23,000



If the cost of acquisition is greater than the fair value of the net identifiable assets acquired, then goodwill is

recorded as a noncurrent asset on the balance sheet. In this situation, Pelican would report goodwill of $23,000 on

the date of ac­quisition. After the date of acquisition, goodwill is tested for impairment each year.

Assuming Pelican paid $120,000 for Swan

Acquisition cost



$120,000



Plus: Fair value of previously held shares

Plus: Fair value of noncontrolling interest



--



Less: Fair value, net identifiable assets



(137,000)



Bargain Purchase



$ (17,000)



The $17,000 bargain purchase would be recorded as a gain in the current period on Pelican’s income statement.







E. Pelican Corp. and Swan Corp.—Date of Combination Consolidated Balance Sheet—Acquisition Method

(100% Acquisition)

At the date of acquisition, a consolidated balance sheet is prepared. This section continues our example of

Peli­can’s 100% acquisition of Swan. The entry below is the entry recorded on Pelican’s books at the date of

acquisition.



EXAMPLE

1. Investment Entry on Pelican Company’s Books

The entry to record the 100% acquisition on Pelican Company’s books was

Investment in stock of Swan Corp.

Common stock

Additional paid-in capital



160,000

16,000

144,000



To record the issuance of 16,000 shares of Pelican’s $1 par value stock with a fair value of $10 per share to

acquire 100% of Swan Corp.

Although common stock is used for the consideration in our example, Pelican could have used debentures, cash,

or any other form of consideration acceptable to Swan’s stockholders to make the business acquisition.

The following is the worksheet to prepare the consolidated balance sheet immediately after Pelican’s acqui­

sition of Swan. Notice that the balance sheet of Pelican has changed from the balance sheet issued prior to the

acquisition of Swan. The investment ac­count increased Pelican’s assets by $160,000, the acquisition cost of the

investment. Also the capital stock and additional paid-in capital account of Pelican (the acquirer) have increased

for the 16,000 shares of $1 par value Pelican stock issued. Common stock increased $16,000 ($1 par × 16,000

shares), and additional paid-in capital increased by $144,000 ($9 × 16,000 shares).



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PELICAN CORP. AND SWAN CORP.—CONSOLIDATED WORKING PAPERS

For Date of Acquisition—1/1/Y2

Acquisition Method—100% Acquisition

Adjustments and

eliminations

Pelican



Swan



Debit



Consolidated

balances



Credit



Balance sheet 1/1/Y2

Cash



30,000



24,000



54,000



Accounts receivable



35,000



9,000



44,000



Inventories



23,000



16,000



(b)1,000



40,000



Equipment



240,000



60,000



(b)12,000



312,000



Accumulated depreciation



(40,000)



(10,000)



Investment in stock of Swan



160,000



Difference between cost and book

value



(a)56,000



Goodwill



--



Patents



--



Client list



--



12,000



(b)2,000



(52,000)



(a)160,000



--



(b)56,000



--



(b)23,000



23,000



(b)3,000



15,000



(b)5,000



5,000



Trademark



--



Total assets



448,000



111,000



455,000



Accounts payable



(b)14,000



14,000



6,000



7,000



13,000



80,000



--



80,000



Capital stock



136,000



60,000



(a) 60,000



136,000



Additional paid-in capital



164,000



10,000



(a) 10,000



164,000



62,000



34,000



(a) 34,000



62,000



448,000



111,000



Bonds payable



Retained earnings

Total liabilities and equity



218,000



218,000



455,000



2. Difference between Acquisition Cost and Book Value of Acquiree

To prepare the consolidated balance sheet, calculate the difference between (1) the aggregate of the acquisi­

tion cost, plus the fair value of previously held shares, plus the fair value of noncontrolling interest, and (2) the

ac­quirer’s interest in the net book value of the assets of the acquiree. This difference can be attributed to under­

valued assets, newly identified intangible assets, and goodwill as shown below:

Swan Corp.

Undervalued assets

Inventory



1,000



Equipment



12,000



Accumulated depreciation



(2,000)



Patents



3,000



New identifiable intangible assets

Client list



5,000



Trademark



14,000



Goodwill



23,000



Total undervalued assets, new intangible assets, and goodwill



56,000



The difference of $56,000 will be accounted for by preparing consolidated working paper entries

to eliminate the ac­quiree’s eq­uity accounts, revalue the acquiree’s existing assets to fair values,



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record any newly identified intangible assets, and record good­will. Note that the book value of the

acquiree can also be calculated by adding the equity ac­counts of the acquiree at date of ac­quisition. A

reconciliation of the cost to acquire Swan and the book value of Swan can also be calculated by using

the equity accounts of Swan as shown below.

Acquisition cost



$160,000



Plus: Fair value of previously held shares

Plus: Fair value of noncontrolling interest

Less: Book value at date of acquisition

Swan Corp.’s:

Capital stock



(60,000)



Additional paid-in capital



(10,000)



Retained earnings



(34,000)

(104,000)



Total



$ 56,000



Differential



Again, this difference is due to undervalued assets, newly identified intangible assets, and unrecorded goodwill.

3. Completing the Consolidated Trial Balance Worksheet

The worksheet on the date of acquisition is completed in two steps.

Step 1: Eliminate the acquiree’s equity accounts, the acquirer’s investment account, and establish the differential

(the differ­ence between acquisition cost and the book value of the acquiree’s net assets).

Step 2: Eliminate the differential account and record asset write-ups to fair value, new identifiable intangible

as­sets, and good­will.

The elimination entries are then posted to the worksheet, and the consolidated worksheet is totaled.

The Step 1 entry is to eliminate the acquiree’s equity account, eliminate the investment account on the acquirer’s

books, and re­cord the differential as shown below.

(a)  Capital stock—B Co.



60,000



Additional paid-in capital—Swan Corp.



10,000



Retained earnings—Swan Corp.



34,000



Differential



56,000



Investment in stock of Swan Corp.



160,000



NOTE: Swan’s stockholders’ equity accounts are eliminated. Also an account called

“Differential” is debited in the workpaper entry. The differential account is a temporary

account to record the difference between the cost of the investment in Swan on the Pelican’s

books and the book value of Pelican’s 100% interest in Swan.

The next step is to allocate the differential to the specific accounts by making the following workpaper entry:

(b) Inventories



1,000



Equipment



12,000



Patents



23,000



Client list



5,000



Trademark



14,000



Accumulated depreciation

Differential



c15.indd 736



3,000



Goodwill



2,000

56,000



13-05-2014 07:47:26







Module 18: Business Combinations and Consolidations



737



This entry reflects the allocations prepared in Step 2 and recognizes the Pelican’s revaluation of assets to fair

value, the newly iden­tified intangible assets, and goodwill.

Our example does not include any other intercompany accounts as of the date of combination. If any existed,

they would be eliminated to fairly present the consolidated entity. Examples of other reciprocal accounts will be

shown later in this module.

When the consolidated worksheet is finished, check the worksheet for possible errors. First, you should reduce

the investment in Swan’s account to zero. If the entries for write-up of existing assets to fair value, recording newly

iden­tified intangible assets, and recording goodwill are done accurately, the differential account will also be zero.

The common stock account and additional paid-in capital account in the consolidated worksheet should reflect

only the balances of the acquirer’s accounts. At date of acqui­sition, the retained earnings account will only reflect

the balance of the acquirer’s account. Finally, check to see that the acquiree’s equity accounts are eliminated.



NOW REVIEW MULTIPLE-CHOICE QUESTION 16 THROUGH 25

































F. Consolidated Financial Statements Subsequent to Acquisition

1. The concepts used to prepare subsequent consolidated statements are essentially the same as those used to pre­

pare the consolidated balance sheet at the acquisition date.

a. The income statement and statement of retained earnings are added to reflect the results of operations since

the acquisition date.

b. Furthermore, some additional reciprocal accounts may have to be eliminated because of intercompany trans­

actions between the acquirer and the acquiree.

c. Please note that the financial statements of a consolidated entity are prepared using the same accounting

prin­ciples that would be employed by a single, unconsolidated enterprise. The only difference is that some

reciprocal accounts appearing on both companies’ books must be eliminated against each other before the

two corporations may be presented as one consolidated economic entity.

d. Your review should concentrate on the accounts and amounts appearing on the consolidated statements

(amounts in the last column of the worksheet). This “end-result” focus will help provide the understanding

of why certain elimination entries are necessary.

2. An expanded version of the consolidated worksheet is necessary if the income statement and retained earnings

statement must also be prepared.

a. A comprehensive format often called “the three statement layout” is an integrated vertical array of the

income statement, the retained earnings statement, and the balance sheet.

b. The net income of the period is carried to the retained earnings statement and the ending retained earnings

are carried down to the balance sheet.

c. If you are required to prepare just the consolidated balance sheet, then eliminating entries involving nominal

ac­counts (income statement accounts and the “Dividends declared” account) would be made directly against the

ending balance of retained earnings presented on the balance sheet.

3. The following discussion assumes the acquirer is using the partial equity method to account for the majority

in­vestment.







a. Some firms may use the cost method during the period to account for investment income because it requires

fewer book adjustments to the investment account.







(1) In cases where the cost method is used during the period, one approach is to adjust the investment and

in­vestment income accounts to the equity method through an entry on the workpaper and the consolida­

tion process may then be continued.

(2) Assuming that an income statement and retained earnings statement are being prepared in addition to the

balance sheet, the general form of this restatement from cost to equity entry is made on the workpa­pers.







Dividend income (for income recognized using cost method)

Investment in acquiree (% of undistributed income of sub)

Equity in subsidiary’s income (for income recognized using equity method)



c15.indd 737



xx

xx

xx



13-05-2014 07:47:26



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