Chapter 2
Consolidation of Financial Information
Business combinations and consolidation
- A business combination
- Is the formation of a single economic entity
- Occurs whenever one company gains control over another
- Business combinations can be created in several different ways
- Statutory merger - only one company remains
- Co. A acquires the assets and liabilities of Co. B, then Co. B is dissolved
- Co. A acquires all of the capital stock of Co. B. Co. B then dissolves and transfers all assets and liabilities to Co. A.
- Statutory consolidation - newly formed corporation
- The assets or capital stock of two or more companies are transferred to a newly formed corporation.
- Acquisition - both companies remain
- Co. A acquires a controlling interest in the voting stock of Co. B. Neither company is dissolved.
- Consolidation - combines the financial information of all members of a business combination into a single set of financial statements that represents the entire economic
entity.
- Permanent consolidation - if the entire company is dissolved. Enter all account balances into the financial records of the surviving company.
- Periodic consolidation - if separate incorporation is maintained. Consolidation process is simulated through worksheets and consolidating entries for reporting
purposes.
Purchase Method
- Applicable whenever one company acquires another. It is distinguished by three characteristics.
- One company is clearly the dominant purchasing party
- A bargained exchange transaction has taken place to gain control over the second company
- A historical cost figure can be determined based on the acquisition price paid.
- Price includes any direct costs of creating the combination
- Record stock issuance costs by reducing paid-in-capital. Do not consider these a part of the acquisition price.
Purchase method - dissolution of the acquired company
- Purchasers - records assets and liabilities being purchased at fair market value on date of acquisition
- Allocate - excess of purchase price over book value
- First, to undervalued assets and liabilities
- Then, to goodwill
- When purchase price is less than book value
- Record assets and liabilities at their fair market value
- Reduce noncurrent assets first
- If noncurrent assets cannot absorb entire reduction, establish a deferred credit balance
Purchase method - separate incorporation of all parties is retained
- Consolidation figures are the same as when dissolution occurs
- Use a worksheet to simulate the consolidation process so financial statements can be periodically produced.
Pooling of interests - No longer allowed - all business combinations must be accounted for using the purchase method. However, the application of the purchase method is
applied prospectively. As a result combinations that were accomplished prior to SFAS No. 141 may still be accounted for as poolings which will affect the fundamental
asset valuation, income recognition and financial ratios for years to come. When poolings were allowed, they were only applicable when ownership interests are united by
exchanging equity securities.
- Neither party is the acquiring company
- Precise cost figures from the exchange of securities are difficult to determine.
- Transaction affects the stockholders rather than the company
- Note: - Prior to the pooling method being eliminated, any business combination meeting 12 criteria established by the APB Opinion #16 had to be accounted for as a
pooling. If any one of the criteria were not met, the combination was a purchase, by default.
Pooling of interests - dissolution has occurred
- Determination of the acquisition price is not relevant
- All direct costs of creating the combination are expensed as incurred.
- Goodwill is never recognized in a pooling of interests, and no valuation adjustments are recorded.
- Book values are combined to produce a consolidated financial record. (Recall that the pooling affects the owners rather than the companies)
- Results of operations (both parties) are combined retroactively, as if the companies had always been together.
- Controversy
- Any cost figures indicated by the exchange transaction that created the combination are ignored.
- Income balances previously reported are altered since operations are combined retroactively.
- Reported net income is usually higher in subsequent years than in a purchase since there is no goodwill or valuation adjustments requiring amortization.
- Pooling of interests where separate incorporation is maintained also combines the book value of the companies for periodic reporting purposes but the process is carried
out on a worksheet.