Chapter 3

Consolidations - Subsequent to the Date of Acquisition

Complications subsequent to acquisition

• Purchase combinations will continue to require a different set of procedures than poolings because of the purchase price allocations and their amortization or impairment.

• In all combinations within its own internal record, the acquiring company will utilize a specific method to account for the investment in the acquired company

• Three alternatives are available



• Cost method (book value method in a pooling)



• Equity method



• Partial equity method

• Depending on the method applied, the acquiring company will record earnings from its ownership of the acquired company. This total must be eliminated on the consolidation worksheet and be replaced by the subsidiary's revenues and expenses.

• Under each of these three methods, the balance in the investment account will also vary. It too must be removed in producing consolidated statements and be replaced by the subsidiary's assets and liabilities.

Purchase combinations where the equity method has been applied

• Assuming the purchase was made during the current fiscal period

• The parent adjusts its own Investment account to reflect the subsidiary's income and dividend payments as well as any amortization expense relating to purchase price allocations.



• Worksheet entries are then used to establish consolidated figures for reporting purposes



• Entry S offsets the subsidiary's stockholders' equity accounts ( as of the purchase date) against the book value component of the Investment account



• Entry A recognizes the allocations made within the purchase price to specific subsidiary accounts and/or to goodwill



• Entry I eliminates the investment income balance accrued by the parent.



• Entry D removes intercompany dividend payments.



• Entry E records the current excess amortization expenses on the allocations within the original purchase price



• Entry P eliminates intercompany payable/receivable balances

• Assuming the purchase was made during a previous fiscal year

• Most of the consolidation entries described above remain applicable regardless of the time that has elapsed since the combination was formed

• The amount of the subsidiary's stockholders' equity to be removed in Entry S will differ each period to reflect the balance as of the beginning of the current year.

• The allocations established by entry A will also change in each subsequent consolidation. Only the unamortized balances remaining as of the beginning of the current period are recognized in this entry.

Purchase combinations where the other methods have been applied

• If the cost method is applied by the parent company, the intercompany Dividends eliminated in Entry I will only consist of the dividends transferred from the subsidiary. No separate Entry D is needed.

• If the partial equity method is in use, the intercompany income to be removed in Entry I is the equity accrual only; no amortization expense is included. Intercompany dividends are eliminated through Entry D.

• In any time period after the year of purchase



• The cost method recognizes neither income in excess of dividend payments nor amortization expense. Thus, for all years prior to the current period, both of these figures must be entered directly into the consolidation. Entry *C is used for this purpose. It converts all prior amounts to equity method balances.



• The partial equity method does not recognize excess amortization expenses. Therefore, Entry *C converts the appropriate account balances to the equity method by recognizing the expense that relates to all of the past years.

Bargain purchases

• As discussed in Chapter 2, bargain purchases occur when the parent company is able to pay less than fair market value for a subsidiary.

• Any reductions recorded in the value assigned to noncurrent assets must be amortized, thus decreasing expense. Further necessary reductions are reported as an extraordinary gain.

• Amortization of bargain purchase reductions has been criticized because the procedure inflates the future earnings reported by the business combination.

Contingent consideration

• In a purchase, the final price paid by the acquiring company may ultimately depend upon some future event such as the earnings of the subsidiary or the market value of any stock issued.

• If additional assets must be conveyed by the parent at a later date, the original purchase price is recalculated. Hence, goodwill is increased in the consolidated statements or (if a bargain purchase has occurred) reductions in asset adjustments are decreased or removed.

• If additional stock is issued at a later date, the new shares are recorded at fair market value but previously issued share are adjusted to this same value.

Push-down accounting

• A subsidiary acquired in a purchase may record any allocations directly onto its own financial records rather than through the use of a worksheet. Subsequent amortization expense could also be recorded by the subsidiary.

• Push-down accounting reports the assets and liabilities of the subsidiary at the amount the new owner paid. It also assists the new owner in evaluating the profitability that the subsidiary is adding to the business combination.

• Push-down accounting can also make the consolidation process easier since allocations and amortization need not be included as worksheet entries

Pooling subsequent to business combinations

• The acquired company's stockholders' equity must still be removed on the worksheet along with various reciprocal balances: intercompany income, dividends, and payable/receivable accounts. However, some differences do exist.

• Since all asset, liability and expense accounts are consolidated at book value, neither Entry A nor Entry E are needed; no allocations or amortization are recorded.

Goodwill Impairment - SFAS No. 142

• When is goodwill impaired?

• Goodwill is considered impaired when the fair value of its reporting unit falls below its carrying value. Goodwill should not be amortized, but should be tested for impairment at the reporting unit level (operating segment or lower identifiable level).

• Goodwill should be tested for impairment at least annually.

• Interim impairment testing may be necessary in the presence of negative indicators such as an adverse change in the business climate or market, legal factors, regulatory action, an introduction of competition, or a loss of key personnel.

• How is goodwill tested for impairment?

• All acquired goodwill should be assigned to reporting units. It would not be unusual for the total amount of acquired goodwill to be divided among a number of reporting units. Goodwill may be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit.

• Goodwill is tested for impairment using a 2-step approach

• The first step simply compares the fair value of a reporting unit to its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired and no further analysis is necessary.

• The second step is a comparison of goodwill to its carrying amount. If the implied value of a reporting unit's goodwill is less than its carrying value, goodwill is considered impaired and a loss is recognized. The loss is equal to the amount by which goodwill exceeds its implied value.

• The implied value of goodwill should be calculated in the same manner that goodwill is calculated in a business combination. That is, an entity should allocate the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price. The excess "purchase price" over the amounts assigned to assets and liabilities is the implied value of goodwill. This allocation is performed only for purposes of testing goodwill for impairment and does not require entities to record the "step-up" in net assets or any unrecognized intangible assets.

• How is the impairment recognized in financial statements?

• The aggregate amount of goodwill impairment losses should be presented as a separate line item in the operating section of the income statement unless goodwill impairment loss is associated with a discontinued operation.

• A goodwill impairment loss associated with a discontinued operation should be included (on a net-of-tax basis) within the results of discontinued operations.