C H A P T E R. 2. Updated Sixth Edition. Consolidation of Financial Information. Why do Firms Combine?. Vertical integration. Cost savings. Quick access to new markets. Economies of scale. More attractive financing opportunities. Diversification of business risk. .
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Updated Sixth Edition
Consolidation of Financial Information
There are 3 basic types of combinations.
Acquisition of Majority Interest
The parent does not prepare separate financial statements
Consolidated financial statements are prepared.
The Sub still prepares separate financial statementsConsolidation of Financial Information
If the acquisition is made by issuing stock, the cost of the acquisition is equal to the MARKET VALUE of the stock issued.
Let’s look at some different situations where the Purchase Method would be used.
On 1/1/02, Large acquired 100% of Tiny for $300,000 cash.
Prepare the entry to record Large’s purchase.
Tiny’s fair market value was $300,000 which is equal to the price paid by Large. Record the purchased assets at their market value.
Note: Goodwill should be viewed as a residual amount remaining after all other identifiable and separable intangible assets have been identified.
On 1/1/02, Huge acquires 100% of Small for $250,000 cash.
Small has no identifiable, separable intangible assets.
Goodwill will be recorded as an intangible asset on Huge’s books, but will not be amortized.
Large will record $33,000 of Goodwill and will record the other purchased assets at their FMV.
In the event that the difference is substantial enough to eliminate all the non-current asset balances of the acquired company . . .
. . . The remainder is to be reported as an extraordinary gain (SFAS 141)
Record the financial information for both Parent and Sub on the worksheet.
Remove the Investment in Sub balance.
Remove the Sub’s equity account balances.
Adjust the Sub’s net assets to FMV.
Allocate any excess of cost over BV to identifiable, separable intangible assets or goodwill.
Combine all account balances.
On 1/1/03, Huge acquires 100% of Small for $250,000 cash.
Small holds a trademark that is valued at $25,000.
Let’s look at the computation of Goodwill next.
We use these numbers for steps #4 & #5.
Customer Base dissolved.
Trademarked Brand Names
Effective Advertising Programs
Rights (broadcasting, development, use, etc.)
Patents & Copyrights
Strong labor relations
Assembled, trained workforce
Favorable government relationsSFAS 141Business Combinations
Intangible Asset Examples
Let’s look at Pooling of Interests. dissolved.
Historically, business combinations have been accounted for as “Purchases” or “Pooling of Interests.”
In its SFAS 141, “Business Combinations”, the FASB states that all business combinations should be accounted for using the purchase method.
The purchase method is not to be applied prospectively, leaving intact prior poolings of interests.
Therefore, it is important to understand how to account for PAST poolings.
The ownership intersts of two, or more, companies were combined into one new company.
No single company was dominant.
Precise cost figures were difficult to obtain.
To use pooling of interests, 12 strict criteria had to be met.
In a pooling, one company obtained essentially “all” of the other company’s stock.
The transaction involvee the exchange of common stock. No exchange of cash was allowed.Historical Review of Pooling of Interests
The Book Values of the two combining companies were joined. No Goodwill was recorded.
Revenues and expenses were combined retroactively for the two companies.
On 12/31/99, EarthCo merged with Small, Inc. by giving 60,000 shares of $1 par value common stock (FMV = $30 per share) for substantially all of Small’s common shares.
Using the information provided for EarthCo and Small, Inc., prepare the journal entry necessary to complete the combination, assuming Small was NOT dissolved.
The Investment account for EarthCo should be equal to the BV of Small at the beginning of the period.
Prepare the entry to record the combination transaction.
Common Stock + Paid-In Capital in the entry should equal Common Stock + Paid-In Capital for Small. Since Small’s total was $80,000 ($70,000 + $10,000), and we have already entered $60,000 for the issued Common Stock of EarthCo, then we put $20,000 in Paid-In Capital here.
Note the altered balances on EarthCo’s books. combined into one new company.
Post the consolidating entry and add the balances. combined into one new company.
I can’t take much more of this!