Chapter Three

Consolidations –
Subsequent to
the Date of
Acquisition

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 Learning Objective 3-1

Recognize the complexities in

preparing consolidated financial
reports that emerge from
the passage of time.

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 Consolidation – The Effects
of the Passage of Time
The passage of time creates complexities for internal
record keeping and the balance of the investment
account varies due to the accounting method used.
A worksheet and consolidation entries are used to
eliminate the investment account and record the
subsidiary’s assets and liabilities to create a single set of
financial statements for the combined business entity.

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 Learning Objective 3-2

Identify and describe the various methods

available to a parent company in order to
maintain its investment in subsidiary
account in its internal records.

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 Investment Accounting
by Acquiring Company

For each subsidiary owned, an asset, the investment

account, and an income account are created to
record the earnings on the investment.
The acquiring company selects one of these three
methods have emerged as the most prominent to
account for its investment:
 Equity Method
 Initial Value Method
 Partial Equity Method

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 Investment Accounting by Acquiring
Company
What is the advantage of each?

Equity Method: The acquiring company totals give a true

representation of consolidation figures.

Initial Value (or “Cost”) Method: It is easy to apply and gives

a good measurement of cash flows generated by the
investment.

Partial Equity Method: Usually gives balances

approximating consolidation figures, but is easier to apply
than equity method

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 Investment Accounting
by Acquiring Company
Comparison of internal reporting of
investment methods.
Method Investment Income Account
Equity Continually adjusted to Income accrued as
reflect ownership of earned; amortization and
acquired company. other adjustments are
recognized.
Initial Value Remains at Initially- Dividends declared
Recorded cost recorded as Dividend
Income
Partial Equity Adjusted only for accrued Income accrued as
income and dividends earned; no other
declared by acquired adjustments recognized.
company.

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 Learning Objective 3-3

Prepare consolidated financial

statements subsequent to acquisition
when the parent has applied in its
internal records:
a. the equity method.
b. the initial value method.
c. the partial equity method.
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LO 3 -3a Subsequent Consolidation –
Equity Method

During the year, the parent will adjust its

investment account for the Subsidiary under
application of the equity method. The original
investment, recorded at the date of acquisition, is
adjusted for:

1. FMV adjustments and other intangible assets,

2. The parent’s share of the sub’s income (loss),
3. The receipt of dividends from the sub.

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 Subsequent Consolidation -
Equity Method Example
Parrot Company obtains all of the outstanding common stock of
Sun Company on January 1, 2014. Parrot acquires this stock for
$800,000 in cash. Sun Company’s balances are shown below.

Book Values Fair Values

1/1/14 1/1/14 Difference
Current assets . . . . . . . . . . . . . . . . . . $320,000 $ 320,000 –0–
Trademarks (indefinite life) . . . . . . . . 200,000 220,000 20,000
Patented technology (10-year life) . . . 320,000 450,000 130,000
Equipment (5-year life) . . . . . . . . . . . 180,000 150,000 (30,000)
Liabilities . . . . . . . . . . . . . . . . . . . . . . .(420,000) (420,000) –0–
Net book value . . . . . . . . . . . . . . . . . . $600,000 $ 720,000 $120,000
Common stock—$40 par value . . . .$(200,000)
Additional paid-in capital . . . . . . . . . . (20,000)
Retained earnings, 1/1/14 . . . . . . . . . .(380,000)
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 Subsequent Consolidation -
Equity Method Example
PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2014
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company. . . . . . . . . . . . . . . . . . .(600,000)
Excess of fair value over book value . . . . . . . . . . 200,000
Allocation to specific accounts based on fair values:
Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 20,000
Patented technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,000
Equipment (overvalued) . . . . . . . . . . . . . . . . . . . . . . . . . (30,000)
120,000
Excess FV not specifically identified—goodwill. . . . . . $ 80,000
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 Subsequent Consolidation -
Equity Method Example
Amortization computation:
Useful Annual
Account Allocation Life Amortization
Trademarks $ 20,000 Indefinite –0–
Patented technology 130,000 10 years $13,000
Equipment (30,000) 5 years (6,000)
Goodwill 80,000 Indefinite –0–
$ 7,000

Amortization will be $7,000 annually for five

years until the equipment fair value reduction
is fully removed.
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 Subsequent Consolidation -
Equity Method Example
Assume Sun Company earns income of $100,000 in 2014 and
pays a $40,000 cash dividend on August 1, 2014.

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 Subsequent Consolidation -
Worksheet Entries
For the first year, the parent prepares five entries on
the workpapers to consolidate the two companies.

S) Eliminates the subsidiary’s Stockholders’ equity account

beginning balances and the book value component within the
parent’s investment account.
A) Recognizes the unamortized Allocations as of the beginning of
the current year associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period
on the allocations from the original adjustments to fair value.
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 Subsequent Consolidation Equity
Method Example Entry S

Note: If this is the first year of the investment, and the

investment was made at a time other than the beginning of
the fiscal year, then pre-acquisition income of the sub must
be accounted for in the retained earnings balance.

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 Subsequent Consolidation Equity
Method Example Entry A

Note: In the first year, FV adjustments are calculated in the

allocation computation. In subsequent years, FV adjustments
must be reduced by any depreciation taken in prior
consolidations.

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 Subsequent Consolidation Equity
Method Example Entries I & D

Note: Entry I removes Sun’s income recognized by Parrot during

the year so Sun’s revenue and expense accounts (and current
amortization expense) can be brought into the consolidated totals.

Note: Entry D removes the intra-entity transfer of cash for the

dividends distributed to Parrot from Sun.
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 Subsequent Consolidation Equity
Method Example Entry E

Note that depreciation expense is reduced for the tangible asset

equipment (fair value was less than book value). Patented
Technology amortization expense was recognized for the year.

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LO 3-3b Applying the Initial Value Method

The parent company can use the initial value method or the
partial equity method for internal record-keeping.
Application of either alternative changes the balances recorded
by the parent over time and the consolidation process, but
neither of these approaches affect any of the final consolidated
balances reported.
Just three parent’s accounts vary because of the method applied:
• Investment account.
• Income recognized from the subsidiary.
• Parent’s retained earnings (periods after year of combination).

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 Applying the Initial Value Method
If the Initial Value Method is used by the parent to account for
the investment in the first year, the consolidation entries will
change slightly.

The parent will record the sub’s activity differently under this
method, so the accounts will differ from the Equity Method.

1. No adjustments are recorded in the Investment account for

current year income, dividends paid by the subsidiary, or
amortization of purchase price allocations.
2. Dividends received from the subsidiary are recorded as
Dividend Revenue.

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 Consolidation Entries -
Initial Value Method
Two entries for the initial value method are different
than those for the equity method.

Entry S is the same as the Equity Method.

Entry A is the same as the Equity Method.
Entry I is different using Initial Value Method: It
eliminates the Parent’s Dividend Income account and the
Sub’s Dividends Paid account.
There is no Entry D.
Entry E is the same as the Equity Method.
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 LO 3-3c Consolidation Entries –
Partial Equity Method

The same two entries differ for the Partial Equity Method .
Entry S is the same as the Equity Method.
Entry A is the same as the Equity Method.
Entry I is different using Partial Equity Method:
It eliminates the Parent’s equity in the sub’s income and
reduces the investment account.
Entry D eliminates the dividend income account.
Entry E is the same as the Equity Method.

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 Consolidation Entries –
Other than Equity Method
Remember . . .
 Entries S, A, and E are the same for all three
methods.
 The parent’s record-keeping is limited to two
periodic journal entries:
 annual accrual of subsidiary income and
 receipt of dividends.
 So, the Investment and Income account balances
differ for the other methods, and so will the
worksheet Entries I and D.

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 Consolidation Entries –
Subsequent Years
 Neither the Initial Value or Partial Equity Method
provides a full-accrual-based measure of the subsidiary
activities on the parent’s income.
 The initial value method uses the cash basis for income
recognition.
 The partial equity method only partially accrues
subsidiary income.
 A new worksheet adjustment is needed to convert the
parent’s beginning of the year retained earnings balance
to a full-accrual basis.

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 Consolidation Entries –
Subsequent Years

 For consolidation purposes, the beginning retained earnings

account must be increased (Initial Value Method) or
decreased (Partial Equity Method) to create the same effect as
the equity method.
 Entry *C. The C refers to the Conversion being made to
equity method (full accrual) totals. The asterisk indicates that
this entry relates solely to transactions of prior periods.

 Entry *C should be recorded before other worksheet entries

to align the beginning balances for the year.

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 Other Consolidation Entries

In addition to the Entries S, A, I, D, E, and *C,

intercompany debt (payables and/or receivables)
must be eliminated in entry P.
No matter which method the Parent chooses to record
the Sub’s activity, the consolidated totals are always
the same!
This is because all the entries that were made during
the year are eliminated regardless of the method used
or the amount!

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Consolidated Totals Subsequent to Acquisition

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 Learning Objective 3-4

Understand that a parent’s internal

accounting method for its subsidiary
investments has no effect on the resulting
consolidated financial statements.

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 Investment Accounting by
Acquiring Company

 A parent’s choice of internal accounting method for

subsidiary investments has no effect on the resulting
consolidated financial statements.
 The selection of a particular method does not affect the
totals ultimately reported for the combined companies.
The internal accounting method used does require
distinct procedures for consolidation of the financial
information from the separate organizations.

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 Learning Objective 3-5

Discuss the rationale for the goodwill

impairment testing approach.

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 Goodwill and Other Intangible Assets
(ASC Topic 350)

FASB ASC Topic 350, “Intangibles-Goodwill and

Other,” provides accounting standards for reporting
income statement effects of impairment of intangibles
acquired in a business combination.

In accounting for goodwill subsequent to the

acquisition date, GAAP requires an impairment
approach rather than amortization.

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 Learning Objective 3-6

Describe the procedures for conducting a

goodwill impairment test.

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 Goodwill and Other Intangible Assets
(ASC Topic 350)

Once goodwill has been recorded, the value will

remain unchanged until:

1. All or part of the related subsidiary is sold,

2. There has been a permanent decline in value in

which case we test for impairment and record an
impairment loss if the item is impaired.

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 Goodwill Impairment –
Two-Step Test
Step 1
Fair value (with allocated goodwill) is compared to
the carrying value (including goodwill) of the
consolidated entity’s reporting unit.
Does fair value of the reporting unit exceed
carrying value?

Goodwill is NOT A second step must be

impaired. No further taken to test for
testing is required. impairment.
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 Determination of Implied
Fair Value of Goodwill

The implied value of goodwill is calculated

similar to the initial determination of goodwill
in a business combination.
1. Allocate the fair value of the reporting unit
to all its identifiable assets and liabilities.
2. Subtract the fair value of the net assets
from the fair value of the reporting unit.
The excess is “implied goodwill”.
3. Compare the resulting “implied goodwill”
to the “recorded goodwill” on the books.
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Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test - Step One

Stop

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 Goodwill Impairment –
Two-Step Test
Implied value of the related goodwill can be determined
using quoted market prices, similar businesses, or present
value of future cash flows.
Step 2
Is “implied goodwill” less than “recorded goodwill”?

Goodwill is NOT An impairment loss is

impaired. No recorded for the excess
further testing is carrying value over
required. implied fair value.
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 Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test -Step Two

Stop

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 Goodwill Impairment Test Example

Newcall’s Acquisition Fair Value

Reporting Units Goodwill January 1, 2015
DSM Wired $ 22,000,000 $950,000,000
DSM Wireless 155,000,000 748,000,000
Vision Talk 38,000,000 502,000,000

Newcall tests for goodwill impairment of DSM

Wireless. The implied fair value of goodwill is
compared to its carrying value using the following
allocation of the fair value of DSM Wireless at year
end…
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Goodwill Impairment Test Example

DSM Wireless Dec. 31, 2015, fair value $600,000,000

Fair values of DSM Wireless net assets at Dec. 31, 2015:
Current asset $ 50,000,000
Property 125,000,000
Equipment 265,000,000
Subscriber list 140,000,000
Patented technology 185,000,000
Current liabilities (44,000,000)
Long-term debt (125,000,000)
Value assigned to identifiable net assets 596,000,000
Value assigned to goodwill 4,000,000
Carrying value before impairment 155,000,000
Impairment loss $151,000,000
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 Goodwill Impairment Test Example

Goodwill is now valued at $4,000,000.

Newcall reports a $151,000,000 separate line item
goodwill impairment loss in the operating section of its
consolidated income statement.
Additional disclosures required:
(1) the facts and circumstances leading to the impairment
(2) the method used to determine fair value of the
associated reporting unit.
The reported values for all of DSM Wireless’ remaining
assets and liabilities do not change.
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 Zero or Negative Carrying Amounts

The ASC requires special application of testing

procedures if a reporting unit has a zero or
negative carrying amount.
In that case, the ASC permits an entity to forego
step 2 of impairment test unless it is more likely
than not that goodwill is impaired.
The entity must consider the same factors as in
the qualitative assessment for individual reporting
units.

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 Comparison of U.S. GAAP and
International Accounting Standards

Under US GAAP: IFRS Under IAS 36:

Goodwill is allocated to Goodwill is allocated to cash-
reporting units, usually generating units – at a level
operating segments, expected much lower than an
to benefit from it. operating segment.
A two-step process is used to A one-step process is used to
test for impairment. test for impairment.
If the carrying amount of Goodwill is reduced for any
goodwill is more than its excess carrying value, down
implied value, an impairment to zero, and then other assets
loss is recognized. are reduced pro-rata.

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 Other Intangibles

All identified intangible assets with finite lives should

be amortized over their economic useful life that
reflects the pattern of decline in the economic
usefulness of the asset.
Factors that should be considered in determining the
useful life of an intangible asset include
• Legal, regulatory, or contractual provisions.
• The effects of obsolescence, demand, competition,
industry stability, rate of technological change, and
expected changes in distribution channels.
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 Other Intangibles

Intangible assets with indefinite lives (extends beyond the

foreseeable future) are tested for impairment on an
annual basis. An entity has the option to first perform
qualitative assessments to determine whether “it is more
likely than not” the asset is impaired.
If so, a quantitative test must be performed. The asset’s
carrying value is compared to its fair value. If fair value is
less than carrying value, the intangible asset is considered
impaired and an impairment loss is recognized. The
asset’s carrying value is reduced accordingly.

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 Learning Objective 3-7

Understand the accounting and reporting

for contingent consideration subsequent
to a business acquisition.

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 Contingent Consideration
in Business Combinations

If part of the consideration to be transferred in an

acquisition is contingent on a future event:
 The acquiring firm estimates the fair value of a cash
contingency and records a liability equal to the
present value of the future payment.
 The liability will continue to be measured at fair value
with adjustments recognized in income.
 Contingent stock payments are reported as a
component of stockholders’ equity, and are not
remeasured at fair value.

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 Learning Objective 3-8

Understand in general the requirements

of push-down accounting and when its use
is appropriate.

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 Push Down Accounting

Push-down accounting permits acquired subsidiary to

record fair value allocations and subsequent amortization
in its accounting records.
SEC requires push-down accounting for separate
subsidiary statements if no substantial outside ownership
exists. Generally limited for external reporting, also used
internally.
Method simplifies the consolidation process and provides
better information for internal evaluation.

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