1. Consolidation of financial information is required for external reporting purposes when one
organization gains control of another, thus forming a single economic entity. In many
combinations, all but one of the companies is dissolved as a separate legal corporation.
Therefore, the consolidation process is carried out fully at the date of acquisition to bring
together all accounts into a single set of financial records. In other combinations, the companies
retain their identities as separate enterprises and continue to maintain their own separate
accounting systems. For these cases, consolidation is a periodic process necessary whenever the
parent produces external financial statements. This periodic procedure is frequently
accomplished through the use of a worksheet and consolidation entries.
2. Current financial reporting standards require the acquisition method in accounting for
business combinations. Under the acquisition method, the fair value of the consideration
transferred provides the starting point for valuing the acquired firm. The fair value of the
consideration transferred by the acquirer includes the fair value of any contingent consideration.
The acquired company assets and liabilities are consolidated at their individual acquisition-date
fair values. Direct combination costs are expensed as incurred because they are not part of the
acquired business fair value. Also, the fair value of all acquired in-process research and
development is recognized as an asset in business combinations and is subject to subsequent
3. If the consideration transferred for an acquired firm exceeds the total fair value of the acquired
firm’s net assets, the residual amount is recognized in the consolidated financial statements as
goodwill, an intangible asset. When a bargain purchase occurs, individual assets and liabilities
acquired continue to be recorded at their fair values and a gain on bargain purchase is
4. Particular attention should be given to the recognition of intangible assets in business
combinations. An intangible asset must be recognized in an acquiring firm’s financial statements
if the asset arises from a legal or contractual right (e.g., trademarks, copyrights, artistic materials,
royalty agreements). If the intangible asset does not represent a legal or contractual right, the
intangible will still be recognized if it is capable of being separated from the firm (e.g., customer
lists, noncontractual customer relationships, unpatented technology).
1. The procedures used to consolidate financial information generated by the separate companies
in a business combination are affected by both the passage of time and the method applied by the
parent in accounting for the subsidiary. Thus, no single consolidation process that is applicable to
all business combinations can be described.
2. The parent might elect to utilize the equity method to account for a subsidiary. As discussed
in Chapter 1, the parent accrues income when earned by the subsidiary. The parent records
dividend declarations by the subsidiary as reductions in the investment account. The effects of
excess fairvalue amortizations or any intra-entity transactions also are reflected within the
parent’s financial records. The equity method provides the parent with accurate information
concerning the subsidiary’s impact on consolidated totals; however, it is usually somewhat
complicated to apply.
3. The initial value method and the partial equity method are two alternatives to the equity
method. The initial value method recognizes only the subsidiary’s dividends as income while the
asset balance remains at the acquisition-date fair value. This approach is simple and typically
reflects cash flows between the two companies. Under the partial equity method, the parent
accrues the subsidiary’s income as earned but does not record adjustments that might be required
by excess fair-value amortizations or intra-entity transfers. The partial equity method is easier to
apply than the equity method, and, in many cases, the parent’s income is a reasonable
approximation of the consolidated total.
4. For a consolidation in any subsequent period, all reciprocal balances must be eliminated.
Thus, the subsidiary’s equity accounts, the parent’s investment balance, intra-entity income,
dividends, and liabilities are removed. In addition, the remaining unamortized portions of the
fair-value allocations are recognized along with excess amortization expenses for the period. If
the equity method has not been applied, the parent’s beginning Retained Earnings account also
must be adjusted for any previous income or excess amortizations that have not yet been
5. For each subsidiary acquisition, the parent must assign the acquired assets and liabilities
(including goodwill) to individual reporting units of the combined entity. The reporting units
should be at operating segment level or lower and serve as the basis for future assessments of fair
value. Any value assigned to goodwill is not amortized but instead is tested annually for
impairment. Firms have the option to perform a qualitative assessment to evaluate whether a
reporting unit’s fair value more likely than not exceeds its carrying amount. If the assessment
shows excess fair value over carrying amount for the reporting unit, a firm can forgo further
testing. Otherwise, a two-step test is performed. First, if the fair value of any reporting unit
below its carrying amount, then the implied value of the associated goodwill is recomputed.
Second, the recomputed implied value of goodwill is compared to its carrying amount. An
impairment loss must then be recognized if the carrying amount of goodwill exceeds its implied
6. Subsequent to a business combination, any newly recognized subsidiary identifiable
intangible assets (i.e., other than goodwill) considered to possess indefinite lives are not
amortized but instead are assessed for impairment on an annual basis. Similar to goodwill
impairment assessment, an entity has the option to first perform qualitative assessments for its
indefinite-lived intangibles to see if further quantitative tests are necessary. For intangible assets
with finite lives, amortization expense is recognized over the intangible asset’s useful life. The
amortization method should reflect the pattern of decline in the economic usefulness of the asset.
If no such pattern is apparent, the straight-line method of amortization should be used.
7. The acquisition-date fair value assigned to a subsidiary can be based, at least in part, on the
fair value of any contingent consideration. For contingent obligations that meet the definition of
a liability, the obligation is adjusted for changes in fair value over time with corresponding
recognition of gains or losses from the revaluation. For contingent obligations classified as
equity, no remeasurement to fair value takes place. In either case the initial value recognized in
the combination does not change regardless of whether the contingency is eventually paid or not.
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