8.5 to 8.6

Question 1

How are business combinations differentiated?

Answer 1

IFRS does not differentiate business combinations.

Under US GAAP:
Merger: acquiring firm absorbs the acquired firm, which ceases to exist

Acquisition: Both entities continue to exist in a parent-subsidiary relationship. The parent prepares consolidated financial statements and reports its minority interest

Consolidation: A new entity is formed that absorbs both of the combining companies

Question 2

What are the accounting methods for business combinations?

Answer 2

1. Historically two accounting methods were used: purchase method and pooling of interest method
2. Pooling of interest has been eliminated from IFRS and US GAAP
3. Purchase method has been replaced by the acquisition method

Question 3

What is the acquisition method also known as?

Answer 3

The consolidation method or consolidation

Question 4

Describe the pooling of interests method in terms of balance sheet treatment?

Answer 4

1. It would view each company as equal so that neither acquired the other
2. The two firm’s assets and liabilities would be combined based on historical book values

Question 5

What were the key attributes of the pooling method?

Answer 5

1. Two firms are combined using historical book values
2. Operating results from prior periods are restated as though the two firms were always combined
3. Ownership interests continue, and accounting bases are maintained

Question 6

What is important to note about the pooling method?

Answer 6

1. Fair values play no role in accounting for a business combination under the pooling method
2. The actual price paid was suppressed from the financial statements

Question 7

Are there any exemptions where the pooling method can still be used?

Answer 7

Yes - for transactions reported prior to 2001 IFRS and 2004 US GAAP

Question 8

What is the acquisition method?

Answer 8

1. It is required by IFRS and US GAAP for business combinations
2. The fair value of consideration is the measure for acquisitions, and it also includes the fair value of any contingent consideration at the acquisition date
3. Direct costs of the business combination are expensed as incurred

Question 9

What is the balance sheet treatment under the acquisition method?

Answer 9

1. The assets and liabilities are combined. However, the current assets of the acquiring company will be lowered by the amount of cash used to acquire the company
2. The shareholders equity of the acquired company is ignored
3. A minority interest account is created for the portion of the acquired company not owned by the acquirer

Question 10

What is the purpose of the minority interest account?

Answer 10

1. 100% of the acquired assets and liabilities of the acquired company are reported on the balance sheet, even if the acquirer owns less than 100% of the business
2. The remaining percentage interest not owned is reported through a minority interest account

Question 11

How does the acquisition method differ from the equity method in terms of balance sheet treatment?

Answer 11

1. Under the equity method, the acquiring company will report its (percentage interest) in the acquired company in a one-line investment account on the balance sheet
2. The assets and liabilities of the acquired company are ignored
3. The current assets of the acquirer will be lowered by the amount of cash consideration
4. The shareholders equity of the acquired company is still ignored

Question 12

What is the income statement treatment of the acquisition method?

Answer 12

1. The revenue and expenses of the two companies are combined so that 100% of the acquired revenues and expenses are reported
2. A minority interest account is created for the portion of net income not owned by the acquirer
3. The minority interest amount is simply the minority interest ownership % multiplied by the subsidiary’s net income

Question 13

How does the income statement treatment of the acquisition method differ from the equity method?

Answer 13

Under the equity method, the company would report its ownership share of the acquired companies net income in a one-line account in the income statement. It would not report a minority interest

Question 14

What is the overall income statement impact of using the acquisition method?

Answer 14

1. It results in higher revenues and expenses compared to the equity method
2. However, the net income is the same under each method