Ch. 3 Consolidation: afterwards Flashcards
Subsequent
Coming after something in time
Why will a parent maintain separate legal status for a subsidiary corporation?
To better utilize its inherent value as a going concern
Objective of consolidation (through passage of time)
Combine asset, liability, revenue, expense and equity accounts
Of parent and its subsidiaries
When must a parent company report consolidated net income?
Subsequent to an acquisition
Because of separate record keeping systems, the subsidiary’s expenses typically are based on…
2) what is the consequence?
Their original book values, not acquisition date values parent must recognize
2) adjustments made that reflect amortization of excess of parent’s
Consideration transferred over subsidiary book value
What is removed from revenues and expenses on consolidated worksheet?
Effects of intra-entity transactions are removed
3 Other complications introduced by time factor, in consolidation process
1 parent must select/apply accounting method to monitor
Relationship between 2 companies
2 parents investment account is eliminated on worksheet
3 income figure accrued by parent is removed each period
parent must select/apply accounting method to monitor
Relationship between 2 companies, what is the complexity in the consolidation process?
Investment balance recorded by parent varies depending on
Method chosen
parents investment account is eliminated on consolidation worksheet, for what reason?
So subsidiary’s assets and liabilities can be consolidated
income figure accrued by parent is removed each period, why?
So subsidiary’s revenues and expenses can be included when
creating income statement for combined business entity
For internal record-keeping, the parent has a choice for…
Monitoring the activities of its subsidiaries
3 most prominent internal record-keeping methods a parent can use to monitor its subsidiaries
1 equity method
2 initial value method AKA cost method
3 partial equity method
Typically the fair value of the consideration transferred by the parent will serve as…
The recorded valuation basis on the parent’s books
Subsequent to acquisition date, the 3 methods produce difference
Account balances for parent’s…3 things
1 investment in its subsidiaries
2 income recognized from its subsidiaries activities
3 retained earnings accounts
Selection of an internal record keeping method by the parent does…
Not affect the totals ultimately reported for combined companies
What does a parent’s choice of an internal accounting method lead to?
Leads to distinct procedures for consolidating financial information from separate organizations
The internal reporting philosophy of the acquiring company often determines…
He accounting method choice for its subsidiary investment
Equity method, what does it embrace?
Embraces full accrual accounting in maintaining the investment
Account and related income over time
Under the equity method, when does the acquiring company accuse income?
When the subsidiary earns it
equity method: to match the additional fair value recorded in combination against income
Amortization expense stemming from original excess fair value allocations is recognized
Recognized through periodic adjusting entries
Treatment of unrealized gains on intra-entity transactions under the equity method?
2) treatment of subsidiary dividends
Deferred
2) reduce investment balance
When the parent has complete ownership, equity method earnings from the subsidiary, combined with the parent’s other income sources create what?
Create total income figure reflective of entire combined business
Entity
What is the equity method often referred to as?
Single-line consolidation
When is the equity method especially popular for internal reporting purposes?
Popular in Companies where management periodically (monthly,
Quarterly) measures subsidiary’s profitability
using accrual based income figures
initial value method: the parent recognizes income from its share of…
Any subsidiary dividends when declared
Because little time typically elapses between dividend declaration and cash distribution, the initial value method frequently reflects…
The cash basis for income recognition
How is the investment balance recorded on the parent’s financial records under the initial value method?
Investment balance remains on parent’s financial records at
Initial fair value assigned on acquisition date
Why might a parent select the initial value method for internal record keeping purposes? 2 and example
1 Parent doesn’t require an accrual based income measure of
Subsidiary performance
2 easy to apply, avoid complexity of equity method
Ex. Parent may wish to assess subsidiary performance on its
Ability to generate cashflows, on revenues generated or
Other non income basis
Partial equity method: parent recognizes the reported income…
Accruing from the subsidiary
Partial equity method: subsidiary dividends declared…
Reduce the investment balance
Differences between the partial equity method and equity method?
Under partial equity method equity no adjustments are recorded for amortization or deferral of unrealized gains
What parent companies would prefer using the partial equity method, when full equity method is unnecessary?
Parent companies that rely on internally designed performance
Measures (rather than GAAP net income)
to evaluate subsidiary Management or make resource allocations
If the parent chooses a particular internal record keeping method (initial value, equity or partial equity method), how will it affect amounts reported on consolidated financial statements to external users?
It will not affect amounts reported on consolidated financial
Statements to external users
Equity method: investment account
Continually adjusted to reflect current owner’s equity of acquired
Company
Equity method: income account
Income accrued as earned
Amortization and other adjustments are recognized
Equity method: advantages
Acquiring company totals give true representation of consolidation
Figures
Initial value method: investment account
Remains at acquisition date value assigned
Initial value method: income account
Dividends declared recorded as dividend income
Initial value method: advantages
Easy to apply
Often reflects cash flows from subsidiary
Partial equity method: investment account
Adjusted only for accrued income and dividends declared by target
Partial equity method: income account
Income accrued as earned
No other adjustments recognized
Partial equity method: advantages
Usually gives balances approximating consolidation figures
Easier to apply than equity method
Under the equity method, what is the journal entry to recognize amortizations on allocations made in acquisition of subsidiary?
12/31/14
Equity in Subsidiary Earnings. Xxx
Investment in Sun Company Xxx
Application of equity method: target’s assets and liabilities are adjusted to reflect allocations originated from their…
Acquisition date fair values
Application of equity method: because of a passage of time, what must be recognized in allocations of target’s assets and liabilities?
Income effects (amortizations)
Must be recognized
Application of equity method: reciprocal or intra-entity accounts
Reciprocal or intra entity accounts must be offset
Intra entity
Describes transfers of assets across business entities
affiliated Through common stock ownership or other control
Mechanisms
Computation of consolidated figures: Revenues
Revenues of parent and subsidiary added together
Computation of consolidated figures: COGS
COGS parent and subsidiary added together
Computation of consolidated figures: amortization expense
Balance of parent and subsidiary combines, along with additional
Amortization from recognition of excess fair value over book value
Computation of consolidated figures: depreciation expense
Depreciation expense of parent and sub added together,
along With reduction in asset depreciation (ex. Equipment acquired
At less than FMV)
Computation of consolidated figures: equity in subsidiary earnings
Investment income recorded by parent is eliminated so subsidiary’s
Revenues and expenses can be included in consolidated totals
Computation of consolidated figures: net income
Consolidated revenues less consolidated expenses
Computation of consolidated figures: retained earnings
Include only parent figure if not owned prior to statement date
Computation of consolidated figures: dividends declared
Parent company balance only
Because subsidiary’s dividends are attributable intra entity to
Parent (not an outside party)
Computation of consolidated figures: current assets
Parents book value plus subsidiary’s book value
Computation of consolidated figures: investment in subsidiary
Asset recorded by parent is eliminated
so subsidiary’s assets and liabilities can be included in consolidated
Totals
Computation of consolidated figures: trademarks, patented technology
Parent’s book value + sub’s book value
+ sub’s acquisition date fair value
Consolidation from use of equity method: equipment (acquired below fair value)
Parent’s book value + subsidiary’s book value
- fair value allocation reduction + current year expense reduction
Computation of consolidated figures: goodwill
Residual allocation
Goodwill is not amortized
Computation of consolidated figures: total assets
Vertical summation of consolidated assets
Computation of consolidated figures: liabilities
Parent’s book value + subsidiary’s book value
Computation of consolidated figures: common stock
Parent’s book value
Subsidiary shares owned by parent treated as if no longer outstanding
Computation of consolidated figures: additional paid-in capital
Parent’s book value
Subsidiary shares owned by parent treated as if they’re no longer
Outstanding
Computation of consolidated figures: total liabilities and equities
Vertical summation of consolidated liabilities and equities
Work sheet entries define
The catalyst for developing totals to be reported by entity
But aren’t physically recorded in individual account balances of
Either company
Because consolidated statements are prepared for the parent company owners, the subsidiary equity accounts are…
Not relevant to business combination and should be deleted
Consolidation Entry S: Removal of subsidiary’s beginning stockholder’s equity balances For year against book value portion of investment account. What accounts are credited and debited in journal entry?
Common stock sun company. 200,000
Additional paid in capital sun co. 20,000
Retained earnings sun company. 380,000
Investment in Sun co. (Removal BV). 600,000
Consolidation Entry A: adjusts the subsidiary balances from their book values to acquisition date fair values and includes goodwill created by
Acquisition. What accounts are credited and debited in journal entry?
(3 of 5 accounts included: trademarks, patented technology, equipment)
Trademarks. Xxx
Patented Technology. Xxx
Goodwill. Xxx
Equipment. Xxx
Investment in Sun Company. Xxx
Consolidation entry I: removes subsidiary income recognized by Parrot during year Sun’s underlying revenue and expense accounts (and current amortization exp.) can be brought into consolidated totals.
What accounts are credited and debited in journal entry?
Equity in Subsidiary Earnings. Xxx
Investment in Sun Company. Xxx
Consolidation Entry D: designed to offset impact of the impact of dividends declared by removing the subsidiary’s dividends declared account. What accounts are credited and debited in journal entry?
Investment in Sun Company. Xxx
Dividends declared. Xxx
Consolidation Entry E: recognizes current year’s excess amortization expense relating to adjustments of Sun’s assets to acquisition date fair values. What accounts are credited and debited in journal entry?
(2 of 4 accounts are equipment and patented technology)
Amortization expense. Xxx
Equipment. Xxx
Patented Technology. Xxx
Depreciation expense. Xxx
Excess amortization expenses
Name for all adjustments for expenses resulting from excess
Acquisition date fair value allocations
Worksheet entry necessary for consolidation when parent has applied equity method: Entry S, 2 things
Eliminates subsidiary’s stockholder’s equity accounts as of
Beginning of current year
Eliminates equivalent book value component within parent’s
Investment account
Worksheet entry necessary for consolidation when parent has applied equity method: Entry A
Recognizes unamortized allocations at beginning of current year
Associated with original adjustments to fair value
Worksheet entry necessary for consolidation when parent has applied equity method: Entry I
Eliminates the impact of intra-entity subsidiary income accrued
By the parent
Worksheet entry necessary for consolidation when parent has applied equity method: Entry D
Eliminates the impact of intra entity subsidiary dividends
Worksheet entry necessary for consolidation when parent has applied equity method: Entry E
Recognizes excess amortization expenses for current period
On the allocations from original adjustments to fair value
When the parent employs the equity method, it’s net income and retained earnings…
Mirror consolidated totals
How do you calculate Equity in Subsidiary Earnings balance?
Net income - amortization expense
Worksheet entry necessary for consolidation when parent has applied equity method: consolidation entry P
Eliminates an intra entity payable
3 changes made when utilizing the either equity method, partial equity method or initial value method?
1 eliminates reciprocal accounts
2 assigns unamortized fair value allocations to specific amounts
3 records amortization exp. For current year
3 parent accounts that vary because of method applied
1 investment account
2 income recognized from subsidiary
3 parent’s retained earnings (in periods after initial year)
Using the initial value method rather than the equity method changes which entries?
Entries I and D
How is consolidation entry I different under the initial value method compared to the equity method?
Under initial value method parent records dividends declared
By subsidiary as income
In contrast to equity method, parent has not accrued subsidiary
Income, nor has amortization been recorded, therefor there’s no
Further income elimination
How is consolidation entry D different under the initial value method compared to the equity method?
When initial value method is applied, parent records intra-entity
Dividends as income
Because dividends were already removed from consolidated
Totals in entry I, no separate entry D is needed
Initial value method vs. Equity method: significant difference of parent’s separate statements
Under initial value method: parent’s separate statements do
Not reflect consolidated income totals
Why does the parent’s reported net income or retained earnings province an accurate portrayal of consolidated figures under the initial value method?
Because equity adjustments (ex. Excess amortizations) aren’t
Recorded
2 differences of partial equity method in contrast to other methods?
1 parent’s separate records for this investment and its related
income
2 worksheet entries I and D
Under the partial equity approach, the parent’s record keeping is limited to 2 periodic journal entries. What are they?
1 annual accrual of subsidiary income
2 recognition of dividends
What’s a significant goal of the consolidation for both the initial value method and partial equity method?
Establishment of an appropriate beginning retained earnings
Figure
Consolidated financial statements require a full accrual based measurement for both…
Income and retained earnings
Neither partial equity method or initial value method provides a full accrual based…
Measure of subsidiary activities on the parent’s income
If a method other than the equity method is used, worksheet changes must be made to the parent’s…
Beginning Retained earnings account in every subsequent
Year
Consolidation Entry C
Refers to conversion being made to equity method (full-accrual)
Totals
Should be recorded before other worksheet entries to align
Beginning balances for the year
3 entries affected by choice between 3 internal reporting methods?
Entries I, C and D
Consolidated Totals Subsequent to acquisition: current revenues 2
1 Parent revenues included
2 subsidiary revenues included (but only for period since
Acquisition)
Consolidated Totals Subsequent to acquisition: current expenses 3
1 parent expenses included
2 sub expenses included since acquisition
3 amortization exp. Of excess fair value allocations included by
Recognition on worksheet
Consolidated Totals Subsequent to acquisition: investment (or dividend) income
Income recognized by parent is eliminated and effectively
Replaced by subsidiary’s revenues and expenses
Consolidated Totals Subsequent to acquisition: Retained Earnings, beginning balance 3
1 parent balance included
2 change in sub balance since acquisition included
3 past amortization expenses as excess of fair value allocations
Consolidated Totals Subsequent to acquisition: assets and liabilities 3
1 parent balance included
2 sub balance after adjusting for acquisition date fair values
3 intra-entity receivable/payable balances eliminated
Consolidated Totals Subsequent to acquisition: Goodwill investment in subsidiary 2
1 original fair value allocation included
2 asset account recorded by parent eliminated on worksheet
So balance not included in consolidated figures
Consolidated Totals Subsequent to acquisition: Capital stock and additional paid in capital
Parent balances only are included
They will be adjusted at acquisition date if stock was issued
Why is goodwill impairment testing used instead of amortization?
Because goodwill is considered to have an indefinite life
FASB reasoned that goodwill never decreases in a…
Rational and systematic manner
What happens when goodwill becomes impaired?
Requires loss recognition and reduction in amount reported on
Consolidated balance sheet
Goodwill impairment tests are performed at the…
Reporting unit level within the combined entity
How does entry I differ between the equity method, initial value method and partial equity method when applied?
Equity method: equity income accrual (including amortization exp.)
Eliminated
Initial value method: dividend income eliminated
Partial equity method: equity income accrual eliminated
How does entry D differ between the equity method, initial value method and partial equity method when applied?
Equity method: intra entity dividends declared by subsidiary
Eliminated
Initial value method: no entry, intra entity dividends eliminated
In entry I
Partial equity method: same as equity method
How does entry C differ between the equity method, initial value method and partial equity method when applied?
Equity method: no entry, equity income for prior years already
Recognized with amortization expenses
Initial value method: increase in subsidiary’s book value during
Prior years and excess amortization exp. Recognized
Partial equity method: excess amortization expenses for prior
Years recognized
Entry C: effect on initial value method and partial equity method
Conversion is made to the equity method
Entry P
Intra-entity payable receivable balances are offset
What are the only adjustment entries following the year of acquisition that differ from adjustment entries in the initial year of acquisition?
Entry A and Entry C
How does entry A differ in the initial year of acquisition from subsequent years?
Initial year: excess fair value is allocated to assets and liabilities
Based on difference in book and fair values, residual is assigned to
Goodwill
Subsequent years: unamortized excess fair value at beginning of
year is allocated to specific accounts and goodwill
Qualitative tests: goodwill
Option to see if further goodwill impairment tests are needed
As impairment tests are costly
How do Combined companies typically organize themselves?
Into separate units along distinct operating lines
What does each individual operating unit have a responsibility for?
Managing its assets and liabilities to earn profits for combined
Entity
Where do operating units report information about their earnings activities and why?
2) what are these operating units known as?
To top management to support decision making
2) reporting units
In a business combination: Assets, liabilities and goodwill are assigned to the firm’s…
Reporting units based on where they’re employed
An individual reporting unit where goodwill resides is the appropriate level for what?
Goodwill impairment testing
In practice which 2 levels do firms often assign goodwill too?
1 reporting units at level of reporting segment
2 reporting units at lower level within segment of combined
Enterprise
Separate testing of goodwill within individual reporting units prevents…
Masking of goodwill impairment in one reporting unit with
Increases in value in other reporting units
What does the qualitative approach assess?
Likelihood that reporting unit’s fair value is less than it’s
Carrying amount
More likely than not threshold
More than 50% probability of occurring
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: macroeconomic conditions 4
1 Deterioration in general economic conditions
2 limitations in accessing capital
3 fluctuations in foreign currency exchange rates
4 other developments in equity and credit markets
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: industry and market considerations 5
1 deterioration in environment entity operates
2 increased competition
3 decline in metrics relative to peers and absolute
4 change in market for entity’s products/services
5 regulatory or political development
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: cost factors 3
1 increase in raw materials
2 labor costs
3 other costs that have negative effect on earnings
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: overall financial performance 2
1 decline in cashflows
2 decline in actual/planned revenue or earnings
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: other relevant entity specific events 4
1 change in managment/key personnel
2 change in strategy
3 change in customers
4 contemplation of bankruptcy or litigation
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: events affecting reporting unit 4
1 change in carrying amount of net assets
2 selling or disposal of reporting unit
3 testing recoverability of significant asset
4 recognition of goodwill impairment loss of subsidiary that is
Component of reporting unit
In assessing whether a reporting unit’s fair value exceeds its carrying amount a firm must examine: share price
If applicable, sustained decrease
If a reporting unit’s fair value is deemed greater than its carrying amount, then it’s…
Collective net assets are maintaining their value
When is rigorous testing for goodwill impairment appropriate?
Circumstances suggest that reporting unit’s fair value is likely
Less than carrying amount
2 steps in goodwill impairment test
1 calculate and compare the fair value of reporting unit to its
Carrying amount including goodwill
2 calculate and compare the implied fair value of the reporting unit’s
Goodwill with the carrying amount of that goodwill
Step 1: is the carrying amount of Reporting Unit More than its fair value
Consolidated entity calculates fair values for each of its reporting
Units with allocated goodwill
If reporting unit’s fair value exceeds carrying amount, it’s goodwill
Is not considered compared, otherwise goodwill impairment may
Exist
Step 2: Is Goodwill’s implied value less than its carrying amount
1 Compares fair value (implied value) of goodwill to its carrying
amount
2 Current fair value of reporting unit is allocated across unit’s
Identifiable assets and liabilities, with any excess considered
Implied goodwill
3 if implied goodwill is less than carrying amount, impairment
Has occurred and loss is recognized
An impairment loss for goodwill can’t exceed…
The carrying amount of goodwill
Goodwill impairment testing: when reporting unit has a 0 or negative carrying amount
Special application of testing procedure where performing
Step 2 of the impairment test is mandatory
3 differences between GAAP and IFRS for goodwill recognition
1 goodwill allocation
2 impairment testing
3 determination of impairment loss
GAAP VS IFRS: Goodwill Allocation in business combination, 2 for each
GAAP: 1 goodwill allocated to reporting unit’s expected to benefit
From goodwill
2 reporting units are operating segments and business component
One level below operating segment
IFRS: 1 goodwill allocated to cash generating units
2 cash generating units represent lowest level within entity where
Goodwill is monitored, also can’t be larger than operating segment
GAAP VS IFRS: Impairment testing, 2 for GAAP, 1 for IFRS
GAAP:1 firms have option to perform qualitative assessment to
Evaluate if goodwill impairment more than 50% likely
2 if likely must perform 2 step test
IFRS: one step approach compares fair and carrying amounts
Of each cash generating unit with goodwill
GAAP VS IFRS: Determination of Impairment loss, 2 for each
GAAP:1 excess of reporting unit’s fair value over fair value of
Identifiable assets
2 if carrying amount of goodwill is greater than its implied fair
Value, an impairment loss is recognized
IFRS: 1 any excess carrying amount over fair value of cash
Generating unit is first assigned to reduce goodwill
2 goodwill is reduced to 0, then other assets of cash generating
Unit reduced on pro rata basis
Indefinite life
How should an indefinite intangible be treated?
Life that extends beyond the foreseeable future
Should not be amortized, just tested for impairment
For intangible assets with finite lives, the amortization method should reflect what?
The pattern of decline in economic usefulness of the asset
Or if no pattern, straight line amortization should be used
Residual value of intangible
Acquiring company has commitment to purchase intangible at
End of its useful life
Or if market exists for intangible asset
What 4 factors should be used in determining the useful life of an intangible asset?
1 legal, regulatory and contractual provisions
2 effects of obsolescence, demand, completion, industry stability,
Rate of technological change, expected changes in distribution
Channels
3 enterprise’s expected use of intangible
4 level of maintenance expenditure required to obtain asset’s
Expected future benefits
2 main Qualitative factors included in qualitative assessment of indefinite life intangible
1 costs of using intangible, legal and regulatory factors
2 industry and market considerations
Contingent consideration, what does the target firm ask for?
What might the acquiring firm think?
Asks for consideration based projections of its future performance
Acquirer may not agree with target firm’s projections
Contingent consideration, how is it used to close the deal?
Agreements for acquirer’s future payments to former owners are
Common
Contingent consideration: when consideration includes acquirer’s stock, what may the sellers of the target firm request? Why?
Sellers of target may request guaranteed minimum market value
Of stock for period of time
To ensure fair price
Under the acquisition method, how are contingent consideration obligations treated?
Recognized as part of initial value assigned in a business
Combination
Consistent with fair value concept
Contingent consideration: the contingency’s fair value is recognized as part of the acquisition regardless of whether it is based on…
Future performance of target firm
Or future stock prices of acquirer
Contingent consideration: if target corp. meets the future projections and acquiring corp agreement offers stock as consideration, but it’s stock price has fallen what must acquiring corp do?
Issue more shares to target corp former owners
Official accounting pronouncements give virtually no guidance as to the impact of an acquisition on…
Why is this significant in recent years?
The separate financial statements of the subsidiary
2) because of acquisitions by private equity firms
What is the issue when an organization acquires a target and issues its shares back to the public?
What should be reported in the subsidiary’s financial statements
Being distributed in this offering?
Push-down accounting
Direct recording of fair value allocations and subsequent
Amortization by subsidiary
Allocations include goodwill stemming from parent’s acquisition
Push-down accounting: balance sheet accounts should be reported at…
Cost incurred by present stock holders (rather than cost incurred
By the company
The SEC has indicated that push down accounting… 2
Should be used in separate financial statements for substantially
Wholly owned subsidiaries
SEC requires push down accounting when ownership is over 95%
and objects to it when ownership is less than 80%
When is push down accounting encouraged by the SEC?
Acquired subsidiary has outstanding public debt or preferred stock
Aside from little outside ownership, push down accounting is only required when the subsidiary desires to…
Issue securities (debt or stock) to the public regulated by the SEC
How does Push down accounting have advantages for internal reporting?
1 simplifies the consolidation process
2 provides better info for internal evaluation
How does push down accounting simplify the consolidation process?
entries A and E not needed
Only need to eliminate effects of intra entity transactions
