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Chapter 14 Equity accounting and consolidations
Second edition update, June 2005.
Fair value adjustments and goodwill [p. 435 et seq.]
A parent company rarely acquires a subsidiary at a price equal to the book value of the
latter net assets. The price it pays reflects its assessment of the cash flows those net assets
are expected to generate. The amount may be more or less than book value. As a result, a
positive or negative "œconsolidation difference arises. How is this difference accounted
for?
In most countries, the difference is accounted for in two steps. First, the investor company
revalues the individual assets and liabilities of the acquired company to fair value at the
date of acquisition. (In countries which observe historical cost accounting strictly, this is a
consolidation exercise only: the subsidiary books are not altered.) "œFair value means
market value or a current valuation. The reason for this adjustment is clear. If the investor
company purchased assets from the investee on an individual basis, it would record them
at their fair value at the date of exchange.
Any remaining excess of purchase price over fair value of net assets at acquisition is
described as "œgoodwill. Goodwill represents the capitalised value of the "œabove-normal
earnings attributable to an acquired company or collection of assets. In the second of the
two steps, the goodwill is recognised as an intangible asset on the consolidated balance
sheet. This is now a universal practice. However, until recently companies in certain
countries were allowed to write off goodwill against reserves. Although this practice is no
longer permitted, the impact on corporate balance sheet
