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CHAPTER 3
CONSOLIDATIONS—SUBSEQUENT TO
THE DATE OF ACQUISITION
I. Several factors serve to complicate the consolidation process when it occurs subsequent
to the date of acquisition. In all combinations within its own internal records the acquiring
company will utilize a specific method to account for the investment in the acquired
company.
1. Three alternatives are available
a. Initial value method (also known as the cost method)
b. Equity method
c. Partial equity method
2. Depending upon the method applied, the acquiring company will record earnings
from its ownership of the acquired company. This total must be eliminated on the
consolidation worksheet and be replaced by the subsidiary’s revenues and
expenses.
3. Under each of these three methods, the balance in the Investment account will
also vary. It too must be removed in producing consolidated statements and be
replaced by the subsidiary’s assets and liabilities.
II. For combinations subsequent to the acquisition date, certain procedures are required. If
the parent applies the equity method, the following process is appropriate.
A. Assuming that the acquisition was made during the current fiscal period
1. The parent adjusts its own Investment account to reflect the subsidiary’s income
and dividend declarations as well as any amortization expense relating to excess
acquisition-date fair value over book value allocations and goodwill.
2. Worksheet entries are then used to establish consolidated figures for reporting
purposes.
a. Entry S offsets the subsidiary’s stockholders’ equity accounts against the
book value component of the Investment account (as of the acquisition date).
b. Entry A recognizes the excess fair over book value allocations made to
specific subsidiary accounts and/or to goodwill.
c. Entry I eliminates the investment income balance accrued by the parent.
d. Entry D removes intra-entity dividend declarations
e. Entry E recognizes the current excess amortization expenses on the excess
fair over book value allocations.
f. Entry P eliminates any intra-entity payable/receivable balances.
B. Assuming that the acquisition was made during a previous fiscal period
1. Most of the consolidation entries described above remain applicable regardless
of the time that has elapsed since the combination was formed.
2. The amount of the subsidiary’s stockholders’ equity to be removed in Entry S will
differ each period to reflect the balance as of the beginning of the current year
3. The allocations established by entry A will also change in each subsequent
consolidation. Only the unamortized balances remaining as of the beginning of
the current period are recognized in this entry.
III. For a combination where the parent has applied an accounting method other than the
equity method, the consolidation procedures described above must be modified.
A. If the initial value method is applied by the parent company, the intra-entity dividends
eliminated in Entry I will only consist of the dividends transferred from the subsidiary.
No separate Entry D is needed.
B. If the partial equity method is in use, the intra-entity income to be removed in Entry I
is the equity accrual only; no amortization expense is included. Intra-entity dividends
are eliminated through Entry D.
C. In any time period after the year of acquisition.
1. The initial value method recognizes neither income in excess of dividend
declarations nor excess amortization expense. Thus, for all years prior to the
current period, both of these figures must be entered directly into the
consolidation. Entry*C is used for this purpose; it converts all prior amounts to
equity method balances.
2. The partial equity method does not recognize excess amortization expenses.
Therefore, Entry*C converts the appropriate account balances to the equity
method by recognizing the expense that relates to all of the past years.
IV. Bargain purchases
A. As discussed in Chapter Two, bargain purchases occur when the parent company
transfers consideration less than net fair values of the subsidiary’s assets acquired
and liabilities assumed.
B. The parent recognizes an excess of net asset fair value over the consideration
transferred as a “gain on bargain purchase.”
V. Goodwill Impairment
A. When is goodwill impaired?
1. Goodwill is considered impaired when the fair value of its related reporting unit
falls below its carrying value. Goodwill should not be amortized, but should be
tested for impairment at the reporting unit level (operating segment or lower
identifiable level).
2. Goodwill should be tested for impairment at least annually.
3. Interim impairment testing is necessary in the presence of negative indicators
such as an adverse change in the business climate or market, legal factors,
regulatory action, an introduction of competition, or a loss of key personnel.
B. How is goodwill tested for impairment?
1. All acquired goodwill should be assigned to reporting units. It would not be
unusual for the total amount of acquired goodwill to be divided among a number
of reporting units. Goodwill may be assigned to reporting units of the acquiring
entity that are expected to benefit from the synergies of the combination even
though other assets or liabilities of the acquired entity may not be assigned to
that reporting unit.
2. Goodwill is tested for impairment through an optional assessment process
followed by a two-step approach (if necessary).
a. Entities are allowed the option of conducting a qualitative assessment of
goodwill to assess whether the two-step testing procedure is required. Under
the qualitative assessment, management evaluates relevant events or
circumstances to determine whether it is more likely than not that the fair
value of a reporting unit is less than its carrying amount. If it is more likely
than not that the fair value of a reporting unit is less than its carrying amount,
then the entity performs the two-step testing procedure. Otherwise, no further
tests are required.
b. The first step simply compares the fair value amount of a reporting unit to its
carrying amount. If the fair value of the reporting unit exceeds its carrying
amount, goodwill is not considered impaired and no further analysis is
necessary.
c. The second step is a comparison of goodwill to its carrying amount. If the
implied value of a reporting unit’s goodwill is less than its carrying value,
goodwill is considered impaired and a loss is recognized. The loss is equal
to the amount by which goodwill exceeds its implied value.
3. The implied value of goodwill should be calculated in the same manner that
goodwill is calculated in a business combination. That is, an entity should
allocate the fair value of the reporting unit to all of the assets and liabilities of that
unit (including any unrecognized intangible assets) as if the reporting unit had
been acquired in a business combination and the fair value of the reporting unit
was the value assigned at a subsidiary’s acquisition date. The excess
“acquisition-date” fair value over the amounts assigned to assets and liabilities is
the implied value of goodwill. This allocation is performed only for purposes of
testing goodwill for impairment and does not require entities to record the “step-
up” in net assets or any unrecognized intangible assets.
C. How is the impairment recognized in financial statements?
1. The aggregate amount of goodwill impairment losses should be presented as
a separate line item in the operating section of the income statement
unless a goodwill impairment loss is associated with a discontinued
operation.
2. A goodwill impairment loss associated with a discontinued operation should
be included (on a net-of-tax basis) within the results of discontinued
operations.
VI. Contingent consideration
A. The fair value of any contingent consideration is included as part of the consideration
transferred.
B. If the contingency results in a liability (typically a cash payment), changes in the fair
value of the contingency are recognized in income as they occur.
C. If the contingency calls for an additional equity issue at a later date, the acquisition-
date fair value of the contingency is not adjusted over time. Any subsequent shares
issued as a consequence of the contingency are simply recorded at the original
acquisition-date fair value. This treatment is similar to other equity issues (e.g.,
common stock, preferred stock, etc.) in the parent’s owners’ equity section.
VII. Push-down accounting
A. A subsidiary may record any acquisition-date fair value allocations directly onto its
own financial records rather than through the use of a worksheet. Subsequent
amortization expense on these allocations could also be recorded by the subsidiary.
B. Push-down accounting reports the assets and liabilities of the subsidiary at the
amount the new owner paid. It also assists the new owner in evaluating the
profitability that the subsidiary is adding to the business combination.
C. Push-down accounting can also make the consolidation process easier since
allocations and amortization need not be included as worksheet entries.
Answers to Discussion Questions
How Does a Company Really Decide which Investment Method to Apply?
Students can come up with dozens of factors that Pilgrim should consider in choosing its
internal method of accounting for its subsidiary, Crestwood Corporation. The following is only a
partial list of possible points to consider.
Use of the information. If Pilgrim does not monitor its subsidiary’s income levels closely,
applying the equity method may be not be fruitful. A company must plan to use the data
before the task of accumulation becomes worthwhile. For example, Crestwood may use the
information for evaluating the performance of the subsidiary’s managers.
Amount of excess amortizations. If Pilgrim has paid a significant amount in excess of book
value, its annual amortization charges are high, and use of the equity method might be
preferred to show the amortization effect each reporting period. In this case, waiting until
year end and recognizing all of the expense at one time through a worksheet entry might not
be the best way to reflect the impact of the expense.
Amount of intra-entity transactions. As with amortization, the volume of transfers can be an
important element in deciding which accounting method to use. If few intra-entity sales are
made, monitoring the subsidiary through the application of the equity method is less
essential. Conversely, if the amount of these transactions IS significant, the added data can
be helpful to company administrators evaluating operations.
Answers to Questions
1. a. CCES Corp., for its own recordkeeping, may apply the equity method to its
Investment in Schmaling. Under this approach, the parent's records parallel the
activities of the subsidiary. The parent accrues income as it is earned by the
b. The initial value method. The initial value method can also be utilized by CCES
Corporation. Any dividends declared are recognized as income but no other
c. The partial equity method combines the advantages of the previous two techniques.
Income is accrued as earned by the subsidiary as under the equity method. Similarly,
2. a. The consolidated total for equipment is made up of the sum of Maguire’s book value,
Williams’ book value, and any unamortized excess acquisition-date fair value over
book value attributable to Williams’ equipment.
b. Although an Investment in Williams account is appropriately maintained by the
parent, from a consolidation perspective the balance is intra-entity in nature. Thus,
the entire amount is eliminated in arriving at consolidated financial statements.
subsequent periods by adding the two book values together.
f. Consolidated expenses are determined by combining the parent's and subsidiary
amounts including any amortization expense associated with the acquisition-date fair
value allocations. As discussed in Chapter Five, intra-entity expenses can also
require elimination in arriving at consolidated figures.
3. Under the equity method, the parent accrues subsidiary earnings and amortization
4. In the consolidation process, excess amortizations must be recognized annually for any
portion of the acquisition-date fair value allocations to specific assets or liabilities (other
5. When a parent applies the initial value method, no accrual is recorded to reflect the
subsidiary's change in book value subsequent to acquisition. Recognition of excess
amortizations relating to the acquisition is also omitted by the parent. The partial equity
method, in contrast, records the subsidiary’s book value increases and decreases but
not amortizations. Consequently, for both of these methods, a technique must be
employed in the consolidation process to recognize the omitted figures. Entry *C simply
6. Lambert's loan payable and the receivable held by Jenkins are intra-entity accounts. The
consolidation process offsets these reciprocal balances. The $100,000 is neither a debt
7. Because Benns applies the equity method, the $920,000 is composed of four balances:
a. The original consideration transferred by the parent;
8. The $100,000 attributed to goodwill is reported at its original amount unless a portion of
goodwill is impaired or a unit of the business where goodwill resides is sold.
9. A parent should consider recognizing an impairment loss for goodwill associated with an
acquired subsidiary when, at the reporting unit level, the fair value is less than its
10. The acquisition-date fair value of the contingent payment is part of the consideration
transferred by Reimers to acquire Rollins and thus is part of the overall fair value
11. At present, the Securities and Exchange Commission requires the use of push-down
accounting for the separate financial statements of a subsidiary where no substantial
outside ownership exists. Thus, if Company A owns all of Company B, the push-down
method of accounting is appropriate for the separately issued statements of Company B.
12. When push-down accounting is applied, the subsidiary adjusts the book value of its
assets and liabilities based on the acquisition-date fair value allocations. The subsidiary
then recognizes periodic amortization expense on those allocations with definite lives.
Answers to Problems
4. A Paar’s equipment book value—12/31/14.............................. $294,000
Kimmel’s equipment book value—12/31/14........................ 190,400
Original acquisition-date allocation to Kimmel's equipment
5. A
9. B Phoenix revenues $498,000
Phoenix expenses 350 ,000
Net income before Sedona effect 148,000
Consolidated net income $203 ,000
-or-
Consolidated revenues $783,000
10. A (same as Phoenix because of equity method use).
11. C Consideration transferred at fair value $600,000
Book value acquired 420 ,000
Three years since acquisition, ¼ of acquisition-date value remains.
14. D The $105,000 excess acquisition-date fair value allocation to equipment is
15. (35 Minutes) (Determine consolidated retained earnings when parent uses
various accounting methods. Determine Entry *C for each of these methods)
a. CONSOLIDATED RETAINED EARNINGS--EQUITY METHOD
Herbert (parent) balance—1/1/14 ................................... $400,000
Herbert income—2014 ..................................................... 40,000
Herbert dividends—2015.................................................. (10,000)
Rambis income—2015 ..................................................... 30,000
Amortization—2015 ........................................................ (12 ,000)
Consolidated retained earnings, 12/31/15...................... $496 ,000
PARTIAL EQUITY METHOD AND INITIAL VALUE METHOD
Consolidated RE are the same regardless of the method in use: the
b. Investment in Rambis—equity method
Rambis fair value 1/1/14.............................................................. $574,000
Rambis income 2014................................................................... 20,000
Investment account balance 1/1/15........................................... $577 ,000
Investment in Rambis—partial equity method
Investment in Rambis—Initial value method
Rambis fair value 1/1/14.............................................................. $574 ,000
Investment account balance 1/1/15........................................... $574 ,000
15. (continued)
c. ENTRY *C
EQUITY METHOD
since that method has already been applied.
PARTIAL EQUITY METHOD
Amortization for the prior years (only 2014 in this case) has not been
recorded and must be brought into the consolidation through worksheet
entry *C:
ENTRY *C
Retained earnings, 1/1/15 (Parent) ...................... 12,000
INITIAL VALUE METHOD
Amortization for the prior years (only 2014 in this case) has not been
recorded and must be brought into the consolidation through worksheet
entry *C. In addition, only dividend income has been recorded by the
parent ($5,000 in 2014). In this prior year, Rambis reported net income of
$20,000. Thus, the parent has not recorded the $15,000 income in
excess of dividends. That amount must also be included in the
consolidation through entry *C:
ENTRY *C
16. (30 Minutes) (A variety of questions on equity method, initial value method,
and partial equity method.)
a. An allocation of the acquisition price (based on the fair value of the
shares issued) must be made first.
Acquisition fair value (consideration paid by Haynes) $135,000
Excess fair value assigned to specific Remaining Annual excess
accounts based on fair value life amortizations
Acquisition-date fair value............................................... $135,000
2014 Income accrual ........................................................ 110,000
2014 Dividends declared by Turner ............................... (50,000)
2014 Amortizations (above) ............................................ (4,000)
b. Net income of Haynes ..................................................... $240,000
Net Income of Turner ....................................................... 130,000
c. Equipment balance Haynes ............................................ $500,000
Equipment balance Turner .............................................. 300,000
Parent's choice of an investment method has no impact on consolidated
totals.
16. (continued)
d. If the initial value method was applied during 2014, the parent would
have recorded dividend income of $50,000 rather than $110,000 (as
equity income). Income is, therefore, understated by $60,000. In
addition, amortization expense of $4,000 was not recorded. Thus, the
January 1, 2015, retained earnings is understated by $56,000 ($60,000 –
$4,000). Worksheet Entry *C thus serves to adjust the parent’s
beginning retained earning to a full accrual basis:
If the partial equity method was applied during 2014, the parent would
have failed to record amortization expense of $4,000. Retained earnings
are overstated by $4,000 and are corrected through Entry *C:
If the equity method was applied during 2014, consolidated retained
