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MODULE 2 PACKET
PrE 7 – ACCOUNTING FOR BUSINESS COMBINATIONS

MODULE 2 CONSOLIDATED FINANCIAL STATEMENTS:

Welcome to Module 2
In this module, we will discuss the preparation of consolidated financial statements on the date of
acquisition. At the end of this module, you will be answering multiple choice questions and straight
problems.

CONSULTATION HOURS:
Virtual time: During your class schedule
Phone or Messenger: Weekdays from 1pm to 130pm

MODULE 2 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Apply the acquisition method in stock acquisition
2. Prepare entries to record stock acquisition and consolidation elimination entries
3. Prepare consolidated statement of financial position

COURSE CONTENT FOR MODULE 2:

ACTIVITY DESCRIPTION TIME TO

COMPLETE
Lecture discussion Consolidated Financial Statements 3 hours
Activity Problem Solving 2 hours
Quiz Summative quiz for module 2 (to be announced) 1 hour

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LECTURE DISCUSSIONS

Definition of Terms
1. Consolidated financial statements are statements of a group in which the assets, liabilities, equity,
income, expenses, and cash flows of the parent and its subsidiaries are presented as those of a single
economic entity.
2. Control of an investee. An investor has control when it is exposed, or has rights, to variable returns
from its involvement with the investee and has the ability to affect those returns through its power
over the investee.
3. Group refers to a parent and its subsidiaries. Wherein the parent company controls one or more
entities; and the subsidiary is the entity controlled by another (such as a parent)

ELEMENTS OF CONTROL
1. Power over the investee (e.g. voting rights from common stocks)
2. Exposure or rights to variable returns from its involvement with the investee
3. Link between power and returns ( an entity with 60% voting stocks but no seat on the board cannot
have power and ability to affect its returns)

As a review, asset acquisition lets you compare the consideration transferred with the fair value of the net assets of
the acquiree to determine whether there is goodwill or gain on acquisition. What happens is a transfer of the net assets
of the acquiree to the acquirer. In this problem, no goodwill exist. No consolidation process is necessary.

Plane Company and Star Company – Statement of Financial Position – December 1, 2020
Plane Star
Cash 130,000 -
Inventory 70,000 40,000
Plant and Equipment 300,000 170,000
Liabilities 280,000 110,000
Common Stock 180,000 80,000
Retained Earnings 40,000 20,000

Plane acquired the assets of Star for P100,000 cash. The Inventory 40,000
book values of the net assets of Star Co. are assumed to be Plant and Equipment 170,000
equal to their fair values. Accounts Payable 110,000
Cash 100,000

Plane Company
Statement of Financial Position Subsequent to Net Asset Acquisition
Cash 30,000
Inventory 110,000
Plant and Equipment 470,000
TOTAL 610,000
Liabilities 390,000
Common Stock 180,000
Retained Earnings 40,000
TOTAL 610,000

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A 100% stock acquisition and an asset acquisition produce the same consolidated statement of financial
position after acquisition. However, when the stock acquisition is less than 100% it will result to a non-
controlling interest in the consolidated financial statement (which does not exist under assets acquisition.)
In asset acquisition, an acquirer buys the net assets of another entity and no parent-subsidiary relationship
exists, while stock acquisition results from the parent acquiring a controlling interest in the equity (not net
assets) of the subsidiary.

2.1 STOCK ACQUISITION

Consolidated Statement of Financial Position – Date of Acquisition

Plane Company and Star Company – Statement of Financial Position – December 1, 2020
Plane Star
Cash 130,000 -
Inventory 70,000 40,000
Plant and Equipment 300,000 170,000
Liabilities 280,000 110,000
Common Stock 180,000 80,000
Retained Earnings 40,000 20,000

Acquisition of a Wholly Owned Subsidiary

Plane will acquire all outstanding stocks of Star Investment in Star Company 100,000
for P100,000 Cash 100,000

Case 1: Acquisition at Book Value: consideration (price paid) = book value of acquired interest
100,000 = 100,000

Plane Star
Cash 30,000 -
Inventory 70,000 40,000
Plant and Equipment 300,000 170,000
Investment in Star Company 100,000
TOTAL ASSETS 500,000 210,000
Liabilities 280,000 110,000
Common Stock 180,000 80,000
Retained Earnings 40,000 20,000
TOTAL LIABILITIES & EQUITY 500,000 210,000

The change was in the decrease of Plane’s cash in exchange of the Investment in Star Company.

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Working Paper Elimination Entry. Before preparing the Common Stock – Star 80,000
consolidated statement of financial position, the Retained Earnings – Star 20,000
Investment in Star Co. account should be eliminated since Investment in Star Company 100,000
the two companies will be treated as one.

Consolidated Working Paper Elimination Entry. The first 2 columns present the individual statement of
financial position of Plane and Star, followed by the elimination entries and the consolidated statement.

Plane Star Elimination Consolidated

Debit Credit
Cash 30,000 - 30,000
Inventory 70,000 40,000 110,000
Plant and Equipment 300,000 170,000 470,000
Investment in Star Company 100,000 100,000
TOTAL ASSETS 500,000 210,000 610,000

Liabilities 280,000 110,000 390,000

Common Stock 180,000 80,000 80,000 180,000
Retained Earnings 40,000 20,000 20,000 40,000
TOTAL LIABILITIES & EQUITY 500,000 210,000 100,000 100,000 610,000

The elimination entry is not recorded in either the parent’s or subsidiary’s accounting records; It is only
part of the working paper for the preparation of the consolidated statement.

For consolidated paid-in capital amounts, only the parent company’s amount is reported since the
subsidiary’s paid-in capital amounts are always eliminated in the process of consolidation.

Only the retained earnings of the parent company are included in the statement in accordance with
the principle that acquisition accounting reflects a fresh start after acquisition of stock and not a
combination of existing stockholders’ interest.

The amounts in the consolidated column reflects the financial position of a single economic entity
comprising two legal entities, after eliminating all intercompany balances.

Case 2: Acquisition at More than Book Value

When the book values of the net assets of the subsidiary are equal to their fair values, and the consideration
given is more than the book value of interest acquired from the subsidiary, the excess is treated as goodwill.

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Plane Company acquired 100% of Star’s outstanding Investment in Star Company 110,000
common stock for P110,000 cash on Dec. 1, 2020. Cash 110,000

After the above entries has been posted, the Plane will have Cash balance of P20,000 and Investment in Star
Company at P110,000.

The excess of the consideration given over the book value is Goodwill:
Consideration given 110,000
Less: 100% interest acquired
Common Stock – Star 80,000
Retained earnings – Star 20,000 100,000
Goodwill 10,000

The excess may be attributable to: 1) Difference between the book value of the subsidiary’s assets and/or
liabilities and their fair values, 2) existence of goodwill in the subsidiary company. In the above
example, since the book value of the net assets in this example is equal to their fair values, the excess is
treated as goodwill.

Working Paper Elimination Entry.

Common Stock – Star 80,000
Retained Earnings – Star 20,000
Goodwill 10,000
Investment in Star Company 110,000

Consolidated Working Paper Elimination Entry.

Plane Star Elimination Consolidated
Debit Credit
Cash 20,000 - 20,000
Inventory 70,000 40,000 110,000
Plant and Equipment 300,000 170,000 470,000
Goodwill 10,000 10,000
Investment in Star Company 110,000 110,000
TOTAL ASSETS 500,000 210,000 610,000

Liabilities 280,000 110,000 390,000

Common Stock 180,000 80,000 80,000 180,000
Retained Earnings 40,000 20,000 20,000 40,000
TOTAL LIABILITIES & EQUITY 500,000 210,000 100,000 100,000 610,000

The assets and liabilities of Star are combined with those of Plane to arrive at the consolidated balances.
Only Plane’s stockholders’ equity accounts are extended in the consolidated column.

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Case 3: Acquisition at Less than Book Value

The excess of the fair value of the net identifiable assets over the price paid is treated as gain on acquisition
or gain on bargain purchase.

Assume that Plane Company acquired Investment in Star Company 80,000

100% of Star’s outstanding common stock Cash 80,000
for P80,000 cash on December 1, 2020.

After the above entries has been posted, the asset accounts of Plane will be:
Cash 50,000
Investment in Star Company 80,000

The difference (excess) between the consideration given and the book value of interest acquired is:
Consideration given 80,000
Less: 100% interest acquired
Common Stock – Star 80,000
Retained earnings – Star 20,000 100,000
Gain on acquisition (bargain purchase) (20,000)

Working Paper Elimination Entry.

Common Stock – Star 80,000
Retained Earnings – Star 20,000
Investment in Star Company 80,000
Retained Earnings – Plane (Gain) 20,000

Consolidated Working Paper Elimination Entry

Plane Star Elimination Consolidated
Debit Credit
Cash 50,000 - 50,000
Inventory 70,000 40,000 110,000
Plant and Equipment 300,000 170,000 470,000
Investment in Star Company 80,000 80,000
TOTAL ASSETS 500,000 210,000 630,000

Liabilities 280,000 110,000 390,000

Common Stock 180,000 80,000 80,000 180,000
Retained Earnings – Plane 40,000 20,000 60,000
Retained Earnings – Star 20,000 20,000
TOTAL LIABILITIES & EQUITY 500,000 210,000 100,000 100,000 630,000

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Affiliated companies should prepare a full set of financial statements: Statement of Financial Position,
Statement of Income And Comprehensive Income, Statement of Cash Flows, Statement of Stockholders
Equity, and Notes to Financial Statements.

The consolidated balance sheet reports the sum of the assets and liabilities of a parent and its subsidiaries
as if they constituted a single company. Assets and liabilities are summed in their entirety, whether the
parent owns 100% or a smaller controlling interest.

Intercompany profits in assets arising from subsequent transactions must be eliminated, because an entity
cannot profit on transactions with itself.

Intercompany Accounts to be Eliminated

Parent’s Accounts Subsidiary’s Account
Investment in Subsidiary BV of stockholder’s equity & over/undervaluation of assets
& liabilities
Intercompany receivable (payable) Intercompany payable (receivable)
Advances to/(from) subsidiary Advances (to)/from parent
Interest income / (expense) Interest expense / (income)
Dividend income / (declared) Dividend declared / (income)
Management fee received from subsidiary Management fee paid to parent

Acquisition of Partially Owned Subsidiary (Less than 100% interest)

The consolidation of a parent company and its partially owned subsidiary differs from the consolidation of
a wholly owned subsidiary in one major respect – the recognition of non-controlling interest (formerly
minority interest).

The non-controlling interest in the net income of the subsidiary is presented in the consolidated statement
of comprehensive income and the non-controlling interest in the subsidiary’s net assets is shown in the
consolidated statement of financial position in total and is not broken down into common stock, share
premium (additional paid-in capital), and retained earnings. The NCI must be shown as a component of
stockholders’ equity.

Measurement of Non-controlling Interest:

1. Fair Value - Any goodwill is allocated between the parent and the NCI.
It may be possible to determine the acquisition-date fair value on the basis of active market
prices of the equity shares not held by the acquirer. When the market price is not available, the
acquirer should measure the fair value of the non-controlling interests using other valuation
techniques.

2. Non-controlling interest’s proportionate share of the acquiree’s identifiable net assets - Any goodwill
is assigned only to the parent
Illustration taken from P. Guerrero, Advanced Accounting Vol. 2, 2017 edition

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900,000 - 280,000

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Why debit?
if there is an expense debit RE

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The
value of
NCI is
= + given in
this
problem

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If instead of
goodwill, there is
gain on acquisition,
retained earnings is
credited

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Illustration taken from P. Guerrero, Advanced Accounting Vol. 2, 2017 edition

620,000
x 20%

don't use120k

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Techniques in the Calculation and Allocation of Goodwill and/or Gain on Acquisition

100% Acquisition
Fair value of subsidiary ABC
or Consideration Transferred If the subsidiary has an existing
Less: Book value of SE of subsidiary goodwill, this will only be added to the
FV NA Allocated excess computed goodwill in the consolidated
Less: Over/under valuation of A and L statement of financial position.
Goodwill (Bargain Purchase Gain)

Partial acquisition – full-goodwill approach

Fair value of subsidiary
or Consideration Transferred xx / % acquired
Less: Book value of SE of subsidiary @ 100%
Allocated excess
Less: Over/under valuation of A and L
Goodwill (Bargain Purchase Gain)

Under the full-goodwill method, at acquisition date, the NCI in the subsidiary is measured at fair value
determined on the basis of the market prices for shares not acquired by the parent, or if these are not
available, a valuation technique is used.

The consideration paid by the acquirer is not sufficient to measure the fair value of the NCI.

WITH GOODWILL:

Step 1: Enter the value for column A2 (sum of fair values of company's net identifiable assets). Then
enter appropriate percentage of that value into column B2 and C2. These amounts are fixed
regardless of the price paid by the parent.
Step 2: Enter the price paid by the parent for the controlling interest in B1
Step 3: Compare B1, the price paid by the parent, and B2, the parent’s share of the fair value of the
company's net identifiable assets. If B1 is more than B2, enter B3 the difference, which is the
goodwill applicable to the parent. Then complete C1. Normally, this amount will be
proportionate to B1. It can be a different amount (based on estimated fair value) but never less
than C2. Compute the value of C3 and complete the remaining columns.
70% 30%
(A) (B) (C)
Company Implied FV Parent Price (%) NCI Value (%)
420k if; 120k-cnt be use; must be greater
1. Company fair value than 150 k
2. FV of net assets excluding goodwill 500k 350k 150k
3. Goodwill

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WITH GAIN ON ACQUISITION:

Step 1: Enter and allocate fair values

Step 2: Enter the price paid by the parent
Step 3: Calculate the gain applicable to the parent (B2 is more than B1) and complete the remaining
columns. C1 cannot be less than C2.

(A) (B) (C)

Company Implied FV Parent Price (%) NCI Value (%)
1. Company fair value
2. FV of net assets excluding goodwill
3. Gain on acquisition XX XX XX

Any excess of the C1 over Investment in Subsidiary Company XX

C2 will result to an entry NCI XX
Retained Earnings – Parent Company (gain on acquisition) XX

Subsidiary with a Recorded Goodwill at Acquisition Date

A pre-existing goodwill on the books of the acquired company is ignored in the computation and allocation
of excess.

Peer Co. transferred P180,000 cash and 10,000 common shares with P12 fair value per share for 75%
outstanding shares of Sky Company. It incurred indirect costs of P12,000 and stock issuance costs of
P8,000. The separate balance sheets of Sky Co. before the consolidation were as follows: 25% is the NCI

100%-75% = 25%

No value of NCI
was given in the
problem, so we
will use the
consideration paid
to determine the
entire value of the
subsidiary.
P180,000
P120,000
P300,000 / 75%

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300k / 75%

Total FV Parent (75%) Subsidiary (25%)

Consideration transferred 400,000 300,000 100,000
Less: Book value of interest acquired
Common Stock 200,000
APIC 20,000
Retained Earnings 80,000
Total Equity 300,000 300,000 300,000
Interest Acquired 75% 25%
Book Value 225,000 75,000
Excess 100,000 75,000 25,000
Adjustment of identifiable accounts
Investment in Sky Company 300,000
Increase in Inventory less 15,000
Cash 180,000
Increase in Land less 60,000 Common stock, P10 par 100,000
Decrease in buildings & equipment less (10,000) APIC 20,000
Acquisition of Sky Company
Increase in bonds payable less (35,000)
Total 30,000 Retained earnings (expense) 12,000
Cash 12,000
Goodwill 70,000 For acquisition-related costs
OR
Partial acquisition – full-goodwill approach APIC 8,000
Fair value of subsidiary 300,000/75% Cash 8,000
Costs to issue and register stocks
or Consideration Transferred 400,000
Less: Book value of SE of subsidiary 300,000
Allocated excess 100,000
Less: Over/under valuation of A and L (30,000)
Goodwill 70,000

25,000

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Worksheet for Consolidated Balance Sheet

Computed
goodwill is
P70,000
plus Sky’s
existing goodwill
of P5,000

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Making it easy for you, watch … https://www.youtube.com/watch?v=6vCWOj06lTo

It’s PEARDECK time!!!

ACTIVITY for Module 2 to be answered in NEO LMS

1.

2. Since, the fair value of the NCI is not given, an implied FV will be used

3. If Pub had plant assets with book value of P300,000 and fair value of P450,000, how much plant
assets is recorded in the consolidated financial statements?
180 000, 560 000

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4.

Items 5 to 6.

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