Chapter Three

Consolidations—
Subsequent to
the Date of
Acquisition

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 Learning Objective 3-1

Recognize the complexities in preparing

consolidated financial reports that
emerge from the passage of time.

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 Consolidation—The Effects
Created by the Passage of Time
 The passage of time creates complexities for internal
record-keeping and the balance of the investment
account varies due to the accounting method used.
 A worksheet and consolidation entries are used to
eliminate the investment account and record the
subsidiary’s assets and liabilities to create a single set
of financial statements for the combined business
entity.

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 Consolidated Net Income
Determination
 A worksheet combines separately recorded revenues
and expenses of parent and subsidiary.
 Separate record-keeping systems result in subsidiary’s
expenses based on original book values, not
acquisition-date values that the parent must
recognize.
 Adjustments are made to reflect amortization of
excess consideration transferred from parent over
subsidiary’s book value.
 Effects of any intra-entity transactions are removed.

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 Investment Accounting—Parent
 For internal record-keeping, parent uses an accounting
method to monitor the two companies’ relationship.
 Parent’s investment account balance and amount of
income recognized vary over time depending upon the
method chosen.
 On the worksheet, parent’s investment account is
eliminated so subsidiary’s actual assets and liabilities can
be consolidated.
 Income accrued by parent is removed and subsidiary’s
revenues and expenses are included to create an income
statement for the combined business entity.

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 Learning Objective 3-2

Identify and describe the various

methods available to a parent company
in order to maintain its Investment in
Subsidiary account in its internal
records.

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 Investment Accounting by the
Acquiring Company
Record-keeping if parent can exert control over
subsidiary:
 External financial reporting: Consolidation is
required.
 Internal record-keeping: Parent selects an investment
accounting method to monitor activities of subsidiary.
 Three prominent methods used to account for
investments are:
 Equity method
 Initial value method
 Partial equity method
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 Advantages of Each Investment
Accounting Method
 Equity method: Full accrual accounting—creates a
total income figure reflective of the entire combined
business entity.
 Initial value (or “cost”) method: Cash basis
accounting—easy to apply and gives a good
measurement of cash flows generated by the
investment.
 Partial equity method: Accrual accounting without
equity adjustments—usually gives balances
approximating consolidation figures but easier to
apply than equity method.
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 Summary of Three
Internal Accounting Techniques

Method adopted:
 Affects only separate financial records.
 Has no impact on subsidiary’s balances.
 Does not affect amounts reported on consolidated
financial statements to external users.
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 Learning Objective 3-3a

Prepare consolidated financial statements

subsequent to acquisition when the
parent has applied the equity method in
its internal records.

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 Subsequent Consolidation—Equity
Method Example
Parrot Company obtains all of the outstanding common stock of
Sun Company on January 1, 2020. Parrot acquires this stock for
$800,000 in cash. Sun Company’s balances are shown below.

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Equity Method Example—Allocation
of Subsidiary Fair Value
EXHIBIT 3.2 Excess Fair-Value Allocation

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 Equity Method Example—
Amortization
EXHIBIT 3.3 Annual Excess Amortization

Amortization includes amortization of definite-lived intangibles and

depreciation of tangible assets. The acquisition-date fair value of
Sun’s equipment is $30,000 less than its book value, a fair-value
reduction and an expense reduction.
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Equity Method Example—Subsequent
Consolidation
Assume Sun Company earns income of $100,000 in 2020, declares a
$40,0000 cash dividend August 1, and pays the dividend August 8.

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Equity Method Example—Subsequent
Consolidation (2 of 3)
Assume Sun Company earns income of $100,000 in 2020, declares a
$40,0000 cash dividend August 1, and pays the dividend August 8.

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Equity Method Example—Subsequent
Consolidation (3 of 3)

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Subsequent Consolidation—Worksheet
Entries
Five entries consolidate the companies. Worksheet entries develop
totals reported by the entity but are not physically recorded in the
account balances of either company. The entries are:
S) Eliminates the subsidiary’s Stockholders’ equity account
beginning balances and the book value component within the
parent’s investment account.
A) Recognizes the unamortized Allocations as of the beginning of
the current year associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period
on the allocations from the original adjustments to fair value.

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 Subsequent Consolidation—Entry S

Consolidation Entry S

Entry S removes:
1) Investment in Sun Company account and adds each asset
and liability book values to the consolidated figures.
2) Sun’s stockholders’ equity accounts as of the beginning of
the year.
The label “Entry S” always refers to the removal of a
subsidiary’s beginning stockholders’ equity balances.
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Subsequent Consolidation—Entry A
Consolidation Entry A

Entry A adjusts subsidiary balances from their book

values to acquisition-date fair values and includes
goodwill created by the acquisition. It represents the
Allocations made in connection with the excess of the
subsidiary’s fair values over its book values.
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 Subsequent Consolidation—
Entries I and D
Consolidation Entry I

Entry I removes Sun’s income recognized by Parrot during

the year so Sun’s revenue and expense accounts (and current
amortization expense) can be brought into the consolidated
totals.
Consolidation Entry D

Entry D removes the intra-entity transfer of cash for the

dividends distributed to Parrot from Sun.
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 Subsequent Consolidation—Entry E
Consolidation Entry E

Entry E recognizes current year excess amortization expenses

relating to the adjustments of Sun’s assets to acquisition-date
fair values. It adjusts depreciation expense for the tangible
asset equipment and adjusts amortization expense for the
intangible asset patented technology.

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Consolidation Worksheet—Equity
Method Applied

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 Consolidation Subsequent to Year of
Acquisition—Equity Method
Assume the January 1, 2023, Sun Company’s Retained
Earnings balance has risen to $600,000. That account had a
reported total of only $380,000 on January 1, 2020. Sun’s book
value apparently has increased by $220,000 during the 2020–
2022 period.

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 Consolidation Subsequent to Year of
Acquisition—Equity Method (continued)
To analyze procedural changes due to passage of time,
assume:
 Parrot Company continues to hold its ownership of
Sun Company as of December 31, 2023.
 Sun now has a $40,000 liability payable to Parrot.
 January 1, 2023, Sun’s Retained Earnings balance is
$600,000.
 Sun’s book value has increased by $220,000.

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 Consolidation Subsequent to Year of
Acquisition—Equity Method (concluded)
Parrot reports an Equity in Subsidiary Earnings balance
of $153,000 (net income of $160,000–$7,000 excess
amortization).
The balance in the Investment in Sun Company account
has been adjusted for:
1. The annual accrual of Sun’s income ($160,000).
2. The receipt of $70,000 in dividends from Sun.
3. The recognition of annual excess amortization
expenses ($7,000).

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 Subsequent Consolidation—Entry P
In addition to Entries S, A, I, D, and E, Entry P must be
prepared.
 Entry P eliminates an intra-entity Payable.
 Intra-entity reciprocal accounts do not relate to
outside parties.
 Sun’s $40,000 payable and Parrot’s $40,000 receivable
must be removed because the companies are being
reported as a single entity.
All worksheet entries relate specifically to either previous
years (S and A) or the current period (I, D, E, and P).

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Consolidation Worksheet Subsequent to Year
of Acquisition—Equity Method Applied

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 Learning Objective 3-3b

Prepare consolidated financial statements

subsequent to acquisition when the
parent has applied the initial value
method in its internal records.

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Subsequent Consolidations—Investment Recorded
Using Initial Value or Partial Equity Method

The parent company can use the initial value method or

the partial equity method for internal record-keeping.
Application of either alternative changes the balances
recorded by the parent over time and the consolidation
process.
Neither of these approaches affect any of the final
consolidated balances reported.

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Subsequent Consolidations—Accounts
That Vary
Just three parent’s accounts vary because of the method
applied:
 Investment account.
 Income recognized from the subsidiary.
 Parent’s retained earnings (periods after year of
combination).
Only differences found in these balances affect the
consolidation process when another method is applied.
Accounting for these three balances any time after the
acquisition date is of special importance.

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Consolidation Entries—Initial Value
Method
Two entries for the initial value method are different
from those for the equity method.
 Entry S is the same as the equity method.
 Entry A is the same as the equity method.
 Entry I is different using the initial value method:
 It eliminates the parent’s Dividend Income account
and the sub’s Dividends Declared account.
 Entry D is not needed.
 Entry E is the same as the equity method.

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 Applying the Initial Value Method
When the initial value method is used by the parent, the
income and investment accounts on the parent company’s
separate statements vary.
Significant differences between the initial value method
and the equity method:
 Parent’s separate statements do not reflect
consolidated income totals when the initial value
method is used.
 Because equity adjustments are not recorded, neither
parent’s reported net income nor its retained earnings
provides an accurate portrayal of consolidated
figures.
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 Learning Objective 3-3c

Prepare consolidated financial statements

subsequent to acquisition when the
parent has applied the partial equity
method in its internal records.

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Consolidation Entries—Partial Equity
Method
The same two entries are different for the partial equity
method.
 Entry S is the same as the equity method.
 Entry A is the same as the equity method.
 Entry I is different using the partial equity method:
 It eliminates the parent’s equity in the sub’s
income and reduces the Investment account.
 Entry D eliminates the Dividends Declared account.
 Entry E is the same as the equity method.

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Consolidation Entries—Comparison of
Methods
Remember:
 Entries S, A, and E are the same for all three methods.
 The parent’s record-keeping is limited to two periodic
journal entries:
 Annual accrual of subsidiary income.
 Receipt of dividends.
 The Investment and Income account balances differ
for the other methods and so will the worksheet
Entries I and D.

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 Learning Objective 3-4

Understand that a parent’s internal

accounting method for its subsidiary
investments has no effect on the resulting
consolidated financial statements.

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Consolidation Subsequent to Year of Acquisition—
Initial Value and Partial Equity Methods

 Consolidated financial statements require a full accrual-

based measurement of both income and retained
earnings.
 Neither the initial value nor the partial equity method
provides a full accrual-based measure.
 The initial value method uses the cash basis for
income recognition of dividends.
 The partial equity method only partially accrues
subsidiary income.
 New worksheet adjustments are needed to convert the
parent’s beginning-of-the-year retained earnings
balance to a full-accrual basis.
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 Consolidation Subsequent to Year of
Acquisition—Entry *C
 Beginning Retained Earnings account must be increased
or decreased to create the same effect as the equity
method.
 Entry *C. The C refers to the Conversion being made to
equity method (full-accrual) totals. The asterisk indicates
that this entry relates solely to transactions of prior
periods.
 Entry *C, the adjustment of the parent’s beginning
Retained Earnings, should be recorded before other
worksheet entries to align the beginning balances for the
year.
 After the initial year of acquisition, an Entry *C is
required if the parent has not applied the equity method.
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Consolidated Totals Subsequent to
Acquisition
EXHIBIT 3.15 Consolidated Totals Subsequent to Acquisition

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 Consolidated Worksheet Entries

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3-40
 Other Consolidation Entries
In addition to the Entries S, A, I, D, E, and *C,
intercompany debt (payables and/or receivables) must be
eliminated in entry P.
If a subsidiary’s long-term debt exceeds its fair value:
 A consolidation entry is required to decrease the long-
term debt reported in the consolidated balance sheet.
 In periods subsequent to acquisition, worksheet entries
are needed to increase the interest expense to be
recognized in the consolidated balance sheet.

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 Learning Objective 3-5

Discuss the rationale for the goodwill

impairment testing approach.

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Goodwill and Other Intangible Assets
(ASC Topic 350)
 FASB ASC Topic 350, “Intangibles—Goodwill and
Other,” provides accounting standards for reporting
income statement effects of impairment of intangibles
acquired in a business combination.
 When accounting for goodwill subsequent to the
acquisition date, GAAP requires an impairment
approach rather than amortization.
 FASB reasoned that goodwill can decrease over time.
 However, it does not do so in a “rational and
systematic” manner.

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Goodwill and Other Intangible Assets
(ASC Topic 350)—Impairment
 Goodwill impairment losses are reported as operating
items in the consolidated income statement.
 FASB provides firms the option to conduct a qualitative
analysis to assess whether further testing procedures are
appropriate.
 If circumstances indicate a potential decline in the fair
value of a reporting unit below its carrying amount,
further tests are required to see if goodwill is the source
of the decline.

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 Learning Objective 3-6

Describe the procedures for conducting a

goodwill impairment test.

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 When to Test Goodwill for
Impairment?
 FASB ASC (paragraph 350-20-35-28) requires an entity
to assess its goodwill for impairment annually for each
reporting unit where goodwill resides.
 More frequent impairment assessment is required if
events or circumstances change that make it more likely
than not that reporting unit’s fair value has fallen below
its carrying amount.

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Goodwill Impairment Test: Is the Carrying Amount of a
Reporting Unit More Than Its Fair Value?

 Calculate fair values for each reporting unit with

allocated goodwill.
 Fair value (with allocated goodwill) is compared to the
carrying value (including goodwill) of the consolidated
entity’s reporting unit.
 Does fair value of the reporting unit exceed carrying
value?
 If yes, goodwill is NOT impaired and remains at its
current carrying amount.
 If no, goodwill impairment is the excess of carrying
amount over the fair value of the reporting unit and a
loss is recorded.
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 Goodwill Impairment Test Example
 Assume that on January 1, 2020, investors form Newcall
Corporation to consolidate the telecommunications
operations of DSM, Inc., and VisionTalk Company in a
deal valued at $2.2 billion.
 Newcall organizes each former firm as an operating
segment. Additionally, DSM comprises two divisions—
DSM Wired and DSM Wireless—that along with
VisionTalk are treated as independent reporting units for
internal performance evaluation and management reviews.
 Newcall recognizes $215 million as goodwill at the merger
date and allocates this entire amount to its reporting units.

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Goodwill Impairment Test Example—
Unit Goodwill Fair Values
Each reporting unit’s acquisition-date fair values are as
follows:

Newcall tests for goodwill impairment. DSM Wireless’s

fair value has fallen to $650 million, well below its
current carrying amount. The company attributes the
decline in value to a failure to realize expected cost-saving
synergies with VisionTalk.
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 Goodwill Impairment Test Example—
Allocation of Fair Value
Newcall derived implied fair value of goodwill through the
following allocation of the December 31, 2020 fair value of
DSM Wireless:

Newcall reports a $70 million goodwill impairment loss as a separate line

item in the operating section of its consolidated income statement.

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 Comparisons with International
Accounting Standards
 IFRS and U.S. GAAP require an assessment for goodwill
impairment at least annually and more frequently if
impairment is indicated. Both state that goodwill
impairments, once recognized, are not recoverable.
 U.S. GAAP: Goodwill acquired in a business
combination is allocated to reporting units (operating
segments or a business component one level below)
expected to benefit from the goodwill.
 IFRS: International Accounting Standard (IAS) 36
requires goodwill acquired in a business combination to
be allocated to cash-generating units at which goodwill is
monitored.
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 Comparisons with International
Accounting Standard—Fair Values
 U.S. GAAP: A reporting unit’s goodwill impairment is
computed as the excess of carrying amount over fair value.
Goodwill impairment is limited to goodwill carrying
amount for each unit.
 IFRS: Any excess carrying amount over fair value for a
cash-generating unit is first assigned to reduce goodwill. If
goodwill is reduced to zero, other assets of the cash-
generating unit are reduced pro-rata based on carrying
amounts of the assets.
 FASB and IASB will include impairment recognition and
reporting in a future convergence project.

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 Learning Objective 3-7

Describe the rationale and procedures for

impairment testing for intangible assets
other than goodwill.

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 Other Intangibles—Finite Lives
 All identified intangible assets with finite lives should be
amortized over their economic useful life that reflects the
pattern of decline in the economic usefulness of the asset.
 Factors to be considered in determining the useful life of
an intangible asset include:
 Legal, regulatory, or contractual provisions.
 The effects of obsolescence, demand, competition,
industry stability, rate of technological change, and
expected changes in distribution channels.
 The enterprise’s expected use of the intangible asset.
 The level of maintenance expenditure required to
obtain the asset’s expected future benefits.
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 Other Intangibles—Indefinite Lives
 Intangible assets with indefinite lives are tested for
impairment on an annual basis. An entity has the
option to first perform qualitative assessments to
determine whether “it is more likely than not” that
the asset is impaired.
 If so, a quantitative test must be performed. The
asset’s carrying value is compared to its fair value. If
fair value is less than carrying value, the intangible
asset is considered impaired and an impairment loss is
recognized. The asset’s carrying value is reduced
accordingly.

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 Learning Objective 3-8

Understand the accounting and reporting

for contingent consideration subsequent
to a business acquisition.

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Contingent Consideration in Business
Combinations—Future Performance
 Contingency agreements, consideration based on
future performance, often accompany business
combinations.
 The acquiring firm estimates the fair value of the
contingency and records a liability equal to the
present value of the future payment if
appropriate.
 The liability continues to be measured at fair
value with corresponding recognition of gains or
losses from the revaluation.

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Contingent Consideration in Business
Combinations—Equity Obligations
 Contingent obligations classified as equity are
reported as a component of stockholders’ equity.
 Equity contingencies are not remeasured at fair
value.
 Whether contingent obligations are a liability or
equity, the initial value recognized in the
combination does not change regardless of whether
the contingency is eventually paid or not.
 A loss from revaluation of a contingent performance
obligation is reported in the consolidated income
statement as a component of ordinary income.
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