1. Chapter Three Consolidations – Subsequent to the Date of Acquisition
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2. Consolidation – The Effects of the Passage of Time
Learning Objective 3-1:
Recognize the complexities in preparing consolidated financial reports that emerge from 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.
Despite complexities created by the passage of time, the basic objective of all consolidations remains the same: to combine asset, liability, revenue, expense, and equity accounts of a parent and its subsidiaries. From a mechanical perspective, a worksheet and consolidation entries continue to provide structure for the production of a single set
of financial statements for the combined business entity.
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.

3. Investment Accounting by Acquiring Company
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.
An asset account, investment account, and an income account is created for each subsidiary owned.
For a parent company’s external financial reporting, consolidation of a subsidiary becomes
necessary whenever control exists. For internal record-keeping, though, the parent
has a choice for monitoring the activities of its subsidiaries. Although several variations
occur in practice, three methods have emerged as the most prominent: the equity method,
the initial value method, and the partial equity method. At the acquisition date, each investment accounting method (equity, initial value, and partial equity) begins with an identical value recorded in an investment account. 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 the acquisition date, the three methods produce different account balances for the parent’s investment in subsidiary, income recognized from the subsidiary’s activities, and retained earnings accounts. Importantly, the selection of a particular method does not affect the totals ultimately reported for the combined companies. However, the parent’s choice of an internal accounting method does lead to distinct procedures for consolidating the financial information from the separate organizations.
The acquiring company selects one of three methods :
Equity Method
Initial Value Method
Partial Equity Method

4. Investment Accounting by Acquiring Company
Comparison of internal reporting of investment methods.
Method
Investment
Income Account
Equity
Continually adjusted to reflect ownership of acquired company.
Income accrued as earned; amortization and other adjustments are recognized.
Initial Value
Remains at Initially-Recorded cost
Dividends declared recorded as Dividend Income
Partial Equity
Adjusted only for accrued income and dividends declared by acquired company.
Income accrued as earned; no other adjustments recognized.
Comparison of internal reporting of investment methods.
Equity Method
Continually adjusted to reflect ownership of acquired company.
Income accrued as earned; amortization and other adjustments are recognized.
Initial Value
Remains at Initially-Recorded cost. Dividends declared recorded as Dividend Income
Partial Equity
Adjusted only for accrued income and dividends declared by acquired company. Income accrued as earned; no other adjustments recognized.
Some parent companies rely on internally designed performance measures (rather than GAAP net income) to evaluate subsidiary management or for resource allocation decisions. For such companies, a full equity method application may be unnecessary for internal purposes. In these cases, the partial equity method, although only approximating the GAAP income measure, may be sufficient for decision making. Nonetheless, no matter what method the parent chooses to internally account for its subsidiary, the selection of a particular method (i.e., initial value, equity, or partial equity) does not affect the amounts ultimately reported on consolidated financial statements to external users.

5. Subsequent Consolidation – Equity Method
Learning Objective 3-3a:
Prepare consolidated financial statements subsequent to acquisition when the parent has applied the equity method in its internal records.
During the year, the parent will adjust its investment account for the Subsidiary under application of the equity method. The original investment, recorded at the date of acquisition, is adjusted for:
The equity method embraces full accrual accounting in maintaining the investment account and related income over time. Under the equity method, the acquiring company accrues income when the subsidiary earns it. To match the additional fair value recorded in the combination against income, amortization expense stemming from the original excess fair-value allocations is recognized through periodic adjusting entries. Unrealized gains on intra-entity transactions are deferred; subsidiary dividends serve to reduce the investment balance. As discussed in Chapter 1, the equity method creates a parallel between the parent’s investment accounts and changes in the underlying equity of the acquired company. When the parent has complete ownership, equity method earnings from the subsidiary, combined with the parent’s other income sources, create a total income figure reflective of the entire combined business entity. Consequently, the equity method often is referred to as a single-line consolidation. The equity method is especially popular in companies where management periodically (e.g., monthly or quarterly) measures each subsidiary’s profitability using accrual-based income figures.
During the year, the parent will adjust its investment account for the Subsidiary under application of the equity method. The original investment, recorded at the date of acquisition, is adjusted for:
FMV adjustments and other intangible assets,
The parent’s share of the sub’s income (loss),
The receipt of dividends from the sub.
FMV adjustments and other intangible assets,
The parent’s share of the sub’s income (loss),
The receipt of dividends from the sub. 2

6. Subsequent Consolidation – Allocating FMV
PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2014
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company (600,000)
Excess of fair value over book value ,000
Allocation to specific accounts based on fair values:
Trademarks $ 20,000
Patented technology ,000
Equipment (overvalued) (30,000)
120,000
Excess FV not specifically identified—goodwill $ 80,000
PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2014
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company (600,000)
Excess of fair value over book value ,000
Allocation to specific accounts based on fair values:
Trademarks $ 20,000
Patented technology ,000
Equipment (overvalued) (30,000)
120,000
Excess FV not specifically identified—goodwill $ 80,000 17

7. Recording Net Income and Dividends
Assume subsidiary, Sun Company, earns income of $100,000 in 2014 and pays a $40,0000 cash dividend on August 1, 2014.
Assume Sun Company earns income of $100,000 in 2014 and pays a $40,0000 cash dividend on August 1, 2014.
1/1/14 Investment in Sun Company ,000
Cash ,000
To record the acquisition of Sun Company.
8/1/14 Cash ,000
Investment in Sun Company ,000
To record receipt of cash dividend from subsidiary
under the equity method.
12/31/14 Investment in Sun Company ,000
Equity in Subsidiary Earnings ,000
To accrue income earned by 100% owned subsidiary.
12/31/14 Equity in Subsidiary Earnings ,000
Investment in Sun Company ,000
To recognize amortizations on allocations made in acquisition of sub. 23

8. Subsequent Consolidation - Worksheet Entries
For the first year, the parent prepares five entries on the workpapers to consolidate the two companies.
S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the book value component within the parent’s investment account.
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.
Subsequent Consolidation - Worksheet Entries
For the first year, the parent prepares five entries on the workpapers to consolidate the two companies.
S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the book value component within the parent’s investment account.
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. 3

9. Applying the Initial Value Method
Learning Objective 3-3b:
Prepare consolidated financial statements subsequent to acquisition when the parent has applied the initial value method for internal record-keeping.
Application of either method changes the balances recorded by the parent over time, but neither affect any of the final consolidated balances reported.
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).
The parent company may opt to use the initial value method or the partial equity method for internal record-keeping rather than the equity method. Application of either alternative changes the balances recorded by the parent over time and, thus, the procedures followed in creating consolidations. However, choosing one of these other approaches does not affect any of the final consolidated figures to be reported.
When a company utilizes the equity method, it eliminates all reciprocal accounts, assigns
unamortized fair-value allocations to specific accounts, and records amortization
expense for the current year. Application of either the initial value method or the partial
equity method has no effect on this basic process. For this reason, a number of the consolidation entries remain the same regardless of the parent’s investment accounting method.
In reality, just three of the parent’s accounts actually vary because of the method applied:
• The investment account.
• The income recognized from the subsidiary.
• The parent’s retained earnings (in periods after the initial year of the combination).

10. Consolidation Entries – Partial Equity Method
Learning Objective 3-3c: Prepare consolidated financial statements subsequent to acquisition when the parent has applied the partial equity method in its internal records. For the Partial Equity Method, entry S, A, D, and entry E are the same as the Equity Method. Entry I is different using Partial Equity Method: It eliminates the Parent’s equity in the sub’s income and reduces the investment account.

11. Consolidation Entries – Other than Equity Method
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 and
receipt of dividends.
So, the Investment and Income account balances differ for the other methods, and so will the worksheet Entries I and D.
Consolidation Entries – Other than Equity Method
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 and
receipt of dividends.
So, the Investment and Income account balances differ for the other methods, and so will the worksheet Entries I and D.

12. Investment Accounting by Acquiring Company
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.
The selection of a particular method does not affect the totals ultimately reported for the combined companies.
The internal accounting method used does require distinct procedures for consolidation of the financial information from the separate organizations.
Investment Accounting by Acquiring Company
A parent’s choice of internal accounting method for subsidiary investments has no effect on the resulting consolidated financial statements.
The selection of a particular method does not affect the totals ultimately reported for the combined companies.
The internal accounting method used does require distinct procedures for consolidation of the financial information from the separate organizations.

13. Goodwill and Other Intangible Assets (ASC Topic 350)
Learning Objective 3-5: Discuss the rationale for the goodwill impairment testing approach.
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.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of either amortization or impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.

14. Goodwill and Other Intangible Assets (ASC Topic 350)
Learning Objective 3-6: Describe the procedures for conducting a goodwill impairment test.
Once goodwill has been recorded, the value will remain unchanged until:
All or part of the related subsidiary is sold, or
There has been a permanent decline in value in which case we test for impairment and record an impairment loss if the item is impaired.
Once goodwill has been recorded, the value will remain unchanged until:
All or part of the related subsidiary is sold,
There has been a permanent decline in value, in which case we record an impairment loss.

15. Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test - Step One
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of either amortization or impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
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16. Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test -Step Two
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of either amortization or impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
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17. Comparison of U.S. GAAP and International Accounting Standards
Under US GAAP: Goodwill is allocated to reporting units, usually operating segments, expected to benefit from it. A two-step process is used to test for impairment. If the carrying amount of goodwill is more than its implied value, an impairment loss is recognized.
IFRS Under IAS 36:
Goodwill is allocated to cash-generating units – at a level much lower than an operating segment.
A one-step process is used to test for impairment.
Goodwill is reduced for any excess carrying value, down to zero, and then other assets are reduced pro-rata.
Comparison of U.S. GAAP and International Accounting Standards
Under US GAAP:
Goodwill is allocated to reporting units, usually operating segments, expected to benefit from it.
A two-step process is used to test for impairment.
If the carrying amount of goodwill is more than its implied value, an impairment loss is recognized.
IFRS Under IAS 36:
Goodwill is allocated to cash-generating units – at a level much lower than an operating segment.
A one-step process is used to test for impairment.
Goodwill is reduced for any excess carrying value, down to zero, and then other assets are reduced pro-rata.

18. Other Intangibles
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.
Intangible assets with indefinite lives (extends beyond the foreseeable future) 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” the asset is impaired.
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 that should 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.
Any recognized intangible assets considered to possess indefinite lives are not amortized but
instead are assessed for impairment on an annual basis. Similar to goodwill impairment
assessment, an entity has the option to first perform qualitative assessments for its indefinite-lived intangibles, to see if further quantitative tests are necessary. According to the FASB ASC ( ), if an entity elects to perform a qualitative assessment, it examines events and
circumstances to determine whether it is more likely than not (that is, a likelihood of more than
50 percent) that an indefinite-lived intangible asset is impaired. Qualitative factors include costs
of using the intangible, legal and regulatory factors, industry and market considerations, and
other. If the qualitative assessment indicates impairment is unlikely, no addition tests are needed. If the qualitative assessment indicates that impairment is likely, the entity then must perform a quantitative test to determine if a loss has occurred. To test an indefinite-lived intangible asset for impairment, its carrying amount is compared to its fair value. If the fair value is less than the carrying amount, then the intangible asset is considered impaired and an impairment loss is recognized. The asset’s carrying amount is reduced accordingly for the excess of its carrying amount over its fair value.

19. Contingent Consideration in Business Combinations
Learning Objective 3-7: Understand the accounting and reporting for contingent consideration subsequent to a business acquisition.
If part of the consideration to be transferred in an acquisition is contingent on a future event:
The acquiring firm estimates the fair value of a cash contingency and records a liability equal to the present value of the future payment.
The liability will continue to be measured at fair value with adjustments recognized in income.
Contingent stock payments are reported as a component of stockholders’ equity, and are not remeasured at fair value.
Under the acquisition method, contingent consideration obligations are recognized as
part of the initial value assigned in a business combination, consistent with the fair-value
concept. Therefore, the acquiring firm must estimate the fair value of the contingent portion
of the total business fair value. The contingency’s fair value is recognized as part of
the acquisition regardless of whether it is based on future performance of the target firm
or the future stock prices of the acquirer.
Subsequent to acquisition, obligations for contingent consideration that meet the definition of a liability will continue to be measured at fair value with adjustments recognized in income. Those obligations classified as equity are not subsequently remeasured at fair value, consistent with other equity issues (e.g., common stock).

20. Push Down Accounting
Learning Objective 3-8: Understand, in general, the requirements of push-down accounting and its appropriate use. Method permits acquired subsidiary to record fair value allocations and subsequent amortization in its accounting records. SEC requires push-down accounting for separate subsidiary statements if no substantial outside ownership exists. Generally limited for external reporting, also used internally. Method simplifies the consolidation process and provides better information for internal evaluation.
Push Down Accounting
Push-down accounting permits an acquired subsidiary to record fair value allocations and subsequent amortization in its accounting records.
SEC requires push-down accounting for separate subsidiary statements when no substantial outside ownership exists.
Generally limited for external reporting, but increasingly popular internally.
Simplifies the consolidation process.
Provides better information for internal evaluation.