Chapter 2: Consolidation of Financial Information

*Contingent Consideration*

*An *additional element of consideration transferred:* acquisition agreements often contain *provisions to pay former owners* (tyipcally cash or additional shares of the acquirer's stock) *upon achievement of specified future performance measures* *Can be useful in negotiation when two parties disagree w/each other's estimates of future cash flows for the target firm or when valuation uncertainty is high *Walt Disney Co.: "subsequent changes in the estimated fair value, if any, will be recognized in earnings"

Morgan Co. acquires all of the outstanding shares of Jennings, Inc., for cash. Morgan transfers consideration more than the fair value of the company's net assets. How should the *payment in excess of fair value* be accounted for in the consolidation process?

*Any excess of the fair value of the consideration transferred over the net amount assigned to the individual assets acquired and liabilities assumed is recognized by the acquirer as goodwill

Catron Corporation is having liquidity problems, and as a result, it sells all of its outstanding stock to Lambert, Inc., for cash. Because of Catron's problems, Lambert is able to acquire this stock at less than the fair value of the company's net assets. How is the *reduction in price* accounted for within the consolidation process?

*Any excess of the net amount assigned to the individual assets acquired and liabilities assumed over the fair value of the consideration transferred is recognized by the acquirer as a *"gain on bargain purchase"* Reported in current income of the combined entity

When does an accounting consolidation occur for a combination when *all companies retain incorporation* [neither company dissolves?

*Because the companies preserve their legal identities, each continues to maintain its own independent accounting records *Thus, *NO permanent consolidation of the account balances is ever made* *^Rather, *the consolidation process must be carried out ANEW EACH TIME the reporting entity prepares F/S(s) for external reporting purposes*

If the goal of business activity is to maximize the firm's value, in what ways do business combinations help achieve that goal?

*Business combinations- a strategy for growth and competitiveness: 1. Size and scale are becoming critical as firms compete in today's markets 2. Valuable *synergies* 3. If large firms can be more efficient in delivering goods and services, they gain a competitive advantage and become more profitable for the owners 4. Increases in scale can produce larger profits from enhanced sales volume despite smaller (more competitive) profit margins 5. Cost effective- not only share expenses [elimination of duplicate efforts] but also improve each other's business (i.e. delivery reach/time, coordination of raw material purchases, etc.) can lead to substantial savings *continuous expansion of their organizations into diversified areas (branch out with you subsidiaries)

[still Step 5] A One-Time Permanent Consolidation vs. The FIRST of many Periodic Consolidations

*By increasing the subsidiary's book value to fair value, the reported balances are the same as in other examples where dissolution occurred. *The use of a worksheet does NOT alter the consolidated figures but only the method of deriving those numbers*

*IF* separate incorporation is *maintained*

*Companies that form a business combination will often retain their separate legal identities as well as their individual accounting systems. o ^In such cases, internal financial data continues to be accumulated by each organization. o *Separate financial reports may be required for outside shareholders (a noncontrolling interest), the government, debt holders, etc. o This information may also be utilized in corporate evaluations and other decision making.

The Acquisition Method When *Separate Incorporation is Maintained*

*Fair value remains the basis for initially consolidating the subsidiary's A and L *DIFFERENCES in accounting for combinations in which each co. remains a legally incorporated separate entity: -*the consolidation of the financial information is *only simulated; the acquiring co. does not physically record the acquired A and L *A worksheet and consolidating entries are employed using data gathered from these separate companies *When the *subsidiary remains separate*, the *parent establishes an investment account* that *initially reflects* the acquired firm's acquisition-date fair value

Preexisting Goodwill on Subsidiary's Books

*How should a parent treat this preexisting goodwill? *The *new owner simply excludes* the carrying amount of any *preexisting goodwill from the subsidiary's acquisition-date book value* *^realloacting any preexisting subsidiary goodwill via a CR in Consolidation Worksheet Entry "A" [^This worksheet CR to the subsidiary's goodwill balance is then offset by worksheet entries to identifiable A and L, followed by a DR to the new goodwill from the combination] *The logic of ^this being that the total business fair value is first allocated to the identified A and L; ONLY IF an *excess amount remains* after recognizing the fair values fo the net identified A *is any goodwill recognized*

Consolidation Values and related Acquisition Accounting: (1) Consideration transferred *equals* the fair values of net identified assets acquired

*Identified A acquired and L assumed are recorded *at their fair values*

Consolidation Values and related Acquisition Accounting: (3) Considerations transferred is *less than* the fair values of net identified A acquired. The total of the indiv. fair values of the net identified As acquired effetively becomes the acquired busienss fair value

*Identified A acquired and L assumed are recorded *at their fair values* *The *excess amount of net identified A fair value* over the consideration transferred is recorded as a *gain on bargain purchase*

Consolidation Values and related Acquisition Accounting: (2) Considerations transferred is *greater than* the fair values of net identified A acquired

*Identified A acquired and L assumed are recorded *at their fair values* *The *excess consideration transferred* over the net identified asset fair value is recorded as *goodwill*

When does the net amount of fair values for the A acquired and L assumed serve as the acquired firm's valuation basis?

*In a BP, the net asset fair value effectively replaces the consideration transferred as the acquired firm's valuation basis

Additional Issues: Intangibles Two essential Criteria in determining whether to recognize an intangible asset ina busines com

*Intangible assets often comprise the largest proportion of an acquired firm

Business Combinations: Managerial Income

*Managers of successful firms also receive substantial benefits in salaries, especially if their compensation contracts are partly based on stock market performance of the firm's shares

*Conglomerates*

*Many firms seek the continuous expansion of their organizations, often into diversified areas. ^They do so by managing a vast network of different businesses (in varying areas), known as conglomerates. *Entry into new industries is immediately available to the parent w/out having to construct facilities, develop products, train mgmt, or create market recognition

[Step 6] Subtract consolidated expenses from revenues to arrive at a net income

*NOTE: because this is an *acquisition-date worksheet*, we consolidate no amounts for Smallport's revenues and expenses ^*Having just been acquired, Smallport has nto yet earned any income for BigNet owners. Subsequent to acquisition, the Smallport's R and E accounts will be consolidated w/BigNet's

*Convergence b/w U.S. and International Accounting Standards* (for business combinations and consolidation): Why is this a *remarkable accomplishment*?

*The joint project on business combinations represents *one of the first successful implementations of the agreement b/w the two standard-setting groups to coordinate efforts on future work with the goal of developing high-quality comparable standards for both domestic and cross-border financial accounting

Which valuation technique employed for assets acquired and liabilities assumed is often useful for acquired in-process research and development?

*The multi-period Income Approach

How should a parent consolidate its subsidiary's *revenues and expenses*?

*The revenues and expenses (both current and past) of the PARENT are INCLUDED within reported figures. *HOWEVER, the revenues and expenses of the SUBSIDIARY are consolidated *from the date of the acquisition forward* within the worksheet consolidation process. ^The operations of the subsidiary are only applicable to the business combination if earned *subsequent to its creation*. ^^Revenues, Expenses, Net Income, Retained Earnings, Dividends Declared of the subsidiary are *NOT reported on the parent's consolidated FS(s)* *STEP 3 of the Consolidation process is *Consolidation Entry "S"* which *eliminates the subsidiary's stockholder's equity accounts* DR *Common Stock* (Subsidiary Co.) DR *Additional Paid-In Capital* (Subsidiary Co.) DR *Retained Earnings* (Subsidiary Co.) CR *Investment in Subsidiary Co.*

Acquisition Method- Equity and Income Accounts

*Under the acquisition method, *ONLY* the subsidiary's revenues, expenses, dividends, and equity *transactions that occur SUBSEQUENT to the takeover affect the business combination*

Goodwill: An Indefinite Life

*Unlike other A, we consider goodwill as unidentifiable because we presume it emerges from several other assets acting together to produce an expectation of enhanced profitability

3 Valuation Techniques Employed for Assets Acquired and Liabilities Assumed: [ADDITIONAL INFORMATION] *Cost Approach vs. Used Assets

*Used assets can present a particular valuation challenge if active markets only exist for newer versions of the asset (i.e. certain technology/products become outdated- overtime or very quickly, like Blockbuster vs. Netflix) *^Thus, the cost to replace a particular asset reflects both its *estimated replacement cost* and the *effects of obsolescence*

When does the consolidation of financial information into a single set of statements become necessary?

*When the business combination of two or more companies creates a single economic entity

When are consolidated financial reports to be prepared?

*Whenever one firm has a controlling financial interest in another *Although ownership of a majority voting interest is the usual condition for a controlling financial interest, *the power to control may also exist w/a lesser % of ownership through governance contracts, leases, or agreements w/other stockholders* *IF,* "controlling financial interest" exists *THEN,* prepare consolidated financial reports

What is a *business combination*?

*a transaction (i.e. acquisition of controlling voting stock) or other events (i.e. contractual agreements) in which an acquirer obtains control over one or more businesses *can be part of an overall managerial strategy to maximize shareholder value ^Managers may be hired to direct resources so that the firm's value grows over time [in this way, owners receive a return on their investment]

What is the fundamental principle of the acquisition method?

*an acquirer must identify the assets acquired and the liabilities assumed in the business combination [to be measured at their acquisition-date fair values, *with only a few exceptions*]

Define *Goodwill* [in a business combination]

*an asset representing the *future economic benefit* arising in a business combination that are *NOT* individually identified and separately recognized *Goodwill often embodies the expected synergies* as well as non-recognized intangibles of the acquired firm such as employee expertise

Worksheets:

*are a part of neither company's accounting records nor the resulting F/S(s), yet serves as a *catalyst* to bring together the two independent sets of financial information *are an efficient structure for organizing and adjusting the information used to prepare externally reported consolidated statements *On the worksheet, the investment account is effectively replaced w/the acquisition-date fair values of Smallport's A and L along w/(potentially) goodwill created by the combination

How does the Acquisition Method treat contingent obligations?

*as a negotiated component of the fair value of the consideration transferred ^*According to this view, contingencies have value to those who receive the consideration and represent measurable obligations of the acquirer Listed in Consdieration Transferred calculation as "Fair Value of contingent performance liabilitiy"

Worksheet Entries

*either adjust or eliminate various account balances of the parent and subsidiary *Because no actual union occurs, neither company ever records consolidation worksheet entries in its journals

[Step 3] Consolidation Entry "S"

*eliminates Smallport's stockholder's equity accounts *"S" is a reference to beginning subsidiary stockholder's equity *a worksheet entry and accordingly does not affect the financial records of either co. *This entry also eliminates a large component of the investment account that equates to the book value of the subsidiary's NA *This portion of the parent's Investment in Smallport Co. account balance is eliminated and replaced by the specific subsidiary A and L that are already listed in teh second column of the worksheet

[Step 5] All accounts are extended into the Consolidated Totals column

*for some assets such as "Current Assets," this process simply adds Smallport and BigNet book values *BUT, when applicable, this extension also include any allocations to establish the acquisition-date fair value of Smallport's A and L [worksheet JEs]

*Obsolescence*

*meant to capture *economic declines in value* including both *technological obsolescence* and *physical deterioration* *relates to the treatment of used assets under the Cost Approach of valuing assets acquired and liabilities assumed

[Step 4] Consolidation Entry "A"

*removes the excess payment in the Investment in Smallport Co. and assigns it to the specific accounts indicated by the fair-value allocation schedule *"A" indicates the allocation made in connection with Smallport's acquisition-date fair value *Consolidation Entry "A" *completes the* [simulated] *elimination of the Investment* in Smallport Co. account balance. [*the investment remains on BigNet's book*, but it does not appear on the consolidated B/S. Instead the *investment account is replaced on the worksheet w/Smallport's actual As and Ls* as shown in Step 5

*WHY* is a *worksheet needed*?

*the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity. ^*HOWEVER*, the financial information must be brought together periodically *W/OUT disturbing the accounting systems of the indiv. companies*

What is the *starting point* in *valuing and recording a business combination*?

*the fair value of the *consideration transferred* to acquire a business from its former owners

Define Fair Value

*the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction b/w market participants at the measurement date

Bargain Purchases:

*typically considered anomalous [businesses generally do not sell assets or businesses at prices below their fair values] *Usually in forced or distressed sales *The acquisition method records the identified A acquired and L assumed at their individual Fair Values *^In a BP situation, ^this net asset fair value effectively replaces the consideration transferred as the acquired firm's valuation basis for financial reporting *The acquirer recognizes this gain on its I/S in the period the acquisition takes place

When does an accounting consolidation occur for a *statutory merger* or a *statutory consolidation*?

*when the acquired co. (or companies) is (are) legally dissolved, only one [PERMANENT] accounting consolidation ever occurs *Date of Acquisition: the surviving co. simply *records the various account balances from each of the dissolving companies* *after the balances have been transferred to the survivor, the financial records of the acquired companies are closed out as part of the dissolution

(1) Acquisition Method when *Dissolution* takes place

*when the acquired firm's legal status is dissolved in a business combination, the *continuing firm takes direct ownership of the former firm's assets and assumes its liabilities*: Thus, *the continuing firm records the following JEs:* 1. The fair value of the *consideration transferred* by the acquiring firm to the former owners of the acquiree, and 2. The identified *assets acquired and liabilities assumed* at their indiv. fair values

*Items* of Consideration Transferred for the Acquired Business

- *cash* - *securities* (either stocks or debt/liabilities/NP) - *contingent performance liability* - *other* property or obligations

Acquired *In-Process research and Development* General Info

- IPR&D asset is *initially considered an indefinite-lived intangible asset* [and is *NOT* subject to *amortization*] UNTIL the *project is completed or abandoned* [i.e. until its useful life is determined to be no longer indefinite] - IPR&D is then *tested for impairment annually or more frequently* if events or changes in circumstances indicate that the asset might be impaired - Similar to costs that result in goodwill and other internally generated intangibles (e.g., customer lists, trade names, etc.), *IPR&D costs are expensed as incurred in ongoing business activities* ^*For a business combination:* *R&D expenditures incurred subsequent to the date of acquisition will continue to be expensed *SEE JE* *Acquired IPR&D assets initially

Acquired *In-Process research and Development* Requires *significant estimates and assumptions* including but not limited to:

- Projecting regulatory approvals - Estimating future cash flows from product sales resulting from completed products and in-process projects - Developing appropriate discount rates and probability rates by project

Applying the acquisition method *involves recognizing and measuring:*

- The *consideration transferred* for the acquired business and any non-controlling interest - The separately identified *assets acquired and liabilities assumed* - *Goodwill*, or a *gain from a bargain purchase*

Business Combination Profitability Characteristics

- Vertical integration of one firm's output and another firm's distribution or further processing - Cost savings through elimination of duplicate facilities and staff [share expenses] - Quick entry for new and existing products into domestic and foreign markets - Economics of scale allowing greater efficiency and negotiating power - The ability to access financing at more attractive rates. As firm size increases, negotiating power w/financial institutions can increase also - Diversification of business risk

*WHEN does the consolidation take place?*

-*IF dissolution takes place*, a *permanent consolidation occurs* at the date of the combination -*IF separate incorporation is maintained*, the consolidation process is carried out *at regular intervals* [PERIODICALLY] whenever F/S(s) are to be prepared

*WHAT is to be consolidated?*

-*IF dissolution takes place*, appropriate account balances are physically consolidated in the surviving co.'s financial records [*booked on the actual records*] -*IF separate incorporation is maintained*, only the financial statement information [*NOT the actual records*] is consolidated

*HOW are the accounting records affected?*

-*IF dissolution takes place*, the surviving co.'s *accounts are adjusted to include appropriate balances of the dissolved co.* The dissolved co.'s *records are closed out*. -*IF separate incorporation is maintained*, each co. *continues to retain its own records*. *Using worksheets* facilitates the periodic consolidation process *w/out disturbing the indiv. accounting systems*

*Bargain Purchase of a Separately Incorporate Subsidiary*- Prob. 28 [OG]

-If the consideration transferred is less than the fair value of a newly acquired subsidiary's identifiable NA, then the *parent records a bargain purchase gain on its books as part of the investment acquisition journal entry* ^A.k.a. the first *prerequisite JE* prepared

Within the consolidation process, what is the *PURPOSE* of a *worksheet*?

-The purpose of a worksheet is *to organize and structure the process of simulating a consolidation b/w two companies that maintain their separate identities to be carried out on a regular, periodic basis without affecting the financial records* of the various component companies*. *Worksheets are a part of neither company's accounting records nor the resulting FS(s) *Entries either adjust or eliminate various account balances of the parent and subsidiary* *The worksheet entries serve as a *catalyst* to bring together the two independent sets of financial information

T/F: FASB ASC Presumption that consoidated FS(s) are...

...more meaningful than separate F/S(s) and that they are usually necessary for fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities

3 Additional Categories of Costs typically accompany business combinations, regardless of whether dissolution takes palce:

1) *Direct Combination Costs* (e.g., accounting, legal, investment banking, appraisal fees, etc.) 2) *Indirect Combination Costs* (e.g., internal costs such as allocated secretarial or managerial time) 3) *Stock Issuance Costs* (e.g., Amounts incurred to register and issue securities *SEE JE

Acquisition-Date Fair-Value Allocations: Additional Issues In determining whether to recognize an intangible asset in a business combination two specific criteria are essential

1. *Contractual/Legal Criterion:* Does the intangible asset arise from contractual or other legal rights? 2. *Separability Criterion:* Is the tangible asset capable of being sold or otherwise separated from the acquired enterprise? ^*The acquirer is not required to have the intention to sell, license, or otherwise exchange the intangible in order to meet ^this criterion

3 Valuation Techniques Employed for Assets Acquired and Liabilities Assumed:

1. *Market Approach [PRESENT]*- Estimates fair values *using other market transactions involving similar A or L* ^^*OFTEN USED FOR: *maretable securities* and *some tangible assets who have established markets* that can provide comparable market values for estimating fair values 2. *Income Approach [FUTURE]*- Relies on multi-period estimates of future cash flows projected to be generated by an asset ^These projected CFs are then *discounted at a required rate of return* that reflects the time value of money and the risk associated w/realizing the future estimated CFs ^^*OFTEN USED FOR: obtaining fair value estimates of *intangible assets* and *acquired in-process research and development* 3. *Cost Approach [PAST]*- Estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility ^SEE Card: Cost Approach vs. Used assets ^^*OFTEN USED FOR: many *tangible assets* acquired such as property, plant, and equipment

Describe the *different types of legal arrangements* that can take place to create a business combination.

1. *Statutory merger*: only one of the original companies remains in business as a legally incorporated enterprise. [Co. 2 Dissolves] - *Assets and Liabilities* can be acquired w/the seller then dissolving itself as a corporation - *All of the capital stock* of a company can be acquired with the assets and liabilities then transferred to the buyer followed by the seller's dissolution Combination: *Facebook and WhatsApp* 2. *Statutory consolidation* - assets or capital stock of two or more companies are transferred to a newly formed corporation - *BOTH original companies DISSOLVE, ONLY the NEW now exists *WESTROCK Ex.* 3. Acquisition by one co. of a *controlling interest in the voting stock* of a second. - Dissolution does NOT take place; both parties retain their separate legal incorporation - Each co. maintains an independent accounting system - *to reflect the combination, the acquiring company enters the takeover transaction into its own records by *establishing a single investment asset account* - *Marshal and Tucker Prob. #28 4. *Control* of a Variable Interest Entity (VIE) - *control is exercised through contractual arrangements with a sponsoring firm that, although it technically may not own the VIE, becomes its "primary beneficiary" with rights to its residual profits - Ex: contracts in the form of leases, participation rights guarantees, or other interests -PAST CONCERN: off-balance sheet financing/reporting was being accomplished by the formerly applicable equity method

2 Forms of Consolidation

1. Acquisition method when *dissolution* takes place 2. Acquisition method when *separate incorporation is maintained*

Potential Reasons for Goodwill For reference: BigNet (acquirer) Smallport (acquiree)

1. BigNet may expect its A to act in concert w/those of Smallport, thus creating *SYNERGIES* what will produce profits beyond the total expected for the individual companies 2. Smallport's history of *profitability* 3. S's *reputation* 4. S's *quality of personnel* 5. The *current economic condition of the industry* in which Smallport operates

*3* recent business combination examples of *distinct motivations to combine*:

1. Facebook and WhatsApp 2. AT&T and DirecTV 3. Rock-Tenn and Meadwest Vaco [Read Straight From TB]

*Benefits* of keeping both entities alive and *w/sperate legal identities* (specifically the acquired co.)

Better utilization of such factors as: - licenses - trade names - employee loyalty - company reputation

Acquisition Method- One of the *first steps regardless of the acquired firms dissolution status*:

Compare *consideration transferred* to the *fair value of the net identifiable* assets acquired and liabilities assumed to determine if *GOODWILL or a GAIN on BARGAIN PURCHASE* should be recorded

The Acquisition Method- STEP 1: Calculate Consideration Transferred for the Acquired Business

Consideration Transferred = *Sum of*: 1. the *acquisition date fair values of the assets* transferred by the acquirer [Cash or Common Stock used to purchase controlling interest] + 2. the *liabilities incurred* by the *acquirer to former owners of the acquiree*, and + 3. the equity interest issued by the acquirer* [Amortization of undervalued assets]

T/F: The acquisition method only applies to business combinations where the acquired firm maintains its separate incorporation.

FALSE, *Regardless of whether the acquired firm maintains its separate incorporation *or dissolution takes place*, current standards require the acquisition method to account for business combinations

T/F: Both the parent and subsidiary would record the following event: Psych, Inc. achieves legal control over Monk Co. by acquiring a majority of voting stock.

FALSE, *to reflect the combination, the acquiring company enters the takeover transaction into its own records by *establishing a single investment asset account* *However*, the newly acquired subsidiary *OMITS* any recording of this event; its stock is simply transferred to the parent from the subsidiary's shareholders ^THUS, *the subsidiary's financial records are NOT directly affected by a takeover*

T/F : Consolidation Worksheet Entry "S" takes on fair value adjustments and is the final step to eliminating the investment account [for the SIMULATED consolidation]

FALSE; "S": S/E Equity "A": F.V. Adjustments

Business Combinations using the Acquisition Method embrace a *fair-value* measurement attribute. Adoption of this attribute reflects what?

FASB's change of emphasis from Cost Principle [purchase price] to Fair Value Measurement

To recognize an asset (*Goodwill*) or to recognize a gain (*Gain on Bargain Purchase*)

Goodwill: Excess of *consideration transferred* over the *acquisition-date net amount of the identified assets acquired and the liabilities assumed* *[CT *>* A-D NA] Gain on Bargain Purchase: Excess of *collective fair value of the net identified assets acquired and liabilities assumed* over the *consideration transferred* *[CT *<* A-D NA] ^*The *fair value of the net assets acquired replaces the consideration transferred as the valuation basis* for the acquired firm ^^*Can be a result of various distress sales ^^^Before recognizing a gain on bargain purchase, the acquirer *must reassess whether it has correctly identified and measured all of the acquired A and L*

What is often the *best source* of the *fair value of consideration transferred* in a business combination? (if available)

Market Values (i.e. stock prices)

When does the consideration transferred serve as the acquired firm's valuation basis?

Only if the consideration EQUALS or EXCEEDS the net amount of fair values for the A acquired and L assumed

T/F: Business Combinations- Even though the various companies may retain their legal identities as separate corporations, the resulting information is more meaningful to outside parties when consolidated into a single set of F/S(s)

TRUE

T/F: In all business combinations, only goodwill reflected in the current acquisition is brought forward in the consolidated entity's financial reports.

TRUE

T/F: The *specific format* is a *critical factor* in the subsequent consolidation of financial information

TRUE

T/F: Current accounting standards require that acquired In-Process Research and Development (IPR&D) be measured at acquisition-date fair value and recognized in consolidated F/S(s) as an A

TRUE; *Past Standards:* required immediate expense treatment for acquired IPR&D *Arguments about the future economic benefits of IPR&D ultimately persuaded FASB to require asset recognition *Uses the *income approach* to valuating assets and liabilities

T/F: In a bargain purchase, the fair values of the A received and all L assumed in a business combination are considered more relevant for asset valuation than the consideration transferred

TRUE; *In a BP situation, ^this net asset fair value effectively replaces the consideration transferred as the acquired firm's valuation basis for financial reporting

T/F: Our concern lies in the fair values of ONLY the A and L of the acquired; the capital stock, retained earnings, dividend, revenue, and expense accounts represent historical measurements rather than any type of future values

TRUE; Although these *equity and income accounts* can give some indication of the organization's overall worth, they are NOT property and thus *are NOT transferred in the combination*

T/F: The FASB ASC Topics "Business Combinations" (805) and "Consolidation"(810) represent outcomes of a joint project b/w the FASB and the IASB.

TRUE; OBJECTIVE: - domestic and cross-border financial reporting - a common set of principles and related guidance that produces decision-useful information and minimizes exceptions to those principles - *to improve the completeness, relevance, and comparability of financial information about business combinations*

T/F: Although it remains on BigNet's books, the Investment in Smallport account is eliminated entirely in consolidation

TRUE; Through Consolidation Entries "S" and "A"

T/F: One of the first steps in the consolidation process is to close Smallport's R, E, and Dividend accounts into its RE account.

TRUE; [Step 2] *These activities occurred before Smallport was acquired; thus, the new owner should NOT include any pre-combination subsidiary revenues or expenses in the consolidated statements

T/F: The acquisition method does not consider the related costs of business combinations as part of the fair value received by the acquirer

TRUE; pg. 55

ASC's definition of *control*

The *direct or indirect ability to determine the direction of mgmt and policies through ownership, contract, or otherwise* [The *power to control* may also exist with a lesser % of ownership, for example, by contract, lease, agreement w/other stockholders, or by court decree]

What schedule effectively serves as a convenient supporting schedule for the consolidation worksheet and is routinely prepared for every consolidation?

The Acquisition-Date Fair-Value Allocation Schedule [Step 1]

Legacy Effects

[Appendices- NOT on Exam] We're still recent enough that the prior use of the purchase method (cost principle) over the fair value measurement

"Subsidiary Dissolved" means

a *permanent one time* consolidation

Determining the fair value of contingent future payments typically involves:

probability and risk assessments based on circumstances existing on the acquisition date

*REGARDLESS OF the *elements that constitute the consideration transferred*, WHAT *comprises the valuation basis for the acquired firm* in consolidated financial reports?

the combined fair values of the parent's considerations transferred and the non-controlling interest

What is a consequence of implementing a fair-value concept to acquisition accounting?

the recognition of an unrealized gain on the bargain purchase

In producing F/S(s) for external distribution,...

the reporting entity *transcends the boundaries of incorporation to encompass (i.e. consolidate) all companies for which control is present*

What is the *accounting valuation basis* for consolidating *assets and liabilities* in a business combination?

• Acquisition Method: Acquisition-date Fair Value for recording all combinations ^Replaces the purchase method/cost method/original book values

Jones Co. obtains all the common stock of Hudson, Inc., by issuing 50,000 shares of its own stock. Under these circumstances, *why might the determination of a fair value for the consideration transferred be difficult*?

• The shares may be *newly issued* (if Jones has just been created) so that *no accurate value has yet been established* • Jones may be a *closely held corporation* [few people- usually family owned) so that *no fair value is available* for its shares • The *number of newly issued shares* (especially if the amount is *large in comparison to the quantity of previously outstanding shares*) may *cause the price of the stock to fluctuate* widely so that no accurate fair value can be determined during a reasonable period of time • Jones' stock may have *historically experienced drastic swings in price*. Thus, a quoted figure at any specific point in time may not be an adequate representative value for long-term accounting purposes

Consolidation Objective and Overview

• When FS(s) represent more than one corporation • *OBJECTIVE* of Consolidation: to report the financial position, results of operations, and cash flows for the combined entity *Reciprocal accounts [Investment Account] and intra-entity transactions [arms-reach transactions/sales, usually inventory] must be adjusted or eliminated to ensure that all reported balances truly represent the single entity • *IF* the acquired company is *legally dissolved*, *a permanent consolidation* is produced on the *date of acquisition* by entering all account balances *into* the financial records of the *surviving company*. • *IF* separate incorporation is *maintained*, consolidation is *periodically simulated* whenever FS(s) are to be prepared. This process is carried out through the *use of worksheets and consolidation entries*. Consolidation worksheet entries are used to *adjust and eliminate subsidiary company accounts*. *Entry "S" eliminates* the *equity accounts of the subsidiary*. *Entry "A"* *allocates excess payment* amounts to identifiable assets and liabilities based on the fair value of the subsidiary accounts. [SEE pg. 57 Consolidation Entries] *(Consolidation journal entries are NEVEER recorded in the books of either company, they are worksheet entries only.)