Kế toán, kiểm toán - Chapter two: Consolidation of financial information

Chapter TwoConsolidation of Financial InformationCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Learning Objective 2-1Discuss the motives forbusiness combinations.2-2Business CombinationsFASB Accounting Standards Codification (ASC) Business Combinations (Topic 805) and Consolidation (Topic 810) provide guidance using the “acquisition method”.The acquisition method embraces the fair value measurement for measuring and assessing business activity.2-3Reasons Firms CombineVertical integrationCost savings Quick entry into new marketsEconomies of scaleMore attractive financing opportunitiesDiversification of business risk Business ExpansionIncreasingly competitive environment2-4Recent Notable Business Combinations2-5Learning Objective 2-2Recognize when consolidation of financial information into a single set of statements is necessary.2-6The Consolidation ProcessConsolidated financial statements provide more meaningful information than separate statements.Consolidated financial statements more fairly present the activities of the consolidated companies.Yet, consolidated companies may retain their legal identities as separate corporations.2-7 “There is a presumption that consolidated statements are more meaningful.. and that they are usually necessary for a fair presentation when one of the companies in the group has a controlling financial interest..” FASB ASC (810-10-10-1)Learning Objective 2-3Define the term business combination and differentiate across various forms of business combinations.2-8Business Combinations2-9A business combination . . . refers to a transaction or other event in which an acquirer obtains control over one or more businesses.is formed by a wide variety of transactions or events with various formats. can differ widely in legal form. unites two or more enterprises into a single economic entity that require consolidated financial statements.2-10Business CombinationsFASB Control ModelThe FASB provides guidance and defines control when accounting for business combinations with this control model: The FASB ASC Glossary, in addition to majority share ownership, further describes control as the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.The FASB continues its effort to develop comprehensive guidance for consolidation of all entities, including entities controlled by voting interests.2-11Subsidiaries’ financial dataPrepare a single set of consolidated financial statements.Parent’s financial dataConsolidation of Financial Information2-12To report the financial position, results of operations, and cash flows for the combined entity.Reciprocal accounts and intra-entity transactions are adjusted or eliminated to. . .brought togetherWhat is to be consolidated?If dissolution occurs: All appropriate account balances are physically consolidated in the financial records of the survivor.If separate incorporation maintained: only the Financial statement information (on work papers, not the actual records) is consolidated.2-13When does consolidation occur?If dissolution occurs:Permanent consolidation occurs at the combination date.If separate incorporation maintained: the consolidation process is carried out at regular intervals whenever financial statements are to be prepared.2-14How does consolidation affect the accounting records?If dissolution occurs:Dissolved company’s records are closed out.Surviving company’s accounts are adjusted to include appropriate balances of the dissolved company.If separate incorporation is maintained:Each company continues to retain its own records. Worksheets facilitate the periodic consolidation process without disturbing individual accounting systems.2-15Learning Objective 2-4Describe the valuation principles of the acquisition method.2-16The Acquisition Method The acquisition method embraces the fair value in measuring the acquirer’s interest in the acquired business.Applying the acquisition method involves recognizing and measuring:the consideration transferred for the acquired business and any non-controlling interest.separately identified assets acquired and liabilities assumed.goodwill, or a gain from a bargain purchase.2-17Fair ValueFair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Market Approach – The market approach estimates fair values using other market transactions involving similar assets or liabilities.The Income Approach – The income approach relies on multiperiod estimates of future cash flows projected to be generated by an asset.The Cost Approach – estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.2-18LO 5Acquisition Method What if the consideration transferred does NOT EQUAL the Fair Value of the Assets acquired?2-19If the consideration is LESS than the Fair Value of the Assets acquired, we got a BARGAIN!! And we will record a GAIN on the acquisition!!If the consideration is MORE than the Fair Value of the Assets acquired, the difference is attributed to GOODWILLLearning Objective 2-5Determine the total fair value of the consideration transferred for an acquisition and allocate that fair value to specific subsidiary assets acquired(including goodwill) and liabilities assumed or to a gain on bargain purchase.2-20Procedures for Consolidating Financial Information2-21Legal and accounting distinctions divide business combinations into separate categories. Various procedures are utilized in this process according to the following sequence:Acquisition method when dissolution takes place.2. Acquisition method when separate incorporation is maintained.Acquisition Method Example Purchase Price = Fair Value2-22Assume BigNet Company owns Internet communications equipment and other business software applications. It seeks to expand its operations and plans to acquire Smallport on December 31. Smallport Company owns similar assets. Smallport’s net assets have a book value of $600,000 and a fair value of $2,550,000. Fair values for assets and liabilities are appraised; capital stock, retained earnings, dividend, revenue, and expense accounts represent historical measurements. The equity and income accounts are not transferred in the combination.Acquisition Method Example Purchase Price = Fair Value2-23Basic Consolidation InformationLearning Objective 2-6Prepare the journal entry to consolidate the accounts of a subsidiary if dissolutiontakes place.2-24Consideration Transferred = Net Identified Asset Fair Values2-25Dissolution of SubsidiaryConsideration Transferred Exceeds Net Identified Asset Fair Values2-26Dissolution of SubsidiaryConsideration Transferred Is Less Than Net Identified Asset Fair Values2-27Dissolution of SubsidiaryRelated Costs of Business Combinations2-28Acquisition Method - Accounting for Costs Frequently Associated with Business CombinationsRelated Costs of Business CombinationsDirect Costs of the acquisition (attorneys, appraisers, accountants, investment bankers, etc.) are NOT part of the fair value received, and are immediately expensed.Indirect or Internal Costs of acquisition (secretarial and management time) are period costs expensed as incurred.Costs to register and issue securities related to the acquisition reduce their fair value.2-29Acquisition Method - Subsidiary Is Not Dissolved2-30Separate Incorporation MaintainedDissolution does not occur.Consolidation process is similar to previous example.Fair value is the basis for initial consolidation of subsidiary’s net assets. Subsidiary is a legally incorporated separate entity.Each company maintains independent record-keepingConsolidation of financial information is simulated.Acquiring company does not physically record the transaction. Learning Objective 2-7Prepare a worksheet to consolidate the accounts of two companies that form a business combination if dissolution doesnot take place.2-31The Consolidation Worksheet2-32Consolidation worksheet entries (adjustments and eliminations) are entered on the worksheet only. Steps in the process:Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition date fair value similar to the equity method procedures. 2. Financial information for Parent and Sub is recorded in the first two columns of the worksheet (with Sub’s prior revenue and expense already closed).The Consolidation Worksheetcontinued. . .2-333. Remove the Sub’s equity account balances.Remove the Investment in Sub balance.Allocate Sub’s Fair Values, including any excess of cost over Book Value to identifiable assets or goodwill.Combine all account balances and extend into the Consolidated totals column.Subtract consolidated expenses from revenues to arrive at net income.Acquisition Method – Consolidation Workpaper Example2-34Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition date fair value similar to the equity method procedures.Acquisition Method – Consolidation Workpaper Example2-35The first two columns of the worksheet show the separate companies’ acquisition-date book value financial figures. BigNet’s accounts have been adjusted for the investment and combination costs, and Smallport’s revenue, expense, and dividend accounts have been closed to retained earnings. Acquisition Method – Consolidation Workpaper Example continued . . .2-36Acquisition Method – Consolidation Workpaper Journal Entries2-37Learning Objective 2-8Describe the two criteria for recognizing intangible assets apart from goodwill in a business combination.2-38Acquisition Date Fair-Value Allocations – Additional IssuesIn determining whether to recognize an intangibleasset in a business combination, two specific criteria are essential.Does the intangible asset arise from contractual or other legal rights?Is the intangible asset capable of being sold or otherwise separated from the acquired enterprise?2-39Acquisition Date Fair-Value Allocations – Additional IssuesIntangibles are assets that:Lack physical substance (excluding financial instruments)Arise from contractual or other legal rights (most intangibles in business combinations meet the contractual-legal criterion).Is capable of being sold or otherwise separated from the acquired enterprise2-40Preexisting goodwill recorded in the acquired company’s accounts is ignored in the allocation of the purchase price. IPR&D that has reached technological feasibility is capitalized as an intangible asset at fair value with an indefinite life that is reviewed for impairment. Ongoing R&D is expensed as incurred.Intangible Assets That Meet the Criteria for Recognition Separately from Goodwill2-41Convergence between U. S. and International StandardsIASB International Financial Reporting Standard 3 (IFRS 3) Revised and FASB ASC topics 805, Business Combinations, and 810, Consolidation, effectively converged accounting for business combinations.In 2011, the IASB issued IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosure of Interests in Other Entities - effective beginning in 2013. New definition of control focuses on the power to direct the activities of an entity, exposure to variable returns, and a linkage between power and returns.2-42Learning Objective 2-9Identify the general characteristics of the legacy purchase and pooling of interest methods of accounting for past business combinations. Understand the effects that persist today in financial statements from the use of these legacy methods.2-43Legacy Methods – Purchase and Pooling of Interests Methods2002 to 2008: Purchase MethodPrior to 2002: Purchase Method Or The Pooling Of Interests Method 2-44Since the ACQUISITION METHOD is applied to business combinations occurring in 2009 and after, the two prior methods are still in use.Purchase Method – An Application of the Cost MethodHow the cost-based purchase method differs from the fair value-based acquisition method.Acquisition date allocations (including bargain purchases)Direct combination costsContingent considerationIn-Process R&D expensed under the Purchase Method, unless it had reached technological feasibility2-45Purchase Method – An Application of the Cost MethodValuation basis was “cost”The value of the consideration transferred, PLUS the direct costs of the acquisition,IGNORE any indirect costs of the acquisition,IGNORE any contingent payments.The total cost of the acquisition was allocated proportionately to the net assets based on their fair values, with any excess going to goodwill.2-46Purchase Method –  Purchase Price < Fair ValueUnder the purchase method, a bargain purchase occurred when the sum of the individual fair values of the acquired net assets exceeded the purchase cost. Current assets and liabilities were recorded at fair value, and some non-current assets were reduced proportionately. Long-term assets were reduced because their fair-value estimates were considered less reliable than current items and liabilities. 2-47If the difference in purchase price and fair value was substantial enough to eliminate all the non-current asset account balances of the acquired company, the remainder was reported as an extraordinary gain.Pooling of Interests Historical ReviewPrior to 2002, under certain criteria, combinations could be accounted for as “Pooling of Interests” when one company acquired all of another company’s stock – using its own stock as consideration (no cash!)These Pooling combinations are left intact going forward.2-482-49Book values of the assets and liabilities of both companies became the book values reported by the combined entity. The revenue and expense accounts were combined both before and after the combination.Reported income was typically higher than under the purchase accounting method. Not only did firms retrospectively combine incomes, there was less depreciation and amortization expense.Pooling of Interests Historical Review