Excess fair value undervalued equipment Excess fair value overvalued patented technology The figures earned by the subsidiary prior to the takeover are not included Accounts payable Long-term debt Common stock Additional paid-in cap.
Retained earnings Total liab. Consolidated , 2,, 1,, S 2,, A , ,, A , 2,, , 16,, , 6,, 3,, -0 6,, 3,, 16,, Prior to preparing a consolidation worksheet, Marshall records the three transactions that occurred to create the business combination. Investment in Tucker To record payment of stock issuance costs. Add the two book values. Add the two book values plus the fair value adjustment. Summation of the above individual figures. Add the two book values plus the debt incurred by the parent in acquiring the subsidiary.
Summation of the above figures. Accounts Cash Buildings net Equipment net Accounts payable Common stock Additional paid-in capital Total liab. Prepare a consolidated balance sheet Consideration transferred at fair value Book value Excess fair over book value Allocation of excess fair value to specific assets and liabilities: to computer software Computer software , Buildings net , Equipment net , Client contracts -0Research and devlopment asset -0Goodwill -0Total assets 1,, Accounts payable Notes payable Common stock Additional paid-in capital Retained earnings Total liabilities and equities.
Case 2: Bargain Purchase under acquisition method Fair value of consideration transferred Fair value of net identifiable assets Gain on bargain purchase.
Problem Because this basis exceeds the amount paid, Allerton recognizes a gain on bargain purchase. This is an exception to the general rule of using the fair value of the consideration transferred as the basis for recording the combination. Part h. The fair value of the consideration includes Fair value of stock issued Contingent performance obligation Fair value of consideration transferred.
Stock issue costs reduce additional paid-in capital. In a business combination, direct acquisition costs such as fees paid to investment banks for arranging the transaction are recognized as expenses. Revenues and expenses of the subsidiary from the period prior to the combination are omitted from the consolidated totals.
Only the operational figures for the subsidiary after the purchase are applicable to the business combination. The previous owners earned any previous profits. This amount indicates a bargain purchase calculated as follows: Fair value of consideration transferred Receivables Patented technology Customer relationships Research and development asset Liabilities Gain on bargain purchase. Also, use worksheet to derive consolidated totals.
In accounting for the combination of NewTune and On-the-Go, the fair value of the acquisition is allocated to each identifiable asset and liability acquired with any remaining excess attributed to goodwill. Because On-the-Go continues as a separate legal entity, NewTune first records the acquisition as an investment in the shares of On-the-Go. NewTune, Inc.
On-the-Go Co. Note: The accounts of NewTune have already been adjusted for the first three journal entries indicated in the answer to Part b. The consolidated balance sheets in parts a. The economic substances of the two forms of the transaction are identical and, therefore, so are the resulting financial statements.
The difference is in the journal entry to record the acquisition in the parent company books. Cash Receivables and inventory Property, plant and equipment Investment in Seguros Research and development asset Goodwill Trademarks Total assets Liabilities Contingent performance obligation Common stock Additional paid-in capital.
Chapter 02 - Consolidation of Financial Information Retained earnings 1,, Total liabilities and equities 3,, Answers to Appendix Problems Also compare to acquisition method.
Purchase Method 1. Purchase price including acquisition costs Fair values of net assets acquired Goodwill. Pre-acquisition revenues and expenses were excluded from consolidated results under the purchase method, but were included under the pooling method. Poolings, in most cases, produce higher rates of return on assets than purchase accounting because the denominator typically is much lower. Future EPS under poolings were also higher because of lower future depreciation and amortization of the smaller asset base.
Managers whose compensation contracts involved accounting performance measures clearly had incentives to use pooling of interest accounting whenever possible.
Continuing employment. The terms of continuing employment by the selling shareholders who become key employees may be an indicator of the substance of a contingent consideration arrangement. The relevant terms of continuing employment may be included in an employment agreement, acquisition agreement, or some other document. A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is compensation for postcombination services.
Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than compensation. Duration of continuing employment. If the period of required employment coincides with or is longer than the contingent payment period, that fact may indicate that the contingent payments are, in substance, compensation.
Level of compensation. Situations in which employee compensation other than the contingent payments is at a reasonable level in comparison to that of other key employees in the combined entity may indicate that the contingent payments are additional consideration rather than compensation. Incremental payments to employees.
If selling shareholders who do not become employees receive lower contingent payments on a per-share basis than the selling shareholders who become employees of the combined entity, that fact may indicate that the incremental amount of contingent payments to the selling shareholders who become employees is compensation. Number of shares owned. The relative number of shares owned by the selling shareholders who remain as key employees may be an indicator of the substance of the contingent consideration arrangement.
For example, if the selling shareholders who owned substantially all of the shares in the acquiree continue as key employees, that fact may indicate that the arrangement is, in substance, a profit-sharing arrangement intended to provide compensation for postcombination services. Alternatively, if selling shareholders who continue as key employees owned only a small number of shares of the acquiree and all selling shareholders receive the same amount of contingent consideration on a per-share basis, that fact may indicate that the contingent payments are additional consideration.
The preacquisition ownership interests held by parties related to selling shareholders who continue as key employees, such as family members, also should be considered.
Linkage to the valuation. If the initial consideration transferred at the acquisition date is based on the low end of a range established in the valuation of the acquiree and the contingent formula relates to that valuation approach, that fact may suggest that the contingent payments are additional consideration.
Alternatively, if the contingent payment formula is consistent with prior profitsharing arrangements, that fact may suggest that the substance of the arrangement is to provide compensation. Formula for determining consideration.
The formula used to determine the contingent payment may be helpful in assessing the substance of the arrangement. For example, if a contingent payment is determined on the basis of a multiple of earnings, that might suggest that the obligation is contingent consideration in the business combination and that the formula is intended to establish or verify the fair value of the acquiree.
In contrast, a contingent payment that is a specified percentage of earnings might suggest that the obligation to employees is a profit-sharing arrangement to compensate employees for services rendered. Suggested answer: Note: This case was designed to have conflicting indicators across the various criteria identified in the FASB ASC for determining the issue of compensation vs.
Thus, the solution is subject to alternative explanations and student can be encouraged to use their own judgment and interpretations in supporting their answers. This contingency is not dependent on continuing employment criteria a. The profit-sharing component of the employment contract appears to be compensation. Criteria g. Criteria a. Although the employees receive non-profit sharing compensation similar to other employees criteria c. For example, that might be the case for an acquired intangible asset that the reporting entity plans to use defensively by preventing others from using it.
Nevertheless, the reporting entity shall measure the fair value of a nonfinancial asset assuming its highest and best use by market participants. According to ASC a defensive intangible asset should be accounted for as a separate unit of accounting i. The identifiable assets acquired in a business combination should be measured at their acquisition-date fair values ASC A fair value measurement assumes the highest and best use of an asset by market participants.
Highest and best use is determined based on the use of the asset by market participants, even if the intended use of the asset by the reporting entity is different ASC Importantly, highest and best use provides maximum value to market participants. The benefit a reporting entity receives from holding a defensive intangible asset is the direct and indirect cash flows resulting from the entity preventing others from realizing any value from the intangible asset defensively or otherwise.
The period over which a defensive intangible asset diminishes in fair value is a proxy for the period over which the reporting entity expects a defensive intangible asset to contribute directly or indirectly to the future cash flows of the entity.
ASC A It would be rare for a defensive intangible asset to have an indefinite life because the fair value of the defensive intangible asset will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors. Additionally, if an acquired intangible asset meets the definition of a defensive intangible asset, it shall not be considered immediately abandoned.
ASC B. Celgene accounted for its March 7, acquisition of Avila Therapeutics using the acquisition method. Property, plant, and equipment Platform technology intangible asset In-process research and development product rights Net deferred tax liability Total fair value of net identifiable assets Goodwill.
Celgene determined these allocations by estimating fair values for each of the assets acquired and the liabilities assumed. As shown in the part 3. Acquired in-process research and development product rights are accounted for as an intangible asset with an indefinite life. Read Now. Go explore.
Stock issuance costs were recorded as a reduction in paid-in capital and are not considered to be a component of the acquisition price. Purchase method procedures 1. The assets and liabilities acquired were measured by the buyer at fair value as of the date of acquisition. Any portion of the payment made in excess of the fair value of these assets and liabilities was attributed to an intangible asset commonly referred to as goodwill.
If the price paid was below the fair value of the assets and liabilities, the acquired company accounts were still measured at fair value except that certain noncurrent asset values were reduced by the excess cost. If these values were not great enough to absorb the entire reduction, an extraordinary gain was recognized. A pooling of interests reflected united ownership of two companies through the exchange of equity securities.
The characteristics of a pooling are fundamentally different from either the purchase or acquisition methods. Neither party was truly viewed as an acquiring company. Precise cost figures from the exchange of securities were difficult to ascertain. The transaction affected the stockholders rather than the companies. Pooling of interests accounting 1. Because of the nature of a pooling, an acquisition price was not relevant.
Since no acquisition price was computed, all direct costs of creating the combination were expensed immediately. No new goodwill was recognized from the combination. Similarly, no valuation adjustments were recorded for any of the subsidiary assets or liabilities. The book values of the two companies were simply brought together to produce consolidated financial statements. A pooling was viewed as a uniting of the owners rather than the two companies.
The results of operations reported by both parties were combined on a retroactive basis as if the companies had always been together. Controversy historically surrounded the pooling of interests method.
Cost figures indicated by the exchange transaction were ignored. Income balances previously reported were combined on a retrospective basis. Reported net income was usually higher in subsequent years than in a purchase because the lack of valuation adjustments reduced amortization.
A newly acquired entity may elect the option to apply pushdown accounting in the reporting period immediately following the acquisition. When push-down accounting is elected, A. The subsidiary revalues its assets and liabilities based on the acquisition-date fair value allocations. The subsidiary then recognizes periodic amortization expense on those allocations with definite lives.
In the case of a bargain purchase gain, pushdown accounting recognize an adjustment to its additional paid-in capital, not as a gain in its income statement.
The parent uses no special procedures when push-down accounting is being applied. However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary. A business combination is the process of forming a single economic entity by the uniting of two or more organizations under common ownership. The term also refers to the entity that results from this process.
This transaction is labeled a statutory merger if the acquired company transfers its assets and liabilities to the buyer and then legally dissolves as a corporation. Both companies retain their separate legal identities although the common ownership indicates that only a single economic entity exists.
Consolidated financial statements represent accounting information gathered from two or more separate companies. This data, although accumulated individually by the organizations, is brought together or consolidated to describe the single economic entity created by the business combination. Companies that form a business combination will often retain their separate legal identities as well as their individual accounting systems.
In such cases, internal financial data continues to be accumulated by each organization. Separate financial reports may be required for outside shareholders a noncontrolling interest , the government, debt holders, etc. This information may also be utilized in corporate evaluations and other decision making. However, the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity.
The purpose of a worksheet is to organize and structure this process. The worksheet allows for a simulated consolidation to be carried out on a regular, periodic basis without affecting the financial records of the various component companies. Several situations can occur in which the fair value of the 50, shares being issued might be difficult to ascertain.
Thus, a quoted figure at any specific point in time may not be an adequate or representative value for long-term accounting purposes.
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