Business CombinationsMost organizations, large and small, hold ownership in other companies.

FASB 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-*

Business CombinationsSeparate organizations tied together through common control under common management are combined into a single entity.

FASB Accounting Standards Codification (ASC) Business Combinations (Topic 805) and Consolidation (Topic 810) provide guidance using the acquisition method.

The acquisition method embraces a fair value measurement attribute that reflects the FASBs increasing emphasis on fair value for measuring and assessing business activity.

Business Combinations

Financial statements that represent a parent and its subsidiaries as a SINGLE ENTITY are known as consolidated financial statements.

Ownership can exist through a majority voting interest or with a lesser percentage of ownership through governance contracts, leases, or agreements with other stockholders.2-*

The company that exerts control is known as the parent and the separate controlled companies are known as subsidiaries.Financial statements that represent a parent and its subsidiaries as a SINGLE ENTITY are known as consolidated financial statements

Consolidated financial reports are prepared whenever one firm has a controlling financial interest in another. Ownership through a majority voting interest or with a lesser percentage of ownership through governance contracts, leases, or agreements with other stockholders.

Reasons Firms CombineVertical integrationCost savings Quick entry into new marketsEconomies of scaleMore attractive financing opportunitiesDiversification of business risk Business ExpansionIncreasingly competitive environmentLO 12-*

Reasons Firms CombineVertical integrationCost savings Quick entry into new marketsEconomies of scaleMore attractive financing opportunitiesDiversification of business risk Business ExpansionIncreasingly competitive environment

The 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. 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)LO 22-*

The 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.

Business Combinations Business combinations . . .

can be achieved through transactions or events in which an acquirer obtains control over one or more businesses.

Create single economic entities.

Can be formed by a variety of events but can differ widely in legal form.

Require consolidated financial statements.LO 32-*

2

Business combinations . . . can be achieved through transactions or events in which an acquirer obtains control over one or more businesses. Create single economic entities. Can be formed by a variety of events but can differ widely in legal form. Require consolidated financial statements.

Business Combinations2-*

A business combination refers to a transaction or other event in which an acquirer obtains control over one or more businesses.Business combinations are formed by a wide variety of transactions or events with various formats. For example, each of the following is identified as a business combination although it differs widely in legal form. In every case, two or more enterprises are being united into a single economic entity so that consolidated financial statements are required. There are five types of combinations that are required to prepare consolidated statements: 1.Statutory merger through asset acquisition 2.Statutory merger through capital stock acquisition 3. Statutory consolidation through capital stock or asset acquisition. 4. Acquisition of more than 50% of the voting stock 5. Control through ownership of variable interests.

FASB Control ModelThe FASB provides guidance and defines control when accounting for business combinations with this control model: A reporting entity has the power to direct the activities of another entity when it has the current ability to direct the activities of the entity that significantly affect the entity's returns.The power criterion defines control both operationally through majority voting shares and conceptually through contractual rights.2-*

FASB Control ModelThe FASB provides guidance and defines control when accounting for business combinations with this control model: A reporting entity has the power to direct the activities of another entity when it has the current ability to direct the activities of the entity that significantly affect the entity's returns.The power criterion defines control both operationally through majority voting shares and conceptually through contractual rights.

Subsidiaries financial dataPrepare a single set of consolidated financial statements.Parents financial dataConsolidation of Financial Information2-*To 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 together2-*

4

Parents and subsidiaries financial data are brought together to 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 prepare a single set of consolidated financial statements.

What is to be consolidated?If dissolution occurs:All account balances are actually consolidated in the financial records of the survivor.If separate incorporation maintained:Financial statement information (on work papers, not the actual records) is consolidated.2-*

What is to be consolidated?If dissolution occurs:All account balances are actually consolidated in the financial records of the survivor.If separate incorporation maintained:Financial statement information (on work papers, not the actual records) is consolidated.

When does consolidation occur?If dissolution occurs:Permanent consolidation occurs at the combination date.

If separate incorporation maintained:Consolidation occurs at regular intervals, whenever financial statements are prepared.2-*2-*

When does consolidation occur?If dissolution occurs:Permanent consolidation occurs at the combination date.

If separate incorporation maintained:Consolidation occurs at regular intervals, whenever financial statements are prepared.

How does consolidation affect the accounting records?If dissolution occurs:Dissolved companys records are closed out.Surviving companys accounts are adjusted to include all balances of the dissolved company.If separate incorporation is maintained:Each company continues to retain its own records.worksheets facilitates the periodic consolidation process without disturbing individual accounting systems.

2-*

How does consolidation affect the accounting records?If dissolution occurs:Dissolved companys records are closed out.Surviving companys accounts are adjusted to include all balances of the dissolved company.If separate incorporation is maintained:Each company continues to retain its own records.worksheets facilitates the periodic consolidation process without disturbing individual accounting systems.

The Acquisition Method Used to account for business combinations.

Requires recognizing and measuring at fair value:Consideration transferred for the acquired business Noncontrolling interestSeparately identified assets and liabilitiesGoodwill or gain from a bargain purchaseAny contingent considerations.LO 42-*

The Acquisition Method Used to account for business combinations.

Requires recognizing and measuring at fair value:Consideration transferred for the acquired business Noncontrolling interestSeparately identified assets and liabilitiesGoodwill or gain from a bargain purchaseAny contingent considerations.

Fair ValueAsset valuations established usingThe Market Approach fair value can be estimated referencing similar market trades.

The Income Approach fair value can be estimated using the discounted future cash flows of the asset.

The Cost Approach estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.LO 52-*

Fair ValueAsset valuations established usingThe Market Approach fair value can be estimated referencing similar market trades.

The Income Approach fair value can be estimated using the discounted future cash flows of the asset.

The Cost Approach estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.

Acquisition Method What if the consideration transferred does NOT EQUAL the Fair Value of the Assets acquired?If 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 GOODWILL2-*

Acquisition Method What if the consideration transferred does not equal the Fair Value of the Assets acquired?If the consideration is more than the fair value of the assets acquired, the difference is attributed to goodwill. If 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!!

Acquisition Method Example Purchase Price = Fair ValueBigNet pays $2,550,000 ($550,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. As is typical, the $2,550,000 fair value of the consideration transferred by BigNet represents the fair value of the acquired Smallport business.Dissolution of Subsidiary2-*

19

BigNet pays $2,550,000 ($550,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. As is typical, the $2,550,000 fair value of the consideration transferred by BigNet represents the fair value of the acquired Smallport business.

Consideration Transferred = Net Identified Asset Fair ValuesBigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . .1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . . . . . 550,000Common Stock (20,000 shares issued at $10 par value) 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . 1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.Dissolution of SubsidiaryLO 62-*

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Journal entry: BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . . .600,000Capitalized Software . . . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . . . . . . 550,000Common Stock (20,000 shares issued at $10 par value). . . 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.

Acquisition Method Example Purchase Price > Fair ValueBigNet pays $3,000,000 ($1,000,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $3,000,000 fair value of the consideration transferred by BigNet is greater than the fair value of the acquired Smallport business.Dissolution of Subsidiary2-*

19

BigNet pays $3,000,000 ($1,000,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $3,000,000 fair value of the consideration transferred by BigNet is greater than the fair value of the acquired Smallport business.

Acquisition Method ExamplePurchase Price > Fair ValueBigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . .1,200,000Customer Contracts . . . . . . . . . . . . . . . . . 700,000Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . .450,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . 1,000,000Common Stock (20,000 shares at $10 par value) . . . . 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . 1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.Dissolution of Subsidiary2-*

Journal entry:BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . 700,000Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . .450,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . 1,000,000Common Stock (20,000 shares at $10 par value) . . . . . . . 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . .1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.

Acquisition Method Example Purchase Price < Fair ValueBigNet pays $2,000,000 by issuing 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $2,000,000 fair value of the consideration transferred by BigNet is less than the fair value of the acquired Smallport business.Dissolution of Subsidiary2-*

19

BigNet pays $2,000,000 by issuing 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $2,000,000 fair value of the consideration transferred by BigNet is less than the fair value of the acquired Smallport business.

Acquisition Method ExamplePurchase Price < Fair ValueBigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . .1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Common Stock (20,000 shares issued at $10 par value) 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . 1,800,000Gain on Bargain Purchase . . . . . . . . . . . . . . . . . . . . . . 550,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.Dissolution of Subsidiary2-*

Journal entry:BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Common Stock (20,000 shares issued at $10 par value) . . . .200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000Gain on Bargain Purchase . . . . . . . . . . . . . . . . . . . . . . 550,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.

Related 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-*

Related 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.

Acquisition MethodSeparate Incorporation MaintainedDissolution does not occur.

Consolidation process is similar to previous example.

Fair value is the basis for initial consolidation of subsidiarys net assets.

Subsidiary is a legally incorporated separate entity.

Consolidation of financial information is simulated.

Acquiring company does not physically record the transaction. LO 72-*

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When separate incorporation is maintained:Dissolution does not occur.Consolidation process is similar to previous example.Fair value is the basis for initial consolidation of subsidiarys net assets. Subsidiary is a legally incorporated separate entity.Consolidation of financial information is simulated.Acquiring company does not physically record the transaction.

The Consolidation Worksheet

Consolidation 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 Subs prior revenue and expense already closed).LO 72-*

6

Consolidation 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. The financial information for Parent and Sub are recorded in the first two columns of the worksheet (with Subs prior revenue and expense already closed).

The Consolidation Worksheetcontinued. . .3. Remove the Subs equity account balances.

Remove the Investment in Sub balance.

Allocate Subs 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.2-*

6

Remove the Subs equity account balances.Remove the Investment in Sub balance.

5. Allocate Subs Fair Values, including any excess of cost over Book Value to identifiable assets or goodwill.6. Combine all account balances and extend into the Consolidated totals column.7. Subtract consolidated expenses from revenues to arrive at net income.

Acquisition Method Consolidation Workpaper Example2-*

30

Example of consolidation worksheet, exhibit 2.6, on page 56 in the textbook.

Acquisition Date Fair-Value Allocations Additional IssuesIntangibles are assets that:Lack physical substance (excluding financial instruments)Arise from contractual or other legal rightsCan be sold or otherwise separated from the acquired enterprisePreexisting goodwill recorded in the acquired companys 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.LO 82-*

Acquisition Date Fair-Value Allocations Additional IssuesIntangibles are assets that:Lack physical substance (excluding financial instruments)Arise from contractual or other legal rightsCan be sold or otherwise separated from the acquired enterprise

Preexisting goodwill recorded in the acquired companys 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.

Business CombinationsSeparate organizations tied together through common control under common management are combined into a single entity.

FASB Accounting Standards Codification (ASC) Business Combinations (Topic 805) and Consolidation (Topic 810) provide guidance using the acquisition method.

The acquisition method embraces a fair value measurement attribute that reflects the FASBs increasing emphasis on fair value for measuring and assessing business activity.

The company that exerts control is known as the parent and the separate controlled companies are known as subsidiaries.Financial statements that represent a parent and its subsidiaries as a SINGLE ENTITY are known as consolidated financial statements

Consolidated financial reports are prepared whenever one firm has a controlling financial interest in another. Ownership through a majority voting interest or with a lesser percentage of ownership through governance contracts, leases, or agreements with other stockholders.Reasons Firms CombineVertical integrationCost savings Quick entry into new marketsEconomies of scaleMore attractive financing opportunitiesDiversification of business risk Business ExpansionIncreasingly competitive environment

The 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

Business combinations . . . can be achieved through transactions or events in which an acquirer obtains control over one or more businesses. Create single economic entities. Can be formed by a variety of events but can differ widely in legal form. Require consolidated financial statements.

A business combination refers to a transaction or other event in which an acquirer obtains control over one or more businesses.Business combinations are formed by a wide variety of transactions or events with various formats. For example, each of the following is identified as a business combination although it differs widely in legal form. In every case, two or more enterprises are being united into a single economic entity so that consolidated financial statements are required. There are five types of combinations that are required to prepare consolidated statements: 1.Statutory merger through asset acquisition 2.Statutory merger through capital stock acquisition 3. Statutory consolidation through capital stock or asset acquisition. 4. Acquisition of more than 50% of the voting stock 5. Control through ownership of variable interests. FASB Control ModelThe FASB provides guidance and defines control when accounting for business combinations with this control model: A reporting entity has the power to direct the activities of another entity when it has the current ability to direct the activities of the entity that significantly affect the entity's returns.The power criterion defines control both operationally through majority voting shares and conceptually through contractual rights.

4

Parents and subsidiaries financial data are brought together to 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 prepare a single set of consolidated financial statements.

What is to be consolidated?If dissolution occurs:All account balances are actually consolidated in the financial records of the survivor.If separate incorporation maintained:Financial statement information (on work papers, not the actual records) is consolidated.

When does consolidation occur?If dissolution occurs:Permanent consolidation occurs at the combination date.

If separate incorporation maintained:Consolidation occurs at regular intervals, whenever financial statements are prepared.How does consolidation affect the accounting records?If dissolution occurs:Dissolved companys records are closed out.Surviving companys accounts are adjusted to include all balances of the dissolved company.If separate incorporation is maintained:Each company continues to retain its own records.worksheets facilitates the periodic consolidation process without disturbing individual accounting systems.

The Acquisition Method Used to account for business combinations.

Requires recognizing and measuring at fair value:Consideration transferred for the acquired business Noncontrolling interestSeparately identified assets and liabilitiesGoodwill or gain from a bargain purchaseAny contingent considerations.

Fair ValueAsset valuations established usingThe Market Approach fair value can be estimated referencing similar market trades.

The Income Approach fair value can be estimated using the discounted future cash flows of the asset.

The Cost Approach estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.

Acquisition Method What if the consideration transferred does not equal the Fair Value of the Assets acquired?If the consideration is more than the fair value of the assets acquired, the difference is attributed to goodwill. If 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!!

19

BigNet pays $2,550,000 ($550,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. As is typical, the $2,550,000 fair value of the consideration transferred by BigNet represents the fair value of the acquired Smallport business.

20

Journal entry: BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . . .600,000Capitalized Software . . . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . . . . . . 550,000Common Stock (20,000 shares issued at $10 par value). . . 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.

19

BigNet pays $3,000,000 ($1,000,000 cash and 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share) for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $3,000,000 fair value of the consideration transferred by BigNet is greater than the fair value of the acquired Smallport business.Journal entry:BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . 700,000Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . .450,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Cash (paid by BigNet) . . . . . . . . . . . . . . . . . . . . . . 1,000,000Common Stock (20,000 shares at $10 par value) . . . . . . . 200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . .1,800,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.

19

BigNet pays $2,000,000 by issuing 20,000 unissued shares of its $10 par value common stock that is currently selling for $100 per share for all of Smallports assets and liabilities.

Smallport then dissolves as a legal entity. The $2,000,000 fair value of the consideration transferred by BigNet is less than the fair value of the acquired Smallport business.Journal entry:BigNet Companys Financial RecordsDecember 31Current Assets . . . . . . . . . . . . . . . . . . . . . . . 300,000Computers and Equipment . . . . . . . . . . . . . . 600,000Capitalized Software . . . . . . . . . . . . . . . . . . 1,200,000Customer Contracts . . . . . . . . . . . . . . . . . . . 700,000Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000Common Stock (20,000 shares issued at $10 par value) . . . .200,000Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000Gain on Bargain Purchase . . . . . . . . . . . . . . . . . . . . . . 550,000To record acquisition of Smallport Company. Assets acquired and liabilities assumed are recorded at fair value.Related 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.

20

When separate incorporation is maintained:Dissolution does not occur.Consolidation process is similar to previous example.Fair value is the basis for initial consolidation of subsidiarys net assets. Subsidiary is a legally incorporated separate entity.Consolidation of financial information is simulated.Acquiring company does not physically record the transaction.

6

Consolidation 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. The financial information for Parent and Sub are recorded in the first two columns of the worksheet (with Subs prior revenue and expense already closed).

6

Remove the Subs equity account balances.Remove the Investment in Sub balance.

5. Allocate Subs Fair Values, including any excess of cost over Book Value to identifiable assets or goodwill.6. Combine all account balances and extend into the Consolidated totals column.7. Subtract consolidated expenses from revenues to arrive at net income.

30

Example of consolidation worksheet, exhibit 2.6, on page 56 in the textbook.Acquisition Date Fair-Value Allocations Additional IssuesIntangibles are assets that:Lack physical substance (excluding financial instruments)Arise from contractual or other legal rightsCan be sold or otherwise separated from the acquired enterprise

Preexisting goodwill recorded in the acquired companys 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.