1. Identify and describe the various methods available to the parent company to maintain its investments in a subsidiary (equity, initial value, and partial equity methods). Describe the features of each method .
Consolidation is a term that is used to refer to the oscillating of security prices within a corridor and it’s usually associated with market indecisiveness. From another perspective consolidation also refers to a compilation of financial statements which helps to merger and present a parent company and those acquired. The objective of consolidation despite difficulties caused passage of time is always; a combination of assets, liabilities, revenue, expenses, and equity accounts of a parent with its acquired firm or firms. In such cases, it's the parent company buying majority percentage of the ownership of the subsidiary companies while the rest can be purchased by Non-controlling interest. In some cases, it occurs that a parent company can make the purchase of the complete ownership of the subsidiary making it the sole owner. In this term paper, we are going to look at Consolidations after the date of acquisition and what it entails.
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The parent company usually uses some methods for it to preserve its investments in the acquired firms. The company uses these choices to help in monitoring of internal record-keeping. To observe the activities of the subsidiaries the parent company uses the equity method, the initial value method and lastly the partial equity method (Masulis & Simsir , 2018). The role of these methods is to provide different account balances for the acquirer's investment in the subsidiary. The techniques also produce the income that is recognized from the subsidiary's activities and the earnings accounts that are retained after consolidation. The three methods, each plays a role at the acquisition date and the investment accounting methods each start with an equal value that is recorded in an investment account. When making the selection of the methods, it is important to note that it does not have any effect on the amount that is finally reported for the combined companies.
Under the equity method, when a subsidiary earns income, the acquiring company will accrue it. With the use of periodic adjusting entries, there is recognition of amortization expense that stems from the initial excess fair-value allocations. Under this approach, the acquiring firm's record matches those of the subsidiary. Application of the method makes both the income and investment balances of the parent to correctly replicate the consolidated amounts recorded. The significance of this method is in monitoring the income of the combined business. With equity method, unrealized gains on intra-entity transactions are postponed and also under the method the subsidiary dividends will be used to reduce the investment balance. The only setback of using equity method is that it can be time-consuming and challenging to apply.
The initial value method is another method used in consolidation. In this method, the parent will acknowledge income that results from the shares of the subsidiary dividends upon declaration. The income that the subsidiary earns may not be accepted or recognized. As for the investment balance, it will be retained in the parent's financial records at the original fair value that is allocated at the acquisition date. So in the initial value method, there are no other investment records that added. The initial value method is easy to apply because of the above compositions. The initial value method from its resulting accounting balances may not be able to project the parent's representation of the totals that accrue from consolidating the parent and the subsidiary.
As for the Partial Equity method, the parent makes recognition of income which is reported as accruing from the subsidiary. The process will combine the advantages attributed to the two methods applied above. The same way income is accrued as earned by the subsidiary in the equity method it employs under this method. Also similarly, the dividends in this method to reduce the investment balances. The only distinction is that there are no entries recorded and amortization, in particular, is not acknowledged by the parent. From all the three methods that a parent chooses, it is notable that no specific method will affect the totals that are finally reported on the consolidated financial statements, which are available for the external users.
2. Describe the process of preparing consolidated financial statement after the acquisition. Consolidation worksheet, Consolidation Entries (S, I, A, D, E) using different methods (equity, partial equity and initial value)
When preparing consolidated financial statements, the company must distinguish between two types of reserves, that is, Pre and Post-acquisition reserves. Under this, the cost of savings that were in the holding entity's accounts is replaced with the fair value of the assets and liabilities of the acquired firm. The pre-acquisition reserves include; the profits that are retained and other reserves that can be found in the financial statements of the subsidiary upon the date of acquisition. Intra-group activities such as intra-entity trading too have to be included in the preparation of the financial statements ( Schwarzbichler et al. 2018) . On consolidation, reconciliation of current accounts must be done and in the process items on transit are adjusted. The adjustment of assets and liabilities is for reflection of the allocations that result from acquisition-date fair values. Reciprocating accounts or intra-entities must be offset. In scenarios where one company is indebted to the other than, receivable and payable balances must be excluded for external reporting reasons. Because the companies are now seen as one entity, it is necessary to do away with the receivable and payable accounts.
There is three procedures usually involve consolidation accounting. These processes involve; combination, offsetting, and eliminating in full intragroup assets. In the first procedure of combining, the parent company has to combine all assets, liabilities, income expenses, and other valuables with those that belonged to the acquired firm. The offsetting procedure is also known as to eliminate, and it means that after the combination has been done of items that are alike, then the firm has to eliminate the parent company’s equity portion in the acquired firm and its investments in the subsidiary. Recognition is made for any controlling interest and goodwill. Lastly in the procedure is the elimination of intragroup transactions. It is known that there are always a lot of transactions between a parent company and its subsidiary. When the two are now merged to form one company, then it means that there are no transactions that external users can be able to see. Hence, all transactions b3tween the parent and subsidiary have to be eliminated. After the above procedures, the parent company can now add all combined numbers with its adjustments and finally have consolidated statement of financial statement.
3. Discuss the rationale for the goodwill impairment testing approach. Describe the procedures for conducting a goodwill impairment test.
The goodwill impairment tests are usually done at the reporting unit level within a joint entity. The rationale for this test is because goodwill is considered to have everlasting life. Goodwill impairment refers to the charge that is usually recorded by companies on their financial statements after the realization that there is an asset which is associated with the goodwill that may not be of economic value (Johansson et al., 2016). During the acquisition of a firm by another, the price paid might be of excess to the value of the assets and liabilities purchased and hence they are recorded as goodwill. A company records goodwill impairment in the circumstance where there is a decrease of cash flows of the acquired property resulting in a value lower than what was paid for by the parent. The test is done in two steps; the first step is the determination of whether the carrying amount of a reporting unit is more than its fair value. In cases where the fair value is recorded to be more than the carrying value, it implies that there is no existence of any impairment and hence, there is no need to write goodwill. When the fair value recorded is less, then the company opts for the second step, where it has to apply the appropriate amount to recognizable assets and liabilities of the reporting unit. What exceeds as the balance from the fair value is recorded as the new goodwill, and a goodwill impairment charge is booked.
4. Describe rationale and procedures for impairment test for intangible assets other than goodwill.
Impairment of intangible assets is done through the application of optional qualitative impairment assessment to determine the possibility of an asset which is not subject to amortization not being impaired (Carvalho & Rodrigues, 2016). All the identifiable assets are supposed to be amortized over their economic usefulness unless they are regarded indefinite. The test done here is the calculation of the fair value of the intangible asset for an impairment test. Comparison is made between the fair value and the carrying value of the intangible asset. The policy outlines that the increased carrying amount of an asset that is not goodwill, and which is usually associated with the reversal of an impairment loss, is not supposed to exceed the carrying amount that could have been recorded in case there was no impairment loss recognized from the past.
5. Describe the accounting and reporting for contingent consideration subsequent to a business acquisition.
Contingent consideration obligations are always measured regarding fair value concept and recognized as part of the initial value. Contingent consideration is still part of the purchase price in spite of the possibility of payment not being done. Inclusion of contingent consideration in the purchase price is aimed at increasing the goodwill amount recognized at acquisition. The subsequent accounting that results is dependent on the classification of that Contingent consideration (Wangerin, 2018). The firm acquiring another is supposed to classify the review as either a liability or equity. When labeled as a liability, the consideration is reported at fair value in each reporting period to a period when the contingent has been resolved. When the contingent consideration is reported as equity, then, there is no subsequent re-measuring, and when it is determined, it will be accounted for within equity but with no accompanying profits or losses.
In conclusion, consolidation is used in cases where a firm is acquiring another or other firms. The aim is to combine assets, liabilities, and other financial holdings of the parent firm and its subsidiaries. In the acquisition of another firm, the parent must maintain investments of the subsidiary through methods such Equity method, Initial value method, and partial Equity method. Consolidated financial statements are made for the stockholders and the creditors of the parental company to use concerning investment.
References
Carvalho, C, Rodrigues, AM (2016) The recognition of goodwill and other intangible assets in business combinations–The Portuguese case- Australian Accounting- Wiley Online Library
Johansson, SE, Hjelström, T, Hellman, N (2016) Accounting for goodwill under IFRS: A critical analysis- Journal of International Accounting – Elsevier
Masulis, RW, Simsir, SA (2018) Deal initiation in mergers and acquisitions -of Financial and Quantitative Analysis, - Cambridge. Or
Schwarzbichler, M, Steiner, C, Turnheim, D (2018) Acquisitions : Impact on Consolidated Financial Statement - Financial Steering, - Springer
Wangerin, D (2018) M&A due diligence, post- acquisition performance, and financial reporting for business combinations - Available at SSRN 2118836 - papers.ssrn.com
