Patrick corporation acquired 100 percent of o brien company

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chapter

In 1996, Berkshire Hathaway, Inc., acquired all of the outstanding stock of Geico, Inc., an insurance company. Although this transaction involved well-known companies, it was not unique; mergers and acquisitions have long been common in the business world.

Berkshire Hathaway’s current financial statements indicate that Geico

is still a component of this economic entity. However, Geico, Inc., con-

tinues as a separate legally incorporated concern long after its acquisi-

tion. As discussed in Chapter 2, a parent will often maintain separate legal

status for a subsidiary corporation to better utilize its inherent value as a

going concern.

For external reporting purposes, maintenance of incorporation cre-

ates an ongoing challenge for the accountant. In each subsequent period,

consolidation must be simulated anew through the use of a worksheet and

consolidation entries. Thus, for many years, the financial data for Berkshire

Hathaway and Geico (along with dozens of other subsidiaries) have been

brought together periodically to provide figures for the financial statements

that represent this business combination.

As also discussed in Chapter 2, the acquisition method governs the

way we initially record a business combination. In periods subsequent to

acquisition, the fair-value bases (established at the acquisition date) for sub-

sidiary assets acquired and liabilities assumed will be amortized (or tested

for possible impairment) for proper income recognition. Additionally, some

combinations require accounting for the eventual disposition of contingent

consideration, which, as presented later in this chapter, continues to follow a

fair-value model.

In the next several sections of this chapter, we present the procedures

to prepare consolidated financial statements in the years subsequent to

acquisition. We start by analyzing the relation between the parent’s inter-

nal accounting method for its subsidiary investment and the adjustments

required in consolidation. We also examine the specific procedures for

amortizing the acquisition-date fair-value adjustments to the subsidiary’s

assets and liabilities. We then cover testing for goodwill impairment and

post-acquisition accounting for contingent consideration. Finally, an appen-

dix presents the alternative goodwill model available as a reporting option

for private companies.

3 Consolidations— Subsequent to the Date of Acquisition

Learning Objectives After studying this chapter, you should be able to:

LO 3-1 Recognize the complexities in preparing consolidated financial reports that emerge from the passage of time.

LO 3-2 Identify and describe the various methods available to a parent company in order to maintain its investment in subsidiary account in its internal records.

LO 3-3 Prepare consolidated financial statements subsequent to acquisition when the parent has applied in its internal records:

a. The equity method. b. The initial value method. c. The partial equity method.

LO 3-4 Understand that a parent’s internal accounting method for its subsidiary investments has no effect on the resulting consolidated financial statements.

LO 3-5 Discuss the rationale for the goodwill impairment testing approach.

LO 3-6 Describe the procedures for conducting a goodwill impairment test.

LO 3-7 Describe the rationale and procedures for impairment testing for intangible assets other than goodwill.

LO 3-8 Understand the accounting and reporting for contingent consideration subsequent to a business acquisition.

LO 3-9 Appendix: Describe the alternative accounting treatments for goodwill and other intangible assets available for business combinations by private companies.

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90 Chapter 3

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Consolidation—The Effects Created by the Passage of Time In Chapter 2, consolidation accounting is analyzed at the date that a combination is created. The present chapter carries this process one step further by examining the consolidation pro- cedures that must be followed in subsequent periods whenever separate incorporation of the subsidiary is maintained.

Despite complexities created by the passage of time, the basic objective of all consolida- tions remains the same: to combine asset, liability, revenue, expense, and equity accounts of a parent and its subsidiaries. From a mechanical perspective, a worksheet and consolidation entries continue to provide structure for the production of a single set of financial statements for the combined business entity.

Consolidated Net Income Determination Subsequent to an acquisition, the parent company must report consolidated net income. Con- solidated income determination involves first combining the separately recorded revenues and expenses of the parent with those of the subsidiary on a consolidated worksheet. Because of separate record-keeping systems, however, the subsidiary’s expenses typically are based on their original book values and not the acquisition-date values the parent must recognize. Consequently, adjustments are made that reflect the amortization of the excess of the par- ent’s consideration transferred over the subsidiary book value. Additionally, the effects of any intra-entity transactions are removed.

The Parent’s Choice of Investment Accounting The time factor introduces other complications into the consolidation process as well. For internal record-keeping purposes, the parent must select and apply an accounting method to monitor the relationship between the two companies. The investment balance recorded by the parent varies over time as a result of the method chosen, as does the income subsequently rec- ognized. These differences affect the periodic consolidation process but not the figures to be reported by the combined entity. Regardless of the amount, the parent’s investment account is eliminated (brought to a zero balance) on the worksheet so that the subsidiary’s actual assets and liabilities can be consolidated. Likewise, the income figure accrued by the parent is removed each period so that the subsidiary’s revenues and expenses can be included when creating an income statement for the combined business entity.