Module 5 & 6

A. Course Code – Title : C-APrE7 Accounting for Business Combinations

B. Module No – Title : MO 5 & 6 – Consolidation at Acquisition Date part 1 & 2
C. Time Frame : 2 weeks - 6 hours
D. Materials : Syllabus, Learning Plan, Curriculum Map, Writing
Materials, Accounting Standards and Books.
1. Overview
This module will discuss accounting for investment at the date of acquisition and the
preparation of a consolidated statement of financial position only. Accounting for
subsidiary investments and consolidation of financial statements in subsequent periods are
discussed in the next module.
2. Desired Learning Outcomes
At the end of the learning session, you should be able to:
a. Understand the reasons for consolidation
b. Identify parent-subsidiary relationship
c. Identify the scope of control
d. Enumerate the requirements for consolidation
e. Understand and apply consolidation procedures
f. Prepare consolidated financial statements

3. Content/Discussion

CONSOLIDATION AT ACQUISITION DATE

The preceding module discussed business combination where control over another
entity is achieved through asset acquisition. Recall that in asset acquisition the acquirer
gives a consideration in exchange for the acquired company's assets and liabilities which
are permanently transferred to and recorded in acquirer's books. This signals the
dissolution of the acquired company. This chapter contains a discussion of a business
combination where control is achieved through stock acquisition. The rules are practically
the same as in the preceding module except for the consolidation of the financial
statements which is an added requirement for investments with stock control. It discusses
accounting for a parent-subsidiary relationship and the preparation of consolidated
financial statements for a group of enterprises under the control of the parent company.
REASONS FOR STOCK ACQUISITION
There are numerous reasons why a corporation would rather acquire stock control
than acquire the net assets of another corporation: simpler to achieve control with lesser
legal and processing costs to be incurred, assets of the parent company are protected from
possible attachment by subsidiary creditors, lesser amount of investment involved since
only majority shares are needed to achieve control instead of acquiring all the assets of the
acquired company.
PARENT-SUBSIDIARY RELATIONSHIP
Control by a corporation over the resources and operation of another corporation is
possible through the acquisition of its majority- voting common stock. Control is the power
to govern the financial and operating policies of an enterprise.
Acquiring majority shares of stocks of another corporation may result in a parent-
subsidiary relationship where the parent, who is the acquirer/investor, obtains control
over the subsidiary, who is the acquire/investee. The affiliates or group (a parent and its
subsidiaries) may still exist as separate legal entities and maintain separate accounting
records. A corporation called a holding corporation may be formed solely for the purpose
of holding the stocks of and supervising the operations of other corporations. Controlling
interest is that portion of the equity of the consolidated group belonging to the parent
company and its stockholders. Non-controlling interest (formerly called minority interest
in PFRS 3 2004) is that portion of the profit or loss and subsidiary equity that are owned by
the subsidiary shareholders other than the parent company.
SCOPE OF CONTROL
The standard defines a subsidiary as being controlled by a parent company. Control
is the criterion for identifying a parent-subsidiary relationship and hence the basis for
consolidation. Control is presumed to exist when the parent acquires more than 50%
ownership over the subsidiary. The acquisition may be done directly or indirectly through
the subsidiary. To illustrate, assume that Owen Corporation owns 80% interest in More
Corporation and 30% interest in Ross Corporation. More Corporation, in turn, owns 60%
interest in Ross Corporation. Therefore, Owen Corporation directly owns 80% interest of
More Corporation and 30% of Ross Corporation. Likewise, Owen Corporation indirectly
owns 48% interest of Ross Corporation because of its 80% interest over More Corporation
who owns 60% of Ross. Its total ownership over Ross Corporation is therefore 78% (30% +
48%).

Parent's capacity to control does not hinge alone on the 50 + 1 percent rule. The
standard states that an acquisition of 50% or less may still lead to a presumption that
control exists when there is:
1) power over more than one half of the voting rights by virtue of an agreement
with the other investors;
2) power to govern the financial and operating policies of the enterprise under a
statute or an agreement;
3) power to appoint or remove the majority of the members of the board of
directors or equivalent governing body; or
4) power to cast the majority of votes at meetings of the board of directors or
equivalent
governing body.

ACCOUNTING FOR STOCK INVESTMENT

 The standard provides that consolidated financial statements (considered primary
reports) should be prepared by a parent to consolidate its investments in subsidiaries. For
consolidation purposes, investments in subsidiaries, associates and jointly controlled
entities are accounted for under the equity method. This method is based on the equity
relationship between investor and investee with a view of considering them as a single
economic unit because of the significant influence or control the investor has on the
financial and operational activities of the investee.

Preparing consolidated financial statements does not preclude the preparation of

separate financial statements for each of the combined entities. The standard states that in
a parent's separate financial statements (considered secondary reports) investments in
subsidiaries, associates and jointly controlled entities are to be accounted for either: a) at
cost, or b) in accordance with PAS 39. The same accounting shall be applied for each
category of investment. In parent's separate financial statements, subsidiaries to be
consolidated may not be accounted for under the equity method.

It should be noted that PAS 28 (Investment in Associates) which was approved in

March 2001 and became effective January 2002 states that an investment of 20% or more
of the voting stock of the investee, whether directly or indirectly, should lead to a
presumption that in the absence of evidence to the contrary, an investor has the ability to
exercise significant influence over an investee. Significant influence means that the investor
participates in the financial and operating policy decisions of the investee, called an
associate, but has no control over investee's decisions. When preparing consolidated
financial statements, investments in associates should be accounted under the equity
method except when 1) the investment is acquired and held exclusively with the view of
subsequently disposing it within twelve months from acquisition date and 2) management
is actively seeking for a buyer. PAS 28.18 also states that investor should cease using the
equity method for investments in associates when investor no longer has significant
influence over the associate.
Since in this module the focus will be on accounting for investment and
consolidation at acquisition date, the recording under both methods, equity and cost, poses
no difference. From the recorded initial value, the investment amount may change over
time depending on whether the company is using the equity method or the cost method.
This will be discussed in the next chapter.
WHAT IS TO BE CONSOLIDATED?
In a statutory merger or consolidation, where the acquired company is dissolved, all
assets and liabilities are physically transferred and recorded in the books of the acquirer.
There is automatic consolidation. In stock acquisition, the subsidiary company is not
dissolved and neither are its assets and liabilities physically transferred and recorded in
the books of the parent company. Parent merely recognizes a right over the investee by
debiting the account Investment in Stocks. Subsidiary still prepares separate financial
statements. However, these separate financial statements must be consolidated with the
parent's financial statements since the parent is considered as a new reporting entity by
the standard. To facilitate the consolidation, a working paper is prepared periodically and a
set of adjustment and elimination entries are included in it without upsetting the official
records of the affiliates. This has to be done regularly as if one is starting anew since the
working paper does not form part of the official accounting records of the affiliates.
Consolidation is perhaps the most complicated accounting procedure that requires
preparation of consolidated reports.

REQUIREMENTS FOR CONSOLIDATION

The standard defines consolidated financial statements as financial statements of a
group reported as those of a single entity. As legal entities, separate financial statements
are required for the parent company and the subsidiary company. As the parent company
is viewed as a new reporting entity, the separate financial statements of the affiliates are
required to be consolidated. The consolidated financial statements provide a
comprehensive view of the financial position and operations of the enterprises under the
parent's control.
The standard also requires consolidated financial statements be prepared for all
subsidiaries consolidated whether foreign or domestic and even when subsidiaries are
engaged in dissimilar activities for as long as control exists. A subsidiary which operates
under severe long-term restrictions that impairs it from transferring funds to the parent
does not negate it from being consolidated. Neither are investors who are venture capital
organizations or mutual fund/unit trust entities exempt from being consolidated or
subsidiaries that have been consolidated before but are now held available for sale.

The standard exempts the parent from preparing consolidated financial statements
if and only if all the following four conditions are met:
1) It is a wholly owned subsidiary or is a partially owned subsidiary and its other
owners(including those not otherwise entitled to vote) have been informed about and do
not object to the parent not presenting consolidated financial statements.
2) The parent's debt or equity instruments are not traded in the market.
3) The parent has not filed or intends to file its financial statements with a securities
commission or other regulatory organization for the purpose of issuing any class of
instruments in a public market.
4) The ultimate or any intermediate parent of the parent produces consolidated
financial statements available for public use that comply with international Financial
Reporting Standards.
The aforementioned conditions are also the same grounds for exemption in using
the equity method.
Where each of the assets, liabilities, revenues and expenses of the subsidiaries are
combined item by item or line by line and presented in the consolidated financial
statements, a full consolidation is achieved. Although the equity method represents a one-
line consolidation in that it indicates how much of the net assets of the subsidiary is owned
by the parent, it is not a substitute for full consolidation.
Subsidiaries are also excluded from consolidation if control is intended to be
temporary because parent has the intention of disposing its investment within twelve
months from acquisition date and that management is actively seeking a buyer.
CONSOLIDATION PROCEDURES
This is similar to the combined financial statements of the home office and the
branch where on a line by line basis, each of the assets, liabilities, equity, revenues and
expenses are added together. And just like in home office and branch accounting,
intragroup balances and intragroup transactions (reciprocal accounts and transactions)
should also be eliminated in full.
The following are the steps that should be undertaken:
1) The investment account and the parent's equity interest over the subsidiary are
eliminated.
2) Revaluation of assets and liabilities are taken up with the difference between the
consideration paid and the subsidiary equity acquired recognized either as goodwill or gain
from bargain purchase.
3) All intragroup transactions (between parent and subsidiary) are eliminated in full.
Examples:
receivables against payables, income against expense, dividends from/to one another.
4) Assets and liabilities of the parent and its subsidiary are combined, item by item, at
100% even if ownership interest of the parent is not 100%.
5) If the portion of equity owned by the parent is less than 100%, the share of the
controlling interest as well as the share of the non-controlling interest in the net assets of
the subsidiary (including revaluations and goodwill) should be separately presented in the
equity section of the consolidated statement of financial position.
Other rules that must be followed:
6) The financial statements of both parent and its subsidiaries must be of the same
reporting date. If not, adjustments should be made for the significant effects of transactions
occurring between that date and the date of the parent's financial statements. Difference in
date shall, in no way, be more than three months.
7) Additionally, consolidated financial statements shall be prepared using uniform
accounting policies. If not, adjustments should be made to conform to the policies of the
parent company.

GENERAL RULE IN ASSESSING CONSIDERATION GIVEN AND FAIR VALUE OF THE

SUBSIDIARY INTEREST
Accounting for investments whether acquisition of net assets or equity ownership
follows the same rules as described in Partnership Dissolution. The consideration is
recorded at the exchange price, that is, the cash paid if it is on cash basis, or at the fair value
of the property, or debt or securities given up. If the acquisition is by exchange of securities,
then it is recorded at the fair value of the securities given up or the fair value of the
securities acquired whichever is more clearly determinable. Incidental expenses such as
the out of pocket costs like professional fees, commission, legal fees and taxes as well as
indirect costs like allocated administrative costs should be immediately expensed. The
excess or difference between the consideration and equity ownership over the investee's
net assets as revalued is also accounted as positive goodwill or negative goodwill (gain in
business combination). Additionally, it is important to mention that when goodwill is
recognized it means that the value of the subsidiary's equity is based on the fair value of the
consideration given by the parent. On the other hand, a gain implies that the basis used is
the fair value of the subsidiary's interest rather than the consideration given by the parent
company.

ILLUSTRATION 1. TOTAL OWNERSHIP INTEREST, CONSIDERATIONEQUAL TO

SUBSIDIARY INTEREST
The following are the financial position statements of P Co. and S Co. as at December 31,
2010 when P Co. decided to acquire all the shares of S Co. for P150,000:
P Co. S Co.
Cash and other current assets P 250,000 P120,000
Plant Assets 70,000 50,000
Total P 320,000 P 170,000

Liabilities P 140,000 P 70,000

Share Capital, par P100 125,000 75,000
Share premium 30,000 10,000
Retained Earnings 25,000 15,000
Total P 320,000 P 170,000

The Board of both companies approved the business combination and agreed to revalue
the plant assets of S Co to P100,000. P Company made the corresponding payment on
January 2, 2011 and recorded the stock acquisition as follows:
Investment in Stocks of S Co P150,000
 Cash P150,000
Based on the investment entry, cash is reduced and the investment account is set up
to make statement of financial position ready for consolidation.

Table for Determination and Allocation of Excess:

Consideration paid in cash P150,000
100% subsidiary interest acquired 100,000
Excess P 50,000
Revaluation of Plant Assets (50,000)
Goodwill (Gain) P0

Note that instead of net assets, the acquisition is described as subsidiary interest
acquired (represented by the shareholders' equity of the subsidiary) since what parent
acquired are the shares of stocks of the subsidiary.
The working paper to effect the consolidation of the statement of financial position
will appear as follows:
P CORPORATION AND SUBSIDIARY S CORPORATION WORKING PAPER FOR
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
January 2, 2011
Adjustment &
Elimination Entries Consolidated
P Co. S Co. Debit Credit Financial Position
Cash and other current assets 100,00020,000 220,000
Plant Assets 70,000 50,000 50,000 170,000
Investment in Stocks of S Co. 150,000* 150,000
Total 320,000 170,000 390,000

Liabilities 140,000 70,000 210,000

Share Capital, par P100 125,000 75,000 75,000 125,000
Share Premium 30,000 10,000 10,000 30,000
Retained Earnings 25,000 15,000 15,000 25,000
Total Liabilities & SHE 320,000 170,000 150,000 150,000 390,000

The investment account* in the first money column shows in one line the right of the
parent over the assets and liabilities of the subsidiary company. Hence, it is called a one-
line consolidation. In a full consolidation shown in the last money column, since the
subsidiary's assets and liabilities are to be combined item by item the investment account
should be eliminated otherwise there will be a duplication. Removing the investment
account requires the removal of the reciprocal account in the books of the subsidiary which
is the Shareholders' Equity accounts. Note that the plant assets were increased by P50,000
in compliance with the rule that assets and liabilities of the subsidiary company should be
measured and recognized at fair value.

Take note of the working paper adjustment and elimination entry:

Share Capital, S Co 75,000
Share Premium, S Co. 10,000
Retained Earnings, S Co. 5,000
Land 50,000
Investment In Stocks of S Co. 150,000

The consolidated financial position will appear, thus:

P CORPORATION AND SUBSIDIARY S CORPORATION
CONSOLIDATED FINANCIAL POSITION
January 2, 2011
ASSETS LIABILITIES & SHAREHOLDERS' EQUITY
Cash & Other Current Assets P220,000 Liabilities P210,000
Plant Assets 170,000 Share Capital, par P100 125,000
Share Premium 30,000
Retained Earnings 25,000
TOTAL ASSETS P390,000 TOTAL LIABILITIES & SHE P390,000

The following rules should be observed in the preparation of the working paper:
1. The adjustments and elimination entries are not entered in either the parent's or
subsidiary's records, but are simply working paper entries.
2. The shareholders' equity of the parent appears in the consolidated shareholders' equity
while the shareholders' equity of the subsidiary for the parent's share (which is 100%) is
eliminated.
3. Adjusting the plant asset at the fair market value is not recorded in the books of the
subsidiary but only in the working paper unless you use push down accounting. The assets
and liabilities are combined line by line except for the reciprocal accounts that should be
eliminated. Thus, the consolidated financial position presents financial information about
the group as though it were a single enterprise.
DETERMINING SUBSIDIARY'S VALUE
Recall that in the preceding chapter the premium price to be paid as consideration for the
net assets acquired could be determined based on the quoted prices of the assets and
liabilities in the active market or if there is none, based on the quoted prices of similar
assets and liabilities in the active market. In the absence of quoted prices, another recourse
would be to determine the estimated cash flows that these assets will generate in the future
and then discount these to their present value. In this chapter, since acquisition is in the
form of shares of stocks, the quoted market price of the shares of the subsidiary company
would be the most appropriate basis in determining the financial value of the firm as well
as the basis for the consideration to be given by the parent company.

REVALUATION OF ASSETS
Assets and liabilities should be consolidated based on their fair values (as required
in PFRS 3) for all types of business combinations. In this chapter, parent company obtains
control over another company even if it purchases less than 100% interest. Be that as it
may, following the economic entity theory that the firm is one economic enterprise hence
revaluation of assets must be at 100%. This way, both controlling and non-controlling
interests share in the revaluation of assets. This is also defended on the ground that the
consideration given for the majority shares acquired by the parent is the best overall
indicator of the value of the subsidiary company as a whole. It is likewise defended on the
ground that there is consistency in valuing the firm when its assets and liabilities are
valued in its entirety.

ILLUSTRATION 2. PARTIAL OWNERSHIP INTEREST, CONSIDERATION EQUAL TO FAIR

VALUE OF SUBSIDIARY INTEREST ACQUIRED
The following are the statements of financial position of P Co.and S Co. as of January
2, 2011, just after P Co. acquired 80% of the stocks of S Co. for P100,000.
P Co. S Co.
Cash and Other Current Assets P 150,000 P 120,000
Plant Assets 70,000 50,000
Investment in Stock of S Co. 100,000
Total Assets P 320,000 P 170,000

Liabilities P 140,000 P 70,000

Share Capital 125,000 75,000
Share Premium 30,000 10,000
Retained Earnings 25,000 15,000
Total Liabilities & Stockholders' Equity P 320,000 P 170,000
 A review of the assets of S Co shows that these are at fair values except for the plant
assets which should be P75,000. A table should be prepared to determine goodwill or gain.
Table For Determination and Allocation of Excess:
S Co. Controlling Non-Controlling
Total Value Interest Interest (NCI)
100% 80% 20%
Consideration and Implied Value P125,000 P100,000 P 25,000
Subsidiary interest (book value) (100,000) ( 80,000) (20,000)
Excess P 25,000 P20,000 P 5,000
Plant Asset Revalued (75,000-50,000) ( 25.000) (20,000) (5,000)

The implied value of the firm is based on the consideration given by the parent
company: P100,000/80%= P125,000. Take note on how the share of the parent
(controlling interest) and share of the other subsidiary stockholders called non-controlling
interest are determined and that the plant assets must be revalued at the total amount and
shared by both parent and NCI.

The working paper will appear as follows:

P CORPORATION AND SUBSIDIARY S CORPORATION
WORKING PAPER FOR CONSOLIDATED FINANCIAL POSITION
January 2, 2011

Adjustments & Non- Consolidated

Eliminations Controlling Financial
P Co. S Co. Debit Credit Interest Position

Cash 150,000 120.000 270,000

Plant Assets 70,000 50,000 25,000 145,000
Investment in Stocks of S Co. 100,000 100,000
Total Assets 320,000 170,000 415,000
Liabilities 140,000 70,000 210,000
Share Capital, par 100 125,000 75,000 60,000 15,000 125,000
Share Premium 30,000 10,000 8,000 2,000 30,000
Retained Earnings 25,000 15,000 12,000 3,000 25,000
Share of NCI in Asset Rev 5,000 5,000
20% Non-Controlling Interest 25,000 25,000
Total Liabilities & SHE 320,000 170,000 105,000105,000 - 415,000

The following additional rules must be observed in the preparation of the working paper:
1. The non-controlling interest must reflect the same figures as shown in the table
presented before the working paper.
2. The shareholders' equity of the parent appears in the consolidated shareholders' equity
while the shareholders' equity of the subsidiary is eliminated.
3. Note that this time not all of the shareholders' equity of S Co. were eliminated because
controlling interest is only 80%. Non-controlling interest is retained in the consolidated
shareholders' equity for the remaining 20% or P25,000. 4. Assets should be revalued at
100% to be shared 80% and 20% by the parent and its subsidiary.
5. The assets and liabilities of the subsidiary are combined 100% even if the percent of
ownership of the parent is only 80. The portion not belonging to the parent is represented
by the title non-controlling interest. It means that P25,000 of the net assets of P125,000
(195,000-70,000) belongs to the non-controlling interest.
Note that the share of the parent in the consolidated assets and liabilities is
P180,000 (415,000-210,000- P25,000). This is the same as the parent's separate net assets
of P180,000 (320,000-140,000), including the one line consolidation represented by the
title Investment in Stocks of S Co of P100,000, found in the first money column. Another
proof is the parent's stockholders' equity which is also P180,000. It proves that the full
consolidation and the one line consolidation give the same result except that there is a
difference in the arrangement or presentation.

The consolidated statement of financial position will appear, thus:

P CORPORATION AND SUBSIDIARY S CORPORATION
CONSOLIDATED FINANCIAL POSITION
January 2, 2011
ASSETS LIABILITIES & STOCKHOLDERS'
EQUITY
Cash & Other Current Assets P270,000 Liabilities P210,000
Plant Assets 145,000 Shareholders' Equity:
Share Capital, par P100 P125,000
Share Premium 30,000
Retained Earnings 25,000
Controlling Interest 180,000*
Non-Controlling Interest 25,000
TOTAL LIABILITIES &
TOTAL ASSETS P415,000 STOCKHOLDERS' EQUITY P 415,000
*Note how the shareholders' equity is presented with two equity accounts: controlling
interest and non-controlling interest.

The adjustment and elimination entry appears in the working paper as follows:
Share Capital, S Co. 60,000
Share Premium 8,000
Retained Earnings, S Co. 12,000
Plant Assets of S Co 25,000
Investment in Stocks of S Co. 100,000
Share of NCI in Asset Revaluation 5,000
To eliminate P's share and recognize revaluation in plant assets.

Share Capital, S Co. 15,000

Share Premium 2,000
Retained Earnings, S Co. 3,000
Share of NCI in Asset Revaluation 5,000
Non-Controlling Interest 25,000
To set up share of non-controlling interest.

Alternatively, a compound entry may be prepared:

Share Capital, S Co. 75,000
Share Premium 10,000
Retained Earnings, S Co. 15,000
Plant Assets of S Co 25,000
Investment in Stocks of S Co. 100,000
Non-Controlling Interest 25,000

In which case the working paper will appear as follows:

WORKING PAPER FOR CONSOLIDATED FINANCIAL POSITION
January 2, 2011
Adjustments & Non- Consolidated
 Eliminations Controlling Financial
P Co. S Co. Debit Credit Interest Position

Cash 150,000 120.000 270,000

Plant Assets 70,000 50,000 25,000 145,000
Investment in Stocks of S Co. 100,000 100,000
Total Assets 320,000 170,000 415,000
Liabilities 140,000 70,000 210,000
Share Capital, par 100 125,000 75,000 75,000 125,000
Share Premium 30,000 10,000 10,000 30,000
Retained Earnings 25,000 15,000 15,000 25,000
20% Non-Controlling Interest 25,000 25,000 25,000
Total Liabilities & SHE 320,000 170,000 100,000 100,000 415,000

I prefer to use the first method in preparation for the working paper post
acquisition date which is the topic for discussion in the next module.
RECOGNITION OF GOODWILL
The preceding illustrations showed the equity over the subsidiary company equal to
the consideration given. If the consideration is more than the fair value of the subsidiary
interest acquired, goodwill from the business combination should be recognized. Goodwill
is recognized both for the parent and the other subsidiary shareholders (in case of partial
interest). Again, the implied value of the subsidiary may be based on the consideration
given by the Parent. Appropriate value of the subsidiary however is based on fair market
value of its stock.
RECOGNITION OF GAIN ON BARGAIN PURCHASE
When the subsidiary interest is greater than the consideration given by the Parent,
the excess is recognized as a gain. In this case, the value of the firm follows the fair value of
the subsidiary interest. Unlike goodwill and asset revaluation which are recognized at
100%, gain is only recognized for the parent"
VALUATION OF NON-CONTROLLING INTEREST
Note that non-controlling interest may be valued three ways:
1. Fair value is given
2. Fair value is computed using the consideration transferred by the parent less control
premium divided by the % acquired by the parent, then multiply it by the non-controlling
interest %.
3. Proportionate share of non-controlling interest
DISCLOSURES
The following disclosures shall be made as part of the consolidated financial
statements:
a) the number of subsidiaries being consolidated and the ownership percentages in
each.
b) the nature of the relationship between the parent and a subsidiary when the
parent does not own, direct or indirectly through subsidiaries, more than half of the voting
power;
c) the reasons why the ownership, directly or indirectly, through subsidiaries, when
suchfinancial statements are used to prepare consolidated financial statements and are as
of a reporting date or for a period that is different from that of the parent, and the reason
for using a different reporting date or period;
d) the reporting date of the financial statements of a subsidiary when such financial
statements are used to prepare consolidated financial statement and are as of a reporting
date or for a period that is different from that of the parent, and the reason for using a
different reporting date or period; and
e) the nature and extent of any significant restrictions on the ability of subsidiary to
transfer funds to the parent in the form of cash dividends or repayment of loans and
advances.
When separate financial statements are prepared the following information should
be disclosed:
a) the fact that the financial statements are separate financial statements and that
exemption from consolidation has been used; name and country of incorporation or
residence of the acquirer who prepared the consolidated reports according to PAS and the
address where consolidated reports are obtainable;
b) a list of significant investments in subsidiaries, jointly controlled entities and
associates including the name, country of incorporation or residence, ownership interest
and, if different, proportion of voting power held; and
c) description of the method used for accounting investment listed under b) above.
4. Progress Check
a. Understand the reasons for consolidation
b. Identify parent-subsidiary relationship
c. Identify the scope of control
d. Enumerate the requirements for consolidation
e. Understand and apply consolidation procedures
f. Prepare consolidated financial statements

5. Assignment
1) What is the appropriate title for a company that is organized for the sole purpose of
holding shares of stock of subsidiary companies?
 2) For expansion purposes, why is the acquisition of stocks preferable over the
acquisition
of net assets whether under the merger form or consolidation form?
3) Why are consolidated financial statements of affiliated companies prepared?
4) Define the following terms: control, consolidation, subsidiary, parent, affiliates, non-
controlling interest.
5)What is the presumption when a company owns 20% to 50% shares of stock of
another company. How are the constituent parties called? What accounting method is
appropriate?
6) What is the presumption when a company owns more than 50% shares of stock of
another company and how are the constituent parties called? What accounting method is
appropriate?
7) Why must the investment account be eliminated when consolidating subsidiary
company's financial statements with the parent company's financial statements?
8) Is there a difference between the shareholders' equity of the parent company and
the consolidated shareholders' equity?
9) How is the implied value of the firm determined? What is the implication in the
valuation of the firm when the consideration is higher than the value of the subsidiary
interest acquired? And when the subsidiary interest acquired is higher than value of the
consideration given?
10) What is the accounting treatment, in the parent's separate financial statements, for
investments in the common stock of a subsidiary included in the consolidated financial
statements?
11) Explain why the identifiable assets and liabilities consolidated in full regardless of
the percent of ownership of the parent company over the subsidiary's net assets?
12) What is the rule in consolidating the stockholders' equity of a parent company and a
partially owned subsidiary company? Will the subsidiary's stockholders' equity be totally
eliminated?

6. Evaluation

Consolidation at Date of Acquisition

The financial statements of Parent Company and Subsidiary Company as of December 31,
2008 are shown below:

Parent Fair value Subsidiary Fair Useful

value Life
Cash P 8,000 P 6,000 P 1,000 P
1,00
 0
Receivables 4,000 4,000 3,000 3,00
0
Inventory 3,000 3,500 2,000 2,50
0
Land 8,000 10,000 6,000 8,00
0
Building, net 10,000 10,000 5,000 6,00 10
0 years
Equipment, net 6,000 7,000 3,000 2,00 4
0 years
Total assets P 39,000 P 20,000

Payables P 20,000 20,000 P 5,000 5,00

0
Ordinary shares 15,000 10,000
Share premium 2,000 3,000
Retained earnings 2,000 2,000
Total liabilities and P 39,000 P 20,000
equity

On January 1, 2009, Parent Company purchased 80% of Subsidiary by issuance of P10,000

par value shares with P15,000 fair value. Stock issue costs on the issuance were 500. Direct
acquisition costs were P1,000 while indirect acquisition cost were P500. Both Parent and
Subsidiary uses FIFO method for inventories. The non-controlling interest has fair value of
P5,000.

Required: Prepare a consolidated statement of financial position as of the date of

acquisition.

E. References
1. Manuel, Z.V. (2016). Advanced Accounting. Manila, Philippines: Zenaida Manuel
2. Advanced Financial Accounting and Reporting review materials by Wency Giron
 Module 7 & 8

F. Course Code – Title : C-APrE7 Accounting for Business Combinations

G. Module No – Title : MO 7 & 8 – Consolidation at Subsequent Date
H. Time Frame : 2 weeks - 6 hours
I. Materials : Syllabus, Learning Plan, Curriculum Map, Writing
Materials, Accounting Standards and Books.
7. Overview
In the preceding module, a discussion was made on how to consolidate the
statement of financial position of the affiliates at acquisition date. This module will discuss
the effects of the subsidiary company's transactions on the parent's investment account
post acquisition date. It will also discuss the procedures for consolidating not only the
statement of financial position but also the statement of income and the statement of
retained earnings of the affiliates. The preparation of consolidated financial statements
after the acquisition date poses a complication because of two factors - the time that
elapsed from acquisition date to the next consolidation date and the investor's method of
accounting for stock investments.
2. Desired Learning Outcomes
At the end of the learning session, you should be able to:
a. Differentiate equity method from cost method
b. Account for investments under equity and cost method
c. Understand the purpose of preparing working paper
d. Understand the procedures in preparing consolidated financial
statements subsequent to acquisition date
e. Apply the accounting concepts pertaining consolidation

3. Content/Discussion

EQUITY METHOD AND COST METHOD COMPARED

The standard states that in a parent's separate or secondary financial statements,
investments in subsidiaries, associates and in other controlled entities should be either
carried at cost or in accordance with IAS 39, Financial Instruments: Recognition and
Measurement. However, the equity method is required when preparing consolidated
financial statements (considered primary reports) unless the parent is exempted from
doing so, or the investment is held for sale in accordance with PFRS 5 or unless significant
influence over the associate is lost.
 Equity Method. This method recognizes initially the investment of the parent
company at cost and adjusts it subsequently for its share in the net profit earned or net loss
incurred and dividends received from the subsidiary company. It also takes into
consideration adjustments (depreciation, amortization, cost of sales) for assets that were
revalued at acquisition date, unless the revaluations at acquisition date were already
recorded by the subsidiary (using push down accounting). Additionally, in its income
statement, the parent recognizes another account: Income Over Subsidiary.
Cost Method. This method records the investment at cost on acquisition date and
maintains it at that amount notwithstanding changes in financial position brought about by
the income earned or loss incurred by the subsidiary. The investment cost is affected only
by changes in the investment made by the parent when it purchases additional shares or
disposes its shares over the subsidiary company.

ILLUSTRATION 1. ACCOUNTING FOR INVESTMENT USING THE EQUITY METHOD AND

THE COST METHOD
P Company acquired 8,000 of the voting common shares of S Company and paid
P185,000 in cash. The shareholders' equity of S Company on this date, January 1, 2010,
consisted of the following:

Share Capital, P10 par P100,000

Share Premium 50,000
Retained Earnings 60,000
Total P210,000

Assets are fairly valued on January 1, 2010 and S Company reported net income at
year end of P30,000, declared and paid on Dec. 1, 2010 P25,000 dividends. The balance of
the investment account on December 31, 2010 will depend on the method used:

Investment in S Company: Equity Method Cost Method

Jan. 1 Acquisition P185,000 P185,000
Dec. 1 Dividends received (80% of P25,000) (20,000)
Dec. 31 Share in net income (80% x P30,000) 24,000
Dec. 31 Balance P189,000 P185,000
Income from Subsidiary:
Dec. 31 Share in net income (80% x P30,000) P24,000
Dividends (80% x P25,000) P20,000
Journal entries that will appear on P Company's book are as follows:

Equity Method Cost Method

Investment in Stocks, S Co. 185,000 Investment in Stocks, S Co. 185,000
Cash 185,000 Cash 185,000
-Acquired 80% S Co shares.

Cash 20,000 Cash 20,000

Investment in Stocks, S Co 20,000 Dividends Income 20,000
-Dividends received from S

Investment in Stocks, S Co 24,000 No entry

Income from Subsidiary 24,000
-To record share in S Co net income.

Under the equity method, the parent recognizes the Income from Subsidiary which
has a balance of P24,000. The Investment account has an ending balance of P189,000.
Under the cost method, the parent company recognizes Dividend Income of
P20,000. The investment balance remains the same at P185,000. Had dividends been more
than the net income earned by S Company, say P40,000, then the entry of P Company under
the cost method would have been:
Cash (80% x 40,000) 32,000
Dividend Income (80% x 30,000) 24,000
Investment in S Company Stocks 8,000

Since only 80% of P30,000 or P24,000 was earned by P Company on S Company

income of P30,000 but the dividend share is 80% of P40,000 or P32,000, the difference is
recorded as a return of investment. This poses no problem under the equity method, since
dividends received are considered as return of investment and always credited to the
investment account.

Adjustment and elimination entries for purposes of consolidation will appear thus:

Equity Method Cost Method

1) Income from Subsidiary 24,000* Dividend Income 20,000**
Dividends, S Co. 20,000 Dividends, S Co 20,000
 Investment in Stocks S Co 4,000
2) Share Capital, S Co. 80,000 Share Capital, S Co. 80,000
Share Premium, S Co. 40,000 Share Premium, S Co. 40,000
Retained Earnings, $ Co. 48,000 Retained 'Earnings, S Co. 48,000
Goodwill 21,250 Goodwill 21,250
Investment in Stocks, S Co. 185,000 Investment in Stocks, S Co. 185,000
Share of NCI in Goodwill 4,250 Share of NCI in Goodwill 4,250
3) Share Capital, S Co. 20,000 Share Capital, S Co. 20,000
Share Premium, 10,000 Share Premium, S Co. 10,000
S Co. Retained Earnings, 13,000 Retained Earnings, S Co. 13,000
S Co. Share of NCI in Goodwill 14,250 Share of NCI in Goodwill 4,250
Non-Controlling Interest 47,250 Non-Controlling Interest 47,250

Note that the difference between the two methods lies only in the first entry where the
*income from subsidiary is debited under the equity method while **dividend income is
debited under the cost method. The income account and the dividend share are eliminated
under both methods. Under the equity method, recall that the investment account has a
balance of P189,000 at the end of the year. This is reduced by P4,000 (refer to first entry)
representing the amount of change between the beginning balance and the ending balance.
It retroacts to its original balance of P185,000. Under the cost method the investment
account is still P185,000 even at the end of the year.
The second and third entries are the same for both methods. These are also the
adjustment and elimination entries prepared at acquisition date. Table for determination
and allocation of excess to support this will show the following:
Controlling Non-Controlling
Total Value Interest 80% Interest 20%
Consideration and Implied Value P231,250 P185,000 P46,250
Subsidiary Interest 210,000 168,000 42,000
Goodwill P 21,250 P17,000 P 4,250

This is similar to the table prepared at acquisition date. Even on a subsequent date
(one year after), the table for determination and allocation of excess is still important and
should be prepared. See to it that the investment account is a zero balance (after the second
entry). For consolidation purposes, the cost method should give the same results as the
equity method.
ILLUSTRATION 2. WORKING PAPER FOR CONSOLIDATION UNDER THE EQUITY
METHOD Using illustration 1, the following are the trial balance of the parent and
subsidiary as at the end of the year December 31, 2010:
 P Corporation S Corporation
Cash & Other Current Assets P 150,000 P 60,000
Machinery and Equipment (net) 400,000 185,000
Investments in Stocks, S Co 189,000* -
Cost of Sales 100,000 75,000
Operating Expenses 50,000 30,000
Dividends 10,000 25,000
P 899,000 P 375,000

Liabilities 90,000 30,000

Share Capital, par P100 500,000 100,000
Share Premium - 50.000
Retained Earnings 60,000 60,000
Sales 225,000 135,000
Income from Subsidiary 24,000* -
P 899,000 P 375,000

The working paper for consolidation, under the equity method will appear, thus:
P COMPANY AND SUBSIDIARY S COMPANY
Working Paper for Consolidated Financial Statements
December 31, 2010

Adjustment & NCI

Elimination Entries
INCOME STATEMENT P Co. S Co. Debit Credit Consolidated
Sales 225,000 135,000 360,000
Cost of Sales 100,000 75,000 175,000
Gross Profit 125,000 60,000 185,000
Expenses 50,000 30,000 80,000
Net Operating Income 75,000 30,000 105,000
Equity in S Co. Income 24,000 ________ 1)24,000 __________
Consolidated Net Income 105,000
Share of NCI in Net Income 6,000 6,000
Net income carried forward 99,000 30,000 6,000 99,000

RETAINED EARNINGS
Balance, Jan 01 – P Co. 60,000 60,000
 S Co. 60,000 2) 48,000 12,000
Net income 99,000 30,000 6,000 99,000
159,000 90,000 18,000 159,000
Dividends declared & paid
P Co. 10,000 10,000
S Co. ________ 25,000 1)20,000 5,000 _________
Balance, Dec 31 149,000 65,000 13,000 149,000

FINANCIAL POSITION
Cash & Other Current Assets 150,000 60,000 210,000
Plant & Equipment 400,000 185,000 585,000
Inv. In Stocks of S Co. 189,000 1)4,000
2)185,000
Goodwill _________ __________ 2)21,250 21,250
Total 739,000 245,000 816,250

Liabilities 90,000 30,000 120,000

Share Capital 500,000 100,000 2)80,000 20,000 500,000
Share Premium 50,000 2)40,000 10,000
Retained Earnings 149,000 65,000 13,000 149,000
NCI Share in GW 2)4,250 4,250
NCI 47,250 47,250
Total 739,000 245,000 213,250 213,250 816,250

The following are worth noting in the preparation of the working paper for consolidation
under the equity method:
a) The working paper is under the financial statement format consisting of three layers:
income statement, retained earnings, and the statement of financial position.
b) The first two money columns refer to the individual financial statements of the parent
company and the subsidiary company.
c) The next two money columns refer to the adjustment and elimination entries.
d) The net income reported by the parent company in the first money column which is
P99,000 is also the consolidated net income in the last money column. Take note of the
Income from Subsidiary which in one line represents the subsidiary's net income. This is
called a one-line consolidation. When the income statement items are to be combined
item by item, then Income from Subsidiary should be eliminated or else there will be a
duplication of net income in the consolidated column. The last money column shows a full
consolidation where the subsidiary's revenues and expenses are consolidated item per
item with that of the parent company. Either we retain the Income from Subsidiary as a one
line consolidation of subsidiary's net income (parent's separate income statement) or drop
this and combine the revenues and expenses item by item (consolidated income
statement).
e) Since there is only a partially owned interest, not all of the consolidated income belongs
to the parent company. The non-controlling interest column shows the share of the
subsidiary's other shareholders in the net income which is presented and brought forward
to the last money column as a deduction from total consolidated net income to come up
with share of the parent in the consolidated net income.
f) Note that the items presented in the parent's, separate retained earnings statement are
also the items presented in the consolidated retained earnings statement. The share of the
parent in the shareholders' equity of the subsidiary is eliminated and the balance is
retained as non-controlling interest.
g) The shareholders' equity of the parent in the first money column is also the consolidated
figures in the final money column.
h) The subsidiary company's total shareholders' equity is not 100% eliminated because it
is not wholly owned by the parent company, 20% is extended to the non-controlling
interest column and consolidated column.
Presentation of Consolidated Income Statement
The amendment requires, for transparency purposes, that the amount of
consolidated net income attributable to the parent and to the non-controlling interest be
clearly identified and presented on the face of the consolidated statement of income.
Consolidated net income is the result after combining the revenues and expenses, item by
item, from which the share of the non-controlling interest is deducted to arrive at the share
of the controlling interest.
Attribution of Loss
Non-controlling interest continues to be attributed its share of losses even if that
attribution results in a deficit non-controlling interest balance. In contrast, before the
amendments made by the standard, when the share in losses applicable to the minority
interest (now called non-controlling interest) exceeds the minority interest in the equity
capital of the subsidiary, such excess and any further losses applicable to the minority
interest were charged against the majority interest (now called controlling interest).

ILLUSTRATION 3. WORKING PAPER FOR CONSOLIDATION (COST METHOD)

Using illustration 2 but assume that the trial balance of the parent and the
subsidiary as at Dec. 31, 2010 appears as follows:
P Corporation S Corporation
Cash & Other Current Assets P 150,000 P 60,000
Machinery and Equipment (net) 400,000 185,000
Investments in Stocks, S Co 185,000 -
Cost of Sales 100,000 75,000
Operating Expenses 50,000 30,000
Dividends 10,000 25,000
P 895,000 P 375,000

Liabilities 90,000 30,000

Share Capital, par P100 500,000 100,000
Share Premium - 50.000
Retained Earnings 60,000 60,000
Sales 225,000 135,000
Dividend Income 20,000 -
P 895,000 P 375,000

The working paper for consolidation, under the equity method will appear, thus:
P COMPANY AND SUBSIDIARY S COMPANY
Working Paper for Consolidated Financial Statements
December 31, 2010

Adjustment & NCI

Elimination Entries
INCOME STATEMENT P Co. S Co. Debit Credit Consolidated
Sales 225,000 135,000 360,000
Cost of Sales 100,000 75,000 175,000
Gross Profits 125,000 60,000 185,000
Expenses 50,000 30,000 80,000
Net Operating Income 75,000 30,000 105,000
Equity in S Co. Income 20,000 ________ 1)20,000 __________
Consolidated Net Income 105,000
Share of NCI in Net Income 6,000 6,000
Net income carried forward 95,000 30,000 6,000 99,000

RETAINED EARNINGS
Balance, Jan 01 – P Co. 60,000 60,000
 S Co. 60,000 2) 48,000 12,000
Net income 95,000 30,000 6,000 99,000
159,000 90,000 18,000 159,000
Dividends declared & paid
P Co. 10,000 10,000
S Co. ________ 25,000 1)20,000 5,000 _________
Balance, Dec 31 145,000 65,000 13,000 149,000

FINANCIAL POSITION
Cash & Other Current Assets 150,000 60,000 210,000
Plant & Equipment 400,000 185,000 585,000
Inv. In Stocks of S Co. 185,000 1)185,000
Goodwill _________ __________ 2)21,250 21,250
Total 739,000 245,000 816,250

Liabilities 90,000 30,000 120,000

Share Capital 500,000 100,000 2)80,000 20,000 500,000
Share Premium 50,000 2)40,000 10,000
Retained Earnings 145,000 65,000 13,000 149,000
NCI Share in GW 2)4,250 4,250
NCI 47,250 47,250
Total 735,000 245,000 209,250 209,250 816,250

Under the cost method, the net income of the parent in its separate income
statement is not the same amount as the consolidated net income because this method
lacks the one line consolidation feature. The retained earnings of the parent in its separate
retained earnings statement is not also the same as the consolidated retained earnings. The
consolidated financial statements in the last money column (refer to illustration 2) are the
same (as in this illustration) whether you use the equity method or the cost method.
ILLUSTRATION 4. CONSOLIDATION TWO YEARS AFTER ACQUISITION
(EQUITY METHOD) To continue with illustration 2, assume that at the end of December 31,
2011, S Company earned P50,000 and declared dividends of P30,000. The following will be
the entries of P Company in its books using the equity method:
2011 Investment in Stocks, S Co 40,000
Income from Subsidiary 40,000
-80% share in S Co. net income.

Cash 24,000
Investment in Stocks, S Co 24,000
 -80% share in S Company dividends.

Balance of the Investment Account will be (P189,000 + 40,000 - 24,000) P205,000, while
the Income from Subsidiary will be P40,000. Eliminating entries in the working paper will
appear thus:
Income from Subsidiary 40,000
Dividends, SCO 24,000
Investment in Stocks, S Co 16,000
(Again, eliminate the income account and the dividends received from S Company.
Reduce the investment account by the amount of change brought about by the subsidiary
transactions during the year. Note that after this entry, the investment balance will retroact
as of December 31, 2010 in the amount of P189,000).
Share Capital, S Company 80,000
Share Premium, S Company 40,000
Retained Earnings, S Company* 52,000
Goodwill* 21,250
Investment in Stocks, S Co. 189,000
Share of NCI in GW 4,250

Share Capital, S Company 20,000

Share Premium, S Company 10,000
Retained Earnings, S Company* 13,000
Share of NCI in Goodwill 4,250
Non-Controlling Interest 47,250

Since the investment account to be eliminated is as of December 31, 2010, the other
accounts* should also be as at December 31, 2010. Share Capital and Share Premium will
still be the same since there were no additional stock transactions during 2010. Retained
Earnings changed to P65,000 because of the 2010 net income and dividends. The non-
controlling interest must be of the same balance as that of December 31, 2010 (refer to
illustration 2). NCI at the end of the year will change because of the 2011 net income and
dividend share:
January 1, 2011 P47,250
Net income (50,000 x 20%) 10,000
Dividends (30,000 x 20%) (6,000)
December 31, 2011 P51,250
ILLUSTRATION 5. CONSOLIDATION TWO YEARS AFTER ACQUISITION DATE (COST
METHOD)
Under the cost method, the additional entry of the parent company on December 31,
2011 will only be as follows:

Cash 24,000
Dividend Income 24,000
-80% share in S Co. dividends.

This time, however, four adjustments and elimination entries will be prepared
against the three entries prepared in 2010:
1) Dividend Income 24,000
Dividend, S Co 24,000

2) Investment in Stocks, S Co 4,000

Retained Earnings 4,000

(The 2nd entry updates the investment account for the difference between the
Dividend Income reported in the first year of P20,000 against the Income from Subsidiary
of P24,000. This is a retroactive adjustment from cost to equity so that Investment becomes
P189,000)
3) Share Capital, S Company 80,000
Share Premium, S Company 40,000
Retained Earnings, S Company 52,000
Goodwill 21,250
Investment in Stocks of S Company 189,000
Share of NCI in Goodwill 4,250

4)Share Capital, S Company 20,000

Share Premium, S Company 10,000
Retained Earnings, S Company 13,000
Share of NCI in Goodwill 4,250
Non-Controlling Interest 47,250
(Note that the two last entries are the same under both methods).
 4. Progress Check
a. Differentiate equity method from cost method
b. Account for investments under equity and cost method
c. Understand the purpose of preparing working paper
d. Understand the procedures in preparing consolidated financial
statements subsequent to acquisition date
e. Apply the accounting concepts pertaining consolidation
5. Assignment
1. Explain how the parent accounts for investment in stocks carried under the
equity method.
2. What are the basic accounting differences between the equity method and the
cost method in accounting for investment in stock?
3. What is Income from Subsidiary and why must this be eliminated when preparing
consolidated income statement?

6. Evaluation
Using the problem given in the Module 5 and 6 (Evaluation), answer the following problem:
Consolidation Subsequent to Date of Acquisition (no inter-company transactions)
During 2009, there is no inter-company transaction between the two companies except for
dividends declared by the subsidiary. As of December 31, 2009, the financial statements of
the two companies are shown below:

Balance sheet as of Parent Subsidiar

12/31/2009 y
Cash P 2,000 P 3,500
Receivables 7,500 6,500
Investment in subsidiary 15,000 -
Inventory 4,500 6,000
Land 8,000 6,000
Building 10,800 4,500
Equipment 4,800 2,500
Total assets P 52,600 P 29 ,000

Payables P 16,100 P 14,000

Ordinary shares 25,000 10,000
Share premium 6,500 3,000
Retained earnings 5,000 2,000
Total liabilities and P 52,600 P 20,000
equity

2009 Income Parent Subsidiar

Statement y
Sales P 50,000 P 20,000
Less: cost of sales 30,000 14,000
Gross Profit P 20,000 P 6,000
Dividend income 2,000 -
Less: Expenses 15,000 5,000
Profit P 7,000 P 1,000

Required: Prepare consolidated financial statement on December 31, 2009.

J. References
3. Manuel, Z.V. (2016). Advanced Accounting. Manila, Philippines: Zenaida Manuel
4. Advanced Financial Accounting and Reporting review materials by Wency Giron