Accounting for Business CombinationsInvestments and AcquisitionsAgendaInvestments in the Stock of Other CompaniesEquity Investment Accounting RationaleSignificant Influence  Equity MethodEquity Investment Journal Entries – For The Investing CompanyControl  Consolidation MethodConsolidation Method: Initial purchaseConsolidation Method: Initial purchaseConsolidation Method: Initial purchaseConsolidation Method: Initial purchaseConsolidation Method: Initial purchaseConsolidation Method: Initial purchaseIntuition Behind Consolidation MethodSchematic of a 100% AcquisitionConsolidation: Post-purchase EventsConsolidation: Post-purchase EventsConsolidation: Post-purchase EventsConsolidation: Post-purchase Events<100% AcquisitionConsolidation Method when Price ≠ FV ≠ BVConsolidation: Initial purchase100% Purchase and Price ≠ FV ≠ BVConsolidation: Initial purchase100% Purchase and Price ≠ FV ≠ BVConsolidation: Initial purchase100% Purchase and Price ≠ FV ≠ BVConsolidation: Initial purchase100% Purchase and Price ≠ FV ≠ BVWhat Happens To Goodwill in Subsequent Years?Goodwill ImpairmentGoodwill impairment chargesIssues In Goodwill AccountingOverall Idea Behind Consolidation AdjustmentsSummary1Accounting for Business Combinations15.501/516 AccountingSpring 2004Professor S. RoychowdhurySloan School of ManagementMassachusetts Institute of TechnologyApril 26, 20042Investments and AcquisitionsAgenda¾ Understand that the accounting method used for acquisitions depends on the extent to which the investor exerts influence over the investee.¾ Understand the effects of dividends received and investee income on the financial statements of the investor under the equity method.¾ Understand the effects of consolidated accounting on the balance sheet and income statement of the investor.Investments in the Stock of Other Companies3¾ The accounting method for stock investments depends on the degree of influence the investing company has on the decisions of the investee.¾ Three methods of accounting for this investment:Ownership: <20% 20-50% >50%Influence: “passive”“significant influence”“controlling”Reporting Method:Mark-to-marketEquity ConsolidationEquity Investment Accounting Rationale4¾For any company:Ending RE = Beginning RE + Net Income – Dividends¾Following the same logic =>Ending value of investment on investing company’s books =Beginning value of investment + investor’s share of investee’s net income – investor’s share of investee’s dividendsSignificant Influence Î Equity Method5¾ Assume the following events1. Purchase: Investor acquires 48,000 shares amounting to 40% of EECorporation for $10 per share2. Dividends: EE Corporation pays a dividend of $60,000 or 50 cents per share3. Affiliate earnings: EE Corporation Earns $100,000 in Net Income¾ Record these events on BSE of investor company.Long-termCash Investment R/E Comment1. Purchase (480,000) 480,0002. Dividends 24,000 (24,000) 40% × $60,0003. Aff. earnings 40,000 40,000 Investmentincome6Equity Investment Journal Entries – For The Investing Company¾ At the time of investment Dr Long Term Investments 480,000 Cr Cash 480,000¾ At the time of dividends payment Dr Cash 24,000 Cr Long Term Investments 24,000¾ At the time investee declares net income Dr Long Term Investments 40,000 Cr Investment income 40,000Control Î Consolidation Method7¾ When the investor controls the investee, The investor corporation = parent. The investee corporation = subsidiary. The parent prepares consolidated financial statements that treat the parent and the subsidiary as a single economic entity even though they are separate legal entities.¾ Consolidated financial reporting brings together multiple sets of financial records at the time of reporting to outsiders Each subsidiary maintains its own set of books that is independent of who owns it, whether it is one person/company or one million. Parent has its set of books pre-consolidation.Consolidation Method: Initial purchase8¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 $ 150Investment in S 500 150Liabilities 200 40 S. E. 300 110500 150Consolidation Method: Initial purchase9¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 390 $ 150Investment in S 110500 500 150Liabilities 200 40 S. E. 300 110500 150Consolidation Method: Initial purchase10¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 390 $ 150Investment in S 110500 500 150Liabilities 200 200 40 S. E. 300 300 110500 500 150Consolidation Method: Initial purchase11¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 390 $ 150 540Investment in S 110500 500 150Liabilities 200 200 40 240S. E. 300 300 110500 500 150Consolidation Method: Initial purchase12¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 390 $ 150 540 Investment in S 110 –110500 500 150Liabilities 200 200 40 240S. E. 300 300 110 –110500 500 150EliminatedConsolidation Method: Initial purchase13¾ P Co. acquires 100% of S Co.’s stock for $110 cash.¾ Assume the book value of S’s assets, liabilities, and shareholder’s equity equal their market value.P Co. P Co. Consolidatedpre-acq. post-acq. S Co.Adjustment P+S Cash, other assets $ 500 390 $ 150 540 Investment in S 110 –110 0500 500 150 540Liabilities 200 200 40 240S. E. 300 300 110 –110 300500 500 150 540EliminatedIntuition Behind Consolidation Method14¾ The effect of consolidation is to treat P’s