Consolidation (business)
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≠Consolidation is the act of merging many things into one. In business, it often refers to the mergers or acquisitions of many smaller companies into much larger ones. The financial accounting term of consolidation refers to the aggregated financial statements of a group company as consolidated account. The taxation term of consolidation refers to the treatment of a group of companies and other entities as one entity for tax purposes.
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[edit] Business Consolidations
[edit] Types of Business Consolidations
There are three forms of business combinations:
- Statutory Merger: a business combination that results in the liquidation of the acquired company’s assets and the survival of the purchasing company.
- Statutory Consolidation: business combination that creates a new company in which none of the previous companies survive.
- Stock Acquisition: a business combination in which the purchasing company acquires the majority, more than 50%, of the common stock of the acquired company and both companies survive.
- Amalgamation: Means an existing Company which is taken over by another existing company. In such course of amalgamation, the consideration may be paid in cash or in Kind, and the purchasing company servises in this process.
[edit] Common Terminology Used in Business Consolidations
- Parent-subsidiary relationship: the result of a stock acquisition where the parent is the acquiring company and the subsidiary is the acquired company.
- Controlling Interest: When the parent company owns a majority of the common stock.
- Non-controlling interest or Minority interest: the rest of the common stock that the other shareholders own.
- Wholly owned subsidiary: when the parent owns all the outstanding common stock of the subsidiary.
[edit] Accounting treatment
A company can acquire another company in two ways:
- By purchasing the net assets.
- By purchasing the common stock of another company.
Regardless of the method of acquisition direct costs, costs of issuing securities and indirect costs are treated:
- Direct costs: the acquiring company capitalizes direct costs paid to outside parties as part of the total acquisition cost.
- Costs of issuing securities: these costs reduce the issuing price of the stock.
- Indirect and general costs: the acquiring company expenses these costs as they are incurred.
- Purchase of Net Assets
- Treatment to the acquiring company:
When purchasing the net assets the acquiring company records in its books the receipt of the net assets and the disbursement of cash, the creation of a liability or the issuance of stock as a form of payment for the transfer.
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- Treatment to the acquired company:
The acquired company records in its books the elimination of its net assets and the receipt of cash, receivables or investment in the acquiring company (if what was received from the transfer included common stock from the purchasing company). If the acquired company is liquidated then the company needs an additional entry to distribute the remaining assets to its shareholders.
- Purchase of common stock
- Treatment to the purchasing company
When the purchasing company acquires the subsidiary through the purchase of its common stock, it records in its books the investment in the acquired company and the disbursement of the payment for the stock acquired.
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- Treatment to the acquired company:
The acquired company records in its books the receipt of the payment from the acquiring company and the issuance of stock.
FASB 141 Disclosure Requirements FASB 141 requires disclosures in the notes of the financial statements when business combinations occur. Such disclosures are: The name and description of the acquired entity and the percentage of the voting equity interest acquired. The primary reasons for acquisition and descriptions of factors that contributed to recognition of goodwill. The period for which results of operations of acquired entity are included in the income statement of the combining entity. The cost of the acquired entity and if it applies the number of shares of equity interest issued, the value assigned to those interests and the basis for determining that value. Any contingent payments, options or commitments. The purchase and development assets acquired and written off.
[edit] Reporting Intercorporate Interest – Investments in Common Stock
1. 20 % ownership or less:
When a company purchases 20% or less of the outstanding common stock, the purchasing company’s influence over the acquired company is not significant. (APB 18 specifies conditions where ownership is less than 20% but there is significant influence).
The purchasing company uses the cost method to account for this type of investment. Under the cost method, the investment is recorded at cost at the time of purchase. The company does not need any entries to adjust this account balance unless the investment is considered impaired or there are liquidating dividends, both of which reduce the investment account.
Liquidating dividends: Liquidating dividends occur when there is an excess of dividends declared over earnings of the acquired company since the date of acquisition. Regular dividends are recorded as dividend income whenever they are declared.
Impairment loss: An impairment loss occurs when there is a decline in the value of the investment other than temporary.
2. 20% to 50% ownership
When the amount of stock purchased is between 20% and 50% of the common stock outstanding, the purchasing company’s influence over the acquired company is often significant. The deciding factor, however, is significant influence. If other factors exist that reduce the influence or if significant influence is gained at an ownership of less than 20%, the equity method may be appropriate (FASB interpretation 35 underlines the circumstances where the investor is unable to exercise significant influence). To account for this type of investment the purchasing company uses the equity method. Under the equity method, the purchaser records its investment at original cost. This balance increases with income and decreases for dividends from the subsidiary that accrue to the purchaser.
Treatment of Purchase Differentials: At the time of purchase, purchase differentials arise from the difference between the cost of the investment and the book value of the underlying assets.
Purchase differentials have two components:
- The difference between the fair market value of the underlying assets and their book value.
- Goodwill: the difference between the cost of the investment and the fair market value of the underlying assets.
Purchase differentials need to be amortized over their useful life; however, new accounting guidance states that goodwill is not amortized or reduced until it is permanently impaired, or the underlying asset is sold.
3. More than 50% ownership
When the amount of stock purchased is 50% of the outstanding common stock, the purchasing company has control over the acquired company. Control in this context is defined as ability to direct policies and management. In this type of relationship the controlling company is the parent and the controlled company is the subsidiary. The parent company needs to issue consolidated financial statements at the end of the year to reflect this relationship. Consolidated financial statements show the parent and the subsidiary as one single entity. During the year, the parent company can use the equity or the cost method to account for its investment in the subsidiary. Each company keeps separate books. However at the end of the year a consolidation working paper is prepared to combine the separate balances and to eliminate the intercompany transactions, the subsidiary’s stockholder equity and the parent’s investment account. The result is one set of financial statements that reflect the financial results of the consolidated entity.
