Business, Legal & Accounting Glossary
Consolidation is a process that aggregates the total assets, liabilities and results of the parent and its subsidiaries (the group) in the consolidated financial statements.
In Law, this is the process of combining a number of different pieces of legislation into one document. For example, Acts of Parliament may be passed that specifically consolidate a number of earlier Acts. Note that this is subtly different from ‘codification’ (see: Codification) which is an attempt to write down general principles from the wealth of case law.
Consolidation or amalgamation 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 a 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. Under the Halsbury’s Laws of England, ‘amalgamation’ is defined as “a blending together of two or more undertakings into one undertaking, the shareholders of each blending company, becoming, substantially, the shareholders of the blended undertakings. There may be amalgamations, either by transfer of two or more undertakings to a new company, or to the transfer of one or more companies to an existing company”. Thus, the two concepts are, substantially, the same. However, the term amalgamation is more common when the organizations being merged are private schools or regiments.
There are three forms of business combinations:
Amalgamated Company is formed when in the process of amalgamation, the combined company is formed out of the transaction. The amalgamated company is otherwise called the transferee company. The company or companies, which merge into the new company, are called the transferor companies and, the company, into which the transferor companies merge, is known as the transferee company.
“Amalgamating company”: The company or companies, which are merged, are called the “amalgamating companies”. The amalgamating company or companies are also called the “transferor company/companies.”
A company can acquire another company in two ways:
Regardless of the method of acquisition direct costs, costs of issuing securities and indirect costs are treated:
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.
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.
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.
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.
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 — Associate Company
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:
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 – Subsidiary
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.
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This glossary post was last updated: 18th April, 2020 | 77 Views.