Question

Define acquisition method Also list the first 2 consolidation entries for acquisitions.

Answer 1

What is 'Acquisition'

An acquisition is a situation whereby one company purchases most or all of another company's shares in order to take control. An acquisition occurs when a buying company obtains more than 50% ownership in a target company.

Acquisition method of accounting
when an acquiree buys another company and the acquirer uses GAAP; the acquirer must record the event using the acquisition method. It views the purchase as the whole firm, not just the sum of its parts.

In other words:

When one company controls another company the controlling company is called the parent and the controlled company is called the subsidiary. Since the parent controls the operating and financing decisions of the subsidiary, it is worthwhile to look at both the companies' financial performance and financial position together. Consolidated financial statements are prepared to achieve this objective. US GAAP and IFRS require the consolidated financial statements to be prepared under the acquisition method.

In the acquisition method, the parent includes all the assets of the subsidiary on its consolidated balance sheet and includes all the subsidiary's revenues and expenses in its consolidated revenues and expenses. It creates a component called 'non-controlling interest' or 'minority interest' in its equity section which represents the claim of others on the subsidiary's net assets. A line item also appears on the consolidated income statement below net income which represents net income attributable to the non-controlling interest.

Example

Company ABC currently holds 75% of the outstanding share capitals of Company XYZ. Company ABC's assets are $30 million, its liabilities are $20 million and its shareholders' equity is $10 million. Company XYZ's assets are $10 million, its liabilities are $7 million and its equity is $3 million.

Company ABC will include the assets of Company XYZ on its balance sheet so its total assets will be $40 million ($30 million + $10 million), its total liabilities will be $27 million ($20 million + $7 million). Its equity will be $13 million ($40 million minus $27 million) but it will have two components: first component would result to the interest of the Company ABC in Company XYZ's net assets while the other component is called the non-controlling interest and it represents the interest of other Company XYZ’s shareholders who hold the remaining 25% of the outstanding shares. Non-controlling interest on Company ABC's balance sheet would equal 25% of Company XYZ's net assets ($10 million minus $7 million) which equals $0.75 million. The equity component that represents Company ABC's interest is hence $12.25 million (total equity of $13 million minus non-controlling interest of $0.75 million).

Consolidation entry:

Fixed assets   Dr.

Current Assets Dr.

Goodwill A/c     Dr. (If credit side is more than debit side than the difference will be considered as goodwill)

                  To Current Liabilities (which is payable to third party)

                  To Cash (Amount which the acquiring company agrees to pay to acquirer)