Advanced Accounting: Chapter 1-2 Key Concepts (Investment accounting & Acquisition Method)

This set reviews key concepts from Advanced Accounting Chapters 1 and 2, focusing on investment accounting methods (fair value, cost, equity, acquisition) and the acquisition method for business combinations, including goodwill, contingent consideration, fair value valuation approaches, and consolidation principles.

What are the four methods used to account for an investment in another company?

Fair value method, Cost method, Equity method, and The Acquisition Method (consolidation).

When is the Equity Method generally applicable according to GAAP guidelines?

When the investor has the ability to significantly influence the investee, typically 20%–50% of the outstanding voting stock.

What is the usual threshold for a controlling financial interest that requires consolidation?

Owning more than 50% of the outstanding voting shares, though control can exist with less than 50% via contracts, agreements, or other arrangements.

How is the consideration transferred in a business combination measured?

At fair value, with contingent consideration included as part of the consideration transferred.

Name the three main fair value valuation approaches used for assets and liabilities in acquisitions.

Market approach, income approach, and cost approach.

How is goodwill determined in a business combination?

If consideration transferred exceeds the fair value of net assets acquired, the excess is goodwill; if equal, neither; if less, a bargain purchase occurs (gain).

What is the bargain purchase gain?

A gain recognized when the fair value of net assets acquired exceeds the consideration transferred (i.e., consideration < fair value of net assets).

How are direct combination costs and stock issuance costs treated in the acquisition method?

Direct combination costs are expensed as incurred; stock issuance costs reduce paid-in capital (APIC).

What is fair value, per ASC 820 definitions?

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

What does the acquisition method require regarding assets and liabilities in a business combination?

Assets acquired and liabilities assumed are recorded at fair value on the acquisition date; contingent consideration is included.

How many consolidation journal entries are typically required after acquiring a subsidiary?

One permanent consolidation journal entry; after that, no additional consolidation entries are needed.

What is a Variable Interest Entity (VIE)?

A special purpose entity used for certain arrangements; consolidation can occur when a party has a controlling financial interest through variable interests.

What does ASC 810-10-10-1 presume about consolidated financial statements?

There is a presumption that consolidated financial statements are more meaningful and usually necessary for fair presentation when there is a controlling financial interest.

What is the role of Noncontrolling Interest (NCI) fair value in acquisitions?

The fair value of the NCI adds to the valuation of the acquired firm and is considered in the purchase allocation.

What are some indicators that an investor has significant influence over an investee?

Board representation, participation in policy-making, involvement in management decisions; standstill agreements; concentrated ownership among a few shareholders.

In the equity method, how does the investor's Investment in Investee account change with investee income and dividends?

Investment increases by the investor’s share of investee income and decreases by the investor’s share of dividends; excess asset amortization may be recognized for finite-life assets.

How are investee losses accounted for under the equity method?

Investee losses reduce the investor’s investment; if the investment balance goes to zero, the equity method stops and impairment or fair-value accounting may follow.

What happens if control is achieved without dissolving the subsidiary?

Control without dissolution means the parent may consolidate the subsidiary, which remains a separate legal entity in some structures.

How are goodwill and finite-life intangibles treated in asset-excess allocations under the acquisition method?

Goodwill is not amortized; finite-life assets (like certain identifiable intangibles) are amortized over their useful lives; indefinite-life intangibles are not amortized.

What is the role of fair value when measuring assets and liabilities on acquisition date in problems?

Use the acquisition-date fair values to determine goodwill or bargain purchase; differences from book value drive the allocation.

According to ASU, what is a business

that is comprised of inputs and processes applied to those inputs that create outputs. Why

Why was a defintion of business needed

to clarify the criteria for identifying what constitutes a business for accounting purposes and to ensure consistent application of the acquisition method.

The motives for business combinations

Vertical integration, Cost saving, quick entryinto new markets, increased negotiating power, financing at more attractive rates

What is a business combination

a transaction where two or more entities are merged into one entity, often involving the transfer of ownership and control.

What is a business consolidation

the process of combining the financial statements of two or more entities to present them as a single entity for accounting purposes. This involves the elimination of intercompany transactions and balances.

Consolidation provides…

more meaningful information to shareholders, fair presentation, and each company may retain a seperate legal identity

To explain the process of preparing consolidated financial statements for a business combination

1. How is a business combination formed

2. What constitutes a controlling financial interest

3. How is the consolidation process carried out

Statutory Merger

Only one of the original companies remains in business as a legally incorporated enterprise. In a statutory merger, the surviving company absorbs the other entity, ending its existence. This typically involves the transfer of assets and liabilities and capital stock

Statutory Consolidation

A legal consolidation where two or more companies combine to form a new entity, with both original companies ceasing to exist. The new entity takes on all assets, liabilities, and operational responsibilities.

Control without dissolution

A situation where one company acquires another while allowing the acquired company to continue operations as a separate legal entity. This arrangement enables the acquirer to exert influence or control over the acquired company's decisions without merging its business operations.

According to ASC, what is control

The ability to direct the financial and operating policies of an entity to obtain benefits from its activities by voting shares.

Consideration Transferred (paid)

The amount paid by an acquirer to obtain control over another entity, which may include cash, stock, or other assets. It is a key component in determining the fair value of an acquisition.

Contingent consideration

Additional payments that may be required after the acquisition, contingent on future events or performance targets being met.

Assets acquired and Liabilities Assumed at Fair Value (what is being purchased)

The total value of identifiable assets and liabilities a buyer acquires in a business combination, measured at fair value on the acquisition date.

Market Approach

A method of valuing an entity by comparing it to similar companies or transactions in the marketplace to establish fair value.

Income Approach

A valuation method that estimates the value of an entity based on its expected future income, discounted to present value using a discount rate.

Cost Approach

A valuation method that determines the value of an asset by calculating the costs to acquire or replace it, minus depreciation and obsolescence.

Calculate FVNA

Price - FVNA = GW

Journal Entry for Direct combination costs

Legal Expense

Cash

Stock Issuance

APIC

Cash

Steps to dissolve acquired entity

1. Appropiate account balances are physically consolidated

2. Permanent consolidation occurs at the combination date

   All identifiable assets and liabilities are evaluated at fair value.