The business combination method I selected is the acquisition method. Business combinations have implemented the newly created accounting treatment called the “acquisition method. ” The major changes in the acquisition method involve variations to fair value measurement, goodwill recognition, and non-controlling interests. Under this method, the parent company reported the net assets of the acquired company at the price that it was paid for.
This price included any ash payment, the fair market value of any shares Issued, and the present value of any promises to pay cash In the future. A key aspect of the purchase method Is that the parent consolidates the book value of all the subsidiary’s assets and liableness and then the fair value, broken down between N.B. and FM Increments, of the subsidiary assets and liabilities are added to the parent’s own assets and liabilities. The parent and the subsidiary prepare their own separate financial statements since they are two separate legal entities.
The parent also prepares consolidated uncial statements by combining the separate financial statements of both the parent and the subsidiary. Any inter-company transactions between the two are eliminated in the consolidated financial statements since the parent and the subsidiary is considered as one economic unit. Under a consolidated entity, the same results are produced regardless of how the transaction is legally structured as both the parent and the subsidiary are exposed to the same consequences and rewards. The Investment In a subsidiary should be valued at the most reliable value.
For example, either at the fair value of consideration given or the fair value of consideration received. The purchase price is often different than the book value because balance sheet values do not necessarily equal market value. The purchase discrepancy is the excess of purchase price over net book value of the subsidiary’s shareholders’ equity or net book value of identifiable net assets Page 2 and goodwill. The purchase discrepancy is first allocated to the recorded assets and liabilities to revalue them from book value to fair value on the acquisition date.
Under the purchase method, the cost of acquisition includes any direct costs such as finder’s fees, costs of registering and issuing shares, and amounts paid to accountants, lawyers, appraisers, and other consultants according to section 1 581. 27 of the CIA Hand Book. Any expenses directly Incurred for Issuing shares (costs of registering and Issuing shares) are treated as a capital transaction, which reduces the amount recorded for share Issue. Goodwill Is recorded as the excess of the price paid over the fair value of the acquired company’s identifiable net assets.
In proportionate interest in goodwill is recognized. Therefore, the non-controlling interest (NC’) share of the subsidiary net assets is only the subsidiary book value, with no goodwill allocation. The motivation behind this is that the consolidated company should only recognize the percentage of the fair value increment and goodwill that was actually purchased by the parent. Goodwill is also measured periodically for impairment. If it is deemed to be impaired, it is written down to the new reduced value. Any negative goodwill is eliminated by writing down to specified stets.
The approved business combinations rules states that if transactions in which an acquirer obtains control of one or more businesses, it must be accounted for using the newly adopted acquisition method, which is also known as the “new- entity method. ” All business combinations are to be accounted for by applying the acquisition method after January 1, 2011 as per SEAS 141, FIRS 3, and section 1582 of the CIA Handbook. A requirement of this method is that the acquirer must be clearly identified in every business consolidation.
Below are several Page 3 eye component changes in the acquisition method: Measurement of the subsidiary net identifiable assets is based on the fair value of the subsidiary as a whole, rather than based on the cost of purchase at the acquisition date. The acquisition date is the closing date that the purchaser obtains control of the acquired business. For example, the parent will still have full control of the entire subsidiary even if they purchased less than 100% of the net identifiable assets.
The parent includes the full fair value of the subsidiary in the consolidated financial statements and then allocates to the non-controlling interest. The key difference between the purchase method and the acquisition method is that in the acquisition method, all of the FM increment and all of the goodwill is recognized, including the portion attributable to the non-controlling interest. The Justification behind this idea is that a business in control of another entity should be able to fully control all of their assets and liabilities.
Therefore, parent and subsidiary are portrayed as being one cohesive Under the acquisition method, consideration transferred at fair economic unit. Value is the best evidence of the fair value. The purchaser will need to use professional Judgment to determine the fair value of the acquirer if there is no consideration transferred on the acquisition date or if consideration is not a good representative of the fair value. Fair value measurement does not include assets held for sale, deferred taxes, operating leases, employee benefit plans, and goodwill.
Unlike the purchase method, any direct acquisition costs are excluded from the purchase price. Transaction costs associated with the purchase reduces the amount of consideration given and thus reduces fair value as well. The proposal is a significant departure from the purchase method. Goodwill under the acquisition method differs from the purchase method because it is computed as the difference between the fair value of the business and the sum of both the net Page 4 assets acquired and liabilities assumed.
This means that the full fair value of goodwill would be recognized, rather than only the proportion attributable to the acquirer. It is being treated like other assets to maintain consistency. A key difference from the purchase method is that goodwill under the acquisition method ill also recognize the portion attributable to the non-controlling interests. Finally, the acquisition method has strengths in achieving appropriate accounting treatment for consolidation, it also has raised concerns. A major criticism of the acquisition method is the requirement to use fair value measurement.
Consideration for 100 percent is straight forward and strongly supported. However, the fair value measurements in less than 100 percent acquisitions may lack guidance in determining appropriate fair value. For partial acquisitions, the fair value of the inconsideration given up may not be representative of the fair value of the target firm as a whole. In sticky situations, such as the non-transfer of consideration, or related parties, the fair value of the consideration given may not be reliable to measure the fair value of the subsidiary.
There may be unique underlying economic and legal characteristics of the two entities that can cause complex valuation issues, and thus making it almost impossible to measure the fair value of the consolidated entity. In conclusion, I as CEO would recommend the implementation of the acquisition teeth. I believe merits of the new change outweigh the weaknesses. The acquisition method’s main advantage is that it helps improve the comparability and consistency of financial information reported by companies who issue consolidated financial statements.
Even though there may be a difficulty in determining fair value if no cash or another readily measurable Page 5 consideration is available; many business combinations go through this. That issue is currently being accounted for under SEAS 141 and there has never been any history of significant issues pertaining to that matter. The acquisition method gives a clearer view of the true financial position of the entity, which will be more useful to investors. Both relevance and reliability will be achieved.
Overall, fair value better reflects future benefits of an acquisition than cost. The exclusion of acquisition related costs from the cost of an asset is consistent with the cost principle of accounting. These costs should be recognized as expenses rather than including it in goodwill. The costs do not provide any initial economic value at the time of purchase and therefore should be expensed. This approach can give a more liable and relevant measure of the true fair value of consideration exchanged at the acquisition date.
Accounting for goodwill under the new method should provide a shaper base for measurement than the purchase method, where goodwill is solely based on the residual value of price paid. Goodwill at fair value will also offer improved comparability with other similar business acquisitions. There should be no distortion associated with factors that affect the fair value of the purchase price, such as an embedded control premium. The usefulness of information about a non-controlling interest has greatly been improved because the revised tankards specified a basis of measurement in fair value.
