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Purchase Method of Accounting The more frequently encountered method of accounting for a business combination is the purchase method

of accounting. Under the purchase method of accounting, the acquisition is recorded in the same manner as the acquisition of any single asset-that is , at its fair market value. To account for a combination by the purchase method, it is necessary first to determine the total cost of theacquisition. If the purchase consideration consist solely of cash the total amount of cash will be the cost acquired enterprise. If the enterprise issues its own stock as part of the cost in an acquisition, determination of the total price may prove to be more difficult. If the stock is actively traded, the market price of the stock is probably the most reliable indicator of value. If the buyer places restrictions on the subsequent resale of the stock by the seller, however, that might indicate a different value for the issued stock from the value obtained from the current market price. For private enterprises and enterprises that have limited stock trading, placing a value on the shares can be difficult. The buyer and seller must agree on the share price as it affects both their tax positions. Having determined the total cost of the acquired enterprise, the purchaser must mark the assets and liabilities acquired at their fair value. Application of the purchase method of accounting involves:
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Identifying the acquiring company Determining the date used to report the acquisition Determining the cost of the acquired entity. This includes: Valuing the consideration paid or in some cases, the net assets acquired Accounting for the direct costs of the business combination Accounting for contingent consideration Identifying the assets acquired and liabilities assumed Allocating the purchase price that is, allocating the cost of the acquired entity to the assets acquired and the liabilities assumed

Accounting subsequent to the business combination Questionnaire: What Is Consolidation in Accounting? Business consolidations are an advanced accounting concept.

Business combinations are when a company takes another company's financial statement and brings it together with its own. Consolidations allow companies to disclose all of their financial information from all of their properties to their investors. This gives a more accurate description of a company and the company's results for the year. Other People Are Reading Consolidation Accounting Tutorial How to Consolidate Accounts 1.
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Methods There are three different methods of consolidation in accounting: cost, equity and acquisition method. Accountants use the cost method when a parent owns between zero percent and 20 percent of a company. Accountants use the equity method when a parent owns between 20 percent and 50 percent of a company. Accountants use the acquisition method when a parent owns more than 50 percent of a company. Cost Method

The cost method will record the acquisition of the subsidiary at the amount it cost the parent to purchase ownership in the subsidiary. At the end of each year, the accountant must adjust the investment in the subsidiary account to fair value. This creates an unrealized gain or loss. Dividends from the subsidiary are reported as income on the income statement. Sponsored Links Download Free Software Download Free PC Manager Software. Easy File Transfer. Download Now ! mobogenie.com/download-software Equity Method

The equity method records the acquisition of a subsidiary at the cost to purchase ownership in the subsidiary. Earnings from the subsidiary increase the ownership account of the subsidiary by the parent company's percent of ownership in the subsidiary. For example, if a subsidiary had $100,000 in income and a parent owns 40 percent, then the ownership account will increase by $40,000 on the parent's financial statements. Dividends decrease the ownership account. Acquisition Method

Value the investment at the fair value of the amount given. For example, if a company pays $100,000 and provides a $25,000, the ownership is valued at $125,000. When consolidating, the accountant must eliminate the stockholder's equity section of the subsidiary, revalue assets to fair value, eliminate the ownership in the subsidiary account, create a non-controlling interest account and record goodwill or gain. Inter-company Transactions

Only eliminate inter-company transactions when the accountant consolidates the two financial statements. Generally, the financial statements will only be consolidated under the acquisition method. Sponsored Links

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How the Equity Method Relates to Consolidated Financial Statements


If a company acquires more than 50% of the voting stock of another company, it's said to have a controlling interest, because by voting those shares, the investor actually can control the company acquired. The investor is referred to as the parent; the investee is termed the subsidiary. For reporting purposes (although not legally), the parent and subsidiary are considered to be a single reporting entity, and their financial statements are consolidated. Both companies continue to operate as separate legal entities and the subsidiary reports separate financial statements. However, because of the controlling interest, the parent company reports consolidated financial statements. p. 645 Consolidated Consolidated financial statementscombination of the separate fi financial nancial statements of the parent and subsidiary each period into a single statements combine aggregate set of fi nancial statements as if there were only one the individual company. combine the separate financial statements of the parent elements of the and the subsidiary each period into a single aggregate set of parent and financial statements as if there were only one company. This entails subsidiary an item-by-item combination of the parent and subsidiary statements. statements (after first eliminating any amounts that are shared by the separate financial statements).28 For instance, if the parent has $8 million cash and the subsidiary has $3 million cash, the consolidated balance sheet would report $11 million cash. Two aspects of the consolidation process are of particular interest to us in understanding the equity method. First, in consolidated financial statements, the acquired company's assets are included in the financial statements at their fair values as of the date of the acquisition, rather than their book values on that date. Second, if the acquisition price is more than the sum of the separate fair values of the acquired net assets (assets less liabilities), that difference is recorded as an intangible assetgoodwill.29 We'll return to the discussion of these two aspects when we reach the point in our discussion of the equity method where their influence is felt. As we'll see, the equity method is in many ways a partial consolidation. We use the equity method when the investor can't control the investee but can exercise significant influence over the operating and financial policies of an investee.