Overview of the new accounting standards of FASB NO. 141R and 160.

Author:Yang, James G.S.

    The subjects of business combination and consolidated financial statements have been changed under FASB Nos. 141R and 160, respectively. The former concerns acquisition costs, goodwill, gain on bargain purchases, and step acquisition. Whereas, the latter deals with the fair value of the subsidiary, noncontrolling interest, consolidation elimination entries, equity transaction after consolidation, and deconsolidation. In fact, both subjects are related to each other. This paper explains what accountants should know regarding these two new accounting standards. Many examples are given for illustrative purposes.


    The acquisition of another company may involve various costs. These acquisition costs must be classified into two categories: direct costs and indirect costs. Direct costs are the costs directly associated with the issuance of the equity or debt securities, such as stock underwriting costs, brokerage commission, stock certificate printing costs, stock registration fees, etc. Whereas, indirect costs encompass finder's fees, legal, accounting, advisory, consulting, professional, valuation, administration expenses, etc. Under the new accounting standards, the direct costs are immediately charged to expense, while the indirect costs reduce the equity of "additional paid-in capital" (FASB No. 141R, paragraph 59). This indicates that none of these acquisition costs increases the investment asset account.


    When acquiring a subsidiary company, both the acquired assets and the consideration transferred must be measured at their fair value. If the former is less than the latter, the difference must be treated as "goodwill" in the Balance Sheet (FASB No. 141R, paragraph 34). In other words, the book value of the subsidiary assets will no longer be carried forward into the combined assets. For example, Subsidiary Company has only one asset, inventory, with a carrying value of $100,000 and a current market value of $110,000. Parent Company issues 10,000 shares of $10 par value per share common stock at a current market price of $13 per share to acquire all of the Subsidiary's outstanding common stock. This business combination results in a goodwill of $20,000 [(10,000 shares x $13)-110,000].


    On the contrary, if the fair value received is greater than the consideration transferred, the difference shall be treated as "gain on bargain purchase" and is included as earnings in the Income Statement (FASB No. 141R, paragraph 36). This is quite an astonishing requirement under the new standards. It is completely different from the old standards. For instance, in the preceding example, if the Subsidiary's inventory has a current market value of $150,000, this business combination now yields a gain on bargain purchase of $20,000 [(10,000 shares x $13)-150,000].


    If the acquisition of another company involves more than one step, then the situation becomes more complicated. The previous investment may not obtain controlling interest. As such, it might be treated as investment in trading securities, investment in available-for-sale securities or long-term investment using the cost method. As such, the investment income of the previous investment was recognized only to the extent of dividend received. The undistributed earnings were not recognized and the goodwill was never recognized. Now, the acquirer acquires additional stock and the business combination takes place. The previous investment must be remeasured at the fair value of the subsidiary. In other words, the undistributed earnings must now be recaptured. As a result, the gain must be recognized. The goodwill must also be established. No matter how the previous investment was treated, it is now cancelled. The subsidiary is merged into the parent. Goodwill is equal to the difference between the fair value of the subsidiary's net assets and the parent's consideration transferred plus the fair value of the previous investment (FASB No. 141R, paragraph 38).

    GAIN ON PREVIOUS INVESTMENT: Cost of Investment #1 (10%) ($11,000) - Share of Subsidiary's net assets on 1-1-Year 2 = 10% x (100,000 + 50,00 - 20,000) = 10% x 130,000 = 13,000 GAIN on Investment #1 ($13,000-11,000) = 2,000 GOODWILL OF BUSINESS COMBINATIO: Updated Investment #1 on 1-1-Year 2 = $13,000 $11,000 + 2,000 = + Cost of investment $2 =...

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