When do you know when the consolidation vs. the purchase method is appropriate for intercorporate investments? From the reading, it seems like both can be used as long as the investor takes a controlling interest in the investee. Or am I wrong? Maybe the purchase method is used only when there is a combination of two companies. But, can two businesses be combined if the investor only buys 75% of the investee, as described on p. 134 and 135 of Book 2 of Schweser (seems like this would still just mean a controlling interest)? Any help/clarification would be greatly appreciated.
My two cents… 1. We are aware that pooling is no longer allowed under current US GAAP. This implies purchase accounting. 2. Depending upon the ownership brought (i guess your question is greater than 50%) with control, full consolidation is allowed with allowances for minority interest (if ownership stake is less than 100%). To your question regarding two business purchases, the answer is yes with an allowance for minority interest (25%).
As far as I can tell you always use the Purchase method.
BTON04 nailed it I believe, i think your “consolidation” referred to the pooling method, not actually accounting for it consolidated.
the reading on intercorporate investments rambles on, esp. in the CFAI text. I think there are two distinct aspects that must be recognized. Company A buys out Company B: (This is an investment nonetheless) two approaches: Purchase Method Pooling Method (no longer allowed in either US GAAP or IFRS, but important because of long term implication on the BS of company that has done this in the past). Company A invests in Company B: *** % Interest and Degree of Control **** Passive -> < 20% stake -> HTM, HFT, AFS Active -> between 20-50% -> Equity, Consolidation, Prop Consolidation, JV Also here, since you could set up a company which is off-balance sheet (VIE) you have a portion of the VIE stuff creeping in here. Do not know if the above makes sense, but making a distinction in this manner is helpful in deciphering and working thro’ the rest of the chapter (at least for me).
There are two methods for controlling interest investment: purchase method and pooling interest method. Pooling interest method is no longer allowed in US GAAP and IFRS. We still need to know it because it is prospective, not retrospective, which means new mergers/acquisitions could not use pooling interest method anymore, but old ones will keep using it.
Consolidation is not so much an accounting method as a mechanical process. If you buy 100% of a company (or maybe just create a 100% owned sub to separetly account for some business activity) you will need to consolidate the parent sub legal entities into one GAAP consolidated financial statement. If you buy 100% of a company you could also dissolve the separate legal entity of the sub and merge it into the parent. There is that one time consolidation process, but going forward there is no longer a consolidation process becuase you only have one company (this is what’s happening with many of the bank acquisitions). If you buy less than 100% of a company you can’t dissolve it (unless you pay off the minority shareholders, in which case you are back to 100% rules) so for each accounting reporting period you need to manuaaly consolidate the parent and sub, and record the appropriate minority interest in the consolidated entity.
Just to be sure we get this right: I think it’s wrong to ask for “consolidation vs purchase method”. The “purchase method” _is_ one way of consolidating. The “pooling method” is another (except that it’s no longer allowed). The process goes like this: First you determine whether you have a controlling interest in the subsidiary (usually happens when you have 50% shares or more). If you do, you’re going to consolidate. Now, how do you combine the balance sheets and income statements of your two companies? This is where “purchase vs pooling” comes in. “Pooling” essentially combines all the assets without making any adjustments. “Purchase” will in some cases increase the book value of some assets. That’s why companies would prefer the “pooling”. It would give them better ROA measures.