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The economic entity principle implies that when a parent company acquires a subsidiary, their financial statements should be consolidated, because they are now a single economic entity. How does an accountant actually produce these consolidated financial statements? Read on.
The purchase price is the total amount paid by the acquirer to the acquired company. It includes any cash, debt or equity issued as part of the transaction.
A journal entry for an all cash acquisition would look like this:
| Investment in Subsidiary | XXX | |
| Cash | XXX |
A journal entry for an all stock acquisition would look like this:
| Investment in subsidiary | XXX | |
| Common Stock | XXX | |
| Additional Paid-in-Capital | XXX |
If Pennsylvania Honey Company acquired Greensburg Honey Company for $500,000 by paying $200,000 in cash and paid the rest by issuing 30 shares of Pennsylvania Honey Company with a par value of $1,000 and a fair value of $9,000, then the journal entry would be recorded like this:
| Investment in subsidiary | $500,000 | |
| Cash | $200,000 | |
| Common Stock | $30,000 | |
| Additional Paid-in-Capital | $270,000 |
All costs, whether direct, indirect or general, should be expensed as incurred and recorded in the Income Statement of the acquiring company. The journal entry would look like this:
| Expense | XXX | |
| Cash | XXX |
Any legal or underwriting fees associated with issuing debt or equity securities to finance the acquisition should be netted against the proceeds of those securities. It should be recorded as a reduction to the amount of cash received from issuing those securities.
| Additional Paid-in-Capital | XXX | |
| Cash | XXX |
Pennsylvania Honey Company incurred the following expenses for its acquisition of Harrisburg Honey Company: Accounting costs ($1,500), legal costs ($1,000), general and administrative costs ($1,500), finders fees ($5,000) and flotation costs ($5,000).
| Expense | $9,000 | |
| Additional Paid-in-Capital | $5,000 | |
| Cash | $14,000 |
A contingent consideration is an obligation of the acquiring company to transfer additional assets or equity interests to the owners of the acquired company if some future conditions are met. It’s an incentive for improving performance after the acquisition.
The contingent consideration is recognized and measured at fair value as of the acquisition date. It’s classified as either a liability or as equity.
If the contingent consideration is classified as a liability, then it is measured at fair value at each reporting date until the arrangement is resolved. Any changes in its value are recorded as a component of operating income.
If the contingent consideration is classified as equity, then its initial fair value measurement is not changed. When it’s settled, it stays within equity at its initial value even if that fair value changes on the settlement date.
A consolidated balance sheet is prepared by adding together the assets, liabilities and equity balances of the two companies and eliminating all inter-company transactions and balances. Find the details about the balance sheet consolidation process at this post.
A consolidated income statement is prepared by adding together the revenues, expenses, gains and losses of the two companies and eliminating all inter-company transactions and balances. Find the details about the income statement consolidation process at this post.
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Hi there! I'm Matt. I'm a Christian, husband and father of four. I'm a graduate of Calvin, Harvard, Cardiff and Johns Hopkins Universities. I have a PhD in Economics, an MBA in Finance and an MS in Data Analytics. I'm a numbers guy who can communicate well!
I began this service to work directly with the small and mid-sized business owners who grow our great country's economy. Since 1999, I've worked with owners across industries from high tech IT and robotics to small farmers and artists. I've also helped and advised nonprofits from churches to civic organizations.
I also served as a Finance Staff Officer and eventually as the National Division Chief for Measurement Research within the US Coast Guard. The research and methods I created there continue to guide strategic decisions to this day.
I enjoy being active outdoors, especially in wild lands. Hiking, biking and fly fishing are some of my favorite pastimes.
I also love dogs! I'm an AKC obedience evaluator, and I train service and therapy dogs.
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