Controlling Interest Investments: Accounting for Business Combinations

Control of a subsidiary typically occurs when the parent/investor company owns more the 50% of the investee’s voting stock.  However, an investor company can retain control with less than 50% voting ownership.

IFRS and GAAP require that the financial statements of a controlling investor company and its controlled subsidiaries be consolidated.

Business Combination Types (4)

1. Statutory Merger – two companies combine, but only one entity survives; the investor may pay cash, issue stock, or issue debt to finance its investment.
2. Statutory Consolidation – two companies combine, but both cease to exist and a new company is formed.
3. Acquisition – the two companies remain legally distinct entities, but are associated through a parent company-subsidiary relationship.  In situations where the parent owns less than 100% of the subsidiary, then minority interest will be reported on the parent company’s financial statements.
4. Variable Interest Entities (VIEs) – also called Special Purpose Entities (SPEs), VIEs are consolidated when the parent company, serving as the VIE’s sponsor, is the primary beneficiary of the VIE’s activities.

Methods of Accounting for Business Combinations (3)

Purchase Method: Under the purchase method, the assets and liabilities of the acquired company are combined onto the financial statements of the acquiring company at fair market values on the transaction date.

Pooling of Interests Method: Under the pooling method, the assets and liabilities of the parent and subsidiary are simply combined. The method simply adds the asset and liability book values appearing on the parent’s and subsidiary’s balance sheet. This method was disallowed by GAAP in 2001 and disallowed by IFRS in 2004.

Acquisition Method: U.S. GAAP requires the acquisition method when accounting for controlling interest business combinations, starting in December 2008. The acquired identifiable assets and liabilities are recognized at full fair value, even if the parent purchases less than 100% of the subsidiary.