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.
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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 per cent and 20 per cent of a company. Accountants use the equity method when a parent owns between 20 per cent and 50 per cent of a company. Accountants use the acquisition method when a parent owns more than 50 per cent of a company.
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 unrealised gain or loss. Dividends from the subsidiary are reported as income on the income statement.
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 per cent of ownership in the subsidiary. For example, if a subsidiary had £65,000 in income and a parent owns 40 per cent, then the ownership account will increase by £26,000 on the parent's financial statements. Dividends decrease the ownership account.
Value the investment at the fair value of the amount given. For example, if a company pays £65,000 and provides a £16,250, the ownership is valued at £81,250. 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.
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.
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