Consolidation Process

Question: To illustrate the consolidation process, assume that Tiny has earned revenues of $800,000 and incurred

expenses of $500,000 during the year to date. In addition, the company reports a single asset, land costing

$400,000 but with a $720,000 fair value. The only liability is a $300,000 note payable. Thus, the company’s net

book value is $100,000 ($400,000 land less $300,000 note payable). Tiny also owns the rights to a well-known

trademark that has no book value because it was developed many years ago at little or no cost. However, it is now

estimated to be worth $210,000.

The assets and liabilities held by Tiny have a net fair value of $630,000 ($720,000 land plus $210,000 trademark

less $300,000 note payable). Because the company has been extremely popular and developed a large customer

base, Giant agrees to pay $900,000 to acquire all the outstanding stock. If consolidated financial statements are

created at the time of a corporate acquisition, what figures are reported by the business combination?

Answer: In consolidating Giant and its subsidiary Tiny at the date of this acquisition, neither the subsidiary

revenues of $800,000 nor its expenses of $500,000 are included. Their financial impact occurred prior to the

takeover by Giant; those profits benefitted the previous owners. Therefore, only the revenues and expenses

reported by Giant make up consolidated income statement totals determined on the day the parent acquires the

subsidiary.

At the same time, consolidated balance sheet totals will not show any “investment in Tiny Company” as in the

other methods demonstrated above. Instead, Tiny’s land is added to Giant’s own totals at its $720,000 fair value.

The trademark is consolidated at $210,000 to reflect the amounts paid by Giant to acquire ownership of the

subsidiary. The note payable is added to the consolidated figures at $300,000, which was its fair value as well as

its book value. Subsidiary assets and liabilities are included in consolidated totals as if purchased by the parent.