Consolidation of Financial Statements Research Paper

Consolidation of Financial Statements - Research Paper Example This paper seeks to analyze how the acquisition method compares with the earlier two methods in consolidation of financial statements, its impact on financial statement reporting quality, potential Impact on decision making and International implications of consolidation of financial statements. The paper also discussed the differences between the standards of IFRS and GAAP in respect of consolidation of financial statements with a view to resolve the differences for enhancing uniformity, comparability and transparency in consolidation of financial statements. Acquisition Method Primarily there are two types of treatment under this method. In the first one, the investor acquires assets (and often liabilities) and investee goes out of business and the investor continues to do the business with the controlling interest. The investee company becomes a subsidiary and the stock of investee is shown as investment in the investor’s books of accounts. This process involves accounting for the fair value of the company acquired by ascertaining fair value of the assets and liabilities including contingencies based on risks associated as well as the consideration in line with the international standards. If the consideration is not equal to fair value either it is treated as good will where consideration exceeds fair value or as gain on acquisition where the consideration is less than the fair value. Direct costs associated with the acquisition are expensed. It may include fees payable to legal advisors, appraisers, auditing firms and investment bankers. Indirect costs of acquisition such as secretarial and managerial efforts are expensed. However, fair value is reduced by the costs associated with registration and issue of securities. In the second case, the acquired company continues to function as a separate entity without dissolution. In this case, the financial statements of such entity are considered in the accounts / financial statements of the acquired compa ny. The balances are consolidated separately without formal entries in the books of accounts. Assets with indefinite life are reviewed periodically for impairment in line with the accounting / reporting standards. How Purchase Method differs from Acquisition Method Application of fair-value principle is common to both the purchase method and the acquisition method. However, under Purchase Method transactions costs are included in the purchase price in the books of accounts of the subsidiary. The transaction costs and restructuring costs included in fair value under purchase method are considered as business expenses under acquisition method. Also, fair value is measured as on acquisition date under acquisition method. The acquisition method is based on recognition and measurement of the assets. The acquisition method takes into account non-controlling interests and contingencies, whereas purchase method ignores this aspect. Pooling of interest method The investor records investment in sub account and consolidation is outside the books of accounts by eliminating investment account and equity account in subsidiary’s accounts. Book values of the companies are simply combined together in consolidation of financial statements. Goodwill is not recorded in the books of accounts. Revenues and expenses are added together with retrospective effect. Rezaee, Z. (2001, p. 291) stated â€Å"Under the pooling of interest method: (1) carrying amounts on the books of combining entities should be carried forward; (2) no goodwill should be recognized; and (3) prior financial statements should be restated as if the combining entity had always been combined.† Acquisition method has significant improvements over this method to suit the needs of the businesses. Impact on financial stateme