Acquisition Method

When one company controls another company, the controlling company is called the parent and the controlled company is called the subsidiary. As the parent controls the operating and financing decisions of the subsidiary, it makes sense to look at both companies as a single entity. This objective is achieved by preparing the parent's consolidated financial statements. US GAAP and IFRS require the consolidated financial statements to be prepared under the acquisition method.

In the acquisition method, the parent includes all the assets and liabilities of the subsidiary in its consolidated statement of financial position and the subsidiary's post-acquisition revenues and expenses in its consolidated statement of profit or loss on a line-by-line basis. It involves elimination of the subsidiary's share capital, retained earnings and other reserves against the investment in subsidiaries appearing in the parent company's financial statements. Where the investment in subsidiaries is higher than the fair value of the net identifiable assets of the subsidiary, the difference is recognized as goodwill.

Where the subsidiary is not wholly-owned, the consolidated financial statements separately present the shareholders' equity, net income and other comprehensive belonging to the minority shareholders. The consolidated statement of financial position shows a single figure titled 'non-controlling interest' which represents the claim of minority shareholders on the subsidiary's net assets. An amount also appears in the consolidated statement of profit or loss and consolidated statement of other comprehensive income showing net income and other comprehensive income attributable to non-controlling shareholders.

Example

Company P currently holds 75% of the outstanding share capital of Company S. Company P's assets are $30 million, its liabilities are $20 million and its shareholders' equity is $10 million. Company S's assets are $10 million, its liabilities are $7 million and its equity is $3 million.

Company P will include the assets of Company S in its consolidated balance sheet (at their fair value) so its total assets will be $40 million ($30 million + $10 million), and its total liabilities will be $27 million ($20 million + $7 million). The total shareholders' equity will be $13 million ($40 million minus $27 million) but it will have two components: the first component representing the interest of Company P in Company S's net assets, and the second component (called the non-controlling interest) representing the interest of other Company S shareholders who hold the remaining 25% of the outstanding shares.

Non-controlling interest in Company P's consolidated balance sheet is equal to 25% of Company S's net assets ($10 million minus $7 million) i.e. $0.75 million. The equity component that represents Company P's interest is hence $12.25 million (total equity of $13 million minus non-controlling interest of $0.75 million).

by Obaidullah Jan, ACA, CFA and last modified on
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