Business combinations occur frequently in our corporate environment. Most large companies have one or more subsidiaries in a business combination to expand their market share. Perhaps, some companies acquire another to fill the gaps in their production processes to be efficient or just to broaden their visibility to become more profitable. Whatever the reason for an acquisition, the CFO or the Controller is tasked with how to handle acquisitions in their ERP system. What is your business combination? Can you consolidate? What are the key elimination transactions in the consolidation processes? How does your ERP system handle business combinations?
This blog is the first part of a series that will focus on consolidation in a parent-subsidiary relationship, intercompany transactions, elimination entries and consolidated worksheet. This first part of the blog will go over some concepts and whether an acquisition qualifies for consolidation or not. I will expand future series to illustrate consolidation worksheets including elimination entries and how to use an ERP system to handle consolidations.
What is a business combination?
A business combination occurs when a company in its expansion strategy, acquires another company. A business combination could be a merger or a consolidation. In a business combination accounted for as a merger, the acquirer combines the net assets and liabilities of the acquiree and the two companies become a single entity. The acquirer pretty much gulps the acquiree into itself to become one company. Consolidation, on the other hand, occurs when the one company acquires substantial shares of another and exercises control. In a consolidation situation both companies exist as separate legal entities but, in substance, they are one company.
Does your acquisition qualify for consolidation?
A mere acquisition of another company’s shares does not qualify for a business consolidation. The following guidelines are used to determine if a company in an acquisition, qualifies to consolidate:
- Acquisition of less than 20% of another company’s stock, does not qualify for consolidation. The purchasing company by acquiring less than 20% means it does not exercise significant influence. Cost Method is used.
- Acquisition of 20 – 50% of another company’s stock, does not qualify for consolidation. The purchasing company by acquiring 20-50% though, do exercise significant influence but lacks control. Equity Method is used.
- Acquisition of more than 50% of another company’s stock, does constitute significant influence and control. Consolidation is used.
Method of accounting for consolidation?
Up until 2001, the method of accounting for consolidations was the pooling of interest and purchase method but FASB ASC 805 eliminated both pooling interest and purchase methods. Per FASB ASC 805-10-05, a business combination in a consolidation must be accounted for under the Acquisition Method.
What is an Acquisition Method for consolidation?
Look out for part 2 of this series to learn about the Acquisition Method for consolidation!
How does your ERP system handle business combinations? If you need assistance, MIBAR can help! Contact us for more information.