Methods of acquiring controlling interest

            One company may acquire a controlling interest in another
company either:
(a)      By creating a new company and retaining more than 50% of share
holdings of he new entity or;
(b)      By acquiring more than 50% of the outstanding shares of an
existing company. Both ways of acquiring a controlling interest are widely used.
A holding company may  acquire the voting
capital stock of an existing company in either two ways.
1.         Exchanging shares of holding company stock for more than 50%
of outstanding voting capital stock of the subsidiary (owned by shareholder of
the subsidiary).

If certain additional
criteria are met, this type of acquisition is called pooling of interests. In
this situation, the shareholders of the subsidiary, give up the subsidiary
share and become shareholders of only the holding company.
2.          Purchasing by the parent, using cash, other assets or debts
of more than 50% of the outstanding shares from shareholder of the subsidiary.
This type of acquisition is known as combination by purchase. In this situation
the shareholders of the subsidiary sell more than 50% of their shareholding and
are net shareholders of either holding or subsidiary.
The pooling of interest and
purchase methods have different impact on the consolidated financial
statements.
Pooling of Interest Method
When one company acquires
another by exchanging shareholdings, the shareholders of the two companies have
pooled their ownership interest. This transaction is not viewed as a
purchased/sale transaction, and as a result, the cost principle is not applied.
For example, where H. Co’s cash is N205,000
and S. Co’s N35,000, using the pooling
method, the consolidated balance sheet will report a cash balance of N10,000 and the balance sheet of Co. S
shows a payable to co. H of N10,000.
During consolidation, these amounts are eliminated. The separate balance sheet
of H. Co and S. Co are shown below: 

 

Total Liabilities and
Owners Equity                                            N650,000                                           N180,000

Other amounts to be
eliminated in the consolidation process of these two balance sheets are:
(a)      The debit balance of N150,000
in Co.H investment account will be replaced on the consolidation balance sheet
with the assets (less the liabilities) of Co.S. to prevent double accounting.
The credit balance of N100,000 in the
Co.S common shares is to be owned by co.H. It is an inter company item that
should be eliminated.
            Finally the difference between the balances in Investment
account and common Share Account of Co.S. N150,000
N100,000 = N50,000 must be eliminated from the contributed capital from
pooling of interest.
(b)      Co.H shows a receivable of N10,000
from co.S and the accounts of Co.S show this is payable to Co.H. This amount is
inter – company debt. When the two balance sheets are combined into a single
consolidated balance sheet, intercompany debt must be eliminated because there
is no external debt or receivable for the combined entity.
Basically, consolidation
involves combining the balances in each account on the financial statements of
the holding and subsidiary companies. The result is the consolidated financial
statements that would appear if there a single entity. When the holding company
consolidates the balance sheet shown above, Co.H and its subsidiary Co.S (100%
owned) the consolidated Balance Sheet (polling of Interest Method) is as
presented below:
Separate
Balance
Sheets 
Eliminations
Consolidate d Bal.
Sheets 
Co.H
Co.S
Dr 
Cr
Assets
N
N
N
N
Cash
205,000
35,000
240,000
Accounts Receivable (Net)
15,000
30,000
45,000
Receivable from Co.S
10,000
-10,000
– 0 –
Inventories
170,000
70,000
240,000
Investment in Co.S
10,000
– 150,000
– 0 –
Plants and Equipment
(Net)
100,000
45,000
145,000
650,000
180,000
670,000
liabilities
Accounts payable
60,000
20,000
80,000
Payable to Co.H
10,000
10,000
0 –
Owner Equity
Common shares, Co.H
360,000
360,000
Common shares, Co.H
100,000
100,000
0 –
Contributed capital from
pooling
90,000
  50,000
40,000
Retained Earnings Co.S
140,000
50,000
19,000
Total liabilities and
Owners equity
659,000
180,000
160,000
160,000
670,000
Purchase Method
When a company pays cash to
acquire the shares of another company, a purchase transaction takes place. The
purchase of assets must be recorded in conformity with the cost principle. Thus
in the acquisition date, the investment account for the holding company must be
measured at cost which is the market value of the acquired shares at date of
purchase.

Required: List and show the items to
be eliminated for the purpose of preparing a consolidation sheet. Prepare
Consolidated balance sheet reflecting 100% acquisition of Co.S interest by Co.H
on January 1, 1996.
SOLUTION:
Eliminations:
Co.H investment account
balance of N165,000 represents market
value at date of acquisition. It must be eliminated against shareholders equity
of the subsidiary N150,000) to acquire
Co.S for two reasons.
1.        The plant and equipment
owned by Co.s had a market value of N50,000
at acquisition (compared with the book value of N45,000 reported by Co.S).
2.         Co.S had development a good reputation with its customers
which increased the over all value of Co.s. The difference between the cost and
book value of the investment may be analyzed as follows:
                                                                                                   N                       N
Purchase price for 100%
interest n Co.S                                                          165,000
Net assets purchased, value
at Market, book value           180,000
+    Market value increment of
plant and equipment             5,000
                                                                                                            185,000

Less Liabilities assumed                                                                 30,000

Total market value
purchased                                                                          155,000
                     Goodwill
purchased                                                                         10,000
Co.H paid N165,000 each for Co.S which had net
assets (total assets less Liabilities) with a market value of N155,000. Therefore the goodwill cost of
reputation, customer appeal and general acceptance of the business that an
acquired company had developed over the years.
To eliminate Co.H
investment account and owners equity of Co.S the following five steps are
necessary.

1.         Increase the plant and equipment of Co.S, from the book
value of N45,000 to the market value of
N50,000. The increase is N5,000.
2.         Recognize the N10,000
goodwill purchase as an asset.
3.         Eliminate the investment account balance of N165,000.
4.         Eliminate the Co.S ordinary share capital balance of N100,000
5          Eliminate the Co.S retained earnings balance of N50,000.
Having taken care of these
adjustments, we have the following consolidated

Co.S & Its Subsidiary Co.S (100% owned) Consolidated
Balnce Sheet (Purchased Method) At January 1, 1996 (Immediately after
acquisition)
Separate Bal. Sheet
Eliminations
     
Dr             Cr
Consolidated balance sheet
Assets:
Co.H
N
Co.S
N
N
N
N
Cash
40,000
35,000
75,000
Accounts
Received
(A/R Net)
15,000
30,000
45,000
Receivable from Co.S
10,000
10,000
-0-
Inventories
170,000
70,000
240,000
Investment in Co.S
165,000
165,000
-0-
Plant and Equipment (Net)
100,000
45,000
-5,000
150,000
Goodwill
10,000
10,000
Total Assets

500,000

180,000
520,000
Liabilities
Account Payable
60,000
20,000
80,000
Payable to Co.S
10,000
10,000
-0-
Owner’s Equity
Ordinary Shares, Co.H
300,000
300,000
Ordinary Share, Co.S
100,000
-10,000
-0-
Retained  Earnings Co.S
140,000
140,000
Retained Earning Co.S
50,000
50,000
-0-
500,000
180,000
175,000
175,000
520,000
We shall further illustrate
the purchase method of consolidation with the demonstration problem below.

The charlemco Ltd acquired
all the outstanding ordinary shares of Oprimo Company Ltd July 1, 1995 for N450,000. The balance sheets for the two
companies on the date of acquisition were as shown below:

 

Required:
         
(a)      Prepare a work sheet for a consolidation balance sheet on the
date of acquisition.
(b)      Prepare a consolidated balance sheet for July1, 1995
Solution:
It is possible that the purchase
price of 100% interest in Oprimo Co. Ltd paid by Charlemo may have included
goodwill. Thus it becomes necessary to determine whether the purchase was above
or below the market value. First, the process is as illustrated below: 

                                                                                                N                                 N
Purchase price for 100%
interest in
 Oprimo Co. Ltd                                                                                                450,000
Net assets purchase/value
at Market,
        book value                                                        512,850
  +   Market value increasing
Building
and Land (7,500 + 15,000)                                     22,500
                                                                                     535,350
less Liabilities assumed                                          104,550
Total market value
purchased                                                                      430,800
Goodwill Purchased                                                                                             19,200 

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