Chapter 14 Equity accounting and consolidations
Second edition update, June 2005.
Fair value adjustments and goodwill [p. 435 et seq.]
A parent company rarely acquires a subsidiary at a price equal to the book value of the latter's net assets. The price it pays reflects its assessment of the cash flows those net assets are expected to generate. The amount may be more or less than book value. As a result, a positive or negative ?consolidation difference' arises. How is this difference accounted for?
In most countries, the difference is accounted for in two steps. First, the investor company revalues the individual assets and liabilities of the acquired company to fair value at the date of acquisition. (In countries which observe historical cost accounting strictly, this is a consolidation exercise only: the subsidiary's books are not altered.) ?Fair value' means market value or a current valuation. The reason for this adjustment is clear. If the investor company purchased assets from the investee on an individual basis, it would record them at their fair value at the date of exchange.
Any remaining excess of purchase price over fair value of net assets at acquisition is described as ?goodwill'. Goodwill represents the capitalised value of the ?above-normal' earnings attributable to an acquired company or collection of assets. In the second of the two steps, the goodwill is recognised as an intangible asset on the consolidated balance sheet. This is now a universal practice. However, until recently companies in certain countries were allowed to write off goodwill against reserves. Although this practice is no longer permitted, the impact on corporate balance sheets ? in the form of low shareholders' equity relati ...