 Hello and welcome to this session in which we would look at the acquisition method when one company purchase another company Specifically in this session, we're gonna be assuming that each company is going to retain its own separate accounting record And the reason I am emphasizing this point because in the prior session we looked at acquisition or combination Where the company that's being acquired dissolved and it's gone. So this is a one-time event versus When each company maintain its own separate record, we're gonna be using Worksheets and now we're introducing the idea the important idea of a worksheet when we when we do consolidation when we combine two companies We are still going to be using the fair value method Valuing everything at fair value when we do this Combination when we do this consolidation process that each company would retain its own record now If you want to take a look at the prior session when the solution takes place I would say this is easier again because it happens how many times once it happens once and we're done We bring older assets will bring older liabilities on the books to our books and life will go on This topic is extremely important. Whether you're an accounting students or a CPA candidate Therefore, I invite you to visit my website farhat lecturers calm. I don't replace your CPA review course You can keep your course. I am a useful addition. I can explain the material differently I can show you how to approach the questions differently I can provide you alternative resources to help you along your CPA review course So your risk to try me is one month of subscription your potential gain is passing the exam Are you willing to take that risk to pass the exam? That's all you have to do try me for a month And if not for anything take a look at my website to find out how well or not while your university doing on the CPA exam I do have resources for other courses as well Please connect with me only then if you haven't done so like this recording share it with other connect with me on Instagram Facebook Twitter and Reddit now to illustrate this concept I'm going to go to an Excel sheet and show you the same example that we work in the prior example So if you haven't looked at the prior example, that's fine But if it's helpful if you look at the prior data, so this is the example we're gonna we're going to be working with we have So this is the example we're gonna be working with we have the buyer company and the seller company the buyer Company is buying the seller company is buying them And here are the book value for the purchaser and the book value for the seller Now we're gonna be using the fair value measurement Therefore we measure everything that we're buying at fair value for example just a review their current assets They have 300,000 the book value the fair value is also 300,000 they have computer and equipment of 400,000 It's worth 600,000. They have capitalized software of 100,000. It's worth way more 1.2 million Under books they don't have they have a customer contract that they did not record because they cannot record the customer contract We think it's worth 700,000 their liabilities are worth 200,000 well the fair value of the liabilities if we have to pay it 250 okay, so notice Their net asset or net equity at fair value is two million five hundred and fifty thousand now We're gonna buy this company and what's the deal? Here's the deal. We are going to issue 26,000 shares at one hundred dollar per share. So this is two point six million dollar We're gonna be paying and we're gonna be pay professional fee of forty thousand for arranging the deal remember if we have any brokerage fee that's gonna be Account for it separately is an expense. So this is basically this is an expense This is not part of the deal and guess what in this deal. We're gonna be dealing with a contingent clause What is a contingent clause a contingent clause occur when the buyer and the seller they disagree on the fair value? So remember these these fair values are basically an estimate estimate But there's gonna be a disagreement to resolve this is disagreement to kind of reduce the uncertainty the buyer would say look Look if we if we can earn a certain amount of money Okay, basically if we if we can earn that much money will pay you extra and here's the deal Here's the contingent clause. We're gonna pay eighty three thousand two hundred more to the shareholders Okay, in addition to this two point six million if the seller earnings exceed three hundred thousand for year one So simply put if you can earn more than three hundred thousand guess what we owe you an additional eighty three thousand Now this is basically a contingent liability. How do we record this contingent liability? We have to Estimate what is the probability of that happening? We're gonna assume it's 25 percent of that happening 25% chance also since we are responsible for paying this liability a year from now We're gonna discount it and we're gonna assume the discount rate is 4% So when we discount this liability eighty three thousand two hundred times point two five of chance happening times point nine nine Six one five three eight. This is the time value of money one year at 4% now if you don't know the time value of money Then you should go into my intermediate accounting and learn about the time value of money And what we come up with when we this this this when we compute these numbers We come up with a contingent liability of 20,000 simply put this is a new liability. Guess what? Let's go ahead and Record the purchase. So how much are we going to pay for this purchase? How what's the consideration giving for this problem? Well the consideration giving is two million two two two million 620 which is the stocks Plus the contingent liability that we are responsible. Let's go ahead and journalize this entry because we need to journalize the entry So basically we are going to debit an investment in the seller company Two million six hundred and twenty. We're gonna record a liability and we issued the stocks Remember common stock is the number of shares times the par value we're showing twenty six stop twenty six thousand shares The par value is ten dollars, which is giving in the right here. The par value is ten dollars And the remaining is additional paid in capital now what we have to do immediately now We have an investment on the parents book a contingent liability We have to increase our common stock common stock used to be Common stock used to be one point six million. This is a credit balance not a negative now We're gonna have to add to it two hundred and sixty thousand and we have to increase to our paid in capital So let me show you how things looks like after we complete this First we have to put the investment on the books now on the parent company on the big company big company books We have a new account called an investment account also our We have a new account called contingent liability. Also, this is on the parents book And our common stock went from one point six million and we added to it the new stocks that we issued also additional paid in capital went from forty thousand and we added to it the Two million three hundred and forty so it's three two million three hundred and forty So what I'm trying to show you is those accounts common stock Has been updated and additional paid in capital has been updated after we issue the stocks now We also paid forty thousand to arrange the fee while the forty thousand is an expense We debit an expense we credit cash and basically cash comes out of retain comes out of current assets Therefore, we used to have one million one hundred thousand We're gonna reduce cash by current assets, which is cash by forty thousand Just so those are the figures that you need to be aware of because when you go when we go to the consolidated balance sheet You're gonna see different figures. I want you to understand why we did this. Okay, so the first thing we do is we record the Record the purchase. How much did we pay for the asset? Go ahead and record the purchase. That's fine. We did this Okay, now what what are we going to do next after we record the purchase? We're gonna have to allocate We're gonna have to allocate because we paid more than the book value of this company The book value is two million five hundred and fifty. We paid more. So now we're gonna have to allocate The extra for the fair value of the asset. What we have to do first is find the difference What is the difference is what is the difference in the assets and liabilities that we purchase because this is what we have to record the Current assets are the same. There's no difference We have a computer undervalued by two hundred thousand We have kept capitalized software undervalued by one point one million and we have Customer contract undervalued and we have no stable. That's undervalued. Now. What's gonna happen is this we're gonna have to allocate the extra so Let's start with this process We paid two million six hundred and twenty for a company that's worth on the books on the books notice on the books It's worth only six hundred thousand. Therefore, we paid extra We paid extra of two million two million and twenty thousand That's how much we paid extra. That's the difference now. What are we gonna do? Well, we already know that certain assets are undervalued. For example, their computer equipment is undervalued by two hundred thousand So what are we going to do? We're gonna allocate of this amount two hundred thousand to the computer equipment same thing with The capitalized software. We're gonna allocate to that one million one hundred thousand customer contract are undervalued by seven hundred thousand and Their liabilities are undervalued by fifty thousand. So after we allocate this two million The basically we're gonna take this difference and allocate this difference to those assets and liabilities We're gonna have a remaining balance a few if you go ahead and allocate the difference We're gonna have a remaining balance of guess what seventy thousand. What do we call any? Unexplained or any remaining balance after we allocate all this you you guessed it. We're gonna call it We're gonna record it as goodwill because we have to record this additional 70,000 so basically you take a picture of this or write these numbers down because when we go to the worksheet to show you how this all work We have 70,000 of goodwill on the on the worksheet. So, you know what it's coming from So let's go to the worksheet to start this consolidation Process because this is important. So after we allocate we can start the consolidation process. So here's what we have This is a worksheet. We have We have let me make it a little bit smaller. Okay, this is Better we have all the accounts first We have the income statement accounts for big and small and remember we don't have any income statement account for small because remember What I told you we purchased this company December 31st by that time the last day of the year They don't have revenues and expenses because they close them and the reason we did this is to keep it simple Don't don't worry. We're gonna have those income statement account consolidation in future Sessions retained earning the same thing. We don't have anything because everything is closed out Everything is closed out to retained earnings or simply put the retained earnings. It Includes everything that we need to that we need to have We have current assets for the big company current assets for small company and we don't have any adjustments. So let's start the Should let's do the journal entries first basically, let's do the journal entries first So what do we have to do when we do consolidation the few things that we need to be aware of Okay, we have to eliminate we have to eliminate the Company that we purchased equity accounts. So basically come and stock additional paid-in capital in retained earnings This is one of the steps we have to complete those has to be gone because the only equity account that survive That survive under the consolidated total is The is the parent company but before we do that, let me just go through the income statement and retained earnings. Let me Show you this. So basically we have big company 1 million small company. They have no revenue. We have no adjustments Therefore the consolidated revenue is a million. We have big company 840,000 no small company expenses no adjustments total expenses consolidated 840 Consolidated net income is 160 we're gonna do same thing through the retained earnings net income and declared dividend because we don't have anything for the small company It's all has been closed out. So this is all what's surviving now Let's go ahead and start with the balance sheet. The balance sheet is We're gonna have 1 million and 60,000 as of the beginning balance for current assets And I'm just gonna go through this plus 300,000 Therefore the consolidated current assets is 1,000,360 now the investment account cannot The investment account has to be go down to zero because when we consolidate we're gonna bring everything We're gonna consolidate the big and the small and the investment account What why did we use the investment account? We this investment account represent the equity of the other business the equity of the other business means This is the equity of the other business the 100,000 the 20,000 in the 40 therefore what we have to do We have to eliminate so part of the elimination process Basically, we have to eliminate the stockholders equity of the subsidiary. So they have a credit balance What do we have to do? We're gonna have to debit them. So I'm gonna debit common stock 100,000 I'm gonna debit Additional paid in capital 20,000 I'm gonna debit retained earning 480,000 I have to eliminate those and where do I eliminate them against those they equal to if I add them up the equal to 600,000 and I'm gonna go ahead and Credit my investment account. I'm gonna credit investment account 600,000 so this is the first the journal entry. Let me put it and maybe in a different yellow. So this is the well Let me do it in a different color This is the first journal entry consolidate the journal entry and notice what's gonna happen here when I take this is The the green is a debit and the yellow is a credit. So when I take the debit Take the difference between the debit and the credit. They should equal to zero So I should so they should eat the the subsidiary balance that should equal to zero now all what survive simply put all What survive is the equity of the business the equity of the main company. Okay, so simply put Let me do it. Let me do it from the beginning. So I have common stock of 1,000,000 860 Well, I'm gonna bring it here because there's no adjustment for that. I have common stock of a Power value common stock for the subsidiary for 100,000 and 100,000 plus 100,000 minus it's gonna give me zero. I have additional paid-in capital to 2,000,380,000 I'm gonna add the 20,000 from the subsidiaries then remove 20,000 from the subsidiary simply put if I take this plus this Minus this minus those three numbers together. I'm gonna only end up. Sorry. I made a an error here Formula error. So basically all what's gonna survive is the 2,000,380 the additional paid-in capital for the parent company So basically the sub the sub common stock is gone the sub additional pay this capital is gone and Same thing with retained earning. I will take my retained earning plus the retained earning minus the adjustment And that's gonna give me only 920,000 so simply put notice the stock the owner's equity accounts, which is common stock Additional paid-in capital and retained earning the only one that survive is the parents So this is one of the things you should be also always looking for and on the exam They try to trick you. What should be the on the consolidated the Balance sheet at the subsidiaries equity account and they would list always zero on the consolidated balance sheet Why because we're gonna close them to the investment account. So that's that's done Now I'm not gonna close the investment account yet because I need to also close the investment account And the reason is I need to close it because when I purchase the other companies I purchased their asset I cannot keep my investment account and purchase their asset. So what I'm gonna do now Simply put what's gonna happen is this Of the two million two two million and twenty thousand. I'm sorry I paid an extra look of the two million of the two million of the two million six hundred and twenty I I Bought their equity six hundred thousand already took care of this now I need I still have two million and twenty thousand that I have to allocate to those assets Now what I'm gonna do I'm gonna have to allocate to those other assets in other words I'm gonna have to debit the additional assets the amount that they require So they are at fair value starting with the computer equipment the computer equipment We said it's undervalued by two hundred thousand. So I'm gonna go ahead now I have computer equipment one point three million the book value of their computer equipment four hundred thousand I'm gonna debit notice. This is a debit. I'm gonna debit an additional 200,000 to reflect the fair value so the computer equipment and the consolidated on the consolidated total should be one point nine million Same thing with the capitalized software. I have capitalized software of half a million They have capitalized software of one million, but what we find out is they also have Their capitalized software is worth an additional 1,000,000 100,000 Let me do the put the commons here therefore What I'm gonna do I'm gonna take my capitalized software add their capitalized book value software then add The fair value therefore on the consolidated balance sheet. We have capitalized software of one point seven million. So this is the second debit Now customer contract. I have no customer contract. They had zero customer contract But when we bought them we know that they have they should have seven hundred thousand of customer contract Therefore, I have to add this debit and that's basically zero plus zero plus seven hundred thousand equal to seven hundred thousand So under on the consolidated balance sheet. We have seven hundred thousand worth of worth of Worth of customer contract on all what I'm doing is all what I'm doing is I'm taking dose the two hundred thousand I accounted for the one point one the seven hundred thousand. I still have the notes payable and the goodwill Let me go ahead and record the goodwill. We did not have goodwill earlier now We're gonna have a goodwill of fifty thousand So I'm gonna have a goodwill of fifty thousand on the consolidated Balance sheet. This is my goodwill of fifty. I'm sorry not fifty seventy thousand The Consolidate the goodwill is seventy thousand That's seventy thousand So now let's take a look at their notes payable their notes payable. I have three hundred thousand of notes payable I mean the parent company or big company small company has two hundred thousand then I'm gonna have to add fifty thousand of Liabilities, okay, fifty thousand of liabilities. Why because their liabilities are worth More than what's on the books. Therefore what I'm gonna do. I'm gonna add all the notes payable and the adjustment and overall we have liabilities of five hundred and fifty thousand contingent liability. We have now a contingent liability of Twenty twenty thousand remember. The reason is negative is to show it's a credit. I Accounted for stockholders equity. Let's see if total assets equal to stop total stockholders equity. So let me That's it. Let me see this. I don't think it's gonna I'm gonna I'm gonna show you what's missing But let me copy it first and just have the formula here So formula is five million seven hundred and thirty thousand now. Well The reason is because the investment account is zero Okay, the info for the investment account to be zero. I'm missing a credit So now the investment account. Let me show you that now it does not balance until I do the credit So if I take two million six hundred and twenty minus the credit This is not gonna balance now now it doesn't balance So what I have to do all the debits that I have all the debits that I have minus the Fifty thousand credit the adjustment is two million two hundred thousand remember. I have to reduce my investment account by two million Two hundred thousand. Let me now Minus the two million the other credit for the investment now. It's equal now. They oops minus it. What did I do? Okay, so it's This account minus 600,000 minus two million and 20,000 maybe I have too many zeros. Let me just check my zeros here Okay There we go. All right two million two hundred thousand therefore the second entry So I'm gonna put this in a different color the highlight in a different color. I'm gonna highlight in maybe light blue Okay, so this is the Second entry. This is the second entry. I debit the accounts the assets. I debit the assets and I credit the investment to bring the investment down to zero and I put the liabilities on the books Therefore at the end of the consolidation notice now they equal to each other Remember the investment account has to zero down. I'm good. This is one check you can do the equity account on the equity account that survive as the parent company, which is what the one million eight hundred sixty check 2 million 380 checked and the 920. Okay, why because the the I eliminated the subsidiaries Equity because they don't appear on the consolidated Then I take my investment account and allocate the investment account to the various assets and liabilities and my investment account should go That should go down to zero. I would say this is a simple process. The reason I say this is I would say a basic or Baby steps. Why because we did not have any income statement to worry about or Statements of retained earning but again, the reason is this is a starting point because this is the first time we're doing this So I'm gonna do this step by step. This is the mechanics for the For the entries now remember those are actual entries So but entries those entries are on the worksheet. Okay? In other words, you're gonna have to debit debit debit debit common stock for the subsidiaries debit additional paid in capital debit retained earning and credit investment That's that's one entry Just make sure you know this. I just have them here as debits and credits and those are These entries. Where do they go? They go on the worksheet basically on the side. We take care of them. Why because we keep each company's Separate at the end of the day each company separate So we do those consolidated entries to prepare the consolidated Financial statements again at the end of this recording. I would like to remind you worksheet is an important topic on the CPA exam Okay, again, I don't replace your CPA review course. I can be useful edition. I can teach you this give me a chance That's all what I'm gonna tell you if you want an alternative explanation backup explanation because your CPA review course may assume You know this I teach you this from scratch. Good luck study hard and of course stay safe