Purchase method is one method of accounting for acquisition of one company by another. This method is used when the stock of a subsidiary is acquired by cash payment. It is also used when a parent issues bonds payable or capital stock to acquire the stock of a subsidiary company.
Under the purchase method, the acquiring corporation records the net assets acquired at the fair market value of the consideration given. Any excess of the purchase price over the fair market value of the net identifiable assets is recorded as goodwill. The acquiring corporation then records periodic charges to income for the depreciation of the excess price over book value of net identifiable assets. Goodwill is subject to an annual impairment test. Note that goodwill already on the books of the acquired company is not brought forth. Net income of the acquired company is brought forth from the acquisition date to year end. The direct costs of the purchase reduce the fair value of securities issued and indirect costs are expensed.
Therefore, in preparing consolidated financial statements, a worksheet is used to determine the necessary elimination entries. These entries are used for this purpose only. They are not recorded in the financial records of the parent or its subsidiaries. The worksheet will contain the asset and liability account balances for the parent and each subsidiary. Debit and credit columns are provided for intercompany eliminations and a column is provided for the consolidated asset and liability account balances.
Intercompany eliminations include elimination of:
- Intercompany debt.
- Intercompany stock ownership.
- Intercompany revenue and expenses.
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