Consolidation fundamentals
Consolidation is required when one entity has a controlling financial interest — typically majority voting interest, or being the primary beneficiary of a variable interest entity (VIE).
What gets eliminated
- The parent's investment account against the subsidiary's equity
- Intercompany receivables and payables
- Intercompany sales and cost of sales (100%, even for partially owned subsidiaries)
- Unrealized profit in ending inventory and on intercompany fixed asset transfers, until realized through sale to an outside party
IMPORTANT: Intercompany transactions are eliminated in full (100%), not by ownership percentage. However, for upstream sales (subsidiary → parent), the eliminated unrealized profit is allocated between the controlling and noncontrolling interests. Downstream sales (parent → subsidiary) are allocated entirely to the controlling interest.
Step acquisitions
When control is achieved in stages, the acquirer remeasures its previously held equity interest to fair value at the acquisition date and recognizes the resulting gain or loss in earnings. Goodwill is then measured using the full acquisition-date fair values.
EXAMPLE: An investor holds 30% of a company (carrying amount $3,000,000) and buys another 40% for $5,500,000, achieving control. The previously held 30% has a fair value of $4,000,000 at that date. The investor recognizes a $1,000,000 gain ($4,000,000 − $3,000,000) and measures the acquisition using $9,500,000 of total consideration plus the fair value of any noncontrolling interest.
Changes in ownership after control
IMPORTANT: Once control exists, buying more shares or selling shares without losing control is an equity transaction — no gain or loss is recognized in income. The difference is recorded in additional paid-in capital. Only a transaction that results in loss of control triggers gain or loss recognition and remeasurement of any retained interest to fair value.
Measurement period
The acquirer has up to one year from the acquisition date to finalize provisional amounts as new information about facts existing at the acquisition date emerges. Adjustments are made retrospectively to goodwill, not through earnings.