A business combination is an event which leads to one company controlling the other. The company that acquires control is called the acquirer while the company being acquired is called the target. Since the operating and financing decisions of the target are controlled by the acquirer after the business combination, it is useful to treat both the companies as a single company and prepare their consolidated financial statements.
The acquirer normally controls the company by purchasing its common stock. Accounting standards prescribe different accounting treatment for different extents of stock holding based on the nature of influence or control.
Neither Significant Influence nor Control
Investments up to 20% of the acquirer's outstanding stock are treated as financial instruments and are normally carried at fair value.
Significant Influence: Equity Method or Proportionate Consolidation
Investments in 20% to 50% of the outstanding common stock of the acquirer results in significant influence and acquirer and target are called associates. Such investments are accounted for using equity method (under US GAAP) or equity method or proportionate consolidation method (under IFRS).
Control: Acquisition Method and Consolidation
Investments in more than 50% of the acquirer's outstanding common stock results in control of the target by the acquirer. The acquirer and target are called parent and subsidiary respectively. Such investments are accounted for under the acquisition method.
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