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© The McGraw-Hill Companies, Inc., 2004
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Chapter Three
Consolidations Consolidations – Subsequent – Subsequent to the Date of to the Date of AcquisitionAcquisition
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SFAS No. 142 - Goodwill and Other Intangible Assets
For fiscal periods beginning AFTER
December 15, 2001, goodwill will no longer
be amortized.
The “nonamortization” rule will apply to both previously recognized
and newly acquired goodwill.
Any unamortized goodwill that arose from pre-SFAS 142 combinations will
be henceforth carried on the
books as a permanent asset.
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SFAS No. 142 - Goodwill and Other Intangible Assets
Generally, once goodwill has been recorded, the value will remain unchanged.
Sale of all or part of therelated subsidiary.
Any impairm ent in the valueof goodw ill should be reported
as an extraordinary item.
A determ ination that goodw illhas experienced a permanent
im pairm ent of value.
Tw o circum stances exist thatw ill result in adjusting the am ount
of goodw ill on the consolidated balance sheet.
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Consolidation - The Effects of the Passage of Time
The parent can account for its investment one of three ways:
Equity MethodCost MethodPartial Equity
Let’s compare the three methods briefly.
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Investment AccountingExh.3-1
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Before the consolidation balances can be determined, the Parent’s investment account must be adjusted to reflect the
application of the equity method.
Subsequent Consolidation - Equity Method
Record the Investment in Sub on the acquisition date.
Recognize the receipt of dividends from the sub.
Recognize a share of the sub’s income (loss).
FMV adjustments and other intangible assets.
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On 1/1/05, Dad Co. purchases 100% of Kid,
Inc. for $900,000 cash.
Kid’s net assets on 1/1/05 was
$600,000.
Consolidation ExampleEquity Method
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Consolidation ExampleEquity Method
Before preparing the
Equity adjustments, determine the Goodwill and amortization
expense.
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Assume that Current Assets
have a remaining
useful life of 1 year, and the
buildings, has a remaining
useful life of 10 years.
Consolidation ExampleEquity Method
Amortization computation:
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Amortization computation:
Consolidation ExampleEquity Method
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First, prepare the entry to recognize First, prepare the entry to recognize Dad’s share of Kid’s net income.Dad’s share of Kid’s net income.
Dad owns 100% of Kid.Dad owns 100% of Kid.Kid’s Net Income = $150,000Kid’s Net Income = $150,000
Consolidation ExampleEquity Method
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Consolidation ExampleEquity Method
Kid's Net Income for 2005 150,000$ % of Kid owned by Dad 100%Equity Adjustment 150,000$
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Consolidation ExampleEquity Method
Second, prepare the entry to recognize Second, prepare the entry to recognize Dad’s share of Kid’s dividends.Dad’s share of Kid’s dividends.
Dad owns 100% of Kid.Dad owns 100% of Kid.Kid’s Net Income = $150,000Kid’s Net Income = $150,000
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$400,000 dividends were paid $400,000 dividends were paid by Kid to Dad during the by Kid to Dad during the
year.year.
Consolidation ExampleEquity Method
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Finally, record the amortization of the fair market value adjustments.
Consolidation ExampleEquity Method
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The Amortization Expense from the earlier computation = $27,000
Consolidation ExampleEquity Method
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Subsequent Consolidation - Worksheet Entries
5 basic entries are posted to the worksheet.1. S - The Sub’s equity accounts are eliminated.2. A - The other intangible assets are recorded and
the Sub’s assets are Adjusted to FMV. 3. I - The Equity in Sub Income account is
eliminated.4. D - The Sub’s Dividends are eliminated.5. E - Amortization Expense is recorded for the
FMV adjustments and other intangible assets associated with the consolidated entity.
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Consolidation EntriesEquity Method
Entry SEliminate the sub’s equity balances as of
the beginning of the period.Plug the difference to Investment in Sub.
If (1) this is the first year of the investment, and (2) the investment was made at a time other than the beginning of the fiscal year, then Preacquisition Income must be accounted for (see Chapter 4).
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Consolidation EntriesEquity Method
Entry AAdjust sub’s assets and liabilities to FMV.
Set up the Goodwill account and the other intangible assets. The difference is a reduction of the
Investment in Subsidiary account.
In the first year of the investment, the FMV adjustments for this entry will be identified during the computation of Goodwill. In subsequent years, the FMV adjustments and the other intangible assets identified must be
reduced by any depreciation (amortization) taken in prior periods. (including in-process R&D)
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Consolidation EntriesEquity Method
Entry IEliminate the Equity in Sub Income account.
Plug the difference to Investment in Sub.
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Consolidation EntriesEquity Method
Entry DEliminate sub’s current Dividends.
Plug the difference to Investment in Sub.
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Consolidation EntriesEquity Method
Entry ERecord amortization expense for the current
period associated with the FMV adjustments and the other intangible
assets identified during the combination.Remember to never amortize land or
goodwill!
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Consolidation at 12/31/05Equity Method Example
Using the 12/31/05 adjusted balances,
prepare the consolidation at
12/31/05.
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Note Dad’s updated
numbers.Now, post the consolidation entries to the worksheet.
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Consolidation, 2 or more years Consolidation, 2 or more years after acquisitionafter acquisition
Let’s do question Let’s do question Excel Case on page 144 in the text.Note – we must remember certain key procedural Note – we must remember certain key procedural
changes. See slides 18, 19 and 22:changes. See slides 18, 19 and 22:
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Applying the Cost Method
If the COST METHOD is used by the parent If the COST METHOD is used by the parent company to account for the investment, then the company to account for the investment, then the consolidation entries will change only slightly.consolidation entries will change only slightly.
Remember . . . Remember . . .
1. No adjustments are recorded in the Investment account for current year operations, dividends paid by the subsidiary, or amortization of purchase price allocations.
2. Dividends received from the subsidiary are recorded as Dividend Revenue.
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Consolidation EntriesCost Method
Entry SEliminate the sub’s equity balances as of the
beginning of the period.Plug the difference to Investment in Sub.
This entry is the same under both the Equity Method and the Cost Method.
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Consolidation EntriesCost Method
Entry AAdjust sub’s assets and liabilities to FMV.
Set up the Goodwill account and the other intangible assets. The difference is a reduction of the Investment in Subsidiary
account.This entry is the same under both the Equity Method and the Cost
Method.
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Consolidation EntriesCost Method
Entry IThis entry is different under the Cost Method.
Eliminate the Parent’s Dividend Income account.
Also, eliminate the Sub’s Dividends Paid account.
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Consolidation EntriesCost Method
Entry DUnder the Cost Method we DO NOT
make an Entry D.
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Consolidation EntriesCost Method
Entry ERegardless of the method used, we must
record the amortization of the purchase price allocations. This entry is the same as the
Equity Method.
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Other Consolidation Entries
In addition to the Entries S, A, I, D, & E, you must also eliminate intercompany payables or receivables.
So far, we have assumed that the parent acquired 100% of the subsidiary in the combination. If control acquired is < than 100%, an additional adjustment must be made (see Chapter 4).
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Goodwill Impairment
Goodwill is not amortized. It is assigned an
“indefinite” useful life. Generally, goodwill
will be carried at it’s acquisition cost.
At some future point in time, the goodwill may become permanently impaired.
SFAS No. 142 calls
for an annual test
of impairment
for Goodwill.
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Goodwill Impairment ExamplesExh.3-15
2002 Goodwill Impairment Write-downs
Company 2002 Write-DownAOL Time Warner 54,000,000,000$ Boeing 1,800,000,000$ Blockbuster 1,800,000,000$ SBC Communications 1,800,000,000$ General Electric 1,000,000,000$ Coca-Cola 926,000,000$ AT&T 856,000,000$ Safeway 700,000,000$ Verizon Communications 500,000,000$
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Goodwill Impairment Test
Step 1 Compare fair value of
REPORTING UNIT to carrying value of the REPORTING UNIT
Step 2 Compare fair value of
GOODWILL to carrying value of GOODWILL
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Goodwill Impairment Test - Step 1Is the Fair Value of a Reporting Unit Less Than Carrying Value?
Compare the Reporting Unit’s Fair Value to its
Carrying Value. If Fair Value of the
Reporting Unit is < Carrying Value, GO TO
STEP 2. Recompute Fair Value
if the previous Fair Value can not be used?
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Goodwill Impairment Test - Step 1Is the Fair Value of a Reporting Unit Less Than Carrying Value?
Use the most recent Fair Value if: The net assets of the reporting unit have not
changed significantly since the most recent fair value determination.
AND The most recent fair value determination >
the carrying amount of the reporting unit by a substantial margin.
AND It is remote that computing a new fair value
would result in an amount < the current carrying amount of the reporting unit.
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Goodwill Impairment Test - Step 2
If the fair value of a reporting unit < its carrying
value, then Step 2 is performed.
If goodwill’s fair value falls below its carrying value, then impairment has occurred, and an
extraordinary impairment loss is
recorded.
Three Complexities Arise
The assignment of acquisition value to reporting units
The periodic determination of the fair values of reporting units
The determination of the implied fair value of goodwill
?
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A Reporting Unit can be:
A component of an operating segment.
A segment of an enterprise.
The entire enterprise.
Assignment of Acquisition Value to Reporting Units
To better assess potential declines in value for goodwill,
the goodwill must be assigned to its
related REPORTING UNIT.
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Basis for determining fair value:
Market price, if the reporting unit is publicly traded.
Market price of comparable businesses.
Business valuation techniques using PV.
Periodic Determination of the Fair Value of a Reporting Unit
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Use the fair value of the reporting unit as the “purchase price”.
Allocate the “purchase price” to all identifiable assets and liabilities of the reporting unit.
Compare the resulting “implied goodwill” to the goodwill on the books.
If “implied goodwill” < recorded goodwill, impairment has occurred.
Determination of the Implied Fair Value of Goodwill
The “impliedimplied” fair value of Goodwill is
calculated in a similar manner
as the determination of
goodwill in a business
combination.
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Closing Observations Related to the Testing of Goodwill for Impairment
Determining the “fair value” of the reporting segment adds a new,
potentially costly periodic task of
consolidated financial reporting.
The fair values of the assets and liabilities of
the reporting unit used in the test for impairment
do not impact the amounts reported on the
consolidated financial statements.
A decline in the value of the reporting unit does NOT necessarily signal an impairment
of goodwill under SFAS No. 142.
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Goodwill Impairment TestExample
Assume the fair value of Dad
Co.’s investment in
Kid, Inc. at 12/31/06 has
fallen to $450,000.
Is Goodwill Impaired?
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Goodwill Impairment TestExample
STEP 1STEP 1Fair value of the
investment < the carrying
amount of the investment, so go to Step 2.
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Goodwill Impairment TestExample
STEP 2STEP 2The implied
Goodwill < the carrying amount of the Goodwill, so an impairment write-
down is necessary.
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Goodwill Impairment TestExample
Goodwill Impairment EntryThe Goodwill needs to be written down by $50,000. The entry should be recorded as an extraordinary item on the consolidated
financial statements, if it is material.
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This stuff This stuff is a is a
breeze, breeze, ain’t it?ain’t it?
End of Chapter 3