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Accounting 471/875

Accounting 471/875. Chapter 3. Criteria for Cost vs Equity Method. Percentage of Outstanding Voting Stock Acquired. 0%. 20%. 50%. 100%. 1. Level of economic influence. “Significant Influence”. Nominal. Control. 2. Valuation basis. Cost Method. Equity Method.

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Accounting 471/875

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  1. Accounting 471/875 Chapter 3

  2. Criteria for Cost vs Equity Method Percentage of Outstanding Voting Stock Acquired 0% 20% 50% 100% 1.Level of economic influence “Significant Influence” Nominal Control 2.Valuation basis Cost Method Equity Method 3.Financial statement presentation Investment Account Separate Financial Statements Consolidated Financial Statements

  3. Cost Method vs Equity Method

  4. Cost Method vs Equity Method

  5. Cost Method vs Equity Method

  6. GW=$105,000-103,500=$1,500 Equipment RI(D)=($62,000-60,000)*75%=$1,500 Building RI(D)=($103,000-100,000)*75%=$2,250 Land RI(D)=($28,000-$25,000)*75%=$2,250 AC FV * % BV * % $105,000 $103,500 =$97,500+(1,500+2,250+2,250) $97,500 =(100,000+30,000)*75%

  7. Effective June 30, 2001, New Rules for Accounting for Business Combination • SFAS 141 - Accounting for Business Combinations • Supercedes APB Opinion 16 • Eliminates use of pool-of-interests method • Modifies current purchase accounting method • New intangible asset recognition criteria • Expanded disclosure requirements • SFAS 142 - Accounting for Goodwill and Intangible Assets • Supercedes APB Opinion 17 • Goodwill not amortized • Goodwill subject to annual impairment test

  8. Goodwill Impairment • In SFAS 142, FASB mandates a purchase accounting method for business combinations that requires companies to: • Conduct an annual goodwill impairment test • Based on fair value of the reporting unit • However, goodwill will not be amortized • If goodwill impaired: • Impairment loss recognized in income statement • Amount of goodwill reduced on balance sheet

  9. Goodwill Impairment Test Three-Step Approach Step 1: Determine Potential Goodwill Impairment • Calculate fair value of reporting unit (FVRU) • Calculate carrying value (book value) of reporting unit (CVRU), including goodwill. • If FVRU  CVRU, goodwill is not impaired, do nothing. • If FVRU < CVRU, potential goodwill impairment, go to Step 2

  10. Goodwill Impairment Test Three-Step Approach Step 2: Calculate Implied Fair Value of Goodwill • Implied fair value of goodwill of reporting unit (IFVGWRU) = FVRU – Fair Value of Identifiable Net Assets of Reporting Unit (FVINARU) • If IFVGWRU > Carrying Value (book value) of Goodwill of Reporting Unit (CVGWRU), do nothing • If IFVGWRU < CVGW, go to Step 3

  11. Goodwill Impairment Test • Three-Step Approach • Step 3: Calculate Goodwill Impairment Loss • Goodwill impairment loss = CVGWRU - IFVGWRU • must recognize goodwill impairment loss as separate line on income statement • must reduce amount of goodwill on balance sheet by amount of goodwill impairment loss.

  12. Goodwill Impairment Test • New Rules Illustrated • On January 1, 20X1, A Corporation paid $1,000 to acquire all of the outstanding common stock of B Corporation. The following is reported on the B Corporation’s balance sheet at the date of acquisition:

  13. Goodwill Impairment Test New Rules Illustrated • The recorded value of the identifiable net assets is $650 ($1,000 minus ($100 + $250)). • The fair value of the identifiable net assets is $800 ($150 above the recorded value) because of appreciated real estate. • Thus, at the date of acquisition, A Corporation pays $200 ($1,000 – $800) above the fair value of the identifiable assets to purchase B Corporation. • According to A Corporation’s management, the company is willing to pay the $200 premium because it believes that access to B Corporation’s customer base will be especially profitable.

  14. Goodwill Impairment Test Calculation of Goodwill – Date of Acquisition Fair Value of Identifiable Net Assets Book Value of Identifiable Net Assets Purchase Price Goodwill = $200 Revaluation Increment = $150 $1,000 $800 $650

  15. Goodwill Impairment Test New Rules Illustrated • Assume that B Corporation has a net loss for the year ended December 31, 20X1 and management forecasts continuing losses. • Accordingly, the fair value of the recorded goodwill may be impaired and an impairment test is warranted. • The fair value of B Corporation (FVRU) at December 31, 20X1 is determined to be $725. • The carrying value of B Corporation (CVRU) at December 31, 20X1, including goodwill, is determined to be $800. • The fair value of the identifiable net assets of B Corporation (FVINARU) at December 31, 20X1 is determined to be $700.

  16. Goodwill Impairment Test Calculation of Implied Goodwill – 12/31/X1 Fair Value of Identifiable Net Assets Book Value of Identifiable Net Assets FVRU IFVGWRU = $25 Revaluation Increment = $100 $725 $700 $600

  17. Goodwill Impairment Test Three-Step Approach

  18. Goodwill Impairment Test • When the impairment test is completed, the company concludes the fair value of the reporting unit is now only $25 greater than the fair value of the identifiable net assets of B Corporation. • Thus, the implied fair value of the goodwill has fallen to $25. • As a result, A Corporation will report a $175 goodwill impairment loss as a separate line item on the income statement and report goodwill totaling $25 on the balance sheet.

  19. Goodwill Impairment Worksheet

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