Acc 424 Financial Reporting II

1. Acc 424Financial Reporting II Lecture 7 Waste Management Case Supplementary slides

2. Waste Management CasePart A • Is the lack of restatement of prior earnings for the poolings acquisitions proper accounting? • What is the impact on the time-series of earnings numbers?

3. Waste Management CasePart B • If the “insignificant” acquisitions had been accounted for using the purchase method, what additional amounts of goodwill would have been recorded in 1987, 1988, 1989 & 1990? • What would be the percentage increase in recorded goodwill on 12/31/89?

4. Waste Management CasePart B - Worksheet 1/1/90-6/30/90 1989 1988 1987 ($000) Consideration given • # of companies acquired47 97 168 102 • stock issued for poolings (as recorded) Common stock (pp. 9, 10 & 16) $1,262 $ 3,464 - 9,455 Additional paid-in capital (pp. 9, 10) 1,872 10,494 - 2,897 Treasury stock (p.10)* ______ ______ - 10,045 $3,134 $13,958 $0 $22,397 *Presumably 5,026 2 (2-1 split) - 9,455 = 10,053-9,455 = 598 thousand shares Note that there are no entries for retained earnings • cash & notes for acquisitions $238,842 $300,623 $303,601 $60,064

5. Waste Management CasePart B - Worksheet 1/1/90-6/30/90 1989 1988 1987 (000) ProForma Purchase Accounting # of common shares issued1,262 3,464 0 5,026.5  Average share price $37$27.10$18.53$38.22 = Market value of Issued Shares $46,694 $93,874 $0 $192,113 Less: Amount recorded for shares $3,134$13,958 $0 $22,397 Estimate of Unrecorded Goodwill $43,560 $79,916 $0 $169,716 Unrecorded amortization per year $1,089 $1,998 $0 $4,243

6. Waste Management CasePart B Percentage increase in goodwill 1987 1988 1989 ($000) Recorded goodwill (X) p.4 $642,870 $838,069 $1,004,950 Accumulated amortization p.12 58,902 79,764 109,327 Gross Goodwill $701,772$917,833$1,114,277 Annual unrecorded Goodwill (slide 5) 169,716 0 79,916 Unrecorded Goodwill from prior year(s) 39/40 of $169,716 165,473 38/40 of $169,716 _______ _______ 161,230 Unrecorded Goodwill (Y) $169,716 $165,473 $ 241,146 As a % of recorded Goodwill (X) 26.4% 19.7% 24%

7. Waste Management CasePart C By how much would the 1989 year and the first 6 months of 1990 net incomes differ under purchase accounting? (assume acquisitions occur at the midpoint of each period & a 40 year amortization period) 1987 1988 1989 1990 Annual unrecorded amortization $4,243$ 0$1,998$1,089 Half-period assumption 2,121 0 999 544 Previous years’ unrecorded amort. ______ 4,2434,243 2,121 Total additional amortization $2,121 $4,243 $5,242 $2,665 Income before taxes$584,067 $746,340 $850,681 $512,538 Addtnl amortization as a % .36% .57% .62% .52%

8. Waste Management CasePart D What factors may have influenced the company’s choice of consideration used in acquisitions? • Meeting analysts’ income statement & EPS expectations could have been part of it • Consider 1989 & look at goodwill generated by purchases & goodwill that would have been generated if poolings were treated as purchases • Purchases • assume all cash deals were purchases & rest were pooling • cash consideration (‘000s) $300,623 • increase in recorded gross goodwill see slide 6 - $1,114,277 - 917,833 = $196,444 or 65.35% of consideration • Poolings with purchase treatment • market value of share consideration (slide 5) $ 93,874 • book value (assume equals fair market value of assets) 13,958 • goodwill $ 79,917 or 85.13% of consideration

9. Waste Management CasePart E Why would the company record a gain ($70,826,000) when its subsidiary (Chemical Waste Management) sells previously unissued shares to the other shareholders? • The shares were issued at a price above book value, Waste Management’s interest in Chemical Waste Management’s net assets increases. The gain is recorded as the increase in share of net assets minus any goodwill attaching to the proportionate interest given up. • Suppose P owns an 80% interest in S (8,000 shares) and the investment in S is $180,000 equal to 80% of S’s $200,000 owners’ equity plus $20,000 unamortized goodwill. The average cost per share of P’s investment is 180,000/8,000 = $22.50. Assume S issues 2,000 to other shareholders at a price of $25 per share. • S’s owners’ equity is now $200,000 + 50,000 = $250,000 and P’s proportionate interest is 8,000/12,000 = 66.67%. P’s share of net assets is 2/3 of $250,000 or $166,667 up from $160,000 for a gross gain of $6,667. But, P’s share in S has fallen from 80% to 66.67% and the share of goodwill attached to that loss of interest has to be matched against the gross gain. Goodwill was $20,000 and 13.33/80 = 16.67% of that has been to be given up, so the reduction in goodwill is .1667  $20,000 = $3,333. • The net gain then is $6,667 - $3,333 = $3,333. Intuitively you can think of the gain as arising from P effectively selling 1/6th of its shares (1/6 of 8,000 = 1,333) for a $2.50 profit each. 1,333  $2.50 = $3,333

10. Waste Management CasePart E • Does it seem like a gain to you? • The entry under this approach (SAB 51) is: Investment in S $3,333 Gain on sale $3,333 • What alternative accounting treatments could have been used? • The alternative (APB opinion 9) is to record the increase in share of net assets in S as “Additional paid-in capital” • In the example case the entry would have been Investment in S $6,667 Additional paid-in capital $6,667 Note this increases P’s equity by more than the gain on sale • A strict reading of SAB 51 seems to indicate that taxes should be provided for this. But perhaps because it was a stock issue there is no need for taxes

11. Waste Management CasePart E What do you think of the non-recurring loss of an almost identical amount to the $70,826,000 non-taxable gain? • 4th quarter charges principally related to a provision for “the future impact of anticipated federal regulations which will govern post-closure liabilities related to the company’s solid waste landfills • According to Briloff they reflect contingencies that came to roost during 1989 and according to SFAS #5 had to be recognized that year

12. Waste Management CasePart F How can an investment in Wheelabrator Technologies Inc (WTI) result in a non-recurring gain? (see note 9 and cash flow statement for 1988) • Waste Management transferred some assets in order to get 22% of WTI. The book value must have been lower than market value • Assuming the book value is “x” the journal entry should have been: Investment in WTI $x + $11.354 Assets x Non-recurring gain 11.354 What method of accounting is Waste Management using for the income from the investment in WTI? • Equity method (see cash flow statement for 1988)

13. Waste Management CasePart G Do you find Briloff’s arguments persuasive? Why? Why not? • Accounting for Chemical Waste’s offering • attempt to offset loss? (timing) • too liberal? • taxes? • Write-off required? • Non-restatement of earnings an attempt to influence trend of earnings? • Effect of pooling rather than purchase have a significant effect on earnings? • The goodwill is a large proportion of the acquisition costs - is it there? • small acquisitions - what are they delivering? • 40 year life for amortization?

14. Waste Management CasePart G Should Briloff’s article impact stock prices?