C H A P T E R

1. C H A P T E R 3 Updated Sixth Edition Consolidations - Subsequent to the Date of Acquisition

2. Consolidation - The Effects of the Passage of Time • In Chapter 2, we looked at consolidation on the date of the combination was created. • As time passes, the investment account changes, and the consolidation process becomes more complex.

3. Consolidation - The Effects of the Passage of Time The parent can account for its investment one of three ways: • Equity Method • Cost Method • Partial Equity Let’s compare the three methods briefly.

4. Investment Accounting Exh. 3-1

5. SFAS No. 142 - Goodwill and Other Intangible Assets For fiscal periods beginning AFTER December 15, 2001, goodwill will no longer be amortized. Any unamortized goodwill that arose from pre-SFAS 142 combinations will be henceforth carried on the books as a permanent asset. The “nonamortization” rule will apply to both previously recognized and newly acquired goodwill.

6. SFAS No. 142 - Goodwill and Other Intangible Assets Generally, once goodwill has been recorded, the value will remain unchanged.

7. Subsequent Consolidation - Equity Method First, the Parent’s books must be adjusted to reflect the application of the equity method to the investment account. • 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.

8. Subsequent Consolidation - Worksheet Entries 5 basic entries are posted to the worksheet. • The Sub’s equity accounts are eliminated. • The other intangible assets are recorded and the Sub’s assets are adjusted to FMV. • The Equity in Sub Income account is eliminated. • The Sub’s dividends are eliminated. • Amortization Expense is recorded for the FMV adjustments and other intangible assets associated with the consolidated entity.

9. Consolidation Entries Entry S Eliminate 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).

10. Consolidation Entries Entry A Adjust 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 taken in prior periods.

11. Consolidation Entries Entry I Eliminate the Equity in Sub Income account. Plug the difference to Investment in Sub.

12. Consolidation Entries Entry D Eliminate sub’s Dividends. Plug the difference to Investment in Sub.

13. Consolidation Entries Entry E Record amortization expense for the period associated with the FMV adjustments and the other intangible assets identified during the combination. Remember to never amortize land or goodwill!

14. Consolidation ExampleEquity Method On 12/31/03, Giant purchases 100% of Tiny for $750,000 cash.

15. Consolidation ExampleEquity Method The BV of Tiny’s net assets is $357. The FMV of Tiny’s net assets is $589.

16. Consolidation ExampleEquity Method Record the initial investment on Giant’s books. Next, compute goodwill. Assume that Tiny owns a database that has an assessed value of $150.

17. Consolidation ExampleEquity Method Goodwill computation: The details about FMV adjustments will be needed later when we do the consolidation at the end of 2002.

18. As of the date of acquisition, the balances for each company are entered into the worksheet. Enter the consolidation entries on the worksheet.

21. Note that Entries I, D, & E relate to amounts such as income that arise with the passage of time. Therefore, they are not prepared on the date of acquisition.

22. Purchase Consolidation Example Balances at 12/31/04 All amounts are in thousands.

23. We have not yet updated Giant’s numbers for the equity method entries. The clue is that there is no account balance for Equity in Sub Income.

24. Purchase Consolidation ExampleEquity Entries for 2004

25. Purchase Consolidation ExampleEquity Entries for 2004 $50,000 dividends were paid by Tiny during the year.

26. Purchase Consolidation ExampleEquity Entries for 2002 Intangible Asset & FMV adjustment amortization is computed as follows:

27. Purchase ConsolidationExample Amortization computation: Assume that the building, equipment, and data base each have a remaining useful life of 10 years.

28. Purchase ConsolidationExample Amortization computation:

29. Note Giant’s updated numbers. Now, post the consolidation entries to the worksheet.

36. 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).

37. Goodwill Impairment • Goodwill is not amortized. • 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.

38. Testing for Goodwill ImpairmentStep 1 Goodwill is NOT impaired if: • The net assets of the reporting unit (the subsidiary) 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.

39. Testing for Goodwill ImpairmentStep 2 If the fair value of a reporting unit falls below 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. • 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 Three Complexities Arise

40. Assignment of Acquisition Value to Reporting Units A Reporting Unit can be: • A component of an operating segment. • A segment of an enterprise. • The entire enterprise. To better assess potential declines in value for goodwill, the goodwill must be assigned to its related REPORTING UNIT.

41. Periodic Determination of the Fair Value of a Reporting Unit Basis for determining fair value: • Market price, if the reporting unit is publicly traded. • Market price of comparable businesses. • Business valuation techniques using PV.

42. Determination of the Implied Fair Value of Goodwill The “implied” fair value of Goodwill is calculated in a similar manner as the determination of goodwill in a business combination. • 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.

43. 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.

44. End of Chapter 3 This stuff is a breeze, ain’t it?