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Chapter Three

Chapter Three. Consolidations – Subsequent to the Date of Acquisition. SFAS No. 142 - Goodwill and Other Intangible Assets. For fiscal periods beginning AFTER December 15, 2001, goodwill will no longer be amortized.

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Chapter Three

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  1. Chapter Three Consolidations – Subsequent to the Date of Acquisition

  2. 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.

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

  4. 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.

  5. Investment Accounting Exh. 3-1

  6. 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. Before the consolidation balances can be determined, the Parent’s investment account must be adjusted to reflect the application of the equity method.

  7. Consolidation ExampleEquity Method 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.

  8. Consolidation ExampleEquity Method Before preparing the Equity adjustments, determine the Goodwill and amortization expense.

  9. Consolidation ExampleEquity Method Amortization computation: Assume that Current Assets have a remaining useful life of 1 year, and the buildings, has a remaining useful life of 10 years.

  10. Consolidation ExampleEquity Method Amortization computation:

  11. Consolidation ExampleEquity Method First, prepare the entry to recognize Dad’s share of Kid’s net income. Dad owns 100% of Kid. Kid’s Net Income = $150,000

  12. Consolidation ExampleEquity Method

  13. Consolidation ExampleEquity Method Second, prepare the entry to recognize Dad’s share of Kid’s dividends. Dad owns 100% of Kid. Kid’s Net Income = $150,000

  14. Consolidation ExampleEquity Method $400,000 dividends were paid by Kid to Dad during the year.

  15. Consolidation ExampleEquity Method Finally, record the amortization of the fair market value adjustments.

  16. Consolidation ExampleEquity Method The Amortization Expense from the earlier computation = $27,000

  17. Subsequent Consolidation - Worksheet Entries 5 basic entries are posted to the worksheet. • S - The Sub’s equity accounts are eliminated. • A - The other intangible assets are recorded and the Sub’s assets are Adjusted to FMV. • I - The Equity in Sub Income account is eliminated. • D - The Sub’s Dividends are eliminated. • E - Amortization Expense is recorded for the FMV adjustments and other intangible assets associated with the consolidated entity.

  18. Consolidation EntriesEquity Method Entry S Eliminate the sub’s equity balances as of the beginningof 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).

  19. Consolidation EntriesEquity Method 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 reducedby any depreciation (amortization) taken in prior periods. (including in-process R&D)

  20. Consolidation EntriesEquity Method Entry I Eliminate the Equity in Sub Income account. Plug the difference to Investment in Sub.

  21. Consolidation EntriesEquity Method Entry D Eliminate sub’s current Dividends. Plug the difference to Investment in Sub.

  22. Consolidation EntriesEquity Method Entry E Record 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!

  23. Consolidation at 12/31/05Equity Method Example Using the 12/31/05 adjusted balances, prepare the consolidation at 12/31/05.

  24. Note Dad’s updated numbers. Now, post the consolidation entries to the worksheet.

  25. Consolidation, 2 or more years after acquisition Let’s do question Excel Case on page 144 in the text. Note – we must remember certain key procedural changes. See slides 18, 19 and 22:

  26. Applying the Cost Method If the COST METHOD is used by the parent company to account for the investment, then the consolidation entries will change only slightly. Remember . . . No adjustments are recorded in the Investment account for current year operations, dividends paid by the subsidiary, or amortization of purchase price allocations. Dividends received from the subsidiary are recorded as Dividend Revenue.

  27. Consolidation EntriesCost Method Entry S Eliminate 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.

  28. Consolidation EntriesCost Method 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. This entry is the same under both the Equity Method and the Cost Method.

  29. Consolidation EntriesCost Method Entry I This entry is different under the Cost Method. Eliminate the Parent’s Dividend Income account. Also, eliminate the Sub’s Dividends Paid account.

  30. Consolidation EntriesCost Method Entry D Under the Cost Method we DO NOT make an Entry D.

  31. Consolidation EntriesCost Method Entry E Regardless of the method used, we must record the amortization of the purchase price allocations. This entry is the same as the Equity Method.

  32. 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).

  33. 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.

  34. Goodwill Impairment Examples Exh. 3-15

  35. 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

  36. 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?

  37. 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.

  38. Goodwill Impairment Test - Step 2 • 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 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 ?

  39. 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.

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