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Consolidation Subsequent to Acquisition

Consolidation Subsequent to Acquisition. Passage of time affects revaluations of subsidiary assets and liabilities Triggers effects on Income statement amounts The investment account on the parent’s books due to use of the complete equity method. Complete Equity Method.

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Consolidation Subsequent to Acquisition

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  1. Consolidation Subsequent to Acquisition • Passage of time affects revaluations of subsidiary assets and liabilities • Triggers effects on • Income statement amounts • The investment account on the parent’s books due to use of the complete equity method

  2. Complete Equity Method • Used internally by parent company • Differs from the equity method used for external reporting • Internal Reporting • External Reporting • Impairment losses on indefinite life intangibles including goodwill • Equity in net income reduced for impairment losses • No equity in net income adjustment for impairment • All unconfirmed downstream profits are deducted • Deducted to the extent of the investor’s ownership interest • Unconfirmed profits on downstream sales

  3. Goals of the Consolidation Elimination Process • Eliminates equity method income on the parent’s books and declared dividends on the subsidiary’s books • Eliminates stockholders’ equity accounts on the subsidiary’s books against the investment account on the parent’s books • Adjusts the subsidiary’s assets and liabilities for remaining acquisition date revaluations and eliminate the remainder of the investment balance • Adjusts reported expenses for current year revaluation write-offs

  4. Eliminating Entries C Current – Eliminate the current year equity method entries Equity – Eliminate subsidiary’s beginning-of-year equity balances Revalue – Recognize the beginning-of-current-year fair value revaluations Write-Off – Recognize current year revaluation write-offs E R O

  5. Consolidation Process Example Suppose Time Warner pays $75 million for Midwest Cable on January 1, 2010. Midwest’s book value is $10 million. Book and fair values are the same except for equipment with fair value $15 million higher than book value. Midwest has unreported identifiable intangibles valued at $2 million. Acquisition analysis:

  6. Consolidation Process Example continued Midwest reports net income of $5 million and declares and pays cash dividends of $1 million to Time Warner in 2010. Revalued equipment has a remaining life of 20 years. Identifiable intangibles have 4 years of remaining life. Straight-line depreciation and amortization is used. Goodwill is not impaired. Complete equity method:

  7. Consolidation Process Example continued Time Warner’s books To record equity in net income for 2010: To record dividends received in 2010:

  8. Consolidation Process Example continued Eliminating entries at December 31, 2010: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-year value: To eliminate the subsidiary's beginning-of-year equity accounts against the investment account:

  9. Consolidation Process Example continued Eliminating entries at December 31, 2010: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance: To write off equipment and identifiable intangibles revaluations for the current year, by recognizing additional depreciation and amortization expense:

  10. Consolidation Working Paper for Time Warner and Midwest Cable Exhibit 4.1

  11. Consolidated Financial Statements for Time Warner and Midwest Cable

  12. Consolidated Financial Statements for Time Warner and Midwest Cable

  13. Complete Equity Method • Also known as ‘one-line consolidation’ = Consolidated net income Parent’s net income = Consolidated retained earnings Parent’s retained earnings • Equivalence of parent’s net income and consolidated net income Exhibit 4.2

  14. One-Line Effects on Investor’s Books Investor’s Balance Sheet Assets: Investment in subsidiary…….$ xx Investee’s assets and liabilities Investor’s Income Statement Other revenue: Equity in income………..…….$ xx Investee’s revenues and adjusted expenses

  15. Revaluations in Subsequent Years • Requires recognition of write-offs of reported revaluations over time • Inventories • Write off in year of reported sale • Plant and equipment • Write off each year of useful life • Previously unreported intangibles • Write off each year of useful life, or if impaired • Long-term debt • Write off premium/discount over remaining life • Reported in eliminating entry ‘O’

  16. Revaluations of Inventories The book value of a subsidiary’s inventory acquired on January 1, 2011 is $800,000, with its fair value at $1 million. FIFO is used. Subsidiary’s accounting records: To record sale of beginning inventory during 2011: Calculate the adjustment to be made: Consolidation working paper: Eliminating entry to revalue cost of sales to acquisition cost:

  17. Revaluations of Depreciable Assets The book value of a subsidiary’s equipment on January 1, 2011 is $50 million, with its fair value at $70 million, with a remaining useful life of 10 years and no residual value. Straight-line depreciation is used. Consolidation working paper: Eliminating entry to revalue depreciation to reflect fair value at date of acquisition: *or accumulated depreciation

  18. Revaluations of Long-Term Debt The subsidiary reports $100 million of 5% bonds payable at January 1, 2011, issued in 2010 at par, and due on December 31, 2020. The fair value of the bonds is $90 million on January 1, 2011. Bond discount amortization: $10,000,000 ÷ 10 years = $1,000,000 Consolidation working paper: Eliminating entry to amortize bond discount for 2011:

  19. Previously Reported Intangibles With Limited Lives • Amortized over estimated useful life • Amortized amount equal to recorded amount of the asset less estimated residual value (usually zero) • Amortization method reflects the pattern in which the economic benefits are consumed • Generally straight-line method Examples: Favorable lease agreements and customer lists

  20. Previously Reported Intangible Assets with Indefinite Lives • If no factors appear to limit the intangible asset’s life, the life is deemed to be indefinite • Examples • Brand names • Franchises • Goodwill • Acquired in-process research and development

  21. Impairment Testing for Intangibles Other Than Goodwill • If carrying amount of the asset exceeds its fair value • Recognize an impairment loss • Once impairment loss is recorded, no reversal is allowed for increases in value • Guided by SFAS 144

  22. Impairment Testing for Intangibles Other Than Goodwill Two step process Step 1: Undiscounted cash flows expected from the future use of the asset and its subsequent disposition Less Than Asset’s carrying value? Impairment has incurred Yes Step 2: Amount of loss = Book value of intangible asset less Present value of the future cash flows No No impairment

  23. Goodwill • An indefinite life intangible • Per SFAS 142, must be regularly tested for impairment • Impairment losses reported in the operating section of the income statement • If material, reported as a separate line item • Goodwill has meaning only in the context of a business unit • Represents a variety of intangible benefits connected with that business, beyond its tangible and identifiable intangible net assets

  24. Goodwill Impairment • Testing required at least annually unless circumstances indicate the likelihood of impairment is remote • More frequent testing needed for • A significant downturn in the business climate • Adverse legal or regulatory outcomes • Unanticipated new competition • Loss of key personnel • Expectation that a reporting unit will be sold

  25. Impairment Testing for Goodwill Two step process Step 1: Is fair value of the reporting unit Less Than Carrying value? Impairment may be incurred Yes No Step 2: Estimate implied fair value of the reporting unit’s goodwill. Is the implied fair value Less Than its carrying amount? No No impairment Yes Impairment is incurred Write-off is required

  26. Amortization of Specific IntangiblesExample On January 1, 2012, Primus Telecommunication Group acquires all of the voting stock of Matrix Internet. Previously unrecorded intangibles at acquisition are: 2012 amortization (in millions): Must be assessed for impairment at least annually

  27. Impairment of Specific Intangibles Example continued The following information is provided by Primus at December 31, 2012: Impairment loss (in millions): Impairment loss of $40 million must be reported.

  28. Impairment of Goodwill Example Primus Telecommunication Group acquires all of the voting stock of Matrix Internet with goodwill as follows: Impairment testing at the end of the year: Step 1 - Compare the fair value to the book value of each reporting unit. Goodwill may be impaired

  29. Impairment of Goodwill Example continued Step 2 - Compare fair value of the unit to the fair value of the identifiable net assets of the unit: Goodwill assigned to Wholesale Carrier is impaired by $160 million. To record amortization expense and impairment losses on previously unreported intangibles and goodwill for 2012:

  30. Consolidation in Subsequent Years Illustration IBM buys all of the voting stock of DataFile, Inc. on July 1, 2010 for $25 million cash. DataFile’s book value was $5.3 million. Goodwill calculation:

  31. Consolidation in Subsequent Years Illustration continued Exhibit 4.3 Revaluation Write-Off information for DataFile Acquisition:

  32. Consolidation after One Year Illustration continued DataFile reports income of $3 million and paid dividends of $400,000 to IBM during its fiscal year ending June 30, 2011. Equity in income calculation:

  33. Consolidation after One Year Illustration continued DataFile reports income of $3 million and paid dividends of $400,000 to IBM during its fiscal year ending June 30, 2011. Equity method entries on IBM’s books during fiscal 2011: To record equity in net income for fiscal 2011: To record dividends received in fiscal 2011: Balance in investment account

  34. Consolidation Working Paper after One Year Illustration continued Exhibit 4.4

  35. Consolidation after One Year Illustration continued Eliminating entries: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-the year value: To eliminate the subsidiary's beginning-of-year equity accounts against the investment account balance:

  36. Consolidation after One Year Illustration continued Eliminating entries: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance:

  37. Consolidation after One Year Illustration continued Eliminating entries: To adjust current year cost of goods sold to reflect inventory revaluation: To adjust current year depreciation expense to reflect plant and equipment revaluation: To adjust current year amortization expense to reflect revaluations of limited life intangibles:

  38. Consolidation after One Year Illustration continued Eliminating entries: To adjust current year interest expense to reflect long-term debt revaluation: To record brand names impairment for the current year:

  39. Consolidation after One Year Illustration continued Consolidated financial statements:

  40. Consolidation after One Year Illustration continued Consolidated financial statements:

  41. Consolidation after Two Years Illustration DataFile reports income of $3.5 million and pays dividends of $200,000 for its fiscal year ending June 30, 2012. Year-end impairment testing reveals no impairment loss for brand names, and $700,000 impairment to goodwill. Calculation of equity in income of DataFile for 2012:

  42. Consolidation after Two Years Illustration DataFile reports income of $3.5 million and paid dividends of $200,000 to IBM during its fiscal year ending June 30, 2012. Equity method entries on IBM’s books during fiscal 2012: To record equity in net income for fiscal 2012: To record dividends received in fiscal 2012: Balance in investment account

  43. Consolidation after Two Years Illustration continued Exhibit 4.5

  44. Consolidation after Two Years Illustration continued Eliminating entries: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-the year value: To eliminate the subsidiary's beginning-of-year equity accounts against the investment account:

  45. Consolidation after Two Years Illustration continued Eliminating entries: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance:

  46. Consolidation after Two Years Illustration continued Eliminating entries: To adjust current year depreciation expense to reflect plant and equipment revaluation: To adjust current year amortization expense to reflect revaluations of limited life intangibles:

  47. Consolidation after Two Years Illustration continued Eliminating entries: To adjust current year interest expense to reflect long-term debt revaluation: To record goodwill impairment for the current year:

  48. Consolidation after Two Years Illustration continued Consolidated financial statements:

  49. Consolidation after Two Years Illustration continued Consolidated financial statements:

  50. IFRS for Acquired Specific Intangibles • IAS 38 criteria to be reportable • Intangible must be either separable or contractual • Similar to U.S. GAAP • Generally carried at cost less accumulated amortization and impairments • IFRS allows fair value reporting in limited circumstances

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