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CHAPTER 6

CHAPTER 6. THE PURCHASE METHOD: POSTACQUISITION PERIODS AND PARTIAL OWNERSHIPS. FOCUS OF CHAPTER 6. Consolidation Worksheets: 100% Ownerships --Postacquisition Periods The Purchase Method: Partial Ownerships Conceptual issues Analyzing cost

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CHAPTER 6

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  1. CHAPTER 6 THE PURCHASE METHOD: POSTACQUISITION PERIODS AND PARTIAL OWNERSHIPS

  2. FOCUS OF CHAPTER 6 • Consolidation Worksheets: 100% Ownerships--Postacquisition Periods • The Purchase Method: Partial Ownerships • Conceptual issues • Analyzing cost • Consolidation Worksheets: Partial Ownerships • At the Acquisition Date • Postacquisition Periods

  3. Postacquisition Subsidiary Earnings: The Only Reportable Earnings Under The Purchase Method • ONLY the subsidiary’s postacquisitionearnings are reported in the consolidated financial statements. • The subsidiary’s preacquisitionearnings(included in its retained earnings account) are ALWAYSeliminated against the parent’s Investment account in consolidation.

  4. Parent’s Amortization of Cost in Excess of Book Value: How Handled? • Non-Push-Down Accounting: • Equity Method: • Recorded in parent’sgeneral ledger. • Maintains built-in checking features. • Cost Method: • Recorded on consolidation worksheets. • Push-Down Accounting: • Parent has no amortization--sub records it. G/L W/S

  5. Parent’s Amortization of Excess Cost:What is Sub’s True Earnings? • Non-Push-Down Accounting: Sub’s reported net income (based on OLD BASIS)........... $24,000 Less--Parent’s amortization of excess cost................. (8,000) Sub’s true net income (based on NEW BASIS)......... $16,000 • Push-Down Accounting: Sub’s reported net income....... $16,000

  6. Liquidating Dividends: A Special Situation • Because an acquired subsidiary usually hasa retained earnings balance at the acquisition date, a unique issue arises for acquired subsidiaries: HOW TO REPORT DIVIDENDS THAT ARE IN EXCESS OF THE SUBSIDIARY’S POSTACQUISITION EARNINGS? • Such dividends are called liquidating dividends.

  7. Liquidating Dividends: They Differ From “Regular” Dividends • Dividendsin excess ofpostacquisition earnings are a return of the parent’s originalinvestment. • Parent’s Accounting Treatment: • CREDIT to the Investment account under: • Equity method (the usual treatment). • Cost method (the usual treatmentis to credit Dividend Income).

  8. Liquidating Dividends: Acquired vs. Created Subsidiaries • Can a createdsubsidiary declare a liquidating dividend?NO • No such thing exists for a created subsidiary.

  9. Liquidating Dividends: What Is their Significance for Tax? • A central issue in taxation is whether a distribution to a shareholder is a dividendor a return of capital. • The concept of “EARNINGS & PROFITS” (E & P) exists in the Internal Revenue Code for makingthis determination. Code

  10. Goodwill: It Must be Assignedto a “Reporting Unit” • A reporting unit is (1) an “operating segment” (as defined in FAS 131) or (2) one level below an operating segment. • The reporting unit could be: • The acquired business alone (the subsidiary or division). • The acquired business and the parent combined. • The acquired business and one or more of the parent’s other subsidiaries or divisions.

  11. Testing Goodwill for Impairment:A Two-Step Process • Step 1: Is the reporting unit’s fair value (FV) below the reporting unit’s carrying value (CV)? • If NO, stop. • If YES, perform step 2.

  12. Testing Goodwill for Impairment:A Two-Step Process • Step 2: Calculate the “implied value” of goodwill as follows: • On a memo basis, allocate the reporting unit’s FV to its assets and liabilities in a “purchase price allocation fashion.” • Excess of reporting unit’s FV over FV of assets/liabilities (as allocated) is “implied goodwill” of the reporting unit. [Thus implied GW is residually determined.]

  13. Testing Goodwill for Impairment:A Two-Step Process • Step 2 (cont.) • If the implied FV of GW is less than the carrying value of GW, the excess carrying value is the GW impairment loss to be reported. • Report any GW impairment loss in earnings—as a separate line item, if material.

  14. Testing Goodwill for Impairment:A Two-Step Process • Goodwill Impairment Test--How Often? • At least annually. • At interim periods when certain “triggering events” occur that indicate that goodwill of a reporting unit may be impaired.

  15. Testing Goodwill for Impairment:A Two-Step Process • The Annual GW Impairment Test--It does not require a formal FV determination each year if: • Components of the reporting unit have not changed significantly. • Previous FV of the reporting unit exceeded its CV by a substantial margin. • The likelihood that the reporting unit’s FV is less than its CV is remote.

  16. Goodwill: Determining the“Reporting Unit’s” Fair Value • The following items are included in determining the reporting unit’s fair value: • Tangible net assets. • Recognized intangible assets. • Unrecognized intangible assets.

  17. Partial Ownerships: The Purchase Method--”Partial” or “Full “Valuation • Extent of Revaluation of Undervalued Assets and Goodwill: • Parent Company Concept: Partial valuation (could be anywhere from 51% to 99%) • Economic Unit Concept: Full valuation 75% 100%

  18. Partial Ownerships: The Purchase Method--Undervalued Assets • Extent of Revaluation of Subsidiary’s Undervalued Assets: • Parent company concept..... < 100% of CV • Revalued only to the extent of the parent’sOWNERSHIP INTEREST. • Economic unit concept........ 100% of CV • The offsetting credit for the additional valuation increasesthe NCI in the consolidated B/S.

  19. Partial Ownerships:The Purchase Method--Goodwill • Extent of Valuation of Goodwill: • Parent company concept................. < 100% • Valued only to the extent it isbought and paid for by the parent. • Economic unit concept.................... 100% • The offsetting credit for the additional valuationincreasesthe NCI in the consolidated B/S.

  20. Review Question #1 • A parent records amortization of cost in excess of book value under which method? • A. Push-down basis of accounting. • B. Non-push down basis of accounting. • C. Both A and B. • D. None of the above.

  21. Review Question #1--With Answer • A parent records amortization of cost in excess of book value under which method? • A. Push-down basis of accounting. • B. Non-push down basis of accounting. • C. Both A and B. • D. None of the above.

  22. Review Question #2 • A parent charges the amortization of its cost in excess of book value to: • A. Goodwill expense. • B. Excess cost expense. • C. Excess cost & goodwill expense. • D. Equity in net income of subsidiary. • E. None of the above.

  23. Review Question #2--With Answer • A parent charges the amortization of its cost in excess of book value to: • A. Goodwill expense. • B. Excess cost expense. • C. Excess cost & goodwill expense. • D. Equity in net income of subsidiary. • E. None of the above.

  24. Review Question #3 • A special type of dividend that can occur only with an acquired subsidiary is a: • A. Treasury stock dividend. • B. Liquidating dividend. • C. Deemed dividend. • D. Constructive dividend. • E. None of the above.

  25. Review Question #3--With Answer • A special type of dividend that can occur only with an acquired subsidiary is a: • A. Treasury stock dividend. • B. Liquidating dividend. • C. Deemed dividend. • D. Constructive dividend. • E. None of the above.

  26. Review Question #4 • When a liquidating dividend occurs, the parent credits which account? • A. Retained earnings. • B. Dividend income. • C. Investment in subsidiary • D. Liquidating dividend income. • D. None of the above.

  27. Review Question #4--With Answer • When a liquidating dividend occurs, the parent credits which account? • A. Retained earnings. • B. Dividend income. • C. Investment in subsidiary • D. Liquidating dividend income. • D. None of the above.

  28. Review Question #5 • Goodwill’s book value is $90,000 and its implicit value is $60,000. The reporting unit’s carrying value is $800,000 and its fair value is $810,000. What is the goodwill impairment write-down? • A. Zero. • B. $10,000. • C. $20,000. • D. $30,000. • D. $50,000.

  29. Review Question #5--With Answer • Goodwill’s book value is $90,000 and its implicit value is $60,000. The reporting unit’s carrying value is $800,000 and its fair value is $810,000. What is the goodwill impairment write-down? • A. Zero. (Step 2 was not needed) • B. $10,000. • C. $20,000. • D. $30,000. • D. $50,000.

  30. Review Question #6 • Under which concept is goodwill imputed to the noncontrolling interest for consolidated financial reporting purposes? • A. The economic unit concept. • B. The parent company concept. • C. Both A and B. • D. None of the above.

  31. Review Question #6--With Answer • Under which concept is goodwill imputed to the noncontrolling interest for consolidated financial reporting purposes? • A. The economic unit concept. • B. The parent company concept. • C. Both A and B. • D. None of the above.

  32. End of Chapter 6 • Time to Clear Things Up--Any Questions?

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