Slide

3-1

Chapter Three

Consolidations
Subsequent
to the Date of
Acquisition

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-2

SFAS No. 142 - Goodwill and Other

Intangible Assets
For
Forfiscal
fiscalperiods
periods
beginning
beginningAFTER
AFTER
December
December15,
15,2001,
2001,
goodwill
goodwillwill
willno
nolonger
longer
be
beamortized.
amortized.

The
Thenonamortization
nonamortization
rule
rulewill
will apply
applyto
toboth
both
previously
previouslyrecognized
recognized
and
andnewly
newlyacquired
acquired
goodwill.
goodwill.
McGraw-Hill/Irwin

Any
Anyunamortized
unamortized
goodwill
goodwillthat
that arose
arose
from
from pre-SFAS
pre-SFAS142
142
combinations
combinationswill
will
be
behenceforth
henceforth
carried
carried on
on the
the
books
books as
asaa
permanent
permanentasset.
asset.

The McGraw-Hill Companies, Inc.

Slide
3-3

SFAS No. 142 - Goodwill and Other

Intangible Assets
Generally,
Generally,once
once goodwill
goodwill has
has been
been recorded,
recorded,the
the
value
valuewill
will remain
remainunchanged.
unchanged.
T w o c irc u m s ta n c e s e x is t th a t
w ill r e s u lt in a d ju s tin g th e a m o u n t
o f g o o d w ill o n th e c o n s o lid a te d b a la n c e s h e e t.

S a le o f a ll o r p a r t o f th e
r e la te d s u b s id ia r y .

A d e t e r m in a t i o n t h a t g o o d w ill
h a s e x p e r ie n c e d a p e r m a n e n t
im p a ir m e n t o f v a lu e .

A n y im p a ir m e n t in th e v a lu e
o f g o o d w ill s h o u ld b e r e p o r te d
a s a n e x tr a o r d in a ry ite m .
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-4

Consolidation - The Effects of the

Passage of Time
The
The parent
parent can
can
account
account for
for its
its
investment
investment one
one
of
of three
three ways:
ways:

Equity
Equity Method
Method

Cost
Cost Method
Method

Partial
Partial Equity
Equity

McGraw-Hill/Irwin

Lets compare
the three
methods
briefly.

The McGraw-Hill Companies, Inc.

Slide
3-5

Investment Accounting

McGraw-Hill/Irwin

Exh.
3-1

The McGraw-Hill Companies, Inc.

Slide
3-6

Subsequent Consolidation - Equity

Method
Before the consolidation balances can
be determined, the Parents investment
account must be adjusted to reflect the
application of the equity method.

Record
Recordthe
theInvestment
Investmentin
inSub
Subon
onthe
the

acquisition
acquisitiondate.
date.

Recognize
Recognizethe
thereceipt
receiptof
of dividends
dividendsfrom
fromthe
the
sub.
sub.

Recognize
Recognizeaashare
shareof
ofthe
thesubs
subsincome
income
(loss).
(loss).

FMV
FMVadjustments
adjustmentsand
andother
other intangible
intangible
assets.
assets.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-7

Consolidation Example
Equity Method

On 1/1/05, Dad
Co. purchases
100% of Kid,
Inc. for $900,000
cash.
Kids net assets
on 1/1/05 was
$600,000.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-8

Consolidation Example
Equity Method

Before
preparing the
Equity
adjustments,
determine the
Goodwill and
amortization
expense.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-9

Consolidation Example
Equity 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.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-10

Consolidation Example
Equity Method
Amortization computation:

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-11

Consolidation Example
Equity Method

First,
First,prepare
preparethe
theentry
entryto
torecognize
recognize
Dads
Dadsshare
shareof
ofKids
Kidsnet
net income.
income.
Dad
Dadowns
owns 100%
100%of
of Kid.
Kid.
Kids
KidsNet
Net Income
Income== $150,000
$150,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-12

Consolidation Example
Equity Method

Kid's
Kid'sNet
NetIncome
Income for
for2005
2005
%
%of
ofKid
Kid owned
owned by
byDad
Dad
Equity
EquityAdjustment
Adjustment

McGraw-Hill/Irwin

$$150,000
150,000
100%
100%
$$150,000
150,000

The McGraw-Hill Companies, Inc.

Slide
3-13

Consolidation Example
Equity Method

Second,
Second,prepare
preparethe
theentry
entryto
to recognize
recognize
Dads
Dadsshare
shareof
of Kids
Kidsdividends.
dividends.
Dad
Dadowns
owns100%
100%of
ofKid.
Kid.
Kids
KidsNet
Net Income
Income==$150,000
$150,000
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-14

Consolidation Example
Equity Method

$400,000
$400,000 dividends
dividends were
were paid
paid
by
by Kid
Kid to
to Dad
Dad during
during the
the
year.
year.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-15

Consolidation Example
Equity Method

Finally,
Finally,record
record the
the amortization
amortization of
of the
the
fair
fair market
market value
value adjustments.
adjustments.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-16

Consolidation Example
Equity Method

The
The Amortization
Amortization Expense
Expense from
from the
the
earlier
earlier computation
computation == $27,000
$27,000
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-17

1.
1.
2.
2.
3.
3.
4.
4.
5.
5.

Subsequent Consolidation Worksheet Entries

55 basic
basic entries
entries are
are posted
posted to
to the
the worksheet.
worksheet.
SS -- The
The Subs
Subs equity
equity accounts
accounts are
are eliminated.
eliminated.
A
A-- The
The other
other intangible
intangible assets
assets are
are recorded
recorded and
and
the
the Subs
Subs assets
assets are
are Adjusted
Adjusted to
to FMV.
FMV.
II -- The
The Equity
Equity in
in Sub
Sub Income
Income account
account is
is
eliminated.
eliminated.
D
D -- The
The Subs
Subs Dividends
Dividends are
are eliminated.
eliminated.
EE -- Amortization
Amortization Expense
Expense is
is recorded
recorded for
for the
the
FMV
FMV adjustments
adjustments and
and other
other intangible
intangible assets
assets
associated
associated with
with the
the consolidated
consolidated entity.
entity.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-18

Consolidation Entries
Equity Method
Entry
Entry SS
Eliminate
Eliminatethe
thesubs
subsequity
equitybalances
balancesas
asof
of
the
thebeginning
beginning of
ofthe
theperiod.
period.
Plug
Plugthe
thedifference
differenceto
toInvestment
Investment in
in Sub.
Sub.

IfIf(1)
(1)this
thisis
isthe
thefirst
firstyear
yearof
ofthe
theinvestment,
investment,and
and(2)
(2)the
theinvestment
investmentwas
was
made
madeat
ataatime
timeother
otherthan
thanthe
thebeginning
beginningof
ofthe
thefiscal
fiscalyear,
year,then
then
Preacquisition
(see
Chapter
4).
PreacquisitionIncome
Incomemust
mustbe
beaccounted
accountedfor
for
(see
Chapter
4).
The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin

Slide
3-19

Consolidation Entries
Equity Method
Entry
EntryAA
Adjust
Adjust subs
subsassets
assets and
and liabilities
liabilitiesto
toFMV.
FMV.
Set
Setup
upthe
theGoodwill
Goodwill account
account and
and the
theother
otherintangible
intangible
assets.
assets. The
Thedifference
difference is
isaa reduction
reduction of
of the
the
Investment
Investmentin
inSubsidiary
Subsidiaryaccount.
account.

In
Inthe
thefirst
firstyear
yearof
ofthe
theinvestment,
investment,the
theFMV
FMVadjustments
adjustmentsfor
forthis
thisentry
entrywill
will
be
beidentified
identifiedduring
duringthe
thecomputation
computationof
ofGoodwill.
Goodwill. In
Insubsequent
subsequentyears,
years,
the
theFMV
FMVadjustments
adjustmentsand
andthe
theother
otherintangible
intangibleassets
assetsidentified
identifiedmust
mustbe
be
reduced
reducedby
byany
anydepreciation
depreciation(amortization)
(amortization)taken
takenin
inprior
priorperiods.
periods.
(including
(includingin-process
in-processR&D)
R&D) The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin

Slide
3-20

Consolidation Entries
Equity Method
Entry
Entry II
Eliminate
Eliminatethe
theEquity
Equityin
in Sub
SubIncome
Incomeaccount.
account.
Plug
Plugthe
thedifference
differenceto
toInvestment
Investment in
in Sub.
Sub.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-21

Consolidation Entries
Equity Method
Entry
Entry D
D
Eliminate
Eliminatesubs
subscurrent
current Dividends.
Dividends.
Plug
Plugthe
thedifference
differenceto
toInvestment
Investment in
in Sub.
Sub.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-22

Consolidation Entries
Equity 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!

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-23

Consolidation at 12/31/05
Equity Method Example

Using the
12/31/05
adjusted
balances,
prepare the
consolidation at
12/31/05.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-24

Note
Note Dads
Dads
updated
updated
numbers.
numbers.
Now,
Now, post
post the
the
consolidation
consolidation
entries
entries to
to the
the
worksheet.
worksheet.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-25

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-26

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-27

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-28

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-29

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-30

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-31

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-32

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-33

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-34

McGraw-Hill/Irwin

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Slide
3-35

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-36

Consolidation, 2 or more years

after acquisition

Lets
Letsdo
doquestion
question Excel
ExcelCase
Caseon
onpage
page144
144 in
inthe
thetext.
text.
Note
Notewe
wemust
must remember
remember certain
certain key
keyprocedural
procedural
changes.
changes.See
Seeslides
slides18,
18,19
19and
and22:
22:

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-37

Applying the Cost Method

IfIf the
theCOST
COSTMETHOD
METHODis
is used
used by
bythe
the parent
parent
company
companyto
toaccount
account for
forthe
theinvestment,
investment,then
thenthe
the
consolidation
consolidationentries
entrieswill
willchange
changeonly
onlyslightly.
slightly.

Remember . . .
1.
1. No
Noadjustments
adjustmentsare
arerecorded
recordedin
inthe
the
Investment
Investmentaccount
accountfor
for current
currentyear
year
operations,
operations,dividends
dividends paid
paidby
bythe
the subsidiary,
subsidiary,
or
oramortization
amortizationof
of purchase
purchaseprice
priceallocations.
allocations.
2.
2. Dividends
Dividendsreceived
received from
from the
thesubsidiary
subsidiaryare
are
recorded
recordedas
asDividend
DividendRevenue.
Revenue.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-38

Consolidation Entries
Cost Method
Entry
EntrySS
Eliminate
Eliminatethe
thesubs
subsequity
equitybalances
balancesas
asof
ofthe
the
beginning
beginningof
ofthe
theperiod.
period.
Plug
Plugthe
thedifference
differenceto
toInvestment
Investmentin
inSub.
Sub.
This
Thisentry
entryis
isthe
thesame
sameunder
underboth
boththe
theEquity
EquityMethod
Methodand
and
the
theCost
CostMethod.
Method.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-39

Consolidation Entries
Cost Method
Entry
EntryAA
Adjust
Adjustsubs
subsassets
assetsand
andliabilities
liabilitiesto
toFMV.
FMV.
Set
Setup
upthe
theGoodwill
Goodwillaccount
accountand
andthe
theother
otherintangible
intangibleassets.
assets.
The
Thedifference
differenceis
isaareduction
reductionof
ofthe
theInvestment
Investmentin
inSubsidiary
Subsidiary
account.
account.
This
Thisentry
entryis
isthe
thesame
sameunder
underboth
boththe
theEquity
EquityMethod
Methodand
andthe
theCost
Cost
Method.
Method.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-40

Consolidation Entries
Cost Method
Entry
EntryII
This
Thisentry
entryis
isdifferent
different under
under the
theCost
CostMethod.
Method.
Eliminate
Eliminatethe
theParents
ParentsDividend
DividendIncome
Income
account.
account.
Also,
Also,eliminate
eliminatethe
theSubs
SubsDividends
DividendsPaid
Paid
account.
account.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-41

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-42

Consolidation Entries
Cost Method
Entry
EntryEE
Regardless
Regardlessof
of the
themethod
methodused,
used,we
wemust
must
record
recordthe
theamortization
amortizationof
of the
thepurchase
purchaseprice
price
allocations.
allocations. This
Thisentry
entryis
isthe
thesame
sameas
asthe
the
Equity
EquityMethod.
Method.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-43

Other Consolidation Entries

In
Inaddition
additionto
tothe
theEntries
EntriesS,
S,A,
A,

I,I,D,
D, &&E,
E, you
youmust
mustalso
also
eliminate
eliminateintercompany
intercompany
payables
payablesor
or receivables.
receivables.

So
Sofar,
far,we
wehave
haveassumed
assumed that
that
the
theparent
parentacquired
acquired100%
100%of
of
the
thesubsidiary
subsidiaryin
inthe
the
combination.
combination. IfIfcontrol
control
acquired
acquiredis
is<< than
than100%,
100%,an
an
additional
additional adjustment
adjustment must
mustbe
be
made
made(see
(seeChapter
Chapter 4).
4).

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-44

Goodwill Impairment

Goodwill
Goodwillis
isnot
not

amortized.
amortized.

ItItis
isassigned
assignedan
an

indefinite
indefiniteuseful
usefullife.
life.

Generally,
Generally,goodwill
goodwill

will
willbe
becarried
carried at
at its
its
acquisition
acquisitioncost.
cost.

At
At some
somefuture
futurepoint
point
in
intime,
time, the
thegoodwill
goodwill
may
maybecome
become
permanently
permanently
impaired.
impaired.

McGraw-Hill/Irwin

SFAS No.
142 calls
for an
annual test
of
impairment
for
Goodwill.

The McGraw-Hill Companies, Inc.

Slide
3-45

Goodwill Impairment Examples

Exh.
3-15

2002 Goodwill Impairment Write-downs

Company
AOL Time Warner
Boeing
Blockbuster
SBC Communications
General Electric
Coca-Cola
AT&T
Safeway
Verizon Communications

McGraw-Hill/Irwin

2002 Write-Down
$ 54,000,000,000
$ 1,800,000,000
$ 1,800,000,000
$ 1,800,000,000
$ 1,000,000,000
$
926,000,000
$
856,000,000
$
700,000,000
$
500,000,000

The McGraw-Hill Companies, Inc.

Slide
3-46

Goodwill Impairment Test

Step
Step 11

Compare
Comparefair
fair value
valueof
of

REPORTING
REPORTING UNIT
UNITto
to
carrying
carryingvalue
valueof
of the
the
REPORTING
REPORTING UNIT
UNIT

Step
Step 22

Compare
Comparefair
fair value
valueof
of

GOODWILL
GOODWILLto
to
carrying
carryingvalue
valueof
of
GOODWILL
GOODWILL

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-47

Goodwill Impairment Test - Step 1

Is the Fair Value of a Reporting Unit Less
Than Carrying Value?

Compare
Compare the
the Reporting
Reporting

Units
Units Fair
Fair Value
Value to
to its
its
Carrying
Carrying Value.
Value.

IfIf Fair
Fair Value
Value of
of the
the
Reporting
Reporting Unit
Unit is
is <<
Carrying
Carrying Value,
Value, GO
GO TO
TO
STEP
STEP 2.
2.

Recompute
Recompute Fair
Fair Value
Value ifif
the
the previous
previous Fair
Fair Value
Value
can
can not
not be
be used?
used?
McGraw-Hill/Irwin

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Slide
3-48

Goodwill Impairment Test - Step 1

Is 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

McGraw-Hill/Irwin

It is remote that computing a new fair value

would result in an amount < the current
carrying amount of the reporting unit.

The McGraw-Hill Companies, Inc.

Slide
3-49

Goodwill Impairment Test - Step 2

IfIfthe
thefair
fair value
valueof
ofaa
reporting
reporting unit
unit<< its
itscarrying
carrying
value,
value,then
then Step
Step22 is
is
performed.
performed.

IfIf goodwills
goodwills fair
fair value
value
falls
falls below
below its
its carrying
carrying
value,
value, then
then impairment
impairment
has
has occurred,
occurred, and
and an
an
extraordinary
extraordinary
impairment
impairment loss
loss is
is
recorded.
recorded.
McGraw-Hill/Irwin

Three Complexities Arise

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

The McGraw-Hill Companies, Inc.

Slide
3-50

Assignment of Acquisition Value to

Reporting Units

To better assess
potential declines in
value for goodwill,
the goodwill must be
assigned to its
related REPORTING
UNIT.

McGraw-Hill/Irwin

A
AReporting
Reporting Unit
Unit
can
can be:
be:

A
Acomponent
component of
of
an
an operating
operating
segment.
segment.

A
Asegment
segment of
of
an
an enterprise.
enterprise.

The
The entire
entire
enterprise.
enterprise.

The McGraw-Hill Companies, Inc.

Slide
3-51

Periodic Determination of the Fair

Value of a Reporting Unit
Basis
Basisfor
for determining
determiningfair
fair
value:
value:

Market
Market price,
price,ififthe
the
reporting
reportingunit
unit is
ispublicly
publicly
traded.
traded.

Market
Market price
priceof
of
comparable
comparablebusinesses.
businesses.

Business
Businessvaluation
valuation
techniques
techniquesusing
usingPV.
PV.

McGraw-Hill/Irwin

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Slide
3-52

Determination of the Implied Fair Value

of Goodwill
The implied
implied
fair value of
Goodwill is
calculated in a
similar manner
as the
determination of
goodwill in a
business
combination.

McGraw-Hill/Irwin

Use
Usethe
thefair
fairvalue
valueof
ofthe
the

reporting
reporting unit
unitas
asthe
the
purchase
purchaseprice.
price.

Allocate
Allocatethe
thepurchase
purchase
price
priceto
to all
allidentifiable
identifiable
assets
assetsand
andliabilities
liabilitiesof
of
the
thereporting
reportingunit.
unit.

Compare
Comparethe
theresulting
resulting
implied
impliedgoodwill
goodwillto
tothe
the
goodwill
goodwillon
onthe
thebooks.
books.

IfIfimplied
implied goodwill
goodwill<<
recorded
recorded goodwill,
goodwill,
impairment
impairmenthas
hasoccurred.
occurred.

The McGraw-Hill Companies, Inc.

Slide
3-53

Closing Observations Related to the

Testing of Goodwill for Impairment
Determining
Determiningthe
thefair
fair
value
value of
of the
thereporting
reporting
segment
segment adds
addsaanew,
new,
potentially
potentiallycostly
costly
periodic
periodictask
taskof
of
consolidated
consolidatedfinancial
financial
reporting.
reporting.

The
Thefair
fairvalues
valuesof
of the
the
assets
assetsand
andliabilities
liabilitiesof
of
the
thereporting
reporting unit
unit used
used in
in
the
thetest
testfor
forimpairment
impairment
do
do not
notimpact
impactthe
the
amounts
amountsreported
reportedon
onthe
the
consolidated
consolidated financial
financial
statements.
statements.

AAdecline
declinein
inthe
thevalue
valueof
ofthe
thereporting
reportingunit
unit
does
doesNOT
NOT necessarily
necessarilysignal
signalan
animpairment
impairment
of
of goodwill
goodwillunder
underSFAS
SFASNo.
No.142.
142.
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Slide
3-54

Goodwill Impairment Test

Example

Assume the fair

value of Dad
Co.s
investment in
Kid, Inc. at
12/31/06 has
fallen to
$450,000.
Is Goodwill
Impaired?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-55

Goodwill Impairment Test

Example

STEP 1
Fair value of the
investment <
the carrying
amount of the
investment, so
go to Step 2.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-56

Goodwill Impairment Test

Example

STEP 2
The implied
Goodwill < the
carrying amount of
the Goodwill, so an
impairment writedown is necessary.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-57

Goodwill Impairment Test

Example
Goodwill
Goodwill Impairment
Impairment Entry
Entry
The
TheGoodwill
Goodwillneeds
needs to
to be
be written
written down
down by
by
$50,000.
$50,000. The
Theentry
entryshould
should be
be recorded
recorded as
as
an
anextraordinary
extraordinaryitem
item on
on the
theconsolidated
consolidated
financial
financial statements,
statements,ifif itit is
ismaterial.
material.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
3-58

End of Chapter 3

This stuff
is a
breeze,
aint it?
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.