Accounting for Business Combinations - Chapter 1,2,3
Definition of a business
"An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return."
Provisional Amounts
- All provisional amounts flow through the BS not the IS -Prospectively adjust those amounts when better information becomes available. -Also, the investor can recognize additional assets or liabilities if new information is obtained that would have resulted in the recognition of those assets and liabilities as of the acquisition date. Examples Patent XXX Good will XXX Goodwill XXX Liability XXX
Examples of events that could change ,more likely than not, the fair value of a reporting unit below its carrying amounts
-Macroeconomic events -Industry or market factors
Case 7
-just because you've elected to have the straight line amortization you still have to test for impairment if a situation arises -Benefits to using entity level is that it is simplified and you can also hide poor performing reporting units -But having to reverse all the amortizations can be very costly if they do decide to go public -If equity investment is zero or less than zero you can assume that goodwill is impaired and can skip step 1 and test for the impairment loss
ASU 2017-04 (Optional Step 0 and Step 1 of Simplified Method)
0) Has an event occurs or circumstances change that indicate that the fair value of the entity may be below its carrying amount? -IF yes go to Step 1 -IF no then no impairment 1) Calculate FV of the reporting unit and compare its carrying amount INCLUDING goodwill (FV<CV) If yes then Impair Write off the difference up to the difference OR when the Goodwill account is zero, which ever comes first Equity income xxx Equity investment xxx
Acquisition-date Consolidation entries
1.Eliminate the changes in the Equity Investment account during the period [C], 2.Eliminate the beginning balance of the Equity Investment account [E] and [A], and 3.Record the depreciation and/or amortization of the AAP [D]. Adj C E A D I
Acquisition-date Consolidation allocation of AAP
AAP = Purchase price - BV of subsidiary (net assets) FV of Subsidiary's account= AAP + BV of subsidiary -Allocate acquisition accounting premium to over/undervalued assets and liabilities with the remainder going to goodwill •Note: If the purchase price is less than the fair value of the subsidiary's acquired net assets, the parent company will recognize a "bargain purchase" gain.
Amortization of Inventory
Amortize completely when sold We always assume that inventory not sold last year is sold this year. So the $30,000 allocated to undervalued beginning inventory (because the acquisition took place on 1/1/2019) would have been completely amortized this year when the inventory was sold.
Goodwill
Amount paid for an existing business above the book value of its net assets, allocated to under/over valued assets/liabilities. Remainder is plugged into Goodwill An intangible asset that is only recorded in transactions that qualify as business combinations.
Goodwill and how it is accounted for
An asset and must meet the conceptual definition of an asset in order to be recognized on the balance sheet. 1.Does the parent company control the Goodwill asset? 2.Will the Goodwill asset provide future benefits? •The second question must be answered each year. •Goodwill must be tested annually for impairment and written down if impaired.
Net assets
Assets - Liabilities= Stockholder's Equity
Consolidation at the End of the Second Year Following the Acquisition
BOY Equity Investment account consists of the book value of the subsidiary's Stockholders' Equity plus the unamortized AAP at January 1, 20X2 EOY Equity Investment account is equal to the BOY balance plus the net equity earned that year (NI- depreciation/amortization expense) from the subsidiary minus any dividends received
FASB ASC 805
Business Combinations
How do deferred taxes arise
By temporary differences in account values between the book basis and the tax basis
ADJ Entry Calculation
Change in RE on subsidiary's books (Beg RE-Beg RE of the current year) - sum of the cumulative AAP amortization expense
FASB ASC 810
Consolidations
What is contingent consideration (Case 4 )
Contingent consideration affects purchase price The earn out consideration is contingent so it is included in the purchase price -Employment status requirement will turn the contingent considerations into post combination compensation expense (ie not included in purchase price) Delayed consideration is not contingent because it will be realized later on in time but is still realized in the purchase price but since it is guaranteed it should be included in the purchase price. as a post combination compensation expense
Intercompany sales rules for deferrals at different levels of influence
Control- •Defers 100% of the downstream sales (investor to investee) •Only the portion of gross profits it owns for upstream sales (investee to investor) Significant Influence - •Defers only the proportion of gross profit it owns •Assume the investor owns 30% of the investee, the gross profit on the intercompany sale is $30. The investor defers $9 ($30 x 30%).
[I] Consolidation Entry
Eliminates intercompany activity or intercompany balances
Decreasing an asset or increasing a liability will do what to goodwill
INCREASE Goodwill
Market Approach
Includes the use of market multiples (and ranges of multiples) derived from a set of comparables.
Stock acquisition
Instead of purchasing the net assets, the investor purchases all (100%) of the investee's outstanding common stock from its shareholders. The acquirer simply adds the equity investment account to their books. Expense transaction cost immediately. Equity investment xxx Expense xxx Cash xxx CS (par) xxx APIC xxx
Consolidations on the acquisition date or at year end
ONLY the E and A consolidation entries because no time has passed for any changes or depreciation/amortization
Change from fair value to equity method steps
Original Cost +-FV adj +Cost of the New Additional purchase (Prospective approach) 1.Recognizing the unrealized holding gains/ losses from AOCI 2.Investor should add the cost of acquiring the additional shares in the investee (if any) to the current basis of their previously held interest. (Example) 1. Recognize the fair value adjustment: Dr. Equity Investment 25,000 Cr. Unrealized Holding Gain 25,000 2. Add the new basis to our Equity Investment Dr. Equity Investment 30,000 Cr. Cash 30,000
Purchase price vs Transaction Price
Purchase price- How much is allocated to the FV of the purchase Transaction price-How much is allocated to the FV of the purchase PLUS any transaction costs
Legal vs Financial entities
The parent company and its subsidiary are two separate legal entities, but the same economic entity if consolidated (control)
Bargain Acquisition
Total fair value of the investee company is LESS than the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed (i.e., the amount computed for Goodwill is negative) (purchase price< FV of sub's net assets) The investor recognizes the negative Goodwill as an ordinary gain in its income statement on the acquisition date. Equity Investment xxx Cash xxx Gain on Bargain xxx -This is the only exception for the equity investment to be recorded at the fv instead of the purchase price (ALL EQUITY INVESTMENT IS RECORDED AT FV)
Measurement Period
Within 1 year from the consolidation date
Required Disclosures
a.The name and a description of the acquiree b.The acquisition date c.The percentage of voting equity interests acquired d.The primary reasons for the business combination and a description of how the acquirer obtained control of the acquiree e.transactions that are recognized separately from the acquisition of assets and assumptions of liabilities in the business combination, all of the following: f.The disclosure of separately recognized transactions required in (e) shall include the amount of acquisition-related costs, the amount recognized as an expense, and the line item or items in the income statement in which those expenses are recognized. The amount of any issuance costs not recognized as an expense and how they were recognized also shall be disclosed. g.In a business combination achieved in stages, both of the following:
For transactions that are recognized separately from the acquisition of assets and assumptions of liabilities in the business combination, all of the following: (Required Disclosures)
•A description of each transaction •How the acquirer accounted for each transaction •The amounts recognized for each transaction and the line item in the financial statements in which each amount is recognized •If the transaction is the effective settlement of a preexisting relationship, the method used to determine the settlement amount.
When Should Goodwill Be Evaluated for Impairment?
•Companies are required to test Goodwill for impairment every year. • Goodwill also MUST be tested for impairment between the annual evaluation dates IF "an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount"
A business combination achieved in stages, both of the following:
•The acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately before the acquisition date •The amount of any gain or loss recognized as a result of remeasuring to fair value the equity interest in the acquiree held by the acquirer before the business combination and the line item in the income statement in which that gain or loss is recognized.
.If the acquirer is a public business entity, all of the following: (Required Disclosures)
•The amounts of revenue and earnings of the acquiree since the acquisition date included in the consolidated income statement for the reporting period •The revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period (supplemental pro forma information) a •If comparative financial statements are presented, the revenue and earnings of the combined entity for the comparable prior reporting period as though the acquisition date for all business combinations that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period (supplemental pro forma information).
Consolidation Entries for a Bargain Purchase
•The net result is that the gain on the bargain acquisition is recognized in the consolidated income statement immediately upon acquisition.
Contingent Consideration Rules (Cash/Revenue)
-Acquisition Accounting requires recognition of contingent consideration at the acquisition date. -Contingent consideration recorded at FV and is included in the purchase price Equity investment xxx Cash xxx Consideration Liability xxx -If the fair value of the liability changes, that increase or decrease will be reflected in income. Consideration Liability xxx Loss on Consideration xxx Cash xxx OR Consideration Liability xxx Gain on Consideration xxx Cash xxx
ADJ Consolidation Example (Cost Method) See full example in addendum slides
-Assume that on January 1, 2011, a parent company purchased a subsidiary for $1,000,000 and recognized AAP of $40,000 with a useful life of 10 years. -Assume that each year between January 1, 2011 and December 31, 2015, the subsidiary reported net income of $20,000 and paid dividends of $10,000. 1) Cost method - record 10K of revenue each year (dividends) 2) Equity method - record 16K of equity income each year (20K related to sub's net income minus 4K of AAP amortization) 3) Cumulative difference over 5 years = 30K = 5 * (16K - 10K) The [ADJ] Entry Equity Investment (P) (BOY) 30k Retained Earnings (P) (BOY) 30k
Reporting Rules for Equity Method
-For internal reporting purposes, the investor can account for the investee using the equity method even after it gains control. -However, for external financial reporting purposes, when the investor gains control over the investee, the investor must issue consolidated financial statements
Contingent Consideration Rules (Stock/Performance)
-If the contingency is related to the issuance of additional shares, the share obligation is not revalued and the difference between the original estimate and that ultimately realized is reflected in additional Paid-In Capital Equity Investment xxx CS xxx APIC (APIC+Contingency) xxx Example •Selling shareholders may feel that the true profitability of their company has not yet been revealed and demand additional purchase price if benchmarks are reached. If contingency is met and is a fixed equity issuance APIC xxx CS xxx
Intercompany Sales Rules
-The gross profit on the intercompany sale must be deferred and cannot be recognized until those inventories are sold outside of the reporting group. (If not applied, would double count revenue) -Deferral Equity income xxx Equity investment xxx -Reversal Equity investment xxx Equity Income xxx
2 Step Test (Optional Step 0 and Step 1 and Step 2)
0) Has an event occurs or circumstances change that indicate that the fair value of the entity may be below its carrying amount? -IF yes go to Step 1 -IF no then no impairment 1) Calculate the FV of the reporting unit and compare to its carrying amount INCLUDING GOODWILL. Is the fair value of the reporting unit less than its carrying value ? (FV<CV) if yes then, move to step 2 2) Calculate and compare implied FV of reporting unit Goodwill with the carrying amount of Goodwill Is the Goodwill component of the Equity Investment account impaired? (FV<CV) If yes then recognize impairment (cant reverse impairments)
2 Methods to calculate/test for impairment
1) 2-Step Test 2) ASU 2017-04 Companies can use either standard until 2022
Acquisition Method accounting (SFAS ASC 805) Net asset acquisition THAT Does Constitutes as a business characteristics
1) Acquired net assets are recorded on the balance sheet at fair value, regardless of the amount paid by the acquirer. 2) All transaction costs are expensed in the period they are incurred. 3) Any difference between the fair value of those net assets and the purchase price paid for them (the AAP) recorded as Goodwill. Assets xxx Expense xxx Goodwill xxx Liabilities xxx Cash xxx CS xxx APIC xxx
Equity investments when purchase price exceeds book value of net assets (ie investee's equity)
1) Acquirer has purchased two groups of assets -Stockholder's equity (e.g., net assets) and -An additional previously unrecorded asset 2) Investor determines what the unrecorded asset is. (still through equity investment until consolidation) 3) Depreciates (amortizes) the asset in accordance with standards (on investor's books) Dr. Equity income xxx Cr. Equity Investment xxx
Recognition Principle
1) As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree (FASB ASC 805-20-25-1) 2) As of the acquisition date, they must meet the definition of assets or liabilities in FASB Statement 6 (ASC 805-20-25-2) 3) They must be part of the business combination and not the results of a separate transaction (ASC 805-20-25-3). (i.e. We want the information on the balance sheet to be relevant (not just having all the accounts bunch of goodwill))
[ A ] Consolidation Entry
1) Assigns the remaining equity investment account (ie the unamortized beginning of the period AAP) to the appropriate assets and liabilities as of the BEGINNING of the accounting period PPE, net (S) (BOY) xxx Patent (S) (BOY) xxx Goodwill (S) (BOY) xxx Equity Investment (P) (BOY) xxx
[Adj] Consolidation Entry
1) Changes the equity investment account and the parent company's retained earnings account to an "as-if-equity-method" basis as of the BEGINNING of the accounting period 2) Backs out the cumulative cost-method activity that has been recorded in the parent's retained earnings account since acquisition, and 3) Inserts the cumulative retained earnings activity that would have been recorded if the parent company used the equity method. Equity Investment (P) (BOY) xxx Retained Earnings (P) (BOY) xxx
Two criticisms of the equity method
1) There can be a substantial difference between the BV and the FV of the equity invesmtnet account under the equity method. (since there is no adjustment to FV until the investment is sold) 2) Investor reports income from the investee proportional to their share but that income isn't necessarily cash , only receive cash from dividends. (So books are not always 100% representative of the company's status)
Measurement of Goodwill
1) Total value of the investee company is allocated to all of the tangible and intangible assets acquired (net of the liabilities assumed). 2) Goodwill is the difference between the value of the investee company and the value of its net tangible and intangible assets. 3) It is not computed directly. (i.e. it is a plug figure)
Post-Acquisition Consolidation (Parent uses cost method)
1) Under the cost method, the Equity Investment balance always remains UNCHANGED at its original acquisition date amount. 2) Any dividends received by the parent are recorded as dividend income. 3) Consolidated net income will NOT equal the parent company's pre-consolidation net income, and 4) Consolidated owners' equity will NOT equal the parent company's pre-consolidation owners' equity. !!!!!Will be writing off dividend income instead of Equity income!!!!!!!
Cost Method
1) Use cost method when investor CANNOT readily determine the fair value 2) Investment is always reported at its original cost and any dividends that the investor receives are treated as dividend income (increase RE).
Goodwill Amortization Qualifications for a Private Company (2)
1) Whether the acquiring company qualifies as a "private company" (i.e., entities that are not public business entities, not-for-profit entities, or employee benefit plans), and 2) Whether the acquiring (private) company elects to adopt the Goodwill amortization exception available to private companies
Consolidated Statement of Cash Flows steps
1. Add back the noncash expense relating to the depreciation and amortization of the AAP. (In the year of acquisition) 2) The net cash paid for an acquisition is recorded in the investing section. 3) The changes in working capital accounts (current assets and liabilities) are computed based on amounts excluding the effects of the acquisition.
Summary of Post-Acquisition Consolidation(Parent uses the Equity Method)
1. Consolidated net income will equal the parent company's pre-consolidation net income, and 2. Consolidated owners' equity will equal the parent company's pre-consolidation owners' equity. 3. Consolidated return on equity (i.e., net income ÷ owners' equity) will equal the parent company's pre-consolidation return on equity!
Implied FV of Goodwill and impairment calculation
FV of Sub -FV of Net assets (excluding Goodwill) = Implied FV of Goodwill Implied FV -Carrying value of goodwill =Goodwill impairment
2 Step Test Impairment Process
Fair values are estimated for all of the identifiable net assets in the reporting unit and the net sum of these fair values is deducted from the fair value of the reporting unit (i.e., as a stand-alone entity) to arrive at the implied fair value of Goodwill. •The implied fair value of Goodwill is then compared to the carrying value of Goodwill assigned to the reporting unit. IF Implied FV<CV then write off the difference Equity income xxx Equity investment xxx
Net asset acquisition
The acquirer purchases some or all of the assets of the acquiree, and may assume selected liabilities, like a mortgage on a building it is acquiring. The acquirer adds all of the acquired assets and liabilities to their books. Depending whether or not if the acquisition does or does not constitute as a business will determine what how to allocate the cost(WA) or at FV, whether or not to include transaction expense in the purchase price or to expense it immediately, and whether or not Goodwill is used as a plug figure for AAP.
How to account for Discontinued Operations and criteria
The acquirer shall measure an acquired long-lived asset (or disposal group) that is classified as held for sale at the acquisition at fair value less cost to sell." (NET REALIZABLE VALUE) 1) Management has authority to approve and commits to a plan to sell the asset (or disposal group) 2) The asset is ready for immidiate sale in its present condition 3) Initiated the plan to sell the asset (ie looking for buyers, etc ) 4) The sale of the asset is probable and will be done so within one year 5) Market price of the asset must be reasonable (ie close the the FV of the asset) 6) That the plan to sell is unlikely to be withdrawn
Reporting Units (Public)
•For all public companies (and all private companies that do not adopt the Goodwill-amortization exception), all Goodwill impairment tests are performed at the reporting unit level (FASB ASC 350-20-35).
Reporting Units (Private)
•If a private company chooses to adopt the Goodwill amortization exception, then FASB ASC 350-20-35-65 requires the company to also make a policy election of whether to test Goodwill for impairment at the entire-company level OR at the reporting unit level
Taxable Deferred tax treatment
•If a selling party pays taxes on the difference between the tax basis of an asset and the sales value of an asset, then the tax basis of the asset can be "stepped up" to its new sales value. (i.e. there will be no difference between the tax and book basis)
Non-Taxable Deferred tax treatment
•If the selling party does not pay taxes on the gain in an asset transfer, then tax law usually requires the asset's old tax basis to carry over from the selling party's tax books to the buying party's tax books. (most likely will result in some temporary differences in book and tax basis)
Asset Acquisition of a group of assets that do NOT constitute a business characteristics
•Include liabilities assumed in acquisition ("net assets") •Include transaction costs •Assign relative fair values to acquired assets (used by percentages) Assets xxx Liabilities xxx Cash xxx CS xxx APIC xxx
Change from cost method to equity method steps
•No retrospective action needed or unrealized gains/ losses adjustments. •Simply account for new investment Original cost + New acquisition
The Annual Evaluation of Goodwill Impairment (Private)
•Private companies that adopt the Goodwill amortization exception are not required to test Goodwill for impairment on an annual basis; •Instead, Goodwill is tested for impairment if an event occurs or circumstances change that indicate that the fair value of the entity may be below its carrying amount.
Accounting for a sale of an equity investment.
•Record receipt of cash •Remove the Equity Investment from the balance sheet •Recognize difference as gain or loss
Consolidation Entries
1) Consolidation entries only appear on a separate worksheet off of both the parent's and subsidiary's books (parents responsibility to consolidate) 2) These are fictitious entries that are used only for external reporting and DO NOT actually impact EITHER the parent's or sub's books. (acquisition entries actually impact the books) 3) Equity Investment account will be reduced to a zero balance on the consolidated balance sheet. 4) The book value of Stockholders' Equity on the consolidated balance sheet is equal to the book value of Stockholders' Equity of the parent, just like before 5) The process of consolidation will eliminate the investment account and replace it with the fair value of the net assets of the subsidiary in the post-consolidation financial statements.
Degrees of influence and their corresponding accounting method
1) Insignificant (<20%) Fair value Method 2) Significant( 20%-50%) Equity Method 3) Control (>50%) Equity Method with Consolidation
3 Valuation Techniques
1) Market Approach-- 2) Income Approach-- 3) Cost Approach--
Consolidated Statement of Cash Flows Rules
1) NOT the sum of the statements of cash flows of the individual companies in the consolidated group. 2) Prepared from the consolidated income statement and a comparative consolidated balance sheet.
Two types of business combinations
1) Net asset acquisition -Acquirer directly purchases the individual net assets that constitute a business. 2) Stock acquisition- Acquirer purchases the business by acquiring its voting shares.
Two ways control can be achieved under US GAAP
1) Quantitative majority of the voting equity interest. 2) Qualitatively determined power to direct an entity's activities and a majority of the entity's economic risks and rewards (i.e., the primary beneficiary of a variable interest entity), regardless of the level of equity ownership
[D] Consolidation Entry
1) Recognize the current-period AAP depreciation and amortization of the AAP in the consolidated income statement Operating Expense (S) xxx Patent (S) xxx PPE, net (S) xxx
Instances where control does not exist
1) Same examples as those for significant influence 2) Is a variable interest entity, 3) Is in bankruptcy, (Belongs to creditors) 4) Has business activities that are controlled by a foreign government. (At risk in locations such as Russia, China, Venezuela)
Acquisition-Related Costs and how to account for them
1) Services provided by attorneys, accountants, and investment bankers 2) Indirect costs, such as office expenses of the investor company 3) Stock issuance cost (flows through APIC ) already taken out of proceeds so flows down to reduce APIC (SO DOES NOT IMPACT THE PURCHASE PRICE) APIC xxx Cash or AP xxx 4) Transaction costs -Expense in the income statement of the investor company in the period of the acquisition Expense xxx Cash or AP xxx
How to account for deferred taxes
1) Taxes count as an identifiable net asset in business combinations, so taxes will affect the amount of goodwill recognized. DTL= Increase Goodwill DTA= Decrease Goodwill 2) NOT necessarily recognized at fair value. 3) The acquirer records a deferred tax liability for the expected tax obligation arising from the increase in asset value. 4) That deferred tax liability (or deferred tax asset relating to tax loss carry-forwards) must be recognized on the consolidated balance sheet. 5) The single most important determinant of temporary differences in a business combination is the underlying "tax type" of the combination.
Measurement Principle
1) The acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values (FASB ASC 805-20-30-1) 2) Fair value: "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." (FASB ASC 820-10-20) •The market participants in this hypothetical market are assumed to be independent of the reporting entity, knowledgeable of the asset or liability, and able and willing to transact for the asset or liability.
Indicators of absence of significant influence
1) The investee challenges the investor's ability to exercise significant influence, such as by litigation or complaints to governmental regulatory authorities. 2) The investor and investee sign an agreement under which the investor surrenders significant rights as a shareholder. 3) Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor. 4) The investor tries and fails to obtain representation on the investee's board of directors. 5) The investor needs or wants more financial information to apply the equity method than is available to the investee's other shareholders and fails.
Steps to account for Deferred taxes in a business combination
1. Recognize the fair values of the identifiable net assets (i.e., not goodwill) according to FASB ASC 805. 2.Identify the tax bases of the identifiable net assets according to relevant tax laws and regulations. 3. Compute the difference between the financial reporting bases and the tax bases of the identifiable net assets. 4. Recognize the deferred tax assets and/or deferred tax liabilities by multiplying the temporary differences by the appropriate tax rate. 5. After deferred taxes are computed, the acquiring company will calculate the amount of goodwill recognized pursuant to the business combination.
What happens when a stock contingent consideration is not a fixed amount of equity but a variable amount instead and how does it impact the balance sheet of the parent company? (case 2)
It would be considered a liability (financial instrument) instead of an equity consideration Still contingent consideration but the entry is treated as a liability instead of a equity contingency . Equity investment xxx Contingent Liability xxx ASC 480 trumps ASC 815
Allocating to assets and liabilities with AAP
Overvalued assets= Cr Undervalued assets = Dr Overvalued liabilities = Dr Undervalued liabilities = Cr Remainder(if any) goes to goodwill
Deferred Tax Liability: (DTL)
Pay less taxes now and owe more later Asset book basis > Asset tax basis OR Liability book basis < Liability tax basis
Deferred Tax Asset: (DTA)
Pay more taxes now and owe less later Asset book basis < Asset tax basis OR Liability book basis > Liability tax basis
The Annual Evaluation of Goodwill Impairment (Public or Private companies that don't elect to use the exception)
Public companies and private companies that do not adopt the Goodwill amortization exception are required to annually evaluate Goodwill to determine if it is impaired.
Increasing an asset or decreasing a liability will do what to goodwill
REDUCE Goodwill
Income Approach
Techniques include present value, option-pricing models, and "the multiperiod excess earnings method, which is used to measure the fair value of certain intangible assets."
Contingent asset (Case 3)
The lawsuit is an existing liability prior to the acquisition this allows the parent company to book a contingent asset on the books once they determined the other lawsuit was deemed probable and estimable within the measurement period Contingent Asset xxx Goodwill xxx
Fair Value and it's Market
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." (FASB ASC 820-10-20) •The market participants in this hypothetical market are assumed to be independent of the reporting entity, knowledgeable of the asset or liability, and able and willing to transact for the asset or liability.
Cost Approach
Valuation technique "based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost).
When to discontinue using the equity method
When the reported amount of the Equity Investment is reduced to zero, the investor ceases to use the equity method to account for its Equity Investment Can Occur through 1.Investee company losses 2.Payment of dividends by the investee to the investor in excess of the amount of cumulative Equity Income reported by the investor 3.Write-down of the Equity Investment by the investor as a result of its determination that the fair value of the investment has permanently declined
For the purpose of testing Goodwill for impairment, acquired assets and assumed liabilities must be assigned to individual reporting units as of the acquisition date if both... (Assigning Goodwill to Reporting Units)
a.The asset will be employed in or the liability relates to the operations of a reporting unit, and b.The asset or liability will be considered in determining the fair value of the reporting unit. •After the identifiable assets and liabilities are assigned to the reporting unit, then the acquiring company must calculate the amount of Goodwill assigned to each reporting unit.
Business combinations can be structured in two tax types
•Taxable •Nontaxable •The descriptions "taxable" and "nontaxable" are from the perspective of the selling party in the business combination.
Changing from Equity Method to FV or Cost Method steps
•The amount at which the Equity Investment is reported (i.e., its book value) on the date of change becomes the cost of the security. •Account for the security using either the cost or fair value methods as usual from that point forward.
Required Disclosures for Equity Method Investments (FASB ASC 323-10-50)
a.The name of each investee and percentage of ownership of common stock, the accounting policies of the investor with respect to investments in common stock, and the difference, if any, between the amount at which an investment is carried and the amount of underlying equity in net assets and the accounting treatment of the difference. b.For those investments in common stock for which a quoted market price is available, the aggregate value of each identified investment based on the quoted market price usually should be disclosed. This disclosure is not required for investments in common stock of subsidiaries. c.When investments in common stock of corporate joint ventures or other investments accounted for under the equity method are, in the aggregate, material in relation to the financial position or results of operations of an investor, it may be necessary for summarized information as to assets, liabilities, and results of operations of the investees to be presented in the notes or in separate statements, either individually or in groups, as appropriate. d.Conversion of outstanding convertible securities, exercise of outstanding options and warrants and other contingent issuances of an investee may have a significant effect on an investor's share of reported earnings or losses. Accordingly, material effects of possible conversions, exercises or contingent issuances should be disclosed in notes to the financial statements of an investor.
Journal Entry for Impairment
•"Impairment is the condition that exists when the carrying amount of a long-lived asset (asset group) exceeds its fair value." •If we test Goodwill for impairment and find it to be impaired, we must write it down with a journal entry similar to the following (assuming the parent uses the equity method): Equity Income xxx Equity Investment xxx
Accounting when there is control
•Can continue to account for the investment internally using the equity method •Must consolidate the financial statements of both companies when reporting externally
When do the investor and investee become the same company under Financial and Legal purposes
•Financial purposes •Legal purposes
Restructuring activities
1) Costs the investor expects (with respect to restructuring) but is not obligated to incur in the future are not liabilities at the acquisition date. (i.e NO liability is recognized as of the acquisition date, and the liability is recognized when they actually consolidate) 2) The investor recognizes those costs in its post-combination financial statements in accordance with other applicable generally accepted accounting principles. 3) Investee must have a preexisting liability. 4) If obligated, you are required to recognize as a liability EXAMPLE On the acquisition date, an acquiree has an existing liability/obligation related to a restructuring that was initiated one year before the business combination was contemplated. In addition, in connection with the acquisition, the acquirer identified several operating locations to close and selected employees of the acquiree to terminate to realize certain anticipated synergies from combining operations in the postcombination period. Six months after the acquisition date, the obligation for this restructuring action is recognized, as the recognition criteria under ASC 420 and IAS 37 are met.
Equity Investment (Equity Method)
1) Dividends are NOT income! Everything flows through the Equity Investment account. -Dividends decrease the investee's retained earnings because they are a return of capital. Thus, they also decrease the equity investment account balance. 2) Investor is only entitled to investee's income subsequent to the date of purchase. -Income (loss) from the investee increases (decreases) the equity investment account. 3) No adjustments to Equity Investment account for fair value changes. (recognize when sold) 4) Equity investment is recorded at its purchase price (recorded on investor's books only)
[C] Consolidation Entry
1) Eliminates all changes in the parent's books caused by investment bookkeeping during the year 2) When the parent uses the equity method to account for the pre-consolidation Equity investment account it reverses out all entries to the equity investment account during the consolidation period, leaving only the beginning balance Equity Income (P) xxx Dividends (S) xxx Equity Investment (P) xxx
[E] Consolidation Entry
1) Eliminates the portion of the investment account related to the book value of the subsidiary's stockholder's equity at the BEGINNING of the accounting period 2) After this entry, the investment account should equal the beginning of period unamortized AAP CS (S) (BOY) xxx Retained Earnings (S) (BOY) xxx APIC (S) (BOY) xxx Equity Investment (P) (BOY) xxx
Goodwill impairment Rules for Public Companies
1) Goodwill is NOT amortized like most identifiable intangible assets. 2)Along with Goodwill, all indefinite-lived intangible assets must be evaluated, at least ANNUALLY, for impairment. 3) Further, companies must conduct this annual evaluation during the SAME TIME of year
Qualifications for the investee to be considered a business (4) + (3 optional)
1) Has begun planned principle activities 2) Has inputs and processes that can be applied to those inputs 3) Is pursuing a plan to produce outputs 4) Able to obtain access to interested customers ---------------------------- 5) Likely has goodwill but doesn't need to have goodwill. 6) Is hopefully generating a return (but not required) 7) Hopefully has outputs, but does not need them.
Preacquisition Contingencies Rules
1) If the fair value of the asset or liability arising from a contingency can be determined during the measurement period, that asset or liability is recognized AT THE ACQUISITION DATE 2) FASB expects the liability relating to warranty obligations MUST be recognized on the date of acquisition -1 year from the acquisition date is the measurement date -Liability contingencies (probable, reasonably possible, remote) -Asset contingencies, can only be recorded during an acquisition
If equity investment is less than 100% ownership characteristics
1) If the investor owns less than 100% of the investee, only the proportionate share of income is recognized in equity income (Own 60%, receive 60% of earnings and dividends) -Same applies for inter-company sales
Fair Value Method
1) Insignificant Influence 2) Recognize dividends as income (doesn't reduce the investment account) 3) Investment account is composed of the original cost plus (minus) the fair value adjustments
Intangible asset rules
1) Intangible assets should be separately recognized from goodwill if they can be identified. -If you don't then equity income and investment will be over valued since they are not being amortized if they were left in goodwill 2) Intangible assets are considered to be separately identifiable if they meet either of the following criteria: •The intangible asset arises from contractual or other legal rights, or •The intangible is separable, that is, it can be separated or divided from the acquired entity and sold, rented, licensed, or otherwise transferred.
Indicators of Significant Influence
1) Investor representation on the board of directors 2) Investor participation in policy making process of the investee 3) Extent of ownership of investee voting shared by the investor in relation to the concentration of other shareholdings (i.e. owns 15% and the next highest shareholder owns .0002%) 4) Material intercompany transactions between the investor and investee 5) Interchange of managerial personnel between the investor and investee 6) Technological dependency of the investee on the investor
Acquired R&D Assets
1) Investors value and recognize research and development assets acquired in a business combination at their fair values just like any other assets acquired •Tangible research and development assets are accounted for in accordance with their nature. •Intangible research and development assets in progress, should be considered indefinite-lived until the associated research and development activities are either completed or abandoned. -Completed= amortize -Abandoned= write off
Goodwill Amortization Rules for Private Companies
1) Required to amortize the Goodwill "on a straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate." 2)However, if a private company attempts to transition to being a public business entity (e.g., by registering its common stock with the SEC and issuing the shares to investors via an Initial Public Offering), then the company will be required to retroactively restate its financial statements without the private-company exception included in the financial statements.
Good will impairment (case 5)
The company should test impairment of goodwill at least once at the same time every year unless circumstance have occurred that might indicate impairment, then you would test at that earlier date.
