MACC 513 Midterm Exam

What should you always remember about the eliminating entries?

The eliminating entries are made on the consolidation working paper ONLY, and are NOT reported in actual accounts of the parent or the subsidiary -> also eliminating debits will always equal the eliminating credits

What does "noncontrolling interest" mean and where does it appear in the financial statements?

The portion of a subsidiary's stock held by investors other than the company with controlling interest -> even when parent owns < 100% of a sub, it consolidates 100% of the sub's assets, liabilities, revenues, and expenses with its own accounts a) On consolidated BS, NCI in sub's net assets appears as a separate line in equity section b) On consolidated IS, NCI's share of sub's income appears as a separate line representing portion of consolidated income attributable to NCI c) NCI in comprehensive income is separately reported on consolidated statement of comprehensive income

How are previously unreported identifiable intangibles valued by the parent in years subsequent to acquisition?

These intangibles may have limited or indefinite lives A) For limited lives: amortize over useful life and periodically test for impairment B) For indefinite lives: valued at FV at acquisition and periodically tested for impairment -> note: acquired in-process R&D costs are considered indefinite-lived until project is completed or abandoned

Describe the IFRS standards related to joint arrangements

These may either be: - joint operations (gives investor rights to entity's individual assets and obligations) -> proportionate consolidation - joint ventures (gives investors rights to entity's net assets) -> equity method

Describe impairment testing for limited-life intangibles under US GAAP

Two-step process: 1) Recoverability test: Compare undiscounted cash flows expected from future use with asset's BV - If UCF > BV -> no impairment so STOP here - If UCF < BV -> impairment occurred and go to step 2 2) Amount of impairment loss is the difference between the asset's BV and its FV (measured at PV of expected cash flows) -> impairment loss = BV - PV of discounted CFs

What simplification do we use throughout the text in consolidation?

We assume the parent uses the complete equity method to report the investment on its own books

What is a variable interest entity?

When investee is a separate legal entity controlled by another company - similar to stock acquisition but control occurs through a legal relationship rather than stock ownership - VIE if entity must obtain guarantees from other parties to obtain financing or if equity holders don't have the usual rights and responsibilities pertaining to equity ownership -> e.g. leasing arrangement where company creates separate legal entity to purchase long-term assets, funded by loans guaranteed by company they are leasing these back to (Enron!)

How are goodwill impairment losses treated in consolidation?

(O) elimination entry records the impairment loss on the workpaper in the year loss occurs - Dr. Impairment loss, Cr. Goodwill

What is included in measuring acquisition cost?

- Assets/cash transferred by acquirer to acquiree owners - Liabilities incurred by acquirer and owed to acquiree owners - Stock issued by acquirer to former acquiree owners -> stock must be valued as of date acquirer achieves control (adds uncertainty)

Describe the relevance of elimination entries regarding revaluation of a subsidiary's assets and liabilities in subsequent years

- Changes for *previous years* are reflected in the beginning-of-year revaluations of (R) - Reported changes for the *current year* appear in the (O) entry

Describe how the acquirer values an acquiree's previously reported assets and liabilities

- FV of acquired assets is based on the acquirer's planned use of those assets - FV may be estimated using quoted market prices, appraisals, estimated selling prices, estimated replacement costs, PV of future cash flows discounted at appropriate discount rate - identifiable intangibles already reported on acquiree's BS are reported at FV (usually estimated by discounted expected cash inflows) - if acquiree already has goodwill or deferred tax position, these are assumed to have FV = 0 for purposes of recording the acquisition -> replaced with goodwill and deferred taxes resulting from acquisition

How is goodwill accounted for in private companies?

- Goodwill is amortized straight-line over 10 years or less - Test for impairment at either company or reporting unit level only when "triggering event" indicates possibility of impairment - Option to perform qualitative test, and if impairment is more likely than not, GW impairment is amount by which company or unit's BV > FV -> less costly because it doesn't require annual testing and is at the overall company level -> new test eliminates requirement to estimate FV of net assets and unreported assets and liabilities by assuming overvaluation is due to GW and not other assets

If price paid to acquire a business doesn't equal its FV, what does the acquiring company record?

- If acquisition cost > FV of net assets -> record goodwill - If acquisition cost < FV of net assets -> record bargain gain

Why is the complete equity method known as a "one-line consolidation"?

- Investment account is a one-line summary of assets and liabilities of the investee - Equity in net income is a one-line summary of revenues and adjusted expenses of the investee - Equity in other comprehensive income is a one-line summary of the various components of the various components of the investee's OCI

Describe the fair value hierarchy for the valuation of intangibles

- Level 1: quoted prices in an active market for identical assets - Level 2: quoted market prices for similar assets - Level 3: valuation based on unobservable estimated attributes -> in all cases, intangible is valued at the highest and best use

What are the pros and cons of pushdown accounting?

- PRO: When FV of sub's assets exceed BV at acquisition date, pushdown accounting increases reported asset and equity values -> CON: reduces future reported income through increased depreciation, amortization, impairment on revalued assets including previously unreported intangibles -> CON: New basis distorts income-based financial trend analysis, because pre-acquisition expenses are based on historical cost and post-acquisition expenses reflect revaluation to FV - PRO: If sub has negative equity, revaluation process may result in positive equity - PRO: Eliminates need to maintain 2 sets of records for same assets - CON: Acquisition is likely to be nontaxable and tax reporting for sub's assets is based on historical cost, so company will have to maintain 2 sets of valuations for net assets

Before starting on the elimination entries, what must you remember to change about the parent or subsidiary's accounts?

- Reduce parent's cash by the amount used to acquire the sub (including merger expenses and registration fees) - Increase parent's liabilities by any earnout liability - Subtract any merger expenses from RE - If acquisition is a bargain purchase, report the gain in the parent's NI and close it to RE

What is the objective of consolidation?

- Report affairs of a group of affiliated corporations as a single economic entity - Remove effects of reported transactions and relationships between components of reporting entity -> reflects transactions with outside parties - Final product is as if acquiring company had treated the acquisition as a merger (each time financial statements are prepared)

Can impairment losses ever be reversed?

- Under US GAAP, impairment losses can never be reversed in the future - IFRS allows impairment losses for long-lived assets *other than goodwill* to be reversed and increase income -> but new BV is limited to amount that would have been reported at historical cost basis

What adjustments need to be made when calculating equity in net income? (simplified version from Ch 1)

1) Basis differences: any investment cost in excess of investee's BV - equity in NI must reflect write-offs of additional assets not recorded on the investee's books -> applies to identifiable assets, but any adjustment to goodwill impairment is prohibited 2) Unconfirmed inventory profits: if merchandise is not yet sold to an unrelated outside party at year-end, gross margin isn't yet earned and must be removed when calculating equity in NI

Describe the quantitative testing of a reporting unit's goodwill under US GAAP

1) Compare unit's current FV to its BV - If FV > BV -> no impairment - If FV < BV -> assets are overvalued and must be written down 2) Amount of GW impairment = reporting unit's BV - FV - Overvaluation is attributed entirely to GW -> If difference between BV and FV exceeds the GW balance, GW is written off entirely and other assets are evaluated for impairment Note: Because FV can never be zero, a unit with zero or negative BV will never have GW impairment - but company must disclose these units exist and their amount of GW

What are the requirements for reporting previously unreported intangibles?

1) Contractual or other legal rights 2) Separable (can be sold, rented, licensed, otherwise transferred) -> meeting *either* criterion is sufficient to require recognition of intangible

Describe the two steps of the variable interest model and questions involved for each

1) Determine if entity is a VIE - Are entity's equity investors the controlling interest? - If entity is NOT a VIE -> apply voting interest model 2) If VIE, determine if company is the primary beneficiary - Does the company control the VIE? -> Primary beneficiary consolidate the VIE

Under GAAP, what determines whether control exists between a parent and a subsidiary?

1) For equity investments: Voting interest model - consolidate if parent owns (directly or indirectly) more than 50% of outstanding shares -> exceptions: (a) majority of ownership doesn't lead to control or (b) parent owns less than 50% but control is achieved by other means 2) For non-equity investments: Variable interest model -> involves two step process: (1) determine if entity is a variable interest entity and (2) if VIE, determine if company is the primary beneficiary -> primary beneficiary consolidates the VIE

Compare the likelihood of impairment under IFRS vs. US GAAP for limited-life intangibles and goodwill

1) For limited-life intangibles: IFRS will likely report greater impairment losses for the same factual situation as GAAP because there's no recoverability test: -> Under GAAP intangibles may have BV < undiscounted future cash flows and company won't have to proceed with second step (which is equivalent to IFRS's test) 2) For goodwill: IFRS uses smaller basis of assessment for testing impairment of goodwill -> Cash generating units (CGUs) are likely to be smaller in size (narrower) than reporting units used under US GAAP so gains in one CGU may offset losses in value of another CGU in the same reporting unit

Describe the changed aspects of goodwill impairment under new FASB standards effective 2020

1) Goodwill must be tested for impairment *at least annually* unless circumstances indicate the likelihood of impairment is remote -> more frequent testing may be needed based on events or changing circumstances 2) Now have option to *qualitatively* assess whether it's more likely than not (>50%) reporting unit's FV < BV -> if NOT, company is not required to test reporting unit for GW impairment -> company has unconditional option to skip qualitative test and go straight to quantitative, but can go back and resume use of qualitative test at any future time

Describe the three approaches to valuation of intangibles

1) Market: quoted market prices of identical or similar assets -> Transaction value of arm's-length sale 2) Income: calculation of PV of future cash flows -> most common method, but relies on management estimates of cash flows and discount rate 3) Cost: estimate of replacement cost of services provided by the asset -> most applicable if asset doesn't generate income

Describe the different types of business combinations

1) Merger: one company absorbs another company in exchange for cash, debt, or stock -> may purchase assets and liabilities directly or acquire and retire stock -> acquired company ceases to exist as a legal entity 2) Consolidation: new corporation is organized to absorb activities of two or more existing corporations -> shares of existing corporations are retired and only the new corporation continues to exist as a legal entity 3) Asset acquisition: one firm acquires a subset of assets of another firm (often a division or product line) -> selling firm may continue to survive as a legal entity or liquidate entirely 4) Stock acquisition: acquiring firm obtains all or most of voting shares of another firm -> each firm continues as a separate legal entity -> investment in acquired firm is treated as intercorporate investment on parent's books

Describe the two broad different types of controlling investments

1) Mergers, consolidations, and asset acquisitions: investor records acquired assets and liabilities directly on its book at FV -> investee ceases to exist as a separate entity and investor reports subsequent activities directly in its own financial statements 2) Stock acquisitions: investor = "parent" and investee = "subsidiary" which are separate legal entities who record transactions on their own books -> at end of each reporting period, accountant consolidates separate financial statements for presentation -> subjunctive: as if investor had reported investee's assets and liabilities directly on its books along with subsequent activities

Describe the entry the parent makes on its own books to report equity in net income of a subsidiary and it's share of dividends received from the sub

1) Parent reports equity in net income of subsidiary adjusted for revaluation write-offs like depreciation, amortization, and impairment - Dr. Investment - Cr. Equity in NI - Cr. Equity in AOCI 2) Parent reduces investment account by any dividends issued by the subsidiary: - Dr. Cash - Cr Investment

Describe the qualitative analysis for determining whether an entity is a VIE

1) Prove entity can obtain financing on its own 2) Show entity has level of equity comparable with entities who can obtain financing without outside support -> if qualitative analysis isn't conclusive, move on to quantitative analysis

Describe the computation of goodwill

1) Start with acquisition cost 2) Subtract BV of subsidiary's SE to get cost in excess of BV 3) List and sum differences between sub's FV and BV -> negative if overvalued (FV < BV) -> positive if undervalued (FV > BV) 4) Subtract sum of differences from excess of acquisition cost over BV of sub to get goodwill

Describe the quantitative analysis for determining whether an entity is a VIE

1) Take PV of expected future cash flows 2) Find residual returns = PV of CFs - Investment's FV 3) Find expected gains/losses = probability x residual returns 4) If equity investment is less than sum of expected losses, this indicates the entity's equity investment is not sufficient to absorb entity's risks, so classify as VIE

What are the categories of intercorporate debt investments?

1) Trading (FV-NI) 2) Available for sale (FV-OCI) 3) Held to maturity (amortized cost)

Broadly, what is pushdown accounting and when does it happen?

A "fresh start" -> option exists under US GAAP when a change of control event occurs -> not allowed under IFRS because IASB doesn't want any company to create goodwill on its own books 1) Acquired company may revalue its assets and liabilities to FV to mirror values determined by acquiring company -> acquired company's books will reflect acquirer's acquisition cost 2) New basis implies a new start for company, reflected in its equity accounts by zeroing out its RE and AOCI -> total effect of revaluation and resetting RE and AOCI is reflected in sub's equity -> adjustment may be to APIC or separate "pushdown capital" account 3) Typically applied as of date of acquisition, but may wait until a subsequent period and treat it as a change in accounting method

What is a special purpose entity?

A legal structure formed for specific business activity with little or no equity investment - typically obtain financing through debt and have small outside equity interest that obtains a secure return with little risk -> Ex 1) Securitization: SPE issues debt backed by receivables, uses that money to buy receivables, then uses the collection proceeds from receivables to pay interest and principal on the debt -> Ex 2) Leasing: SPE obtains loans, purchases long-lived assets, leases these assets to company and uses the lease payments to pay off debt -> Ex 3) Joint ventures: formed to legally separate risk, allowing financing to be obtained at a lower cost

Describe goodwill allocation and impairment testing under IFRS

A) Goodwill is allocated to cash generating units (CGUs) which are the smallest group of assets with independent cash inflows -> likely to be smaller in size (narrower) than reporting units used under US GAAP B) NO option for qualitative test -> GW must be quantitatively tested for each CGU C) Requires CGU's BV to be compared with it's recoverable amount (similar to FV in practice) -> GW is impaired if CGU's BV > recoverable amount -> decline in FV assumed to be decline in GW, so amount of GW impairment loss = CGU's BV - it's recoverable amount

How is acquired long-term debt valued in subsequent years if its FV differs from BV at acquisition?

A) If market rates > coupon rate -> FV of bond < par value, so there's a discount on the bond B) If market rates < coupon rate -> FV bond > par value, so there's a premium on the bond - for convenience we assume straight-line amortization of the discount/premium over the bond's remaining life with (O) entry -> Dr. Interest expense, Cr. Bonds payable for discount (or reverse for premium) -> this eliminating entry is made each year that the bond remains outstanding

How are mergers, consolidations, and asset acquisitions reported?

Acquired assets and liabilities are reported at FV at acquisition date - acquiring company doesn't revalue its own assets - typically price paid exceeds total FV of specific net assets -> excess amount paid is attributed to goodwill

How does a company account for the acquiree's depreciable assets in a business combination?

Acquirer reports asset at FV, which is *parent's* original cost (not the subsidiary's) -> Subsidiary's original cost and accumulated depreciation are irrelevant - Begin depreciation at acquisition date

Describe how deferred tax positions relate to acquisitions

Acquirer's basis in acquired assets depends on whether acquisition is taxable or nontaxable: -> DTLs arise when acquirer reports tangible and identifiable assets acquired at FV, but their tax basis remains at the acquiree's BV a) If taxable: acquiree pays taxes on its gain on acquisition - gain = acquisition price - tax basis of net assets sold - acquirer's tax basis = FV, so valuation is same for book & tax purposes, and *no DTL/As arise* b) If nontaxable: acquiree doesn't pay tax on gain - tax basis of acquired assets remains at acquiree's company's tax basis, but acquirer still records at FV on books, so acquiring company records a *DTL if tax basis < BV* and a *DTA if tax basis > BV* -> recognition of DTA/L increases or decreases the FV of net assets acquired, which changes goodwill -> *DTL increases goodwill* and DTA decreases goodwill

What is contingent consideration (AKA "earnout liability")?

Additional payments dependent on measurement of future performance - required to be reported as liability at date of acquisition and considered a component of acquisition cost -> acquirer must make good-faith estimate of PV of expected payment (consider both probability and timing) - usually liability, but occasionally classified as equity - only consider payments related to services *already performed* (severance and vested stock options count)

What happens if acquired assets are subsequently depreciated/amortized during the measurement period based on original valuation?

Adjusting entry must include correction of already recorded related expense/loss -> as part of FASB's simplification initiative, effects of measurement changes on income are only required to be reported in year of discovery with no retroactive adjustments -> E.g. if you find out PPE FV was lower, you Dr. Goodwill, Cr. PPE, net, Cr. Depreciation expense (related to any depreciation on artificially high value) -> even though excess applies to prior year

List some unreported intangibles that do not meet either criterion for reporting

Assembled workforce, potential contracts, favorable location, business reputation -> these are neither contractual nor separable so they are not recorded separately -> instead reported as goodwill

Broadly describe how controlling investments are treated by the investor

Assets, liabilities, revenues, and expenses of controlled investee are combined with those of the investor for presentation in its financial statements

Describe the IFRS standards related to credit losses of debt investments

CECL model: based on expected credit losses over the next 12 months (instead of life of investment under US GAAP) - losses expected for the *life* of the investment are only recorded if there's a *"significant deterioration"* of credit quality

When the parent uses the complete equity method what is true about consolidated net income and consolidated other comprehensive income?

Consolidated NI = NI from the parent's own operations + Equity in NI of sub - Write-offs of any over/undervaluations of sub

Describe the IFRS standards related to controlling investments

Consolidation is determined by whether investor *controls* entity whether through stock ownership or contractual relationship -> requires qualitative analysis of entity's relationship with another entity -> don't have to worry about VIEs like we do under US GAAP

How is in-process R&D treated under US GAAP?

Costs of internally generated R&D are required to be expensed as incurred - if *acquired in a business combination*, must be reported as an asset at FV regardless of whether R&D has alternative future use -> capitalization is in line with accurate measurement of assets acquired

Describe the general model for impairment testing of AFS and HTM debt securities

Current expected credit loss (CECL) model: - impairment loss caused by credit loss and/or market-related loss over the life of the investment -> credit loss (related to financial health of issuer) is difference between carrying value and PV of cash flows -> market-related loss (when interest rates go up, bond prices go down) is the difference between PV of cash flows and FV - investment is impaired if its FV is below its cost -> impairment loss = difference between COST and FV (not carrying value)

How do you determine acquisition date?

Date acquiring company obtains control

Describe the IFRS standards related to equity investments with no significant influence

Default is fair value through NI, but if investment is not held for trading, investment may be recorded using FV through OCI method -> gains or losses are NOT reclassified to income when investment is sold

Describe the IFRS standards related to accounting for debt securities

Default is to report investments at FV with all changes in value reported in NI -> but fair value through OCI or amortized cost options may be chosen if appropriate

Describe how to account for a step acquisition when the acquirer already has a controlling interest but then buys the remaining noncontrolling interest

Difference between consideration paid and BV of NCI is absorbed in contributed capital (APIC) -> No revaluation of assets and liabilities so NI is not affected 1) When initially achieved control, acquirer recorded acquiree's assets and liabilities at FV and created noncontrolling interest account -> reported as part of acquiring corporation's equity on BS 2) When noncontrolling interest is acquired, NCI account is removed and any difference between acquisition cost and BV of NCI is absorbed into acquirer's equity (Dr. NCI in net assets (equity), Dr. APIC, Cr. Cash)

On the date of a stock acquisition what occurs with the financial records of the parent and subsidiary?

Each retains separate financial records - acquiring company reports the investment as one line on its BS and doesn't report individual assets and liabilities acquired - acquired company makes NO journal entry at all -> ownership of shares changed hands, but cash/assets paid, or stock issued, by acquirer went to shareholders and not the acquired company itself -> only effect on acquiree: dividends paid will now go to parent rather than previous shareholders

Describe the reporting for equity investments with significant influence

Equity method required if investor exercises significant influence over the operating and financial decisions of the investee -> significant influence is typically assumed if investor owns 20-50% of investee's voting stock

To what does the "fair value option" refer?

FASB ASC 825 allows companies to elect fair value reporting for eligible intercorporate investments, with all value changes reported in income as incurred - optional for debt securities, but required for equity securities -> the text assumes companies *do not* choose the fair value election for debt securities

Describe how joint ventures are accounted for under US GAAP

If 50/50 split: each investor has significant influence, so equity method is required - each investor reports its interest as a one-line equity investment in the asset section of its BS, but separate assets and liabilities of JV don't appear on either investor's BS - each investor reports its equity in the JV's NI on one line in its IS, but separate revenues and expenses of JV don't appear on IS of either investor If non-50/50 split (e.g. 40/60): investor with 40% interest continues using equity method, but investor with 60% interest would consolidate the investee for its financial statements

Describe impairment testing of equity method investments under US GAAP

If FV declines below carrying value, and this decline is judged other than temporary, investment is written down and the loss appears on the income statement -> any subsequent changes in FV are not reported

How is acquired inventory valued in subsequent years (LIFO vs. FIFO)?

If FV doesn't equal BV when acquired: A) If sub uses *FIFO*: oldest inventory is sold first so (O) entry revalues COGS to FV and (R) revalues inventory to FV at acquisition date -> no consolidation entries are needed in subsequent years after the sub no longer carries the original inventory on its books B) If sub uses *LIFO*: beginning inventory likely has NOT been sold, so there is NO eliminating entry (O) -> (R) entry still revalues inventory to FV at date of acquisition but without a subsequent write-off until inventory is sold

How do you determine if an entity is a VIE?

If entity has any *one* of the below characteristics: a) Total equity investment at risk doesn't allow entity to finance its activities without additional subordinated financial support provided by other parties b) Equity investment at risk lacks *any* of the below: - i) voting power to make decisions about significant activities - ii) Obligation to absorb the expected residual returns of the entity - iii) Right to receive expected residual returns of entity c) Equity investors' voting rights are not proportional to their obligation to absorb losses, rights to receive residual returns, or both AND substantially all of the entity's activities are conducted on behalf of an investor with disproportionately few voting rights

Describe how the equity method incorporates substantial investee losses

If investee incurs substantial losses, recognition of equity in net losses and OCL may exceed the carrying value of the investment a) If losses are considered temporary: - Losses are recorded even though investment balance becomes negative b) If losses are not considered temporary: - Equity method is suspended once investment balance reaches zero -> if investee reports future profits, investor can resume equity method, but must wait until its share of profits equals its share of losses incurred during suspension period

Describe how a step acquisition from significant influence to controlling interest is handled

If investor holds investment using equity method (i.e. 30%) and acquires remaining 70% to achieve control: - First, revalue equity method investment to FV and report gain or loss in NI (Dr. Investment, Cr. Gain on equity method investment) - Then, include FV of equity method investment as part of acquisition cost when recording controlling interest transaction -> e.g. if we pretend acquirer reports assets and liabilities directly on its books: Dr. Net assets, Dr. Goodwill, Cr. Cash, Cr. Investment -> for external reporting, investment account is replaced by individual assets and liabilities of investee, valued at FV at acquisition date

Why would a company be motivated to keep a subsidiary off its BS?

If the subsidiary is highly leveraged, consolidation will negatively affect the parent's financial ratios -> unlike the equity method which has almost no leverage impact

What is an important distinction to be made when estimating a contingent consideration?

Important to distinguish between payments for services already performed and payments for services to be provided in the future - severance and vested stock options relate to past performance so they're part of acquisition cost - FV of stock option issued relate to future performance so they're a prepayment and expensed as services are performed in the future - if contingent payments are terminated when former owner is no longer employed, payments are compensation rather than part of acquisition cost -> recognized as compensation expense as payments earned by employee

How is R&D expensed under IFRS?

Internally generated research is expensed, but in-process research acquired in a business combination is capitalized (like under US GAAP) -> internally generated *development costs* are required to be capitalized under certain circumstances (whereas only certain software development costs are capitalized under US GAAP)

Describe how the equity method incorporates other comprehensive income

Investor adjusts investment and OCI for its share of the investee's yearly OCI For example: - Dr. Investment - Cr. Unrealized gain on AFS inventory (OCI)

Describe the criteria for deciding when control exists under IFRS

Investor must possess all 3 of the following to conclude it controls and must consolidate the investee: 1) Power over investee (ability to direct significant activities) 2) Exposure or rights to investee's variable returns 3) Ability to use power over investee to influence amount of returns to investor

What is the key question in determining whether an entity is a VIE?

Is the entity able to finance its activities *without* additional support, such as guaranteed loans or future funding commitments, from affiliated entities? -> there are qualitative and quantitative ways to establish sufficiency of entity's equity

What classification is given to redeemable preferred stock?

Liability

What is the definition of a business combination?

Occurs when control is obtained over a business - Business has elements of: input, process, output - if substantially all of the FV of gross assets acquired is concentrated in a single identifiable asset or group of similar assets, this set is NOT considered a business - if purchase is only of PPE, assets acquired are valued at cost -> if cost doesn't equal FV, cost is allocated to acquired assets on relative FV basis (no goodwill or bargain gain is reported)

Describe impairment testing for indefinite-life intangibles under US GAAP

One-step process: A) Qualitative test (optional): determine whether it's more likely than not (>50%) that the asset's FV < BV -> if this indicates impairment is likely, move on to perform quantitative test B) Quantitative test: estimate FV of asset and compare to its BV - if FV < BV, loss = BV - FV Note: if economic conditions indicate possible impairment, you can skip qualitative test and go straight to quantitative

Describe the consolidation procedures for VIEs

Parallel those for a controlling equity investment - FV of VIE's assets and liabilities are consolidated with the primary beneficiary's - if primary beneficiary (PB) and VIE are already under common control, assets and liabilities of VIE remain at BV -> because PB generally owns none of VIE's equity, *difference between VIE assets and liabilities reported as NCI in the equity section* of PB's consolidated BS

What do you need to pay attention to when looking at the accounts taken from the parent or sub's book on a consolidation working paper?

Pay attention to the parentheses for SE accounts - RE and AOCI could have a debit (deficit) balance -> to check yourself remember that common stock will always have a credit balance and treasury stock will always have a debit balance

How does a company account for the acquiree's previously reported goodwill in a business combination?

Previously reported GW is assigned FV of zero - GW arising from a previous combination between sub and another company is not an identifiable asset and is not separately recorded

Describe how pushdown accounting works with a bargain gain

Pushdown capital account reflects the revaluation of identifiable net assets and resets RE and AOCI to zero, but no goodwill is recognized

Describe the IFRS standards related to impairment of investments with significant influence

Quantitative impairment test compares investment's BV with recoverable amount which is the higher of market value or value-in-use (PV of investment's expected future cash flows while held by investor) -> in contrast to GAAP which requires impairment recognition only when the decline is other than temporary

Describe the reporting for equity investments with no significant influence (typically < 20% ownership)

Reported at FV (same as for trading debt securities) -> changes in value are reported in NI as they occur -> no need for impairment testing

Describe the accounting treatment of available for sale debt securities

Reported at FV as current or noncurrent - as market price changes, unrealized gains and losses are reported in OCI and closed to AOCI - when sold, unrealized gain or loss is recategorized from AOCI to retained earnings (using "Reclassification of gain/loss on AFS securities" account) -> so entire gain or loss appears in income when security is sold

Describe the accounting treatment of held to maturity debt securities

Reported at amortized cost - no gains or losses reported unless security is not held to maturity - use effective interest method to amortize discount or premium

Describe the accounting treatment of trading debt securities

Reported at fair value - as market price changes, gains and losses are reported on the income statement -> all realized and unrealized gains and losses flow through net income

Under which financial statement section are goodwill impairment losses recorded?

Reported in operating section of income statement and reported as a separate line if loss is material

How are pre-acquisition contingencies accounted for in a business combination?

Reported only if, during the measurement period, its FV is determinable, and it's probable that it exists (e.g. warranty liability or some lawsuits) -> changes in value reported in same way as changes in other estimated values related to business combinations

Who must consolidate a VIE?

Reporting entity with a controlling interest = VIE's primary beneficiary - Goal is to require consolidation of all entities within a company's control - A reporting entity has controlling interest if it possesses *both*: a) Power to direct activities of VIE that most significantly affect its economic performance b) Obligation to absorb losses or right to receive benefits of VIE that are potentially significant to VIE

On what unit basis is goodwill tested for impairment under US GAAP?

Reporting unit: FV of GW is assessed in terms of the reporting unit to which it belongs -> usually an operating segment of the business

When is the equity method required and what is it meant to do?

Required if investor exercises significant influence over the investee - Investment performance should parallel investee's performance: 1) Investment account increases by share of investee's income 2) Investor reports share of investee's income in NI 3) Investment account reduced by dividends distributed by investee to investor -> investor's investment balance changes in proportion to changes in the investee's retained earnings

Describe how pushdown accounting works with goodwill

Sub makes revaluation entry on its own books - revaluation "gain" and zeroed out RE & AOCI are accumulated in a pushdown capital account (credit) - if revaluation process results in a "loss" or RE or AOCI are debits, the impact on the pushdown capital account is negative -> consolidated balances are unaffected by the decision to use this method, but eliminating entry (R) is no longer needed

How is goodwill arising from a business combination assigned to reporting units?

GW is assigned to one or more reporting units including acquired and existing units A) Newly-acquired units: assigned in same way it's determined for acquisition as a whole -> unit's GW = FV of unit - FV of identifiable net assets of unit B) Existing reporting units: "with and without" approach used -> unit's FV estimated before business combo and again after business combo -> increase in FV = unit's assigned GW Note: these procedures may not assign GW to individual reporting units in an amount exactly equal to entire GW reported for the acquisition -> solution is to make reasonable, consistent adjustments to the assigned units so that the sum = exact GW total

How do you determine the acquiring company?

Generally, who initiated and who's largest

Describe how a change from no significant influence to significant influence over an investment is handled

Handled prospectively: previous accounting reports investment at FV with changes in value reported in NI - when significant influence is obtained, the cost of the transaction leading to significant influence (if any) is added to the current investment balance (Dr. Investment, Cr. Cash) -> ignore any changes in the FV of the investment at the date of acquisition and only increase investment by cash paid -> going forward the investor uses equity method

Describe how the 2001 Enron collapse affected the perception of special purpose entities

Highlighted limitation of bright-line consolidation standards - SPEs are used to hide debt and losses from investors -> on the other hand, IASB has a subjective standard for control so they don't need to have specific standard for VIEs

Describe the market model for valuing intangibles

IFRS (not US GAAP) allows identifiable intangibles that are traded in an active market to be "marked to market" A) Increases in value reported to "revaluation surplus" which is a component of OCI (unless this increase is a reversal of a previously reported impairment loss) B) Decreases in value reduce revaluation surplus (with reductions exceeding previous increases reported in NI) -> amortization expense in future year is based on the revalued amount -> any remaining revaluation surplus is reclassified to RE on sale or disposal but is never included in periodic net income

Compare how the concept of control differs under IFRS compared to US GAAP

IFRS has only *one* set of criteria for deciding when control exists: focus on principles-based definition of control applicable to all organizations regardless of financial and governance structure -> consistent standard based on principle of control rather than bright-lines that can be circumvented under US GAAP -> Under IFRS there's no division between VIEs and non-VIEs like there is under US GAAP

How are intangibles tested for impairment under IFRS?

IFRS requires a *one-step* test for all intangible assets (finite-lived or indefinite-lived) - Compare asset's BV to its recoverable amount which is the *greater* of the asset's: a) Value-in-use = PV of expected future cash flows b) Net market value = FV less selling costs -> if there's no active market, value-in-use is the proper measure

Why must the investor make adjustments to the investee's reported income related to basis differences? (simplified version from Ch 1)

When the investment cost differs from the investee's book value - investment cost is usually > BV at acquisition date because: -> the investee reports noncurrent assets at cost less accumulated depreciation instead of at fair value -> internally developed intangibles aren't on BS

How are subsequent changes in the value of contingent consideration treated after a business combination?

a) Changes in value resulting from clarification of facts that existed at date of acquisition (measurement period adjustments) -> Dr. Goodwill, Cr. Earnout liability b) Changes resulting from events after acquisition date - If contingent consideration is reported as equity, no value changed reported - If contingent consideration is reported as liability, all changes in the value are reported in income at each reporting date until settled (Dr. loss on earnout (NI), Cr. Earnout liability)

How are credit related losses and market-related losses treated under the CECL model?

a) If investor intends to sell (or is more likely than not to sell) the security before the loss is recovered: -> Impairment loss (Cost - FV) is reported in income and *directly reduces the investment balance* b) If investor intends to hold security and not sell it before the loss is recovered: the impairment loss is divided into 2 parts: 1) Credit loss (attributable to decline in PV of expected cash flows) -> reported on income statement and *reduces investment through allowance* -> reversals of credit losses also go through income statement 2) Market-related (attributable to rise in interest rates) -> reported in OCI and *directly reduces the investment balance* c) If unrealized gains/losses have previously been recorded and security incurs a credit loss, any amounts recorded in AOCI are reclassified to income as appropriate

How are subsequent changes in values treated after a business combination?

a) If value change results from clarification of facts existing at date of acquisition -> treated as corrections to initial acquisition entry (Dr. Goodwill, Cr. PPE) - within *measurement period* during which value changes can be reported as corrections to initial acquisition entry -> ends one year from acquisition date b) If value change is caused by events occurring after acquisition date -> reported following normal GAAP (Dr. Loss on equipment, Cr. PPE)

How are the different kinds of business combinations presented?

a) Mergers, consolidations, and asset acquisitions: all assets acquired and all liabilities assumed are recorded directly on the books of the acquiring company b) Stock acquisitions: parent/subsidiary relationship created and acquired company is treated as intercorporate investment by acquiring company - acquiring corporation does NOT record assets and liabilities of acquired corporation on its books -> instead, records investment in subsidiary account which is a one line summation of interest in underlying assets and liabilities -> consolidated BS is the same as if the acquiring company had reported assets and liabilities directly on its books like in a merger or acquisition

How are various types of acquisition-related costs recorded?

a) Out-of-pocket merger expenses to outside consultants, lawyers, etc. (including internally provided services) are expensed as incurred -> NOT included in acquisition cost b) Registration costs for securities issued in an acquisition reduce the net value of related equity accounts -> NOT included in acquisition cost because cash paid for fees adds to acquisition cost and is netted out of total FV of stock issued c) Acquisition-related restructuring costs: unless represented by acquisition-date liabilities, costs are expenses as incurred -> NOT included in acquisition cost