Advanced Accounting Exam 1 Chapters 3-4

Consolidated net income is computed at the combined entity level and then

Allocated to the noncontrolling and controlling interests.

The statement of changes in owners' equity provides:

An allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests.

Initial (cost) value method:

Cash basis accounting—easy to apply and gives a good measurement of cash flows generated by the investment. Investment: Remains at acquisition-date value assigned Dividends declared recorded as dividend income

Entry D

Eliminates the subsidiary Dividends.

Entr A example

Entry A adjusts subsidiary balances from their book values to acquisition-date fair values and includes goodwill created by the acquisition. It represents the Allocations made in connection with the excess of the subsidiary's fair values over its book values.

With a control premium

Goodwill is impacted (increased)

Change in Control - Postacquisition Control Achieved in Steps

If the parent previously held a noncontrolling interest in the acquired firm, the parent re-measures its interest to fair value and recognizes a gain or loss. The parent accounts for additional subsidiary shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders.

Factors to be considered in determining the useful life of an intangible asset include:

Legal, regulatory, or contractual provisions. The effects of obsolescence, demand, competition, industry stability, rate of technological change, and expected changes in distribution channels. The enterprise's expected use of the intangible asset. The level of maintenance expenditure required to obtain the asset's expected future benefits.

Consoldiation Entry A - NCI Present

NCI credited

Intangible Assets with INDEFINITE Lives

NOT amortized Tested for impairment on an annual basis

When control of a subsidiary is acquired at a midyear date

New parent must compute the subsidiary's book value as of acquisition date to determine excess total fair value over book value allocations. Excess amortization expenses, any equity accrual, and dividend distributions are recognized for a period of less than a year. Because only net income earned by the subsidiary after the acquisition date accrues to the new owners, it is appropriate to include only post-acquisition revenues and expenses in consolidated totals.

If it sells less than the entire investment - sales of subsidiary stock

Parent must select a cost-flow assumption if it has made more than one purchase. For securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions often are applied.

Entry P example

Sun's $40,000 payable and Parrot's $40,000 receivable must be removed because the companies are being reported as a single entity. DR: AP CR: AR

Accounting for NCI in Subsidiary NI

The $11,000 noncontrolling interest share of adjusted subsidiary net income is equivalent to the noncontrolling interest share of consolidated net income, which is then subtracted from consolidated net income to determine the parent's interest in consolidated net income. The noncontrolling shareholders' portion of consolidated net income is limited to their 10 percent share of adjusted subsidiary income. They own a 10 percent interest in the subsidiary company but no ownership in the parent firm.

Control Achieved in Steps - Acquisition Method

The acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained. The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed—fair value at the date control is obtained.

A reporting unit's goodwill impairment is computed as

The excess of carrying amount over fair value. Goodwill impairment is limited to goodwill carrying amount for each unit.

If the noncontrolling interest's proportionate share of subsidiary's fair values exceeds its total fair value

The excess reduces goodwill recognized by the parent.

Consolidated Financial Reporting in a Presence of a Noncontrolling Interest

The parent, with controlling interest, must consolidate 100 percent of its subsidiary's financial information as a single economic unit, regardless of the parent's level of ownership. The acquisition method requires that the subsidiary be valued at the acquisition-date fair value.

A step acquisition occurs

when control is achieved in a series of equity acquisitions.

Intangible Assets with Finite Lives

Amortized over their economic useful life that reflects the pattern of decline in the economic usefulness of the asset.

Initial Value Method - Consolidation ENTRIES

Entry S is the same as the equity method. Entry A is the same as the equity method. Entry I is different using the initial value method: It eliminates the parent's Dividend Income account and the sub's Dividends Declared account. INSTEAD OF EQUITY IN SUB EARNINGS AND INVESTMENT IN INVESTEE ACCOUNTS HERE NO INCOME OR AMORTIZATION ADJUSTMENTS Entry D is not needed. Entry E is the same as the equity method.

Equity Method

Full accrual accounting—creates a total income figure reflective of the entire combined business entity. Investment: Continually adjusted to reflect current owner's equity of acquired company Income, amortizations, and other adjustments are recognized

Goodwil and other intangible assets impairment

GAAP requires impairment and not amortization FASB provides firms the option to conduct a qualitative analysis to assess whether further testing procedures are appropriate. If circumstances indicate a potential decline in the fair value of a reporting unit below its carrying amount, further tests are required to see if goodwill is the source of the decline.

Entry S Example

Investment in Sun Company account and adds each asset and liability book values to the consolidated figures. Sun's stockholders' equity accounts as of the beginning of the year.

The parent company must determine and enter each of these figures when constructing a worksheet:

Noncontrolling interest in subsidiary at beginning of current year. Net income attributable to noncontrolling interest. Subsidiary dividends attributable to noncontrolling interest. Noncontrolling interest as of the end of the year (three balances above combined).

Consolidated NI Determination

A worksheet combines separately recorded revenues and expenses of parent and subsidiary. Separate record-keeping systems result in subsidiary's expenses based on original book values, not acquisition-date values that the parent must recognize. Adjustments are made to reflect amortization of excess consideration transferred from parent over subsidiary's book value. Effects of any intra-entity transactions are removed.

Partial equity method

Accrual accounting without equity adjustments—usually gives balances approximating consolidation figures but easier to apply than equity method. Investment: Adjusted only for accrued income and dividends declared by the acquired company (no amortization) Income accrued as earned; no other adjustments recognized

U.S. GAAP requires fair value measurement

Acquisition-date fair value provides a basis for reporting noncontrolling interest, which is adjusted for its share of subsidiary income and dividends subsequent to acquisition.

Goodwill acquired in a business combination

Allocated to reporting units (operating segments or a business component one level below) expected to benefit from the goodwill

Indefinite Intangible Asset Impairment

An entity has the option to first perform qualitative assessments to determine whether "it is more likely than not" that the asset is impaired. If so, a quantitative test must be performed. The asset's carrying value is compared to its fair value. If fair value is less than carrying value, the intangible asset is considered impaired and an impairment loss is recognized. The asset's carrying value is reduced accordingly.

Contingent obligations are classified as

Component of Stockholders' equity Equity contingencies are not remeasured at fair value. Whether contingent obligations are a liability or equity, the initial value recognized in the combination does not change regardless of whether the contingency is eventually paid or not.

Contingent Consideration in Business Combinations - Future Performance

Contingency agreements, consideration based on future performance, often accompany business combinations. The acquiring firm estimates the fair value of the contingency and records a liability equal to the present value of the future payment if appropriate. The liability continues to be measured at fair value with corresponding recognition of gains or losses from the revaluation.

Equity method to accrue income earned by subsidiary

DR: Investment in Investee CR: Equity in Subsidiary Earnings

Loss of Control - Parent Company Sales of Subsisidary Stock - Acquisition Method

If the sale results in the loss of control, parent recognizes any resulting gain or loss in consolidated net income. If the former parent retains any of its former subsidiary's shares, the investment should be remeasured to fair value on the date control is lost. Any resulting gain or loss from the remeasurement should be recognized in the parent's net income.

Consolidated Net Income

Includes 100 percent of both the parent's and the subsidiary's net income, adjusted for excess acquisition-date fair value over book value amortizations. Once the consolidated net income is determined, it is allocated to the parent company and the noncontrolling interests. Noncontrolling interests' ownership pertains only to the subsidiary; its share of consolidated net income is limited to a share of the adjusted subsidiary's net income.

Applying the Initial Value Method

Income and investment accounts on the parent company's separate statements vary Parent's separate statements do not reflect consolidated income totals when the initial value method is used. Because equity adjustments are not recorded, neither parent's reported net income nor its retained earnings provides an accurate portrayal of consolidated figures.

Parent's accounts vary because of the method applied (Initial Value or Partial Equity)

Investment account Income recognized from the subsidiary Parent's RE (periods after year of combination)

A loss from revaluation of a contingent performance obligation

Reported in consolidated income statement as a component of ordinary income

Partial Ownership Consolidations - Acquisition Method

The acquisition method incorporates 100 percent of the subsidiary's assets and liabilities at their acquisition-date fair values in the consolidated financial statements. Subsequent to acquisition, changes in current fair values for assets and liabilities are not recognized. Subsidiary assets acquired and liabilities assumed are reflected in future consolidated financial statements using acquisition-date fair values net of subsequent amortizations (or reduced for impairment).

Effects of Using the Initial Value Method

The initial value method ignores two accrual-based adjustments: The parent does not accrue the percentage of subsidiary net income earned in past years in excess of dividends. The parent does not record amortization expense under the initial value method.

Method adopted

-Affects only separate financial records. -Has no impact on subsidiary's balances. -Does not affect amounts reported on consolidated financial statements to external users.

Is the Carrying Amount of a Reporting Unit More than its fair value?

1. Calculate fair values for each reporting unit with allocated goodwill. 2. Fair value (with allocated goodwill) is compared to the carrying value (including goodwill) of the consolidated entity's reporting unit.

If a subsidiary's long-term debt EXCEEDS fair value

A consolidation entry is required to decrease the long-term debt reported in the consolidated balance sheet. In periods subsequent to acquisition, worksheet entries are needed to increase the interest expense to be recognized in the consolidated balance sheet.

If the total fair value of the acquired firm is less than the collective sum of its identifiable net assets:

A gain on purchase occurs Parent recognizes the entire gain in current income. No gain is ever allocated to the noncontrolling interest.

Goodwill impairment is assessed

Annually for each reporting unit where goodwill resides More frequent impairment assessment is required if events or circumstances change that make it more likely than not that reporting unit's fair value has fallen below its carrying amount.

Initial Value or Partial Equity Method - Investment Recorded - Subsequent Consolidation

Application of either alternative changes the balances recorded by the parent over time and the consolidation process. Neither of these approaches affects any of the final consolidated balances reported.

Goodwill impairments once recognized

Are NOT recoverable

Goodwill impairment LOSSES reported

As operating items in the consolidated income statement.

Entry *C - Consolidation Subsequent Year of Acquisition

Beginning Retained Earnings account must be increased or decreased to create the same effect as the equity method. The C refers to the Conversion being made to equity method (full-accrual) totals. (*) The asterisk indicates that this entry relates solely to transactions of prior periods. Entry *C, the adjustment of the parent's beginning Retained Earnings, should be recorded before other worksheet entries to align the beginning balances for the year. After the initial year of acquisition, an Entry *C is required if the parent has not applied the equity method.

Entry *C is added to the worksheet to

Convert the previously recorded balances to the equity method.

Equity method to recognize amortization

DR: Equity in Subsidiary Earnings CR: Investment in INvestee

Entry E example

Entry E recognizes current year excess amortization expenses relating to the adjustments of Sun's assets to acquisition-date fair values. It adjusts depreciation expense for the tangible asset equipment and adjusts amortization expense for the intangible asset patented technology.

Entry I example

Entry I removes Sun's income recognized by Parrot during the year so Sun's revenue and expense accounts (and current amortization expense) can be brought into the consolidated totals.

Three prominent methods used to account for investments are:

Equity Initial Value Partial Equity

Goodwill Impairment Test Question

Is the Carrying Amount of a Reporting Unit More than its fair value?

Consolidation Entry S - NCI present

NCI credited

Entry A

Recognizes the unamortized Allocations as of the beginning of the current year associated with the adjustments to fair value.

NCI and Consolidations - Worksheet

The consolidation is substantially unchanged with the presence of a noncontrolling interest.

Consolidated Financial Statements - Statement of Changes in Owners' Equity

The statement of changes in owners' equity provides details of the ownership changes for the year for both the controlling and noncontrolling interest shareholders. Note the placement of the noncontrolling interest in the subsidiary's equity in the consolidated owners' equity section. If appropriate, each component of other comprehensive income is allocated to the controlling and noncontrolling interests.

NCI: Total acquired firm fair value

The total acquired firm fair value in a partial acquisition is the sum of two components at the acquisition date = 1.) The fair value of the controlling interest. PLUS 2.) The fair value of the noncontrolling interest at the acquisition date.

Entry P

eliminates an intra entity payable

Noncontrolling Interest in a Subsidiary

A significant number establish control with a lesser amount of stock If the parent doesn't own 100 percent of the company, outside owners are referred to as a noncontrolling interest.

Entry I

Eliminates the subsidiary Income accrued by the parent.

Entry S

Eliminates the subsidiary's Stockholders' equity account beginning balances and the book value component within the parent's investment account.

Comparison of Methods - Consolidation Entries

Entries S, A, and E are the same for all three methods. The parent's record-keeping is limited to two periodic journal entries: -Annual accrual of subsidiary income. -Receipt of dividends. The Investment and Income account balances differ for the other methods and so will the worksheet Entries I and D.

Partial Equity Method -Entry *C

Entry *C is used to convert to the equity method. In this case, only the amortization expense for the prior years must be included. Parent accrues its share of reported subsidiary income, but it does not recognize any acquisition-date excess fair value amortization expenses.

Conversion to Equity Method from Initial Value Method (Entry *C)

Entry *C is used to convert to the equity method. Combine: The increase (since acquisition) in the subsidiary's retained earnings during past years (net income less dividends) times the parent's ownership percentage. The parent's percentage of total amortization expense for these same past years. -Entry (I) removes both intra-entity dividend income and subsidiary dividends to the parent. (Entry D is unnecessary.)

Entry D example

Entry D removes the intra-entity transfer of cash for the dividends distributed to Parrot from Sun.

Partial Equity Method - Consolidation ENTRIES

Entry S is the same as the equity method. Entry A is the same as the equity method. Entry I is different using the partial equity method: It eliminates the parent's equity in the sub's income and reduces the Investment account. DOES NOT INCLUDE AMORTIZATION Entry D eliminates the Dividends Declared account. Entry E is the same as the equity method.

Investment Accounting - Parent

For internal record-keeping, parent uses an accounting method to monitor the two companies' relationship. Parent's investment account balance and amount of income recognized vary over time depending upon the method chosen. On the worksheet, parent's investment account is eliminated so subsidiary's actual assets and liabilities can be consolidated. Income accrued by parent is removed and subsidiary's revenues and expenses are included to create an income statement for the combined business entity. EXTERNAL REPORTING: CONSOLIDATION REQUIRED

Does fair value of the reporting unit exceed carrying value? = NO

Goodwill impairment is the excess of carrying amount over the fair value of the reporting unit Loss recorded

Does fair value of the reporting unit exceed carrying value? = Yes

Goodwill is NOT impaired and remains at current carrying amount

Allocating Acquired Goodwill to the Controlling and Noncontrolling Interests

Goodwill is apportioned across controlling and noncontrolling interests. Parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest over its share of the fair value of the net assets. Then any remaining goodwill is attributed to the NCI Could be 0 because sometimes no excess -Allocated goodwill will not always be proportional to the percentages owned

If the price per share paid by the parent equals the noncontrolling interest per share fair value

Goodwill is recognized proportionately across the two ownership groups. -When a large percentage of the acquiree's voting stock is purchased, the consideration paid by the parent may be reflective of the acquiree's total fair value

Consolidated Financial Statements - BS

Identifiable assets acquired and liabilities assumed are adjusted to their full individual fair values at the acquisition date.

No change in Contorl - Postacqusition Control Achieved in Steps

If after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place. The parent accounts for additional subsidiary shares acquired as an equity transaction—consistent with transactions with other owners, as opposed to outsiders.

Maintain Control - Parent Company Sale of Subsidiary Stock - Acquisition Method

If the parent maintains control, it recognizes no gains or losses - the sale is shown in the equity section. The parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital.

Entry E

Recognizes excess amortization Expenses for the current period on the allocations from the original adjustments to fair value.