CH 3 - ADV

on its acquisition-date consolidated balance sheet, will report the contingent performance obligation under liabilities and the contingent stock payment as a component of stockholders' equity. Subsequent to acquisition, however, the accounting for contingent consideration differs depending on it balance sheet classification as a liability or equity. In each accounting period subsequent to acquisition,

-An obligation for contingent consideration classified as a liability is remeasured to current fair value. An increase (decrease) in the fair value of the contingent consideration obligation is recognized in each period's net income as a revaluation loss (gain). -An obligation for contingent consideration classified as equity is not subsequently remeasured to fair value, consistent with other equity issues (e.g., common stock).

Importantly, the selection of a particular method does ____ the totals ultimately reported for the combined companies.

NOT affect

What are the entries made when preparing consolidated statements? EQUITY METHOD

PREVIOUS YEARS: S: offsets reciprocal amounts representing the subsidiary's book value as of the beginning of the current year A: adjust assets/liabilities to acquisition date fair values CURRENT PERIOD: I: eliminate equity investment income D: remove dividends NOT paid by the parent E: record excess amortization expenses P: eliminate intra-entity payables and receivables (cannot conduct business with one's self)

This chapter refers to acquired companies that ___

retain incorporation.

For intangible assets with finite lives, the amortization method should reflect the pattern of decline in the economic usefulness of the asset. Ifno such pattern is apparent,

the straight-line method of amortization should be used. The amount to be amortized should be the value assigned to the intangible asset less any residual value. In most cases, the residual value is presumed to be zero. However, that presumption can be overcome if the acquiring enterprise has a commitment from a third party to purchase the intangible at the end of its useful life or an observable market exists for the intangible asset.

All identified intangible assets should be amortized over their economic useful life unless such life is considered indefinite.

A recognized intangible asset with an indefinite life should not be amortized unless and until its life is determined to be finite. Importantly, indefinite does not mean "infinite." Also, the useful life of an intangible asset should not be considered indefinite because a precise finite life is not known.

Regarding the additional required stock issue, note that ClearView's total paid-in capital (Common Stock plus APIC) remains unchanged from the total $867,000 recorded at the acquisition date.

Contingent equity is not adjusted to fair value over time but remains at its originally recorded amount.

At the acquisition date, each investment accounting method (equity, initial value, and partial equity) begins with an _____ recorded in an investment account. Typically the fair value of the consideration transferred by the parent will serve as the recorded valuation basis on the parent's books.

identical value

The length of the amortization period for identifiable intangibles (i.e., those not included in goodwill) depends primarily on the assumed economic life of the asset. Factors that should 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.

Goodwill impairment tests are performed at the reporting unit level within a combined entity. As discussed next, all assets acquired (including goodwill) and liabilities assumed in a business combination must be assigned to reporting units within a consolidated enterprise.

Current financial reporting standards require, at a minimum, an annual assessment for potential goodwill impairment.

Combined companies typically organize themselves into separate units along distinct operating lines.

Each individual operating unit has responsibility for managing its assets and liabilities to earn profits for the combined entity. These operating units report information about their earnings activities to top management to support decision making. Such operating units are known as reporting units.

For impairment testing, the consolidated entity calculates fair values for each of its reporting units with allocated goodwill. Each reporting unit's fair value is then compared with its carrying amount (including goodwill).

If an individual reporting unit's fair value exceeds its carrying amount, its goodwill is not considered impaired —goodwill remains at its current carrying amount. Alternatively, if the fair value of a reporting unit has fallen below its carrying amount, then goodwill impairment is measured as the excess of the carrying amount over the fair value of the reporting unit, and a loss is recognized. The impairment loss equals the excess of the carrying amount of the reporting unit goodwill over its fair value. However, the impairment loss is limited to the carrying amount of goodwill.

By acquiring Sax, Pax has taken on (and effectively borrowed) $105,000 of fair- value debt but will only have to pay back $100,000 at the debt's maturity date. The additional $5,000 excess fair over book value (that will not be repaid) is recognized as a reduction in overall interest expense, similar to amortizing a bond premium. Therefore, when consolidated statements are prepared, interest expense is reduced over the life of the long-term debt.

Increasing or decreasing long-term debt involves both entries A and E

Initial Value Method: Entries

S & A-- same I-- removes dividend Income (d: dividend income, c: dividends declared) D-- not used E-- same P-- same

Partial Equity Method: Entries

S & A-- same I-- removes equity income D-- same E-- same P-- same

At first glance, it may seem counterintuitive that when long-term debt is increased, interest expense is decreased. Certainly for plant assets like equipment, when we increase their carrying amounts to acquisition-date fair values on the worksheet, we increase the related depreciation expense. Why do we seem to do the opposite for long-term liabilities?

The answer can be seen in the fact that even though the acquisition-datefair value of the subsidiary's long-term debt exceeds its carrying amount,the acquisition does not affect the subsidiary's contractual obligation for repaying the debt. The ultimate amount of debt to be repaid at maturity remains the same.

Contingent Consideration— Postcombination (not willing to pay now)

To close the deal, future contingent payment agreements from the acquirer to the former owners of the target, also known as "earnouts," are common. Such contingent payments may be in the form of cash or the acquirer's equity shares—with each form requiring separate accounting in periods subsequent to a business combination.

Any recognized intangible assets considered to possess indefinite lives are not amortized but instead are assessed for impairment on an annual basis.13 Similar to goodwill impairment assessment, an entity has the option to first perform qualitative assessments for its indefinite-lived intangibles to see if further quantitative tests are necessary. According to the FASB ASC (350-30-65-3), if an entity elects to perform a qualitative assessment, it examines events and circumstances to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired.

To test an indefinite- lived intangible asset for impairment, its carrying amount is compared to its fair value. If the fair value is less than the carrying amount, then the intangible asset is considered impaired and an impairment loss is recognized. The asset's carrying amount is reduced accordingly for the excess of its carrying amount over its fair value.

For internal recordkeeping purposes, the parent must select and apply an accounting method to monitor the relationship between the two companies. The investment balance recorded by the parent varies over time as a result of the method chosen, as does the income subsequently recognized. These differences affect the periodic consolidation process but not the figures to be reported by the _______. Regardless of the amount, the parent's investment account is eliminated (brought to a zero balance) on the worksheet so that the subsidiary's actual assets and liabilities can be consolidated. Likewise, the income figure accrued by the parent is removed each period so that the subsidiary's revenues and expenses can be included when creating an income statement for the combined business entity

combined entity

The FASB reasoned that although goodwill can decrease over time, it does not do so in the "rational and systematic" manner that periodic amortization suggests. Only upon recognition of an impairment loss (or partial sale of a subsidiary) will goodwill decline from one period to the next. Goodwill impairment losses are reported as ____.

operating items in the consolidated income statement.

Because of separate recordkeeping systems, however, the subsidiary's expenses typically are based on their original book values and not the acquisition-date values the parent must recognize. Consequently, adjustments are made that

reflect the amortization of the excess of the parent's consideration transferred over the subsidiary book value. Additionally, the effects of any intra entity transactions are removed.

Thus, all goodwill impairment testing is performed at ____, rather than collectively at the combined entity level. Separate testing of goodwill within individual reporting units also prevents the masking of goodwill impairment in one reporting unit with contemporaneous increases in the value of goodwill in other reporting units.

the reporting unit level

The qualitative approach assesses the likelihood that a reporting unit's fair value is less than its carrying amount. The more-likely- than-not threshold is defined as having a likelihood of more than

50 percent.

Alternatively, if Optima failed to meet either the $70,000 operating cash flow threshold or the $100,000 net income threshold, Clear View would record the following adjustments to its records:

The preceding illustrations demonstrate that the initial fair value assigned to the acquired firm continues as the acquisition-date valuation for the business combination, regardless of whether the contingency thresholds are met or not.

In assessing whether a reporting unit's fair value exceeds its carrying amount, a firm must examine all relevant facts and circumstances, including:

-Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets. -Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline (both absolute and relative to its peers) in market-dependent multiples or metrics, a change in the market for an entity's products or services, or a regulatory or political development. -Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings. -Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings. -Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation. -Events affecting a reporting unit such as a change in the carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all or a portion of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit. -If applicable, a sustained decrease (both absolute and relative to its peers) in share price. (FASB ASC, para. 350-20-35-3C)

For internal recordkeeping, though, the parent has a choice for monitoring the activities of its subsidiaries. Although several variations occur in practice, three methods have emerged as the most prominent:

-the equity method, -the initial value method, -the partial equity method.

In practice, firms often assign goodwill to reporting units either at the level of a reporting segment—as described in ASC Topic 280, "Segment Reporting"—or at a lower level within a segment of a combined enterprise. Reporting units may thus include the following:

-A component of an operating segment at a level below that operating segment. Segment management should review and assess performance at this level. Also, the component should be a business in which discrete financial information is available and should differ economically from other components of the operating segment. -The segments of an enterprise. -The entire enterprise.

Subsequent to the acquisition date, however, the three methods produce different amounts on the parent company's accounting records for the following:

-Investment in subsidiary -Income recognized from the subsidiary's activities -Retained earnings

Because impairment testing procedures can be costly, the FASB provides firms the option to first conduct ____ 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, then a further test determines the existence of goodwill impairment.

a qualitative

Entry *C (only used if Equity method not applied)

adjust beginning RE and the Investment Acct to full accrual/equity basis