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1. Chapter Three Consolidations–Subsequent to the Date of Acquisition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

4. Consolidation – The Effects of the Passage of Time For each subsidiary owned, there is an ASSET (the INVESTMENT account that represents the value of the investment), and an INCOME account that represents the earnings on the investment. Let’s briefly compare the three methods and how they affect these two accounts. 3-

5. Investment Accounting 3- Method Investment Account Income Account Equity Continually adjusted to reflect ownership of acquired company. Income accrued as earned; amortization and other adjustments are recognized. Initial Value Remains at Initially-Recorded cost Cash received is recorded as Dividend Income Partial Equity Adjusted only for accrued income and dividends received from acquired company. Income accrued as earned; no other adjustments recognized.

6. Investment Accounting 3- What is the advantage of each? Equity Method: The acquiring company totals give a true representation of consolidation figures. Initial Value (or “Cost”) Method: It is easy to apply and gives a good measurement of cash flows generated by the investment. Partial Equity Method: Usually gives balances approximating consolidation figures, but is easier to apply than equity method

8. Subsequent Consolidation - Equity Method Example Parrot Company obtains all of the outstanding common stock of Sun Company on January 1, 2010. Parrot acquires this stock for $800,000 in cash. Sun Company’s balances are shown below. 3- Book Values Fair Values 1/1/10 1/1/10 Difference Current assets . . . . . . . . . . . . . . . . . . .$ 320,000 $ 320,000 –0– Trademarks (indefinite life) . . . . . . . . . 200,000 220,000 20,000 Patented technology (10-year life) . . . . 320,000 450,000 130,000 Equipment (5-year life) . . . . . . . . . . . . .180,000 150,000 (30,000) Liabilities . . . . . . . . . . . . . . . . . . . . . . .(420,000) (420,000) –0– Net book value . . . . . . . . . . . . . . . . . .$ 600,000 $ 720,000 $120,000 Common stock—$40 par value . . . . .$(200,000) Additional paid-in capital . . . . . . . . . . . (20,000) Retained earnings, 1/1/10 . . . . . . . . . . (380,000)

9. Subsequent Consolidation - Equity Method Example 3- FV of consideration transferred by Parrot Company. . $ 800,000 Book Value of Sun Company . . . . . . . . . . . . . . . . . . . . .(600,000) Excess of fair value over book value . . . . . . . . . .200,000 Allocation to specific accounts based on fair values: Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,000 Patented technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,000 Equipment (overvalued) . . . . . . . . . . . . . . . . . . . . . . . . . . (30,000) 120,000 Excess FV not specifically identified—goodwill. . . . . . . $ 80,000 PARROT COMPANY 100 Percent Acquisition of Sun Company Allocation of Acquisition-Date Subsidiary Fair Value January 1, 2010

10. Subsequent Consolidation - Equity Method Example Amortization computation: 3- Useful Annual Account Allocation Life Amortization Trademarks $ 20,000 Indefinite –0– Patented technology 130,000 10 years $13,000 Equipment (30,000) 5 years (6,000) Goodwill 80,000 Indefinite –0– $ 7,000 Amortization will be $7,000 annually for the first five years , until the equipment allocation is fully removed.

11. Subsequent Consolidation - Equity Method Example Parrot Company will record an entry at the date of acquisition, but what happens after that? Let’s assume Sun Company earns income of $100,000 in 2010 and pays a $40,0000 cash dividend on August 1, 2010. 3-

12. Subsequent Consolidation - Equity Method Example 3- 1/1/10 Investment in Sun Company . . . . . 800,000 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000 To record the acquisition of Sun Company. 8/1/10 Cash . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 Investment in Sun Company. . . . . . . . . 40,000 To record receipt of cash dividend from subsidiary under the equity method. 12/31/10 Investment in Sun Company. . . . 100,000 Equity in Subsidiary Earnings . . . . . . 100,000 To accrue income earned by 100% owned subsidiary. 12/31/10 Equity in Subsidiary Earnings . . . . 7,000 Investment in Sun Company . . . . . . . . . 7,000 To recognize amortizations on allocations made in acquisition of subsidiary.

13. Subsequent Consolidation – Worksheet Entries 3- After the parent company’s books are updated under the equity method , how do we consolidate the two companies? We will prepare FIVE different entries for the consolidation workpaper !

15. Subsequent Consolidation – Equity Method – Example Entry S 3- Note: If this is the first year of the investment, and the investment was made at a time other than the beginning of the fiscal year, then pre-acquisition income of the sub must be accounted for in the retained earnings balance. Common Stock (Sun Company). . . . 200,000 APIC (Sun Company) . . . . . . . . . . . . 20,000 R/E, 1/1/10 (Sun Company) . . . . . . . 380,000 Investment in Sun Company . . . . . . . . . . 600,000

16. Subsequent Consolidation – Equity Method – Example Entry A 3- Trademarks . . . . . . . . . . . . . . .20,000 Patented technology . . . . . . .130,000 Goodwill . . . . . . . . . . . . . . . . .80,000 Equipment . . . . . . . . . . . . . . . . . . 30,000 Investment in Sun Company . . . 200,000 Note: In the first year , the FV adjustments for this entry are calculated in the allocation computation . In subsequent years , the FV adjustments must be reduced by any depreciation taken in prior consolidations.

17. Subsequent Consolidation – Equity Method–Example Entry I&D 3- Equity in Subsidiary Earnings . . .93,000 Investment in Sun Company. . . . . . . 93,000 Investment in Sun Company . . . . 40,000 Dividends Paid . . . . . . . . . . . . . . . . 40,000

28. Goodwill and Other Intangible Assets (ASC Topic 350) AFTER December 15, 2001, goodwill is no longer amortized. This applies to both previously recognized and newly acquired goodwill. Unamortized goodwill left from prior combinations is carried on the books as a permanent asset (subject to impairment review). 3-

31. Goodwill Impairment – Two-Step Test 3- Step 2 Is the fair value of Goodwill less than its carrying value? If NO , then Goodwill is NOT impaired, and there is no further testing required. If YES , then an extraordinary impairment loss is recorded.

37. Goodwill Impairment Test Example 3- Newcall’s Acquisition Fair Value Reporting Units Goodwill January 1, 2011 DSM Wired $ 22,000,000 $950,000,000 DSM Wireless 155,000,000 748,000,000 Rocketel 38,000,000 492,000,000 Visiontalk 6,000,000 710,000,000 Newcall then compares the implied fair value of the DSM Wireless goodwill to its carrying value using the following allocation of the fair value of DSM Wireless at year end …

38. Goodwill Impairment Test Example 3- DSM Wireless Dec. 31, 2011, fair value $600,000,000 Fair values of DSM Wireless net assets at Dec. 31, 2011: Current assets $ 50,000,000 Property 125,000,000 Equipment 265,000,000 Subscriber list 140,000,000 Patented technology 185,000,000 Current liabilities (44,000,000) Long-term debt (125,000,000) Value assigned to identifiable net assets 596,000,000 Value assigned to goodwill 4,000,000 Carrying value before impairment 155,000,000 Impairment loss $151,000,000