7 Cost Method Equity Method DateDr.Cr.Entry by Dunn to record acquisition of 75% of Hunt’s shares:1/1/X1Invest in Hunt105,000CashEntry by Dunn to record receipt of 20X1 dividend from Hunt ($10,000 * 75%):12/31/X17,500Dividend IncEntry by Dunn to record share of Hunt’s 20X1 net income ($20,000 * 75%):No Entry Required15,000Inc. from HuntEntry by Dunn to record amort. of revaluation increment (decrement) for 20X1:750($1,500/5)+($2,250/5)=$750Entry by Dunn to record impairment of goodwill for 20X1:
9 Cost Method Equity Method DateDr.Cr.Entry by Dunn to record receipt of 20X2 dividend from Hunt ($6,000 * 75%):12/31/X2Cash4,500Invest in Hunt3,000Div Inc (plug to balance)1,500Entry by Dunn to record share of Hunt’s 20X2 net loss ($8,000 * 75%):No Entry RequiredInc. from Hunt6,000Entry by Dunn to record amort. of revaluation increment (decrement) for 20X2:750See entry for 12/31/X1Entry by Dunn to record impairment of goodwill for 20X2:500
10 20X120X2Total SinceAcquisitionNet Income * % Owned$15,000($6,000)$9,000Dividends * % Owned7,5004,50012,000Total NI Since Acq – Total Div Since Acq($3,000)If Total NI Since Acq – Total Div Since Acq is Negative, Reduce Investment Account by Excess of Total Div over Total NI or Amount of Dividends Received, whichever is lowerIf Total NI Since Acq – Total Div Since Acq is Positive, Do not reduce Investment account
11 Effective June 30, 2001, New Rules for Accounting for Business Combination SFAS Accounting for Business CombinationsSupercedes APB Opinion 16Eliminates use of pool-of-interests methodModifies current purchase accounting methodNew intangible asset recognition criteriaExpanded disclosure requirementsSFAS Accounting for Goodwill and Intangible AssetsSupercedes APB Opinion 17Goodwill not amortizedGoodwill subject to annual impairment test
12 Goodwill ImpairmentIn SFAS 142, FASB mandates a purchase accounting method for business combinations that requires companies to:Conduct an annual goodwill impairment testBased on fair value of the reporting unitHowever, goodwill will not be amortizedIf goodwill impaired:Impairment loss recognized in income statementAmount of goodwill reduced on balance sheet
13 Goodwill Impairment Test Three-Step ApproachStep 1: Determine Potential Goodwill ImpairmentCalculate fair value of reporting unit (FVRU)Calculate carrying value (book value) of reporting unit (CVRU), including goodwill.If FVRU CVRU, goodwill is not impaired, do nothing.If FVRU < CVRU, potential goodwill impairment, go to Step 2
14 Goodwill Impairment Test Three-Step ApproachStep 2: Calculate Implied Fair Value of GoodwillImplied fair value of goodwill of reporting unit (IFVGWRU) = FVRU – Fair Value of Identifiable Net Assets of Reporting Unit (FVINARU)If IFVGWRU > Carrying Value (book value) of Goodwill of Reporting Unit (CVGWRU), do nothingIf IFVGWRU < CVGW, go to Step 3
15 Goodwill Impairment Test Three-Step ApproachStep 3: Calculate Goodwill Impairment LossGoodwill impairment loss = CVGWRU - IFVGWRUmust recognize goodwill impairment loss as separate line on income statementmust reduce amount of goodwill on balance sheet by amount of goodwill impairment loss.
16 Goodwill Impairment Test New Rules IllustratedOn January 1, 20X1, A Corporation paid $1,000 to acquire all of the outstanding common stock of B Corporation. The following is reported on the B Corporation’s balance sheet at the date of acquisition:Current assets$ 200Current liabilities$ 100Non-current assets800Long-term liabilities250Stockholders’ equity650Total assets$1,000Total liab & stkholders’ equity
17 Goodwill Impairment Test New Rules IllustratedThe recorded value of the identifiable net assets is $650 ($1,000 minus ($100 + $250)).The fair value of the identifiable net assets is $800 ($150 above the recorded value) because of appreciated real estate.Thus, at the date of acquisition, A Corporation pays $200 ($1,000 – $800) above the fair value of the identifiable assets to purchase B Corporation.According to A Corporation’s management, the company is willing to pay the $200 premium because it believes that access to B Corporation’s customer base will be especially profitable.
18 Goodwill Impairment Test of Identifiable Net Assets Calculation of Goodwill – Date of AcquisitionFair Valueof Identifiable Net AssetsBook Valueof IdentifiableNet AssetsPurchasePriceGoodwill = $200Revaluation Increment = $150$1,000$800$650
19 Goodwill Impairment Test New Rules IllustratedAssume that B Corporation has a net loss for the year ended December 31, 20X1 and management forecasts continuing losses.Accordingly, the fair value of the recorded goodwill may be impaired and an impairment test is warranted.The fair value of B Corporation (FVRU) at December 31, 20X1 is determined to be $725.The carrying value of B Corporation (CVRU) at December 31, 20X1, including goodwill, is determined to be $800.The fair value of the identifiable net assets of B Corporation (FVINARU) at December 31, 20X1 is determined to be $700.
20 Goodwill Impairment Test of Identifiable Net Assets Calculation of Implied Goodwill – 12/31/X1Fair Valueof Identifiable Net AssetsBook Valueof IdentifiableNet AssetsFVRUIFVGWRU = $25Revaluation Increment = $100$725$700$600
21 Goodwill Impairment Test Three-Step ApproachStep 1: Determine Potential Goodwill ImpairmentFair value of B Corp. (FVRU)$725Carrying value of B Corp. (CVRU)800Potential Goodwill Impairment($ 75)Step 2: Calculate Implied Fair Value of GoodwillFair value of identifiable net assets of B (FVINARU)700Implied fair value of goodwill of B Corp. (IFVGWRU)$ 25Step 3: Calculate Goodwill Impairment LossCarrying value of goodwill of B Corp. (CVGWRU)$ 20025Goodwill impairment loss$175
22 Goodwill Impairment Test When the impairment test is completed, the company concludes the fair value of the reporting unit is now only $25 greater than the fair value of the identifiable net assets of B Corporation.Thus, the implied fair value of the goodwill has fallen to $25.As a result, A Corporation will report a $175 goodwill impairment loss as a separate line item on the income statement and report goodwill totaling $25 on the balance sheet.