1. Accounting 471/875
Chapter 3

2. Criteria for Cost vs Equity Method
Percentage of Outstanding Voting Stock Acquired 0%
20%
50%
100%
1. Level of economic influence
Nominal
“Significant Influence”
Control
2. Valuation basis
Cost
Method
Equity Method
3. Financial statement presentation
Investment Account
Separate Financial Statements
Consolidated
Financial Statements

3. Cost Method vs Equity Method

4. Cost Method vs Equity Method

5. Cost Method vs Equity Method

7. Cost Method Equity Method
Date
Dr.
Cr.
Entry by Dunn to record acquisition of 75% of Hunt’s shares:
1/1/X1
Invest in Hunt
105,000
Cash
Entry by Dunn to record receipt of 20X1 dividend from Hunt ($10,000 * 75%):
12/31/X1
7,500
Dividend Inc
Entry by Dunn to record share of Hunt’s 20X1 net income ($20,000 * 75%):
No Entry Required
15,000
Inc. from Hunt
Entry by Dunn to record amort. of revaluation increment (decrement) for 20X1:
750
($1,500/5)+($2,250/5)=$750
Entry by Dunn to record impairment of goodwill for 20X1:

8. AC FV * % BV * %
 GW=$105, ,500=$1,500
Equipment RI(D)=($62,000-60,000)*75%=$1,500
Building RI(D)=($103, ,000)*75%=$2,250
Land RI(D)=($28,000-$25,000)*75%=$2,250
$105, $103,500 =$97,500+(1,500+2,250+2,250) $97,500 =(100,000+30,000)*75%

9. Cost Method Equity Method
Date
Dr.
Cr.
Entry by Dunn to record receipt of 20X2 dividend from Hunt ($6,000 * 75%):
12/31/X2
Cash
4,500
Invest in Hunt
3,000
Div Inc (plug to balance)
1,500
Entry by Dunn to record share of Hunt’s 20X2 net loss ($8,000 * 75%):
No Entry Required
Inc. from Hunt
6,000
Entry by Dunn to record amort. of revaluation increment (decrement) for 20X2:
750
See entry for 12/31/X1
Entry by Dunn to record impairment of goodwill for 20X2:
500

10. 20X1
20X2
Total Since
Acquisition
Net Income * % Owned
$15,000
($6,000)
$9,000
Dividends * % Owned
7,500
4,500
12,000
Total 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 lower
If 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 Combinations
Supercedes APB Opinion 16
Eliminates use of pool-of-interests method
Modifies current purchase accounting method
New intangible asset recognition criteria
Expanded disclosure requirements
SFAS Accounting for Goodwill and Intangible Assets
Supercedes APB Opinion 17
Goodwill not amortized
Goodwill subject to annual impairment test

12. Goodwill Impairment
In SFAS 142, FASB mandates a purchase accounting method for business combinations that requires companies to:
Conduct an annual goodwill impairment test
Based on fair value of the reporting unit
However, goodwill will not be amortized
If goodwill impaired:
Impairment loss recognized in income statement
Amount of goodwill reduced on balance sheet

13. Goodwill Impairment Test
Three-Step Approach
Step 1: Determine Potential Goodwill Impairment
Calculate 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 Approach
Step 2: Calculate Implied Fair Value of Goodwill
Implied 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 nothing
If IFVGWRU < CVGW, go to Step 3

15. Goodwill Impairment Test
Three-Step Approach
Step 3: Calculate Goodwill Impairment Loss
Goodwill impairment loss = CVGWRU - IFVGWRU
must recognize goodwill impairment loss as separate line on income statement
must reduce amount of goodwill on balance sheet by amount of goodwill impairment loss.

16. Goodwill Impairment Test
New Rules Illustrated
On 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
$ 200
Current liabilities
$ 100
Non-current assets
800
Long-term liabilities
250
Stockholders’ equity
650
Total assets
$1,000
Total liab & stkholders’ equity

17. Goodwill Impairment Test
New Rules Illustrated
The 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 Acquisition
Fair Value
of Identifiable Net Assets
Book Value
of Identifiable
Net Assets
Purchase
Price
Goodwill = $200
Revaluation Increment = $150
$1,000
$800
$650

19. Goodwill Impairment Test
New Rules Illustrated
Assume 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/X1
Fair Value
of Identifiable Net Assets
Book Value
of Identifiable
Net Assets
FVRU
IFVGWRU = $25
Revaluation Increment = $100
$725
$700
$600

21. Goodwill Impairment Test
Three-Step Approach
Step 1: Determine Potential Goodwill Impairment
Fair value of B Corp. (FVRU)
$725
Carrying value of B Corp. (CVRU)
800
Potential Goodwill Impairment
($ 75)
Step 2: Calculate Implied Fair Value of Goodwill
Fair value of identifiable net assets of B (FVINARU)
700
Implied fair value of goodwill of B Corp. (IFVGWRU)
$ 25
Step 3: Calculate Goodwill Impairment Loss
Carrying value of goodwill of B Corp. (CVGWRU)
$ 200 25
Goodwill 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.

23. Goodwill Impairment Worksheet