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Accounting 471/875 Chapter 3. Criteria for Cost vs Equity Method Percentage of Outstanding Voting Stock Acquired 20%50%100%0% 1. Level of economic influence.

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Presentation on theme: "Accounting 471/875 Chapter 3. Criteria for Cost vs Equity Method Percentage of Outstanding Voting Stock Acquired 20%50%100%0% 1. Level of economic influence."— Presentation transcript:

1 Accounting 471/875 Chapter 3

2 Criteria for Cost vs Equity Method Percentage of Outstanding Voting Stock Acquired 20%50%100%0% 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

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7 Cost MethodEquity Method DateDr.Cr.Dr.Cr. Entry by Dunn to record acquisition of 75% of Hunt’s shares: 1/1/X1Invest in Hunt105,000Invest in Hunt105,000 Cash105,000 Cash105,000 Entry by Dunn to record receipt of 20X1 dividend from Hunt ($10,000 * 75%): 12/31/X1Cash7,500Cash7,500 Dividend Inc7,500 Invest in Hunt7,500 Entry by Dunn to record share of Hunt’s 20X1 net income ($20,000 * 75%): 12/31/X1No Entry RequiredInvest in Hunt15,000 Inc. from Hunt15,000 Entry by Dunn to record amort. of revaluation increment (decrement) for 20X1: 12/31/X1No Entry RequiredInc. from Hunt750 Invest in Hunt750 ($1,500/5)+($2,250/5)=$750 Entry by Dunn to record impairment of goodwill for 20X1: 12/31/X1No Entry Required

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 $105,000 $103,500 =$97,500+(1,500+2,250+2,250) $97,500 =(100,000+30,000)*75%

9 Cost MethodEquity Method DateDr.Cr.Dr.Cr. Entry by Dunn to record receipt of 20X2 dividend from Hunt ($6,000 * 75%): 12/31/X2Cash4,500Cash4,500 Invest in Hunt3,000 Invest in Hunt4,500 Div Inc (plug to balance)1,500 Entry by Dunn to record share of Hunt’s 20X2 net loss ($8,000 * 75%): 12/31/X2No Entry RequiredInc. from Hunt6,000 Invest in Hunt6,000 Entry by Dunn to record amort. of revaluation increment (decrement) for 20X2: 12/31/X2No Entry RequiredInc. from Hunt750 Invest in Hunt750 See entry for 12/31/X1 Entry by Dunn to record impairment of goodwill for 20X2: 12/31/X2No Entry RequiredInc. from Hunt500 Invest in Hunt500

10 20X120X2 Total Since Acquisition Net Income * % Owned$15,000($6,000)$9,000 Dividends * % Owned7,5004,50012,000 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 $1,000 to acquire all of the outstanding common stock of B Corporation. The following is reported on the B Corporation’s balance sheet at the date of acquisition: Current assets$ 200Current liabilities$ 100 Non-current assets800Long-term liabilities250 Stockholders’ equity650 Total assets$1,000Total liab & stkholders’ equity$1,000

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 Purchase Price Book Value of Identifiable Net Assets Fair Value of Identifiable Net Assets $650$800$1,000 Goodwill = $200Revaluation Increment = $150 Calculation of Goodwill – Date of Acquisition

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 FVRU Fair Value of Identifiable Net Assets $600$700$725 IFVGWRU = $25Revaluation Increment = $100 Calculation of Implied Goodwill – 12/31/X1 Book Value of Identifiable Net Assets

21 Goodwill Impairment Test 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 B Corp. (FVRU)$725 Fair value of identifiable net assets of B (FVINARU)700 Implied fair value of goodwill of B Corp. (IFVGWRU)$ 25 Step 3: Calculate Goodwill Impairment Loss Carrying value of goodwill of B Corp. (CVGWRU)$ 200 Implied fair value of goodwill of B Corp. (IFVGWRU)25 Goodwill impairment loss$175 Three-Step Approach

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


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