1. CHAPTER 6 THE PURCHASE METHOD: POSTACQUISITION PERIODS AND PARTIAL OWNERSHIPS

2. FOCUS OF CHAPTER 6 Consolidation Worksheets: 100% Ownerships—Postacquisition Periods The Purchase Method: Partial Ownerships – Conceptual issues – Analyzing cost Consolidation Worksheets: Partial Ownerships – At the Acquisition Date – Postacquisition Periods

3. Postacquisition Subsidiary Earnings: The Only Reportable Earnings Under The Purchase Method ONLY the subsidiary’s postacquisition earnings are reported in the consolidated financial statements. The subsidiary’s preacquisition earnings (included in its retained earnings account) are ALWAYS eliminated against the parent’s Investment account in consolidation.

4. Parent’s Amortization of Cost in Excess of Book Value: How Handled? Non-Push-Down Accounting: – Equity Method: Recorded in parent’s general ledger. Maintains built-in checking features. – Cost Method: Recorded on consolidation worksheets. Push-Down Accounting: – Parent has no amortization—sub records it. GL

5. Parent’s Amortization of Excess Cost: What is Sub’s True Earnings? Non-Push-Down Accounting: Sub’s reported net income (based on OLD BASIS)........... $24,000 Less—Parent’s amortization of excess cost................. (8,000) Sub’s true net income (based on NEW BASIS)......... $16,000 Push-Down Accounting: Sub’s reported net income....... $16,000

6. Liquidating Dividends: A Special Situation Because an acquired subsidiary usually has a retained earnings balance at the acquisition date, a unique issue arises for acquired subsidiaries: HOW TO REPORT DIVIDENDS THAT ARE IN EXCESS OF THE SUBSIDIARY’S POSTACQUISITION EARNINGS? – Such dividends are called liquidating dividends.

7. Liquidating Dividends: They Differ From “Regular” Dividends Dividends in excess of postacquisition earnings are a return of the parent’s original investment. Parent’s Accounting Treatment: – CREDIT to the Investment account under: Equity method (the usual treatment). Cost method (the usual treatment is to credit Dividend Income).

8. Liquidating Dividends: Acquired vs. Created Subsidiaries Can a created subsidiary declare a liquidating dividend? NO No such thing exists for a created subsidiary.

9. Liquidating Dividends: What Is their Significance for Tax? A central issue in taxation is whether a distribution to a shareholder is a dividend or a return of capital. The concept of “EARNINGS & PROFITS” (E & P) exists in the Internal Revenue Code for making this determination.

10. Goodwill: It Must be Assigned to a “Reporting Unit” A reporting unit is (1) an “operating segment” (as defined in FAS 131) or (2) one level below an operating segment. The reporting unit could be: –The acquired business alone (the subsidiary or division). –The acquired business and the parent combined. –The acquired business and one or more of the parent’s other subsidiaries or divisions.

11. Testing Goodwill for Impairment: A Two-Step Process Step 1: Is the reporting unit’s fair value (FV) below the reporting unit’s carrying value (CV)? –If NO, stop. If YES, perform step 2.

12. Testing Goodwill for Impairment: A Two-Step Process Step 2: Calculate the “implied value” of goodwill as follows: –On a memo basis, allocate the reporting unit’s FV to its assets and liabilities in a “purchase price allocation fashion.” –Excess of reporting unit’s FV over FV of assets/liabilities (as allocated) is “implied goodwill” of the reporting unit. (Thus implied GW is residually determined.)

13. Testing Goodwill for Impairment: A Two-Step Process Step 2 (cont.) –If the implied FV of GW is less than the carrying value of GW, the excess carrying value is the GW impairment loss to be reported. –Report any GW impairment loss in earnings—as a separate line item, if material.

14. Testing Goodwill for Impairment: A Two-Step Process Goodwill Impairment Test—How Often? –At least annually. –At interim periods when certain “triggering events” occur that indicate that goodwill of a reporting unit may be impaired.

15. Testing Goodwill for Impairment: A Two-Step Process The Annual GW Impairment Test—It does not require a formal FV determination each year if: –Components of the reporting unit have not changed significantly. –Previous FV of the reporting unit exceeded its CV by a substantial margin. –The likelihood that the reporting unit’s FV is less than its CV is remote.

16. Goodwill: Determining the “Reporting Unit’s” Fair Value The following items are included in determining the reporting unit’s fair value: –Tangible net assets. –Recognized intangible assets. –Unrecognized intangible assets.

17. Partial Ownerships: The Purchase Method—”Partial” or “Full “Valuation Extent of Revaluation of Undervalued Assets and Goodwill: – Parent Company Concept: Partial valuation (could be anywhere from 51% to 99%) Economic Unit Concept: Full valuation

18. Partial Ownerships: The Purchase Method—Undervalued Assets Extent of Revaluation of Subsidiary’s Undervalued Assets: – Parent company concept..... < 100% of CV Revalued only to the extent of the parent’s OWNERSHIP INTEREST. – Economic unit concept........ 100% of CV The offsetting credit for the additional valuation increases the NCI in the consolidated B/S.

19. Partial Ownerships: The Purchase Method—Goodwill Extent of Valuation of Goodwill: – Parent company concept................. < 100% Valued only to the extent it is bought and paid for by the parent. – Economic unit concept.................... 100% The offsetting credit for the additional valuation increases the NCI in the consolidated B/S.

20. Review Question #1 A parent records amortization of cost in excess of book value under which method? A. Push-down basis of accounting. B. Non-push down basis of accounting. C. Both A and B. D. None of the above.

21. Review Question #1 With Answer A parent records amortization of cost in excess of book value under which method? A. Push-down basis of accounting. B. Non-push down basis of accounting. C. Both A and B. D. None of the above.

22. Review Question #2 A parent charges the amortization of its cost in excess of book value to: A. Goodwill expense. B. Excess cost expense. C. Excess cost & goodwill expense. D. Equity in net income of subsidiary. E. None of the above.

23. Review Question #2 With Answer A parent charges the amortization of its cost in excess of book value to: A. Goodwill expense. B. Excess cost expense. C. Excess cost & goodwill expense. D. Equity in net income of subsidiary. E. None of the above.

24. Review Question #3 A special type of dividend that can occur only with an acquired subsidiary is a: A. Treasury stock dividend. B. Liquidating dividend. C. Deemed dividend. D. Constructive dividend. E. None of the above.

25. Review Question #3 With Answer A special type of dividend that can occur only with an acquired subsidiary is a: A. Treasury stock dividend. B. Liquidating dividend. C. Deemed dividend. D. Constructive dividend. E. None of the above.

26. Review Question #4 When a liquidating dividend occurs, the parent credits which account? A. Retained earnings. B. Dividend income. C. Investment in subsidiary D. Liquidating dividend income. E. None of the above.

27. Review Question #4 With Answer When a liquidating dividend occurs, the parent credits which account? A. Retained earnings. B. Dividend income. C. Investment in subsidiary. D. Liquidating dividend income. E. None of the above.

28. Review Question #5 Goodwill’s book value is $90,000 and its implicit value is $60,000. The reporting unit’s carrying value is $800,000 and its fair value is $810,000. What is the goodwill impairment write-down? A. Zero. B. $10,000. C. $20,000. D. $30,000. D. $50,000.

29. Review Question #5 With Answer Goodwill’s book value is $90,000 and its implicit value is $60,000. The reporting unit’s carrying value is $800,000 and its fair value is $810,000. What is the goodwill impairment write-down? A. Zero. (Step 2 was not needed) B. $10,000. C. $20,000. D. $30,000. D. $50,000.

30. Review Question #6 Under which concept is goodwill imputed to the noncontrolling interest for consolidated financial reporting purposes? A. The economic unit concept. B. The parent company concept. C. Both A and B. D. None of the above.

31. Review Question #6 With Answer Under which concept is goodwill imputed to the noncontrolling interest for consolidated financial reporting purposes? A. The economic unit concept. B. The parent company concept. C. Both A and B. D. None of the above.

32. End of Chapter 6 Time to Clear Things Up—Any Questions?