Description 6 attachmentsSlide 1 of 6attachment_1attachment_1attachment_2attachment_2attachment_3attachment_3attachment_4attachment_4attachment_5attachment_5attachment_6attachment_6.slider-slide > img { width: 100%; display: block; } .slider-slide > img:focus { margin: auto; } Unformatted Attachment Preview The TMA Questions PART A In 2018. CVS Health Corporation reported a $6.1 billion charge for the impairment of goodwill in one of its reporting units (segments) in its 10-K annual report. Referring to CVS Health’s 2018 financial statements and any other information from the media, address the following: 1. CVS Health’s segments serve as its reporting units for assessing goodwill for potential impairments. Which segment suffered a 2018 impairment? Describe the revenue model for this segment. 2. Discuss in details the underlying business reasons that required CVS Health to record a goodwill impairment in 2018? Do not provide general reasons. 3. How did CVS Health reflect the 2018 goodwill impairment in its income statement and cash flow statement? 4. Describe in your own words the goodwill impairment testing steps performed by CVS Health in 2018 and the consequent loss measurement. (Support your answer by writing the page number(s) in the annual report, from which you get your answer) https://www.annualreports.com/HostedData/AnnualReportArchive/c/NYSE_CVS_2018.pdf PART B 1- Explain in details, the differences between the IFRS and GAAP (after FASB issued ASU 2017-04 to simplify the accounting for goodwill impairment) regarding the following: – Assignment/allocation of goodwill. (i.e. The levels at which goodwill is assigned /allocated) – Impairment of goodwill and test(s) applied and its steps (i.e. Methods of determining impairment of goodwill) – How impairment loss is recognized and allocated.(i.e. impairment loss[charge] calculation and allocation) Answer this question in a tabular format, like the following one: IFRS GAAP Assignment/allocation of goodwill Impairment of goodwill How impairment loss is recognized and allocated (You must support your answer in this question with quality and up to date references.) 2- If the accountant did not prepare the elimination entry of unrealized profit in inventories at the end of any year, this will affect the consolidated net income in that year and in all subsequent years. Discuss this statement and support your answer with a numerical example. 3- What is the difference between upstream sale of inventory and a downstream sale? Why is it important to know the direction of sale when preparing the consolidated financial statements? PART C 1) Firms should conduct the impairment test for goodwill at least annually. Accounting standards require more frequent impairment testing if some events occurs. a) Identify the main events upon which goodwill undergoes a test for its impairment. b) Provide two recent examples from the real world for companies that made the goodwill impairment test and reported impairment charges (Excluding CVS Health Corporation & Dell Technologies Inc.). Your answer must be in a tabular format, and cover all the following points: Example 1 Name of the company The year – The amount and details of these impairment charges as mentioned in the annual report – The URL(Internet address) of the annual report – The page number(s) in the annual report. The specific underlying business reasons that required these companies to record the goodwill impairment charges. Example 2 (Answers not provided in a tabular format will be disregarded and any examples given dated before the year 2001 will not be considered. 2) Provide examples from the real world for successful and unsuccessful mergers and acquisitions cases in recent years and state the specific reasons behind their success or failure. (Do not provide general reasons behind success or failure & only one example should be provided for each case, any examples given dated before the year 2001 will not be considered). PART D: On January 1, 2018, Pal Corporation acquired 80% of the voting stock of Secam Corporation for $24,000 when Secam had Capital Stock of $10,000 and Retained Earnings of $8,000. On this date, the book value of Secam’s assets and liabilities was equal to the fair value, except for inventories, , which were understated on the books by $1,000 and were sold in 2018, land which was undervalued by $2,000, and equipment with a remaining useful life of 5 years under the straight-line method which was undervalued by $3,000. Any remainder was assigned to goodwill. Financial statements for the two corporations at the end of the fiscal year ended December 31, 2019 appear in the first two columns of the partially completed consolidation working papers. Pal has accounted for its investment in Secam using the equity method of accounting. Pal Corporation owed Secam Corporation $200 on open account at the end of the year. Dividends receivable in the amount of $900 payable from Secam to Pal is included in Pal’s net receivables. Required: 1) Prepare the elimination entries required for consolidation on December 31, 2019. Show all your calculations. 2) Complete the consolidation working papers for Pal Corporation and Subsidiary for the year ended December 31, 2019. INCOME STATEMENT Sales Income from Secam Cost of Sales Depreciation Expense Other expenses Non control1ing Interest Share Net income Retained Earnings 1/1 Pal Secam 20,000 1,920 (8,000) (2,000) (3,600) 13,000 8,320 5,020 Add: Net income Less: Dividends Retained Earnings 12/31 BALANCE SHEET 8,320 (4,000) 9,340 Cash Receivables—net Inventories Land Equipment and Buildings-net 2,880 2,200 3,000 2,000 15,000 Investment in Secam Corp Goodwill 24,640 (6600) (2000) (1,400) 3,000 10,000 3,000 (2,000) 11,000 3,800 1,200 2,400 3,200 13,400 Unamortized Excess TOTAL ASSETS LIAB. & EQUITY 49,720 24,000 Accounts Payable Dividends Payable Capital Stock Ret. Earnings Nonctl Interest 1/1 Nonctl. Interest 12/31 LIAB. & EQUITY 8.380 4,000 28,000 9,340 2,000 1,000 10,000 11,000 49,720 24,000 Eliminations Debit Credit Consolidated Advance Financial Accounting: B326 Chapter 1: Business Combination Objectives 1: Understand the economic motivations underlying business combination • The main objective of businesses today is to increase the wealth of its shareholders. • To do so, it has to expand internally (expand its facilities) or externally (mergers and acquisitions). • In general business combination is done, to increase its profitability or increase the efficiency (vertical and horizontal integration). Types of Business Combinations Business combinations unite previously separate business entities. • Horizontal integration: same business lines and markets • Vertical integration: operations in different, but successive stages of production or distribution, or both • Conglomeration: unrelated and diverse products or services Reasons for Combinations Cost advantage • Its less expensive to obtain the needed facility through business combination rather than developing it. Lower risk • Less risky to by already developed product line than developing one • Diversity is the only way to reduce the risk for single product company and to expand. Fewer operating delays • Plant facilities acquired from business combination is ready to use and meet the environmental and governmental regulation. Which will reduce delays in construction and approvals. Avoidance of takeovers • To avoid takeovers of small companies from large ones Acquisition of intangible assets • Business combinations bring the tangible and intangible asset (patent, database, mineral right) Other: • business and other tax advantages, personal reasons Objective- 2: Learn about alternative forms of business combinations, from both the legal and accounting perspectives • Legal Form of Combination • Merger • Occurs when one corporation takes over all the operations of another business entity and that other entity is dissolved. • Merger occur when (A+B=A) : • Company A purchases the assets of Company B for cash, other assets, or Company A debt/equity securities. Company B is dissolved; Company A survives with Company B’s assets and liabilities. • Company A purchases Company B stock from its shareholders for cash, other assets, or Company A debt/equity securities. Company B is dissolved. Company A survives with Company B’s assets and liabilities. • Consolidation • Occurs when a new corporation is formed to take over the assets and operations of two or more separate business entities and dissolves the previously separate entities. • Consolidation occur when (E+F=D): • Company D is formed and acquires the assets of Companies E and F by issuing Company D stock. Companies E and F are dissolved. Company D survives, with the assets and liabilities of both dissolved firms. • Company D is formed acquires Company E and F stock from their respective shareholders by issuing Company D stock. Companies E and F are dissolved. Company D survives with the assets and liabilities of both firms. Acquisition • When corporation acquires the productive asset of another business entity and integrates those assets into its own operation. • When one corporation obtains operating control over the productive facilities of another entity by acquiring a majority of its outstanding voting stock. • The acquired company may not be dissolve and does not have to go out of existence. • Acquisition occur (A+B=A+B): • Company A buys asset of company B for cash or buys its shares for cash and does not dissolve the company. Which will give company A legal owner ship of asset Objective 3: Introduce accounting concepts for business combinations, emphasizing the acquisition method. Business combination: • According to GAAP “A transaction or other event in which an acquirer obtains control of one or, more businesses. Transaction sometimes referred to as true mergers or mergers equals also are business combination”. • Accounting concept for business combination focus on the creation of a single entity and the independence of the combining companies before their union. • previously, separate businesses are brought together into one when their recourse and operation come under control of one single management which means: • one or more corporation become subsidiaries • one company transfers its net assets to another • each company transfers its net assets to newly formed corporation • parent – subsidiary relationship • A parent – subsidiary relationship is formed when: – Less than 100% of the firm is acquired, or – The acquired firm is not dissolved. • • Subsidiary – A corporation becomes subsidiary when another operation acquire a majority of its outstanding shares. – Majority of shares more than 50% of its voting shares. – In a combination of less than 100%, the combining companies necessarily retain separate legal entity and separate accounting records even though they become one in the financial reporting. • Background of accounting for business combination • previously the accounting method for business combination is pooling interest method in 1950. • the pooling method has faced a lot of difficulties which had lead for the introduction of new method called acquisition method. • pooling method uses historical cost rather than fair value( as acquisition method) • in 2001 the pooling method has been eliminated from FASB because: – pooling provide less relevant information to statement users – pooling ignores economic value exchanges in the transaction and makes subsequent performance evaluating impossible – comparing firms using alter native method is difficult of investors.. • Recording Guidelines • Record assets acquired and liabilities assumed using the fair value principle. • If equity securities are issued by the acquirer, charge registration and issue costs against the fair value of the securities issued, usually a reduction in additional paid-in-capital. • Charge other direct combination costs (e.g., legal fees, finders’ fees) and indirect combination costs (e.g., management salaries) to expense. • When the acquiring firm transfers its assets other than cash as part of the combination, any gain or loss on the disposal of those assets is recorded in current income. • The excess of cash, other assets and equity securities transferred over the fair value of the net assets (A – L) acquired is recorded as goodwill. • If the net assets acquired exceeds the cash, other assets and equity securities transferred, a gain on the bargain purchase is recorded in current income. Recording issuance of shares Dr Investment in Subsidiary (#shares * per XX share) Common Stock (#shares * par) Additional Paid-in capital (difference) Cr XX XX • Example: • Poppy Corp. issues 100,000 shares of its $10 par value common stock for Sunny Corp. Poppy’s stock is valued at $16 per share. (in thousands) Dr Investment in Subsidiary Cr 1,600 Common Stock 1,000 Additional Paid-in capital 600 • Poppy Corp. pays cash for $80,000 in finder’s fees and consulting fees and for $40,000 to register and issue its common stock. (in thousands) Dr Investment expense 80 Additional Paid-in capital 40 Cash Cr 120 If Sunny Corp. is dissolved, Poppy Corp. will allocate the investment’s cost to the fair value of the identifiable assets acquired and liabilities assumed. Any excess of investment cost over fair value of net assets is recorded as goodwill. If Subsidiary is dissolved: Assigning the cost of subsidiary to net assets on the basis of their fair values: Dr Receivables Inventories Plant assets Goodwill Cr XX XX XX XX XX OR Accounts payable Notes payable Investment in Subsidiary Gain from bargain purchase XX XX XX Objective 4: Cost Allocations Using the Acquisition Method Recording Fair values in an acquisition Identify the Net Assets Acquired • Tangible assets acquired, • Intangible assets acquired, and • Liabilities assumed Assign Fair Values to Net Assets: Use fair values determined, in preferential order, by: ➢ Established market prices ➢ Present value of estimated future cash flows, discounted based on observable measures ➢ Other internally derived estimations • Goodwill • The goodwill resulting from business combination : The acquirer shall recognize goodwill as of the acquisition date measured as excess of (A) over (B): • The aggregate of the following: ▪ The consideration transferred measured at fair value at acquisition date ▪ The fair value of any non controlling interest ▪ The acquisition fate fair value of the acquirers previously held equity interest in the acquire. ▪ The net of the acquisition date (fair value ) amount of the identifiable assets and liabilities acquired and the liabilities assumed . • Recognition and measurement of other intangible asset: • Firms should recognize intangible asset separate from goodwill only if they fall into one or two category : ❑Separable criterion ❑Contractual legal criterion • Intangible asset which is not separated should be recognize within the goodwill value. • Contingent consideration in an acquisition • Contingency arises when a need of additional amount to the previous stockholders of the acquired company. • The contingent consideration is an acquisition must be measured and recorded at fair value. • Contingent consideration can be classified into: ➢contingent consideration as an equity ➢contingent consideration as an liabilities • contingent consideration as an equity • Acquirer agree to issue additional shares of stock to the acquiree if the acquiree meets an earnings goal in the future. • At the date of acquisition the investment and paid in capital account are increased by the fair value of the contingent consideration. • The accounting treatment of subsequent changes in the fair value: ➢ Does not re-measure the fair value of the contingency at each reporting date until the contingency is resolved. ➢ The change in fair value is reflected in the equity account • contingent consideration as an liabilities • Acquirer agree to pay additional cash to the acquiree if the acquiree meets an earnings goal in the future ❑At the date of acquisition the investment and liabilities account are increased by the fair value of the contingent consideration • The accounting treatment of subsequent changes in the fair value: ❑It re-measure the fair value of the contingency at each reporting date until the contingency is resolved. ❑The change in fair value reported as gain or loss in the earning and liabilities is adjusted accordingly • Cost and fair value compared – Goodwill or Bargain Purchase • We compare the cost of the investment of the identifiable asset which were recorded to the fair value ❑If cost of investment > total identifiable asset less liabilities then the excess will be assigned to the goodwill. ❑If cost of investment < total identifiable asset less liabilities then the excess will be recorded as bargain purchase which recognized as a gain by the acquirer. Current GAAP for goodwill and other intangible assets: • Goodwill is impaired not amortize • All intangible and goodwill with indefinite useful should be impaired not amortize. • Goodwill amortization is not permitted and firms may not write goodwill back up reverse the impact of prior period amortization Recognizing and measurement impairment losses • Goodwill impairment test : • Firms first compare carrying values to fair value at the business reporting unit level • If the fair value is less than carrying amount then the impact of measurement has to recorded. • Compare of the carrying amount of goodwill to its implies value . Impairment has to be booked and we can not reverse previous impairment Impairment test of goodwill • Test for impairment of goodwill should be done at least once a year. If any of the below events occur a test is required: ➢ A significant adverse change in legal factors or in the business climate ➢ An adverse action or assessment by a regular ➢ Unanticipated competition ➢ Loss of key personnel ➢ A more likely than not expectation that a reporting unit or a significant portion of the unit will be sold ➢ Recognition of a goodwill impairment loss in the financial of a subsidiary. Amortization vs. non- amortization • Intangible asset with define useful life should be amortize over the time, company may use the amortization according to the use of the asset, if there is no patent then the firm should strait line amortization • Example 1: Acquisition with goodwill • Pitt Corporation acquires the net assets of Seed Company in an acquisition consummated on December 27, 2016. The assets and liabilities of Seed Company on this date, at their book values and at fair values, are as follows (in thousands): Cash Net Receivables Inventory Land Buildings, net Equipment, net Patents Total Book Value $ 50 150 200 50 300 250 0 Fair Value $ 50 140 250 100 500 350 50 $1,000 $1,440 Accounts Payable Notes Payable Other Liabilities 60 150 40 60 135 45 Total Liabilities $ 250 $ 240 Net Assets $ 750 $ 1,200 • Pitt Corporation pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par common stock with a market value of $20 per share for the net assets of Seed Co. Required: prepare the journal entries to record the previous transactions. Cost of the investment > Fair value of net assets Goodwill= cost of the investment – Fair value of net asset = [cash + (shares * market value)] – [fair value of asset – fair value of liabilities] [400 + (50 shares × $20)] – [1,440- 240]=200 Journal Entries 1. Entry to record the acquisition of the net assets: Investment in Subsidiary Cash Common stock Additional Paid-in capital Dr 1,400 Cr 400 500 500 2- Entry to assign the cost of subsidiary to net assets on the basis of their fair values Dr Cash Net receivables Inventories Land Buildings Equipment Patents Goodwill Accounts payable Notes payable Other liabilities Investment in Seed Co. Cr 50 140 250 100 500 350 50 200 60 135 45 1,400 • Example 2: Acquisition with Bargain Purchase • Pitt Corporation acquires the net assets of Seed Company in an acquisition consummated on December 27, 2016. The assets and liabilities of Seed Company on this date, at their book values and at fair values, are as follows (in thousands): Pitt Corporation issues 40,000 shares of its $10 par common stock with a market value of $20 per share , and it also gives a 10%, five-year note payable for $200,000 for the net assets of Seed Company. Required: prepare the journal entries to record the previous transactions. Answer Cost of the investment < Fair value of net assets Gain from bargain purchase= cost of the investment - Fair value of net assets = [(shares * market value) + Note payable] – [fair value of asset – fair value of liabilities] [(40 shares × $20) + $200]– [1,440- 240]=200 Journal Entries 1- Entry to record the acquisition of the net assets: Dr Investment in Subsidiary Note payable Common stock Additional capital Cr 1,000 200 400 400 2- Entry to assign the cost of subsidiary to net assets on the basis of their fair values Dr Cash Net receivables Inventories Land Buildings Equipment Patents Accounts payable Notes payable Other liabilities Investment in Seed Co. Gain from bargain purchase Cr 50 140 250 100 500 350 50 60 135 45 1,000 200 In January 1, 2017 Lake Company has acquired 90% of Pink Company for $3,150,000 on the date of the acquisition the subsidiary had retained earnings $900,000 and a capital of $2,100,000. Separate balance sheet as of 1 January 2017 for Lake Company and its Subsidiary. Exercise-1 Parent Subsidiary Cash Receivable Land Property Investment in Subsidiary Total assets 60,000 35,000 1,550,000 1,500,000 3,150,000 6,295,000 85,000 40,000 750,000 2,200,000 3,075,000 Account payable Other liabilities Capital stock Retained earnings Total equity and liabilities 55,000 87,000 4,900,000 1,253,000 6,295,000 60,000 15,000 2,100,000 900,000 3,075,000 • Prepare the journal entry on parent’s books to account for the investment in subsidiary • Is there any Goodwill raised from the business combination? If yes, compute the amount of Goodwill. • Record the elimination entry required for consolidation as of January 1, 2017. • Prepare the consolidated balance sheet Workpaper as of January 1, 2017. • Calculate the Investment amount of the parent and Noncontrolling interest in the subsidiary as of January 1, 2018, assuming that on December 31, 2017, the subsidiary has distributed $10,000 of cash dividends and has a net income of $90,000. Answer: a. The parent entry to account for the investment in subsidiary. Dr Investment in subsidiary Cash Cr 3,150,000 3,150,000 b. Goodwill Total FV= amount paid/ % Ownership = 3,150,000/90% = 3,500,000 Excess = 3,500,000 – (2,100,000+ 900,000) = 500,000 Goodwill = 500,000 C. Elimination entry required for consolidation as of January 1, 2017. • Capital stock- subsidiary RE – subsidiary Goodwill Investment in subsidiary NCI-Equity Dr 2,100,000 Cr 900,000 500,000 3,150,000 350,000 d. The consolidated balance sheet Workpaper as of January 1, 2017. • Parents Subsidiary Cash Receivable Land Property Investment in Subsidiary goodwill Total assets 60,000 35,000 1,550,000 1,500,000 3,150,000 6,295,000 3,075,000 Account payable Other liabilities Capital stock Retained earnings NCI-Equity Total equity and liabilities 55,000 87,000 4,900,000 1,253,000 60,000 15,000 2,100,000 900,000 adjustment Dr. Cr 85,000 40,000 750,000 2,200,000 500,000 Consolidated balance sheet 145,000 75,000 2,300,000 3,700,000 315,0000 500,000 6,720,000 2,100,000 900,000 350,000 6,295,000 3,075,000 115,000 102,000 4,900,000 1,253,000 350,000 6,720,000 e. New investment amount - parent Original Amount Add: adjusted net income (90,000*90%) 3,150,000 81,000 Less: Dividends (10,000* 90%) (9,000) = new investment 3,222,000 New NCI Original Amount Add: adjusted net income (90,000*10%) Less: Dividends (10,000* 10%) = new NCI 350,000 9,000 (1,000) 358,000 Chapter- 3 An introduction to consolidated financial statements. Objectives 1: Recognize the benefits and limitations of consolidated financial statements. • Business combination consummated through stock acquisition • Business combination includes combination in which one or more companies subsidiaries of parent corporation • Business combinations occur – Acquire controlling interest in voting stock – More than 50% – May have control through indirect Objective 2: Understand the requirements for inclusion of a subsidiary in consolidated financial statements. • • • • • The reporting entity Business combination brings two previously separated corporation under the control of one management. Although the corporation bring control of the entity under the parent, separate legal entity are maintained with separate records. Separate parent and subsidiary financial statement are converted into consolidated financial statement that reflect the financial position and results of operation of the combined entity. Consolidated financial statements are : – Primarily benefit the owners and creditors of the parent – Not primarily intended for the non-controlling owners nor the subsidiary’s creditors – Subsidiaries issue separate statements for the benefit of their owners and creditors • why maintain separate legal entity – To maintain customer loyalties – Legal reason, major lawsuit against a subsidiary results in a significant loss the parent cannot held accountable for more than the loss of the investment. • Parent – subsidiary relationship – A corporation becomes a subsidiary when another corporation acquires controlling interest in its outstanding voting stock. – In a 100 percent acquisition, the investee continues to operate as a separate legal entity. – Subsidiaries, or affiliates, continue as separate legal entities and prepare their own financial reports. – Consolidated financial statements are : • Primarily benefit the owners and creditors of the parent • Not primarily intended for the non-controlling owners nor the subsidiary’s creditors • Subsidiaries issue separate statements for the benefit of their owners and creditors • Consolidation policy • Consolidation of financial statement is required for companies which have more than 50% voting shares • Consolidation has more information that if parent view his financial separately. • Cases where a subsidiary may be excluded from consolidation: – – – – – Control doesn’t rest with majority owner Joint ventures Acquisitions of groups of assets that do not constitute a business Combination between entities under common control Combination of not-for-profit entities or acquisition of a for-profit company by a not-for-profit entity Objective 3: Apply the consolidation concepts to parent company recording of the investment in a subsidiary at the date of acquisition. Consolidation of balance sheet in date of acquisition Four cases in consolidation of balance sheet in date of acquisition: ➢ Parent acquire 100% of subsidiary book value ➢ Parent acquires 100% of subsidiary with goodwill ➢ Parent acquires 90% of subsidiary with goodwill ➢ Parent acquires 90% of subsidiary fair value of net asset does not equal to the Book value of the net asset. (assigning excess to identifiable asset) Case 1: Parent acquire 100% of subsidiary book value We eliminate the: ▪ investment in subsidiary (books of the parent) and ▪ the equity of the subsidiary (books of subsidiary) Elimination entry: Description Dr Capital stock- subsidiary XX RE – subsidiary XX Investment in subsidiary Cr XX • Example 1: Parent acquire 100% of subsidiary book value • Penn acquires 100% of Skelly for $40, which equals the book value and fair values of the net assets acquired. Required: ▪ Prepare journal entry to account for investment in Skelly Company. ▪ Prepare elimination entries ▪ Prepare Workpaper for Consolidated Balance sheet at date of acquisition Answer: Purchase price (fair value) = 100% book value 40 40 ‫؞‬No Excess 1- Entry to account for investment Description Dr Investment in subsidiary 40 Cash Cr 40 2- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Investment in subsidiary Cr 40 3- Workpaper for Consolidated Balance sheet Description Cash Other current assets Net plant Investment in subsidiary Total Accounts payable Other curr. liabilities Capital stock Retained earnings Total Parent Subsidiar y 20 45 60 40 10 15 40 - 165 20 25 100 20 165 65 15 10 30 10 65 Elimination entry Dr Cr 40 30 10 Consolidate d balance sheet 30 60 100 0 190 35 35 100 20 190 Objective 4: Allocate the excess of the fair value over the book value of the subsidiary at the date of acquisition. Case 2: Parent acquires 100% of subsidiary with goodwill • When the company acquire the subsidiary at a value higher than the book value of the net asset, there will be goodwill. • Goodwill = fair value of net asset – book value of the asset • Fair value of the net asset= acquisition price / parent ownership % • We eliminate the investment in subsidiary (books of the parent) and the equity of the subsidiary (books of subsidiary) and a goodwill account is created Elimination entry Description Dr Capital stock- subsidiary XX RE – subsidiary XX Goodwill XX Investment in subsidiary Cr XX Example 2: Parent acquires 100% of subsidiary with goodwill Penn acquires 100% of Skelly for $50, with the following information: Required: • Prepare elimination entries • Prepare Workpaper for Consolidated Balance sheet at date of acquisition Answer • Purchase price (fair value) ≠ 100% book value • 50 40 • ‫؞‬Excess = 10 • NO differences between fair values and book values of identifiable net assets. • ‫؞‬the total excess of fair value over book value will be assigned to Goodwill 1- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Goodwill 10 Investment in subsidiary Cr 50 2- Workpaper for Consolidated Balance sheet Description Parent Subsidiary Cash Other current assets Net plant Investment in subsidiary Goodwill Total Accounts payable Other curr. liabilities Capital stock Retained earnings Total 10 45 60 50 10 15 40 - Elimination entry Dr Cr 50 10 165 20 25 100 20 165 65 15 10 30 10 65 30 10 Consolidated balance sheet 20 60 100 0 10 190 35 35 100 20 190 Objective 5: Learn the concept of non-controlling interest when the parent company acquires less than 100% of the subsidiary's outstanding common stock. • Non controlling interest • A non controlling interest in a subsidiary should be displayed and labeled in the consolidation balance sheet as a separate component of equity • Income attributable to non controlling interest is not an expense or loss but a deduction from consolidated net income to compute income attributable to the controlling interest. • Both components of consolidation net income should be disclosed on the face of the consolidated income statement Case 3: Parent acquires 90% of subsidiary with goodwill • • • • • • According to acquisition method asset and liabilities including non controlling interest are measured using fair value .Except for employee benefits and deferred tax which is booked using the book value. Asset and liabilities is recorded at 100% fair value on the date of acquisition based on the price paid by the parent for the controlling interest, even if the parent has acquired less than 100%. Fair value are not recalculated in future reporting date . Impairment if assets including goodwill has to be recorded. Financial liabilities and asset may be revaluated but its optional. The difference between the subsidiary fair value and the book value is recoded as goodwill. • • To solve: – • • Fair value of the net asset= acquisition price / parent ownership % – • • Calculate the goodwill: Goodwill = fair value of net asset – book value of the asset – • Calculate the fair value of the net asset: Calculate the NCI NCI = Fair value of the net asset * NCI ownership% Elimination entry Description Dr Capital stock- subsidiary XX RE – subsidiary XX Goodwill XX Cr Investment in subsidiary XX NCI - Equity XX Example 3: Parent acquires 90% of subsidiary with goodwill Penn acquires 90% of Skelly for $45, with the following information: Required: • Prepare elimination entries • Prepare Workpaper for Consolidated Balance sheet at date of acquisition. Answer Implied fair value of net asset= acquisition price = 45 = 50 Parent ownership % 90% Excess =Implied fair value of net asset – book value of net assets = 50 – (65-25)= 10 NO differences between fair values and book values of identifiable net assets ‫؞‬the total excess of fair value over book value will be assigned to Goodwill. ‫؞‬Goodwill = 10 NCI = Implied fair value of net asset × NCI ownership% = 50 × 10% = 5 1- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Go

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The TMA Questions
PART A
In 2018. CVS Health Corporation reported a $6.1 billion charge for the impairment of goodwill
in one of its reporting units (segments) in its 10-K annual report. Referring to CVS Health’s
2018 financial statements and any other information from the media, address the following:
1. CVS Health’s segments serve as its reporting units for assessing goodwill for potential
impairments. Which segment suffered a 2018 impairment? Describe the revenue model
for this segment.
2. Discuss in details the underlying business reasons that required CVS Health to record a
goodwill impairment in 2018? Do not provide general reasons.
3. How did CVS Health reflect the 2018 goodwill impairment in its income statement and
cash flow statement?
4. Describe in your own words the goodwill impairment testing steps performed by CVS
Health in 2018 and the consequent loss measurement.
(Support your answer by writing the page number(s) in the annual report, from which
you get your answer)
https://www.annualreports.com/HostedData/AnnualReportArchive/c/NYSE_CVS_2018.pdf
PART B
1- Explain in details, the differences between the IFRS and GAAP (after FASB issued ASU
2017-04 to simplify the accounting for goodwill impairment) regarding the following:
– Assignment/allocation of goodwill. (i.e. The levels at which goodwill is assigned
/allocated)
– Impairment of goodwill and test(s) applied and its steps (i.e. Methods of determining
impairment of goodwill)
– How impairment loss is recognized and allocated.(i.e. impairment loss[charge] calculation
and allocation)
Answer this question in a tabular format, like the following one:
IFRS
GAAP
Assignment/allocation of goodwill
Impairment of goodwill
How impairment loss is
recognized and allocated
(You must support your answer in this question with quality and up to date
references.)
2- If the accountant did not prepare the elimination entry of unrealized profit in inventories at
the end of any year, this will affect the consolidated net income in that year and in all
subsequent years. Discuss this statement and support your answer with a numerical example.
3- What is the difference between upstream sale of inventory and a downstream sale? Why is
it important to know the direction of sale when preparing the consolidated financial statements?
PART C
1) Firms should conduct the impairment test for goodwill at least annually. Accounting
standards require more frequent impairment testing if some events occurs.
a) Identify the main events upon which goodwill undergoes a test for its impairment.
b) Provide two recent examples from the real world for companies that made the goodwill
impairment test and reported impairment charges (Excluding CVS Health Corporation &
Dell Technologies Inc.). Your answer must be in a tabular format, and cover all the
following points:
Example 1
Name of the company
The year
– The amount and details of these
impairment charges as mentioned
in the annual report
– The URL(Internet address) of the
annual report
– The page number(s) in the annual
report.
The specific underlying business
reasons that required these
companies to record the goodwill
impairment charges.
Example 2
(Answers not provided in a tabular format will be disregarded and any examples given
dated before the year 2001 will not be considered.
2) Provide examples from the real world for successful and unsuccessful mergers and
acquisitions cases in recent years and state the specific reasons behind their success or
failure. (Do not provide general reasons behind success or failure & only one example
should be provided for each case, any examples given dated before the year 2001 will
not be considered).
PART D:
On January 1, 2018, Pal Corporation acquired 80% of the voting stock of Secam Corporation
for $24,000 when Secam had Capital Stock of $10,000 and Retained Earnings of $8,000. On
this date, the book value of Secam’s assets and liabilities was equal to the fair value, except for
inventories, , which were understated on the books by $1,000 and were sold in 2018, land
which was undervalued by $2,000, and equipment with a remaining useful life of 5 years under
the straight-line method which was undervalued by $3,000. Any remainder was assigned to
goodwill.
Financial statements for the two corporations at the end of the fiscal year ended December 31,
2019 appear in the first two columns of the partially completed consolidation working papers.
Pal has accounted for its investment in Secam using the equity method of accounting. Pal
Corporation owed Secam Corporation $200 on open account at the end of the year. Dividends
receivable in the amount of $900 payable from Secam to Pal is included in Pal’s net receivables.
Required:
1) Prepare the elimination entries required for consolidation on December 31, 2019. Show all
your calculations.
2) Complete the consolidation working papers for Pal Corporation and Subsidiary for the
year ended December 31, 2019.
INCOME STATEMENT
Sales
Income from Secam
Cost of Sales
Depreciation Expense
Other expenses
Non control1ing Interest Share
Net income
Retained Earnings 1/1
Pal
Secam
20,000
1,920
(8,000)
(2,000)
(3,600)
13,000
8,320
5,020
Add: Net income
Less: Dividends
Retained Earnings 12/31
BALANCE SHEET
8,320
(4,000)
9,340
Cash
Receivables—net
Inventories
Land
Equipment and Buildings-net
2,880
2,200
3,000
2,000
15,000
Investment in Secam Corp
Goodwill
24,640
(6600)
(2000)
(1,400)
3,000
10,000
3,000
(2,000)
11,000
3,800
1,200
2,400
3,200
13,400
Unamortized Excess
TOTAL ASSETS
LIAB. & EQUITY
49,720
24,000
Accounts Payable
Dividends Payable
Capital Stock
Ret. Earnings
Nonctl Interest 1/1
Nonctl. Interest 12/31
LIAB. & EQUITY
8.380
4,000
28,000
9,340
2,000
1,000
10,000
11,000
49,720
24,000
Eliminations
Debit
Credit
Consolidated
Advance Financial Accounting:
B326
Chapter 1: Business Combination
Objectives 1: Understand the
economic motivations underlying
business combination
• The main objective of businesses today is to
increase the wealth of its shareholders.
• To do so, it has to expand internally (expand
its facilities) or externally (mergers and
acquisitions).
• In general business combination is done, to
increase its profitability or increase the
efficiency (vertical and horizontal integration).
Types of Business Combinations
Business combinations unite previously separate
business entities.
• Horizontal integration: same business lines
and markets
• Vertical integration: operations in different,
but successive stages of production or
distribution, or both
• Conglomeration: unrelated and diverse
products or services
Reasons for Combinations
Cost advantage
• Its less expensive to obtain the needed facility through business
combination rather than developing it.
Lower risk
• Less risky to by already developed product line than developing one
• Diversity is the only way to reduce the risk for single product
company and to expand.
Fewer operating delays
• Plant facilities acquired from business combination is ready to use
and meet the environmental and governmental regulation. Which
will reduce delays in construction and approvals.
Avoidance of takeovers
• To avoid takeovers of small companies from large
ones
Acquisition of intangible assets
• Business combinations bring the tangible and
intangible asset (patent, database, mineral right)
Other:
• business and other tax advantages, personal
reasons
Objective- 2: Learn about alternative forms of
business combinations, from both the legal and
accounting perspectives
• Legal Form of Combination
• Merger
• Occurs when one corporation takes over all the
operations of another business entity and that
other entity is dissolved.
• Merger occur when (A+B=A) :
• Company A purchases the assets of Company B for cash,
other assets, or Company A debt/equity securities. Company
B is dissolved; Company A survives with Company B’s assets
and liabilities.
• Company A purchases Company B stock from its
shareholders for cash, other assets, or Company A
debt/equity securities. Company B is dissolved. Company A
survives with Company B’s assets and liabilities.
• Consolidation
• Occurs when a new corporation is formed to take over
the assets and operations of two or more separate
business entities and dissolves the previously separate
entities.
• Consolidation occur when (E+F=D):
• Company D is formed and acquires the assets of Companies E and
F by issuing Company D stock. Companies E and F are dissolved.
Company D survives, with the assets and liabilities of both
dissolved firms.
• Company D is formed acquires Company E and F stock from their
respective shareholders by issuing Company D stock. Companies E
and F are dissolved. Company D survives with the assets and
liabilities of both firms.
Acquisition
• When corporation acquires the productive asset of another
business entity and integrates those assets into its own
operation.
• When one corporation obtains operating control over the
productive facilities of another entity by acquiring a
majority of its outstanding voting stock.
• The acquired company may not be dissolve and does not
have to go out of existence.
• Acquisition occur (A+B=A+B):
• Company A buys asset of company B for cash or buys its
shares for cash and does not dissolve the company. Which
will give company A legal owner ship of asset
Objective 3: Introduce accounting
concepts for business combinations,
emphasizing the acquisition method.
Business combination:
• According to GAAP “A transaction or other event in which an
acquirer obtains control of one or, more businesses. Transaction
sometimes referred to as true mergers or mergers equals also are
business combination”.
• Accounting concept for business combination focus on the creation
of a single entity and the independence of the combining
companies before their union.
• previously, separate businesses are brought together into one when
their recourse and operation come under control of one single
management which means:
• one or more corporation become subsidiaries
• one company transfers its net assets to another
• each company transfers its net assets to newly formed corporation
• parent – subsidiary relationship
• A parent – subsidiary relationship is formed when:
– Less than 100% of the firm is acquired, or
– The acquired firm is not dissolved.
•
• Subsidiary
– A corporation becomes subsidiary when another operation
acquire a majority of its outstanding shares.
– Majority of shares more than 50% of its voting shares.
– In a combination of less than 100%, the combining companies
necessarily retain separate legal entity and separate accounting
records even though they become one in the financial reporting.
• Background of accounting for business combination
• previously the accounting method for business combination is
pooling interest method in 1950.
• the pooling method has faced a lot of difficulties which had lead for
the introduction of new method called acquisition method.
• pooling method uses historical cost rather than fair value( as
acquisition method)
• in 2001 the pooling method has been eliminated from FASB
because:
– pooling provide less relevant information to statement users
– pooling ignores economic value exchanges in the transaction and
makes subsequent performance evaluating impossible
– comparing firms using alter native method is difficult of investors..
• Recording Guidelines
• Record assets acquired and liabilities assumed using the fair value
principle.
• If equity securities are issued by the acquirer, charge registration and issue
costs against the fair value of the securities issued, usually a reduction in
additional paid-in-capital.
• Charge other direct combination costs (e.g., legal fees, finders’ fees) and
indirect combination costs (e.g., management salaries) to expense.
• When the acquiring firm transfers its assets other than cash as part of the
combination, any gain or loss on the disposal of those assets is recorded
in current income.
• The excess of cash, other assets and equity securities transferred over the
fair value of the net assets (A – L) acquired is recorded as goodwill.
• If the net assets acquired exceeds the cash, other assets and equity
securities transferred, a gain on the bargain purchase is recorded in
current income.
Recording issuance of shares
Dr
Investment in Subsidiary
(#shares * per XX
share)
Common Stock (#shares * par)
Additional Paid-in capital (difference)
Cr
XX
XX
• Example:
• Poppy Corp. issues 100,000 shares of its $10 par value
common stock for Sunny Corp. Poppy’s stock is valued at $16
per share. (in thousands)
Dr
Investment in Subsidiary
Cr
1,600
Common Stock
1,000
Additional Paid-in capital
600
• Poppy Corp. pays cash for $80,000 in finder’s fees and
consulting fees and for $40,000 to register and issue its
common stock. (in thousands)
Dr
Investment expense
80
Additional Paid-in capital
40
Cash
Cr
120
If Sunny Corp. is dissolved, Poppy Corp. will
allocate the investment’s cost to the fair value of
the identifiable assets acquired and liabilities
assumed. Any excess of investment cost over fair
value of net assets is recorded as goodwill.
If Subsidiary is dissolved:
Assigning the cost of subsidiary to net assets on the basis of
their fair values:
Dr
Receivables
Inventories
Plant assets
Goodwill
Cr
XX
XX
XX
XX
XX
OR
Accounts payable
Notes payable
Investment in Subsidiary
Gain from bargain purchase
XX
XX
XX
Objective 4:
Cost Allocations Using the Acquisition Method
Recording Fair values in an acquisition
Identify the Net Assets Acquired
• Tangible assets acquired,
• Intangible assets acquired, and
• Liabilities assumed
Assign Fair Values to Net Assets:
Use fair values determined, in preferential order, by:
➢ Established market prices
➢ Present value of estimated future cash flows,
discounted based on observable measures
➢ Other internally derived estimations
• Goodwill
• The goodwill resulting from business combination :
The acquirer shall recognize goodwill as of the acquisition
date measured as excess of (A) over (B):
• The aggregate of the following:
▪ The consideration transferred measured at fair value at acquisition
date
▪ The fair value of any non controlling interest
▪ The acquisition fate fair value of the acquirers previously held equity
interest in the acquire.
▪ The net of the acquisition date (fair value ) amount of the
identifiable assets and liabilities acquired and the liabilities
assumed .
• Recognition and measurement of other
intangible asset:
• Firms should recognize intangible asset
separate from goodwill only if they fall into
one or two category :
❑Separable criterion
❑Contractual legal criterion
• Intangible asset which is not separated should
be recognize within the goodwill value.
• Contingent consideration in an acquisition
• Contingency arises when a need of additional
amount to the previous stockholders of the
acquired company.
• The contingent consideration is an acquisition
must be measured and recorded at fair value.
• Contingent consideration can be classified into:
➢contingent consideration as an equity
➢contingent consideration as an liabilities
• contingent consideration as an equity
• Acquirer agree to issue additional shares of stock to
the acquiree if the acquiree meets an earnings goal in
the future.
• At the date of acquisition the investment and paid in
capital account are increased by the fair value of the
contingent consideration.
• The accounting treatment of subsequent changes in
the fair value:
➢ Does not re-measure the fair value of the contingency at
each reporting date until the contingency is resolved.
➢ The change in fair value is reflected in the equity account
• contingent consideration as an liabilities
• Acquirer agree to pay additional cash to the acquiree if
the acquiree meets an earnings goal in the future
❑At the date of acquisition the investment and liabilities
account are increased by the fair value of the contingent
consideration
• The accounting treatment of subsequent changes in
the fair value:
❑It re-measure the fair value of the contingency at each
reporting date until the contingency is resolved.
❑The change in fair value reported as gain or loss in the
earning and liabilities is adjusted accordingly
• Cost and fair value compared – Goodwill or
Bargain Purchase
• We compare the cost of the investment of the
identifiable asset which were recorded to the fair
value
❑If cost of investment > total identifiable asset less
liabilities then the excess will be assigned to the
goodwill.
❑If cost of investment < total identifiable asset less liabilities then the excess will be recorded as bargain purchase which recognized as a gain by the acquirer. Current GAAP for goodwill and other intangible assets: • Goodwill is impaired not amortize • All intangible and goodwill with indefinite useful should be impaired not amortize. • Goodwill amortization is not permitted and firms may not write goodwill back up reverse the impact of prior period amortization Recognizing and measurement impairment losses • Goodwill impairment test : • Firms first compare carrying values to fair value at the business reporting unit level • If the fair value is less than carrying amount then the impact of measurement has to recorded. • Compare of the carrying amount of goodwill to its implies value . Impairment has to be booked and we can not reverse previous impairment Impairment test of goodwill • Test for impairment of goodwill should be done at least once a year. If any of the below events occur a test is required: ➢ A significant adverse change in legal factors or in the business climate ➢ An adverse action or assessment by a regular ➢ Unanticipated competition ➢ Loss of key personnel ➢ A more likely than not expectation that a reporting unit or a significant portion of the unit will be sold ➢ Recognition of a goodwill impairment loss in the financial of a subsidiary. Amortization vs. non- amortization • Intangible asset with define useful life should be amortize over the time, company may use the amortization according to the use of the asset, if there is no patent then the firm should strait line amortization • Example 1: Acquisition with goodwill • Pitt Corporation acquires the net assets of Seed Company in an acquisition consummated on December 27, 2016. The assets and liabilities of Seed Company on this date, at their book values and at fair values, are as follows (in thousands): Cash Net Receivables Inventory Land Buildings, net Equipment, net Patents Total Book Value $ 50 150 200 50 300 250 0 Fair Value $ 50 140 250 100 500 350 50 $1,000 $1,440 Accounts Payable Notes Payable Other Liabilities 60 150 40 60 135 45 Total Liabilities $ 250 $ 240 Net Assets $ 750 $ 1,200 • Pitt Corporation pays $400,000 cash and issues 50,000 shares of Pitt Corporation $10 par common stock with a market value of $20 per share for the net assets of Seed Co. Required: prepare the journal entries to record the previous transactions. Cost of the investment > Fair value of net assets
Goodwill= cost of the investment – Fair value of
net asset
= [cash + (shares * market value)] – [fair value of
asset – fair value of liabilities]
[400 + (50 shares × $20)] – [1,440- 240]=200
Journal Entries
1. Entry to record the acquisition of the net assets:
Investment in Subsidiary
Cash
Common stock
Additional Paid-in capital
Dr
1,400
Cr
400
500
500
2- Entry to assign the cost of subsidiary to net assets on the
basis of their fair values
Dr
Cash
Net receivables
Inventories
Land
Buildings
Equipment
Patents
Goodwill
Accounts payable
Notes payable
Other liabilities
Investment in Seed Co.
Cr
50
140
250
100
500
350
50
200
60
135
45
1,400
• Example 2: Acquisition with Bargain Purchase
• Pitt Corporation acquires the net assets of
Seed Company in an acquisition consummated
on December 27, 2016. The assets and
liabilities of Seed Company on this date, at
their book values and at fair values, are as
follows (in thousands):
Pitt Corporation issues 40,000 shares of its $10
par common stock with a market value of $20
per share , and it also gives a 10%, five-year note
payable for $200,000 for the net assets of Seed
Company.
Required: prepare the journal entries to record
the previous transactions.
Answer
Cost of the investment < Fair value of net assets Gain from bargain purchase= cost of the investment - Fair value of net assets = [(shares * market value) + Note payable] – [fair value of asset – fair value of liabilities] [(40 shares × $20) + $200]– [1,440- 240]=200 Journal Entries 1- Entry to record the acquisition of the net assets: Dr Investment in Subsidiary Note payable Common stock Additional capital Cr 1,000 200 400 400 2- Entry to assign the cost of subsidiary to net assets on the basis of their fair values Dr Cash Net receivables Inventories Land Buildings Equipment Patents Accounts payable Notes payable Other liabilities Investment in Seed Co. Gain from bargain purchase Cr 50 140 250 100 500 350 50 60 135 45 1,000 200 In January 1, 2017 Lake Company has acquired 90% of Pink Company for $3,150,000 on the date of the acquisition the subsidiary had retained earnings $900,000 and a capital of $2,100,000. Separate balance sheet as of 1 January 2017 for Lake Company and its Subsidiary. Exercise-1 Parent Subsidiary Cash Receivable Land Property Investment in Subsidiary Total assets 60,000 35,000 1,550,000 1,500,000 3,150,000 6,295,000 85,000 40,000 750,000 2,200,000 3,075,000 Account payable Other liabilities Capital stock Retained earnings Total equity and liabilities 55,000 87,000 4,900,000 1,253,000 6,295,000 60,000 15,000 2,100,000 900,000 3,075,000 • Prepare the journal entry on parent’s books to account for the investment in subsidiary • Is there any Goodwill raised from the business combination? If yes, compute the amount of Goodwill. • Record the elimination entry required for consolidation as of January 1, 2017. • Prepare the consolidated balance sheet Workpaper as of January 1, 2017. • Calculate the Investment amount of the parent and Noncontrolling interest in the subsidiary as of January 1, 2018, assuming that on December 31, 2017, the subsidiary has distributed $10,000 of cash dividends and has a net income of $90,000. Answer: a. The parent entry to account for the investment in subsidiary. Dr Investment in subsidiary Cash Cr 3,150,000 3,150,000 b. Goodwill Total FV= amount paid/ % Ownership = 3,150,000/90% = 3,500,000 Excess = 3,500,000 – (2,100,000+ 900,000) = 500,000 Goodwill = 500,000 C. Elimination entry required for consolidation as of January 1, 2017. • Capital stock- subsidiary RE – subsidiary Goodwill Investment in subsidiary NCI-Equity Dr 2,100,000 Cr 900,000 500,000 3,150,000 350,000 d. The consolidated balance sheet Workpaper as of January 1, 2017. • Parents Subsidiary Cash Receivable Land Property Investment in Subsidiary goodwill Total assets 60,000 35,000 1,550,000 1,500,000 3,150,000 6,295,000 3,075,000 Account payable Other liabilities Capital stock Retained earnings NCI-Equity Total equity and liabilities 55,000 87,000 4,900,000 1,253,000 60,000 15,000 2,100,000 900,000 adjustment Dr. Cr 85,000 40,000 750,000 2,200,000 500,000 Consolidated balance sheet 145,000 75,000 2,300,000 3,700,000 315,0000 500,000 6,720,000 2,100,000 900,000 350,000 6,295,000 3,075,000 115,000 102,000 4,900,000 1,253,000 350,000 6,720,000 e. New investment amount - parent Original Amount Add: adjusted net income (90,000*90%) 3,150,000 81,000 Less: Dividends (10,000* 90%) (9,000) = new investment 3,222,000 New NCI Original Amount Add: adjusted net income (90,000*10%) Less: Dividends (10,000* 10%) = new NCI 350,000 9,000 (1,000) 358,000 Chapter- 3 An introduction to consolidated financial statements. Objectives 1: Recognize the benefits and limitations of consolidated financial statements. • Business combination consummated through stock acquisition • Business combination includes combination in which one or more companies subsidiaries of parent corporation • Business combinations occur – Acquire controlling interest in voting stock – More than 50% – May have control through indirect Objective 2: Understand the requirements for inclusion of a subsidiary in consolidated financial statements. • • • • • The reporting entity Business combination brings two previously separated corporation under the control of one management. Although the corporation bring control of the entity under the parent, separate legal entity are maintained with separate records. Separate parent and subsidiary financial statement are converted into consolidated financial statement that reflect the financial position and results of operation of the combined entity. Consolidated financial statements are : – Primarily benefit the owners and creditors of the parent – Not primarily intended for the non-controlling owners nor the subsidiary’s creditors – Subsidiaries issue separate statements for the benefit of their owners and creditors • why maintain separate legal entity – To maintain customer loyalties – Legal reason, major lawsuit against a subsidiary results in a significant loss the parent cannot held accountable for more than the loss of the investment. • Parent – subsidiary relationship – A corporation becomes a subsidiary when another corporation acquires controlling interest in its outstanding voting stock. – In a 100 percent acquisition, the investee continues to operate as a separate legal entity. – Subsidiaries, or affiliates, continue as separate legal entities and prepare their own financial reports. – Consolidated financial statements are : • Primarily benefit the owners and creditors of the parent • Not primarily intended for the non-controlling owners nor the subsidiary’s creditors • Subsidiaries issue separate statements for the benefit of their owners and creditors • Consolidation policy • Consolidation of financial statement is required for companies which have more than 50% voting shares • Consolidation has more information that if parent view his financial separately. • Cases where a subsidiary may be excluded from consolidation: – – – – – Control doesn’t rest with majority owner Joint ventures Acquisitions of groups of assets that do not constitute a business Combination between entities under common control Combination of not-for-profit entities or acquisition of a for-profit company by a not-for-profit entity Objective 3: Apply the consolidation concepts to parent company recording of the investment in a subsidiary at the date of acquisition. Consolidation of balance sheet in date of acquisition Four cases in consolidation of balance sheet in date of acquisition: ➢ Parent acquire 100% of subsidiary book value ➢ Parent acquires 100% of subsidiary with goodwill ➢ Parent acquires 90% of subsidiary with goodwill ➢ Parent acquires 90% of subsidiary fair value of net asset does not equal to the Book value of the net asset. (assigning excess to identifiable asset) Case 1: Parent acquire 100% of subsidiary book value We eliminate the: ▪ investment in subsidiary (books of the parent) and ▪ the equity of the subsidiary (books of subsidiary) Elimination entry: Description Dr Capital stock- subsidiary XX RE – subsidiary XX Investment in subsidiary Cr XX • Example 1: Parent acquire 100% of subsidiary book value • Penn acquires 100% of Skelly for $40, which equals the book value and fair values of the net assets acquired. Required: ▪ Prepare journal entry to account for investment in Skelly Company. ▪ Prepare elimination entries ▪ Prepare Workpaper for Consolidated Balance sheet at date of acquisition Answer: Purchase price (fair value) = 100% book value 40 40 ‫؞‬No Excess 1- Entry to account for investment Description Dr Investment in subsidiary 40 Cash Cr 40 2- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Investment in subsidiary Cr 40 3- Workpaper for Consolidated Balance sheet Description Cash Other current assets Net plant Investment in subsidiary Total Accounts payable Other curr. liabilities Capital stock Retained earnings Total Parent Subsidiar y 20 45 60 40 10 15 40 - 165 20 25 100 20 165 65 15 10 30 10 65 Elimination entry Dr Cr 40 30 10 Consolidate d balance sheet 30 60 100 0 190 35 35 100 20 190 Objective 4: Allocate the excess of the fair value over the book value of the subsidiary at the date of acquisition. Case 2: Parent acquires 100% of subsidiary with goodwill • When the company acquire the subsidiary at a value higher than the book value of the net asset, there will be goodwill. • Goodwill = fair value of net asset – book value of the asset • Fair value of the net asset= acquisition price / parent ownership % • We eliminate the investment in subsidiary (books of the parent) and the equity of the subsidiary (books of subsidiary) and a goodwill account is created Elimination entry Description Dr Capital stock- subsidiary XX RE – subsidiary XX Goodwill XX Investment in subsidiary Cr XX Example 2: Parent acquires 100% of subsidiary with goodwill Penn acquires 100% of Skelly for $50, with the following information: Required: • Prepare elimination entries • Prepare Workpaper for Consolidated Balance sheet at date of acquisition Answer • Purchase price (fair value) ≠ 100% book value • 50 40 • ‫؞‬Excess = 10 • NO differences between fair values and book values of identifiable net assets. • ‫؞‬the total excess of fair value over book value will be assigned to Goodwill 1- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Goodwill 10 Investment in subsidiary Cr 50 2- Workpaper for Consolidated Balance sheet Description Parent Subsidiary Cash Other current assets Net plant Investment in subsidiary Goodwill Total Accounts payable Other curr. liabilities Capital stock Retained earnings Total 10 45 60 50 10 15 40 - Elimination entry Dr Cr 50 10 165 20 25 100 20 165 65 15 10 30 10 65 30 10 Consolidated balance sheet 20 60 100 0 10 190 35 35 100 20 190 Objective 5: Learn the concept of non-controlling interest when the parent company acquires less than 100% of the subsidiary's outstanding common stock. • Non controlling interest • A non controlling interest in a subsidiary should be displayed and labeled in the consolidation balance sheet as a separate component of equity • Income attributable to non controlling interest is not an expense or loss but a deduction from consolidated net income to compute income attributable to the controlling interest. • Both components of consolidation net income should be disclosed on the face of the consolidated income statement Case 3: Parent acquires 90% of subsidiary with goodwill • • • • • • According to acquisition method asset and liabilities including non controlling interest are measured using fair value .Except for employee benefits and deferred tax which is booked using the book value. Asset and liabilities is recorded at 100% fair value on the date of acquisition based on the price paid by the parent for the controlling interest, even if the parent has acquired less than 100%. Fair value are not recalculated in future reporting date . Impairment if assets including goodwill has to be recorded. Financial liabilities and asset may be revaluated but its optional. The difference between the subsidiary fair value and the book value is recoded as goodwill. • • To solve: – • • Fair value of the net asset= acquisition price / parent ownership % – • • Calculate the goodwill: Goodwill = fair value of net asset – book value of the asset – • Calculate the fair value of the net asset: Calculate the NCI NCI = Fair value of the net asset * NCI ownership% Elimination entry Description Dr Capital stock- subsidiary XX RE – subsidiary XX Goodwill XX Cr Investment in subsidiary XX NCI - Equity XX Example 3: Parent acquires 90% of subsidiary with goodwill Penn acquires 90% of Skelly for $45, with the following information: Required: • Prepare elimination entries • Prepare Workpaper for Consolidated Balance sheet at date of acquisition. Answer Implied fair value of net asset= acquisition price = 45 = 50 Parent ownership % 90% Excess =Implied fair value of net asset – book value of net assets = 50 – (65-25)= 10 NO differences between fair values and book values of identifiable net assets ‫؞‬the total excess of fair value over book value will be assigned to Goodwill. ‫؞‬Goodwill = 10 NCI = Implied fair value of net asset × NCI ownership% = 50 × 10% = 5 1- Elimination entry Description Dr Capital stock- subsidiary 30 RE – subsidiary 10 Go