CHAPTER
6
THE PURCHASE
METHOD:
POSTACQUISITION
PERIODS
AND PARTIAL
OWNERSHIPS
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
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.
Parent’s Amortization of Cost in
Excess of Book Value: How Handled?
• Non-Push-Down Accounting:
GL
– 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.
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
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.
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).
Liquidating Dividends:
Acquired vs. Created Subsidiaries
• Can a created subsidiary declare a
liquidating dividend?
NO
• No such thing exists for a created
subsidiary.
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.
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.
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.
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.)
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.
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.
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.
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.
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
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.
–
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.
–
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
End of Chapter 6
• Time to Clear Things Up—Any
Questions?