Chapter 5 - Consolidation Subsequent to Acquisition Date PDF

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Chapter 5Consolidation Subsequent toAcquisition Datecombination.PROBLEMSProblem 5-1 (20 min.) This problem involves a calculation of goodwill impairment loss and a comparison of the calculation of goodwill at the date of acquisition compared to goodwill after an impairment loss.Problem 5-2 (30 min.)...

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Chapter 5 Consolidation Subsequent to Acquisition Date

A brief description of the major points covered in each case and problem. CASES Case 5-1 In this case, students must discuss how to value employees and patentable products and how these assets should be amortized or checked for impairment on an annual basis. Case 5-2 In this case, adapted from a CPA exam, students are asked to determine appropriate accounting policies relating to a restructuring of a real estate company. A special purpose balance sheet needs to be prepared that reports all assets and liabilities at fair value.

Case 5-3 In this case, adapted from a CPA exam, students are asked to provide advice in managing a new company providing warranties for new homes. Students must also recommend appropriate accounting policies relating to revenue recognition, warranty obligations and a business combination involving some unique factors in allocating the acquisition cost. Case 5-4 In this real life case, students are asked to provide advice in resolving a salary dispute for a hockey team. The owner of the hockey team states that he cannot afford the demands from the union. However, consolidated statements are not being prepared for the combined operations of the hockey team and Stadium, which is a subsidiary of the hockey team. Case 5-5 In this case, adapted from a CPA exam, management appears to be manipulating income to minimize the payment required under a share-redemption agreement. Students are required to apply special accounting policies when analyzing controversial accounting issues including the valuation of inventory, capitalization policies, goodwill, and related party transactions. Case 5-6 In this case, adapted from a CPA exam, management appears to be manipulating income to maximize its bonus. Students must recommend appropriate accounting policies relating to revenue recognition, research and development costs and identifiable assets in a business

combination.

PROBLEMS Problem 5-1 (20 min.) This problem involves a calculation of goodwill impairment loss and a comparison of the calculation of goodwill at the date of acquisition compared to goodwill after an impairment loss. Problem 5-2 (30 min.) This problem requires the preparation of journal entries under the cost method and equity method, calculation of various amounts for the consolidated financial statements for the third year after acquisition and calculation of the equity method balance in the investment account. Problem 5-3 (25 min.) This problem requires the calculation of various consolidated amounts for the income statement and balance sheet for the fifth year after acquisition and an indication of the impact of goodwill impairment on key financial statement items. Problem 5-4 (15 min.) The consolidated balance sheet as well as the balance sheet of a parent and its less than 100%- owned subsidiary are presented. Students are required to answer four questions about the parent and its subsidiary. Problem 5-5 (25 min.) Selected information from the financial statements of a parent and its 85%-owned subsidiary for a two-year period is given and the student is required to calculate the amounts for various items that would appear in the consolidated statements during this period. Problem 5-6 (40 min.) This is a tricky problem in which details of changes in the parent’s investment account over a three-year period are given. The student is asked to calculate amounts from the subsidiary's financial statements as well as amounts for certain items on the consolidated statements.

Problem 5-7 (30 min) Consolidated financial statements and a calculation of consolidated retained earnings are required for a parent and its 80%-owned subsidiary for the third year after acquisition. Noncontrolling interest is measured using the trading price of the subsidiary at the date of acquisition. Problem 5-8 (25 min.) This problem involves the calculation of goodwill and equipment for the consolidated statements and a series of questions comparing the cost and equity methods and the affects, if any, of these methods on the preparation of consolidated financial statements. Problem 5-9 (40 min.) A relatively straightforward question requiring the preparation of consolidated financial statements one year after acquisition date. Problem 5-10 (60 min.) This problem requires the preparation of consolidated financial statements four years after a parent acquired 80% control in a subsidiary. Part of the acquisition cost is allocated to unrecognised trademarks. Students must also assess the impact on two ratios of not allocating any of the acquisition cost to the trademarks.

Problem 5-11 (50 min.) This problem requires the preparation of consolidated financial statements two and one-half years after a parent acquired 80% control in a subsidiary. Also required are calculations of goodwill, goodwill impairment and non-controlling interest under the parent company extension theory. The parent uses the equity method for internal reporting. Problem 5-12 (55 min.) Consolidated financial statements of a 75%-owned subsidiary, four years after acquisition is required after impairment tests for goodwill and software have been performed. Also required are calculations of goodwill impairment loss and non-controlling interest under the parent company extension theory and an explanation of how the use of the parent company extension theory would affect the debt to equity ratio.

Problem 5-13 (55 min.) The preparation of consolidated financial statements is required four and one-half years after the acquisition of an 80%-owned subsidiary. Also required are calculations of goodwill, goodwill impairment and non-controlling interest under the parent company extension theory. Problem 5-14 (55 min.) Consolidated financial statements of a parent and its 80%-owned subsidiary four years after acquisition are required. Problem 5-15 (50 min.) This question requires the preparation of consolidated financial statements three years after acquisition. The parent uses the equity method for internal reporting. Also required are calculations of the investment account had the parent used the cost method and calculation and interpretation of 3 key ratios under the three different reporting methods.

SOLUTIONS TO REVIEW QUESTIONS 1. There are two steps involved in testing the goodwill for impairment: i) Compare the recoverable amount of each cash-generating unit with its carrying amount (including goodwill). If the recoverable amount is the larger amount, there is no impairment of goodwill. If the recoverable amount is the smaller amount the next step (ii) is performed. ii) If the recoverable amount is less than the carrying amount, an impairment loss should be recognized and should be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit; and b) then, to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit. However, an entity shall not reduce the carrying amount of an individual asset below the higher of its recoverable amount and zero. The amount of the impairment loss that could not be allocated to an individual asset because of this limitation shall be allocated pro rata to the other assets of the unit (group of units). 2. The process for testing for impairment is essentially the same in that the assets are written down to recoverable amount when they are less than the carrying amount. Recoverable

amount is defined as the higher of fair value less costs of disposal and value in use. When the intangible assets must be tested for impairment is not the same for the different types of intangible assets. Goodwill impairment tests must be conducted at least once a year unless it is clear that there has been no impairment during the year and more often than once a year when there is an indication that the cash-generating unit may be impaired. For intangible assets with a definite useful live, the recoverable amount is only compared to carrying amount if there is an indication that the asset may be impaired. Intangible assets with indefinite useful lives must be checked for impairment on an annual basis and whenever there is an indication that the intangible asset may be impaired.

3. The asset “Investment in subsidiary” on the balance sheet of the parent company is removed and replaced with the individual assets and liabilities from the balance sheet of the subsidiary (which are remeasured by the unamortized acquisition differential), and by the non-controlling interest in the net assets of the subsidiary (in cases of less than 100% ownership). The item of income “Investment income” on the income statement of the parent company is removed and replaced with the income and expenses from the income statement of the subsidiary (adjusted for the amortization of the acquisition differential), and by the non-controlling interest in the net income of the subsidiary (in cases of less than 100% ownership). As well, any intercompany transactions such as payables and receivables would be eliminated upon consolidation, whereas under the equity method they remain.

4. Under the equity method: Cash

7,500

Investment in subsidiary

7,500

Under the cost method: Cash Dividend revenue

7,500 7,500

5. IFRS does not specify any method for internal record keeping purposes because the parent is required to prepare consolidated statements for external financial reporting purposes, and these statements are not affected by the method used by the parent to record the investment. However, if the parent wants to issue separate entity financial statements in accordance with GAAP, IAS 27 requires that the investment in subsidiary on the separate

entity financial statements shall be reported at cost or in accordance with IAS 39 Financial Instruments: Recognition and Measurement (or IFRS 9 Financial Instruments: Classification and Measurement if it is adopted early).

6. The dividends that appear in the retained earnings column in the consolidated statement of changes in equity are those of the parent company only. The subsidiary’s dividends that were paid outside the entity to the non-controlling shareholders would appear on a statement of changes in non-controlling interest (if such a statement was prepared). The subsidiary’s dividends that were paid to the parent do not appear on any consolidated statement because no cash left the combined economic entity.

7. This statement is partially true. As long as the parent continues to control the subsidiary and as long as the subsidiary continues to hold the land, this part of the acquisition differential will be used to remeasure the land on all subsequent consolidated balance sheets. If the land is sold by the subsidiary, the acquisition differential will in part be used to determine the loss or gain for consolidated purposes and will no longer appear on the consolidated balance sheet. If consolidation of this subsidiary ceases (due to loss of control), the acquisition differential would become redundant since the acquisition differential only appears within the consolidated financial statements.

8. What this statement means is that in addition to recording the investor’s share of net income earned by the investee since acquisition, entries must also be made for the amortization of the acquisition differential, and for the holdback and realization of any unrealized profits regardless of whether the profit was recorded by the investee or the investor. The calculations for these entries are identical to those that would be made when consolidating.

9. The unamortized acquisition differential was: Investment account Shareholders’ equity

120,000 125,000 75%

93,750

Parent’s share of unamortized acquisition differential (i.e., 75%)

26,250

Implied value of unamortized acquisition differential (26,250 / 75%)

35,000

(If equity method journal entries had been made to holdback unrealized profits, we would not get this result.)

10. The elimination of intercompany receivables and payables has no effect on consolidated shareholders’ equity or non-controlling interest.

11. Any fair value excess arising from the acquisition must be eliminated or amortized on consolidation in the same way that a cost of an individual asset purchased directly by an entity is eliminated or amortized. The matching principle states that the cost of an asset should be expensed in the same period as the benefits received from using the asset. The benefits are received over the useful life of an asset. Consequently, assets such as property, plant and equipment should be amortized over their useful lives and assets such as inventory should be expensed in the year they are sold.

12. The balance sheet accounts of the parent that have different balances are: Investment in subsidiary, and Retained earnings. In addition, the following two income statement accounts differ in amount and their description: Dividend income (using the cost method) Investment income (or equity earnings) (using the equity method) 13. This adjusts the parent's retained earnings under the cost method to what they would be using the equity method. Under the equity method, the retained earnings of the parent contain the parent's share of the subsidiary's net income since acquisition. Under the cost method, the parent's retained earnings contain the parent's share of the subsidiary's dividends since acquisition. Net income less dividends equals the change in retained earnings. When we add the parent's share of the increase in the retained earnings of the subsidiary to the retained earnings of the parent, the resultant amount now contains the parent's share of the subsidiary's net income earned since acquisition. 14. The subsidiary’s revenue and expenses included in the consolidated income statement are only those that have occurred since acquisition. Also, the non-controlling interest is based

on the subsidiary’s income earned subsequent to the date of acquisition.

*15.The initial entry adjusts the parent's investment account and retained earnings at the beginning of the year to equity method balances. The investment account now reflects the equity method balance at the beginning of the current year. 16. Under the cost method, the parent has recorded only its share of dividends received from the subsidiary. It has not recorded its share of the subsidiary’s change in retained earnings or its share of the amortization of the acquisition differential. Therefore, an entry or entries must be made on the consolidation to record the parent’s share of the subsidiary’s change in retained earnings and its share of the amortization of the acquisition differential. Since the starting point for consolidation is the separate entity records of the parent and subsidiary, a cumulative entry is required each year on consolidation to adjust the parent company’s retained earnings to what it would be under the equity method. When the equity method is used, the parent’s retained earnings already reflect its share of the subsidiary’s retained earnings and its share of the amortization of the acquisition differential.

SOLUTIONS TO CASES Case 5-1 a)

None of the acquisition cost should be allocated to BIO’s skilled workers as long as the workers are not under contract. The skilled workers are not capable of being separated or divided from the acquired enterprise and cannot be sold, transferred, licensed, rented, or exchanged. Therefore, the value of the skilled workers would be included as a part of goodwill.

b)

Part of the acquisition cost should be allocated to patentable technology because this technology has a value in the marketplace and it could be separated or divided from the acquired enterprise and sold, transferred, licensed, rented, or exchanged. An appraiser could be hired to estimate a value for the patentable technology. The technology would be amortized over its expected useful life, which is likely to be short because of rapid changes in technology. The technology would be checked for impairment whenever events or changes in circumstances indicate that its carrying amount may not be

recoverable. c)

Goodwill is the difference between the acquisition cost and the fair value of identifiable net assets. The goodwill can only be determined once all of the identifiable assets including the patentable technology and identifiable liabilities have been measured at fair value. According to IAS 36, goodwill of a cash-generating unit should be tested for impairment on an annual basis, unless all of the following criteria have been met: (a)

The assets and liabilities that make up the cash-generating unit have not changed significantly since the most recent determination of recoverable amount.

(b)

The most recent determination of recoverable amount resulted in an amount that exceeded the carrying amount of the cash-generating unit by a substantial margin.

(c)

Based on an analysis of events that have occurred and circumstances that have changed since the most recent determination of recoverable amount, the likelihood that today’s recoverable amount would be less than the current carrying amount of the reporting unit is remote.

A two-step impairment test should be used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any: (a)

The recoverable amount of the cash-generating unit should be compared with its carrying amount, including goodwill, in order to identify a potential impairment. When the recoverable amount of a cash-generating unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is unnecessary.

(b)

When the recoverable amount is less than the carrying amount, an impairment loss should be recognized and should be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order:

(i)

first, to reduce the carrying amount of any goodwill allocated to the cashgenerating unit; and

(ii)

then, to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit. However, an entity shall not reduce the carrying amount of an individual asset below the higher of its recoverable amount and zero. The amount of the impairment loss that could not be allocated to an individual asset

because of this limitation shall be allocated pro rata to the other assets of the unit (group of units).

Case 5-2 Memo to:

Board of Directors of GIL

From:

CPA

Subject:

Financial Accounting & Reporting Policies

As requested, I have prepared a report recommending appropriate accounting and reporting policies related to GIL’s November 30, Year 3 financial statements.

Users and Needs In determining appropriate accounting policies for GIL, I considered the users of GIL’s financial statements and their information needs. There are many users, with varied and often conflicting information needs. Accordingly, I have had to make assumptions when ranking the users in order to determine the most appropriate policies. The users of GIL’s financial statements are as follows:



The bank will be concerned about liquidity and its security. Cash flow and current value information would be useful for this purpose.



Sam and Ida Growth will be concerned that the valuation of GIL’s net assets are calculated fairly so that the redemption value of their preferred shares is fair. They will also want information...