THE PURCHASE METHOD:

1
CHAPTER 6

• THE PURCHASE METHOD
• POSTACQUISITION PERIODS
• AND PARTIAL OWNERSHIPS

2
FOCUS OF CHAPTER 6

• Consolidation Worksheets 100 OwnershipsPostacqu
  isition Periods
• The Purchase Method Partial Ownerships
• Conceptual issues
• Analyzing cost
• Consolidation Worksheets Partial Ownerships
• At the Acquisition Date
• Postacquisition Periods

3
Postacquisition Subsidiary Earnings The Only
Reportable Earnings Under The Purchase Method

• ONLY the subsidiarys postacquisition earnings
  are reported in the consolidated financial
  statements.
• The subsidiarys preacquisition earnings
  (included in its retained earnings account) are
  ALWAYS eliminated against the parents Investment
  account in consolidation.

4
Parents Amortization of Cost in Excess of Book
Value How Handled?

• Non-Push-Down Accounting
• Equity Method
• Recorded in parents general ledger.
• Maintains built-in checking features.
• Cost Method
• Recorded on consolidation worksheets.
• Push-Down Accounting
• Parent has no amortizationsub records it.

GL
5
Parents Amortization of Excess Cost What is
Subs True Earnings?

• Non-Push-Down Accounting Subs reported net
  income (based on OLD BASIS)...........
  24,000 LessParents amortization
  of excess cost................. (8,000)
  Subs true net income (based on NEW
  BASIS)......... 16,000
• Push-Down Accounting Subs reported net
  income....... 16,000

6
Liquidating Dividends A Special Situation

• Because an acquired subsidiary usually has a
  retained earnings balance at the acquisition
  date, a unique issue arises for acquired
  subsidiaries HOW TO REPORT DIVIDENDS THAT ARE
  IN EXCESS OF THE SUBSIDIARYS POSTACQUISITION
  EARNINGS?
• Such dividends are called liquidating dividends.

7
Liquidating Dividends They Differ From
Regular Dividends

• Dividends in excess of postacquisition earnings
  are a return of the parents original investment.
• Parents Accounting Treatment
• CREDIT to the Investment account under
• Equity method (the usual treatment).
• Cost method (the usual treatmentis to credit
  Dividend Income).

8
Liquidating Dividends Acquired vs. Created
Subsidiaries

• Can a created subsidiary declare a liquidating
  dividend?
• NO
• No such thing exists for a created subsidiary.

9
Liquidating Dividends What Is their
Significance for Tax?

• A central issue in taxation is whether a
  distribution to a shareholder is a dividend or a
  return of capital.
• The concept of EARNINGS PROFITS (E P)
  exists in the Internal Revenue Code for making
  this determination.

10
Goodwill It Must be Assignedto 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
  parents other subsidiaries or divisions.

11
Testing Goodwill for ImpairmentA Two-Step
Process

• Step 1 Is the reporting units fair value (FV)
  below the reporting units carrying value (CV)?
• If NO, stop. If YES, perform step 2.

12
Testing Goodwill for ImpairmentA Two-Step
Process

• Step 2 Calculate the implied value of goodwill
  as follows
• On a memo basis, allocate the reporting units FV
  to its assets and liabilities in a purchase
  price allocation fashion.
• Excess of reporting units FV over FV of
  assets/liabilities (as allocated) is implied
  goodwill of the reporting unit. (Thus implied GW
  is residually determined.)

13
Testing Goodwill for ImpairmentA 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 earningsas a
  separate line item, if material.

14
Testing Goodwill for ImpairmentA Two-Step
Process

• Goodwill Impairment TestHow Often?
• At least annually.
• At interim periods when certain triggering
  events occur that indicate that goodwill of a
  reporting unit may be impaired.

15
Testing Goodwill for ImpairmentA Two-Step
Process

• The Annual GW Impairment TestIt 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 units FV is
  less than its CV is remote.

16
Goodwill Determining theReporting Units Fair
Value

• The following items are included in determining
  the reporting units fair value
• Tangible net assets.
• Recognized intangible assets.
• Unrecognized intangible assets.

17
Partial Ownerships The Purchase
MethodPartial or Full Valuation

• Extent of Revaluation of Undervalued Assets and
  Goodwill
• Parent Company Concept Partial valuation (could
  be anywhere from 51 to 99)
• Economic Unit Concept Full valuation

18
Partial Ownerships The Purchase
MethodUndervalued Assets

• Extent of Revaluation of Subsidiarys Undervalued
  Assets
• Parent company concept..... lt 100 of CV
• Revalued only to the extent of the parents
  OWNERSHIP INTEREST.
• Economic unit concept........ 100 of CV
• The offsetting credit for the additional
  valuation increases the NCI in the consolidated
  B/S.

19
Partial Ownerships The Purchase MethodGoodwill

• Extent of Valuation of Goodwill
• Parent company concept................. lt 100
• Valued only to the extent it is bought and paid
  for by the parent.
• Economic unit concept....................
  100
• The offsetting credit for the additional
  valuation increases the NCI in the consolidated
  B/S.

20
Review Question 1

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

21
Review Question 1With Answer

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

22
Review Question 2

• A parent charges the amortization of its cost in
  excess of book value to
• A. Goodwill expense.
• B. Excess cost expense.
• C. Excess cost goodwill expense.
• D. Equity in net income of subsidiary.
• E. None of the above.

23
Review Question 2With Answer

• A parent charges the amortization of its cost in
  excess of book value to
• A. Goodwill expense.
• B. Excess cost expense.
• C. Excess cost goodwill expense.
• D. Equity in net income of subsidiary.
• E. None of the above.

24
Review Question 3

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

25
Review Question 3With Answer

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

26
Review Question 4

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

27
Review Question 4With Answer

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

28
Review Question 5

• Goodwills book value is 90,000 and its implicit
  value is 60,000. The reporting units carrying
  value is 800,000 and its fair value is 810,000.
  What is the goodwill impairment write-down?
• A. Zero.
• B. 10,000.
• C. 20,000.
• D. 30,000.
• D. 50,000.

29
Review Question 5With Answer

• Goodwills book value is 90,000 and its implicit
  value is 60,000. The reporting units carrying
  value is 800,000 and its fair value is 810,000.
  What is the goodwill impairment write-down?
• A. Zero. (Step 2 was not needed)
• B. 10,000.
• C. 20,000.
• D. 30,000.
• D. 50,000.

30
Review Question 6

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

31
Review Question 6With 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.

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End of Chapter 6

• Time to Clear Things UpAny Questions?