Consolidation Subsequent to Acquisition Passage of time affects revaluations of subsidiary assets and liabilities Triggers effects on Income statement amounts The investment account on the parent’s books due to use of the complete equity method

Complete Equity Method Used internally by parent company Differs from the equity method used for external reporting Internal Reporting External Reporting Impairment losses on indefinite life intangibles including goodwill Equity in net income reduced for impairment losses No equity in net income adjustment for impairment All unconfirmed downstream profits are deducted Deducted to the extent of the investor’s ownership interest Unconfirmed profits on downstream sales

Goals of the Consolidation Elimination Process Eliminates equity method income on the parent’s books and declared dividends on the subsidiary’s books Eliminates stockholders’ equity accounts on the subsidiary’s books against the investment account on the parent’s books Adjusts the subsidiary’s assets and liabilities for remaining acquisition date revaluations and eliminate the remainder of the investment balance Adjusts reported expenses for current year revaluation write-offs

C E R O Eliminating Entries Current – Eliminate the current year equity method entries Equity – Eliminate subsidiary’s beginning-of-year equity balances Revalue – Recognize the beginning-of-current-year fair value revaluations Write-Off – Recognize current year revaluation write-offs E R O

Consolidation Process Example Suppose Time Warner pays $75 million for Midwest Cable on January 1, 2010. Midwest’s book value is $10 million. Book and fair values are the same except for equipment with fair value $15 million higher than book value. Midwest has unreported identifiable intangibles valued at $2 million. Acquisition analysis: Acquisition cost   $75,000,000 Book value of Midwest Cable 10,000,000 Cost in excess of Midwest Cable's book value 65,000,000 Differences between fair value and book value: Equipment $15,000,000 Identifiable intangibles 2,000,000 17,000,000 Goodwill $48,000,000

Consolidation Process Example continued Midwest reports net income of $5 million and declares and pays cash dividends of $1 million to Time Warner in 2010. Revalued equipment has a remaining life of 20 years. Identifiable intangibles have 4 years of remaining life. Straight-line depreciation and amortization is used. Goodwill is not impaired. Complete equity method: Midwest Cable's reported income for 2010 $5,000,000. Adjustments for revaluation write-offs:   Equipment ($15,000,000/20) (750,000) Identifiable intangibles ($2,000,000/4) (500,000) Equity in income of Midwest Cable $3,750,000

Consolidation Process Example continued Time Warner’s books To record equity in net income for 2010: Investment in Midwest Cable 3,750,000   Equity in income of Midwest Cable To record dividends received in 2010: Cash 1,000,000   Investment in Midwest Cable Investment in Midwest Cable 75,000,000 3,750,000   1,000,000 77,750,000

Consolidation Process Example continued Eliminating entries at December 31, 2010: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-year value: (C) Equity in income of Midwest Cable 3,750,000   Dividends 1,000,000 Investment in Midwest Cable 2,750,000 To eliminate the subsidiary's beginning-of-year equity accounts against the investment account: (E) Common stock, par 100,000   Additional paid-in capital 400,000 Retained earnings, January 1 9,500,000 Investment in Midwest Cable 10,000,000

Consolidation Process Example continued Eliminating entries at December 31, 2010: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance: (R) Plant and equipment, net 15,000,000   Identifiable intangibles 2,000,000 Goodwill 48,000,000 Investment in Midwest Cable 65,000,000 To write off equipment and identifiable intangibles revaluations for the current year, by recognizing additional depreciation and amortization expense: (O) Operating expenses 1,250,000   Plant and equipment, net 750,000 Identifiable intangibles 500,000

Consolidation Working Paper for Time Warner and Midwest Cable Exhibit 4.1

Consolidated Financial Statements for Time Warner and Midwest Cable

Consolidated Financial Statements for Time Warner and Midwest Cable

Complete Equity Method Also known as ‘one-line consolidation’ = Parent’s net income Consolidated net income Parent’s retained earnings = Consolidated retained earnings Equivalence of parent’s net income and consolidated net income Exhibit 4.2

One-Line Effects on Investor’s Books Investor’s Balance Sheet Assets: Investment in subsidiary…….$ xx Investee’s assets and liabilities Investor’s Income Statement Other revenue: Equity in income………..…….$ xx Investee’s revenues and adjusted expenses

Revaluations in Subsequent Years Requires recognition of write-offs of reported revaluations over time Inventories Write off in year of reported sale Plant and equipment Write off each year of useful life Previously unreported intangibles Write off each year of useful life, or if impaired Long-term debt Write off premium/discount over remaining life Reported in eliminating entry ‘O’

Revaluations of Inventories The book value of a subsidiary’s inventory acquired on January 1, 2011 is $800,000, with its fair value at $1 million. FIFO is used. Subsidiary’s accounting records: To record sale of beginning inventory during 2011: Cost of goods sold 800,000   Inventory Calculate the adjustment to be made: Cost of goods sold on consolidated income statement $1,000,000 Cost basis of beginning inventory 800,000 Eliminating adjustment on working paper $ 200,000 Consolidation working paper: Eliminating entry to revalue cost of sales to acquisition cost: (O) Cost of goods sold 200,000   Inventory

Revaluations of Depreciable Assets The book value of a subsidiary’s equipment on January 1, 2011 is $50 million, with its fair value at $70 million, with a remaining useful life of 10 years and no residual value. Straight-line depreciation is used. Annual depreciation recorded by subsidiary ($50 M ÷ 10 yrs) $5,000,000 Depreciation at fair value ($70 M ÷ 10 yrs) 7,000,000 Additional depreciation on working paper $2,000,000 Consolidation working paper: Eliminating entry to revalue depreciation to reflect fair value at date of acquisition: (O) Depreciation Expense 2,000,000   Plant and equipment, net * *or accumulated depreciation

Revaluations of Long-Term Debt The subsidiary reports $100 million of 5% bonds payable at January 1, 2011, issued in 2010 at par, and due on December 31, 2020. The fair value of the bonds is $90 million on January 1, 2011. Bond discount amortization: $10,000,000 ÷ 10 years = $1,000,000 Consolidation working paper: Eliminating entry to amortize bond discount for 2011: (O) Interest expense 1,000,000   Bonds payable (or bond discount)

Previously Reported Intangibles With Limited Lives Amortized over estimated useful life Amortized amount equal to recorded amount of the asset less estimated residual value (usually zero) Amortization method reflects the pattern in which the economic benefits are consumed Generally straight-line method Examples: Favorable lease agreements and customer lists

Previously Reported Intangible Assets with Indefinite Lives If no factors appear to limit the intangible asset’s life, the life is deemed to be indefinite Examples Brand names Franchises Goodwill Acquired in-process research and development

Impairment Testing for Intangibles Other Than Goodwill If carrying amount of the asset exceeds its fair value Recognize an impairment loss Once impairment loss is recorded, no reversal is allowed for increases in value Guided by SFAS 144

Impairment Testing for Intangibles Other Than Goodwill Two step process Step 1: Undiscounted cash flows expected from the future use of the asset and its subsequent disposition Less Than Asset’s carrying value? Impairment has incurred Yes Step 2: Amount of loss = Book value of intangible asset less Present value of the future cash flows No No impairment

Goodwill An indefinite life intangible Per SFAS 142, must be regularly tested for impairment Impairment losses reported in the operating section of the income statement If material, reported as a separate line item Goodwill has meaning only in the context of a business unit Represents a variety of intangible benefits connected with that business, beyond its tangible and identifiable intangible net assets

Goodwill Impairment Testing required at least annually unless circumstances indicate the likelihood of impairment is remote More frequent testing needed for A significant downturn in the business climate Adverse legal or regulatory outcomes Unanticipated new competition Loss of key personnel Expectation that a reporting unit will be sold

Impairment Testing for Goodwill Two step process Step 1: Is fair value of the reporting unit Less Than Carrying value? Impairment may be incurred Yes No Step 2: Estimate implied fair value of the reporting unit’s goodwill. Is the implied fair value Less Than its carrying amount? No No impairment Yes Impairment is incurred Write-off is required

Amortization of Specific Intangibles Example On January 1, 2012, Primus Telecommunication Group acquires all of the voting stock of Matrix Internet. Previously unrecorded intangibles at acquisition are: Intangible asset (in millions) Fair Value Useful Life Customer Lists $150 5 years Brand names 240 4 years 2012 amortization (in millions): Customer lists $150 ÷ 5 = $30 Brand names $240 ÷ 4 = $60 Total amortization expense $90 Must be assessed for impairment at least annually

Impairment of Specific Intangibles Example continued The following information is provided by Primus at December 31, 2012: Intangible asset (in millions) Total expected future cash inflows, undiscounted Total expected future cash inflows, discounted Customer lists $100 $80 Brand names 200 125 Impairment loss (in millions): Identifiable intangible (in millions) Book value Step 1 Step 2 Book value greater than undiscounted cash flow? Impairment loss = Book value less discounted cash flow Customer lists $150 - $30 = $120 Yes ($120 > $100) $120 - $80 = $40 Brand names $240 - $60 - $180 No ($180 < $200)   Impairment loss of $40 million must be reported.

Impairment of Goodwill Example Primus Telecommunication Group acquires all of the voting stock of Matrix Internet with goodwill as follows: Intangible asset Fair Value Useful Life Goodwill $3,200 million Indefinite Goodwill assigned to Broadband unit $1,920 million Goodwill assigned to Wholesale Carrier unit 1,280 million Total goodwill $3,200 million Impairment testing at the end of the year: Step 1 - Compare the fair value to the book value of each reporting unit. Broadband Wholesale Carrier Fair value of unit $17,600 million. $8,640 million. Book value of unit (15,040) million (8,960) million Difference $ 2,560 million. $ (320) million Goodwill may be impaired

Impairment of Goodwill Example continued Step 2 - Compare fair value of the unit to the fair value of the identifiable net assets of the unit: Fair value of Wholesale unit $8,640 million Fair value of identifiable net assets of Wholesale 7,520 million Current fair value of goodwill 1,120 million Carrying amount of goodwill 1,280 million Difference $ 160 million Goodwill assigned to Wholesale Carrier is impaired by $160 million. To record amortization expense and impairment losses on previously unreported intangibles and goodwill for 2012: (O) Amortization expense 90,000,000   Impairment loss on identifiable intangibles 40,000,000 Goodwill impairment loss 160,000,000 Customer lists 70,000,000 Brand names 60,000,000 Goodwill

Consolidation in Subsequent Years Illustration IBM buys all of the voting stock of DataFile, Inc. on July 1, 2010 for $25 million cash. DataFile’s book value was $5.3 million. Goodwill calculation: Acquisition cost   $25,000,000 Book value of DataFile 5,300,000 Cost in excess of DataFile's book value 19,700,000 Differences between fair value and books value: Current assets $ (300,000) Plant and equipment;, net 10,000,000 Patents and copyrights 4,000,000 Brand names 1,000,000 Lease agreements 600,000 Customer relationships 3,000,000 Long-term debt (2,000,000) 16,300,000 Goodwill $ 3,400,000

Consolidation in Subsequent Years Illustration continued Exhibit 4.3 Revaluation Write-Off information for DataFile Acquisition:

Consolidation after One Year Illustration continued DataFile reports income of $3 million and paid dividends of $400,000 to IBM during its fiscal year ending June 30, 2011. Equity in income calculation: DataFile's reported income for fiscal 2011 $ 3,000,000 Adjustments for revaluation write-offs of:   Current assets (cost of goods sold) 300,000 Plant and equipment (depreciation expense) (400,000) Patents and copyrights (amortization expense) (800,000) Brand names (impairment loss) (100,000) Lease agreements (amortization expense) (300,000) Customer relationships (amortization expense) (1,000,000) Long-term debt (Interest expense) 500,000 Equity in income of DataFile $ 1,200,000

Consolidation after One Year Illustration continued DataFile reports income of $3 million and paid dividends of $400,000 to IBM during its fiscal year ending June 30, 2011. Equity method entries on IBM’s books during fiscal 2011: To record equity in net income for fiscal 2011: Investment in DataFile 1,200,000   Equity in income of DataFile To record dividends received in fiscal 2011: Cash 400,000   Investment in DataFile Investment in DataFile 25,000,000 1,200,000   400,000 25,800,000 Balance in investment account

Consolidation Working Paper after One Year Illustration continued Exhibit 4.4

Consolidation after One Year Illustration continued Eliminating entries: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-the year value: (C) Equity in income of DataFile 1,200,000   Dividends 400,000 Investment in DataFile 800,000 To eliminate the subsidiary's beginning-of-year equity accounts against the investment account balance: (E) Common stock, par 500,000   Additional paid-in capital 2,000,000 Retained earnings, July 1 2,800,000 Investment in DataFile 5,300,000

Consolidation after One Year Illustration continued Eliminating entries: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance: (R) Plant and equipment, net 10,000,000   Patents and copyrights 4,000,000 Brand names 1,000,000 Lease agreements 600,000 Customer relationships 3,000,000 Goodwill 3,400,000 Current assets 300,000 Long-term debt 2,000,000 Investment in DataFile 19,700,000

Consolidation after One Year Illustration continued Eliminating entries: To adjust current year cost of goods sold to reflect inventory revaluation: (O-1) Current assets 300,000   Cost of goods sold To adjust current year depreciation expense to reflect plant and equipment revaluation: (O-2) Operating expense (depreciation) 400,000   Plant and equipment, net To adjust current year amortization expense to reflect revaluations of limited life intangibles: (O-3) Operating expense (amortization) 2,100,000   Patents and copyrights 800,000 Lease agreements 300,000 Customer relationships 1,000,000

Consolidation after One Year Illustration continued Eliminating entries: To adjust current year interest expense to reflect long-term debt revaluation: (O-4) Long-term debt 500,000   Operating expense (interest) To record brand names impairment for the current year: (O-5) Operating expense (impairment loss) 100,000   Brand names

Consolidation after One Year Illustration continued Consolidated financial statements:

Consolidation after One Year Illustration continued Consolidated financial statements:

Consolidation after Two Years Illustration DataFile reports income of $3.5 million and pays dividends of $200,000 for its fiscal year ending June 30, 2012. Year-end impairment testing reveals no impairment loss for brand names, and $700,000 impairment to goodwill. Calculation of equity in income of DataFile for 2012: DataFile's reported income for fiscal 2012 $ 3,500,000 Adjustments for revaluation write-offs of:   Plant and equipment (depreciation expense) (400,000) Patents and copyrights (amortization expense) (800,000) Lease agreements (amortization expense) (300,000) Customer relationships (amortization expense) (1,000,000) Long-term debt (Interest expense) 500,000 Goodwill (Impairment loss) (700,000) Equity in income of DataFile $ 800,000

Consolidation after Two Years Illustration DataFile reports income of $3.5 million and paid dividends of $200,000 to IBM during its fiscal year ending June 30, 2012. Equity method entries on IBM’s books during fiscal 2012: To record equity in net income for fiscal 2012: Investment in DataFile 800,000   Equity in income of DataFile To record dividends received in fiscal 2012: Cash 200,000   Investment in DataFile Investment in DataFile 25,800,000 800,000   200,000 26,400,000 Balance in investment account

Consolidation after Two Years Illustration continued Exhibit 4.5

Consolidation after Two Years Illustration continued Eliminating entries: To eliminate equity in net income on the parent's books, dividends on the subsidiary's books, and restore the investment account to its beginning-of-the year value: (C) Equity in income of DataFile 800,000   Dividends 200,000 Investment in DataFile 600,000 To eliminate the subsidiary's beginning-of-year equity accounts against the investment account: (E) Common stock, par 500,000   Additional paid-in capital 2,000,000 Retained earnings, July 1 5,400,000 Investment in DataFile 7,900,000

Consolidation after Two Years Illustration continued Eliminating entries: To recognize the beginning-of-year revaluations and eliminate the remainder of the investment account balance: (R) Plant and equipment, net 9,600,000   Patents and copyrights 3,200,000 Brand names 900,000 Lease agreements 300,000 Customer relationships 2,000,000 Goodwill 3,400,000 Long-term debt 1,500,000 Investment in DataFile 17,900,000

Consolidation after Two Years Illustration continued Eliminating entries: To adjust current year depreciation expense to reflect plant and equipment revaluation: (O-1) Operating expense (depreciation) 400,000   Plant and equipment, net To adjust current year amortization expense to reflect revaluations of limited life intangibles: (O-2) Operating expense (amortization) 2,100,000   Patents and copyrights 800,000 Lease agreements 300,000 Customer relationships 1,000,000

Consolidation after Two Years Illustration continued Eliminating entries: To adjust current year interest expense to reflect long-term debt revaluation: (O-3) Long-term debt 500,000   Operating expense (interest) To record goodwill impairment for the current year: (O-4) Operating expense (impairment loss) 700,000   Goodwill

Consolidation after Two Years Illustration continued Consolidated financial statements:

Consolidation after Two Years Illustration continued Consolidated financial statements:

IFRS for Acquired Specific Intangibles IAS 38 criteria to be reportable Intangible must be either separable or contractual Similar to U.S. GAAP Generally carried at cost less accumulated amortization and impairments IFRS allows fair value reporting in limited circumstances

Intangibles Reported Using the Cost Model Under IFRS Same as U.S. GAAP Intangibles with limited lives Amortized over the period the intangible is expected to produce cash flows Amortization methods same as for plant and equipment Estimates used in reporting periodic amortization must be reviewed regularly Estimated changes reflected in future periods only Intangibles with indefinite lives Not amortized Assumptions must be reassessed each period Same as U.S. GAAP

Intangibles Reported Using the Cost Model Under IFRS All identifiable intangibles reported at cost are subject to impairment testing Impairment testing differs from U.S. GAAP IAS 36 impairment testing One-Step Test Greater of Asset’s ‘Value-in-use’ (Generally present value of future expected cash flows) Compared to Book value or Net market value (fair value less selling costs)

Intangibles Reported Using the Cost Model Under IFRS Example The following information is provided by Primus at December 31, 2012: Intangible asset (in millions) Book value Total expected future cash inflows, undiscounted Total expected future cash inflows, discounted Customer lists $120 $100 $80 Brand names 180 200 125 There is no active market for the intangibles. Impairment loss: Customer lists $120,000,000 – $80,000,000 = $40,000,000 Brand names $180,000,000 – $125,000,000 = 55,000,000 Total impairment loss $95,000,000 U.S. GAAP impairment loss = $40 million IFRS impairment loss = $95 million

Intangibles Reported Using Revaluation Model Under IFRS IAS 38 defines fair value as market value Mark-to-market allowed under IFRS Limited to intangibles traded in an active market Examples: Liquor licenses in some states, franchise rights Increases in value reported directly in equity Except for reversals of previously reported impairment losses Decreases in value reported directly in equity Except for reductions exceeding previous increases which are reported in income

Intangibles Reported Using Revaluation Model Under IFRS Example Generic computer software valued at $10 million with an active trading market is acquired in a business combination on January 1, 2011. The software has a 5-year estimated life, and no residual value. Straight-line amortization is used. Fair value at December 31, 2011 is $12,000,000. To record amortization on the computer software for 2011: Annual amortization = $10,000,000 ÷ 5 years = $2,000,000 Amortization expense 2,000,000   Computer software To revalue the computer software to fair value as of December 31, 2011: $12,000,000 – [$10,000,000 – $2,000,000] = $4,000,000 Computer software 4,000,000   Revaluation surplus (OCI)

Intangibles Reported Using Revaluation Model Under IFRS Example continued Fair value at December 31, 2012 is $8,000,000. The adjusted basis is $12,000,000 fair value at end of 2011. To record amortization on the computer software for 2012: Annual amortization = $12,000,000 ÷ 4 years = $3,000,000 Amortization expense 3,000,000   Computer software To revalue the computer software to fair value as of December 31, 2012: $8,000,000 – [$12,000,000 – $3,000,000] = ($1,000,000) Revaluation surplus (OCI) 1,000,000   Computer software

Goodwill Impairment Under IFRS Differs from U.S. GAAP in two ways Goodwill is allocated to ‘cash generating units’ (CGUs), not operating units One step computation of impairment loss Book value less fair value of the CGU Loss limited to carrying value of goodwill IFRS impairment loss likely to be higher than under U.S. GAAP.

Goodwill Impairment Under IFRS Primus Telecommunication Group acquires all of the voting stock of Matrix Internet on January 1, 2012. Information on December 31, 2012 values is as follows: Amounts in millions Book value of goodwill Fair value of CGU Book value of CGU Fair value of identifiable net assets Broadband internet $ 320 $ 8,000 $ 4,800 $ 7,040 Broadband data 1,600 9,600 10,240 8,640 Wholesale VoIP 960 4,800 5,440 4,480 Wholesale data services 320 3,840 3,520 3,040 Totals $3,200 $26,240 $24,000 $23,200

Goodwill Impairment Under IFRS continued Comparing each unit’s book value with its fair value: (in millions) Broadband Internet Broadband Data Wholesale VoIP Wholesale Data Services Fair value of CGU $8,000 $9,600 $4,800 $3,840 Book value of CGU 4,800 10,240 5,440 3,520 Impairment? No Yes Impairment loss - $640 Book value exceeds fair value so impairment loss of $1,280,000,000 must be recognized U.S. GAAP impairment loss = $160,000,000 IFRS impairment loss = $1,280,000,000