1. 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

2. 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

3. 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

4. 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

5. Consolidation Process Example
Suppose Time Warner pays $75 million for Midwest Cable on January 1, 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

6. Consolidation Process Example continued
Midwest reports net income of $5 million and declares and pays cash dividends of $1 million to Time Warner in 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

7. 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

8. 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

9. 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

10. Consolidation Working Paper for Time Warner and Midwest Cable
Exhibit 4.1

11. Consolidated Financial Statements for Time Warner and Midwest Cable

12. Consolidated Financial Statements for Time Warner and Midwest Cable

13. 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

14. 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

15. 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’

16. 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

17. 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

18. 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, 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)

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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.

28. 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

29. 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
$ 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

30. 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

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

32. 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

33. 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

34. Consolidation Working Paper after One Year Illustration continued
Exhibit 4.4

35. 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

36. 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

37. 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

38. 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

39. Consolidation after One Year Illustration continued
Consolidated financial statements:

40. Consolidation after One Year Illustration continued
Consolidated financial statements:

41. 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, 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
$ ,000

42. 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

43. Consolidation after Two Years Illustration continued
Exhibit 4.5

44. 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

45. 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

46. 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

47. 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

48. Consolidation after Two Years Illustration continued
Consolidated financial statements:

49. Consolidation after Two Years Illustration continued
Consolidated financial statements:

50. 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

51. 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

52. 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)

53. 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

54. 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

55. 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, 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)

56. 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

57. 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.

58. Goodwill Impairment Under IFRS
Primus Telecommunication Group acquires all of the voting stock of Matrix Internet on January 1, 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 $
$ 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

59. 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