1. Chapter Three Consolidations – Subsequent to the Date of Acquisition
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2. Learning Objective 3-1
Recognize the complexities in preparing consolidated financial reports that emerge from the passage of time.
Recognize the complexities in preparing consolidated financial reports that emerge from the passage of time.

3. Consolidation – The Effects of the Passage of Time
The passage of time creates complexities for internal record keeping and the balance of the investment account varies due to the accounting method used. A worksheet and consolidation entries are used to eliminate the investment account and record the subsidiary’s assets and liabilities to create a single set of financial statements for the combined business entity.
Despite complexities created by the passage of time, the basic objective of all consolidations remains the same: to combine asset, liability, revenue, expense, and equity accounts of a parent and its subsidiaries. From a mechanical perspective, a worksheet and consolidation entries continue to provide structure for the production of a single set
of financial statements for the combined business entity.
A worksheet and consolidation entries are used to eliminate the investment account and record the subsidiary’s assets and liabilities to create a single set of financial statements for the combined business entity.

4. Learning Objective 3-2
Identify and describe the various methods available to a parent company in order to maintain its investment in subsidiary account in its internal records.
Identify and describe the various methods available to a parent company in order to maintain its investment in subsidiary
account in its internal records.

5. Investment Accounting by Acquiring Company
For each subsidiary owned, an asset, the investment account, and an income account are created to record the earnings on the investment.
The acquiring company selects one of these three methods have emerged as the most prominent to account for its investment:
For a parent company’s external financial reporting, consolidation of a subsidiary becomes
necessary whenever control exists. For internal record-keeping, though, the parent
has a choice for monitoring the activities of its subsidiaries. Although several variations
occur in practice, three methods have emerged as the most prominent: the equity method,
the initial value method, and the partial equity method. At the acquisition date, each investment accounting method (equity, initial value, and partial equity) begins with an identical value recorded in an investment account. Typically the fair value of the consideration transferred by the parent will serve as the recorded valuation basis on the parent’s books. Subsequent to the acquisition date, the three methods produce different account balances for the parent’s investment in subsidiary, income recognized from the subsidiary’s activities, and retained earnings accounts. Importantly, the selection of a particular method does not affect the totals ultimately reported for the combined companies. However, the parent’s choice of an internal accounting method does lead to distinct procedures for consolidating the financial information from the separate organizations.
Equity Method
Initial Value Method
Partial Equity Method

6. Investment Accounting by Acquiring Company
What is the advantage of each?
Equity Method: The acquiring company totals give a true representation of consolidation figures.
Initial Value (or “Cost”) Method: It is easy to apply and gives a good measurement of cash flows generated by the investment.
Partial Equity Method: Usually gives balances approximating consolidation figures, but is easier to apply than equity method
What is the advantage of each?
Equity Method: The acquiring company totals give a true representation of consolidation figures.
Initial Value (or “Cost”) Method: It is easy to apply and gives a good measurement of cash flows generated by the investment. Subsequent to acquisition, the initial value method (also known as the cost method ) uses the cash basis for income recognition. The parent recognizes income from its share of subsidiary dividends when declared. No recognition is given to the income earned by the subsidiary. The investment balance remains permanently on the parent’s financial records at the initial fair value assigned at the acquisition date. The initial value method might be selected because the parent does not require an accrual-based income measure of subsidiary performance. For example, the parent may wish to assess subsidiary performance on its ability to generate cash flows, on revenues generated, or some other nonincome basis. Also, some firms may find the initial value method’s ease of application attractive. Because the investment account is eliminated in consolidation, and the actual subsidiary revenues and expenses are eventually combined, firms may avoid the complexity of the equity method unless they need the specific information provided by the equity income measure for internal decision making.
Partial Equity Method: Usually gives balances approximating consolidation figures, but is easier to apply than equity method. A third method available to the acquiring company is a partial application of the equity method. Under this approach, the parent recognizes the reported income accruing from the subsidiary. Subsidiary dividends when declared reduce the investment balance. However, no other equity adjustments (amortization or deferral of unrealized gains) are recorded. Thus, in many cases, earnings figures on the parent’s books approximate consolidated totals but without the effort associated with a full application of the equity method.

7. Investment Accounting by Acquiring Company
Comparison of internal reporting of investment methods.
Method
Investment
Income Account
Equity
Continually adjusted to reflect ownership of acquired company.
Income accrued as earned; amortization and other adjustments are recognized.
Initial Value
Remains at Initially-Recorded cost
Dividends declared recorded as Dividend Income
Partial Equity
Adjusted only for accrued income and dividends declared by acquired company.
Income accrued as earned; no other adjustments recognized.
Comparison of internal reporting of investment methods.
Equity Method
Continually adjusted to reflect ownership of acquired company.
Income accrued as earned; amortization and other adjustments are recognized.
Initial Value
Remains at Initially-Recorded cost. Dividends declared recorded as Dividend Income
Partial Equity
Adjusted only for accrued income and dividends declared by acquired company. Income accrued as earned; no other adjustments recognized.
Some parent companies rely on internally designed performance measures (rather than GAAP net income) to evaluate subsidiary management or for resource allocation decisions. For such companies, a full equity method application may be unnecessary for internal purposes. In these cases, the partial equity method, although only approximating the GAAP income measure, may be sufficient for decision making. Nonetheless, no matter what method the parent chooses to internally account for its subsidiary, the selection of a particular method (i.e., initial value, equity, or partial equity) does not affect the amounts ultimately reported on consolidated financial statements to external users.

8. Learning Objective 3-3
Prepare consolidated financial statements subsequent to acquisition when the parent has applied in its internal records: a. the equity method. b. the initial value method. c. the partial equity method.
Prepare consolidated financial statements subsequent to acquisition when the parent has applied in its internal records:
a. the equity method.
b. the initial value method.
c. the partial equity method.

9. Subsequent Consolidation – Equity Method
LO 3 -3a
During the year, the parent will adjust its investment account for the Subsidiary under application of the equity method. The original investment, recorded at the date of acquisition, is adjusted for:
FMV adjustments and other intangible assets,
The parent’s share of the sub’s income (loss),
The receipt of dividends from the sub.
The equity method embraces full accrual accounting in maintaining the investment account and related income over time. Under the equity method, the acquiring company accrues income when the subsidiary earns it. To match the additional fair value recorded in the combination against income, amortization expense stemming from the original excess fair-value allocations is recognized through periodic adjusting entries. Unrealized gains on intra-entity transactions are deferred; subsidiary dividends serve to reduce the investment balance. As discussed in Chapter 1, the equity method creates a parallel between the parent’s investment accounts and changes in the underlying equity of the acquired company. When the parent has complete ownership, equity method earnings from the subsidiary, combined with the parent’s other income sources, create a total income figure reflective of the entire combined business entity. Consequently, the equity method often is referred to as a single-line consolidation. The equity method is especially popular in companies where management periodically (e.g., monthly or quarterly) measures each subsidiary’s profitability using accrual-based income figures.
During the year, the parent will adjust its investment account for the Subsidiary under application of the equity method. The original investment, recorded at the date of acquisition, is adjusted for:
FMV adjustments and other intangible assets,
The parent’s share of the sub’s income (loss),
The receipt of dividends from the sub. 2

10. Subsequent Consolidation - Equity Method Example
Parrot Company obtains all of the outstanding common stock of Sun Company on January 1, Parrot acquires this stock for $800,000 in cash. Sun Company’s balances are shown below.
Book Values Fair Values
1/1/ /1/ Difference
Current assets $320,000 $ 320, –0–
Trademarks (indefinite life) , , ,000
Patented technology (10-year life) , , ,000
Equipment (5-year life) , , (30,000)
Liabilities (420,000) (420,000) –0–
Net book value $600,000 $ 720, $120,000
Common stock—$40 par value $(200,000)
Additional paid-in capital (20,000)
Retained earnings, 1/1/ (380,000)
As a basis for this illustration, assume that Parrot Company obtains all of the outstanding
common stock of Sun Company on January 1, Parrot acquires this stock for $800,000 in cash.
The book values as well as the appraised fair values of Sun’s accounts follow:
Book Values Fair Values
1/1/ /1/14 Difference
Current assets $ 320,000 $ 320, –0–
Trademarks (indefinite life) , , ,000
Patented technology (10-yrs) 320, , ,000
Equipment (5-year life) , ,000 (30,000)
Liabilities (420,000) (420,000) –0–
Net book value , $ 720,000 $120,000
Common stock—$40 par value$(200,000)
Additional paid-in capital (20,000)
Retained earnings, 1/1/ (380,000)
Parrot considers the economic life of Sun’s trademarks as extending beyond the foreseeable future and thus having an indefinite life. Such assets are not amortized but are subject to periodic impairment testing. For the definite lived assets acquired in the combination (patented technology and equipment), we assume that straight-line amortization with no salvage value is appropriate. 9

11. Subsequent Consolidation - Equity Method Example
PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2014
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company (600,000)
Excess of fair value over book value ,000
Allocation to specific accounts based on fair values:
Trademarks $ 20,000
Patented technology ,000
Equipment (overvalued) (30,000)
120,000
Excess FV not specifically identified—goodwill $ 80,000
PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2014
FV of consideration transferred by Parrot Company. $ 800,000
Net Book Value of Sun Company (600,000)
Excess of fair value over book value ,000
Allocation to specific accounts based on fair values:
Trademarks $ 20,000
Patented technology ,000
Equipment (overvalued) (30,000)
120,000
Excess FV not specifically identified—goodwill $ 80,000 17

12. Subsequent Consolidation - Equity Method Example
Amortization computation:
Useful Annual
Account Allocation Life Amortization
Trademarks $ 20,000 Indefinite –0–
Patented technology 130, years $13,000
Equipment (30,000) 5 years (6,000)
Goodwill ,000 Indefinite –0–
$ 7,000
Amortization computation:
Account Allocation Life Amortization
Trademarks $ 20,000 Indefinite –0–
Patented technology 130, years $13,000
Equipment (30,000) 5 years (6,000)
Goodwill ,000 Indefinite –0–
$ 7,000
Amortization will be $7,000 annually for five years until the equipment fair value reduction is fully removed.
Amortization will be $7,000 annually for five years until the equipment fair value reduction is fully removed. 22

13. Subsequent Consolidation - Equity Method Example
Assume Sun Company earns income of $100,000 in 2014 and pays a $40,0000 cash dividend on August 1, 2014.
Assume Sun Company earns income of $100,000 in 2014 and pays a $40,0000 cash dividend on August 1, 2014.
1/1/14 Investment in Sun Company ,000
Cash ,000
To record the acquisition of Sun Company.
8/1/14 Cash ,000
Investment in Sun Company ,000
To record receipt of cash dividend from subsidiary
under the equity method.
12/31/14 Investment in Sun Company ,000
Equity in Subsidiary Earnings ,000
To accrue income earned by 100% owned subsidiary.
12/31/14 Equity in Subsidiary Earnings ,000
Investment in Sun Company ,000
To recognize amortizations on allocations made in acquisition of sub. 23

14. Subsequent Consolidation - Worksheet Entries
For the first year, the parent prepares five entries on the workpapers to consolidate the two companies.
S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the book value component within the parent’s investment account.
Recognizes the unamortized Allocations as of the beginning of the current year associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period on the allocations from the original adjustments to fair value.
Subsequent Consolidation - Worksheet Entries
For the first year, the parent prepares five entries on the workpapers to consolidate the two companies.
S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the book value component within the parent’s investment account.
Recognizes the unamortized Allocations as of the beginning of the current year associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period on the allocations from the original adjustments to fair value. 3

15. Subsequent Consolidation Equity Method Example Entry S
Note: If this is the first year of the investment, and the investment was made at a time other than the beginning of the fiscal year, then pre-acquisition income of the sub must be accounted for in the retained earnings balance.
Common Stock (Sun Company) ,000
APIC (Sun Company) ,000
R/E, 1/1/14 (Sun Company) ,000
Investment in Sun Company ,000
Note: If this is the first year of the investment, and the investment was made at a time other than the beginning of the fiscal year, then pre-acquisition income of the sub must be accounted for in the retained earnings balance.
Entry S removes Sun’s stockholders’ equity accounts as of the beginning of the
year. Subsidiary equity balances generated prior to the acquisition are not relevant to the
business combination and should be deleted. The elimination is made through this entry
because the equity accounts and the $600,000 component of the investment account represent
reciprocal balances: Both provide a measure of Sun’s book value as of January 1, 2012.
Before moving to the next consolidation entry, a clarification point should be made.
In actual practice, worksheet entries are usually identified numerically. However, as in
the previous chapter, the label “Entry S” used in this example refers to the elimination
of Sun’s beginning Stockholders’ Equity. As a reminder of the purpose being served, all
worksheet entries are identified in a similar fashion. Thus, throughout this textbook,
“Entry S” always refers to the removal of the subsidiary’s beginning stockholders’ equity
balances for the year against the book value portion of the investment account.

16. Subsequent Consolidation Equity Method Example Entry A
Note: In the first year, FV adjustments are calculated in the allocation computation. In subsequent years, FV adjustments must be reduced by any depreciation taken in prior consolidations.
Trademarks ,000
Patented technology ,000
Goodwill ,000
Equipment ,000
Investment in Sun Company ,000
Note: In the first year, FV adjustments are calculated in the allocation computation. In subsequent years, FV adjustments must be reduced by any depreciation taken in prior consolidations. Consolidation Entry A adjusts the subsidiary balances from their book values to acquisition-date fair values (see Exhibit 3.2). This entry is labeled “Entry A” to indicate
that it represents the Allocations made in connection with the excess of the subsidiary’s
fair values over its book values. Sun’s accounts are adjusted collectively by the $200,000
excess of Sun’s $800,000 acquisition-date fair value over its $600,000 book value. 20

17. Subsequent Consolidation Equity Method Example Entries I & D
Note: Entry I removes Sun’s income recognized by Parrot during the year so Sun’s revenue and expense accounts (and current amortization expense) can be brought into the consolidated totals.
Equity in Subsidiary Earnings ,000
Investment in Sun Company ,000
“Entry I” (for Income) removes the subsidiary income recognized by Parrot during the year
so that Sun’s underlying revenue and expense accounts (and the current amortization expense)
can be brought into the consolidated totals. The $93,000 figure eliminated here represents the
$100,000 income accrual recognized by Parrot, reduced by the $7,000 in excess amortizations.
For consolidation purposes, the one-line amount appearing in the parent’s records is not appropriate and is removed so that the individual revenues and expenses can be included. The entry originally recorded by the parent is simply reversed on the worksheet to remove its impact.
Investment in Sun Company ,000
Dividends Paid ,000
The dividends declared by the subsidiary during the year also must be eliminated from
the consolidated totals. The entire $40,000 dividend goes to the parent so that,
from the viewpoint of the consolidated entity, it is simply an intra-entity transfer of cash.
The distribution did not affect any outside party. Therefore, “Entry D” (for Dividends)
is designed to offset the impact of this transaction by removing the subsidiary’s Dividends
Paid account. Because the equity method has been applied, Parrot’s receipt of this
money was recorded originally as a decrease in the Investment in Sun Company account.
To eliminate the impact of this reduction, the investment account is increased.
Note: Entry D removes the intra-entity transfer of cash for the dividends distributed to Parrot from Sun. 21

18. Subsequent Consolidation Equity Method Example Entry E
Note that depreciation expense is reduced for the tangible asset equipment (fair value was less than book value). Patented Technology amortization expense was recognized for the year.
Amortization Expense ,000
Equipment ,000
Patented Technology ,000
Depreciation Expense ,000
Note that depreciation expense is reduced for the tangible asset equipment (fair value was less than book value). Patented Technology amortization expense was recognized for the year.
This final worksheet entry records the current year’s excess amortization expenses relating
to the adjustments of Sun’s assets to acquisition-date fair values. Because the equity
method amortization was eliminated within Entry I, “Entry E” (for Expense) now
records the current year expense attributed to each of the specific account allocations
(see Exhibit 3.3). We adjust depreciation expense for the tangible asset equipment
and we adjust amortization expense for the intangible asset patented technology.
As a matter of custom, we refer to the adjustments to all expenses resulting from excess
acquisition-date fair-value allocations collectively as excess amortization expenses. 21

19. Applying the Initial Value Method
LO 3-3b
The parent company can use the initial value method or the partial equity method for internal record-keeping.
Application of either alternative changes the balances recorded by the parent over time and the consolidation process, but neither of these approaches affect any of the final consolidated balances reported.
Just three parent’s accounts vary because of the method applied:
• Investment account.
• Income recognized from the subsidiary.
• Parent’s retained earnings (periods after year of combination).
The parent company may opt to use the initial value method or the partial equity method for internal record-keeping rather than the equity method. Application of either alternative changes the balances recorded by the parent over time and, thus, the procedures followed in creating consolidations. However, choosing one of these other approaches does not affect any of the final consolidated figures to be reported.
When a company utilizes the equity method, it eliminates all reciprocal accounts, assigns
unamortized fair-value allocations to specific accounts, and records amortization
expense for the current year. Application of either the initial value method or the partial
equity method has no effect on this basic process. For this reason, a number of the consolidation entries remain the same regardless of the parent’s investment accounting method.
In reality, just three of the parent’s accounts actually vary because of the method applied:
• The investment account.
• The income recognized from the subsidiary.
• The parent’s retained earnings (in periods after the initial year of the combination).

20. Applying the Initial Value Method
If the Initial Value Method is used by the parent to account for the investment in the first year, the consolidation entries will change slightly.
The parent will record the sub’s activity differently under this method, so the accounts will differ from the Equity Method.
No adjustments are recorded in the Investment account for current year income, dividends paid by the subsidiary, or amortization of purchase price allocations.
Dividends received from the subsidiary are recorded as Dividend Revenue.
If the Initial Value Method is used by the parent to account for the investment in the first year, the consolidation entries will change slightly.
The parent will record the sub’s activity differently under this method, so the accounts will differ from the Equity Method.
No adjustments are recorded in the Investment account for current year income, dividends paid by the subsidiary, or amortization of purchase price allocations.
Dividends received from the subsidiary are recorded as Dividend Revenue.
Although the initial value method theoretically stands in marked contrast to the equity
method, few reporting differences actually exist. In the year of acquisition, Parrot’s income
and investment accounts relating to the subsidiary are the only accounts affected.
Under the initial value method, income recognition in 2012 is limited to the $40,000
dividend received by the parent; no equity income accrual is made. At the same time,
the investment account retains its $800,000 initial value. Unlike the equity method,
no adjustments are recorded in the parent’s investment account in connection with
the current year operations, subsidiary dividends, or amortization of any fair-value
allocations.

21. Consolidation Entries - Initial Value Method
Two entries for the initial value method are different than those for the equity method. Entry S is the same as the Equity Method. Entry A is the same as the Equity Method. Entry I is different using Initial Value Method: It eliminates the Parent’s Dividend Income account and the Sub’s Dividends Paid account. There is no Entry D. Entry E is the same as the Equity Method.
Consolidation Entries - Initial Value Method
Two entries for the initial value method are different than those for the equity method.
Entry S is the same as the Equity Method.
Entry A is the same as the Equity Method.
Entry I is different using Initial Value Method: It eliminates the Parent’s Dividend Income account and the Sub’s Dividends Paid account.
There is no Entry D.
Entry E is the same as the Equity Method. 4

22. Consolidation Entries – Partial Equity Method
LO 3-3c
The same two entries differ for the Partial Equity Method . Entry S is the same as the Equity Method. Entry A is the same as the Equity Method. Entry I is different using Partial Equity Method: It eliminates the Parent’s equity in the sub’s income and reduces the investment account. Entry D eliminates the dividend income account. Entry E is the same as the Equity Method.

23. Consolidation Entries – Other than Equity Method
Remember . . .
Entries S, A, and E are the same for all three methods.
The parent’s record-keeping is limited to two periodic journal entries:
annual accrual of subsidiary income and
receipt of dividends.
So, the Investment and Income account balances differ for the other methods, and so will the worksheet Entries I and D.
Consolidation Entries – Other than Equity Method
Entries S, A, and E are the same for all three methods.
The parent’s record-keeping is limited to two periodic journal entries:
annual accrual of subsidiary income and
receipt of dividends.
So, the Investment and Income account balances differ for the other methods, and so will the worksheet Entries I and D.

24. Consolidation Entries – Subsequent Years
Neither the Initial Value or Partial Equity Method provides a full-accrual-based measure of the subsidiary activities on the parent’s income.
The initial value method uses the cash basis for income recognition.
The partial equity method only partially accrues subsidiary income.
A new worksheet adjustment is needed to convert the parent’s beginning of the year retained earnings balance to a full-accrual basis.
Consolidation Entries – Subsequent Years
Neither the Initial Value or Partial Equity Method provides a full-accrual-based measure of the subsidiary activities on the parent’s income.
The initial value method uses the cash basis for income recognition.
The partial equity method only partially accrues subsidiary income.
A new worksheet adjustment is needed to convert the parent’s beginning of the year retained earnings balance to a full-accrual basis.

25. Consolidation Entries – Subsequent Years
For consolidation purposes, the beginning retained earnings account must be increased (Initial Value Method) or decreased (Partial Equity Method) to create the same effect as the equity method.
Entry *C. The C refers to the Conversion being made to equity method (full accrual) totals. The asterisk indicates that this entry relates solely to transactions of prior periods.
Entry *C should be recorded before other worksheet entries to align the beginning balances for the year.
Consolidation Entries – Subsequent Years
For consolidation purposes, the beginning retained earnings account must be increased (Initial Value Method) or decreased (Partial Equity Method) to create the same effect as the equity method.
Entry *C. The C refers to the Conversion being made to equity method (full accrual) totals. The asterisk indicates that this entry relates solely to transactions of prior periods.
Entry *C should be recorded before other worksheet entries to align the beginning balances for the year.

26. Other Consolidation Entries
In addition to the Entries S, A, I, D, E, and *C, intercompany debt (payables and/or receivables) must be eliminated in entry P.
No matter which method the Parent chooses to record the Sub’s activity, the consolidated totals are always the same!
This is because all the entries that were made during the year are eliminated regardless of the method used or the amount!
Other Consolidation Entries
In addition to the Entries S, A, I, D, E, and *C, intercompany debt (payables and/or receivables) must be eliminated in entry P.
No matter which method the Parent chooses to record the Sub’s activity, the consolidated totals are always the same!
This is because all the entries that were made during the year are eliminated regardless of the method used or the amount!

27. Consolidated Totals Subsequent to Acquisition
Consolidation Entries – Subsequent Years
For consolidation purposes, the beginning retained earnings account must be increased (Initial Value Method) or decreased (Partial Equity Method) to create the same effect as the equity method.
Entry *C. The C refers to the Conversion being made to equity method (full accrual) totals. The asterisk indicates that this entry relates solely to transactions of prior periods.
Entry *C should be recorded before other worksheet entries to align the beginning balances for the year.

28. Learning Objective 3-4
Understand that a parent’s internal accounting method for its subsidiary investments has no effect on the resulting consolidated financial statements.
Understand that a parent’s internal accounting method for its subsidiary investments has
no effect on the resulting consolidated financial statements.

29. Investment Accounting by Acquiring Company
A parent’s choice of internal accounting method for subsidiary investments has no effect on the resulting consolidated financial statements.
The selection of a particular method does not affect the totals ultimately reported for the combined companies.
The internal accounting method used does require distinct procedures for consolidation of the financial information from the separate organizations.
Investment Accounting by Acquiring Company
A parent’s choice of internal accounting method for subsidiary investments has no effect on the resulting consolidated financial statements.
The selection of a particular method does not affect the totals ultimately reported for the combined companies.
The internal accounting method used does require distinct procedures for consolidation of the financial information from the separate organizations.

30. Discuss the rationale for the goodwill impairment testing approach.
Learning Objective 3-5
Discuss the rationale for the goodwill impairment testing approach.
Discuss the rationale for the goodwill impairment testing approach.

31. Goodwill and Other Intangible Assets (ASC Topic 350)
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
—Goodwill and Other, provides accounting standards for determining, measuring, and reporting goodwill impairment losses. Because goodwill is considered to have an indefinite life, an impairment approach is used rather than amortization.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.

32. Describe the procedures for conducting a goodwill impairment test.
Learning Objective 3-6
Describe the procedures for conducting a goodwill impairment test.
Discuss the rationale for the goodwill impairment testing approach.

33. Goodwill and Other Intangible Assets (ASC Topic 350)
Once goodwill has been recorded, the value will remain unchanged until:
All or part of the related subsidiary is sold,
There has been a permanent decline in value in which case we test for impairment and record an impairment loss if the item is impaired. OR
Once goodwill has been recorded, the value will remain unchanged until:
All or part of the related subsidiary is sold,
There has been a permanent decline in value, in which case we record an impairment loss.

34. Goodwill Impairment – Two-Step Test
Step 1 Fair value (with allocated goodwill) is compared to the carrying value (including goodwill) of the consolidated entity’s reporting unit. Does fair value of the reporting unit exceed carrying value?
YES NO
Goodwill Impairment – Two-Step Test
Step 1
Fair value (with allocated goodwill) is compared to the carrying value (including goodwill) of the consolidated entity’s reporting unit.
Does fair value of the reporting unit exceed carrying value?
If yes, Goodwill is NOT impaired. No further testing is required.
If no, A second step must be taken to test for impairment.
Goodwill is NOT impaired. No further testing is required.
A second step must be taken to test for impairment.

35. Determination of Implied Fair Value of Goodwill
The implied value of goodwill is calculated similar to the initial determination of goodwill in a business combination.
Allocate the fair value of the reporting unit to all its identifiable assets and liabilities.
Subtract the fair value of the net assets from the fair value of the reporting unit. The excess is “implied goodwill”.
Compare the resulting “implied goodwill” to the “recorded goodwill” on the books.
Determination of Implied Fair Value of Goodwill
The implied value of goodwill is calculated similar to the initial determination of goodwill in a business combination.
Allocate the fair value of the reporting unit to all its identifiable assets and liabilities.
Subtract the fair value of the net assets from the fair value of the reporting unit. The excess is “implied goodwill”.
Compare the resulting “implied goodwill” to the “recorded goodwill” on the books.

36. Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test - Step One
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of either amortization or impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
Stop

37. Goodwill Impairment – Two-Step Test
Implied value of the related goodwill can be determined using quoted market prices, similar businesses, or present value of future cash flows. Step 2 Is “implied goodwill” less than “recorded goodwill”? NO
YES
Goodwill Impairment – Two-Step Test
Implied value of the related goodwill can be determined using quoted market prices, similar businesses, or present value of future cash flows.
Step 2
Is “implied goodwill” less than “recorded goodwill”?
If no, Goodwill is NOT impaired. No further testing is required.
If yes, An impairment loss is recorded for the excess carrying value over implied fair value.
Goodwill is NOT impaired. No further testing is required.
An impairment loss is recorded for the excess carrying value over implied fair value.

38. Goodwill Impairment—Qualitative Assessment: Goodwill Impairment Test -Step Two
FASB ASC Topic 350, “Intangibles-Goodwill and Other,” provides accounting standards for reporting income statement effects of either amortization or impairment of intangibles acquired in a business combination.
In accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization.
Stop

39. Goodwill Impairment Test Example
Newcall’s Acquisition Fair Value
Reporting Units Goodwill January 1, 2015
DSM Wired $ 22,000,000 $950,000,000
DSM Wireless 155,000, ,000,000
Vision Talk ,000, ,000,000
Newcall tests for goodwill impairment of DSM Wireless. The implied fair value of goodwill is compared to its carrying value using the following allocation of the fair value of DSM Wireless at year end…
To illustrate the testing procedures for goodwill impairment, assume that on January 1, 2015,
investors form Newcall Corporation to consolidate the telecommunications operations of
DSM, Inc., and VisionTalk Company in a deal valued at $2.2 billion. Newcall organizes each
former firm as an operating segment. Additionally, DSM comprises two divisions—DSM
Wired and DSM Wireless—that along with VisionTalk are treated as independent reporting
units for internal performance evaluation and management reviews. Newcall recognizes
$215 million as goodwill at the merger date and allocates this entire amount to its reporting
units. 17

40. Goodwill Impairment Test Example
DSM Wireless Dec. 31, 2015, fair value $600,000,000
Fair values of DSM Wireless net assets at Dec. 31, 2015:
Current asset $ 50,000,000
Property ,000,000
Equipment ,000,000
Subscriber list 140,000,000
Patented technology 185,000,000
Current liabilities (44,000,000)
Long-term debt (125,000,000)
Value assigned to identifiable net assets ,000,000
Value assigned to goodwill ,000,000
Carrying value before impairment ,000,000
Impairment loss $151,000,000
DSM Wireless Dec. 31, 2015, fair value $600,000,000
Fair values of DSM Wireless net assets at Dec. 31, 2015:
Current asset $ 50,000,000
Property ,000,000
Equipment ,000,000
Subscriber list 140,000,000
Patented technology 185,000,000
Current liabilities (44,000,000)
Long-term debt (125,000,000)
Value assigned to identifiable net assets ,000,000
Value assigned to goodwill ,000,000
Carrying value before impairment ,000,000
Impairment loss $151,000,000

41. Goodwill Impairment Test Example
Goodwill is now valued at $4,000,000.
Newcall reports a $151,000,000 separate line item goodwill impairment loss in the operating section of its consolidated income statement.
Additional disclosures required: (1) the facts and circumstances leading to the impairment
(2) the method used to determine fair value of the associated reporting unit.
The reported values for all of DSM Wireless’ remaining assets and liabilities do not change.
Newcall reports a $151,000,000 goodwill impairment loss as a separate line item in the
operating section of its consolidated income statement. Additional disclosures are required
describing
the facts and circumstances leading to the impairment and
the method of determining the fair value of the associated reporting unit (e.g., market prices, comparable business, present value technique, etc.). The reported amounts for the other assets and liabilities of DSM Wireless remain the same and are not changed based on the goodwill testing procedure.

42. Zero or Negative Carrying Amounts
The ASC requires special application of testing procedures if a reporting unit has a zero or negative carrying amount.
In that case, the ASC permits an entity to forego step 2 of impairment test unless it is more likely than not that goodwill is impaired.
The entity must consider the same factors as in the qualitative assessment for individual reporting units.
One final issue regarding goodwill impairment testing deserves mentioning. When a reporting
unit has a zero or negative carrying amount, the ASC requires a special application
of the testing procedure. An exception is needed because a zero or negative carrying
amount for a reporting unit accompanied by a positive fair value would always permit an
entity to forego Step 2 of the impairment test even though its underlying goodwill might
be impaired. Therefore, in such circumstances, the ASC requires an entity to perform
Step 2 of the impairment test when it is more likely than not that a goodwill impairment
exists. In judging the likelihood of goodwill impairment, an entity must consider the
same factors as in the qualitative assessment for individual reporting units.

43. Comparison of U.S. GAAP and International Accounting Standards
Under US GAAP: Goodwill is allocated to reporting units, usually operating segments, expected to benefit from it. A two-step process is used to test for impairment. If the carrying amount of goodwill is more than its implied value, an impairment loss is recognized.
IFRS Under IAS 36:
Goodwill is allocated to cash-generating units – at a level much lower than an operating segment.
A one-step process is used to test for impairment.
Goodwill is reduced for any excess carrying value, down to zero, and then other assets are reduced pro-rata.
Comparison of U.S. GAAP and International Accounting Standards
Under US GAAP:
Goodwill is allocated to reporting units, usually operating segments, expected to benefit from it.
A two-step process is used to test for impairment.
If the carrying amount of goodwill is more than its implied value, an impairment loss is recognized.
IFRS Under IAS 36:
Goodwill is allocated to cash-generating units – at a level much lower than an operating segment.
A one-step process is used to test for impairment.
Goodwill is reduced for any excess carrying value, down to zero, and then other assets are reduced pro-rata.

44. Other Intangibles
All identified intangible assets with finite lives should be amortized over their economic useful life that reflects the pattern of decline in the economic usefulness of the asset.
Factors that should be considered in determining the useful life of an intangible asset include
• Legal, regulatory, or contractual provisions.
• The effects of obsolescence, demand, competition, industry stability, rate of technological change, and expected changes in distribution channels.
All identified intangible assets with finite lives should be amortized over their economic useful life that reflects the pattern of decline in the economic usefulness of the asset.
Factors that should be considered in determining the useful life of an intangible asset include
• Legal, regulatory, or contractual provisions.
• The effects of obsolescence, demand, competition, industry stability, rate of technological
change, and expected changes in distribution channels.

45. Other Intangibles
Intangible assets with indefinite lives (extends beyond the foreseeable future) are tested for impairment on an annual basis. An entity has the option to first perform qualitative assessments to determine whether “it is more likely than not” the asset is impaired.
If so, a quantitative test must be performed. The asset’s carrying value is compared to its fair value. If fair value is less than carrying value, the intangible asset is considered impaired and an impairment loss is recognized. The asset’s carrying value is reduced accordingly.
Any recognized intangible assets considered to possess indefinite lives are not amortized but
instead are assessed for impairment on an annual basis. Similar to goodwill impairment
assessment, an entity has the option to first perform qualitative assessments for its indefinite-lived intangibles, to see if further quantitative tests are necessary. According to the FASB ASC ( ), if an entity elects to perform a qualitative assessment, it examines events and
circumstances to determine whether it is more likely than not (that is, a likelihood of more than
50 percent) that an indefinite-lived intangible asset is impaired. Qualitative factors include costs
of using the intangible, legal and regulatory factors, industry and market considerations, and
other. If the qualitative assessment indicates impairment is unlikely, no addition tests are needed. If the qualitative assessment indicates that impairment is likely, the entity then must perform a quantitative test to determine if a loss has occurred. To test an indefinite-lived intangible asset for impairment, its carrying amount is compared to its fair value. If the fair value is less than the carrying amount, then the intangible asset is considered impaired and an impairment loss is recognized. The asset’s carrying amount is reduced accordingly for the excess of its carrying amount over its fair value.

46. Learning Objective 3-7
Understand the accounting and reporting for contingent consideration subsequent to a business acquisition.
Understand the accounting and reporting for contingent consideration subsequent to a business acquisition.

47. Contingent Consideration in Business Combinations
If part of the consideration to be transferred in an acquisition is contingent on a future event:
The acquiring firm estimates the fair value of a cash contingency and records a liability equal to the present value of the future payment.
The liability will continue to be measured at fair value with adjustments recognized in income.
Contingent stock payments are reported as a component of stockholders’ equity, and are not remeasured at fair value.
Under the acquisition method, contingent consideration obligations are recognized as
part of the initial value assigned in a business combination, consistent with the fair-value
concept. Therefore, the acquiring firm must estimate the fair value of the contingent portion
of the total business fair value. The contingency’s fair value is recognized as part of
the acquisition regardless of whether it is based on future performance of the target firm
or the future stock prices of the acquirer.
Subsequent to acquisition, obligations for contingent consideration that meet the definition of a liability will continue to be measured at fair value with adjustments recognized in income. Those obligations classified as equity are not subsequently remeasured at fair value, consistent with other equity issues (e.g., common stock).

48. Learning Objective 3-8
Understand in general the requirements of push-down accounting and when its use
is appropriate.
Understand in general the requirements of push-down accounting and when its use is appropriate.

49. Push Down Accounting
Push-down accounting permits acquired subsidiary to record fair value allocations and subsequent amortization in its accounting records. SEC requires push-down accounting for separate subsidiary statements if no substantial outside ownership exists. Generally limited for external reporting, also used internally. Method simplifies the consolidation process and provides better information for internal evaluation.
Push Down Accounting
Push-down accounting permits an acquired subsidiary to record fair value allocations and subsequent amortization in its accounting records.
SEC requires push-down accounting for separate subsidiary statements when no substantial outside ownership exists.
Generally limited for external reporting, but increasingly popular internally.
Simplifies the consolidation process.
Provides better information for internal evaluation.