Board Meeting Handout July 9, 2003 Norwalk, CT Business Combinations II—Purchase Method Procedures The Board will discuss: • Issues surrounding the initial allocation between the controlling and noncontrolling interests of the full amount of goodwill1 that arises in an acquisition of a less than 100 percent controlling interest. • Issues surrounding the subsequent allocation of goodwill impairment losses between the controlling and noncontrolling interests in a less than 100 percent owned subsidiary for which the full amount of goodwill was recognized. • Whether the fair value of an intangible asset that does not meet the criteria for recognition as an intangible asset apart from goodwill at the acquisition date (and, thus, is included in the amount recorded as goodwill) should be reclassified from goodwill if that intangible asset subsequently meets the criteria for recognition apart from goodwill. Initial Allocation Between the Controlling and Noncontrolling Interests of the Full Amount of Goodwill in an Acquisition of a Less Than 100 Percent Controlling Interest 1. How should the full amount of goodwill be allocated (or assigned) between the controlling and the noncontrolling interests in an acquisition of a less than 100 percent controlling interest in a subsidiary? • Alternative One: The goodwill allocated to the controlling interest would be calculated as the difference between the consideration paid for the ownership interest acquired and the controlling interest’s share of the fair value of the identifiable net assets acquired. The remainder of the goodwill would be allocated to the noncontrolling interests. • Alternative Two: The goodwill would be allocated between the controlling and noncontrolling interests based on their relative ownership interests in the fair value of the acquiree. 1 The full amount of goodwill is measured as the difference between the fair value of the acquired entity taken as a whole and the sum of the fair values of all of the identifiable net assets acquired on the acquisition date. Unlike present practice, when an entity acquires a controlling interest in a partially owned entity (subsidiary), the full amount of goodwill includes goodwill related to the interests of noncontrolling shareholders in that acquired entity. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. • Alternative Three: If another unit of the controlling interest is expected to benefit from the synergies of the combination, first assign the related goodwill to that other unit. Then allocate the remainder of the goodwill assigned to the acquiree between the controlling and noncontrolling interests based on their relative ownership interests in the acquiree. 1.a Should the guidance that requires goodwill to be assigned to the reporting unit expected to obtain the benefits of the synergies of the combination apply regardless of whether the subsidiary is wholly or partially owned? Paragraphs 34 and 35 of FASB Statement No. 142, Goodwill and Other Intangible Assets, provide the standards and guidance for assigning goodwill to reporting units, including units that were assigned none of the assets acquired or liabilities assumed. Paragraph 34 states: For the purpose of testing goodwill for impairment, all goodwill acquired in a business combination shall be assigned to one or more reporting units as of the acquisition date. Goodwill shall be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit. Illustration of Alternatives for Allocating the Full Amount of Goodwill If a Less Than 100 Percent Controlling Interest in a Subsidiary Is Acquired (Assuming the Guidance in Paragraphs 34 and 35 of Statement 142 Applies) Assume the following: Total fair value of Subsidiary Fair value of Subsidiary’s identifiable assets and liabilities Goodwill $ 190 150 $ 40 Controlling interest acquired Consideration paid Goodwill expected to be recovered in another unit of Parent 50% $ 100 $ 12 Under Alternative One, goodwill would be allocated as follows: Goodwill—Parent’s share (consideration paid of $100 less Parent's share of the identifiable net assets acquired of $75) Goodwill recoverable at another reporting unit of Parent Goodwill expected to be recovered in Subsidiary: Goodwill—Parent’s share ($25 - $12) Goodwill—Noncontrolling interests' share Total goodwill 2 $ 25 $ 12 13 15 $ 40 Under Alternative Two, goodwill would be allocated as follows: Goodwill—Parent’s share (50% of $40 total goodwill) $ 20 Goodwill recoverable at another reporting unit of Parent Goodwill expected to be recovered in Subsidiary: Goodwill—Parent’s share ($20 - $12) Goodwill—Noncontrolling interests' share Total goodwill $ 12 8 20 $ 40 Under Alternative Three, goodwill would be allocated as follows:2 Goodwill—Parent’s share $ 26 Goodwill recoverable at another reporting unit of Parent Goodwill expected to be recovered in Subsidiary: Goodwill—Parent’s share (50% of remainder) Goodwill—Noncontrolling interests' share (50% of remainder) Total goodwill $ 12 14 14 $ 40 2.a If Alternative One is selected for initial allocation of the full amount of goodwill, does the Board wish to clarify how goodwill should be allocated to the controlling and noncontrolling interests if no consideration is paid by the acquirer on the date of the business combination? Alternative One, as currently worded, could be interpreted to mean that if no consideration is exchanged on the date of the business combination, then all of the goodwill should be allocated to the noncontrolling interest. Control of a business could be obtained without the acquirer paying any consideration on the acquisition date, for example, if minority veto rights lapse. If Alternative One is selected for the initial allocation of goodwill in Question 1, and no consideration is paid on the date of the business combination, should the goodwill allocated to the controlling interest be measured as the difference between the fair value of the acquirer’s investment in the acquiree at the acquisition date and the controlling interest’s share of the fair value of the identifiable net assets acquired? 2 Under Alternative Three (as in this example), the goodwill assigned to the controlling interest could be greater than the difference between the consideration paid and the percentage of the net identifiable assets acquired. [$100 paid for 50 percent controlling interest compared to $101 fair value of acquiree assigned to the controlling interest ($75 for 50 percent of the identifiable assets plus $26 in goodwill).] 3 2.b If Alternative One is selected for initial allocation of the full amount of goodwill, does the Board wish to clarify how goodwill should be allocated to the controlling and noncontrolling interests if, on the date of the business combination, the consideration paid does not represent the total controlling interest owned because control was obtained as part of a step acquisition? In a step acquisition, the current wording of Alternative One could result in the controlling interest being allocated less than its ownership interests in the full amount of goodwill. This is because the consideration paid at the acquisition date is unlikely to be the appropriate basis for measuring all of the goodwill that should be allocated to the controlling interest. If Alternative One is selected for the initial allocation of goodwill in Question 1, and control of a business combination is achieved as part of a step acquisition, should the goodwill allocated to the controlling interest be measured as the difference between: • The fair value at the acquisition date of the acquirer’s previously held investment in the acquiree, plus the fair value of the consideration paid for the additional ownership interest that resulted in the acquirer obtaining control of the acquiree, and • The controlling interest’s share of the fair value at the acquisition date of the acquiree’s identifiable net assets. Illustration of Allocating Goodwill Under Alternative One (Question 1) in a Step Acquisition Assume the following: Fair value of Subsidiary Fair value of Subsidiary’s identifiable assets and liabilities Goodwill $ 190 150 $ 40 Controlling interest acquired (before the business combination the acquirer owned 40%) Total controlling interest owned Consideration paid for 10% controlling interest 10% 50% $ 22 This would result in the following application of Alternative One in a step acquisition: Fair value of previously held ownership interest (40% x $190) Consideration paid for additional 10% interest Total “consideration paid” Less: Parent’s share of identifiable net assets (50% x $150) Goodwill attributable to parent 4 $ 76 22 $ 98 75 $ 23 Subsequent Allocation of Goodwill Impairment Losses Between the Controlling and Noncontrolling Interests If the Full Amount of Goodwill Was Recognized Initially 3. Should the Board (i) specify how goodwill impairment losses should be allocated between the controlling and noncontrolling interests or (ii) only indicate that losses should be allocated on a reasonable and consistent basis? 3.a If the Board decides to specify how to allocate goodwill impairment losses, how should those losses be allocated if the reporting unit incurring the loss is a standalone partially owned subsidiary? • Alternative One: Allocate goodwill impairment losses between the controlling and noncontrolling interests on a pro rata basis using the relative carrying amounts of the goodwill allocated to them. If a change in ownership interests in a subsidiary occurs, the carrying value of goodwill allocated to that subsidiary should be reallocated between the controlling and noncontrolling interests to reflect the changes in relative ownership interests (whether an impairment loss occurs or not). • Alternative Two: Allocate goodwill impairment losses to the controlling and noncontrolling interests based on the actual ownership percentages at the date of the impairment. Illustration of Allocating Goodwill Impairment Losses Under Alternative One If the Subsidiary Is a Stand-Alone Reporting Unit Assume Parent acquired a 50 percent controlling interest and $40 of goodwill was allocated initially to the controlling and noncontrolling interests of the partially owned subsidiary as follows: Goodwill—Parent’s share Goodwill—Noncontrolling interests' share Total goodwill $ $ 25 15 40 Now assume that Parent purchased one-half of the outstanding noncontrolling interest, increasing its ownership in Subsidiary from 50 percent to 75 percent. Then Subsidiary incurs a $16 impairment loss. 5 The impairment loss would be allocated under Alternative One as follows: % Initial Allocation Goodwill— Parent’s share Goodwill— Noncontrolling interests' share Total goodwill Ownership Change Goodwill Adjustment3 Adjusted Carrying Value of Goodwill % Allocation of Impair. Loss % New % Carrying Basis $ 25 62.5 $ 7.5 $ 32.5 81.3 ($ 13) 81.3 $ 19.5 81.3 15 $ 40 37.5 100.0 (7.5) 0 7.5 $ 40.0 18.7 100.0 (3) ($ 16) 18.7 100.0 4.5 $ 24.0 18.7 100.0 3.b If the Board decides to specify how to allocate goodwill impairment losses, how should those losses be allocated if the reporting unit incurring the loss includes all or part of one or more partially owned subsidiaries? • Alternative One: Require goodwill of partially owned subsidiaries to be assigned and tested for impairment at the subsidiary level. Partially owned subsidiaries, therefore, would be treated as separate reporting units for impairment testing. • Alternative Two: Allocate the impairment loss among the components of the reporting unit using the relative value method. Under this method, the portion of the impairment loss attributable to the partially owned subsidiary would be determined by multiplying the loss by the proportion of the fair value of the subsidiary to the fair value of the reporting unit as a whole. • Alternative Three: Allocate the impairment loss among the components of the reporting unit using the relative carrying value of goodwill method. Under this method, the portion of the impairment loss attributable to the partially owned subsidiary would be determined by multiplying the loss by the proportion of the carrying value of the goodwill assigned to the subsidiary to the carrying value of goodwill of the reporting unit as a whole. 3 Since Parent purchased one-half of the outstanding noncontrolling interest’s ownership interest, transfer one-half of the goodwill allocated to the noncontrolling interest to Parent. 6 Subsequent Reclassification of Intangible Assets from Goodwill 4. Should intangible assets that are included in the amount recorded as goodwill at the date of acquisition because they do not meet the criteria for separate recognition be reclassified from goodwill if they subsequently meet those criteria? Certain IASB Board members expressed some concern about whether those intangible assets should continue to be subsumed in goodwill indefinitely. According to paragraph 39 of Statement 141 an intangible asset is recognized apart from goodwill if it arises from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired entity or from other rights and obligations). If an intangible asset does not arise from contractual or other legal rights, it is recognized apart from goodwill only if it is separable—that is, capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged (regardless of whether there is an intent to do so). An intangible asset that cannot be sold, transferred, licensed, rented, or exchanged individually is considered separable if it can be sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset, or liability. • Alternative One: Require an intangible asset that forms part of the goodwill at the acquisition date to be subsequently reclassified from goodwill and recognized separately if it meets the criteria for separate recognition within a short period of time after the acquisition date (for instance, one year) as a result of a subsequent event. • Alternative Two: Do not adjust goodwill for events that occur subsequent to the business combination. 7 Board Meeting Handout July 9, 2003 Norwalk, CT Financial Instruments: Liabilities and Equity The Board will discuss objectives and planning for redeliberations of the second phase of its liabilities and equity project. The Board will address the following questions: 1) Should the project scope be expanded to include financial instruments (and, potentially, components of financial instruments) with characteristics of both assets and equity? a) If the scope is expanded to include financial instruments with asset characteristics, the Board will need to consider whether to amend the definition of an asset found in FASB Concepts Statement No. 6, Elements of Financial Statements, to include financial instruments embodying rights to receive the issuer’s own shares. 2) Does the Board agree with the stated objectives for the second phase of the liabilities and equity project ? The stated objectives are to: a) Improve accounting and reporting by issuers for financial instruments that contain characteristics of both liabilities and equity (or of both assets and equity, or of all three), but have been presented entirely as liabilities, entirely as assets, entirely as equity, or between the liabilities section and the equity section of the statement of financial position b) Amend the definitions of elements in Concepts Statement 6 so that the Board’s decisions in FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and in the planned Statements for the second phase of the project are consistent with those concepts. The Board also will be asked for input and suggestions related to the staff’s proposed project plan to accomplish those objectives. Possible discussion topics include: • Whether the plan includes the main issues to be redeliberated • Whether the general sequence of the redeliberations plan is appropriate o The staff has proposed to begin by resolving issues related to definitions and classification. Next would come resolving issues related to the unit of accounting (whether to separate) and how to separate (using measurement methods). That might be called a “fresh look” approach. o Alternatively, the project could first address separation issues (both whether and how to separate) and then turn to definitions. That might be called a “pick up where we left off” approach, using the ownership relationship notion and other tentative conclusions developed in the ED and prior redeliberations as the starting point. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. • Whether the proposed approach to international convergence and SEC interaction is good o The plan is to assess the potential to achieve international convergence on an issue by issue basis. o The plan is to collaborate closely with the SEC staff regarding potential effects on existing SEC literature, such as the guidance promulgated in Accounting Series Release No. 268, “Presentation in Financial Statements of Redeemable Preferred Stock.” • Whether the estimated timing of the plan and staff resources appear reasonable. 2 Board Meeting Handout 107 Replacement Project At its July 9, 2003 meeting, the Board will discuss four alternative future steps for the FAS 107 project. The alternative future steps identified by the staff are: 1. Retain the FAS 107 project and revise its objectives to only address issues related to the definition of a financial instrument, the scope exclusions embodied in paragraph 8 of FAS 107, and the display objective. 2. Remove the FAS 107 project from the Board’s agenda and re-assign the display objective to the Reporting Financial Performance project. 3. Remove the FAS 107 project from the Board’s agenda and do not address display issues until all measurement issues have been resolved. 4. Establish a new project to codify and simplify all disclosures about financial instruments. The staff will also ask the Board to consider the implications of the selected alternative on the Board’s April 9th decision to amend FAS 115 regarding valuation of restricted stock. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.
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