I have a question about the solution to the above question and I am wondering if anyone can offer some hints? According to the revised solution from CFAI (see the errata), the Total Asset Turnover under consolidation method should be: (950+510)/(2140-320+1070+60)=0.495 I understand the nominator (which is the sum of the revenue of the two companies). The denominator looks a bit imposing. It looks like CFAI is taking the Total Asset of the two companies, subtract the investment (at cost) and add 60M. Anyone knows where does the 60 come from? The same magic number (60) seems to be used when evaluation using the proportionate method. The answer is (950+0.5 * 510)/[1820+(1070+60)/2]=0.505. Any hints would be appreciated. Thanks in advance! 
P.S. This is a question worth studying, because it illustrates an example in which proportionate method performs better than both Equity and Consolidation methods.
goodwill for 50% worth of the company is 30. so for full company it is 30/.5 = 60.
I believe Goodwill is only recorded in the acquiring company. So shouldn’t it be 30 (=320-580 * 0.5), not 60, for the consolidation method? The denominator for the proportionate method makes more sense, since it is (1820+1070/2+30).
Hi, eltia. There are two things that are helpful: (1) Recall that under the consolidation method (whether US GAAP or IFRS), you need to bring the ENTIRE – not half, not a quarter, not a tenth – the ENTIRE fair value of the acquired company’s identifiable assets and liabilities onto the parent’s books on a line item by line item basis. In particular, this means that you bring the ENTIRE fair value of 60 of the identified licensing rights onto the parent’s books (on a line item by line item basis). (2) We are deailing with a “bargain purchase” option, i.e., you will need to know how to account for this properly, since when it comes to “bargain purchase” options, US GAAP and IFRS differ. We know this is a “bargain purchase” because the FAIR VALUE (not book value) of Boswell’s net assets (which now includes the 60 of licenses) is higher than the purchase price of 320. Indeed the fair value is Boswell’s net asset is (1,070 + 60) – 490 = 640. Initially the journal entry to reflect the investment is: Dr. Investment in Boswell - 320 Cr. Cash – 320 The consolidation method (whether US GAAP or IFRS) demands that we reclass the “Investment in Boswell” account to individuals asset and liability accounts: Dr. Cash – 20 Dr. Receivables – 45 Dr. Inventory – 75 Dr. PPE – 930 Dr. Licenses – 60 Cr. Current liabilities – 90 Cr. Long term debt – 400 Cr. Investment in Boswell – 320 My debits of 1,130 exceed my credits of 810 (by 320). That means there is negative goodwill. Under US GAAP, negative goodwill is used to reduce non-current assets of the parent. However, we are dealing with IFRS. As such, we make no such reduction. Instead, the “negative goodwill” is recognized as profit on NimMount’s books (see bottom of p. 43 of the Reading). So the correct set of journal entries under IFRS is Dr. Cash – 20 Dr. Receivables – 45 Dr. Inventory – 75 Dr. PPE – 930 Dr. Licenses – 60 Cr. Profit from purchase - 320 Cr. Current liabilities – 90 Cr. Long term debt – 400 Cr. Investment in Boswell – 320 So as you can see, under a “bargain purchase”, IFRS yields no goodwill. Doing the correct journal entries as prescribed by IFR Standards helps to avoid the mental trap of thinking there is any goodwill to record. Of course, you would not record the purchase this way, if this were not a “bargain purchase”. Most of the normal textbook examples involve paying more than the fair value – in which case you would most likely have with some goodwill. In any case, NinMount’s assets are: Cash (70); Receivables (115); Inventory (205); PPE (2,500); Licenses (60). The sum of these assets is 2,950.
A VERY BIG thank you to cadlag. You just helped me find a section I need to re-read and potentially saved me one vignette on the exam. I was reading Schweser on this section and the Goodwill part always puzzles me. It seems for this particular section, CFAI text has done a better job. Thanks again!
It is NOT NEGATIVE GOODWILL. It is reclassed as Minority Interest (Non-Controlling Interest in IFRS). Total Assets Boswell=1070 (as in the balance sheet given now) Total Liabs Boswell=490 (as in balance sheet given now) Purchase Price=320 Share of Net Assets of Boswell=0.5 * (1070-490)=290 Excess of Purchase Price of FV Net Assets=320-290=30
Thanks for your response, CP. Highly appreciated a different opinion on the subject. I haven’t read the section on CFAI text yet, so I would reserve my judgment until I read through the section. Intuitively, however, I believe I understand where the 60 comes from now (320-580/2=30, which is only half of the license due to the 50% stake. Therefore, 60 would be the full amount). It also appears to me that, this case does not involve a bargain purchase, because Purchase Price = 320 > 580*0.5 = 290 = FV. To compute the total asset under Consolidation, I would be more inclined to reason it as follows: NinMount’s Asset + Boswell’s Asset + 60M Licenses - 320M investment (since this is counted twice when we sum the total assets of the two companies) To compute the total asset under Proportionate, I would be more inclined to reason it as follows: NinMount’s Asset - 320M investment (since only a portion of this would be accounted for by the Boswell’s asset) + 50% of Boswell’s Asset + 50% of License The above are my guesses. So let me read the whole section first and I would come back to you with any new findings that I have. Thanks again!
CP, How come your assets of 2,950 do not equal the sum of your liabilities and equities of 2,920? This might be a clerical ovesight. In any case, your response and my respone do not appear to be inconsistent with each other at all. I purposefully did not provide the journal entries to reflect the minority interest, since those journal entries do not figure into the calculation of the fixed asset turnover. Your presentation is complete. Eltia, What if we did not know about this question in the Reading? What if someone told you that a company named NinMount was paying 320 to purchase a controlling interest in a company with (net) fair value of 640. Now would it be a “bargain purchase”?
the extra 60 (50% of that) would go in to the Minority interest as well. So Minority interest would be 320 instead of 290.
I read through the relevant section in the CFAI text. This is how I would compute Total Assets Turn Over (TATO) under the three methods: Equity method = 950 / 2140 = 0.44. (This is straight forward, because the BS already reflect the purchase paid by NinMount. So using the BV of Total assets would do.) Consolidation method. First, we determine if there is any Goodwill: Purchase Price (320k) LESS: Fair Value of Net Asset (580K * 0.5 = 290K) = Excess over Purchase Price (30k) Attributable to: Licenses (30k, as given in the question) ADD: Goodwill (0k) = 30k So there is no Goodwill (and hence no need to test for impairment). Therefore, TATO = (950+510)/(2140+1070-320+30/0.5) = 1460/2950 = 0.49. The idea for the denominator is that, we are summing the assets of the two companies after the purchase has been made. However, there is a portion (50% of Boswell’s equity) that are being counted twice, so this portion needs to be removed, together with the licenses. I would rather calculate the denominator as [2140+(1070-290)+30]. Finally for proportionate consolidation, TATO = (950+150*0.5)/[2140-320+(1070+60)/2] = 1205/2385 = 0.51. I would rather calculate the denominator as [(2140-320)+(1070/2+30)]. In summary: there is no Goodwill and this is not a bargain purchase.
Full goodwill
= Fair Value of entity as a WHOLE - Fair Value of identifiable net assets
= Purchase price/%acquired - FV identifiable net assets
=320/50% - 580 = 60