Question

In: Accounting

Q3. On January 1, 2016, ATM Corporation acquired all of the common stock of ZED Company...

Q3. On January 1, 2016, ATM Corporation acquired all of the common stock of ZED Company for $300,000. On that date, ZED's identifiable net assets had a fair value of $250,000. The assets acquired in the purchase of ZED are considered to be a separate reporting unit of ATM Corporation. The carrying value of ZED's investment at December 31, 2016, is $310,000. The fair value of the net assets (excluding goodwill) at that date is $220,000 and the fair value of the reporting unit is determined to be 260,000.

Required:

1) Explain how goodwill is tested for impairment for a reporting unit.

2) Determine the amount, if any, of impairment loss to be recognized at December 31, 2016.

Solutions

Expert Solution

(a)

Impairment refers to the reduction in the value of asset due to negative change in the external environment of the entity. Impairment occurs when the market value is less than the recorded value (in the balance sheet) of the asset.

Impairment Recognition: The entity should test for impairment loss when there are indicators for impairment. Some of the indicators that may lead to an impairment of the asset are:

  • Major physical damage to the asset.
  • Significant changes in the Economic or legal factors.
  • Drastic reduction in the market price.

The goodwill must be tested for impairment annually. Acquired goodwill and other indefinite-lived intangible assets should be reported in balance sheet at fair value. Testing for impairment is required when a ‘triggering event’ (such as the economic or legal factors, loss of a key customer or unanticipated competition) occurs that could reduce the asset’s value.

Following steps are followed for testing and calculating of goodwill impairment:

  1. Compare the fair value of the reporting unit to its carrying amount.
  2. If the fair value is lower, then goodwill impairment should be calculated.
  3. Goodwill impairment is calculated by subtracting the fair value of unit from the carrying value of the unit subject to the carrying value of goodwill in the books of company.

(b)

On January 1, 2016

Cost of investment at the fair value of consideration given BY ATM                                          $300000

Less ATM’S share of the fair value of the net assets of ZED                                                     $ 250000

Goodwill attributable to ATM on 1 Jan, 2016                                                                              $ 50000

On December 31, 2016

The fair value of the reporting unit = $260000

Carrying value of the reporting unit = $310000

Because the fair value of the reporting unit ($260000) is lower than its carrying value ($310000), there is impairment of $50,000 in the operating unit, which should be first written off against goodwill of $50000 recorded in the books.


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