The Difference between Investment Cost and Fair Market Value
The difference between the cost of investment and the fair market value of a subsidiary business on the date of sale is known as goodwill. The venture takes place after a corporate merger. However, the goodwill is not recorded in the parent company's trial balance, which in this case is Wolf Pack Transport Corporation. Instead, the goodwill will be registered in a separate account known as an investment in a subsidiary. Maggie Valley Depot Incorporation is the subsidiary entity in this situation since Wolf Park has a majority stake in Maggie Valley. When a primary company and a subsidiary company combine their liabilities, assets, and operating accounts into one financial statement, the undertaking is known as consolidation. The investment account is broken down into various components during consolidation. It is at this point that the goodwill is separately presented as a segment of the consolidated financial statement balances. Also, other components such as subsidiary fair value adjustments are also presented separately. Therefore, a parent company records goodwill in the investment in a subsidiary account where the goodwill is recorded as an asset. On the other hand, the subsidiary company records goodwill as equity in its accounts. It is only after the consolidation of the financial statements that the goodwill is presented as a part of its balances.
SFAS 141 and SFAS 141 (R)
SFAS 141 and SFAS 141 (R) refer to the purchase method and acquisition method respectively. Compared to a cost-based measure, the acquisition method, SFSA 141 (R), holds a fair value concept as measured by the transfer of fair value of consideration. Three departures are required to achieve this and they include;
- Direct combination costs which are considered as incurred expenses as opposed to being considered as part of the investment cost.
- Contingent consideration obligations which are considered to be a section of the purchase price. Contingent consideration occurs between a previous owner of an acquiree and an acquiring entity and which refers to the transfer of equity interest and extra assets to the previous owners. The undertaking is the responsibility of the acquiring entity.
- The occurrence of a bargain purchase. The acquisition of the financial assets of a corporate organization by another entity at an amount which is lower than the fair market value is known as a bargain purchase. Assets and liabilities are taken into account when a combination occurs. In fact, at the date of combination, the acquirer assesses and determines the fair values of assumed and acquired assets and liabilities respectively when a bargain purchase takes place. The outcome of the undertaking is that the recorded amounts of the liabilities and assets are above their fair values as per their assessment and also as stated under SFAS 141. It is during the acquisition date that the recognition of bargain purchase occurs.
Recognizing Investment Loss in Value
An investment loss in value should be recognized unless the decline is temporary. Inability to recover the investments carrying amount, inability to maintain an earnings capacity which would give reason to the investments carrying amount is enough evidence to show a loss in value. In the case of Wolf Park and Maggie Valley depot, the competition which caused customers to shift business to the competitors and the decline in the price for warehouse services is evidence that Maggie Valley Depot cannot maintain an earnings capacity which would justify the investment's carrying amount. An investment's loss in value is indicated by an investment's carrying amount which is higher than the investment's current fair value. However, it is important to note that a loss in value is not essentially indicated by operating losses. The difference between revenues and costs incurred in the line of operations of a business is termed as operating losses and this cannot be used to indicate a loss in value. Also, a loss in value is not indicated by a decreasing market price which is quoted lower than the carrying amount.
Decline in Market Value of Holdings
A decline in the market value of a holding is said to occur when the assessed value of the holding which happens at the beginning of the year is more than the current market value of the holding. Regarding the case of Maggie Valley Depot and Wolf Park, the latter company employed the use of the equity method to keep track of the investments made in Maggie Valley Depot Corporation. When a company invests in another firm, the expectation is that the investment made will generate profits. In this case, Wolf Park was looking to gaining profits through dividends and capital gains. The profits generated from the investments are assessed through an accounting technique known as the equity method. The investor firm records the profit generated in its income statement. Investment adjustments are made in the event of a loss or an earning. Since Wolf Park has a twenty-five percent equity investment in Maggie Valley Depot, any earnings or losses on the investment should be adjusted accordingly. Wolf Park reported a decline in its market value of the stock ownership in Maggie Valley Depot and, therefore, the loss should be recorded as a loss on investment. This ultimately decreases the investment's carrying value. Wolf Park will use the equity method to report its investment's carrying value which is independent of market fair value change. Therefore, Wolf Park will report the decline in the current year financial statements.
Impairment of Intangible Assets
Impairment of intangible assets refers to a permanent decrease in the value of the assets. A review of impairment of intangible assets occurs annually. In the financial statements of a company, when the goodwill's varying value supersedes that of its fair value, a goodwill impairment charge is recorded. During the purchase of an asset related to goodwill, there are financial expectations from the undertaking. However, when there is strong evidence that assets linked to the goodwill cannot meet the financial expectation, an earnings charge is recorded in the income statements as goodwill impairment, and it is considered as an expense. According to SFAS No. 142, the financial statements of a company are not affected when purchased goodwill value is not impaired. Therefore, an increase in the value of purchased goodwill is not recognized in the financial statements. In the case of Maggie Valley Depot and Wolf Park regarding goodwill, the former incorporation received a sum of three thousand dollars as goodwill from the latter company. Competition in the warehouse transportation and distribution sector led to the drop in the market value for Wolf's park investment in Maggie Valley Depot. With customers shifting business to the new competitors and the expected decline in prices of warehouse service, there is enough evidence that the assets will decrease in value and this calls for the goodwill impairment.
