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Arachnophobia a case on impairment and accounting ethics answers

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9 Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case


Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/iace-52460 by Kathryn Hansen on 22 May 2020ISSUES IN ACCOUNTING EDUCATION American Accounting Association Vol. 34, No. 3 DOI: 10.2308/iace-52460


August 2019


pp. 59–69


Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case on Evaluating the Efficacy of Authoritative Guidance


Casey J. McNellis Walter R. Teets Gonzaga University


I. THE CASE


Background


AM Enterprises (AM), a private global conglomerate of consumer product manufacturers in the landscaping/gardening space, purchased 100 percent of the stock of two companies, ZD Corporation (ZD) and Hope Industries (Hope), in January 2015. This was a bold move for AM, as the acquisitions represented a new venture for the company and the entrance into a new segment in which it had no experience. As a result of the transactions, AM initially reported $3.2 million of goodwill on its consolidated balance sheet, $2 million relating to the acquisition of ZD and $1.2 million relating to Hope.


The New Segment


ZD produces and sells high-end household accessories in retail markets across the United States. The company’s top- selling products are its premium lines of kitchen and bathroom cabinet hardware and light fixtures. ZD’s products are primarily sold through large retailers and wholesalers in large metropolitan areas. In recent years, however, company management has made a focused effort on selling directly to consumers through the company website. Accordingly, ZD marketing personnel have developed strategic advertising approaches to direct customers to its commerce website. Management anticipates that this initiative will greatly improve product margins and, thus, it is expected that direct-to-consumer sales will surpass sales through retailers/wholesalers within the next five years.


We thank Valaria P. Vendrzyk (editor), Mark Kohlbeck (associate editor), and two anonymous reviewers for their guidance throughout the review process. We appreciate the perspectives offered by Paul Bahnson (Boise State University) and Joshua Herbold (University of Montana) for improving the case materials. We also thank Xiaoqing Huang for her help in the data collection and formatting of the manuscript.


An earlier version of this case was presented at the 2018 Northwest Accounting Research Group (NWARG) meeting in Leavenworth, WA. We are grateful for the feedback provided by the conference participants.


Editor’s note: Accepted by Valaria P. Vendrzyk.


Submitted: December 2018


Accepted: May 2019 Published Online: June 2019


59


Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/iace-52460 by Kathryn Hansen on 22 May 2020Hope is a manufacturer of premium home de´cor with an emphasis on quality decorative linens and unique wall decorations. The company mainly sells its products in company-owned retail stores located in upscale shopping districts in urban populations. However, a limited line of Hope products can be found at other select brick-and-mortar retailers. Additionally, the company generates a small amount of revenue via its website. Due to the nature of the company products, Hope management has faced several challenges in developing a greater online presence, yet these struggles have also hampered the expansion of its competitors. Ultimately, management has plans to develop brand awareness that will allow for brick-and- mortar expansion into more suburban areas.


Upon the purchase of ZD and Hope, AM formally established a new segment, Household Goods, for financial reporting purposes. The segment is headed by an executive team, which provides oversight of the management teams at both companies. AM’s corporate controller, Tracy Roberts, was promoted to Vice President of Finance—Household Goods following the merger.


From 2015 to 2018, the strategic acquisitions proved to be wise investments, as both ZD and Hope posted significant growth and continued to produce unique products each year. In 2019, however, the companies moved in opposite directions. ZD continued its impressive growth. Hope, on the other hand, encountered significant competition and regulatory setbacks, leading to diminished profitability and derailing the company’s strong start under AM’s control. However, Hope did benefit from some strategic land acquisitions in prior years that have appreciated considerably in value.


Goodwill


Prior to the acquisitions, in response to changes in generally accepted accounting principles in the United States (i.e.,


U.S. GAAP) and in the interest of effective portfolio management, the company developed a policy of subjecting each reporting unit to formal quantitative impairment tests of goodwill every five years, with the first such test to take place for the fiscal year 2019 financial statements. Due to the success of ZD and Hope each year and in comparison to competitors prior to 2019, AM financial reporting personnel concluded, year after year, that a formal quantitative goodwill impairment test was unnecessary.


However, pursuant to the new policy, the company made preparations toward the end of 2019 to test all of its reporting units. In conjunction with these tests, Roberts indicated that multiple fixed asset groupings within Household Goods experienced significant declines in market value, and thus the segment personnel would be testing all fixed asset groupings for impairment. AM hired Dynamic Equity, a large consulting firm specializing in corporate valuation, to conduct appraisals that are necessary for the goodwill impairment testing process. In addition, Morgan Mickelson, AM’s Director of Financial Reporting, requested financial information from the accounting records of ZD and Hope from Roberts, including relevant fair value information regarding both companies’ assets and liabilities. That information, in conjunction with Dynamic’s appraisal reports, will be used in goodwill impairment testing. Dynamic’s reports highlighted December 31, 2019 fair values in the amounts of $11,339,000 and $14,070,000 for ZD and Hope, respectively.


At the time Mickelson made the request, Roberts was in the final stages of overseeing impairment tests of the segment’s fixed assets, finalizing the valuation of inventory, and reviewing the impact of interest rate changes on the fair value of the company’s bond obligations. Essentially, Roberts had compiled all of the necessary information for the consideration of these areas, and in the coming weeks, planned to run a final analysis to determine their impact on the financial statements. Roberts was confident that all of the other assets and liabilities were reported at appropriate amounts that approximated fair values. The preliminary 2019 Balance Sheet Summary for each company provided by Roberts is presented in Appendix A.


In addition, Roberts also provided relevant information related to the ongoing impairment testing of property, plant, and equipment, valuation of inventory, and consideration of bonds payable:


· Property, Plant, & Equipment, net, is reported at historical cost less accumulated depreciation (i.e., $15,000,000 for ZD) on the preliminary 2019 Balance Sheet Summary. The tables in Appendix B contain information Roberts has compiled for fixed asset impairment testing.


· Current Assets on the preliminary 2019 Balance Sheet Summary includes inventory reported with the last-in-first-out


(LIFO) approach, using the dollar-value LIFO method applied to a single inventory cost pool. Relevant information for these cost pools compiled by Roberts for the analysis of inventory valuation is presented in Appendix C.


· ZD’s Bonds Payable consists of a single issuance of 8,000 bonds, each with a face value of $1,000 and a maturity date of


12/31/2024. The bonds have a coupon rate of 6 percent (payable annually) and were issued at face value. At 12/31/19, the prevailing market rate was 5 percent. Hope’s Bonds Payable includes a single issuance of 6,200 bonds, each with a face value of $1,000 and a maturity date of 12/31/2023. The bonds have a coupon rate of 4 percent (payable annually) and were issued at face value. At 12/31/19, the prevailing market rate was 5 percent.


4 McNellis and Teets


3 Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case


 Issues in Accounting Education Volume 34, Number 3, 2019


 Issues in Accounting Education Volume 34, Number 3, 2019


APPENDIX A


Preliminary Balance Sheet Summaries


Panel A: ZD Corporation


ZD Corporation Balance Sheet Summary December 31, 2019


Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/iace-52460 by Kathryn Hansen on 22 May 2020


Assets


Current Assets


25,000,000


Property, Plant, & Equipment, net


15,000,000


Total Assets


40,000,000


Liabilities


Current Liabilities


21,000,000


Bonds Payable (maturity date–12/31/2024)


8,000,000


Total Liabilities


29,000,000


Stockholders’ Equity


Common Stock/Additional Paid-In-Capital


8,000,000


Retained Earnings


3,000,000


Total Stockholders’ Equity


11,000,000


Total Liabilities and Stockholders’ Equity


40,000,000


Panel B: Hope Industries


Hope Industries Balance Sheet Summary


December 31, 2019


Assets


Current Assets


16,500,000


Property, Plant, & Equipment, net


11,500,000


Total Assets


28,000,000


Liabilities


Current Liabilities


13,800,000


Bonds Payable (maturity date–12/31/2023)


6,200,000


Total Liabilities


20,000,000


Stockholders’ Equity


Common Stock/Additional Paid-In-Capital


10,000,000


Retained Earnings


(2,000,000)


Total Stockholders’ Equity


8,000,000


Total Liabilities and Stockholders’ Equity


28,000,000


APPENDIX B


Property, Plant, and Equipment Information


Panel A: ZD Corporation


Asset Groupinga


Book Value


Fair Market Value


Sum of Undiscounted Future Cash Flows


1


1,250,000


800,000


1,500,000


2


3,400,000


3,600,000


4,200,000


3


960,000


850,000


900,000


4


1,080,000


900,000


1,200,000


5


3,800,000


3,850,000


3,900,000


6


1,600,000


1,750,000


2,000,000


7


440,000


300,000


400,000


8


820,000


600,000


1,000,000


9


750,000


860,000


980,000


10


900,000


1,075,000


1,200,000


15,000,000


14,585,000


17,280,000


a Groups based upon lowest level in which related cash flows are independent of other assets.


Panel B: Hope Industries


Asset Groupinga


Book Value


Fair Market Value


Sum of Undiscounted Future Cash Flows


1


4,180,000


4,265,000


4,850,000


2


1,200,000


900,000


1,100,000


3


865,000


880,000


1,200,000


4


2,085,000


3,980,000


3,470,000


5


1,430,000


2,480,000


2,200,000


6


295,000


1,895,000


2,800,000


7


1,445,000


2,000,000


2,150,000


11,500,000


16,400,000


17,770,000


a Groups based upon lowest level in which related cash flows are independent of other assets.


Panel A: ZD Corporation


APPENDIX C


Inventory Information


Net


Net Realizable


Dollar-Value LIFO Cost


Replacement Cost


Realizable Value


Value Less Normal Profit Margin


5,000,000 4,100,000 6,000,000 4,800,000


Panel B: Hope Industries


Dollar-Value LIFO Cost


Replacement Cost


Net Realizable Value


Net Realizable Value Less Normal Profit Margin


Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/iace-52460 by Kathryn Hansen on 22 May 2020


3,700,000 3,850,000 4,600,000 3,300,000


REFERENCES


Alford, R. M., T. M. DiMattia, N. T. Hill, and K. T. Stevens. 2011. A series of revenue recognition research cases using the Codification.


Issues in Accounting Education 26 (3): 609–618. https://doi.org/10.2308/iace-50029


Chandra, U., S. K. Dutta, and D. J. Marcinko. 2018. Revenue recognition at TSA, Inc.—A roller coaster ride. Issues in Accounting Education 33 (3): 101–116. https://doi.org/10.2308/iace-52099


Financial Accounting Standards Board (FASB). 2017. Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Accounting Standards Update 2017-04. Norwalk, CT: Financial Accounting Foundation.


Gujarathi, M. R. 2012a. Super Electronics, Inc.: Financial reporting of sales incentives and vendor allowances using FASB Codification.


Issues in Accounting Education 27 (2): 461–474. https://doi.org/10.2308/iace-50005


Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/iace-52460 by Kathryn Hansen on 22 May 2020Gujarathi, M. R. 2012b. Max-Value Stores, Inc.: Financial reporting of gift cards. Issues in Accounting Education 27 (3): 783–798. https://doi.org/10.2308/iace-50080


Gujarathi, M., and T. Noga. 2012. Regal Hair Salon: Tax and financial reporting of gift cards. Journal of Accounting Education 30 (1): 131–142. https://doi.org/10.1016/j.jaccedu.2012.06.005


Gujarathi, M. R., and A. Yezegel. 2014. Spectacular Airlines, Inc.: Implications of the transition to IFRS in the context of cross-border acquisitions. Issues in Accounting Education 29 (1): 247–269. https://doi.org/10.2308/iace-50583


McNellis, C. J. 2018a. Middle Road Media: A codification research case on the accounting for software development activities. Issues in Accounting Education 33 (3): 135–144. https://doi.org/10.2308/iace-52128


McNellis, C. J. 2018b. Dynamic Divestures: A codification exercise on the reporting of discontinued operations. Issues in Accounting Education 33 (1): 53–63. https://doi.org/10.2308/iace-51882


McNellis, C. J., R. F. Premuroso, and R. E. Houmes. 2015. Using the Codification to research a complex accounting issue: The case of goodwill impairment at Jackson Enterprises. Issues in Accounting Education 30 (1): 35–46. https://doi.org/10.2308/iace-50949


Persellin, J. S., M. K. Shaub, and M. S. Wilkins. 2014. Arachnophobia: A case on impairment and accounting ethics. Issues in Accounting Education 29 (4): 577–586. https://doi.org/10.2308/iace-50890


PwC. 2017. Simplifying goodwill impairment testing. In the Loop (July 19). Available at: https://www.pwc.com/us/en/cfodirect/ publications/in-the-loop/step-2-goodwill-impairment-test.html


Savage, A., D. C. Cerf, and R. A. Barra. 2013. Accounting for the public interest: A revenue recognition dilemma. Issues in Accounting Education 28 (3): 691–703. https://doi.org/10.2308/iace-50463


 Issues in Accounting Education Volume 34, Number 3, 2019

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