Arachnophobia a case on impairment and accounting ethics answers

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

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 Issues in Accounting Education Volume 34, Number 3, 2019