Future Charter Financial Analysts, welcome aboard. Level two candidates, you're in the right place. We are going to get started in just a couple of minutes here. So sit back, relax, grab yourself a cup of coffee, a Red Bull, whatever you need. We got about two minutes till we get started.
All right, folks, two minutes. And I will now entertain you with my DJing skills while we are waiting to get started. I got some of my colleagues at UWorld back there, Sam, David.
uh james they're they're big time dancers so uh hopefully you could see them if they turn on their camera they're gonna do their moves for you well i don't know about moves pete but uh the only good moves we want to see are like the the good learning you're going to give to everyone tonight i'm too fast for the camera Do you have that cowbell? What happened? Did you add the cowbell in that?
The cow? No, no cow. You want the cowbell. i gotta bust that out hold on i don't think i have that here two minutes minute and a half 90 seconds Go, Sam!
Well, I'm dancing, but no one is ever going to see that, Pete. Come on, Sam. Do those moves. Do those moves. I think not.
But thank you. I got to play something for Sam. Hold on.
Hold on. One minute. Go, Sam!
Let's go. All right. Future charter holders.
How are you, Sam, James, David? Are we ready? Are we ready? Yes, we are.
All right. I'm excited. Yeah. Yeah. Yeah.
All right. Here we go. Well, thank you so much, folks, for joining us. Welcome aboard. We are going to use your time wisely tonight.
You are going to become a resident expert at intercorporate investment. So if you buy somebody, you don't have significant influence. So you're going to treat it as amortized costs, fair value through P&L, fair value through OCI. What if you have significant influence? Then you got to know the equity method.
And when you have control, you got to consolidate. And we're going to use full goodwill or partial goodwill. Tons of exciting stuff. But before we get started with all that, my name is Pete Olinto.
I happen to be one of the lead instructors here for the CFA review program, as well as the CPA. So I've been a charter holder for quite some time, as you can see the gray hair. So it goes back, way back. Yeah, so I'm very happy to be here.
I'm a professional test taker. So, yeah, I don't like to do the work, but past CPA exam, bar exam, different levels of the CFA, I'm proud to say I never had to retake any of those tests. But that is definitely not because I have a high IQ. And my colleagues here at UWorld who are on this call right now can attest to the fact that my IQ is in the left tail.
But the difference between success and failure, level two in particular, is obviously, as you know, the time and effort you put in. You want to work hard, but you want to work smart. So you don't want to get lost in the weeds.
You also got to use some good judgment. Anybody who's telling you. not to study derivatives or some of the accounting topics because it takes a while to kind of get intimately familiar with the subject matter. Listen, easy topic, ethics, no math involved, really crazy hard questions. I kid you not.
If you thought the level one ethics was difficult, wait to get to levels two and three. So yeah, straightforward topic, the questions could be really challenging. On the other hand, some of the accounting, the derivatives, forward futures, option swaps, it takes a little while. I get it. The first time you go through it, you're probably not reviewing it.
You're probably learning it for the first time. We get that. Although we're called a review course, we know that a lot of you are actually seeing some of this content for the very first time. So we'll teach you what you need to know to get through the exam.
But most importantly, when you fight through it and you can master some of the tougher topics, exam day, the questions tend to be relatively straightforward for the tougher topics because the nature of the material itself is very challenging. so they don't have to go nuts making the questions really tricky like with the ethics it's either that or the ethics just doesn't come to me naturally i i don't know i mean i was telling sam the other day so long as you don't get caught that's ethical right sam or is that not right i don't know i forget that's why i don't teach the ethics but uh we are very very happy that you're joining with us tonight so if you uh enjoy what you're seeing here and you want to enroll with We want to thank you for your time monetarily. So 25% off the retail price.
So you've got this QR code here, which I'll put up again on the back end. But yeah, this is what it is. So we appreciate your time tonight.
Okay, so it's a free event monetarily, but not free in terms of your time. So we are going to use your time wisely. With that being said. Sam, I am, or James, is there anything by way of intro I did not say that I should have said? If you want to say hello real quick, is there anything you guys want to add to my intro?
Well, Pete, no, there's no way you can improve on perfection, but I just wanted to say thank you to all the people who are attending this. My name is Sam Gottlieb. I'm the Director of CFA Education here at UWorld, and we're really glad to have you with us. You're really going to get... A lot of good information from Pete tonight.
And, you know, I would take all the advantage of this and his knowledge and experience that you can. So having said that, Pete, it is all yours. All right.
Here we go. So, folks, we're going to learn by doing. All right. So this is a lot of what we do in the course as well, especially when it's math intensive.
We're not going to lecture math. You've got to see it being done. So we're going to go through questions again. High level. My goal is to cover.
uh debt securities uh preferred equity common equity where you have no significant influence i'll review those concepts uh then i'll talk about equity method as well as consolidation so let's start with our first question exam date folks before you read through the facts i call it legalized cheating you generally want to start with the question stem so you can get a feel for hey what's the topic what are the rules i've got to be looking for etc so they tell us at the end of year one What are we going to report on the income statement and the balance sheet, respectively, if this investment in Swiss landing company is classified as held to maturity? Now, held to maturity is also known today around the world as amortized cost. So folks, this is a debt security. With debt securities, you have no voting rights.
So there's no significant influence, folks. No voting. If you don't get the vote, there's no way you can have influence on the company.
So amortized cost. Then you're thinking. What are the rules?
Well, on the balance sheet, we do not mark to market value. It's on your books at amortized cost. Do not, they're going to give you market value.
Do not mark to fair market value. Now, on the income statement, what you're going to have is interest income. There should be no. unrealized gains and losses. Why not?
Because you're not marking to market value. And if you're going to hold it to maturity, there should be no realized gains and losses because you shouldn't be selling it. Now, legally, they can't stop you from selling it. Okay. But the hell to maturity.
But if you do sell it, I'll show you how to calculate the gain or loss. Okay. So basically, you do not mark to market value.
You just got to put it on the books at amortized cost. All right. So they tell us now in the first year, Eastern Inc. invests $150,000.
Therein lies your cost. in swiss landing we bought debt securities the par value of the securities is 160 we only paid 150. now be careful folks we're doing this from the perspective of the investor the buyer let me just quickly review but what if you're the issuer what if you're the borrower what do they do no journal entries folks what you got to know for the exam well if you're issuing what's the cash received you have a financing inflow of 150 000. Okay, that would be your financing inflow. But now you got to repay the face value.
160,000 is going to be your financing outflow. Your initial carrying value has to equal the cash received. So your initial carrying value is what you sold it for, 150. This is a loser. You're borrowing 150, but you got to repay 160. That's a loss, but we don't call it a loss because that would violate the matching principle.
Instead, what do we call that $10,000? A difference. deferred loss, an unamortized, a currently unrecorded loss, an unamortized discount. Okay.
Disco, I'm just going to abbreviate disco, an unamortized discount. Okay. Little by little, that discount will be amortized over the life of the bond by making the interest expense greater than the coupon paid.
So as we record the discount, The unamortized amount goes down, the carrying value is going to get pulled up towards par. So people ask me, hey, Pete, is a discount a gain or a loss? I don't know. Which side of the fence do you want? Because if you're the issuer, the borrower, that discount is a deferred loss.
We call it an unamortized discount. Your interest expense every period will be greater than the coupon paid. On the flip side, if you're the investor. which we're doing here folks we're going to be on this side of the coin you're the bond holder that's a deferred gain a deferred gain your interest income is actually going to be greater than the coupon received and this is what we're focusing in on tonight all righty so they tell us we paid 150 face value 160 4 that's coupon rate that's going to dictate your coupon payment not your interest expense. The only time, excuse me, your interest income, the only time your interest income is going to equal the coupon received is if you buy it at par.
We didn't buy it at par. We bought it at a discount. So what do we know? Our interest income will be greater than that 4%. They tell us at the time of the purchase, the market rate was 5%.
There's your yield to maturity. Ah, makes sense, right? My yield would have been 4 if I paid 160, but because I paid less than 150. 150 my yield to maturity is greater than my coupon so your coupon divided by the price there's your yield anytime you buy it at a discount you're expecting your yield to be greater than the coupon receipt all right exciting stuff we are kicking ass baby they tell us um let's see well he bought it at fair value when he bought it fair value is 150 now the fair value at the end of year one 145 that is distractor information when you put the debt on your books at amortized cost that's distractor information that would be relevant if it were fair value through P&L or fair value through OCI. Fair value through P&L, still called held for trading in practice in a lot of places. Fair value through OCI, a lot of people still refer to it as available for sale.
Depends upon what region you are around the world. So you can see that terminology still lingering. Okay.
So question number one, they want to know, what are we going to report on the income statement? if it's initially classified as held to maturity so here we go put the pen to your paper what you write you will remember and folks take a screenshot if you want those facts so you can review get your money's worth all right free questions so let me show you no journal entries from the perspective of the investor the bond holder our side what happens to their balance sheet when they buy this investment well cash just went down by what did they pay 150 dropping the zeros investment in debt securities. 160 is the face, but they didn't pay the face. They got a 10,000 unamortized discount, folks. That is a contra asset that reduces the carrying value of this asset.
So the carrying value of this investment is 150. So a current asset went down, a non-current asset just went up. Total assets, no change, all right? Total assets, no change. Now, your current ratio is gonna be lower than what it was because instead of having that cash, we made an investment so our current ratio is lower, but total assets, no change. As we amortize the discount.
by making the interest income greater than the interest expense, the carrying value is going to get pulled up towards par. All right. So let's take a look now. What was that coupon rate?
4%. Am I correct on that? 4%. So let's take a look at our coupon.
You ready? Our face value, 160 times our coupon rate. And I do believe it was annual paid. So our carrying value, carrying value at the beginning of the period. 150 times the market rate, which I believe was 5%.
Your market rate was 5%. This is how the investor gets their interest income. So my interest income is going to be 7.5, 7,500 dropping to zeros. Yet the coupon received the par value, 160, times the coupon rate, 6%. I'm going to go ahead and close this out.
excuse me four percent i'm making up my own numbers right coupon was four percent so the part-time's coupon 6400 6.4 the difference between the interest income that goes on the income statement and the cash received that goes on the statement of cash flow where does that go on the statement of cash flow under u.s gap that's going to be cash flow operating under ifrs That interest, that coupon received under IFRS could be cash flow operating or cash flow from investing. The difference between the two, that's a little piece of that discount, the amortization of the discount. All righty.
So the carrying value was 150. The carrying value is now going to be 150 plus that 1.1. The carrying value now 151.1. Do not mark. to fair market value.
We do not mark to fair market value if it's on the books at amortized cost. So you ready? Our interest income on our income statement, $7,500. The carrying value on the balance sheet, 151.1.
All right. That's if we account for it at amortized cost. So we just answered our first question. What's going to be on the income statement? and what's the carrying value on the balance sheet the income statement is not the coupon that is the most common wrong answer choice the coupon received only equals the interest income if you buy the bond at face value we didn't buy it at face bought it at a discount so 7500 and the carrying value is being pulled up towards par as we amortize the discount one question down 450 000 to go isn't this fun stuff come on man what would you rather be doing all right question number two what if it's initially designated instead at fair value okay what if they designated at fair value so if they designated at fair value if classified as a fair value investment that means you're going to use your held for trading rules fair value through p l your balance sheet we're going to mark to fair market value, 145. And on the income statement, you're gonna report your interest income, realized gains and losses, as well as unrealized gains and losses.
All righty. So if they decide instead to designate it at fair value. You ready? $145,000. What is the carrying value?
How do you find your gain or loss? If it's designated at fair value, unrealized gain or loss on that debt security. It's the difference between the amortized cost, $150,000, plus the $1.1, $150,000, $1.1.
what the carrying value would have been if it was on the books at cost, but that's really amortized costs where the carrying value always gets pulled towards par versus the fair market value at the end of the year. And I do believe the fair market value was 145. So folks, we have a loss and that loss is 6.1. Okay.
If it's fair value through P&L, that's going to go on the income statement. If instead it's fair value through OCI, what we used to call available for sale, then that would go on the balance sheet as part of other comprehensive income direct to equity. all righty direct to equity okay so let's take a look at this question again they tell us will that loss be reported um let's see uh i'm sorry if eastern uh is designated at fair value uh at the end of the year most likely an unrealized what are we going to have a loss but not oci that that's if it's fair value through oci or available for sale that's the most common wrong answer choice we don't have a gain we have a loss and where's that loss going to go on the income statement when an asset is designated at fair value anytime an asset is designated at fair value that means you use your fair value through p l you're held for trading rules apply okay you're held for trading rules are gonna apply alrighty let's try another one What if Eastern initially designates the investment in Swiss landing as available for sale instead?
Then on the balance sheet, we are going to mark to fair market value. It'll be 145. The difference is that unrealized loss of 6,100 is going to go direct to equity. part of oci interest income not the coupon received the interest income the carrying value 150 times that market rate at issuance five percent that's 7 500 that'll go on the income statement okay now reading comprehension folks they want to know which of these is least likely to be accurate so the correct answer is a false statement. If it's true, it's an incorrect answer.
The security is going to be reported on the balance sheet at the end of the year at 145. That is a true statement, thus an incorrect choice. The unrealized loss will be reported, let's say, the unrealized loss will be reported as OCI in year two. No, in year two, not year two, that 145 would be reported at the end of year one, so per the- facts, that 145 was the carrying value at the end of year one. Now they sell the investment in the first day of year two. When you actually sell it, that gives rise to a realized gain or loss.
So the unrealized loss is in year one, not year two. The unrealized loss, folks, is in year one. not year two. I'll show you how to do the realized loss. So that is actually the correct answer because that's the false statement.
C is incorrect because it's also true. The carrying value used to determine the gain or loss at the time of sale, is that greater than the initial price of the investment? That's a true statement and thus a wrong answer.
How is that true? The carrying value at time of... sale.
To determine the carrying value, use to determine the gain or loss at the time of sale. Is that greater than the initial price versus the initial price? What was our initial price? 150. What would be the carrying value at the time of sale? To calculate gain or loss.
To calculate gain or loss if it's classified. as available for sale, fair value through OCI. It would be your amortized cost at the time of sale.
It'll be your amortized cost, 150 plus the 1.1, 151.1. Is that in fact greater than our initial purchase price? Yes, it is. Okay, so what I wanna do with you now is show you how you calculate your gain or loss, all three.
classifications so if it's classified as fair value through oci available for sale that category you take your selling price minus the amortized cost at time of sale that's how you get your gain or loss so our selling price is your is the same as the fair market value at the end of year one they sold it a day later on the first day of the year They sell it for $145,000. So you take your selling price, $145,000 minus the amortized cost at the time of sale, $151.1. They're going to record a loss of $6.1 on the income statement. But here's the key. You've got to reverse any profit or loss on unrealized gains or losses that went direct.
to equity. So folks, in year one, in year one, we recorded a loss of 6.1. We've got to reverse that.
Okay, so we recorded a loss of 6.1. We've got to reverse that. That'll make equity go up. And then by putting this loss on the income statement of 6.1, equity goes right back down.
You don't want to double count the loss. We're just moving it from OCI. onto the income statement, and now it's going to make retained earnings go down, because if the net income goes down, your retained earnings goes down, equity goes down.
So whenever it's a debt security classified as fair value through OCI, the way you calculate your gain or loss is selling price minus amortized cost at the time of sale, and then any profit or loss that had gone direct to equity gets reversed. Okay, what if they classified it as fair value through P&L? also known as a trading security or held for trading you take your selling price minus the carrying value at time of sale selling price 45 145 carrying value at the time of sale we marked it to market value last year mark to fair market value 145 zero in year two we had already recorded the six point one loss already went on the income statement in year one making net income lower which made your retained earnings lower which made your equity lower okay major retained earnings lower which made your equity lower now what if they had classified it kept it at amortized cost there's no mark to fair market value so it's your selling price minus carrying value at time of sale which would be amortized cost by the way this is called sometimes held to maturity that's still thrown around but amortized cost so the selling price 145 the carrying value at the time of sale the 150 we amortized in year one 1100 of the discount 151.1 6.1 loss which would go on the income statement making retained earnings lower making equity lower so under any methodology you're going to wind up with the same equity on the balance sheet retained earnings lowered by 6100 equity lower by 6100 okay now next item i want to review with you when you have different types of investment, debt and preferred equity.
You have no voting rights, folks, no voting. Thus, the only way to account for that, no significant influence. Either it's gonna be fair value through P&L or fair value through OCI or held to maturity, amortized cost. And that's pretty much for debt only.
because that's held to maturity preferred equity unless it has a mandatory redemption held to maturity that's dead only all righty now if it's common equity now you got to be careful with common equity you have voting rights so since you have voting rights there's three potential ways with common equity that could be fair value through p l okay or fair value through oci under ifrs under u.s gap we only allow fair value through oci under u.s gap only allows fair value through oci for debt security so possibly preferred equity if it has the mandatory redemption in which case it's like that all right but ifrs common equity fair value through p l or fair value through oci if you have no significant influence. How do I know that? You own less than 20%.
Now, the 20% is a benchmark, but it's not controlling. You got to look for other facts. You might own 15, but have significant influence because somehow you have a seat on the board.
Or you might have 25%, but have no significant influence because you don't have a seat on the board or whatever. So the 20% is a benchmark, but look for other facts. You might use the equity method of accounting, equity method, which I'll illustrate. That's when you have significant influence, significant influence.
And look for ownership of at least 20. and not more than 50. Again, that's the benchmark. You've got to have a seat on the board, some influence over policies and what have you. Now, you're going to have to use the acquisition method. You've got to consolidate.
Anytime you have control, where you own more than 50% of the voting stock, or it's a special purpose entity, that variable interest entity, where even though you don't have control, At the end of the day, you're absorbing the majority of losses. You have the majority of the profit. This entity was set up to benefit you.
You got to consolidate, okay? With consolidation, there's two ways to consolidate. Full goodwill, US GAAP, you got to do full goodwill.
Full or partial goodwill method. Full or partial goodwill method under IFRS. US GAAP is very strict.
They say you got to use full goodwill. All righty, one down, one down, five million to go. Sam, James, how we doing, baby?
You enjoying this? Is everybody enjoying this? Is this fun stuff? Are they excited? Are people typing in like this is the best day ever?
Give me more, I want more. Yeah, well, come on, that's from Grease. Give me more, give me more.
Like, does he have a car? Give me more. Nah, that's not how the song goes.
All right, shut up, stupid, keep going. All right, so here we go. I got all these facts. I have no idea what to do with all these facts, but I got some questions. So what do we call it?
Legalized cheating, folks. You ready? What's the amount of goodwill that I'm going to report on the post combination? So if I'm consolidating, if I'm going to consolidate, then I need to know, am I going to do full goodwill or partial? Which by the way, only applies, the full versus the partial only applies when you buy.
less than 100%. You own at least 50, but not 100. Then you got to worry about the full or the partial goodwill. When you buy 100% of another company, full and partial are the same thing.
All right. Then they also want to know, hey, what's your additional pain in capital? All right. So let's take a look at what we got.
They tell me Prime Inc. acquired, here we go, 100% wholly owned. So partial goodwill, full goodwill, throw it out the window. It's all the same.
Partial and full goodwill only apply when you own less than 100, but not more than 50. So you don't have to worry about full or partial goodwill. All right. How do we buy this company? We issued 1 million shares. Is that a sign of optimism or pessimism?
Pessimism. Because I'm going to make you my partner. You ain't going anywhere.
Just in case you gave me false information to entice me to buy your business. I ain't giving you cash. No way. I'll give you my stock for your stock. and if you gave me false information i go down i'm taking you with me if i'm more optimistic i'll pay cash and if i'm really optimistic then you know what i'll borrow the money to pay you and buy you out okay so that's corporate finance issues as we're going to see later all right so when you buy stock of another company how do we pay so when you buy stock of another company how Do you pay for it?
That's the key. How do you pay for it? All righty. So what's going to happen is on your balance sheet, if you pay cash, cash goes down, non-current assets and investment in the subsidiary is going to go up.
Total assets, no change. Just the change in form. Total assets, no change.
Or maybe you're going to pay with debt. Non-current assets go up. You've got this investment in this subsidiary. Non-current assets go up.
Debt goes up. You borrow. So if parent liabilities go up, consolidated liabilities go up. If the parent pays with cash, if parent cash goes down, consolidated cash goes down. Now, oftentimes I get a question and say, wait a second, Pete, if the parent...
is giving the money to this investment, doesn't it stay within the consolidated group? No, because the parent doesn't pay the money to the entity. The buying company pays it to the shareholders of that company that are being bought out, taking the cash and going away.
So when the parent pays cash, the parent cash goes down, consolidated cash goes down. If the parent pays with debt, parent liabilities go up, consolidated liabilities go up. If the parent issues their stock, but the other company's stock, investment and subsidiary, non-current assets go up, parent equity goes up. Use the fair market value of the equity, okay? So parent equity, parent paid-in capital, the parent's stated capital and additional paid-in capital go up.
So consolidated equity. is going to go up alrighty consolidated equity is always equal to the parent stand alone equity post consolidation plus any non-controlling interest sometimes they call it a minority interest okay plus any non-controlling interest all righty so how did we pay for it all righty so when you buy and you pay cash folks when you buy and you pay cash if you pay cash where does that go on the statement of cash flow that would be an investing outflow so as a general rule folks as a general rule anytime you pay cash it's generally an investing outflow what's the major exception when you pay cash and it's classified as a current asset which is generally the case if it's held for trading fair value through p l held for trading anytime it's listed as a current asset then it's cash outflow operating cash outflow operating all right so let's see we got you ready i'm excited i'm excited here we go okay so we issued a million shares of our stock the par value is a dollar fifty that is distractor information for right now i want to know what's the fair market value of that stock at the time of the transaction fifteen dollars so here we go my purchase price for this 100 stake step number one purchase price for that 100 stake a million shares times a fair market value of 15 dollars per share 15 million dollars dropping to zero less 100% because we bought all of it 100% of the fair market value of the identifiable equity now what do I mean by the fair market value the identifiable equity I want the fair market value of the identifiable assets on or off the balance sheet folks I just want to know does it have a value Now, the accounting rules might say, hey, let's be conservative. This doesn't have a value.
You know, let's expense it immediately to be conservative, like R&D. Nonsense, though. That in-process R&D might not have a book value, but it might have a substantial fair market value.
And when you internally develop your own patented products, the book value of that is very low. It's pretty much the legal fee to get your patent protection. But the market value could be astronomical. So we want the fair market value of all assets on or off the balance sheet.
Then I want to subtract from that the fair market value of all identifiable liabilities. Same thing, on or off the balance sheet. I don't care what the accounting rules say about, hey, is the loss probable?
Can you reasonably estimate it? Nonsense, man. I want to take a look at this for myself and determine, you know what? What's the present value of some payment I may have to pay in the future? and i'm going to put that on the balance sheet when i value the company and i don't want the book value of the company's liabilities now how do you get fair market value the book value of liabilities is when you discount the future payments at the cost of borrowing when the debt was issued the fair market value of debt is calculated by calculating the present value of the future payments and discounting it back to today using the current market rate all righty that's the difference all right difference between the two Therein lies the fair market value of the identifiable equity.
All right, so I look at the facts. They tell me, here's the book value of the parent, the buying company. Here's the book value of the subsidiary versus the fair market value of the subsidiary. I'm looking for the fair market value of the subsidiary. That's what I want.
So their total assets, here's the fair market value of the identifiable assets. Here's the fair market value of the identifiable liabilities. They did the work for me. The fair market value of the identifiable equity is 7720. So let's take that purchase price of 15 million for 100% of this company. 100% of the fair market value of the identifiable equity, 7720, 7720. So the difference between the two.
Why did you pay an extra $72.80? What the hell is that about? That is unidentifiable excess. I have no idea why you didn't pay $77.20. You paid almost double that.
You paid $15 million. What the hell for? I don't know.
But we can't have something called, I don't know, that would make all the MBAs look bad. So what do we call, I don't know, to protect the MBAs? We call it goodwill. But actually, it's, I don't know, man. And supposedly, you know, it's that intangible, you know, brand and.
customer and reputation, all that crap could be here today, gone tomorrow. Very suspect. Just because you paid $15 million doesn't mean anybody else would.
You might try to sell it the next day and not be able to sell it for anywhere near $15 million. And that could wipe out that goodwill just like that. All right.
But nonetheless, that's what we call goodwill. So question number one is done. Therein lies your goodwill. $72.80.
All righty. Now, how did we finance this acquisition? We issued our own stock. 1 million shares, par value of 1.5.
This is the parent company's pre-consolidation balance sheet. This is the pre-consolidation balance sheet. So folks, the capital stocks no longer 9 million.
The capital stock, the state of capital. We just issued 1 million shares, 1 million shares times the par value. of 1.5, that's 1,500,000. The capital stock, also known as stated capital, is now going to be 9 million plus that 1,500,000.
That is now going to be 10,500,000. And the additional paid in capital, a million shares, fair market value of 15 minus the par value of 1.5, well, that's 13.5 times a million shares additional paid in capital is going to go up by 13.5 million so the additional paid in capital was 12 million add another 13 million 500 that's 25 million 500. all right so stated capital just went up additional paid in capital goes up retained earnings no change all righty so the net assets were $42,500,000. Your assets minus your liabilities get you, obviously, your net assets, or add up the individual pieces, and you get $42,500,000. $42,500,000 was the parent equity.
That was the parent equity pre-consolidation, pre-acquisition, parent equity pre-acquisition. We issued a million shares with a fair market value of $42,500,000. 15 a share 15 per share that's 15 million dollars so the parent equity post consolidation 57 500 that is the parent equity post consolidation now parent or i should say consolidated equity is going to equal Your parent equity post-consolidation plus any non-controlling interest. The non-controlling interest here is zero. The parent equity post-consolidation is $57,500,000.
That means consolidated equity is going to be $57,500,000. Another way to get consolidated equity, consolidated assets minus consolidated liabilities. That's another way to get your consolidated equity.
All right, so we've got a couple of different ways of arriving at that 57,500,000. Let's answer this specific question. They wanna know what's gonna be your total assets, total assets on the post-combination balance sheet and additional paid-in capital.
Well, we've already solved for the additional paid-in capital piece. The additional paid-in capital. Post consolidation is the parent standalone plus the $13,500,000.
The fair market value in excess of par, $13.5 per share times a million, $13.5. The additional paid in capital is $25,500,000. So we know the answer's got to be A. But how else can we get that $91,850,000?
You ready? How do we get that $91,850,000? What are our consolidated assets? Folks, your consolidated assets, the parent assets, okay, the parent assets.
book value you take the book value of the parent if they ever give you fair market value of the buyer that's distractor information book value of the parent plus the fair market value of the subsidiary 70 million plus 14 million well hey that's 84 million uh 570. now that's certainly not what we have here 91 million 850. Where the hell did they get $91,850,000? Folks, whenever you buy a company, you said, remember that goodwill we calculated, that goodwill of $72,800,000? The goodwill has to be inserted as a non-current asset on the consolidated balance sheet.
The only place you will ever find goodwill is on a consolidated balance sheet. Okay, that is the purchase price in excess of the fair market value, the identifiable equity. There's no full or partial when you buy 100% of the company. It's a moot point.
I'll show you partial and full goodwill later when you buy less than 100%. So now let's take that 70 to 80 and add that in. So we've got the total assets. Here we go. Parent company, 70 book value, fair market value, the sub plus that 70 to 80. When you add it together, what are our consolidated assets?
91,850. Why am I screaming at you guys? Because I have one volume obnoxious, all righty?
But there it is. There are your consolidated assets. Now, what are your consolidated liabilities? You ready? Parent liabilities, book value, fair market value of the subsidiary's liabilities, fair market value of the subsidiary.
So now let's find our consolidated liabilities. So our consolidated assets, I want to keep this as neat as I can, consolidated assets were the $70 million plus the $14,570,000 plus the goodwill of $72,080 for a total of $91,850. So that was the parent book value, the subsidiary fair market value, and the goodwill. consolidated liabilities the parent liabilities 27 500 plus the subsidiaries liabilities at fair market value 68.50 the sum of the two 34 350. that gets us our consolidated equity what's our consolidated equity 57 557 million 500. consolidated equity has to equal what parent equity Post consolidation plus any non-controlling interest.
What was the parent equity again? Post consolidation. The parent equity post consolidation.
What did we say that was? 57,500,000. Where was that?
Parent equity post consolidation. Where did you go? I know I did it somewhere. Parent equity post, there it is.
Parent equity post consolidation. Parent equity. 42 million 500 parent equity 42 million 500 plus the fair market value of the stock issued in that acquisition 15 million some of the two 57 million 500 woomp there it is baby alrighty and the parent equity post consolidation parent equity post consolidation, the stated capital, $10,000,005, the additional paid-in capital, $25,500,000, and the retained earnings, $21,500,000, $57,500,000, breaking it piece by piece.
And the stated capital of $10,000,000, and the additional paid-in capital of $25,500,000 was the parent standalone number, stated capital nine, plus the par value of the stock issued, additional paid-in capital, parent standalone, plus the additional paid-in capital with the stock issue, $10 million, $5 million, $25 million, $5 million. There it is. Now look, I'm a CPA by trade, taught accounting for many years.
If you're learning this for the first time, you know what? At best, the light bulb might be flickering a little bit right now. All right, I get that.
What we do here... is not the way we teach it on the video course. Just so you know, the video course doesn't start with problems.
It starts by explaining the rules, then giving basic examples. What I'm doing here is kind of like the highest level of application, actually jumping into multiple questions like an actual vignette, an actual problem, okay? This is at the highest level of application. So if you haven't studied into corporate investment yet, relax. OK, the light bulb flickers.
You go back, you review the rules. So the way the way you were able to set up the CFA course, which is phenomenal, they write the text, tons of practice questions. We've got the videos that walk you through the rules step by step.
Nice. Not reading to you. That's not what we do.
We go through problems, examples, basic to illustrate. You then try practice questions on your own. Then we have Saturday live online virtual classes where we then do what I'm doing here tonight, which is actually practice application. So you get it all. And you know, what you need is dependent upon the topic you're studying.
Like I got equity analysts at Pete. They say, Pete, I don't need to watch you talk about free cash flow to firm, free cash flow to equity, residual income, dividend discounts, what I do. So they're not going to watch that video.
They'll go right to the questions. and maybe attend the Saturday class to see what the vignettes look like, you know, if it's an area of expertise. You know, so everybody's got their strengths and weaknesses.
The pieces of the puzzle you choose to utilize are dependent upon your personalized background. But, man, if you said to me, Pete, I don't know anything, then we got it all. We'll walk you through every topic. But it's not going to take you 300 hours.
It might take you closer to 1,000 hours, but you could do it if you want to. All right. Let's go, baby. Let's try another one. Ready?
Question number four. So we got question number four. Nah, it's a pooling. I don't want to do that one. That's not a fun one.
I want to do a fun one. Here we go. Let's try this one. Okay.
If this is exam day, I have no idea what to do with all these facts. You don't start there. Let's take a look at the questions first.
Let's see what they want us to do. What's the equity income? The YZ has to report on its income statement. They just gave me the formula that I've committed to memory to calculate equity income. So you ready?
What you write, you will, as a professional test taker, folks, you know what I can tell you? You got to engage as many senses as you can when you study to remember that information. Watching lectures is great.
Listening is great, but you got to put the pen to the paper and speak it. That's right. What you speak and what you write, those senses, when you engage that is going to embed that in your memory long term so you can remember it exam day.
All right. So you shouldn't be dating. You know, if you're on any of those dating apps, get off because Tinder will only hinder your performance. You don't need any of that crap. It's a distraction.
But should you be out on a date and you want to see, hey, do I possibly have my soulmate sitting across from me? Talk to them about the equity method of accounting. And if they're still there at the end of the date, you know, you found your soulmate. and i also hope you have good health insurance because they probably have mental health issues but that's another story all right so equity method of accounting you ready here is your formula write it down with me here we go you're going to start with your beginning carrying value your purchase price that's what you start with your beginning carrying value your purchase price you are going to add your percentage share of that subsidiary's net income you are going to add actually you're going to subtract Your percentage share of what I call excess depreciation.
You're going to see what that is. You're going to subtract your percentage share of the recognized profits. You'll see what that is. And then you are going to subtract your percentage share of dividends.
That's right. Dividends are not income. Under the equity method, they are not income. They are return of your investment. It reduces your carrying value.
This is how you're going to get the ending carrying value on the balance sheet. Do not mark it to market value unless it's permanently impaired. We do not mark to fair market value. That will be distractor information.
The sum of these three items right here, the sum of those three items, that is your equity income that will go on. the investor's income statement. You know what they call the equity method of accounting? They call it one line accounting. Why one line?
Because all I'm going to see on my income statement with respect to that investment, equity income from that investment. That's it. And on my balance sheet, you know what I'm going to show for that investment? My ending carrying value. That's it.
I do not see the subsidiary, the affiliate, the subsidiary, or if you want to call them an affiliate. I do not see their assets and liabilities. No idea.
I don't see it. And the affiliates, revenues and expenses, gains and losses, their revenue, expenses, gains and losses. No idea. I don't see it. Okay.
You are not consolidating with the equity method. So it's not very transparent because I have no idea if this equity income is sustainable or not because I don't know what's driving it. Okay, I'm picking up this as an asset, but I have no idea what the liabilities are of that affiliate. No clue. All right, so it's one line.
That's it. Not very transparent. All right, so what I want to do here with you is the following. When do you use the equity method of accounting again? You're going to use the equity method anytime it's common equity.
You got to have significant influence. And what is evidence of significant influence you own between 20 and 50? Okay, 20 and 50. I own 30%.
As soon as I see that, I think, hey, equity method. And then I immediately think, oh yeah, dividends are not income. They are not. They are return of investment and do not mark to fair market value. They're going to give you fair market value, but that is distractor information.
All right. So YZ invest. So YZ is the investor, the buyer, the investor. GC is the investee, all right?
So they buy 30% of the investee. The two companies have done business together for many years. This investment increases YZ's influence.
They have influence over operational. So they're telling you they have significant influence. Here is the book value and fair value, all right?
I don't want the fair market value. I want the book value. Now notice the PP&E, the book value was 30 million lower. than the fair market value just want to make note of that okay liability so here we go fair market value of my identifiable assets fair market value of my identifiable assets here's the fair market value of my identifiable liabilities herein lies the fair market value of that identifiable equity what percent did i buy 30 percent how much did we pay we paid 75 million for a 30 interest so here we go don't no journal entries folks you got to understand big picture so from the perspective of the investor they paid 75 million dollars it looks like cash cash is going to go down by 75 million current assets are down investment in affiliate a non-current asset is going to go up by 75 million total assets no change Total assets, no change, just the change in form. Current assets down, non-current assets up.
We are less liquid now because we use cash to make this investment. All right. Total assets, no change, just the change in form.
Okay. So now let's set it up. Purchase price, 75 million.
So my purchase price, and I do believe we bought a... 30% stake, my purchase price for that 30% stake dropped to zero, $75 million, less the fair market value of the identifiable equity. We said that was $80 million times my 30% stake.
Logically, you would have thought we would have paid $24 million, but we did not. We paid $75 million. Why?
I don't know. Maybe you got OCD issues and there was a bidding war and you got caught up emotionally and now you've overpaid. But I have no idea why you paid so much trip, man. You got to be kidding me.
But, folks, that is unidentifiable excess. That is goodwill. Really, it's unidentifiable excess. And that's a lot, 51 million.
But here's the thing. We are not consolidating. We are not consolidating because there's no control. Therefore.
This 51 million does not appear, does not appear anywhere on the investor's balance sheet. That 51 million, this is what's on the balance sheet, the purchase price, the purchase price, that goodwill, this is a problem that's embedded. In that carrying value of 75 million, it is not separately reported.
That's problematic because I'd like to know why in the hell you spent 51 million more than the fair market value. I can see spending more than the book value. Okay. Now, as a matter of fact, in this question, what is the book value here?
The book value of the equity, 50 million. Okay. The 50 million. All right.
So our purchase price. Purchase price, 75 million. Purchase price, 75 million, okay, for a 30% stake. All righty.
Now, 30% of the book value of the equity, 50 million times 30%, 15 million, the unidentifiable excess. is $60 million over book value, $60 million over book value, okay? So, you know, I could see paying over book value, but why in the hell did you pay, you know, over the fair market value? So, that's another story, all righty? That's another story.
So, why did you pay so much over the fair market value? I don't know. Now, the question becomes, can any of this over the book value be identified?
Yeah. Okay. And that's not all.
That's excess over book value. Let me just properly label it. Excess over book value.
Okay. Now, can any of that be identifiable excess versus the unidentifiable excess? We know the unidentifiable excess is that 51 million.
okay can anything else be identified yeah on the balance sheet remember we pointed out 30 million dollars of pp e where the fair market value is greater than the book value 30 million times the percent we bought 30 percent 9 million of that 60 million is identifiable okay i understand 9 million of the excess overbook value okay that's identifiable that that's pp e that's 30 of the fair market value over the book value for the pp and eight that 30 million but what in the hell's the deal with the other 51 million right 60 minus nine there's that 51 what's i don't know all right but that's embedded in the purchase price okay now let's start popping in numbers here now legalized cheating is beautiful because i already got this set up all right so i just want to erase this so i have room to write let me show you the numbers now you ready my purchase price 75 million dollars did this affiliate have any net income well they tell us gc accounts for its plant equipment that's the buyer that's the investor excuse me the investee okay that's the company yz investor And then we've got GC, the company they invested in, and they bought a 30% stake, okay? So YZ bought a 30% stake. All right, I always wanna be mindful of that.
Okay, so now they account for this plant and equipment using straight line depreciation. You see this fair value over book value for PP&E? So long as it doesn't relate to land. Land doesn't get depreciated, but any other PP&E.
fair market value over book value, that excess of fair value is 30 million. Well, that's going to have to be depreciated over that 10-year period. So that excess of 30 million divided by 10 years, the quote-unquote excess depreciation is going to be 3 million per year, 3 million per year, okay?
Now, GC, the investee, reports net income of $20 million. They pay dividends of $5 million. It quickly becomes information overload. Start plugging in as you get the data. So the investee, their net income was $20 million.
How much of that belongs to us? Just 30%. So take that $20 million, GC's net income, 30% of that belongs to us.
You add $6 million. Excess depreciation, we said was 3 million. How much did we buy?
30% of the company. So that's 900,000 of excess depreciation that's gonna reduce our equity income. Okay, dividends. Dividends they just said were how much?
Short-term memory, not 5 million. How much of that belongs to us? 5 million times 30%.
1,500,000, that is not. income, but that reduces my carrying value, okay? Now I go back to my facts. GC sold inventory to YZ.
Folks, that's called an upstream sale, upstream from the investee to the investor, okay? Easy multiple choice. They made a profit of $6 million.
You've got to eliminate intercompany profits because you can't sell to yourself. You can only recognize that profit. when it's flipped and sold to outsiders. So GC made a $6 million profit.
How much of that do I have to de-recognize? Well, they tell me. That $6 million profit that they made on selling goods to YZ, how much did YZ sell to outsiders? YZ only sold half. That means one half of this profit has to be de-recognized.
50% of the profit is okay. It's been sold to outsiders. 50% has to be de-recognized. So 6 million times 50. 50%, the percentage that has to be de-recognized because it was not sold to outsiders. Let's say 30% of that was sold to outsiders by YZ.
Then 70% would have to be de-recognized. It's just a coincidence this is 50-50. So $3 million of profit has got to be de-recognized because it has not been sold to outsiders.
So the de-recognized profit, folks, is $3 million, but we only own 30%. 40%. So 30% of that has to be derecognized.
That's another 900,000, coincidentally the same number. What is my equity income? My equity income is the sum of those three numbers, 6 million minus 900 minus 900, equity income, 4 million two. There's my equity income.
And what's my ending carrying value? 75 plus my percentage share of the net income minus. My percentage share of the excess depreciation minus the percentage share of derecognized profits minus my share of the dividends.
What's my ending carrying value? $77,700,000. $77,700,000.
That is the ending carrying value on the balance sheet, and we do not mark the fair market value. Okay. When a company consolidates, if you have...
control. You have to consolidate. It's called the acquisition method. You have to consolidate.
Okay. The parent is going to have their own financial statements. The parent's going to have their own income statement and balance sheet. The affiliate is going to have their own income statement and their own balance sheet. We have to consolidate.
So what happens is on the parent's standalone financial statements, on the parent... Stand alone balance sheet. They are going to show investment in subsidiary, whatever that carrying value is.
Upon consolidation, eliminate that account, eliminate that investment in affiliate, and instead pick up 100% of their assets, 100% of their liabilities, and insert, remember to insert goodwill. On the consolidated balance sheet. All righty. So parent standalone balance sheet, they account for that investment using the equity method internally, internally on their own standalone financial statement. Internally, they account for that investment just as we've done here using the equity method.
But upon consolidation, they're going to get rid of that investment in affiliates, 77,700,000. And instead, they're going to pick up 100% of the affiliates assets at. fair market value on the date of acquisition, 100% of their liabilities at fair market value, and then we are going to insert goodwill onto the consolidated balance sheet, okay? Now, if there's non-controlling interest, that becomes part of consolidated equity, and I'll show you how to do that.
We're going to do a consolidation in a minute, okay? Now, on the parent standalone income statement, on the parent stand alone income statement. They're going to have equity income.
In this example, what was that? $4,200,000. Upon consolidation, we are going to eliminate that equity income.
And instead, we're going to pick up 100% of their revenue and gains, 100% of their expenses and losses. Okay. Consolidated net income is always gonna equal parent alone net income using that equity method internally, using that equity method internally.
But it has much greater disclosure, folks. Consolidated net income is gonna equal the parent standalone net income, but boy oh boy, the ratio's gonna change. Consolidated net income divided by consolidated sales.
no change to the numerator, but boy, your profit margin is going to be way lower because if you look at the parent net income, that's going to be the exact same as the consolidated net income. But when you have the parent alone sales in the denominator much lower, the parent profit margin is going to be much higher than the consolidated profit margin. Consolidated equity.
is always gonna equal the parent equity using the equity method internally plus any non-controlling interest. And the non-controlling interest, the size, the amount is dependent upon whether you use full goodwill or partial goodwill. All right, but that's the equity method of accounting.
We use that whenever we have significant influence. All righty? Okay, not so bad. Guys, how we doing?
You guys enjoying this? Sam, James. David, Chad, whoever's out there, you guys excited?
You guys want to sit for the CFA again? Like, Sam, like, you want to study again? What's going on? My whole life is studying, Pete.
Great job with this so far. Nah, nah, I saw you. I heard you whispering to James that, James, you should be doing this.
Pete's horrible. That New York accent, no one can understand him. Normally, they'd have captions at the bottom translating my New York accent.
Do I sound like I'm from James? do i sound like i'm from new york james about as new yorker as a ninja turtle oh man all right james just recently got out of jail yes so uh we're gonna send you back to no we didn't i'm only serious all right so where i was going with that i have no idea let's do our next question you ready we got three more questions let's go baby let's go chris stone a charterholder good for you chris you see chris took you world i know that for a fact so i can't start here i have no idea what to do with this mountain of information so legalized cheating where do we go we go down here compared to the method that matheson used in previous cash investments what's gonna i have no idea it doesn't help me at all they want to know assume we comply with u.s gap what's the amount the goodwill ah u.s gap you got to use the full goodwill method Now, how do you do the foot? Now, see, this is going to lead me so I could read the facts in context.
Okay. Step number one, I got to calculate the implied fair value for a 100% stake in this business, the implied fair value for 100% stake. Step number two, I want to find the fair market value of the identifiable equity.
If I bought 100%, what would be the fair market value of the identifiable equity? Okay, I can then calculate 100% of the goodwill. That's why they call it full. You could calculate all of it.
You see, by reading the questions first, it gives you a path. You start controlling yourself and you don't get bogged down by, right? By the mountain of information.
They love to give distractor information as no bearing on the solution. That's why legalized cheating is the way to go. Just make sure these formulas are coming out of your head and not a tattoo on your leg.
That's right. I read somewhere, I don't think it was the, I think it was the bar exam, but somebody tattooed. I don't know if it was a permanent tattoo, but like some rules and stuff, and they got busted and all that kind of stuff.
I took the bar exam in New York City. They actually busted a girl with cheat notes. She kept going to the bathroom. It was obvious something was up. She had diarrhea and she was cheating, but they caught her in the bathroom with cheat notes.
Now, I don't know if they were looking through the stall because that would be invasion of privacy, but nonetheless, it was great for me. It broke up the monotony of the day. She came out crying. It was cool. All right, so here we go.
Chris Stone, a charterholder. For Matheson Industries, our employer, duty of loyalty, Matheson has made a number of intercorporate investment in recent years, typically making, normally they pay with cash in exchange for 20 to 30%. So that would be for those investments, they would be doing significant influence equity method.
And if they're paying cash, current assets down because cash is down, investment in affiliate. Non-current asset up, total assets, no change. So that's what they've been doing, okay?
Now they generally take a board seat, so that means they have significant influence, all right? So they contribute to operating decisions, but not influence dividend, but they take a board seat, they got influence. Now Stone is in charge.
A review, Stone, I'm thinking of Stoned. You know why I'm thinking of Stone? Because I took my kids to a Ranger game the other day, and as soon as we get out of the tunnel there, you start smelling the weed.
I mean, like, you know, come on, man. You know, I mean, I want my kids to have brain cells for a little while, but nonetheless, the smell of weed is everywhere. I'm wondering how that's affecting the pass rates for all these high stakes exams. Is smoking weed helping or hurting?
I don't know. But Stone is in charge of reviewing Matheson's largest investment to date on January 1. Here we go. They issued 4 million shares. They didn't pay cash. $1 par, but I'm looking for the fair market value.
They bought 80%. Stop right there. That means you have control.
That means you've got to consolidate. Now, if you only bought 80%, 1 minus the 80, 20% is the minority interest, the non-controlling interest. Now, they tell me the current market value of the stock is $20 a share.
So, 4 million shares. 4 million shares at $20 a share. Purchase price for that 80% stake, the purchase price, 80 million for that 80% stake. So I have one piece of the puzzle.
I've got that 80 million. Now, on the balance sheet, they did not pay cash. Cash, no change.
They didn't pay cash. So investment, a non-current asset is gonna go up 80. million. And then the parent equity, 80 million going to go up.
Some of that's going to go to stated capital, 4 million shares at a dollar a share, 4 million in stated capital, 76 million the balance in additional paid in capital. But equity went up, assets went up, no change. They didn't pay with debt.
So the parent equity is going to go up. Now, this is the information for both companies prior to the transaction. all righty so the parent standalone equity prior to this transaction so this is prior to the 45 the 65 the 150 and then they just issued another 80 million all right so total equity post acquisition is going to be the sum of all these amounts this is how we're going to get total equity post acquisition. All right.
That 80 million. Okay. Now the subsidiary, the company we bought, here's the fair market value of the identifiable assets, 140. Okay. The inventory, same amount, current assets, same, but the PP&E plus 15 million, we're going to have to calculate excess depreciation. All right.
So the fair market value of the identifiable assets, 140. the fair market value of the identifiable liabilities 770 so here's the fair market value of the identifiable equity so i'm going to take my purchase price that was how much did we say 80 million dollars for an 80 stake 80 million which equals 80 percent of the total fair value right they paid 80 million for an 80 stake they did not buy 100 of this company okay so what i want to do is i want to step one calculate the implied fair value what is the implied fair value so we're gonna have to go back to high school do some algebra divide both sides by 80 so we divide both sides by 80 what is the implied fair value for a 100 stake therefore the implied fair value for 100 stake Implied fair value for 100% stake. Step number one is complete. So we know that's 100 million. All righty.
So I'm going to go back to my setup. Implied fair value for 100% stake, 100 million. What's the fair market value of the identifiable equity?
Fair market value of the identifiable equity, 70 million. So. 70 million for 100% stake.
So what's 100% of the goodwill? $30 million. That is 100% under the full goodwill method. All right. So we got one piece of the puzzle.
There is your full goodwill. Okay. Now I want to continue this.
You ready? Let's find the non-controlling interest. Okay. So let's keep going. Full goodwill.
What would be the non-controlling interest? So we bought 80%. We did not buy 20%.
Multiply that by the implied fair value for that 100% stake, 100 million. That's 20 million. That is the non-controlling interest under the full goodwill method.
Okay, that is the non-controlling interest under full goodwill. All righty. so that becomes part of your consolidated equity that's going to be part of the consolidated equity and the goodwill's got to be inserted inserted on the consolidated Ballot sheet, 30 million.
Okay, that's the beauty, greater transparency. All right, now what if we were doing partial goodwill? So let me now show you all this partial goodwill. Find some white space here.
There we go. Okay, partial goodwill, not an option, not allowed under US GAAP, IFRS only. And under IFRS, they give you the option you could do partial or you could do full so how would you do partial goodwill you ready step one the purchase price for an eighty percent stake that was four million shares four million shares at a fair market value per share of twenty dollars so that's eight million Okay, now I want you to subtract from that the fair market value of the identifiable equity, the identifiable assets minus the identifiable liabilities. That was 70 million times that 80% stake. That's 56 million.
So that's 80 million minus 56 million. Okay, so the fair market value, the identifiable equity, 70 million times that 80% state, 56 million. So the partial goodwill, 24 million. That is 80% of the goodwill.
Now, I could check myself. You ready? If 24 million is 80%, what would be 100%?
24 divided by 0.80, what would be 100% of the goodwill? oh yeah 30 million 30 million is that right 30 million that's 100 of the goodwill right 100 of the goodwill is 30 million and i could work in the other direction if the full goodwill if the full goodwill is 30 million and i multiply that by 80 percent then what would be the partial goodwill oh yeah 24 million you got your check figure we know we're on the right track all right notice the difference the full goodwill 30 less the partial goodwill 24 that's a difference of less the partial goodwill of 24 that's a difference of 6 million that's also going to be the difference in your non-controlling interest. So the non-controlling interest under full goodwill, the non-controlling interest under full goodwill, we said that was 20 million, right? 20 million, you take the implied fair value for 100% stake, 100 million, multiply it by 20%.
There's your non-controlling interest, full goodwill. Your difference is gonna be 6 million. So what's going to be the non-controlling interest under the partial goodwill?
It's got to be 14. If we don't get 14, we did something wrong. Okay, if we don't get 14, we did something wrong. Let's see if we can calculate that 14 million now directly. All right, so partial goodwill, we know purchase price for an 80% stake, 80 million. Fair market value of the identifiable equity, 70 million.
70 million times 80%, 56 million, partial goodwill, 24. Take that fair market value of that identifiable equity, the fair market value of the identifiable equity, 70 million. Multiply that by the non-controlling interest, 20%. What's 20%?
14 million. There is your non-controlling interest under the partial goodwill. Same result, different format.
Okay, $6 million difference in goodwill, $6 million difference in non-controlling interest, folks. So full versus partial, the goodwill, 30 versus 24, the non-controlling interest, 20 versus 14, a difference of six, 30 minus six, 20 minus six. There's your difference because under partial goodwill. Partial goodwill, the goodwill is going to be lower by six.
That means the consolidated equity is going to be lower by six. Under partial goodwill, the difference between partial and full goodwill, your goodwill is lower by six. Consolidated equity is going to be lower by six. And remember.
Your consolidated equity is your parent equity post-acquisition plus any non-controlling interest. And the non-controlling interest will either be under full goodwill. Under full goodwill, it'll be 20. Under partial goodwill, it'll be...
14 but the parent equity post acquisition is that parent equity pre-acquisition okay the parent equity pre-acquisition this all adds up to 260 your net assets 260 plus the 80 340 okay 340. so consolidated equity consolidated equity is either gonna be 340 plus 20 or 340 plus 14. So consolidated equity, full goodwill, 340 plus that 20, 360. Under partial goodwill, 340 plus 14, 354, a difference of six. What's another way to get your consolidated equity? Consolidated assets. Minus your consolidated liabilities, same result, different format.
There's your consolidated equity. With the consolidated assets, book value of the parent plus fair market value of the sub plus the goodwill. Let's see if we can't get the 360 full goodwill. What would be our consolidated assets? You ready?
What would be our consolidated assets? We've got the parent assets, 580. plus the 140 so full goodwill parent assets 580 subsidiary assets at fair market value what did i just say that was subsidiary assets 140 plus the full goodwill full goodwill we said was 30 30. 580 plus the 140. What is that? Let's see. 580 plus the 140. I can't do math in my head. Let's see.
Let me do it correctly. You ready? 580 plus the 140 plus the 30, 750. That's the consolidated assets. Now. parent liabilities 320 plus the 70 320 plus the 70 parent liabilities 320 subsidiary liabilities at fair market value 170 so our let me just double check that so that's uh 320 plus the 70 not 170 320 plus 70 so that's 390 that's your consolidated liability 750 minus the 390 now if i don't get 360 i'm gonna cry but i don't have to cry because we did it correct we know what we're doing consolidated equity why am i showing you multiple approaches because what the way you solve that exam day is dependent upon the given information.
All right. So you've got to be ready. Now, look, if it's partial goodwill, if it's partial goodwill, you still got the parent 580 plus the subsidiary's assets 140 plus the partial goodwill of 24. So instead of 750, 740. for the consolidated assets, lower by six. And then your liabilities would be exactly the same, 390. There's your consolidated liabilities. Consolidated equity, instead of 360, 354. The difference being the size of the goodwill affecting the consolidated assets.
And then the consolidated equity is also just the difference in the non-controlling interest, 20 versus the 14. Parent equity, post-consolidated. post-acquisition plus the size of the non-controlling interest. And there it is.
All right. So let's see if we can't answer another question here. So let's see.
So we answered that one. Let's answer the first one. Compared to the method used in Matheson's previous cash investments, the investment in jd jt we did not pay cash we issued stock instead so relatively speaking relatively speaking since we did not use cash our cash is higher relatively speaking because we did not use cash Will we have a lower current ratio?
Not lower. We're looking for most likely a true statement. Since we didn't use cash, our current ratio would be higher, not lower, okay?
Would we have a lower debt to equity? Well, let's see. We used equity instead. We issued stock.
So relatively speaking, our equity would be higher. Debt to equity would be lower. That is a true statement. debt to equity would not be higher it would be lower because we're using equity instead of cash we'd have a lower debt to equity now again there's a sign to this right folks your return on asset times your degree of financial leverage is your return on equity degree of financial leverage is an amplifier it amplifies your potential return as well as the risk assumed Your degree of financial leverage for our purposes in the DuPont model, either take your asset divided by your equity or one plus your debt divided by your equity.
If your equity is higher and you've got a lower degree of financial leverage, we're assuming less risk because we didn't use our cash. We're keeping our cash available to service our debt, pay interest, pay principal. Instead, we issued equity.
So the good news is we have lower risk. The bad news is. Lower degree of financial leverage, lower return on equity.
All righty. Now, a strategic question. When would it be a good idea? When would it be a good idea to use leverage? So long as you believe your return on asset is going to be greater than your after-tax cost of debt.
Your after-tax cost of debt. Borrow, okay? The bigger the... spread, the more confident you are, then you want a bigger degree of financial leverage.
All right, because this is your hurdle rate when you use debt, your after-tax cost of borrowing, your yield to maturity times one minus the tax rate. But what's your hurdle when you use cash or you don't use cash? Your return on asset versus the opportunity cost, the opportunity cost. on the cash, the opportunity cost on that cash. What was the hurdle?
What was the rate of return you were earning on that cash? Probably pretty low, okay? Probably pretty low. That after-tax investment income on that cash is probably a pretty low hurdle. So it might be a good idea, if you're confident in this acquisition, to maybe use your cash rather than issuing your own stock.
Okay, because that's a pretty low hurdle, the opportunity cost on whatever that cash was invested in. I mean, what kind of rate, even today, what are you getting? You know, 3%, 4%, 5%.
You know, and then after tax, you know, it's relatively low hurdle. All righty. Now, the key is how optimistic or pessimistic you are about the acquisition, right?
So we'll see that in corporate finance. All right, let's try another one. So did we answer that question? We did. uh answer that one we did all right so here we go here's another question now stone questions some of the assumptions used in the fair value assigned to the assets she believes the uh the inventory is understated by 10 million so folks we have an excess over fair market value of identifiable equity okay so if we assign more of the excess paid if the excess over the book value.
If the excess assigned to the identifiable assets go up, then the amount assigned to the unidentifiable assets, the goodwill has got to go in what direction? Down. It's got to go down, right? That makes sense, right?
So the more you assign to the identifiable assets, the less you have assigned to the unidentifiable. Okay, they want to know, hey, what's that going to do to your minority interest if you're doing the partial goodwill method? So let's just see, what's that going to do? And let me get rid of this.
I want to have some space here. So partial goodwill, we're going to change the facts. You ready? Partial goodwill. so we're changing the facts so we have um let's say the fair market value of the identifiable assets is going to go up by 10 million dollars so the fair market value of the identifiable assets that's going to go up by 10 million all righty so the fair market value of the identifiable assets the fair market value of the identifiable assets was 140. we're going to increase that Okay, the fair market value of the identifiable assets was 140, was 140. We're now going to increase the inventory.
We're going to increase that by 10. So the fair market value of the identifiable assets is now going to be 150. The fair market value of the identifiable liabilities, no change. What was the... Fair market value of the identifiable liabilities.
Let's see. The fair market value of the identifiable liabilities, no change. Come on, man.
Where is that number of 70? All righty. So fair market value of the identifiable equity is now, let's say, 80. All right. Partial goodwill method.
You ready? Partial goodwill. So the purchase price for an 80% stake. purchase price for that 80 stake no change 80 million in stock in stock fair market value of the identifiable equity is now 80 million times 80 percent so that is now 64 million so that means the partial goodwill is now lower it's 16 million versus what it was the partial goodwill um let's see the partial goodwill was 24 okay versus 24. all right so the partial goodwill is going down now the non-controlling interest the fair market value of the identifiable equity that 80 million 80 million times one minus that 80 percent 20 stake the non-controlling interest coincidentally is now 16 million that was 14 million so it did go up by 2 million the non-controlling interest under the partial goodwill method went up by 2 million all righty so the partial goodwill did go up by 2 million so they want to know True or false?
An increase of 2 million in the minority interest of partial goodwill. That is a true statement. Now, why is being correct? And this is another thing I love about you, world.
Not only do we tell you why the right answer is right, but they spend a lot of time in the written, detailed, explanatory answers telling you why the wrong answers was wrong. Why are choices two and three false? Total assets would increase regardless of whether full goodwill or partial goodwill is used.
That's a. false statement why total assets no change total assets no change the identifiable assets are going up by 10 the unidentifiable assets are going down by 10. we just moved it from unidentifiable to identifiable okay so the unidentifiable assets are going down the identifiable assets are going up by 10 so total assets no change okay and then the full goodwill method well let's see what would happen under the full goodwill method so let's go back wherever i had that set up right here what if we were doing full goodwill methods so this was partial goodwill all right what if we were doing full goodwill so we again paid 80 million dollars for an 80 percent Stake, step number one, we divide both sides by the 0.80. So implied fair value for a 100% stake is therefore 100 million.
Now, the fair market value of the identifiable equity, that would no longer be, that was 140 minus 70, that was 70. Okay, now the fair market value of the identifiable equity is 80. Okay, so instead of being... so instead of being 70 million which it was before we're adding 10 so now the fair market value the identifiable equity 70 plus the 10 80 100 stake alrighty so your full goodwill your full goodwill is now 20 million it was the full goodwill was how much 30 million full goodwill is going down by 10 million because we just assigned that 10 million to inventory an identifiable asset rather than unidentifiable the non-controlling interest full goodwill non-controlling interest full goodwill is based upon that implied fair value for 100 stake so 100 million no change times one minus the 80 percent 20 no change the non-controlling interest 20 million. Same as it was before. No change. Under full goodwill, the amount assigned to the non-controlling interest does not change.
Under the partial goodwill, it does. Under the partial goodwill, it was 24. It's now 16. But under the full goodwill method, the non-controlling interest doesn't change because we calculate it using the implied fair value. That didn't change. and multiplying by the non-controlling interest.
That didn't change. So that's why that third choice there is incorrect. Okay, choice number three, false statement, wherever that was.
Okay, the full goodwill method, the reported goodwill is gonna be higher. No, it's not. Okay, it's not gonna change.
That's a false statement. All righty, how we doing on time? We got time for another one.
What do you think, Sam? One more for good luck, and then I'll take some questions if there are any. What do you think?
Hello? Sam, you still there? Is anybody there? Holy crap.
Have I been talking to myself? Let's do it. Would you all fall asleep?
What's going on? All right, let's do another one. For good luck. You ready? Here's all your facts.
I have no idea what to do with all these facts. No clue. So where do I go?
The question stem. They tell me Swiss complies with IFRS and they recognize minority interest. Okay. Remember that's an option.
They could do full goodwill. So we're thinking implied fair value for a 100% stake, implied fair value for that 100% stake minus the fair market value of the identifiable equity, 100%. That's how we will get 100% the full goodwill.
Okay, cool. Now, they're preparing their post-combination consolidated balance sheet. James is an analyst at Swiss. Her employer, duty of confidentiality, believes the book value of Kirk's inventory is undervalued again. So folks, if the identifiable assets go up, the unidentifiable assets go down.
dollar for dollar full goodwill just like we saw if an adjustment to fair value were made to account for that analysis what's the most likely change to the post-combination consolidated balance sheet well the inventory would have to go up the goodwill would have to go down which one says inventory up goodwill down Nothing to do with minority interest. We just saw the minority interest is not going to change. Why does the minority interest not change? Because the implied fair value for a 100% stake does not change. Times the minority interest, that does not change.
So the minority interest, that does not change. Do we have a decrease in reported goodwill? Yes, we do. Do we have an increase in total assets?
No. Total assets, no change. Just change in form. Total assets, No change, just that the inventory will be higher, the goodwill will be lower. All righty, the goodwill will be lower.
Now, correct answer choice B. Now, I want you to think about how they could test this kind of backdoor. Would a company want to do this?
Would a company want to assign more to the identifiable or less to the identifiable? That is the question. Is it to your advantage to assign more to the inventory?
No. Why not? Because if the inventory is on the books at a higher amount, when you sell that, the cost of goods sold is going to be higher.
If the cost of goods sold is higher, then the consolidated profit is eventually going to be what? Lower. Goodwill.
No amortization. Now, look, there is a disadvantage in the sense that people get very nervous when a large percentage of your assets, total assets, is in goodwill. I get that.
But in terms of future profitability, you don't want more assigned to the, you don't even want more assigned to the PP&E because the more that's assigned to the PP&E, that excess depreciation is going to go up. What's that, again, going to do to the parent net income, the consolidated net income? Lower it. So in a theory type question, you know, all things being equal, you know what? If you're looking to maximize consolidated profitability, you want to assign more of that purchase price to goodwill and less to identifiable assets that you will eventually have to amortize or depreciate that additional amount, okay?
be on the lookout by the way for in process r d that is generally another asset that is not on the on the balance sheet of the subsidiary but it has a fair market value so you got to read carefully don't just look what's on the balance sheet there might be in the notes in process r d that you've got to add to the fair market value of the assets that are on the balance sheet all right when that balance sheet is marked to market um don't forget to insert the goodwill on the consolidated balance sheet right the goodwill does not appear on either company's um balance sheet standalone that's only on the consolidated financial statement okay so i think we got just enough time here for a couple of questions on the back end so uh i gotta put back up here i know i know i know i was supposed to show something cool and let me get that back up all right so you guys have seen that so anybody who joined us late We are very grateful for your attendance. I know this was relatively long, but we're looking to earn your business, folks. We shop around for the silliest of things, clothing, shoes, cars.
This is going to change the trajectory of the rest of your life. Level two is the obstacle, man. Level one is not that big of a deal.
And boy, if you get through level two, level three, you're going to get through. Level two is the big one. All right. So you've got to get through this. You've got to choose the right course.
So we appreciate your time tonight because you attended. You're going to get this discounted price, that QR code. We also want to get your input.
You know, we'd love to hear from you. We're looking for testimonials. So look, we want to earn business and with social media, you know the way everything is sold today through influencers. We want you to the extent that you think or you want to sample our product.
We would love for you all, you know, the truth though, you know, whatever it is. But this is what sells courses today. CPA, CFA, bar exam, whatever it is. So if you think we're worthy of a testimonial, we would love that. You just answer a couple of questions.
And then the 25% off, again, is our thank you for attending tonight. But, yeah, that's all I got. I feel like I just gave birth to a level three candidate. Oh, my goodness. So, guys, what do we got?
Any questions for me? Anything I can add, any value? I don't usually have any value, but if I have any, Sam, anybody, is there anything I could do? Hello, any questions for me?
Hey, sorry about that. No, you know what? There were just some people who had a few questions just about if they could get the recording for this and that sort of thing. But as far as substance, I think you explained it all pretty well.
And there wasn't anybody out there who we have any hanging questions. There is somebody. and i didn't i'll pass this along but somebody wanted to know when you were talking about at the beginning like the health and maturity debt that uh he wanted to know if the uh having the health and maturity debt hurt silicon valley bank right and i know that's not part of the curriculum strictly speaking but um their investments in held to maturity Yeah, I mean, this was like at the beginning of your of your materials when you were just talking about the less the majority interest. Yeah.
So, you know, well, I'll tell you how it ties to the CFA curriculum is, you know, strategically. If right, if you think interest rates are going to go down on the debt you hold and you think the fair market value is going to go up, you would certainly want to get that unrealized gain on your on your income statement. So you would want to.
classify it fair value through P&L if you think rates are going to go down and the fair market value is going to go up. You probably don't want it on your books at amortized cost, nor do you want it listed as available for sale fair value through OCI because when it's good news, you want that good news to flow through your income statement to hit your retained earnings, to hit your equity, right? So assuming those debt investments... were in entities where the rates were going down and the value was going up, being on the books at amortized cost would hurt them because chances are the fair market value would have been above the amortized cost. Right.
And one other question that just came in. So you mentioned you don't teach ethics, but one of our attendees wanted to know that in addition to FSA, what other sections? do you typically teach? I am the derivatives man, the equity man, the debt man, pretty much portfolio management. I mean, most topics I don't do the econ.
I don't do the ethics. Yeah. Alternative investments. I mean, I pop in, you know, on the videos on a variety of different courses, classes. I'm on the live online.
Oh yeah. I should mention folks. virtual live on lap we just saw that sam what was that february 17th is that right the saturday live online so look there's you know don't delay because if you're looking to sit in uh may you want to start studying sooner rather than later but the saturday live online starts february 17th but guys we have an awesome awesome team i mean i'm one person here but honestly the brain trust behind me blows me i kid you not to tell my iqs in the left tail sam And James and those folks, David, their IQ is this way.
Excuse it to the right, making me look even dumber than I already am. So look, I'm a part of this team and I'm happy to be a part of it. So I will see you guys in the accounting, the derivatives, the equity.
I'll see you portfolio management, a variety of different topics, but really a phenomenal team. And I think on the live online Saturdays, a lot of Darren DeGraff. If you know Darren, he's got every credential under the sun.
And in addition to being one of the smartest people I know, he's probably one of the nicest people as well. It's just really good folks here at UWorld. You know, so your questions, you know, everybody, it's a team effort here. We're always happy to help you out. But yeah, I'll see you in most topics, but not the ethics.
You know, as I said, that doesn't come to me intuitively. No more to say on that. And yeah, and the econ, I'm not, we got PhDs in econ who can run circles around me.
So I defer to those folks. Well. And finally, we did have a few, you know, thank yous.
One of our attendees has indicated that Pete and Darren really helped me a lot through level one. So thank you for that. And hopefully we will be able to get you through level two and then level three after that.
So love it. So on behalf of everyone, Sam, I'll let you close. But I just want to thank you guys sincerely for your time tonight. Again, that testimonial, if you.
feel that we're worthy boy does that help us and help me and and help us as a course get the word out there we'd love that so in that 25 off that's pretty cool and sam i'll let you i'm gonna say goodbye but sam it's all yours just to wrap it up thank you mr olinto so again folks thank you so much uh for attending tonight uh we really appreciate your time and um if there's any other questions that you have on this that you can certainly put them through and uh we can either get them to peter or somebody else here uh within you world might be able to feel those and answer those as well and uh again thanks for your time and we hope to see you down the line let's go see you in level three or actually level two then level three see you guys later good night have a good one thank you