Assignment: Research Memo
QuaLity Waste RemovaL - A QuaLitative AnaLysis of GoodwiLL Impairment
The purpose of this case is for you to work on your research skiLLs as they reLate to financiaL accounting issues. This means you wiLL read accounting standards and appLy them to a particuLar situation. WhiLe this is particuLarLy usefuL for those who pLan to take the CPA exam, it is generaLLy usefuL for everyone as it forces you to work on your abiLity to generate LogicaL arguments to unstructured situations as weLL as Learn to use research to support your arguments. This case focuses the appLication of research to accounting for goodwiLL impairments.
REQUIRED:
You are to address the "Accounting Considerations" questions under the requirements Listed at the end of the case. You shouLd identify the appropriate Literature in the ASC and then appLy that Literature to the case facts. In some cases there may not be expLicit guidance, but rather you must infer from the case facts and the ASC.
Your memo shouLd be 2 to 3 typed, singLe-spaced pages.
You shouLd prepare the memos in pairs of two peopLe (not 3, not 4, just 2). PLease submit one memo per pair. I suggest that you each bring a copy of your memo to cLass to use during cLass discussion of the case.
A guide for writing professionaL research memos (with 2 exampLes) wiLL be posted on Canvas.
Provides another market in which the Company may be able to add tuck-in acquisitions in the future.
Acquisition Process
The acquisition group is overseen by Yvonne Upton, acquisition director, and Carter King, acquisition manager. Both are actively involved in identifying potential acquisition targets. Before formal negotiations can begin, the Company enters into a nondisclosure agreement with the target, when it seeks information related to the target's revenues and customer base. As part of the nondisclosure agreement, the target provides financial information to EW. Ms. Upton and Mr. King analyze the revenues of the target and perform due diligence procedures to evaluate the data provided. Mr. King (1) works with operations management to estimate how the target's cost structure would change under the Company's cost structure and (2) analyzes synergies to the extent they exist. Mr. King then analyzes any other factors that are part of the negotiations including the real estate and equipment included in the deal, any unusual contracts present, and the quality of the target's relationships. Ms. Upton reviews this analysis and ultimately provides a recommendation to the board of directors related to the target and a suggested acquisition price. If the acquisition is recommended, Ms. Upton provides a suggested acquisition price which is supported by the acquisition group's analysis.
After an acquisition is completed, the Company uses Sky Valuations LLC, a regional valuation firm, to assist the acquisition group to determine the appropriate purchase price allocation. Typically, most of the purchase price is assigned to goodwill, the remainder is assigned to identifiable intangible assets (customer lists and noncompete agreements), property and equipment, and accounts receivable.
Goodwill Considerations and the Adoption of Step Zero
The Company's chief operating officer, P. Ernest Worrell, is EW's chief operating decision maker. The Company has historically been managed as one reporting unit consisting of its collection operations.
The Company's annual goodwill assessment date is December 31. Historically, the annual assessment was made up of a two-step process described in ASC 350-20-35, which included (1) an analysis of whether an impairment existed (by determining whether the fair value of a reporting unit is less than its carrying value) and (2) a measurement of the impairment (which is only necessary if the fair value of a reporting unit is less than its carrying value).
EW historically used Sky Valuations to assist in this annual assessment. During each of the last three years, the Company had concluded that the fair value of its collection reporting unit was greater than its carrying value. In its most recent assessment performed as of December 31, 2011, the fair value of the Company was determined to be $230 million compared to its carrying value of $49 million, providing a cushion greater than $180 million.
As of January 1, 2012, the Company adopted ASU 2011-08, Testing Goodwill for Impairment, which allows it to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. After performing this qualitative assessment, which is known as "step zero," the Company is only required to perform step 1 (identification of potential impairment) if management determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value.
Current-Year Acquisition
In January 2012, EW entered into an agreement to purchase MW Trash Brothers (Trash Bros) for $100 million. Trash Bros operated waste removal businesses in many of the same markets that the Company operated in, but, more importantly, it also operated six landfills within EW's footprint. The landfills will allow EW to reduce its disposal costs and earn revenues off of its competitors from their disposals.
The acquisition closed on March 15, 2012, when Trash Bros's residential and commercial collection operations were folded into EW's collection operations. However, Trash Bros's landfill director was retained by EW and became the VP of landfill operations at EW. He currently serves directly under Mr. Worrell. Since the acquired waste removal businesses are similar to EW's existing collection business, the acquired waste removal businesses were added to EW's collections operation reporting unit.
The Company's controller, Oscar T. Grout, determined that the landfill division was a new reporting unit because the business was dissimilar from its other reporting units and would be managed separately. Mr. Grout directed the monthly reporting provided to Mr. Worrell to discreetly present the landfill operations separately from the collections operations.
Sky Valuations assisted management in allocating the purchase price, which ultimately resulted in additional goodwill of $65 million of which $30 million was related to the new landfill reporting unit.
Current Year Step-Zero Analysis
In the current year, management moved forward with a qualitative assessment of both reporting units. Mr. Grout prepared the analysis that was reviewed by the Company's CFO.
Required:
Accounting considerations:
o Question 1A: Can management apply a step-zero analysis to both reporting units as of December 31, 2012, current year measurement date?
o Question 1B: If so, what is an appropriate measure of fair value (herein referred to as the entity's "baseline" measure of fair value) for the entity to use to perform the qualitative assessment of goodwill on the newly acquired reporting unit?
o Question 1C: The newly acquired reporting unit will most likely have a very low cushion; what affect would this have on the conclusions of the qualitative assessment? (Consider ASC 350-20-35-3F and 35-3G when developing your response.)
• Control considerations:
o Question 2: What controls should management have in place to appropriately perform the step-zero analysis for its reporting units?
• Audit considerations:
o Question 3: What audit procedures should be performed to evaluate the step-zero analysis?