Trash Talk Company Information Waste Management (“WM” or the “Company”) is a reg

Question

Trash Talk

Company Information

Waste Management (“WM” or the “Company”) is a regional waste removal company that operates primarily in the South.   It is privately owned. The Company earns revenues from residential and commercial garbage and recycling collections.

A summary of WM’s financial results as of and for the year ended December 31, 2012, is as follows:

Growth Strategy

The Company actively seeks out local waste companies in its current or adjacent markets. Acquisitions of businesses inside WM’s territory are referred to as “tuck-in acquisitions.” Tuck-in acquisitions allow the Company to expand its revenue base and at the same time reduce its cost per customer. (Cost reductions are primarily the result of improved route efficiencies.) Expanding into new markets provides another means of revenue growth and 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 acquisition director, Brittany Trosclair and Daniel Posway, 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 WM. Ms. Trosclair and Mr. Posway analyze the revenues of the target and perform due diligence procedures to evaluate the data provided. Mr. Posway (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. Posway 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. Trosclair 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. Trosclair provides a suggested acquisition price which is supported by the acquisition group’s analysis.

After an acquisition is completed, the Company uses Land 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 non-compete agreements), property and equipment, and accounts receivable.

Goodwill Considerations and the Adoption of Step Zero

The Company’s chief operating officer, E. Jayde Platenburg, is WM’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).

WM historically used Land 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, 2012, the fair value of the Company was determined to be $230 million compared to its carrying value of $49 million, providing a cushion in excess of $180 million.
As of January 1, 2013, the Company adopted ASU 201122-08, 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 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 2013, WM entered into an agreement to purchase EU 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 WM’s footprint. The landfills will allow WM to reduce its disposal costs and earn revenues off of its competitors from their disposals.

The acquisition closed on March 15, 2013, when Trash Bros’s residential and commercial collection operations were folded into WM’s collection operations. However, Trash Bros’s landfill director was retained by WM and became the VP of landfill operations at WM. He currently serves directly under Ms. Platenburg. Since the acquired waste removal businesses are similar to WM’s existing collection business, the acquired waste removal businesses were added to WM’s collections operation reporting unit.

The Company’s controller, Ashleigh Castin, 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. Ms. Castin directed the monthly reporting provided to Ms. Platenburg to discreetly present the landfill operations separately from the collections operations.

Land Valuations assisted management in allocating the purchase price, which ultimately resulted in additional goodwill of $75 million of which $40 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. Ms. Castin prepared the analysis that was reviewed by the Company’s CFO.

Required:
Question A: Can management apply a step-zero analysis to both reporting units as of December 31, 2013, current year measurement date?
Question B: 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?
Question C: 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?

12/31/2012 (in millions) 12/31/2012 (io millions) Income summary Revenues Operating expenses..158 SG&A; expenses Interest expense S 255 Current assets 2 Net income ldentifiable intangible assets, net Liabilities and equity $24 Accounts payable &accrued; exp. Line of credit Current portion of long-term debt Current liabilities Total liabilities and equity $ 320

Explanation / Answer

Ans A

Yes

Management can apply a step zero analysis to both reporting units as of Dec 31 2013,current year measurement date

Ans B

The fair value of an asset (or liability) is the amount at which that asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Thus, the fair value of a reporting unit refers to the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties. Quoted market prices in active markets are the best evidence of fair value and shall be used as the basis for the measurement, if available. However, the market price of an individual equity security (and thus the market capitalization of a reporting unit with publicly traded equity securities) may not be representative of the fair value of the reporting unit as a whole. The quoted market price of an individual equity security, therefore, need not be the sole measurement basis of the fair value of a reporting unit.

If quoted market prices are not available, the estimate of fair value shall be based on the best information available, including prices for similar assets and liabilities and the results of using other valuation techniques. A present value technique is often the best available technique with which to estimate the fair value of a group of net assets (such as a reporting unit). If a present value technique is used to measure fair value, estimates of future cash flows used in that technique shall be consistent with the objective of measuring fair value. Those cash flow estimates shall incorporate assumptions that marketplace participants would use in their estimates of fair value. If that information is not available without undue cost and effort, an entity may use its own assumptions. Those cash flow estimates shall be based on reasonable and supportable assumptions and shall consider all available evidence. The weight given to the evidence shall be commensurate with the extent to which the evidence can be verified objectively. If a range is estimated for the amounts or timing of possible cash flows, the likelihood of possible outcomes shall be considered. Concepts Statement 7 discusses the essential elements of a present value measurement provides examples of circumstances in which an entity’s cash flows might differ from the market cash flows , and discusses the use of present value techniques in measuring the fair value of an asset or a liability
In estimating the fair value of a reporting unit, a valuation technique based on multiples of earnings or revenue or a similar performance measure may be used if that technique is consistent with the objective of measuring fair value. Use of multiples of earnings or revenue in determining the fair value of a reporting unit may be appropriate, for example, when the fair value of an entity that has comparable operations and economic characteristics is observable and the relevant multiples of the comparable entity are known. Conversely, use of multiples would not be appropriate in situations in which the operations or activities of an entity for which the multiples are known are not of a comparable nature, scope, or size as the reporting unit for which fair value is being estimated

Ans C

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?  

This will contradict the conclusions of the qualitative assesement.

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