APPENDIX A: Sample Brief Memorandum

RE: Sonys Goodwill and Segment Reporting

Facts:

Sony is a Japanese multinational company that decided to expand its entertainment business in the United States. Sony purchased CBS Records and Columbia Pictures to form Sony Music and Sony Pictures. Because of these acquisitions, Sony assumed debt of $1.2 billion and allocated $3.8 billion to goodwill. On Sonys Annual Report filed with the SEC, Sony reported only two industry segments: electronics and entertainment. Although Sony Music was profitable, Sony Pictures produced continued losses of approximately $1 billion. When Sony purchased the motion pictures operations, it projected a loss for only five years because it assumed that the motion pictures entertainment would become profitable. However, Sony suffered a significant loss after amortization and the costs of financing the acquisition for the past four years. Moreover, in the current year, Sony Pictures sustained a loss of nearly $450 million, double the amount that Sony had planned. To date, Sony Pictures has had total net losses of nearly $1 billion. Early in the year, Sony declared that it had written down $2.7 billion in goodwill associated with the acquisition of Sony Pictures. Sony combined the results of Sony Music and Sony Pictures and reported them as Sony Entertainment. Little profit was shown in Sony Entertainment. Sonys consolidated financial statements did not disclose the losses from Sony Pictures.

Issues:

1. Whether an annual write-down of goodwill and its impairment is necessary under FAS 142 for the acquisition of a company with continued losses.

2. Whether financial statement disclosures of two segments are needed when one industry has two businesses with different financial trends in order to avoid misleading financial statement users under Securities Exchange Act Section 13(a).

Conclusions:

1. A write-down of goodwill of an acquired entity with continuous losses is required under FAS 142.

2. The financial statement disclosure of only two industries when one industry has two businesses with different financial trends is misleading under Securities Exchange Act 13(a) and needs revising under FAS 131.

Authorities on goodwill:

A summary of the relevant authorities on goodwill is as follows:

Goodwill is an intangible asset that often arises from a business combination. It is a separate line item in the statement of financial position. Goodwill is not amortizable because it has an indefinite useful life. Potential impairment of goodwill in each reporting unit requires annual testing. IAS 36.10. A reporting unit includes segments of an operating unit for which disclosure is needed. The impairment is generally measured by comparing the fair value to the reported carrying value of goodwill. IAS 36.105. Impairment losses are recognized in the income statement. IAS 36.126. The notes to the financial statements must disclose each goodwill impairment loss if the loss is probable and can be reasonably estimated. The segment from which the business arose must disclose the loss. IAS 36.129.

Caution: Previously, goodwill was presumed to have a finite life and was amortized over 40 years. Also, the tax treatment of goodwill differs from financial accounting. Goodwill is a qualifying intangible for amortization over 15 years under IRC 197(a) and (d)(1)(A).

Authorities on segment disclosure:

The following is a summary of the relevant portions of accounting and SEC accounting literature on segment disclosure:

Segment disclosure reporting is required of public companies in their annual financial statements. IFRS 8.2. The objective of segment disclosure is to provide users of financial statements with information about the businesss different types of business activities and various economic environments. IFRS 8.1. Operating segments earn revenues and expenses, have results regularly reviewed by management, and have discrete types of financial information. IFRS 8.5. Operating segments should be recognized if the revenue is 10 percent or more of the combined revenues or assets are 10 percent or more of the combined assets. IFRS 8.13. Disclosure of segment information must include nonfinancial general information such as how the entity identified its operating segments and the types of products and services from which each reportable segment derives its revenues. IFRS 8.22. Required financial information includes the reported segment profit or loss, segment assets, the basis of measurement. IFRS 8.21. Reconciliation is required of the totals of segment revenues, reported segment profit or loss, segment assets, and other significant items to corresponding business enterprise amounts. IFRS 8.28.

Filing reports periodically with the SEC is required for every issuer of a security under the Exchange Act of 1934. The reports must include any information needed to ensure that the required financial statements were not misleading in light of the circumstances. Prior to 2008, foreign-owned companies with registered securities had to reconcile the accounting in the annual financial statement to U.S. GAAP under SEC Form 20-F.

Application of authorities:

1. The carrying value of Sony Pictures exceeded its fair value; the carrying amount of Sony Pictures goodwill exceeded the implied fair value of Sony Pictures goodwill. The impairment of goodwill loss was probable and can be reasonably estimated.

2. Sony should report separate information about each operating segment that met any of the 10 percent quantitative thresholds.

3. Sony may not combine Sony Music and Sony Pictures as one reportable segment for any of the following reasons. They do not have similar economic characteristics. These businesses are not similar in the nature of the products, the nature of the production processes, the type or class of customer for their products and services, and the methods used to distribute their products.

4. Sony should disclose segmental information for Sony Music and Sony Pictures, providing information about their reported segment profit or loss. Other information to report includes the types of products from which each reportable segment derives its revenues, any reconciliations needed of the total segment revenues, and interim period information.

5. The amount assigned to goodwill acquired was significant in relation to the total cost of acquiring Sony Pictures. Thus, Sony must disclose the following information for goodwill in the notes to Sony Entertainments financial statements: (1) the total amount of goodwill and the expected amount deductible for tax purposes and (2) the amount of goodwill by reportable segment.

6. The authoritative sources require recognizing writing down goodwill of an acquired entity with continuous losses. Write down goodwill when a loss is probable and can be reasonably estimated. On the other hand, Sony must provide separate financial reporting for Sony Pictures because Sony Music and Sony Pictures do not share similar economic characteristics.

Read Appendix A, Sample Brief Memorandum. In 23 pages (12-point font, double-spaced), critique the memorandum based on what we've learned so far in the course. For example, does the memorandum use the SEC's plain English concepts and cite authoritative sources?