Case 04-9 Healthcare Depot Part 1 - Deloitte

Case 04-9: Healthcare Depot—Part 1 Handout 1Page 2two reportable segments: (1) Pharmaceutical Distribution and (2) Medical-SurgicalProducts and Services (“Medical-Surgical”).In addition, the footnote indicates that for disclosure purposes, the following twooperating segments are aggregated to form the Pharmaceutical Distribution reportablesegment:• Drug Depot Company (DDC), which sells pharmaceuticals, over-the-countermedicines, health and beauty aids, and other health-related products to hospitals,managed care facilities, independent and chain retail pharmacies, and food/drugcombination stores.• Specialty Healthcare (“Specialty”), which sells a comprehensive supply ofinjectables, vaccines, plasma, and oncology products to physicians, clinics, andother health-care providers.Healthcare Depot believes that Medical-Surgical, DDC, and Specialty are all operatingsegments under Statement 131, and thus represent the starting point for identifying thereporting units.Paragraph 30 of Statement 142 defines the reporting unit as an operating segment or onelevel below. One level below would be defined appropriately as a reporting unit if (1) the“component constitutes a business for which discrete financial information is available,”and (2) the “segment management regularly reviews the operating results of thatcomponent.”Healthcare Depot has identified the following components for the noted operatingsegments:Medical-SurgicalNo components.DDC• DDC Distribution Corp. is the primary operating component of the segment and isresponsible for procurement, sales, and distribution for all products and channels.• Healthcare Holding (“HC Holding”) is a legal entity that was created by DDC tohold its various investments in private and start-up medical research companies.Specialty• Oncology Care Specialists (OCS) specializes in the distribution of oncologyproducts.• Diabetes Depot specializes in the distribution of injectables and vaccines fordiabetes.Copyright 2007 © Deloitte Development LLCAll Rights Reserved

Case 04-9: Healthcare Depot—Part 1 Handout 1Page 3“Segment managers” review monthly operating profit and loss statements and internalfinancial information (e.g., long-range plans, forecasts, actual results) for Medical-Surgical, DDC, HC Holding, OCS, and Diabetes Depot. In addition, OCS and DiabetesDepot have common customer contracts, which is feasible because of similarities inproducts and methods of production and distribution. As a result, the long-term financialperformances of these two components have historically been similar.On the basis of the above, the Company believes that the following organizational chartidentifies Healthcare Depot’s five “reporting units” as defined by Statement 142:HEALTHCAREDEPOTPharmaceuticalDistributionNOMedical-SurgicalProducts andServicesYES - #1Drug DepotCompany (DDC)NOSpecialtyHealthcare(Specialty)NODDCDistribution Corp.YES - #2HealthcareHolding (HC Holding)YES - #3Oncology CareSpecialists (OCS)YES - #4DiabetesDepotYES - #5Copyright 2007 © Deloitte Development LLCAll Rights Reserved

Case 04-9Healthcare DepotPart 2 — Allocation of Assets, Liabilities, and Goodwill to Reporting UnitsThis case study is the second part of a three-part case involving business combinations,goodwill, and other intangible assets. Participants should use the facts and solutionspresented in Part 1— Identification of Reporting Units when addressing the requirementsof this case study.Bob Pedrotti (the engagement partner) also requested that a review be performed of theCompany’s allocations to ensure that management was properly interpreting the guidanceof FASB Statement No. 142, Goodwill and Other Intangible Assets. Virginia Blackburn(CFO) provided him with an excerpt from the “Summary of Corporate Allocations toReporting Units” report that summarizes management’s allocation of assets, liabilities,and goodwill from the corporate ledger to the reporting units for the purpose of testinggoodwill for impairment (see Handout 2).Required:Has management appropriately allocated the (selected) corporate assets, liabilities, andgoodwill to the reporting units for the purpose of testing goodwill for impairment (seeHandout 2)?Copyright 2007 © Deloitte Development LLCAll Rights Reserved.

Case 04-9: Healthcare Depot—Part 2 Handout 2Page 1SUMMARY OF CORPORATE ALLOCATIONS TO REPORTING UNITSSource: Corporate Balance Sheet as of December 31, 2002Prepared by Healthcare DepotASSETSTrademark — Net (a) 4,523,000Goodwill — Net (b) 25,350,000LIABILITIESRestructuring Accrual (c) 643,000Environmental Liability (d) 8,750,000Pension Obligation (e) 1,960,000(a) Healthcare Depot acquired the Medical-Surgical reportable segment and “M-S”trademark in 1995. Since the acquisition, the Company has operated Medical-Surgical as a stand-alone entity. However, the trademark was retained on thecorporate ledger for accounting purposes. To test goodwill for impairment, theCompany allocated 100 percent of the carrying value of the trademark to Medical-Surgical.(b) This amount represents previously recognized entity-level goodwill, which is a resultof synergies obtained from former acquisitions and was being amortized over a 40-year period. Because all reporting units are expected to benefit from these synergies,Healthcare Depot allocated the goodwill to the reporting units on the basis of theirrelative fair values. Effective January 1, 2002, amortization of goodwill wasdiscontinued.(c) In December 2002, Healthcare Depot announced a company-wide restructuringprogram. The remaining accrual comprises the estimated costs for (1) the closure oftwo distribution facilities at OCS ($425,000) and (2) a 25 percent reduction inworkforce at Diabetes Depot ($218,000). Because these liabilities are directly relatedto the operations of the specifically identified reporting units (OCS and DiabetesDepot) and would be considered in determining the fair value of the reporting units,the Company deemed it appropriate to allocate liabilities of $425,000 and $218,000 toOCS and Diabetes Depot, respectively.(d) In May 2001, Healthcare Depot disposed of a reporting unit that manufacturedpackaging supplies. At the time of the sale, several of the reporting unit’s facilitieswere under inspection by the Environmental Protection Agency. The results of theenvironmental impact study indicated a land contamination issue that would requireremedial action; thus, the environmental liability was removed from the salesagreement’s scope and was retained by the company. The Company deemed itappropriate to allocate the liability to the current reporting units on the basis of theirrelative fair values.(e) Healthcare Depot has several defined benefit pension plans covering virtually allsalaried and hourly employees. For each employee, the benefits are based on years ofservice and average compensation. As a result, the Company deemed it appropriateCopyright 2007 © Deloitte Development LLCAll Rights Reserved.

Case 1: Handout 3 Page 2to allocate the pension obligation to the reporting units on the basis of their relativefair values.Copyright 2004 Deloitte FoundationAll Rights Reserved

Case 04-9Healthcare DepotPart 3 — Goodwill Impairment TestThis case study is the third part of a three-part case involving business combinations,goodwill, and other intangible assets. Participants should use the facts and solutionspresented in Part 1 — Identification of Reporting Units and Part 2 — Allocation ofAssets, Liabilities, and Goodwill to Reporting Units when addressing the requirements ofthis case study.To test its goodwill for impairment under FASB Statement No. 142, Goodwill and OtherIntangible Assets, Healthcare Depot provided the following information as of January 1,2003, the date it chose to perform its annual goodwill impairment test for each of itsreporting units. Healthcare Depot’s effective tax rate is 40 percent.Goodwill Impairment Test — Step OneHealthcare Depot — Selected BusinessComponentsMedical- DDC Distribution HCSurgical Corp. HoldingFair Value 1 $125,000,000 $236,000,000 $75,000,000Carrying Value of Net Assets(Excluding Goodwill) 118,800,000 231,700,000 72,250,000Carrying Value of Goodwill 3,200,000 10,500,000 2,150,0001 Fair value was determined using the best information available and reflects an amount at which thereporting unit could be bought or sold in a current transaction between willing parties.Required:Using the above information, perform step one of the goodwill impairment test for eachof the selected business components, as required by Statement 142.Copyright 2007 © Deloitte Development LLCAll Rights Reserved.

Case 04-9: Healthcare Depot—Part 3 Page 2Goodwill Impairment Test — Step TwoHealthcare Depot — Selected BusinessComponentsMedical- DDC Distribution HCSurgical Corp. HoldingFair Value — Tangible Net Assets $27,950,000 $53,000,000 $24,350,000Fair Value — Recognized Intangibles 61,000,000 75,000,000 45,000,000Fair Value — Unrecognized Intangibles:Assembled Workforce 3,250,000 9,000,000 1,500,000Patent 0 75,000,000 0Customer List 0 15,500,000 5,000,000In-Process R&D 4,700,000 12,000,000 0Computer Software 5,000,000 0 0Note that fair value amounts were determined using the best information available andreflect an amount at which the net assets or intangible assets could be bought or sold in acurrent transaction between willing parties.Required:• For business components in which the carrying amount exceeds its fair value, reviewthe information above and perform the second step of the transitional goodwillimpairment test.• Indicate the appropriate journal entry or entries to record to recognize goodwillimpairment loss, if any.Copyright 2007 © Deloitte Development LLCAll Rights Reserved.