ELIKEM VULLEY ECEL PROFESSIONAL INSTITUTE
Basic principle The basic principle of a consolidated statement of financial position is that it shows all assets and liabilities of the parent and subsidiary. Intra-group items are excluded, e.g. receivables and payables shown in the consolidated statement of financial position only include amounts owed from/to third parties.
The investment in the subsidiary (S) shown in the parent s (P s) statement of financial position is replaced by the net assets of S. The cost of the investment in S is effectively cancelled with the ordinary share capital and reserves of the subsidiary. This leaves a consolidated statement of financial position showing: the net assets of the whole group (P + S) the share capital of the group which always equals the share capital of P only and the retained profits, comprising profits made by the group (i.e. all of P s historical profits + profits made by S post-acquisition).
A standard group accounting question will provide the accounts of P and the accounts of S and will require the preparation of consolidated accounts. The best approach is to use a set of standard workings. (W1) Establish the group structure Date of acquis. A 80% This indicates that P owns 80% of ord. shares of S B Working 1 will show: How much of the subsidiary is owned by P How long P has had control over S This will be useful for working out the share of S's results since acquisition.
At the date At the Post acquisition of acquisition reporting date Stated capital x x - - Retained earnings x x x - Revaluation reserve x x x Fair value adjustment x(x) x/(x) x/(x) - Post acq n depn/amort FV x/(x) x/(x) - PURP if the sub is the seller (x) (x) - x (w3) x
Working 2 shows the value of S's net assets at various points in time, giving an approximation of what the fair value of S is. The first column shows the fair value of S at acquisition, which can be used to calculate goodwill (in Working 3) The second column shows the fair value of S's net assets at the year end The final column shows the post-acquisition movement in S's net assets. This increase or decrease will be split between the 2 parties that own S (the parent and the NCI), according to their % ownership. Note: If there is a post-acquisition revaluation surplus, the group share of the post-acquisition revaluation would be added to the total revaluation surplus and not taken to retained earnings.
Parent holding (investment) at fair value NCI value at acquisition (*) Less: Fair value of net assets at acquisition (W2) Goodwill on acquisition Impairment () ()
(*) If fair value method adopted: NCI value = fair value of NCI's holding at acquisition (number of shares NCI own subsidiary share price). (*) If proportion of net assets method adopted: NCI value = NCI % fair value of net assets at acquisition (from W2). If goodwill is positive, take it as a non-current asset to the statement of financial position. If goodwill is negative, it is regarded as a gain on a bargain purchase and is taken as a gain to retained earnings in Working 5.
NCI value at acquisition (as in (W3)) NCI share of post-acquisition reserves (W2) NCI share of impairment (fair value method only) () This shows the value of the subsidiary that is not owned by the parent at year end.
P's retained earnings (100%) P's % of sub's post-acquisition retained earnings Less: Parent share of impairment (W3) () Less: unwinding finance cost () Less: PURP if P is the seller () Less: transaction cost on acquisition () Add: Excess depreciation Add: Gain on bargain purchase This shows the retained earnings that are attributable to the parent's shareholders.
Goodwill (W3) Assets (P + S) Total assets Equity capital (Parent's only) Retained earnings (W5) Other components of equity (W5) Non-controlling interest (W4) Total equity Liabilities (P + S) Total equity and liabilities
IFRS 3 revised governs accounting for all business combinations other than joint ventures and a number of other unusual arrangements not included in this syllabus. The definition of goodwill is: Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. Goodwill is calculated as the excess of the consideration transferred and amount of any non-controlling interest over the net of the acquisition date identifiable assets acquired and liabilities assumed.
Positive goodwill Capitalized as an intangible non-current asset. Tested annually for possible impairments. Amortization of goodwill is not permitted by the standard. Impairment of positive goodwill If goodwill is considered to have been impaired during the post-acquisition period it must be reflected in the group financial statements. Accounting for the impairment differs according to the policy followed to value the non-controlling interests.
Proportion of net assets method: Dr. Group reserves (W5) Cr. Goodwill (W3) Fair value method: Dr. Group reserves (% of impairment attributable to the parent (W5)) Dr. NCI (% of impairment attributable to NCI (W4)) Cr. Goodwill (W3)
Arises where the cost of the investment is less than the value of net assets purchased. IFRS 3 does not refer to this as negative goodwill (instead it is referred to as a bargain purchase), however this is the commonly used term. Most likely reason for this to arise is a misstatement of the fair values of assets and liabilities and accordingly the standard requires that the calculation is reviewed. After such a review, any negative goodwill remaining is credited the statement of profit or loss. directly to
Pre-and post-acquisition profits Pre-acquisition profits are the reserves which exist in a subsidiary company at the date when it is acquired. They are capitalized at the date of acquisition by including them in the goodwill calculation. Post-acquisition profits are profits made and included in the retained earnings of the subsidiary company following acquisition. They are apportioned between the group retained earnings and the NCI.
When looking at the reserves of S at the year end, e.g. revaluation reserve, a distinction must be made between: those reserves of S which existed at the date of acquisition by P(preacquisition reserves) and the increase in the reserves of S which arose after acquisition by P(postacquisition reserves). As with retained earnings, only the group share of post-acquisition reserves of S is included in the group reserves in the statement of financial position, with the remainder being added to the NCI. If there is a post-acquisition revaluation reserve in the subsidiary, then the group share of this is added to the revaluation reserve in the statement of financial position.
What is a non-controlling interest? In some situations a parent may not own all of the shares in the subsidiary, e.g. if P owns only 80% of the ordinary shares of S, there is a non-controlling interest of 20%. Note, however, that P still controls S. Accounting treatment of a non-controlling interest As P controls S: in the consolidated statement of financial position, include all of the net assets of S (to show control). give back the net assets of S which belong to the non-controlling interest within the equity section of the consolidated statement of financial position (calculated in (W4)).
Daniel acquired 80% of the ordinary share capital of Craig on 31 December 206 for Ghc78,000. At this date the net assets of Craig were Ghc85,000. What goodwill arises on the acquisition (i) if the NCI is valued using the proportion of net assets method (ii) if the NCI is valued using the fair value method and the fair value of the NCI on the acquisition date is Ghc19,000?
To ensure that an accurate figure is calculated for goodwill: the consideration paid for a subsidiary must be accounted for at fair value the subsidiary s identifiable assets and liabilities acquired must be accounted for at their fair values. Calculation of cost of investment The cost of acquisition includes the following elements: cash paid fair value of any other consideration i.e. deferred/contingent considerations and share exchanges. Incidental costs of acquisition such as legal, accounting, valuation and other professional fees should be expensed as incurred. The issue costs of debt or equity associated with the acquisition should be recognized in accordance with IFRS 9/IAS 32.
In some situations not all of the purchase consideration is paid at the date of the acquisition, instead a part of the payment is deferred until a later date deferred consideration. Deferred consideration should be measured at fair value at the date of the acquisition (i.e. a promise to pay an agreed sum on a predetermined date in the future taking into account the time value of money). The fair value of any deferred consideration is calculated by discounting the amounts payable to present value at acquisition. Any contingent consideration should be included at fair value, which will be given in the exam. (A contingent consideration is an agreement to settle in the future provided certain conditions attached to the agreement are met. These conditions vary depending on the terms.
There are two ways to discount the deferred amount to fair value at the acquisition date: (1) The examiner may give you the present value of the payment based on a given cost of capital. (For example, Ghc1 receivable in three years time based on a cost of capital of 10% = Ghc0.75) (2) You may need to use the interest rate given and apply the discount fraction where r is the interest rate and n the number of years to settlement 1 (1 + r) n
Each year the discount is then "unwound". This increases the deferred liability each year (to increase to future cash liability) and the discount is treated as a finance cost. This is also applied to any contingent consideration, as the fair value given will be at the present value. As it is based on uncertain events, the fair value of the contingent consideration at acquisition could be different to the actual consideration transferred. Any differences are normally treated as a change in accounting estimate and adjusted prospectively in accordance with IAS 8. Therefore the liability will be increased or decreased at the year end, with the movement being shown in retained earnings.
Often the parent company will issue shares in its own company in return for the shares acquired in the subsidiary. The share price at acquisition should be used to record the cost of the shares at fair value. Example: Jack acquires 24 million Ghc1 shares (80%) of the ordinary shares of Becky by offering a share-for-share exchange of two shares for every three shares acquired in Becky and a cash payment of Ghc1 per share payable three years later. Jack's shares have a current market value of Ghc2. The cost of capital is 10% and Ghc1 receivable in 3 years can be taken as Ghc0.75. (i) Calculate the cost of investment and show the journals to record it in Jack's accounts. (ii) Show how the discount would be unwound.
Types of intra-group trading P and S may well trade with each other leading to the following potential problem areas: current accounts between P and S loans held by one company in the other dividends and loan interest unrealized profits on sales of inventory unrealized profits on sales of non-current assets
Current accounts If P and S trade with each other then this will probably be done on credit leading to: a receivables (current) account in one company s SFP a payables (current) account in the other company s SFP. These are amounts owing within the group rather than outside the group and therefore they must not appear in the consolidated statement of financial position. They are therefore cancelled (contra d) against each other on consolidation.
Cash/goods in transit At the year end, current accounts may not agree, owing to the existence of in-transit items such as goods or cash. The usual rules are as follows: If the goods or cash are in transit between P and S, make the adjusting entry to the statement of financial position of the recipient: cash in transit adjusting entry is: goods in transit adjusting entry is: Dr. Group Cash/Bank Cr. Group Receivables Dr. Group Inventory Cr. Group Payable this adjustment is for the purpose of consolidation only.
Profits made by members of a group on transactions with other group members are: recognized in the accounts of the individual companies concerned, but in terms of the group as a whole, such profits are unrealized and must be eliminated from the consolidated accounts. Unrealized profit may arise within a group scenario on: inventory where companies trade with each other non-current assets where one group company has transferred an asset another. to The key is that we need to remove this profit by creating a provision for unrealized profit (PURP)
When one group company sells goods to another a number of adjustments may be needed. Current accounts must be cancelled (see earlier in this chapter). Where goods are still held by a group company, any unrealized profit be cancelled. Inventory must be included at original cost to the group (i.e. cost to the company which then sold it). must
The process to adjust is: (1) Determine the value of closing inventory included in an individual company s accounts which has been purchased from another company in the group. (2) Use markup or margin to calculate how much of that value represents profit earned by the selling company. (3) Make the adjustments. These will depend on who the seller is. If the seller is the parent company, the profit element is included in the holding company s accounts and relates entirely to the group. Adjustment required: Dr. Group retained earnings (deduct the profit in W5) Cr. Group inventory
If the seller is the subsidiary, the profit element is included in the subsidiary company s accounts and relates partly to the group, partly to noncontrolling interests (if any). Adjustment required: Dr. Subsidiary retained earnings (deduct the profit in W2 at reporting date) Cr. Group inventory
If one group member sells non-current assets to another group member adjustments must be made to recreate the situation that would have existed if the sale had not occurred: There would have been no profit on the sale. Depreciation would have been based on the original cost of the asset to the group. Selling price at transfer date Cost/Carrying amount at transfer date Profit on sales Adjustment required if P is the seller: Adjustment required if S is the seller: () Dr. Group Retained earnings Cr. PPE Dr. Subsidiary s Retained earnings Cr. PPE
Adjustment required for depreciation at the reporting date: Calculate the depreciation on the selling price assuming transfer Calculate the depreciation on the cost/cv assuming no transfer Excess depreciation () Adjustment if S is the seller: Adjustment if P is the seller: Dr. PPE Cr. Group retained earnings(w5) Dr. PPE Cr. Subsidiary s retained earnings(w2)
Parent company (P) transfers an item of plant to its subsidiary (S) for Ghc6,000 at the start of 201. The plant originally cost P Ghc10,000 and had an original useful economic life of 5 years when purchased 3 years ago. The useful economic life of the asset has not changed as a result of the transfer. What is the unrealized profit on the transaction at the end of the year of transfer (201)?
Calculation of reserves at date of acquisition If a parent company acquires a subsidiary mid-year, the net assets at the date of acquisition must be calculated based on the net assets at the start of the subsidiary's financial year plus the profits of the subsidiary up to the date of acquisition. To calculate this it is normally assumed that S s profit after tax accrues evenly over time. However, there may be exceptions to this. The most common one of these is an intra-group loan from the parent to the subsidiary. If this is the case, the subsidiary will have interest in the post-acquisition period that it wouldn't have had in the pre-acquisition period.
P bought S on 1 July 201. S's retained earnings at 31 December 201 are Ghc15,000 and S's profit for the year was Ghc8,000. Immediately after acquisition, P gave S a loan of Ghc40,000 which carried interest of 10%. What were S's retained earnings at acquisition?