ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)
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Chapter 4: Group financial statements
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There has been no dividend payment by S in the year. The profit after tax of Entity P
for the year was $530,000. There has been no impairment of goodwill.
Required
Calculate the consolidated profit for the year to 31 December Year 7, and the
allocation of this profit between the equity holders of the parent and the non-
controlling interests in S.
Answer
Step 1
Establish the percentage share in the subsidiary of the parent P and the non-
controlling interests.
%
Parentshare:(400,000/600,000)×100%
66.67
NCIshare:(200,000/600,000)×100% 33.33
100.00
Step 2
Establish the post-acquisition profit of the subsidiary.
Since there has been no dividend payment, the annual profit for the subsidiary can
be calculated as the difference between the net assets of Entity S at the end of the
year and the net assets at the beginning of the year.
$
Netassetsofsubsidiaryat31DecemberYear7(2,000–
400)
1,600,000
Netassetsofsubsidiaryat1JanuaryYear7 1,330,000
Profitfortheyearaftertax
270,000
Post‐acquisitionprofit(4months,therefore4/12×
$270,000)
90,000
Step 3
Allocate the subsidiary’s post-acquisition profit between the parent’s equity
shareholders and the non-controlling interests in Entity S.
$
ParentPshare:66.67%×$90,000
60,000
NCIshare:33.33%×$90,000 30,000
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Step 4
Calculate the profit for the year for the group as a whole, and separate into the
parent’s share and the profit attributable to the NCI:
$
ProfitfortheyearofEntityP
530,000
Post‐acquisitionprofitofsubsidiaryS 90,000
Consolidatedprofitfortheyear
620,000
Attributableto:
Equityholdersoftheparent(530,000+60,000) 590,000
Non‐controllinginterests
30,000
620,000
Other adjustments to the consolidated profit or loss: impairment of goodwill
There may be other adjustments to the consolidated profit or loss for the year.
One such adjustment is impairment of goodwill. When purchased goodwill is
impaired, the impairment does not affect the individual financial statements of the
parent company or the subsidiary. The effect of the impairment applies exclusively
to the consolidated statement of financial position and the consolidated statement of
comprehensive income.
If goodwill is impaired:
it is written down in value in the consolidated statement of financial position,
and
the amount of the write-down is charged as an expense in profit or loss, usually
as an administration expense.
When the partial goodwill method of accounting is used, a write-down in goodwill
affects the parent entity only, not the non-controlling interests. It should therefore
be deducted from the profit attributable to the equity holders in the parent.
When the full goodwill or fair value method is used, a write-down in goodwill
affects both the parent company shareholders and the NCI, and the impairment
attributable to each is calculated using the method explained earlier.
NCI and losses
When a group reports a loss for the year rather than a profit, IAS 27 (revised)
requires that the loss should be attributed to the owners of the parent company and
the NCI, in the same way that profits are allocated between them.
This requirement is different from the rule in the previous version of IAS 27.
Previously, it was permitted to allocate a share of a consolidated loss to the NCI
only if the NCI had entered into a binding obligation to fund their share of the loss.
Chapter 4: Group financial statements
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Other aspects of IFRS 3 (revised)
Fair values at acquisition and recognitiion criteria
Recognition of intangible assets at acquisition
Bargain purchases
Measuring the cost of an acquisition (the consideration)
Fair value adjustments in a subsequent period
Fair value adjustments in the income statement
3 Other aspects of IFRS 3 (revised)
3.1 Fair values at acquisition and recognition criteria
When a subsidiary is acquired, the parent company acquires a share of the fair value
of the net identifiable assets of the subsidiary. The assets and liabilities of the
subsidiary are re-measured at fair value for the purpose of consolidation, and
goodwill attributable to the parent entity at acquisition is the difference between the
purchase consideration and the parent’s share of the fair value of the net assets of
the subsidiary.
Establishing fair value is therefore an important requirement in accounting for
acquisitions. Fair value is the amount at which an asset could be exchanged or a
liability settled, between knowledgeable, willing parties in an arm’s length
transaction.
IFRS 3 states that the acquirer (parent company) at the acquisition date should
recognise, separately from goodwill:
the identifiable assets acquired
the liabilities assumed, and
any non-controlling interest in the subsidiary (‘acquiree’).
The recognition of assets and liabilities in the subsidiary is subject to certain rules.
To qualify for recognition, assets and liabilities must meet the definitions of
assets and liabilities in the IASB Framework.
The application of the recognition rules by the acquirer may result in recognising
some assets that the acquiree (subsidiary) does not recognise in its financial
statements. For example the acquirer might acquire rights in brand names or
patent rights that the acquired subsidiary does not include in its financial
statements. Recognising intangible assets at acquisition is described in more
detail later.
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The table below shows how different types of asset and liability should be valued.
Item Fair value
Marketable
investments
Current market value
Non-marketable
investments
Estimated values that take into consideration features such as:
(a) price earnings ratios
(b) dividend yield
(c) expected growth rates of comparable investments
Trade and other
receivables
Present values of the amounts to be received. This is normally
the same as the book value. Discounting is not usually
required because amounts are expected to be received within
a few months.
Inventories:
finished goods
Selling price less the sum of:
(a) the costs of disposal, and
(b) a reasonable profit allowance for the selling effort of
the acquirer based on profit for similar finished goods.
Inventories: work
in progress
Selling price of finished goods less the sum of:
(a) costs to complete,
(b) costs of disposal, and
(c) a reasonable profit for the completing and selling
effort based on profit for similar finished goods.
Inventories: raw
materials
Current replacement costs
Land and
buildings
Market value
Plant and
equipment
Normally market value. Use depreciated replacement cost if
market value cannot be used (e.g., because of the specialised
nature of the plant and equipment or because the items are
rarely sold, except as part of a continuing business).
Intangible assets Described later.
Trade and other
payables; long-
term debt and
other liabilities.
Present values of amounts to be disbursed in meeting the
liability determined at appropriate current interest rates. For
current liabilities this is normally the same as book value.
Contingent liabilities
Many acquired businesses will contain contingent liabilities such as contingent
liabilities for the settlement of legal disputes or for warranty liabilities. IFRS 3 states
that contingent liabilities should be recognised at acquisition ‘even if it is not
probable that an outflow of resources embodying economic benefits will be required
to settle the obligation.’
Chapter 4: Group financial statements
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The contingent liabilities should be measured at fair value at the acquisition
date. (Contingent assets are not recognised).
After the acquisition date, contingent liabilities should subsequently be re-
measured in the consolidated statement of financial position at the higher of the
original amount and the amount that would be reported under the relevant
standard, IAS 37. However, the contingent liabilities cannot be recognised in the
entity’s individual financial statements (and the rules of IAS 37 apply).
Deferred tax
Deferred income tax assets and liabilities are recognised and measured in
accordance with IAS 12 Income Taxes, rather than at their acquisition-date fair
values.
Restructuring costs
An acquirer should not recognise a liability for the cost of restructuring a subsidiary
or for any other costs expected to be incurred as a result of the acquisition
(including future losses).
This is because a plan to restructure a subsidiary after an acquisition cannot be a
liability at the acquisition date. For there to be a liability (and for a provision to be
recognised) there must have been a past obligating event. This can only be the case
if the subsidiary was already committed to the restructuring before the acquisition.
This means that the acquirer cannot recognise a provision for restructuring or
reorganisation at acquisition and then release it to profit and loss in order to
’smooth profits’ or reduce losses after the acquisition.
Example
Entity P acquired 100% of the shares of Entity S on 1 May at a cost of $700,000. The
statements of financial position of the entities at the acquisition date were as
follows:
Attheacquisitiondate
1May
P
S
$
$
Non‐currentassets:
Property,plantandequipment 500,000
350,000
InvestmentinS 700,000
‐
1,200,000
350,000
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Currentassets
Inventory 70,000
60,000
Othercurrentassets 130,000
110,000
1,400,000
520,000
Equity
Ordinaryshares 300,000
200,000
Sharepremium 200,000
100,000
Retainedearnings 580,000
170,000
1,080,000
470,000
Currentliabilities 320,000
50,000
1,400,000
520,000
The fair value of the subsidiary’s inventory at 1 May is estimated as $52,000.
The fair value of the non-current assets of the subsidiary at 1 May is estimated as
$420,000.
The directly attributable costs of the acquisition were $45,000 paid in cash. This
payment has not been included in the statement of financial position for P above.
(Note: If the payment had been included, the ‘other current assets’ of P would be
$45,000 lower and the cost of the investment in S would be $45,000 higher.)
P uses the partial goodwill method of accounting for non-controlling interests, so
that NCI is valued at a proportionate share of the fair value of the net assets in S.
The goodwill is calculated as follows:
$
Fairvalueofnetassets:
Non‐currentassets 420,000
Inventory 52,000
Othercurrentassets 110,000
Liabilities (50,000)
532,000
Considerationpaid 700,000
Goodwill
168,000
A consolidated statement of financial position as at the date of acquisition will be as
follows, after recording the acquisition costs of $45,000. These costs reduce the
current assets and the profits of the parent P.
Chapter 4: Group financial statements
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PGroup
ConsolidatedstatementoffinancialpositionasatthedateofacquisitionofS
$
Non‐currentassets:
Property,plantandequipment (500,000+420,000) 920,000
Goodwillatcost
168,000
Currentassets
Inventory (70,000+52,000) 122,000
Othercurrentassets (130,000+110,000–45,000) 195,000
1,405,000
Equity
Ordinaryshares(Ponly)
300,000
Sharepremium(Ponly)
200,000
Consolidatedretainedearnings (580,000–45,000) 535,000
1,035,000
Currentliabilities (320,000+50,000) 370,000
1,405,000
Note that the statement of financial position of the subsidiary S at the date of
acquisition is adjusted as follows, for the purpose of consolidation:
S
Adjustedstatementoffinancialpositionat1May
Non‐currentassets: $
Property,plantandequipment 420,000
Currentassets
Inventory 52,000
Othercurrentassets 110,000
582,000
Equity
Ordinaryshares 200,000
Sharepremium 100,000
Revaluationreserve(420,000–350,000)–seeNote1 70,000
Retainedearnings–seeNote2 162,000
532,000
Currentliabilities 50,000
582,000
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Notes
(1) A revaluation reserve is created for the revaluation of the non-current assets.
The retained earnings are adjusted downwards to allow for the downwards
revaluation of the inventory by $8,000.
(2) The retained earnings of the subsidiary after the fair value adjustments are
calculated as follows:
$
RetainedearningsintheaccountsofSasattheacquisitondate 170,000
Minusdownwardadjustmenttoinventoryvaluation(60,000–
52,000)
(8,000)
AdjustedretainedearningsofsubsidiaryS 162,000
3.2 Recognition of intangible assets at acquisition
Intangible assets should be recognised when a subsidiary is acquired, regardless of
whether or not they are recognised in the financial statements of the subsidiary
itself. If the intangible can be separately identified, it must be recognised as an asset
at acquisition, even if obtaining a reliable measure of its value is difficult.
The acquirer (parent company) is required to recognise intangibles such as brands,
licences and customer relationships. As a consequence of recognising such
intangibles:
The amount of purchased goodwill is smaller than it would be if the intangibles
had not been recognised.
After the acquisition, the intangibles that have been recognised are subject to
amortisation (whereas goodwill is not amortised and is only subject to
impairment).
For example if a company acquires a subsidiary which has a contractual agreement
with a major customer that has three years remaining, the value of the customer
relationship should be recognised as an intangible asset and amortised over the next
three years.
Guidelines on the implementation of IFRS 3 give some suggestions about what
types of intangible asset might be recognised in an acquisition, and provide five
broad categories of intangible:
Marketing-related intangible assets, such as the value of brand names, trade
marks, and internet domain names
Customer-related intangible assets, such as customer lists, a backlog of customer
orders, contracts with customers or relationships with non-contractual
customers
Artistic-related intangible assets, such as the value of films, photographs,
musical works and pictures owned by the acquiree
Contract-related intangible assets such as the value of licences, royalty rights,
lease agreements, construction permits, broadcasting rights and franchising
rights
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Technology-based intangible assets, such as patented technology, non-patented
technology, software and databases.
Example
H acquires S. At the acquisition date, S has a four-year agreement to supply regular
quantities of a product to a customer, C. Customer C has indicated that he is likely
to renew the agreement at the end of the four-year period.
In this situation, H should recognise the following intangibles on acquisition of S,
separately from goodwill:
(1) Existing four-year customer agreement
(2) Long-term customer relationship.
Example
H acquires S. At the acquisition date, S has a backlog of unfulfilled customer orders
amounting to three months of output and sales. 80% of the customers of S are
recurring and long-standing customers
In this situation, H should recognise the following intangibles on acquisition of S,
separately from goodwill:
(1) Backlog of current orders
(2) Long-term customer relationships.
Operating leases
IFRS 3 requires that if a subsidiary (acquiree) is the lessee for an operating lease, the
acquirer (parent) must recognise an intangible asset or a liability at acquisition, to
the extent that the terms of the lease are more favourable (intangible asset) or less
favourable (liability) than current market rates for similar operating leases.
3.3 Bargain purchases
Goodwill is not amortised. However, it is subject to an annual impairment test.
Occasionally, there may be ‘negative goodwill’, when the cost of the shares acquired
in the subsidiary is less than the parent’s share of the fair value of the net assets of
the subsidiary. The value of the goodwill is therefore a negative amount.
‘Negative goodwill’ is not described as such by IFRS 3. Instead, IFRS 3 refers to
‘bargain purchases’.
If the acquirer’s interest in the fair value of the acquired identifiable net assets
exceeds the cost of the investment in the subsidiary, this excess must be
recognised immediately as a gain in profit and loss, attributable to the
shareholders in the parent entity.
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Before an acquirer can conclude that there has been a bargain purchase and that
‘negative goodwill’ has arisen, however, it must re-assess:
− the identification and measurement of the assets, liabilities, and contingent
liabilities of the acquired subsidiary, and
− the measurement of the cost of the acquisition.
3.4 Measuring the cost of an acquisition (the consideration)
IFRS 3 states that the purchase consideration for an acquisition (business
combination) is the sum of:
the fair values, at the acquisition date, of the assets transferred by the acquirer,
such as cash
the liabilities incurred by the acquirer to the former owners of the acquiree
equity instruments issued by the acquirer in exchange for control of the acquiree.
The purchase consideration may include some deferred consideration.
When the acquirer issues shares as part of the purchase consideration and the shares
are quoted equity instruments, they are normally valued at their market price at the
acquisition date for the purpose of measuring the consideration/acquisition cost.
Costs directly attributable to the business combination include legal, accountancy
and similar fees. These must be expensed and do not form part of the purchase
consideration.
Deferred consideration
Sometimes all or part of the cost of an acquisition is deferred and does not become
payable until a later date.
The amount of any deferred consideration (the amount not payable immediately) is
discounted to its present value at the acquisition date.
Contingent consideration
Sometimes the final cost of the combination is contingent on (depends on) a future
event. For example, an acquirer could agree to pay an additional amount if the
acquired subsidiary’s profits exceed a certain level within three years of the
acquisition.
In a situation such as this, the contingent payment should be included in the cost of
the combination (discounted to present value if the payment will occur more than
12 months in the future).
Under the rules of the previous IFRS 3, contingent consideration was recognised as
part of the purchase consideration only if it was probable (more likely than not) that
the contingent consideration would actually have to be paid.