Slide 22.1 Accounting for Groups at the Date of Acquisition Chapter 22.

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Accounting forGroups at the Date of Acquisition

Chapter 22

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The main purpose of this chapter is to explain the reasons for preparing consolidated financial statements at the date of acquisition and to show how to prepare such statements.

Main purpose

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By the end of this chapter, you should be able to:• explain the need for consolidated financial statements;• define the meaning of IFRS 10 terms ‘control’ and

‘subsidiary’;• prepare consolidated accounts at the date of acquisition

and calculate goodwill for a wholly-owned subsidiary;• explain the treatment of goodwill;• account for non-controlling interests under the two

options available in IFRS 3;• understand the need for fair value adjustments and

prepare consolidated financial statements reflecting such adjustments.

Objectives

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Accounting for groups atdate of acquisition

• Definition of a group under IFRS 10• Definition of control:

– rights to variable returns

– ability to affect those returns

– through power over the investee• Reasons for preparing consolidated accounts.

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Definition of a group

• One enterprise controls another enterprise

– Directly

– Indirectly.

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Control considerations

Control assumed if > 50% of voting rightsControl may exist where < 50%.

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Control may exist where < 50%voting rightsAgreement with other investors gives power

over > 50%Power over financial and operating policies

by an agreementPower to appoint or remove majority of board

membersPower to cast the majority of votes at a board

meeting.

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Reasons for preparingconsolidated accountsBecause many corporations have controlling

interests in other business entities, financial statements for the parent company alone can be misleading. For this reason, parent companies are legally required to prepare consolidated financial statements that include data about the financial performance of subsidiaries

Prevent manipulation Inflating sales by selling within the group More meaningful EPS figure Better measurement of management performance using

ROCE.

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Alternative methods of preparing consolidated accountsThe purchase method

Fair value of parent company’s investment Fair value of identifiable net assets in subsidiary Difference is goodwill

Pooling of interests method No longer permitted under IFRS 3.

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Purchase method illustrated – the Rose group

1 January 20X0

Rose plc acquired 100% of 10,000 £1 common shares in Tulip plc for £1.50 per share.

In calculating the cost of the resources acquired, remember the accounting equation,

A = L + E,

Or A – L = E, where A - L = net assets

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The Rose group statement of financial position on acquisition

Rose has bought the Equity in Tulip, which is represented by Tulip’s net assets.

Tulip’s equity is £14,000, and the amount paid was 10,000 x £1.50 = £15,000

£ £ £

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The Rose group statement of financial position on acquisition (Continued)

££

£

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The Rose group statement of financial position on acquisition (Continued)

Why do you think the share capital and retained earnings of Tulip are not added to the balance sheet of the group (combined companies)?

Answer: The value of the equity has already been included in the

value of the assets and liabilities acquired.

£

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Treatment of goodwillPositive goodwill

Impairment test in accordance with IAS 36 Must be done yearly Once applied, it cannot be reversed in a subsequent

accounting period

Negative goodwill Recognise immediately in Income Statement under IFRS

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Why does negative goodwill occur?Errors in measuring fair values of acquired companyRecognition of future costs to be incurredPurchased at a bargain price

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Non-controlling interests

Share of acquired company not held (owned) by parent Non-controlling – also called “minority interest”

All assets and liabilities controlled are included in the consolidated accounts Non-controlling interest = amount not owned by parent.

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Non-controlling interest in consolidated statement of financial position

Method 1Share of net assets of subsidiary at reporting date

Method 2Share of net assets of subsidiary PLUS goodwill

apportioned to the non-controlling interest.

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The Bird group

1 January 20X0

Bird acquired 80% of 10,000 £1 common shares in Flower for £1.50 per share.

Therefore, Bird will own 80% of 10,000 shares = 8,000 shares, which represent 80% of Flower’s equity.

The cost of these shares is:

8,000 x £1.50 = £12,000

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Bird group – statement of financial position on acquisition

£ £ £

Non-controlling interest

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Bird group – statement of financial position on acquisition (Continued)

££

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Bird group – statement of financial position on acquisition (Continued)

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Non-controlling interest using method 2If using Method 2 to measure the non-controlling

interest, we need to know the fair value of the non-controlling interest in the subsidiary at the date of acquisition. Let us assume in this case that this fair value is £2,900

Goodwill that is attributed to the non-controlling interest is as follows:

£

Fair value of non-controlling interest at date of acquisition

20% (the share attributable to the non-controlling interest) of the net assets at the date of acquisition (£14,000)

Attributable goodwill 100

(2,800)

2,900

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The consolidated statement of financial position using method 2

£

Non-current assets other than goodwill 31,000

Goodwill (£800 + £100) 900

Net current assets 14,000

45,900

Share capital 16,000

Retained earnings 27,000

Non-controlling interest (£2,800 + £100) 2,900

45,900

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Treatment fair value andbook value differ (IFRS 3)Assume Flower’s non-current assets were

Book value £11,000 Fair value £11,600

Recognise parent’s % 80% of (11,600 − 11,000) = 480 Increase non-current assets Reduce goodwill.

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Fair value and book value differ (Continued)

£ £ £

Non-controlling interest

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££

Fair value and book value differ (Continued)

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How to calculate fair values – IFRS 3

Tangible assets Fair Value based on market value Depreciated replacement cost if no market value

available

Intangible assets Fair Value based on market value Best arm’s-length estimate if no market value.

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How to calculate fair values – IFRS 3 (Continued)InventoriesFinished goods

Selling price less cost of sale and reasonable profit

Work-in-progress Selling price less cost to complete, cost of sale and

reasonable profit

Raw materials Current replacement cost.

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Monetary assets and liabilities Amount to be received or disbursed Discounted if significant

Marketable securities Current market values

Non-marketable securities Estimated value based on performance.

How to calculate fair values – IFRS 3 (Continued)

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IFRS 13

Fair Value Measurementprice in an orderly transactionbetween market participants.

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1. Explain how negative goodwill may arise and its accounting treatment.

2. Explain how the fair value is calculated for:• Tangible non-current assets• Inventories• Monetary assets.

3. Explain why only the net assets of the subsidiary and not those of the parent are adjusted to fair value at the date of acquisition for the purpose of consolidated accounts.

Review questions

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4. Coil SA/NV is a company incorporated under the laws of Belgium. Its accounts are IAS compliant. It states in its 2003 accounts (in accordance with IAS 27, para. 13):

Principles of consolidation

The consolidated Financial statements include all subsidiaries which are controlled by the Parent Company, unless such control is assumed to be temporary or due to long-term restrictions significantly impairing a subsidiary’s ability to transfer funds to the Parent Company.

Required: Discuss whether these are acceptable reasons for excluding a subsidiary from the consolidated financial statements under the revised IAS 27.

Review questions (Continued)

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Review questions (Continued)

6. Parent plc acquired Son plc at the beginning of the year. At the end of the year there were intangible asset reported in the Consolidated accounts for the value of a domain name and customer lists. These assets did not appear in either the Parent or Son’s Statements of Financial Position.

Required: Discuss why assets only appear in the consolidated accounts.

Slide 22.1 Accounting for Groups at the Date of Acquisition Chapter 22.

Documents

Transcript of Slide 22.1 Accounting for Groups at the Date of Acquisition Chapter 22.