OVERVIEW
Objective
¾
To explain the accounting adjustments which must be made before consolidation can proceed.ADJUSTMENTS
GOODWILL ITEMS NOT
ACCOUNTED FOR
¾ Background
¾ Proposed dividends
¾ Partially recorded dividends ¾ Dividends paid out of
pre-acquisition profits
¾ Goodwill
¾ Bargain purchases
¾ Initial accounting determined provisionally
¾ Impairment of goodwill
REVALUATION IN THE ACCOUNTS
OF SUBSIDIARY GROUP ACCOUNTING
POLICY ADJUSTMENTS
¾ Definition
¾ Cost of acquisition
¾ Recognition
¾ Measurement
¾ Exceptions to recognition and measurement principles
¾ Fair values – general guidance
¾ Exam question complication
¾ How is the revaluation accounted for? ¾ Post acquisition changes in
other reserves
ACCOUNTING FOR GOODWILL
1
ADJUSTMENTS
¾
Consolidation problems are usually tackled in two stages:Stage 1 Process the individual company adjustments.
Stage 2 Do the consolidation.
¾
Stage 2 was introduced in the previous session.Commentary
With the exception of one or two further complications which for the most part are outside the scope of the syllabus that is all there is to the technique of consolidation.
¾
This session examines the adjustments which are necessary before consolidation can proceed. Once these adjustments are processed consolidations are rarely more complexthan the examples in the previous session.
2
ITEMS NOT ACCOUNTED FOR
2.1
Background
¾
The accounts as presented to be consolidated are often incomplete or incorrect. The approach is to start by correcting them.Commentary
This heading could encompass just about anything e.g. deferred tax, leases etc. A common example concerns proposed dividends.
2.2
Proposed dividends
¾
May be presented with draft statement of financial position of group companies and told that the companies have declared dividends before the year end but have not yetrecognised them in the financial statements.
¾
Need to consolidate final statement of financial position of individual companies after closing adjustments.Process adjustments to finalise individual statement of financial position before consolidating
¾
In books of proposing companyDr Equity (in SOCIE) X
¾
If the subsidiary is proposing the dividend, the parent will receive its share. This dividend now represents reserves-in-transit. The parent must record its dividend receivable.Dr Dividend receivable X
Cr Profit or loss X
with share of dividend receivable from the subsidiary.
¾
The dividend receivable and liability are inter-company balances and must be cancelled.¾
Consolidated statement of financial position will reflect in liabilities: Parent’s proposed dividends;
Non-controlling interest’s share of the subsidiary’s proposed dividends.
2.3
Partially recorded dividends
¾
You will not always need to record all the entries shown above. Some may already be recorded in the information given in a question.¾
Read the question carefully for directions e.g.: If the question states “the company has declared a dividend at the year end but has not yet recorded it”, no entries have been made in the information given.
If liabilities for proposed dividends are shown in the statement of financial position given, there is no need to record dividends in the paying company’s books.
If the question states that the parent does not record dividends until received, the parent’s statement of financial position must be adjusted for dividends due from the subsidiary.
2.4
Dividends paid out of pre-acquisition profits
¾
IAS 27 was amended in May 2008, the previous version required that any dividends paid by the subsidiary out of pre-acquisition profits should be deducted from the cost of investment, in the parent’s accounting records.¾
The amendment to IAS 27 has taken out the definition of the cost method of accounting. As a result of this amendment it now means that any dividends that are paid out of the subsidiary’s pre-acquisition profits will be included in the parent’s profit or loss and will not be deducted from the cost of investment.3
GROUP ACCOUNTING POLICY ADJUSTMENTS
¾
Such a requirement is rare in practice because a situation that required it would by definition be contrary to IFRS.¾
It might be needed in the cases of: Mid year acquisition – where the parent has not yet imposed its policies on the subsidiary; or
Where the subsidiary was foreign and was following local GAAP.
4
GOODWILL
4.1
Definition
¾
IFRS 3 defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised”.¾
In essence it is the difference between the cost of the acquisition and the acquirer’s interest in the fair value of its identifiable net assets as at the date of the exchange transaction.This is reflected in consolidation workings as:
$ Cost (the value of the part of the business owned) X Acquirer’s share of the fair value of the identifiable net assets
of the subsidiary as at the date of acquisition (X)
____
X
____
¾
As a result of the revisions to IFRS 3, issued in 2008, the non-controlling interests’ share of goodwill may be recognised as part of the acquisition process. The option to measure non-controlling interests is allowed on a transaction-by-transaction basis.¾
As a result of this change in the possible measurement of both goodwill and non-controlling interests IFRS 3 specifies the goodwill calculation as follows:$ Acquisition date fair value of the consideration transferred X Amount of any non-controlling interests in the entity acquired. X Less: Acquisition date amounts of identifiable assets acquired and liabilities assumed measured in accordance with IFRS 3. (X)
____
Goodwill X
Commentary
For exam purposes it would be expected that the examiner will indicate at what value the non-controlling interest is to be measured.
Illustration 1
Parent acquires 80% of Subsidiary for $120,000. The fair value of the controlling interests’ share in subsidiary is $28,000, whilst the value of non-controlling interests based upon the proportionate share of identifiable net assets acquired would give a value of $25,000. The fair value of the
subsidiary’s net assets on acquisition have been identified as $125,000. Goodwill can be calculated as either: (a) (b)
$ $
Cost of investment 120,000 120,000
Non-controlling interests ______ 28,000 ______ 25,000
148,000 145,000 Fair value of net assets acquired (125,000) ______ (125,000) ______
Goodwill ______ 23,000 ______ 20,000
If non-controlling interests are valued at fair value (a), then the value of goodwill and controlling interests will be higher to the extent of the non-controlling interests’ share of the fair value of the subsidiary.
¾
There are several issues to address: What is included in cost of acquisition? The meaning of the term “identifiability”. Calculation of the fair value.
Accounting for the revaluation in the accounts of the subsidiary. Accounting for the goodwill arising on consolidation.
4.2
Cost of acquisition — Fair value of purchase consideration
¾
An acquisition is accounted for at its cost. Cost is: Amount of cash or cash equivalents paid; and
The fair value of the other purchase consideration given.
Commentary
This is a change from the previous version of IFRS 3 which required directly
attributable costs to be included in the cost of investment. As a result of this change, the amount of goodwill recognised will be smaller.
4.2.1
Deferred consideration
¾
Deferred consideration – cost of the acquisition is the present value of the consideration, taking into account any premium or discount likely to be incurred in settlement (and not the nominal value of the payable).¾
If cash is to be paid sometime in the future, then the amount will need to be discounted to present value and that amount included as the fair value in the cost calculation.¾
The increase in present value, through the passage of time, will be a finance cost charged to profit or loss.Illustration 2
Parent acquired 60% of Subsidiary on 1 January 2007 for $100,000 cash payable immediately and $121,000 after 2 years. The fair value of Subsidiary’s net assets at acquisition amounted to $300,000. Parent’s cost of capital is 10%. The deferred consideration was completely ignored when preparing group
accounts as at 31 December 2007.
Required:
Calculate the goodwill arising on acquisition and show how the deferred consideration should be accounted for in Parent’s consolidated financial statements.
Solution
Cost of investment in Subsidiary at acquisition: $100,000 + $121,000/1.21 = $200,000
Goodwill $000
Cost 200
Share of net assets acquired (60% × 300,000) (180) ____
20 ____
Deferred consideration
Double entry at 1 January:
Dr Cost of Investment in Subsidiary $100,000
On 31 December, due to unwinding of discount, the deferred consideration will equal $121,000/1.1 = 110,000
Dr Group retained earnings $10,000
Cr Deferred consideration $10,000
¾
In the consolidated statement of financial position, the cost of investment in Subsidiary will be replaced by the goodwill of $20,000, the deferred consideration will equal $110,0004.2.2
Contingent consideration
¾
When a business combination agreement provides for an adjustment to the cost, contingent on future events, the acquirer includes the acquisition date fair value of the contingent consideration in the calculation of the consideration paid.¾
If the contingent settlement is to be in cash, then a liability will be recognised. and If settlement is to be through the issue of further equity instruments, then the credit entry will be to equity.¾
Any non-measurement period changes to the contingent consideration recognised will be accounted for in accordance with the relevant IFRS and will not impact upon the original calculation of goodwill.4.3
Recognition
4.3.1
Introduction
¾
The identifiable assets and liabilities acquired are recognised separately as at the date of acquisition (and therefore feature in the calculation of goodwill) .¾
This may mean that some assets, especially intangible assets, will be recognised in the consolidated statement of financial position that were not recognised in the subsidiary’s single entity statement of financial position.¾
Any future costs that the acquirer expects to incur in respect of plans to restructure the subsidiary must not be recognised as a provision at the acquisition date. They will be treated as a post-acquisition cost.Commentary
Such liabilities are not liabilities of the acquiree at the date of acquisition. Therefore they are not relevant in allocating the cost of acquisition.
4.3.2
Contingent liabilities of the acquiree
¾
IAS 37 Provisions, Contingent Liabilities and Contingent Assets does not require contingent liabilities to be recognised in the financial statements.¾
However, if a contingent liability of the subsidiary has arisen due to a present obligation that has not been recognised (because an outflow of economic benefits is not probable,) IFRS 3 requires this present obligation to be recognised in the consolidated financial statements as long as its fair value can be measured reliably4.4
Measurement
¾
All assets and liabilities of the subsidiary that are recognised in the consolidated statement of financial position are measured at their acquisition date fair values.¾
The non-controlling interests of the subsidiary are measured at either: the fair value; or
at the non-controlling interests’ proportionate share of the subsidiary’s identifiable net assets.
Commentary
The choice can be made for each acquisition, so a company does not have to be consistent in its measurement of non-controlling interests relating to separate acquisitions.
4.5
Exceptions to recognition and measurement principles
4.5.1
Exceptions to both recognition and measurement principles
¾
Deferred taxes are recognised and measured in accordance with IAS 12.¾
Employee benefits are recognised and measured in accordance with IAS 19.¾
Any indemnification assets, (e.g. a guarantee given by the seller against a future event or contingency), are recognised and measured using the same principles of recognition and measurement as for the item that is being indemnified.4.5.2
Exceptions to measurement principles
¾
A reacquired right, (i.e. a right to use an asset of the parent granted previously to the subsidiary), is recognised as an intangible asset and measured according to the remaining contractual term of the related contract.Commentary
¾
Any share based payment awards of the subsidiary that are to be replaced with share based payment awards of the parent are measured in accordance with IFRS 2.¾
Any non-current assets classed as held for sale are measured in accordance with IFRS 5.4.6
Fair values — general guidance
¾
Marketable securities – current market values.¾
Non-marketable securities – estimated values that take account of price earnings ratios,dividend yields and expected growth rates of comparable securities of entities with similar characteristics.
¾
Receivables – at the present values of the amounts to be received, determined atappropriate current interest rates, less allowances for uncollectibility and collection costs, if necessary.
Discounting is not required for short-term receivables when the difference between the nominal amount of the receivable and the discounted amount is not material.
¾
Inventories : finished goods and merchandise at selling price less:
−
costs of disposal; and−
a reasonable profit allowance for the acquirer’s selling effort (based on profit for similar items); work in progress at selling price of finished goods less:
−
costs to complete;−
costs of disposal; and−
a reasonable profit allowance for the completing and selling effort (based on profit for similar finished goods; and raw materials at current replacement costs.
¾
Land and buildings – at their current market value.¾
Plant and equipment – at market value normally determined by appraisal.Depreciated replacement cost may be used as a substitute where there is no evidence of market value (see IAS 16).
¾
Intangible assets – at fair value determined: by reference to an active market;
Commentary
The impact in the consolidated financial statements is that intangible assets will be
recognised that were not recognised in the subsidiary’s single entity accounts. Examples of intangible assets that may be recognised include:
¾
brands;¾
trademarks;¾
customer lists; and¾
production backlogs.Although IFRS 3 includes a long list of possible intangible assets that might be recognised in the consolidated statement of financial position, in practice the
process of identifying and measuring them would be extremely time consuming and costly.
¾
Defined benefit plans assets or liabilities at present value of the defined benefit obligationless the fair value of the plans assets.
¾
Tax assets and liabilities – at the amount of the tax benefit arising from tax losses or thetaxes payable in respect of the profit or loss, assessed from the perspective of the
combined entity or group resulting from the acquisition. The tax recognised will be after allowing for the effects of fair valuing the assets, liabilities and contingent liabilities of the acquiree. The amount recognised is not discounted.
¾
Accounts and notes payable – long-term debt, liabilities, accruals and other claims payableat the present values of amounts to be disbursed in meeting the liability determined at appropriate current interest rates.
Commentary
Discounting is not required for short-term liabilities when the difference between the nominal amount of the liability and the discounted amount is not material.
¾
Onerous contracts and other identifiable liabilities of the acquiree – at the present values ofamounts to be disbursed in meeting the obligation determined at appropriate current interest rates.
¾
Contingent Liabilities of the acquiree will be valued at the amounts third parties wouldcharge to take them over. The amount reflects all expectations about future cash flows.
5
ACCOUNTING FOR THE REVALUATION IN THE
ACCOUNTS OF SUBSIDIARIES
5.1
Exam question complication
¾
Revaluations may or may not have been reflected in the financial statements of the subsidiary at the date of acquisition. In an exam question it is likely that they will not have been. For a revaluation upwards create a revaluation reserve in net assets working (fair value less book value of net assets at acquisition) at acquisition and reporting date.
Commentary
May need to adjust post-acquisition depreciation to base on revalued amount.
For a revaluation downwards create a provision against retained earnings in net assets working (book value less fair value of net assets at acquisition) at acquisition and reporting date.
¾
Any goodwill in the subsidiary’s statement of financial position is not part ofidentifiable assets and liabilities acquired. If the subsidiary’s own statement of financial position at acquisition includes goodwill, this must be written off.
Reduce retained earnings at acquisition and reporting date by goodwill in the subsidiary’s statement of financial position at acquisition. Do this in the net assets working.
5.2
How is the revaluation accounted for?
¾
IFRS 3 refers to this as “allocation of the cost of acquisition”. IFRS 3 requires the whole revaluation to be reflected in the consolidated group accounts. The non-controlling interest balance will reflect their share of the revaluation.
Commentary
Example 1
As at 31 December 2007
Parent Subsidiary
$ $
Non-current assets:
Tangibles 1,800 1,000
Cost of investment in Subsidiary 1,000
Current assets 400 300
_____ _____ 3,200 1,300 _____ _____
Issued capital 100 100
Retained earnings 2,900 1,000
Current liabilities 200 200
_____ _____ 3,200 1,300 _____ _____
Further information:
Parent bought 80% of Subsidiary on the 31 December 2005.
At the date of acquisition Subsidiary’s retained earnings stood at $600 and the fair value of its net assets were 1,000. The revaluation was due to an asset that had a remaining useful economic life of 10 years as at the date of acquisition. Goodwill has been impaired by $40 since acquisition.
Required:
Solution
As at 31 December 2007
$ Non-current assets:
Goodwill Tangibles
Current assets _____
_____
Issued capital
Retained earnings
Non-controlling Interest
Current liabilities
_____ _____
WORKINGS
(1) Net assets summary
At consolidation At acquisition
$ $ $
Issued capital
Retained earnings As per the question
Extra depreciation ______
Fair value adjustments ______ ______
Net assets
(2) Goodwill
$ Cost
Share net assets acquired
______
______ Remaining as asset
Impaired to CRE
(3) Non-controlling interest
______
(4) Consolidated retained earnings
$ Parent
Share of Subsidiary
Goodwill ______
______
5.3
Post acquisition changes in subsidiary reserves
¾
Parent’s share of the subsidiary’s post acquisition retained earnings are included in the consolidated retained earnings.¾
If the group has a policy of regularly revaluing their assets then the parent’s share of the subsidiary’s post acquisition change in revaluation will be included in a consolidated revaluation reserve. The controlling interest’s share will be included in the non-controlling interest figure in the statement of financial position.6
ACCOUNTING FOR GOODWILL
6.1
Goodwill
¾
Goodwill reflects the future economic benefits arising from assets that are not capable of being identified individually or recognised separately.¾
It is initially measured at cost, being the excess of the cost of the acquisition over the acquirer’s interest in the fair value of the identifiable assets and liabilities acquired as at the date of the acquisition. It is recognised as an asset.¾
Subsequent to initial recognition goodwill is carried at cost less any accumulated impairment losses.¾
Goodwill is tested annually for impairment, any loss is expensed to profit or loss. Refer back to the session on IAS 36 Impairment of Assets for the accounting entries.Commentary
Prior to the issue of IFRS 3, goodwill was capitalised and amortised over its useful life.
6.2
Bargain purchases
¾
If on initial measurement the fair value of the acquiree’s net assets exceeds the cost of acquisition (excess), then the acquirer reassesses: the value of net assets acquired;
that all relevant assets and liabilities have been identified; and
that the cost of the combination has been correctly measured.
¾
If there still remains an excess after the reassessment then that excess is recognised immediately in profit or loss. This excess (gain) could have arisen due to: future costs not being reflected in the acquisition process;
measurement of items not at fair value, if required by another standard, such as deferred tax being undiscounted;
6.3
Initial accounting determined provisionally
6.3.1
Provisional accounting
¾
If accurate figures cannot be assigned to elements of the business combination then provisional values are assigned to those elements at the date of acquisition.¾
Any new information that becomes available, relating to acquisition date assets and liabilities, is retrospectively adjusted against the initial provisional amounts recognised as long as the information is known within the “measurement period”.6.3.2
Measurement period
¾
The measurement period is the period after the acquisition date during which the parent may adjust the provisional amounts recognised in respect of the acquisition of a subsidiary.¾
The measurement period cannot exceed one year after the acquisition date.6.3.3
Subsequent adjustments
¾
Any other adjustments are treated in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. An error in acquisition values is treated retrospectively.
Illustration 3
Parent acquires 80% of Subsidiary for $60,000. The subsidiary’s net assets at date of acquisition were $62,500. At the end of the first year goodwill has been impaired by $1,000.
In the year following acquisition, but within 12 months of the acquisition date, it was identified that the value of land was $2,500 greater than that recognised on acquisition. The value of goodwill at the end of year 2 was valued at $7,400. Year 1:
Cost of investment 60,000
Net assets on acquisition (62,500 × 80%) ______ 50,000
Goodwill ______ 10,000
Goodwill charge to profit or loss 1,000
Year 2:
Cost of investment 60,000
Net assets on acquisition (65,000 × 80%) ______ 52,000
Goodwill on acquisition 8,000
Goodwill at year end ______ 7,400
Goodwill charge to profit or loss ______ 600
Journal
Dr Land 2,500
Dr Profit or loss (goodwill) 600
Cr Goodwill (9,000 – 7,400) 1,600
Cr Non-controlling interest (2,500 × 20%) 500
Cr Opening retained earnings 1,000
6.4
Impairment of goodwill
6.4.1
General
¾
Goodwill on acquisition must be allocated to a cash generating unit (CGU) that benefits from the acquisition. A CGU need not necessarily be a unit of the subsidiary acquired, it could be a unit of the parent or another subsidiary in the group.¾
The unit must be at least that of an operating segment as defined by IFRS 8 OperatingSegments.
¾
Each CGU must be tested annually for impairment. The test must be carried out at the same time each year, but does not have to be carried out at the year end.6.4.2
Partially owned subsidiary
¾
Any goodwill in a partially owned subsidiary must be grossed up to include the minority share of goodwill for the purposes of the impairment test.¾
Any impairment will firstly be allocated against this grossed up goodwill figure.¾
Any impairment in excess of this grossed up goodwill will then be allocated against the remaining assets of the CGU on a pro-rata basis.Illustration 4
Parent acquires 75% of Subsidiary. The carrying value of the subsidiary’s net assets on 30 June 2008 was $1,800, this included $300 of goodwill. The
recoverable amount of the subsidiary on the same day was $1,640. Impairment:
Goodwill grossed up (300 × 100/75) 400
Other net assets ______ 1,500
1,900
Recoverable amount 1,640
______
Impairment 260
______
7
CONSOLIDATED WORKINGS
(1) Establish group structure W1(2) Process individual company adjustments
do the double entry on the face of the question (as far as possible) (3) Net assets summary W2
one for each subsidiary
aim is to show the net assets position at two points in time.
At reporting At
date acquisition
Issued capital X X
Retained earnings
per Q X X
Adjustments (X) (X)
______ ______
X X
Fair value
difference X X
______ ______
X X
______ ______
NON-CONTROLLING GOODWILL
INTEREST
×% × Net asset at reporting date Cost X
Share net assets acquired x% × Net assets at
CONSOLIDATED RETAINED EARNINGS acquisition (X)
_____
¾ All of Parent X
per Q X _____
Adjustments (X)
_____
X
× x% ¾ Subsidiary share of post
acquisition profits
¾ Goodwill adjustment (X)
_____
FOCUS
You should now be able to:
¾
explain why it is necessary to use fair values for the consideration for an investment in a subsidiary together with the fair values of a subsidiary’s identifiable assets andliabilities when preparing consolidated financial statements;
¾
describe and apply the required accounting treatment of consolidated goodwill;¾
account for the effects of fair value adjustments to: depreciating and non-depreciating non-current assets; inventory;
monetary liabilities;
assets and liabilities not included in the subsidiary’s own statement of financial position, including contingent liabilities;
¾
indicate why the value of purchase consideration for an investment may be less than the value of the acquired identifiable net assets and how the difference should be accounted for;¾
account for goodwill impairment;EXAMPLE SOLUTION
Solution 1
As at 31 December 2007
$ Non-current assets:
Goodwill 160
Tangibles
(1,800 + (1,000 + 300 − [2/10 × 300])) 3,040
(Current assets (400 + 300) 700
_____ 3,900 _____
Issued capital 100
Retained earnings 3,132
Non-controlling Interest 268
Current liabilities (200+200) _____ 400
3,900 _____
WORKINGS
(1) Net assets summary
At consolidation At acquisition
$ $ $
Issued capital 100 100
Retained earnings
As per the question 1,000 600
Extra depreciation (60) 940 ______
Fair value adjustments 300 300
______ ______
(2) Goodwill
$
Cost 1,000
Share net assets acquired
80% × 1,000 ______ (800)
200 ______ Recognise as asset 160
Impaired 40
(3) Non-controlling interest
20% × 1,340 $268
______
(4) Consolidated retained earnings
$
Parent 2,900
Share of Subsidiary
80% (940 – 600) 272
Goodwill (40)
