Consolidation III

Consolidation –III
The consolidated statement of

financial position –
Complication of acquisition
Advanced Accounting Problems.
SEPTEMBER 20, 2017

PROF WAQAR HASSAN RANDHAWA
Hailey College Of commerce
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Hailey College Of Commerce
Advanced Accounting Problems – Consolidation III
POSSIBLE COMPLICATIONS: BEFORE CONSOLIDATION
Acquisition-related costs
Acquisition-related costs are costs the acquirer incurs to effect a business

combination. They include advisory, legal, accounting, valuation and other
professional or consulting fees. These costs are not capitalised as part of the cost of
acquisition but expensed in the periods in which they are incurred. (This is different
rule to that which applies to the purchase of property, plant and equipment or
intangibles). A question may incorrectly capitalise the costs. You would have to
correct this before consolidating.
Acquired intangible assets
A question might provide information about an unrecognised asset of the subsidiary.

You would have to include the asset in the subsidiary’s financial statements before
consolidating them.
Reason
Goodwill is recognised by the acquirer as an asset from the acquisition date.

It is initially measured as the difference between:
■ The cost of the acquisition plus the non-controlling interest; and
■ The net of the acquisition date amounts of identifiable assets acquired and
liabilities assumed (measured in accordance with IFRS 3).
When a company acquires a subsidiary, it may identify intangible assets of the

acquired subsidiary, which are not included in the subsidiary’s statement of financial
position. If these assets are separately identifiable and can be measured reliably, they
should be included in the consolidated statement of financial position as intangible
assets, and accounted for as such. This can result in the recognition of assets and
liabilities not previously recognized by the acquiree.
Example:
Course Instructor
Waqar Hassan Randhawa
ACA (ICAEW) FCCA (UK) PMP.
waqarhrandhawa@gmail.com
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P bought 80% of S 2 years ago. At the date of acquisition S’s retained earnings stood
at Rs. 600,000. The fair value of its net assets was not materially different from the
book value except for the fact that it had a brand which was not recognised in S’s
accounts. This had a fair value of 100,000 at this date and an estimated useful life of
20 years. The statements of financial position P and S as at 31 December 20X1 were
as follows:
A consolidated statement of financial position as at 31 December 20X1 can be

prepared as follows:
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Fair value exercise at acquisition
A question might provide information about the fair value of a subsidiary’s assets
at the date of acquisition. You might have to revalue the assets in the subsidiary’s
financial statements before consolidating them. Reason Goodwill is recognised by the
acquirer as an asset from the acquisition date.
It is initially measured as the difference between:

■ The cost of the acquisition plus the non-controlling interest; and
■ The net of the acquisition date amounts of identifiable assets acquired and liabilities
assumed (measured in accordance with IFRS 3).
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IFRS 3 requires that most assets and liabilities be measured at their fair value.
Definition: Fair value

Fair value: The price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date.
In every example so far it has been assumed that the fair value of the assets and
liabilities of the subsidiary were the same as their book value as at the date of
acquisition. In practice this will not be the case. In other cases a question will include
information about the fair value of an asset or assets as at the date of acquisition.
The net assets of a newly acquired business are subject to a fair valuation exercise.
Where the subsidiary has not reflected fair values at acquisition in its accounts, this
must be done before consolidating. Note that this is almost always the case
Revaluation upwards
The asset is revalued in the consolidation working papers (not in the general ledger of
the subsidiary). The other side of the entry is taken to a fair value reserve as at the
date of acquisition. This will appear in the net assets working and therefore become
part of the goodwill calculation.
The reserve is also included in the net assets working at the reporting date if the
asset is still owned by the subsidiary. If a depreciable asset is revalued the post-
acquisition depreciation must be adjusted to take account of the change in the value
of the asset being depreciated.
Revaluation downwards
Write off the amount to retained earnings in the net assets working (book value
less fair value of net assets at acquisition) at acquisition and at the reporting date
if the asset is still owned.
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Example:
at Rs. 600,000 and the fair value of its net assets were Rs. 1,000,000. This was Rs.
300,000 above the book value of the net assets at this date. The revaluation was due
to an asset that had a remaining useful economic life of 10 years as at the date of
acquisition. The statements of financial position P and S as at 31 December 20X1
were as follows:
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Prepared as follows:
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Explanation of extra depreciation
If a depreciable asset is revalued (which is usually the case) the post-acquisition

depreciation must be adjusted to take account of the change in the value of the asset
being depreciated.
In this example, two years ago the subsidiary had an asset which had a fair value
Rs.300,000 greater than its book value. This valuation was not recorded in the
financial statements of the subsidiary so the subsidiary’s figures need to be
retrospectively adjusted, for the purposes of consolidation, at each year end
.Depreciation of an asset is based on its carrying amount. Depreciation of an asset
increases when it is revalued. Therefore, the extra depreciation necessary as a result of
the fair value adjustment is Rs. 30,000 per annum (Rs. 300,000/10 years). The
acquisition was 2 years ago so extra depreciation of Rs. 60,000 (Rs. 30,000 × 2 years)
must be recognised retrospectively.
POSSIBLE COMPLICATIONS: DURING CONSOLIDATION
Mid-year acquisitions
Goodwill is measured at the date of acquisition of the subsidiary. H may not acquire S
at the start or end of a year. If S is acquired mid-year, it is necessary to calculate the
net assets at date of acquisition in order to calculate goodwill, non-controlling interest
and consolidated retained earnings. This usually involves calculating the subsidiary’s
retained earnings at the date of acquisition. The profits of the subsidiary are assumed
to accrue evenly over time unless there is information to the contrary.
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Example:
P bought 70% of S on 31st March this year. S’s profit for the year was Rs. 12,000
The statements of financial position P and S as at 31 December 20X1 were as follows:

Prepared as follows:
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Types of intra-group transaction
In many groups, business and financial transactions take place between entities within
the group. These ‘intra-group’ transactions might be:
■ The sale of goods or services between the parent and a subsidiary, or between two
subsidiaries in the group
■ transfers of non-current assets between the parent and a subsidiary, or between two
subsidiaries in the group
■The payment of dividends by a subsidiary to the parent (or by one subsidiary to

another subsidiary)
■ loans by one entity in the group to another, and the payment of interest on
intra-group loans.
The need to eliminate intra-group transactions on consolidation
Intra-group transactions should be eliminated on consolidation. In other words, the

effects of intra-group transactions must be removed from the financial statements on
consolidation.
The purpose of consolidated accounts is to show the financial position and the
financial performance of the group as a whole, as if it is a single operating unit. If
intra-group transactions are included in the consolidated financial statements, the
statements will show too many assets, liabilities, income and expenses for the group as
a single operating unit.
The consolidated financial statements represent the financial position and

performance of a group of companies as if they are a single economic entity. A single
economic entity cannot owe itself money!
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IFRS 10 therefore requires that:
■ Intra-group balances and transactions, including income, expenses and Dividends,

must be eliminated in full.
■ Profits or losses resulting from intra-group transactions that are recognized

in inventory or non-current assets must be eliminated in full.
The above adjustment is simply a cancellation of the inter-company receivable in one

group member’s statement of financial position against the inter-company payable in
another group member’s statement of financial position.
Items 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 convention followed is to follow the item
through to its ultimate destination and adjust the books of the ultimate recipient.
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Unrealised profit – Inventory
Inter-company balances are cancelled on consolidation. The main reason for these
arising is intercompany (or intra group) trading. The other example you will come
across is inter-company transfers of non-current assets.
If a member of a group sells inventory to another member of the group and that
Inventory is still held by the buying company at the yearend:
■ The Company that made the sale will show profit in its own accounts.
■ This is fine from the individual company viewpoint but the profit has not been
realized by the group.
■ The Company that made the purchase will record the inventory at cost to itself.
■ This is fine from the individual company view but consolidation of this value will
result in the inclusion in the financial statements of a figure which is not at cost to the
group.
IFRS 10 requires that the unrealized profit be removed in full from the closing
inventory valuation. It gives no further guidance on how this should be done.
This is an inventory valuation adjustment and can be processed in the consolidated

financial statements
There is a complication to think about. If S is the selling company the purpose of the
above adjustment is to reduce the profit of the subsidiary because there is unrealised
profit on the inter-company transaction and reduce the inventory held
by P as it is not at cost to the group.
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If the profit of the subsidiary is being reduced then NCI should share in that
Reduction. This implies a second journal as follows:
The two journals can be combined as follows to produce a composite adjustment

in questions which only require the preparation of the statement of financial position.
Example:
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at Rs. 1,600 During the year S sold goods to H for Rs. 20,000 which gave S a profit of
Rs. 8,000. H still held 40% of these goods at the year end. The statements of financial
position P and S as at 31 December 20X1 were as follows:
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Unrealised profit – Transfers of non-current assets

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One member of a group may sell a non-current asset to another member of the
group. The company making the sale will recognise a profit or loss on disposal. The
company buying the asset will include the asset at purchase cost in its own accounts
and depreciation will be based on that amount. This cost will be different to cost to
the group.
As far as the group is concerned no transfer has occurred. The group accounts
must reflect non-current assets at the amount they would have been stated at
had the transfer not been made.
Summary of adjustments:
■ Remove profit from the financial statements of the company that made the sale;
and
■ Correct the depreciation charge in the financial statements of the company that
made the purchase.
These two adjustments establish the transferred asset at its cost less accumulated
depreciation to the group. The double entry is shared to the NCI as appropriate in the
consolidated statement of financial position.
■ If the sale was to S the NCI would share the depreciation adjustment.
■ If the sale was from S to H the NCI would share the profit adjustment.
This is best seen with an illustration.
Example:
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H owns 80% of S. There was a transfer of an asset within the group for Rs. 15,000 on
1 January 20X3. The original cost to H was Rs. 20,000 and the accumulated
depreciation at the date of transfer was Rs. 8,000. Both companies depreciate such
assets at 20% per year on cost to the company, recognising a full year’s depreciation in
the year of purchase and none in the year of sale.
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POSSIBLE COMPLICATIONS: AFTER CONSOLIDATION

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Accounting for goodwill
Goodwill is carried as an asset. It is not depreciated or amortised but instead it is

subject to an annual impairment review. This means that the recoverable amount of
goodwill must be estimated on an annual basis. If the recoverable amount is less than
the carrying amount, the goodwill is written down to the recoverable amount. The
amount of the impairment is included as a charge against profit in the consolidated
statement of comprehensive income.
Example:
P acquired 80% of S when the retained earnings of S were Rs. 20,000. The values for
assets and liabilities in the statement of financial position for S represent fair values.
A review of goodwill at 31 December 20X1 found that goodwill had been impaired,
and was now valued at Rs. 55,000. The statements of financial position of a parent
company P and its subsidiary S at 31 December 20X1 are as follows:
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Negative goodwill and bargain purchases

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A bargain purchase is a business combination in which the calculation of goodwill

leads to a negative figure. When this happens the acquirer must then review the
procedures used to measure the amounts recognised at the acquisition date for all of
the following:
■ The identifiable assets acquired and liabilities assumed;

■ The non-controlling interest in the acquiree (if any); and
■ the consideration transferred.
Any amount remaining after applying the above requirements is recognised as a gain
in profit or loss on the acquisition date. This means that in most cases when a bargain
purchase occurs, the ‘negative goodwill’ should be added to the consolidated profit
for the group for the year.
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Consolidation III

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Consolidation –III

The consolidated statement of

SEPTEMBER 20, 2017

POSSIBLE COMPLICATIONS: BEFORE CONSOLIDATION

Acquisition-related costs are costs the acquirer incurs to effect a business

Acquired intangible assets

A question might provide information about an unrecognised asset of the subsidiary.

Goodwill is recognised by the acquirer as an asset from the acquisition date.

■ The cost of the acquisition plus the non-controlling interest; and

When a company acquires a subsidiary, it may identify intangible assets of the

A consolidated statement of financial position as at 31 December 20X1 can be

Fair value exercise at acquisition

It is initially measured as the difference between:

Definition: Fair value

A consolidated statement of financial position as at 31 December 20X1 can be

Explanation of extra depreciation

If a depreciable asset is revalued (which is usually the case) the post-acquisition

POSSIBLE COMPLICATIONS: DURING CONSOLIDATION

A consolidated statement of financial position as at 31 December 20X1 can be

Types of intra-group transaction

■The payment of dividends by a subsidiary to the parent (or by one subsidiary to

The need to eliminate intra-group transactions on consolidation

Intra-group transactions should be eliminated on consolidation. In other words, the

The consolidated financial statements represent the financial position and

IFRS 10 therefore requires that:

■ Intra-group balances and transactions, including income, expenses and Dividends,

■ Profits or losses resulting from intra-group transactions that are recognized

The above adjustment is simply a cancellation of the inter-company receivable in one

Unrealised profit – Inventory

This is an inventory valuation adjustment and can be processed in the consolidated

The two journals can be combined as follows to produce a composite adjustment

Unrealised profit – Transfers of non-current assets

This is best seen with an illustration.

POSSIBLE COMPLICATIONS: AFTER CONSOLIDATION

Accounting for goodwill

Goodwill is carried as an asset. It is not depreciated or amortised but instead it is

Negative goodwill and bargain purchases

A bargain purchase is a business combination in which the calculation of goodwill

■ The identifiable assets acquired and liabilities assumed;

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