Advanced Financial
Accounting: Chapter 3
Group Reporting II: Application of
the Acquisition Method under
IFRS 3
Tan & Lee Chapter 3
© 2009
1
Learning Objectives
1.
2.
3.
4.
5.
6.
7.
8.
9.
Understand the difference between investor’s separate financial
statements and the consolidated statements;
Understand the consolidation process;
Appreciate the acquisition method and its implications;
Know how to determine the cost of consideration transferred;
Understand the identification of the acquirer;
Know how to recognize and measure identifiable net assets under
IFRS 3;
Understand the nature of goodwill;
Review the concept of non-controlling interests (NCI) with respect
to parent and entity theories; and
Know how to prepare consolidation journal entries relating to fair
value adjustment at acquisition date and subsequent years
Tan & Lee Chapter 3
© 2009
2
Content
1.
Introduction
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
3
Separate Vs Consolidated Financial
Statements
Separate financial
statements
(Legal entity)
Income recognition
Asset recognition
Tan & Lee Chapter 3
Consolidated financial
statements
(Economic entity)
Dividends
Share of profits
Investment in a
Subsidiary carried at:
• Cost (IAS 27) or
• As a financial
instrument (IAS 39)
Investment in Subsidiary:
• Investment is eliminated
and subsidiary’s net assets
are added to the parent (IAS
27)
Investment in an
associate carried at:
• Cost (IAS 28) or
• As a financial
instrument (IAS 39)
Investment in an associate:
• Equity method (IAS 28)
© 2009
4
Content
1.
Introduction
2.
Overview of
of the
the consolidation
consolidation process
process
Overview
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
5
Consolidation Process
Legal entities
Parent’s
Financial
Statements
+
Subsidiaries'
Financial
Statements
Economic entity
+/-
Consolidation adjustments
and eliminations
=
Consolidated
financial
statements
• Consolidation is the process of preparing and presenting the
financial statements of a group as an economic entity
• No ledgers for group entity
• Consolidation worksheets are prepared to:
– Combine parent and subsidiaries financial statements
– Adjust or eliminate intra-group transactions and balances
– Allocate profit to non-controlling interests
Tan & Lee Chapter 3
© 2009
6
Intragroup Transactions
• Intragroup transactions are eliminated to:
– Show the financial position, performance and cashflow of the economic (not
legal) entity
– Avoid double counting of transactions
Example:
• Parent sold inventory to subsidiary for $2M
• The original cost of inventory is $1M
• Subsidiary eventually sold the inventory to external parties for $3M
Q: What is the journal entry to eliminate intragroup sales transaction?
Consolidation adjustment
Dr
Sale
Cr
Cost of sale
Tan & Lee Chapter 3
2,000,000
2,000,000
© 2009
7
Intragroup Transactions
Extract of consolidation worksheet
Parent's
Income
Statement
Subsidiary’s
Income
Statement
Sales
$2,000,000
$3,000,000
Cost of
sales
(1,000,000)
(2,000,000)
Gross
profit
$1,000,000
$1,000,000
Consolidation
elimination entries
and adjustments
Dr
Cr
2,000,000
2,000,000
Consol.
Income
Statement
Without
elimination
$3,000,000
$5,000,000
(1,000,000)
($3,000,000)
$2,000,000
$2,000,000
Note: Without elimination the consolidated sales and cost of sales figures
will be overstated by $2 M.
Tan & Lee Chapter 3
© 2009
8
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition
acquisition method
method
The
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
9
Business Combinations 結合
Business
combinations
Where an acquirer
obtains control of
one or more
businesses (IFRS 3
App A)
Examples: IFRS 3 App B:B6
Legal merger
of net assets
of acquired
businesses into
acquirer’s books
Tan & Lee Chapter 3
Businesses
become
subsidiaries of
acquirer
© 2009
Net assets
of combining
entities transferred
to a newly-formed
entity
Former
owners of a
combining entity
obtains control
of combined entity
10
The Acquisition Method
• IFRS 3 requires all business combinations to be accounted for using
the acquisition method
4-step
• The procedures:
approach:
Identify the acquirer
IFRS 3:5
Determine the acquisition date
Group
financial
statements
if acquire
subsidiaries
Recognize and measure the identifiable assets acquired
the liabilities assumed and any non-controlling
interest in the acquiree; and
Tan & Lee Chapter 3
Recognize and measure goodwill or
a gain from a bargain purchase
© 2009
11
Identify the Acquirer
• IFRS 3 requires the identification of the acquirer in all circumstances
– Acquirer is the entity that obtains control of another combining entities
– Control is the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities
Tan & Lee Chapter 3
© 2009
12
Identify the Acquirer
Additional control criteria under IFRS 3 Appendix B
Based on consideration
transferred
Acquirer is the entity that:
Based on entity size
Acquirer is the entity that:
Based on dominance
Acquirer is the entity:
• Transfers cash or other
assets or incurs liabilities to
acquire another entity
• Has the largest relative
voting rights in a combined
entity
• Whose owners have the
ability to elect, appoint or
remove a majority of
directors
 Issues shares as purchase
consideration
• Holds the largest minority
voting interest in the
combined entity (if no other
entity has significant voting
interest)
• Whose management is
dominant in the combined
entity
 Pays a premium over the
fair value of the equity
interest
Tan & Lee Chapter 3
• Is relatively larger in size
© 2009
•Who initiates the business
combination
13
Identify the Acquirer
• Reverse acquisition
– Legal parent is the acquiree and legal subsidiary is the acquirer
– Often initiated by the legal subsidiary
– Has other motive of entering into such an arrangement (eg. Backdoor
listing)
• Exchange of shares in a reverse acquisition
1. Company A (Legal parent) takes
over shares of Company B from
owners
Company A
(Legal parent)
2. Company A issues own shares
to owners of Company B as
purchase consideration
3. Company B has the power to govern
the financial and operating policies of the
legal parent
Tan & Lee Chapter 3
Owners of Company B
(Legal subsidiary)
© 2009
Company B
(Legal subsidiary)
14
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the
the amount
amount of
of consideration
consideration transferred
transferred
Determining
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
15
Determine the Amount of Consideration
Transferred
Consideration
transferred
=
Fair value
of assets
transferred
+
Fair value
of liabilities
incurred
+
Fair value of
equity
interests
issued by
acquirer
+
Fair value of
contingent
consideration
• Fair value of the consideration transferred:
– Determined on the acquisition date
– Acquisition date is the date when the acquirer obtains control and not
the date when consideration is transferred
Tan & Lee Chapter 3
© 2009
16
Fair Value of Assets Transferred
or Liabilities Assumed
• If assets transferred or liabilities assumed are not carried at fair
value in the acquirer’s separate financial statements:
– Remeasured gain or loss is recognized in the acquirer’s separate
financial statements
– Remeasured gain or loss is not recognized if the assets or liabilities
remain in the combined entity’s financial statements
• If transfer of monetary assets or liabilities are deferred:
– The fair value will be the present value of the future cashflows
– Eg. Future cash settlement of $1,000,000 is due 3 years later and 3%
interest is levied
Fair value = $1,000,000/ (1+0.03)^3
= $915,142
Tan & Lee Chapter 3
© 2009
17
Fair value of Equity Interests Issued
by the Acquirer
• Fair value of equity interests issued is measured by:
– Market price
– If market price is not available or not reliable:
• A proportion of acquirer’s fair value or proxied by the fair value of
equity interest acquired, whichever is more reliably measurable
Tan & Lee Chapter 3
© 2009
18
Illustration 1:
Fair Value of Equity Issued
P Ltd acquires 100% of S Co through an issue of 5,000,000 shares
to the vendors of S Co.
P Ltd
Number of existing shares
Number of new shares issued
Market price per share
Fair value of equity
Tan & Lee Chapter 3
© 2009
S Co
10,000,000
2,000,000
5,000,000
-
$2.00
-
$24,000,000
$9,000,000
19
Illustration 1:
Fair Value of Equity Issued
Q1: P Ltd’s market price is a reliable indicator
Consideration transferred = 5,000,000 shares x $ 2.00
= $10,000,000
Q2: P Ltd’s market price is not a reliable indicator; a proportional
interest in the fair value of P Ltd is a better estimate
Consideration transferred = (5,000,000/15,000,000) x $24,000,000
= $8,000,000
Q3: Fair value of S Co is a better estimate
Consideration transferred = $9,000,000
Tan & Lee Chapter 3
© 2009
20
Fair Value of Contingent Consideration
• Contingent consideration
– Obligation (right) of the acquirer to transfer (receive) additional assets or
equity interests to (from) acquiree’s former owner if specific event
occurs
• Eg. Acquirer gets a refund of a part of the consideration transferred if the
acquiree does not achieve the target profit
– Fair value of the contingent consideration (refund) is added to (deducted
from) consideration transferred
Tan & Lee Chapter 3
© 2009
21
Acquisition-Related Costs
• All acquisition-related costs are expensed off
• Costs of issuing debt are recognized in accordance with IAS 39
– As yield adjustment to the cost of borrowing and are amortized over the
life of the loan
– Journal entry for the payment of debt issuance cost
Dr
Unamortized debt issuance costs
Cr
Cash
• Costs of issuing equity are recognized in accordance with IAS 32
– A reduction against equity
– Journal entry to record the payment of cost of issuing equity
Tan & Lee Chapter 3
Dr
Equity
Cr
Cash
© 2009
22
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
5.
Recognition and
and measurement
measurement of
of identifiable
identifiable assets,
assets, liabilities
liabilities and
and
Recognition
goodwill
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
23
Elimination of Investment Account
What the parent is paying for
Consideration
transferred
=
Eliminated against
subsidiary’s share
capital and preacquisition retained
earnings
•
Share of book
value of
subsidiary’s
net assets at
acquisition
date
+
Share of
excess of fair
value over
book value of
identifiable net
assets
+
Goodwill
Investment account is eliminated
– Substituted with subsidiary’s 1. identifiable net assets and 2.goodwill (residual)
– Avoid recognizing assets in two forms (investment in parent’s balance sheet and
individual assets and liabilities of the subsidiary)
Tan & Lee Chapter 3
© 2009
24
Recognition Principle
Business Combination accounted under the acquisition method
At acquisition date, the acquirer will recognize
subsidiary’s net assets at fair value
To qualify for recognition:
Identifiable net assets must meet the
definition of an asset or a liability
Identifiable net assets must be priced into
the “consideration transferred”
Rationale:
There has been an exchange transaction
at arm-length pricing
Tan & Lee Chapter 3
© 2009
There is an effective ”purchase”* of the
subsidiary’s identifiable assets and
liabilities at fair value
*Look at next slice
25
Recognition Principle
Effective purchases
Meaning:
Under acquisition method, an acquirer obtains control through
purchases of equity interests in an acquiree, there is deemed
to be an effective purchases of the assets and assumption of
the liabilities of the acquiree
by an acquirer.
Tan & Lee Chapter 3
© 2009
26
Recognition Principle
Fair value
differential
(FV-BV) of
identifiable net
assets
Book value of
subsidiary’s
identifiable net
assets
In separate
financial
statements
Tan & Lee Chapter 3
Book value of
subsidiary’s
identifiable net
assets
recognized in
consolidated
financial
statements
© 2009
At acquisition date:
• Fair value differential
will be recognized in
the consolidation
worksheet
In subsequent years:
• Depreciation/amortization/
cost of sale of asset will be
based on the fair value
recognized at the
acquisition date
These entries have to be reenacted every year until
disposal of investment
27
Intangible Assets
• IFRS 3 requires the acquirer to recognize the fair value of an
acquiree’s unrecognized identifiable asset (e.g. intangible asset) in
the combined financial statements
– Justified by the acquisition of the subsidiary by the parent
•
To qualify for recognition, the intangible asset must be:
Example:
• Assembled workforce with specialized
knowledge
Or must
arise from
contractual
or legal
rights
Tan & Lee Chapter 3
• Fails to meet the separability
criterion
• Opportunity gains from an operating
lease in favorable market conditions
• Meets the contractual-legal
© 2009
criterion
28
Contingent Liabilities & Provisions
• Contingent liabilities are recognized if they are:
– Present obligations arising from past events and
– Reliably measurable in their fair value, even if outcome is not probable
(IFRS 3:23)
• Provisions for restructuring & termination cost are recognized if they
are:
Probable
outflow of
economic
resources
Reliably
measurable
Present
constructive or
legal obligations
arising from past
events
Tan & Lee Chapter 3
© 2009
29
Indemnification Assets 賠償
• Contractual indemnity
– Provided by the sellers of the acquiree to the acquirer to make good any
loss arising from contingency or an asset or a liability
• Treatment for indemnity
– The acquirer has to recognize an “indemnification asset” at the same
time the indemnified asset or liability is recognized
– The indemnification asset is measured on the same basis as the
indemnified asset or liability
• Eg. An acquiree is exposed to a contingent liability. Based on
probabilistic estimation, the FV of the contingent liability is $100,000.
The seller provides a contractual guarantee to indemnify the
acquirer of the loss.
– In the consolidated balance sheet, contingent liabilities and an
indemnification asset of $100,000 will be recognized at fair value
Tan & Lee Chapter 3
© 2009
30
Deferred Tax Relating to FV Differentials of
Identifiable Assets and Liabilities
• The recognition of fair value differential may give rise to future tax
payable or future tax deduction
– tax effects need to be accounted for if the basis of taxation does not
change in a business combination
– i.e. If original asset is deductible based on book value, the FV
differential will give rise to a temporary taxable/deductible different
FV > Book value of identifiable assets
Deferred tax liabilities
FV < Book value of identifiable assets
Deferred tax assets
FV < Book value of identifiable liabilities
Deferred tax liabilities
FV > Book value of identifiable liabilities
Deferred tax assets
• No deferred tax liability is recognized on goodwill
Tan & Lee Chapter 3
© 2009
31
Measurement Period
•
IFRS 3 allows adjustments to be made retrospectively回顧地 to
goodwill, fair value of identifiable net assets and consideration
transferred:
–
–
If new information about facts and circumstances existing at
acquisition date arises,
Within 1 year of acquisition date
•
After 1 year, any correction of errors will be deemed as a prior period adjustment
•
Any change in estimate arising from new information on facts
and circumstances after the acquisition date will be recognized in
the current period and not retrospectively
Tan & Lee Chapter 3
© 2009
32
Goodwill
• A premium that a parent pays to acquire the subsidiary
– Must be recognized separately as an asset
– Determined as a residual
• IFRS 3 allows 2 ways of determining goodwill:
Goodwill
=
Fair value of consideration transferred
+
Amount of non-controlling interests
+
Fair value of the acquirer’s previously
held interest (before control was
achieved) in the acquiree
-
Acquiree’s
recognized net
identifiable assets
measured in
accordance with
IFRS 3
Measured at fair value at acquisition date
(include goodwill)
Amount of noncontrolling interests
Measured as a proportion of identifiable
assets as at acquisition date
Tan & Lee Chapter 3
© 2009
33
Goodwill
Goodwill
Integral to the entity as
a whole, not individually
identifiable or severable
as a standalone asset
An expectation of
future economic benefits
arising from acquisition
Tan & Lee Chapter 3
© 2009
34
Goodwill
• The “top-down approach” (Johnson and Petrone, 1998) results in
measurement errors in goodwill
Consideration transferred +
Amount of non-controlling interests
Overpayment for an
acquisition or
overvaluation of
consideration
transferred
Identifiable net assets
Measurement and
recognition errors
Above errors impact
goodwill
Tan & Lee Chapter 3
Goodwill
residual
© 2009
35
Goodwill
•
In a “bottom-up” approach (Johnson and Petrone, 1998), goodwill is
substantiated as follows:
Goodwill
Internally-generated
goodwill
“Going concern element” and
represent the ability of an
entity to generate higher rate
of return over its individual
assets or “core goodwill”
Tan & Lee Chapter 3
Fair value of synergies
Generated from the unique
combination of the acquirer
and acquiree or “combination
goodwill”
© 2009
36
Gain From a Bargain Purchase
• A gain from bargain purchase arises when:
Fair value of consideration transferred
+
Amount of non-controlling interests
+
Fair value of the acquirer’s previously
held interest in the acquiree
<
Acquiree’s net
identifiable assets
measured in
accordance with
IFRS 3
• The acquirer must re-assess the fair value of identifiable net assets,
consideration transferred and non-controlling interests. If there is no
measurement error:
– The gain will be recognized immediately in the income statement
Tan & Lee Chapter 3
© 2009
37
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interest
interestsunder
underIFRS
IFRS33
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
38
Non-Controlling Interests’ Share of Goodwill
• IFRS 3 Para 19 allows NCI to be measured in either of two ways
Non-controlling interests
Measured at Fair
value at acquisition
date (include
goodwill)
Measured as a
proportion of identifiable
assets as at acquisition
date
(Fair value option)
Tan & Lee Chapter 3
© 2009
39
Non-Controlling Interests’ Share of Goodwill
• Under the fair value option:
– FV is determined by either the active market prices of subsidiary’s
equity share at acquisition date or other valuation techniques
– FV per share of NCI may differ from parent due to control premium paid
by parent
– NCI comprises of 3 items:
Non – controlling
interests
Share of book value
of net assets
Tan & Lee Chapter 3
Share of
unamortized
FV adjustment
(FV - BV)
© 2009
Share of
unimpaired goodwill
40
Non-Controlling Interests’ Share of Goodwill
• Under the fair value option:
– Journal entry to record NCI at fair value (re-enacted each year):
Dr
Dr
Dr
Dr/Cr
Share capital of subsidiary
Retained earnings at acquisition date
Other equity at acquisition date (eg. RS, SP, GR)
FV differentials (FV- BV)/ (BV-FV)
Dr
Dr/Cr
Cr
Goodwill (Parent & NCI)
Deferred tax asset/ (liability) (JUST)on fair value
adjustment
Investment in subsidiary
Cr
Non-controlling interests (At fair value) -FP
Tan & Lee Chapter 3
© 2009
41
Non-Controlling Interests’ Share of Goodwill
• Under the 2nd option:
– NCI is a proportion of the acquiree’s identifiable net assets
– NCI comprises of 2 items:
Non – controlling
interests
Share of
unamortized
of FV adjustments
(FV- BV)
Share of book value
of net assets
Tan & Lee Chapter 3
© 2009
42
Non-Controlling Interests’ Share of Goodwill
• Under the 2nd option:
– Journal entry to record NCI (re-enacted each year):
Dr
Dr
Dr
Dr
Dr
Dr/Cr
Cr
Cr
Tan & Lee Chapter 3
Share capital of subsidiary
Retained earnings at acquisition date
Other equity at acquisition date
FV differentials
Goodwill (Parent only)
Deferred tax asset/ (liability) on FV adjustment
Investment in S subsidiary
Non-controlling interests
(NCI % x FV of identifiable net assets of that
company)
© 2009
43
Non-Controlling Interests’ Share of Goodwill
NCI measured at FV
NCI measured as a
proportion of the
acquiree’s identifiable
net assets
Book value of net assets
Fair value – Book value of
net assets
Goodwill
Tan & Lee Chapter 3
© 2009
44
Accounting for Non-Controlling Interests
under IFRS 3
• In consolidation, non-controlling interests have a share of:




Profit after tax
Dividends declared
Share capital
Retained earnings and other comprehensive income (eg. Revaluation
reserve) at acquisition date
 Change in retained earnings and other comprehensive income from the
date of acquisition to the current period
 Fair value differential of a subsidiary’s net assets at acquisition date
 Goodwill (if the fair value alternative is adopted)
Tan & Lee Chapter 3
© 2009
45
Reconstructing NCI on Balance Sheet
Date of
acquisition
Beginning of
current year
End of current
year
NCI have a share of
NCI have a share of
NCI have a share of
1. Share capital
1. Change in share capital*
1. Profit after tax
2. Retained earnings
2. Change in retained
earnings
2. Current amortization of
fair value differential
3. Change in other equity
3. Current impairment of
goodwill
3. Other equity
4. Fair value differentials
5. Goodwill
4. Past amortization of fair
value differential
5. Past impairment of
goodwill
Tan & Lee Chapter 3
© 2009
4. Dividends as a
repayment of profits
5. Change in other equity
46
Allocation to Non-controlling Interests
1.
Allocation of the change in equity from date of acquisition to the
current year
•
To transfer the NCI’s share of subsidiary’s retained earnings to NCI
Dr Retained earnings (NCI % x
in RE from acquisition date to
beginning of current period)
Cr NCI
2.
Allocation of current profit after tax to NCI
Dr Income to NCI
Cr NCI
Tan & Lee Chapter 3
© 2009
47
Allocation to Non-controlling Interests
3.
Allocation of dividends to NCI
•
•
•
A realization of residual in a subsidiary
Reduces the NCI’s stake in the net assets of the subsidiary
Elimination of dividends as follows:
Dr
Dr
Cr
4.
Dividend income (Parent)
NCI (BS)
Dividends declared (Subsidiary)
Can NCI be a debit balance?
•
If NCI’s share of losses in a subsidiary > NCI’s existing share of
subsidiary’s net assets:
•
NCI will have a debit balance under IAS 27
Tan & Lee Chapter 3
© 2009
48
Analytical check on Non-controlling
Interests’ balance
NCI’s share of:
NCI’s balance at
year-end
=
a) Book value of net assets of subsidiary at
year-end -/+ unrealized profit/loss from
upstream sale
b) Unamortized balance of FV adjustments at
year-end
c) Unimpaired balance of goodwill at yearend
Tan & Lee Chapter 3
© 2009
49
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects
Effects of
of amortization,
amortization, depreciation
depreciation and
and disposal
disposal of
of undervalued
undervalued
or
or overvalued
overvalued assets
assets and
and liabilities
liabilities subsequent
subsequentto
to acquisition
acquisition
8.
Goodwill impairment tests
Tan & Lee Chapter 3
© 2009
50
In Subsequent PERIOD
• At acquisition date, we recognize:
– Fair value of identifiable net assets,
– Intangibles, contingent liabilities, and
– Deferred tax assets or liabilities on the above
• In subsequent years:
– Amortization, depreciation and cost of sales of the acquired assets must be
based on the fair value as at acquisition date
– Since net assets are carried at book value in the separate financial statements,
the subsequent amortization/depreciation/disposal are adjusted in the
consolidation worksheet
– Eg. When an identified asset is sold or depreciated:
BV of expense in
separate
financial
statements
Tan & Lee Chapter 3
+
(FV- BV) adjustment
to expense
Adjusted in consolidation
worksheet
© 2009
=
FV of expense
in consolidated
financial
statements
51
Illustration 2:
Amortization of Fair Value Differentials
• P Co paid $6,200,000 and issued 1,000,000 of its own shares to
acquire 80% of S Co on 1 Jan 20X5
• Fair value of P Co’s share is $3 per share
• Fair value of net identifiable assets is as follows:
Book value
Leased property
4,000,000
In-process R&D
Other assets
Liabilities
Remaining useful life
5,000,000
20 years
2,000,000
10 years
1,900,000
1,900,000
(1,200,000)
(1,200,000)
Contingent liability
(100,000)
Net assets
4,700,000
Share capital
1,000,000
Retained earnings
3,700,000
Shareholders’ equity
4,700,000
Tan & Lee Chapter 3
Fair value
© 2009
7,600,000
52
Illustration 2:
Amortization of Fair Value Differentials
Additional information:
• Contingent liability of $100,000 was recognized as a provision by
the acquiree in Dec 20X5
• FV of NCI at acquisition date was $2,300,000
• Net profit after tax of S Co for 31 Dec 20X5 was $1,000,000
• No dividends were declared during 20X5
• Shareholders’ equity as at 31 Dec 20X5 was $5,700,000
Q1 : Prepare the consolidation adjustments for P Co for 20X5
Q2 : Perform analytical check on balance of NCI as at 31 Dec 20X5
Tan & Lee Chapter 3
© 2009
53
Illustration 2:
Amortization of Fair Value Differentials
• Consideration transferred = Cash consideration + Fair value
of share issued
= $6,200,000 + (1,000,000 x $3)
= $9,200,000
• Deferred tax liability = 20% x ($7,600,000 - $4,700,000)
= $580,000
• Goodwill = Consideration transferred + NCI – Fair value of net
identifiable assets, after-tax
= $9,200,000 + $2,300,000 – ($7,600,000 - $580,000)
= $4,480,000
Tan & Lee Chapter 3
© 2009
54
Illustration 2:
Amortization of Fair Value Differentials
• P’s share of goodwill = Consideration transferred – 80% x Fair
value of net identifiable assets, after tax
= $9,200,000 – 80% x $7,020,000
= $9,200,000 – $5,616,000
= $3,584,000
• NCI’s share of goodwill = Consideration transferred – 20% x Fair
value of net identifiable assets, after tax
= $2,300,000 – 20% x $7,020,000
= $2,300,000 – $1,404,000
= $896,000
Tan & Lee Chapter 3
© 2009
55
Illustration 2:
Amortization of Fair Value Differentials
Consolidation adjustments for 20X5
CJE 1: Elimination of investment in S
Dr
Dr
Dr
Dr
Dr
Cr
Cr
Cr
Cr
Share capital
Retained earnings
Leased property
In-process R&D
Goodwill
Contingent liability
Deferred tax liability
Investment in S
Non-controlling interests
Tan & Lee Chapter 3
1,000,000
3,700,000
1,000,000
2,000,000
4,480,000
100,000
580,000
9,200,000
2,300,000
© 2009
56
Illustration 2:
Amortization of Fair Value Differentials
CJE 2: Depreciation and amortization of excess of FV over book value
Dr
Dr
Cr
Depreciation of leased property
Amortization of in-process R&D
Accumulated depreciation
Cr
Accumulated amortization
Under dep. by
$50k
Dep. of
leased
property
$200,000
50,000
200,000
Under amort. by
$200k
Dep exp:
$50,000
$200,000
50,000
200,000
Amort exp:
$200,000
Amort. of
R&D
$0
Based on
book value
Tan & Lee Chapter 3
Based on
book value
Based on FV
© 2009
Based on FV
57
Illustration 2:
Amortization of Fair Value Differentials
CJE 3: Reversal of entry relating to provision for lawsuit
Dr
Cr
Provision for lawsuit -FP
Loss from lawsuit -I/S
100,000
100,000
Note: Contingent liability was already recognized in CJE 1. The
recognition by the acquiree results in double counting; hence this
reversal entry is necessary
CJE 4: Tax effects on CJE 2 & CJE 3
Dr
Deferred tax liability
Cr
Tax expense
Tan & Lee Chapter 3
20% * (200k
+50k -100k)
30,000
30,000
© 2009
58
Illustration 2:
Amortization of Fair Value Differentials
CJE 5: Allocation of current year profit to non-controlling interests (NCI)
Dr
Cr
Income to NCI
NCI
176,000
176,000
Net profit after tax
Excess depreciation
Excess amortization
Reversal of loss from lawsuit
Tax effects on FV adjustments
Adjusted net profit
NCI’s share (20%)
Tan & Lee Chapter 3
1,000,000
(50,000)
(200,000)
100,000
30,000
880,000
176,000
© 2009
59
Illustration 2:
Amortization of Fair Value Differentials
NCI balance:
NCI at acquisition date (CJE 1)
Income allocated to NCI for 20x5 (CJE 5)
NCI as at 31 Dec 20x5
Tan & Lee Chapter 3
© 2009
$2,300,000
176,000
$2,476,000
60
Illustration 2:
Amortization of Fair Value Differentials
Q2 : Perform an analytical check on the balance of NCI as at 31 Dec 20X5
Non – controlling
interests
Share of
unamortized
FV adjustment
Share of book value
of net assets
$5,700,000 x 20%
= $1,140,000
Tan & Lee Chapter 3
+
($1,000,000 x 19/20 x
80% x 20%) +
($2,000,000 x 9/10 x
80% x 20%) =
$440,000
© 2009
Share of
unimpaired goodwill
+
$896,000
= $2,476,000
61
Content
1.
Introduction
2.
Overview of the consolidation process
3.
The acquisition method
4.
Determining the amount of consideration transferred
5.
Recognition and measurement of identifiable assets, liabilities and
goodwill
6.
Accounting for non-controlling interests under IFRS 3
7.
Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
8.
Goodwill impairment
impairment tests
tests
Goodwill
Tan & Lee Chapter 3
© 2009
62
Goodwill Impairment Test
• IAS 36: Goodwill has to be reviewed annually for impairment loss
– Reviewed as part of a cash-generating unit (CGU)
• CGU is the lowest level at which the goodwill is monitored for internal
management purposes and
• Not larger than a segment determined under segment reporting
– Goodwill will be allocated to each of the acquirer’s CGU, or group of
CGUs
Tan & Lee Chapter 3
© 2009
63
Goodwill Impairment Test
1.
Carrying amount:
–
–
2.
Net assets of the cash-generating unit
It includes entity goodwill attributable to parent and NCI
Recoverable amount:
–
Higher of 1.FV less cost to sell (an arms-length measure), or
•
–
2.Value in use
•
3.
Uses market based inputs in the pricing mechanism
Uses internal or entity-specific input to determine the future cash flows
If carrying amount > recoverable amount
–
–
–
Impairment loss is allocated to goodwill
Then to other assets in proportion to their individual carrying amounts
Impairment once made is not reversible, as it may result in the
recognition of internally-generated goodwill which is prohibited under
IAS 38
Tan & Lee Chapter 3
© 2009
64
Goodwill Impairment Test
Steps for impairment test
Determine the carrying amount of the CGU
Determine the recoverable amount of the CGU
Recoverable amount: Higher of fair value or value in use
If carrying amount ≤
recoverable amount
If carrying amount ≥
recoverable amount
No impairment loss
Allocate impairment loss
to goodwill first and
balance to other net assets
Tan & Lee Chapter 3
© 2009
65
Goodwill Impairment Test
NCI at FV at acquisition
date
Goodwill on consolidation
Carrying amount of cashgenerating unit
Impairment loss
Tan & Lee Chapter 3
NCI as a proportion of
identifiable net asset at
acquisition date
Includes NCI’s share of
goodwill
Excludes NCI’s share of
goodwill
Goodwill is allocated to
cash-generating unit without
further adjustment
Goodwill has to be grossed
up to include NCI’s share
Notionally adjusted goodwill
= Recognized goodwill/
parent’s interest
Impairment loss is shared
between parent and NCI on
the same basis on which
profit or loss is allocated
© 2009
Impairment loss is borne
only by parent as goodwill
for NCI is not recognized
66
Conclusion
• All business combinations are accounted for using the acquisition
method:
– Consideration transferred = Fair value of (assets transferred + liabilities
incurred + equity interests issued by acquirer + contingent
consideration)
– Investment account is eliminated and substituted with:
• Subsidiary’s identifiable net assets; and
• Goodwill
– Goodwill = Fair value of (consideration transferred + non-controlling
interests + acquirer’s previously held interest in the acquiree) –
Acquiree’s recognized net identifiable assets
Tan & Lee Chapter 3
© 2009
67
Conclusion
• In consolidation:
– All intragroup balances and transactions are eliminated
– Non-controlling interests have a share of:
 Profit after tax
 Dividends declared
 Share capital
 Retained earnings and other comprehensive income (eg. Revaluation
reserve) from acquisition date to current period
 Fair value differential of a subsidiary’s net assets at acquisition date
 Goodwill (if the fair value alternative is adopted)
– In the subsequent years, amortization, depreciation and cost of sales of
the acquired assets are based on fair value as at acquisition date
Tan & Lee Chapter 3
© 2009
68
Conclusion
•
•
•
•
•
•
•
•
Dr/ Cr Goodwill/ Gain from a bargain purchases
Dr/Cr FV (whole)
Dr/Cr FV (diff)
Dr Net Asset
Cr/ Dr Contingent Liability / Contingent Asset
Cr Investment in a subsidiary
Cr NCI
Cr/ Dr Deferred Tax Liability/ Deferred Tax asset
Tan & Lee Chapter 3
© 2009
69