Group accounting – basic groups p2

Overview of interests in other entities

 

The following diagram presents an overview of the varying types of interests in other entities, together with identification of applicable reporting standards.

The standards referred to in the diagram above cover a range of group accounting issues:

 

• IFRS 10 Consolidated Financial Statements

 

• IFRS 11 Joint Arrangements

 

• IFRS 12 Disclosure of Interests in Other Entities

 

• IAS 28 Investments in Associates and Joint Ventures

 

These standards, as well as IFRS 3 Business Combinations, are covered in this chapter. IFRS 9 Financial Instruments was dealt with earlier in the publication.

 

 

Group accounting – basic groups

 

 

2 Definitions

 

IFRS 10 Consolidated Financial Statements says that an entity that is a parent is required to prepare consolidated financial statements. The standard provides the following definitions:

 

A parent is an entity that controls another entity.

 

A subsidiary is an entity that is controlled.

 

An investor controls an investee when:

 

• the investor has power over the investee, and

 

• the investor is exposed, or has rights, to variable returns from its involvement with the investee, and

 

• the investor has the ability to affect those returns through its power over the investee.

 

Consolidated financial statements present the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries as if they were a single economic entity.

 

3 Revision from F7: Consolidation techniques

 

Consolidated statement of financial position

 

Producing a consolidated statement of financial position involves five standard workings. These will help you to understand the structure of the group and to calculate goodwill, the non-controlling interest and group reserves.

 

The first step in any examination question should be to determine the group structure.

 

(W1) Group structure

This working is useful to decide the status of any investments. If one entity is controlled by another entity then it is a subsidiary and must be consolidated.

 

In numerical exam questions, control is normally presumed to exist if one company owns more than half of the voting capital of another entity.

 

Once the group structure has been determined, set up a proforma statement of financial position.

 

Group statement of financial position as at the reporting date

 

	$000
Goodwill (W3)	X
Assets (P + S)	X
	–––
Total assets	X
	–––
Equity capital (Parent’s only)	X
Retained earnings (W5)	X
Other components of equity (W5)	X
Non-controlling interest (W4)	X
	–––
Total equity	X
Liabilities (P + S)	X
	–––
Total equity and liabilities	X
	–––
You will need to do the following:

 

– Eliminate the carrying amount of the parent’s investments in its subsidiaries (these will be replaced by goodwill)

 

– Add together the assets and liabilities of the parent and its subsidiaries in full

 

– Include only the parent’s balances within share capital and share premium

 

– Set up and complete standard workings 2 – 5 to calculate goodwill, the non-controlling interest and group reserves.

 

(W2) Net assets of each subsidiary

 

This working sets out the fair value of the subsidiary’s identifiable net assets at acquisition date and at the reporting date.

 

	At acquisition At reporting date
	$000	$000
Equity capital	X	X
Share premium	X	X
Other components of equity	X	X
Retained earnings	X	X
Goodwill in the accounts of the sub.	(X)	(X)
Fair value adjustments (FVA)	X	X
Post acq’n dep’n/amort. on FVA		(X)
PURP if the sub is the seller		(X)
	–––––––––	–––––––––
	X	X
	(to W3)
	–––––––––	–––––––––

 

Remember to update the face of the statement of financial position for adjustments made to the net assets at the reporting date (such as fair value uplifts and provisions for unrealised profits (PURPS)).

 

The fair value of the subsidiary’s net assets at the acquisition date are used in the calculation of goodwill.

 

The movement in the subsidiary’s net assets since acquisition is used to calculate the non-controlling interest and group reserves.

 

(W3) Goodwill
	$000
Fair value of purchase consideration	X
NCI at acquisition**	X
	–––
Less: fair value of identifiable net assets at acquisition	X
(per net assets working)	(X)
	–––
Goodwill at acquisition	X
Less: impairment to date	(X)
	–––
Goodwill to consolidated SFP	X
	–––

 

 

**if full goodwill method adopted, NCI value = FV of NCI at date of acquisition. This will normally be given in a question.

 

**if proportionate goodwill method adopted, NCI value = NCI % of the fair value of the net assets at acquisition (per W2).

 

(W4) Non-controlling interest
	$000
NCI value at acquisition (W3)	X
NCI % of post-acquisition movement in net assets (W2)	X
Less: NCI % of goodwill impairment (fair value method only)	(X)
	–––
NCI to consolidated SFP	X
	–––
(W5) Group reserves
Retained earnings
	$000
Parent’s retained earnings (100%)	X
For each subsidiary: group share of post-acquisition
retained earnings (W2)	X
Add: gain on bargain purchase (W3)	X
Less: goodwill impairment** (W3)	(X)
Less: PURP if the parent was the seller	(X)
	–––
Retained earnings to consolidated SFP	X
	–––

 

• If the NCI was valued at fair value at the acquisition date, then only the parent’s share of the goodwill impairment is deducted from retained earnings.

 

Other components of equity
	$000
Parent’s other components of equity (100%)	X
For each subsidiary: group share of post-acquisition
other components of equity (W2)	X
	–––
Other components of equity to consolidated SFP	X
	–––

 

 

Consolidated statement of profit or loss and other comprehensive income

 

Step 1: Group structure

 

This working is useful to decide the status of any investments. If one entity is controlled by another entity then it is a subsidiary and must be consolidated.

 

In numerical exam questions, control is normally presumed to exist if one company owns more than half of the voting capital of another entity.

 

Step 2: Pro-forma

 

Once the group structure has been determined, set up a proforma statement of profit or loss and other comprehensive income.

 

Remember to leave space at the bottom to show the profit and total comprehensive income (TCI) attributable to the owners of the parent company and the profit and TCI attributable to the non-controlling interest.

 

Group statement of profit or loss and other comprehensive income for the year ended 30 June 20X8

 

	$000
Revenue (P + S)	X
Cost of sales (P + S)	(X)
	––––
Gross profit	X
Operating costs (P + S)	(X)
	––––
Profit from operations	X
Investment income (P + S)	X
Finance costs (P + S)	(X)
	––––
Profit before tax	X
Income tax (P + S)	(X)
	––––
Profit for the period	X
Other comprehensive income (P + S)	X
	––––
Total comprehensive income	X
	––––

 

Profit attributable to:
Equity holders of the parent (bal. fig)	X
Non-controlling interest (Step 4)	X
	––––
Profit for the period	X
	––––
Total comprehensive income attributable to:
Equity holders of the parent (bal. fig)	X
Non-controlling interest (Step 4)	X
	––––
Total comprehensive income for the period	X
	––––

 

Step 3: Complete the pro-forma

 

Add together the parent and subsidiary’s incomes and expenses and items of other comprehensive income on a line-by-line basis.

 

• If the subsidiary has been acquired mid-year, make sure that you pro-rate the results of the subsidiary so that only post-acquisition incomes, expenses and other comprehensive income are consolidated.

 

• Ensure that you eliminate intra-group incomes and expenses, unrealised profits on intra-group transactions, as well as any dividends received from the subsidiary.

 

Step 4: Calculate the profit/TCI attributable to the non-controlling interest

 

Remember, profit for the year and TCI for the year must be split between the group and the non-controlling interest. The following proforma will help you to calculate the profit and TCI attributable to the non-controlling interest.

 

	Profit	TCI
	$000	$000
Profit/TCI of the subsidiary for the year	X	X
(pro-rated for mid-year acquisition)
PURP (if S is the seller)	(X)	(X)
Excess depreciation/amortisation	(X)	(X)
Goodwill impairment (under FV model only)	(X)	(X)
	–––	–––
×NCI%	X	X
	–––	–––
Profit/TCI attributable to the NCI	X	X
	–––	–––

 

Associates

 

Definitions

 

An associate is defined as ‘an entity over which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor’ (IAS 28, para 3).

 

Significant influence is the power to participate in, but not control, the financial and operating policy decisions of an entity. IAS 28 states that:

 

• Significant influence is usually evidenced by representation on the board of directors, which allows the investing entity to participate in policy decisions.

 

• A holding between 20% and 50% of the voting power is presumed to give significant influence, unless it can be clearly demonstrated that this is not the case.

 

• It is presumed that a holding of less than 20% does not give significant influence, unless such influence can be clearly demonstrated.

 

Accounting for associates

 

Associates are not consolidated because the parent does not have control. Instead they are accounted for using the equity method.

 

Statement of financial position

 

IAS 28 requires that the carrying amount of the associate is determined as follows:

 

	$000
Cost	X
Add: P% of increase in reserves	X
Less: impairment losses	(X)
Less: P% of unrealised profits if P is the seller	(X)
Less: P% of excess depreciation on fair value adjustments	(X)
	–––
Investment in associate	X
	–––
The investment in the associate is shown in the non-current assets
section of the consolidated statement of financial position.

 

Statement of profit or loss and other comprehensive income

 

For an associate, a single line item is presented in the statement of profit or loss below operating profit. This is made up as follows:

 

	$000
P% of associate’s profit after tax	X
Less: Current year impairment loss	(X)
Less: P% of unrealised profits if associate is the seller	(X)
Less: P% of excess depreciation on fair value adjustments	(X)
Share of profit of associate	–––
	X
	–––

 

Within consolidated other comprehensive income, the group should present its share of the associate’s other comprehensive income (if applicable).

 

Adjustments

 

Dividends received from the associate must be removed from the consolidated statement of profit or loss.

 

Transactions and balances between the associate and the parent company are not eliminated from the consolidated financial statements because the associate is not a part of the group.

 

The group share of any unrealised profit arising on transactions between the group and the associate must be eliminated.

 

• If the associate is the seller:

 

– Dr Share of the associate’s profit (P/L)/Retained earnings (SFP)

 

–   Cr Inventories (SFP)

 

• If the associate is the purchaser:

 

–   Dr Cost of sales (P/L)/Retained earnings (SFP)

 

–   Cr Investment in the associate (SFP)

 

General points and disclosures

 

IAS 28 notes the following:

 

• The financial statements used to equity account for the associate should be drawn up to the investor’s reporting date. If this is not possible, then the difference in reporting dates should be less than three months.

 

• The associate’s accounting policies should be harmonised with those of its investor.

 

• The investor should disclose its share of the associate’s contingencies.

 

• A list and description of significant associates should be disclosed. This will note the ownership interests and voting interests for each associate.

 

Note that the equity method is not used in the following situations:

 

• the investment is classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

 

• the investor is itself a subsidiary, its owners do not object to the equity method not being applied and its debt and equity securities are not publicly traded. In this case, the investor’s parent must present consolidated financial statements that do use the equity method.

 

 

 

Illustration 1 – Consolidated statement of financial position

 

Summarised financial statements for three entities for the year ended 30

 

June 20X8 are as follows:

 

Statements of financial position

 

	Borough	High	Street
Assets	$	$	$
Property, plant and	100,000	80,000	60,000
equipment
Investments	121,000	–	–
Inventories	22,000	30,000	15,000
Receivables	70,000	10,000	2,000
Cash and cash equivalents	47,000	25,000	3,000
	–––––––	–––––––	–––––––
	360,000	145,000	80,000
	–––––––	–––––––	–––––––

 

 

Equity and liabilities
Equity capital ($1 shares)	100,000	75,000	35,000
Retained earnings	200,000	50,000	40,000
Other components of equity	10,000	5,000	–
Liabilities	50,000	15,000	5,000
	–––––––	–––––––	–––––––
	360,000	145,000	80,000
	–––––––	–––––––	–––––––

 

On 1 July 20X7, Borough purchased 45,000 shares in High for $100,000. At that date, High had retained earnings of $30,000 and no other components of equity. High’s net assets had a fair value of $120,000 and the fair value of the non-controlling interest was $55,000. It is group policy to value the non-controlling interest at acquisition at fair value.

 

The excess of the fair value of High’s net assets over their carrying amounts at the acquisition date relates to property, plant and equipment. This had a remaining estimated useful life of five years at the acquisition date. Goodwill has been subject to an impairment review and it was determined to be impaired by $7,000.

 

On 1 July 20X7, Borough purchased 10,500 equity shares in Street for $21,000. At that date, Street had retained earnings of $25,000 and no other components of equity.

 

During the year Borough sold goods too High for $10,000 at a margin of 50%. By the reporting date, High had only sold 80% of these goods. Included in the receivables of Borough and the liabilities of High are intra-group balances of $5,000.

 

On 5 July 20X8, Borough received notification that an employee was claiming damages against them as a result of a work-place accident that took place on 30 April 20X8. Lawyers have advised that there is a 60% chance that Borough will lose the case and will be required to pay damages of $30,000.

 

Required:

 

Prepare the consolidated statement of financial position as at 30 June 20X8.

 

Solution

 

Borough Group statement of financial position as at 30 June 20X8

 

Non Current Assets	$
Goodwill (W3)	28,000
Property, plant and equipment	192,000
($100,000 + $80,000 + $15,000 (W2) – $3,000 (W2))
Investment in Associate (W7)	25,500
Current Assets
Inventories ($22,000 + $30,000 – $1,000 (W6))	51,000
Receivables ($70,000 + $10,000 – $5,000 inter.co)	75,000
Cash and cash equivalents ($47,000 + $25,000)	72,000
	–––––––
	443,500
	–––––––
Equity capital	100,000
Retained earnings (W5)	179,500
Other components of equity (W5)	13,000
Non-controlling interest (W4)	61,000
	–––––––
Total equity	353,500
Liabilities	90,000

($50,000 + $15,000 – $5,000 inter.co + $30,000 (W8))

 

–––––––

 

443,500

 

–––––––

 

(W1) Group structure

 

Borough is the parent

 

High is a 60% subsidiary (45/75)

 

Street is a 30% associate (10.5/35)

 

Both acquisitions took place a year ago

 

(W2) Net assets of High
	Acq	Rep date
	$	$
Equity capital	75,000	75,000
Other components of equity	–	5,000
Retained earnings	30,000	50,000
Fair value adjustment (FVA)	15,000*	15,000
Depreciation on FVA ($15,000/5)	–	(3,000)
	––––––	––––––
*bal fig	120,000	142,000
	––––––	––––––
(W3) Goodwill
		$
Consideration		100,000
FV of NCI at acquisition		55,000
		–––––––
		155,000
FV of net assets at acquisition (W2)		(120,000)
		–––––––
Goodwill at acquisition		35,000
Impairment		(7,000)
		–––––––
Goodwill at the reporting date		28,000
		–––––––
(W4) Non-controlling interest
		$
Fair value of NCI at acquisition (given)		55,000
NCI % of post-acquisition net assets		8,800
(40% × ($142,000 – $120,000) (W2))
NCI share of goodwill impairment		(2,800)
(40% × $7,000)		–––––––

61,000

 

–––––––

 

(W5) Group reserves
Group retained earnings
	$
Parent	200,000
Provision (W8)	(30,000)
Share of post-acquisition retained earnings:
High: 60% × (($50,000 – $3,000) – $30,000) (W2)	10,200
Street: 30% × ($40,000 – $25,000)	4,500
Group share of goodwill impairment	(4,200)
(60% × $7,000)
PURP (W6)	(1,000)
	–––––––
	179,500
	–––––––
Other components of equity
	$
Parent	10,000
Share of post-acquisition other components of equity:
High: 60% × ($5,000 – $nil) (W2)	3,000
	–––––––

13,000

 

–––––––

 

(W6) Provision for unrealised profit

 

The profit on the intra-group sale was $5,000 (50% × $10,000).

 

The unrealised profit still in inventory is $1,000 (20% × $5,000).

 

The parent was the seller, so retained earnings is adjusted in (W5)

 

Dr Retained earnings	$1,000
Cr Inventories	$1,000
(W7) Investment in the associate	$
Cost	21,000
Share of increase in retained earnings	4,500
(30% × ($40,000 – $25,000))	–––––––
	25,500
	–––––––

 

(W8) Provision

 

The obligating event, the accident, happened during the reporting period. This means that there is an obligation from a past event, and a probable outflow of resources that can be measured reliably. A provision is therefore required for the best estimate of the amount payable, which is $30,000. This is charged to the statement of profit or loss so will reduce retained earnings in (W5).

 

Dr Retained earnings	$30,000
Cr Provisions	$30,000

 

 

Illustration 2 – Consolidated statement of profit or loss

 

H has owned 80% of the ordinary shares of S and 30% of the ordinary shares of A for many years. The information below is required to prepare the consolidated statement of profit or loss for the year ended 30 June 20X8.

 

Statements of profit or loss for the year ended 30 June 20X8

 

	H	S	A
	$	$	$
Revenue	500,000	200,000	100,000
Cost of sales	(100,000)	(80,000)	(40,000)
	–––––––	–––––––	–––––––
Gross profit	400,000	120,000	60,000
Distribution costs	(160,000)	(20,000)	(10,000)
Administrative expenses	(140,000)	(40,000)	(10,000)
	–––––––	–––––––	–––––––
Profit from operations	100,000	60,000	40,000
Tax	(23,000)	(21,000)	(14,000)
	–––––––	–––––––	–––––––
Profit after tax	77,000	39,000	26,000
	–––––––	–––––––	–––––––

 

Note: There were no items of other comprehensive income in the year.

 

At the date of acquisition, the fair value of S’s plant and machinery, which at that time had a remaining useful life of ten years, exceeded the book value by $10,000.

 

During the year S sold goods to H for $10,000 at a margin of 25%. By the year-end H had sold 60% of these goods.

 

The group accounting policy is to measure non-controlling interests using the proportion of net assets method. The current year goodwill impairment loss was $1,200, and this should be charged to administrative expenses.

 

By 30 June 20X8 the investment in A had been impaired by $450, of which the current year loss was $150.

 

On 1 January 20X8, H signed a contract to provide a customer with support services for the following twelve months. H received the full fee of $30,000 in advance and recognised this as revenue.

 

Required:

 

Prepare the consolidated statement of profit or loss for the year ended 30 June 20X8.

 

Solution

 

Group statement of profit or loss for the year ended 30 June 20X8

 

	$
Revenue	675,000
($500,000 + $200,000 – $10,000 (W3) – $15,000 (W4))
Cost of sales	(172,000)
($100,000 + $80,000 + $1,000 (W2) – $10,000 (W3) +
$1,000 (W3))
	–––––––
Gross profit	503,000
Distribution costs ($160,000 + $20,000)	(180,000)
Administrative expenses	(181,200)
($140,000 + $40,000 + $1,200 GW imp)
	–––––––
Profit from operations	141,800
Share of profit of associate	7,650
((30% × $26,000) – $150 impairment)
	–––––––
Profit before tax	149,450
Tax ($23,000 + $21,000)	(44,000)
	–––––––
Profit for the period	105,450
	–––––––

 

Attributable to:
Equity holders of the parent (bal. fig)	98,050
Non-controlling interest (W5)	7,400
	–––––––
Profit for the period	105,450
	–––––––

 

Workings

 

(W1) Group structure

(W2) Excess depreciation
$10,000/10 years = $1,000.
The adjusting entry is:
Dr Cost of sales	$1,000
Cr PPE	$1,000
(W3) Intra-group trading
The $10,000 trading between S and H must be eliminated:
Dr Revenue	$10,000
Cr Cost of sales	$10,000

 

The profit on the sale was $2,500 (25% × $10,000). Of this, $1,000 ($2,500 × 40%) remains within the inventories of the group. The PURP adjustment is therefore:

 

Dr Cost of sales	$1,000
Cr Inventories	$1,000

 

(W4) Revenue

 

The performance obligation is satisfied over time. Based on the passage of time, the contract is 50% (6/12) complete so only 50% of the revenue should be recognised by the reporting date. Therefore $15,000 ($30,000 × 50%) should be removed from revenue and held as a liability on the SFP.

 

Dr Revenue		$15,000
Cr Contract liability		$15,000
(W5) Profit attributable to NCI
	$	$
S’s profit for the year	39,000
PURP (W3)	(1,000)
Excess depreciation (W2)	(1,000)
	––––––
× 20%	37,000	––––––
Profit attributable to NCI		7,400
		––––––

 

Note: If the parent had sold goods to the subsidiary then the PURP adjustment would not be included when calculating the profit attributable to the NCI.

 

Goodwill has been calculated using the share of net assets method.

 

Therefore, none of the impairment loss is attributable to the NCI.

 

 

 

Illustration 3 – Associates

 

Paint has several investments in subsidiary companies. On 1 July 20X1, it acquires 30% of the ordinary shares of Animate for $2m. This holding gives Paint significant influence over Animate.

 

At the acquisition date, the fair value of Animate’s net assets approximate to their carrying values with the exception of a building. This building, with a remaining useful life of 10 years, had a carrying value of $1m but a fair value of $1.8m.

 

Between 1 July 20X1 and 31 December 20X1, Animate sold goods to Paint for $1 million making a profit of $100,000. All of these goods remain in the inventory of Paint. This sale was made on credit and the invoice has not yet been settled.

 

Animate made a profit after tax of $800,000 for the year ended 31 December 20X1. At 31 December 20X1, the directors of Paint believe that the investment in the associate needs impairing by $50,000.

 

Required:

 

Prepare extracts from the consolidated statement of financial position and the consolidated statement of profit or loss showing the treatment of the associate for the year ended 31 December 20X1.

 

 

 

Solution

 

Consolidated statement of financial position	$
Investment in associate (W1)	2,058,000
Consolidated statement of profit or loss
Share of profit of associate (W2)	28,000

 

Note: No adjustment is required for receivables and payables held between Paint and Animate.

 

(W1) Investment in associate	$
Cost	2,000,000
Share of post-acquisition profit	120,000
(30% × $800,000 × 6/12)
Share of excess depreciation	(12,000)
(30% × (($1.8m – $1m)/10 years) × 6/12)
Impairment	(50,000)
	––––––––
Investment in associate	2,058,000
	––––––––

 

The inventory is held within the group so the parent’s share of the PURP is credited against inventory rather than the investment in the associate.

 

	(W2) Share of associate’s profit	$
	P’s share of A’s profit after tax	120,000
	(30% × $800,000 × 6/12)	(50,000)
	Impairment
	P’s share of excess depreciation	(12,000)
	(30% × (($1.8m – $1m)/10 years) × 6/12)	(30,000)
	P’s share of PURP
	(30% × $100,000)	––––––––
	Share of profit of associate	28,000
		––––––––

 

 

4 Control

 

Consolidated statements are produced if one entity controls another entity. It is often presumed that control exists if a company owns more than 50% of the ordinary shares of another company. However, in section B of the P2 exam, the examiner may test the definition of control in more detail.

 

According to IFRS 10, an investor controls an investee when:

 

• the investor has power over the investee, and

 

• the investor is exposed, or has rights, to variable returns from its involvement with the investee, and

 

• the investor has the ability to affect those returns through its power over the investee.

 

IFRS 10 identifies a range of circumstances that may need to be considered when determining whether or not an investor has power over an investee, such as:

 

• exercise of the majority of voting rights in an investee

 

• contractual arrangements between the investor and other parties

 

• holding less than 50% of the voting shares, with all other equity interests held by a numerically large, dispersed and unconnected group

 

• holding potential voting rights (such as convertible loans) that are currently capable of being exercised

 

• the nature of the investor’s relationship with other parties that may enable that investor to exercise control over an investee.

 

It is therefore possible to own less than 50% of the ordinary shares of another entity and to still exercise control over it.

 

Application of IFRS 10 control definition

 

An investor has 48 per cent of the voting rights of another entity. The remaining 52 per cent of the voting rights are held by thousands of other shareholders, none of whom individually hold more than 1 per cent of the voting rights. These other shareholders have no relationship with one another.

 

Due to the size of its holding and the relative size of the other shareholdings, the investor believes that it controls the investee.

 

 

 

Test your understanding 1 – Control

 

Parsley has a 40% holding in the ordinary shares of Oregano. Another investor has a 10% shareholding in Oregano whilst the remaining voting rights are held by thousands of shareholders, none of whom individually hold more than 1 per cent of the voting rights. Parsley also holds debt instruments that, as at 30 April 20X4, are convertible into ordinary shares of Oregano at a price of $4 per share. At 30 April 20X4, the shares of Oregano trade at $3.80 per share. If the debt was converted into ordinary shares, Parsley would hold 60% of the voting rights in Oregano. Parsley and Oregano undertake similar activities and would benefit from synergies.

 

Required:

 

Discuss how Parsley’s investment in the ordinary shares of Oregano should be treated in the consolidated financial statements for the year ended 30 April 20X4.

 

Exemptions from consolidation

 

Intermediate parent companies

 

An intermediate parent entity is an entity which has a subsidiary but is also itself a subsidiary of another entity. For example:

IFRS 10 permits a parent entity not to present group financial statements provided all of the following conditions apply:

 

• it is a wholly-owned, or partially-owned subsidiary where owners of the non-controlling interest do not object to the non-preparation

 

• its debt or equity instruments are not currently traded in a domestic or foreign market

 

• it is not in the process of having any of its debt or equity instruments traded on a domestic or foreign market

 

• the ultimate parent entity produces consolidated financial statements that comply with IFRS Standards and which are available to the public.

 

If this is the case, IAS 27 Separate Financial Statements requires that the following disclosures are made:

 

• the fact that consolidated financial statements have not been presented

 

• a list of significant investments (subsidiaries, joint ventures and associates) including percentage shareholdings, principal place of business and country of incorporation

 

• the bases on which those investments listed above have been accounted for in its separate financial statements.

 

Investment entities

 

An investment entity is defined by IFRS 10 as an entity that:

 

• obtains funds from investors and provides them with investment management services, and

 

• invests those funds to earn returns from capital appreciation, investment income, or both, and

 

• measures the performance of its investments on a fair value basis.

 

Investment entities do not consolidate an investment over which they have control. Instead, the investment is measured at fair value at each reporting date with gains and losses recorded in profit or loss.

 

 

 

Invalid reasons to exclude a subsidiary from consolidation

 

In addition to the valid reasons to exclude a subsidiary from consolidation considered earlier, directors of the parent entity may seek to exclude a subsidiary from group accounts for several invalid reasons, including:

 

• Long-term restrictions on the ability to transfer funds to the parent. This exclusion from consolidation is not permitted as it may still be possible to control a subsidiary in such circumstances.

 

• The subsidiary undertakes different activities and/or operates in different locations, thus being distinctive from other members of the group. This is not a valid reason for exclusion from consolidation.

Indeed it could be argued that inclusion within the group accounts of such a subsidiary will enhance the relevance and reliability of the information contained within the group accounts.

 

• The subsidiary has made losses or has significant liabilities which the directors would prefer to exclude from the group accounts to improve the overall reported financial performance and position of the group. This could be motivated, for example, by determination of directors’ remuneration based upon group financial performance. This is not a valid reason for exclusion from consolidation.

 

• The directors may seek to disguise the true ownership of the subsidiary, perhaps to avoid disclosure of particular activities or events, or to avoid disclosure of ownership of assets. This could be motivated, for example, by seeking to avoid disclosure of potential conflicts of interest which may be perceived adversely by users of financial statements.

 

 

• The directors may seek to exclude a subsidiary from consolidation in order for the group to disguise its true size and extent. This could be motivated, for example, by trying to avoid legal and regulatory compliance requirements applicable to the group or individual subsidiaries. This is not a valid reason for exclusion from consolidation.

 

 

 

5 The acquisition method

 

IFRS 3 applies to business combinations. A business combination is where an acquirer obtains control of a business.

 

IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable of being conducted and managed to provide a return in the form of dividends, lower costs, or other economic benefits’ benefits’ (IFRS 13, Appendix A). Therefore:

 

• if the assets acquired are not a business, the transaction should be accounted for as the purchase of an asset

 

• if the assets acquired do constitute a business, the transaction is accounted for by applying the acquisition method outlined in IFRS 3.

 

The acquisition method has the following requirements:

 

• Identifying the acquirer

 

• Determining the acquisition date

 

• Recognising and measuring the subsidiary’s identifiable assets and liabilities

 

• Recognising goodwill (or a gain from a bargain purchase) and any non-controlling interest.

 

Although you will be aware of many of these requirements from your previous studies, as well as from the illustrations earlier in this chapter, you are expected to have a more detailed knowledge of each of these elements for the P2 exam.

 

Identifying the acquirer

 

The acquirer is the entity that has assumed control over another entity.

 

In a business combination, it is normally clear which entity has assumed control.

 

The acquirer

 

Lyra pays $1 million to obtain 60% of the ordinary shares of Pan.

 

Lyra is the acquiring company.

 

 

 

However, sometimes it is not clear as to which entity is the acquirer. For these cases, IFRS 3 provides guidance:

 

• The acquirer is normally the entity that has transferred cash or other assets within the business combination

 

• If the business combination has not involved the transfer of cash or other assets, the acquirer is usually the entity that issues its equity interests.

 

Other factors to consider are as follows:

 

• The acquirer is usually the entity whose (former) management dominates the combined entity

 

• The acquirer is usually the entity whose owners have the largest portion of voting rights in the combined entity

 

• The acquirer is normally the bigger entity.

 

Test your understanding 2 – Identifying the acquirer

 

Abacus and Calculator are two public limited companies. The fair values of the net assets of these two companies are $100 million and $60 million respectively.

 

On 31 October 20X1, Abacus incorporates a new company, Phone, in order to effect the combination of Abacus and Calculator. Phone issues its shares to the shareholders of Abacus and Calculator in return for their equity interests.

 

After this, Phone is 60% owned by the former shareholders of Abacus and 40% owned by the former shareholders of Calculator. On the board of Phone are 4 of the former directors of Abacus and 2 of the former directors of Calculator.

 

Required:

 

With regards to the above business combination, identify the acquirer.

 

The acquisition date

 

The acquisition date is the date on which the acquirer obtains control over the acquiree. This will be the date at which goodwill must be calculated and from which the incomes and expenses of the acquiree will be consolidated.

 

Identifiable assets and liabilities

 

The acquirer must measure the identifiable assets acquired and the liabilities assumed at their fair values at the acquisition date.

 

Remember, when completing a consolidated statement of financial position, these fair value uplifts are adjusted in the net assets table (W2).

 

Goodwill in the subsidiary’s individual financial statements is not an identifiable asset because it cannot be separately disposed of.

 

Fair value of the identifiable net assets of the acquiree

 

Identifiable assets

 

IFRS 3 says that an asset is identifiable if:

 

• It is capable of disposal separately from the business owning it, or

 

• It arises from contractual or other legal rights, regardless of whether those rights can be sold separately.

 

The identifiable assets and liabilities of the subsidiary should be recognised at fair value where:

 

• they meet the definitions of assets and liabilities in the Conceptual Framework for Financial Reporting, and

 

• they are exchanged as part of the business combination rather than a separate transaction.

 

Items that are not identifiable or do not meet the definitions of assets or liabilities are subsumed into the calculation of purchased goodwill.

 

 

Contingent liabilities

 

Contingent liabilities that are present obligations arising from past events and that can be measured reliably are recognised at fair value at the acquisition date. This is true even where an economic outflow is not probable. The fair value will incorporate the probability of an economic outflow.

 

Provisions

 

A provision for future operating losses cannot be created as this is a post-acquisition item. Similarly, restructuring costs are only recognised to the extent that a liability actually exists at the date of acquisition.

 

Fair value – exceptions

 

There are some exceptions to the requirement to measure the subsidiary’s net assets at fair value when accounting for business combinations. Assets and liabilities falling within the scope of the following standards should be valued according to those standards:

 

• IAS 12 Income Taxes

 

• IAS 19

 

• IFRS 2 Share-based Payment

 

• IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

 

 

 

Test your understanding 3 – Fair value of identifiable net assets

 

P purchased 60% of the shares of S on 1 January 20X1. At the acquisition date, S had share capital of $10,000 and retained earnings of $190,000.

 

The property, plant and equipment of S includes land with a carrying value of $10,000 but a fair value of $50,000.

 

Included within the intangible assets of S is goodwill of $20,000 which arose on the purchase of the trade and assets of a sole-trader business. S has an internally generated brand that is not recognised (in accordance with IAS 38). The directors of P believe that this brand has a fair value of $150,000.

 

In accordance with IAS 37, the financial statements of S disclose the fact that a customer has initiated legal proceedings against them. If the customer wins, which lawyers have advised is unlikely, estimated damages would be $1m. The fair value of this contingent liability has been assessed as $100,000 at the acquisition date.

 

The directors of P wish to close one of the divisions of S. They estimate that this will cost $200,000 in redundancy payments.

 

Required:

 

What is the fair value of S’s identifiable net assets at the acquisition date?

 

 

 

Goodwill

 

Goodwill should be recognised on a business combination. This is calculated as the difference between:

 

• The aggregate of the fair value of the consideration transferred and the non-controlling interest in the acquiree at the acquisition date, and

 

• The fair value of the acquiree’s identifiable net assets and liabilities.

 

Purchase consideration

 

When calculating goodwill (W3), purchase consideration transferred to acquire control of the subsidiary must be measured at fair value.

 

When determining the fair value of the consideration transferred, remember that:

 

• Contingent consideration is included even if payment is not deemed probable. Its fair value will incorporate the probability of payment occurring.

 

• Acquisition costs are excluded from the calculation of purchase consideration.

 

– Legal and professional fees are expensed to profit or loss as incurred

 

– Debt or equity issue costs are accounted for in accordance with IFRS 9 Financial Instruments.

 

Contingent consideration

 

IFRS 3 says that contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests if specified future events occur or conditions are met.

 

In an examination question the acquisition date fair value of any contingent consideration (or details of how to calculate it) would be given.

 

The payment of contingent consideration may be in the form of equity or a liability (issuing a debt instrument or cash) and should be recorded as such under the rules of IAS 32 Financial Instruments: Presentation (or other applicable standard).

 

Changes in the fair value of any contingent consideration after the acquisition date are dealt with in IFRS 3.

 

• Changes due to additional information obtained after the acquisition date that affects the facts or circumstances as they existed at the acquisition date are accounted for retrospectively. This means that the liability (and goodwill) are remeasured. This further information must have been obtained within twelve months of the acquisition date.

 

• Changes due to events after the acquisition date (for example, meeting an earnings target which triggers a higher payment than was provided for at acquisition) are treated as follows:

 

– Contingent consideration classified as equity shall not be remeasured. Its subsequent settlement shall be accounted for within equity (e.g. Cr share capital/share premium Dr retained earnings).

 

– Contingent consideration classified as an asset or a liability shall be remeasured at fair value with the movement recognised in profit or loss.

 

Note: Although contingent consideration is usually a liability, it may be an asset if the acquirer has the right to a return of some of the consideration transferred if certain conditions are met.

 

 

 

Test your understanding 4 – Purchase consideration

 

Following on from TYU 3, the purchase consideration transferred by P in exchange for the shares in S was as follows:

 

• Cash paid of $300,000

 

• Cash to be paid in one year’s time of $200,000

 

 

• 10,000 shares in P. These had a nominal value of $1 and a fair value at 1 January 20X1 of $3 each

 

• $250,000 to be paid in one year’s time if S makes a profit before tax of more than $2m. There is a 50% chance of this happening. The fair value of this contingent consideration can be measured as the present value of the expected value.

 

Legal fees associated with the acquisition were $10,000.

 

Where required, a discount rate of 10% should be used.

 

Required:

 

Per IFRS 3, what is the fair value of the consideration transferred to acquire control of S?

 

 

 

Goodwill and the non-controlling interest

 

The calculation of goodwill will depend on the method chosen to value the non-controlling interest at the acquisition date.

 

IFRS 3 provides a choice in valuing the non-controlling interest at acquisition:

 

EITHER:                                                         OR:

 

 

Method 1 – The proportionate

 

share of net assets method

 

NCI % × Fair value of the net

 

assets of the subsidiary at the

acquisition date

 

 

Method 2 – The fair value method

 

Fair value of NCI at date of acquisition. This is usually given in the question.

 

 

 

If the NCI is valued at acquisition as their proportionate share of the acquisition net assets, then only the acquirer’s goodwill will be calculated.

 

• Where an exam question requires the use of this method, it will state that ‘it is group policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s identifiable net assets’.

 

If the NCI is valued at acquisition at fair value, then goodwill attributable to both the acquirer and the NCI will be calculated. This is known as the ‘full goodwill method’.

 

 

• Where an exam question requires the use of this method, it will state that ‘it is group policy to value the non-controlling interest using the full goodwill method’ or that ‘the non-controlling interest is measured at fair value’.

 

Test your understanding 5 – Goodwill

 

Following on from ‘Test your understandings’ 3 and 4, the fair value of the non-controlling interest at the acquisition date is $160,000.

 

Required:

 

Calculate the goodwill arising on the acquisition of S if the non-controlling interest at the acquisition date is valued at:

 

• fair value

 

• its proportion of the fair value of the subsidiary’s identifiable net assets.

 

 

Non-controlling interest – choice of method

 

The method used to measure the NCI should be decided on a transaction by transaction basis. This means that, within the same group, the NCI in some subsidiaries may have been measured at fair value at acquisition, whilst the NCI in other subsidiaries may have been measured at acquisition using the proportionate basis.

 

 

 

Measurement period

 

During the measurement period, IFRS 3 requires the acquirer in a business combination to retrospectively adjust the provisional amounts recognised at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date.

 

This would result in goodwill arising on acquisition being recalculated.

 

The measurement period ends no later than twelve months after the acquisition date.

 

Measurement period illustration

 

P bought 100% of the shares of S on 31 December 20X1 for $60,000. On the acquisition date, it was estimated that the fair value of S’s net assets were $40,000.

 

For the year ended 31 December 20X1, P would consolidate S’s net assets of $40,000 and would also show goodwill of $20,000 ($60,000 – $40,000).

 

However, P receives further information on 30 June 20X2 which indicates that the fair value of S’s net assets at the acquisition date was actually $50,000. This information was determined within the measurement period and so is retrospectively adjusted for.

 

Therefore, the financial statements for the year ended 31 December 20X1 will be adjusted. P will now consolidate S’s net assets of $50,000 and will show goodwill of $10,000 ($60,000 – $50,000).

 

 

 

Bargain purchases

 

If the share of net assets acquired exceeds the consideration given, then a gain on bargain purchase (‘negative goodwill’) arises on acquisition. The accounting treatment for this is as follows:

 

• IFRS 3 says that negative goodwill is rare and therefore it may mean that an error has been made in determining the fair values of the consideration and the net assets acquired. The figures must be reviewed for errors.

 

• If no errors have been made, the negative goodwill is credited immediately to profit or loss.

 

 

6 Impairment of goodwill

 

IAS 36 Impairment of Assets requires that goodwill is tested for impairment annually.

 

Goodwill does not generate independent cash inflows. Therefore, it is tested for impairment as part of a cash generating unit.

 

A cash generating unit is the ‘smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets’ (IAS 36, para 6).

 

For exam purposes, a subsidiary is normally designated as a cash generating unit.

 

Accounting for an impairment

 

An impairment loss is the amount by which the carrying amount of an asset or a cash generating unit exceeds its recoverable amount.

 

Recoverable amount is the higher of fair value less costs to sell and value in use.

 

Impairment losses on a subsidiary will firstly be allocated against goodwill and then against other assets on a pro-rata basis.

 

Accounting for an impairment with a non-controlling interest

 

Full method of valuing NCI

 

Goodwill calculated under the fair value method represents full goodwill. It can therefore be added together with the other net assets of the subsidiary and compared to the recoverable amount of the subsidiary’s net assets on a like for like basis.

 

Any impairment of goodwill is allocated between the group and the NCI based upon their respective shareholdings.

 

Proportionate method of valuing NCI

 

If the NCI is valued at acquisition at its share of the subsidiary’s net assets then only the goodwill attributable to the group is calculated. This means that the NCI share of goodwill is not reflected in the group accounts. As such, any comparison between the carrying amount of the subsidiary (including goodwill) and the recoverable amount of its net assets will not be on a like-for-like basis.

 

 

• In order to address this problem, goodwill must be grossed up to include goodwill attributable to the NCI prior to conducting the impairment review. This grossed up goodwill is known as total notional goodwill.

 

• As only the parent’s share of the goodwill is recognised in the group accounts, only the parent’s share of the goodwill impairment loss should be recognised.

 

Illustration 4 – Impairment of goodwill

 

A owns 80% of B. At 31 October 20X6 the carrying amount of B’s net assets is $60 million, excluding goodwill of $8 million that arose on the original acquisition.

 

The recoverable amount of the net assets of B is $64 million.

 

Calculate the impairment loss if:

 

• the NCI at acquisition was measured at fair value

 

• the NCI at acquisition was measured at its proportion of the fair value of the subsidiary’s identifiable net assets.

 

 

 

Solution

 

• Full goodwill method

 

	$m
Goodwill	8
Net assets	60
	––––
Carrying amount	68
Recoverable amount	64
	––––
Impairment	4
	––––

 

The impairment loss will be allocated against goodwill, reducing it from $8m to $4m.

 

The $4m impairment expense will be charged to profit or loss. Of this, $3.2m ($4m × 80%) is attributable to the group and $0.8m ($4m × 20%) is attributable to the NCI.

 

(b) Proportionate method
	$m	$m
Goodwill	8
Unrecognised NCI (20/80 × $8m)	2
Total notional goodwill	––––	10
Net assets		60
		––––
Carrying amount		70
Recoverable amount		64
		––––
Impairment		6
		––––

 

The impairment loss is allocated against the total notional goodwill.

 

Only the group’s share of goodwill has been recognised in the financial statements and so only the group’s share (80%) of the impairment is recognised. The impairment charged to profit or loss is therefore $4.8m and goodwill will be reduced to $3.2m ($8m – $4.8m).

 

 

 

Test your understanding 6 – Happy

 

On 1 January 20X5, Lucky group purchased 80% of Happy for $500,000. The fair value of the identifiable net assets of Happy at the date of acquisition amounted to $590,000.

 

The carrying amount of Happy’s net assets at 31 December is $520,000 (excluding goodwill). Happy is a cash-generating unit.

 

At 31 December 20X5 the recoverable amount of Happy’s net assets is $530,000.

 

Required:

 

Calculate the impairment loss and explain how this would be dealt with in the financial statements of the Lucky group. if:

 

• the NCI at acquisition was measured at its fair value of $130,000.

 

• the NCI at acquisition was measured at its share of the fair value of Happy’s identifiable net assets.

 

Impact on the financial statements

 

If goodwill is calculated using the fair value method (i.e. the non-controlling interest is valued at fair value at the acquisition date), then goodwill and the non-controlling interest will be higher than if the proportionate method was used. Although this will reduce the return on capital employed, it will also strengthen the gearing ratio.

 

The higher asset value reported when using the fair value method may lead to higher impairment losses being charged to profit or loss.

 

 

 

Test your understanding 7 – Pauline

 

On 1 April 20X7 Pauline acquired the following non-current investments:

 

• 6 million equity shares in Sonia by an exchange of two shares in Pauline for every four shares in Sonia plus $1.25 per acquired Sonia share in cash. The market price of each Pauline share at the date of acquisition was $6 and the market price of each Sonia share at the date of acquisition was $3.25.

 

• 30% of the equity shares of Arthur at a cost of $7.50 per share in cash.

 

Only the cash consideration of the above investments has been recorded by Pauline. In addition $1,000,000 of professional costs relating to the acquisition of Sonia is included in the cost of the investment.

 

The summarised draft statements of financial position of the three companies at 31 March 20X8 are presented below:

 

	Pauline	Sonia	Arthur
	$000	$000	$000
Assets
Non-current assets
Property, plant and	36,800	20,800	36,000
equipment
Investments in Sonia and	26,500	–	–
Arthur
Financial assets	13,000	–	–
	––––––	––––––	––––––
	76,300	20,800	36,000

 

 

Current assets
Inventories	13,800	12,400	7,200
Trade receivables	6,400	3,000	4,800
	––––––	––––––	––––––
Total assets	96,500	36,200	48,000
	––––––	––––––	––––––
Equity and liabilities
Equity shares of $1 each	20,000	8,000	8,000
Retained earnings
– at 31 March 20X7	32,000	12,000	22,000
– for year ended 31	18,500	5,800	10,000
March 20X8	––––––	––––––	––––––
Non-current liabilities	70,500	25,800	40,000
7% Loan notes	10,000	2,000	2,000
Current liabilities
Trade payables	16,000	8,400	6,000
	––––––	––––––	––––––
	96,500	36,200	48,000
	––––––	––––––	––––––

 

The following information is relevant to the preparation of the consolidated statement of financial position:

 

• At the date of acquisition Sonia had an internally generated brand name. The directors of Pauline estimate that this brand name has a fair value of $2 million, an indefinite life and has not suffered any impairment.

 

• On 1 April 20X7, Pauline sold an item of plant to Sonia at its agreed fair value of $5 million. Its carrying amount prior to the sale was $4 million. The estimated remaining life of the plant at the date of sale was five years.

 

• During the year ended 31 March 20X8 Sonia sold goods to Pauline for $5.4 million. Sonia had marked up these goods by 50% on cost. Pauline had a third of the goods still in its inventory at 31 March 20X8. There were no intra-group payables or receivables at 31 March 20X8.

 

 

• Pauline has a policy of valuing non-controlling interests at fair value at the date of acquisition. For this purpose the share price of Sonia at this date should be used. Impairment tests on 31 March 20X8 concluded that the recoverable amount of the net assets of Sonia were $34 million.

 

• The financial assets in Pauline’s statement of financial position are classified as fair value through profit or loss. In the draft financial statements, they are held at their fair value as at 1 April 20X7. They have a fair value of $18 million as at 31 March 20X8.

 

Required:

 

Prepare the consolidated statement of financial position for the Pauline group as at 31 March 20X8.

 

 

 

7 IFRS 11 – Joint arrangements

 

IFRS 11 Joint Arrangements adopts the definition of control as included in IFRS 10 (see earlier within this chapter) as a basis for determining whether there is joint control.

 

Joint arrangements are defined ‘as arrangements where two or more parties have joint control’ (IFRS 11, Appendix A). This will only apply if the

 

relevant activities require unanimous consent of those who collectively control the arrangement.

 

Joint arrangements may take the form of either:

 

• joint operations

 

• joint ventures.

 

The key distinction between the two forms is based upon the parties’ rights and obligations under the joint arrangement.

 

IFRS 11 Joint arrangements

 

Joint operations

 

Joint operations are defined as joint arrangements whereby ‘the parties that have joint control have rights to the assets and obligations for the liabilities’ (IFRS 11, Appendix A). Normally, there will not be a

 

separate entity established to conduct joint operations.

 

Example of a joint operation

 

A and B decide to enter into a joint operation to produce a new product. A undertakes one manufacturing process and B undertakes the other. A and B have agreed that decisions regarding the joint operation will be made unanimously and that each will bear their own expenses and take an agreed share of the sales revenue from the product.

 

Joint ventures

 

Joint ventures are defined as joint arrangements whereby ‘the parties have joint control of the arrangement and have rights to the net assets of the arrangement’ (IFRS 11, Appendix A). This will normally

 

be established in the form of a separate entity to conduct the joint venture activities.

 

Example of a joint venture

 

A and B decide to set up a separate entity, C, to enter into a joint venture. A will own 55% of the equity capital of C, with B owning the remaining 45%. A and B have agreed that decision-making regarding the joint venture will be unanimous. Neither party will have direct right to the assets, or direct obligation for the liabilities of the joint venture; instead, they will have an interest in the net assets of entity C set up for the joint venture.

 

 

 

Accounting for joint arrangements

 

Joint operations

 

If the joint operation meets the definition of a ‘business’ then the principles in IFRS 3 Business Combinations apply when an interest in a joint operation is acquired:

 

• Acquisition costs are expensed to profit or loss as incurred

 

• The identifiable assets and liabilities of the joint operation are measured at fair value

 

• The excess of the consideration transferred over the fair value of the net assets acquired is recognised as goodwill.

 

At the reporting date, the individual financial statements of each joint operator will recognise:

 

• its share of assets held jointly

 

• its share of liabilities incurred jointly

 

• its share of revenue from the joint operation

 

• its share of expenses from the joint operation.

 

The joint operator’s share of the income, expenses, assets and liabilities of the joint operation are included in its individual financial statements and so they will automatically flow through to the consolidated financial statements.

 

Joint ventures

 

In the individual financial statements, an investment in a joint venture can be accounted for:

 

• at cost

 

• in accordance with IFRS 9 Financial Instruments, or

 

• by using the equity method.

 

In the consolidated financial statements, the interest in the joint venture entity will be accounted for using the equity method. The treatment of a joint venture in the consolidated financial statements is therefore identical to the treatment of an associate.

 

 

 

Test your understanding 8 – A, B, C and D

 

A, B and C establish a new entity, which is called D. A has 50 per cent of the voting rights in the new entity, B has 30 per cent and C has 20 per cent. The contractual arrangement between A, B and C specifies that at least 75 per cent of the voting rights are required to make decisions about the activities of entity D.

 

Required:

 

How should A account for its investment in D in its consolidated financial statements?

 

 

Illustration 5 – Joint operation – Blast

 

Blast has a 30% share in a joint operation. The assets, liabilities, revenues and costs of the joint operation are apportioned on the basis of shareholdings. The following information relates to the joint arrangement activity for the year ended 30 November 20X2:

 

• The manufacturing facility cost $30m to construct and was completed on 1 December 20X1 and is to be dismantled at the end of its estimated useful life of 10 years. The present value of this dismantling cost to the joint arrangement at 1 December 20X1, using a discount rate of 8%, was $3m.

 

• During the year ended 30 November 20X2, the joint operation entered into the following transactions:

 

–   goods with a production cost of $36m were sold for $50m

 

–   other operating costs incurred amounted to $1m

 

–   administration expenses incurred amounted to $2m.

 

 

Blast has only accounted for its share of the cost of the manufacturing facility, amounting to $9m. The revenue and costs are receivable and payable by the two other joint operation partners who will settle amounts outstanding with Blast after each reporting date.

 

Required:

 

Show how Blast will account for the joint operation within its financial statements for the year ended 30 November 20X2.

 

 

 

Solution – Blast

 

Profit or loss impact:	$m
Revenue ($50m × 30%)	15.000
Cost of sales ($36m × 30%)	(10.800)
Operating costs ($1m × 30%)	(0.300)
Depreciation (($30m + 3m) × 1/10 × 30%)	(0.990)
Administration expenses ($2m × 30%)	(0.600)
Finance cost ($3m × 8% × 30%)	(0.072)
	–––––
Share of net profit re joint operation (include in retained	2.238
earnings within SOFP)	–––––

 

 

Statement of financial position impact:	$m
Property, plant and equipment (amount paid = share of cost)	9.000
Dismantling cost ($3m × 30%)	0.900
Depreciation ($33m × 1/10 × 30%)	(0.990)
	–––––
	8.910
	–––––
Trade receivables (i.e. share of revenue due)	15.000
Non-current liabilities:	–––––
Dismantling provision (($3m × 30%) + $0.072)	0.972
Current liabilities:	–––––
Trade payables ($10.8m + $0.3m + $0.6m) (i.e. share of	11.700
expenses to pay)	–––––

 

The amounts calculated above should be classified under the appropriate headings within the statement of profit or loss for the year or statement of financial position as appropriate.

 

Note also that where there are amounts owed to and from a joint operating partner, it may be acceptable to show just a net amount due to or from each partner.

 

 

 

8 Other issues in group accounting

 

 

IFRS 12 Disclosure of Interests in Other Entities

 

IFRS 12 is the single source of disclosure requirements for business combinations. Disclosure requirements include:

 

• disclosure of significant assumptions and judgements made in determining whether an investor has control, joint control or significant influence over an investee

 

• disclosure of the nature, extent and financial effects of its interests in joint arrangements and associates

 

• additional disclosures relating to subsidiaries with non-controlling interests, joint arrangements and associates that are individually material

 

• significant restrictions on the ability of the parent to access and use the assets or to settle the liabilities of its subsidiaries

 

• extended disclosures relating to “structured entities”, previously referred to as special-purpose entities, to enable a full understanding of the nature of the arrangement and associated risks, such as the terms on which an investor may be required to provide financial support to such an entity.

 

 

 

IAS 27 Separate Financial Statements

 

IAS 27 applies when an entity has interests in subsidiaries, joint ventures or associates and either elects to, or is required to, prepare separate non-consolidated financial statements.

 

In separate financial statements, investments in subsidiaries, joint ventures or associates can be accounted for:

 

• at cost

 

• in accordance with IFRS 9 Financial Instruments, or

 

• by using the equity method.

 

In separate financial statements, dividends received from an investment are recognised in profit or loss unless the equity method is used. If the equity method has been used, then dividends received reduce the carrying amount of the investment.

 

 

Current issues – proposed amendments

 

The following exposure draft, relating to group accounting issues, is examinable in P2.

 

ED/2014/4 Measuring Quoted Investments in Subsidiaries, Joint Ventures and Associates at Fair Value

 

There are instances when investments in a subsidiary, joint venture or associate are required to be measured at fair value. For example:

 

• Investment entities do not consolidate entities over which they have control but instead measure them at fair value through profit or loss

 

• Investments in subsidiaries, joint ventures or associates may be held at fair value in individual (non-consolidated) financial statements.

 

Some users of IFRS Standards are unsure how fair value should be determined in these instances. The Board therefore wish to clarify that the fair value for quoted investments in subsidiaries, joint ventures and associates should be determined by multiplying the quoted price by the number of shares held.

 

 

 

Current issues – criticisms of IFRS 3

 

The Board has conducted a post-implementation review of IFRS 3 Business Combinations. Users of the standard raised the following issues.

 

Definition of a business

 

• More guidance is needed on when an asset acquisition is not a business.

 

• Some industries might consider a set of assets to be a business, whereas others might not. This limits comparability, because of the large differences between accounting for asset purchases and accounting for business combinations.

 

• Based on the difficulties involved in establishing whether a ‘business’ has been acquired, some have argued that the differences in the accounting treatment of asset purchases and business combinations are not justified and should be reduced.

 

Fair values

 

• The requirement to fair value the assets and liabilities of the acquired subsidiary at the acquisition date makes it difficult to compare entities that grow via acquisitions with those that grow organically.

 

• Recognising the inventory of a subsidiary at its acquisition date fair value will reduce profit margins in the next period, thus reducing comparability year-on-year.

 

Intangibles

 

• IFRS 3 requires entities to recognise separable intangibles at fair value at the acquisition date, but this proves difficult if no active market exists.

 

Contingent consideration

 

• The calculation of the fair value of contingent consideration is extremely subjective, increasing the risk of bias and reducing comparability.

 

• Contingent consideration may be linked to the success of a long-term development project. It has been argued that changes in the fair value of the consideration in such scenarios should be recorded against the development asset, rather than in profit or loss.

 

Goodwill

 

• Some have argued that a gain on a bargain purchase should not be recognised in profit or loss, but rather in other comprehensive income, because it distorts the performance profile of an entity.

 

• It is argued that goodwill impairment reviews are complex, subjective and time-consuming.

 

• It has been argued that the requirement to subject goodwill to annual impairment reviews, rather than to amortise it, increases volatility in profit or loss.

 

• Over time, purchased goodwill will be replaced by internally generated goodwill. Per IAS 38 Intangible Assets, internally generated goodwill should not be recognised as an asset and so some argue that the purchased goodwill should be amortised (rather than be subject to annual impairment review).

 

NCI

 

• Allowing a measurement choice for the NCI at acquisition reduces comparability between entities.

 

• Measuring the fair value of the NCI can be problematic, and highly judgemental, if the entity is not listed.

Test your understanding answers

 

 

Test your understanding 1 – Control

 

An investor controls an investee if the investor has:

 

• ‘power over the investee

 

• exposure, or rights, to variable returns from its involvement with the investee

 

• the ability to use its power over the investee to affect the amount of the investor’s returns’ (IFRS 10, para 7).

 

When assessing control, an investor considers its potential voting rights. Potential voting rights are rights to obtain voting rights of an investee, such as those arising from convertible instruments or options.

 

Potential voting rights are considered if the rights are substantive. This would mean that the rights need to be currently exercisable. Other factors that should be considered in determining whether potential voting rights are substantive, according to IFRS 10, include:

 

• whether the exercise price creates a financial barrier that would prevent (or deter) the holder from exercising its rights

 

• whether the party or parties that hold the rights would benefit from the exercise of those rights.

 

Parsley has voting rights that are currently exercisable and these should be factored into an assessment of whether control exists. The fact that the exercise price on the convertible instrument is out of the money (i.e. the exercise price is higher than the current market price) could potentially deter Parsley from taking up these voting rights. However, these options are not deeply out of the money. This may also be compensated by the fact that synergies would arise on the acquisition. This would suggest that it is likely that Parsley will exercise the options. The potential voting rights should therefore be considered substantive.

 

Based on the above, Parsley has control over Oregano. Oregano should be treated as a subsidiary and consolidated.

 

Test your understanding 2 – Identifying the acquirer

 

If the business combination has not involved the transfer of cash or other assets, the acquirer is usually the entity that issues its equity interests. This might point towards Phone being the acquirer, since Phone has issued shares in exchange for the shares of Abacus and Calculator.

 

However, other circumstances must be considered:

 

• The acquirer is usually the entity whose (former) management dominates the management of the combined entity.

 

• The acquirer is usually the entities whose owners retain or receive the largest portion of the voting rights in the combined entity.

 

• The acquirer is normally the entity whose size is greater than the other entities.

 

All three of these circumstances would point towards Abacus being the acquirer. This would appear to reflect the substance of the transaction since Phone has been incorporated by Abacus as a way of enabling a business combination with Calculator.

 

 

 

Test your understanding 3 – Fair value of identifiable net assets

 

	$
Share capital	10,000
Retained earnings	190,000
Fair value uplift ($50,000 – $10,000)	40,000
Goodwill	(20,000)
Brand	150,000
Contingent liability	(100,000)
Fair value of identifiable net assets at acquisition	–––––––
	270,000
	–––––––

 

Goodwill in the subsidiary’s own financial statements is not an identifiable asset because it cannot be disposed of separately from the rest of the business.

 

No adjustment is made to the fair value of the net assets for the estimated redundancy provision. This is because no obligation exists at the acquisition date.

 

Test your understanding 4 – Purchase consideration

 

	$
Cash paid	300,000
Deferred cash ($200,000 × (1/1.1))	181,818
Shares (10,000 × $3)	30,000
Contingent consideration ($250,000 × 50% × (1/1.1))	113,636
Fair value of consideration	–––––––
	625,454
	–––––––

 

The legal fees are expensed to the statement of profit or loss.

 

Test your understanding 5 – Goodwill

 

	Fair value	Net assets
	method	method
	$	$
Consideration (TYU 4)	625,454	625,454
Add: NCI at acquisition	160,000	108,000
(part b = 40% × $270,000)	–––––––	–––––––
	785,454	733,454
FV of identifiable net assets at	(270,000)	(270,000)
acquisition (TYU 3)	–––––––	–––––––
	515,454	463,454
	–––––––	–––––––

 

The fair value method calculates both the group’s goodwill and the goodwill attributable to the non-controlling interest. Therefore, goodwill is higher under this method.

 

The proportion of net assets method only calculates the goodwill attributable to the group. Goodwill is lower under this method.

 

Test your understanding 6 – Happy

 

(a) Full goodwill method
Goodwill arising on acquisition:	$000
Fair value of consideration paid	500
NCI at acquisition	130
	–––––
	630
Less: fair value of net assets at	(590)
acquisition	–––––
Goodwill	40
	–––––
Impairment review:
	$000
Goodwill	40
Net assets	520
	––––
Carrying amount	560
Recoverable amount	(530)
	––––
Impairment	30
	––––

 

The impairment loss is allocated against goodwill, reducing it from $40,000 to $10,000.

 

The $30,000 impairment expense will be charged to the statement of profit or loss. Of this, $24,000 (80% × $30,000) is attributable to the group and $6,000 (20% × $30,000) is attributable to the NCI.

 

(b) Proportionate method
Goodwill arising on acquisition:		$000
Fair value of consideration paid		500
NCI share of net assets at acquisition (20% × $590,000)		118
	–––––
		618
Less: fair value of net assets at acquisition		(590)
	–––––
Goodwill		28
Impairment review:	–––––
$000		$000
Goodwill	28
Unrecognised NCI (20/80 × $28,000)	7
––––
Total notional goodwill		35
Net assets		520
		––––
Carrying amount		555
Recoverable amount		(530)
		––––
Impairment		25
		––––

 

The impairment loss is firstly allocated to the notional goodwill. However, only the group’s share of the goodwill was recognised in the financial statements and so only the group’s share of the impairment is recognised.

 

The total impairment recognised is therefore $20,000 (80% × $25,000). This will be charged to the statement of profit or loss and is all attributable to the group.

 

Test your understanding 7 – Pauline

 

Consolidated statement of financial position as at 31 March 20X8

 

Assets	$000
Non-current assets
Property, plant and equipment	56,800
($36,800 + $20,800 – $800 (W8))
Goodwill (W3)	6,800
Intangible assets (W2)	2,000
Investment in associate (W6)	21,000
Financial assets (W9)	18,000
	–––––––
Current assets	104,600
Inventories ($13,800 + $12,400 – $600 (W7))	25,600
Trade receivables ($6,400 + $3,000)	9,400
	–––––––
Total assets	139,600
Equity and liabilities	–––––––
Equity attributable to equity holders of the parent
Equity shares of $1 each ($20,000 + $3,000 (W3))	23,000
Share premium (W3)	15,000
Retained earnings (W5)	58,200
	–––––––
	96,200
Non-controlling interest (W4)	7,000
	–––––––
Total equity	103,200
Non-current liabilities
7% Loan notes ($10,000 + $2,000)	12,000
Current liabilities
Trade payables ($16,000 + $8,400)	24,400
Total equity and liabilities	–––––––
	139,600
	–––––––

 

Workings

 

(W1) Group structure

(W2) Net assets – Sonia
At acquisition date		At reporting date
	$000	$000
Equity capital	8,000	8,000
Retained earnings	12,000	17,800
Fair value adj:
Brand	2,000	2,000
PURP (W7)		(600)
	–––––––	–––––––
	22,000	27,200
	–––––––	–––––––
(W3) Goodwill
		Sonia
Fair value of consideration		$000
Share exchange (6m × 2/4 × $6)		18,000
Cash paid (6m × $1.25)		7,500
		–––––––
		25,500
FV of NCI at acquisition (2m × $3.25)		6,500
		–––––––
		32,000
Less FV of net assets at acquisition (W2)		(22,000)
Goodwill at acquisition		–––––––
		10,000
Impairment (W10)		(3,200)
		–––––––
Goodwill at reporting date		6,800
		–––––––

 

The 3 million shares issued by Pauline in the share exchange at a value of $6 each would be recorded as $1 per share in equity capital and $5 per share in share premium. This gives an increase in equity capital of $3 million and a share premium of $15 million.

 

(W4) NCI
	$000
Fair value of NCI at acquisition (W3)	6,500
NCI share of post-acquisition net asset movement
(25% × ($27,200 – $22,000)) (W2)	1,300
NCI share of goodwill impairment	(800)
(25% × $3,200) (W10)	––––––
	7,000
	––––––
(W5) Group retained earnings
	$000
100% of Pauline’s retained earnings ($32,000 + $18,500)	50,500
Professional costs written off	(1,000)
Gain on financial assets (W9)	5,000
P% of Sonia’s post-acquisition retained earnings**
(75% × (($17,800 – $600) – $12,000) (W2))	3,900
P% of Arthur’s post-acquisition retained earnings
(30% × $10,000)	3,000
PPE PURP (W8)	(800)
P% of goodwill impairment	(2,400)
(75% × $3,200) (W10)	–––––––
	58,200
	–––––––

 

• It is worth noting that, if the subsidiary has no ‘other components of equity’, then you could simply take P’s share of the subsidiary’s post-acquisition net assets movement:

 

75% × ($27,200 – $22,000 (W2)) = $3,900.
(W6) Investment in associate	$000
Cost (8,000 × 30% × $7.50)	18,000
P’s share post-acquisition reserves ($10,000 × 30%)	3,000
	–––––––

21,000

 

–––––––

 

(W7) PURP in inventory

 

Intra-group sales are $5.4 million on which Sonia made a profit of $1,800,000 ($5,400,000 × 50/150).

 

The unrealised profit still in inventory is therefore $600,000 ($1,800,000 × 1/3).

 

Sonia is the seller so the profit must be removed from Sonia’s retained earnings in W2.

 

The adjusting entry is:
Dr Retained earnings (W2)	$600,000
Cr Inventories	$600,000

 

(W8) PURP in PPE

 

The carrying amount of the PPE is $4m ($5m – ($5m/5 years)).

 

If no group transfer had happened, then the carrying amount would have been $3.2m ($4m – ($4m/5 years).

 

PPE must therefore be reduced by $800,000 ($4m – $3.2m). Pauline is the seller so the profit impact must be adjusted against Pauline’s retained earnings in W5. The adjusting entry is:

 

Dr Retained earnings (W5)	$800,000
Cr PPE	$800,000

 

(W9) Financial assets

 

The financial assets must be remeasured to fair value and the gain recorded through profit or loss.

 

The gain on revaluation to fair value is $5m ($18m – $13m). This will be recorded in profit or loss and will increase group retained earnings in W5.

 

 

(W10) Impairment
	$000
Goodwill (W3)	10,000
Net assets (W2)	27,200
	––––––
Carrying amount	37,200
Recoverable amount	(34,000)
	––––––
Impairment	3,200
	––––––

 

The impairment loss will be charged against goodwill.

 

Full goodwill has been calculated so the impairment expense must be allocated between the NCI (W4) and retained earnings (W5).

 

Test your understanding 8 – A, B, C and D

 

A does not control the arrangement because it needs the agreement of B when making decisions. This would imply that A and B have joint control of the arrangement because decisions about the activities of the entity cannot be made without both A and B agreeing.

 

In the consolidated financial statements of the A Group, D should be treated as a joint venture. This is because it is a separate entity over which A has joint control. The joint venture will be accounted for using the equity method.