Accounting for Groups at the Date of Acquisition

1
Chapter 22
Accounting forGroups at the Date of Acquisition
2
Main purpose
The main purpose of this chapter is to explain
the reasons for preparing consolidated financial
statements at the date of acquisition and to show
how to prepare such statements.
3
Objectives

• By the end of this chapter, you should be able
  to
• explain the need for consolidated financial
  statements
• define the meaning of IFRS 10 terms control and
  subsidiary
• prepare consolidated accounts at the date of
  acquisition and calculate goodwill for a
  wholly-owned subsidiary
• explain the treatment of goodwill
• account for non-controlling interests under the
  two options available in IFRS 3
• understand the need for fair value adjustments
  and prepare consolidated financial statements
  reflecting such adjustments.

4
Accounting for groups atdate of acquisition

• Definition of a group under IFRS 10
• Definition of control
• rights to variable returns
• ability to affect those returns
• through power over the investee
• Reasons for preparing consolidated accounts.

5
Definition of a group

• One enterprise controls another enterprise
• Directly
• Indirectly.

6
Control considerations

• Control assumed if gt 50 of voting rights
• Control may exist where lt 50.

7
Control may exist where lt 50voting rights

• Agreement with other investors gives power
• over gt 50
• Power over financial and operating policiesby an
  agreement
• Power to appoint or remove majority of board
  members
• Power to cast the majority of votes at a board
  meeting.

8
Reasons for preparingconsolidated accounts

• Because many corporations have controlling
  interests in other business entities, financial
  statements for the parent company alone can be
  misleading. For this reason, parent companies are
  legally required to prepare consolidated
  financial statements that include data about the
  financial performance of subsidiaries
• Prevent manipulation
• Inflating sales by selling within the group
• More meaningful EPS figure
• Better measurement of management performance
  using ROCE.

9
Alternative methods of preparing consolidated
accounts

• The purchase method
• Fair value of parent companys investment
• Fair value of identifiable net assets in
  subsidiary
• Difference is goodwill
• Pooling of interests method
• No longer permitted under IFRS 3.

10
Purchase method illustrated the Rose group

• 1 January 20X0
• Rose plc acquired 100 of 10,000 1 common shares
  in Tulip plc for 1.50 per share.
• In calculating the cost of the resources
  acquired, remember the accounting equation,
• A L E,
• Or A L E, where A - L net assets

11
The Rose group statement of financial position on
acquisition

• Rose has bought the Equity in Tulip, which is
  represented by Tulips net assets.
• Tulips equity is 14,000, and the amount paid
  was 10,000 x 1.50 15,000

12
The Rose group statement of financial position on
acquisition (Continued)
13
The Rose group statement of financial position on
acquisition (Continued)

• Why do you think the share capital and retained
  earnings of Tulip are not added to the balance
  sheet of the group (combined companies)?
• Answer
• The value of the equity has already been included
  in the value of the assets and liabilities
  acquired.

14
Treatment of goodwill

• Positive goodwill
• Impairment test in accordance with IAS 36
• Must be done yearly
• Once applied, it cannot be reversed in a
  subsequent accounting period
• Negative goodwill
• Recognise immediately in Income Statement under
  IFRS 3.
• Why does negative goodwill occur?
• Errors in measuring fair values of acquired
  company
• Recognition of future costs to be incurred
• Purchased at a bargain price

15
Non-controlling interests

• Share of acquired company not held (owned) by
  parent
• Non-controlling also called minority interest
• All assets and liabilities controlled are
  included in the consolidated accounts
• Non-controlling interest amount not owned by
  parent.

16
Non-controlling interest in consolidated
statement of financial position

• Method 1
• Share of net assets of subsidiary at reporting
  date
• Method 2
• Share of net assets of subsidiary PLUS goodwill
  apportioned to the non-controlling interest.

17
The Bird group

• 1 January 20X0
• Bird acquired 80 of 10,000 1 common shares in
  Flower for 1.50 per share.
• Therefore, Bird will own 80 of 10,000 shares
  8,000 shares, which represent 80 of Flowers
  equity.
• The cost of these shares is
• 8,000 x 1.50 12,000

18
Bird group statement of financial position on
acquisition
19
Bird group statement of financial position on
acquisition (Continued)
20
Bird group statement of financial position on
acquisition (Continued)
21
Non-controlling interest using method 2

• If using Method 2 to measure the non-controlling
  interest, we need to know the fair value of the
  non-controlling interest in the subsidiary at the
  date of acquisition. Let us assume in this case
  that this fair value is 2,900
• Goodwill that is attributed to the
  non-controlling interest is as follows

22
The consolidated statement of financial position
using method 2
23
Treatment fair value andbook value differ (IFRS
3)

• Assume Flowers non-current assets were
• Book value 11,000
• Fair value 11,600
• Recognise parents
• 80 of (11,600 - 11,000) 480
• Increase non-current assets
• Reduce goodwill.

24
Fair value and book value differ (Continued)
25
Fair value and book value differ (Continued)
26
How to calculate fair values IFRS 3

• Tangible assets
• Fair Value based on market value
• Depreciated replacement cost if no market value
  available
• Intangible assets
• Fair Value based on market value
• Best arms-length estimate if no market value.

27
How to calculate fair values IFRS 3 (Continued)

• Inventories
• Finished goods
• Selling price less cost of sale and reasonable
  profit
• Work-in-progress
• Selling price less cost to complete, cost of sale
  and reasonable profit
• Raw materials
• Current replacement cost.

28
How to calculate fair values IFRS 3 (Continued)

• Monetary assets and liabilities
• Amount to be received or disbursed
• Discounted if significant
• Marketable securities
• Current market values
• Non-marketable securities
• Estimated value based on performance.

29
IFRS 13

• Fair Value Measurement
• price in an orderly transaction
• between market participants.

30
Review questions

• Explain how negative goodwill may arise and its
  accounting treatment.
• Explain how the fair value is calculated for
• Tangible non-current assets
• Inventories
• Monetary assets.
• Explain why only the net assets of the subsidiary
  and not those of the parent are adjusted to fair
  value at the date of acquisition for the purpose
  of consolidated accounts.

31
Review questions (Continued)

• Coil SA/NV is a company incorporated under the
  laws of Belgium. Its accounts are IAS compliant.
  It states in its 2003 accounts (in accordance
  with IAS 27, para. 13)
• Principles of consolidation
• The consolidated Financial statements include
  all subsidiaries which are controlled by the
  Parent Company, unless such control is assumed to
  be temporary or due to long-term restrictions
  significantly impairing a subsidiarys ability to
  transfer funds to the Parent Company.
• Required Discuss whether these are acceptable
  reasons for excluding a subsidiary from the
  consolidated financial statements under the
  revised IAS 27.

32
Review questions (Continued)

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