Chapter 12 - Group accounts: Basic principles Flashcards
What international accounting standards are we concerned with in this chapter?
- IFRS3 - Business Combinations
What is a group?
A group is created where one company, the parent (P) buys shares in another company, the subsidiary (S), such that the parent company controls the subsidiary. A group may include one or many subsidiaries
Define the single entity concept
It refers to the idea that a group of companies, typically comprising a parent company and its subsidiaries, should be treated as a single economic entity when preparing consolidated financial statements.
When a parent company owns controlling interests in one or more subsidiaries, the financial statements of the entire group are consolidated as if they belong to a single entity. This ensures that the consolidated financial statements present a unified picture of the group’s financial position and performance, eliminating intra-group transactions to avoid double counting.
What are the three types of investments that are considered under IFRS3?
Under IFRS 3 – Business Combinations, three key types of investments are considered based on the level of control or influence that the investor has over the investee:
* Subsidiary
* Associate
* Investment
What is the definition of a ‘subsidiary’, the criteria for recognition and the type of accounting method used to account for them?
A subsidiary is defined as an entity that is controlled by another entity, referred to as the parent.
An entity is recognised as a subsidiary if the acquirer has control over the acquiree - generally presumed when the investor holds over 50% of the voting power of the investee
To account for subsidiaries we use the consolidation method
What is the definition of ‘control’?
Control means the ability to govern the financial and operating policies of an entity with a view to gaining economic benefit from its activities.
IFRS 10 Consolidated financial statements states that an investor controls an investee if it has:
* Power over the investee (whether or not it is exercised), and
* Exposure, or rights, to variable returns from the investee, and
* The ability to use its power over the investee to affect the amount of the returns
Under what circumstances is an acquirer considered to control another entity, the acquiree?
The acquirer (parent) gains control over an acquiree (subsidiary) usually by acquiring more than half of the voting rights (>50%).
Control also exists where the parent:
* Has power over a majority of the voting rights, through an agreement with others
* Can govern the financial and operating policies of the subsidiary under statute or agreement
* Can appoint or remove the majority of the members of the board of directors (or equivalent top management) of the subsidiary, or
* Can cast the majority of votes at the subsidiary’s board meetings.
i.e. control does not always mean >50% of the shares
What is the definition of a ‘associate’, the criteria for recognition and the type of accounting method used to account for them?
An associate is an entity over which an investor has significant influence, but not control or joint control.
An entity is recognised as an associate if the acquirer has significant influence over the acquiree - generally presumed when the investor holds between 20% and 50% of the voting power of the investee
To account for subsidiaries we use the equity method
What is the definition of ‘significant influence’?
Significant influence is the power to participate in the financial and operating policy decisions of an investee but not control or jointly control those policies. It allows the investor to affect the investee’s strategic decisions but without exercising full control over its operations.
What is the definition of a ‘investment’, the criteria for recognition and the type of accounting method used to account for them?
Investments in other entities are assets held for accretion of wealth.
They are recognised as investments if they holding them does not grant signficant influence or control over the entity - generally presumed when the investor holds less tha 20% of the voting power of the investee
To account for subsidiaries we use the cost method - valued at cost
According to IFRS3, what is the definition of a ‘non-controlling interest’?
Non-Controlling Interest (NCI) is defined in IFRS 10 – Consolidated Financial Statements as the portion of equity in a subsidiary that is not attributable to the parent company. It represents the ownership interests in a subsidiary held by shareholders who do not have control over the subsidiary.
This is only applicable for non-wholly owned subsidiaries
Under IFRS3, how should the value of ‘non-controlling interest at acquisition’ be measured?
IFRS3 allows two methods of measuring the non-controlling interest at acquisition:
* At the NCI’s share of the acquiree’s net assets (proportionate basis) - shareholding %
* At fair value (which will then be given in the question). This method results in the non-controlling interest recognising a proportion of goodwill at acquisition.
Each business combination is treated separately, so the choice in respect of one acquisition is not binding for subsequent combinations - i.e. an entity can value the NCI of two subsidiaries using one method for one and one method for the other
Under IFRS3, what is the definition of ‘goodwill’?
Under IFRS 3, goodwill is defined as an intangible asset, recognised in the SOFP, that arises when a parent company acquires a subsidiary for a price greater than the fair value of the identifiable net assets (assets minus liabilities) of the acquired entity.
In essence, goodwill represents the future economic benefits that cannot be separately identified or recognized as individual assets, such as brand reputation, customer relationships, employee expertise, and synergies from combining the businesses.
Under IFRS3, what is the definition of ‘a gain on a bargain purchase’?
Under IFRS 3 , a gain on a bargain purchase (also known as negative goodwill) occurs when a parent company acquires a subsidiary for a price less than the fair value of the identifiable net assets (assets minus liabilities) of the acquired entity.
Outline the calculation for the value of goodwill/bargain purchase
Under IFRS3, how should the value of a gain on a bargain purchase be initially recognised? (do not outline the method to work out goodwill)
Goodwill is valued at the consideration paid for acquisition plus the non-controlling interest (NCI) at acquision less the fair value of net assets acquired - this will give a positive figure
Goodwill is recognised as an intangible asset in the SOFP
Under IFRS3, how should the value of goodwill be initially recognised? (do not outline the method to work out goodwill)
A gain on a bargain purchase is valued at the consideration paid for acquisition plus the non-controlling interest (NCI) at acquision less the fair value of net assets acquired - this will give a negative figure
A gain on a bargain purchase is recognised as income in the SOPOL in the period in which the acquisition is made, and retained earnings will therefore increase
What types of consideration are typically involved in a business acquisition and how should they be accounted for in the calculation of goodwill? Additionally, how should these considerations be treated after the fact?
1. Cash
- At Acquisition: Fair value = amount of cash paid.
- After Acquisition: Not applicable (n/a).
2. Equity Instruments (e.g. shares in parent company)
- At Acquisition: Fair value = published price of quoted shares on date of exchange.
- After Acquisition: n/a.
3. Deferred Consideration (definite future cash payment)
- At Acquisition: Fair value = discounted present value of future payment.
- After Acquisition: Liability increases as discount unwinds → creates a finance cost in parent company.
4. Contingent Consideration (future cash payment dependent on conditions)
- At Acquisition: Fair value = includes probability of payment + time value of money.
- After Acquisition: Adjust liability for changes in fair value, post-acquisition. → Reflected in profit or loss of parent company.
How are the identifiable assets and liabilities of a subsidiary recognised and measured at the acquisition date?
General Rule:
All identifiable assets and liabilities must be recognised at their fair value on the acquisition date, even if previously unrecognised by the subsidiary.
1. Tangible & Other Non-Intangible Assets (e.g. land, buildings):
- Recognised if probable that future economic benefits will flow to the acquirer.
- Must be measurable reliably at fair value.
2. Intangible Assets (IAS 38):
- Recognised if identifiable and fair value is measurable reliably.
3. Liabilities (excluding contingent):
- Recognised if probable outflow of economic resources and reliably measurable.
- Only liabilities existing at acquisition date are recognised.
- Excludes: - Reorganisation plans (post-acquisition) - Future losses due to combination
4. Contingent Liabilities:
- Recognised if a present obligation from a past event exists and fair value is measurable reliably.
