Financial Accounting and Reporting Consolidation

Question 1

Acquisition ( Take over )

Answer 1

A company may be acquired by another company. The company being acquired would continue to exist (keep its assets and liabilities)

A                    P(A)
---------------->    |
B                    S(B)

Question 2

Merger

Answer 2

This is when a new company may be formed in order to absorb one or more existing companies (physically take over the assets and liabilities of the company absorbed)
A
—————–> A + B
B

Question 3

Investments

Answer 3

Acquisition of shares in another company

A - - - - - - - > B

Formation of a new company to acquire shares of other entities

         New P 
        /            \
      /                \
 S(A)              S(B)

Question 4

Why do entities invest?

Answer 4

For growth reasons,
To prevent take-overs,
Synergies,
To acquire new sources of supply,
To reduce competition.

Question 5

What Constitutes a Group?

Answer 5

According to IFRS 10, a group exists where one company CONTROLS, either directly or indirectly another company.

Question 6

Establishing control

Answer 6

when control exists the parent has power over the subsidiary.
Power arises from rights and control is assumed when the parent owns >50% of the voting power of the entity.

Question 7

Reporting group accounts

Answer 7

Group accounts are reported by the parent company to show the group as a single economic entity.
IFRS 3 allows only the acquisition method to produce consolidated financial statements, which take account of control and ownership.
Acquisition method is also known as the full line consolidation method or consolidation method.

Question 8

Why are group accounts required?

Answer 8

Investor protection - prevents misleading information in accounts
Prediction - provides a more meaningful EPS figure.
Accountability - provides a better measurement of the performance of a parents management e.g a groups ROCE can be calculated.

Question 9

Presentation of Consolidated Financial Statements

Answer 9

1. Wholly owned subsidiaries :
   The parent owns all the issued shares.
   The ownership interest of the parent in the subsidiary maybe acquired as a result of a single transaction or several different transactions.
2. Partially owned subsidiaries :
   The parent owns less that all the issued shares of the subsidiary
   There is a non-controlling interest (NCI)

Question 10

Example: Basic Consolidation (Parents own 100% of subsidiary) (Proforma)

Answer 10

At acquisition date (£000) workings
Investment —
Other non-current assets XXX (Both parent and subsidiary added together)
Total Assets XXX

Equity
Ordinary shares XXX
Retained earnings XXX
Liabilities XXX (Both parents and subs liab added together)
Total equity and Liab XXX

Question 11

Example: Parent only owns part of a subsidiary (Finding out how much they own)

Answer 11

First you need to work out how much of the subsidiary the parent owns E.g - Parent purchased 600,000 shares in the subsidiary, out of 750,000 issued shares.
600,000 / 750,000 = 80%
As 80% > 50% the parent has control and a group exists.
The parent does not own the other 150,000 shares so this is the Non-controlling interest. (NCI)

Question 12

Example: Parent only owns part of a subsidiary ( Consolidation ) ( 80% Ownership)

Answer 12

Analysis of equity:
Equity in sub(100%) Parents portion of acqn (80%) NCI(20%)
Ordinary shares XXX XXX XXX
RE at acqn XXX XXX XXX
Total XXX XXX XXX

Parents portion of acquisition is cancelled against parents cost of investment in subsidiary consolidation process

Question 13

Example: Parent only owns part of a subsidiary ( Solution Proforma ) ( 80% Ownership)

Answer 13

At acqn date (£000) Workings
Investment –
Other NCA XXX (Both parent and subsidiary NCA added together)
Total Assets XXX
Equity:
Ordinary shares XXX
Retained earnings XXX
Group equity XXX
NCI XXX
Liabilities XXX ( Both parent and subsidiary Laib added together)

Question 14

Goodwill

Answer 14

Goodwill is an intangible asset that arises when the purchase price to acquire a subsidiary is greater than the sum of the fair (market) value of the subsidiary’s identifiable assets minus liabilities.
It is determined at purchase date.

Question 15

Fair value measurement ( used for goodwill )

Answer 15

The parent is required to measure the cost of a business combination as the sum of the fair values at the date of acqn rather than at their historical cost.
Fair value is the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.

Question 16

Identifiable assets and Liabilities

Answer 16

Standards change over time , must consider the most up to date.
E.g Future plans to reorganise the subsidiary’s activities are not liabilities at the acquisition date.
E.g The Identifiable assets acquired and liabilities assumed must be part of the exchange for the subsidiary rather than the result of separate transactions.

Question 17

Impairment of Goodwill

Answer 17

Positive goodwill can be amortised ( gradually write off the initial cost of (an asset) over a period.) but subject to an annual impairment test.
When goodwill is impaired the impairment loss is reduced from the carrying amount of goodwill and recognised in the income statement.
E.g Dr Impairment loss £20,000
Cr Positive goodwill £20,000

Question 18

Negative goodwill calculations

Answer 18

The loss of investment recognised in the parent’s SOFP is cancelled against the net assets of the subsidiary at acqn.

Question 19

Example of Goodwill fair value

Answer 19

A: Fair value of parents holding at acqn (cost of investment) E.g £840
B: Parent’s holding (P%) x Sub’s net assets at fair value e.g 80% x £1050 = £840

If A = B There is no goodwill at acqn
If A>B There is positive goodwill at acqn
If A

Question 20

Accounting treatment of goodwill

Answer 20

Negative goodwill :
This is a gain from a bargain purchase
Recognise immediately in Statement of Comprehensive Income under IFRS 3

Positive goodwill :
This is an intangible asset recognised in the Statement of Financial Position
No amortisation according to IFRS 3
Apply impairment test in accordance with IAS 36

Question 21

Example :Negative Goodwill (Partially owned subsidiary)

Answer 21

Workings Analysis of equity:
Equity in sub(100%) Parents portion (x%) NCI (X%)
Ordinary shares XXX XXX XXX
Retained earnings XXX XXX XXX
Total XXX XXX XXX
Cost of Investment XXX
(XXX)
Negative goodwill = Cost of investment - Total Parents portion

Question 22

Example: Negative goodwill Solution Consolidated SOFP

Answer 22

At acqn Date (£000) Workings
other NCA XXX (Parents and Subs NCA added together)
Total Assets XXX
Ordinary shares XXX
Reatained earnings XXX (Parents RE + The negative goodwill (Gain))
Group Equity XXX
NCI XXX
Liabilities XXX (Parent and Sub liab added together)
Total equity and liab XXX

Question 23

Positive Goodwill calculations

Answer 23

2 different methods:
method 1: Non controlling interests are measured as the share of the net assets of the subsidiary owned by non-group shareholders.
method 2: non controlling interests are measured at the fair value at the date of acqn.

The method used will impact the goodwill figure!

Question 24

Positive goodwill Method 1

Answer 24

This method recognises the parents share of goodwill in the consolidated SOFP based only on the proportion of net assets the parents own.
This is basically the same goodwill that we know from previous studies and is known as the proportion of net assets method or sometimes the partial goodwill method.

Question 25

Positive Goodwill method 2

Answer 25

The fair value of the NCI is determined on the basis of the market prices for shares not acquired by the parent. if these are not available, a valuation technique is used.
Under this method goodwill is recorded relating to the whole of the subsidiary (i.e for the non controlling interest as well as on the parent’s share of goodwill).
Method 2 is know as the fair value model or the full goodwill method.

Question 26

Positive goodwill method 1 Example Part (A)

Answer 26

For instance, partially owned subsidiary was purchased for more than book value on 1st july 20X2
Group (P) acquired 80% (S)’s shares for 200,000.
Total equity of (S) at that date = 164,000
Ordinary shares 40,000
Revaluation Reserve 20,000
Retained earnings 104,000

Financial position as at acqn date Parents Subsidiary
Investment 200 —
Other NCA 3,100 500
Total assets 3,300 500
Ordinary shares £1 500 40
Retained earnings 350 104
Revaluation reserve — 20
Equity 850 164
Liabilities 2,450 336
Total equity and liabilities 3,300 500

80% of shares purchased for £200,000

Question 27

Positive goodwill method 1 Example Part (B) Workings and Solution of CSOFP

Answer 27

Workings 1: Equity in sub (100%) Parents portion(80%) NCI (20%)

Ordinary shares 40 32 8
revaluation reserve 20 16 4
retained earnings 104 83.2 20.8
total 164 131.2 32.8
cost of investment 200
Goodwill 68.8 Positive

At acqn date (£000) workings
Positive goodwill 68.8
Other NCA 3,600 (3100+500)
Total assets 3,668.8
Ordinary shares 500
retained earnings 350
group equity 850
NCI 32.8
Liab 2,786 (2450+3360
Total equity and liabilities 3,668.8

Question 28

Positive goodwill method 2 Example Part (A)

Answer 28

Assume that the parents policy in the previous example is instead to value NCI’s at acqn using the fair value model.
At acquisition the market price of the NCI holding (20%) in the subsidiary was £50,000

Method 1 Method 2
NCI and goodwill NCI and goodwill
(proportion of net assets method) ( fair value method)
(£000) (£000)
Net asset at fair value 164 Net asset at fair value 164
NCI (164 x 20%) (32.8) NCI at fair value (50)
Parents holding (80%) 131.2 Parents holding (80%) 114
Purchase (200) Purchase (200)
Positive goodwill 68.8 Positive goodwill 86

Question 29

Positive goodwill method 2 Example Part (B) Solution of CSOFP

Answer 29

Solution: Method 2
consolidation of SOFP
At acqn date (£000) workings
Positive goodwill 86
other nca 3600 3100+500
Total assets 3686
Ordinary shares 500
retained earnings 350
Group equity 850
NCI 50
Liabilities 2786 2450+336
Total equity and liabilities 3686

Question 30

The need for Intra-group adjustments

Answer 30

One company in a group may be in a trading relationship with another, or may provide management services for another company.
As a result of this, there may be receivables/payables at the end of the reporting period as well as other intra-group transactions.

Question 31

Intra-group trade balances

Answer 31

These balances are internal balances and will not be recognised in the consolidated statement of financial position.
Hence, they are set off against eachother and eliminated on consolidation.
Occasionally the inter-company accounts do not 100% cancel out, because items may have been included in one company’s books and not in the other

Question 32

Intra-group reconcilliations

Answer 32

Assume that both the parent (P) and subsidiary (S) accounts indicate the following intra-group balances at the end of the year end 31 December 20x17;
(P) (S)
Trade receivables from (s) £25,000
Trade payables to (p) £20,000

Consider that (s) remitted, and entered in its books a check in the sum of £5,000 to (p), on 31 december 20x7, this was not received by (p) until 5 jan 20x8

Elimination:Double entry

Cash in transit DR £5,000 (Adjust for at consolidation0
Trade payables to (p) DR £20,000
Trade receivables from (s) CR £25,000

Other intra group accounts are eliminated from eachother

Question 33

Intra group dividends

Answer 33

Dividends declared (but not yet paid) or paid by the subsidiary are accounted for as ‘dividend income from the subsidiary’ in the parents individual income statement.

Adjustments are necessary for consolidated financial statements and inter-company dividends are eliminated.

If a subsidiary has declared (but not yet paid) a dividend before the year end, it will be recognised in the current liabilities of the subsidiary (e.g. dividends payable) and in the current assets of the parent (e.g. dividends receivable) These also need to be eliminated on consolidation.

Question 34

Example Dividends declared (not yet paid)

Answer 34

Assume that a subsidiary declares £100,000 dividneds the subsidiary adjusts for retained earnings for dividends and the parent company recognised the £80,000 dividends from its 80% owned subsidiary.
Initial entries in the individual books:
Subsidiary:
Retained earnings DR £100,000
Dividends payable to (P) CR £80,000
Dividends payable to NCI CR £20,000

Parent:
Dividends receivable from (s) DR £80,000
Dividend income from (s) CR £80,000

Elimination of dividends declared
Reverse entries at consolidation:
Dividend payable to (P) DR £80,000
Retained earnings in (s) CR£ £80,000*

Dividend income from (s) DR £80,000
Dividend receivable from (s) CR £80,000
*note: the uncancelled amount (i.e £20,000) represents NCI and is shown as dividends payable to NCI in the CSFP.

Question 35

Example Dividends Paid

Answer 35

Initial entries in the individual books:

Subsidiary (s)
Retained earnings DR £100,000
Cash to (p) CR £80,000
Cash to NCI CR £20,000

Parent:
Cash DR £80,000
Dividend income from (s) CR £80,000

Elimination of dividends paid
eliminating P’s dividend income from s at consolidation;

Dividend income from (s) DR £80,000
Retained earnings in (s) CR £80,000*
*note:again NCI amount (20,000) is not reversed, as it is not intra-group.

Question 36

Pre-acquisition reserves

Answer 36

These are reserves represented under the equity of the subsidiary as at date of acqn. They are generated before the date of acquisition.
Commonly:
1. Pre acquisition retained earnings
2.Pre-acqn revaluation reserve 
3. Pre-acqn share premium

Question 37

Pre-acqn/Post-acqn Retained earnings

Answer 37

Pre-acqn:
Any profit or losses of a subsidiary made BEFORE the date of acqn are referred to as pre-acqn retained earnings in the CSOFP. These are represented by the equity of the subsidiary that exists as at the date of acquisition
(often shortened to ‘pre-acqn RE’ in workings)

Post-acqn;
Any profits or losses of a subsidiary made AFTER the date of acqn are referred to as post-acqn retained earnings in the consolidated financial statements. These are represented by the equity of the subsidiary that exists as at the date of consolidation.
(Often shortened to ‘post-acqn RE’ in workings)

Question 38

Example: Retained earnings