8 The consolidated statement of financial position

Question 1

The financial statements of a parent and its subsidiaries are combined on a line-by-line basis by adding together like items of assets, liabilities, equity, income and expenses. The following steps are then taken, in order that the consolidated financial statements should show financial information about the group as if it was a single entity.

Answer 1

(a) The carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity of each subsidiary are eliminated or cancelled (b) Non-controlling interests in the net income of consolidated subsidiaries are adjusted against group income, to arrive at the net income attributable to the owners of the parent (c) Non-controlling interests in the net assets of consolidated subsidiaries should be presented separately in the consolidated statement of financial position Other matters to be dealt with include: (a) Goodwill on consolidation should be dealt with according to IFRS 3 (b) Dividends paid by a subsidiary must be accounted for

Question 2

IFRS 10 states that all intragroup balances and transactions, and the resulting unrealised profits, should be eliminated in full. Unrealised losses resulting from intragroup transactions should also be eliminated unless cost can be recovered. This will be explained later in this chapter. True/ False

Answer 2

IFRS 10 states that all intragroup balances and transactions, and the resulting unrealised profits, should be eliminated in full. Unrealised losses resulting from intragroup transactions should also be eliminated unless cost can be recovered. This will be explained later in this chapter.

Question 3

The preparation of a consolidated statement of financial position, in a very simple form, consists of two procedures:

Answer 3

(a) Take the individual accounts of the parent company and each subsidiary and cancel out items which appear as an asset in one company and a liability in another (b) Add together all the uncancelled assets and liabilities throughout the group Items requiring cancellation may include: (a) The asset ‘shares in subsidiary companies’ which appears in the parent company’s accounts will be matched with the liability ‘share capital’ in the subsidiaries’ accounts. (b) There may be intra-group trading within the group. For example, S Co may sell goods on credit to P Co. P Co would then be a receivable in the accounts of S Co, while S Co would be a payable in the accounts of P Co.

Question 4

An item may appear in the statements of financial position of a parent company and its subsidiary, but not at the same amounts

Answer 4

(a) The parent company may have acquired shares in the subsidiary at a price greater or less than their par value. The asset will appear in the parent company’s accounts at cost, while the liability will appear in the subsidiary’s accounts at par value. This raises the issue of goodwill, which is dealt with later in this chapter.(b) Even if the parent company acquired shares at par value, it may not have acquired all the shares of the subsidiary (so the subsidiary may be only partly owned). This raises the issue of noncontrolling interests, which are also dealt with later in this chapter.
(c) The inter-company trading balances may be out of step because of goods or cash in transit.
(d) One company may have issued loan stock of which a proportion only is taken up by the other company. The following question illustrates the techniques needed to deal with items (c) and (d) above.

Question 5

The procedure is to cancel as far as possible. The remaining uncancelled amounts will appear in the consolidated statement of financial position. .

Answer 5

(a) Uncancelled loan stock will appear as a liability of the group. (b) Uncancelled balances on intra-group accounts represent goods or cash in transit, which will appear in the consolidated statement of financial position

Question 6

It was mentioned earlier that the total assets and liabilities of subsidiary companies are included in the consolidated statement of financial position, even in the case of subsidiaries which are only partly owned. A proportion of the net assets of such subsidiaries in fact belongs to investors from outside the group (non-controlling interests). IFRS 3 allows two alternative ways of calculating non-controlling interest in the group statement of financial position. Non-controlling interest can be valued at:

Answer 6

(a) Its proportionate share of the fair value of the subsidiary’s net assets; or (b) Full (or fair) value (usually based on the market value of the shares held by the non-controlling interest).

Question 7

2.3 Procedure (a) Aggregate the assets and liabilities in the statement of financial position ie 100% P + 100% S irrespective of how much P actually owns. This shows the amount of net assets controlled by the group. (b) Share capital is that of the parent only. (c) Balance of subsidiary’s reserves are consolidated (after cancelling any intra-group items). (d) Calculate the non-controlling interest share of the subsidiary’s net assets (share capital plus reserves) True/ False

Answer 7

2.3 Procedure (a) Aggregate the assets and liabilities in the statement of financial position ie 100% P + 100% S irrespective of how much P actually owns. This shows the amount of net assets controlled by the group. (b) Share capital is that of the parent only. (c) Balance of subsidiary’s reserves are consolidated (after cancelling any intra-group items). (d) Calculate the non-controlling interest share of the subsidiary’s net assets (share capital plus reserves)

Question 8

Goodwill arising on consolidation is subjected to an annual impairment review and impairment may be expressed as an amount or as a percentage. The double entry to write off the impairment is:

Answer 8

DEBIT Group retained earnings CREDIT Goodwill However, when NCI is valued at fair value the goodwill in the statement of financial position includes goodwill attributable to the NCI. In this case the double entry will reflect the NCI proportion based on their shareholding as follows. DEBIT Group retained earnings CREDIT Goodwill DEBIT Non-controlling interest

Question 9

Goodwill arising on consolidation is the difference between the cost of an acquisition and the value of the subsidiary’s net assets acquired. This difference can be negative: the aggregate of the fair values of the separable net assets acquired may exceed what the parent company paid for them. This is often referred to as negative goodwill. IFRS 3 refers to it as a ‘gain on a bargain purchase’. In this situation:

Answer 9

(a) An entity should first re-assess the amounts at which it has measured both the cost of the combination and the acquiree’s identifiable net assets. This exercise should identify any errors. (b) Any excess remaining should be recognised immediately in P/L

Question 10

Note that the previous version of IFRS 3 only required contingent consideration to be recognised if it was probable that it would become payable. IFRS 3 (revised) dispenses with this requirement – all contingent consideration is now recognised. It is possible that the fair value of the contingent consideration may change after the acquisition date. If this is due to additional information obtained that affects the position at acquisition date, goodwill should be remeasured. If the change is due to events after the acquisition date (such as a higher earnings target has been met, so more is payable) it should be accounted for under IFRS 9 if the consideration is in the form of a financial instrument (such as loan notes) or under IAS 37 as an increase in a provision if it is cash. Any equity instrument is not remeasured T/F

Answer 10

Note that the previous version of IFRS 3 only required contingent consideration to be recognised if it was probable that it would become payable. IFRS 3 (revised) dispenses with this requirement – all contingent consideration is now recognised. It is possible that the fair value of the contingent consideration may change after the acquisition date. If this is due to additional information obtained that affects the position at acquisition date, goodwill should be remeasured. If the change is due to events after the acquisition date (such as a higher earnings target has been met, so more is payable) it should be accounted for under IFRS 9 if the consideration is in the form of a financial instrument (such as loan notes) or under IAS 37 as an increase in a provision if it is cash. Any equity instrument is not remeasured

Question 11

IFRS 3 requires the acquisition-date fair value of contingent consideration to be recognised as part of the consideration for the acquiree. In an examination question students will be told the acquisition-date fair value or told how to calculate it. t/F

Answer 11

IFRS 3 requires the acquisition-date fair value of contingent consideration to be recognised as part of the consideration for the acquiree. In an examination question students will be told the acquisition-date fair value or told how to calculate it.

Question 12

An agreement may be made that part of the consideration for the combination will be paid at a future date. This consideration will therefore be discounted to its present value using the acquiring entity’s cost of capital. T/F

Answer 12

An agreement may be made that part of the consideration for the combination will be paid at a future date. This consideration will therefore be discounted to its present value using the acquiring entity’s cost of capital

Question 13

Intra-group trading can give rise to unrealised profit which is eliminated on consolidation. T/F

Answer 13

Intra-group trading can give rise to unrealised profit which is eliminated on consolidation. True

Question 14

Any receivable/payable balances outstanding between the companies are cancelled on consolidation. No further problem arises if all such intra-group transactions are undertaken at cost, without any mark-up for profit. However, each company in a group is a separate trading entity and may wish to treat other group companies in the same way as any other customer. In this case, a company (say A Co) may buy goods at one price and sell them at a higher price to another group company (B Co). The accounts of A Co will quite properly include the profit earned on sales to B Co; and similarly B Co’s statement of financial position will include inventories at their cost to B Co, ie at the amount at which they were purchased from A Co. This gives rise to two problems:

Answer 14

a) Although A Co makes a profit as soon as it sells goods to B Co, the group does not make a sale or achieve a profit until an outside customer buys the goods from B Co.
(b) Any purchases from A Co which remain unsold by B Co at the year end will be included in B Co’s inventory. Their value in the statement of financial position will be their cost to B Co, which is not the same as their cost to the group.
The objective of consolidated accounts is to present the financial position of several connected companies as that of a single entity, the group. This means that in a consolidated statement of financial position the only profits recognised should be those earned by the group in providing goods or services to outsiders; and similarly, inventory in the consolidated statement of financial position should be valued at cost to the group

Question 15

Note that where the sale has been made by the parent none of the unrealised profit will be charged to the NCI.

Answer 15

DEBIT Group retained earnings DEBIT Non-controlling interest CREDIT Group inventory (statement of financial position)

Question 16

On consolidation, the usual ‘group entity’ principle applies. The consolidated statement of financial position must show assets at their cost to the group, and any depreciation charged must be based on that cost. Two consolidation adjustments will usually be needed to achieve this.

Answer 16

(a) An adjustment to alter retained earnings and non-current assets cost so as to remove any element of unrealised profit or loss. This is similar to the adjustment required in respect of unrealised profit in inventory.
(b) An adjustment to alter retained earnings and accumulated depreciation is made so that consolidated depreciation is based on the asset’s cost to the group.

Question 17

In practice, these steps are combined so that the retained earnings of the entity making the unrealised profit are debited with the unrealised profit less the additional depreciation.

Answer 17

The double entry is as follows. (a) Sale by parent DEBIT Group retained earnings CREDIT Non-current assets with the profit on disposal, less the additional depreciation
(b) Sale by subsidiary DEBIT Group retained earnings (P’s share of S) DEBIT Non-controlling interest (NCI’s share of S) CREDIT Non-current assets With the profit on disposal, less additional depreciation

Question 18

Provide a Summary: consolidated statement of financial position:

Answer 18

Purpose To show the net assets which P controls and the ownership of those assets. Net assets Always 100% P plus 100% S providing P holds a majority of voting rights Share capital P only Reason Simply reporting to the parent company’s shareholders in another form Retained earnings 100% P plus group share of post-acquisition retained earnings of S less consolidation adjustments Reason To show the extent to which the group actually owns total assets less liabilities Non-controlling interest Fair value at acquisition plus share of post-acquisition retained profit (loss) Reason To show the equity in a subsidiary not attributable to the parent

Question 19

When a parent company acquires a subsidiary during its accounting period the only accounting entries made at the time will be those recording the cost of acquisition in the parent company’s books. At the end of the accounting period the consolidation adjustments will be made. T/F

Answer 19

When a parent company acquires a subsidiary during its accounting period the only accounting entries made at the time will be those recording the cost of acquisition in the parent company’s books. At the end of the accounting period the consolidation adjustments will be made

Question 20

The subsidiary company’s accounts to be consolidated will show the subsidiary’s profit or loss for the whole year. For consolidation purposes, however, it will be necessary to distinguish between:

Answer 20

(a) Profits earned before acquisition (b) Profits earned after acquisition

Question 21

Fair value is defined as follows by IFRS 13 Fair value measurement. It is an important definition.
Fair value. 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.
IFRS 13 provides extensive guidance on how the fair value of assets and liabilities should be established. This standard requires that the following are considered in determining fair value.

Answer 21

(a) The asset or liability being measured (b) The principal market (ie that where the most activity takes place) or where there is no principal market, the most advantageous market (ie that in which the best price could be achieved) in which an orderly transaction would take place for the asset or liability (c) The highest and best use of the asset or liability and whether it is used on a standalone basis or in conjunction with other assets or liabilities (d) Assumptions that market participants would use when pricing the asset or liability

Question 22

Having considered these factors, IFRS 13 provides a hierarchy of inputs for arriving at fair value. It requires that level 1 inputs are used where possible:

Answer 22

Level 1 Quoted prices in active markets for identical assets that the entity can access at the measurement date Level 2 Inputs other than quoted prices that are directly or indirectly observable for the asset Level 3 Unobservable inputs for the asset We will look at the requirements of IFRS 3 regarding fair value in more detail below. First let us look at some practical matters.

Question 23

Fair value adjustment calculations Until now we have calculated goodwill as the difference between the consideration transferred and the book value of net assets acquired by the group. If this calculation is to comply with the definition above we must ensure that the book value of the subsidiary’s net assets is the same as their fair value. There are two possible ways of achieving this:

Answer 23

a) The subsidiary company might incorporate any necessary revaluations in its own books of account. In this case, we can proceed directly to the consolidation, taking asset values and reserves figures straight from the subsidiary company’s statement of financial position. (b) The revaluations may be made as a consolidation adjustment without being incorporated in the subsidiary company’s books. In this case, we must make the necessary adjustments to the subsidiary’s statement of financial position as a working. Only then can we proceed to the consolidation.

Question 24

IFRS 3 sets out general principles for arriving at the fair values of a subsidiary’s assets and liabilities. The acquirer should recognise the acquiree’s identifiable assets, liabilities and contingent liabilities at the acquisition date only if they satisfy the following criteria.

Answer 24

(a) In the case of an asset other than an intangible asset, it is probable that any associated future economic benefits will flow to the acquirer, and its fair value can be measured reliably. (b) In the case of a liability other than a contingent liability, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and its fair value can be measured reliably. (c) In the case of an intangible asset or a contingent liability, its fair value can be measured reliably.

Question 25

An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a result of the business combination. IFRS 3 explains that a plan to restructure a subsidiary following an acquisition is not a present obligation of the acquiree at the acquisition date. Neither does it meet the definition of a contingent liability. Therefore an acquirer should not recognise a liability for such a restructuring plan as part of allocating the cost of the combination unless the subsidiary was already committed to the plan before the acquisition. This prevents creative accounting. An acquirer cannot set up a provision for restructuring or future losses of a subsidiary and then release this to the profit or loss in subsequent periods in order to reduce losses or smooth profits. True/ False

Answer 25

An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a result of the business combination. IFRS 3 explains that a plan to restructure a subsidiary following an acquisition is not a present obligation of the acquiree at the acquisition date. Neither does it meet the definition of a contingent liability. Therefore an acquirer should not recognise a liability for such a restructuring plan as part of allocating the cost of the combination unless the subsidiary was already committed to the plan before the acquisition. This prevents creative accounting. An acquirer cannot set up a provision for restructuring or future losses of a subsidiary and then release this to the profit or loss in subsequent periods in order to reduce losses or smooth profits.

Question 26

The acquiree may have intangible assets, such as development expenditure. These can be recognised separately from goodwill only if they are identifiable. An intangible asset is identifiable only if it:

Answer 26

(a) Is separable, ie capable of being separated or divided from the entity and sold, transferred, or exchanged, either individually or together with a related contract, asset or liability, or (b) Arises from contractual or other legal rights. The acquiree may also have internally-generated assets such as brand names which have not been recognised as intangible assets. As the acquiring company is giving valuable consideration for these assets, they are now recognised as assets in the consolidated financial statements.

Question 27

Contingent liabilities: Contingent liabilities of the acquiree are recognised if their fair value can be measured reliably. This is a departure from the normal rules in IAS 37; contingent liabilities are not normally recognised, but only disclosed. After their initial recognition, the acquirer should measure contingent liabilities that are recognised separately at the higher of:

Answer 27

(a) The amount that would be recognised in accordance with IAS 37 (b) The amount initially recognised

Question 28

The general principle is that the acquirer should measure the cost of a business combination as the total of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree. Sometimes all or part of the cost of an acquisition is deferred (ie does not become payable immediately). The fair value of any deferred consideration is determined by discounting the amounts payable to their present value at the date of exchange. . True/ The general principle is that the acquirer should measure the cost of a business combination as the total of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree. Sometimes all or part of the cost of an acquisition is deferred (ie does not become payable immediately). The fair value of any deferred consideration is determined by discounting the amounts payable to their present value at the date of exchange.

Answer 28

The general principle is that the acquirer should measure the cost of a business combination as the total of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree. Sometimes all or part of the cost of an acquisition is deferred (ie does not become payable immediately). The fair value of any deferred consideration is determined by discounting the amounts payable to their present value at the date of exchange.

Question 29

Where equity instruments (eg ordinary shares) of a quoted entity form part of the cost of a combination, the published price at the date of exchange normally provides the best evidence of the instrument’s fair value and except in rare circumstances this should be used. Future losses or other costs expected to be incurred as a result of a combination should not be included in the cost of the combination. Costs attributable to the combination, for example professional fees and administrative costs, should not be included: they are recognised as an expense when incurred. Costs of issuing debt instruments and equity shares are covered by IAS 32 Financial instruments: presentation, which states that such costs should reduce the proceeds from the debt issue or the equity issue. True/ False

Answer 29

Where equity instruments (eg ordinary shares) of a quoted entity form part of the cost of a combination, the published price at the date of exchange normally provides the best evidence of the instrument’s fair value and except in rare circumstances this should be used. Future losses or other costs expected to be incurred as a result of a combination should not be included in the cost of the combination. Costs attributable to the combination, for example professional fees and administrative costs, should not be included: they are recognised as an expense when incurred. Costs of issuing debt instruments and equity shares are covered by IAS 32 Financial instruments: presentation, which states that such costs should reduce the proceeds from the debt issue or the equity issue.

Question 30

A parent company can assume that, for a subsidiary acquired during its accounting period, profits accrue evenly during the year. True/ false

Answer 30

A parent company can assume that, for a subsidiary acquired during its accounting period, profits accrue evenly during the year.

Question 31

What guidelines are given by IFRS 3 in relation to valuing land and buildings fairly?

Answer 31

Land and buildings should be valued in accordance with IFRS 13 (generally market value)