CH. 11 Basic Groups - Consolidation of SFP & SPLOCI

Question 1

From the shareholders perspective, why is it important to consolidate accounts?

Answer 1

It is important for a group to consolidate all of the entities that a parent controls so that current and potential investors can make informed decisions about providing resources to the entity.

It is impractical for investors to assess all F/S of each sub in the group.

e.g Royal Duch has 100’s of subs and associates, it is not practical for all investors to assess each and every company, to make an informed decision.

Question 2

How do investment entities treat consolidated accounts?

Answer 2

Investment companies are mainly involved in buying and selling shares, ultimately not interested in running the organisations.

• Subs are not consolidated and treated at F.V through profit and loss

This is because it creates more relevant information.

This treatment is mandatory for this sort of company:

1) obtain funds from one or more for the purpose of investment management services

2) invest funds solely for returns of capital appreciation or investment income

3) Measures and evaluates performance on a fair value basis

Typical characteristics: -

• more than one investment
• more than one investor
• investors are not related parties
• ownership interests in the form of equity or similar interests

Question 3

Why can it be difficult to identify the difference between Busines Combination or acquisition of an asset?

Answer 3

3 IFRS 3 Business combinations

Business Combination – A transaction or event In which an acquirer obtains control of a business.

Business – Integrated set of activities and assets capable of being managed to generate a return for the principle.

Note – that definitions does not say it has to be operating.

It can be difficult at times to distinguish the difference in acquiring an asset or a business combination. So a screening test has been proposed.

Test

Is substantially all of the fair value of the assets acquired concentrated in a single identifiable asset?

• Yes – Then it is not a business combination
• No – The business process contains a substantive process that has the ability to convert inputs to outputs.

Question 4

Explain in words how are all Business Combinations (Subsidiaries) accounted for?

Answer 4

VIA the Acquisition Method.

It Requires:

• A- Identifying the Acquirer
• B- Consideration paid on the Acquisition Date
• C- Identifiable assets acquired and liabilities assume and any NCI
• D- Recognising Goodwill or Gain on a bargain purchase

Question 5

IFRS 3: Name the 2 methods on how Non-Controlling Interests measured at acquisition?

Answer 5

• - “Full Goodwill” Method (Fair Value)

or

• - Partial Goodwill Method (Proportionate share of Net Assets)

Question 6

Provide an overview of the consolidation rules of the SOFP?

Answer 6

Question 7

All the steps of Consolidating SOFP

Answer 7

Step 1 - Read Question and draw up w1 Group Structure

Step 2- Draw up Statement and workings proforma’s and transfer numbers across working down the list methodically

Step 3 - Read notes and attempt Workings for Adjustments (e.g Net assets, PURP calculation)

Step 4 - Calculate Goodwill

Step 5 - Calculate Share of Retained Earnings

Step 6 - Calculate Investments in associates/joint venture

Step 7 - Calculate Non-Controlling Interests

Question 8

Consolidation of SFP.

STEP - 1

Answer 8

Step - 1 Read Question and Draw the Group Structure while noting down key figures given.

• *- Percentage of Ownership
• Acquisition Date**
• **Reserves Pre-Acquisition
• Consideration Transferred (Possible workings if the consideration has contingent Liabilties)**
• *- NCI F.V if given or is the policy proportionate.**

Question 9

What are the steps to consolidating SOFP?

Step 2 - Proforma

Answer 9

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

• – 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
  (But don’t add up the final totals until all workings and adjustments have been carried out)
• – Include only the parent’s balances for share capital and share premium

Question 10

Consolidation of SFP

Step 3 - Right down adjustments and attempt the workings of the net asset.

Answer 10

Question 11

Step 3 - Adjustments

What are the Types of Adjustments For Intragroup Transactions?

Answer 11

- All intragroup assets, liabilities, equity, income and expenditure and cash flows are eliminated in full.

Cancellation of group balances

• Dr – Payables (Creditors)
• Cr - Receivables (Debtors)

Goods or cash in transit - Just Complete the transaction

• Dr - Inventories/cash
• Cr – Payables/receivables

- Elimination of UNREALISED PROFITS on intragroup transactions. PURPS

Parent Sales to Sub

• Dr – RE of Parent in the SFP / Cost of sales (If you’re doing P/L)
• Cr – GROUP inventories

Sub Sales to Parent

• Dr – R.E of Sub in the SFP/ Cost of sales (If you’re doing P/L)
• Cr – GROUP inventories

>>>The rule is always to reduce the profits of the selling company.

Cancellation of intragroup sales/purchases - P/L ADJUSTMENT

• Dr – Group Revenue
• Cr – Group COS

Question 12

Step 4 - Goodwill Calculation BPP Method

Full Goodwill Method - Nci at F.V

And

Partial Goodwill Method - Nci at the proportionate share

Answer 12

Question 13

Step 5 - Groups Retained Earnings and Other Reserves - Kaplan Method

Answer 13

Question 14

Step 5 - Groups Retained Earnings and Other Reserves - BPP Method

Answer 14

Question 15

STEP 6 NCI Calculation

Answer 15

NCI @ Acquisition
+ Share of Movement in R.E
= C/B of NCI

• IF THE FULL GOODWILL METHOD was used, make sure to remove the impairment of any goodwill to date.

Question 16

Step 7 Investment in Associate calculation

Answer 16

Question 17

Steps to consolidate a Statement of Profit and Loss and Other Comprehensive Income (SPLOCI)

Answer 17

• Step 1 Read Question and Draw up group structure.
• Step 2 Draw up SPLOCI proforma & The Profits attributable section
• Step 3 Transfer figures to proforma
  
  • Remember to only bring in Income and Expenses from the date of acquisition,
  • - this means if there was a mid-year acquisition, revenues and expenses should be consolidated from the acquisition date.
• ​Step 4 Calculate the Profit/Total Comprehensive Income Attributable to the parent and non-controlling interest

Question 18

Step 1 of Consolidated SPLOCI

Answer 18

Read the Question and Write down the Group Structure.

Make notes on the following.

• Percentage of Ownership
• Date of acquisition
• Mid-Year Acquisition Yes or No
• Bullet Point for adjustments

Question 19

Step 2 - of Consolidated SPLOCI

Answer 19

Write down the pro forma for SPLOCI

Specific attention to profits and total comprehensive income attributable to the parent and the NCI

Question 20

Step 3 - of Consolidated SPLOCI

Answer 20

Add together the parent and subsidiary’s

• - incomes
• - expenses
• - items of other comprehensive income

on a line-by-line basis.

Key Note If the subsidiary has been acquired mid-year,

• Make sure that you prorate the results of the subsidiary so that only post-acquisition incomes, expenses and other comprehensive income are consolidated.

Key note - Eliminate any:

• Intra-group incomes and expenses,
• Unrealised profits on intra-group transactions,
• as well as any dividends received from the subsidiary.

All other adjustments are to be calculated

- Impairments

Question 21

Step 4 - of Consolidated SPLOCI

Answer 21

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.

Again remember to prorate profits.

Question 22

How is an associate Defined:

Answer 22

An associate is defined as

• “an entity over which the investor has s_ignificant influence_ and which is neither a subsidiary nor a joint venture of the investor’.

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

• Significant influence is usually evidenced by representation on the board of directors, which allows the investing entity to participate in policy decisions.
• Holding between 20% and 50% of the voting power is presumed to give significant influence.

The existence of significant influence normally entails at least one of the following:

• Representation on the board of directors
• Ability to influence policymaking
• Significant levels of transactions between the entity and the investee
• Management personnel being shared between the entity and the investee
• Provision of important technical information.

Question 23

How are Associates accounted for in the SFP?

Investment in associate balance sheet line item

Answer 23

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

• The investment in the associate is shown in the non-current assets section of the consolidated SFP

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

£££ - Cost
£/(£) - P% of post-acquisition reserves
(£££) - Impairment losses on the investment
(£££) - P% of unrealised profits if P is the seller
(£££) - P% of excess depreciation on fair value adjustments

–––
= £££ - Investment in associate X

Question 24

How is an associate accounted for in the consolidated P/L?

Answer 24

A single line item is presented in the P/L below operating profit.

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

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

Question 25

What Types of adjustments are related with Associate consolidation?

Answer 25

Adjustments

• Dividends received from the associate must be removed from the consolidated P/L
  a share of the profits will be calculated and consolidated.
• INTRA GROUP BALANCES ARE NOT ELIMINATED from the CSFP because the associate is not a part of the group.
• Fair Value adjustments and the associated Depreciation or amoritisation

PURPS WITH ASSOCIATES

• The group share of any PURPS arising on transactions between the group and the associate must be eliminated.
  
  • Associate is the seller to parent:
    
    • Dr - Share of the associate’s profit (P/L)/ Retained earnings (SFP)
    • Cr - Inventories (SFP)
  • Associate is the purchaser:
    
    • Dr Cost of sales (P/L)/Retained earnings (SFP)
    • Cr Investment in the associate (SFP)

Contribution of an asset as an investment

• When an investor contributes assets in exchange for an equity interest in the associate, the investor recognises the portion of the gain or loss on disposal attributable to the other investors in the associate
• i.e. if the investor owns 40% of the associate, it recognises 60% of the gain or loss.

Question 26

Explain IFRS 10 Consolidated Financial statements key requirements.

Answer 26

• Ultimate Controlling Parent must consolidate the financial statements of all subsidiaries (and any sub’s owned by the sub) as a single economic entity.

On Consolidation

1. Uniform accounting principles should be used, adjustments must be made so that consolidated financial statements a suitable for consideration.
2. Consolidated Statements are prepared for the same reporting period.
   ​​If this is not impracticable, the most recent F/S are used, and must;

• The difference be no more the 3 months
• Adjustments for effects of significant transactions in the period
• The length of reporting periods to be the same.

Question 27

When is there an Exemption for a parent from Consolidated financial statements?

Answer 27

• There is an overall parent which wholly-owns a subsidiary and it’s subsidiaries. Or a partially owned subsidiary with the consent of the NCI.
• The Ultimate parent or intermediate parent produces the group F/S
• Debt or equity is not publicly traded
• Not intending to file with listing stock exchange or regulatory body

Question 28

How is a sub, associate or J.V treated in the parent’s own accounts (not the group accounts)?

1.3 Accounting treatment in the separate financial statements of the investor

Answer 28

On treating subs, associated and Joint Ventures valued at:

• Cost
• Fair Value (IFRS 9) (As financial asset - Investment in shares)
• Equity Acc (IAS 28)

Question 29

Define a Subsidiary and the 3 requirements of control/power?

Answer 29

Subsidiary: is an entity is controlled by another entity.

Control: the power to govern the financial and operating policies to obtain benefits

Control / Power if all 3 criteria are met: -

• 1. Power: Existing right that gives the ability to direct relevant activities

E.g Voting rights of 51% or more or rights to appoint and remove key management and directors.

• 2. Exposure to risk or Right rewards to the variable returns from involvement.

E.g Rights to dividends or returns variable based on the performance

• 3. The ability to use the right to affect the amount of returns

E.g has the right to make changes in the company but actually may not choose to do so.

Question 30

How do you identify the acquiring entity?

Answer 30

Identifying the acquirer (Buyer)

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.

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.

Question 31

How do you identify the acquisition date?

Answer 31

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.

Question 32

How does the acquirer measure the identifiable assets acquired and the liabilities assumed at their fair values at the acquisition date?

Answer 32

Identifiable assets and liabilities

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 2010 Conceptual Framework and
• Exchanged as part of the business combination rather than a separate transaction.

**Note that IFRS 3 was not updated to refer to the revised element definitions in the 2018 Conceptual Framework.

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

Watch out for the following items:

• Contingent liabilities
  
  • 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 for future operating losses
  
  • ​cannot be created as this is a post-acquisitionitem. Similarly, restructuring costs are only recognised to theextent that liability actually exists at the date of acquisition.
• Intangible assets are recognised at fair value.
  
  • If they are separable or arise from legal or contractual rights.
• *This might mean that the parent** recognises an intangible asset that the subsidiary did not recognise in its individual financial statements,
• *e.g. an internally generated brand name.**
• Goodwill in the subsidiary’s individual financial statements is NOT consolidated.
  
  • This is because it is not separable and it does not arise from legal or contractual rights.

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 Employee Benefits
• IFRS 2 Share-based Payment
• IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

Question 33

When should goodwill be recognised?

Answer 33

Goodwill
Goodwill should be recognised on a business combination.

This is calculated as the difference between:

• F.V of the consideration transferred
• *PLUS: the NCI in the acquiree at the acquisition date**
• *LESS: The fair value of the acquiree’s identifiable net assets and liabilities.**
• =GOODWILL

Question 34

How do you calculate the Consideration Transferred?

Hint

Cash
Contingent Considerations
Share Issue
Replacement share-based schemes

Answer 34

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

When determining the fair value of the consideration transferred:

• Cash on the day
• Contingent consideration is included even if payment is not deemed probable.
  
  • Its fair value will incorporate the probability of payment occurring.
• ​Shares in the parent transferred, are Valued at the F.V on the date of acquisition.
• Replacement share-based payment schemes
  (when share-based remuneration scheme is replaced with a share-based contract of the parent)
  Consideration transferred in exchange for control of a subsidiary could include replacement share-based payment schemes exchanged for share-based payments schemes held by the subsidiary’s employees. If the acquirer is obliged to issue replacement share-based payments to employees of the subsidiary in exchange for their existing schemes:
• Then the fair value of the replacement scheme must be allocated between:
  
  • Purchase consideration,
    
    • The amount allocated as purchase consideration cannot exceed the value of the original share scheme at the date of acquisition.
  • Post-acquisition remuneration expense.
    
    • The amount attributable to post-acquisition service is recognised in accordance with IFRS 2 Share-based Payments.
• 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.

Question 35

What choice does IFRS 3 provide in valuing the non-controlling interest at acquisition:

Answer 35

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

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

• Full Fair Value (Full goodwill method)
  goodwill attributable to both the acquirer and the NCI will be calculated
• Partial Goodwill Method / Proportionate share of net assets method-
• only the acquirer’s goodwill will be calculated.

The method used can 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.

Question 36

What is negative goodwill on purchase (bargain purchase)

and

How is it treated?

Answer 36

• *Bargain purchase**
• *If the share of net assets acquired exceeds the consideration transferred, then again 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 may suggest that errors were made when determining the fair value of the consideration transferred and the net assets acquired.
  The figures should be reviewedfor accuracy.
• If no errors have been made, the negative goodwill is credited immediately to profit or loss.

Question 37

What are the invalid reasons for excluding a subsidiary?

Answer 37

• 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 the determination of directors’ remuneration based upon group financial performance.
• 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.
• Exclude a subsidiary 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.

Question 38

What are the requirements of IFRS 12 Disclosure of Interests in Other Entities?

Answer 38

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.

Question 39

What are the requirements of IAS 27 Separate Financial Statements?

Answer 39

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 to reduce the carrying amount of the investment.

Question 40

What are Criticisms of IFRS 3 Business Combinations?

Answer 40

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

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.

Intangible assets

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

Contingent consideration

• Measuring the F.V of contingent consideration is 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 again on a bargain purchase should not be recognised in profit or loss, but rather in OCI, because it distorts the performance profile of an entity.
• Goodwill impairment reviews are complex, subjective and time-consuming.
• Performing annual impairment reviews in respect of goodwill, rather than amortising 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. As such, some argue that 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.