Session 7 Flashcards
(21 cards)
What is a business combination under IFRS 3.A and what is the purpose of consolidated accounts?
Business Combination (IFRS 3.A)
A transaction where an acquirer obtains control over one or more businesses.
→ Also called mergers or mergers of equals.
Purpose of M&A: Growth, Synergies, Market expansion, Cost reduction, Access to technology/resources
Who Must Consolidate?
- Any company that controls another entity
- Capital market-oriented companies → Must use IFRS
- Non-capital market companies → May use IFRS or HGB
Purpose of Consolidated Accounts:
- Present the group as a single economic entity
- Combine all: Assets, liabilities, equity, income, expenses, and cash flows
- Dividends often based on consolidated profit
What determines the consolidation scope under IFRS and what defines control under IFRS 10?
Consolidation Scope (Overview):
- Parent/Subsidiary (Control): → Full consolidation
- Joint Arrangements: → Proportional or equity method
- Associates (Significant Influence): → Equity method
- Financial Assets: → Fair value or amortized cost
IFRS 10: Concept of Control
To have control, all 3 conditions must be met:
- Power to direct relevant activities
- Exposure to variable returns from the investee
- Ability to use power to affect those returns
- Typical Case: 50% of voting rights = control
- Exception: Control may exist even with <50% ownership via:
→ Contractual arrangements
→ De facto control
What are the different types of investments under IFRS, their control level, and consolidation methods?
Associated Companies (IAS 28)
- ≥ 20% ownership → Presumed significant influence
- < 20% ownership → Presumed no influence, unless proven otherwise
- Significant influence can also arise from:
- Board representation
- Participation in policymaking
- Material transactions
→ Substance over form matters
Joint Arrangements (IFRS 11)
- Joint Operation → Rights to assets and obligations → recognize share of items
- Joint Venture → Rights to net assets → equity method
What are the main steps in the full consolidation process, and why is standardization important?
Purpose: Produce consolidated financial statements that present a group of entities as a single economic unit.
Three Main Steps in Full Consolidation:
- Combine: Aggregate individual financial statements of parent and subsidiaries.
- Offset: Eliminate intercompany equity holdings (e.g., parent investment vs. subsidiary equity).
- Eliminate intra-group transactions, including: Internal balances and debts; Intercompany revenues, expenses, and profits
Standardization Required:
- Ensures consistency and comparability across all group entities.
- Needed before consolidation can begin.
- Involves aligning formats (e.g., income statement, balance sheet structure).
- Many companies use “consolidation packages” for uniform data input.
What are unconsolidated accounts, and how do they differ from consolidated accounts?
Unconsolidated Accounts:
- Parent company’s financial statements show investments in affiliates as one single line item (“Investments in affiliates”).
- Affiliates’ individual assets and liabilities are NOT integrated.
Difference from Consolidated Accounts:
- Consolidated: Integrates assets, liabilities, income, and expenses of affiliates line by line.
- Unconsolidated: Only shows total investment value, no detailed integration of affiliates’ financials.
Purpose: Simplified view of ownership without detailed internal information.
What happens in the combination step of consolidation, and what is the result?
Combination Step (Consolidation):
- Add all individual assets and liabilities from parent and affiliates.
- Eliminate parent’s “Investments in affiliates” against the affiliates’ equity.
Result:
- Consolidated Assets: Total assets from parent and affiliates (including goodwill).
- Consolidated Liabilities: Sum of all liabilities.
- Consolidated Equity: Represents equity of the entire group (not just the parent).
Purpose: Present the group as a single economic entity (one company, not separate legal entities).
What happens in the offset step of consolidation, and how are goodwill and non-controlling interest (NCI) treated?
Offsetting (Step 2):
Eliminate double-counted equity by offsetting:
- Parent’s investment in subsidiary (asset)
- Parent’s share of subsidiary’s equity
Goodwill:
- If investment paid > share of subsidiary’s net assets:
- Difference is goodwill (intangible asset).
Non-controlling Interest (NCI):
- If parent owns <100% (e.g., 80%), remaining share (20%) is external ownership.
- Shown separately as NCI within consolidated equity.
Example:
- Eliminate investment: remove parent’s investment and parent’s share of subsidiary equity.
- Recognize NCI: remaining external shareholders’ equity share.
Why and how are intragroup transactions eliminated during consolidation?
Objective => Eliminate internal transactions to:
- Avoid double-counting
- Present the group as a single economic entity
- Reflect only external activities
Why do acquisition prices often exceed book values, and how is the acquisition method applied under IFRS 3?
Reasons Purchase Price > Book Value:
- Intangibles (brand, technology, relationships)
- Synergies (cost savings, cross-selling)
- Strategic value (market access, competition removal)
- Growth & earning potential
- Undervalued assets (e.g., real estate)
→ Excess recorded as goodwill.
Acquisition Method (IFRS 3):
Two key accounting steps:
- Recognize assets/liabilities at fair value.
- Recognize goodwill (excess price over net fair value).
Process (IFRS 3.5):
- Identify the acquirer.
- Determine the acquisition date.
- Measure and recognize: Acquired assets/liabilities at fair value, Non-controlling interests (NCI)
- Recognize goodwill or bargain purchase gain.
What is purchase price allocation?
Purchase Price Allocation:
- Allocates purchase price to acquired assets and liabilities at fair value.
- Uncovers hidden reserves/liabilities (market transaction reveals true economic value).
What distinguishes Revalued Equity from Goodwill in purchase price allocation?
The higher the purchase price above fair value (revalued equity), the greater the amount allocated to goodwill.
What is the general method for calculating goodwill during an acquisition?
General Method:
1.Calculate Fair Value of Net Assets:
FairValueofNetAssets = (FairValueofallacquiredAssets) −
(FairValueofallassumedLiabilities)
2.Calculate Goodwill:
Goodwill = PurchasePrice − FairValueofNetAssets
Interpretation:
- If the result is positive, this is Goodwill.
- If the result is negative, it’s a Bargain Purchase Gain.
How does an acquisition affect consolidated financial statements, and what are the key consolidation steps (capital consolidation)?
Effects on Consolidated Statements:
- Buyer’s assets/liabilities: Recorded at original cost.
- Target’s assets/liabilities: Recorded at fair value.
- Goodwill: Recorded if purchase price > target’s net asset fair value.
=> Higher goodwill if assets undervalued or liabilities overvalued. - Income Statement: Combines revenues/costs of both companies.
- Internal transactions: Removed.
Consolidation Steps (Capital Consolidation):
- Record acquisition in parent’s financials.
- Revalue target’s assets/liabilities to fair value.
- Combine balance sheets (parent + target).
- Eliminate double-counting:
- Remove parent’s investment in target and target’s equity.
- Replace with target’s net assets and goodwill.
How do business combinations (e.g., mergers & acquisitions) typically affect financial ratios like RNOA, and why?
What is a bargain purchase in an acquisition, and how is it treated in accounting?
A bargain purchase occurs when the buyer pays less than the fair value of the acquired net assets.
Possible reasons:
- Assets/liabilities were misvalued.
- Seller under pressure to sell quickly.
Accounting Treatment:
- Recheck fair value estimates for accuracy.
- If still valid, record the difference as an immediate gain in the Income Statement under “Other income.”
How does consolidation work in subsequent years after an initial acquisition?
Key Principles:
- Initial consolidation is done once, usually at acquisition date.
- Subsequent consolidations:
-Reapply prior adjustments (e.g. depreciation on revalued assets).
-Ensure accuracy over time in group financials.
-Focus on updating, not repeating the full process.
Steps for Subsequent Consolidation:
- Use the updated financials of the subsidiary for the current year.
- Reapply initial adjustments:
- Keep goodwill
- Maintain asset revaluations, liability adjustments, etc.
Typical Follow-Up Adjustments:
- Depreciate/amortize revalued assets.
- Release liability adjustments if they are overstated.
- Recognize income only when justified (e.g. reversals or materialized gains).
- Test goodwill and assets for impairment annually.
What is a Cash-Generating Unit (CGU) and how is goodwill impairment tested under IFRS?
Definition of CGU:
- A CGU is the smallest group of assets that independently generates cash inflows.
- Think of it as a region, product line, or division with standalone financial performance.
Identification Guidance:
- Assets with an active market can be their own CGU.
- Shared assets (e.g. HQ or R&D) must be allocated consistently and reasonably.
- Goodwill from acquisitions must be allocated to CGUs expected to benefit from synergies.
Goodwill Impairment:
- Not amortized, but tested annually (impairment-only approach).
- Impairment is triggered when:
Recoverable amount of CGU < Carrying amount of CGU
Process:
Allocate goodwill to one or more CGUs.
Allocation must:
- Match the lowest level of internal monitoring.
- Not exceed segment size per IFRS 8 Operating Segments.
→ If impaired, the loss is recorded in the income statement, even if there are no visible signs.
How is the impairment of a CGU calculated and allocated under IFRS?
Step 1: Determine the Recoverable Amount
- Defined as the higher of:
1. Value in use = PV of expected future cash flows
1. Fair value less costs to sell = Market sale price – selling costs
Step 2: Compare to Carrying Amount
- Impairment loss = Carrying amount – Recoverable amount
- Impairment is recorded if: Carrying amount > Recoverable amount
Step 3: Allocate the Impairment
- Reduce goodwill first (fully written off if necessary).
- If excess impairment remains, allocate it proportionally across other CGU assets (e.g., machinery, PP&E, current assets).
Key Rule: Goodwill impairment is not reversible in future periods.
Example Summary:
- Carrying value: €850 | Recoverable amount: €650
- Impairment loss: €200
- Goodwill reduced by €100
- Remaining €100 allocated to other assets proportionally
Journal Entry:
Dr Impairment loss (P&L) 200
Cr Goodwill 100
Cr Machinery 53
Cr PP&E 20
Cr Current Assets 27
When is the equity method used, and how is the investment initially recognized and adjusted when the purchase price differs from the investor’s share of net assets?
When is the equity method used?
- For associates (typically 20–50% ownership)
- For joint ventures
Initial Recognition Rule: Investment is recorded at cost (purchase price).
Adjustment if:
1.Cost > Share of fair value of net assets:
- Difference = Goodwill
- Included in the investment account (not shown separately)
2.Cost < Share of fair value of net assets:
- Difference = Income
- Recognized in the income statement
How is the carrying amount of an investment adjusted under the equity method in subsequent years?
New carrying amount = Initial cost + Share of profit − Dividends received −
Amortization of hidden reserves
Example:
- Initial investment: €500k
- Associate equity: €1,200k
- Ownership: 25%
- ROE = 30% → Net income = €360k
→ Buyer’s share = 25% × 360 = €90k - Dividend payout = 60k → Buyer’s share = €15k
- Hidden reserves: €120k amortized over 5 years → €24k/year
→ Buyer’s share = 25% × 24 = €6k
➡ Updated carrying amount = €500k + €90k – €15k – €6k = €569k
Journal Entries:
- Profit share
Dr Investment in Associate €90
Cr Income from Associate €90 - Dividends received
Dr Cash €15
Cr Investment in Associate €15 - Amortization of hidden reserves
Dr Income from Associate €6
Cr Investment in Associate €6
