Advanced Financial

Accounting
SDUST
2022
K Antonovich
Tutorial Week 3
 Concepts, examples,
questions
Chapter 3 – Group Reporting
II: Application of the
Acquisition Method under
IFRS 3
Introduction

Recap of chapter 3
• Acquisition method: recognize and measure
identifiable net assets at fair value + recognize
goodwill
− Recognition and measurement principles

• Different forms of business combination but in

substance they share common features
− Acquirer who gains control of one or more
businesses
− Acquisition of a subsidiary = Acquisition of its
3
Consolidation Example

CPD Box
Mommy Corp has
owned 80% shares of
Baby Ltd since Baby’s
incorporation.
• Opposite are SFPof
Mommy and Baby at
31 December 20X4

• Note: CU means
currency unit
Prepare consolidated statement of financial
position of Mommy Group as at 31 December
20X4. Measure NCI at its proportionate share
of Baby’s net assets.

Please note here that in the above statements

of financial position, all assets are with “+” and
all liabilities are with “-“. I use it this way
because for me it’s easier to verify and identify
mistakes, but it’s up to you
3 Steps in Consolidation Procedures

1. Combine like items of assets, liabilities, equity,

income, expenses and cash flows of the parent
with those of its subsidiaries;
2. Offset (eliminate): the carrying amount of the
parent’s investment in each subsidiary; and the
parent’s portion of equity of each subsidiary;
3. Eliminate in full .intragroup assets and liabilities,
equity, income, expenses and cash flows relating
to transactions between entities of the group
Step 1: Combine
After you make sure that all subsidiary’s assets and
liabilities are stated at fair values and all the other
conditions are met, you can combine, or add up like
items.

It’s very easy when a parent (Mommy) and a subsidiary

(Baby) use the same format of the statement of financial
position – you just add Mommy’s PPE and Baby’s PPE,
Mommy’s cash and Baby’s cash balance, etc.
In reality, companies use their own format for presenting
their financial position and therefore it can be difficult to
combine. That’s exactly WHY so many groups use their
“consolidation packages” and subsidiaries’ accountants
must fill them up along with preparing own financial
statements.
In our case study, combined numbers looks as follows

Of course, there are some

strange and redundant
numbers, for example both
Mommy’s and Baby’s
share capital, but we
haven’t finished yet!
Step 2: Eliminate
After combining like items, we need to offset
(eliminate):

• the carrying amount of the parent’s investment in

each subsidiary; and
• the parent’s portion of equity of each subsidiary;
• and, recognize any non-controlling interest and
goodwill.
So let’s proceed. The first two items are easy – just remove
Mommy’s investment into Baby (CU – 70 000), and remove Baby’s
share capital in full (CU + 80 000).

As there is some non-controlling interest of 20%, you need to

remove its share in Baby’s post-acquisition retained earnings of CU
9 000 (20%*CU 45 000).

Wait a second – how do we know that all Baby’s reserves (retained

earnings) of CU 45 000 are post-acquisition?

Well, the question says that Mommy has owned Baby’s shares
since its incorporation, therefore full Baby’s retained earnings are
post-acquisition.

Be careful here, because you absolutely need to differentiate pre-

acquisition retained earnings from post-acquisition retained
earnings, but here, we’re not going to complicate the things.
Then we need to recognize any non-controlling interest and
goodwill
Non-controlling interest at 31 December 20X4
Mommy has owned 80% of Baby’s share and therefore, non-
controlling interest owns remaining 20% of Baby’s net assets.

The question asks to measure non-controlling interest at

proportionate share on Baby’s net assets, so here’s how it looks
like at the end of the reporting period:

Baby’s net assets are CU 125 000 as at 31 December 20X4,

equating to Baby’s share capital of CU 80 000 and Baby’s post-
acquisition reserves of CU 45 000.

Non-controlling interest at 31 December 20X4 is 20% of Baby’s

net assets of CU 125 000, which is CU 25 000. Recognize it
with minus, as we are crediting equity with non-controlling
interest
Initial recognition of goodwill
There might be some goodwill arisen on initial recognition. Let’s
calculate it. Please don’t forget that we calculate goodwill based on
numbers on acquisition, not on 31 December 20X4.

The goodwill is calculated as:

Fair value of consideration transferred: in this case, we simply take
Mommy’s investment in Baby of CU 70 000;
Add any non-controlling interest at acquisition: here, we’re not
adding the non-controlling interest calculated above, as it’s the
measurement on 31 December 20X4. At acquisition, the value of non-
controlling interest is 20% of Baby’s net assets on its incorporation of
CU 80 000 (share capital only). It equals CU 16 000.
When a business combination was achieved in stages, you would
need to add the acquisition-date fair value of the acquirer’s previously-
held equity interest in the acquiree, but in this example, it’s not
applicable,
Deduct Baby’s net assets at acquisition: CU – 80 000.
Goodwill acquired in a business combination comes to CU 6 000 (70
000 + 16 000 – 80 000).
The elimination entry looks as follows (sign “+” indicates a
debit entry; sign “-“ indicates a credit entry):

Amou
Description Debit Credit
nt

Remove Mommy’s investment -70 FP – Investment

in Baby 000 in Baby

Remove Baby’s share capital in +80 FP – Baby’s

full 000 share capital

Remove 20% (NCI) of Baby’s +9 FP – Retained

post-acquisition retained 000 earnings
earnings

-25 FP – Non-
Recognize non-controlling
000 controlling
interest on 31 December 20X4
interest

+6 FP – Intangible
Recognize goodwill acquired in
000 assets
a business combination
(goodwill)

Check 0
I have transferred this journal entry into our consolidation
worksheet, and it looks as follows
Eliminate Intragroup Transactions
Parents and subsidiaries trade with each other
very often.

However, when you look at both parent and

subsidiary as 1 company, which is the purpose of
consolidation, then you find out that there’s no
transaction at all.

In other words, group has not performed any

transaction from the view of some external user.

Therefore, you need to eliminate all transactions happening

within the group, between a parent and its subsidiaries.
Looking to above
individual statements
of financial position of
Mommy and Baby
you see that Mommy
has a receivable to
Baby of CU 8 000
and Baby has a
payable to Mommy of
CU 8 000. Perhaps
these 2 items relate
to the same
transaction between
them, and we need to
eliminate them, by
debiting payables
and crediting
receivables:
Final steps
After we have
completed all steps
or consolidation
procedures, we can
add up all the
combined numbers
with our adjustments
and thus we arrive at
consolidated
statement of financial
position. You can
revise all the steps
and formulas in Excel
file that I will provide.
Here’s how it looks
like:
Please note the following:
• Consolidated numbers are simply sum of Mommy’s
balance, Baby’s balance and all adjustments or entries
(Steps 1-3).
• Mommy’s investment in Baby’s shares is 0 as we
eliminated it in the step 2. The same applies for Baby’s
share capital and consolidated statement of financial
position shows only a share capital of Mommy (parent).
• There’s a goodwill of CU 6 000 and non-controlling
interest of CU 25 000, as we have calculated above.
• Consolidated retained earnings are CU 98 000 and they
consist of:
• Mommy’s retained earnings of CU 62 000 in full, and
• Mommy’s share (80%) on Baby’s post-acquisition
retained earnings of CU 45 000, that is CU 36 000
Note also that we have not considered elimination of
specific intragroup transactions; for example, parent
sells inventory to subsidiary, these will be considered
in the lecture
Questions – Chapter 3
1. Fill in the missing word. A
business combination involving
entities or businesses under _______
control is a business combination in
which all of the combining entities or
businesses are ultimately controlled
by the same party or parties both
before and after the business
combination, and that control is not
transitory..
 Concepts, examples,
questions
Chapter 4 – Group Reporting
III
Impairment review of proportionate
goodwill
At the year-end, an impairment review is
being conducted on a 60%-owned
subsidiary. At the date of the impairment
review the carrying amount of the
subsidiary’s net assets were $250 and the
goodwill attributable to the parent $300
and the recoverable amount of the
subsidiary $700.
Required
Determine the outcome of the impairment review
Solution
In conducting the impairment review of proportionate
goodwill, it is first necessary to gross it up.

Proportionate goodwill Grossed up Goodwill

including the
notional
unrecognised
NCI
$300 x 100/60 = $500

Now, for the purposes of the impairment review,

the goodwill of $500 together with the net assets
of $250 form the carrying amount of the cash-
generating unit
Impairment review
Carrying amount
Net assets $250
Goodwill $500
$750
Recoverable amount ($700)
Impairment loss $50

The impairment loss does not exceed the total of the

recognised and unrecognised goodwill so therefore it is
only goodwill that has been impaired. The other assets are
not impaired. As proportionate goodwill is only
attributable to the parent, the impairment loss will not
impact NCI. Only the parent’s share of the goodwill
impairment loss will actually be recorded, ie 60% x $50 =
$30
The impairment loss will be applied to write down
the goodwill, so that the intangible asset of
goodwill that will appear on the group statement of
financial position will be $270 ($300 – $30).

In the group statement of financial position, the

accumulated profits will be reduced $30. There is
no impact on the NCI.

In the group statement of profit or loss, the

impairment loss of $30 will be charged as an extra
operating expense. There is no impact on the NC
100% OWNERSHIP
For example, let's assume that Company
XYZ purchases Company ABC. The book
value of Company ABC's assets is $10
million, but for various good reasons,
Company XYZ pays $15 million for
Company ABC. Because Company XYZ
paid $15 million for $10 million worth of
assets, Company XYZ records $5 million of
goodwill as an asset on its balance sheet.
After the acquisition, Company ABC's sales fall by
40% over the year because Company XYZ changed
its product line, which proved unpopular. Also, a
competitor introduced a newer, lighter, faster, and
cheaper product. As a result, Company ABC's fair
market value falls to $8 million.

A year has now passed, and for Company XYZ, this

means comparing the fair value of Company ABC to
the book value on XYZ's financial statements. If the
fair value of Company ABC is less than the book
value (that is, if Company XYZ were to sell Company
ABC today, it wouldn't get a price equal to or greater
than its recorded value), Company XYZ must make a
goodwill impairment
In this example, Company XYZ would compare
Company ABC's current fair market value of $8
million plus the $5 million of goodwill (a total of
$13 million) to the $15 million it has recorded as
Company ABC's value on its books.
The difference between the two is $2 million,
and Company XYZ must therefore reduce the
goodwill on its books by that amount. The
goodwill entry on its balance sheet goes from
$5 million to $3 million, and its total assets fall
correspondingly
Example - Sale of inventories at a profit to
parent company (using periodic inventory
system)
P Limited purchases all inventories from its wholly
owned subsidiary, S Limited. During the accounting
year to 31 March 2008, P Limited purchases goods
from S Limited at $480,000 (on credit terms), which
represents 25% in excess of cost. During the year to
31 December 2007, P Limited sold goods to
outsider for $440,000 (on credit terms). The amount
of inventories of P Limited as at 31 March 2008 was
$96,000. Both P Limited and S Limited use the
periodic inventory system and have a year end of 31
March. P Limited and S Limited need to prepare the
following journal entries for the above transactions:
P Limited
DR. Intercompany purchase 480,000
CR. Intercompany accounts payable 480,000

DR Accounts receivable 440,000

CR Sales 440,000

CR Inventories 96,000
CR Cost of Sales 96,000
(recognizes that not all inventory was sold)

S Limited
DR Intercompany accounts receivable 480,000
CR Intercompany sales 480.000
The accounting entries needed to eliminate the intra-group
transactions and the related unrealized profits on
inventories are:
31/03/2008
Dr. Intercompany sales – S $480,000
Cr. Intercompany purchases – P $480,000
To eliminate intercompany purchases and sales.

31/03/2008
Dr. Intercompany accounts payable – P $480,000
Cr. Intercompany accounts receivable – S $480,000
To eliminate intercompany receivable and payable

31/03/2008
Dr. Consolidated retained earnings $19,200
Cr. Inventory – P [$96,000 -
$96,000/(1+25%)] $19,200
To eliminate unrealized profit on inventories
Example – Sale of inventories at a profit to a
subsidiary (using perpetual inventory system)
S Limited is the wholly owned subsidiary of P Limited.
During the accounting year to 31 December 2007, P
Limited sold goods to S Limited at a price of $2.4 million

S
HI
on credit terms, the gross profit of which is 25% of selling

LT
price. All the inventories of S Limited are purchased from
P Limited. Both P Limited and S Limited use the perpetual

AL
inventory system and have the year end of 31 December.
K
The balances of inventory of S Limited at 31 December
EC
2006 and 31 December 2007 were $0.3 million and $0.45
CH

million respectively. During the year to 31 December

2007, S Limited sold goods to outsiders for $2.5 million on
credit terms. On31 December 2007, there were no
outstanding intercompany payables and receivables
between P Limited and S Limited.
P Limited
$m $m
Dr. Intercompany accounts receivable 2.4
Cr. Intercompany sales 2.4

Dr. Intercompany cost of goods sold

[$2.4 X (1-25%)] 1.8
Cr. Inventories 1.8

Dr. Cash 2.4

Cr. Intercompany accounts receivable 2.4
S Limited
$m $m
Dr. Inventories 2.4
Cr. Intercompany accounts payable 2.4

Dr. Intercompany accounts payable 2.4

Cr. Cash 2.4

Dr. Accounts Receivable 2.5

Cr. Sales 2.5

Dr. Cost of goods sold * 2.25

Cr. Inventories
($0.3 + $2.4 - $0.45) 2.25

* Remember COS = Opening inventory + purchases – Closing inventory

The accounting entries needed to eliminate the intra-group
transactions and the related unrealized profits in inventories
are:
31/12/2007
Dr. Consolidated retained earnings
($300,000 x 25%) $75,000
Dr. Intercompany sales – P $2,400,000
Cr. Intercompany cost of
goods sold – P [$2,400,000 x (1 – 25%)] $1,800,000
Cr. Cost of goods sold – S
[($300,000+$2,400,000- $450,000)x25%] $562,500
Cr. Inventories – S ($450,000 x 25%) $112,500

(To eliminate intercompany sales, cost of sales, and unrealized

profit on inventories)
Questions – Chapter 4
True or False: One of the first steps in
the consolidation process is to eliminate
the investment in subsidiary account. In a
subsequent year however, the elimination
of the investment has to be repeated
because the parent’s legal entity financial
statements would include the investment
in subsidiary balance.