1. Prepare the acquisition analysis at 1 January 2017 2. Prepare the business combination valuation entries and pre-acquisition entries at 1 Januart 2017 3. Prepare the business combination valuation entries and pre-acquisition entries at 31 December 2017
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1.pptxAccounting for Group Structure – An Introduction
WORKSHOP
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Ch 26 & 27.
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Topic intended learning outcomes
explain the purpose of consolidated financial statements
discuss the meaning and application of the criterion of control
discuss the consolidation process in the case of wholly owned entities and the initial adjustments required in the consolidation worksheet
prepare an acquisition analysis for the parent’s acquisition of a subsidiary
prepare the consolidation worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries
prepare the consolidation worksheet entries in periods subsequent to the acquisition date
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Consolidated financial statements:
Involves the preparation of a single set of financial statements.
Involves combining the financial statements of the individual entities in a group.
So that they show the financial position and financial performance of the group of entities.
Presented as if they were a single economic entity.
Consolidated financial statements
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Consolidated financial statements are ‘…the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity’.
Relevant standards:
AASB 10/IFRS 10 Consolidated Financial Statements
AASB 3/IFRS 3 Business Combinations.
Consolidated financial statements
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Group – a parent and its subsidiaries
Parent – an entity that controls one or more entities
Subsidiaries – an entity that is controlled by another entity
Consolidated financial statements
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A Ltd
B Ltd
Parent
“control” must exist (more on this later)
Subsidiary
The group is referred to as the “A Ltd Group”
Consolidated financial statements
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A parent is an entity that controls one or more entities.
Control is the criterion for identifying when a parent-subsidiary relationship exists.
Significant judgement is often required in determining whether control exists.
Control
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Control
The following three elements are required in order for an investor to have control:
power over the investee
exposure, or rights, to variable returns from its involvement with the investee
the ability to use its power over the investee to affect the amount of the investor’s returns.
All three elements must be present for control to exist.
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Power is defined as ‘…existing rights that give the current ability to direct the relevant activities’.
Control – Power
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Power arises from rights
Most rights arise from a legal contract. Examples in AASB 10/IFRS 10 include:
voting rights
rights to appoint, reassign or remove members of the investee’s key management personnel
rights to appoint or remove another entity that participates in management decisions
rights to direct the investee to enter into, or veto any changes to, transactions that affect the investee’s returns.
Control – Power
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Power arises from rights
Rights must be substantive – the holder must have the practical ability to exercise the rights.
Control – Power
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Power arises from rights
Judgment is required in determining whether rights are substantive. Factors to consider per AASB 10/IFRS 10 are:
Whether the party that holds the rights would benefit from exercising the rights – e.g. potential voting rights.
Whether there are any barriers that prevent a holder from exercising rights.
Where multiple parties are involved, whether there is a mechanism in place to enable those parties to practically exercise the rights.
Control – Power
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Control – Power
Power arises from rights
If a right is purely protective, then the holder does not have power.
Protective rights are designed to protect the interest of the party holding those rights without giving the party power over the entity to which the rights relate.
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Power arises from rights
Example of protective rights include the following:
a lenders’ right to restrict a borrower from undertaking certain activities
the right of a party holding a non-controlling interest to approve various transactions
the rights of a lender to seize the assets of a borrower in the event of default.
Control – Power
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Power is the ability to direct – rather than actually directing.
The ability to direct must be current.
e. g. consider the impact of an investor that holds call options.
It must be relevant activities that are being directed:
that is activities of the investee that significantly affect the investee’s returns.
Control – Power
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Voting rights
Where the investor holds more than 50%, power is assumed if:
relevant activities are directed by a vote of the holder of the majority of shares, or
a majority of the members of the governing body that directs the relevant activities are appointed by a vote of the holder of the majority of shares.
Control – Power
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Voting rights
Where the investor holds less than 50% of voting shares of investee, determining whether investor has control requires examining potential actions of holders of other shares in investee:
attendance at AGM
level of dilution and disorganisation or apathy of remaining shareholders
existence of a contracts.
Control – Power
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Examples of returns that can exist in parent-subsidiary relationship include:
dividends
obtaining scarce raw materials on priority basis
gaining access to subsidiary’s distribution network, patents
economies of scale
denying or regulating access to subsidiary’s assets to competitors.
The returns must have the potential to vary according to the performance of the entity
Exposure or rights to variable returns
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The third element requires that the parent has the ability to increase its benefits and limit its losses from the subsidiary’s activities.
Remember, all three elements must be present for control to exist.
Ability to use the power to affect returns
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No Control
No parent –subsidiary relationship
No consolidation
Consolidation involves combining financial statements of individual entities to show financial position and performance of group as if it were single entity.
Consolidated financial statements are prepared by:
(i) Aggregating (combining), line by line, like items of assets, liabilities, equity, income and expenses.
(ii) Adjusting these combined figures for inter-group transactions between entities within the group (covered in following chapters).
Consolidated process
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Simple consolidation worksheet for the A Ltd group
| A Ltd | B Ltd | Consolidation | |||
| Current assets | 50 000 | + | 20 000 | = | 70 000 |
| Non current assets | 150 000 | + | 120 000 | = | 270 000 |
| Total assets | 200 000 | 140 000 | 340 000 | ||
| Total liabilities | (80 000) | + | (30 000) | = | (110 000) |
| Net assets | 120 000 | 110 000 | 230 000 |
Consolidation does not involve adjustments in the accounts of the entities. Consolidated financial statements are an additional set of financial statements and are prepared in a consolidation worksheet.
Consolidated financial statements
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Consolidation involves adding together the financial statements of the parent and subsidiaries and making a number of adjustments:
Business combination valuation entries – required to adjust the carrying amount of the identifiable assets acquired and the liabilities assumed of the subsidiary to fair value.
Pre-acquisitions entries – required to eliminate the carrying amount of the parent’s investment in each subsidiary against the pre-acquisition equity of that subsidiary.
Consolidation process in the case of wholly owned entities
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Consolidation involves adding together the financial statements of the parent and subsidiaries and making a number of adjustments:
Transactions between entities within the group subsequent to acquisition date (chapter 28).
Consolidation process in the case of wholly owned entities
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To facilitate the addition process a consolidation worksheet is used:
No adjustments are made in the accounting records of the individual entities
Therefore the entries must be made each time a cons. worksheet is prepared
Consolidation worksheets
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An acquisition analysis compares the cost of acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at acquisition to determine whether there is:
Goodwill on acquisition (where cost > FVINA).
Bargain purchase (where cost < FVINA).
NOT the book value
The acquisition analysis
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Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2016 for a cash consideration of $400,000.
At that time the net assets of Lotech Ltd were represented as follows:
| $ | |
| Share capital | 300,000 |
| Retained earnings | 50,000 |
| Net assets | 350,000 |
Book value of identifiable net assets (BVINA)
Lecture example – background information
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When Hitech acquired its investment in Lotech the following information applied:
Land held by Lotech was undervalued by $10,000.
A building held by Lotech was undervalued by $45,000. The building had originally cost $100,000 2 years ago and was being depreciated at 10% per year.
A contingent liability relating to an unsettled legal claim with a fair value of $3,000 was recorded in the notes to Lotech’s financial statements.
The tax rate is 30%.
Lecture example – background information
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| $ | ||
| Cost of acquisition | 400,000 | |
| Book value of net assets | ||
| - Share capital | 300,000 | |
| - Retained earnings | 50,000 | |
| Total book value of net assets | 350,000 | |
| Fair value adjustments | ||
| - After tax increase in land | 7,000 | |
| - After tax increase in building | 31,500 | |
| - After tax recognition of provision for legal claim | (2,100) | |
| Total fair value adjustments | 36,400 | |
| FVINA | 386,400 | |
| X %age acquired | 100% | 386,400 |
| Goodwill/(bargain purchase) on acquisition | 13,600 |
A
Cash consideration
B
BVINA
Adjust to fair value & add. of cont. liability
10,000 x (1 – 30%) = 7,000
45,000 x (1 – 30%) = 31,500
(3,000) x (1-30%) = (2,100)
C
B + C = D
A – D
If +ve = Goodwill
If –ve = Bargain Purchase
No previously held equity interest
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Example facts as per slide 15
Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2016 for a cash consideration of $400,000
Net assets = $350,000 as Share capital $300,000 + Retained earnings $50,000
Slide 16 information
Land held by Lotech was undervalued by $10,000
A building held by Lotech was undervalued by $45,000.
The building had originally cost $100,000 2 years ago and was being depreciated at 10% per year
A contingent liability relating to an unsettled legal claim with a fair value of $3,000 was recorded in the notes to Lotech’s financial statements
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Parent has previously held equity interest in the subsidiary
Where control is achieved in stages:
the previously held equity instruments in the acquiree.
must be adjusted to fair value prior to performing the acquisition analysis.
Example:
Hitech acquired 15% of Lotech on 30 June 2010 and the remaining 85% on 30 June 2016.
Acquisition analysis
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Parent has previously held equity interest in the subsidiary
Additional entries are required in the parents books in accordance with AASB 9/IFRS 9 Financial Instruments:
recognising the increase (decrease) to fair value FV in profit or loss
unless the parent has elected to recognise changes in fair value as other comprehensive income.
Acquisition analysis and consolidation entries remain unchanged.
Acquisition analysis
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Business combination valuation entries
If the BV of subsidiary assets and liabilities > < FV.
Or, if a contingent liability exists, then “business combination valuation” adjustments are required:
to increase or decrease subsidiary’s recorded assets and liabilities book values to fair value;
to recognise previously unrecognised assets (e.g. internally generated intangibles) at fair value; or
to recognise subsidiary’s contingent liabilities as liabilities at fair value.
Consolidation worksheet entries at the acquisition date
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Business combination valuation entries
Business Combination Valuation Reserve (BCVR) account is used to record these adjustments.
The BCVR is similar to the Asset Revaluation Surplus (ARS) account.
Consolidation worksheet entries at the acquisition date
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Where the BCVR entry is done in the ARS account in the subsidiary’s books:
it is recorded in the G/L and
therefore automatically carries forward to future periods once entered.
BUT
Where the entry is done in the BCVR on consolidation (i.e. on the worksheet) it must be manually carried forward to future periods.
Consolidation worksheet entries at the acquisition date
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Equity balances that existed in the subsidiary prior to acquisition date are referred to as pre-acquisition equity:
all movements after the date of acquisition are referred to as post-acquisition.
You cannot have an investment in yourself, nor can you have equity in yourself.
From a consolidated viewpoint, these items should not exist i.e. they must be eliminated to avoid double counting.
Pre-acquisition entries
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The pre-acquisition entry:
Eliminates the asset “Investment in subsidiary” (in the parent’s books)
Against the pre-acquisition equity (in the subsidiary’s books)
The pre-acquisition entry required for the lecture example is:
DR Share capital 300,000
DR Retained earnings 50,000
DR BCVR 50,000
CR Investment in Lotech 400,000
These figures are taken from the acquisition analysis (refer to slide 15 earlier)
Pre-acquisition entries
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| Hitech Ltd. | Lotech Ltd. | Adjustments | Group | ||
| $’000 | $’000 | DR | CR | $’000 | |
| Cash in bank | 460 | 200 | 660 | ||
| Deferred Tax Asset | 0.9 | 0.9 | |||
| Land | - | 200 | 10 | 210 | |
| Building | 100 | 25 | 125 | ||
| Accumulated Depreciation | - | -20 | 20 | - | |
| Investment in Lotech Ltd | 400 | - | 400 | 0 | |
| Goodwill | - | - | 13.6 | 13.6 | |
| 860 | 480 | 1,009.50 | |||
| Creditors | 160 | 130 | 290 | ||
| Deferred Tax Liability | 3 + 13.5 | 16.5 | |||
| Provision for legal claim | 3 | 3 | |||
| Share capital | 600 | 300 | 300 | 600 | |
| Retained earnings | 100 | 50 | 50 | 100 | |
| BCVR | 2.1 + 50 | 7 + 31.5 +13.6 | 0 | ||
| 860 | 480 | 1,009.50 |
Note these values
Pre-acquisition entry
In the equity section of the statement of financial position the subsidiary’s balances have been eliminated in full, so the group balances = parent’s balances
Example: pre-acquisition entry at acquisition date
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The consolidation journals will be posted onto the consolidation worksheet at 30 June 2016 (the date of acquisition)
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So far, we have considered the consolidation journals required if a consolidation was being prepared on the acquisition date.
How do these journals change if a consolidation is being prepared on a later date?
How do transactions and events occurring post-acquisition impact on the business combination valuation adjustment entries?
How do post-acquisition transactions and events impact on the pre-acquisition entry?
Worksheet entries subsequent to acquisition date
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Super retail group case study
Obtain a copy of the most recent annual report of the Super Retail Group.
Identify and review the information on the subsidiaries included within the Super Retail GROUP.
How many subsidiaries are there? Where are they located? What do they do? How does the parent company CONTROL these subsidiaries?
Do the consolidated accounts provide a relevant and reliable measure of the group’s performance and position? In the absence of consolidated accounts, how could you review how well the group was performing?
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Workshop Case study
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conclusion
This topic has reviewed the nature of group structures and explored the basic consolidation procedures.
What is a subsidiary?
What are the key steps to consolidate?
Next week, we continue our study of consolidation procedures and explore how to eliminate the effects of transactions between members of a group.
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