BCF 405 Financial Reporting - Module 4 PDF

96 Financial Reporting
Unit 4: Business Combinations

Notes
Structure
4.1 Introduction
4.2 Consolidated Financial Statements of Group Companies
4.3 Concept of a Group
4.4 Purposes of Consolidated Financial Statements
4.5 Minority Interest
4.6 Goodwill
4.7 Treatment of Pre-acquisition
4.8 Post-acquisition Profit
4.9 Preparation and Interpretation of Consolidated Financial Statement including a
Single Subsidiary and an Associate
4.10 Summary
4.11 Check Your Progress
4.12 Questions and Exercises
4.13 Key Terms
4.14 Further Readings
Objectives
After studying this unit, you should be able to:
 Understand the Concept and meaning of Financial Statements of Group
Companies
 Discuss the Purposes of consolidated financial statements
 Explain the Treatment of pre-acquisition
4.1 Introduction
Business combinations are combinations formed by two or more business units, with a
view to achieving certain common objective (specially elimination of competition); such
combinations ranging from loosest combination through associations to fastest
combinations through complete consolidations.
L.H. Haney defines a combination as follows:
“To combine is simply to become one of the parts of a whole; and a combination is
merely a union of persons, to make a whole or group for the prosecution of some
common purposes.”
Read this topic to know about the causes of formation of business combination.
Causes of Business Combinations

Some of the outstanding causes leading to the formation of business combinations are
described below:
1. Wasteful Competition: Competition, which is said to be the ‘salt of trade’, by going
too far, becomes a very powerful instrument for the inception and growth of
business combinations. In fact, competition, according to Haney, is the major
driving force, leading to the emergence of combinations, in industry.
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Business Combinations 97
2. Economies of Large-Scale Organization: Organisation of production on a large
scale brings a large number of well-known advantages in its wake – like technical
economies, managerial economies, financial economies, marketing economies and Notes
economies vis-a-vis greater resistance to risks and fluctuations in economic
activities. Economies of large scale operations, thus become, a powerful force
causing increased race for combinations.
3. Desire for Monopoly Power: Monopoly, a natural outcome of combination, leads
to the control of market and generally means larger profits for business concerns.
The desire to secure monopolistic position certainly prompts producers to join
together less than one banner.
4. Business Cycles: Trade cycles, the alternate periods of boom and depression,
lead to business combinations. Boom period i.e. prosperity period leading to an
unusual growth of firms to reap rich harvest of profits results in intense competition;
and becomes a ground for forming combinations.
Depression, the times of economic crisis-with many firms having to only option to
close down-prompts business units to combine to ensure their survival.
5. Joint Stock Companies: The corporate form of business organization is a
facilitating force leading to emergence of business combinations. In joint stock
companies, control and management of various corporate enterprises can be
concentrated, in a ‘small group of powerful persons through acquiring a controlling
amount of shares of different companies.
6. Influence of Tariffs: Tariffs have been referred to as “the mother of all trusts”.
(A trust is a form of business combinations). Tariffs do not directly result in
combinations; they prepare the necessary ground for it. In fact, imposition of tariffs
restricts foreign competition; but increases competition among domestic producers.
Home producers resort to combinations, to protect their survival.
7. Cult of the Colossal (or Respect for Bigness): In the present-day-world,
business units of bigger size are more respected than units of small size. Those
who believe in the philosophy of power and ambition, compel small units to
combine; and are instrumental in forming powerful business combinations, in a
craze for achieving bigness.
8. Individual Organising Ability: The scarcity of organizing talent has also induced
the formation of combinations, in the business world. Many-a-times, therefore,
combinations are formed due to the ambition of individuals who are gifted with
organising ability. The number of business units is far larger than the skilled
business magnates; and many units have to combine to take advantage of the
organising ability of these business brains.
Causes of Business Combinations — At a Glance
1. Wasteful competition
2. Economics of large scale organisation
3. Desire of monopoly power
4. Business cycles
5. Joint stock companies
6. Influence of tariffs
7. Cult of the colossal (or Respect of bigness)
8. Individual organising ability
Types of Business Combinations:

Business combinations are of the following types:
1. Horizontal Combinations.
2. Vertical Combinations.

3. Lateral or Allied Combinations: Lateral combination refers to the combination of
those firms which manufacture different kinds of products; though they are allied in
Notes some way.
Lateral combination may be:
(a) Convergent lateral combination: In convergent lateral combination, different
industrial units which supply raw-materials to a major firm, combine together
with the major firm. The best illustration is found in a printing press, which may
combine with units engaged in supply of paper, ink, types, cardboard, printing
machinery etc.
(b) Divergent lateral combination: Divergent lateral integration takes place when
a major firm supplies its product to other combing firms, which use it as their
raw material. The best example of such combination may be found in a steel
mill which supplies steel to a number of allied concerns for the manufacture of a
variety of products like tubing, wires, nails, machinery, locomotives etc.
4. Diagonal (or Service) Combinations: This type of combination takes place when
a unit providing essential auxiliary goods / services to an industry is combined with
a unit operating in the main line of production. Thus, if an industrial enterprise
combines with a repairs workshop for maintaining tools and machines in good
order; it will be effecting diagonal combination.
5. Circular (or Mixed) Combinations: When firms engaged in the manufacture of
different types of products join together; it is known as circular or mixed
combination. For example, if a sugar mill combines with a steel works and a cement
factory; the result is a mixed combination.
Forms of Business Combinations

By the phrase ‘forms of combinations’, we mean the degree of combination, among the
combining business units.
According to Haney, combinations may take the following forms, depending on the
degree or fusion among combining firms:
1. Associations:
(a) Trade associations
(b) Chambers of commerce
(c) Informal agreements
2. Federations:
(a) Pools
(b) Cartels
3. Consolidations – Partial and Complete:
(a) Partial Consolidations:
 Combination trusts
 Community of interest
 Holding company
(b) Complete Consolidations:
 Merger
 Amalgamation

The following chart depicts the above forms of business combinations:
Notes
Following a brief account of the above forms of business combinations:

1. Associations: Forms of Business Combinations in this Category are as following:
(i) Trade Associations: A trade association comes into being when business
units engaged in a particular trade or industry or in closely related trades come
together for the promotion of their economic and business interests. Such an
association is organized on a non-profit basis and its meetings are used largely
for a discussion of matters affecting the common interests of members such as
problems of raw- materials, labour, tax-laws etc.
Most of the trade associations are organised on a local or territorial basis. A
trade association is the loosest form of combination and it does not interfere
with the internal management of a member unit.
(ii) Chambers of Commerce: Chambers of commerce is voluntary associations of
persons connected with commerce and industry. Their membership consists of
merchants, brokers, bankers, industrialists, financiers etc.
Chambers of commerce is formed in the same way as associations, with the
ultimate objective of promoting and protecting the interests of business
community. But they differ from trade associations in that they do not confine
their interests only to a particular trade or industry; but stand for the business
community in a particular region, country, or even the world, as a whole.
Chambers of commerce act as spokesmen of business community and make
suggestions to the government regarding legislations that will foster trade and
industry. The constitution and composition of chambers of commerce vary from
country to country. In most of the countries, they are voluntarily organised by
businessmen; though the government maintains close contacts with them.
(iii) Informal Agreements: Informal agreements are types of business
combinations which may be formed for the purpose of regulating production or
for dividing the markets or for fixation of prices etc. Such agreements require
the surrender of some freedom by the combining business units; though
ownership and control of combining units is not affected.
Informal agreements among business magnates are often concluded secretly at
social functions like dinners or at meetings of trade associations etc. These

agreements are merely understanding among the parties and no written
documents are prepared. As they depend mainly on the honour and sincerity of
Notes members; they are referred to as Gentlemen’s agreements.
2. Federations: Forms of Business Combinations in this Category are as following:
(i) Pools: Under the pool form of business combination, the members of a pooling
agreement join together to regulate the demand or supply of a product without
surrendering their separate entities, in order to control price.
Important Types of Pools are:
 Output Pools: Under these pools, the current demand for the product of the
industry is estimated; and quotas of output for various member units are
fixed. Member units are expected to produce only up-to the quota, and sell
their products at a price determined by the pooling association.
 Traffic Pools: Such pools are formed by shipping companies, airlines,
railway companies and road transport agencies; with the basic objective to
limit competition through a division of the area of operation.
 Market Pools: These pools are formed with the objective of ensuring a
certain demand to each member. For this purpose, the entire market is
divided among the members in any of these three ways by customers, or by
products or by territories.
 Income and Profit Pools: In these pools, members of the pooling
association are required to deposit a very high percentage (say 80%) of the
gross receipts in the common pool for re-distribution among members on
an agreed basis.
(ii) Cartels (Kartells): Basically cartel is the European name for the American
pools. According to Von Beckerath, “A cartel is a voluntary agreement of
capitalistic enterprises of the same branch for a regulation of the sales market
with a view to improving the profitableness of its members’ business.”
Von Beckerath mentions the following broad types of cartels:
 Price-Fixing Cartels: In this type, prices are fixed for goods and members
cannot sell below those prices.
 Term-Fixing Cartels: In this type, terms regarding sales e.g. rate of
discount, period of credit; terms of payment etc. are prescribed.
 Customer Assigning Cartels: In this type, each member unit is allotted
certain customers.
 Zonal Cartels: In this type, division of market among units takes place; but
generally these cartels are formed for dividing the world market.
 Quota-Fixing Cartels: In this type, production quotas are fixed for each
member; and no member would produce more than the allotted quota.
 Syndicates (or Cartels Proper): This type of cartel is brought into existence,
through an agreement among a number of competing producers to
establish a joint selling agency (called syndicate) for the exclusive sales of
their products. Member units sell their products to the syndicate at a price
called the accounting price.
The syndicate sells to consumers at a price higher than the accounting
price; and the profits earned are distributed among members on an agreed
basis.
3. Consolidations: As a Form of Business Combinations, Consolidations may be:
(a) Partial Consolidations: Under partial consolidations, the combining units
surrender their freedom for all practical purposes to the combination
organisation; but retain respective individual entities nominally.
Popular Types of Partial Consolidation are the following:

 Combination Trusts: A combination trusts is an arrangement by which the
business control is entrusted to the care of trustees, by a number of
business concerns. It consists in the transfer to trustees of the voting rights Notes
arising from the possession of shares.
The trust has a separate legal existence. The control and administration of
the combining units are consolidated; and they have to forgo a large
measure of their independence and autonomy in directing their affairs. The
shareholders of combining companies get trust certificates from the Board
of Trustees; which show their equitable interest in the income of the
combination.
 Community of Interest: When trusts were declared illegal in the U.S.A.; the
business leaders devised a new form of combination ‘Community of
interest’, for keeping a number of companies under some kind of common
control.
A community of interest may be defined as form of business combination in
which, without any central administration, the business policy of several
companies is controlled, by a group of common shareholders or directors.
 Holding Company: A holding company is a concept recognized by law in
India and most other countries. A holding company is any company which
holds more than half of the equity share capital of other companies or
controls the composition of the board of directors of other companies
(called the subsidiary companies).
Further, a company which is a subsidiary of another subsidiary company
will be the subsidiary of that other holding company too. For example, if C is
a subsidiary of B; and B is a subsidiary of A; then C will be deemed to be a
subsidiary of A through the medium of B.
(b) Complete Consolidations: Complete consolidation is that form of business
combination under which there is a complete fusion of the combining units and
the separate entities of these units are surrendered in favour of the
consolidated unit.
There are Two Forms of Complete Consolidation:
 Merger: In merger, one or more companies merge with another existing
company. The absorbing company retains its entity and enlarges its size
through merger. The company which is absorbed, on the other hand, loses
its entity in the absorbing company.
 Amalgamation: An amalgamation implies the creation of a new company by
a complete consolidation of two or more combining units. Under
amalgamation none of the existing companies retains its entity. There is a
complete fusion of various existing companies, leading to the formation of
an altogether new company.
4.2 Consolidated Financial Statements of Group Companies

Consolidated financial statements are the combined financial statements of a parent
company and its subsidiaries. Because consolidated financial statements present an
aggregated look at the financial position of a parent and its subsidiaries, they let you
gauge the overall health of an entire group of companies as opposed to one company's
standalone position.
BREAKING DOWN 'Consolidated Financial Statements'

Consolidated financial statements report the aggregate of separate legal entities. A
parent company can operate as a separate corporation apart from its subsidiary
companies. Each of these entities reports its own financial statements and operates its
own business. However, because the subsidiaries are considered to form one economic

entity, investors, regulators, and customers find consolidated financial statements more
beneficial to gauge the overall position of the entity.
Notes
Consolidated Statement of Income
The consolidated financial statements only report income and expense activity from
outside of the economic entity. Any revenue earned by the parent that is an expense of
a subsidiary is omitted from the financial statements. This is because the net change in
the financial statements is $0. The revenue generated from one legal entity is offset by
the expenses in another legal entity. To avoid overinflating revenues, all internal
revenues are omitted.
Consolidated Balance Sheet

Certain account receivable balances and account payable balances are eliminated from
the consolidated balance sheet. These eliminated amounts relate to the amounts owed
to or from parent or subsidiary entities. Similar to the income statement, this is to simply
reduce the balances reported as the net effect is $0. All cash, receivables, and other
assets are reported on the consolidated as well as all liabilities owed to external parties.
Reporting Requirements
Consolidated financial statements must be prepared using the same accounting
methods across the parent and subsidiary entities. If relevant, the parent and
subsidiaries must all be accounted for using generally accepted accounting principles
(GAAP) if the consolidated financial statements are to be in accordance with GAAP. All
subsidiary equity accounts such as common stock or retained earnings must be
eliminated. A non-controlling interest account may be used if the subsidiary is not wholly
owned. When preparing the consolidated financial statements, the subsidiary’s balance
sheet accounts are readjusted to the current fair market value of the financial assets.
Ownership Calculation Methods

There are three ways to calculate the ownership interest between companies. Only
companies that are owned are included in the consolidated financial statements.
Ownership is based upon the total amount of stock owned. If a company owns less than
20% of another company's stock, it may use the cost method of financial reporting. If a
company owns more than 20% but less than 50%, the company uses the equity
method. Under both of these methods, consolidated financial statements are not
permitted.
4.3 Concept of a Group

The common notion that “man is a social being” and “No man is an island” defines the
nature of group. This indicates that man is not isolated as to the development of
particular pattern of behavior as molded by the influence of the group in the society.
These are the definitions of group:
1. A group is defined as the interdependence and complementation of the share
traditions, beliefs, norms and values.
2. A group is the collective effort of the members in a given society with common
aspirations, values and behaviors.
3. A group is an organized members of the society with a given purpose, goal, and
mission in the institution
4. A group is the process of interaction and communication of the other members of
the society.
In social group, it refers to the social relationships about the role and status as
influence by the culture in a society. Usually, the social groups vary from various
institution and organization wherein the collective purpose is achieved. It is also created
by the professional organizations and associations in business, government and

sectoral institutions. The examples of small groups are teams, fraternities, sororities,
and other interest groups.
Notes
Importance of Group
The significance of group is the integration of the acceptable norms of the society
including the development of social experiences. These are the gradual individual
transformations along the interaction and communication of the groups; the social
control; transmission of culture and tradition; and the development of language,
behavior and laws of the society.
1. It is a means of social control to conform the acceptable standards in the
society.
The individual is strongly influence by collective laws and norms usually imposed by
the elders and the institutions. The gradual development of the society has been
constantly adhered by the imposition of socially acceptable laws. It also
corresponds by the formulation of sanctions from those who would violate by the
imposed law of the community. It neutralizes the social threats in the formation of
stable society.
2. The group transmits the norms, traditions, beliefs and values of a given
culture.
The society exists by the interaction of social groups. It is the social transmitter
indicates along the development of traditions and cultures. The social interaction
may now shape as stable group and constantly evolved by the process of
socialization, acculturation and amalgamation including outside influence that may
affect the development of the culture.
3. The group provides the development of personal influence as it interacts with
the other members of the society.
The individual mingles by certain group of society. This is the basis of development
of personality as it learns the norms, laws, beliefs, fads, values and other cultural
values of the community .In psychology, the development of personality is the result
of interaction of the social environment. It transmits the human activities and defines
the personality of the individual as influenced by the attitudes, behavior and values
in the society.
4. The group creates and modifies the social environment based on common
culture and tradition.
The society is shaped by the group who has been providing the creation of common
tradition and culture. This is done by the amalgamation and acculturation of the
social groups including the intervening complementation of the physical
environment. Finally, the social modification translates by the discovery and
invention; and physical adaptation of environment. The social results may also
come in by the collective societal beliefs about their understanding and experience
of supernatural beings through religion and morality. The human adaptation has its
own flexibility and dynamism as to the conformed behavioural actions that later on
collectively define the culture and tradition as it transformed to an ethnic group.
5. The group is the sources of ideas and information through the interaction and
communication of the members of the society.
The concept of interaction and communication provides the ingredient of the social
transformation of the society. The individual learns the developed language and
manage to teach them with the offspring. Likewise, it is the basis to communicate
with other members of the group based on the result of the development of
language. The language provides the conformity on the human sensory to analyze
the social ideas of the collective group of people in the community.

Classification of Group
1. Social Membership: The common membership of the group is what we call
Notes in-group. It defines the social orientation along feeling of belongingness and
companionship. The social preference of the in-group derives from group
associations. The opposite side of this is the out-group; it connotes more on an
antagonistic group that sometimes create group conflicts such as the existence of
fraternities.
There are those groups that may identify certain level of reference based on
political and economic affiliations. This group is called reference group that
characterize by the idea of recognition and respect among other members of
society. There are also the small groupings of the society which consider as the
peer group.
In at larger scale of social interaction of the group, the voluntary association entails
the membership of individual or group such as the regional associations, military
organizations and other voluntary organization.
2. Social Interaction of Groups: The social group is further classified according
primary group and secondary group. The primary group responds to the face-to-
face communication which is more personal and intimate in nature. While the
secondary group entails the formal communication in business or government
organization. The organization position and designation gives credence in the way
the group communicate each other.
3. Nature of Social Groups: The group provides specific form as to the nature of
interaction in the society. The nature of social group is either informal group or
formal group. When the social interaction responds to the shared emotions, beliefs
and sentiments of the members of the group then it is called informal groups. The
advantage of this group is the sense of belongingness as interacts the common
social interests and issues in the society. On the other hand, the formal organization
adheres the rigid formal structure wherein the line authority in the position is
respected in the organizational structure. It is therefore created by the
organizational communication in public and private organization with formal sets of
philosophy, mission, vision and goals as adhered by the motive for profit or service-
oriented enterprise.
Finally, the concept of the Gemeinschaft and Gesselschaft formulated by Ferdinand
Tonnies may also form part on the nature of social groups. The Gemeinschaft
considers the social interaction of the rural areas or communities wherein the set of
values, beliefs, norms, culture and tradition is deeply embedded by the way they
communicate each other. While the Gesselschaft recognizes the distinct feature in
urban areas as the social groups are characterize by formal, impersonal and
fragmented relationships. Usually, it considers the highly sophisticated culture, and
impersonal way of social interaction.
Social Role and Status

These are the important concepts we should know about the study of group along role
and status of the society:
 Social Role is the expected social position based on the particular status of the
individual played in a given institution or organization. There is an expected
behavior pattern that connects to a particular role. These are some definitions of
role: (1) It is a pattern of expected behavioral actions in the society; (2) It is a
designation or position with a cloth of authority as prescribe by the organization.
The role has it form as it plays in the societal interaction. The separation and
departure to a vocation or career may be called as role exit. The prefix term as
former or ex exemplifies the notion of role exit. While social functions on the
multiple roles in the society which creates behavioural conflict and confusion is
called role conflict. The dual role on social affection and friendship creates serious

implication in applying the assigned organizational authority and power which is
called role strain.
 Social Status is the enforcement of organizational designation and position that
Notes
needs to utilize the impersonal way of communication. The CEOs, presidents,
supervisors, or managers may require the other members of the group to recognize
the impersonal way to communicate in the organization. It requires the utmost
respect to their assigned organizational positions.
4.4 Purposes of Consolidated Financial Statements

According to GAAP (Generally Accepted Accounting Principles), parent companies
must prepare consolidated financial statements to report on the financial well-being of
both the parent company and all its subsidiaries.
These statements are often prepared with the use of financial consolidation
software which takes financial figures from each individual subsidiary and combines
them into one overall report. Since each subsidiary also prepares its own standalone
financial report, consolidated financial statements may seem to some to be an
unnecessary extra step.
But is this really the case?
An analysis of the importance of consolidated financial statements reveals these
statements offer several benefits to investors, financial analysts and others who may be
evaluating the health of the parent company. In this article, we will review consolidated
financial reports in more detail including the unique benefits they offer.
Who Prepares Consolidated Financial Reports?

Consolidated financial reports are prepared by any parent company that owns one or
more subsidiaries. For example, it is common for one company to purchase smaller
companies that can complement the primary business and make it even stronger. The
smaller companies can help the profitability of the parent company while also continuing
to operate as separate entities.
Each subsidiary must prepare its own financial statements including balance sheet,
income statement, statement of cash flows and statement of retained earnings. This
information for each subsidiary is then combined using consolidation software to create
consolidated financial reports that represent the financial position of the parent
company.
How Consolidated Financial Reports Are Prepared?

Financial consolidation software is typically used to prepare consolidated financial
reports because it is not as simple as adding up the financial statements from each
subsidiary. In the consolidated report, the transactions among subsidiaries or a
subsidiary and a parent company are eliminated to avoid double counting. For example,
if a parent company purchases goods or services from a subsidiary, the parent
company’s purchase and the subsidiary’s sale are both eliminated so this transaction
doesn’t distort the final figures. It can be quite tedious to do this manually but
consolidated software simplifies the preparation of the final reports.
Benefits of Consolidated Financial Reports

Consolidated financial reports are a GAAP requirement for good reason. Some of the
many benefits of consolidated financial reports include:
 Complete Overview: Consolidated statements allow investors, financial analysts,
business owners and other interested parties to get a complete overview of the
parent company. At a glance, they can view the overall health of the business and
how each subsidiary impacts the parent company.

 Reducing Paperworl: With consolidated financial statements, there is also less
paperwork involved. If the parent company owns nine subsidiaries, there are 40
Notes separate standalone financial reports to view i.e. the four basic financial statements
for each subsidiary plus the parent company. Not only would it be hard to track
down all these records, it would be extremely difficult to look over each of them and
try to get an overall view of how the business is performing. Consolidated financial
statements cut this pile of reports down to just four consolidated reports. This
results in less paperwork and less effort being expended to assess a parent
company’s financial health.
 Simplification: Consolidation software cuts out all transactions that occur between
subsidiaries and the parent company since, in the grand scheme of the business,
these things cancel each other out. Eliminating these transactions gives a simplified
view of business performance.
 Updates to Consolidated Financial Statements: Over time, consolidated financial
statements will continue to evolve to make the process of evaluating a parent
company even more transparent. One of the reasons for this is that in the past
some companies have used consolidated reports to hide losses and liabilities in
special subsidiaries that were created specifically for hiding these financial
problems. The Financial Accounting Standards Board and the International
Accounting Standards Board regularly revisit the definitions and requirements for
consolidated statements in order to make them more reliable and easier to use.
4.5 Minority Interest

A minority interest, which is also referred to as non-controlling interest (NCI), is
ownership of less than 50% of a company's equity by an investor or another company.
For accounting purposes, minority interest is a fractional share of a company amounting
to less than 50% of the voting shares. Minority interest shows up as a noncurrent
liability on the balance sheet of companies with a majority interest in a company,
representing the proportion of its subsidiaries owned by minority shareholders.
BREAKING DOWN 'Minority Interest'

In accounting terms, if a company owns a minority interest in another company but only
has a minority passive position, for example it is unable to exert influence holding only
less than 20% of the subsidiary's voting stock, then only dividends received from the
minority interest are recorded from this investment. This is referred to as the cost
method; the ownership stake is treated as an investment at cost and any dividends
received are treated as dividend income.
The alternative accounting method for a minority interest is referred to as the equity
method, where the company has a minority active position, such as being able to exert
influence by having greater than 20% but less than 50% of the voting shares. Both
dividends and a percent of income are recorded on the company's books. Dividends are
treated as a return of capital, decreasing the value of the investment on the balance
sheet. The percentage of income the minority interest is entitled to from the company is
added to the investment account on the balance sheet as it effectively increases its
equity share in the company.
The parent company with the majority interest owns greater than 50% but less than
100% of a subsidiary's voting shares and recognizes a minority interest on its financial
statements. The parent company consolidates the financial results of the subsidiary with
its own, and as a result, a proportional share of income shows up on the parent
company's income statement attributable to the minority interest. Likewise, a
proportional share of equity in the subsidiary company shows up on the parent's
balance sheet attributable to the minority interest. The minority interest can be found in
the noncurrent liability section or equity section of the parent company's balance sheet
under U.S. GAAP rules. Under IFRS, however, the minority interest must be recorded in
the equity section of the balance sheet.

Example of Minority Interest
ABC Corporation owns 90% of XYZ Inc., which is a $100 million company. ABC records Notes
a $10 million minority interest as a noncurrent liability to represent the 10% of XYZ Inc.
it does not own. XYZ Inc. generates $10 million in net income, so ABC recognizes
$1 million, or 10% of $10 million, of net income attributable to minority interest on its
income statement. Correspondingly, ABC marks up the $10 million minority interest by
$1 million on the balance sheet. The minority interest investors do not record anything
unless they receive dividends, which are booked as income.
4.6 Goodwill
IFRS 3 Business Combinations outline the accounting when an acquirer obtains control
of a business (e.g. an acquisition or merger). Such business combinations are
accounted for using the 'acquisition method', which generally requires assets acquired
and liabilities assumed to be measured at their fair values at the acquisition date.
A revised version of IFRS 3 was issued in January 2008 and applies to business
combinations occurring in an entity's first annual period beginning on or after 1 July
2009.
History of IFRS 3
Date Development Comments
July 2001 Project added to IASB agenda History of the

(carried over from the old IASC) project
5 December 2002 Exposure Draft ED 3 Business Comment deadline

Combinations and related 4 April 2003
exposure drafts proposing
amendments to IAS 36 and IAS
38 published
31 March 2004 IFRS 3 Business Combinations Effective for

(2004) and related amended business
versions of IAS 36 and IAS 38 combinations for
issued which the
(IFRS 3 supersedes IAS 22) agreement date is
on or after 31 March
2004
29 April 2004 Exposure Draft Combinations by Comment deadline

Contract Alone or Involving 31 July 2004
Mutual Entities published
(These proposals were not
finalised, but instead considered
as part of the June 2005 exposure
draft)
30 June 2005 Exposure Draft Proposed Comment deadline

Amendments to IFRS 3 published 28 October 2005
10 January 2008 IFRS 3 Business Combinations Applies to business

(2008) issued combinations for
which the
acquisition date is
on or after the
beginning of the first
annual reporting
period beginning on
or after 1 July 2009
Contd…
6 May 2010 Amended by Annual Effective for annual

Improvements to IFRSs 2010 periods beginning
Notes (measurement of non-controlling on or after 1 July
interests, replaced share-based 2010
payment awards, transitional
arrangements for contingent
consideration)
12 December 2013 Amended by Annual Applicable for

Improvements to IFRSs business
2010-2012 Cycle (contingent combinations for
consideration) which the
acquisition date is
on or after 1 July
2014
12 December 2013 Amended by Annual Effective for annual

Improvements to IFRSs periods beginning
2011-2013 Cycle (scope on or after 1 July
exception for joint ventures) 2014
Related Interpretations
None
Amendments under consideration by the IASB
IFRS 3 — Definition of a business
IFRS 3/IFRS 11 — Re-measurement of previously held interests
Common control transactions
Summary of IFRS 3
Background
IFRS 3 (2008) seeks to enhance the relevance, reliability and comparability of
information provided about business combinations (e.g. acquisitions and mergers) and
their effects. It sets out the principles on the recognition and measurement of acquired
assets and liabilities, the determination of goodwill and the necessary disclosures.
IFRS 3 (2008) resulted from a joint project with the US Financial Accounting
Standards Board (FASB) and replaced IFRS 3 (2004). FASB issued a similar standard
in December 2007 (SFAS 141(R)). The revisions result in a high degree of convergence
between IFRSs and US GAAP in the accounting for business combinations, although
some potentially significant differences remain.
Key Definitions
[IFRS 3, Appendix A]
A transaction or other event in which an acquirer obtains control of one or more
businesses. Transactions sometimes referred to as 'true mergers' or 'mergers of equals'
are also business combinations as that term is used in [IFRS 3]
An integrated set of activities and assets that is capable of being conducted and
managed for the purpose of providing a return in the form of dividends, lower costs or
other economic benefits directly to investors or other owners, members or participants.
The date on which the acquirer obtains control of the acquiree.
The entity that obtains control of the acquiree.

The business or businesses that the acquirer obtains control of in a business
combination.
Notes
Scope
IFRS 3 must be applied when accounting for business combinations, but does not apply
to:
The formation of a joint venture* [IFRS 3.2(a)]
The acquisition of an asset or group of assets that is not a business, although
general guidance is provided on how such transactions should be accounted for [IFRS
3.2(b)].
Combinations of entities or businesses under common control (the IASB has a
separate agenda project on common control transactions) [IFRS 3.2(c)].
Acquisitions by an investment entity of a subsidiary that is required to be measured
at fair value through profit or loss under IFRS 10 Consolidated Financial Statements.
[IFRS 3.2A].
* Annual Improvements to IFRSs 2011–2013 Cycle, effective for annual periods
beginning on or after 1 July 2014, amends this scope exclusion to clarify that is applies
to the accounting for the formation of a joint arrangement in the financial statements of
the joint arrangement itself.
Determining whether a transaction is a business combination

IFRS 3 provides additional guidance on determining whether a transaction meets the
definition of a business combination, and so accounted for in accordance with its
requirements. This guidance includes:
Business combinations can occur in various ways, such as by transferring cash,
incurring liabilities, issuing equity instruments (or any combination thereof), or by not
issuing consideration at all (i.e. by contract alone) [IFRS 3.B5].
Business combinations can be structured in various ways to satisfy legal, taxation
or other objectives, including one entity becoming a subsidiary of another, the transfer
of net assets from one entity to another or to a new entity [IFRS 3.B6].
The business combination must involve the acquisition of a business, which
generally has three elements: [IFRS 3.B7].
Inputs – an economic resource (e.g. non-current assets, intellectual property) that
creates outputs when one or more processes are applied to it.
Process – a system, standard, protocol, convention or rule that when applied to an
input or inputs, creates outputs (e.g. strategic management, operational processes,
resource management).
Output – the result of inputs and processes applied to those inputs.
Method of accounting for business combinations
Acquisition method
The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3) is
used for all business combinations. [IFRS 3.4]
Steps in applying the acquisition method are: [IFRS 3.5]
 Identification of the 'acquirer'
 Determination of the 'acquisition date'

Recognition and measurement of the identifiable assets acquired, the liabilities
assumed and any non-controlling interest (NCI, formerly called minority interest) in the
Notes acquiree.
Recognition and measurement of goodwill or a gain from a bargain purchase
Identifying an acquirer
The guidance in IFRS 10 Consolidated Financial Statements is used to identify an
acquirer in a business combination, i.e. the entity that obtains 'control' of the acquiree.
[IFRS 3.7].
If the guidance in IFRS 10 does not clearly indicate which of the combining entities
is an acquirer, IFRS 3 provides additional guidance which is then considered:
The acquirer is usually the entity that transfers cash or other assets where the
business combination is effected in this manner [IFRS 3.B14].
The acquirer is usually, but not always, the entity issuing equity interests where the
transaction is effected in this manner, however the entity also considers other pertinent
facts and circumstances including: [IFRS 3.B15]
 relative voting rights in the combined entity after the business combination
 the existence of any large minority interest if no other owner or group of owners has
a significant voting interest
 the composition of the governing body and senior management of the combined
entity
 the terms on which equity interests are exchanged
The acquirer is usually the entity with the largest relative size (assets, revenues or
profit) [IFRS 3.B16]
For business combinations involving multiple entities, consideration is given to the
entity initiating the combination, and the relative sizes of the combining entities. [IFRS
3.B17]
Acquisition date
An acquirer considers all pertinent facts and circumstances when determining the
acquisition date, i.e. the date on which it obtains control of the acquiree. The acquisition
date may be a date that is earlier or later than the closing date. [IFRS 3.8-9]
IFRS 3 does not provide detailed guidance on the determination of the acquisition
date and the date identified should reflect all relevant facts and circumstances.
Considerations might include, among others, the date a public offer becomes
unconditional (with a controlling interest acquired), when the acquirer can effect change
in the board of directors of the acquiree, the date of acceptance of an unconditional
offer, when the acquirer starts directing the acquiree's operating and financing policies,
or the date competition or other authorities provide necessarily clearances.
Acquired assets and liabilities

IFRS 3 establishes the following principles in relation to the recognition and
measurement of items arising in a business combination:
 Recognition principle: Identifiable assets acquired, liabilities assumed, and non-
controlling interests in the acquiree, are recognised separately from goodwill [IFRS
3.10]
 Measurement principle: All assets acquired and liabilities assumed in a business
combination are measured at acquisition-date fair value. [IFRS 3.18]

Exceptions to the recognition and measurement principles
The following exceptions to the above principles apply: Notes
 Contingent liabilities: The requirements of IAS 37 Provisions, Contingent
Liabilities and Contingent Assets do not apply to the recognition of contingent
liabilities arising in a business combination [IFRS 3.22-23]
 Income taxes: The recognition and measurement of income taxes is in accordance
with IAS 12 Income Taxes [IFRS 3.24-25]
 Employee benefits: Assets and liabilities arising from an acquiree's employee
benefits arrangements are recognised and measured in accordance with IAS 19
Employee Benefits (2011) [IFRS 2.26]
 Indemnification assets: An acquirer recognises indemnification assets at the
same time and on the same basis as the indemnified item [IFRS 3.27-28]
 Reacquired rights: The measurement of reacquired rights is by reference to the
remaining contractual term without renewals [IFRS 3.29]
 Share-based payment transactions: These are measured by reference to the
method in IFRS 2 Share-based Payment
 Assets held for sale IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations is applied in measuring acquired non-current assets and disposal
groups classified as held for sale at the acquisition date.
In applying the principles, an acquirer classifies and designates assets acquired
and liabilities assumed on the basis of the contractual terms, economic conditions,
operating and accounting policies and other pertinent conditions existing at the
acquisition date. For example, this might include the identification of derivative financial
instruments as hedging instruments, or the separation of embedded derivatives from
host contracts. [IFRS 3.15] However, exceptions are made for lease classification
(between operating and finance leases) and the classification of contracts as insurance
contracts, which are classified on the basis of conditions in place at the inception of the
contract. [IFRS 3.17]
Acquired intangible assets must be recognised and measured at fair value in
accordance with the principles if it is separable or arises from other contractual rights,
irrespective of whether the acquiree had recognised the asset prior to the business
combination occurring. This is because there is always sufficient information to reliably
measure the fair value of these assets. [IAS 38.33-37] There is no 'reliable
measurement' exception for such assets, as was present under IFRS 3 (2004).
Goodwill
Goodwill is measured as the difference between:
The aggregate of (i) the value of the consideration transferred (generally at fair value),
(ii) the amount of any non-controlling interest (NCI, see below), and (iii) in a business
combination achieved in stages (see below), the acquisition-date fair value of the
acquirer's previously-held equity interest in the acquiree, and
the net of the acquisition-date amounts of the identifiable assets acquired and the
liabilities assumed (measured in accordance with IFRS 3). [IFRS 3.32]
This can be written in simplified equation form as follows:
Goodwill = Consideration transferred + Amount of non-controlling interests + Fair
value of previous equity interests – Net assets recognised
If the difference above is negative, the resulting gain is a bargain purchase in profit
or loss, which may arise in circumstances such as a forced seller acting under
compulsion. [IFRS 3.34-35] However, before any bargain purchase gain is recognised
in profit or loss, the acquirer is required to undertake a review to ensure the

identification of assets and liabilities is complete, and that measurements appropriately
reflect consideration of all available information. [IFRS 3.36]
Notes
Choice in the measurement of non-controlling interests (NCI)
IFRS 3 allows an accounting policy choice, available on a transaction by transaction
basis, to measure non-controlling interests (NCI) either at: [IFRS 3.19]
 fair value (sometimes called the full goodwill method), or
 the NCI's proportionate share of net assets of the acquiree.
The choice in accounting policy applies only to present ownership interests in the
acquiree that entitle holders to a proportionate share of the entity's net assets in the
event of a liquidation (e.g. outside holdings of an acquiree's ordinary shares). Other
components of non-controlling interests at must be measured at acquisition date fair
values or in accordance with other applicable IFRSs (e.g. share-based payment
transactions accounted for under IFRS 2 Share-based Payment). [IFRS 3.19]
Example
P pays 800 to acquire an 80% interest in the ordinary shares of S. The aggregated fair
value of 100% of S's identifiable assets and liabilities (determined in accordance with
the requirements of IFRS 3) is 600, and the fair value of the non-controlling interest (the
remaining 20% holding of ordinary shares) is 185.
The measurement of the non-controlling interest, and its resultant impacts on the
determination of goodwill, under each option is illustrated below:
NCI based on NCI based on

fair value net assets
Consideration transferred 800 800
(1) (2)
Non-controlling interest 185 120
985 920
Net assets (600) (600)
Goodwill 385 320
1. The fair value of the 20% non-controlling interest in S will not necessarily be
proportionate to the price paid by P for its 80% interest, primarily due to any control
premium or discount [IFRS 3.B45]
2. Calculated as 20% of the fair value of the net assets of 600.
Business combination achieved in stages (step acquisitions)

Prior to control being obtained, an acquirer accounts for its investment in the equity
interests of an acquiree in accordance with the nature of the investment by applying the
relevant standard, e.g. IAS 28 Investments in Associates and Joint Ventures (2011),
IFRS 11 Joint Arrangements, IAS 39 Financial Instruments: Recognition and
Measurement or IFRS 9 Financial Instruments. As part of accounting for the business
combination, the acquirer remeasures any previously held interest at fair value and
takes this amount into account in the determination of goodwill as noted above [IFRS
3.32] Any resultant gain or loss is recognised in profit or loss or other comprehensive
income as appropriate. [IFRS 3.42]

The accounting treatment of an entity's pre-combination interest in an acquiree is
consistent with the view that the obtaining of control is a significant economic event that
triggers a remeasurement. Consistent with this view, all of the assets and liabilities of Notes
the acquiree are fully remeasured in accordance with the requirements of IFRS 3
(generally at fair value). Accordingly, the determination of goodwill occurs only at the
acquisition date. This is different to the accounting for step acquisitions under IFRS
3(2004).
Measurement period
If the initial accounting for a business combination can be determined only provisionally
by the end of the first reporting period, the business combination is accounted for using
provisional amounts. Adjustments to provisional amounts, and the recognition of newly
identified asset and liabilities, must be made within the 'measurement period' where
they reflect new information obtained about facts and circumstances that were in
existence at the acquisition date. [IFRS 3.45] The measurement period cannot exceed
one year from the acquisition date and no adjustments are permitted after one year
except to correct an error in accordance with IAS 8. [IFRS 3.50]
Related transactions and subsequent accounting
General principles
In general:
 transactions that are not part of what the acquirer and acquiree (or its former
owners) exchanged in the business combination are identified and accounted for
separately from business combination
 the recognition and measurement of assets and liabilities arising in a business
combination after the initial accounting for the business combination is dealt with
under other relevant standards, e.g. acquired inventory is subsequently accounted
under IAS 2 Inventories. [IFRS 3.54]
When determining whether a particular item is part of the exchange for the acquiree
or whether it is separate from the business combination, an acquirer considers the
reason for the transaction, who initiated the transaction and the timing of the
transaction. [IFRS 3.B50]
Contingent consideration
Contingent consideration must be measured at fair value at the time of the business
combination and is taken into account in the determination of goodwill. If the amount of
contingent consideration changes as a result of a post-acquisition event (such as
meeting an earnings target), accounting for the change in consideration depends on
whether the additional consideration is classified as an equity instrument or an asset or
liability: [IFRS 3.58]
If the contingent consideration is classified as an equity instrument, the original
amount is not remeasured.
If the additional consideration is classified as an asset or liability that is a financial
instrument, the contingent consideration is measured at fair value and gains and losses
are recognised in either profit or loss or other comprehensive income in accordance
with IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Recognition and
Measurement.
If the additional consideration is not within the scope of IFRS 9 (or IAS 39), it is
accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and
Contingent Assets or other IFRSs as appropriate.
Note: Annual Improvements to IFRSs 2010–2012 Cycle changes these
requirements for business combinations for which the acquisition date is on or after 1
July 2014. Under the amended requirements, contingent consideration that is classified
as an asset or liability is measured at fair value at each reporting date and changes in
fair value are recognised in profit or loss, both for contingent consideration that is within
Notes the scope of IFRS 9/IAS 39 or otherwise.
Where a change in the fair value of contingent consideration is the result of
additional information about facts and circumstances that existed at the acquisition
date, these changes are accounted for as measurement period adjustments if they arise
during the measurement period (see above). [IFRS 3.58]
Acquisition costs
Costs of issuing debt or equity instruments are accounted for under IAS 32
Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition
and Measurement/IFRS 9 Financial Instruments. All other costs associated with an
acquisition must be expensed, including reimbursements to the acquiree for bearing
some of the acquisition costs. Examples of costs to be expensed include finder's fees;
advisory, legal, accounting, valuation and other professional or consulting fees; and
general administrative costs, including the costs of maintaining an internal acquisitions
department. [IFRS 3.53]
Pre-existing relationships and reacquired rights

If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the
acquirer had granted the acquiree a right to use its intellectual property), this must must
be accounted for separately from the business combination. In most cases, this will lead
to the recognition of a gain or loss for the amount of the consideration transferred to the
vendor which effectively represents a 'settlement' of the pre-existing relationship. The
amount of the gain or loss is measured as follows:
 for pre-existing non-contractual relationships (for example, a lawsuit): by reference
to fair value
 for pre-existing contractual relationships: at the lesser of (a) the
favourable/unfavourable contract position and (b) any stated settlement provisions
in the contract available to the counterparty to whom the contract is unfavourable.
[IFRS 3.B51-53]
However, where the transaction effectively represents a reacquired right, an
intangible asset is recognised and measured on the basis of the remaining contractual
term of the related contract excluding any renewals. The asset is then subsequently
amortised over the remaining contractual term, again excluding any renewals. [IFRS
3.55]
Contingent liabilities
Until a contingent liability is settled, cancelled or expired, a contingent liability that was
recognised in the initial accounting for a business combination is measured at the
higher of the amount the liability would be recognised under IAS 37 Provisions,
Contingent Liabilities and Contingent Assets, and the amount less accumulated
amortisation under IAS 18 Revenue. [IFRS 3.56]
Contingent payments to employees and shareholders

As part of a business combination, an acquirer may enter into arrangements with selling
shareholders or employees. In determining whether such arrangements are part of the
business combination or accounted for separately, the acquirer considers a number of
factors, including whether the arrangement requires continuing employment (and if so,
its term), the level or remuneration compared to other employees, whether payments to
shareholder employees are incremental to non-employee shareholders, the relative
number of shares owns, linkages to valuation of the acquiree, how the consideration is
calculated, and other agreements and issues. [IFRS 3.B55]

Where share-based payment arrangements of the acquiree exist and are replaced,
the value of such awards must be apportioned between pre-combination and post-
combination service and accounted for accordingly. [IFRS 3.B56-B62B] Notes
Indemnification assets
Indemnification assets recognised at the acquisition date (under the exceptions to the
general recognition and measurement principles noted above) are subsequently
measured on the same basis of the indemnified liability or asset, subject to contractual
impacts and collectibility. Indemnification assets are only derecognised when collected,
sold or when rights to it are lost. [IFRS 3.57]
Other issues
In addition, IFRS 3 provides guidance on some specific aspects of business
combinations including:
 business combinations achieved without the transfer of consideration, e.g. 'dual
listed' and 'stapled' arrangements [IFRS 3.43-44]
 reverse acquisitions [IFRS 3.B19]
 identifying intangible assets acquired [IFRS 3.B31-34]
Disclosure
Disclosure of information about current business combinations is as follows:
An acquirer is required to disclose information that enables users of its financial
statements to evaluate the nature and financial effect of a business combination that
occurs either during the current reporting period or after the end of the period but before
the financial statements are authorised for issue. [IFRS 3.59]
Among the disclosures required to meet the foregoing objective are the following:
[IFRS 3.B64-B66]
 name and a description of the acquiree
 acquisition date
 percentage of voting equity interests acquired
 primary reasons for the business combination and a description of how the acquirer
obtained control of the acquiree
 description of the factors that make up the goodwill recognised
 qualitative description of the factors that make up the goodwill recognised, such as
expected synergies from combining operations, intangible assets that do not qualify
for separate recognition
 acquisition-date fair value of the total consideration transferred and the acquisition-
date fair value of each major class of consideration
 details of contingent consideration arrangements and indemnification assets
 details of acquired receivables
 the amounts recognised as of the acquisition date for each major class of assets
acquired and liabilities assumed
 details of contingent liabilities recognised
 total amount of goodwill that is expected to be deductible for tax purposes
 details about any transactions that are recognised separately from the acquisition of
assets and assumption of liabilities in the business combination
 information about a bargain purchase
 information about the measurement of non-controlling interests
 details about a business combination achieved in stages

 information about the acquiree's revenue and profit or loss
information about a business combination whose acquisition date is after the end of
Notes 
the reporting period but before the financial statements are authorised for issue
Disclosure of information about adjustments of past business combinations

An acquirer is required to disclose information that enables users of its financial
statements to evaluate the financial effects of adjustments recognised in the current
reporting period that relate to business combinations that occurred in the period or
previous reporting periods. [IFRS 3.61]
Among the disclosures required to meet the foregoing objective are the following:
[IFRS 3.B67]
 details when the initial accounting for a business combination is incomplete for
particular assets, liabilities, non-controlling interests or items of consideration (and
the amounts recognised in the financial statements for the business combination
thus have been determined only provisionally)
 follow-up information on contingent consideration
 follow-up information about contingent liabilities recognised in a business
combination
 a reconciliation of the carrying amount of goodwill at the beginning and end of the
reporting period, with various details shown separately
 the amount and an explanation of any gain or loss recognised in the current
reporting period that both:
 relates to the identifiable assets acquired or liabilities assumed in a business
combination that was effected in the current or previous reporting period, and
 is of such a size, nature or incidence that disclosure is relevant to understanding the
combined entity's financial statements.
4.7 Treatment of Pre-acquisition

It means the period starting from th date of borrowing and ending on March 31st
immediately preceding to the year of completion of construction/acquisition.
For example, Mr. A has taken a loan on 1-4-2010 for construction of a house and
the construction was completed on 1-07-2012.
In this case, pre-construction period shall be the period starting from 1-04-2010 and
ending on 31-3-2012:
 Important point. The period from 1-04-2012 to 30-06-12 shall not be included in
the preconstruction period.
 Tax treatment. Interest for pre-acquisition/pre-construction period shall be allowed
as deduction in 5 equal installments starting from the previous year in which the
house is acquired or the construction is completed and for the next 4 previous
years.
 Important point. If the construction/acquisition of house is completed during a
particular previous year then whole interest of that previous year shall be treated as
post-construction period interest. In other words, no part of that previous year’s
interest shall be treated as ‘pre-acquisition period interest’.
Date of loan =1-4-2010
Date of completion of construction =30-6-2012
Annual interest =` 50,000
Current previous year = 2013-14

Calculate Pre-acquisition and Post-acquisition Period interest for Previous Year
2013-2014.
Notes
Note. If the whole or any part of pre-acquisition / construction period interest is

claimed as deduction under any other provision of the Act then that much interest shall
not be allowed as deduction under the head house property.
Other Important Points

1. Basis of allowability. Interest on housing loan is allowed as deduction on accrual
basis. Thus, interest accured/outstanding at end of the previous year is also allowed
as deduction for that previous year. Even if an assessee maintains books of
accounts on cash basis, the interest on housing loan shall be allowed as deduction
on accrual basis.
2. Loan taken to repay the original loan. Interest on new loan taken to repay the
original housing loan is also allowed as deduction.
3. Interest on delayed payment of interest. It is not allowed as a deduction.
4. Who may be lender? Housing loan may be taken from any lender, i.e., the lender
may be a bankor any financial institution, or any company, or any friend or relative
of the assessee or any other person.
5. Interest payable outside India (Section 25). If interest on loan is payable outside
India then deduction shall be allowed only if tax is deducted at source out of such
interest. In other words, if interest is paid without deduction of tax at source then it
shall not be allowed as deduction. However, the requirement of TDS is not
necessary if there is any person in India who may be treated as an agent of the
lender u/s 163 (who is outside India) in respect of such interest.
6. Applicability of Maximum limit. In case of self-occupied house property, the
maximum limit of interest is in respect of both pre-acquisition period interest and
post-acquisition period interest.
7. Loan taken to repay outstanding interest on old housing loan. Interest on such new
loan is not allowed as deduction.
8. Interest on loan shall be allowed on deduction out of the Net annual value of the
house for which the loan has been taken. Thus, interest on loan taken for house A
shall not be allowed as deduction out of net annual value of house B.
9. Interest on money borrowed for the payment of municipal tax etc. is not allowed as
deduction.

Notes
4.8 Post-acquisition Profit

The profits earned by the subsidiary after the purchase of shares by the holding
company are revenue profits or post-acquisition profits. If the fall in the value of the
assets occurs after the date of acquisition, the loss is treated as an ordinary revenue
loss.
Consolidated financial statements were not examined at the equivalent level in the
old syllabus. They have now been included in F1 as an introduction to consolidated
financial statements in preparation for the F2 exam.
The F1 syllabus excludes non-controlling interests, all subsidiaries must be 100%
owned by the parent entity. Questions could include one or more subsidiaries. The
syllabus includes associated entities but we will not be able to consider them in this
article.
The F1 syllabus specifies that you should be able to prepare a consolidated
statement of financial position and a consolidated statement of comprehensive income
for a group in relatively straightforward circumstances. Questions could be set requiring
either one of these consolidated statements or both of them.
Preparing Consolidated Financial Statements

IAS 27 ‘Consolidated and separate financial statements’ defines a subsidiary as an
entity that is controlled by another entity. An entity has control if it has the ability to
direct the operating and financial policies of another with a view to gaining economic
benefit. If an entity owns 100% of another entity it will usually have control.
When preparing consolidated financial statements:
We are replacing the cost of the investment in the holding entity’s accounts with the fair
value of the assets and liabilities of the subsidiary.
Goodwill is likely to arise on acquisition. Shares purchased at the market price may
not reflect the fair value of the assets and liabilities of the subsidiary. Any difference
between the amount paid and the value of the assets is goodwill.
There must be no double counting. All items that relate to transfers within the group
must be eliminated on consolidation.
Pre-acquisition and post-acquisition reserves

When preparing consolidated financial statements it is important to distinguish between
pre-acquisition reserves and post-acquisition reserves. Pre-acquisition reserves are
retained profits and other reserves that exist in a subsidiary’s statement of financial
position at the date of acquisition. Pre-acquisition reserves are capitalised at the date of

acquisition by including in the goodwill calculation. They must not be included in the
consolidated income statement or consolidated statement of financial position.
Notes
Profits/losses (including unrealised gains and losses) made after acquisition that
are shown in the subsidiary reserves can be included in the consolidated statement of
comprehensive income and in reserves in the consolidated statement of financial
position.
Intra-group activities
The impact of any intra-group activities must be cancelled out in the consolidated
financial statements.
Inter-entity trading. Sales and purchases figures need to be adjusted on the income
statement to remove double counting of the sales. Any goods in closing inventory at the year end
will include unrealised profit in the inventory value, this must be removed.
Current accounts should be reconciled, making adjustments for any items in transit and then
cancelled out on consolidation.
Intra/inter-group dividends received are cancelled on consolidation against dividends paid.
Consolidated financial statements use the same underlying format as single entity
financial statements, so you do not need to learn new formats for consolidated financial
statements.
Consolidated Financial Statement preparation – Checklist

 Calculate group holdings and establish the status of each entity in the question
(subsidiary, associate or investment), W1
 Establish fair value of assets acquired and calculate net assets of the subsidiary,
W2
 Calculate goodwill arising on acquisition, W3
 Adjust for any intra-group activities, W4
 Calculate balance carried forward on consolidated retained earnings, W5
 Calculate balance carried forward on consolidated reserves, W6
 Prepare consolidated financial statements, statement of financial position and/or
consolidated statement of comprehensive income.
Now, let us use this approach in answering a typical question. X holds shares in Y.
On 1 April 2006 X purchased 600,000 shares in Y at a cost of $1.60 per share. The fair
value of Y’s tangible assets at 1 April 2006 was $126,000 more than book value. The
retained profits of Y at 1 April 2006 were $120,000. The excess of fair value over book
value was attributed to buildings held by Y. At 1 April 2006 the buildings had an
estimated remaining useful life of 21 years. The draft summarised financial statements
for the two entities as at 31 March 2010 are given below:

Summarised statement of financial position at 31 March 2010
Notes X Y
$000 $000
Non-current assets
Property, plant and equipment 1,210 700
Investment in Y at cost 960
2,170 700
Current assets
Sundry 1,780 620
Current a/c with Y Ltd 80
1,860 620
Total assets 4,030 1,320
Equity and reserves
Equity shares of $1 each 2,000 600
Retained earnings 400 300
2,400 900
Current liabilities
Trade payables 1,630 360
Current a/c with X plc 60
1,630 420
4,030 1,320

Summarised statement of comprehensive income for the year ended 31 March
2010
Notes
X Y
$000 $000
Revenue 910 390
Cost of sales (461) (171)
449 219
Other income - dividends received 50
Expenses (110) (43)
389 176
Finance cost (30) (22)
359 154
Taxation (43) (12)
Profit for the year 316 142
Additional information:
1. Y paid an interim dividend of $50,000 on 31 December 2009.
2. Y sent a cheque for £20,000 to X on 30 March 2010.
3. X occasionally trades with Y. In November 2009 X sold Y goods for $90,000. X
uses a mark up of 50% on cost. On 31 March 2010 Y had not paid for the goods
and they were all still in Y’s closing inventory.
Required
Prepare a consolidated, summarised statement of comprehensive income for the year
ended 31 March 2010 and a consolidated statement of financial position for the X group
of entities as at 31 March 2010.
Solution
All figures are in $000

Workings (following the checklist above)
Note: Narrative and journal entries are shown here to aid understanding of the
process of consolidation; they are not required in an exam answer.
1. Calculate group holdings: X’s holding in Y is 600,000 shares out of 600,000,
therefore treat Y as a wholly owned subsidiary of X.
2. Fair value of net assets of Y at acquisition: Fair value of the net assets is the
same as the total of share capital plus all pre-acquisition reserves. As buildings are
revalued upwards at acquisition it will create a revaluation reserve at the date of
acquisition. This must be treated as a pre-acquisition reserve and included in the
fair value of net assets at acquisition.

Shares 600
Retained earnings at 1 April 2006 120
Notes
Fair value adjustment 126
Total 846
The fair value of the buildings increased by 126 and has a useful life of 21 years.
Assuming straight line depreciation with no residual value, that is, 126/21=6. Y was
purchased four years ago, so the amount of extra depreciation since acquisition is
6 x 4 = 24.
Debit Credit
Consolidated retained earnings 24
Property, plant and equipment 24
3. Goodwill - Y
Cost of shares acquired 960
Fair value of net assets acquired (W2) 846
Goodwill 114
4. Intra/inter-group activities
(a) Current accounts Debit Credit: Y sent a cheque to X. When this is received
and banked it will increase bank balance and reduce the current account.
Entries are:
Sundry current assets (bank) 20
Current account with Y 20
Now the current accounts agree, so cancel current accounts on consolidation
and ignore in the consolidated financial statements.
Current account with X 60
Current account with Y 60
The only item appearing in the consolidated statements is the adjustment to
bank of 20.
(b) Intra-group trading: As the mark up is given in the question we will have to
convert it to the selling price margin.
Mark up on cost 50% = 33⅓% margin on selling price.
Selling price 90; unrealised profit = 90 x 33⅓% = 30
As all the goods are in closing inventory we need to cancel the unrealised profit
of 30 from closing inventory in both the statement of comprehensive income
and the statement of financial position.
Debit Credit
Consolidated revenue 90
Consolidated cost of sales 90
Consolidated cost of sales 30
Consolidated sundry current assets (inventory) 30
(c) Interim dividend paid by Y: Cancel the other income item in X against the
dividend paid by Y. Then ignore in the financial statements as it has no effect.
Note that the dividend paid by Y would be shown in its statement of changes in
equity.
5. Consolidated retained earnings: Make sure that you collect all the adjustments
above that effect the post-acquisition profit of the group.
Balance - X, from question 400
Y – group share of post acquisition profits (300 – 120) 180

Deduct post-acquisition increase in depreciation due to fair value adjustment (W2)
(24)
Cancel unrealised profit in inventory (4ii) (30)
Notes
Total 526
6. Prepare consolidated financial statements: The first part is to add together the
parent and its subsidiary amounts for each line of the statements. The only
exceptions to this are share capital, where you put in the parent entity’s share
capital on its own and retained earnings where you use the figure calculated in W5.
In the statements below the figures from the question are shown first, then the
adjustments from the workings are shown with workings reference.
X group consolidated statement of comprehensive income

$000
Revenue (910+390-90 [w4ii]) 1,210
Cost of sales (461+171-90 [w4ii] +30 [w4ii] +24 [w2]) 596 614
Expenses (110+43) (153)
461
Finance cost (30+22) (52)
409
Taxation (43+12) (55)
Profit for the year 354
X group - consolidated statement of financial position as at 31 March 2010

$000
Non-current assets
Goodwill [W3] 114
Property, plant and equipment
(1210+700+126 [w2] -24 [w2]) 2,012
2,126
Current assets
Sundry assets
(1,780+620-30 [w4ii] +20 [w4i]) 2,390
4,516
Equity and reserves
Ordinary shares 2,000
Retained earnings [W5] 526
2,526
Current liabilities
Trade payables
(1,630+360) 1,990
4,516

4.9 Preparation and Interpretation of Consolidated Financial

Statement including a Single Subsidiary and an Associate
Notes
The 2013 Act mandates preparation of consolidated financial statements (CFS) by all
Companies, including unlisted Companies, having one or more subsidiaries, joint
ventures or associates. Previously, the Securities and Exchange Board of India (SEBI)
required only listed Companies to prepare CFS. Mandating preparation of CFS is a step
in the right direction to align the reporting requirements to the international reporting
practices, since standalone financial statements do not present a true picture from an
economic entity perspective.
Consolidated financial statements normally include consolidated balance Sheet,
Consolidated statement of profit and loss, and notes, explanatory material that form an
integral part thereof, and also consolidated cash flow statement (in case a parent
present its own cash flow statement). Consolidated financial statements are presented,
to the extent possible, in the same format as adopted by the parent for its separate
financial statement.
Objective of CFS
A Move to Greater Transparency, The Government of India, in its endeavor to enforce
and raise compliance standards, has legislated the Companies Act, 2013, the much
required code for corporates in India in line with the developments taking place
worldwide and in order to meet the growing demands of stakeholders towards greater
transparency and ease of understanding.
The Concept of CFS was brought with an objective of achieving the true and fair
view of reporting the position of the company for the financial year, since the
consolidated financial Statements are generally considered as the primary financial
statements from an economic entity perspective, whereas the standalone Financial
Statements projects only the position of the company in its individual performance and it
does not provide the true and fair view to the shareholders about the overall
performance of the company with its subsidiaries.
Key compliance requirements:

1. CFS is to be prepared and laid before an AGM, in addition to SFS. Audited
accounts of the listed companies, along with those of the subsidiaries, have to be
made available on the website.
2. Audited accounts of all of the subsidiaries are required to be prepared and provided
to shareholders on request
Requirement of Consolidation of Financial Statement

Section 129 sub section 3 states that ‘Where a company has one or more subsidiaries,
it shall, in addition to financial statements provided under sub-section (2), prepare a
consolidated financial statement of the company and of all the subsidiaries in the same
form and manner as that of its own which shall also be laid before the annual general
meeting of the company along with the laying of its financial statement under
sub-section (2)’.
Explanation: for the purposes of this sub-section, the word “subsidiary” shall
include Associate Company and Joint Venture.
Financial Statement: As per section 2 clause 40
“Financial Statement” in relation to a company, includes—
1. A balance sheet as at the end of the financial year;
2. A profit and loss account, or in the case of a company carrying on any activity not
for profit, an income and expenditure account for the financial year;
3. Cash flow statement for the financial year;

4. A statement of changes in equity, if applicable; and
5. Any explanatory note annexed to, or forming part of, any document referred to in
sub-clause (i) to sub-clause (iv):
Notes
Associate Company: “Associate Company”, in relation to another company,
means a company in which that other company has a significant influence, but
which is not a subsidiary company of the company having such influence and
includes a joint venture company.
“Significant Influence” means control of at least twenty per cent. of total share
capital, or of business decisions under an agreement.
Companies which have to consolidate its Financial Statement:
1. Where a Company have one or more subsidiary (ies).
2. Where a Company have Associate Company (ies).
3. Where a Company have Joint Venture(s).
4. Where a Company have Foreign Subsidiary (ies)
5. Where a Company have wholly owned subsidiary.
6. Where a Company have Subsidiaries, Associates and joint ventures all.
Applicability of Provision of Companies Act, 2013

Manner of Preparation of CSF: As stated in Section 129 (4) the provisions of this Act
applicable to the preparation, adoption and audit of the financial statements of a holding
company shall, mutatis mutandis, apply to the consolidated financial statements of the
Company. The consolidation of financial statements of the company shall be made in
accordance with the provisions of Schedule III of the Act and the applicable accounting
standards (i.e. AS 21- Consolidated Financial Statements, AS 23-Accounting for
Investments in Associates in Consolidated Financial Statements& AS 27-Financial
Reporting of Interests in Joint Ventures).
Presentation of Notes in CSF

As per MCA General Circular No. 39/2014 dated 14th October, 2014 Government has
received representations from stakeholders seeking clarifications on the manner of
presentation of notes in Consolidated Financial Statement (CFS) to be prepared under
Schedule III to the Companies Act, 2013(Act). These representations have been
examined in consultation with the Institute of Chartered Accountants of India (ICAI) and
it is clarified that Schedule III to the Act read with the applicable Accounting Standards
does not envisage that a company while preparing its CFS merely repeats the
disclosures made by it under stand-alone accounts being consolidated. In the CFS, the
company would need to give all disclosures relevant for CFS only.
It is clear from the above mentioned circular that there is no need to repeat the
disclosures relates to only stand alone account of the Company. The would need to
give all the disclosures relevant for CSF Only.
Accounting Standard
In case of a company covered under sub-section (3) of section 129 which is not
required to prepare consolidated financial statements under the Accounting Standards,
it shall be sufficient if the company complies with provisions on consolidated financial
statements provided in Schedule III of the Act.
According to Companies (Accounts) Rules, 2014 the consolidation of financial
statements of the Company shall be made in accordance with the provision of schedule
III to the Act and the applicable accounting standards. However, a Company which is
not required to prepare consolidated financial statements under the accounting
standards, it shall be sufficient if the Company complies with provisions on consolidated
financial statements provided in schedule III of the Act.

Other
Notes The Consolidated financial statements shall also be approved by the Board of Directors
before they are signed on behalf of the board, along with its own financial statements
and shall also be laid before the annual general meeting of the Company along with the
laying of its own financial statement.
Effective date of applicability

From Financial Year: 01.04.2014 - 31.03.2015
The provision of this section applicable on all the Companies w.e.f. 01st April, 2014.
Every Company which falls under Section 129(3) requires preparing consolidated
financial statement along with stand alone statement for the financial year commencing
from 1st day of April, 2014 and ending on 31st March, 2015.
Exceptions:
As there were no transitional provisions for the Company preparing CSF for the First
time therefore exemption was given to below mentioned companies from preparation of
consolidation financial statement for the financial year commencing from 1st day of
April, 2014 and ending on 31st March, 2015.
1. A company having subsidiary or subsidiaries incorporated outside India only.
2. In case of a company which does not have a subsidiary or subsidiaries but has one
or more associate companies or joint ventures or both 9 for the consolidation of
financial statement in respect of associate companies or joint ventures or both, as
the case may be.)
3. An intermediate wholly-owned subsidiary Company incorporated in India would not
be required to prepare CFS. The requirements, however, remain unchanged for
those intermediate wholly-owned subsidiary Companies whose immediate parent is
a Company incorporated outside India.
Example on Point no III

Only A will prepare CFS. A & B will prepare CFS. B will prepare CFS.
FAQ’s
1. Who will prepare the Consociated Financial Statement?
As stated in Section 129 It is duty of the Parent Company (Management) to prepare
the consolidated financial statement of the company and laid the same before the
Annual General Meeting along with Stand alone financial statement.
2. What are the provisions in relation to audit of the consolidated Financial Statement
of the Company?
As stated in Section 129 the provisions of this Act relating to audit applicable on
holding company shall, mutatis mutandis, apply to the consolidated financial
statements of the Company. Therefore, all the provision of Audit applicable to stand
alone financial statement will be applicable on audit of consolidated financial
statements.
In determining control, whether potential equity shares (eg option, convertible
bonds, debentures etc) need to be considered?
The potential equity shares of the investee held by the investor should not be taken
into account for determining the voting power of investor.
3. Who will audit the consolidated Financial Statement of the Company?
There could be two situations in an audit of consolidated financial statements –
when the parent’s auditor is also the auditor of all the components to be included in
the consolidated financial statements and when the parent’s auditor is not the

auditor of one or more subsidiaries and therefore uses the work of other auditor in
the audit.
The Auditor of the consolidated financial statements may not necessarily be the
Notes
auditor of the separate financial statements of the parent or one or more of the
components included in the consolidated financial statement.
4. If a Company have more than one Subsidiary then whether both the Parent
Company will consolidate the account of Subsidiary?
A Company can be subsidiary of two Companies. If more than 50% of paid up
share capital is hold by one Company and another Company control the
composition of Board of Directors.
In such cases, both parents to consolidate the same subsidiary
5. If Company (A) is subsidiary of another Company (B) on 29.03.2014 but not the
subsidiary as on 31.03.2015 whether for the financial year ended 31.03.2015
Company (B) consolidate the account of Company (A)?
For the purpose of consolidate of financial statement relation of holding and
subsidiary will be considered as on 31.03.2015. In the above situation A is not
subsidiary on 31.03.2015 therefore there is no need to prepare consolidated
financial statement.
6. Whether need to consolidate account of LLP?
First Situation: LLP as Joint Venture
A joint venture is a contractual arrangement whereby two or more parties undertake
an economic activity, which is subject to joint control.
If a Company enters into a joint venture agreement with a LLP in which Company
control more than 20% of business decision. Such Joint venture LLP shall be
consider as associate as per definition of Section 2(6) of CA, 2013.
As a joint venture or associate there is need to consolidate the accounts of such
LLP with the Company.
Second Situation: LLP as Subsidiary:
(a) As per clause 87 of section 2 of CA, 2013 “subsidiary company” or “subsidiary”,
in relation to any other company (that is to say the holding company), means a
company in which the holding company exercises or controls more than one-
half of the total share capital either at its own or together with one or more of its
subsidiary companies.
(b) As per explanation of this definition: the expression “company” includes
anybody corporate.
(c) As per section 3 of LLP Act, LLP is Body Corporate.
Therefore, LLP as a Body Corporate fall under the definition of Subsidiary.
Therefore, Company required consolidating the accounts of LLP.
(a) Whether a company H ltd is required to consolidate its subsidiary which is a
Limited Liability Partnership (LLP) or a partnership firm?
(b) Would the answer be different if LLP is an associate or joint venture of H Ltd?
 As per rule 6 of Companies (Accounts) Rules, 2014, under the heading
‘Manner of consolidation of accounts’ it is provided that consolidation of
financial statements of a company shall be done in accordance with the
provisions of Schedule III to the Companies Act, 2013 and the applicable
Accounting Standards.
It is noted that relevant Indian Accounting Standard i.e., Ind AS 110, Consolidated
Financial Statements provides that where an entity has control on one or more
other entities, the controlling entity is required to consolidate all the controlled
entities. Since, the word ‘entity’ includes a company as well as any other form of
entity, therefore, LLPs and partnership firms are required to be consolidated.

Similarly, under Accounting Standard (AS) 21, as per the definition of subsidiary, an
enterprise controlled by the parent is required to be consolidated. The term
Notes ‘enterprise’ includes a company and any enterprise other than a company.
Therefore, under AS also, LLPs and partnership firms are required to be
consolidated.
Accordingly, in the given case, H ltd is required to consolidate its subsidiary which is
an LLP or a partnership firm.
 If LLP or a partnership firm is an associate or joint venture of H ltd, even then
the LLP and the partnership firm need to be consolidated in accordance with
the requirements of applicable Accounting Standards.
If Company A hold 35% Equity Shares and 75% preference share capital of
Company B, then Whether Company B shall be Subsidiary of Company A?
Definition of Subsidiary: “subsidiary company” or “subsidiary”, in relation to any
other company (that is to say the holding company), means a company in which the
holding company exercises or controls more than one-half of the total share capital
either at its own or together with one or more of its subsidiary companies.
As per Definition holding will be determine on the basis of total share capital
(equity + preference). According to this Company B will be consider as subsidiary of
Company A and because of holding of 75% of preference share capital Company A
required to prepare the consolidate financial statement including Company B.
7. What is the time period for filing of CSF with the ROC?
As stated in section 137(1) A copy of the financial statements, including
consolidated financial statement, if any, along with all the documents which are
required to be or attached to such financial statements under this Act, duly adopted
at the annual general meeting of the company, shall be filed with the Registrar
within thirty days of the date of annual general meeting.
A Company H ltd has no subsidiaries, but has investment in an associate and a
joint venture. Whether H Ltd. is required to prepare consolidated financial
statements for the year ending March 31, 2016, in the context of Companies
(Accounting Standards) Rules, 2006.
Section 129 (3) of the Companies Act, 2013 provides that where a company has
one or more subsidiaries, it shall prepare a consolidated financial statement of the
company and of all the subsidiaries. Further, an explanation to this sub section
provides that the word “subsidiary” shall include associate company and joint
venture.
In view of the above, in the given case, though H ltd does not have any subsidiary,
it is required to prepare consolidated financial statements for its associate and joint
venture in accordance with the applicable Accounting Standards, viz, AS 23,
Accounting for Investments in Associates in Consolidated Financial Statements and
AS 27,Financial Reporting of Interests in Joint Ventures, respectively.
Some Practical Questions

1. D has 3 wholly-owned subsidiary who hold 30% each in P, but D has no holding in
P. How should P be consolidated?
D exercise control over more than 50% of total voting power of P, indirectly through
D’s wholly-owned subsidiaries. Therefore, irrespective of whether or not A exercises
any direct control over the operations of P, D would have to consolidate P directly
as a subsidiary, in preparing its CFS.
2. A Limited is controlled by two enterprises; one control by virtue of ownership of
majority of the voting power and the other controls, by virtue of an agreement, the
composition of the Board of directors so as to obtain economic benefits from its
activities. Who should consolidate the accounts of A Limited?

In such rare cases, both the controlling enterprises should consolidate the financial
statements of A Limited. Because A limited is subsidiary Company of both the
controlling enterprises. Notes
3. If Company A holds 50% shares of Company B. One another shareholder of
Company B grants a power of attorney to Company A for exercising voting power
on his behalf at AGM. Whether Company A required consolidating financial
statement of Company B.
No, the power of attorney doesn’t result in Company A controlling the ownership,
directly or indirectly through subsidiary (ies).
4. If P is holding 60% in Q and Q is holding 60% in R and R is holding 25% in S then
whether P and Q will consolidate the accounts of S.
As per Act R will consolidate account of S, Q will consolidate the accounts of R
(which already include S) and P will consolidate accounts of Q (which already
include Q,R,S). I am in favour that one has to look at the group as one entity, since
group is consolidated, S should be consolidate.
5. A has an 90% interest in subsidiary B. A holds direct interest of 25% of C and B
holds a 30% interest in entity C. All shares have equal voting rights. Is company C a
subsidiary or an associate Company of A.
Company C is subsidiary of Company A. Company A controls entity B and
therefore, it controls (90%*30)= 27% voting power that B hold over C. in addition, A
itself has a 25% direct interest and relating voting power, in entity C. Entity A’s total
voting power in C is (25% + 27%=52%). Company A controls C and should
therefore consolidate C as a Subsidiary.
Effective of Companies Bill, 2016 on Consolidation of Accounts:

1. Effect of Change in Definition of Subsidiary Company: Definition of Subsidiary:
“subsidiary company” or “subsidiary”, in relation to any other company (that is to say
the holding company), means a company in which the holding company exercises
or controls more than one-half of the total share capital either at its own or together
with one or more of its subsidiary companies.
Bill: The Bill recommended that the term “Total Share Capital” be replaced with the
term ‘Total Voting Power’, as equity share capital should be the basis for
determining holding/ subsidiary status.
Effect: This would also prevent the occurrence of such a situation in which a
preference shareholder becomes the holding company under the Act, however,
during consolidation, the equity shareholder would show it as its subsidiary in its
books of accounts.
2. Effect of Change in Section 129(3): Language of Section: Where a company has
one or more subsidiaries, it shall, in addition to financial statements provided under
sub-section (2), prepare a consolidated financial statement of the company.
Explanation.—for the purposes of this sub-section, the word “subsidiary” shall
include associate company and joint venture.
Bill: The following shall be substituted: Where a company has one or more
subsidiaries or associate companies, it shall, in addition to financial statements
provided under sub-section (2), prepare a consolidated financial statement of the
company
Effect: According to the substitution joint ventures will be excluding from the ambit
of subsidiary for the purpose of consolidation of accounts. But it will not effect that
much because joint venture are still include in the associate Company.
3. Effect of Change in Section 134(1) (Signing of Financial Statement): Language
of Section: The financial statement, including consolidated financial statement, if
any, shall be approved by the Board of Directors before they are signed on behalf of
the Board at least by the chairperson of the company where he is authorized by the
Board or by two directors out of which one shall be managing director and the Chief

Executive Officer, if he is a director in the company, the Chief Financial Officer and
the company secretary of the company, wherever they are appointed, or in the case
Notes of a One Person Company, only by one director, for submission to the auditor for
his report thereon
Bill: The following shall be substituted: The financial statement, including
consolidated financial statement, if any, shall be approved by the Board of Directors
before they are signed on behalf of the Board at least by the chairperson of the
company where he is authorized by the Board or by two directors out of which one
shall be managing director, if any, and the Chief Executive Officer, if he is a director
in the company, the Chief Financial Officer and the company secretary of the
company, wherever they are appointed,
Effect: As per the Bill, 2016, the CEO shall sign the financial statements including
the Consolidated Financial Statements irrespective of the fact whether such CEO is
also a director or not.
4.10 Summary
IFRS 3 (Revised), Business Combinations, will result in significant changes in
accounting for business combinations. IFRS 3 (Revised) further develops the
acquisition model and applies to more transactions, as combinations by contract alone
and of mutual entities are included in the standard. Common control transactions and
the formation of joint ventures are not dealt with by the standard. IFRS 3 (Revised)
affects the first accounting period beginning on or after 1 July 2009. It can be applied
early, but only to an accounting period beginning on or after 30 June 2007. Importantly,
retrospective application to earlier business combinations is not allowed.
Purchase Consideration
Some of the most significant changes in IFRS 3 (Revised) are in relation to the
purchase consideration, which now includes the fair value of all interests that the
acquirer may have held previously in the acquired business. This includes any interest
in an associate or joint venture, or other equity interests of the acquired business. Any
previous stake is seen as being ‘given up’ to acquire the entity, and a gain or loss is
recorded on its disposal.
If the acquirer already held an interest in the acquired entity before acquisition, the
standard requires the existing stake to be re-measured to fair value at the date of
acquisition, taking into account any movement to the income statement together with
any gains previously recorded in equity that relate to the existing holding. If the value of
the stake has increased, there will be a gain recognised in the statement of
comprehensive income (income statement) of the acquirer at the date of the business
combination. A loss would only occur if the existing interest has a book value in excess
of the proportion of the fair value of the business obtained and no impairment had been
recorded previously. This loss situation is not expected to occur frequently.
The requirements for recognition of contingent consideration have been amended.
Contingent consideration now has to be recognised at fair value even if payment is not
deemed to be probable at the date of the acquisition.
Example 1
Josey acquires 100% of the equity of Burton on 31 December 2008. There are three
elements to the purchase consideration: an immediate payment of $5m, and two further
payments of $1m if the return on capital employed (ROCE) exceeds 10% in each of the
subsequent financial years ending 31 December. All indicators have suggested that this
target will be met. Josey uses a discount rate of 7% in any present value calculations.
Requirement: Determine the value of the investment.

Solution
The two payments that are conditional upon reaching the target ROCE are contingent Notes
consideration and the fair value of $(1m/1.07 + 1m/1.072) ie $1.81m will be added to
the immediate cash payment of $5m to give a total consideration of $6.81m.
All subsequent changes in debt-contingent consideration are recognised in the
income statement, rather than against goodwill, as they are deemed to be a liability
recognised under IAS 32/39. An increase in the liability for good performance by the
subsidiary results in an expense in the income statement, and under-performance
against targets will result in a reduction in the expected payment and will be recorded
as a gain in the income statement. These changes were previously recorded against
goodwill.
The nature of the contingent consideration is important as it may meet the definition
of a liability or equity. If it meets the definition of an equity, then there will be no re-
measurement as per IAS 32/39. The new requirement is that contingent consideration is
fair valued at acquisition and, unless it is equity, is subsequently re-measured through
earnings rather than the historic practice of re-measuring through goodwill. This change
is likely to increase the focus and attention on the opening fair value calculation and
subsequent re-measurements.
The standard also requires any gain on a ‘bargain purchase’ (negative goodwill) to
be recorded in the income statement, as in the previous standard.
Transaction costs no longer form a part of the acquisition price; they are expensed
as incurred. Transaction costs are not deemed to be part of what is paid to the seller of
a business. They are also not deemed to be assets of the purchased business that
should be recognised on acquisition. The standard requires entities to disclose the
amount of transaction costs that have been incurred.
The standard clarifies accounting for employee share-based payments by providing
additional guidance on valuation, as well as on how to decide whether share awards are
part of the consideration for the business combination or are compensation for future
services.
4.11 Check Your Progress

Multiple Choice Questions
1. Which of the following does not result in a business combination for Pryor Ltd.?
(a) Pryor acquired an operating division of Nyle Ltd.
(b) Pryor acquired all the assets of Burchak Ltd.
(c) Pryor made a basket purchase of 40% of Neilly Ltd.'s assets.
(d) Pryor acquired 65% of Kelly Co.'s voting shares.
2. According to a survey of CFOs, what is the main reason for mergers?
(a) Empire building
(b) Risk reduction
(c) Market power
(d) Operating synergies
3. Which of the following acquisition-related costs are not expensed in the period
incurred?
(a) Cost of issuing debt
(b) Valuation fees
(c) Accounting fees
(d) Finder's fees

4. In acquiring Au Ltd., Trinh Ltd. included a provision for contingent consideration.
The value of this consideration will be determined by an event that will occur after
Notes the acquisition date. How should the recognition of the amount of the contingency
be accounted for?
(a) As an adjustment to the acquisition value
(b) As a gain/loss on the statement of comprehensive income
(c) As an adjustment to retained earnings
(d) As an adjustment to goodwill
5. Which of the following is not a classification for intangible assets under IFRS 3?
(a) Customer-related
(b) Artistic-related
(c) Internal development
(d) Technology-based
6. Which of the following is not an acceptable method for valuing intangible assets?
(a) Cost-based
(b) Income-based
(c) Market-based
(d) Tax-based
7. When would it be more advantageous for a purchaser to acquire a company's
assets rather than its shares?
(a) The company to be acquired has large tax loss carryovers that it will be unable
to use.
(b) The purchaser plans to retain the acquired enterprise as a separate entity.
(c) The book value of the seller's shares is lower than the market value of the
shares.
(d) The company to be acquired has capital assets that have fair values which
exceed their book values.
8. Lang Ltd. acquired 100% of Linford Ltd. through a direct exchange. In the
exchange, Lang issued $7,500,000 in shares to Linford. What journal entry must
Lang record to reflect the exchange?
(a) DR Investment in Linford Ltd. $ 7,500,000 CR Common shares $ 7,500,000
(b) DR Common shares $ 7,500,000 CR Retained earnings $ 7,500,000
(c) DR Investment in Linford Ltd. $ 7,500,000 CR Cash $ 7,500,000
(d) No journal entry is required.
9. Lang Ltd. acquired 100% of Linford Ltd. through a direct exchange. In the
exchange, Lang issued $ 7,500,000 in shares to Linford. What journal entry must
Linford record to reflect the exchange?
(a) DR Cash $ 7,500,000 CR Common shares $ 7,500,000
(b) No journal entry is required.
(c) DR Cash $ 7,500,000 CR Retained earnings $ 7,500,000
(d) DR Common shares $ 7,500,000 CR Retained earnings $ 7,500,000
10. Under IAS 16, under what circumstances can the revaluation model be used to
measure property, plant, and equipment (PPE)?
(a) When the fair value can be reliably measured
(b) When the value of the PPE has been impaired

(c) When the fair value of the PPE exceeds the book value by 10%
(d) When the PPE includes unrecorded intangible assets
Notes
4.12 Questions and Exercises
1. Define consolidated Financial Statements of Group Companies.
2. Explain the concept of a Group.
3. What are the purposes of consolidated financial?
4. What are statements?
5. Define minority interest.
6. Explain Goodwill.
7. Explain the Treatment of pre-acquisition and post-acquisition profit.
8, What do you mean by Preparation and Interpretation of Consolidated financial
statement including a single subsidiary and an associate?
4.13 Key Terms

 Business: "An integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing a return in the form of
dividends, lower costs, or other economic benefits directly to."
 Acquiree: The business that is being acquired.
 Acquirer: The entity that obtains control of the acquiree.
 Acquisition date: The date on which the acquirer obtains control of the acquiree.
 Business combination: A transaction or event in which the acquirer obtains
control of one or more businesses.
Check Your Progress: Answers

1. (c) Pryor made a basket purchase of 40% of Neilly Ltd.'s assets.
2. (d) Operating synergies
3. (a) Cost of issuing debt
4. (b) As a gain/loss on the statement of comprehensive income
5. (c) Internal development
6. (a) Cost-based
7. (c) The book value of the seller's shares is lower than the market value of the
shares.
8. (c) DR Investment in Linford Ltd. $ 7,500,000 CR Cash $ 7,500,000
9. (a) DR Cash $ 7,500,000 CR Common shares $ 7,500,000
10. (a) When the fair value can be reliably measured
4.14 Further Readings

 Financial Accounting, V.K. Goyal – 2007.
 Accounting for Beginners, Shlomo Simanovsky – 2010.
 A Textbook of Financial Accounting, Hanif – 1986.
 Financial Accounting, P.C. Tulsian – 2002.

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96 Financial Reporting

Unit 4: Business Combinations

Causes of Business Combinations

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Types of Business Combinations:

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Forms of Business Combinations

Amity Directorate of Distance & Online Education

Following a brief account of the above forms of business combinations:

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Amity Directorate of Distance & Online Education

4.2 Consolidated Financial Statements of Group Companies

BREAKING DOWN 'Consolidated Financial Statements'

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Consolidated Balance Sheet

Ownership Calculation Methods

4.3 Concept of a Group

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Amity Directorate of Distance & Online Education

Social Role and Status

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4.4 Purposes of Consolidated Financial Statements

Who Prepares Consolidated Financial Reports?

How Consolidated Financial Reports Are Prepared?

Benefits of Consolidated Financial Reports

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4.5 Minority Interest

BREAKING DOWN 'Minority Interest'

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Date Development Comments

July 2001 Project added to IASB agenda History of the

5 December 2002 Exposure Draft ED 3 Business Comment deadline

31 March 2004 IFRS 3 Business Combinations Effective for

29 April 2004 Exposure Draft Combinations by Comment deadline

30 June 2005 Exposure Draft Proposed Comment deadline

10 January 2008 IFRS 3 Business Combinations Applies to business

6 May 2010 Amended by Annual Effective for annual

12 December 2013 Amended by Annual Applicable for

12 December 2013 Amended by Annual Effective for annual

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Determining whether a transaction is a business combination

Method of accounting for business combinations

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Recognition and measurement of goodwill or a gain from a bargain purchase

Acquired assets and liabilities

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Amity Directorate of Distance & Online Education

NCI based on NCI based on

Consideration transferred 800 800

Net assets (600) (600)

Goodwill 385 320

Business combination achieved in stages (step acquisitions)

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Related transactions and subsequent accounting

Pre-existing relationships and reacquired rights

Contingent payments to employees and shareholders

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Amity Directorate of Distance & Online Education

Disclosure of information about adjustments of past business combinations

4.7 Treatment of Pre-acquisition

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Note. If the whole or any part of pre-acquisition / construction period interest is

Other Important Points