Chapter 3 – Group Reporting II

CHAPTER 3

GROUP REPORTING II

Related Assignment Materials

Illustrations* Problems* Other assignments*

LO1 Understand the difference
Concept Question
between the investor’s
3.3
separate financial
statements and
consolidated financial
statements;
LO2 Understand the differences
3.1 Case 3.1, Concept
in various modes of
Question 3.3
business combinations and
the similarities in their
economic substance;
LO3 Appreciate the significance
3.4, 3.5, 3.5B Case 3.1, Concept
of the acquisition method
Question 3.1
and its implications for
consolidation;
LO4 Know how to determine
3.2 3.1, 3.2, 3.3, 3.4,
the amount of
3.6, 3.7, 3.8, 3.9,
consideration transferred;
3.10
LO5 Understand special issues
3.9 Case 3.1, Concept
concerning control and
Question 3.3
identification of the
acquirer;
LO6 Know how to recognize
3.3, 3.4, 3.5 3.5, 3.6, 3.7, 3.8, Research Question
and measure identifiable
3.9, 3.10, 3.11, 3.12 3.1, 3.2
assets, liabilities, and
goodwill in accordance Concept Question
with IFRS 3 requirements; 3.2
LO7 Understand the nature of
3.4, 3.5 3.6, 3.7, 3.8, 3.9, Case 3.1
goodwill;
3.10
LO8 Understand the nature and
accounting for investment
entities; and
LO9 Understand the accounting
for settlement of pre-
existing interests and
employee compensation
arrangements in business
combinations.
* See additional information on next page that pertains to these illustrations, problems and other
assignments

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Chapter 3 – Group Reporting II

Additional Information on Related Assignment Material

Narrated PowerPoint Correlation Guide

Learning Objective Slides

LO1 3-9

LO2 10-18

LO3 19-20

LO4 25-32

LO5 21-24

LO6 33-48, 55-75

LO7 51-54

LO8 63-68

LO9 70-75

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Chapter 3 – Group Reporting II

Chapter Outline Notes

A. Introduction – In many countries, companies must provide
financial information at two levels; Separate financial
statements or consolidated financial statements.
1. Differences between investor’s separate financial
statements and the consolidated statements:
i. Governing rules and regulations
1. Separate financial statements (Legal entity)
a. Corporate regulations
2. Consolidated financial statements (Economic
entity)
a. IFRS 10
ii. Possible exemptions for presentation
1. Separate financial statements (Legal entity)
a. No exemption
2. Consolidated financial statements (Economic
entity)
a. Allowed for exemptions by a parent if it is:
i. A wholly owned or partially owned
subsidiary.
ii. Debt or equity instruments not traded in
public.
iii. Did not file financial statements for
purpose of issuing instruments to
public.
iv. Ultimate parent produces consolidated
financial statements.
iii. Income recognition
1. Separate financial statements (Legal entity)
a. Dividends
2. Consolidated financial statements (Economic
entity)
a. Share of profits
iv. Asset recognition
1. Separate financial statements (Legal entity)
a. Investment in subsidiary/associate carried
at
i. Cost (IAS 27) or
ii. Financial instrument (IFRS 9)
iii. Equity method
2. Consolidated financial statements (Economic
entity)
a. Investment in subsidiary
i. Investment is eliminated and
subsidiary’s net assets are added to the
parent (IAS 27)
b. Investment in an associate
i. Equity method (IAS 28)
2. Overview of the consolidation process - Process of
preparing and presenting the financial statements of a
group as an economic entity
i. Parent’s Financial Statements + Subsidiaries'
Financial Statements +/- Consolidation adjustments
and eliminations

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Chapter 3 – Group Reporting II

= Consolidated financial statements.

ii. Purpose of Consolidation worksheets
1. Combine parent and subsidiaries financial
statements
2. Adjust or eliminate effects of intra-group
transactions and balances
3. Allocate profit to non-controlling interest
iii. Eliminations of Intra-group Transactions
1. Show the financial position, performance and
cash flow of the economic entity.
2. Avoid double counting of transactions.

B. Business Combinations – A business combination is “a

transaction or other event in which an acquirer obtains control
of one or more businesses (IFRS 3 App A). Business
combination involving entities under common control is
outside of scope of IFRS 3
1. Types of business combinations (IFRS 3 App B:B6)
i. Legal merger of net assets of acquired businesses
into acquirer’s books.
1. Acquirer acquires the net assets of the business
directly and not through the purchase of voting
rights in that entity.
2. Goodwill is to be recognized in the acquirer’s
financial statements
3. No NCI is to be recognized
4. Consolidation is not required
ii. Businesses become subsidiaries of acquirer.
1. Acquirer obtains control of separate legal
entities through the acquisition of voting rights
or equity of other legal entities.
2. Goodwill and NCI is to be recognized in the
consolidated financial statements
iii. Net assets of combining entities transferred to a
newly-formed entity.
1. A new entity is formed through the transferring
of assets and liabilities of acquirer and acquire
2. Goodwill is to be recognized in the new entity
3. Consolidation is not required
iv. Former owners of a combining entity obtain control
of combined entity.
1. Results in a reverse takeover where the former
owners of a “legal subsidiary” takes control
over the enlarged economic entity
2. Two (2) key characteristics of business combinations
i. An acquirer has control of the business acquired
1. 3 main attributes of control
a. Power over acquiree.
b. Exposure or rights to variable returns of
acquiree.
c. Ability to use power to affect acquiree’s
returns.
ii. The target of acquisition is a business
1. 2 vital characteristics
a. Integrated set of activities and assets.

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Chapter 3 – Group Reporting II

b. Capable of being conducted and managed

to provide returns to investors and other
stakeholders.

C. Acquisition Method and Implications - IFRS 3 requires all

business combinations to be accounted for using the
acquisition method from the perspective of an acquirer.
1. Various forms of acquisition
i. Acquisition of assets and assumption of liabilities of
acquiree.
1. Include assets and liabilities not previously
recognised by acquiree.
ii. Acquisition of controlling interest in the equity of
acquiree.
1. Deemed to be effective acquisition of assets and
assumption of liabilities of acquiree.
2. Control over an acquiree also deemed acquirer
to have control over net assets of acquiree.
a. Effects: Accounted for as if they are
effects of 1
iii. Combination of 1 and 2
a. Effects: Accounted for as if they are
effects of 1
2. Procedures of acquisition method
i. Identify the acquirer.
ii. Determine the acquisition date.
iii. Recognize and measure the identifiable assets
acquired, the liabilities assumed and any non-
controlling interest in the acquiree
iv. Recognize and measure goodwill or a gain from a
bargain purchase.
3. Identification of the acquirer – IFRS 3 requires the
identification of the acquirer in all circumstances.
i. Acquirer is the entity that obtains control of another
combining entities.
ii. Concept of control is based on IFRS 10 but the
standard may not always conclusively determine the
identity of the acquirer.
iii. IFRS 3 Appendix B provides additional criteria to
identify controlling acquirer:
1. Based on consideration transferred - Acquirer is
the entity that
a. Assets transferred by the acquirer
b. Liabilities incurred by the acquirer to
former owners of the acquiree
c. Equity interests issued by the acquirer
d. Pays a premium over the fair value of the
equity interest.
2. Based on entity size - Acquirer is the entity
a. Whose owners hold the largest relative
voting rights in a combined entity.
b. Whose owners hold the largest minority
voting interest in the combined entity
c. Who is larger in size.
3. Based on dominance - Acquirer is the entity

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Chapter 3 – Group Reporting II

a. Whose owners have the ability to elect,

appoint or remove a majority of directors.
b. Whose management is dominant in the
combined entity
c. Who initiates the business combination.
4. Reverse Acquisition
i. Legal parent is the acquiree and legal
subsidiary is the acquirer.
ii. Often initiated by the legal subsidiary.
iii. Has other motive of entering into such an
arrangement (e.g. backdoor listing).
iv. Often seen as a means of raising public
funds without having to go through the
more costly Initial Public Offering (IPO)

D. Determining the amount of consideration transferred

1. Determining the amount of consideration transferred
i. Consideration transferred = Fair value of assets
transferred + Fair value of liabilities incurred + Fair
value of equity interests issued by acquirer to former
owners + Fair value of contingent consideration
1. Determined on the acquisition date.
a. Date when the acquirer obtains control and
not the date when consideration is
transferred.
b. Acquisition-related costs are not included.
i. All acquisition-related cost are
expensed off
ii. Costs of issuing debt are recognized in
accordance with IAS 39 or IFRS 9. (Dr
Unamortized debt issuance costs, Cr
Cash)
iii. Costs of issuing equity are recognized
in accordance with IAS 32 (Dr Equity,
Cr Cash)
ii. Scenarios
1. If assets transferred or liabilities assumed are
not carried at fair value in the acquirer’s
separate financial statements:
a. Remeasure in fair value and recognize gain
or loss in the acquirer’s separate financial
statements.
b. Remeasured gain or loss is not recognized
if the asset or liabilities remain in the
combined entity’s financial statements.
2. If transfer of monetary assets or liabilities are
deferred:
a. The fair value will be the present value of
the future cash outflows.
i. Fair value of equity interests issued
by the acquirer:
1. By market price (e.g.
published quoted prices of
shares)
2. With reference to either the

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Chapter 3 – Group Reporting II

acquisition date fair value of

the acquirer OR acquiree.
ii. Fair Value of Contingent
Consideration:
1. Has to be estimated
2. Adjusted retrospectively as
a correction of error if
events after acquisition
reveal information that was
missed or misapplied during
the acquisition date.

E. Recognition and measurement of identifiable assets,

liabilities and goodwill
1. Recognition Principle (under the acquisition method):
i. At acquisition date, the acquirer will recognize
acquiree’s net assets at fair value.
1. Underlying assumption:
a. An exchange transaction at arm-length
pricing.
b. Effective “acquisition” of the subsidiary’s
identifiable assets and liabilities at fair
value.
c. In subsequent years:
i. Depreciation/amortization/cost of
sale of asset will be based on the fair
value recognized at the acquisition
date.
ii. These entries have to be re-enacted
every year until the disposal of
investment
ii. Identifiable net assets (INA) must comply with two
conditions to qualify for recognition:
1. Identifiable Net Assets must meet the definition
of an asset or a liability.
2. Identifiable Net Assets must be priced into the
consideration transferred and not a separate
stand-alone transactions
iii. Concept of separate transactions:
1. Transaction that is entered into for the benefit
of acquirer rather than acquiree.
2. Pre-existing relationship with acquiree (e.g. as
supplier).
a. Certain pre-existing relationship can be
classified as “reacquired rights” and should
be recognized as intangible asset.
i. For e.g. reacquiring franchised
rights granted to acquiree.
b. Settlement gain/loss may be recognized
depending on the contractual terms relative
to current market terms and this gain/loss
is recognized separately from the business
combination
iv. Classification of identifiable assets or liabilities:
1. Classification is made with respect to:

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Chapter 3 – Group Reporting II

a. Information;
b. Conditions; and
c. Corporate policies existing as at
acquisition date.
v. Intangible Assets - IFRS 3 requires the acquirer to
recognize the fair value of an acquiree’s intangible
asset in consolidated financial statements
1. Qualification for recognition - the intangible
asset must either:
a. Be Separable (“Separability criterion”) OR
b. Arises from contractual or other legal
rights (“Contractual-legal criterion”)
vi. Criteria for recognition of contingent liabilities &
provisions by acquirer:
1. Present obligations arising from past events and
2. Reliably measurable, even if outcome is not
probable (IFRS 3:23)
vii. Indemnification assets
1. Understanding contractual indemnity:
a. Provided by the former owners of the
acquiree to the acquirer to make good any
subsequent loss arising from contingency
or an asset or a liability.
2. Treatment for indemnity:
a. Acquirer to recognize an “indemnification
asset” at the same time the indemnified
asset or liability is recognized.
b. The indemnification asset is measured on
the same basis as the indemnified asset or
liability
viii. Deferred tax relating to fair value differentials of
identifiable assets and liabilities
1. Recognition of fair value differential may give
rise to future tax payable or future tax deduction
a. Tax effects need to be accounted for
because the basis for taxation does not
change in a business combination
i. FV > Book value of identifiable
assets: DTL
ii. FV < Book value of identifiable
assets: DTA
iii. FV < Book value of identifiable
liabilities: DTL
iv. FV > Book value of identifiable
liabilities: DTA
ix. Non-Controlling Interests (NCI)
1. Arises when acquirer obtains control of a
subsidiary but does not have full ownership of
voting rights.
2. NCI are recognized by the acquirer as equity
based on the following equation:
a. ASSETS* – LIABILITIES** =
EQUITY***
i. * = Carrying amount of acquirer’s
assets + Acq date FV of acquiree’s

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Chapter 3 – Group Reporting II

identifiable assets + Goodwill.

ii. ** = Carrying amount of acquirer’s
liabilities + Acq date of FV of
acquiree’s identifiable liabilities.
iii. *** = Acquirer’s equity + NCI share
of equity of acquiree.
3. IFRS 3 allows NCI at acquisition date to be
measured at either:
a. Fair value; or
b. The present ownership instruments’
proportionate share in the recognized
amount of identifiable assets.

F. Understand the nature of goodwill – It is an unidentifiable

asset whose existence is an important motivation for an
acquirer to obtain control of acquiree.
1. Definition
i. A premium that an acquirer pays to achieve
synergies from business combination.
1. Must be recognized separately as an asset
2. Determined as a residual
2. Treatment under IFRS 3
i. Formula
1. Goodwill = [Fair value of consideration
transferred + Fair value of non-controlling
interests + Fair value of the acquirer’s
previously held interest in the acquiree] –
[Acquiree’s recognized net identifiable assets].
ii. IFRS 3 allows 2 values of determining goodwill
depending on the measurement basis for non-
controlling interests as at acquisition date.
1. NCI measured at fair value as at acquisition
date. (including share of goodwill) OR
2. Measured as a proportion of identifiable net
assets as at acquisition date.
iii. When goodwill is determined as residual, it should
in substance be:
1. An expectation of future economic benefits
arising from acquisition.
2. Integral to the entity as a whole, not
individually identifiable or severable as a
standalone asset.
3. Approaches
i. The “top-down approach”
1. Results in recognition or measurement errors in
goodwill
ii. The “bottom-up” approach
1. Internally-generated Goodwill (Core Goodwill)
a. “Going concern element”
b. Represent the ability of acquiree to
generate higher rate of return than from its
individual assets.
2. Fair value of synergies (Combination goodwill)
a. Generated from the unique combination of
the acquirer and acquiree.

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Chapter 3 – Group Reporting II

G. Gain from Bargain Purchase

1. A gain from bargain purchase occurs when the total
consideration paid is lesser than the acquired fair value
of the net identifiable assets
2. This “negative goodwill” is in essence a windfall gain
to the acquirer

H. Measurement Period
1. A measurement period of 1 year from the date of
acquisition is allowed for retrospective adjustments to
goodwill, fair values and consideration transferred to be
adjusted, if any.
2. Information that relates to events after the acquisition
date are not to be included into the measurement period
adjustments.

I. Purchases of Assets that Do Not Constitute a Business

1. When the target does not constitute a business, the
transaction is accounted for as an acquisition of an asset
or a group of assets, and IFRS 3 will not apply.
2. Hence no goodwill will arise and no consolidation is
required

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Chapter 3 – Group Reporting II

ALTERNATE DEMONSTRATION PROBLEM

Chapter 3

Direct acquisition of net assets of a business

Galaxy Co. and Android Co. concluded on an agreement to transfer the business of Android Co. to
Galaxy Co. on 1 July 20x4 in exchange for the following consideration to be transferred by Galaxy
Co:
 Issue of 850,000 ordinary shares of Galaxy Co. to Android Co. On 1 July 20x4, the fair value
per share of Galaxy Co. was $8 per share.

 Additional payment by Galaxy Co. to Android Co. if the business achieves the following
profit benchmarks during the financial year ending 31 December 20x5:

Condition Payment Probability

Profit equal or greater than $25,000,000 $9,500,000 0.55
Profit between $12,500,000 and
$25,000,000 $4,250,000 0.25
Profit below $12,500,000 0 0.2
The cost of capital of Galaxy Co. was 7% per annum while that of Android Co. was 9% per
annum.
 Transfer of title deeds of freehold land. The fair value of the land on 1 July 20x4 was
$47,250,000 while the carrying amount at cost in Galaxy Co's books was $45,000,000.

 Immediate payment of cash of $6,250,000.

 A due diligence was performed by professional consultants, who provided the following fair
value information as at 1 July 20x4. Deferred tax liabilities include the additional deferred tax
liabilities.

Fair value of
identifiable net assets
Property, plant and equipment $12,500,000
Intangible assets $18,000,000
Inventory $7,500,000
Accounts receivable $11,000,000
Cash $5,250,000
Total assets $54,250,000

Deferred tax liabilities $3,250,000

Loans $22,150,000
Provisions $1,800,000
Account payables $10,000,000
Total liabilities $37,200,000

Fair value of identifiable net assets $17,050,000

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Chapter 3 – Group Reporting II

Requirements:
a. Determine the fair value of the contingent consideration as at 1 July 20x4.
b. Determine the fair value of consideration transferred by Galaxy Co. to Android Co. as at 1
July 20x4.
c. Determine the goodwill to be recognized by Galaxy Co. as at 1 July 20x4.
d. Assume that the consideration was transferred in full on 1 July 20x4, show the journal entries
that have to be passed by Galaxy Co. to record the acquisition.
e. Show the journal entries that have to be passed by Galaxy Co. during the year ended 31
December 20x5, assuming the following information:
i. Property, plant and equipment have an average remaining useful life of 15 years from
acquisition date.
ii. Intangible assets had infinite useful life. On 31 December 20x5, the recoverable
amount of the intangible assets was $15,000,000.
iii. Eighty five percent of the inventory was sold during 20x5.
iv. On 31 December 20x5, the acquired business earned a profit of $52,500,000.

You do not need to pass the tax related entries.

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Chapter 3 – Group Reporting II

SOLUTION: ALTERNATE DEMONSTRATION PROBLEM

Chapter 3

a. Determine the fair value of the contingent consideration as at 1 July 20x4:

Probability Payment Expected value

Profit equal or greater than
$25,000,000 0.55 9,500,000 5,225,000
Profit between $12,500,000 and
$25,000,000 0.25 4,250,000 1,062,500
Profit below $12,500,000 0.2 0 0
6,287,500

Discount factor to be used: 7%

Duration (1 July 20x5 - 31 Dec 20x5) 1.5
Present Value $5,680,706
Unamortized discount $606,794
Present value of the expected value discounted at 7% per annum for 1.5 years is $5,680,706. The
payable is best reflected as a gross amount of $6,287,500 and an unamortized discount of
$606,794. The unamortized discount represents future interest expense on the payable.

Determine the fair value of consideration transferred by Galaxy Co. to Android Co. as at 1
July 20x4.

Consideration transferred
Fair value of equity securities $6,800,000
Fair value of contingent payment $5,680,706
Fair value of land transferred $47,250,000
Cash $6,250,000
Fair value of consideration
transferred $65,980,706

Determine the goodwill to be recognized by Galaxy Co. as at 1 July 20x4.

Goodwill = Fair value of consideration transferred - Fair value of identifiable net assets
= $65,980,706 - $17,050,000
= $48,930,706

Assume that the consideration was transferred in full on 1 July 20x4, show the journal
entries that have to be passed by Galaxy Co. to record the acquisition.

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Chapter 3 – Group Reporting II

JE1: Remeasurement of land before transfer

Dr Land 2,250,000
Cr Remeasurement gain 2,250,000

JE2: Acquisition of business from Android Co

Dr Goodwill $48,930,706
Dr PPE $12,500,000
Dr Intangible assets $18,000,000
Dr Inventory $7,500,000
Dr Accounts receivable $11,000,000
Dr Unamortized discount $606,794
Cr Loans $22,150,000
Cr Provisions $5,050,000
Cr Accounts payables $10,000,000
Cr Share capital $6,800,000
Cr Contingent consideration payable 6,287,500
Cr Land 47,250,000
Cr Cash $1,000,000

Cash of $1,000,000 represents the difference between the cash transferred of $6,250,000 and the
cash balance acquired.

The contingent consideration payable shows two accounts - the gross payable of $6,287,500 and
the unamortized discount of $606,794 (contra account).

Show the journal entries that have to be passed by Galaxy Co. during the year ended 31
December 20x5.

JE1: Depreciation of PPE

Dr Depreciation 833,333
Cr Accumulated depreciation 833,333

JE2: Impairment loss on intangible assets

Dr Impairment loss $3,000,000
Cr Accumulated amortization $3,000,000

JE3: Cost of sales on inventory

Dr Cost of sales $6,375,000
Cr Inventory $6,375,000

JE4: Interest expense on contingent consideration

Dr Interest expense $407,969.04
Cr Unamortized discount $407,969.04

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Chapter 3 – Group Reporting II

Workings:
Date Interest Carrying amount
1 July 20x4 $5,680,706
31 December 20x4 $198,824.72
31 December 20x5 $407,969.04

JE5: Settlement of contingent consideration

Dr Loss on settlement 6,287,500
Dr Contingent consideration $3,212,500
Cr Cash $9,500,000
Galaxy Co. recognized a loss of $6,287,500 on settlement which is the difference between the
expected value of $6,287,500 and final settlement amount of $9,500,000.

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