Session 7: Joint Arrangement & Merger

Joint Arrangements &

Merger Accounting

Session 7
AC2091: Financial Reporting

Learning Outcomes
• describe associates and joint ventures and
how to account for them in consolidation
• prepare consolidated profit and loss or income
statements using the acquisition, equity and
proportional consolidation methods
• be aware of the main ideas underpinning the
now disallowed merger method

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 Session 7: Joint Arrangement & Merger

Relevant Accounting Standards

o IFRS 3 Business Combinations (revised 2008)
o IFRS 10 Consolidated Financial Statements
(from 2013 onwards)
o IFRS 11 Joint Arrangements
o IAS 28 Investments in Associates and Joint
Ventures

Joint Arrangements
• Definition
– Arrangement of which two or more parties have

– Has the following characteristics:

• The parties are bound by

• Contractual arrangement gives two or more of

those parties joint control of the arrangement

[IFRS 11]

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 Session 7: Joint Arrangement & Merger

Joint Arrangements
• Joint control
– Contractually agreed sharing of control of an
arrangement
– Exists only when decisions about
require unanimous
consent of the parties sharing control
[IFRS 11]

Joint Arrangements
• Relevant activities
– activities that significantly affect the investee’s
returns, including the following:
• selling and purchasing of goods or services;
• managing financial assets during their life
(including upon default);
• selecting, acquiring or disposing of assets;
• researching and developing new products or
processes; and
• determining a funding structure or obtaining
funding [IFRS 10]

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 Session 7: Joint Arrangement & Merger

Types of Joint Arrangements

Joint
Arrangements

Joint Venture Joint Operation

Parties have Parties have

rights to net rights to assets
assets of and obligations
arrangement for liabilities

Types of Joint Arrangements

Joint Arrangements
Type Description
Joint Venture  Joint arrangement whereby parties (aka
joint venturers) that have joint control of
the arrangement have rights to the

 Usually established as separate

another entity (e.g. company,
partnership etc.) which each joint
venturer has ownership share
 Not necessary for each joint venturer to
have equal equity stake
 Accounted for using

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 Session 7: Joint Arrangement & Merger

Types of Joint Arrangements

Joint Arrangements
Type Description
Joint Operation  Joint arrangement whereby parties (aka
joint operators) that have joint control of
the arrangement have rights to the

 Examples include joint development of

a product, joint ownership/control of
asset or product line
 Accounted for using

Joint Operation: Accounting Treatment

• Joint operator shall recognise the following in
relation to its interest in the joint operation
o its assets, including its share of any assets held
jointly;
o its liabilities, including its share of any liabilities
incurred jointly;
o its revenue from the sale of its share of the
output arising from the joint operation;
o its share of the revenue from the sale of the
output by the joint operation; and
o its expenses, including its share of any
expenses incurred jointly [IFRS 11]

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 Session 7: Joint Arrangement & Merger

Illustration : Joint Operation

The financial statements of P Ltd and J Ltd as at 31 Dec 20X9
are as follows:
Balance sheets as at 31 Dec 20X9 P Ltd J Ltd
£’000 £’000
Property, plant & equipment 420 200
Investment in J Ltd 100 -
Current assets 180 150
700 350
Share capital 300 200
Retained earnings 220 10
Non-current liabilities 100 80
Current liabilities 80 60
700 350

Illustration : Joint Operation

Income Statements as at 31 Dec 20X9 P Ltd J Ltd
£’000 £’000
Sales 500 200
Cost of Sales 200 120
Gross profit 300 80
Operating expenses 100 60
Profit before tax 200 20
Tax 40 10
Profit after tax 160 10
Dividends paid 60 0
Profit for the year 100 10
.
Retained profit brought forward 120 0
Retained profit carried forward 220 10

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 Session 7: Joint Arrangement & Merger

Illustration : Joint Operation

On 1 January 20X9, P Ltd set up a separate company, J Ltd,
with another joint operator to develop and market a new
product. The arrangement provides for both parties to have
joint control over the new entity. The initial cash contribution
from P was £100,000.

P Ltd has rights to 40% of the assets and obligation for 60%
of liabilities incurred by J Ltd. P also has 50% share in J Ltd’s
revenue from sale of the new product as well as any
expenses incurred jointly. The sole business activity of J Ltd
is the development and sale of the new product.

Required:
Prepare an income statement for year ended 31 December
20X9 and balance sheet of P Ltd as at the same date.

Merger Method (Pooling of Interests)

• Formerly used in accounting for combinations
of equal entities (IAS 22, FRS 7)
–“ ” approach
• Not allowed under IFRS 3
– requires all business combinations to be
accounted for using acquisition method
• Still applicable to combinations involving
entities under
– All combining entities are controlled by same
party or parties both before and after
combination (e.g. group restructuring)

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 Session 7: Joint Arrangement & Merger

Merger Method (Pooling of Interests)

• Accounting principles
– No acquisition has occurred
– Continuation of mutual sharing of risks and
benefits that existed prior to the business
combination
– Accounted for as though
, with the only
exception of joint ownership and management

References: Tan, L.T (2013)

Merger Method (Pooling of Interests)

• Accounting treatment
– Assets & liabilities of combining entities are
consolidated
– , either positive or negative,
is recorded
– Reserves and current-year profit are added
together as if combination occurs since
commencement of business
– Difference between share capital issued and
acquired is adjusted to shareholders’ interests

References: Ng, E.J. (2013)

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 Session 7: Joint Arrangement & Merger

Merger Method (Pooling of Interests)

• Shares issued by parent in merger recorded

– except shares issued prior to the merger

• Cost of merger consists of:
i) Cost of prior equity holdings
ii) Par value of shares issued during the merger
iii) Fair value of any non-equity consideration

References: Tan, L.T (2013)

Merger Method (Pooling of Interests)

• Consolidated Balance Sheet
– Line-by-line addition of items using their
carrying amounts
– Cost of investment in parent’s accounts to be
eliminated against parent’s proportionate
interest in subsidiary's shares (at par value) in
the latter’s balance sheet

References: Tan, L.T (2013)

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 Session 7: Joint Arrangement & Merger

Merger Method (Pooling of Interests)

Consolidated Balance Sheet
Cost of merger = Par value  Line-by-line addition of
of shares acquired retained profits

Cost of merger > Par value  Charged against group’s

of shares acquired reserves, first against
suitable capital reserves and
then revenue reserves

Cost of merger < Par value  Difference taken as capital

of shares acquired reserve (merger reserve) on
consolidation

References: Tan, L.T (2013)

Merger Method (Pooling of Interests)

• Consolidated Income Statement
– Similar to acquisition method except in the year
of acquisition
o Merged companies’ income statement items
consolidated as they stand ( )
– No goodwill (nor any impairment expense)
recognised
– Depreciation based on book (not fair) values
– Intercompany transactions
– Dividends paid after merger eliminated as

References: Tan, L.T (2013)

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 Session 7: Joint Arrangement & Merger

Illustration : Merger
The financial statements of P Ltd and M Ltd as at 31 Dec
20X9 are as follows:
Balance sheets as at 31 Dec 20X9 P Ltd M Ltd
£’000 £’000
Land 350 200
Investment in B Ltd 200 -
Inventory 100 200
Bank 150 100
800 500
Share capital (£1 each) 400 200
Retained earnings 200 100
Long-term bank loan 100 150
Current liabilities 100 50
800 500

Illustration : Merger
Income Statements as at 31 Dec 20X9 P Ltd M Ltd
£’000 £’000
Sales 500 400
Cost of Sales 200 200
Gross profit 300 200
Operating expenses 100 100
Profit before tax 200 100
Tax 40 20
Profit after tax 160 80
Dividends paid 60 0
Profit for the year 100 80
.
Retained profit brought forward 100 20
Retained profit carried forward 200 100

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 Session 7: Joint Arrangement & Merger

Illustration : Merger
On 1 October 20X9, P Ltd issued 200,000 of its shares to the
shareholders of M Ltd in exchange for 180,000 of M Ltd’s
shares. The market share price for P and M were £2 and
£1.50 respectively. The fair value of land for M Ltd on
acquisition date was £250,000.

M Ltd had sold goods worth £50,000 to P Ltd at a mark-up of

50%. £30,000 of these goods are still unsold and remains in
the inventory of P Ltd as at 31 December 20X9

P Ltd and M Ltd are subsidiaries of X Ltd and the group uses
the merger (pooling of interests) method of consolidation.

Required:
Prepare an income statement for year ended 31 December
20X9 and balance sheet of P Ltd as at the same date.

Acquisition vs. Merger Method

Methods of Consolidation
Acquisition Merger (pooling of interest)

 Shares issued  Shares issued accounted for

accounted for at fair at nominal value (i.e. no
value share premium account)
 Assets & liabilities of  Assets & liabilities of
acquired are combining entities are
consolidated at fair consolidated at book values
values
 Goodwill on  No goodwill, either positive
consolidation may arise or negative, is recorded

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 Session 7: Joint Arrangement & Merger

Acquisition vs. Merger Method

Methods of Consolidation
Acquisition Merger (pooling of interest)

 Reserves and profits of  Reserves and current-year

acquired are eliminated profit are added together as
at acquisition date; only if combination occurs since
post-acquisition reserves commencement of business
and profit are included in
consolidated statements
(Ng. E.J; 2013)

 Merger method has been disallowed. Except for

businesses under common/shared control, all other
business combinations are to use acquisition method.
(IFRS 103)

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