Important Notes on Consolidation and Business Combination

Investments in subsidiaries

The important point here is control. IFRS 10 states that an investor controls an investee if and only if it has all
of the following.

(a) Power over the investee

(b) Exposure, or rights, to variable returns from its involvement with the investee
(c) The ability to use its power over the investee to affect the amount of the investor's returns

Investments in associates

The key criterion here is significant influence. Significant influence is presumed to exist if an investor holds
20% or more of the voting power of the investee, unless it can be clearly shown that this is not the case.
However, the existence of significant influence can also be evidenced in other ways.

Representation on the board of directors of the investee

Participation in the policy making process
Material transactions between investor and investee
Interchange of management personnel
Provision of essential technical information

IAS 28 Investments in Associates and Joint Ventures requires the use of the equity method of accounting
for investments in associates.

Accounting for investments in joint arrangements

IFRS 11 classes joint arrangements as either joint operations or joint ventures. The classification of a
joint arrangement as a joint operation or a joint venture depends on the rights and obligations of the
parties to the arrangement.

IFRS 11 requires that a joint operator recognises line by line the following in relation to its interest in a
joint operation:

Its (the joint operation's) assets, including its (the investor's) share of any jointly held assets
Its liabilities, including its share of any jointly incurred liabilities
Its revenue from the sale of its share of the output arising from the joint operation
Its share of the revenue from the sale of the output by the joint operation
Its expenses, including its share of any expenses incurred jointly
In its consolidated financial statements, IFRS 11 requires that a joint venturer recognises its interest in a joint
venture as an investment and accounts for that investment using the equity method in accordance with IAS 28
Investments in Associates and Joint Ventures unless the entity is exempted from applying the equity method.

In its separate financial statements, a joint venturer should account for its interest in a joint venture in accordance
with IAS 27 (2011) Separate Financial Statements, namely:

at cost;
in accordance with IFRS 9 Financial Instruments: Recognition and Measurement; or
using the equity method specified in IAS 28.

Other investments

Investments which do not meet the definitions of any of the above should be accounted for according to IFRS 9
Financial Instruments: Recognition and Measurement. An example of such an investment would be a 15%
shareholding in a company with no significant influence.

Exemption from preparing group accounts

A parent need not present consolidated financial statements if and only if all of the following hold:
(a) The parent is itself a wholly owned subsidiary or it is a partially owned subsidiary of another entity and
its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to,
the parent not presenting consolidated financial statements.
(b) Its debt or equity instruments are not publicly traded.
(c) It is not in the process of issuing securities in public securities markets.
(d) The ultimate or intermediate parent publishes consolidated financial statements that comply with
International Financial Reporting Standards.

Potential voting rights

An entity may own share warrants, share call options or other similar instruments that are convertible
into ordinary shares in another entity.

Exclusion of a subsidiary from consolidation

Where a parent controls one or more subsidiaries, IFRS 10 requires that consolidated financial statements are
prepared to include all subsidiaries, both foreign and domestic, other than:

those held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations;
and
those held under such long-term restrictions that control cannot be operated.

Accounting for subsidiaries and associates in the parent's separate financial statements

A parent company will usually produce its own single company financial statements. In these statements,
governed by IAS 27 Separate Financial Statements, investments in subsidiaries and associates included in the
consolidated financial statements should be either:

accounted for at cost;

in accordance with IFRS 9; or
using the equity method specified in IAS 28 (this follows an August 2014 amendment to IAS 27). Where
subsidiaries are classified as held for sale in accordance with IFRS 5 they should be accounted for in
accordance with IFRS 5.

Consideration transferred

Contingent consideration – initial measurement

IFRS 3 (revised) requires the consideration to be measured at the fair value at the acquisition date. This includes
any contingent consideration payable even if, at the date of acquisition, it is not deemed probable that it will be
paid.

Contingent consideration – subsequent measurement

IFRS 3 (revised) requires contingent consideration to be classified as follows:


A liability where contingent consideration is cash or shares to a specific value
Equity where contingent consideration is a specified number of ordinary shares regardless of their value
Subsequent changes are then dealt with as follows:

(a) If the change is due to additional information obtained that affects the position at the acquisition date, goodwill
should be remeasured.
(b) If the change is due to events which took place after the acquisition date, for example, meeting earnings
targets:

(i) where consideration is recorded as a liability (including a provision), any remeasurement is recorded in profit
or loss (so an increase in the liability due to strong performance of the subsidiary will result in an expense and a
decrease in the liability due to underperformance will result in a gain); and
(ii) where consideration is recorded in equity, remeasurement is not required.

The treatment means that group profits are now reduced where good performance of the subsidiary results in
additional payments to the seller.

Acquisition-related costs

These costs do not form part of consideration within the above calculation. Instead, all finders' fees, legal,
accounting, valuation and other professional fees must be expensed through profit or loss.

Costs incurred to issue securities will be dealt with in accordance with IFRS 9.
The treatment will therefore reduce goodwill values and profits.

Non-controlling interest

The standard allows a choice in valuing the non-controlling interest within the goodwill calculation. It may be
measured either:

as a proportion of the identifiable net assets of the subsidiary at the acquisition date (as in the example above);
or
at fair value of the equity shares held by the non-controlling interest on the acquisition date.

Non-controlling interest – subsequent valuation

Where the non-controlling interest is measured using the proportion of net assets method, the NCI at the
reporting date is calculated as the non-controlling interest's share of the subsidiary's net assets.
Where the non-controlling interest is measured using the fair value method, a consolidation adjustment is
required to recognise the additional goodwill in the consolidated statement of financial position. This is best
achieved using the following calculation:

But if there is any impairment of goodwill, that should be adjusted in calculation of NCI

Important Notes

Remember also that when preparing consolidated financial statements all intra-group balances, transactions,
profits and losses need to be eliminated. Where there are provisions for unrealised profit and the parent is the
seller the adjustment is made against the parent's retained earnings (in the retained earnings working). Where
the subsidiary is the seller its retained earnings are adjusted (in the net assets working) thus ensuring that the
non-controlling interest (ie, the minority interest) bear their share of the provision.

Provision for Unrealised Profit (PURP): Adjusted to Net asset of Subsidiary that’s why it impacts post
acquisition Retained earnings of subsidiary and NCI, if the Subsidiary sells to Parent. But when parent
sells to Subsidiary PURP shall be adjusted to retained earnings of parent.

Impairments and the non-controlling interest

Notional grossing up of goodwill

In order to be comparable with the calculated recoverable amount, the carrying amount of the subsidiary must
include 100% of both its net assets and goodwill. Therefore:
(a) where the proportion of net assets method is used to measure the NCI, goodwill must be notionally adjusted
so that it represents both the parent and NCI share of goodwill (ie, 100% of goodwill). This involves grossing up
the parent's goodwill according to percentage shareholdings; and
(b) where fair value is used to measure the NCI, goodwill already represents 100% of goodwill and no such
adjustment is required.

Restructuring and future losses

An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a result
of the business combination.

Contingent liabilities
Contingent liabilities of the acquirer are recognised if their fair value can be measured reliably. A contingent
liability must be recognised even if the outflow is not probable, provided there is a present obligation.

This is a departure from the normal rules in IAS 37 Provisions, Contingent Liabilities and Contingent Assets;
contingent liabilities are not normally recognised, but only disclosed.
After their initial recognition, the acquirer should measure contingent liabilities that are recognized separately at
the higher of:
(a) the amount that would be recognised in accordance with IAS 37; and
(b) the amount initially recognised.

Adjustments after the initial accounting is complete

Sometimes the fair values of the acquiree's identifiable assets, liabilities or contingent liabilities or the cost of the
combination can only be measured provisionally by the end of the period in which the combination takes
place. In this situation, the acquirer should account for the combination using those provisional values.
The acquirer should recognise any adjustments to those provisional values as a result of completing the initial
accounting:
(a) within twelve months of the acquisition date
(b) from the acquisition date (ie, retrospectively)

This means that:

(a) the carrying amount of an item that is recognised or adjusted as a result of completing the initial accounting
shall be calculated as if its fair value at the acquisition date had been recognized from that date; and
(b) goodwill should be adjusted from the acquisition date by an amount equal to the adjustment to the fair
value of the item being recognised or adjusted.

Any further adjustments after the initial accounting is complete should be recognised only to correct an error
in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Any subsequent
changes in estimates are dealt with in accordance with IAS 8.

IAS 28 Investments in Associates and Joint Ventures

Dividend paid by and profit earned by Associate: Profit increase and dividend decrease the Investment in
associate by Parent.

IFRS 11 Joint Arrangements

Two Types: Joint Arrangement is two types

1. Joint operation (There is no legal entity, i.e. pipeline of Oil, gasoline etc.)
2. Joint venture (Legal entity but jointly control, i.e. Company A and Company B both have joint control
over Company C)
Accounting treatment
The accounting treatment of joint arrangements depends on whether the arrangement is a joint venture
or joint operation.

Accounting for joint operations

IFRS 11 requires that a joint operator recognises line by line the following in relation to its interest in a joint
operation:

(a) Its assets, including its share of any jointly held assets
(b) Its liabilities, including its share of any jointly incurred liabilities
(c) Its revenue from the sale of its share of the output arising from the joint operation
(d) Its share of the revenue from the sale of the output by the joint operation
(e) Its expenses, including its share of any expenses incurred jointly
This treatment is applicable in both the separate and consolidated financial statements of the joint operator.

Joint ventures
IFRS 11 and IAS 28 require joint ventures to be accounted for using the equity method. The rules for equity
accounting are included in IAS 28. These were covered in your Professional studies and are revised above.

Transactions between a joint venturer and a joint venture

Downstream transactions
A joint venturer may sell or contribute assets to a joint venture so making a profit or loss. Any such gain or loss
should, however, only be recognised to the extent that it reflects the substance of the transaction.

Therefore:
only the gain attributable to the interest of the other joint venturers should be recognised in the financial
statements; and
the full amount of any loss should be recognised when the transaction shows evidence that the net realisable
value of current assets is less than cost, or that there is an impairment loss.

Upstream transactions
When a joint venturer purchases assets from a joint venture, the joint venturer should not recognise its share of
the profit made by the joint venture on the transaction in question until it resells the assets to an independent
third party ie, until the profit is realised.
Losses should be treated in the same way, except losses should be recognised immediately if they represent a
reduction in the net realisable value of current assets, or a permanent decline in the carrying amount of non-
current assets.

Step acquisitions

Under IFRS 3 and IFRS 10, acquisition accounting is only applied to business combinations when control
is achieved.

Where a parent acquires control of a subsidiary in stages (a step acquisition), this means that goodwill is only
calculated once, upon initially achieving control. It is not then recalculated in response to further acquisitions of
shares in the same subsidiary.

General principle of Step acquisitions:

There are three possible types of business combinations achieved in stages:
(1) A previously held investment, say 10% of share capital, with no significant influence (accounted
for under IFRS 9), is increased to a controlling holding of 50% or more.
(2) A previously held equity investment, say 35% of share capital, accounted for as an associate
under IAS 28, is increased to a controlling holding of 50% or more.
(3) A controlling holding in a subsidiary is increased, say from 60% to 80%.

'Crossing an accounting boundary':

Under IFRS 3 a business combination occurs only when one entity obtains control over another, which
is generally when 50% or more has been acquired. The 2008 Deloitte guide: Business Combinations and
Changes in Ownership Interests calls this 'crossing an accounting boundary'.

When this happens, the original investment – whether an investment in equity instruments with no significant
influence, or an associate – is treated as if it were disposed of at fair value and reacquired at fair value. This
previously held interest at fair value, together with any consideration transferred, is the 'cost' of the
combination used in calculating the goodwill.

If the 50% boundary is not crossed, as when a shareholding in an existing subsidiary is increased, the
event is treated as a transaction between owners.

Whenever you cross the 50% boundary, you revalue, and a gain or loss is reported in profit or loss for
the year. If you do not cross the 50% boundary, no gain or loss is reported; instead there is an adjustment
to the parent's equity.

Achieving control

When control is achieved:

any previously held equity shareholding should be treated as if it had been disposed of and then
reacquired at fair value at the acquisition date; and
any gain or loss on remeasurement to fair value should be recognised in profit or loss in the period.

Goodwill is calculated as:

Amount
Fair value of consideration paid to acquire control X
Non-controlling interest (valued using either fair value or the proportion of net assets method) X
Fair value of previously held equity interest at acquisition date X
X
Fair value of net assets of acquiree (X)
Goodwill X

Acquisitions that do not result in a change of control

Where an entity increases its investment in an existing subsidiary:
no gain or loss is recognised;
goodwill is not remeasured; and
the difference between the fair value of consideration paid and the change in the non-controlling
interest is recognised directly in equity attributable to owners of the parent.

Disposals

Crossing an accounting boundary revisited

Under IFRS 3 a gain on disposal occurs only when one entity loses control over another, which is generally when
its holding is decreased to less than 50%. As noted above, the Deloitte guide: Business Combinations and
Changes in Ownership Interests calls this 'crossing an accounting boundary' but in this case the investment is
being reduced, rather than increased as in sections 9.1 and 9.2 above.

On disposal of a controlling interest, any retained shareholding (an associate or trade investment) is
measured at fair value on the date that control is lost. This fair value is used in the calculation of the gain or
loss on disposal, and also becomes the carrying amount for subsequent accounting for the retained shareholding.
If the 50% boundary is not crossed, as when the shareholding in a subsidiary is reduced, but control is still
retained, the event is treated as a transaction between owners and no gain or loss is recognised.

Whenever you cross the 50% boundary, you revalue, and a gain or loss is reported in profit or loss for
the year. If you do not cross the 50% boundary, no gain or loss is reported; instead there is an adjustment
to the parent's equity.

Disposal of a whole subsidiary or associate – revision

Parent company's accounts
In the parent's individual financial statements the profit or loss on disposal of a subsidiary or associate
holding will be calculated as:

Amount
Sales proceeds X
Less carrying amount (cost in P's own statement of financial position) (X)
Profit (loss) on disposal X/(X)

Group accounts – disposal of subsidiary

Gain or loss on disposal
In the group financial statements the profit or loss on disposal will be calculated as:

Amount Amount
Proceeds X
Less: amounts recognised before disposal:
Net assets of subsidiary X
Goodwill X
Non-controlling interest (X)
(X)
Profit/loss X/(X)

Alternative Method:

Proceeds X
Less: Consideration paid X
Post-acquisition share of net asset X
X
X/(X)
Group accounts – disposal of associate
In the consolidated financial statements the profit or loss on disposal should be calculated as:

Amount Amount
Proceeds X
Less: cost of investment X
Share of post-acquisition profits retained by associate at disposal X
Impairment of investment to date (X)
(X)
Profit/(loss) X/(X)

Part disposal from a subsidiary holding

Subsidiary to subsidiary
Shares may be disposed of such that a subsidiary holding is still retained eg, a 90% holding is reduced to a 70%
holding.

In this case there is no loss of control and therefore:

no gain or loss on disposal is calculated;
no adjustment is made to the carrying value of goodwill; and
the difference between the proceeds received and the change in the non-controlling interest is accounted for in
shareholders' equity.
Consolidated statement of financial position
Consolidate as normal with the NCI calculated by reference to the year-end shareholding
Calculate goodwill as at the original acquisition date
Record the difference between NCI and proceeds in shareholders' equity as above
Consolidated statement of profit or loss and other comprehensive income
Consolidate the subsidiary's results for the whole year
Calculate the NCI on a pro rata basis
Subsidiary to associate

Shares may be disposed of such that an associate holding is still retained, eg, a 90% holding is reduced to a
30% holding.

Gain or loss on disposal

In this case there is a loss of control, and so a gain or loss on disposal is calculated as:

Amount Amount
Proceeds X
Fair value of interest retained X
X
Less net assets of subsidiary recognised before disposal:
Net assets X
Goodwill X
Non-controlling interest (X)
(X)
Profit/loss X/(X)

Associate to investment

Shares may be disposed of such that an investment is still retained eg, a 40% holding is reduced to a 10%
holding.

Gain or loss on disposal

In this case there is a loss of significant influence, and a gain or loss on disposal is calculated as:

Amount Amount
Proceeds X
Fair value of interest retained X
X
Less: Cost of investment X
Share of post-acquisition profits retained by associate at disposal X
Impairment of investment to date (X)
(X)
Profit/(loss) X/(X)