ACC2001 FINANCIAL ACCOUNTING

Trimester 1 AY2020/21

LECTURE 9: ACCOUNTING FOR BUSINESS

COMBINATIONS III

1
What we have seen so far..

Recap of previous lecture

• Acquisition method: recognize and measure identifiable net assets at fair
value + recognize goodwill at acquisition date

• Different forms of business combination but in substance they share

common features
– Acquirer who gains control of one or more businesses
– Acquisition of a subsidiary = Acquisition of its net assets

• What happens if the acquirer does not wholly own the subsidiary?

2
Non-controlling Interests
• Non-controlling interests (NCI) arises when acquirer obtains control of a
subsidiary but does not have full ownership of voting rights.

• In a business combination, NCI are recognized by the acquirer as equity

based on the following equation
– Rationale: To represent outside interests’ share in the net assets of the acquiree
At acquisition date
Assets – Liabilities = Equity
Carrying Carrying
amount of amount of
acquirer’s acquirer’s Acquirer’s
assets + liabilities + equity +
Acq date FV of Acq date of NCI share of
acquiree’s FV of equity of
identifiable acquiree’s acquiree
assets + identifiable
Goodwill liabilities

3
 Non-controlling Interests
Ownership of the combined entity involving a Joint-ownership of the combined entity
wholly owned subsidiary involving a partially owned subsidiary

Parent company’s shareholders Parent company’s shareholders

30% ownership
Parent company in subsidiary Parent company
100% Non-controlling 70%
ownership shareholders of a ownership
subsidiary
Subsidiary Subsidiary

2 groups of shareholders
Wholly owned by the
1) The parent company’s shareholders; and
parent company’s
2) The non-controlling shareholders of the
shareholders
subsidiary

Question: Is joint ownership equivalent to joint control? 4

Non-controlling Interests

• Termed “partially owned subsidiary”, where the remaining percentage

is owned by shareholders who are collectively referred to as “non-
controlling interest” (NCI)
Parent Non-controlling interests

90% 10%

Subsidiary
Both parent and non-controlling interest have a proportionate share of the
subsidiary’s:
• Net profit; • Share capital
• Dividend distribution; • Retained profits and changes in equity

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Non-controlling Interests

• At each reporting date, group will re-create NCI account in the

consolidated financial statement by recognizing the sequential build up:
– As of acquisition date
– From acquisition date to beginning of the current period
– During the current period

• Assets and liabilities of the subsidiary must be reported in full on the

consolidated financial statements.

• Equity on the consolidated statement of financial position must include

both the interests of equity owners of the parent company and NCI of
partially owned subsidiaries

• NCI is an equity item and must be separately shown from the equity of
the owners of the parent company 6
NCI on the balance sheet

Question: What do the NCI items ($527,746,000 and $674,691,000) represent?

7
NCI on the Profit and Loss Statement

Question: What do the NCI items ($511,000 and $37,847,000) represent?

8
Non-controlling Interests

• NCI only arises in consolidated financial statements where:

– one or more subsidiaries are not wholly owned by the parent (SFRS(I) 10)
• NCI are entitled to their share of retained earnings of the subsidiary from
incorporation
– No distinction between pre-acquisition and post-acquisition retained earnings
for NCI
• Same applies to OCI
– NCI collectively have a share of accumulated OCI arising from incorporation date
to the current reporting date
• NCI are normally a credit balance
– Share of residual interests in the net assets of a subsidiary
– Total equity (parent’s and NCI) = Assets – Liabilities

Can NCI be a debit

balance?
9
Illustration: Pre- versus Post-acquisition reserves

• A acquired 90% of the issued share capital of B on 31 December 20X8 for

a total consideration of $162,000. At that date, B Ltd’s net assets at fair
value were represented by:
• Share capital $150,000
• Retained earnings $30,000
• As at 31 December 20X9, the net assets of B Ltd’s at fair values were
represented by:
• Share capital $150,000
• Retained earnings $70,000

• How should we prepare the consolidation journal entries?

* Pre-acquisition reserves = retained earnings of $30,000
* Post-acquisition reserves = retained earnings of $40,000 ($70,000-$30,000)
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Illustration: Pre-acquisition reserves

Consolidation adjustments at 31 December 20X8 – date of acquisition

Dr Share Capital (B) (90%*150,000) 135,000
Dr Retained earnings (B) (90%*30,000) 27,000
Cr Investment in B Ltd 162,000
(Elimination of investment account)

Dr Share capital (B) (10%*150,000) 15,000

Dr Retained earnings (B) (10%*30,000) 3,000
Cr Non-controlling interest (B/S) (10%*180,000) 18,000
(Record non-controlling interest)

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Illustration: Pre-acquisition reserves

Consolidation adjustments at 31 December 20X8 – date of acquisition

The consolidated journal entry (CJE) can be combined as a single entry:

Dr Share Capital (B) 150,000

Dr Retained earnings (B) 30,000
Cr Investment in B Ltd 162,000
Cr Non-controlling interest (B/S) (10%*180,000) 18,000
(Elimination of investment account and recording of non-controlling
interest)

Proportionate share of the

identifiable net assets
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Allocation to Non-controlling Interests

Subsequent allocation of the change in equity from date of acquisition to the

beginning of the current period

Dr Retained earnings (NCI % × in RE from acquisition date to

beginning of current period)
Cr NCI

• No distinction between pre-acquisition or post-acquisition profits

• To transfer the NCI’s share of subsidiary’s retained earnings to NCI

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Illustration: Post-acquisition reserves

Consolidation adjustments at 31 December 20X9

Dr Share Capital (B) 150,000
Dr Retained earnings (B) 30,000
Cr Investment in B Ltd 162,000
Cr Non-controlling interest (B/S) 18,000
(Elimination of investment account and recording of NCI)

Dr Retained earnings (P/L) 4,000

Cr Non-controlling interest (B/S) 4,000
(Record NCI’s share of post-acquisition RE)

Workings: NCI (B/S) = 10% * ($150,000+$70,000) = $22,000 (at 31 Dec 20X9)

Intuitively, $18,000 (NCI at beginning of year) + $4,000 (share of profit) = $22,000
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Reconciling NCI…

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 Back to the Acquisition Method..

• The procedures:
Identify the acquirer

Determine the acquisition date

Recognize and measure the identifiable assets acquired

Group the liabilities assumed and any non-controlling
financial interest in the acquiree; and NCI: When
statements if the parent
acquire does not
subsidiaries Recognize and measure goodwill or have full
a gain from a bargain purchase ownership
of the
subsidiary

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Non-controlling Interests

• SFRS(I) 3 allows NCI at acquisition date to be measured at either:

– Fair value; or
– The present ownership instruments’ proportionate share in the recognized
amount of identifiable assets

Fair value method Proportionate share of identifiable assets

method
• Obtain a reliable measure of fair • Applies present ownership interests held
value of NCI (e.g. quoted price in by NCI to the recognized amounts of
active market) identifiable net assets to determine initial
amount of NCI
• In absence of quoted price, use
valuation techniques to value NCI
(e.g. peer companies’ valuation or
appropriate assumptions)

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Fair Value Method - NCI

• Under the fair value basis (Method 1):

– FV is determined by either the active market prices of subsidiary’s equity share
at acquisition date or other valuation techniques
– FV per share of NCI may differ from parent because of control premium paid by
parent (e.g. 20% premium over market price to gain control)
– NCI comprises of 3 items:

Non-controlling
Interests at FV

Share of
Share of book value unamortized Goodwill attributable to
of net assets FV adjustment NCI
(FV – BV)

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Proportionate Share Method - NCI

• Under the proportionate share of identifiable assets method (Method 2):

– NCI is a proportion of the acquiree’s identifiable net assets (i.e. not full fair value)
– NCI comprises of 2 items:

Non-controlling
Interests as a proportion of
INA

Share of
Share of book value unamortized
of identifiable net assets of FV adjustments
(FV – BV)
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Non-Controlling Interests’ Share of Goodwill

The FV of NCI that owned 10% of Subsidiary A as at 31 Dec

20×1(Acquisition date) was $25,000. The financial statements of
Subsidiary A as at acquisition date are as shown below. Subsidiary A had
unrecognized intangible assets with fair value of $40,000. Tax rate is 20%.

Determine NCI’s goodwill as at acquisition date.

Subsidiary A’s Statement of Financial Position as at 31 December 20×1:

Net assets 160,000

Equity 140,000
Share Capital 20,000
Retained Earnings 160,000

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Non-Controlling Interests’ Share of Goodwill

Fair value of NCI (Method 1) 25,000

Fair value of identifiable net assets
Book value of equity 160,000
Fair value of intangible assets 40,000
Deferred tax on intangible assets (8,000)
FV of identifiable net assets (100%) 192,000
NCI's share of FV of identifiable net assets (10%) 19,200

NCI's goodwill (25,000 – 19,200) 5,800

Under alternative basis where NCI are measured as a proportion of the

recognized amounts of the identifiable assets as at acquisition date:
✓ NCI’s goodwill is zero
✓ Amount to be recognized as NCI is $19,200 only (Method 2)
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Fair Value Method of Non-controlling Interests

• Typically the fair value of NCI as at acquisition date is as follows:

Fair value of Percentage Fair value of

NCI at = shareholding of x acquiree as at
acquisition date NCI acquisition date

• However, fair value of NCI as at acquisition date would not be

proportional to the fair value of consideration transferred by the
acquirer to obtain control
– Rationale: The consideration transferred would include a control premium

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Goodwill and NCI

• A premium that an acquirer pays to achieve synergies from business combination

– Must be recognized separately as an asset
– Determined as a residual
• SFRS(I) 3 allows 2 ways of determining goodwill:

Goodwill = Fair value of consideration transferred – Acquiree’s recognized

+ net identifiable assets
Non-controlling interests measured in
+ accordance with
Fair value of the acquirer’s previously held SFRS(I) 3
interest in the acquiree

Non-controlling Measured at fair value at acquisition date

interests (include goodwill)

Measured as a proportion of identifiable assets

as at acquisition date

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Illustration: Goodwill and NCI

Illustration 1
On 1 July 20x1, P purchased 1.5 million shares from S Co’s existing owners. Total
number of shares issued by S Co. was 2 million. A reliable FV of S Co’s share was
$10/share. P Co. was obligated to pay an additional $1 million to vendors of S Co. if S
Co. maintained existing profitability over the subsequent two years from 1 July 20x1. It
was highly likely that S Co. would achieve this expectation and the fair value of the
contingent consideration was assessed at $1 million. FV of NCI as at 1 July 20x1 was $5
million. Assume a tax rate of 20%

Additional information of S Co.

• Book value of net assets: $3,650,000
• FV of net assets: $14,350,000
• FV less book value (net assets): $10,700,000
• Share capital: $2,000,000
• Retained earnings: $1,650,000

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Illustration: Goodwill and NCI

Determine the acquirer's interest in the acquiree:

1,500,000
Percentage ownership = (75%)
2,000,000

Consideration transferred: = ($1,500,000 x $10) + $1,000,000 [FV of contingent

= $16,000,000 consideration]

Determine goodwill: Consideration transferred + FV of NCI – FV of identifiable net assets at

acquisition date

Determine deferred tax liability of (20% x $10,700,000) = $2,140,000

Determine FV of identifiable net assets = $14,350,000 – $2,140,000 = $12,210,000
Goodwill = $16,000,000 + $5,000,000 – $12,210,000 = $8,790,000

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Gain from a Bargain Purchase

• A gain from bargain purchase arises when:

Fair value of consideration transferred

<
+ Fair value of
Non-controlling interests identifiable net assets
+
Fair value of the acquirer’s previously held
interest in the acquiree

• In essence, a windfall gain to acquirer

• The acquirer must re-assess the fair value of identifiable net assets,
consideration transferred and non-controlling interests. If there is no
measurement error:
– The gain will be recognized immediately in the income statement

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How reliable is the fair value of goodwill?

Goodwill

Depends on reliable
measurement of
consideration transferred,
future economic benefits
NCI, previously held equity
interests and identifiable
net assets
Integral of
An expectation to the entity as
Integral to the entity as a
a whole, not individually
whole, not individually
identifiable or severableidentifiable or severable as
arising from acquisition a standalone asset
as a standalone asset

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Measurement errors in goodwill

• The “top-down approach” results in measurement errors in goodwill

Consideration transferred +
Overpayment for an
Fair value of non-controlling interests
acquisition or
overvaluation of
consideration transferred

Identifiable net assets

Measurement and
recognition errors
The above errors should not be
included as part of “goodwill”
SFRS(I) 3 suggests that the
“one-year” “measurement
period” is important to
rectify measurement and
recognition errors to
Goodwill ensure the accuracy and
“purity” of goodwill

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Measurement errors in goodwill

• In a “bottom-up” approach:

Goodwill

Internally-generated
Goodwill Fair value of synergies
(Combination goodwill)
(Core Goodwill)

• “Going concern element” and • Generated from the unique

represent the ability of combination of the acquirer
acquiree to generate higher and acquiree
rate of return than from its
• FV of the group > than sum of
individual assets
FV of individual entities

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Measurement Period
• Acquirers are allowed a 12 month measurement period to correct and revise
the following on a retrospectively basis:
– (1) Provisional amounts of goodwill, (2) fair value of identifiable net assets, (3) fair
value of Non-controlling interests, (4) fair value of previously held interests

• SFRS(I) 3 allows adjustments to be made retrospectively to “provisional

amounts” relating to goodwill, fair value of identifiable net assets and
consideration transferred if:
– New information about facts and circumstances existing at acquisition date arises,
– Within 1 year of acquisition date (“Measurement period”)

• Events and circumstances arising after acquisition date does not lead to
measurement period adjustments
‒ Adjustments only allowed because of incorrect or incomplete information available
as at acquisition date but was missed or misapplied

• After measurement period (1 year), any correction of errors will be deemed as

a prior-period adjustment (SFRS(I) 1-8)

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Measurement Period

Retrospective
Error: Discovery of Any correction of
change: Adjust
info on facts and error after end of
goodwill, fair value
circumstances measurement period
of identifiable net
existing as of requires prior period
assets, fair value of
acquisition date item disclosures
NCI as if the
accounting was
completed on
acquisition date
Acquisition 12 months
date End of
measurement
Prospective period
Change in estimate: change: no
Circumstances correction of
arising after goodwill, fair value
acquisition date of identifiable net
assets or fair value
of NCI

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In Subsequent Years
• At acquisition date, we recognize:
– Fair value of identifiable net assets of acquiree as at acquisition date,
– Intangibles assets, contingent liabilities,
– Deferred tax assets or liabilities on the above, and
– Goodwill as a residual
• In subsequent years:
– Subsequent extinguishment of assets and liabilities of subsidiary must be
determined based on the fair values at acquisition date.
– Therefore, subsequent amortization, depreciation and cost of sales of
acquired assets are determined based on fair value as at acquisition date
– Elimination of consideration transferred, recognition of fair value adjustments
and amortization entries must be repeated until:
i. Date of disposal of the investment in subsidiary; or
ii. Date when control is lost
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In Subsequent Years

• In subsequent years
– Acquisition method only recognizes fair value at critical event: acquisition date
• New internally-generated goodwill or subsequent appreciation in fair values
are not recognized subsequent to acquisition date
– Since net assets are carried at book value (carrying amount) in the separate
financial statements, the subsequent amortization/depreciation/disposal are
adjusted in the consolidation worksheet

BV of expense in (FV – BV) adjustment to FV of expense in

separate financial expense consolidated
statements + = financial
Adjusted in consolidation worksheet statements

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 Reconstructing NCI on Statement of Financial
Position

Incorporation Date of Beginning of End of current

date acquisition current year year

NCI have a share of NCI have a share of NCI have a share of

1. Share capital 1. Change in share capital 1. Current year’s Profit
after tax
2. Retained earnings 2. Change in retained
earnings 2. Current amortization
3. Other equity of fair value
3. Change in other equity differential
4. Fair value
differentials 4. Past amortization of 3. Current impairment of
fair value differential goodwill
5. Goodwill
5. Past impairment of 4. Dividends as a
goodwill repayment of profits
5. Change in other equity

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Analysis of Non-Controlling Interests

Share of book
Balance of Share of book value of
Unimpaired
non- value of remaining (FV
= + + goodwill
controlling subsidiary’s – BV) of
attributable
interests at equity at identifiable net
to NCI
reporting date reporting date assets at
reporting date

• The analysis of non-controlling interests enables us to efficiently assess the

balance of non-controlling interests

• Another method of arriving at the non-controlling interests is to build up the

balance chronologically through the consolidation process

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Illustration 2: Comprehensive Example

• P Co. paid $6,200,000 and issued 1,000,000 of its own shares to acquire
80% of S Co. on 1 Jan 20×5
• Fair value of P Co’s share is $3 per share
• Fair value of S Co’s net identifiable assets is as follows:

Book value Fair value Remaining useful life

Leased property 4,000,000 5,000,000 20 years
In-process R&D 2,000,000 10 years
Other assets 1,900,000 1,900,000
Liabilities (1,200,000) (1,200,000)
Contingent liability (100,000)
Net assets 4,700,000 7,600,000

Share capital 1,000,000

Retained earnings 3,700,000
Shareholders’ equity 4,700,000 36
Illustration 2: Comprehensive Example

Additional information:
• Contingent liability of $100,000 was recognized as a provision loss by
the acquiree in legal entity financial statement on Dec 20×5
• FV of NCI at acquisition date was $2,300,000
• Net profit after tax of S Co. for 31 Dec 20×5 was $1,000,000
• No dividends were declared during 20×5
• Shareholders’ equity as at 31 Dec 20×5 was $5,700,000

Q1 : Prepare the consolidation adjustments for P Co. for 20×5

Q2 : Perform analytical check on balance of NCI as at 31 Dec 20×5

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Illustration 2: Comprehensive Example

• Consideration transferred
= Cash consideration + Fair value of share issued
= $6,200,000 + (1,000,000 × $3) = $9,200,000

• Deferred tax liability

= 20% × ($7,600,000 − $4,700,000) = $580,000

• Goodwill
= Consideration transferred + NCI – Fair value of net identifiable assets
= $9,200,000 + $2,300,000 – ($7,600,000 − $580,000)
= $4,480,000

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Illustration 2: Comprehensive Example

• P’s share of goodwill = Consideration transferred – 80% × Fair

value of net identifiable assets, after tax
= $9,200,000 – 80% × $7,020,000
= $9,200,000 – $5,616,000
= $3,584,000

• NCI’s share of goodwill = Fair Value (NCI) – 20% × Fair

value of net identifiable assets, after tax
= $2,300,000 – 20% × $7,020,000
= $2,300,000 – $1,404,000
= $896,000

Usually not proportionate to Parent’s share of

goodwill as the latter includes control premium 39
Illustration 2: Comprehensive Example

Consolidation adjustments for 20×5 ($)

CJE 1: Elimination of Investment in Subsidiary

Dr Share capital 1,000,000

Dr Retained earnings 3,700,000
Dr Leased property 1,000,000
Dr In-process R&D 2,000,000
Dr Goodwill 4,480,000
Cr Contingent liability 100,000
Cr Deferred tax liability (net) 580,000
Cr Investment in S 9,200,000
Cr Non-controlling interests 2,300,000

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Illustration 2: Comprehensive Example

Under dep. by $50k

Dep exp:
$50,000
Dep. of
leased
$200,000 $250,000
property

Based on
Based on FV
book value

CJE 2: Depreciation of excess of FV over book value

Dr Depreciation of leased property 50,000
Cr Accumulated depreciation 50,000

CJE 3: Tax effect on CJE 2

Dr DTL 10,000
Cr Tax expense 10,000 41
Illustration 2: Comprehensive Example

Under amort. by
$200k

Amort exp:
Amort. of $200,000
R&D

$0
Based on Based on FV
book value

CJE 4: Amortization of excess of FV over book value

Dr Amortization of in-process R&D 200,000
Cr Accumulated amortization 200,000

CJE 5: Tax effect on CJE 4

Dr DTL 40,000
Cr Tax expense 40,000 42
Illustration 2: Comprehensive Example

CJE 6: Reversal of entry relating to provision for loss

Dr Provision for loss 100,000

Cr Loss expense 100,000
Note: Contingent liability was already recognized in CJE 1. The recognition by
the acquiree in its legal entity financial statement results in double counting;
hence this reversal entry is necessary

CJE 7: Tax effect on CJE 6

Dr Tax expense 20,000

Cr DTL 20,000

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Illustration 2: Comprehensive Example

CJE 8: Allocation of current year profit to non-controlling interests (NCI)

Dr Income to NCI (P/L) 176,000

Cr NCI (B/S) 176,000

Net profit after tax 1,000,000

Excess depreciation (50,000)
Excess amortization (200,000)
Reversal of loss from contingent liability 100,000
Tax effects on FV adjustments 30,000
Adjusted net profit 880,000
NCI’s share (20%) 176,000

NCI have a share of $176,000 of adjusted profit which represents

• Increase in book value of net assets due to profits in the year
• Decrease in fair value differentials
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Illustration 2: Comprehensive Example

Utilizing the Analytical approach to determine NCI balance:

NCI balance:
NCI at acquisition date (CJE1) $2,300,000
Income allocated to NCI for 20×5 (CJE 8) 176,000
NCI as at 31 Dec 20×5 $2,476,000

Book value of identifiable net assets as at 31 Dec 20×5 $5,700,000

Unamortized balance of fair value adjustments as at 31 Dec 20×5:
Leased property ($1,000,000 × 19/20) 950,000
In-process R&D ($2,000,000 × 9/10) 1,800,000
After-tax unamortized balance at 80% 2,200,000
Adjusted net assets of S Co. $7,900,000
NCI at 20% 1,580,000
Goodwill attributable to NCI (as calculated in slide 39) 896,000
NCI as at 31 Dec 20×5 $2,476,000
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 Illustration 2: Comprehensive Example

Analytical Check: Reconcile the balance to the three NCI components:

Non-controlling
interests

Share of
Share of book value Unamortized Share of
of net assets unimpaired goodwill
FV adjustment

$5,700,000 × 20% ($1,000,000 × 19/20 × $896,000 = $2,476,000

+ 80% × 20%) +
+
= $1,140,000
($2,000,000 × 9/10 ×
80% × 20%) = $440,000

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