2238 Financial Reporting | 2021/2022 T1

Accounting for consolidation

at acquisition

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Acquisition Scenarios
A B
No control or influence
(i.e., <20%):
• Class 4 Financial
instruments
C
Control (i.e., >50%):
Significant influence
• Parent and subsidiary
(i.e., >20% & <50%):
report as one
• Associated company
• Accounting for
• Use the equity method.
consolidation
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No control – Equity investment

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Significant influence and the equity

method
THE RULE

• Investment reported in the consolidated statement of financial position in the non-current asset section

• Initially reported at cost, in subsequent periods recognize its share of the earnings or losses of the
investee

• Income from associates is reported after profit from operations together with finance costs and expenses.
Income reflects the investor´s share of the post-tax results of operations of the investee

• Dividends received from associate companies are subtracted from the cost of investment, reducing the
share of the associate’s profits that was recognized up until that moment

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Significant influence and the equity

method
JOURNAL ENTRIES

• Date of acquisition: Dr Investment in affiliate / Cr Cash

• Subsequent to acquisition – earnings: Dr Investment in affiliate / Cr Equity income in affiliate

• Subsequent to acquisition – dividends: Dr Cash / Cr Investment in affiliate

• Cash taxes are paid only on cash dividends received, while undistributed earnings give rise to
deferred tax liability payable when the earnings are ultimately distributed or the investment is
liquidated: i.e., Dr Income tax expense / Cr Cash (i.e., current tax expense) or Cr Deferred tax
liability (i.e., deferred tax expense)

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Acquisition with control

• When a company acquires another company, the cost of the acquisition is recorded as an investment.

• If the shares acquired give the acquirer control over the acquired company, then the acquirer is referred
to as a parent or holding company, and the acquired company as subsidiary.

• When the parent has control over the subsidiary, the parent prepares consolidated accounts, which
aggregate the assets and liabilities of both parent and subsidiary.

• Accounting for consolidation is prescribed in IFRS 10 and 13

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Defintion of control
• An investor controls an investee if :
– it is exposed, or has rights, to variable returns from its involvement with the investee;
– it has power over the investee whereby the investor has existing rights that give it the ability to direct those
activities that significantly affect the investee´s returns; and
– it has the ability to use its power over the investee to affect the amount of the investor´s returns.

• Control is usually assumed if the investor has purchased more than 50% of the shares of the investee.

• If shares acquired are less than 50%, investor might have control over the investee if investor has power:
– over more than 50% of voting rights through agreement with other investors;
– to govern financial and operating policies under a statute or agreement;
– to appoint or remove majority of board members; or
– to cast the majority of votes at a board meeting.

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Defintion of control // Example

Company A holds 40% of shares of Company B, and the remaining 60% of shares belongs to dispersed
investors.

Should Company A consolidate the accounts of Company B in its financial statements?

• Directors need to exercise judgement when deciding on whether to consolidated the accounts.

• The dispersed investors might be unable to exercise control over the company and so Company A might
need to consolidated the accounts of company B.

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Basic Principles of Consolidated

Financial Statements
On acquisition, assets and liabilities of subsidiary are recorded in the acquirer’s
consolidated statement of financial position at fair value

The difference between the fair value of the consideration paid to acquire an investment
in a subsidiary and the fair value of the identifiable net assets is recognized as goodwill
on the statement of financial position of the acquirer
• Consideration paid can be either shares of the acquirer or cash

To measure the fair value of identifiable net assets of the subsidiary, start from the
book value of the assets and liabilities, and restate them at fair value (e.g.,
historical cost of land should be restated at market value)

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Consolidated Statements

On 1 January 20X0, Rose plc acquired 100% of 10,000 £1 ordinary

voting shares in Tulip plc for £1.50 per share in cash and so gained
control.

Assume the book value of Tulip’s identifiable net assets is equal to

the fair value.

Prepare the consolidated statement of financial position for

Rose plc immediately after the acquisition.

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Consolidated Statements

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Consolidated Statements

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Consolidated Statements with Partly

Owned Subsidiary
• If the parent has acquired less than 100% of the subsidiary, the financial statements of the subsidiary are
consolidated in full and a non-controlling interest is shown as partly financing those net assets.

• IFRS 3 allows for two different methods of measuring the non-controlling interest:

– Method 1: Proportional share of net assets of subsidiary; non-controlling interest is measured as the
proportional share of the net assets of the subsidiary.

– Method 2: Fair value at the date of the acquisition; include non-controlling interest goodwill, measured at fair
value at the date of the acquisition

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Non-Controlling Interests –
Illustration – Method 1
On 1 January 20X0, Bird acquired 80% of 10,000 £1 ordinary voting
shares of Flower for £1.50 per share in cash and so gained control.

The fair value of Flower´s net assets at the date of the acquisition was the
same as their book value.

Prepare the group’s statement of financial position at the acquisition

date using Method 1 for the measurement of the non-controlling
interest.

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Non-Controlling Interests –
Illustration – Method 1

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Non-Controlling Interests –
Illustration – Method 1

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Non-Controlling Interests –
Illustration – Method 2
On 1 January 20X0, Bird acquired 80% of 10,000 £1 ordinary voting
shares of Flower for £1.50 per share in cash and so gained control.

The fair value of Flower´s net assets at the date of the acquisition was the
same as their book value.

Assume that the fair value of a share in Flower is £1.45 prior to Bird’s bid.

Prepare the group’s statement of financial position at the acquisition

date using Method 2 for the measurement of the non-controlling
interest.

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Non-Controlling Interests –
Illustration – Method 2
Non-current assets other than goodwill 31,000
Goodwill (£800 + £100) 900
Fair value of non-controlling interest at date of 2,900
Net current assets 14,000
acquisition
45,900
20% of the net assets at the date of acquisition (2,800)
Share capital 16,000
Attributable goodwill 100 Retained earnings 27,000
Non-controlling interest (£2,800 + £100) 2,900
45,900

• Two figures are different in the consolidated accounts if this method 2 is used: goodwill and non-controlling interests

• Goodwill not only represents the cost of obtaining control, we also credit the non-controlling interest with its own goodwill.

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Differences Between Fair Value

and Book Value – Illustration
On 1 January 20X0, Bird acquired 80% of 10,000 £1 ordinary voting
shares of Flower for £1.50 per share in cash and so gained control.

Assume Flower’s book value of non-current assets was £11,000, and the
market value was £11,600 prior to the acquisition date.

Prepare the group’s statement of financial position at the acquisition date

using Method 1 for the measurement of the non-controlling interest.

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Differences Between Fair Value

and Book Value – Illustration

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Differences Between Fair Value and

Book Value – Illustration

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Parent Issues Shares to Acquire

Subsidiary – Illustration
Assume that Bird issued its own shares to 80% of Flower shareholders who
wanted £1.5 for each Flower share.

Let’s also assume that Bird shares were valued at £2.5 each and were issued
at £1 par value.

Prepare consolidated statement of financial position for Bird at the date of the
acquisition. Use Method 1 for the estimation of the non-controlling interest.

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Parent Issues Shares to Acquire

Subsidiary – Illustration

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Advantages of consolidated
financial statements
Investor protection
Consolidation prevents publication of misleading accounts

Prediction
Consolidation provides more meaningful earnings figures

Accountability
Consolidation provides better measurement of the
performance of the company’s directors

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