Chapter 2

Business Combinations
(IFRS 3)
and
Consolidated Financial
Statements
(IFRS10)
McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc. 2006
 Definitions
 According to IFRS 3, A business combination
is a transaction or other event in which a
reporting entity (the acquirer) obtains control of
one or more businesses (the acquiree).
 IFRS 3 does not apply to the following:
– the formation of a joint venture
– the acquisition of an asset or group of assets that is
not a business as defined
– a combination of entities or businesses under
common control

2
 Classes of Business Combinations

B u s in e s s C o m b in a t io n s

F r ie n d ly T a k e o v e r H o s t ile T a k e o v e r
3
 Friendly Takeovers

 Board of Directors of all constituent

companies amicably determine the
terms of the business combination.
 Proposal is submitted to share holders
of all constituent companies for
approval.

4
 Hostile Takeovers

 Target combinee typically resists the

proposed business combination.
 Target combinee uses one or more of
the several defensive tactics.

5
 Tactics for Defense Used in
Hostile Takeovers
 Pac-man Defense: A threat to undertake a
hostile takeover of the prospective
combinor.
 White Knight: A search for a candidate to
be the combinor in a friendly takeover.
 Scorched Earth: The disposal, by sale or
by spin-off to stockholders, of one or more
profitable business segments.

6
 Tactics for Defense Used in
Hostile Takeovers

 Shark Repellent: An acquisition of

substantial amounts of outstanding
common stock for the treasury or for
retirement, or the incurring of substantial
long-term debt in exchange for
outstanding common stock.

7
 Tactics for Defense Used in
Hostile Takeovers
 Poison Pill: An amendment of the articles of
incorporation or bylaws to make it more difficult
to obtain stockholder approval for a takeover.
 Green Mail: An acquisition of common stock
presently owned by the prospective combinor
at a price substantially in excess of the
prospective combinor’s cost, with the stock
thus acquired placed in the treasury or retired.

8
 Business Combinations:
Why And How?

 In recent years Growth has been main

reason for business enterprises to
enter into a business combination.
 There could be many more reasons.

9
 Business Combinations:
Why And How?

 The external method of achieving

growth is more rapid than growth
through internal methods.
 Obtaining new management strength
or better use of existing management.

10
 Business Combinations:
Why And How?

 Achieving manufacturing or other operating

economies.
 A business combination may be undertaken for
income tax advantages.
 Hostile takeovers are mostly motivated by the
prospect of substantial gain resulting from the
sale of business segments.

11
 Antitrust Considerations
 Antitrust litigations is a one obstacle faced by large
corporations that undertake business combinations.
 The U.S. Government on occasion has opposed
concentration of economic power in large business
enterprises.
 Business combinations have been challenged by the
Federal Trade Commission or the Antitrust Division of
the Department of Justice, under the provisions of
Section 7 of the Clayton Act.

12
 Types of Business Combinations

 Horizontal: A combination involving

enterprises in the same industry.
 Vertical: A Combination involving an enterprise
and its customers or suppliers.
 Conglomerate: A combination between
enterprises in unrelated industries or markets.

13
 Methods for Arranging Business
Combinations

 Statutory Merger
 Statutory Consolidation
 Acquisition of Common Stock
 Acquisition of Assets

14
 Statutory Merger
 It is executed under provisions of applicable
state laws.
 The boards of directors of the constituent
companies approve a plan for the exchange of
voting common stock (and perhaps some
preferred stock, cash or long-term debt) of one
of the corporations (the survivor) for all the
outstanding voting common stock of the other
corporations.

15
 Statutory Merger

 Stockholders of all constituent companies

must approve the terms of the merger.
 Some states require approval by a two-
thirds majority of stockholders, thus
acquiring ownership of those
corporations.

16
 Statutory Merger
 Company “A” acquires Company “B” then
dissolves “B” and liquidates “B”
 Company “B” cease to exist as separate legal
entities
 Company “B” (dissolved) often continues as a
division of the survivor (“A”)
 , which now owns the net assets, rather than
the outstanding common stock, of the
liquidated corporations. Exm.a+b=a or b or ab

17
 Statuary Merger: Illustration
 ABC Corporation pays $10 million to acquire 100%
ownership of XYZ Corporation in a transaction that will be
treated as a statutory merger. The purchase price equals
business fair value. The fair value of XYZ assets is $15
million and the fair value of XYZ liabilities is $5 million.
The accounting entries on ABC Corporation are as follows:
Investment in XYZ Corporation $10 million
Cash or other form of payment $10 million
Assets (from XYZ) $15 million
Liabilities (from XYZ) $ 5 million
Investment in XYZ Corp $10 million
XYZ Corporation will then liquidate (debit liabilities and
equity, credit assets) and cease to exist.
18
 Statutory Consolidation
 Is consummated in accordance with applicable state
laws.
 A new corporation is formed to issue its common
stock for the outstanding common stock of two or more
existing corporations, which then go out of existence.
 The new corporation thus acquires the net assets of
the defunct corporations, whose activities may be
continued as divisions of the new corporation.

19
 Acquisition of Common Stock

 One corporation (the investor) may issue

preferred or common stock, cash, debt or
a combination thereof to acquire from
present stockholders a controlling
interest in the voting common stock of
another corporation (the investee).

20
 Acquisition of Common Stock

 Stock acquisition program may be

accomplished through
 Direct acquisition in the stock market
 Negotiations with the principal
stockholders of a closely held corporation
 Tender offer to stockholders of a publicly
owned corporation.

21
 Acquisition of Common Stock

 A tender offer is a publicly announced

intention to acquire common stock
 For a stated amount of consideration
 A maximum number of shares of the
combinee’s common stock “tendered” by
holders thereof to an agent

22
 Acquisition of Common Stock
 Price per share stated in the tender offer
usually is a premium to prices prior to the
announcement
 A controlling interest in the combinee’s voting
common stock is acquired,
 Corporation becomes affiliated with the
combinor parent company as a subsidiary
but is not dissolved and liquidated and remains
a separate legal entity.

23
 Acquisition of Common Stock

 Business combination through this

method, requires authorization by the
combinor’s board of directors and may
require ratification by the combinee’s
stockholders.
 Most hostile takeovers are accomplished
by this means.

24
 Acquisition of Assets
 Business enterprise may acquire from another
enterprise all or most of the gross assets or net assets
of the other enterprise for cash, debt, preferred or
common stock, or a combination thereof.
 The transaction must be approved by the boards of
directors and stockholders or other owners of the
constituent companies.
 The selling enterprise may continue its existence as a
separate entity or it may be dissolved and liquidated, it
does not become an affiliate of the combinor.

25
 Establishing the Price for A
Business Combination

 This is a very important early step in planning

a business combination.
 The price for a business combination
consummated for cash or debt generally is
expressed in terms of the total dollar amount
of the consideration issued.

26
 Establishing the Price for A
Business Combination

 Common stock is issued by the combinor in a

business combination
 Price is expressed as a ratio of the number of
shares of the combinor’s common stock to be
exchanged for each share of the combinee’s
common stock

27
 Accounting Methods for Business
Combinations
 Major accounting issues affecting business combinations and the
preparation of consolidated or combined financial statements
pertain to the following:
1. The proper recognition and measurement of the assets and
liabilities of the combining entities;
2.The accounting for goodwill or gain from a bargain purchase
(negative goodwill);
3.The elimination of intercompany balances and transactions in
the preparation of consolidated financial statements; and
4. The manner of reporting the non-controlling interest.

28
 Accounting Methods for Business
Combinations (Contd…)

1. The Pooling of interest Method (prior to

2002)
2. Purchase Method (2002 to 2008)
3. Acquisition Method (Since 2009

29
 1 Pooling of interest method

Only used when a company acquired all of

another company’s stock – using its own stock
as consideration (no cash!)

30
 2. Purchase Method

 Valuation basis was “cost”

 Purchase cost allocated proportionately to net
assets based on their fair values, excess to
goodwill.

31
 3. Acquisition Method

The acquisition method is applied to business

combinations beginning in 2009, but previous
accounting methods used are still in effect
today.

32
 Acquisition Method (Contd…)
 Used to account for business combinations.
 Requires recognizing and measuring at fair
value:
 Consideration transferred for the acquired business
 Noncontrolling interest
 Separately identified assets and liabilities
 Goodwill or gain from a bargain purchase
 Any contingent considerations.

33
 Acquition Method (Contd…)
 In Fair value:
 Asset valuations established using…
 The Market Approach – fair value can be estimated
referencing similar market trades.
 The Income Approach – fair value can be estimated using
the discounted future cash flows of the asset.
 The Cost Approach – estimates fair values by reference
to the current cost of replacing an asset with another of
comparable economic utility.

34
 Acquisition Method (Contd…)

 What if the consideration transferred does NOT EQUAL the Fair

Value of the Assets acquired?
 If the consideration is MORE than the Fair Value of the
Assets acquired, the difference is attributed to
GOODWILL
 IIf the consideration is LESS than the Fair Value of the Assets
acquired, we got a BARGAIN!! And we will record a GAIN on

the acquisition!!is LESS than the Fair Value of the

35 Assets acquired, we got a BARGAIN!! And we will

 Contrast of Acquisition Method with Purchase
and Pooling of Interest Methods
 Pooling of interest method (effective for acquisitions completed
prior to June 30, 2001, assuming they met all 12 of the specific
criteria in existence at that time):
– Acquisitions will continue to be consolidated under this
method, until the entities are sold, closed, or otherwise
disposed of.
– Assets and liabilities are consolidated at their book values.
– There are no adjustments to either the balance sheet (fair
value allocations) or the income statement (amortization of fair
value adjustments).
– Income and expense of the acquiree are reported
retrospectively; that is, they are retroactively restated for all
periods presented.

36
 Contrast of Acquisition Method with Purchase
and Pooling of Interest Methods (Contd…)
 Purchase method (effective for acquisitions closed prior to December 15, 2008,
that have been accounted for under the purchase method)
– Acquisitions continue to be accounted for under the purchase method.
– Focus is on historical cost of the acquisition (i.e., the price paid to acquire an
entity).
– Direct combination costs are capitalized as part of the investment cost.
– Stock issuance costs are treated as a reduction of Additional Paid in Capital.
– Bargain purchase results in a proportional reduction of noncurrent assets of
the acquiree with any excess treated as an extraordinary gain.
– Contingent consideration is not recorded as part of acquisition cost until it is
subsequently resolved.
– Acquiree in process research and development costs are included in
acquisition cost only where considered either technologically feasible or
subject to alternative future use.
– Assets and liabilities of the acquiree are reported at fair value, subject to any
reduction in acquiree noncurrent assets due to a bargain purchase .
37
 Contrast of Acquisition Method with Purchase
and Pooling of Interest Methods (Contd…)
 Acquisition method (effective for new acquisitions by acquirers having
fiscal years beginning after December 15, 2008):
– Focus is on fair value of the acquired entity.
– Direct combination costs are expensed.
– Stock issuance costs are treated as a reduction of Additional Paid in
Capital.
– Bargain purchase is treated as income to the acquirer.
– Fair value of contingent consideration at acquisition date is
considered part of the fair value of the acquired entity.
– Subsequent resolution of contingent consideration at a value
different from that recorded at acquisition date is run through the
income statement.
– Acquiree in process research and development costs and other
purchased intangibles are recorded at fair value at acquisition date.
– Preacquisition contingencies that are resolved after the acquisition

38 closing date are expensed.

 Illustration
 ABC Corporation pays $10 million to acquire 100%
ownership of XYZ Corporation in a transaction that will be
treated as a statutory merger. The purchase price equals
business fair value. The fair value of XYZ assets is $15
million and the fair value of XYZ liabilities is $5 million.
Required: Prepare necessary journal entries under the acquisition
method

39
 Soultion
1. Investment in XYZ Corporation $10 million
Cash or other form of payment $10 million

2. Assets (from XYZ) $15 million

Liabilities (from XYZ) $ 5 million
Investment in XYZ Corp $10
million

XYZ Corporation will then liquidate (debit liabilities

and equity, credit assets) and cease to exist.
40
 How does consolidation affect the
accounting records?
 If dissolution occurs:
– Dissolved company’s records are closed out.
– Surviving company’s accounts are adjusted
to include all balances of the dissolved
company.
 If separate incorporation is maintained:
– Each company continues to retain its own
records.
 Worksheets facilitates the periodic
consolidation process without disturbing
41
 IFRS 3: Business Combination
IFRS 10: Consolidated Financial Statements
 In April 2001 the International Accounting
Standards Board (the Board) adopted IAS 22
Business Combinations, which had originally
been issued by the International Accounting
Standards Committee in October 1998.
 IAS 22 was itself a revised version of IAS 22
Business Combinations that was issued in
November 1983.
 International Financial Reporting Standard 3
Business Combinations (IFRS 3) is set out in
paragraphs 1–68 and Appendices A–C
42
 IFRS 3 and IFRS 10

 In March 2004, the Board replaced IAS 22 and

three related Interpretations when it issued
IFRS 3 Business Combinations.
 IFRS 10 Consolidated Financial Statements
(issued May 2011)

43
 IFRS 3
 Measurement and Recognition
 Core principle
– An acquirer of a business recognises the assets acquired and
liabilities assumed at their acquisition-date fair values and
discloses information that enables users to evaluate the nature
and financial effects of the acquisition.
• Applying the acquisition method
• A business combination must be accounted for by
applying the acquisition method, unless it is a
combination involving entities or businesses under
common control or the acquiree is a subsidiary of an
investment entity as defined in IFRS 10

44
 IFRS 3
 Business combinations are accounted for using
the acquisition method through:
– identifying the acquirer;
– determining the acquisition date;
– Acquirer recognises and measure the identifiable
assets acquired and the liabilities assumed and any
non-controlling interest in the acquiree; and
– Acquirer recognises and measures any goodwill
acquired or a gain from a bargain purchase

45
 IFRS 3
 Identifying Acquirer:
– The guidance in IFRS 10 shall be used to identify
the acquirer—the entity that obtains control of
another entity, i.e. the acquiree.
– If a business combination has occurred but applying
the guidance in IFRS 10 does not clearly indicate
which of the combining entities is the acquirer, the
factors in paragraphs B14–B18 shall be considered
in making that determination.

46
 IFRS 3
 Determining the acquisition date
– The date on which the acquirer obtains control of the acquiree
is generally the date on which the acquirer legally transfers the
consideration, acquires the assets and assumes the liabilities
of the acquiree—the closing date.
– However, the acquirer might obtain control on a date that is
either earlier or later than the closing date. For example, the
acquisition date precedes the closing date if a written
agreement provides that the acquirer obtains control of the
acquiree on a date before the closing date. An acquirer shall
consider all pertinent facts and circumstances in identifying the
acquisition date.

47
 IFRS 3
 Recognition
– The IFRS requires the acquirer, having recognised the
identifiable assets, the liabilities and any non-controlling
interests, to identify any difference between:
(a) the aggregate of the consideration transferred,
any non-controlling interest in the acquiree and, in a
business combination achieved in stages, the
acquisition-date fair value of the acquirer’s previously
held equity interest in the acquiree; and
(b) the net identifiable assets acquired.
– The difference will, generally, be recognised as goodwill. If the
acquirer has made a gain from a bargain purchase that gain is
recognised in profit or loss.

48
 IFRS 3
 Disclosure
– The IFRS requires the acquirer to disclose
information that enables users of its financial
statements to evaluate the nature and financial
effect of business combinations that occurred during
the current reporting period or after the reporting
date but before the financial statements are
authorised for issue.
– After a business combination, the acquirer must
disclose any adjustments recognised in the current
reporting period that relate to business
combinations that occurred in the current or
49 previous reporting periods.
 IFRS 3
 Recognition and measurement
– Recognition principle
 separate recognition of identifiable assets acquired,
liabilities and contingent liabilities assumed

– Measurement principle
 assets and liabilities that qualify for recognition are
measured at their acquisition-date fair values

50
 IFRS 3
 Consideration transferred - Measured at the
fair value of the sum of assets transferred and
liabilities assumed
 Acquisition-related costs excluded- must be
recognized as an expense at the time of
acquisition
 Contingent consideration is included at its fair
value at acquisition date (subsequent changes
in fair value are not included in the
consideration transferred at acquisition-date

51
 IFRS 3
 Goodwill
– IFRS (revised ) views the group as an economic
entity and therefore treats all providers of equity
including non-controlling interest as shareholders in
the group.
– Consequently, goodwill will also arise on the non-
controlling interest

52
 IFRS 3
 Goodwill
– Measured as the difference between the
consideration transferred excluding transaction
costs plus value of non-controlling interest in
exchange for the acquiree’s identifiable assets,
liabilities and contingent liabilities
– If the value of acquired identifiable assets and
liabilities exceeds the consideration transferred and
value of the non-controlling interest, the acquirer
immediately recognises a gain (bargain purchase)
– Goodwill is not amortised, but is subject to an
impairment test.

53
 IFRS 3
 Negative Goodwill
– May arise due to:
 errors in measuring the fair value of either the cost of
combination or the acquiree’s identifiable assets, liabilities,
or contingent liabilities
 future costs such as losses being taken into account, or
 there has been a bargain purchase

 Where negative goodwill arises, IFRS 3

requires parent companies to review the fair
54 value exercise to ensure that no assets are
 IFRS 3

 Goodwill Calculation
– Consideration transferred X
– Non-controlling interest X
– Net assets acquired represented by
– Ordinary share capital X
– Share premium X

– Retained earnings on acquisition X (x)

– Goodwill XX

55
 Goodwill

 Goodwill is defined as:

– (the fair value of consideration transferred + the fair
value of any noncontrolling interest in the acquiree +
the fair value of any previously held equity interest
in the acquiree) - the fair value of net assets
acquired.

56
 Illustration
 On July 1, 2X13, Jeffries Incorporated issues 40,000
shares of its common stock in exchange for an initial
acquisition of 80% of Bromard's outstanding shares.
The aggregate fair value of the shares issued is
$4,000,000 ($100 per share). It is determined by
independent appraisal that the remaining 20% of
Bromard has a fair value of $800,000. It is also
determined that the fair value of 100% of the Bromard's
net assets at date of acquisition is $4,200,000. What is
57 the goodwill?
 Solution

 Goodwill = Fair value of consideration

transferred ($4,000,000) + fair value of
noncontrolling interest ($800,000) + fair value
of previously held equity interest (0) - fair value
of net assets acquired ($4,200,000) =
$600,000

58
 Non-controlling interest (NCI)
continued

– If less than 100% of the equity interests of another

entity is acquired in a business combination,
noncontrolling interest is recognised.
– Choice in each business combination to measure
 non-controlling interest either at fair value or
 non-controlling interest’s proportionate share of the (fair
value of the) acquiree’s identifiable net assets.

59
 IFRS 3
 Measurement of Non-controlling interest (NCI)
Method 1
– NCI to be measured at the proportionate share of
the net assets of the subsidiary as at the date of
acquisition.
– At each subsequent reporting date the non-
controlling interest is measured as its percentage
share of the subsidiary’s net assets.

60
 Illustration
 On 1 January 2017, R Ltd acquired 80% of the
10,000,000 Sh.1 Ordinary shares of T Ltd for Ksh.1.50
per share in cash and so gained control. The fair value
of T Ltd’s net assets at that date was the same as their
book value. The retained earnings as at that date
amounted to Ksh. 4,000,000.

– Required: Compute the goodwill acquired on

acquisition and the noncontrolling interest as at that
date

61
 Calculation of goodwill
In ‘000
 Parent Company investment in T Ltd (80% X 10,000,000 X 1.50) 12,000
 Non-controlling interest : (20% X 14,000,000) 2,800

14,800
 Less: Net assets acquired (14,000)
 Goodwill 800

62
 Calculation of Non-Controlling interest in T Ltd

 NCI in Share capital (20% X 10,000,000) 2,000

 NCI in retained earnings as at date of acquisition (20% X 4,000,000) 800
 Representing the NCI in TLtd’s net assets 2,800

63
 Consolidated Financial
Statements (IFRS 10): On
Date of Business
Combination

64
 IFRS 10 : Introduction
 In April 2001 the International Accounting Standards
Board (the Board) adopted IAS 27: Consolidated
Financial Statements and Accounting for Investments
in Subsidiaries, which had originally been issued by the
International Accounting Standards Committee in April
1989.
 IAS 27 replaced most of IAS 3 Consolidated Financial
Statements (issued in June 1976).
 IFRS 10 was Issued in May 2011 and applies to annual
periods beginning on or after 1 January 2013
 IFRS 10: Consolidated Financial Statements is set out
in paragraphs 1–33 and Appendices A–D

65
 IFRS 10: Introduction
 Establishes principles for the presentation and
preparation of consolidated financial
statements when an entity controls one or
more other entities.
 Includes unincorporated entities such as
partnership within definition of subsidiary

66
 IFRS 10: Introduction
 In a group, each individual entity maintains its own
accounting records, but
 Consolidated financial statements are needed to
present the entities together as a single economic
entity for general purpose financial reporting.
 Consolidated financial statements often represent the
only means of obtaining a clear picture of the total
resources of the combined entity that are under the
control of the parent.
67
 According to Appendix A of IFRS 10

 Consolidated financial statements is the

financial statements of a group in which the
assets, liabilities, equity, income, expenses and
cash flows of the parent and its subsidiaries
are presented as those of a single economic
entity.

68
 Who presents consolidated
financial statements?

 An entity that has one or more subsidiaries (a

parent)

69
 IFRS 10: Control
 An investor, regardless of the nature of its
involvement with an entity (the investee), shall
determine whether it is a parent by assessing
whether it controls the investee.
 Thus, an investor controls an investee if and
only if the investor has all the following:
(a) power over the investee
(b) exposure, or rights, to variable returns from its
involvement with the investee; and
(c) the ability to use its power over the investee to
affect the amount of the investor’s returns.

70
 Who need not present consolidated
financial statements?
 A parent if it meets all of the following
conditions:
– It is a subsidiary of another entity and all 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;
– its securities are not publicly traded,
– not in the process of becoming publicly traded, and

71
 Who need not present consolidated
financial statements?
– Its ultimate or any intermediate parent produces
consolidated financial statements that comply with
the IFRSs and are available for public use.
 An investment entity need not present
consolidated financial statements but rather
measure all of its subsidiaries at fair value
through profit or loss.
 Post-employment plans or other long-term
employee benefit plans to which IAS 19 applies

72
 Principle

 Consolidated financial statements present the

financial position and results of operations for a
parent (controlling entity) and one or more
subsidiaries (controlled entities) as if the
individual entities actually were a single
company or entity.

73
 Consolidation procedures
1. Combine like items of assets, liabilities, equity,
income, expenses and cash flows of the
parent with those of its subsidiaries
2. Offset (eliminate) the carrying amount of the
parent's investment in each subsidiary and
the parent's portion of equity of each
subsidiary (IFRS 3 Business Combinations
74 explains how to account for any related
 Consolidation procedures (Contd..)
3. Eliminate in full intragroup assets and liabilities, equity,
income, expenses and cash flows
4. Profits or losses resulting from intragroup transactions
that are recognised in assets, such as inventory and
property, plant and equipment, are eliminated in full.
5. Include the income and expenses of a subsidiary in the
consolidated financial statements from the date it gains
control until the date when the reporting entity ceases
to control the subsidiary
75
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination
P CORPORATION AND S COMPANY
Separate Financial Statements ( prior to business combination)
For Year Ended December 31, 2002

P Corp. S Comp
Income Statements
Revenue:
Net Sales $990,000 $600,000
Interest Revenue 10,000
Total Revenue $1,000,000 $600,000
Costs and Expenses:
Cost of Goods Sold $635,000 $410,000
Operating Expenses 158,333 73,333
Interest Expense 50,000 30,000
Income Taxes Expense 62,667 34,667
Total Costs and Expenses $906,000 $548,000
Net Income $94,000 $52,000

Statements of Retained Earnings

Retained Earnings, begineing of year $65,000 $100,000
Add: Net Income 94,000 52,000
Subtotals $159,000 $152,000
Less: Dividends 25,000 20,000
Retained Earnings, end of year $134,000 $132,000

76
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination
P CORPORATION AND S COMPANY
Separate Financial Statements ( prior to business combination)
For Year Ended December 31, 2002

P Corp. S Comp
Balance Sheets
Assets
Cash $100,000 $40,000
Inventories $150,000 $110,000
Other Current Assets 110,000 $70,000
Receivable from S Company $25,000
Plant Assets (Net) $450,000 $300,000
Patent (Net) $20,000
Total Assets 835,000 540,000

Liabilities and Stockholders' Equity

Payables to P Corp. $25,000
Income Taxes Payable 26,000 10,000
Other Liabilities $325,000 $115,000
Common Stock, $10 par 300,000
Common Stock, $5 par $200,000
Additional Paid-In Capital 50,000 58,000
Retained Earnings $134,000 $132,000
Total Liabilities & Stockholders' Equity 835,000 540,000

77
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

– On December 31 2002, the current fair values of S

company’s identifiable assets and liabilities were the
same as their carrying amounts, except for the
Inventories, Plant Assets (net) and Patent (net).
They were as
Assets Current Fair Value as or 12/31/02
– Inventories $ 135,000
– Plant Assets (net) $ 365,000
– Paten (net) $ 25,000

78
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 Because S was to continue as a separate

corporation and generally accepted accounting
principles do not sanction write-ups of assets
of a going concern.
 S did not prepare journal entries for the
business combination.
 P recorded the combination as a purchase on
December 31, 2002, with following journal
entries.

79
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination
P Corporation ( combinor)
Journal Entries
31-Dec-02

Investment in S Company Common Stock (10,000 x 45) 450000

Common Stock (10,000 x $10) $100,000
$350,000
To record Issuance of 10,000 shares of common stock for all the
outstanding common stock of S company in a business
Combination

Investment in S company Common Stock $50,000

Paid-In-Capital in Excess of Par 35,000
Cash 85,000
To Record payment of out-of-pocket costs of business combination with
S Company, Finder's and Legal fees relating to the combination are
recorded as additional costs of the investment; costs associated with the
SEC registration statement are recorded as an offset to the previously
recorded proceeds from the issuance of common stock.

80
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 The first journal entry is similar to the entry for

statutory merger.
 An Investment in Common Stock ledger
account is debited with the current fair value of
the combinor’s common stock issued to effect
the business combination, and the paid-in-
capital accounts are credited in the usual
manner for any common stock issuance.

81
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 In the second journal entry, the direct out-of-

pocket costs of the business combination are
debited to the Investment in Common Stock
ledger account, and the costs that are
associated with SEC registration statement,
being costs of issuing the common stock, are
applied to reduce the proceeds of the common
stock issuance.

82
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 The foregoing journal entries do not include

any debit or credits to record individual assets
and liabilities of S Company, in the accounting
records of P Corporation, because S was not
liquidated.
 After the posting of foregoing journal entries,
the affected ledger accounts of P Corporation
(the combinor) are as follows:

83
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination
Le dge r Accounts of Combinor Affe cte d by Busine ss Combina tion

Ca sh Account
Da te Ex pla na tion De bit Cre dit Ba la nce Dr/Cr
2002
Dec. 31 Balance Forward 100,000 Dr.
Dec. 31 Out-of-Pocket Costs of business combination 85,000 15,000 Dr.

Insve stme nt S Compa ny Common Stock

Da te Ex pla na tion De bit Cre dit Ba la nce Dr/Cr
2002
Issuance of Common Stock in business
Dec. 31 combination 450,000 450,000 Dr.
Direct Out-of-Pocket costs of business
Dec. 31 combination 50,000 500,000 Dr.

Common Stock, $ 10 Pa r
Da te Ex pla na tion De bit Cre dit Ba la nce Dr/Cr
2002
Dec. 31 Balance Forward 300,000 Cr.
Issuance of Common Stock in business
Dec. 31 combination 100,000 400,000 Cr.

Pa id-In-Ca pita l in Ex ve ss of Pa r
Da te Ex pla na tion De bit Cre dit Ba la nce Dr/Cr
2002
Dec. 31 Balance Forward 50,000 Cr.
Issuance of Common Stock in business
Dec. 31 combination 350,000 400,000 Cr.
Costs of issuing common stock in business
Dec. 31 combination 35,000 365,000 Cr.

84
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 Accounting for the business combination for P Corp.

and S Comp., requires fresh start for the consolidated
entity.
 The business combination involves parent-subsidiary
relationship, so the theory reflects that an acquisition of
the combinee’s net assets by the combinor is involved.
 A consolidated balance sheet is the only consolidated
financial statement issued by P Corp on December 31,
2002.

85
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 The parent company’s investment account and the

subsidiary’s stockholders’ equity accounts do not
appear in the consolidated balance sheet because they
are essentially reciprocal accounts.
 The parent company’s assets and liabilities are
reflected at carrying amounts, and the subsidiary
(combinee) assets and liabilities are reflected at
current fair values, in the consolidated balance sheet.

86
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination

 Goodwill is recognized to the extent the cost of the

parent’s investment in 100% of the subsidiary’s
outstanding common stock exceeds the current fair
value of the subsidiary’s identifiable net assets, both
tangible and intangible.
 Applying foregoing principles to the P Corp and S
Company parent-subsidiary relationship, the following
consolidated balance sheet is produced.

87
 Consolidation Of Wholly Owned
Subsidiary On Date Of Business
Combination
P CORPORATION AND S COMPANY
Consolidated Balance Sheet
31-Dec-02

Assets
Current Assets
Cash ($15,000+$40,000) $55,000
Inventories ($150,000+ $135,000) 285,000
Other ($110,000 + $ 70,000) 180,000
Total Current Assets $520,000
Plant Assets (net) ($450,000 + $365,000) 815,000
Intangible Assets:
Patent (net) ($0 + $25,000) 25,000
Goodwill 15,000 40,000
Total Assets 1,375,000

Liabilities a nd Stockholders' Equity

Liabilities :
Income taxes payable ($26,000 +$10,000) $36,000
Other ($325,000 + $115,000) 440,000
Total Liabilities $476,000
Stockholders' Equity:
Common Stock, $ 10 par $400,000
Additional paid-in-capital 365,000
Retained Earnings 134,000 899,000

88 Total Liabilities and Stockholders' Equity $1,375,000

 Significant Aspects of the
Consolidated Balance Sheet
 The first amounts in the computation of consolidated
assets and liabilities are the parent company’s carrying
amounts; the second amounts are the subsidiary’s
current fair values.
 Inter-company accounts are excluded from the
consolidated balance sheet.
 Goodwill, in the consolidated balance sheet is the cost
of the parent company’s investment less the current
fair value of the subsidiary’s identifiable net assets.

89
 Working Paper for
Consolidate Balance Sheet

 The preparation of consolidated balance sheet

on the date of a business combination usually
requires the use of a working paper for
consolidated balance sheet.
 Developing The Eliminations.
 The following features of the working paper for
consolidated balance sheet on the date of the
business combination should be emphasized.

90
 Working Paper for
Consolidate Balance Sheet

1 The elimination is not entered in either the parent

company’s or the subsidiary’s accounting records; it is
only a part of the working paper for preparation of the
consolidated balance sheet.
2 The elimination is used to reflect differences between
current fair values and carrying amounts of the
subsidiary’s identifiable net assets because the
subsidiary did not write up its assets to current fair
values on the date of the business combination.

91
 Working Paper for
Consolidate Balance Sheet

3 The eliminations column in the working paper for

consolidated balance sheet reflects increases and
decreases, rather than debits and credits. Debits and
credits are not appropriate in working paper dealing
with financial statements rather than trial balance.
4 Inter-company receivables and payables are placed
on the same line of the working paper for
consolidated balance sheet and are combined to
produce a consolidated amount of zero.

92
 Working Paper for
Consolidate Balance Sheet

5 The respective corporations are identified in

the working paper elimination.
6 The consolidated paid-in capital amounts are
those of the parent company only.
Subsidiaries’ paid-in capital amounts always
are eliminated in the process of consolidation.

93
 Working Paper for
Consolidate Balance Sheet

7 Consolidated retained earnings on the date of

a business combination includes only the
retained earnings of the parent company. This
treatment is consistent with the theory that
purchase accounting reflects a fresh start in
an acquisition of net assets, not a combining
of existing stockholder interests.

94
 Working Paper for
Consolidate Balance Sheet

8 The amounts in the Consolidated column of

the working paper for consolidated balance
sheet reflect the financial position of a single
economic entity comprising two legal entities,
with all inter-company balances of the two
entities eliminated.

95
 IFRS 10: Disclosure
 No disclosures specified in IFRS 10.
 IFRS 12 Disclosure of Interests in Other
Entities outlines the disclosures required.

96
 End of chapter 2

Thank you for your Attention!!!

97