CHAPTER ONE

Accounting for
business combinations and
consolidated financial
statements
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 LEARNING OBJECTIVES
At the completion of studying this chapter, you will
be able to:
• Explain business combination and consolidated financial
statements
• explain the concept of control
• apply the requirements of IFRS 10 to preparation of
Consolidation of financial statements
• identify the disclosure requirements business combination
• distinguish between the accounting treatment of
consolidation under US GAAP and IFRS 2
LIST OF APPLICABLE IFRS

Topic List Standards

Business Combination IFRS 3
Consolidation of Financial Statement IFRS 10

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IFRS 3

BUSINESS COMBINATION
 THE OBJECTIVE OF IFRS 3
 The objective of IFRS 3:
 to prescribe the accounting treatment for:
― Business combination

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 THE SCOPE OF IFRS 3
 The Standard is to be applied in accounting for business
combination EXCEPT:
 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
 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).
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THE ACQUISITION METHOD
● Business combinations are accounted for using the acquisition
method, ie
 identifying the acquirer;
 determining the acquisition date;
 recognize and measure the identifiable assets acquired and
the liabilities assumed and any non-controlling interest; and
 recognize and measure any goodwill or bargain purchase.

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IDENTIFYING THE ACQUIRER
● The acquirer is the entity that obtains control of another
entity

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EXAMPLE: WHO IS THE ACQUIRER? 9

● On 31/12/20X0 A has 100 shares in issue.

● On 1/1/20X1 A issued 200 new A shares to the
owners of B in exchange for all of B’s shares.
DETERMINING THE ACQUISITION
DATE
● The acquisition date is the date on which the acquirer
obtains control
 often the date the consideration is transferred, assets
are acquired and liabilities assumed—closing date
 may be other dates (earlier or later than the closing
date) at which control is assumed

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RECOGNITION AND MEASUREMENT
● Recognition principle (IFRS 3.10–17):
 separate recognition of identifiable assets acquired,
liabilities and contingent liabilities assumed (think
Conceptual Framework)
● Measurement principle (IFRS 3.18–20):
 assets and liabilities that qualify for recognition are
measured at their acquisition-date fair values
 measurement at fair value provides relevant
information that is more comparable and
understandable (IFRS 3.BC198)

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EXCEPTIONS TO BOTH THE RECOGNITION
& MEASUREMENT PRINCIPLES
● Income taxes
 deferred tax assets or liabilities arising from acquired assets
or liabilities accounted for using IAS 12
● Employee benefits
 accounted for using IAS 19
● Indemnification assets
 may not be recognised at fair value if it relates to an item not
recognised or measured in accordance with IFRS 3

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 CONSIDERATION TRANSFERRED
● The consideration transferred is measured at the fair value of
the sum of assets transferred and liabilities assumed
 acquisition-related costs are excluded
 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)

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EXAMPLE:
WHAT IS THE COST OF THE BUS COM? 14

● Entity A acquires 75% of entity B in exchange for ETB 85,000

cash and 1,000 entity A shares (fair value = ETB 10,000) issued
for the transfer.
● Entity A incurred ETB 5,000 advisory and legal costs directly
attributable to the business combination and ETB 1,000 share
issue expenses.
GOODWILL
● Goodwill is measured initially indirectly as the difference
between the consideration transferred (see IFRS 3.37–40)
excluding transaction costs 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, the acquirer
immediately recognises a gain (bargain purchase)

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GOODWILL Continued
● Goodwill is not amortised, but is subject to an impairment
test.
● If less than 100% of the equity interests of another entity is
acquired in a business combination, non-controlling interest
is recognized.
● Choice in each business combination to measure non-
controlling interest either at fair value or at the non-
controlling interest’s proportionate share of the acquiree’s
identifiable net assets.

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DISCLOSURE
● Comprehensive disclosure requirements designed to enable
users to evaluate the nature and financial effects of business
combinations (and any adjustments made to prior period
business combinations).
● Refer to IFRS 3.B64–B67.

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 COMPARISON TO THE IFRS FOR SMES
● The main differences between IFRS 3 and Section 19 Business
Combinations and Goodwill of the IFRS for SMEs include:
 the costs associated with acquisition are included in the
consideration transferred rather than being expensed
 changes in the recognized amount of contingent
consideration affect goodwill
 goodwill is amortised over its estimated useful life (or 10
years if a reliable estimate cannot be made)
 non-controlling interest must be measured using the
proportionate share method

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IFRS 10

CONSOLIDATED FINANCIAL STATEMENTS

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INTRODUCTION
● IFRS 10 establishes principles for the presentation and
preparation of consolidated financial statements when an
entity controls one or more other entities.
OBJECTIVE
● Information about
 resources under the control of the group (assets) and
 claims against those resources
 assists users to better assess the prospects for future net
cash inflows to the group which is useful in making
decisions about providing resources to the group.
● The global financial crisis highlighted the importance of
enhancing disclosure requirements, in particular for special
purpose or structured entities.

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IFRS 10 CONSOLIDATED FINANCIAL
STATEMENTS
 Definition of Consolidation:
√ The process of combining the financial statements of a parent
company and one or more legally separate and distinct
subsidiaries as a single economic entity for financial reporting
purposes.

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 DEFINITION OF CONTROL 23
An investor controls an investee when the investor is
exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect
those returns through its power over the investee.
● The power to govern the financing and operating policies of an
entity so as to obtain benefits from its activities and increase,
maintain, or protect the amount of those benefits.
● Consolidation based on control – ‘power so as to benefit’ model
 Investor must have some exposure to risks and rewards
 Exposure is an indicator of control but not control of itself
 Power arises from rights—voting rights, potential voting rights,
other contractual arrangements, or a combination thereof.
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ASSESSING CONTROL OF AN INVESTEE

● Consider the purpose and design
● Identify the activities of the investee that significantly affect
the returns of the investee (relevant activities)
● Identify how decisions about relevant activities are made
● Determine whether the rights of the investor give it the ability
to direct the relevant activities (see next slide)
● Determine whether the investor is exposed, or has rights, to
the variability associated with the returns of the investee
● Determine whether the investor has the ability to use its
power over the investee to affect its own returns
 EXAMPLE: CONTROL 25

● In the absence of evidence to the contrary, in each scenario

below, does A control Z?
i. A owns 100% of Z.
ii. A owns 51% of Z.
iii. A owns 50% of Z.
iv. A owns 50% of Z and holds currently exercisable ‘in the money’
options to acquire another 100 shares in Z.
v. Same as (iv) except B owns the options.
EXAMPLE: STRUCTURED ENTITY 26

● A pharmaceutical manufacturer (entity A) established a viral

research centre (RC) at a university.
● A determined sole & unalterable purpose of RC = research &
develop immunisation & cures for viruses that cause human
suffering.
● RC is owned and staffed by the university.
EXAMPLE: STRUCTURED ENTITY
continued 27

● All costs of establishing & running RC are paid by the

university from the proceeds of a grant from A.
 the budget for the research centre is approved by A
yearly in advance.
● A benefits from the research centre:
 by association with the university; and
 through exclusive right to patent any immunisations and
cures developed.
● Who has the controlling power and why?
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De FACTO CONTROL
● Entity can control with less than 50% of voting rights.
● Factors to consider include:
 size of the holding relative to the size and dispersion of
other vote holders
 potential voting rights
 other contractual rights
● If the above not conclusive consider additional facts and
circumstances that provide evidence of power (eg voting
patterns at previous board meeting, etc)
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EXAMPLE: De FACTO CONTROL

● Entity A owns 45 per cent of the ordinary shares of Entity B to
which voting rights are attached.
● Entity A is the largest shareholder of Entity B.
● It also has the right to appoint the majority of the members of
the Board of Directors of Entity B in accordance with special
rights given to Entity A in the founding document of the entity.
 Does Entity A has control over B so that need to consolidate
the financial statement of entity B? Why?
EXAMPLE: ASSESSING POWER
● Entity A and B each have 50%
ownership interest in the trust.
● Entity A appointed as manager of
trust.
● Manager: manages the assets of
the trust, identifies development
opportunities, manages
development activity and
manages leasing activity.
● Cannot be removed without
cause.
● Relevant activities?
● Who directs?
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EXAMPLE: DELEGATED RIGHTS
Responsible Other ● Responsible entity:
entity investors
√ Broad decision making
powers
√ Removal by simple majority
Investment
trust √ Remunerated via market-
based fee - 1% of assets
under management and
Investment
portfolio 20% of profits over a hurdle
√ Equity interest of 20%
 Is there any controlling
power? If any by whom?
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POTENTIAL VOTING RIGHTS

● Substantive potential voting rights (PVR) can give the holder
power
● Consider the terms and conditions, including:
 Whether there are any barriers that prevent the holder from
exercising
 Whether exercise of the rights would be beneficial to the
holder
 Whether the rights are exercisable when decisions need to
be made
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AGENCY RELATIONSHIPS
● Consider all of the following factors:
 scope of the decision-making authority
 rights held by other parties (ie kick-out rights)
 remuneration of the decision-maker
 other interests that the decision maker holds in the
investee
 JUDGEMENTS AND ESTIMATES
● Factors to consider when assessing whether control exists
include, for example:
 has power over the investee
 exposure, or rights, to variable returns from its involvement
with the investee
 the ability to use its power over the investee to affect the
amount of the investor’s returns.
 assessing the purpose and design of the investee (eg are
voting rights or contractual arrangements the dominant
factor?)

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JUDGEMENTS AND ESTIMATES continued

 identifying relevant activities and how decisions about

those activities are made
 assessing current ability to direct (practical ability to direct
the relevant activities unilaterally?)

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WHO PRESENTS CONSOLIDATED
FINANCIAL STATEMENTS?
● An entity that has one or more subsidiaries (a parent) must
present consolidated financial statements.
● Two exceptions:
• a parent if:
₋ its owners have been informed and do not object,
₋ its securities are not publicly traded or in the process of

becoming publicly traded, and

₋ its parent publishes IFRS-compliant financial statements

that are available to the public.

• Post-employment plans or other long-term employee

benefit plans to which IAS 19 applies

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 PRINCIPLE
● Consolidated financial statements present the parent and all its
subsidiaries as financial statements of a single economic entity
 uniform accounting policies
 same reporting periods
 eliminate intragroup transactions and balances
 non-controlling interest (the equity in a subsidiary that is not
attributable, directly or indirectly, to the parent) is presented
within equity, separately from the parent shareholders’
equity.

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EXAMPLE: CONSOLIDATION
PROCEDURES 38

● On 1/1/20X1 entity A acquires 100% of entity B for ETB 1,000

when B’s share capital & reserves = ETB 700 (net FV of B’s assets &
liabilities = ETB 800).
● B has no contingent liabilities. The ETB 100 difference between
CA & FV is a machine with 5 yrs remaining useful life and nil
residual value.
● B’s profit for the year ended 31/12/20X1 = ETB 400.
● In 20X1 A sold inventory which cost it ETB 100 to B for ETB 150.
● At 31/12/20X1 B’s inventory included ETB 60 inventory bought
from A.
● Ignore taxation effects.
 EXAMPLE:
CONSOLIDATION PROCEDURES continued 39

● The journal entry at acquisition to eliminate A’s investment in

B; recognize goodwill; & eliminate B’s share capital & reserves
accumulated before it became part of the group.

Property, plant & equipment 100

B’s at-acquisition share capital &
700
reserves
Goodwill (asset) 200
A’s investment in B 1,000
EXAMPLE:
CONSOLIDATION PROCEDURES continued 40

● Journal entry to increase depreciation to group values

(remaining estimated useful life = 5 years):

Profit or loss 20
Property, plant & equipment 20
EXAMPLE:
CONSOLIDATION PROCEDURES continued 41

● Journal entry to eliminate intragroup sale of inventory and

the unrealise profit in inventories (ignoring tax effects):

Profit or loss (revenue) 150

Profit or loss (COS) 150
Profit or loss (COS) 20
Inventory (asset) 20
NON-CONTROLLING INTEREST (NCI) 42

● Non-controlling interest (NCI) in net assets consists of:

 the amount of the NCI recognized in accounting for Bus
Com at date of acquisition; plus
 the NCI’s share of recognized changes in equity (ie
recognized changes in Sub’s net assets) since the date
of the combination.
 EXAMPLE: NCI 43

● On 1/1/20X1 entity A acquires 75% of entity B for ETB 1,000

when B’s share capital & reserves = ETB 700 (net FV of B’s assets
& liabilities = ETB 800).
● B has no contingent liabilities. The ETB 100 difference between
CA & FV is a machine with 5 yrs remaining useful life and nil
residual value.
● Ignore taxation effects.
● B’s profit for the year ended 31/12/20X1 = ETB 400.
● In 20X1 A sold inventory which cost it ETB 100 to B for ETB 150.
● At 31/12/20X1 B’s inventory included ETB 60 inventory bought
from A.
EXAMPLE: NCI continued 44

● Eliminate Investment
● Journal entry at acquisition is:

Property, plant & equip. 100

B’s at-acquisition share capital & 700
reserves
Goodwill 400
Non-controlling interest 200
A’s investment in B 1,000
EXAMPLE: NCI continued 45

● Adjust consolidated depreciation

● Journal entry to increase depreciation to group values
(remaining estimated useful life = 5 years):

Profit or loss 20
Property, plant & equipment 20
EXAMPLE: NCI continued 46

● Allocate profit
● Journal entry allocating the NCI their share of B’s profit for
the year:

NCI profit allocation 95

NCI (equity) 95

Calculation:
Profit 400
Depreciation adjust (20)
380
25% attributable to NCI 95
EXAMPLE: NCI continued 47

 Journal entry to eliminate downstream intragroup sale of

inventory and the unrealised profit in inventories (ignoring
tax effects):

Profit or loss (revenue) 150

Profit or loss (COS) 150
Profit or loss (COS) 20
Inventory (asset) 20
EXAMPLE: NCI UPSTREAM SALE 48

 Same as previous example except upstream sale of

inventory (ie from B to A)
 Same journal entries as in previous example and an
additional journal entry (below) to eliminate from NCI their
share of the unrealised profit:

NCI (equity) 5
NCI profit allocation 5
 LOSS OF CONTROL
● If a parent no longer controls a subsidiary, the parent:
 Derecognises the assets and liabilities of the
former subsidiary.
 Recognizes any retained investment at fair value
when control is lost.
 This investment is subsequently accounted for as a
financial instrument or, if appropriate as an
associate or joint venture.
 Recognizes a gain or loss associated with loss of
control.
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COMPARISON WITH THE IFRS FOR
SMES
● Section 19 Business Combinations and Goodwill of the IFRS
for SMEs differs from full IFRSs—in Section 19:
 goodwill is amortised over its estimated useful life (or
10 years if a reliable estimate cannot be made)
 non-controlling interest must be measured using the
proportionate share method
 there is no specified maximum allowable difference
between the reporting periods of the parent and the
subsidiary.

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THE END
Q&A

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