Post on 30-Apr-2018
transcript
Module Preparation Seminar (Part II)
for
Module A on Financial Reporting
Speaker
Ms. Mabel Ho
6 November 2012
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EXECUTIVE TRAINING COMPANY (INTERNATIONAL) LTD
Ms Mabel Ho
ETC Lecturer
ACA (UK), AICPA, CPA (Aust), FCCA, CPA (HK), Msc (Finance), Master (Tax), MBA
Extensive working experience in the financial industry
Acting as Financial Controller for listed companies – performing
strategic management work, forecasting, budgeting, complex
consolidation work and IT implementation
University lecturer for local and overseas universities
Developed unique method of teaching
Professional exam marker
Experienced notes writer
www.etctraining.com.hk
About the Lecturer
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Module Preparation Seminar on Major or
Difficult Syllabus Topics (Part II)
• Business combination and consolidation of
financial statements
Module A Financial Reporting
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Module A Financial Reporting
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In June 2011,
HKICPA issued as a “package of five” new standards
1. HKFRS 10 “Consolidated Financial Statements”
2. HKFRS 11 “Joint Arrangements”
3. HKFRS 12 “Disclosure of Interests in Other Entities”
4. HKAS 27 (2011) “Separate Financial Statements”
5. HKAS 28 (2011) “Investments in Associates and Joint Ventures”
and HKFRS 3 (revised) Business Combinations
They are applicable together. All are examinable in Module A
December 2012 Session – six month rule
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Module A Financial Reporting
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Six-month rule
• A six-month rule is adopted for standards / interpretations.
• The cut-off date for new and revised standards / interpretations
examinable in the December 2012 Session is 31 May 2012.
• Please refer to the student handbook for details of the six-month
rule.
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Module A Financial Reporting
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Effective Period of New Standards
• Effective for period beginning on or after 1 January 2013
• Earlier application is permitted
• If apply any earlier, apply all other standards at the same time
• Encourage to provide information required by HKFRS 12 earlier
• Provide some HKFRS 12 disclosures earlier does not mean early
adoption
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Module A Financial Reporting
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Standards relevant to the preparation and presentation of consolidated financial statements
HKFRS 3 (revised) Business Combinations (deals with methods of accounting for business combinations and the
calculation of goodwill)
HKFRS10 Consolidated Financial Statements (applies specifically to the preparation and presentation of
consolidated financial statements for parent-subsidiary relationship and prescribes the principles of consolidations)
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Module A Financial Reporting
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Module A Financial Reporting
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New Standard on Consolidation
• HKFRS 10 supersedes consolidation in HKAS 27 (Revised) and
HK(SIC) Int 12
• Because of conflict of emphasis between HKAS 27 (Revised) and
HK(SIC) Int 12
HKAS 27 (Revised) on control
HK(SIC) Int 12 on risks and rewards
• Accounting for subsidiaries, joint ventures and associates in
Separate Financial Statements in HKAS27 (2011)
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Module A Financial Reporting
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New Standard on Consolidation
• HKFRS 10 now
Use control as a single basis for consolidation
Explicitly include de facto control
Explicitly include agent vs. principal concepts
• Three elements of control:
Power over the investee
Exposure, or rights, to variable returns from its involvement
with investee and
Ability to use its power to affect the amount of investor’s
returns
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Module A Financial Reporting
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Module A Financial Reporting
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Joint Arrangements
• HKFRS 11 supersedes HKAS 31 and HK(SIC) Int 13
• HKFRS 11 addresses two aspects of HKAS 31
Structure of joint control arrangement determine accounting
treatments
Choice of different accounting treatment
• HKFRS 11 focuses on rights and obligations of arrangement,
rather than legal form
• HKFRS 11 requires equity method for joint ventures [HKAS 28
(2011)]
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Module A Financial Reporting
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Chapter & Chapter Name
Main changes in 2012/13 edition
Chapter 27
Principles of consolidation
• Additional material on the disclosure
requirements in relation to subsidiaries
• Additional material on goodwill
Chapter 29
Consolidated accounts:
accounting for associates and
joint arrangements
• New material on transfers of non-current
assets between group companies and
associates of the group
• Material on disclosure requirements in
relation to associates and joint
arrangements moved from Chapter 27
MA Learning Pack –
Summary of changes 2012-13 Edition
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Module A Financial Reporting
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Content
1. Group Accounts
2. HKFRS 10 Definition of Control
3. HKFRS 10 Consolidated Financial Statements
4. HKFRS3 (Revised) Business Combinations
5. Consolidation Theories
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Group accounts are prepared which show the group
as a single economic entity:
MA – Group Accounts
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SIGNIFICANT INFLUENCE = power to participate in but not control
the financial & operating policy decisions of an investee
• 20 – 50% votes
PARENT: An entity that has one or more subsidiaries
SUBSIDIARY: An entity that is
controlled by another entity
Consolidate
Control: HKFRS 3 / HKFRS 10
JOINT ARRANGEMENT: An entity in which two or more parties have joint
control
HKFRS 11 rules
Contractual arrangement HKFRS 11 /
HKAS 28 (2011)
ASSOCIATE: An entity in which the parent has significant
influence
Equity account
HKAS 28 (2011)
INVESTMENT: Asset held for accretion
of wealth
HKFRS 9 rules
Single company accounts HKFRS 9
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Parent-Subsidiary Relationship
Parent Control Subsidiary
Subsidiary
Subsidiary
Group
Consolidation:
Process of
preparing and
presenting financial
statements of
parent and
subsidiary as if
they were one
economic entity
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Module A Financial Reporting
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Content
1. Group Accounts
2. HKFRS 10 Definition of Control
3. HKFRS 10 Consolidated Financial Statements
4. HKFRS3 (Revised) Business Combinations
5. Consolidation Theories
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MA – HKFRS 10 Definition of Control
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Power • Existing rights that give the current
ability to direct the relevant activities of the investee
• Power may be achieved through holding a majority of voting rights or by other means
Returns • Dividends • Remuneration for servicing investee’s
assets and liabilities • Fees and exposure to loss from
providing credit support. • Returns as a result of achieving
synergies by combining use of assets
Control
if the investor has • Power over the investee, and • Exposure or rights to variable returns from its involvement with the investee, and • The ability to use its power over the investee to affect the amount of returns it
receives to obtain benefits from its activities
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Determination of control
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Power – Example of Rights:
1. Rights to appoint, reassign or remove key management personnel who can direct the relevant activities
2. Rights to appoint or remove another entity that directs the relevant activities
3. Rights to direct the investee to enter or veto changes to transactions for the benefit of the investor
4. Other rights, specified in management contract
Ability rather than contractual right may also indicate POWER over investee
An investor uses POWER in the direction of relevant activities to affect returns
• from its involvement with the investee OR • even through an agent
Control Subsidiary
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Module A Financial Reporting
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Content
1. Group Accounts
2. HKFRS 10 Definition of Control
3. HKFRS 10 Consolidated Financial Statements
4. HKFRS3 (Revised) Business Combinations
5. Consolidation Theories
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MA – HKFRS 10 Consolidated Financial Statements
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Consolidated financial statements include all subsidiaries other than
those held for sale or those who operate under long term restrictions
and so are not controlled.
Exemption A parent need not prepare group accounts if: • It is itself a wholly owned subsidiary • It is partially owned and the other owners
do not object • Its securities are not publicly traded • The ultimate or intermediate parent
publishes HKFRS-compliant consolidated accounts
• Disclosures apply
Preparation • Different reporting dates –
adjustments should be made • Uniform accounting policies – if not,
disclose why. Adjustments should be made on consolidation
• Intra-group transactions are eliminated
A parent not presents consolidated financial statement must comply with HKAS 27 (2011) on separate financial statements
Parent’s account Subsidiaries are accounted for at cost or in accordance with HKFRS 9
HKFRS 9 Financial asset
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Module A Financial Reporting
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Content
1. Group Accounts
2. HKFRS 10 Definition of Control
3. HKFRS 10 Consolidated Financial Statements
4. HKFRS3 (Revised) Business Combinations
5. Consolidation Theories
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MA – HKFRS 3 (Revised) Business Combinations
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Scope of HKFRS3 (Revised)
• Second relevant standard on group accounting and provides guideline
on the measurement of net assets acquired in a business
combination, the non-controlling interest (NCI), goodwill arising
on business combination and necessary disclosures to evaluate a
business combination
• Not apply to
the formation of a joint venture
the acquisition of an asset or group of assets that does not
constitute a business (relevant standards are HKAS 16 and
HKAS 38, goodwill does not arise on such asset purchase)
a combination between entities or businesses under common
control
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MA – HKFRS 3 (Revised) Business Combinations
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Scope of HKFRS3 (Revised)
Example of businesses under common control:
As Apex, Xero and Yoho are under the common control of Pear before and after
the business combination, this business combination is excluded from the
scope of HKFRS3 (Revised).
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Definition of a Business
This determination can be complicated
If the fair value of the acquiree is concentrated in just one or a few
assets, or if there are little or no operations, for the acquiree to be
considered a business, it must have inputs and processes that make it
capable of generating a return or economic benefit for the acquirer’s
investors.
Economics benefits can be in the form of dividends, capital appreciation,
and cost reductions.
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MA – HKFRS 3 (Revised) Business Combinations
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Definition of a Business
Under the framework, an entity determines whether acquiring a
business or assets:
1. Identifies the elements in the acquiree
• Elements may vary on industry, structure and stage of
development
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MA – HKFRS 3 (Revised) Business Combinations
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Definition of a Business
2. Assesses the capability of the acquiree to produce outputs
• Development stage enterprise:
have begun planned principal activities
has employees, intellectual property, other inputs and
processes applied to inputs
is pursuing a plan to produce outputs
obtain access to customers that will purchase the outputs
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MA – HKFRS 3 (Revised) Business Combinations
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Definition of a Business
3. Business need not include all inputs or processes if market
participants are capable of acquiring the business and produce
outputs by using their own inputs and processes (accounting, billing,
payroll & other systems are not processes to create outputs)
4. Acquirer’s intended use of the acquired assets and activities is NOT
a determining factor
5. Goodwill exists in business combination accounted for by applying
acquisition method
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MA – HKFRS 3 (Revised) Business Combinations
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Definition of a Business
Example : Asset Acquisition
• Facts:
– A shipping and warehousing company (the acquiree) provides shipping and storage services to various third parties.
– A consumer retail company (the acquirer) plans to purchase several warehouses from the shipping and warehousing company and intends to use the warehouses to enhance its inventory distribution system.
– The acquiree includes only the land and warehouses. It does not include warehousing contracts with third parties, nor does it include employees, warehouse equipment, or information technology systems, such as inventory-tracking systems.
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MA – HKFRS 3 (Revised) Business Combinations
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Definition of a Business
Example : Asset Acquisition
• Analysis:
– It is unlikely that the acquiree would be a business, but only asset acquisition.
– The acquirer will purchase only inputs (i.e., the physical assets) and no accompanying processes.
– The acquiree is missing significant inputs and processes. Without these missing elements, the acquirer does not meet the definition of a business.
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Module A Financial Reporting
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Content
1. Group Accounts
2. HKFRS 10 Definition of Control
3. HKFRS 10 Consolidated Financial Statements
4. HKFRS3 (Revised) Business Combinations
5. Consolidation Theories
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MA – Consolidation Theories
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Ownership of the combined entity involving a wholly owned subsidiary
Joint-ownership of the combined entity involving a partially owned subsidiary
Parent company’s shareholders
Parent company
Subsidiary
100% ownership
Wholly owned by the parent company’s shareholders
Parent company’s shareholders
Parent company
70% ownership
Subsidiary
Two groups of shareholders 1) The parent company’s shareholders; 2) The non-controlling shareholders of
the subsidiary
Non-controlling shareholders of a subsidiary
30% ownership in
subsidiary
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MA – Consolidation Theories
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• Theories relating to consolidation are critical when the percentage of
ownership in a subsidiary is less than 100%
• Termed “partially owned subsidiary”, where the remaining
percentage is owned by shareholders who are collectively referred to
as “non-controlling interest” (NCI)
Subsidiary
Parent Non-controlling interests (NCI)
90% 10%
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MA – Consolidation Theories
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Both parent and non-controlling interest have a proportionate share of the
subsidiary’s:
1. Net profit;
2. Dividend distribution;
3. Share capital
4. Retained profits and changes in equity
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1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
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[Consolidation Process]
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Parent’s Financial
Statements +
Subsidiaries' Financial
Statements +/- Consolidation adjustments
and eliminations =
Consolidated financial
statements
Legal entities Economic entity
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[Consolidation Process]
• Consolidation is the process of preparing and presenting the financial
statements of a group as an economic entity.
• No ledgers for group entity
• Consolidation worksheets are prepared to:
1. Combine parent and subsidiaries financial statements
2. Adjust or eliminate intra-group transactions and balances
3. Allocate profit to non-controlling interests
Consolidation entails an “asset substitution” - replace parent’s
investment in subsidiary with identifiable assets and liabilities of the
subsidiary with a residual asset called Goodwill.
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[Consolidation Process - Overview]
1. Inter-corporate Shareholdings
• Parent : Ordinary shares held by those outside the consolidated
entity are viewed as the ordinary shares outstanding of the entire
entity.
• Wholly-owned subsidiary : Ordinary shares held entirely within
the consolidated entity are NOT shares outstanding from a
consolidated viewpoint.
Note: A company cannot report in its financial statements an
investment in itself
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[Consolidation Process - Overview]
1. Inter-corporate Shareholdings
• Parent’s common stock remains as the common stock in the
consolidated balance sheet of the reporting entity.
• Parent’s retained earnings (less the unrealized intercompany
profit) remains as the only retained earnings figure in the
consolidated balance sheet.
MA – Consolidation Theories
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Parent
Subsidiary
Parent’s common
stock
Consolidated Entity
Eliminate Subsidiary’s
Common stock
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[Consolidation Process - Overview]
2. Intercompany Receivables and Payables • A single company cannot owe itself money, that is, a company
cannot report (in its financial statements) a receivable to itself and a payable to itself.
• Therefore, an inter-company receivable/payable is eliminated from both receivables and payables in preparing the consolidated balance sheet.
MA – Consolidation Theories
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Parent
Subsidiary
Consolidated Entity
Eliminate Inter-
company
receivable/
payable
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[Consolidation Process - Overview]
3. Inter-company Sales
• The inter-company sale should be removed from the combined
revenues because it does not represent a sale to an external
party.
• Remaining inventory must be restated to its original cost to the
consolidated entity (transferring affiliate).
MA – Consolidation Theories
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Parent
Subsidiary
Consolidated Entity
Cost of
sales
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[Consolidation Process - Overview]
4. Intra-group transactions are eliminated to:
• Show the financial position, performance and cash-flow of the
economic entity (not legal).
• Avoid double counting of transactions.
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[Consolidation Process - Overview]
Example:
• Parent sold inventory to subsidiary for $2M (down-stream sale)
• The original cost of inventory is $1M
• Subsidiary eventually sold the inventory to external parties for $3M
What is the journal entry to eliminate intra-group sales transaction?
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Consolidation adjustment
Dr Sale – Parent’s book 2,000,000
Cr Cost of sales – Sub’s book 2,000,000
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[Consolidation Process - Overview]
Extract of consolidation worksheet
Note: Without elimination the consolidated sales and cost of sales figures
will be overstated by $2 M.
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Parent's
Income
Statement
Subsidiary’s
Income
Statement
Consolidation
elimination entries
and adjustments Consol.
Income
Statement
Without
elimination Dr Cr
Sales $2,000,000 $3,000,000 2,000,000 $3,000,000 $5,000,000
Cost of
sales (1,000,000) (2,000,000) 2,000,000 (1,000,000) ($3,000,000)
Gross
profit $1,000,000 $1,000,000 $2,000,000 $2,000,000
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[Consolidation Process - Overview]
5. Difference between Fair Value and Book Value • Fair value of the consideration given usually reflects the fair value
of the acquiree and differs from its book value.
• An acquiree’s assets and liabilities must be valued based on their acquisition-date fair values, and any excess of the consideration given over the fair values of the net assets is considered goodwill.
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[Consolidation Process - Overview]
6. Non-Controlling interest • Shareholders of the parent are named as controlling interest.
• Shareholders of the subsidiary other than the parent are referred
as “non-controlling” shareholders. Their interests are non-controlling interests on the income and net assets of the subsidiary.
• Computation of income to the non-controlling interest: In uncomplicated situations, it is a simple proportionate share
of the subsidiary’s net income
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[Consolidation Worksheet Example] Statement of Comprehensive Income for the year ended 31 December 20x2
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Consolidation adjustment
/elimination
Consol.
Total
Prince Ltd Silver Ltd Dr Cr
Sales 5,000,000 1,900,000 6,900,000
Cost of sales -4,250,000 -1,520,000 -5,770,000
Gross profit 750,000 380,000 1,130,000
Other expenses -185,000 -155,000 7,400 -351,400
4,000
Operating profit 565,000 225,000 778,600
Dividend income 28,000 0 28,000 0
Profit before tax 593,000 225,000 778,600
Tax, at 20% -113,000 -45,000 800 -157,200
Profit after tax 480,000 180,000 621,400
Income to Non-controlling interests 33,880 -33,880
Profit after Non-controlling interests 587,520
Dividends declared -100,000 -35,000 35,000 -100,000
Profit retained 380,000 145,000 487,520
Retained earnings, 1 January 1,620,000 155,000 5,000 1,280 1,723,040
11,840
6,400
30,000
Retained earnings, 31 December 2,000,000 300,000 126,520 37,080 2,210,560
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[Consolidation Worksheet Example] Statement of Financial Position as at 31 Dec 20x2
Prince Ltd Silver Ltd
Consol.
Total
Consolidation adjustment /elimination
Dr Cr
Fixed assets, net book value 2,200,000 326,000 20,000 12,000 2,534,000
Goodwill 74,000 22,200 51,800
Investment in Silver Ltd, at
cost 230,000 230,000 0
Other investments 120,000 120,000
Inventories 797,000 106,000 903,000
Trade and other receivables 453,000 50,000 503,000
Due from Silver Ltd 60,000 60,000 0
Cash 185,000 20,000 205,000
3,925,000 622,000 94,000 324,200 4,316,800
Share capital 1,150,000 190,000 190,000 1,150,000
Retained earnings 2,000,000 300,000 126,520 37,080 2,210,560
Non-controlling interests 1,600 55,000 107,640
7,000 30,000
2,960 33,880
320
Due to Prince Ltd 60,000 60,000
Deferred tax liability 2,400 4,000 1,600
Trade and other payables 775,000 72,000 847,000
3,925,000 622,000 390,480 160,280 4,316,800
484,480 484,480
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[Consolidation Worksheet Example]
Consolidation adjustments for 20x2
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(1) Elimination entry of balances at 1.1.20x1 required again in 20x2
Dr Share capital 190,000
Dr Retained earnings 5,000
Dr Fixed assets (net) 20,000
Dr Goodwill 74,000
Cr Deferred tax liability 4,000
Cr Investment in Silver Ltd 230,000
Cr Non-controlling interests 55,000
289,000 289,000
(2) Past and present impairment entries for Goodwill
Dr Opening retained earnings (80%*14,800) 11,840
Dr Non-controlling interests (20%*14,800) 2,960
Dr Impairment of goodwill (Current 20x2) 7,400
Cr Goodwill 22,200
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[Consolidation Process]
What the parent pays for through investment in a subsidiary?
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Share of book value of
subsidiary’s net assets on
acquisition date
+/- Share of excess fair value over book
value of identifiable assets and liabilities
(incl. zero book value intangibles and unrecognized
contingent liabilities)
+ Goodwill (an asset relates to
the subsidiary as a whole and is
non-identifiable)
Consideration transferred by
parent = Record as Investment in
Subsidiary
=
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[Consolidation Process]
Asset substitution process in consolidation
1. Eliminate investment account in parent’s book and replace by the
book value of identifiable assets and liabilities of the subsidiary at
acquisition date.
2. Eliminate subsidiary’s share capital, pre-acquisition retained
earnings and other equity items because it is inappropriate to
include them in consolidated equity as they arose prior to the exercise
of control by the parent.
3. The differential represents a) Goodwill and b) excess or deficit of
fair value over book value of identifiable net assets of the
acquired subsidiary at acquisition date.
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1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
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[The Acquisition Method]
• HKFRS 3 (revised) requires all business combinations to be
accounted for using the acquisition method.
• The procedures: 4-step approach
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1. Identify the acquirer
2. Determine the acquisition date
3. Recognize and measure the identifiable assets acquired the liabilities assumed and any non-controlling
interest in the acquiree; and
4. Recognize and measure goodwill or a gain from a bargain purchase
Group
financial
statements
if acquire
subsidiaries
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[The Acquisition Method]
HKFRS 3 (revised) requires the identification of the acquirer in all
circumstances
• Acquirer is the entity that obtains control (HKFRS 10 ) of another
combining entities
• In other words, a business combination is not considered to be a
merger
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1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
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[Determine the Amount of Consideration Transferred]
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Fair value of assets
transferred
+ Fair value of liabilities
incurred
+ Fair value of equity
interests issued by acquirer
Consideration transferred = + Fair value of
contingent consideration
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[Determine the Amount of Consideration Transferred]
HKFRS3 (revised) Principle: Consideration transferred in a business
combination should be measured at Fair value:
• Determined on the acquisition date
• Acquisition date is the date when the acquirer obtains control and
NOT the date when consideration is transferred
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[Determine the Amount of Consideration Transferred]
Fair value of equity interests issued is measured by:
• Market price
• If market price is not available or not reliable:
A proportion of acquirer’s fair value or proxied by the fair value
of equity interest acquired (i.e. acquiree), whichever is more
reliably measurable
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[Determine the Amount of Consideration Transferred]
Illustration 1:
Fair Value of Equity Issued
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[Illustration 1: Fair Value of Equity Issued]
P Ltd acquires 100% of S Co through an issue of 5,000,000 shares to the
sellers of S Co.
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P Ltd S Co
Number of existing shares 10,000,000 2,000,000
Number of new shares issued 5,000,000 -
Market price per share $2.00 -
Fair value of equity $24,000,000 $9,000,000
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[Illustration 1: Fair Value of Equity Issued]
Q1: P Ltd’s market price is a reliable indicator
Consideration transferred = 5,000,000 shares x $ 2.00
= $10,000,000
Q2: P Ltd’s market price is not a reliable indicator; a proportional
interest in the fair value of P Ltd is a better estimate
Consideration transferred = (5,000,000/15,000,000) x $24,000,000
= $8,000,000
Q3: Fair value of S Co (acquiree) is a better estimate
Consideration transferred = $9,000,000
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[Determine the Amount of Consideration Transferred]
Contingent consideration
• Obligation (right) of the acquirer to transfer (receive) additional assets
or equity interests to (from) acquiree’s former owner if specific event
occurs
E.g. Acquirer gets a refund of a part of the consideration
transferred if the acquiree does not achieve the target profit
Fair value of the contingent consideration (refund), measured
at the acquisition date, is added to (deducted from)
consideration transferred
MA – Consolidation Theories
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32
[Determine the Amount of Consideration Transferred]
Changes in the FV of contingent consideration that the acquirer
recognizes after the acquisition date:
• result of additional information about facts and circumstances that
existed at the acquisition date, i.e. such changes are measurement
period adjustments, adjustments to be made retrospectively to
goodwill.
• Result of post-combination change after acquisition date, such as
meeting an earnings target, reaching a specified share price or
reaching a milestone on a R&D project, are not measurement period
adjustments. They are dealt with as follows:
MA – Consolidation Theories
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[Determine the Amount of Consideration Transferred]
a) Contingent consideration classified as equity shall not be re-
measured and its subsequent settlement shall be accounted for within equity.
b) Contingent consideration classified as an asset or a liability that:
1. is a financial instrument (e.g. loan notes) shall be measured at FV and account for the change under HKFRS 9
2. is in the form of cash, account for the change under HKAS 37 (Provisions, Contingent liabilities and Contingent Assets)
MA – Consolidation Theories
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33
[Determine the Amount of Consideration Transferred]
Measurement Period
• HKFRS 3 (revised) allows adjustments to be made retrospectively 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
MA – Consolidation Theories
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[Determine the Amount of Consideration Transferred]
Measurement Period
• Any change in estimate arising from new information on facts and
circumstances after the acquisition date will be recognized in the current period of change and NOT retrospectively.
• Further adjustments retrospectively after the initial accounting (after 1 year) should be recognized only to correct an error as a prior - period adjustment (HKAS 8)
MA – Consolidation Theories
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34
[Determine the Amount of Consideration Transferred]
Acquisition-Related Costs
• All acquisition-related direct and indirect costs are expensed off
• Costs of issuing debt are recognized in accordance with HKFRS 9
As yield adjustment to the cost of borrowing and are amortized
over the life of the loan
Journal entry for the payment of debt issuance cost
MA – Consolidation Theories
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Dr Unamortized debt issuance costs
Cr Cash
67
[Determine the Amount of Consideration Transferred]
Acquisition-Related Costs
• Costs of issuing equity are recognized in accordance with HKFRS 9 Deducted from equity
Journal entry to record the payment of cost of issuing equity
MA – Consolidation Theories
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Dr Equity
Cr Cash
68
35
1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
MA – Consolidation Theories
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[Intangible Assets]
HKFRS3 (Revised) requires the acquirer to recognize the fair value of an
acquiree’s unrecognized identifiable asset (e.g. intangible asset) in the
combined financial statements.
• Justified by the acquisition of the subsidiary by the parent
To qualify for recognition, the intangible asset must be identifiable:
Either Separable OR must arise from Contractual or Legal rights
• E.g. assembled workforce with specialized knowledge
Fails to meet the separability criterion
• E.g. opportunity gains from an operating lease with terms favorable in
relation to current market conditions
Meets the contractual-legal criterion
MA – Consolidation Theories
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36
[Contingent Liabilities & Provisions]
Contingent liabilities are recognized if they are:
• Present obligations arising from past events and
• Reliably measurable in their fair value, even if outcome is not probable
(departure from normal rules in HKAS 37)
• Contingencies must meet the definition of a liability
HKAS 37 is different from HKFRS 3 (Revised), if future outflow is less than
probable, contingent liabilities are not normally recognized in the separate
financial statement of the acquiree, but only disclosed.
MA – Consolidation Theories
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[Indemnification Assets]
Contractual indemnity Provided by the sellers of the acquiree to the acquirer to make good any loss arising from contingency or an asset or a liability
• Treatment for indemnity
The acquirer has to recognize an “indemnification asset” at the same time the indemnified liability is recognized.
The indemnification asset is measured on the same basis as the indemnified asset or liability at the acquisition fair-value.
• E.g. An acquiree is exposed to a contingent liability. Based on probabilistic estimation, the FV of the contingent liability is $100,000. The seller provides a contractual guarantee to indemnify the acquirer of the loss.
In the consolidated statement of financial position, contingent liabilities and an indemnification asset of $100,000 will be recognized at fair value
MA – Consolidation Theories
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37
[Deferred Tax]
The recognition of fair value differential may give rise to future tax payable or
future tax deduction
• tax effects need to be accounted for if the basis of taxation does not change in
a business combination
• i.e. If original asset is deductible based on book value, the FV differential will
give rise to a temporary taxable/deductible difference
The deferred tax benefits can be adjusted against goodwill but limited to the
measurement period. Post acquisition recognition of deferred tax impacts
statement of comprehensive income , NOT goodwill
MA – Consolidation Theories
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FV > Book value of identifiable assets Deferred tax liabilities
FV < Book value of identifiable assets Deferred tax assets
FV < Book value of identifiable liabilities Deferred tax liabilities
FV > Book value of identifiable liabilities Deferred tax assets
73
[Goodwill]
A premium that a parent pays to acquire the subsidiary • Must be recognized separately as an asset • Determined as a residual
HKFRS 3 allows 2 ways of determining goodwill depending on the measurement basis for NCI at the acquisition date
MA – Consolidation Theories
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38
[Goodwill]
MA – Consolidation Theories
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Goodwill Fair value of consideration transferred
+
Amount of non-controlling interests
+ Fair value of the acquirer’s previously held interest (before control was achieved) in
the acquiree
Acquiree’s recognized net identifiable assets
measured in accordance with
HKFRS3
Amount of non-controlling interests
(NCI)
Measured at fair value at acquisition date (include goodwill)
Measured as a proportion of FV of identifiable net assets at acquisition date
= Less
75
[Bargain Purchase]
• Results when at the acquisition date, the
1. fair value of the consideration given by the acquirer +
2. fair value of any non-controlling interest in the acquiree +
3. fair value of acquirer’s previously held interest in the acquiree is
less than the fair value of the acquiree’s net identifiable assets
(NIA),
• if acquisition-date valuations are appropriate, the acquirer
recognizes a gain immediately at the date of acquisition
The amount of the gain must be disclosed, along with where the
gain is reported and the factors that led to it
MA – Consolidation Theories
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39
[Bargain Purchase – Example]
1. AC acquires 80% of the equity interest of TC for cash of $150.
2. The net identifiable assets and liabilities acquired at acquisition date
is $200 (Assets 250- Liabilities 50).
3. The FV of the non-controlling interest in TC is $42.
MA – Consolidation Theories
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[Bargain Purchase – Example]
Gain from bargain purchase:
MA – Consolidation Theories
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Amount of identifiable net assets acquired 200
Less: FV of consideration transferred 150
FV of NCI 42 192
Gain on bargain purchase in AC’s book 8
Dr Asset acquired 250
Cr Cash 150
Cr Liabilities assumed 50
Cr Gain on the bargain purchase (SOCI) 8
Cr NCI (FV) 42
78
40
[Non-Controlling Interests’ Share of Goodwill]
NCI to be measured in either of two ways:
MA – Consolidation Theories
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Non-controlling interests
Measured at Fair value at acquisition date (include goodwill)
(Fair value option)
Measured as a proportion of FV of
identifiable net assets at acquisition date
79
[Non-Controlling Interests’ Share of Goodwill]
MA – Consolidation Theories
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NCI measured at FV
(Fair Value Option)
NCI measured as a proportion of the
acquiree’s identifiable net assets
Book value of net assets
Fair value – Book value (Fair Value Adjustment) of net assets
Goodwill
80
41
[Non-Controlling Interests’ Share of Goodwill]
Under the fair value option:
• 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 due to control premium paid by
parent.
• NCI comprises of 3 items.
MA – Consolidation Theories
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[Non-Controlling Interests’ Share of Goodwill]
Under the fair value option:
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Non-controlling interests
Share of book value of net assets
Share of unamortized FV adjustment
(FV – BV)
Share of unimpaired goodwill
82
42
[Non-Controlling Interests’ Share of Goodwill]
Under the fair value option:
• Journal entry to record NCI at fair value (re-enacted each year):
MA – Consolidation Theories
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Dr Share capital of subsidiary
Dr Retained earnings at acquisition date
Dr Other equity at acquisition date
Dr FV differentials (FV – BV)
Dr Goodwill on consolidation (Parent & NCI)
Dr/Cr Deferred tax asset/ (liability) on fair value adjustment
Cr Investment in subsidiary
Cr Non-controlling interests (At fair value)
83
[Non-Controlling Interests’ Share of Goodwill]
Under the 2nd option:
• NCI is a proportion of the acquiree’s identifiable net assets at fair value
• NCI comprises of 2 items:
Note: No share of goodwill by NCI
MA – Consolidation Theories
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Non-controlling interests
Share of book value of net assets
Share of unamortized FV adjustment
(FV – BV)
84
43
[Non-Controlling Interests’ Share of Goodwill]
Under the 2nd option:
• Journal entry to record NCI (re-enacted each year):
MA – Consolidation Theories
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Dr Share capital of subsidiary
Dr Retained earnings at acquisition date
Dr Other equity at acquisition date
Dr FV differentials
Dr Goodwill (Parent only)
Dr/Cr Deferred tax asset/ (liability) on FV adjustment
Cr Investment in subsidiary
Cr Non-controlling interests (NCI% x FV of identifiable net assets)
85
[Non-Controlling Interests’ Share of Goodwill]
1. A acquires 70% of the equity interest of GC for cash of $700.
2. The net identifiable assets and liabilities acquired at acquisition date
is $740 (Assets 800- Liabilities 60).
3. The FV of the non-controlling interest in GC is $250.
What goodwill arises on acquisition and NCI interests at date of
acquisition assuming NCI is measured (a) as a proportion of the net
assets of GC (b) at FV?
MA – Consolidation Theories
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44
[Non-Controlling Interests’ Share of Goodwill]
MA – Consolidation Theories
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Net assets method
FV method
Consideration 700 700
NCI (30% x $740) 222 250 (FV)
922 950
Net assets acquired (740) (740)
Goodwill 182 210
Parent’s share of goodwill 182 182
NCI’s share of goodwill Nil 28 (FV – 30% x $740)
NCI balance at acquisition 222 250 (222 + G/W 28)
87
1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
MA – Consolidation Theories
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45
[Accounting for Non-Controlling Interests]
In consolidation, non-controlling interests have a share of:
Profit after tax
Dividends declared
Share capital
Retained earnings and other comprehensive income (e.g. Revaluation
reserve) at acquisition date
Change in retained earnings and other comprehensive income from the date
of acquisition to the current period
Fair value differential of a subsidiary’s net assets at acquisition date
Goodwill (if the fair value alternative is adopted)
Note: There is no distinction between pre-acquisition and post-acquisition
retained earnings for NCI. NCI is entitled to the share of retained earnings of
subsidiary from incorporation.
MA – Consolidation Theories
www.etctraining.com.hk 89
1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
MA – Consolidation Theories
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46
[Subsequent to Acquisition]
At acquisition date, we recognize:
• Fair value of identifiable net assets,
• Intangibles, contingent liabilities, and
• Deferred tax assets or liabilities on the above
MA – Consolidation Theories
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[Subsequent to Acquisition]
In subsequent years:
• Amortization, depreciation and cost of sales of the acquired assets
must be based on the fair value as at acquisition date.
• Since net assets are carried at book value in the separate financial
statements, the subsequent amortization/depreciation/disposal are
adjusted in the consolidation worksheet.
• E.g. When an identified asset is sold or depreciated:
MA – Consolidation Theories
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(FV- BV) adjustment to expense =
FV of expense in consolidated
financial statements
BV of expense in separate financial
statements +
Adjusted in consolidation worksheet
92
47
[Subsequent to Acquisition]
Illustration 1:
Subsequent to Acquisition
MA – Consolidation Theories
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[Illustration 1: Subsequent to Acquisition]
• P Co paid $6,200,000 and issued 1,000,000 of its own shares to
acquire 80% of S Co on 1 Jan 20X2.
• Fair value of P Co’s share is $3 per share.
• Fair value of net identifiable assets is as follows:
MA – Consolidation Theories
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48
[Illustration 1: Subsequent to Acquisition]
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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
95
[Illustration 1: Subsequent to Acquisition]
Additional information:
• Contingent liability of $100,000 (law suit) was recognized as a
provision by the acquiree in Dec 20X2
• FV of NCI at acquisition date was $2,300,000
• Net profit after tax of S Co for 31 Dec 20X2 was $1,000,000
• No dividends were declared during 20X2
• Shareholders’ equity as at 31 Dec 20X2 was $5,700,000
• Tax rate 20%
MA – Consolidation Theories
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49
[Illustration 1: Subsequent to Acquisition]
Q1 : Prepare the consolidation adjustments for P Co for 20X2
Q2 : Perform analytical check on balance of NCI as at 31 Dec 20X2
MA – Consolidation Theories
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[Illustration 1: Subsequent to Acquisition]
At Acquisition Date 1 Jan 20x2
MA – Consolidation Theories
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1. Consideration
transferred
= Cash consideration + Fair value of share
issued
= $6,200,000 + (1,000,000 x $3)
= $9,200,000
2. Deferred tax liability = 20% x ($7,600,000 - $4,700,000)
= $580,000
3. Goodwill = Consideration transferred + NCI – Fair value
of net identifiable assets, after-tax
= 9,200,000 + $2,300,000 – ($7,600,000 -
$580,000)
= $4,480,000
98
50
[Illustration 1: Subsequent to Acquisition]
At Acquisition Date 1 Jan 20x2
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4. P’s share of goodwill = Consideration transferred – 80% x Fair value
of net identifiable assets, after tax
= $9,200,000 – 80% x ($7,600,000-$580,000)
= $9,200,000 – $5,616,000
= $3,584,000
5. NCI’s share of goodwill = Consideration transferred (FV) – 20% x Fair
value of net identifiable assets, after tax
= $2,300,000 – 20% x ($7,650,000-$580,000)
= $2,300,000 – $1,404,000
= $896,000
$4,480,000
99
[Illustration 1: Subsequent to Acquisition – Q1]
Consolidation adjustments for 20X2
MA – Consolidation Theories
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CJE 1: Elimination of investment in S on 1 Jan 20x2
Dr Share capital 1,000,000
Dr Retained earnings 3,700,000
Dr FV differential- Leased property 1,000,000
Dr FV differential - In-process R&D 2,000,000
Dr Goodwill on consolidation 4,480,000
Cr Contingent liability (provision for lawsuit) 100,000
Cr Deferred tax liability 580,000
Cr Investment in S 9,200,000
Cr Non-controlling interests (Fair Value) 2,300,000
12,180,000 12,180,000
100
51
[Illustration 1: Subsequent to Acquisition – Q2]
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CJE 2: Depreciation and amortization of excess of FV over book value
Dr Depreciation of leased property ($1,000,000/20) 50,000
Dr Amortization of in-process R&D ($2,000,000/10) 200,000
Cr Accumulated depreciation – leased property 50,000
Cr Accumulated amortization – in-process R& D 200,000
+ Dep exp: $50,000 + Amort. Exp:
$200,000 Dep. of leased
property
$200,000 ($4m/20yrs)
$200,000 Amort. of R&D $0
Based on book value
Based on FV Based on book value
Based on FV
Under dep. by $50k
Under amort. by $200k
101
[Illustration 1: Subsequent to Acquisition – Q2]
Note: Contingent liability was already recognized in CJE 1. The
recognition by the acquiree results in double counting; hence this
reversal entry is necessary
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CJE 3: Reversal of entry relating to provision for lawsuit
Dr Provision for lawsuit 100,000
Cr Loss from lawsuit 100,000
CJE 4: Tax effects on CJE 2 & CJE 3
Dr Deferred tax liability 30,000
Cr Tax expense (tax deduction on FV adjustments) 30,000
20% * (200k +50k
-100k)
102
52
[Illustration 1: Subsequent to Acquisition – Q2]
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CJE 5: Allocation of current year profit to non-controlling interests (NCI)
Dr Income to NCI (Group SOCI) 176,000
Cr NCI (Group SOFP) 176,000
Net profit after tax 1,000,000
Excess depreciation (50,000)
Excess amortization (200,000)
Reversal of loss from lawsuit 100,000
Tax effects on FV adjustments 30,000
Adjusted net profit 880,000
NCI’s share (20% x $880,000) 176,000
103
[Illustration 1: Subsequent to Acquisition – Q2]
MA – Consolidation Theories
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NCI balance:
NCI at acquisition date (CJE 1) at Fair Value $2,300,000
Income allocated to NCI for 20x2 (CJE 5) 176,000
NCI as at 31 Dec 20x2 $2,476,000
104
53
[Illustration 1: Subsequent to Acquisition – Q2]
Non-controlling interests
Share of book value of net assets
Share of unamortized FV adjustment
(FV – BV)
Share of unimpaired goodwill
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$5,700,000 ($4.7m
+ $1m) x 20%
= $1,140,000
+ ($1,000,000 x 19/20 x
80% after tax x NCI
20%) + ($2,000,000 x
9/10 x 80% x 20%) =
$440,000 (after tax)
+ $896,000 = $2,476,000
105
1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
MA – Consolidation Theories
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54
[Goodwill Impairment Test]
HKAS 36: Goodwill has to be reviewed annually for impairment loss
• Reviewed as part of a cash-generating unit (CGU)
CGU is the lowest level in which it has independent cash flows
and the goodwill is monitored for internal management purposes
and
Not larger than a segment determined under segment reporting
• Goodwill will be allocated to each of the acquirer’s CGU, or group of
CGUs.
MA – Consolidation Theories
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[Goodwill Impairment Test]
Steps for impairment test
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1. Determine the carrying amount of the CGU
2. Determine the recoverable amount of the CGU
If carrying amount ≤ recoverable amount
If carrying amount ≥ recoverable amount
No impairment loss Allocate impairment loss
to goodwill first and balance to other net assets
3. Recoverable amount: Higher of Fair Value and Value in Use
108
55
1. Overview of the consolidation process
2. The acquisition method
3. Determining the amount of consideration transferred
4. Recognition and measurement of identifiable assets, liabilities
and goodwill
5. Accounting for non-controlling interests under HKFRS 3
(revised)
6. Effects of amortization, depreciation and disposal of
undervalued or overvalued assets and liabilities subsequent to
acquisition
7. Goodwill impairment tests
8. Elimination of unrealized profits
MA – Consolidation Theories
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[Elimination of Unrealized profit]
Principles Governing Elimination
• Outstanding balances due to or from companies within a group are
eliminated.
• Transactions in the statement of comprehensive income between
the group companies are eliminated.
• Unrealized profit or loss included in assets are eliminated in full
(parent’s unrealized profit in downstream sale; parent’s & NCI’s
share of subsidiary’s unrealized profit in upstream sale).
MA – Consolidation Theories
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56
[Elimination of Unrealized profit]
Principles Governing Elimination
• Tax effects on unrealized profit or loss included in assets should be
adjusted according to HKAS 12 Income Taxes.
• Balances with associates (“significant influence”) are NOT
eliminated.
Associates are not part of the group
MA – Consolidation Theories
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[Elimination of Unrealized profit]
• Regardless of the parent’s percentage ownership of a subsidiary, the
full amount of any unrealized gains and losses must be
eliminated and must be excluded from consolidated net income.
• When a sale is from a parent to a subsidiary, referred to as a
downstream sale, any gain or loss on the transfer accrues to the
parent company’s stockholders.
• When the sale is from a subsidiary to its parent, an upstream sale,
any gain or loss accrues to the subsidiary’s stockholders.
• The direction of the sale determines which shareholder group absorbs
the elimination of unrealized intercompany gains and losses.
MA – Consolidation Theories
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57
[Elimination of Unrealized profit]
Intra-group Transfers of Inventory and Fixed Assets
1. If the transferred asset is an inventory:
• It should be carried at original cost and not the transferred price
• Adjustments are made to:
Eliminate the profit element
Recognize profit only when the inventory is sold to 3rd
party
2. If the transferred asset is a fixed asset:
• The asset should be carried at original cost less accumulated
depreciation
• Subsequent depreciation is based on original cost and not the
transferred price
MA – Consolidation Theories
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[Elimination of Unrealized profit]
Downstream Sale (Sales to Subsidiary)
In downstream sale, NCI’s share of profit of the subsidiary is NOT
affected because the adjustment affects the parent’s profit not the
subsidiary
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Parent
Subsidiary
90 %
owned
Sales were
made from
parent to
subsidiary
Unrealized profit
resides in
Parent’s book
114
58
[Elimination of Unrealized profit]
Upstream Sale (Sales to Parent)
In upstream sale, the unrealized profit resides in the subsidiary. Thus,
NCI’s share of the unrealized profit or loss needs to be adjusted
from the carrying amount of the asset.
MA – Consolidation Theories
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Parent
Subsidiary
90 %
owned
Sales were
made from
subsidiary to
parent Unrealized profit
resides in
Subsidiary’s book
115
[Elimination of Unrealized profit]
Adjustments to Eliminate Unrealized Profit – Upstream Sale
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In the current period:
Dr Sales
Cr Cost of sales (realized)
Cr Inventory (P)
In the following period (if unsold):
Dr Opening RE
Dr NCI (SOFP)
Cr Inventory (P)
In the following period (if sold):
Dr Opening RE
Dr NCI (SOFP)
Cr Cost of sales
Inter-company sales is reversed
(1) Eliminate realized cost of sales
(2) Reverse unrealized profit in inventory
Unsold % x Unrealized profit
Remove unrealized profit in inventory
Adjust cost of sales from transfer price
to original cost 116
59
[Elimination of Unrealized profit]
Illustration 1:
Upstream and Downstream Sales
MA – Consolidation Theories
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[Illustration 1: Upstream and Downstream Sales]
• P invested in 70% of shares of S • Intercompany transfers of inventory are as follows:
• Tax rate: 20% • Net profit after tax of S: $800,000 (31 Dec 20X3), $900,000 (31 Dec 20X4)
MA – Consolidation Theories
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20X3 20X4
Sale of inventory from P to S (downstream sales)
Original cost of inventory
Gross profit
Percentage unsold to 3rd party at year end
$60,000
$(50,000)
$10,000
10%
4%
Sale of inventory from S to P (upstream sales)
Original cost of inventory
Gross profit
Percentage unsold to 3rd party at year end
$200,000
$(170,000)
$30,000
30%
0%
118
60
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X3
1) Eliminate intercompany sales and adjust unrealized profit in
inventory
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Unrealized profit x
percentage unsold
Dr Sales (P’s SOCI) 60,000
Cr Cost of sales (P & S’s SOCI) 59,000
Cr Inventory (S’s SOFP)(10,000 x 10%) 1,000
(Elimination of intercompany sales and adjustment of unrealized profit of P from downstream sale)
Dr Sales (S’s SOCI) 200,000
Cr Cost of sales (P & S’s SOCI) 191,000
Cr Inventory (P’s SOFP)(30,000 x 30%) 9,000
(Elimination of intercompany sales and adjustment of unrealized profit of S from upstream sale)
119
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X3
2) Adjust the tax effects on unrealized profit
MA – Consolidation Theories
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Unrealized profit of
P from unsold
inventory $1,000 x
20%
Unrealized profit of
S from unsold
inventory $9,000 x
20%
Dr Deferred tax asset (Group SOFP) 200
Cr Tax expense (P’s SOCI) 200
(Elimination of intercompany sales and adjustment of unrealized profit of P from downstream sale)
Dr Deferred tax asset (Group SOFP) 1,800
Cr Tax expense (S’s SOCI) 1,800
(Adjustment for tax effects on unrealized profit in inventory of
S from upstream sale)
120
61
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X3
3) Allocate share of S’s current year profit to NCI
* Note: No adjustment is required for the unrealized profit from
downstream sale as profit resides in parent income
MA – Consolidation Theories
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Dr Income to NCI (Group SOCI) 237,840
Cr NCI (Group SOFP) 237,840
Net profit after tax of S * 800,000
Less: Unrealized profit of S from upstream sale (9,000)
Add: Tax on unrealized profit of S 1,800
Adjusted profit after tax of S 792,800
NCI’s share (30%) of S’s Net profit after tax $792,800 237,840
121
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X4
1) Adjust opening RE and unrealized profit in inventory
MA – Consolidation Theories
www.etctraining.com.hk
Need to adjust
NCI’s share of
unrealized profit of
S from upstream
sale
Dr Opening RE (P’s SOFP) 1,000
Cr Cost of sales 600
Cr Inventory (S’s SOFP) (10,000 x 4%) 400
(Adjustment of unrealized profit in RE of P from downstream sale in 31 Dec 20X3)
Dr Opening RE (S’s SOFP) 6,300
Dr NCI (Group SOFP) (9,000 x 30%) 2,700
Cr Cost of sales (P’s SOCI) 9,000
(Adjustment of unrealized profit in RE of S from upstream sale in 31 Dec 20X3)
122
62
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X4
2) Adjust the tax effect
MA – Consolidation Theories
www.etctraining.com.hk
Dr Tax expense ($9,000 x 20%) (Group’s SOCI) 1,800
Cr Opening RE ($1,800 x 70%) (S’s SOFP) 1,260
Cr NCI ($1,800 x 30%) (Group’s SOFP) 540
(Adjustment for tax effects on unrealized profit of S from upstream sale in RE)
Dr Tax expense ($600 x 20%) (Group’s SOCI) 120
Dr Deferred tax asset ($400 x 20%) on unsold inventory of S (Group’s SOFP)
80
Cr Opening RE ($1,000 x 20%) (P’s SOFP) 200
(Adjustment for tax effects on unrealized profit of P from downstream sale in RE and inventory)
123
[Illustration 1: Upstream and Downstream Sales]
31 Dec 20X4
3) Allocate share of S’s current year profit to NCI
MA – Consolidation Theories
www.etctraining.com.hk
Dr Income to NCI (Group SOCI) 272,160
Cr NCI (Group SOFP) 272,160
Net profit after tax of S * 900,000
Add: Realized profit of S from upstream sale 9,000
Less: Tax on realized profit of S (1,800)
Adjusted S’s net profit after tax 907,200
NCI share (30%) of S’s Net profit after tax $907,200 272,160
*Note: Adjustments to current year profit: 1. Realized profit
& tax from prior years is added back
2. Unrealized profit & tax from unsold inventory of S in current year is deducted (none in this year)
124
63
[Illustration 1: Upstream and Downstream Sales]
Lower of cost or market
1. Assume that P parent company purchases inventory for $20,000 and
sells it to S its subsidiary for $35,000.
2. S still holds the inventory at year-end and determines that its market
value (replacement cost) is $25,000 at that time.
3. S writes down the inventory from $35,000 to its lower market value of
$25,000 at the end of the year and records the following:
MA – Consolidation Theories
www.etctraining.com.hk 125
[Illustration 1: Upstream and Downstream Sales]
The following eliminating entry is needed in the consolidation work paper :
MA – Consolidation Theories
www.etctraining.com.hk
Dr Loss on decline in value of inventory (S’s SOCI) 10,000
Cr Inventory (S’s SOFP) 10,000
Write down inventory to market value
Dr Sale (P’s SOCI) 35,000
Cr Cost of sale (P’s SOCI) 20,000
Cr Inventory (S’s SOFP) ($25,000-$20,000) 5,000
Cr Loss on decline in value of inventory (S’s SOCI) 10,000
Eliminate inter-company sales of inventory
126
64
[Illustration 1: Upstream and Downstream Sales]
When fixed assets (FA) are transferred at a marked-up price
• The unrealized profit must be eliminated from the carrying amount of
FA
• It is as though the transfer did not take place from the group’s
perspective
MA – Consolidation Theories
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Original cost
Profit on sale
Mark up
Transfer price
Acc. Dep. Acc. Dep.
NBV NBV
Before Transfer After Transfer
127
[Elimination of Unrealized profit]
Illustration 2:
Upstream Transfer of Fixed Assets
(Sale to Parent)
MA – Consolidation Theories
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65
[Illustration 2: Upstream Transfer of Fixed Assets ]
S transfers to P
• 1 Jan 20X2 S sold equipment to P (owned 90% of S) for $360,000
• The original cost of equipment was $400,000 (10 years useful life)
• The remaining useful life is 8 years from date of transfer
• Net profit after tax of S for YE 31 Dec 20X2 : $500,000,
• Assume a tax rate of 20%
MA – Consolidation Theories
www.etctraining.com.hk
Original cost
= $400,000
Profit on sale
40,000
Transfer price
= $360,000
Acc. Dep. = $80,000
NBV = $320,000
Before Transfer After Transfer
129
[Illustration 2: Upstream Transfer of Fixed Assets ]
31 Dec 20X2
MA – Consolidation Theories
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CJE 2: Reverse of tax on S’s profit on sale
Dr Deferred tax asset (Group SOFP) 8,000
Cr Tax expense (S) $40,000 x 20% 8,000
CJE 1: Restate to original cost and accumulated depreciation and reverse S’s profit on sale
Dr Equipment (P) (400,000-360,000) 40,000
Dr Profit on Sale (S) 40,000
Cr Accumulated depreciation (P) 80,000
130
66
[Illustration 2: Upstream Transfer of Fixed Assets ]
MA – Consolidation Theories
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CJE 3: Correct P’s over-depreciation on unrealized profit included in equipment
Dr Accumulated depreciation (P) 5,000
Cr Depreciation Expense (P) 5,000
Old depreciation ($400,000/10) 40,000
New depreciation ($360,000/8) 45,000
Over-depreciation by applying New depreciation 5,000
CJE 4: Increase in P’s tax arising from correction of over-depreciation
Dr Tax expense (P) ($5,000 x 20%) 1,000
Cr Deferred tax asset (Group SOFP) 1,000
131
[Illustration 2: Upstream Transfer of Fixed Assets ]
31 Dec 20X2
* Note: Upstream sale of FA will affect NCI’s share of profit as
unrealized profit resides in S
MA – Consolidation Theories
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CJE 5: Allocation of S’s current year profit for 20x2
Dr Income to NCI (Group SOCI) 47,200
Cr NCI (Group SOFP) 47,200
Net profit after tax of S 500,000
Less: Unrealized profit on sale (after-tax) (32,000)
Add: Over-depreciation (after-tax) 4,000
Adjusted net profit 472,000
NCI’s share (10%) of S’s net profit after tax $472,000 47,200
132
67
[Accounting for subsidiaries - Summary ]
MA – Consolidation Theories
www.etctraining.com.hk 133
Module A Financial Reporting
www.etctraining.com.hk
Accounting for Associates [HKAS 28 (2011)] and
Joint Arrangements (HKFRS 11)
134
68
The equity method is applied to accounting for associates in the
consolidated financial statements
• It does NOT involve line by line summation of an associate’s
financial statements
• Investment account is NOT eliminated, instead it comprises of:
1. Share of book value of net assets
2. Share of unamortized fair value adjustments
3. Implicit goodwill
• Dividend is a repayment of profit and NOT income under the equity
method
Transfer of assets between investor and associate
• In both upstream and downstream sales: Investor’s share of
unrealized profit arising from transfers is eliminated
MA – Accounting for Associates [HKAS 28 (2011)]
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• The power to participate, but NOT to control
• Default assumption [HKAS 28 (2011)]
– Percentage ownership of ≥ 20% or more of investee’s voting rights
deemed as giving rise to “ significant influence”
• Other evidence of “significant influence”:
– Representation on the board of directors;
– Participation in policy-making processes;
– Material transactions between the investor and investee;
– Inter-change of managerial personnel; or
– Provision of essential technical information
MA – Accounting for Associates [HKAS 28 (2011)]
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69
Multi-level structures
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
P
80%
50%
X
Z
Y
50%
50%
Situation 1
P
40%
80%
A
B
C
50%
20%
Situation 2
Situation 1: P has significant influence over: 1. Y (50% direct interest) 2. Z (65% indirect
interest) 3. P has no control over
Y and Z
Situation 2: P has significant influence over: 1. A (40% direct interest) 2. C (50% direct interest) 3. B (42% indirect interest)
137
Accounting Policy for
Investments In Associates
MA – Accounting for Associates [HKAS 28 (2011)]
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Levels of financial reporting Accounting policy
1. Investor’s separate financial statements: legal entity
Cost or as a financial instrument
(HKFRS 9)
2. Investor’s financial statement with associates but no subsidiaries: economic entity
Equity method made in the investor’s
accounting record
3. Consolidated financial statements (with subsidiaries and associates): economic entity
Equity method made in consolidation
worksheet
138
70
1. Elimination of intra-group balances is not required
• Equity method does not entail line by line aggregation
• Perfectly offsetting items and balances are not required
2. Investment in associate is not eliminated
Investment account captures:
• Implicit goodwill
• Share of fair value of net identifiable assets at acquisition
• Share of change in post-acquisition retained earnings and
other equity
• Realization of profit through dividends
MA – Accounting for Associates [HKAS 28 (2011)]
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MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
Investment in Associates
Investment in associate
Share of book value of net assets
Investor’s share *
(Book value of net
assets -/+ unrealized
profit/loss))
Share of unamortized FV adjustments
Investor’s share * (Unamortized balance of excess of FV over book
value of net identifiable assets at acquisition date)
Implicit goodwill
(Acquisition cost – Share of FV of net identifiable assets
at acquisition date) less impairment Loss
140
71
Illustration 1:
Amortization of FV Adjustments of
Identifiable Net Assets
MA – Accounting for Associates [HKAS 28 (2011)]
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[Illustration 1:
Amortization of FV Adjustments of Identifiable Net Assets]
1. I acquired 20% of A’s share on 1 Jan 20X4
2. Excess of fair value over book value of a depreciable asset at
acquisition date was $5,000,000
3. Depreciation was over remaining life of 10 years
4. Retained earnings as at acquisition date: $15,000,000; as at 1 Jan
20X5: $20,000,000
5. Net profit before tax for 20x5: $10,000,000, tax expense: $2,100,000
6. Tax rate was 20%
Prepare the equity accounting entries for the year ended 31 Dec
20X5
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk 142
72
[Illustration 1:
Amortization of FV Adjustments of Identifiable Net Assets]
Note: This entry capitalizes the share of past profits in the investment
account
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
EA 1: Share of change in retained earnings (RE) from acquisition date to beginning of 20x5
Dr Investment in associate 1,000,000
Cr Opening RE 1,000,000
RE as at 1 Jan 20X5 20,000,000
RE as at acquisition date (1 Jan 20x4) (15,000,000)
Change in RE (20x4) 5,000,000
Share of A’s post-acquisition RE (20% x $5,000,000) 1,000,000
143
[Illustration 1:
Amortization of FV Adjustments of Identifiable Net Assets]
Note:
1) Any adjustments relating to associate’s asset or liabilities are made
against the investment account (a proxy for net assets) 2) This entry can be combined with the previous entry (EA 1)
3) Adjustment includes the tax effects (20%)
MA – Accounting for Associates [HKAS 28 (2011)]
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EA 2: Share of past cumulative depreciation on undervalued fixed assets (after-tax)
Dr Opening RE 80,000
Cr Investment in associate 80,000
20%* ($5,000,000 /
10 years)* (1-20%)
144
73
[Illustration 1:
Amortization of FV Adjustments of Identifiable Net Assets]
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
$5,000,000 /
10 yrs
500,000 x
20%
EA 3: Share of 20x5 profit after tax of associate
Dr Investment in associate 1,500,000
Cr Share of profit of Associates 1,500,000
Net profit before tax 10,000,000
Less: excess depreciation (500,000)
Adjusted net profit before tax 9,500,000
Tax expense 2,100,000
Less: tax on excess depreciation (100,000)
Adjusted tax expense 2,000,000
Share of profit of associate [20%x (9,500,000-2,000,000)] 1,500,000
145
Impairment Test
Goodwill is not tested for impairment as a stand-alone asset
Impairment test is performed for the investment in its entirety
• Carrying amount of the investment is compared with recoverable
amount
• Recoverable amount is the higher of:
Value in use, and
Fair value less cost to sell
Impairment losses:
• Will reduce the investment account
• May attribute to book value of net assets, fair value adjustments or
implicit goodwill
MA – Accounting for Associates [HKAS 28 (2011)]
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74
Illustration 2:
Impairment Test
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk 147
[Illustration 2: Impairment test]
1. P owned 20% of A
2. Past impairment of investment in A: $250,000
3. Current impairment: $100,000
4. Current year net profit before tax: $10,000,000
5. Tax expense: $2,100,000
Q: Prepare the equity accounting entries for the current year
MA – Accounting for Associates [HKAS 28 (2011)]
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75
[Illustration 2: Impairment test]
Note:
1) This entry re-enacts past impairment losses
2) The impairment loss relates to the share owned by the investor;
hence there is no need to apply ownership percentage
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
EA 1: Share of past impairment loss
Dr Opening RE 250,000
Cr Investment in Associate 250,000
149
[Illustration 2: Impairment test]
Assume impairment loss relating to goodwill is non-tax deductible Impairment of goodwill has no tax effect (HKAS12)
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
EA 2: Share of current profit after tax of associate
Dr Investment in associate 1,480,000
Cr Share of profit of Associates (1,900,000 - 420,000) 1,480,000
Share of profit before tax of associate 2,000,000
Less: current impairment loss (100,000)
Adjusted net profit before tax 1,900,000
Share of tax of associate 420,000
20% X
$10,000,000
20% X
$2,100,000
150
76
In both upstream & downstream sales:
Investor recognizes profit only to the extent of unrelated investor’s interest
in associate (1-X%); Investor’s share of profit arising from transfers is
eliminated (X%) against investor’s inventories (where associate is seller),
against investor’s investment (where investor is seller)
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
“Upstream sale”
X %
Investor
Associate
Sales
were
made
from
associate
to
investor
X %
Sales
were
made
from
investor
to
associate
“Downstream sale”
Investor
Associate
151
A Co
B Co Subsidiary
Z Co Associate (30%)
Asset transfers between a subsidiary and an associate
If a group company sells to or buys from an associate,
the group can only recognize the proportion of the unrelated interest
share of unrealized profit
MA – Accounting for Associates [HKAS 28 (2011)]
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77
Asset transfers between a subsidiary and an associate
Example 1: If A sells to Z
• Eliminate 30% unrealized profit, i.e. 70% of the unrealized profit
will be recognized
Example 2: If B sells to Z
• 70% of the unrealized profit will be recognized
• B’s NCI will share a proportion of 70% recognized unrealized profit
Example 3: If Z sells to B
• B’s NCI will not be affected
MA – Accounting for Associates [HKAS 28 (2011)]
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Illustration 3:
Downstream sales
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk 154
78
[Illustration 3: Downstream sales]
1. Investor (I) owned 20% of Associate (A)
2. I sells $200,000 of inventory to A
3. The original cost of inventory is $140,000
4. 1/3 remains in A’s warehouse at the end of the year
5. A’s net profit before tax is $1,000,000 and tax expense is $200,000
6. Tax rate is 20%
Prepare the equity accounting entries for I
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk 155
[Illustration 3: Downstream sales]
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
EA 1: Share of current profit after tax of associate
Dr Investment in associate 156,800
Cr Share of profit of associates (196,000-39,200) 156,800
Profit before tax of associate 1,000,000
Less: Unrealized profit (100%) (20,000)
Adjusted net profit before tax 980,000
I’s share of profit (20%) 196,000
Tax of associate 200,000
Less: tax on unrealized profit ($20,000 x 20%) (4,000)
Adjusted tax expense 196,000
I’s share of tax (20%) 39,200
156
79
[Illustration 3: Downstream sales]
MA – Accounting for Associates [HKAS 28 (2011)]
www.etctraining.com.hk
I’s profit (at group level)
Adjusted
I’s profit (at group level)
Unadjusted
Gross profit from downstream sale
60,000 60,000
Share of A’s pre-tax profit 196,000 200,000
Profit effect 256,000 260,000
I is not able to recognize its share of unrealized profit of $4,000 ($60,000*1/3* 20%). However, I is able to recognize unrealized profit of $16,000 ($60,000*1/3*80%) relates to the unrelated investor’s share as if it had sold the inventory to unrelated investors of A.
157
Associate’s Losses Exceed Investor’s Interests
If an investor’s share of losses of an associate equals or exceeds its
interest in the associate, the investor discontinues recognizing its
share of further losses.
The interest in an associate is the carrying amount of the investment
in the associate under the equity method together with any long-term
interests that, in substance, form part of the investor’s net investment
in the associate.
MA – Accounting for Associates [HKAS 28 (2011)]
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80
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
Joint control: contractually agreed sharing of control which exists only
when decisions about the relevant activities require the unanimous
consent of the parties sharing control
• No single party controls the arrangement
• A party with joint control can prevent any of the other parties from
controlling
• A joint arrangement even if not all parties have joint control; some
may participate but not have joint control
• Apply judgment when assessing whether a party has joint control
159
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
Q: A has 50% voting rights in the arrangement, B has
30% and C has 20%. Contractual arrangement specifies
that at least 75% votes are required to make decision
about relevant activities.
Ans.: A & B have joint control as decisions cannot be
made without their agreement. C is a participating party,
does not have joint control.
160
81
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[Types of Joint Arrangements – HKFRS 11]
Example of Joint operation:
• Boeing builds body of the aircraft, Rolls Royce builds engines of the
aircraft. Boeing and Rolls Royce bear its own costs and take a share
of revenue from the aircraft sale.
• Need to consider the joint operators are entitled to share of assets
and liabilities of the joint arrangement but NOT share of net assets
of the joint arrangement (otherwise it is Joint Venture).
161
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[Types of Joint Arrangements – HKFRS 11]
Example of Joint venture (JV):
• A joint venturer starts operation in a foreign country by setting up a JV
with the local government (faster route to market development)
• Entities transfer the relevant assets and liabilities to a JV in order to
combine their activities in a particular line of business.
162
82
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[Types of Joint Arrangements – HKFRS 11]
• Joint arrangement not structured through separate vehicle is joint
operation (combine HKAS31 concepts of jointly controlled
operations and jointly controlled assets)
• Assets and liabilities held in separate vehicle can be either joint
venture or joint operation. Assess
legal form of separate vehicle
Terms of contractual arrangement and
Other facts and circumstances
163
Joint operation Joint operator should recognize: • Its assets including its share of jointly-held
assets • Its liabilities including its share of jointly-
incurred liabilities • Revenue from the sale of its share of output
from the joint operation • Its share of revenue from the sale of output
by the joint operation • Its expenses including its share of expenses
incurred jointly Treatment is applicable in both separate and consolidated accounts of the joint operator
Joint venture A joint venturer should recognize its interest in a joint venture as an investment and account for that investment using the equity method (HKAS 28)
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[Accounting for joint arrangements – HKFRS11]
In separate financial statements, a joint venturer should account for its interest in a joint venture according to HKAS 27 (2011) Separate Financial Statements
164
83
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[HKFRS 11 Transactions ]
Upstream transactions:
• A joint venturer sells or contributes assets to a joint venture,
only the gain relating to the interest of the other joint venturers
should be recognized,
full amount of any loss should be recognized if it shows evidence
of impairment.
165
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[HKFRS 11 Transactions ]
Downstream transactions:
• A joint venturer purchases assets from a joint venture,
not recognize share of profit made by JV until he resells the assets
to an independent third party,
same for loss except if they represent an impairment loss
166
84
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[HKFRS 11 Transactions – upstream sales]
A contributes inventories to a 50:50 JV, cost to A at $0.7m. Inventories are
still held by JV.
What gain or loss should be recognized by A ? [HKAS 28 (2011)]
a) If transfer @ $1m to JV
b) If transfer @ $0.5m to JV, and
167
MA – Joint Arrangements (HKFRS 11)
www.etctraining.com.hk
[HKFRS 11 Transactions - upstream sales]
a) A’s profit ($1-$0.7)m = $0.3m, but only 50% realized (part attributable
to other venturer). A should recognize gain $0.15m
b) A’s loss ($0.5-$0.7)m= $0.2m of which full amount should be
recognized even though inventories not yet sold. They represent an
impairment loss (reduced NRV)
A’s separate FS
Dr Interest in JV – Inventory contribution 1,000,000
Cr Other income – gain on inventory contribution 150,000
Cr Inventory 700,000
Cr
Interest in JV – unrealized gain on inventory
contribution (eliminated against investment
under equity method)
150,000
168
85
Module A Financial Reporting
www.etctraining.com.hk
Complex and Changes in Group Structures
169
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
[Indirect Ownership Interests]
A parent has an indirect
ownership holding in a
subsidiary when equity in that
subsidiary is held through one or
more of the parent’s subsidiaries
Direct holdings
Indirect holdings
80 %
X Co
(Ultimate parent)
70 %
Y Co
(Intermediate parent)
Z Co
(Indirect Subsidiary)
Y Co’s NCI
Z Co’s NCI
20 %
30 %
14 %
56 %
In Z
X Gp.effective interest 56%
Y Co’s NCI 14%
Z’Co’s NCI 30%
Total 100%
80% x 70%
14% Indirect NCI = 20% x 70%
170
86
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
[Indirect Holding of Associates]
1. NO non-controlling interests in
this structure
2. P equity accounts
– 50% of S’s profit and
– 25% of A’s profit
3. Only investment in S appears on P’s
statement of financial position
50 %
P
50 %
S
A
171
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
[Indirect Holding of Associates]
1. S equity accounts 50% the
results of A
2. P consolidates S and S’s share
of A’s profit
3. Income to non-controlling
interests should include non-
controlling interests’ share 5%
(10% x 50%) of A’s profit
90 %
P
(Ultimate parent)
50 %
S
(Investor)
A
(Associate)
P’s NCI
10 %
172
87
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
[Complex Group Structure]
• P has a direct 40% holding in S2 and also controls S1 which has a
40% holding in S2. Therefore S2 is a sub-subsidiary of P.
• Group effective interest is 40% + (60% x 40%) = 64%
• NCI interest is therefore 36%
• Goodwill in S2:
• Group retained earnings include 64% of S2’s post-acquisition profits
• NCI includes 36% of S2’s post-acquisition profits
Cost of P’s investment in S2 X
60% x cost of S1’s investment in S2 X
NCI (based on 36% holding) X
Net assets of S2 (100%) (X)
X
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MA – Complex and Changes in Group Structures
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[Business Combination Achieved in Stages]
Achieving control through incremental purchases
Goodwill arises on the date when control is achieved
Measurement procedures:
• Previously-held interest must be re-measured to fair value at acquisition
date when control is achieved
• Re-measurement gain or loss will be taken to profit or loss
• If the acquirer has previously recognized fair value increases of previously-
held interests in other comprehensive income
HKFRS3 requires the cumulative amount as other comprehensive income
in the equity, to be re-classified to the income statement as if the
previously-held equity interest was disposed
174
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[Business Combination Achieved in Stages]
Goodwill
Fair value of consideration
transferred
+
Amount of non-controlling interests
+
Fair value of the acquirer’s
previously-held interest in the
acquiree
Acquiree’s
recognized net
identifiable asset
measured in
accordance with
HKFRS3 (Revised)
= Less
175
Illustration 1:
Associate become Subsidiary
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89
[Illustration 1: Associate become Subsidiary]
Assume that on January 1, 20X0, S Co has $200,000 of ordinary shares
outstanding and retained earnings of $60,000.
During 20X0, 20X1, and 20X2, S Co reports the following information:
P Ltd purchases its 80% interest in S Co in several blocks, as follows:
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
Period Net Income Dividends Ending BV
20X0 40,000 0 300,000
20X1 50,000 30,000 320,000
20X2 75,000 40,000 350,000
Purchase date Ownership % Purchase Cost BV Premium
1/1/20X0 20 56,000 52,000 4,000
31/12/20X0 10 35,000 30,000 5,000
1/1/20X2 50 185,000
177
[Illustration 1: Associate become Subsidiary]
Assuming P Ltd has significant influence over S Co and equity account S’s profit:
MA – Complex and Changes in Group Structures
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20X0
Purchase shares (1.1) 56,000
Equity-account income 8,000 ($40,000 x 20%)
Purchase share (12.31) 35,000
Investment in Associate, S (30%) 99,000
20x1
Equity-account income 15,000 (50,000 x 30%)
Dividend received (9,000) (30,000 x 30%)
Investment in Associate, S (30%) 105,000
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[Illustration 1: Associate become Subsidiary]
P Ltd gains control of S Co on January 1, 20X2, 1. The fair value of the 30% equity interest it already holds in S Co is
$111,000,
2. The fair value of S Co’s 20% remaining non-controlling interest is $74,000. ($111,000/30%*20%)
3. The book value of S Co as a whole on that date is $320,000.
MA – Complex and Changes in Group Structures
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[Illustration 1: Associate become Subsidiary]
MA – Complex and Changes in Group Structures
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FV of consideration exchanged for 50% interest 185,000
FV of previously held equity interest (30% interest) 111,000
FV of NCI (20%) 74,000
370,000
BV of S Co (1.1.20x2), assume FV the same (320,000)
Goodwill (Differential) 50,000
180
91
[Illustration 1: Associate become Subsidiary]
P Ltd must re-measure the equity interest it already held in S Co to its
fair value at the date of combination and recognize a gain or loss for
the difference between the fair value and its carrying amount:
MA – Complex and Changes in Group Structures
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FV of previously-held equity interest (30%) 111,000
Carrying amount under HKAS28 (2011) 31/12/20x1 (105,000)
Gain on disposal of investment in associate (P’s SOCI) 6,000
181
[Illustration 1: Associate become Subsidiary]
P Ltd investment account balance at 1/1/20x2:
Dr Investment in S $6,000 Cr Gain on re-measurement of investment
in S $6,000
MA – Complex and Changes in Group Structures
www.etctraining.com.hk
Carrying amount 12/31/20x1 105,000
Gain on disposal of investment 6,000
50% shares acquired at 1/1/20x2 185,000
Investment in S Co (1/1/20x2) 296,000
182
92
[Illustration 1: Associate become Subsidiary]
Consolidation eliminating entries 31/12/20x2:
MA – Complex and Changes in Group Structures
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1. Dr Income to NCI (20%) ($75,000 x 20%) 15,000
Cr NCI (SOFP) 15,000
2. Dr Dividend Income ($40,000 x 80%) 32,000
Dr NCI (20%) ($40,000 x 20%) 8,000
Cr Dividend declared 40,000
3. Dr Share capital 200,000
Dr RE (1.1.20x2) 120,000
Dr Goodwill 50,000
Cr Investment in S Co (1.1.20x2) 296,000
Cr NCI (FV) 74,000
183
[Disposal of Subsidiaries]
a. Derecognizes the assets (including an appropriate allocation of
goodwill) and liabilities of the subsidiary at their carrying amounts
b. Derecognizes the carrying amount of any NCI (including any
components of accumulated other comprehensive income
attributable to the NCI)
c. Recognizes the fair value of the proceeds
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93
[Disposal of Subsidiaries]
d. Recognizes any retained interest in the former subsidiary at its fair
value
e. Reclassifies to income [SOCI], or transfers directly to retained
earnings if required in accordance with other HKFRS, the amounts
recognized in other comprehensive income in relation to that
subsidiary
f. Recognizes any resulting difference as a gain or loss in SOCI
attributable to the parent
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[Disposal of Subsidiaries]
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94
Illustration 2:
60% Subsidiary to 40% Associate
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[Illustration 2: 60% Subsidiary to 40% Associate]
Given :
1. A owns 60% of a subsidiary.
2. A disposes of 20% of the subsidiary for $200 million.
3. At the disposal date,
• the FV of A’s retained interest (40%) $300 million;
• The carrying value of former subsidiary’s identifiable net assets
$500 million
• there is no goodwill and
• NCI are valued at its proportionate share of the net assets
method
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95
[Illustration 2: 60% Subsidiary to 40% Associate]
MA – Complex and Changes in Group Structures
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FV consideration (20%) received by A 200
FV A’s remaining holding (40%: A’s retained interest) 300
500
Less: Amounts recognized prior to disposal
Carrying value of former subsidiary’s Identifiable net asset ($500 x 60%) (300)
Cr Gain on disposal of sub (20%) 200
Gain on disposal ($200-500x20%)
100
Gain on revaluation of retained interest ($300 - $500 x 40%) 100
Gain on disposal of sub (20%) 200
189
Illustration 3:
100% Subsidiary to 60% Subsidiary
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96
[Illustration 3: 100% Subsidiary to 60% Subsidiary]
Given :
1. A owned 100% of a subsidiary on its date of incorporation for $200
million.
2. A sold 40% of the subsidiary for $120 million.
3. Control is still retained (@60%)
4. At the disposal date,
• The FV of the subsidiary’s identifiable net assets were $280
million
• there is no goodwill as the subsidiary was acquired on
incorporation
• NCI are valued at its proportionate share of FV of the
subsidiary’s identifiable net assets
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[Illustration 3: 100% Subsidiary to 60% Subsidiary]
A’s disposal entry: Dr cash $120 Cr Invest in sub $80 Cr gain on disposal $40
Consolidation entry: Dr Gain on disposal $40 , Dr share cap/reserve $200, Cr NCI $112
Cr Investment in sub $120 Cr Equity-controlling interest $8
MA – Complex and Changes in Group Structures
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A’s SOCI
FV consideration (40%) received by A 120
A’s (40%) cost of investment in subsidiary (40%x$200) (80)
Profit on sale 40
No group profit on sale as 60% control is retained.
Adjustment to A (parent)’s equity 120
FV consideration (40%) received by A (112)
Increase in NCI in net assets at date of disposal (40%x$280) 8
Adjustment to parent’s equity
192
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193
Exam Question review
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98
Dec 2011 – Case
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MA – Exam Question Review
Dec 2011 – Case
Question
Global Resources Limited ('GRL'), which is a company incorporated in Hong
Kong and listed in the Growth Enterprise Market of The Stock Exchange of Hong
Kong Limited.
GRL and its subsidiaries (GRL Group) are principally engaged in the natural
resources business in the People's Republic of Bangladesh; and the provision of
medical equipment services and related accessories, and the provision of
medical research and development services in mainland China.
Now, GRL intends to disinvest its investment in the medical research and
development business.
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99
MA – Exam Question Review
Dec 2011 – Case
Question
[Asia Medical Research Limited ('AMR')]
On 1 April 20X8, GRL acquired 600,000 (60%) of the 1,000,000
ordinary shares issued by Asia Medical Research Limited ('AMR') for
$7.5 million in cash. On that date, the fair value of the net identifiable
assets of AMR was the same as their carrying amount, and the share
capital and retained earnings of AMR were $1 million and $9 million
respectively with no other components of equity.
GRL is entitled to appoint three out of the five directors on the board.
All board decisions are made by simple majority resolution.
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MA – Exam Question Review
Dec 2011 – Case
Question
[Asia Medical Research Limited ('AMR')]
On 1 April 20Y1, AMR issued 500,000 shares to a new investor, Simon
Firth Limited ('SFL'), for $8 million. As a result, GRL’s shareholdings in
AMR decreased to 40%.
In addition, SFL has the right to appoint two new directors to the board
making a total of seven directors on the board. The fair value of GRL’s
investment in AMR (previously held 60% interest) was valued at
$9.6 million on 1 April 20Y1.
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100
MA – Exam Question Review
Dec 2011 – Case
Question The draft statements of financial position of the companies at 31 March
20Y1 are:
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MA – Exam Question Review
Dec 2011 – Case
Question
[Asia Medical Research Limited ('AMR')]
a) discuss and advise, with calculations, the accounting
treatments for the investment in AMR in the consolidated
financial statements of GRL on 1 April 20Y1.
(14 marks)
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
The issue of shares by AMR to SFL has reduced GRL’s interest in AMR
to 40 per cent, i.e. less than 50 per cent. Also, GRL is entitled to appoint
only three out of the total seven seats in the board of directors. Therefore,
GRL has lost control of AMR.
Since GRL holds 20 per cent or more of the voting power of AMR, there
is a presumption that GRL has significant influence over AMR and hence
AMR should be accounted for as an associate. In this case, GRL should
stop consolidating AMR from the date that control was lost, i.e. 1 April
20Y1.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
Paragraph 25 of HKFRS 10 Consolidated Financial Statements states
that if a parent loses control of a subsidiary, the parent should de-
recognize the assets and liabilities of the former subsidiary from the
consolidated statement of financial position and recognize any
investment retained in the former subsidiary at its fair value when
control is lost.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
A partial disposal of the investment in AMR, as a subsidiary, but retaining
an interest as an associate creates the recognition of a gain or loss
on the entire interest. A gain or loss should be recognized on the part
that has been disposed of and a further holding gain or loss is
recognized on the investment retained, being the difference between
the fair value of the investment and the carrying amount of the
investment.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
On 1 April 20Y1, the carrying amounts of AMR that should be de-
recognized =
100% of the net identifiable assets of AMR = $12 million
+ goodwill $7.5m + 40% × ($1m + $9m) – $10m = $1.5 million
= $13.5 million
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
GRL should de-recognize the carrying amount of any non-controlling
interests (NCI) in AMR (the former subsidiary) at the date when control is
lost (including any components of other comprehensive income
attributable to them). On 1 April 20Y1, non-controlling interest,
measured at its proportionate share of the AMR’s net identifiable assets,
should be 40% × $12 million = $4.8 million.
GRL should also recognize the fair value of the consideration received
from the transaction. However, in this case, GRL has not received any
consideration from the transaction.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
Any investment retained in AMR (the former subsidiary) should be
recognized at its fair value at the date when control is lost. Thus, GRL
should recognize its investment in AMR at its fair value on 1 April
20Y1, i.e. $9.6 million.
GRL should also reclassify to profit or loss, or transfer directly to
retained earnings any gain or loss previously recognized in other
comprehensive income. However, for the assets of AMR, no gain or
loss has been previously recognized in other comprehensive income.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
The resulting gain,
Investment in AMR = $9.6 million (previously held 60%)
Add Non-controlling interest = $4.8 million (previously held 40%)
Less Net identifiable assets of AMR = $12 million
Less Goodwill = $1.5 million
= $0.9 million should be recognized in profit or loss attributable to
the parent.
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MA – Exam Question Review
Dec 2011 – Case
Answer (a) (subsidiary to associate)
[Asia Medical Research Limited ('AMR')]
May exclude AMR from the consolidation and prepare a terminal entry:
Dr Investment in AMR $9.6 million
Cr Investment in AMR $7.5 million
Cr Retained earnings (11m – 9m) × 60% $1.2 million
Cr Gain on disposal $0.9 million
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105
MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
On 1 April 20Y0, GRL acquired 2,640,000 ordinary shares in China
Development Services Limited ('CDS') for $12 million in cash. Thus
GRL owns 2,640,000 out of the 4,000,000 shares of CDS, giving it a
66% interest.
On 1 April 20Y1, CDS issued 400,000 shares to a new investor, Michael
Sun Limited ('MSL'), for $5.5 million. As a result, GRL’s shareholdings in
CDS decreased to 60 per cent. The carrying amount of CDS’s net
identifiable assets in the consolidated financial statements of GRL, as at
31 March 20Y1, was $12.9 million.
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MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
Other relevant information:
• At the date of acquisition, the fair values of CDS’s assets were equal
to their carrying amounts with the exception that the fair value of
CDS’s inventory was $500,000 below its carrying amount; and it
was written down by this amount shortly after acquisition as an
impairment loss and it has not changed in its fair value since then.
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MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
Other relevant information:
• On 2 April 20Y0, GRL sold an item of plant to CDS at $2.5 million.
Its carrying amount prior to the sale was $2 million. The estimated
remaining useful life of the plant at the date of sale was five years.
GRL, AMR and CDS depreciate their property, plant and equipment
using the straight-line method.
• There were no intra-group payables or receivables at 31 March
20Y1. No dividends were paid during the year by any of the said
companies.
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MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
Other relevant information:
• It is the group’s policy to measure non-controlling interests at its
proportionate share of the subsidiary’s net identifiable assets at the
acquisition date. Goodwill arising from the acquisition of AMR and
CDS has not subsequently been impaired. For the assets of both
AMR and CDS, no gain or loss has been previously recognized in
other comprehensive income.
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MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
Ms Linda Ho, a director of GRL is concerned about the implications of
the above transactions and information. She wondered if it may result in
any gain or loss to be recognized and if it may make any difference in the
consolidation process.
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MA – Exam Question Review
Dec 2011 – Case
Question
[China Development Services Limited ('CDS')]
[Global Resources Limited]
b) discuss and advise, with calculations, the accounting
treatments for the investment in CDS in the consolidated
financial statements of GRL on 1 April 20Y1. (10 marks)
c) prepare an annex to your memorandum showing worksheets
for the consolidated statement of financial position of GRL as at
1 April 20Y1 after considering the transactions and other
information. Ignore the deferred tax implications. (26 marks)
(Show consolidation adjustments in a worksheet with detailed
calculations of each figure, but journal entries are not required)
(14 marks)
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MA – Exam Question Review
Dec 2011 – Case
Answer (b) (subsidiary to subsidiary)
[China Development Services Limited ('CDS')]
The issue of shares by CDS to MSL has reduced GRL’s interest in CDS
from 66 per cent to 60 per cent. Since GRL holds more than 50 per
cent of the voting power of CDS, there is a presumption that GRL has
retained control of CDS and hence CDS should remain as a subsidiary.
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MA – Exam Question Review
Dec 2011 – Case
Answer (b) (subsidiary to subsidiary)
[China Development Services Limited ('CDS')]
Paragraph 23 of HKFRS 10 Consolidated Financial Statements states
that “changes in a parent’s ownership interest in a subsidiary that do not
result in a loss of control are’(i.e. transactions with owners in their
capacity as owners). accounted for as equity transactions’ This
means that no gain or loss from these changes should be recognized in
profit or loss. It also means that no change in the carrying amounts of
the subsidiary’s assets (including goodwill) or liabilities should be
recognized as a result of such transactions. This adopted approach is
consistent with the fact that non-controlling interests are treated as a
separate component of equity.
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MA – Exam Question Review
Dec 2011 – Case
Answer (b) (subsidiary to subsidiary)
[China Development Services Limited ('CDS')]
In such circumstances, the carrying amounts of the controlling and
non-controlling interests shall be adjusted to reflect the changes in
their relative interests in the subsidiary.
Previously, the carrying amount of NCI = 34% of $12.9 million = $4.386
million. After the transaction, NCI = 40% of ($12.9 + $5.5) million =
$7.36 million. Thus, NCI increases by ($7.36 – $4.386) million = $2.974
million
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MA – Exam Question Review
Dec 2011 – Case
Answer (b) (subsidiary to subsidiary)
[China Development Services Limited ('CDS')]
Any difference between the amount by which the non-controlling
interests are adjusted and the fair value of the consideration paid or
received shall be recognized directly in equity and attributed to the
owners of the parent. Thus the difference between the consideration
received ($5.5 million) and the amount that NCI is adjusted ($2.974
million), amounting to $2.526 million should be recognized directly
in parent’s equity
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MA – Exam Question Review
Dec 2011 – Case
Answer (b) (subsidiary to subsidiary)
[China Development Services Limited ('CDS')]
The corresponding consolidation journal entry is summarized as below:
Dr Cash $5.5 million
Cr Non-controlling interest $2.974 million
Cr Equity attributable to owners of the parent $2.526 million
Alternatively:
Dr Cash $5.5 million
Dr Non-controlling interest $4.386 million
Cr Non-controlling interest $7.36 million
Cr Other components of Equity (parent ) $2.526 million
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP) [Global Resources Limited]
Consolidated Statement of Financial Position as at 1 April 20Y1
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP) [Global Resources Limited]
Consolidated Statement of Financial Position as at 1 April 20Y1
221
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP)
[Global Resources Limited]
Goodwill calculations (not required by the question)
Investment in AMR Investment in CDS
$’000 $’000
Purchase consideration (60%) 7,500 (66%) 12,000
NCI (10m × 40%) 4,000 (10m × 34%) 3,400
11,500 15,400
Fair value of net identifiable assets
(1m + 9m) (10,000) (4m + 6.5m – 0.5m) (10,000)
Goodwill 1,500 5,400
222
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP)
[Global Resources Limited]
Journal entries (not required by the question) (All figures in $’000)
(W1) Elimination of investment in CDS
Dr Share capital 4,000
Dr Retained earnings 6,500
Dr Goodwill 5,400
Cr Inventory 500
Cr Investment in CDS 12,000
Cr Non-controlling interests (NCI) 3,400 (4,000 + 6,500 - 500) × 34%
223
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP)
[Global Resources Limited]
Journal entries (not required by the question) (All figures in $’000)
(W2) Impairment of inventory (realized fair value loss shortly after
acquisition date, has to reverse realized loss otherwise double
counting with W1)
Dr Inventory 500
Cr Retained earnings 500
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP)
[Global Resources Limited]
Journal entries (not required by the question) (All figures in $’000)
(W3) Adjustment of 20Y0 unrealized profit in plant (downstream, no
effect on NCI)
Dr Retained earnings 500 (2,500 – 2,000)
Cr Plant 500
Dr Acc. depreciation 100 (500 / 5 years)
Cr Retained earnings 100
225
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MA – Exam Question Review
Dec 2011 – Case
Answer (c) (consolidation worksheet – SOFP)
[Global Resources Limited]
Journal entries (not required by the question) (All figures in $’000)
(W4) Allocation of post-acquisition profit to NCI of CDS
Dr Retained earnings 986 (2,400 + W2 inventory 500) × 34%
Cr NCI 986
226
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