CONSOLIDATION

PART 1

JOIN KHALID AZIZ• ECONOMICS OF ICMAP, ICAP, MA-

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Announcements

Supplementary WorkshopsCommence this weekSchedule on Class-shareAll queries to Rajni

Test 3Saturday 9:00 AMForeign Currency & Liquidation

RevisionLast week, we learnt about 3 forms of

business combinationsDo you remember what they are?

RevisionA B C

1.

Acquires control of B’s net assets

Liquidates

2.

Acquires control of B’s net assets

Continues, holding shares in A

Type 1 and 2 are both ACQUISITIONS

3.

Liquidates Liquidates A new entity (C) is formed

In Type 3, A and B have MERGED

Revision

Apart from these, a business combination may take another form

When 1 company acquires the shares of another company, rather than its net assets

Over the next 3 weeks, we will concentrate on business combinations involving acquisition of shares

Learning ObjectivesYou will be able to1. Define an Economic Entity2. Explain the concept of Control3. Identify factors that indicate

Control4. Differentiate between pre & post

acquisition equity5. Explain the purpose of Elimination

Entries

1.a Economic Entity

An economic entity (or group) includes

a controlling entity &

1 or more controlled entities,

operating together

to achieve objectives consistent with those of the controlling entity

Learning Objective 1

1.a Economic Entity

Vodafone FijiTelecom Fiji

ATH

Example

Amalgamated Telecom Holdings Limited (ATH)

Domestic Telecommunications

Cellular Mobile Telecommunications

Telecommunications

1.b Economic Entity An economic entity constitutes a

reporting entity.Therefore,

1. An additional set of accounts must be prepared

Known as Consolidated Statements2. Using a Consolidation Worksheet

Not in the books of an individual company

1.b Economic Entity

Statements of Telecom

Statements of FINTEL

Statements of Vodafone

Statements of Connect

Statements of Fiji Directories

Consolidated Statements of

ATH

Consolidation Worksheet

2. Control

What is meant by control?

In the context of consolidation

Learning Objective 2

2.a Control Control exists, where one entity is able to influence decision-making of another

entity both financial & operating

to enable the controlled entity to operate with it in achieving its own objectives

2.a Control Decision RulesIf one entity owns more than 50% of the

shares in another other entity Control is presumed to exist

Control may be Direct or Indirect

2.b Direct & Indirect Control

Vodafone (51%)Telecom (100%)

ATH

FNPF (58.2%)

Direct Control (Parent) of ATH

Indirect Control of Telecom & FINTEL

Direct Control (Parent) of Telecom & Vodafone

Subsidiary of ATH Subsidiary of ATH

3. Factors indicating Control

Can control exist when an entity owns less than 50% of the shares in another entity?

Yes, if certain factors are met

Learning Objective 3

3. Factors indicating Control Does the entity have the capacity to1. Dominate composition of Board of

Directors?2. Appoint or remove all or a majority of the

Directors?3. Cast the majority of votes at a meeting of

the Board?4. Control the casting of a majority of votes

at a meeting of the Board?

Can you see why control is linked to Share Ownership?

3. Factors indicating ControlExample

ATH does not own any shares in FINTEL51% owned by Fiji Government49% by Cable & WirelessHowever, ATH has rights to manage

Government’s sharesAs such, it is able to cast a majority of

votes

JOIN KHALID AZIZ• ECONOMICS OF ICMAP, ICAP, MA-

ECONOMICS, B.COM.• FINANCIAL ACCOUNTING OF ICMAP STAGE

1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.

• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

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4. Pre & Post Acquisition EquityWe are talking about equity of the subsidiary.At any time, equity can be divided into1. Pre-acquisition Equity2. Post-acquisition Equity

Learning Objective 4

What is the difference between them?

4. Pre & Post acquisition Equity Subsidiary’s

Post-acquisition Equity

Subsidiary’s Pre-acquisition

Equity

Date of Acquisition

Existing Capital,

Reserves & Retained Profits

Additional Capital,

Reserves & Retained Profits

4. Pre & Post Acquisition Equity The distinction is important because1. Cost of acquisition is compared

with pre-acquisition equity to determine goodwill

2. Treatment of dividends differs for pre & post acquisition equity

Example 1On 1 April 2006, Tonga Ltd acquired all the shares of Nuku Ltd for a cash payment of $225,000On that date, the equity of Nuku Ltd consisted of Share Capital $150,000 Reserves $ 30,000 Retained Profits $ 20,000RequiredRecord the combination in the books of Tonga

Ltd

Business Combinations

Calculate

Fair Value of Identifiable Net Assets Acquired

(FV of INA)

Calculate

Cost of Acquisition (COA)

Calculate

Goodwill or Negative Goodwill

Step 1

Step 2

Step 3

Calculate Fair Valueof Identifiable Net Assets

Since A-L = OEFair value of identifiable net assetsCan also be calculated from the

equity of the acquiree

Step 1

Calculate Fair Valueof Identifiable Net Assets

Step 1

Equity Item Amount

Share Capital 150,000

Reserves 30,000

Retained Profits 20,000

Total $200,000

Calculate Cost of Acquisition

Step 2

Immediate cash payment of $225,000

Calculate GoodwillStep 3

Cost of Acquisition 225,000

Less Fair Value of INA 200,000

Goodwill $ 25,000

Acquirer’s Entries at Date of Acquisition

Tonga Limited receives shares

Dr Shares in Nuku Limited 225,000Cr Cash 225,000

Goodwill to be recognised as part of elimination entry

Step 4

Assumptions This week, we will work with the following

assumptions Consolidation occurs at time of

acquisition Only 1 Subsidiary in the Group Parent owns 100% of shares in

Subsidiary

We will introduce more advanced issues later

5. Elimination Entries

What is an elimination entry?

Learning Objective 5

IllustrationConsider a family of 3Father (employed as a manager)Weekly take-home pay of $500Mother (sells food parcels from home)Collects an average of $100/week Receives $150/week from husband for

housekeeping1 child, Mere (full-time student)Receives $25/week as pocket-money from her

parentsReceives $15/week as allowance from her sponsor

Illustration

Family Member Amount

Father 500

Mother 100 + 150 = 250

Mere 25 + 15 = 40

Calculate how much each family member receives in a week

Illustration

Family Member Amount

Father 500Mother 100 + 150 – 150 = 100Mere 25 + 15 – 25 = 15

Calculate how much the family receives in a week

Total $615We must exclude or eliminate transactions within the family

JOIN KHALID AZIZ• ECONOMICS OF ICMAP, ICAP, MA-

ECONOMICS, B.COM.• FINANCIAL ACCOUNTING OF ICMAP STAGE

1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.

• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

• CONTACT:• 0322-3385752• 0312-2302870• R-1173,ALNOOR SOCIETY, BLOCK

19,F.B.AREA, KARACHI, PAKISTAN.