E-14 Advanced Accounting and Financial Reporting

E-14 Advanced Accounting and Financial Reporting Lecture 05 & 06 IAS 27 Consolidated and Separate Financial Statements IFRS 3 Business Combinations Sajid Shafiq, ACA

IAS 27-Overview • Introduction to Group Accounts • Consolidated Statement of Financial Position of a Subsidiary • Consolidated Statement of Comprehensive Income of Subsidiary (Income Statement) • Consolidated Statement of Changes in Equity • Regulatory Framework IAS 27 Consolidated and Separate Financial Statements

Introduction to Group Accounts FS normally set out the financial position and performance of a single entity. If that entity is controlled by (or controls) another entity (its parent or subsidiary respectively) and there are intra-group transactions, then its FS may not reveal a true picture of its activities. Consolidated Financial Statements(CFS) are prepared on the basis that the group is a single economic entity, by aggregating the transactions and balances of the parent and all its subsidiaries. A group is simply a collection of entities, where one, the parent, controls the activities of the others, its subsidiaries. The preparation of single entity FS would not reflect the economic reality of the financial performance and position under the control of the parent entity. IAS 27 Consolidated and separate financial statements governs the preparation of CFS of Parent and Subsidiaries and is discussed in this Lecture. The treatment in the CFS for investments giving rise to joint control (under IAS 31 Interests in joint ventures) and for those giving rise to significant influence (under IAS 28 Investments in associates) are dealt with in Lecture 07. IAS 27 Consolidated and Separate Financial Statements

Consolidated Statement of Financial Position(CSFP) of Subsidiary • The Rationale, Conceptual Background and Overview of the Technique • The Basic Principles… • Goodwill, • Non Controlling Interest and • Consolidated Retained Earnings • Complications… • Mid Year Acquisition, • Inter company trading • Further Adjustments … • Items not accounted for • Group accounting policy adjustment • Goodwill (Accounting, Revaluation of Subsidiary’s accounts, ) IAS 27 Consolidated and Separate Financial Statements

CSFP of a Subsidiary The rationale • Many companies carry on part of their business through the ownership of other companies which they control-known as subsidiaries • Controlling interests in such companies would generally appear at cost in the accounts of the investing company. • Such interests may result in the control of assets of a very different value to the cost of investment. • In other words, the accounts will not provide the shareholders of the parent company with a true and fair view of what their investment actually represents. The substance of the relationship is not reflected in the accounts. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The rationale-Illustration • The Investment of 15,000 is, in substance, the cost of owning assets of 25,000. • Parent’s shareholder can not see this looking simply at Parent Co’s accounts. • The Solution is to prepare Group Accounts (Consolidated Financial Statements) to reflect this substance IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Conceptual Background • Consolidation involves ‘replacement’ of cost of investment in the Parent’s accounts by what it actually represents i.e. • Parent’s share of the net assets of the Subsidiary as at the reporting date AND • Any remaining element of goodwill which the parent paid for at the date of acquisition • In addition to this, the reserves of the parent must be credited with parent’s share of the subsidiary’s post acquisition reserves… so that the accounts balance IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Overview of the Technique Individual Co. Adjustments +Consolidation Adjustments IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles Example 1 Parent purchased 100% of Subsidiary’s shares on 31 December 2010. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles Example 1 Points to Note: • The share capital of the Group is always the share capital of the Parent. This is always the case • The Cost of Investment in Subsidiary will disappear. It is ‘replaced’ • The assets and liabilities of the Group are simply the sum of those of Parent and Subsidiary. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles Solution: 1 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles This is the simplest of examples. • Cost of Investment EQUALS share of net assets. i.e. there is no Goodwill • Consolidation is AT the date of acquisition • Parent owns 100% of Subsidiary These simplifications will now be relaxed one by one. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles Workings: • Goodwill Cost of Investment Less Share of* Net Assets at ACQUISITION date • Consolidated Retained Earnings Parent’s Plus Share of Subsidiary’s Post acquisition Retained Earnings * An alternative method of Full GW will be discussed later IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles- Goodwill Example 2 Parent purchased 100% of Subsidiary’s shares on 31 December 2010. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Goodwill Example 2 Points to Note: 1 to 3 as above • Part of the cost is goodwill. This must be separately identified IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Goodwill Solution: 2 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles- Post Acquisition reserves Example 3 Parent purchased 100% of Subsidiary’s shares on 31 December 2009 when subsidiary’s reserves stood 2,500. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Post acquisition reserves Example 3 Points to Note: 1 to 4 as above • Parent’s share of the post acquisition profits of Subsidiary is included in the consolidated retained earnings. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Post acquisition reserves Solution: 3 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles- Less than 100% shareholding Example 4 Parent purchased 80% of Subsidiary’s shares on 31 December 2009 when subsidiary’s reserves stood 2,500. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Less than 100% shareholding Example 4 Points to Note: 1 to 3 and 5 as above. However, it is important to note that • ALL the assets and liabilities of the subsidiary shall be added IRRESPECTIVE of the percentage of shareholding. • The percentage in net assets not owned by the parent is shown separately as “Non-controlling Interest” in SFP as a credit balance. • The effect on Goodwill (point 4 above) calculation, after IFRS 3 revised has become a bit tricky. See next slide IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Less than 100% shareholding Example 4… IFRS 3 (Revised) & Effect on Goodwill calculation. • Traditionally, Goodwill was calculated as being excess of Cost of investment by Parent over share of net assets of Subsidiary at acquisition date (as explained in 4 above, called proportionate GW method) • It has long been argued that the traditional method only recognizes the goodwill purchased by the parent rather than the goodwill controlled by it. • IFRS 3 (Revised) now requires that any goodwill attributable to the NCI should also be recognized. (Full GW method). However, proportionate GW is also permitted. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Less than 100% shareholding Example 4… IFRS 3 (Revised) & Effect on Goodwill calculation. There are a number of ways of presenting the information to test the new method: • Stating nothing. This would imply that goodwill for parent shall be increased proportionately with credit to NCI. (as in example 4 above) • The subsidiary’s share price just before the acquisition could be given and then used to value the NCI. It would then be a matter of multiplying the share price by the number of shares held by the NCI. Note that the parent is likely to have paid more than the subsidiary’s pre-acquisition share price in order to gain control. (say 15 Rs per share for example 4) • The question could simply state that the directors valued the NCI at the date of acquisition at a particular value.(say 3,000) • An alternative approach would be to give (in the question) the value of the goodwill attributable to the NCI. In this case, the NCI’s goodwill would be added to the parent’s goodwill (calculated by the old method) and to the carrying amount of the NCI itself. ( say 1,000) Practice each alternative!! IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary The Basic Principles-Less than 100% shareholding Solution: 4 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Mid Year Acquisition, • A parent may acquire subsidiary during the year. In that case, it is necessary to calculate net assets at the date of acquisition. • Unless stated otherwise, it is assumed that subsidiary’s profits accrue evenly over time. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Mid Year Acquisition, Example 5 Parent acquired 100% of Subsidiary at 31 May 2010 for 200,000. Subsidiary’s net assets as at 31 December 2007 were: Share Capital 10,000 Retained Earnings 150,000 160,000 During the year ended 31 December 2010 subsidiary made a profit after tax of 60,000. Required: • Calculate subsidiary’s net assets at acquisition date • Calculate Goodwill • Calculate subsidiary’s profits to be included in the consolidated retained earnings • What would be the effect on goodwill if percentage holding is reduced to 80%, other things remaining the same. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Inter-Company Balances • Unrealized profits • Non-current assets transfer IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Inter-Company Balances • Group accounts represent performance and position of group of companies as if they were a single entity. • If the group companies have outstanding balances from/to one another, these should be cancelled out at the time of consolidation as adding these in respective assets/liabilities of group would be misleading. • In case there are in-transit cash, inventory or other unrecorded items, these have to be accounted for before the cancellation, in the books of entity which ultimately has to record the effect of transaction. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Unrealized profits • If a member of group sells inventory to another member which remains unsold/unconsumed at year end: • Seller would have recorded the profit which the ‘group’ has not realized as yet (on unsold inventory only) • Purchases would be showing the inventory at a value above that what it cost to the group • The element of URP needs to be eliminated from value of consolidated inventory. The corresponding effect may either be • Given to consolidated retained earnings, ignoring the direction of transaction (parent to subsidiary or subsidiary to parent), or • Given to the retained earnings of the SELLER. i.e. allocated to NCI as well if the sale is by subsidiary. Here, direction of the transaction is relevant. • The URP is calculated on UNSOLD inventory only, taking care of Mark up or Margin ratios given in the question • Care must also be taken if inventory in the BUYER’s account is appearing at NRV. The easy approach for examination would be to reverse the effect of NRV adjustment first, and then to proceed in the normal way. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Unrealized profits Example 6 Parent, owning 80% shares of Subsidiary made sale of 120,000 at margin of 20%. One third of which remained unsold at year end. Required: • Calculate unrealized profit to be eliminated from inventory and adjustment required. • The mark up percentage in this transaction. • What adjustment would have been required if inventory were stated at 35,000 (NRV) • Ignoring ‘3’ what if the sale had been made by subsidiary to the parent. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Unrealized profits Solution 6 • Unrealized profit to be eliminated from inventory and adjustment required. • The mark up percentage in this transaction. • In case of NRV adjustment • If the sale had been made by subsidiary to the parent. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading • Non-current assets transfer • The intra-group profit or loss should be removed. • The additional factor as compare to sale of inventory is ‘correction of depreciation charge’ Example 7 Parent, owning 80% of subsidiary sold a plant to subsidiary at 20,000 which had a book value in the books of Parent of 15,000. Subsidiary charged 20% depreciation on this purchased plant. Required: Calculate consolidation adjustment IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Complications-Inter-Company trading Solution 7 • Adjustment -Group • Adjustment in the books of Subsidiary IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments-Items not accounted for This covers, for example, deferred tax, lease, in transit items, dividends etc.. • Proposed Dividends…. • Record by reducing retained earnings and increasing current liability • If declared by subsidiary: • There should be recorded a corresponding ‘receivable’ in the books of parent, being the recipient by increasing consolidated retained earnings • The intra-group receivable & payable shall be cancelled out, leaving only proposed dividend to NCI. This is shown as part of current liabilities and NOT as NCI • Read information given carefully. Examiner may give a situation of partial recording. i.e. for example recorded by subsidiary but not by parent. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments-Items not accounted for • Proposed Dividends…. Example 8 Parent owns 75% of subsidiary. Before the year end of 31 December 2010, a dividend of 10,000 and 5,000 is being declared by parent and subsidiary respectively, which needs to be accounted for as yet. Before accounting for dividends, parent had reserves of 60,000 and subsidiary 45,000 at year end. The acquisition date reserves of subsidiary were 20,000 Required: • Show the adjustments required (double entries) in the books of Parent, Subsidiary and Group • Calculate Consolidated Reserves as at 31 December 2010. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments-Items not accounted for • Proposed Dividends…. Solution 8 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments-Group accounting policy adjustment • IAS 27 requires Parent and Subsidiary to use similar accounting policies for the purpose of Consolidated Financial Statements • If this is not the case, a separate set of Financial Statements with uniform accounting policies will need to be prepared for IAS 27 compliance IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Accounting • Reflects the future economic benefits arising from the assets that are not capable of being identified separately • Initially carried at cost: • Excess of cost of investment by parent over share in net assets of subsidiary at the date of acquisition, plus • The goodwill attributable to NCI • Subsequent to initial recognition, GW is carried at cost less accumulated impairment loss (calculated and recognized under IAS 36) • In case of excess of share in net assets over cost of investment, the acquirer shall review the procedures used to measure • the identifiable assets acquired and liabilities assumed; • the consideration transferred. and should then take the effect immediately in profit- attributable to acquirer • More details on goodwill will be covered with IFRS 3 in Lecture-06. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts • At acquisition date: • Effects the value of asset or liability with corresponding effect on GW (combined i.e. parent’s as well as NCI’s) • In the post acquisition period, effect of extra depreciation is accounted for in the books of Subsidiary (being the owner of assets) • Any goodwill already in the books of acquiree is written off. • Subsequent to acquisition date: • Is accounted for as a normal revaluation. Credit effect of Group’s share is given to Consolidated Revaluation Reserve and remaining to NCI IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts Example 9 P acquires 60% of S on 31 December 2009 for 900,000. the book value of S’s net assets at that date were as follows: Land and building( MV 300,000) 200,000 Goodwill on acquisition of sole trader 50,000 Sundry net assets (at FV) 800,000 1,050,000 Share Capital 100,000 Retained Earnings 950,000 1,050,000 S’s net assets at 31 December 2010 included the following: Land and building-at cost 200,000 Goodwill on acquisition of sole trader 30,000 Retained earnings 1,200,000 Required: Calculate Goodwill, Non Controlling Interest and S’s amount for Consolidated retained earnings. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts Solution 9 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts Example 10 Further Information: P bought 80% of S on 31 December 2006. At that date, S’s reserves stood 600,000 and the fair value of its net assets were 1,000,000. The revaluation was due to an asset which had a remaining life of 10 years at the date of acquisition. The recoverable amount of S’s net assets at year end is 1,500,000. Prepare Consolidated Statement of Financial Position at 31 December 2010. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts Solution 10 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary Further Adjustments Goodwill • Revaluation of Subsidiary’s accounts …….Solution 10 IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary COMPREHENSIVE EXAMPLE IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary COMPREHENSIVE EXAMPLE Further Information: • P acquired 80% of S 2 years ago when balance on S’s accumulated profits was 4,000,000 • At acquisition S’s assets included one with a book value of 1,200,000 and fair value of 1,500,000. this asset was being written off over 10 years • During the year S sold goods to P. At the year end P retained goods at a value of 450,000 above its cost to S. • Before the year end, P proposed a dividend of 200,000 and S proposed a dividend of 100,000. These have not been accounted for as yet. • Goodwill has been impaired by 2,000,000 since the acquisition date. Prepare Consolidated Statement of Financial Position at 31 December 2010. IAS 27 Consolidated and Separate Financial Statements

Consolidated SFP of a Subsidiary SOLUTION to Comprehensive Example IAS 27 Consolidated and Separate Financial Statements

E-14 Advanced Accounting and Financial Reporting