HI5020 Corporate Accounting | My Assignment Tutor

Lecture 6:Accounting for group structuresHI5020 Corporate AccountingHolmes InstituteApplied Business Statistics for ManagersTopics covered in this session:▪ Understand the reasons for preparing consolidated financial statements▪ Understand the basics involved in preparing consolidated financial statements▪ Be able to use a consolidation worksheet to perform relatively simple consolidations▪ Understand that control, and not legal form, is the criterion for determining whether or not toconsolidate an entity▪ Be able to explain what control means, and be able to explain what factors should beconsidered in determining the existence of control▪ Understand the meaning of ‘goodwill’ and how to measure it▪ Be able to provide the journal entries necessary to account for any goodwill or discount thatarises on consolidationHolmes InstituteApplied Business Statistics for ManagersWhat is a Group Structure?• In business, a group, business group, corporate group, or(sometimes) alliance is most commonly a legal entity that is atype of conglomerate or holding company consisting of aparent company & subsidiaries.• Typical examples are Adidas Group• In Australia, CSR Ltd is a good exampleHolmes InstituteApplied Business Statistics for ManagersThe following provides an example of CSR.Parent & SubsidiaryCSRLTDBradford Gyprock AustralBricksMonierTiles100%100%100%100%Economic EntitySeparate Legal EntitiesSubsidiaries SubsidiariesHolmes InstituteApplied Business Statistics for ManagersRationale for consolidating the accounts of differentlegal entities“With so many separate business operations, if they wereprovided as separate financial statements to groups such asinvestors, it would be exceptionally confusing due to thesheer size of the documentation provided.”▪ ‘There will be confusion!”Holmes InstituteApplied Business Statistics for ManagersRationale for consolidating the accounts ofdifferent legal entities▪ To show the results and financial position of a group as if itwere operating as a single economic entity▪ Following the consolidation process, the consolidatedstatement of profit or loss and other comprehensive incomewill show the result derived from operations with partiesexternal to the group of entities▪ Effects of all intragroup transactions are eliminated,Holmes InstituteApplied Business Statistics for ManagersRationale for consolidating the accounts of differentlegal entities▪ The consolidated statement of financial position (balancesheet) will show the total assets controlled by the economicentity and the total liabilities owed to parties outside theeconomic entityHolmes InstituteApplied Business Statistics for ManagersRequirement to produce consolidated financial statementsAASB 10The consolidated financial statements are to include allsubsidiaries of the parent▪ Even where control is only temporary, the consolidatedstatements should incorporate the results of a subsidiary▪ If control is lost during a period then income and expenses ofa subsidiary are to be included in the consolidated financialstatements proportionatelyHolmes InstituteApplied Business Statistics for ManagersAlternative consolidation conceptsthere are three major consolidation concepts:1. The entity concept (adopted by AASB 10)All assets and liabilities of the parent entity and subsidiaries included– Non-controlling interests are treated as part of consolidated equity– Non-controlling interests defined by AASB 10 as ‘the equity in a subsidiary notattributable, directly or indirectly, to a parent’2. The proprietary concept➢All assets and liabilities of the parent entity and only a proportionateshare of the subsidiaries’ assets and liabilities included➢Non-controlling interest is not included3. The parent entity concept➢All assets and liabilities of the parent and subsidiaries are included• Non-controlling interest typically treated as a liabilityHolmes InstituteApplied Business Statistics for ManagersConcept of control▪ The definitions of ‘control’ and ‘subsidiary’ are central to determining the entities tobe consolidated and the nature of the group.As we know, AASB 10 requires that:the consolidated financial statement shall include all subsidiaries of theparent (with the exception of ‘investment entities’)▪ A subsidiary is defined in AASB 10 as:an entity that is controlled by another entityHolmes InstituteApplied Business Statistics for ManagersConcept of controlAccording to AASB 10, an investor controls an investee if and only if the investor has allthe following:a) power over the investee,b) exposure, or rights, to variable returns from its involvement with the investee, andc) the ability to use its power over the investee to affect the amount of the investor’sreturns.Substance-over-form considerations are required to be used in determining the existenceof control, a process that calls for the exercise of professional judgementHolmes InstituteApplied Business Statistics for ManagersConcept of controlThe Basis for Conclusions that accompanied the release of IFRS 10 (and AASB 10)addressed a number of situations that could lead to control, these being:▪ where a majority of voting rights are held by the investor▪ where less than a majority of the voting rights are held by the investor–other ownersare widely dispersed.▪ where the investor holds some potential voting rights in the investee-convertible intoordinary share❑ Control can be passive; it may be possible to exert control over another entityHolmes InstituteApplied Business Statistics for ManagersDirect & Indirect Control• There are a number of existing circumstances where an entityhas either direct or indirect control.• We will look at some examples where an entity has interests inothers and the impactsHolmes InstituteApplied Business Statistics for ManagersExample 1: In this example Company A has acontrolling interest of 70% ownership of issuedshares, will receive 70% of dividendsDirect & Indirect Control (cont.)70%CompanyACompanyBNoncontrollingInterest30%DirectcontrolHolmes InstituteApplied Business Statistics for ManagersExample 2: In this example Company A has acontrolling interest of 75% in Company B, who has60% interest in Company C. Company A hasindirect control in Company CDirect & Indirect Control (cont.)75%CompanyACompanyBNoncontrollingInterest –25%60% CompanyCNoncontrollingInterest –40%Holmes InstituteApplied Business Statistics for ManagersAccounting for business combinations▪ According to AASB 3, a ‘business combination’ is defined as:a transaction or other event in which an acquirer obtains control of one ormore businesses▪ If the assets acquired do not fit the description of a ‘business’, the transactionshall represent the acquisition of a group of assets and the appropriateaccounting treatment would be covered by:➢ AASB 116 Property, Plant and Equipment and AASB 138 Intangible Assetsrather than AASB 3 Business CombinationsHolmes InstituteApplied Business Statistics for ManagersAccounting for business combinationsAASB 3 requires the following:The acquirer shall, at the acquisition date:a) recognise goodwill acquired in a business combination as an asset,andb) initially measure that goodwill at its cost, being the excess of thecost of the business combination over the acquirer’s interest in thenet fair value of the identifiable assets, liabilities and contingentliabilities recognisedHolmes InstituteApplied Business Statistics for ManagersAccounting for the consolidation of separate legalentities (cont.)AASB 3 notes that there are four steps to be considered when accounting for businesscombinations, these being:1. identifying the acquirer2. determining the acquisition date3. recognising and measuring the identifiable assets acquired, the liabilities assumed andany non-controlling interest in the acquiree, and4. recognising and measuring goodwill or a gain from a bargain purchaseHolmes InstituteApplied Business Statistics for ManagersRecognising and measuring the identifiable assetsacquired and the liabilities assumed▪ At the acquisition date, the acquirer is required to recognise:➢ goodwill separately from the identifiable assets acquired➢ the liabilities assumed, and➢ any non-controlling interest in the acquiree▪ By applying the recognition principles contained in AASB 3 it is possible for the acquirer to recogniseassets and liabilities that the acquiree had not previously recognised in its own financial statements▪ Examples of assets that may be recognised by the acquirer, but not previously by the acquiree, wouldinclude acquired identifiable intangible assets, such as a brand name or a patentHolmes InstituteApplied Business Statistics for ManagersRecognising and measuring the identifiable assets acquired and theliabilities assumed▪ Identifiable assets acquired and the liabilities should bemeasured at fair value at the acquisition-dateIn the context of business combinations, AASB 3, par. 32 requires that:The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a)over (b) below:(a) the consideration transferred measured at acquisition-date fair value(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilitiesassumed measured at fair valueHolmes InstituteApplied Business Statistics for ManagersRecognising and measuring goodwillThis rule on the previous slide can be simplified as follows: FAIR VALUE OF CONSIDERATION TRANSFERREDXXXplus Amount of non-controlling interestplus Fair value of any previously held equityinterest in the acquireeXXXXXXXXXless Fair value of identifiable assets acquiredand liabilities assumedGOODWILL ON ACQUISITION DATE(XXX)XXX ▪ The net figure for goodwill will be a positive number. If the number is negative, thenrather than it being considered as goodwill, the amount would be considered as a gainon bargain purchase.Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.2—Calculation of goodwill on acquisitionOn 1 July 2023, Ying Ltd acquired for cash all the issued share capital of YangLtd for an amount of $650 000.On the date of the acquisition, the assets, liabilities and contingent liabilities ofYang Ltd are as follows:Carrying amount ($)Fair value ($) Cash15 00015 000Accounts receivable68 00068 000Inventory112 000131 000Land360 000420 000PlantLoans payableAccounts payableContingent liabilities220 000(170 000)(58 000)–240 000(170 000)(58 000)(46 000) Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.2—SolutionPrice of acquisition $650 000Fair value of identifiable assetsacquired and liabilities assumed: Cash15 000Accounts receivable68 000Inventory131 000Land420 000PlantLoans payable240 000(170 000) Accounts payableContingent liabilities(58 000)(46 000)Total fair value of net assets acquired$600 000 Price paid bythe acquirerFair value of netassets acquiredHow can we explain (and account for) the difference between the price paid andthe fair value of the net assets acquired?Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.2—Solution Price of acquisitionTotal fair value of net assets acquiredPositive difference$650 000$600 000$50,000 The positive difference represents Goodwill on acquisition dateGoodwill is defined (AASB 3 Business Combinations) as:• Future economic benefits arising from assets that are not capable of beingindividually identified and separately recognisedHolmes InstituteApplied Business Statistics for Managers• The purchased goodwill will be brought to account by theparent company as part of the consolidation process and willappear only in the consolidated financial statements.• Only purchased goodwill can be recognised as an asset, andonly for the parent company, who paid for it, the goodwill ispurchased.!!Holmes InstituteApplied Business Statistics for ManagersElimination of pre-acquisition shareholders’equity▪ The investment account in the subsidiary will be eliminated infull against the pre-acquisition shareholders’ funds of thesubsidiary▪ This will avoid the double counting of assets, liabilities andshareholders’ funds of the subsidiaryHolmes InstituteApplied Business Statistics for ManagersWorked Example 25.3—A simple consolidationParent Ltd acquires all the issued capital of Subsidiary Ltd for a cash payment of $500 000 on 30 June 2023.The statements of financial position of both entities immediately following the purchase are: Parent Ltd($000)Subsidiary Ltd($000) Current assets Cash105Accounts receivableNon-current assetsPlant15055800500LandInvestment in Subsidiary Ltd200500100–1 660660Current liabilitiesAccounts payableNon-current liabilitiesLoansShareholders’ equityShare capital60304001501 000200 Retained earnings2002801 660660 Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.3—A simple consolidationIf we assume that the assets in Subsidiary Ltd are fairly valued, and there are nocontingent liabilities to consider, then goodwill acquired by Parent Ltd would bedetermined as: Fair value of purchase considerationLess: Fair value of identifiable assetsacquired and liabilities assumedGoodwill on acquisition$500 000$(480 000)$20 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.3—A simple consolidationThe consolidation entry to eliminate the investment in Subsidiary Ltd would be: Dr Share capital200 000DrRetained earnings280 000DrGoodwill20 000CrInvestment in Subsidiary Ltd500 000 (to eliminate the investment in Subsidiary Ltd and to recognise the goodwill on acquisition)The above entry would be posted to the consolidation worksheet adjustment columnsThe above entry is not made in the journal of either Parent Ltd or Subsidiary Ltd but rather in a separateconsolidation journal, which is then posted to the consolidation worksheet.Holmes InstituteApplied Business Statistics for ManagersWorked Example 25.3—A simple consolidationEliminations andadjustments ConsolidatedParent Ltd Subsidiary Ltd Dr Cr statement($000) ($000) ($000) ($000) ($000)Current assetsCash 10 5 15Accounts receivable 150 55 205Non-current assetsPlant 800 500 1 300Land 200 100 300Investment in Subsidiary Ltd 500 – 500 –Goodwill on acquisition – – 20 201 660 660 1 840Current liabilitiesAccounts payable 60 30 90Non-current liabilitiesLoans 400 150 550Shareholders’ equityShare capital 1 000 200 200 1 000Retained earnings 200 280 280 2001 660 660 500 500 1 840Holmes InstituteApplied Business Statistics for ManagersAccounting for the consolidation of separate legal entitiesSo, a typical consolidation journal entry to eliminate investmentin subsidiary would be recorded in a consolidation journal andposted to a consolidation worksheet.Journal entry DrShare capitalxDrRetained earningsxDrGoodwillxCrInvestment in Subsidiary Ltdx Holmes InstituteApplied Business Statistics for ManagersRecognition of gain on bargain purchase▪ Possible (though not common) for a company to gain control ofan entity for an amount less than the fair value of theproportional share of the net assets acquired (acquired at adiscount)Eliminate investment in subsidiary acquired at discountJournal entry DrShare capitalxDrRetained earningsxCrGain on bargain purchasexCrInvestment in Subsidiary Ltdx Holmes InstituteApplied Business Statistics for ManagersSubsidiary’s assets not recorded at fair valuesAdjustment on consolidationTo revalue non-current assets to fair value Dr Non-current assetsCr Revaluation surplus recognised on consolidationCr Deferred tax liabilityxxx To then eliminate the investment in the subsidiary, as well as the revaluation reserve createdin the previous entry Dr Share capitalDr Retained earningsxxDr Revaluation surplus recognised on consolidation xDr GoodwillCr Investment in subsidiaryxx Holmes InstituteApplied Business Statistics for ManagersConsolidation after the date of acquisition▪ Pre-acquisition shareholders’ funds of the subsidiary are eliminated onconsolidation▪ Typically provides for goodwill on consolidation▪ In the period following acquisition, the subsidiary will generate profits orlosses—to the extent that these results have been generated in the periodafter acquisition, they should be reflected in the results of the economicentity and be included within the consolidated equityResult▪ Post-acquisition earnings (unlike pre-acquisition earnings) are considered tobe part of the earnings of the economic entityHolmes InstituteApplied Business Statistics for ManagersWhat we have learned…………▪ Consolidated financial statements:▪ The concept of control▪ All controlled entities to be included in the consolidationprocess regardless of legal form and field of activities▪ Investment in subsidiary must be eliminated on consolidationagainst the pre-acquisition capital and reserves of thesubsidiary▪ Investment in subsidiary must be eliminated on consolidationagainst the pre-acquisition capital and reserves of thesubsidiary

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