Application of the Acquisition Method under FRS 103

Learning objectives:-
1 Understand the difference between investor
1. investor’s
s separate financial statements
and the consolidated statements.
2 Understand the differences in various modes of business combinations.
2. combinations
3. Understand the significance of the acquisition method under FRS 103 and its
implications for consolidation;
4. Understand special issues concerning control and identification of the
acquirer;
i
5. Know how to recognize and measure identifiable assets, liabilities, and
goodwill
d ill FRS 103 requirements;
i t
6. Understand the nature of goodwill in business combination.
R f
References
• TLK chapter 3
• FRS 110
• FRS 103
Lee Kin Wai 1

2 Levels of Reporting – Difference between Investor’s separate

financial statements and the consolidated statements

Investors separate Consolidated financial

financial statements statements
Typically < 20% FRS 27 and FRS 109 FRS 27 and FRS 109
[
[passive
i investment]
i t t]

1) Fair value through Investment carried at Investment carried at

profit or loss 1) Fair value 1) Fair value

2) Fair value through 2) Fair value 2) Fair value

other comprehensive
income

3) Amortized cost
3) Amortized cost 3) Amortized cost

4) If fair value cannot be

reliably measured 4)) Cost 4)) Cost

Lee Kin Wai 2
 2 Levels of Reporting – Difference between Investor’s separate
financial statements and the consolidated statements

Investors separate
p financial Consolidated financial
statements statements
Investment in FRS 27 FRS 28
associate Investment carried at Investment is accounted for
[significant influence] a) Cost; or using equity method
b) Financial instrument in
accordance
d with
ith FRS 109;
109 or
c) Equity method (FRS 28)

Investment in FRS 27 FRS 110

subsidiary Investment carried at Investment is eliminated and
[control] a) Cost; or net assets of subsidiary are
b) Financial
Fi i l iinstrument
t t iin consolidated with that of
accordance with FRS 109; or parent.
c) Equity method (FRS 28)

Lee Kin Wai 3

Scope of FRS 110

•FRS 110. 4:- A parent shall present consolidated financial statements.

•A parent need not present consolidated financial statements if it meets all these conditions:

(i) it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all

its other owners, including those not otherwise entitled to vote, have been informed about,
and do not object to, the parent not presenting consolidated financial statements;

(ii) its
it debt
d bt or equity
it instruments
i t t are nott traded
t d d in
i a public
bli market
k t (a
( domestic
d ti or fforeign
i
stock exchange or an over-the-counter market, including local and regional markets);

(iii) it did not file,

file nor is it in the process of filing
filing, its financial statements with a securities
commission or other regulatory organisation for the purpose of issuing any class of
instruments in a public market; and

(iv) its ultimate or any intermediate parent produces financial statements that are available for
public use, in which subsidiaries are consolidated or are measured at fair value through profit
or loss
loss.

Lee Kin Wai 4
Overview of Consolidation Process
Overview of Consolidation Process

Legal entities Economic entity

Consolidation
Adjustments and
Eliminations Consolidated
Parent’s  financial
financial  Subsidiary [will be referred  statements
statements financial  to as Consolidation
+ statements Journal Entries 
+ (CJE)] =

•Consolidation is the process of preparing and presenting the financial statements of a

group as an economic entity
•No
No ledgers for group entity
•Consolidation worksheets are prepared to:
Combine parent’s and subsidiaries financial statements
Adj
Adjust or eliminate
li i effects
ff off iintra-group transactions
i and
dbbalances
l
Allocate profit to non-controlling interests
Lee Kin Wai 5

Benefits of consolidation
- eliminates intra-group
g p transaction
– presents the financial performance of the group (economic entity)
Company P owns 100% of company S.
p y p y
Company P generates revenue by providing services ($100) to company S.
Company P recognizes $100 service revenue and company S recognizes $100 service expense.
Company P recognizes $100 service revenue and company S recognizes $100 service expense.

Consolidation entries
Consolidation entries

Income statement
Income statement P S Dr Cr
Cr. Consolidated
Service revenue 100 0 100 0
Service expense
Service expense (100) 100 0
Profit/ (loss) 100 (100) 100 100 0

Is investor likely to  Buy or sell shares ?
y y Buyy sell neutral
Lee Kin Wai 6
 Linkage between FRS 103 Business Combination and FRS 110
consolidated financial statements

FRS 103 B Business

i C
Combination
bi ti
• Establishes principles and requirements for how the acquirer:
(a) recognises and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any non-controlling interest in the
acquiree;
(b) recognises and measures the goodwill acquired in the business
combination or a gain from a bargain purchase; and
p 3 covers FRS 103.
•TLK chapter

FRS 110 consolidated financial statements

establish principles for the presentation and preparation of consolidated
•establish
financial statements when an entity controls another entity.
•FRS 110 does not deal with the accounting requirements for business
combinations and their effect on consolidation,
consolidation including goodwill arising on a
business combination (see FRS 103 Business Combinations).
•TLK chapter 4,5 and 7 covers FRS 110.

Lee Kin Wai 7

FRS 103 Business Combination

•A business combination is “a“ transaction or other event in which an

acquirer obtains control of one or more businesses”.

•FRS 103 does not apply to:

(a) the accounting for the formation of a joint arrangement in the financial
statements off the joint arrangement itself.
f
(b) the acquisition of an asset or a group of assets that does not constitute a
business.
business
(c) a combination of entities or businesses under common control.

•An acquirer has control when it has:-

1. Power over the acquiree;
2 E
2. Exposure or rights
i ht tto variable
i bl returns
t off th
the acquiree
i arising
i i ffrom th
the
acquirer’s involvement with the acquiree; and
3 Ability to use its power to affect the amount of the acquiree
3. acquiree’s
s returns.
returns
Lee Kin Wai 8
 Identifying a business combination
Identifying a business combination

•FRS
S 103.3 - An entity shall determine whether a transaction or other
event is a business combination by applying the definition in this FRS,
which requires that the assets acquired and liabilities assumed
constitute a business. If the assets acquired are not a business, the
reporting entity shall account for the transaction or other event as an
asset acquisition.

• FRS 103.B5-
103 B5 An A acquirer i can control
t l off an acquiree
i i severall ways:-
in
(a) by transferring cash, cash equivalents or other assets (including net
assets that constitute a business);
(b) by incurring liabilities;
(c) by issuing equity interests;
(d) by providing more than one type of consideration;
(e) without transferring consideration, including by contract alone
Lee Kin Wai 9

Modes of business combinations

•FRS 103.B6:- A business combination may be structured in several ways :-

(a) one or more businesses become subsidiaries of an acquirer or the net
assets of one or more businesses are legally merged into the acquirer;
(b) one combining entity transfers its net assets, or its owners transfer their
q y interests,, to another combining
equity g entity
y or its owners;;
(c) all of the combining entities transfer their net assets, or the owners of
those
h entities
i i transfer
f their
h i equity
i iinterests, to a newly
l fformed
d entity
i
(sometimes referred to as a roll-up or put-together transaction); or
(d) a group of former owners of one of the combining entities obtains control
of the combined entity
entity.
Lee Kin Wai 10
 The Acquisition Method

•FRS 103.4 – The acquirer accounts for each business combination by

pp y g the acquisition
applying q method.

•FRS
FRS 103
103.5-
5 Applying the acquisition method requires:
(a) identifying the acquirer;
(b) determining the acquisition date;
((c)) recognising
g g and measuring
g the identifiable assets acquired,
q , the
liabilities assumed and any non-controlling interest in the acquiree; and
(d) recognising and measuring goodwill or a gain from a bargain
purchase.

Lee Kin Wai 11

Identify the acquirer (See FRS 110 appendix B for details)

•The acquirer is usually the entity:
1. That transfers cash /other assets or incurs liabilities to acquire another entity;

2. That issues shares as consideration to acquire shares of another entity (an

exception to this is a reverse acquisition where the issuer is the acquiree);

3. In a business combination primarily effected through a share exchange (that is,

not through transfer of assets or assumption of liabilities);
• Whose owners hold the largest relative voting rights in a combined entity;
• Whose owners hold the largest minority voting interest in the combined entity, if
no other entity has a significant voting interest
•Whose owners have the ability to elect, appoint, or remove a majority of directors
or members of the governing body;
g
• Whose management is dominant in the combined entity;y and
• Pays a premium over the acquisition-date fair value of the equity interests of other
entity;

4. That is relatively larger in size among combining entities; and

5 That initiated the business combination.

5. combination
Lee Kin Wai 12
 Determining the acquisition date 

•FRS 103.8 - The acquirer

q shall identify
y the acquisition
q date, which is the date on
which it obtains control of the acquiree.

•The date on which the acquirer obtains control of the acquiree is generally the
date on which the acquirer legally transfers the consideration
consideration, acquires the assets
and assumes the liabilities of the acquiree — the closing date.

•However, the acquirer might obtain control on a date that is either earlier or later
than the closing date. For example, the acquisition date precedes the closing date
if a written agreement provides that the acquirer obtains control of the acquiree on
a date before the closing date.

Lee Kin Wai 13

Determine the Amount of Consideration Transferred

Consideration  Fair value of  Fair value of 

transferred = Fair value of  + Fair value of  + equity 
+ contingent 
assets  liabilities 
transferred  incurred interests  consideration/ 
/
(Note 1) (refund)
by the  issued by 
acquirer acquirer

• Note 1-
1 Fair value (FV) of the consideration transferred:
– Determined on the acquisition date
– Acquisition date is the date when the acquirer obtains control
and not the date when consideration is transferred
– Acquisition-related
A i iti l t d costs
t iincurred
dbby acquirer
i are nott iincluded
l d d
(i.e. they are expensed off in consolidated financial statements)

14
ILLUSTRATION 3.2 Fair value of equity issued
Adapted from TLK page 86.

•P
P acquires
i 100% off S through
th h an iissue off 5 5,000,000
000 000 shares
h tto th
the owners off S C
Co.
•At the date of exchange:
P Ltd S Co
•Number
Number of existing shares.
shares . . . . . . . . . . . . . . . . 10,000,000
10 000 000 2,000,000
2 000 000
•Number of new shares issued . . . . . . . . . . . . . . 5,000,000
•Market price per share. . . . . . . . . . . . . . . . . . . . $2.00
•Fair value of equity
equity. . . . . . . . . . . . . . . . . . . . . . . $30,000,000
$30 000 000 $9 000 000
$9,000,000

•Situation 1: P Ltd’s market price is a reliable indicator of the fair value of

P Ltd
Ltd’ss quoted equity.
equity
•Consideration transferred = (P’s share issue of 5,000,000 shares × Market
price of $2.00 per share) = $10,000,000

•Situation 2: Fair value of S Co is a better estimate of the fair value of the

shares acquired.
•Since
Si PL Ltd
d iis acquiring
i i 100% off the
h equity
i off S C
Co, the
h ffair
i value
l off the
h equity
i
(i.e., the fair value of S Co as a whole including the implicit goodwill) acquired
by P Ltd is $9,000,000.
•Consideration transferred = $9,000,000
Lee Kin Wai 15

Fair Value of Contingent Consideration 
g
•Contingent consideration
–Obligation
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.
g Event A: acquirer
q g
gets a refund of p
part of the consideration
transferred if the acquiree does not achieve the target profit
•Fair value of contingent consideration or refund will change as new
information arises

–Fair value of the contingent consideration has to be estimated through

determining the present value of the probability-weighted outcome. If the
contingent event leads to a refund (For example, event A) the fair value
of the refund (probability-weighted
(probability weighted outcome) is deducted from
consideration transferred.

–Fair value of contingent consideration is adjusted retrospectively as a

correction of error if events after acquisition reveal information that was
missed or misapplied as at the acquisition date
date.
16
Fair Value of Contingent Consideration
Fair Value of Contingent Consideration 
•An acquirer
q undertakes to ppayy an additional $2 million to
the vendor at the end of 3 years from acquisition date if the
annual profit of the subsidiary falls below $10 million over a
3-year period.
•Probability that annual profit will be < $10 million over the
3-year period = 0.60.
•Probability that annual profit will be >= $10 million over the
3-year period = 0.40.
•Present value factor at 5% at the end of 3 years = 0.8638.

•Fair value of contingent consideration

= 0.8638
0 8638 x [ ( $2$2,000,000
000 000 x 0
0.60)
60) + (0 x 0
0.40)
40) ]
= $1,036,560

17

Acquisition Related Costs

Acquisition‐Related Costs
•All
All acquisition-related
i iti l t d costs
t are expensed d off
ff
•Costs of issuing debt are recognized in accordance with FRS 109 (IFRS 9)
–As yield adjustment to the cost of borrowing and are amortized over
the tenure of the loan
–Journal entry for the payment of debt issuance cost

Dr Unamortized debt issuance costs

Cr Cash

• Costs of issuing equity are recognized in accordance with FRS 32 (IAS 32)
– A reduction against
g equity
q y
– Journal entry to record the payment of cost of issuing equity

Dr Equity
Cr Cash
18
 Recognising and measuring the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree

• As of the acquisition date, the acquirer shall recognise,

separately from goodwill, the identifiable assets acquired, the
li biliti assumed
liabilities d and
d any non-controlling
t lli interest
i t t in
i the
th
acquiree (FRS 103.10).
• Recognition of identifiable assets acquired and liabilities
assumed must comply with 2 conditions:-
– (1) identifiable assets acquired and liabilities assumed
must meet the definitions of assets and liabilities
– (2) identifiable assets acquired and liabilities assumed
must be part of what the acquirer and the acquiree
exchanged in the business combination transaction rather
than the result of separate transactions.
Lee Kin Wai 19

Recognising
g g and measuring
g the identifiable assets acquired,
q , the liabilities
assumed and any non-controlling interest in the acquiree

• FRS103.13:- The acquirer’s application of the recognition principle and

conditions may result in recognising some assets and liabilities that the
acquiree had not previously recognised as assets and liabilities in its
financial statements.

• For example, the acquirer recognises the acquired identifiable intangible

assets such as a brand name
assets, name, a patent or a customer relationship
relationship, that
the acquiree did not recognise as assets in its financial statements
because it developed them internally and charged the related costs to
expense.

(C) Lee Kin Wai 20
 Recognition of identifiable net assets

At acquisition date:
• Fair value differential
will be recognized in
the consolidation
Fair value
worksheet
differential
In subsequent years:
• Depreciation/amortizat
ion/cost of sale of
asset will be based on
the fair value
Book value Fair value of
recognized at the
of subsidiary’s
acquisition date
subsidiary’s identifiable
identifiable net assets These entries have to be
net assets re-enacted every year
until the disposal of
investment
21

Intangible
g Assets

• FRS 103 requires the acquirer to recognize the fair

value of an acquiree’s unrecognized identifiable asset
(e.g. intangible asset) in the consolidated financial
statements

• To qualify for recognition, the intangible asset must

either:
ith
1. Be Separable (“Separability criterion”) OR
2. Arises from contractual or other legal rights
((“Contractual-legal
g criterion”))
Example of intangible assets: Brand names and
customer relationships
22
 Intangible
ta g b e Assets
ssets

Are these considered intangible

g assets?
Assembled workforce with × No: Firm-specific and integrated
specialized knowledge with acquiree
× (Fails separability criterion)

Potential contracts or contracts × No: Fails separability or

under negotiation contractual-legal criterion

Opportunity gains from an  Yes: Meets the contractual-legal

operating lease in favorable criterion
market conditions
Customer and subscriber lists of  Yes: Meets the separability
acquiree
i criterion
it i ((show
h evidence
id off
exchange transactions for
similar types of lists)
23

Contingent liabilities
•FRS 103.22:- FRS 37 Provisions, Contingent Liabilities and Contingent Assets defines a
contingent liabilit
liability as
as:
(a) a possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.

•FRS 103.23:-
103 23:
•The requirements in FRS 37 do not apply in determining which contingent
liabilities to recognise as of the acquisition date. Instead, the acquirer shall
recognise i as off th
the acquisition
i iti date
d t a contingent
ti t liability
li bilit assumed
d iin a b
business
i
combination if it is a present obligation that arises from past events and its fair
value can be measured reliably.
•Therefore, contrary to FRS 37, the acquirer recognises a contingent liability
assumed in a business combination at the acquisition date even if it is not
probable that an outflow of resources embodying
p y g economic benefits will be
required to settle the obligation.
(C) Lee Kin Wai 24
Indemnification assets
•In a business combination, the former owners of the acquiree may provide a
contractual indemnity to the acquirer to make good any subsequent loss arising
from a contingency or an asset or a liability.
liability

•FRS 103.27 :- Accounting for the indemnity:

•1.
1 The acquirer
acq irer has to recogni
recognize e an “indemnification asset” at the same time that
the acquirer recognizes the indemnified asset or liability.
•2. The indemnification asset has to be measured on the same basis as that of the
indemnified asset or liability, that is, at acquisition-date fair value.

q
•At each subsequent reporting
p gpperiod,, the acquirer
q remeasures the carrying
y g
amount of the indemnification asset on the same basis as that of the indemnified
asset or liability. The indemnification asset is derecognized when the acquirer
receives the proceeds or loses right to the asset (FRS 103.57).
103 57)

•Example: An acquiree is exposed to a contingent liability. The FV of the contingent

liability is $100
$100,000.
000 The former owners provide a contractual guarantee to
indemnify the acquirer of the loss. In the consolidated balance sheet, the acquirer
recognizes contingent liabilities and an indemnification asset of $100,000 at FV.

Lee Kin Wai 25

Deferred Tax Relating to Fair Value Differentials of Identifiable

Assets and Liabilities

• The recognition
g of fair value differential may
yggive rise to future
tax payable or future tax deduction
– tax effects need to be accounted for because the basis for
taxation does not change in a business combination
– The excess of fair value over book value of identifiable net
assets will g
give rise to a taxable temporary
p y difference
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

• No deferred tax liability is recognized on goodwill (permanent

difference).
difference)
26
Non-controlling
Non controlling Interests

• Non-controlling
Non controlling interests (NCI) arises when acquirer obtains control
of a subsidiary but does not have full ownership of voting rights.

• In a business combination, NCI are recognized by the acquirer as

equity based on the following equation.
– Rationale: To represent outside interests’ share in the net assets
of the acquiree
Assets – Liabilities = Equity
Carrying amount of Acquirer s
Acquirer’s
Carrying amount of
acquirer’s assets equity
acquirer’s liabilities
+ +
+
Acq date FV of NCI
C share off
Acq date of FV of
acquiree’s equity of
acquiree’s
identifiable assets + acquiree
identifiable liabilities
Goodwill
27

Non-controlling Interests
• FRS 103 : 2 methods to measure NCI at acquisition date :-
1 Fair value; or
1.
2. The present ownership instruments’ proportionate share in the 
recognized amount of identifiable assets

Fair value method Proportionate share of identifiable

assets method
• Obtain a reliable measure • Applies present ownership
of fair value of NCI (e
(e.g.
g interests held by NCI to the
quoted price in active recognized amounts of identifiable
market) net assets to determine initial
amount of NCI
• In absence of quoted price,
use valuation techniques to • If NCI have potential ordinary
value NCI (e.g. peer shares, they should be measured
companies’ valuation or at fair value
appropriate assumptions)
28
 Fair Value Method of Non-controlling
Non controlling Interests

• Typically the fair value of NCI as at acquisition date is

as follows:

Fair value of
Fair value of
Percentage acquiree as
NCI at
acquisition
= shareholding
h h ldi x att
of NCI acquisition
date
date

• Fair value of NCI as at acquisition date would not be

proportional to the fair value of consideration
t
transferred
f d by
b the
th acquirer
i to
t obtain
bt i control.
t l
– Rationale: The consideration transferred would
include a control premium
29

Goodwill

• A premium that an acquirer pays to achieve synergies from business

combination
– Must be recognized separately as an asset
– Determined as a residual

• FRS 103 allows 2 ways of determining goodwill:

Goodwill = Fair value of consideration transferred – Acquiree’s recognized 

+ net identifiable assets 
Fair value of non‐controlling interests
Fair value of non‐controlling interests measured based on 
measured  based on
+ FRS 103
Fair value of the acquirer’s previously held 
q
interest in the acquiree

Fair value of non‐ Measured at fair value at acquisition date 
controlling interests
lli i (include goodwill)
(include goodwill)

Measured as a proportion of identifiable assets 
as at acquisition date
as at acquisition date

30
 Example 1 - consolidation - 100% ownership at book value
Case 1 - consolidation - 100% ownership at book value
Company P paid $600,000 to purchase 100% of the share capital of Company S on 31-12-20X1.
The balance sheet at acquisition date is given below.

Share capital of company S at acquisition date 100,000

Retained earnings of company S at acquisition date 500,000
Fair value differential of company S net assets at acquisition date 0
Fair value of identifiable net assets of subsidiary - 100% 600,000

Investment by P in S (given) 600,000

y 100%
Fair value of net identifiable assets of subsidiary- ((600,000)
, )
Goodwill on consolidation (P) 0

E1
Dr Share capital 100,000
Dr Retained earnings 500,000
D G
Dr Goodwill
d ill 0
Cr Investment in S 600,000
[ eliminate investment in S ]
600,000 600,000

Balance sheet as at 31-12-20X1 Company P Company S Dr Cr. Note Consolidated

Cash 340,000 250,000 590,000
Account receivable 60,000 180,000 240,000
Investment in company S at cost 600,000 0 600,000 E1 0
Building 900,000 200,000 1,100,000
Goodwill 0 0 0
Total assets 1,900,000 630,000 1,930,000

Accounts payable 800,000 30,000 830,000

0
Share Capital 200,000 100,000 100,000 E1 200,000
Retained earnings 900,000 500,000 500,000 E1 900,000
Non-controlling interests 0 0 0
Total liabilities and equity 1,900,000 630,000 600,000 600,000 1,930,000

Check : A = L + E 0 0 0 0

As acquisition date is on 31-12-20X1, the P group has no share of company S net profit in year ended 31-12-20X1 (ie 1-1-20x1 to 31-12-20x1).
The consolidated income statement of P Group consists of P's net profit for the year ended 31-12-20x1 (ie 1-1-20x1 to 31-12-20x1).
The consolidated income statement of P Group exclude company S net profit for the year ended 31-12-20x1 (ie 1-1-20x1 to 31-12-20x1).
Lee Kin Wai 31

Example 2 - consolidation - 70% ownership at book value

Example 2 - consolidation - 70% ownership at book value
Company P paid $ 420,000 to purchase 70% of the share capital of Company S on 31-12-20X1.
The balance sheet at acquisition date is given below.

Share capital of company S at acquisition date 100,000

Retained earnings of company S at acquisition date 500,000
Fair value differential of company S net assets at acquisition date 0
Fair value of identifiable net assets of subsidiary- 100% 600,000
Fair value of identifiable net assets of subsidiary- 70% 420,000
Fair value of identifiable net assets of subsidiary- 30% 180,000

Investment by P in S (given) 420,000

Fair value of identifiable net assets of subsidiary- 70% (420,000)
Goodwill on consolidation (P) 0

E1
Dr. Share capital 100,000
Dr. Retained earnings 500,000
Dr. Goodwill 0
Cr. Investment in S 420,000
Cr. Non-controlling Interests (B/S) 180,000
[ eliminate investment in S ] 600,000 600,000
Non-controlling Interests (B/S) has a 30% share of the fair value of the identifiable net assets of the subsidiary.

Balance sheet as at 31-12-20X1

31 12 20X1 Company P Company S Dr Cr
Cr. Note Consolidated
Cash 520,000 250,000 770,000
Account receivable 60,000 180,000 240,000
Investment in company S at cost 420,000 0 420,000 E1 0
Building 900,000 200,000 1,100,000
Goodwill 0 0 0
Total assets 1 900 000
1,900,000 630 000
630,000 2 110 000
2,110,000

Accounts payable 800,000 30,000 830,000

0
Share Capital 200,000 100,000 100,000 E1 200,000
Retained earnings 900,000 500,000 500,000 E1 900,000
Non controlling interests
Non-controlling 0 0 180 000 E1
180,000 180 000
180,000
Total liabilities and equity 1,900,000 630,000 600,000 600,000 2,110,000

Check : A = L + E 0 0 0 0
Non-controlling Interests (B/S) is measured on proportionate share of net identifiable assets of subsidiary
As acquisition date is on 31-12-20X1, the P group has no share of company S net profit in year ended 31-12-20X1 (ie 1-1-20x1 to 31-12-20x1).
Th consolidated
The lid t d iincome statement
t t t off P Group
G consists
i t off P's
P' nett profit
fit for
f the
th year ended
d d 31-12-20x1
31 12 20 1 (i
(ie 1
1-1-20x1
1 20 1 tto 31
31-12-20x1).
12 20 1)
The consolidated income statement of P Group exclude company S net profit for the year ended 31-12-20x1 (ie 1-1-20x1 to 31-12-20x1).

Lee Kin Wai 32
 Example 3 - consolidation - (1) 70% ownership with fair value
differential in subsidiary
y net assets; ((2)) No g
goodwill
Example 3 - consolidation - (1) 70% ownership with fair value differential in subsidiary net assets; (2) No goodwill
Company P paid $ 532,000 to purchase 70% of the share capital of Company S on 31-12-20X1.
Excess of fair value over book value of building of Company S as at acquisition date was $200,000.
Th balance
The b l sheet
h t att acquisition
i iti d
datet iis given
i b
below.
l T
Tax rate
t iis 20%
Assume NCI is measured based on its proportionate share of fair value of identifiable net assets of S.
Share capital of company S at acquisition date 100,000
Retained earnings of company S at acquisition date 500,000
Fair value differential of company S net assets at acquisition date 200 000
200,000
Deferred tax liability of fair value differential (40,000)
Fair value of identifiable net assets of subsidiary- 100% 760,000 A
Fair value of identifiable net assets of subsidiary- 70% x A 532,000 B
Fair value of identifiable net assets of subsidiary
subsidiary- 30% x A 228 000 C
228,000

Investment by P in S (given) 532,000 D

Fair value of identifiable net assets of subsidiary- 70% (532,000) B
Goodwill on consolidation (P) 0 E=D-B

E1
Dr. Share capital 100,000
Dr
Dr. Retained earnings 500 000
500,000
Dr. Building 200,000
Dr. Goodwill 0
Cr. Investment in S 532,000
Cr Deferred tax liability
Cr. 40 000
40,000
Cr. Non-controlling Interests (B/S) 228,000
[ eliminate investment in S ] 800,000 800,000
Non-controlling Interests (B/S) has a 30% share of the fair value of the identifiable net assets of the subsidiary.
Non-controlling
Non controlling Interests (B/S) is measured on proportionate share of net identifiable assets of subsidiary
Non-controlling Interests (B/S) has no share of goodwill

Lee Kin Wai 33

Example 3 - consolidation - (1) 70% ownership with fair value differential

in subsidiary net assets; (2) No goodwill

Balance sheet as at 31-12-20X1 Company P Company S Dr Cr. Note Consolidated

Cash 380,000 250,000 630,000
Account receivable 60,000 180,000 240,000
Investment in company S at cost 532,000 0 532,000 E1 0
Building 900,000 200,000 200,000 E1 1,300,000
Goodwill 0 0 0
Total assets 1,872,000 630,000 2,170,000

Accounts payable 772,000 30,000 802,000

Deferred tax liability 40,000 E1 40,000
0
Share Capital 200,000 100,000 100,000 E1 200,000
Retained earnings 900,000 500,000 500,000 E1 900,000
Non-controlling interests 0 0 228,000 E1 228,000
Total liabilities and equity 1,872,000 630,000 800,000 800,000 2,170,000

Check : A = L + E 0 0 0 0
As acquisition date is on 31-12-20X1, the P group has no share of company S net profit in year ended 31-12-20X1 (ie 1-1-20x1 to 31-12-20x1).
The consolidated income statement of P Group consists of P's net profit for the year ended 31-12-20x1 (ie 1-1-20x1 to 31-12-20x1).
The consolidated income statement of P Group exclude company S net profit for the year ended 31-12-20x1 (ie 1-1-20x1 to 31-12-20x1).

Lee Kin Wai 34
Example 4 - consolidation - (1) 70% ownership with fair value differential
in subsidiary net assets; (2) P goodwill; (3) NCI has no share of goodwill
goodwill.

Lee Kin Wai 35

Example 4 - consolidation - (1) 70% ownership with fair value differential

in subsidiary net assets; (2) P goodwill; (3) NCI has no share of goodwill.

Lee Kin Wai 36
Example 5 - (1) 70% ownership ; (2) NCI at Fair Value of subsidiary;
(3) P did not pay a control premium.

Lee Kin Wai 37

Example 5 - (1) 70% ownership ; (2) NCI at Fair Value of subsidiary;

(3) P did not pay a control premium.

Lee Kin Wai 38
Example 6 - (1) 70% ownership ; (2) NCI at Fair Value of subsidiary;
(3) P paid a control premium.
premium

Lee Kin Wai 39

Example 6 - (1) 70% ownership ; (2) NCI at Fair Value of subsidiary;

premium
(3) P paid a control premium.

Lee Kin Wai 40
 TLK Illustration 3.3 page 93
Recognition of contingent liability and indemnification asset

•On 1 January 20x3, Prism acquired control of Apex from Valley. On acquisition
d t A
date, Apex h
had
d an obligation
bli ti to t pay license
li fees
f to
t Crimson
Ci ((a thi
third
d party)
t )b
butt
the amount of the fees was in dispute. The dispute was to be settled through an
independent arbitrator. The expected date of settlement was 31 December
20x5. Legal counsel had advised Apex on the likelihood of the outcome as:-
•Outcome Probability Settlement
•Worst case settlement . . . . . . . . . . . . . . . . . . . . . . . . . 0.20 $
$500,000
,
•Moderate case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.10 200,000
•Best case settlement . . . . . . . . . . . . . . . . . . . . . . . . . .. 0.70 0

•As a result of the unresolved fee dispute, Valley agreed to reimburse Prism for
the final settlement amount in the moderate or worst case settlement.

•On 31 December 20x4, legal counsel advised that the likelihood of the
moderate case situation has increased to 0.40 while the likelihood of the best
case settlement is decreased to 0.40.

•On 31 December 20x5, the arbitrator awarded $200,000 to Crimson.

•The cost of capital of Apex is 5% per annum throughout 20x3 to 20x5.
Lee Kin Wai 41

TLK Illustration 3.3 page 93

Recognition of contingent liability and indemnification asset
Determination of fair value of provision and indemnification asset on 1 January 20x3
1 2 3 = (1) x (2)
scenario probability Payment Expected value
worst case 0.20 500,000 100,000
moderate case 0.10 200,000 20,000
best case 0.70 0 0
1.00
Expected value 120,000

expected period (years) 3

p
cost of capital - Apex
p ((who has obligation
g to p
pay
y disputed
p fee)) 0.050
Present value of expected value 103,661

Amortization of interest (before change in estimate)

A B = A X 5% C=A+B
Bond
carrying
value at Interest Bond carrying
start of expense @ value at end of
Year year effective rate year
20x3 103,661 5,183 108,844
20x4 108,844 5,442 114,286
20x5 114 286
114,286 5 714
5,714 120 001
120,001
total 16,340
Assumptions in solution:-
a) At the company level, based on FRS 37 , Prism did not recognize contingent assets in its separate accounts.
b)) Similarly,
y, at the company
p y level,, based on FRS 37,, Apex
p did not recognize
g the contingent
g liability
y in its separate
p account.
Thus the following entries are in Prism's consolidated accounts.

Lee Kin Wai 42
 TLK Illustration 3.3 page 93
Recognition of contingent liability and indemnification asset
1 Jan 20x3
Dr. indemnification asset 103,661
Cr. Provision for license fee (liability) 103,661

31 Dec 20x3
Dr. interest expense (P/L) 5,183
Cr. Provision for license fee (liability) 5,183

Dr. indemnification asset 5,183

Cr. Interest income (P/L) 5,183

31 Dec 20x4
Dr. interest expense (P/L) 5,442
Cr. Provision for license fee (liability) 5,442

Dr. indemnification asset 5,442

Cr. Interest income (P/L) 5,442

Carrying amount of liability before adjustment

1 Jan 20x3 103,661
31 Dec 20x3 5,183
31 Dec 20x4 5,442
Carrying amount of liability @31-12-20x4 before adjustment = 114,286 K

Determination of fair value of provision and indemnification asset on 31 Dec 20x4

(1) (2) 3 = (1) x (2)
scenario probability Payment Expected value
worst case 0.20 500,000 100,000
moderate case 0.40 200,000 80,000
best case 0 40
0.40 0 0
1.00
Expected value 180,000

expected period (years) from 31-12-20x4 to 31-12-20x5 1

cost of capital - Apex (who has obligation to pay disputed fee) 0.050
Present value of expected value @ 31-12-20x4 171,429 L
less:-
Carrying amount of liability @31-12-20x4 before adjustment = 114,286 K
Adjustment to get L 57,143 M = L - K
Carrying amount of liability @31-12-20x4 after adjustment = 171,429

31 dec 20x4
Dr. indemnification asset 57,143
Cr. Provision for license fee (liability) 57,143
Adjustment to get L

Lee Kin Wai 43

TLK Illustration 3.3 page 93

Recognition of contingent liability and indemnification asset

31 dec 20x5
Carrying
y g amount of liabilityy @
@31-12-20x4 after adjustment
j = 171,429
, Q
interest expense in 20x5 = 0.05 x Q 8,571
Carrying amount of liability @31-12-20x5
@31 12 20x5 = 180,000

31 dec 20x5
Dr. interest expense (P/L) 8,571
Cr Provision for license fee (liability)
Cr. 8 571
8,571

Dr. indemnification asset

Dr 8 571
8,571
Cr. Interest income (P/L) 8,571

Lee Kin Wai 44
 TLK Illustration 3.3 page 93
Recognition of contingent liability and indemnification asset

Fi l settlement
Final ttl t amountt (arbitrator
( bit t awarded
d d $200
$200,000
000 tto C
Crimson)
i ) 200
200,000
000
Carrying amount of liability @31-12-20x5 = 180,000
Adjustment from carrying amount to final settlement amount 20,000

On 31 Dec 20x5, the difference between estimated amount and final

settlement
ttl t is
i recognised
i d as gain/i / (l
(loss)) on settlement:-
ttl t
Dr. Loss on settlement 20,000
Dr. Provision for license fee (liability) 180,000
Cr. Cash 200,000
[ Settlement on liability on arbitration. ]

Dr. Cash 200,000

Cr. Indemnification asset 180,000
Cr. Gain on settlement 20,000
[Settlement of indemnification asset ]

Lee Kin Wai 45

TLK – Illustration 3.4 Direct acquisition of net assets of a business

•On 1 July 20x1, Diamond Co and Gold Co concluded on an agreement to transfer the business of Gold Co to Diamond Co in
exchange for consideration to be transferred by Diamond Co to Gold Co as follows:
•(a) Issue of 1,000,000 ordinary shares of Diamond Co to Gold Co on 1 July 20x1, the fair value per share of Diamond Co
was $10 per share
share.
•(b) Additional payment by Diamond Co to Gold Co if the business achieves the following profit benchmarks during the
financial year ending 31 December 20x2:
•Benchmarks Payment Probability
•Profit
Profit greater than $30
$30,000,000
000 000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6 $6,000,000
000 000 0
0.60
60
•Profit between $15,000,000 and $30,000,000 . . . . . . . . . . . . . . . . . . . 3,000,000 0.30
•Profit below $15,000,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0.10
•The cost of capital of Diamond Co was 5% per annum while that of Gold Co was 10% per annum.

•(c) Transfer of title deeds of freehold land. The fair value of the land on 1 July 20x1 was $30,000,000 while the carrying
amount at cost in Diamond Co’s books was $25,000,000.

•(d) Immediate payment of cash of $5,000,000.

•Consultants who performed a due diligence check provided the following fair value information as at 1 July 20x1. Deferred
tax liabilities include the additional deferred tax liabilities arising from the acquisition.
•Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000,000
•Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . 25,000,000
•Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . 6,000,000
•Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,900,000
•Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000,000
•Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $52,900,000
•Deferred
D f d ttax liabilities
li biliti . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1 1,800,000
800 000
•Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000,000
•Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . 3,200,000
•Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,600,000
•Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $32
$32,600,000
600 000
•Fair value of identifiable net assets . . . . . . . . . . . . . . . . . . . . . .. $20,300,000
Lee Kin Wai 46
 TLK – Illustration 3
3.4
4 Direct acquisition of net assets of a business

Required:
1. Determine the fair value of the contingent consideration as at 1 July 20x1.

2. Determine the fair value of consideration transferred by Diamond Co to Gold Co as at 1

2
July 20x1.

3. Determine the goodwill to be recognized by Diamond Co as at 1 July 20x1.

4. Assume that the consideration was transferred in full on 1 July 20x1, show the journal
entries that have to be p
passed by
y Diamond Co to record the acquisition.
q

5. Show the journal entries that have to be passed by Diamond Co during the year ended
31 December 20x2, assuming the following information:
(a) Property, plant, and equipment had an average remaining useful life of ten years from
acquisition date.
(b) Intangible assets had indefinite useful life. On 31 December 20x2, the recoverable
amount of the intangible assets was $20,000,000.
$
(c) Seventy percent of the inventory was sold during 20x2.
(d) On 31 December 20x2, the acquired business earned a profit of $32,000,000.

Lee Kin Wai 47

TLK – Illustration 3.4 Direct acquisition

q of net assets of a business

1. Determination of the fair value of the contingent consideration

1 2 3 = (1) x (2)
scenario probability Payment Expected value
profit >= 30,000,000
30 000 000 0 60
0.60 6 000 000
6,000,000 3 600 000
3,600,000
15,000,000<= profit < 30,000,000 0.30 3,000,000 900,000
profit < 15,000,000
15 000 000 0 10
0.10 0 0
1.00
Expected value 4 500 000
4,500,000

expected
p pperiod (y
(years)) 1.50
cost of capital - Diamond (who needs to pay to Gold) 0.050
Present value of expected value = FV contingent consideration = 4,182,429

Lee Kin Wai 48
 TLK – Illustration 3.4 Direct acquisition
q of net assets of a business

2. Determination of the fair value of consideration transferred

Fair value
al e of equity
eq it securities
sec rities . . 10,000,000
10 000 000 Data 1A = 1,00,000
1 00 000 shares x $1 per share
Fair value of contingent consideration 4,182,429 per part 1 above
Fair value of land transferred . . 30 000 000
30,000,000 Data 1 C
Cash 5,000,000 Data 1 D
Fair value of consideration transferred 49,182,429
•FRS 103
•39 -The consideration the acquirer transfers in exchange for the acquiree includes
any asset or liability resulting from a contingent consideration arrangement (see
paragraph 37). The acquirer shall recognise the acquisition-date fair value of
contingent consideration as part of the consideration transferred in exchange for the
acquiree.
•40 -The
The acquirer shall classify an obligation to pay contingent consideration that
meets the definition of a financial instrument as a financial liability or as equity on the
basis of the definitions of an equity instrument and a financial liability in paragraph 11
of FRS 32 Financial Instruments: Presentation.

Lee Kin Wai 49

TLK – Illustration 3
3.4
4 Direct acquisition of net assets of a business

3. Determination of goodwill
Fair value of consideration transferred 49,182,429 per part 2 above
less
Fair value of identifiable net assets (FVINA) 20,300,000 Given - Note FVINA = FV assets less FV liabilities
Goodwill 28,882,429

FRS 103
32 The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:
( ) the aggregate of:f
(a)
(i) the consideration transferred measured in accordance with this FRS, which generally requires acquisition-date fair value (see paragraph 37);
(ii(ii)) the amount
amo nt of an
any non
non-control
controlling
ling interest in the acq
acquiree
iree meas
measured
red inin accordance with
ith this FRS
FRS; and
(iii) in a business combination achieved in stages (see paragraphs 41 and 42), the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.
(b) the net of the acquisition-date
ion date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this FRS
FRS.
Lee Kin Wai 50
 TLK – Illustration 3.4 Direct acquisition of net assets of a business
4. Jo
4 Journal
rnal entries in 20x1 20 1
The acquirer’s journal entries to record the acquisition are as follows:
1 July 20x1
Dr Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000
Cr Remeasurement g gain . . . . . . . . . . . . . . . 5,000,000
, ,
Remeasurement of land before transfer.

1 July 20x1
Dr. Goodwill 28,882,429 per item (3) above
D
Dr. P
Property,
t plant
l t and
d equipment
i t 10 000 000
10,000,000 given
i - pg. 102
Dr. Intangible assets 25,000,000 given - pg. 102
Dr. Inventory 6,000,000 given - pg. 102
Dr. Accounts receivable 8,900,000 given - pg. 102
Dr. Unamortized discount 317,571
, Note 1
Cr. Loans 20,000,000 given - pg. 102
Cr. Provisions 3,200,000 given - pg. 102
Cr. Accounts payable 7,600,000 given - pg. 102
Cr. Share capital 10,000,000 given - pg. 102
C
Cr. C
Contingent
ti t consideration
id ti paymentt 4 500 000
4,500,000 N t 1
Note
Cr. Land 30,000,000 Data 1C
Cr. Cash 2,000,000 Note 2
Cr. Deferred tax liability 1,800,000 given - pg. 102
79 100 000
79,100,000 79 100 000
79,100,000
Note 1
See item 1 on computation of contingent consideration
Expected value (undiscounted) 4,500,000
Present value of expected value = FV contingent consideration = 4,182,429
Difference = unamortized discount 317,571

Note 2
Cash paid by Diamond to Gold - given 5,000,000 data 1 D
Cash acquired = cash balance in Gold 3 000 000 given - pg
3,000,000 pg. 102
Cash paid less cash acquired 2,000,000
Lee Kin Wai 51

TLK – Illustration 3.4 Direct acquisition of net assets of a business

Data 5A
FV plant and equipment 10,000,000
useful life in years 10
annual depreciation 1,000,000

Dr. Depreciation expense 1,000,000

C
Cr. A
Accumulated
l t d d
depreciation
i ti 1 000 000
1,000,000
Depreciation of property, plant and equipment

Data 5 B
F i value
Fair l of
f iintangible
t ibl assets
t 25 000 000
25,000,000 given
i page 102
less
recoverable amount 20,000,000 data 5 B
impairment loss 5,000,000

Dr. Impairment loss 5,000,000

Cr. Accumulated amortization and impairment 5,000,000
Impairment loss on intangible assets

Data 5C
Fair value of inventory 6,000,000 given page 102
% sold 0.700 Data 5C
cost of sales 4 200 000
4,200,000

Dr. Cost of sales 4,200,000

Cr. Inventory 4,200,000
Cost of sales on inventory

Lee Kin Wai 52
TLK – Illustration 3
3.4
4 Direct acquisition of net assets of a business

contingent consideration (liability)

liability Interest expense
carrying value @ effective rate liability carrying value
Year at start of year 5% per year at end of year
1 july 20x1 4 182 429
4,182,429
31 december 20x1 4,182,429 104,561 4,286,990
31 december 20x2 - rounded 4,286,990 213,010 4,500,000
total 317,571

20x2
Dr. Interest expense 213,010
Cr Unamortized discount 213 010
213,010
Interest expense on contingent consideration

Data 5 D - actual 20x2 p profit = 32,000,000

, ,
Data 1 B - If profit 20x2 > 30,000,000, Diamond must pay 6,000,000 to Gold
20x2
Dr Loss on settlement (P/L) 1,500,000 =6,000,000 - 4,500,000
zerorise
i contingent
ti t
Dr Contingent consideration 4,500,000 consideration - item 1
Cr Cash 6,000,000 Data 1 B
Settlement of contingent consideration.

Lee Kin Wai 53

TLK – Illustration 3.5 Acquisition of a subsidiary

•On 1 July 20x1, P Co purchased 1,500,000 shares from S Co’s existing

owners The total number of shares issued by S Co was 2,000,000.
owners. 2 000 000 A
reliable measure of the fair value of S Co’s share was $10.00 per share.

•P Co was obligated to pay an additional $1,000,000 to the vendors of S

Co if S Co maintained existing profitability over the subsequent two years
from 1 July 20x1.
20x1 It was highly likely that S Co would achieve this
expectation and the fair value of the contingent consideration was
assessed at $1,000,000.

•Fair value of non-controlling interests as at 1 July 20x1 was $5,000,000.

•The identifiable net assets of S Co as at 1 July 20x1 are shown below.

•Tax effects on fair value differences have not yet been recognized.
recognized The tax
effects on fair value differences are to be recognized on the basis that the
tax bases of the identifiable assets acquired and liabilities assumed are not
affected
ff t d by
b the
th business
b i combination.
bi ti A
Assume a ttax rate
t off 20%.
20%
Lee Kin Wai 54
 TLK – Illustration 3.5
3 5 Acquisition of a subsidiary

1. Determine the acquirer’s interest in the acquiree.

Number of shares acquired
q byy P 1,500,000
, ,
Shares in S (100%) 2,000,000
Percentage ownership in S 0.750

22. Determination of the consideration transferred

Number of shares acquired by P 1,500,000
S Price per share
S- 10 00
10.00
Fair value of shares acquired 15,000,000
add:
dd ffairi value
l off contingent
ti t consideration
id ti 1 000 000 given
1,000,000 i
Consideration transferred = 16,000,000
Lee Kin Wai 55

TLK – Illustration 3.5

3 5 Acquisition of a subsidiary

33. Determination of goodwill

Fair value of identifiable assets in company S -100% 16,350,000
less Fair value of identifiable liabilitiess in company S -100% (2,000,000)
F i value
Fair l off id
identifiable
tifi bl nett assets t (FVINA) iin company S -100%
100% 14 350 000
14,350,000
less deferred tax liability on fair value differential
= 20% tax rate x (Fair value less book value of company S 100%)
=20%
20% x (11
(11,200,000
200 000 - 500,000)
00 000) (2 1 0 000)
(2,140,000)
After tax Fair value of identifiable net assets (FVINA) in company S -100% 12,210,000 #

Consideration transferred by P 16,000,000 per item (2) above

fair value of non-controlling interest at acquistion date 5,000,000 given

total consideration transferred by P and fair value of non-controlling interest

at acquistion date 21,000,000
less
After tax Fair value of identifiable net assets (FVINA) in company S -100% (12,210,000) #
Goodwill 8,790,000

Lee Kin Wai 56
TLK – Illustration 3.5
3 5 Acquisition of a subsidiary

CConsolidation
lid ti journal
j l entry
t [CJE]
Dr.. Share capital (S) 2,000,000 Share capital S -100%
Dr. Retained earnings (S) 1,650,000 Retained Earning S - 100%
Dr. Goodwill 8,790,000 per item (3) above
Dr. In-process research and development 10,000,000 fair value differential
Dr. Other intangible assets 1,300,000 fair value differential
Dr. Inventory 150,000 fair value differential
Cr Plant and equipment
Cr. 200,000
200 000 fair value differential
Cr. Accounts receivable 50,000 fair value differential
Cr. Contingent liabilities 500,000 fair value differential
Cr. Investment in S 16,000,000 per item (3) above
Cr. Deferred tax liability 2,140,000 per item (3) above
Cr Non-controlling
Cr. Non controlling interests (B/S) 5 000 000
5,000,000 given
[ eliminate investment in S at acquistion date ]
, ,
23,890,000 23,890,000
, ,

Lee Kin Wai 57

G i f
Gain from a Bargain Purchase
B i P h
• A gain from bargain purchase arises when:

Fair value of consideration transferred

+
Fair value of non-controlling
+
non controlling interests

Fair value of the acquirer’s previously

held interest in the acquiree
< Fair value of
id tifi bl nett
identifiable
assets

• Gain on bargain purchase = A windfall gain to acquirer

• The acquirer must re-assess the fair value of identifiable net assets,
consideration transferred and non-controlling interests.

• If there is no measurement error, the gain will be recognized

immediately in the income statement
58
 TLK – Illustration 3.6 - Gain from a bargain purchase

•P Co, a venture capitalist, paid $600,000 to acquire an 80% interest in S Co. S

Co had been p plagued
g by
y many y troubles, including
g a lawsuit from a competitor
p
for patent infringement. S Co was adjudged to be guilty but was appealing
against the judgment. In view of the uncertainty of the outcome of the lawsuit
and its impact on the future viability of S Co, the existing owner of S Co was
willing to sell the company at a discount to its net fair value
value. The fair values of
the identifiable net assets, non-controlling interests, and the consideration
transferred were reassessed and deemed to be reliably determined. Hence, the
gain arising
g g was taken to the income statement in the yyear of the acquisition.
q
Fair value of non-controlling interests as at acquisition date was $150,000.
•Consideration transferred (A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $600,000
•Fair value of nonnon-controlling
controlling interests (B)(B). . . . . . . . . . . . . . . . . . . . . 150
150,000
000
• Fair value Book value
•Assets. . . . . . . . . . $5,000,000 $5,000,000
•Liabilities. . . .. . . . . . . . . ((3,000,000)
, , ) (3,000,000)
( , , )
•Contingent liabilities. . . . . .(600,000) 0
•Identifiable net assets . . . 1,400,000 $2,000,000
•Share capital
capital. . . . . . . . . . . 500
500,000
000
•Retained earnings. . ……………………. 1,500,000
•Equity. . . . . . . . . . . $2,000,000
•Excess
Excess of book value over fair value. . . . . . . . (600,000)

Lee Kin Wai 59

TLK – Illustration 3.6 - Gain from a bargain purchase

Determination of goodwill
Fair value of identifiable assets in company S -100% 5,000,000
less Fair value of identifiable liabilities in company S -100% (3,600,000)
Fair value of identifiable net assets ((FVINA)) in company
p y S -100% 1,400,000
, ,
ADD - deferred tax ASSET on fair value differential
= 20% tax rate x (Fair value less book value of company S 100%)
=20% x (contingent liabilites 0 - 600,000 ) 120,000 @
After tax Fair value of identifiable net assets (FVINA) in company S -100%
100% 1,520,000
1 520 000 #

Consideration transferred by P 600,000 given

f i value
fair l off non-controlling
t lli iinterest
t t att acquistion
i ti d date
t 150 000 given
150,000 i
total consideration transferred by P and fair value of non-controlling interest
at acquistion date 750,000
less
After tax Fair value of identifiable net assets (FVINA) in company S -100% (1,520,000) #
Goodwill / (GAIN ON BARGAIN PURCHASE) (770,000) &&

Consolidation jjournal entryy [[CJE]]

Dr. Share capital (S). . . . 500,000 Share capital S -100%
Dr. Retained earnings (S) . . 1,500,000 Retained Earning S - 100%
Dr. deferred tax asset 120,000 @
Cr. Contingent liabilities . 600,000 given
Cr. GAIN ON BARGAIN PURCHASE (P/L) 770,000 &&
Cr. Investment in S . . . . . 600,000 given
Cr. Non-controlling interests (B/S) 150,000 given
eliminate investment in S at acquistion date
2,120,000 2,120,000
Lee Kin Wai 60