F2 Advanced Financial Reporting

Module: 12
Piecemeal Acquisitions
1. Overview
Introduction
On August 10, 2015, Google Inc. announced plans to create a new public holding
company (or parent company), named Alphabet Inc. Google CEO Larry Page
made this announcement in a blog post on Google's official blog.

The aim for the creation of this new holding company was to restructure Google by
moving subsidiaries from Google to Alphabet, narrowing Google's scope.
Essentially, this would allow Google to focus on their core web and tech products,
whilst fringe projects (such as Google glass or driver-less cars) would fall under
some other subsidiary within the Alphabet group.

However, Google own a whole range of subsidiaries (in fact, Google have been
party to almost 200 mergers and acquisitions since 2001!). So, the creation of
Alphabet Inc. was actually quite a significant re-structure.

In this chapter, the goal is to go through some of the most important types of
restructure and show you how this is accounted for. Maybe someday you'll be
working for the next Google, and you'll come back to your core knowledge on
changes in group structure!

Group structure changes

The structure of a group can change in numerous ways. We have seen an example
of this in complex groups where acquisitions have happened part way through the
year. Group structure change will impact the degree of control. A group
can change in the following manner:

• Increasing an existing investment (piecemeal acquisition). For

example, a parent increasing the shareholding in a subsidiary from 75%
to 100%.

• Decreasing an existing investment (disposals: full or partial).

For example, a parent decreasing an investment in a subsidiary from 75%
to 50%.

• Group re-organisations. For example, the creation of a new parent

company, as was the case with Alphabet Inc.

A number of scenarios exist for each of the above leading to the formation of a
trade investment (financial asset), associate or subsidiary.
Accounting for group structure changes
The challenge here is recognising how to account for:

• Piecemeal acquisition: The goodwill impact of an additional stake;

non-controlling interest; retained earnings; changes in equity ownership.

• Disposals: Profit on sale in the parent and group accounts; de-

recognition of a subsidiary; accounting for trade investment and
associates; changes in equity ownership.

• Re-organisations: Adjustment for unrealised profits and impairments.

The chapter will look at piecemeal acquisitions, whilst disposals and group restructuring will be
in the following chapter.
2. Piecemeal acquisitions
Definition
A piecemeal acquisition is where a parent (investing) entity acquires
control over a subsidiary (investee) in stages i.e. piece by piece. This is
done by purchasing blocks of shares at different dates. As more shareholding is
acquired, the investment classification changes:

So essentially, you have a parent who gradually increases their stake in a company over time,
perhaps going from a 30% stake to an 80% stake, as is shown in the diagram - starting as an
associate and changing to a subsidiary.
Accounting treatment overview
Before control is established

Prior to the point of achieving control (i.e. greater than 50% holding), the pre-
existing equity interest in the entity is treated according to the
accounting standard that is relevant to the investment
classification:

Investment
Reporting standard Accounting treatment
classification

IFRS 9 Financial Non-current asset

Financial asset (<20%)
Instruments recorded at cost.

Equity accountingbased
Associate and joint IAS 28 Investments in
on the share of
venture (20% - 50%) Associates and JVs
investment.

Share of investment
IFRS 11 Joint
Joint arrangement recorded inindividual
Arrangements
accounts.

So, for example, if Parent P has a 25% investment in Associate A, then P will use
IAS 28 to account for this investment. Before control is established, accounting is
done as usual according to the relevant standard.

Control established

It is only on the date at which control is achieved that we have to consolidate the
subsidiary using acquisition accounting, i.e. recognise goodwill and non-
controlling interests as per IFRS 3 Business Combinations. So, when P increases
their investment to anything over 50%, they will be required to use acquisition
accounting as under IFRS 3.

Existing holdings of shares

One key rule to remember is that shareholdings held prior to gaining

control are revalued to their fair value for the calculation of goodwill. Any
gain or loss is taken to the group's income statement at that date.

Let's say 15% of shares were previously held at a cost of £30,000, and then a further
50% of shares are purchased so control is established. Let's say the 15% of shares
had a market value of £40,000 at the date it's the £40,000 which is used in the
goodwill calculation and the £10,000 gain is charged to the group's income
statement.
Control impact scenarios and their accounting treatment
There are potentially three different cases that lead to an impact on control as a
result of an increased stake:

Increased stake
Case Original stake Control impact
results in…

1 Simple investment Subsidiary Control established

2 Associate Subsidiary Control established

3 Subsidiary Larger subsidiary Control increased

In the first 2 cases, control is established and the accounting treatment handling the
increased investment is the same. In case 3, control already exists and is merely
increased. In such a case, a fundamentally different accounting treatment is
employed.

Let's begin with an example for case 1.

Example case 1 - Piecemeal acquisition: control established

Parent Ltd holds a 10% investment in Subby Ltd at £24,000. On 1 Jun 20X8 it
acquires a further 50% of Subby Ltd at a cost of £150,000. On this date, the fair
values are as follows:

• The 10% investment has a fair value of £25,000.

• The non-controlling interest, NCI, has a fair value of£100,000.

• Subby Ltd’s net assets at fair value are £230,000.

The Parent Ltd Group uses the fair value method to value NCI (which means that
the fair value of the NCI's interest is the fair value of the assets + goodwill for the
NCI).

What is the goodwill arising in Subby Ltd and what is the impact on the
consolidated income statement?

Goodwill

So, as always, goodwill is the cost of investment less net assets. The calculations
need a little care in this case due to the fair values. Let's see how we do this.

The cost of the new investment is £150,000. That's easy!

However, what about the original stake of 10%? Well, since control has been
established for the first time, for the calculation of goodwill, that original
investment is revalued to its fair value.

The original stake had increased from £24,000 to £25,000 by 1st Jun 20X8. The re-
measurement of the original stake thus leads to a gain of £1,000. This gain is
recognised in the profit for the year for the parent.

At the new investment date, the effective investment is the new investment
plus the revalued original investment totals £175,000.

So, that's the amount for 60% of the company. However, NCIs own 40% and the
fair value of their stake is £100,000 making the total value for 100% of the
company £275,000.

As the net assets of the group are £230,000 the total goodwill of Parent Ltd
resulting from this purchase is therefore £45,000.

In summary the goodwill is calculated as:

Cost of additional investment £150,000

+ FV oforiginal investment £25,000
+ FV of NCI £100,000
– FV of net assetsat acquisition (£230,000)
£45,000
Note: You may have noticed that the FV of the NCI of £100,000 is not 40% of the
net assets of £230,000 (= £92,000). The difference of £8,000 is also goodwill,
however it's the NCI's goodwill. Fortunately you do not have to be concerned about
valuing the NCI's stake, that will just be given to you in the exam.
Example Case 2 - Piecemeal acq: associate to subsidiary
The simplified income statements for the period ended 31 Dec 20X8 and
simplified statements of financial position at this date for A Ltd and B Ltd are as
follows:

Income statements for the period ended 31 Dec 20X8

A Ltd B Ltd
£’000 £’000
Revenue 150 40
Operating costs (50) (10)
Profit before tax 100 30
Income tax (25) (5)
Profit for period, PAT 75 25

Statement of financial position as at 31 Dec 20X8

A Ltd B Ltd
£’000 £’000
ASSETS
Investment in B Ltd 200
Other assets 350 360
550 360

EQUITY & LIABILITIES

Share capital 200 100
Retained earnings 250 225
450 325
Liabilities 100 35
550 360

On 31 Dec 20X4, A Ltd acquired 30% of B Ltd for £80,000. At this time the
retained earnings of B Ltd stood at £70,000.

As we can see, at this stage B Ltd was an associate of A Ltd. However, a further
40% of shares were acquired three years later for £120,000 when the retained
earnings were £200,000.

On the acquisition date, the fair value of the existing holding was £100,000 and the
fair value of non-controlling interest (NCI) was also £100,000.

It is group policy to value the NCI on a full fair value basis. Prepare the
consolidated statements as at 31 Dec 20X8.
Income statement

Let's start with the consolidated income statement.

1) Combine income and costs

As always with subsidiaries the first step is to combine the two companies'
income and costs:
A Ltd B Ltd A Group
£'00 £'000 £'00
Revenue 0 40 0
15 19
0 0
Operating costs (50) (10) (60)
Operating profit 100 30

Income tax (25) (5) (30)

PAT 75 25

2. Gain/loss on revaluation to fair value

On the date that associates become subsidiaries, the value of the associate is
revalued to the fair value at the date of the acquisition and this is shown
as a gain or loss.
In this case £80,000 was originally paid for the associate, but on the acquisition
date it had a fair value of £100,000, and so a £20,000 gain is made.
A Ltd B Ltd A Group
£'00 £'000 £'00
Revenue 0 40 0
15 19
0 0
Operating costs (50) (10) (60)
Operating profit 100 30 130
Profit on revaluation 20
PBT 150
Income tax (25) (5) (30)
PAT 75 25 120

3. Non-controlling interest
Of the profits earned in the subsidiary, some of that relates to non- controlling interests. We
must show the profits related to the NCI and group separately.
With the profits of B Ltd being £25,000, and the non-controlling interest being
30%, a total of £7,500 is shown as relating to the NCI.

A Ltd B Ltd A Group

£'00 £'000 £'00
Revenue 0 40 0
15 19
0 0
Operating costs (50) (10) (60)
Operating profit 100 30 130
Profit on revaluation 20
PBT 150
Income tax (25) (5) (30)
PAT 75 25 120

NCI 7.5
A Group 112.5
120

Statement of Financial Position

On to the statement of financial position.

1) Investment, share capital and net assets

It's always useful to build momentum when doing consolidations by tackling some
of the easiest elements first. Remember that:

a) The investment in the subsidiary is removed from the group accounts

b) The share capital is only ever the parent's share capital.

c) Assets and liabilities are combined line by line.

Let's do this:

A Ltd B Ltd 1 2 3 A
Group
£'000 £'000 £'000 £'000 £'000 £'000
ASSETS
B Ltd 200 (200) 0
Other 350 360 710
550 360
EQUITY
Share capital 200 100 (100) 200
Ret. earnings 250 225
450 325
LIABILITIES 100 35 135
550 360

2) Group retained earnings

The parent's retained earnings are £250,000.

From the income section you may remember there was an additional
£20,000 made on revaluation, plus £17,500 made post-acquisition and relating to
the group (£25,000 less the £7,500 NCI stake).

£’000
Parent (retained earnings) 250.0(as per question)
Subsidiary (post-acq'n profits) 17.5
Revaluation gain (original stake) 20.0 Fair value £100k less original cost £80k
287.5
So, this is the group’s retained earnings. From the statements, we know that A has
£250k and B has £225k in retained earnings, which total £475k.
We know the group retained earnings are $287.5k, though, so we need to find
the difference and make the adjustment:

A Ltd B Ltd 1 2 3 A
Group
£'000 £'000 £'000 £'000 £'000 £'000
ASSETS
B Ltd 200 (200) 0
Other 350 360 710
550 360
EQUITY
Share capital 200 100 (100) 200
Ret. earnings 250 225 (187.5) 287.5
450 325
LIABILITIES 100 35 135
550 360

3) Goodwill on acquisition

Next we calculate goodwill, an essential part of any consolidation process.

Let's start with the effective cost of the company at the acquisition date. A Ltd
purchased a further 40% stake for £120,000 and the fair value of the original stake
is now £100,000 and so A Ltd's total investment is £220,000. If we also add the fair
value of the NCI (which is is also £100,000) we have the total fair value of the
company:

£’000
Cost of additional 40% stake 120
Fair value of original 30% stake 100
Fair value of NCI 100 (per question)
320

This is the cost of the investment. From this, we must subtract the fair value of B
Ltd’s net assets at acquisition.
Net assets are the same as share capital plus reserves. We can see that the share
capital is £100,000 for B Ltd and we were told the reserves were
£200,000 at acquisition. Let's take the net assets off the total to find goodwill:

£’000
Cost of additional 40% stake 120
Fair value of original 30% stake 100 (£20k gain post to group profits)
Fair value of NCI 100 (per question)
320
Net assets at acq'n (300) (W2)
Goodwill on acquisition 20

Let's add that to our matrix and add up the SOFP so far:
A Ltd B Ltd 1 2 3 A
Group
£'000 £'000 £'000 £'000 £'000 £'000
ASSETS
Goodwill 20 20
B Ltd 200 (200) 0
Other 350 360 710
550 360 730
EQUITY
Share capital 200 100 (100) 200
Ret. earnings 250 225 (187.5) 287.5
450 325 487.5
LIABILITIES 100 35 135
550 360 622.5

4) Non-controlling interest (NCI)

The question tells us that at acquisition the fair value of the NCI was
£100,000.

As we have seen a further increase of £7,500 was attributed to NCI's post

acquisition.

£’000
NCI (fair value at acq'n) 100.0 (as per question)
NCI (post-acq'n profits) 7.5
107.5

As we can see that works very nicely with our SOFP as adding that in balances the
SOFP.
Our calculation is complete!

Final Statement of Financial Position

£'000
ASSETS
Goodwill 20
Other 710
730
EQUITY
Share capital 200
Ret. earnings 287.5
487.5
LIABILITIES 135
622.5
NCI 107.5
730

Example case 3 - Piecemeal acquisition: control increased

In the third type of piecemeal acquisition there is just an increase in control, this is
not an acquisition but merely an increase in the amount owned and a
decrease in the non-controlling interest.

It is a transaction between equity holders i.e. an adjustment to the parent’s

equity, as their share of equity has increased. The adjustment calculation is as
follows:

Fair value of consideration paid

(X) Decrease in NCI in the net assets at acquisition date X

Decrease in NCI goodwill(see note) X

Adjustment to parent’s equity (X)

Note: NCI goodwill decrease applies only when NCI is held at fair value and
goodwill has been calculated on their share.

Example

Parent Ltd holds a 60% investment in Subby Ltd. On 1 Jun 20X8, it acquires a
further 10% of Subby Ltd at a cost of £50,000. On this date, Subby Ltd’s net assets
are £230,000. Assume in this case that the Parent Ltd Group uses the proportion of
net assets method to value NCI. What is the impact on the group statements?
Reduction in NCI

As Parent Ltd is already a subsidiary, the additional stake results in an increase in

the controlling interest and the consequent reduction in non- controlling interest,
NCI. This means the group has a greater share of the net assets that were originally
attributed to the NCI.

The adjustment to the group share of equity is as follows:

£’000
Fair value of consideration paid (50)
Decrease in NCI in the net assets at acquisition date 23 (= 10% x £230k)
Adjustment to parent’s equity (27)

This will be credited to group retained earnings. Note:

No change to goodwill is required.

3. Chapter summary
Another chapter conquered! Below you'll find a brief summary of the key term and
concepts that we've looked at.

• A piecemeal acquisition is where a parent entity acquires control

over a subsidiary in stages i.e. piece by piece. This is done by
purchasing blocks of shares on different dates.

• There are three ways in which an entity can alter control via an
additional stake in an another entity:

◦ Acquiring control: simple investment (financial asset) to a

subsidiary;

◦ Acquiring control: associate to a subsidiary;

◦ Increasing control: subsidiary to a larger subsidiary.

• Piecemeal acquisition consolidation approach:

◦ Acquisition of control:

▪ At the date of acquiring control, revalue the previously held

equity holding to fair value; Recognise gain/loss in equity;
Calculate the goodwill based on the fair value of the original
and additional stake; Calculate the NCI.

◦ Increase in control:
▪ An adjustment to the parent’s equity based on the difference
between the consideration paid and the decrease in the net assets
of the NCI;

▪ Goodwill is not re-measured, and no gain/loss calculated.