Accounting for group structure (part 2)

Workshop questions: 25.11, 25.18, 25.27, 25.31, 25.34, 25.35

25.11 Goodwill is defined in AASB 3 as:

An asset representing the future economic benefits arising from other assets acquired in
a business combination that are not individually identified and separately recognised.

Goodwill is calculated as the excess of the cost of an acquisition incurred by an entity

(measured at fair value) over the net fair value of the identifiable assets, liabilities and
contingent liabilities acquired. Hence, if items are not recorded at fair value because no
adjusting consolidation journal entry (in the form of an asset revaluation) has been made,
then goodwill will be incorrectly stated.

25.18 Rip Ltd would not be required to include Curl Ltd’s accounts within its consolidated financial
statements. Pursuant to AASB 10, a factor to consider in determining whether to consolidate
an entity is whether any power to be exerted over the entity is being used in the context of
an agency relationship, or whether the power is being exercised to benefit the investor
directly. In defining an ‘agency relationship’, paragraph BC129 of the Basis for Conclusions to
IFRS 10 states:
The Board decided to base its principal/agent guidance on the thinking developed in
agency theory. Jensen and Meckling (1976) define an agency relationship as ‘a
contractual relationship in which one or more persons (the principal) engage another
person (the agent) to perform some service on their behalf which involves delegating
some decision-making authority to the agent.
If an entity has power, but is acting under the direction of another entity––perhaps as an
‘agent’ of that other entity–– then control would not be deemed to exist and the entity
would not be required to consolidate the entity over which it had power. As paragraph 18 of
AASB 10 states:
Thus, an investor with decision-making rights shall determine whether it is a principal or
an agent. An investor that is an agent in accordance with paragraphs B58–B72 does not
control an investee when it exercises decision-making rights delegated to it.
In explaining the above requirement, paragraph BC133 of the Basis for Conclusions to IFRS
10 states:
The Board concluded that the guidance in IFRS 10 that addresses control should apply to
agency relationships, i.e. when assessing control, a decision maker should consider
whether it has the current ability to direct the relevant activities of an investee that it
manages to affect the returns it receives, or whether it uses the decision-making
authority delegated to it primarily for the benefit of other parties.

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In relation to the various factors to consider in determining whether decision-making
authority has been delegated to an agent, paragraph B60 of AASB 10 states:
A decision maker shall consider the overall relationship between itself, the investee
being managed and other parties involved with the investee, in particular all the factors
below, in determining whether it is an agent:
(a) the scope of its decision-making authority over the investee (paragraphs B62 and
B63);
(b) the rights held by other parties (paragraphs B64–B67);
(c) the remuneration to which it is entitled in accordance with the remuneration
agreement(s) (paragraphs B68–B70);
(d) the decision maker’s exposure to variability of returns from other interests that it
holds in the investee (paragraphs B71 and B72).
Different weightings shall be applied to each of the factors on the basis of particular
facts and circumstances.

25.27 Biggin Smallin Elimination and Consolidated

Ltd Ltd adjustments statement
Dr Cr

$000 $000 $000 $000 $000

Statement of profit or loss and other

comprehensive income together with
reconciliation of opening and closing
retained earnings
Profit before tax 300 100 400
Tax (100) (30) (130)
Profit after tax 200 70 270
Retained earnings at 1 July 2022 200 100 1001 200
Statement of financial position
Shareholders’ equity
Retained earnings at 30 June 2023 400 170 470
Share capital 1 000 200 2001 1 000
Revaluation surplus 300 200 1501 350
Current liabilities

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 Accounts payable 60 40 100
Non-current liabilities
Loans 600 250 850
2 360 860 2 770
Current assets
Cash 80 45 125
Accounts receivable 350 95 445
Non-current assets
Land 200 120 320
Plant 1 000 600 1 600
Investment in Smallin Ltd 730 – 7301 –
Goodwill – – 2801 280
2 360 860 730 730 2 770
Consolidation adjustments

1. Dr Share capital 200 000

Dr Retained earnings 100 000

Dr Revaluation surplus 150 000

Dr Goodwill 280 000

Cr Investment in Smallin Ltd 730 000

(to eliminate the investment in Smallin Ltd against

its pre-acquisition capital and reserves)

It is assumed that there were no impairment losses in relation to goodwill. Remember that
there is a general prohibition on the amortisation of goodwill, and goodwill balances will be
adjusted only as a result of the recognition of an impairment loss (which occurs where the
carrying value of the asset exceeds its recoverable amount).

25.31

An investor is required to consolidate those investees that are ‘controlled’. AASB 10 defines ‘control
of an investee’ as follows:

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An investor controls an investee when the investor is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to affect those returns through its power over
the investee.

Paragraph 7 of AASB 10 states:

Thus, an investor controls an investee if and only if the investor has all the following:

(a) power over the investee (see paragraphs 10–14);

(b) exposure, or rights, to variable returns from its involvement with the investee (see
paragraphs 15 and 16); and

(c) the ability to use its power over the investee to affect the amount of the investor’s returns
(see paragraphs 17 and 18).

The application guidance accompanying AASB 10 provides some guidance in relation to the situation
where an investor might have power to control without a majority of the voting rights. Paragraph
B38 states:

An investor can have power even if it holds less than a majority of the voting rights of an investee.
An investor can have power with less than a majority of the voting rights of an investee, for example,
through:

(a) a contractual arrangement between the investor and other vote holders (see paragraph
B39);

(b) rights arising from other contractual arrangements (see paragraph B40);

(c) the investor’s voting rights (see paragraphs B41–B45);

(d) potential voting rights (see paragraphs B47–B50); or

(e) a combination of (a)–(d).

Paragraphs B42 and B43 further state:

B42 When assessing whether an investor’s voting rights are sufficient to give it power, an
investor considers all facts and circumstances, including:

(a) the size of the investor’s holding of voting rights relative to the size and dispersion of
holdings of the other vote holders, noting that:

(i) the more voting rights an investor holds, the more likely the investor is to have existing rights that
give it the current ability to direct the relevant activities;

(ii) the more voting rights an investor holds relative to other vote holders, the more likely the
investor is to have existing rights that give it the current ability to direct the relevant activities;
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(iii) the more parties that would need to act together to outvote the investor, the more likely the
investor is to have existing rights that give it the current ability to direct the relevant activities;

(b) potential voting rights held by the investor, other vote holders or other parties (see
paragraphs B47–B50);

(c) rights arising from other contractual arrangements (see paragraph B40); and

(d) any additional facts and circumstances that indicate the investor has, or does not have, the
current ability to direct the relevant activities at the time that decisions need to be made, including
voting patterns at previous shareholders’ meetings.

B43 When the direction of relevant activities is determined by majority vote and an investor
holds significantly more voting rights than any other vote holder or organised group of vote holders,
and the other shareholdings are widely dispersed, it may be clear, after considering the factors listed
in paragraph 42(a)–(c) alone, that the investor has power over the investee.

To determine whether P Ltd is the parent entity of B Ltd is a matter of professional judgement. On
the basis of the facts presented, and the guidance provided in AASB 10 (see above), it does appear
that P Ltd is able to dominate the composition of the board of directors and is able to have its
favoured resolutions passed. Therefore, it would appear that P Ltd is able to control B Ltd and
therefore would be required to prepare consolidated financial statements. However, should the
dispersion of ownership held by other shareholders reduce in future periods such that some
shareholders hold larger voting blocks, then the ability of P Ltd to control B Ltd might decline such
that P Ltd might subsequently not be the parent of B Ltd.

25.34 Consolidation worksheet journal entries

Fair value adjustment
$
Plant and equipment—cost 720 000
Accumulated depreciation (120 000)
Carrying amount 600 000
Fair value at date of acquisition 750 000
Excess of fair value over carrying amount 150 000

Dr Accumulated depreciation 120 000

Cr Plant and equipment 120 000
Dr Plant and equipment 150 000
Cr Revaluation surplus recognised on consolidation 150 000
Dr Revaluation surplus recognised on consolidation 45 000
Cr Deferred tax liability 45 000

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 (to perform a revaluation as part of a consolidation adjustment)

Declaration of dividends out of pre-acquisition earnings of subsidiary

If the dividend had been declared and fully ratified as at 30 June 2022 then the financial
statements of Winkipop Ltd as at 30 June 2022 should reflect these dividends with the
consequence that retained earnings would have been reduced by $200 000 and an amount
of $200 000 would be shown as a payable. However, when we refer to the statement of
financial position of Winkipop Ltd we see that there is no account for dividends payable, and
accounts payable amounts to only $100 000, which indicates that the proposed dividend has
not been recognised in the financial statements. Therefore, it would appear that the
dividend payment needed further ratification after the end of the reporting period and
therefore was not recognised by either Winkipop Ltd or Bells Ltd as at 30 June 2022.
In relation to the requirement that dividend payments need to be ratified prior to
recognition, and as Chapter 13 explains, Australian accounting standards prohibit the
recognition of a dividend at the end of the reporting period unless the dividend has been
declared prior to year end and the payment of the dividend does not require further
ratification by other parties, such as by the shareholders at the annual general meeting
(which is typically held after the year end). AASB 110 Events After the Reporting Period
specifically prohibits the recognition of dividends as a liability at the end of the reporting
period if the dividends have been declared after the end of the reporting period. As
paragraphs 12 and 13 state:
12. If an entity declares dividends to holders of equity instruments (as defined in AASB 132
Financial Instruments: Presentation) after the end of the reporting period, the entity
shall not recognise those dividends as a liability at the reporting date.
13. If dividends are declared (i.e. the dividends are appropriately authorised and no longer
at the discretion of the entity) after the reporting period but before the financial report
is authorised for issue, the dividends are not recognised as a liability at the end of the
reporting period because they do not meet the criteria of a present obligation in AASB
137. Such dividends are disclosed in the notes in the financial report in accordance with
AASB 101 Presentation of Financial Statements.
The rationale behind this is that dividends declared after the reporting period do not meet
the definition of a present obligation at the end of the reporting period because the entity
has the discretion rather than an unavoidable commitment at the end of the reporting
period to pay the dividends.

At this stage the dividend can be ignored.

Elimination of investment
Share capital $700 000
Retained earnings $200 000
Revaluation surplus

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 As shown in the Winkipop’s accounts 100 000
Revaluation adjustment on consolidation 105 000 $205 000
Total pre-acquisition capital and reserves $1 105 000
Fair value of consideration $950 000
Excess on consolidation $155 000

As shown above, the net assets of Winkipop Ltd are $1 105 000 at acquisition date.
As $950 000 is paid for the investment, there has been a gain on bargain purchase, or
excess, on acquisition. As paragraph 34 of AASB 3 states:
Occasionally, an acquirer will make a bargain purchase, which is a business
combination in which the amount in paragraph 32(b) exceeds the aggregate of the
amounts specified in paragraph 32(a). If that excess remains after applying the
requirements in paragraph 36, the acquirer shall recognise the resulting gain in
profit or loss on the acquisition date. The gain shall be attributed to the acquirer.

Before a gain on a bargain purchase is recognised, AASB 3, paragraph 36, requires that:
Before recognising a gain on a bargain purchase, the acquirer shall reassess
whether it has correctly identified all of the assets acquired and all of the
liabilities assumed and shall recognise any additional assets or liabilities that are
identified in that review. The acquirer shall then review the procedures used to
measure the amounts this Standard requires to be recognised at the acquisition
date for all of the following:
(a) the identifiable assets acquired and liabilities assumed;
(b) the non-controlling interest in the acquiree, if any;
(c) for a business combination achieved in stages, the acquirer’s previously
held equity interest in the acquiree; and
(d) the consideration transferred.
The objective of the review is to ensure that the measurements appropriately
reflect consideration of all available information as of the acquisition date.
The above requirement to reassess the value of assets acquired in the business
combination is consistent with an assumption that an excess on acquisition—which in
the past has been referred to as a ‘discount’—usually results from measurement errors
and seldom constitutes a real gain to the acquirer. The acquirer should therefore, in the
presence of an excess, reassess the fair values of the identifiable assets, liabilities and
contingent liabilities. However, if the excess remains after reassessing the fair values
of both the amount paid for the subsidiary and the net assets acquired, it is to be
recognised immediately as a gain. Hence, from the above workings, the consolidation
entry to eliminate the investment in Winkipop Ltd would be:
30 June 2022
Dr Share capital 700 000
Dr Retained earnings 200 000
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 Dr Revaluation surplus (as recognised by subsidiary) 100 000
Dr Revaluation surplus recognised on consolidation 105 000
Cr Bargain purchase on acquisition 155 000
Cr Investment in Winkipop Ltd 950 000
(to eliminate the investment in Winkipop Ltd against its
pre-acquisition capital and reserves)

25.35 Consolidation worksheet journal entries

Fair value adjustment
$
Land—carrying amount 100 000
Fair value at date of acquisition 140 000
Excess of fair value over carrying amount 40 000
30 June 2022
(a) Dr Land 40 000
Cr Revaluation surplus recognised on consolidation 40 000
(b) Dr Revaluation surplus recognised on consolidation 12 000
Cr Deferred tax liability 12 000
(to perform a revaluation as part of a consolidation adjustment)

Elimination of investment
Share capital $200 000
Retained earnings $150 000
Revaluation surplus recognised on consolidation $28 000
Total pre-acquisition capital and reserves $378 000
Fair value of consideration $500 000
Goodwill on consolidation $122 000

30 June 2022
(c) Dr Share capital 200 000
Dr Retained earnings 150 000
Dr Revaluation surplus recognised on consolidation 28 000
Dr Goodwill 122 000
Cr Investment in Lorne Ltd 500 000
(to eliminate the investment in Lorne Ltd against its
pre-acquisition capital and reserves)

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Consolidation worksheet for Anglesea Ltd and its controlled entity for the period
ending
30 June 2022
Anglesea Ltd Lorne Elimination and Consolidated
Ltd adjustments statement

Dr Cr

$000 $000 $000 $000 $000

Statement of financial
positions
Shareholders’ equity
Retained earnings 300 150 150(c) 300
Share capital 900 200 200(c) 900
Revaluation surplus recognised – – 28(c), 40(a) –
on consolidation 12(b)
Current liabilities
Accounts payable 110 70 180
Non-current liabilities
Deferred tax liability 12(b) 12
Loans 200 190 390
1 510 610 1 782
Current assets
Cash 100 50 150
Accounts receivable 130 90 220
Inventory 200 110 310
Non-current assets
Land 300 100 40(a) 440
Plant 400 350 750
Accumulated depreciation (120) (90) (210)
Goodwill 122(c) 122
Investment in Lorne Ltd 500 – ___ 500(c) –
1 510 610 552 552 1 782

Consolidation worksheet for Anglesea Ltd and its controlled entity for the period
ending
30 June 2014

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 Anglesea Ltd Lorne Elimination and Consolidated
Ltd adjustments statement

Dr Cr

$000 $000 $000 $000 $000

Statement of financial
positions
Shareholders’ equity
Retained earnings 300 150 150(c) 300
Share capital 900 200 200(c) 900
Revaluation surplus – – 28(c), 40(a) –
12(b)
Current liabilities
Accounts payable 110 70 180
Non-current liabilities
Deferred tax liability 12(b) 12
Loans 200 190 390
1 510 610 1 782
Current assets
Cash 100 50 150
Accounts receivable 130 90 220
Inventory 200 110 310
Non-current assets
Land 300 100 40(a) 440
Plant 400 350 750
Accumulated depreciation (120) (90) (210)
Goodwill 122(c) 122
Investment in Lorne Ltd 500 – ___ 500(c) –
1 510 610 552 552 1 782

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