1

CHAPTER FIVE:
CONSOLIDATED FINANCIAL STATEMENTS
SUBSEQUENT TO DATE OF ACQUISITION

BY MELESE Z.(MSc)
 Chapter Objectives and Content

Accounting for investments in subsidiaries

Consolidated financial statements for wholly owned subsidiary
Consolidated financial statements for partially owned subsidiary
Consolidated financial statements: Intra-group trading (Upstream and
Downstream Transactions)
Disclosure requirements

2
Accounting for investments in subsidiaries

For a parent company, two methods are available to account for an

investment in a subsidiary in its own internal accounting records in
periods subsequent to the date of acquisition:

The cost method and

The equity method.
 Cont….d
4

 The cost method is a method of accounting for investments whereby the

investment is initially recorded at cost; income from the subsidiary is
recognized in net income when the investor’s right to receive a
dividend is established.

 IAS 28 defines the equity method, as we discussed in chapter one, as a

method of accounting whereby the investment is initially recognized at
cost and adjusted thereafter for the post-acquisition change in the
investor’s share of net assets of the investee.
 Equity Method ……Cont….d
5

 If used fully and correctly for an investment in a subsidiary, the net

income, other comprehensive income, and retained earnings under
the equity method in the internal records of the parent will be equal to
net income, other comprehensive income, and retained earnings
attributable to the parent’s shareholders on the parent’s
consolidated financial statements.
 Equity Method Cont….d
6

 The only difference is that the consolidated financial statements

incorporate the subsidiary’s values on a line by- line basis, whereas the
equity method incorporates the net amount of the subsidiary’s values
on one line (investment in the subsidiary) on the balance sheet and,
typically, on one line (equity method income from the subsidiary) on
the income statement.

 The equity method captures the net effect of any adjustments that
would be made on the consolidated financial statements.
 CONT…D
7

 The parent’s separate-entity retained earnings accounted for under the

equity method should always be equal to consolidated retained earnings.

 Consolidated net income will be the same regardless of whether the

parent used the cost method or the equity method for its internal
accounting records.

 The parent can choose any method to account for its investment for
internal purposes.
 Consolidated Financial Statements
8

• At acquisition date, we recognize:

– Fair value of identifiable net assets of acquiree as at acquisition date,
– Consideration transferred, contingent liabilities,
– Deferred tax assets or liabilities on the above; and
– Goodwill as a residual
 In subsequent years:
9

Subsequent extinguishment of assets and liabilities of subsidiary must

be determined based on the fair values at acquisition date.
Therefore, subsequent amortization, depreciation and cost of sales of
acquired assets are determined based on fair value
Elimination of Investment in sub and Sub Equity Accounts,
recognition of fair value adjustments and amortization entries
must be repeated until:
i. Date of disposal of the investment in subsidiary; or
ii. Date when control is lost
In Subsequent Years
In subsequent years (Continued)
10

Acquisition method only recognizes fair value at critical event: acquisition

date
New internally-generated goodwill or subsequent appreciation in fair
values are not recognized subsequent to acquisition date
Since net assets are carried at book value in the separate financial
statements, the subsequent amortization/depreciation/disposal are
adjusted in the consolidation worksheet
BV of expense in (FV- BV) adjustment to FV of expense in
separate financial + expense = consolidated
statements Adjusted in consolidation worksheet financial statements

Melese Z.(MSc.)
 Cont….d
11

 Consolidated net income for any fiscal period is made up of the following:

Melese Z.(MSc.)
12

Prepare consolidated financial statements subsequent

to acquisition when the parent has applied in its internal
records: the equity method.

Melese Z.(MSc.)
 Subsequent Consolidation –
Equity Method
13

During the year, the parent will adjust its investment account for the
Subsidiary under application of the equity method. The original
investment, recorded at the date of acquisition, is adjusted for:

1. FV adjustments and Goodwill Impairments

2. The parent’s share of the sub’s income (loss),
3. The receipt of dividends from the sub.

Melese Z.(MSc.)
14

Illustrations-Consolidated financial statements for

wholly owned subsidiary

Melese Z.(MSc.)
 Subsequent Consolidation -
Equity Method Example
15

Parrot Company obtains all of the outstanding common shares of

Sun Company on January 1, 2017. Parrot acquires this shares for
$800,000 in cash. Sun Company’s balances are shown below.

Book Values Fair Values

1/1/17 1/1/17 Difference
Current assets . . . . . . . . . . . . . . . . . . $320,000 $ 320,000 –0–
Trademarks (indefinite life) . . . . . . . . 200,000 220,000 20,000
Patented technology (10-year life) . . . 320,000 450,000 130,000
Equipment (5-year life) . . . . . . . . . . . 180,000 150,000 (30,000)
Liabilities . . . . . . . . . . . . . . . . . . . . . . .(420,000) (420,000) –0–
Net book value . . . . . . . . . . . . . . . . . . $600,000 $ 720,000 $120,000
Common stock—$40 par value . . . .$(200,000)
Additional paid-in capital . . . . . . . . . . (20,000)
Retained earnings, 1/1/17 . . . . . . . . . .(380,000)

Melese Z.(MSc.)
 Subsequent Consolidation -
Equity Method Example
16

PARROT COMPANY
100 Percent Acquisition of Sun Company
Allocation of Acquisition-Date Subsidiary Fair Value
January 1, 2017

FV of consideration transferred by Parrot Company. $ 800,000

Net Book Value of Sun Company. . . . . . . . . . . . . . . . . . . (600,000)
Excess of fair value over book value . . . . . . . . . .200,000
Allocation to specific accounts based on fair values:
Trademarks . . . . . . . . . . . . . . . . . . . .. . . . . . .$ 20,000
Patented technology . . . . . . . . . . .. . . . . . . . . 130,000
Equipment (overvalued) . . . . . . . . . . . . . . . . (30,000)
120,000
Excess FV not specifically identified—goodwill. . . . . . $ 80,000

Melese Z.(MSc.)
 Subsequent Consolidation -
Equity Method Example
17

Amortization computation:
Useful Annual
Account Allocation Life Amortization
Trademarks $ 20,000 Indefinite –0–
Patented technology 130,000 10 years $13,000
Equipment (30,000) 5 years (6,000)
Goodwill 80,000 Indefinite –0–

$ 7,000

Amortization will be $7,000 annually for five years until the

equipment fair value reduction is fully removed.

Melese Z.(MSc.)
 Subsequent Consolidation -
Equity Method Example
18

Assume Sun Company earns income of $100,000 in 2017 and Declare and pays a
$40,0000 cash dividend on August 1, 2017 and August 8, 2017, respectively.

Melese Z.(MSc.)
 Subsequent Consolidation -Worksheet Entries
19

For the first year, the parent prepares five entries on the workpapers to
consolidate the two companies.

S) Eliminates the subsidiary’s Stockholders’ equity account beginning balances and the
book value component within the parent’s investment account.
A) Recognizes the unamortized Allocations as of the beginning of the current year
associated with the adjustments to fair value.
I) Eliminates the subsidiary Income accrued by the parent.
D) Eliminates the subsidiary Dividends.
E) Recognizes excess amortization Expenses for the current period on the allocations
from the original adjustments to fair value.

Melese Z.(MSc.)
 Subsequent Consolidation Equity Method
Example Entry S
20

Note: If this is the first year of the investment, and the investment was made
at a time other than the beginning of the fiscal year, then pre-acquisition
income of the sub must be accounted for in the retained earnings balance.

Melese Z.(MSc.)
 Subsequent Consolidation Equity Method
Example Entry A
21

Note: In the first year, FV adjustments are calculated in the allocation

computation. In subsequent years, FV adjustments must be reduced by any
depreciation taken in prior consolidations.

Melese Z.(MSc.)
 Subsequent Consolidation Equity Method
Example Entries I & D
22

Note: Entry I removes Sun’s income recognized by Parrot during the year so Sun’s
revenue and expense accounts (and current amortization expense) can be brought
into the consolidated totals.

Note: Entry D removes the intra-entity transfer of cash for the dividends
distributed to Parrot from Sun.
Melese Z.(MSc.)
 Subsequent Consolidation Equity Method
23
Example Entry E

Note that depreciation expense is reduced for the tangible asset equipment (fair
value was less than book value). Patented Technology amortization expense was
recognized for the year.

Melese Z.(MSc.)
 PARROT COMPANY AND SUN COMPANY
Consolidation Worksheet
For Year Ending December 31, 2017

24
 Practice Quiz Question #1

When P company pays more than the book value of

net assets of the acquired company (S), how does the
consolidation process differ?
a. P hires an outside accountant to do the work.
b. P tracks the excess value and records it in the consolidation
worksheet.
c. S notifies P of the excess value.
d. P and S ignore the excess amount paid.

Melese Z.(MSc.)
 Practice Quiz Question #2

A parent charges the amortization of its cost in excess

of book value to:
a. Goodwill expense.
b. Excess cost expense.
c. Excess cost & goodwill expense.
d. Income from subsidiary.
e. None of the above.

Melese Z.(MSc.)
 Practice Quiz Question #3

An account of the acquired company that cannot be

revalued to its current fair value under acquisition
accounting is:
a. Notes receivable.
b. Bonds payable.
c. Investment in marketable securities.
d. Patents.
e. None of the above.

Melese Z.(MSc.)
 Practice Quiz Question #4
How do the elimination entries differ in a bargain
purchase scenario from a acquisition at an amount
greater than book value?
a. The differential is ignored in a bargain purchase scenario.
b. The parent company multiplies all numbers by −1.
c. The elimination entry to reclassify expenses related to the
differential increases reported expenses.
e. The elimination entry to reclassify expenses related to the
differential decreases reported expenses.

Melese Z.(MSc.)
 Practice Quiz Question #5

Intercompany income statement accounts are

eliminated in consolidation because they are deemed to
be:
a.Artificial transactions.
b.Potentially manipulative transactions.
c. Internal transactions.
d.At amounts that are not determined on arms-length
basis.
e.none of the above.

Melese Z.(MSc.)
 Practice Quiz Question #7

A parent records amortization of excess value under

which method?
a. Push-down basis of accounting.
b. Non-push down basis of accounting.
c. Both A and B.
d. None of the above.

Melese Z.(MSc.)
31

Consolidated financial statements for partially

owned subsidiary


Melese Z.
 Non-controlling interest
 NCI only arises in consolidated financial statements where:
one or more subsidiaries are not wholly owned by the parent (IFRS 10)

• NCI are entitled to their share of retained earnings of the subsidiary from
incorporation
No distinction between pre-acquisition and post-acquisition retained
earnings for NCI
• Same applies to OCI
NCI collectively have a share of accumulated OCI arising from incorporate
date to the current date
• NCI are normally a credit balance
Share of residual interests in the net assets of a subsidiary
Total equity (parent’s and NCI) = Assets - Liabilities Melese Z.(MSc.)
 Non-Controlling Interests’ Share of Goodwill
33

• IFRS 3 Para 19 allows NCI to be measured in either of two ways

Non-controlling interests

Measured at Fair value Measured as a proportion of

at acquisition date the recognized amounts of
(include goodwill) the identifiable Net assets as
“ Fair value basis” at acquisition date

Melese Z.(MSc.)
 Non-Controlling Interests’ Share of Goodwill
34
• Under the fair value basis:
– FV is determined by either the active market prices of subsidiary’s equity share at
acquisition date or other valuation techniques
– FV per share of NCI may differ from parent because of control premium paid by
parent (e.g. 20% premium over market price to gain control)
– NCI comprises of 3 items:

Non – controlling
interests

Share of
Share of book value unamortized Share of
of net assets FV adjustment unimpaired goodwill
(FV - BV)
Melese Z.(MSc.)
Non-Controlling Interests’ Share of Goodwill
35

• Under the fair value option:

– Journal entry to record NCI at fair value (re-enacted each year):

Dr Share capital of subsidiary

Dr Retained earnings at acquisition date
Dr Other equity at acquisition date
Dr FV differentials (FV- BV)

Dr Goodwill (Parent & NCI)

Dr/Cr Deferred tax asset/ (liability) on fair value adjustment
Cr Investment in subsidiary
Cr FV differentials (BV – FV)

Cr Non-controlling interests (At fair value)

Melese Z.(MSc.)
 Non-Controlling Interests’ Share of Goodwill
36
• Under the 2nd option:
– NCI is a proportion of the acquiree’s identifiable net assets (i.e. not
full fair value)
– NCI comprises of 2 items:

Non – controlling
interests

Share of
Share of book value unamortized
of identifiable net assets of FV adjustments
(FV- BV)
Melese Z.(MSc.)
 Non-Controlling Interests’ Share of Goodwill
37
• Under the 2nd option:
– Journal entry to record NCI (re-enacted each year):

Dr Share capital of subsidiary

Dr Retained earnings at acquisition date
Dr Other equity at acquisition date
Dr FV differentials (FV – BV)
Dr Goodwill (Parent only)
Dr/Cr Deferred tax asset/ (liability) on FV adjustment
Cr FV differentials (BV – FV)
Cr Investment in S subsidiary
Non-controlling interests
Cr (NCI % x FV of identifiable net assets)
Melese Z.(MSc.)
Non-Controlling Interests’ Share of Goodwill
38

NCI measured as a
NCI measured at FV proportion of the acquiree’s
identifiable net assets

Book value of net assets

Fair value – Book value of net

assets

Goodwill

Melese Z.(MSc.)
Illustration 3:
Non-Controlling Interests’ Share of Goodwill
39

The FV of NCI that owned 10% of Subsidiary A as at 31 Dec 2001(Acquisition

date) was $25,000. The financial statements of Subsidiary A as at
acquisition date are as shown below. Subsidiary A had unrecognized
intangible assets with fair value of $40,000. Tax rate is 20%. Determine
NCI’s good will as at acquisition date.

Subsidiary A’s Statement of Financial Position as at 31 December 2001:

Net assets 160,000

Share Capital 100,000

Share Premium 20,000
Retained Earnings 40,000 Melese Z.(MSc.)
 Illustration 3:
Non-Controlling Interests’ Share of Goodwill
40

Fair value of NCI 25,000

Fair value of identifiable net assets
Book value of equity 160,000
Fair value of intangible assets 40,000
Deferred tax on intangible assets (8,000) 192,000

NCI's share of FV of identifiable net assets (10%) 19,200

NCI's goodwill (25,000 - 19,200) 5,800

Under alternative basis where NCI are measured as a proportion of the recognized
amounts of the identifiable assets as at acquisition date:
 NCI’s goodwill is zero
 Amount to be recognized as NCI is $19,200 only
Melese Z.(MSc.)
 Accounting for Non-Controlling Interests under IFRS 3
41

• In consolidation, non-controlling interests have a share of:

 Profit after tax
 Dividends declared
 Share capital
 Retained earnings and other comprehensive income (eg. Revaluation reserve) at
acquisition date
 Change in retained earnings and other comprehensive income from the date of
acquisition to the current period
 Fair value differential of a subsidiary’s net assets at acquisition date
 Subsequent extinguishment of the different between the fair value and book value of
identifiable net assets; and
 Goodwill (if the fair value alternative is adopted)

Melese Z.(MSc.)
Reconstructing NCI on Statement of Financial Position
42

Incorporation Date of Beginning of End of current

date acquisition current year year

NCI have a share of NCI have a share of NCI have a share of

1. Share capital 1. Change in share capital 1. Profit after tax
2. Retained earnings 2. Change in retained 2. Current amortization of
earnings fair value differential
3. Other equity
3. Change in other equity 3. Current impairment of
4. Fair value goodwill
differentials 4. Past amortization of fair
value differential 4. Dividends as a
5. Goodwill repayment of profits
5. Past impairment of
goodwill 5. Change in other equity

Melese Z.(MSc.)
Analytical check on Non-controlling Interests’ balance
43

NCI’s share of (NCI % multiply by):

a) Book value of net assets of subsidiary at year-end
+/- unrealized profit/loss from upstream sale
NCI’s balance at
year-end = b) Unamortized balance of FV adjustments at year-
end
c) Unimpaired balance of goodwill at year end
([Acquisition-date FV of NCI – NCI % x acquisition-
date FV of identifiable net assets] less any
cumulative impairment)

Melese Z.(MSc.)
 Illustration :
Amortization of Fair Value Differentials
44

• P Co paid $6,200,000 and issued 1,000,000 of its own

shares to acquire 80% of S Co on 1 Jan 20X5
• Fair value of P Co’s share is $3 per share
• Fair value of net identifiable assets is as follows:
Book value Fair value Remaining useful life
Leased property 4,000,000 5,000,000 20 years
In-process R&D 2,000,000 10 years
Other assets 1,900,000 1,900,000
Liabilities (1,200,000) (1,200,000)
Contingent liability (100,000)
Net assets 4,700,000 7,600,000

Share capital 1,000,000

Retained earnings 3,700,000
Shareholders’ equity 4,700,000
 Illustration 2:
Amortization of Fair Value Differentials
45

Additional information:
• Contingent liability of $100,000 was recognized as a provision loss
by the acquiree in legal entity financial statement on Dec 20X5
• FV of NCI at acquisition date was $2,300,000

• Tax rate is 20%.

• Net profit after tax of S Co for 31 Dec 20X5 was $1,000,000
• No dividends were declared during 20X5
• Shareholders’ equity as at 31 Dec 20X5 was $5,700,000

Q1 : Prepare the consolidation adjustments for P Co for 20X5

Q2 : Perform analytical check on balance of NCI as at 31 Dec 20X5
 Illustration 2:
Amortization of Fair Value Differentials
46

 Consideration transferred = Cash consideration + Fair value

of share issued
= $6,200,000 + (1,000,000 x $3)
= $9,200,000

 Deferred tax liability = 20% x ($7,600,000 - $4,700,000)

= $580,000

 Goodwill = Consideration transferred + NCI – Fair value of net

identifiable assets, after-tax
= $9,200,000 + $2,300,000 – ($7,600,000 -
$580,000)
= $4,480,000
 Illustration 2:
Amortization of Fair Value Differentials
47

• P’s share of goodwill = Consideration transferred – 80% x Fair

value of net identifiable assets, after tax
= $9,200,000 – 80% x $7,020,000
= $9,200,000 – $5,616,000
= $3,584,000

• NCI’s share of goodwill = Consideration transferred – 20% x Fair

value of net identifiable assets, after tax
= $2,300,000 – 20% x $7,020,000
= $2,300,000 – $1,404,000
= $896,000
Illustration 2:
Amortization of Fair Value Differentials
48

Consolidation adjustments for 20X5

CJE 1: Elimination of investment in Subsidiary

Dr Share capital 1,000,000

Dr Opening retained earnings 3,700,000
Dr Leased property 1,000,000
Dr In-process R&D 2,000,000
Dr Goodwill 4,480,000
Cr Contingent liability 100,000
Cr Deferred tax liability (net) 580,000
Cr Investment in S 9,200,000
Cr Non-controlling interests 2,300,000
 Illustration 2:
Amortization of Fair Value Differentials
49

CJE 2: Depreciation and amortization of excess of FV over book value

Dr Depreciation of leased property 50,000
Dr Amortization of in-process R&D 200,000
Cr Accumulated depreciation 50,000
Cr Accumulated amortization 200,000

Under dep. by Under amort. by

$50k
Dep exp: $200k
$50,000
Amort exp:
$200,000
Dep. of $200,000 $250,000 Amort. of
leased R&D
property
$0
Based on Based on
Based on FV Based on FV
book value book value
 Illustration 2:
Amortization of Fair Value Differentials
50

CJE 3: Reversal of entry relating to provision for loss

Dr Provision for loss 100,000

Cr Loss expense 100,000

Note: Contingent liability was already recognized in CJE 1. The recognition

by the acquiree in its legal entity financial statement results in double
counting; hence this reversal entry is necessary

CJE 4: Tax effects on CJE 2 & CJE 3 20% * (200k

+50k -100k)

Dr Deferred tax liability (net) 30,000

Cr Tax expense 30,000

 Illustration 2:
Amortization of Fair Value Differentials
51

CJE 5: Allocation of current year profit to non-controlling interests

(NCI)

Dr Income to NCI 176,000

Cr NCI 176,000

Net profit after tax 1,000,000

Excess depreciation (50,000)
Excess amortization (200,000)
Reversal of loss from contingent liability 100,000
Tax effects on FV adjustments 30,000
Adjusted net profit 880,000
NCI’s share (20%) 176,000
 Illustration 2:
Amortization of Fair Value Differentials
52

Explanatory note to CJE 5:

 NCI have a share in the extinguishment of the initial FV differences
and in the impairment of goodwill.
 Net profit after tax represents that increase in the book value of

equity of the subsidiary

 Other adjustments relate to the extinguishment of the FV differentials

 NCI have a share of $176,000 of adjusted profit which represents

 Increase in book value

 Decrease in fair value differentials
 Illustration 2:
Amortization of Fair Value Differentials
53

NCI balance:

NCI at acquisition date (CJE1) $2,300,000

Income allocated to NCI for 20x5 (CJE 5) 176,000

NCI as at 31 Dec 20x5 $2,476,000

 Illustration 2:
Amortization of Fair Value Differentials
54

Q2 : Perform an analytical check on the balance of NCI as at 31 Dec

20X5

1st Step: reconstruct the balance of non-controlling interest as at 31 Dec

20x5

NCI as at acquisition date (CJE 1) 2,300,000

Income allocated to NCI for 20x5 (CJE5) 176,000

NCI as at 31 December 20x5 2,476,000

 Illustration 2:
Amortization of Fair Value Differentials
55

2nd step: reconcile the balance to the three components that NCI have
-
Non – controlling
interests

Share of
Share of book value Unamortized Share of
of net assets unimpaired goodwill
FV adjustment

($1,000,000 x 19/20 x $896,000 = $2,476,000

$5,700,000 x 20% + 80% x 20%) +
+
= $1,140,000 ($2,000,000 x 9/10 x 80%
x 20%) = $440,000
 Noncontrolling Interest – Illustration

Assume that King Co. acquires 80% of Pawn Co’s 100,000 outstanding voting
shares on January 1, 2014, for $9.75 per share or a total of $780,000 cash.

The shares are trading at an average of $9.75 per share before and after the
acquisition.

The total fair value of Pawn to be used initially in consolidation is:

Consideration transferred by King. . . . . . $780,000

Noncontrolling interest fair value . . . . . . . .195,000
Pawn’s total fair value on Jan. 1, 2014 . . . $975,000

Melese Z.(MSc.)
 PAWN COMPANY
Account Balances January 1, 2014
Book Value Fair Value Fair value Differences
Current assets . . . . . . . . . . . . . . . . . . . . . . $ 440,000 $ 440,000 –0–
Trademarks (indefinite life) . . . . . . . . . . . 260,000 320,000 $ 60,000
Patented technology (20-year life) . . . . . 480,000 600,000 120,000
Equipment (10-year life) . . . . . . . . . . . . . 110,000 100,000 (10,000)
Long-term liabilities (8 years to maturity) (550,000) (510,000) 40,000
Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 740,000 $ 950,000 $210,000
Common stock . . . . . . . . . . . . . . . . . . . . . . $(230,000)
Retained earnings, 1/1/14 . . . . . . . . . . . . (510,000)

57
Melese Z.(MSc.)
 Noncontrolling Interest -
Excess Fair Value Allocations

Melese Z.(MSc.)
 Noncontrolling Interest - Example

To complete the information needed for this combination,

assume that Pawn Company reports the following
changes in retained earnings since King’s acquisition:

Pawn Company changes in retained earnings since acquisition:

Net income - Current year (2015) . . . . . . . . . . . . $90,000
Less: Dividends declared. . . . . . . . . . . . . . . . . . . . .(50,000)
Increase in retained earnings (2015) . . . . . . . . . . $40,000
Prior years (2014) Increase in retained earnings. $70,000

Melese Z.(MSc.)
Noncontrolling Interest -
Worksheet Example

Melese Z.(MSc.)
 Noncontrolling Interest -
Worksheet Example

King uses the Equity Method to account for Pawn

subsequent to acquisition. The consolidation process
is substantially the same.

At each consolidation, worksheet entries S, A, I, D, and

E are prepare AND…

A row/Column will be added to the worksheet to record

the noncontrolling interest in the subsidiary.

Melese Z.(MSc.)
Noncontrolling Interest –
Worksheet Example

Melese Z.(MSc.)
Noncontrolling Interest –
Worksheet Example

Melese Z.(MSc.)
64
Melese Z.(MSc.)
Consolidated Financial Statement
Income Statement, Owners’ Equity

Melese Z.(MSc.)
Consolidated Financial Statement
Balance Sheet

Melese Z.(MSc.)
 Consolidated Financial Statements: Intra-group trading
(Upstream and Downstream Transactions)
67

• Operational and financial interdependencies within the

group entities
– Lead to intragroup transactions and balances

• Intragroup transactions include for example:

– Buying or selling of inventory
– Transferring of long lived assets
– Rendering or procuring of services
– Providing financing among the companies within the
group
 Elimination of Intragroup Transactions
and Balances
68

• Transfer of assets within the group:

– Rarely transacted at the carrying amounts of the assets
– Profit margin included in transfer price if transaction done on an
arm’s length basis
– Profit is unrealized until the asset is sold to a 3rd party
– Lag between purchase and resale of assets results in
overstatement/understatement of group profit/loss and assets

– From the group’s perspective, the unrealized profit has to be

eliminated and the asset restated to the carrying amount based
on original cost transacted with third parties
– For transferred inventory, the carrying amount for the group
should be the lower of original cost as transacted with third
parties and net realizable value
 Elimination of Intragroup Transactions
and Balances
69

• Intragroup transactions give rise to intragroup balances

– E.g. Loan receivable/payable to or from group companies,
Dividend receivable, Accounts payable/receivable to or from
group companies

• From an economic perspective, an entity is not able to transact

with itself
– Intragroup assets and liabilities, equity, income, expenses and
cash flows relating to transactions between entities of the
group are to be eliminated in full during consolidation
– Elimination adjustments are made in relation to the original
entries passed in the legal entity’s financial statements
 Principles Governing Elimination
70

• Outstanding balances due to or from companies within a group are eliminated

• Transactions in the income statement between the group companies are eliminated
• Profit or loss resulting from intragroup transactions that are included in the asset
are eliminated in full (both parent’s & NCI’s share)
• Tax effects on unrealized profit or loss included in the asset should be adjusted
according to IAS 12 Income Taxes
• Associates (“significant influence) are not part of the group
– Balances with associates are not eliminated
– Unrealized profit or loss from transactions between an investor and its associates
are eliminated to the extent of investor’s interests
 Elimination of Realized Intragroup Transactions
71

 “Offsetting” effect on the group net profit from realized

transactions
 Profit recorded by the selling company offset the expense
recorded by buying company
 Elimination is still required to avoid overstatement of individual
line items

Examples:
1. Transactions relating to interest:
 Usually no time lag in the recognizing of interest by borrower and lender i.e. interest
income exactly offsets the interest expense
 Elimination entry:
Dr Interest Income (lender)
Cr Interest Expense (borrower)
 Elimination of Realized Intragroup Transactions
72

– Exception: borrower capitalizes interest on borrowed money into the cost

of construction of a long-lived asset
Dr Interest Income
Cr Fixed assets in progress

2. Transactions relating to services provided

– Provision and consumption of services are simultaneous
– Elimination entry:
D Service Income
r
Cr Service Expense
– Exception: service receiver capitalizes service fee when the service
provided creates or enhances an asset or extends its useful life
 Elimination of Realized Intragroup Transactions
73

3. Transfers of inventories that are resold to 3rd party in the same period
– Profit recorded by selling company offset the higher cost of sale
recorded by buying company
– Consolidated financial statements should only show the sale to third
parties and the original cost of purchasing the inventory from third
parties
– Elimination entry:

Dr Sales
Cr Cost of Sales
 Downstream Sale
74

Unrealized profit
resides in Parent’s Parent
book
Sales were
made from
90 % parent to
owned subsidiary

Mark-up inventory
remains on Subsidiary
Subsidiary’s SFP

In downstream sale, NCI’s share of profit of the subsidiary is not affected

because the adjustment affects the parent’s profit not the subsidiary
 Upstream Sale
75

Mark-up inventory
remains on Parent’s Parent
SFP

Sales were
made from
90 % subsidiary to
owned parent

Unrealized profit
resides in Subsidiary’s Subsidiary
book

In upstream sale, the unrealized profit resides in the subsidiary. Thus, NCI’s
share of the unrealized profit or loss needs to be adjusted from the carrying
amount of the asset (IFRS 10 Para B86(c))
Goodwill Impairment Test
76

• IAS 36: Goodwill has to be reviewed annually for impairment loss

– Reviewed as part of a cash-generating unit (CGU)

• CGU is the lowest level at which the goodwill is monitored for internal management

purposes and

• Not larger than a segment determined under IFRS 8 Operating Segments

– Goodwill will be allocated to each of the acquirer’s CGU, or group of CGUs

 CGU-Smallest identifiable group of assets that generates cash inflows that are
largely independent of the cash inflows from other assets or groups of assets.
Example
77
A bus company provides services under contract with a municipality that
requires minimum service on each of five separate routes. Assets devoted
to each route and the cash flows from each route can be identified
separately. One of the routes operates at a significant loss.

Because the entity does not have the option to curtail any one bus route, the
lowest level of identifiable cash inflows that are largely independent of the
cash inflows from other assets or groups of assets is the cash inflows
generated by the five routes together. Therefore, the individual bus routes
cannot be identified as cash-generating units. The company as a whole is
identified as the cash-generating unit.
 Goodwill Impairment Test
1.78 Carrying amount:
– Net assets of the cash-generating unit
– It includes entity goodwill attribute to parent and NCI
2. Recoverable amount:
– IAS 36 allows the higher of the below two metrics to determine recoverable
amount:
 Higher of FV less cost to sell (an arms-length measure)
 Uses market based inputs or market participants’ assumptions in the valuation
process

 Value-in-use (VIU)
 Present value of future net cash flows
 Goodwill Impairment Test
79

3. If carrying amount > recoverable amount

 Impairment loss is first allocated to goodwill
 Then to other assets in proportion to their individual carrying
amounts
 Impairment tests to be carried out on annual basis; regardless of
whether indications of impairment exists
 Impairment once made is not reversible, as it may result in the
recognition of internally-generated goodwill which is prohibited
under IAS 38
Goodwill Impairment Test
80
Steps for impairment test

Determine the carrying amount of the CGU

Determine the recoverable amount of the CGU

Recoverable amount: Higher of fair value or value in use

If carrying amount ≤ If carrying amount >

recoverable amount recoverable amount

Allocate impairment loss

No impairment loss to goodwill first and
balance to other net assets
Conclusion
• Two sets of financial statements must be presented:
81

– Investor’s separate financial statements for the legal entity

– Consolidated financial statements for group of companies
• Although two sets of accounts exist, only one set of “books” has to be kept by the
legal entity
 Consolidation worksheets are used to prepare consolidated financial statement

Summation of line items of the financial statements of parents and subsidiaries

• Incorporation of adjustments to eliminate and adjust intragroup transactions and

balances
• Transactions and balances in consolidated financial statement reflect group’s
perspective
Conclusion
82
• All business combinations are accounted for using the acquisition method
– Entails an “asset substitution process”
– Acquirer is deemed to have obtained control of all assets and liabilities of
acquiree.
– Acquisition date is a critical economic event (exchange of economic resources
between acquirer and the former-owners)
– Use of fair values to recognize assets and liabilities
– Unrecognized intangible assets and contingent liabilities recognized if they meet
criteria in IFRS 3
– NCI included as a component in equity
Conclusion
Under the acquisition method:
83
•

– Consideration transferred = Fair value of (assets transferred + liabilities incurred

+ equity interests issued by acquirer + contingent consideration)
– Asset substitution process: Investment account is eliminated and substituted with:
• Subsidiary’s identifiable net assets; and
• Goodwill
– Goodwill = Fair value of (consideration transferred + non-controlling interests +
acquirer’s previously held interest in the acquiree) – acquiree’s recognized net
identifiable assets
84
Appendix-Illustrations on Upstream and Downstream Sales
Illustration 2
85

 P invested in 70% of shares of S

 Intercompany transfers of inventory are as follows:
20X3 20X4
Sale of inventory from P to S $60,000
Original cost of inventory $(50,000)
Gross profit $10,000
Percentage unsold to 3rd party at year end 10% 4%
Sale of inventory from S to P $200,000
Original cost of inventory $(170,000)
Gross profit $30,000
Percentage unsold to 3rd party at year end 30% 0%
 Tax rate: 20%
 Net profit after tax of S: $800,000 (31 Dec 20X3)
$900,000 (31 Dec 20X4)
 Illustration 2:
Upstream and Downstream Sales
86

31 Dec 20X3
CJE 1: Elimination of intercompany sales and adjustment
of unrealized profit from downstream sale
Dr Sale 60,000
Cr Cost of sales 59,000 Residual value

Cr Inventory 1,000 Unrealized profit x

percentage unsold

Cost of sales (as reported in P’s I/s) $50,000

Cost of sales (as reported in S’s I/s) 54,000 (90% of $60,000)
Combined cost of sales 104,000
Cost of sales (from group’s perspective) (45,000) (90% of $50,000)
Amount to be eliminated $59,000
 Illustration 1:
Upstream and Downstream Sales
87

31 Dec 20X3
CJE 1: Elimination of intercompany sales and adjustment
of unrealized profit from downstream sale
Dr Sale 60,000
Cr Cost of sales 59,000 Residual value

Cr Inventory 1,000 Unrealized profit x

percentage unsold

Cost of sales (as reported in P’s I/s) $50,000

Cost of sales (as reported in S’s I/s) 54,000 (90% of $60,000)
Combined cost of sales 104,000
Cost of sales (from group’s perspective) (45,000) (90% of $50,000)
Amount to be eliminated $59,000
 Illustration 1:
Upstream and Downstream Sales
88

CJE 1 is a composite of two sub-entries:

CJE 1(a): Elimination of realized sales from downstream sale

Dr Sales (P) 54,000 (90% x $60,000)
Cr Cost of sales (S) 54,000
Eliminates the sales of P against the cost of sales of S for the proportion of
inventory that was resold to third parties during 20x3

CJE 1(b): Reversal of unrealized sales and removal of profits from inventory
Dr Sales (P) 6,000 (10% x $60,000)
Cr Cost of sales (S) 5,000 (10% x $50,000)
Cr Inventory (S) 1,000 (10% x $10,000)
Reverses the sales, cost of sales and profit in inventory for the proportion of
inventory that remained unsold as at 31 Dec 20x3
 Illustration 2:
Upstream and Downstream Sales
89

CJE 2: Adjustment for the tax effects on unrealized profit

in inventory from downstream sales
Dr Deferred tax asset 200 Unrealized profit
from unsold
Cr Tax expense 200 inventory x 20%

CJE 3: Elimination of intercompany sales and adjustment of unrealized profit

from upstream sale
Dr Sale 200,000
Cr Cost of sales 191,000
Cr Inventory 9,000 (30% x $30,000)

CJE 4: Adjustment for the tax effects on unrealized profit in inventory

from upstream sales
Dr Deferred tax asset 1,800
Cr Tax expense 1,800 (20% x $9,000)
 Illustration 2:
Upstream and Downstream Sales
90

CJE5: Allocation of current profit after tax to non-controlling interests

Dr Income to NCI 237,840
Cr NCI 237,840

Net profit after tax of S for 20x3 * $800,000

Less: unrealized profit from upstream sale (CJE 3) (9,000)
Add: tax expense on unrealized profit (CJE 4) 1,800
Adjusted net profit after tax of S for 20x3 $792,800
NCI’s share of profit after tax for 20x3 (30%) $237,840

* Note: No adjustment is required for the unrealized profit from

downstream sale as profits reside in parent income
 Illustration 2:
Upstream and Downstream Sales
91

31 Dec 20X4
CJE1: Adjustment of unrealized profit from downstream sale in RE as at 1
Jan 20x4
Dr Opening RE 1,000 (10% x $10,000)
Cr Cost of sales 600 (6% x $10,000)
Cr Inventory 400 (4% x $10,000)

CJE 2: Adjustment of tax on unrealized profit from downstream sale in RE

as at 1 Jan 20x4
Dr Tax expense 120
Dr Deferred tax asset 80
Cr Opening RE 200
 Illustration 2:
Upstream and Downstream Sales
92

CJE 3: Allocation of post-acquisition RE as at 1 Jan 20x4

Dr Opening RE 240,000 (30% x $800,000)*
Cr NCI 240,000
*Use unadjusted profit after tax for YE 20x3 to compute NCI’s share of
post-acquisition RE.

CJE 4: Adjustment of unrealized profit from upstream sale in RE as at 1

Jan 20x4
Dr Opening RE 6,300 (70% x 30% x $30,000)
Dr NCI 2,700 (30% x 30% x $30,000)
Cr Cost of sale 9,000 (30% x $30,000)
 Illustration 2:
Upstream and Downstream Sales
93

CJE 5: Adjustment of tax on unrealized profit from upstream sale as at 1

Jan 20x4
Dr Tax expense 1,800
Cr Opening RE 1,260
Cr NCI 540

Combined effect of CJE 3, CJE 4, CJE 5 results in NCI’s share of

adjusted opening RE, which corresponds to CJE 5 passed in 20x3
 Illustration 2:
Upstream and Downstream Sales
94

CJE6: Allocation of current profit after tax to non-controlling interests

Dr Income to NCI 272,160
Cr NCI 272,160

Net profit after tax of S for 20x4* $900,000

Add: realized profit from upstream sale (CJE 4) 9,000
Less: tax expense on realized profit (CJE 5) (1,800)
Adjusted net profit after tax of S for 20x4 $907,200
NCI’s share of profit after tax for 20x4 (30%) $272,160
* Note: adjustment to current year profit is needed for:
1) Realized profit & tax effects from current sale of inventory
transferred from group companies in prior years are added back
2) Unrealized profit & tax effects from unsold inventory transferred
from group companies in current year are deducted