126 Chapter 4 Chapter 4 Consolidated Financial Statements (Part 1) Related standards: PERS 10 Consolidated Financial Statements Section 9 of the PFRS for SMEs Overview on the topic Our discussion on consolidated financial statements is subdivided into the following chapters: Chapter Title Coverage 4 Consolidated FS (Part 1) Basic consolidation procedures 5. Consolidated FS (Part 2) _ Intercompany transactions 6 — Consolidated FS (Part 3) Miscellaneous topics 7 Consolidated FS (Part 4) | Measurement at-other than cost Learning Objectives 1. State the elements of control. 2. Prepare consolidated financial statements at the acquisition date. | 3. Prepare consolidated financial statements at a subsequent | date. eh Introduction PFRS 3 deals with the accounting for a business combination at the acquisition date, while PFRS 10 deals with the preparation and presentation of consolidated financial statements after the business combination. » Consolidated financial statements - “the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.” Group - “a parent and its subsidiaries.” Parent - “an entity that controls one or more entities.” Subsidiary — “an entity that is controlled by another entity.” (PERS 10.Appendix A) v vv Scanned with CamScannerConsolidated Financial Statements (Part 1) 127 All parent entities are required to prepare consolidated financial statements, except as follows: 1. A parent is exempt from presenting consolidated financial statements if: a._ it is a subsidiary of another entity (whether wholly-owned or partially-owned) and all its other owners do not object to its non-presentation of consolidated _ financial statements; b. its debt or equity instruments are not traded in a public market (or being processed for such purpose); and ¢. its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with PFRSs. 2. Post-employment benefit plans or other long-term employee benefit plans to which PAS 19 applies. Control Control is the basis for consolidation. PFRS 10 requires an investor to determine whether itis a parent by assessing whether it controls the investee. > Control of an investee - “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.” (PFRS 10. Appdendix A) Control exists if the investor has all of the following: a. Power over the investee; b. “Exposure, or rights, to variable returns from the investee; and c. Ability to affect returns through use of power. Only (ong/entity is identified to have control over an investee. If two or more investors collectively control an investee, such as when they must act together to direct the investee’s relevant activities, none of them individually controls the investee. Scanned with CamScanner128 Chapter 4 Accordingly, each investor accounts for its interest in the investee in accordance with PFRS 11 Joint Arrangements, PAS 28 Investments in Associates and Joint Ventures or PFRS 9 Financial Instruments, as appropriate, Example: ABC Co. holds 70% of the voting shares of Alphabets, Inc. XYZ, Inc, the former majority owner of Alphabets, holds 10% of the voting shares of Alphabets but retains its power to appoint the majority of the board of directors of Alphabets. The other 20% is held by various shareholders holding shares of 1% or less. Decisions about the relevant activities of Alphabets require-the approval of a majority of votes cast at relevant shareholders’ meetings - 75% of the voting rights of the investee have been cast at recent relevant shareholders’ meetings. Analysis: Neither ABC Co. nor XYZ, Inc. has control over Alphabets Co. Power An investor has power over an investee when the investor has existing rights that give it the current ability to direct the investee's relevant activities. > Relevant activities - “activities of the investee that significantly affect the investee’s returns.” (PERS 10Appendix A) An investor's current ability to direct the investee’s relevant activities is often evidenced by the investor's ability to establish and direct the investee’s operating and financing policies, e.g. making operating and capital decisions, and appointing, remunerating and terminating key management personnel. Power arises from rights and it may be obtained directly from the voting rights conferred by shareholdings. However, power may also arise from other sources, such as contractual arrangements. Examples of rights that can give an investor power: Scanned with CamScannerited Financial Statements (Part 1) 129 Voting rights (or potential voting rights); Rights to appoint or remove members of the investee’s key management personnel or another entity that directs the relevant activities of the investee; c. Rights to direct the investee to enter into transactions for the benefit of the investor; and d. Other decision-making rights that give the investor the ability to direct the investee’s relevant activities. (rrRs 10.815) ge Administrative rights When voting rights do’ not have a significant effect on an investee’s returns, such as when voting rights relate to administrative tasks only and contractual arrangements determine the direction of the relevant activities, the investor needs to assess those contractual arrangements in order to determine whether it has rights sufficient to give it power over the investee. Unilateral rights If two or more investors individually (unilaterally) have the ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee. Protective rights An investor can have power over an investee even if other entities have existing rights that give them the current ability to participate in the direction of the relevant activities, for example when another entity has significant influence. However, an investor that holds only protective rights does not have power over an investee, and consequently does not control the investee. © Protective rights are “rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate.” (PrRs 10.Appendin a) Scanned with CamScanner130 Chapter 4 Examples of protective rights: a. A lender's right to seize the assets of the borrower if the borrower defaults on a loan, or to restrict the borrower from undertaking activities that are detrimental to the lender. b. The right of holders of non-controlling interests to approve capital expenditure above a specified amount, or the issue of equity or debt instruments. Example: Unilateral right and Protective right Entity A holds 10% voting rights in Entity B. Entity A is also the franchisor of Entity B. The franchise agreement confers Entity A some decision-making rights regarding the operations of Entity B. Analysis: The franchise agreement provides. both Entity A (investor/franchisor) and Entity B (investee/franchisee) unilateral rights in directing the'relevant activities of Entity B. In assessing the existence of power, the entity with the ability to direct the activities that most significantly affect the returns of Entity B has power over Entity B. If the decision-making rights granted to Entity A are designed solely to protect the franchise brand (protective right) and the unilateral right of Entity B is to operate the franchise in accordance with the franchise agreement but for its own account, Entity A does not have power over Entity B. Substantive rights In assessing whether it has a power, an investor considers only substantive rights, ie., rights which the investor has the ability to exercise, Application examples - Substantive rights Fact pattern (This applies to each of the independent cases below) - | An investee’s policies over relevant activities can be changed only | at scheduled shareholder's meetings or at special meetings. « The next scheduled shareholders’ meeting is in 8 months. Scanned with CamScannerConsolidated Financial Statements (Part 1) 131 Shareholders that individually or collectively hold at least 5% of the voting rights can call a special meeting to change the existing policies over the relevant activities. This requires giving notice to the other shareholders, which means that a _specialmecting cannot beheld for atleast 0 days. Case #1 An investor holds a majority of the voting rights in the investee. Analysis: The investor's voting rights are substantive because the investor is able to direct the investee’s relevant activities in both a scheduled shareholder's meetirig and a special meeting. Case #2 (PRS 10.824) An investor owns a forward contract (or an option contract that is “in the money’) to purchase a majority of the investee’s shares. The contract's settlement date is in 25 days. Analysis: The investor's voting rights are substantive. The existing shareholders are unable to change the existing policies over the relevant activities because a special meeting cannot be held for at east 30 days, at which point the contract will have been settled. Case #3 The settlement date of the forward contract (or the option contract) in Case #2 is in 6 months. Analysis: The investor's voting rights are not substantive. The existing shareholders can change the existing policies over the relevant activities through a special meeting. Voting rights The investor's ability to direct the relevant activities of an investee is normally obtained through voting or similar rights. Scanned with CamScanner132 Chapter 4 Power with a majority of the voting rights An investor that holds more than half (51% or more) of the voting rights of an investee is'presumed to have power over the investee, except when this is clearly not the case. Holding more than half of the voting rights results to power when: a. The relevant activities are directed through majority vote; or b. A majority of the members of the governing body that directs the relevant activities are appointed through majority vote. Majority of the voting rights but no power An investor does not have power over an investee, even if he holds more than half 6f the voting rights, if: a. The right to direct the investee’s relevant activities is conferred to a third party who is not an agent of the investor. For example, the investee’s relevant activities are subject to direction by a: government, court, administrator; receiver, liquidator or regulator. b. The investor's voting rights are not substantive. Power without a majority of the voting rights An-investor can have power even if he holds 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; . Rights arising from other contractual arrangements; The investor's voting rights; . Potential voting rights; or A combination of (a) - (d). eons Contractual arrangement with other vote holders A contractual arrangement between an investor and other: vote holders can give the. investor power if the contractual arrangement gives the investor: Scanned with CamScannerConsolidated Financial Statements (Part 1) 133 a. The right to exercise the voting rights of other vote holders sufficient to give the investor power; or b. The right to direct how other vote holders vote to enable the investor to make decisions about the relevant activities. * Under the Corporation Code of the Philippines, an example of a contractual arrangement described above is referred to as “proxy.” Example: (PRS 10.843 - B45) Investor A holds 40% of the voting rights of an investee. The other 60% is held by 12 other investors, each holding 5%. A shareholder agreement grants Investor A the right to appoint, remove and set the remuneration of management responsible for directing the relevant activities. To change the agreement, a two-thirds vote-of the shareholders is required. Analysis: Investor A has power over the investee because of his contractual right to appoint, remove and set the remuneration of management. Rights from other contractual arrangements Rights from other contractual arrangements may give an investor the current ability to direct an investee’s relevant activities,. for example, the investee’s manufacturing processes or. other operating or financing activities that significantly affect the investee’s returns. However, in the absence of any other rights, economic dependence of an investee on the investor (such as customer-supplier relationship) does not result to power. The investor's voting rights An investor with less than a majority of the voting rights has power when he has the practical ability to direct the relevant activities unilaterally. ‘ Scanned with CamScanner14 Chapter 4 _ Example 1 Entity A holds 40% of the voting rights of Entity B. The remaining 60% is held by numerous shareholders in very sma denominations. None of, the shareholders make collective decisions. Analysis: Entity A has power over Entity B because the other shareholdings are widely dispersed and are not being exercised collectively. Example 2 Entity A holds 30% of the voting rights of Entity B. Four other investors hold 5% each. The remainder is widely dispersed. None of the shareholders make collective decisions. Decisions about Entity B’s relevant activities require’a majority of vote: Seventy- five percent of the voting rights have been cast in previous shareholders’ meetings Analysis: Entity A has no power over Entity B because it does not have the ability to unilaterally direct Entity B’s relevant activities. This requires the active participation:of the other shareholders. Example3 Entity A holds 40% of the voting rights, of Entity B. Two other investors hold 28% each. The remaining 4% is held by numerous other investors. Analysis: Entity A has no power over'Entity B because the two other investors have the ability to cooperate and prevent Entity A from directing the relevant activities of Entity B. Potential voting rights When determining the existence of control, an investor considers potential voting rights that are currently exercisable, regardless of the intention or financial ability to exercise them. Scanned with CamScannerConsolidated Financial Statements (Part 1) 28 135 Potential voting rights include share warrants, share call options, debt or equity instruments that are convertible into ordinary shares, or other similar instruments that, if exercised, have the potential to give the entity voting power or reduce another party’s voting power over an investee. Potential voting rights are not currently exercisable if they cannot be exercised until a future date or until the occurrence of a future event. However, during consolidation, non-controlling interests are determined on the basis of present ownership interests and do not reflect the effect of potential voting rights. Potential voting rights are considered only for purposes of determining the existence of control, which in turn determines whether an investee should be consolidated. Example: Entity A owns 40% of the voting rights in Entity B. Entity A also holds bonds that are currently convertible into Entity B’s ordinary shares. If the bonds were converted, Entity A’s voting rights would be increased to 60%, Analysis: Entity A has power over Entity B. The existing voting rights plus the potential voting rights result to a majority of the voting rights in Entity B. Substantive removal and other rights held by other parties Substantive removal and other rights Held by other parties may affect the decision maker's ability to direct the relevant activities of an investee. > Removal rights are “rights to deprive the decision maker of its decision-making authority.” (PFRS 10.Appéndix A) Such rights are considered when evaluating whether the decision maker is a principal or an agent for other parties. An investor acting as an agent does not control an investee. For Scanned with CamScanner136 Chapter 4 example, a decision maker that is required to obtain approve! from a small number of other parties for its actions is generally 2x agent. “Exposure or rights to variable returns An investor is exposed, or has a right, to variable returns if its returns from its involvement with the investee vary depending on the investee’s performance. Ability to use power to affect investor's returns The investor's ability to use its power to affect its returns from the investee provides the link between power and variable returns. Only if this ability exists along with power and exposure or right to variable returns does the investor obtain control over the investee. Elements of Control Variable | Power | ___s | Ability to affect returns |¢—_ rétums_| { Control Accounting requirements Reporting dates The financial statements of the parent and its subsidiaries used in preparing consolidated financial statements shall have the same reporting date. If the parent's and its subsidiary’s reporting periods do not coincide, the subsidiary shall prepare financial statements that coincide with the parent's reporting period before consolidation. If this is impracticable, the subsidiary’s financial statements shall be adjusted for significant transactions and events that occur between the end of the subsidiary’s reporting period and that of the parent's. The difference between the parent’s and Scanned with CamScannerConsolidated Financial Statements (Part 1) 137 subsidiary’s end of reporting periods shall not exceed three months. Uniform accounting policies Uniform accounting policies shall be used. If the subsidiary uses different accounting policies, its financial statements need to be adjusted to conform to the parent's accounting policies before they are consolidated. Example: A British parent entity uses the revaluation model to measure its property, but a Philippine subsidiary uses the cost model. Question: In the consolidated financial statements, is the group. allowed to measure the Philippine subsidiary’s property under the cost model? Answer: No, the Philippine subsidiary’s property shall be adjusted to conform to the group’s accounting policy of revaluation model. Consolidation period Consolidation begins from the date the investor obtains control of the investee and ceases when the investor loses control of the investee. For example, if an investor obtains control of an investee on July 1, 20x1, the group’s consolidated financial statements for the year ended December 31, 20x1 shall include only the investee’s results of operations from July 1 to December 31, 20x1. On the other hand, if a parent loses ‘control over its subsidiary on September 30, 20x2, the group’s consolidated financial statements for the year ended December 31, 20x2 shall include only the investee’s results of operations from January 1 to September 30, 20x2. Scanned with CamScanner138 Chapter 4 Measurement Income and expenses Income and expenses of the subsidiary are based on the amounts of the assets and liabilities recognized in the consolidated financial statements at the acquisition date. For example, depreciation expense in the consolidated financial statements is based on the related asset’s acquisition-date fair value, rather than its carrying amount in the subsidiary’s accounting records, ’ Investment in subsidiary Investments in subsidiaries are accounted for in the parent’s separate financial statements either: a. atcost; b. inaccordance with PERS 9; or c. using the equity method. Measurement at cost The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently measured at that amount, unless the investment becomes impaired. Measurement in accordance with PFRS 9 The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently measured at fair value. Measurement using the equity method The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently increased or decreased for the investor's share in the changes in the investee’s equity. Scanned with CamScannerjidated Financial Statements (Part 1) 139 Non-controlling interests (NCI) NCT in the net assets of the subsidiary NCL in net assets is presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. NCL in the net assets of the subsidiary consists of: a. The amount determined at the acquisition date using PERS 3; and b. The NCI's share of changes in equity since the acquisition date. NCL in profit or loss and comprehensive income The profit or loss and each component of other comprehensive income in the consolidated statement of profit or loss and other comprehensive income are attributed to the following: 1, Owners of the parent 2. Non-controlling interests , Total comprehensive income is attributed to the owners of the parent and to the NCI even if this results in the non- controlling interests having a deficit balance. Preparing the Consolidated financial statements Consolidated financial statements are prepared by combining the financial statements of the parent and its subsidiaries line by line by adding together similar items of assets, liabilities, equity, income and expenses. Consolidation at date of acquisition The consolidation procedures at the acquisition date are, simple because only the statements of financial position of the combining entitiés are consolidated. The consolidation involves the following steps: 1. Eliminate the “Investment in subsidiary” account: This tequires: Scanned with CamScanner140 Chapter 4 a. Measuring the identifiable assets acquired and liabilities assumed in the business combination at their acquisition- date fair values. ‘ b. Recognizing the goodwill from the business combination. Eliminating the ‘subsidiary’s pre-combination equity accounts and replacing them with the non-controlling interest. 2. Add, line by line, similar items of assets and liabilities of the combining entities. The subsidiary’s assets arid liabilities are included in the consolidated financial statements at 100% of their amounts irrespective of the interest acquired by the parent. Illustration: Consolidation at acquisition date On January 1, 20x1, ABC Co. (parent) acquires 80% interest in XYZ, Inc. (subsidiary). The financial statements of the combining entities immediately after the business combination are shown below: Parent Subsidiary Cash P10,000 5,000 Accounts receivable 30,000 12,000 Inventory 40,000 23,000 Investment in subsidiary 75,000 - Equipment, net 180,000 40,000 Total assets 335,000 < 80,000 Accounts payable 50,000 6,000 Share capital 170,000 50,000 Share premium 65,000 5 Retained earnings 50,000 24,000 Total liabilities and equity P335,000 ‘80,000 Additional information: «The subsidiary’s assets and liabilities are stated at their acquisition-date fair values, except for the following: : Scanned with CamScannerConsolidated Financial Statements (Part 1) 141 - Inventory, 31,000 - Equipment, net, 48,000 The goodwill determined using PFRS 3 is 3,000. The NCI in the net assets of the subsidiary, also determined using PERS 3, is 18,000. Requirement: Prepare the consolidated statement of financial position. Solution: Step 1: Eliminate the “Investment in subsidiary” account and: a. Measure the subsidiary’s assets and liabilities at their acquisition-date fair values; b. Recognize the goodwill; and c. Replace the subsidiary’s pre-combination equity accounts with the NCI in net assets. i Step 1(a)~Measure Cash 5,000 subsidiary’ assets and, Accounts receivable 30,000 | 12,000 liabilities at Inventory 40000, 31,000 scquisiton-date fir Investment in subsidiary 5,008 e values. Equipment, net 180,000 48,000 Goodwill 3,000 <_| Step 10) - Recognize goodwill Accounts payable 50,000 6,000 a ee Share capital 170,000 50,900 Step 1) - Replace the Sale SE ig | ee NCI in net asséts : Anois: Reuvnntc innet assets, Scanned with CamScanner142 Chapter 4 Step 2: Add, line by line, similar items of assets and liabilities of the combining constituents. Parent Subsidiary Consolidated Cash 10,000 5,000 P15,000 Accounts receivable 30,000 12,000 42,000 Inventory 40,000 31,000 71,000 Investment in subsidiary Equipment, net 180,000 48,000 228,000 Goodwill 3,000 3,000 Total assets 359,000 Accounts payable 50,000 —-P6,000 P56,000 Share capital 170,000 170,000 Share premium 65,000 65,000 Retained earnings 50,000 50,000 NClin net assets 18,000, 18,000 Total liabilities & equity P359,000 § Notes: © 100% of the assets and liabilities of the subsidiary are included in the consolidated financial statement even though the parent holds only 80% interest. This is an application of the following concepts: a. “Substance over form” - the consolidated financial statements report the parent's ability to control the whole of the subsidiary and not just only up to the extent of the legal percentage acquired. b. “Entity theory” - the parent and subsidiary is viewed as a single reporting entity. « The subsidiary’s pre-combination equity ‘accounts (i.e, share capital and retained earings), are eliminated “in full and replaced with the non-controlling interest account. The share capital, share premium, and retained earnings accounts in the consolidated financial statements pertain to the owners of the Scanned with CamScanner‘Consolidated Financial Statements (Part 1) 18 parent, while the non-controlling interest account pertains to the other owners of the subsidiary. ~ The equity structure appearing in the consolidated financial statements reflects that of a “legal entity.” The “group” is not a legal entity, although each member of the group is a separate legal entity. Thus, the consolidated financial statement reflects the equity structure of the legal parent. The equity of the other members of the group is presented in a single line item described as non-controlling interests. The consolidated statement of financial position is shown below: ABC Group Consolidated statement of financial position As of January 1, 20x1 ASSETS Cash 15,000 Accounts receivable 42,000 Inventory 71,000 Equipment, net 228,000 Goodwill 3,000 TOTAL ASSETS 359,000 LIABILITIES AND EQUITY Accounts payable 56,000 Total liabilities 56,000, Share capital 170,000 Share premium 65,000 Retained earnings 50,000 Owners of parent 285,000 ‘Non-controlling interest 18,000 Total equity 303,000 TOTAL LIABILITIES AND EQuiTy P359,000 Observe that the non-controlling interest is presented within equity but separately from the equity of the owners of the parent. Scanned with CamScanner144 Traditional Accounting Method Chapter 4 The consolidated financial statements can also be prepared by using (a) consolidation journal entries and (b) consolidation worksheet. CJE #1: To eliminate investment in subsidiary and recognize goodwill Jon.1, | Inventory 20x1 Equipment . Share capital - XYZ, Inc. Retained earnings — XYZ, Inc. Goodwill Investment in subsidiary Non-controlling interest. to adjust the subsidiary’s assets to acquisition-date fair values, to eliminate the investment in subsidiary and-subsidiary’s pre- combination equity, and to recognize goodwill and non-controlling interest in the consolidated inancial statements 8,000 8,000 50,000 24,000 3,000 75,000 18,000 Scanned with CamScannerConsolidated Financial Statements (Part 1) ‘ABC Group Consolidation Worksheet January 1, 20x1 145 af 5 ABC Co. XYZ, Inc. CJEref.# Consolidation adjustments CJEref.# Consolidated ASSETS Dr. ‘cr. Cash 10,000 5,000 15,000 Accounts receivable 30,000 12,000 SEO, inventory 40,000 23,000 1 8,000 71,000 Investment in subsidiary 75,000 - 75,000 4 - Equipment, net 180,000 40,000 1 8,000 228,000 Goodwill = = 1 3,000 3,000 TOTAL ASSETS 335,000 80,000 359,000 LIABILITIES AND EQUITY = Accounts payable 50,000 6,000 56,000 Total liabilities ‘50,000 6,000 56,00€ ‘Share capital 170,000 50,000 1 50,000 170,00C Share premium 65,000 - 65,00C Retained earnings 50,000 24,000 1 24,000 50,000 Non-controlling interest - - 18,000 1 18,000 Total equity 285,000 74,000 "303,006 TOTAL LIABILITES & EQUITY 335,000 80.000 93,000 93,000, 359,000 ¥ Note: Consolidation journal entries are not recorded in either of the parent's or the subsidiary’s books of accounts. These are prepared only for the purpose of preparing the consolidated financial statements. Consolidation worksheets are also prepared for the same purpose, rather than as formal reports. Scanned with CamScanner146 Chapter 4 Consolidation subsequent to date of acquisition The consolidation procedures subsequent to the acquisition date involve the same procedures of (a) eliminating the investment in subsidiary account and (b) adding, line by line, similar items of assets, liabilities, income and expenses of the parent and the subsidiary. However, this time, changes in the subsidiary’s net assets since the acquisition date are considered. Illustration 1: Consolidation - Subsequent to date of acquisition On January 1, 20x1, ABC acquired 80% interest in XYZ, Inc. for 75,000. Information on acquisition date (Jan. 1, 20x1): « XYZ's net identifiable assets have a carrying amount of 74,000 and fair value of P90,000. The difference is due to the following: Carrying ‘Fair Fair value amount value _ adjustment (FVA) Inventory 20,000 P24,000 4,000, ipment, net 40,000 52,000 12,000 Totals 60,000 76,000 16,000 © The remaining useful life of tHe equipment is 6 years. © ABC measured the NCI at ‘proportionate share’. Information on subsequent reporting date (Dec. 31, 20x1): Statements of financial position As at December 31, 20x1 ABCCo, = XYZ, Inc. ASSETS Cash 23,000 57,000 Accounts receivable 75,000 22,000 Inventory, 105,000 15,000 Investment in subsidiary (at cost) 75,000 Equipment, net 140,000 30,000 TOTAL ASSETS. __P418,000___P 124,000 Scanned with CamScannerConsolidated Financial Statements (Part 1) 447 LIABILITIES AND EQUITY Accounts payable 73,000 30,000 Total liabilities 73,000 30,000 Share capital 170,000 40,000 Share premium 65,000 10,000 Retained earnings 110,000 44,000 Total equity 345,000 94,000 TOTAL LIABILITIES AND_ EQUITY 418,000 124,000 Statements of profit or loss For the year ended December 31, 20x1 ABCCo, XYZ, Inc. Sales 300,000 —--P120,000 Cost of goods sold (165,000) (72,000) Gross profit 135,000 48,000 Depreciation expense (40,000) (10,000) Distribution costs (35,000) 18,000) Profit for the year P60,000 ‘20,000 e There were no dividends declared, no intercompany transactions and no impairment of goodwill in 20x1. Requirement: Prepare the December 31, 20x1 consolidated financial statements. Solutions: The first thing that we should do is to analyze the changes in the subsidiary’s net assets since the acquisition date. We will use the formulas below to simplify this process. Step 1: Analysis of subsidiary's net assets Net XYZ, Inc. Jan. 1, 20x1 Dec. 31, 20x1 ashe Net assets at carrying amount 74,000 94,000 Fair value adjustments (FVA) 16,000 10,000 Net assets at fa value 90,000 P104,000 14,000 Scanned with CamScanner148 Chapter 4 © FVA at acquisition date. FVA at aquisition date ss subsequent depreciation, FVA, 1/1/x1_Useful life Depreciation FVA, 12/31/x1 Inventory ‘4,000 N/A* 4,000 1 Equipment 12,000 yrs. 2,000 10,000 Totals 16,000 P6,000 P10,000 * The entire inventory is assumed to have been sold during the year. Step 2: Goodwill computation The goodwill that is reported in the post-combination financial statements is the amount determined at the acquisition date less accumulated impairment losses. Consideration transferred 75,000 Non-controlling interest in the acquiree (90K x 20%) ~ Step 1 18,000 Previously held equity interest in the acquiree : Total 93,000 Fair value of net identifiable assets acquired (see Step 1) (90,000) Goodwill - Jan. 1, 20x1 3,000 Less: Accumulated impairment losses = Goodwill - Dec. 31, 20x1 P3,000 Step 3: Non-controlling interest in net assets iary's net assets at fair value - Dec. 31, 20x] (see Step 1) 104,000 Multiply by: NCI percentage 20% Non-controlling interest in net assets ~ Dec. 31, 20x1 20,800 Step 4: Consolidated retained earnings Parent's retained earnings - Dec. 31, 20x1 P110,000 Parent's share in the net change in subsidiary's net assets 11,200 Consolidated retained earnings - Dec. 31, 20x1 121,200 Net change in XYZ’s net assets (xe Step 1) P14,000 Multiply by: ABC's interest in XYZ 80% ABC's share in the net change in XYZ’s net assets 11,200 Scanned with CamScannerConsolidated Financial Statements (Part 1) 149 ‘The NCI computed in Step 3 can also be reconciled as follows: NCI at acquisition date 18,000 NCT's share in net change in subsidiary’s net assets (14K x20%) __ 2,800 NCI - Dec, 31,20x1 20,800 Both the parent and NCI share in the post-combination change in the subsidiary’s net assets. The parent's share is included in retained earnings, while the NCI's share is included in NCI. Step.5: Consolidated profit or loss Profits of ABC & XYZ (60K + 20k) 80,000 Depreciation of FVA (see Step 1) (6,000) Consolidated profit 74,000 The consolidated profit is attributed to the owners of the arent and NCI as follow: Owners of parent NCI Consolidated Parent's profit before FVA 60,000 N/A 60,000 Share in XYZ's profit before FVA® 16,000 - 4,000 20,000 Depreciation of FVA (4,800) (1,200) (6,000) Totals - P71,200 _P2,800. __P74,000 — (© (20,000 profit of XYZ x 80% = 16,000 share of ABC); (20K x 20% = 4,000 share of XYZ). This allocation is like the parent saying, “what is yours is ours, what is mine is mine alone.” 6© (© (6,000 depreciation of FVA x 80% = 4,800 share of ABC); (6K x 20% = 1,200 share of XYZ). We now have all the information we need to draft the consolidated financial statements. Recall the _ following consolidation procedures: Scanned with CamScanner