Chapter 28: Consolidation: Wholly Owned entities (part 1)

CQ1 Briefly describe the consolidation process in the case of a parent that
has a wholly owned subsidiary.

Answer:
The consolidation process in the process through which consolidated financial statements are
prepared by adding together, line by line, the financial statements of the parent and its
subsidiary to some very important consolidation adjustments. First, the financial statements
that are added together must be comparable. Therefore, before undertaking the consolidation
process it may be necessary to make adjustments in relation to the content of the financial
statements of the subsidiary. Second, as part of the consolidation process, a number of other
adjustments are made to the parent’s and the subsidiary’s statements, these being expressed in
the form of journal entries. A worksheet or computer spreadsheet is often used to facilitate
the addition process and to make the adjustments.

CQ3 Explain the adjustments that may be required as part of the consolidation
process.

1.Explain the adjustments that may be required as part of the consolidation process.

As part of the consolidation process, a number of other adjustments are made to the parent’s
and the subsidiary’s statements, these being expressed in the form of journal entries.

• As required by AASB 3/IFRS 3, at the acquisition date the acquirer must recognise the
identifiable assets acquired and liabilities assumed of the subsidiary at fair value.
Adjusting the carrying amounts of the subsidiary’s assets and liabilities to fair value and
recognising any identifiable assets acquired and liabilities assumed as part of the business
combination, but not recorded by the subsidiary, is a part of the consolidation process.
The entries used to make these adjustments are referred to in this chapter as the business
combination valuation entries. As noted in section 28.2, these adjusting entries are
generally not made in the records of the subsidiary itself, but in a consolidation
worksheet.
• Where the parent has an ownership interest (i.e. owns shares) in a subsidiary, another set
of adjusting entries are made, referred to in this chapter as the pre ‐acquisition entries. As
noted in paragraph B86(b) of AASB 10/IFRS 10, this involves eliminating the carrying
amount of the parent’s investment in the subsidiary and the parent’s portion of pre‐
acquisition equity in the subsidiary. This avoids double counting of the group’s assets and
equity. The name of these entries is derived from the fact that the equity of the subsidiary
at the acquisition date is referred to as pre ‐acquisition equity, and it is this equity that is

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 being eliminated. These entries are also made in the consolidation worksheet, not in the
records of the subsidiary.
• The third set of adjustments is for transactions between the entities within the group
subsequent to the acquisition date, including sales of inventories or non ‐current assets.
These intragroup transactions are referred to in paragraph B86(c) of AASB 10/IFRS 10.
Adjustments for these transactions are discussed in detail in chapter 29.

CQ6 How does AASB 3/IFRS 3 Business Combinations affect the

acquisition analysis?

The formation of a parent–subsidiary relationship by the parent obtaining control over the
subsidiary is a business combination. The parent, being the controlling entity is an acquirer,
with the subsidiary being the acquiree. The acquisition analysis is then totally based on
AASB 3/IFRS 3. The acquisition analysis reflects the application of the acquisition method:

Step 1: Identify the acquirer – in this case, it is the parent.

Step 2: Determine the acquisition date
Step 3: Recognise and measure the identifiable assets acquired and the liabilities assumed at
fair value. The differences between the carrying amounts and fair values of the
identifiable assets, liabilities and contingent liabilities of the subsidiary are
recognised via business combination valuation reserves. The effect is to recognise
the assets and liabilities of the subsidiary at fair value.
Step 4: Recognise and measure goodwill or a gain from a bargain purchase. The goodwill is
recognised in the BCVR entries while the gain is recognised in the pre-acquisition
entries.

CQ 7: If the parent assesses that the carrying amounts of the subsidiary’s identifiable
assets are not equal to their fair value at acquisition date, explain why adjustments to
these assets are required in the preparation of the consolidated financial statements.

AASB 3/IFRS 3, paragraph 18, requires that identifiable assets and liabilities of the
subsidiary are to be measured at fair value at acquisition date. The standard-setters believe
that the fair value of the assets and liabilities provides the most relevant information to users.

Even though the standard refers to an allocation of the cost of a business combination, the
standard does not require the identifiable assets and liabilities acquired to be recorded at cost.
The only asset acquired that is not measured at fair value is goodwill. The fair value approach
is emphasised by the required accounting for any bargain purchase on combination. It is not
accounted for as a reduction in the fair values of the identifiable assets and liabilities acquired
such that these items are recorded at cost. Instead, the fair values are unchanged and the
excess is recognised as a gain.

CQ 8: If the parent assesses that some of the subsidiary’s identifiable assets and
liabilities are not recorded by the subsidiary at acquisition date, explain why
adjustments to these assets and liabilities are required in the preparation of the
consolidated financial statements.

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According to AASB 3/IFRS 3 and as described in chapter 26, entities need to account for
business combinations using the acquisition method. As part of the acquisition method, an
acquisition analysis is conducted at acquisition date because it is necessary to recognise all
the identifiable assets and liabilities of the subsidiary at fair value (including those previously
not recorded by the subsidiary).

CQ 15: Is it necessary to distinguish pre-acquisition dividends from post-acquisition

dividends? Why?

Discuss:
 the definition of acquisition date
 the meaning of pre-acquisition and post-acquisition equity
 the treatment of dividends according to paragraph 38A of AASB 127/IAS 27: i.e., an
entity shall recognise a dividend from a subsidiary in profit or loss i.e. as revenue –
regardless of whether it is paid from pre- or post-acquisition equity.

Under AASB 127/IAS 27, all dividends declared after acquisition and paid or payable by the
subsidiary to a parent are recognised as revenue in the profit or loss of the parent. However,
the dividends from pre-acquisition equity are, by definition, a distribution of pre-acquisition
equity, which decreases the pre-acquisition equity and may reduce the value of the
investment recognised by the parent. By treating those dividends as revenue, the parent may
overstate its income. To reduce any risk of any possible overstatement of income by a parent,
the IASB looked at the impairment testing of the investment account recorded by the parent.
If the investment account decreases in value as a result of the dividends from pre-acquisition
equity, an impairment loss needs to be recognised by the parent. To determine whether there
is an impairment of the investment account that should be recognised as a result of dividends
distribution, paragraph 12(h) of AASB 136/IAS 36 Impairment of Assets contains a scenario
that may provide evidence that the impairment of the investment account occurred: for an
investment in a subsidiary, joint venture or associate, the investor recognises a dividend from
the investment and evidence is available that:
(i) the carrying amount of the investment in the separate financial statements exceeds the
carrying amounts in the consolidated financial statements of the investee’s net assets,
including associated goodwill; or
(ii) the dividend exceeds the total comprehensive income of the subsidiary, joint venture
or associate in the period the dividend is declared.

As such, the pre-acquisition dividends that cause the impairment of the investment account
determine an adjustment to be posted in the pre-acquisition entries and that is to eliminate the
impairment loss recognised in the individual account by the parent. This entry in the case of
the pre-acquisition dividend complements the pre-acquisition entries necessary to eliminate
the dividend income and dividend paid/declared (in the period of dividend declaration or
payment) and, if the dividend was not yet paid, dividend receivable and dividend payable. If
the dividend is a post-acquisition dividend, the only entries will be those necessary to
eliminate dividend income and dividend paid/declared (in the period of dividend declaration
or payment) and, if the dividend was not yet paid, dividend receivable and dividend payable –
these entries are not part of pre-acquisition entries, but they will be posted in the
consolidation worksheet separately as eliminations of intragroup transactions (see chapter
29).

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Case study 28.3

Misvalued and unrecorded assets and liabilities

Tiwi Ltd has acquired all the shares of Boon Ltd. The accountant for Tiwi Ltd, Ms
Gupta, having studied the requirements of AASB 3/IFRS 3 Business Combinations,
realises that all the identifiable assets and liabilities of Boon Ltd must be recognised in
the consolidated financial statements at fair value. Although she understands the need
to revalue items recorded by the subsidiary at carrying amounts different from fair
value and to recognise previously unrecorded assets or liabilities at fair value, she is
unsure of a number of matters associated with accounting for these assets and liabilities.
She has approached you and asked for your advice.

Required
Write a report for Ms Gupta advising on the following issues.
1. Should the adjustments to fair value be made in the consolidation worksheet or in
the accounts of Boon Ltd?
2. What equity accounts should be used when revaluing or recognising assets and
liabilities?
3. Do these equity accounts remain in existence indefinitely, since they do not seem to
be related to the equity accounts recognised by Boon Ltd itself?

1. From the point of view of AASB 3/IFRS 3 and AASB 127/IAS 27, there is no
specification on where the adjustments are made. However if the assets of the subsidiary are
adjusted to fair value in the accounts of the subsidiary itself then this amounts to adoption of
the revaluation model by the subsidiary and all the regulations in AASB 116/IAS 16 and
AASB 138/IAS 38 apply. In particular, the assets must be continuously adjusted to reflect
current fair values. If, on the other hand, the adjustments are made in the consolidation
worksheet, this is a recognition on consolidation of the cost of the assets to the group entity
rather than an adoption of the revaluation model. Hence the recognition of the subsidiary’s
assets at fair value is to measure cost to the acquirer. There is then no need to make
subsequent adjustments to the assets when the fair values change. Because of the costs
associated with using the revaluation model, it is expected that most entities will make the
adjustments in the consolidation worksheet rather than in the accounts of the subsidiary itself.
Note also that some assets cannot be revalued at fair value in the individual accounts of a
subsidiary (e.g. inventories).

2. The accounting standards do not specify the name of the equity account raised on valuation
of the assets and liabilities of the subsidiary. Hence, an asset revaluation reserve account
could be used for the assets. The text uses a BCVR because adjustments are made to both
assets and liabilities and the BCVR is then a generic account for all adjustments arising as a
result of the business combination.

It is not appropriate to use income for liabilities as the recognition of equity for both assets
and liabilities does not affect current period profit or loss. There is no gain by the acquirer on
recognition of assets or liabilities not recognised by the subsidiary.

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2. The BCVR remains in existence while the underlying assets and liabilities remain unsold,
unconsumed or unsettled. With asset revaluation reserves under the revaluation model
there is no requirement that it ever be transferred to retained earnings, although this is
normal practice and is allowed under AASB 116/IAS 16. Similarly, the BCVR could
remain indefinitely. However, the extra benefits/expenses resulting from using the assets
or settling the liabilities will flow into the subsidiary’s retained earnings account. Hence
the group recognises the net benefits in the BCVR while the subsidiary recognises them
in retained earnings. This situation requires an adjustment in the consolidation worksheet
every year while such a difference in equity classification occurs. If on consolidation as
the assets are used up or sold and the liabilities settled the BCVR is transferred to retained
earnings, no subsequent consolidation adjustment is required.

Case study 28.4

Goodwill

When Mungo Ltd acquired the shares of Kata Ltd, one of the assets in the statement of
financial position of Kata Ltd was $20 000 goodwill, which had been recognised by Kata
Ltd upon its acquisition of a business from Gammon Ltd. Having prepared the
acquisition analysis as part of the process of preparing the consolidated financial
statements for Mungo Ltd, the group accountant has asked for your opinion.

Required
Provide advice on the following issues:
1. How does the goodwill previously recorded by the subsidiary affect the accounting
for the group’s goodwill?
2. If, in subsequent years, goodwill is impaired, for example by $5000, should the
impairment loss be recognised in the records of Mungo Ltd or as a consolidation
adjustment?
Answer:
1. The goodwill recorded by the subsidiary affects the adjustment to goodwill on
consolidation.

 If the acquisition analysis results in the calculation of a group goodwill of, say, $25
000 (by comparing the consideration transferred with the net fair value of identifiable
assets and liabilities that does not include the previously recorded goodwill), then as
the subsidiary has already recorded $20 000, a debit adjustment of $5000 is required
in the consolidation worksheet.
 If the acquisition analysis results in the calculation of a group goodwill of, say, $12
000, then as the subsidiary has already recorded $20 000, a credit adjustment of $8000
is required in the consolidation worksheet.
 If the acquisition analysis determines an excess of, say, $2000, then the whole $20
000 goodwill is eliminated on consolidation.

Any accumulated impairment losses recorded by the subsidiary at acquisition date must be
adjusted for in the consolidation worksheet, normally by writing them off.

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2. The determination of the impairment loss would be based on the subsidiary as a cash
generating unit (CGU) with the consolidated numbers representing the carrying amounts of
the CGU. In writing off goodwill as the result of an impairment loss, the goodwill written off
could be either that recognised by the subsidiary or that recognised on consolidation.

If the goodwill on consolidation is written off this is done via the pre-acquisition entries. If
the subsidiary writes off its recorded goodwill, no adjustment is required on consolidation for
the impairment write-down. If the consolidated goodwill was $25 000 (i.e. an extra $5000
over the existing pre-acquisition goodwill of $20 000), then if an impairment loss of $10 000
occurred, an amount of at least $5000 would have to be written off in the subsidiary’s
accounts.

Application and analysis exercises

Exercise 28.1
Acquisition analysis, acquisition date entries

On 1 July 2024, Babakin Ltd acquired all the issued shares of Moruya Ltd, paying $50
000 cash and transferring 100 000 of its own shares to Moruya Ltd’s former
shareholders. The fair value of Babakin Ltd’s shares at acquisition date was $2 per
share. At that date, the financial statements of Moruya Ltd showed the following
information.

Share capital $ 100 000

General reserve 40 000

Retained earnings 90 000

All the assets and liabilities of Moruya Ltd were recorded at amounts equal to their fair
values at the acquisition date. Babakin Ltd incurred $15 000 in acquisition-related costs
that included $2 500 as share issue costs.

Required
1. Prepare the acquisition analysis at 1 July 2024.
2. Prepare the journal entries for Babakin Ltd to recognise the investment in Moruya
Ltd at 1 July 2024.
3. Prepare the consolidation worksheet entries for Babakin Ltd’s group at 1 July 2024.
(LO3 and LO4)

Solution:
1. Acquisition analysis at 1 July 2024:
Net fair value of identifiable assets
and liabilities acquired = ($100 000 + $40 000 + $90 000) (equity)
= $230 000
Consideration transferred = $50 000 + 100 000 x $2
= $250 000

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Goodwill = $250 000 – $230 000
= $20 000

2. Journal entries for Babakin Ltd to recognise the additional investment in Moruya Ltd at 1
July 2024:
Shares in Moruya Ltd Dr 250 000
Cash Cr 50 000
Share capital Cr 200 000

Acquisition expenses Dr 15 000

Share capital Dr 2 500
Cash Cr 17 500

The acquisition-related costs are not part of the consideration transferred as those amounts
are not paid to the former shareholders of Moruya Ltd in exchange of their shares. Therefore,
they are not recognised as part of the investment in Moruya Ltd: the share issue costs are
treated as a reduction in the share capital (as all the share issue costs), while the remaining
costs are recognised as expenses in the year of acquisition.

3. Consolidation worksheet entries at 1 July 2024:

BCVR entry at 1 July 2024:
There is a BCVR entry only for goodwill identified in the acquisition analysis as all the
identifiable assets and liabilities of Moruya Ltd were recorded at amounts equal to their fair
values at acquisition date.

Goodwill Dr 20 000
Business combination valuation reserve Cr 20 000

Pre-acquisition entry at 1 July 2024:

Retained earnings (1/7/24) Dr 90 000
Share capital Dr 100 000
General reserve Dr 40 000
Business combination valuation reserve Dr 20 000
Shares in Moruya Ltd Cr 250 000

The pre-acquisition entry eliminates the pre-acquisition equity (including the business
combination valuation reserve recognised for the goodwill acquired) against the
investment account recognised by the parent based on the consideration transferred.

Please note that if the fair value of the consideration transferred would have been less than
the net fair value at acquisition date of identifiable assets acquired and liabilities assumed, the
acquisition analysis will identify a gain on bargain purchase instead of a goodwill. Therefore,
there won’t be any BCVR entries in that case and the pre-acquisition entry will need to
eliminate the retained earnings, share capital and the general reserve of the subsidiary at
acquisition date, together with the investment account recognised by the parent and recognise
the gain on bargain purchase. For example, if the fair value of the consideration transferred

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would have been $200 000, the gain on bargain purchase would have been $30 000 and the
only consolidation worksheet entry would have been the following pre-acquisition entry:
Retained earnings (1/7/24) Dr 90 000
Share capital Dr 100 000
General reserve Dr 40 000
Gain on bargain purchase Cr 30 000
Shares in Moruya Ltd Cr 200 000

Exercise 28.2

Acquisition analysis, acquisition date entries

On 1 July 2024, Giralang Ltd acquired the remaining 80% of the issued shares it did
not previously owned in Waratah Ltd, transferring 400 000 shares in Giralang Ltd to
Waratah Ltd’s former shareholders. The fair value of Giralang Ltd’s shares at 1 July
2024 was $3.50 per share. The previously held interest by Giralang Ltd in Waratah Ltd
(i.e. 20% of the issued shares) was recognised in Giralang Ltd’s accounts at the fair
value of $260 000 at 1 July 2024. On 1 July 2024, the financial statements of Waratah
Ltd showed the following information.

Share capital $ 700 000

Asset revaluation surplus 140 000

Retained earnings 460 000

All the assets and liabilities of Waratah Ltd were recorded at amounts equal to their
fair values at the acquisition date. Giralang Ltd incurred $25 000 in acquisition ‐related
costs, including $12 000 in share issue costs.

Required
1. Prepare the acquisition analysis at 1 July 2024.
2. Prepare the journal entries for Giralang Ltd to recognise the acquisition of the
remaining 80% of the issued shares in Waratah Ltd at 1 July 2024.
3. Prepare the consolidation worksheet entries for Giralang Ltd’s group at 1 July 2024.
(LO3 and LO4)

1. Acquisition analysis at 1 July 2024:

Net fair value of identifiable assets

and liabilities acquired = ($700 000 + $140 000 + $460 000) (equity)
= $1 300 000
Consideration transferred = 400 000 x $3.50
= $1 400 000
Fair value of prior investment = $260 000
Total investment at fair value = $1 400 000 + $260 000
= $1 660 000

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Goodwill = $1 660 000 – $1 300 000
= $360 000

2. Journal entries for Giralang Ltd to recognise the additional investment in Waratah Ltd at 1
July 2024:

Shares in Waratah Ltd Dr 1 400 000

Share capital Cr 1 400 000

Acquisition expenses Dr 13 000

Share capital Dr 12 000
Cash Cr 25 000
The acquisition-related costs are not part of the consideration transferred as those amounts
are not paid to the former shareholders of Waratah Ltd in exchange of their shares. Therefore,
they are not recognised as part of the investment in Waratah Ltd: the share issue costs are
treated as a reduction in the share capital (as all the share issue costs), while the remaining
costs are recognised as expenses in the year of acquisition.

3. Consolidation worksheet entries at 1 July 2024:

BCVR entry at 1 July 2024:

There is a BCVR entry only for goodwill identified in the acquisition analysis as all the
identifiable assets and liabilities of Waratah Ltd were recorded at amounts equal to their fair
values at acquisition date.
Goodwill Dr 360 000
Business combination valuation reserve Cr 360 000

Pre-acquisition entry at 1 July 2024:

Retained earnings (1/7/24) Dr 460 000

Share capital Dr 700 000
General reserve Dr 140 000
Business combination valuation reserve Dr 360 000
Shares in Waratah Ltd Cr 1 660 000

The pre-acquisition entry eliminates the pre-acquisition equity (including the business
combination valuation reserve recognised for the goodwill acquired) against the investment
account recognised by the parent based on the consideration transferred and the fair value of
the previously held interest.