Consolidated financial

statements (3)
Advanced Financial Accounting
Fair value and goodwill
 Fair value adjustment

• Individual assets may have a value different to (usually greater than) book
value.
• IFRS3 sets out detailed rules for the measurement of individual assets,
generally known as the fair value exercise.
• ‘Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date’ (Appendix A)
• ‘Fair value means the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm’s length
transaction (i.e. essentially, market value)’.
Fair value adjustment

• Even after the fair value exercise, the price paid for the company
(consideration) will not necessarily equal (will usually be higher than) the
fair value of the underlying assets.
• This means that the price paid will not equal the carrying amount of assets
to be brought into the SFP.
• So the elimination will not work.
• The difference is called goodwill.
Goodwill

• IFRS 3 Appendix A:

‘An asset representing the future economic benefits arising from

other assets acquired in a business combination that are not
individually identified and separately recognised’.
Goodwill

- Pay more than the amount of a target company’s

net assets = positive goodwill
- Bargain purchase (i.e. pay less than the fair value
of the identifiable net assets) = negative goodwill
Goodwill – treatment in FS

• Positive goodwill – recognise in group’s statement of financial position,

i.e. capitalise and annually test for impairment (IAS 36).
• Negative goodwill - recognise in the consolidated statement of profit or
loss, i.e. it will increase the group’s profit for the year.
• None of the negative goodwill is attributed to the NCI as it is considered
to have arisen from the good negotiating skills of the acquirer (parent).
Bargain purchase

• What circumstances may exist that we find ourselves in a bargain

purchase situation?
• Why would a company sell its shares for less than the fair value of
its net assets?

-The shareholders may want to sell quickly

- to raise money quickly
- the shareholder(s) want to retire
N.B. It can be difficult to break-up assets and sell them individually – it
can be quicker to sell shares.
Bargain purchase – How/why?

The directors of the selling company may not realise the

true/fair value of the net assets, i.e. the book values on the SFP
are undervalued, e.g. undervalued land values.

Furthermore, the buyer may have insider knowledge, e.g. the

land value is higher than NBV as a new airport is about to be
built.
Bargain purchase – How/why? (cont.)

Symbiosis – there is a good commercial fit between the parent and

subsidiary; for example:
• Motor manufacturer and car parts manufacturer.
• Restaurant chain and a hotel chain
• Cinema chain and a confectionary chain
 Fair value adjustment and positive Goodwill

• IFRS 3 states that:

• At date of acquisition:
– Goodwill is recognised at cost, i.e. cost of acquisition of the subsidiary less net
assets at fair value.

• Thereafter an annual impairment test is conducted to establish whether

any reduction in the carrying amount is needed.
• Goodwill must not be amortised.
• Goodwill is carried at cost less accumulated impairment losses.
Goodwill example
 Fair value and goodwill example

• P acquires the whole share capital of S on 1.1.X1. It pays £600,000 in

cash.
• The land and buildings of S are considered to have a fair value of
£180,000. Its other assets and liabilities are considered to have fair values
equal to book values. The SFP of S does not reflect the fair value of its
land and buildings.

• SFP of the companies immediately after the acquisition are as follows:

 Fair value and goodwill example
SFP as @ 01/01/x1 P £000 S £000

Assets
Land and buildings 1,800 120
Other non-current assets (NBV) 1,200 80
3,000 200
Investment in S 600 -
Net current assets 900 200
4,500 400
Equity and liabilities
Ordinary share capital 2,000 250

Retained earnings 2,500 150

4,500 400
P Group - Consolidated Statement of Financial Position as @ 01/01/x1
P S Consolidated Notes
£’000 £’000 £’000

Land and buildings

1,800 120
Other non-current assets
1,200 80
Net current assets
900 200

Investment in S
-
600

Goodwill
-
-
Total
4,500 400

Ordinary share capital

2,000 250
Retained earnings
2,500 150
Total
4,500 400
Working one – Group structure
Working two: Net assets of subsidiary
At acquisition
01/01/x1
£,000
Share capital
Retained earnings
Fair-Value adjustment
(Land/buildings 180 FV – 120
NBV)
TOTAL
(What P got for its investment
in S)
Working three Goodwill
£’000

Consideration paid by P
Less: FV of NA @ acquisition
(W2)
Goodwill @ date of
acquisition

Goodwill = consideration paid minus FV of assets

Workings

Workings 4 and 5 are not required in this example:

W4 NCI – There is no NCI – P has 100% ownership

W5 Group RE – This is just P’s RE as S does not have any
post-acquisition RE yet
Non-controlling interests
 Non-controlling interests (NCI)

• If a subsidiary is not wholly (100%) owned by a parent IFRS10 requires

that the group statement of financial position should be presented as if the
subsidiary is wholly owned but the amount of those net assets attributable
to the non-controlling interest should be shown separately.

• NCI is that part of the subsidiary which is not owned by the parent.
• IFRS 3 Appendix A: (non-controlling interest):

• ‘The equity in a subsidiary not attributable, directly or indirectly, to a

parent’.
Non controlling interests

• In consolidated accounts such non-controlling interests i.e. portion of the

profit or loss and those net assets attributable to minority shareholders
(NCI) should be shown separately.

• ‘Non-controlling interests in subsidiaries must be presented in the

consolidated statement of financial position within equity, separately
from the equity of the owners of the parent’ (IFRS 10).
Non-controlling interests

• IFRS 3 allows two different methods for calculating non-controlling

interest in the consolidated statements:
– METHOD 1 (partial)
• At the proportionate share of the fair value of the subsidiary’s identifiable net
assets (goodwill belonging to NCI is not included in NCI)
– METHOD 2 (full)
• At Fair value (full value) (usually based on the market value of the shares
held by the non-controlling interests)

Goodwill is recognised: Fair value less identifiable net assets

Non-controlling interests
Example
Goodwill Example

• Massive Plc acquires a subsidiary, Small Ltd, on 1st January 2017.

• The fair value of the identifiable net assets of Small Ltd were £4,340m.
• Massive Plc acquired 70% of the shares of Small Ltd for £4,290m.
• The NCI was fair valued at £1,366m.

Requirement:
• Compare the value of goodwill under the (1) partial and (2) full value
methods.
Method 1- Partial method (proportional)
£m
Purchase consideration (What Massive Plc paid for Small Ltd) 4,290
+ NCI (30% x 4,340 NA) 1,302
- Fair value of identifiable net assets (4,340)
= Goodwill 1,252

Or Goodwill = Consideration paid 4,290 –

FV of assets (4,340 x 70%) = 3,038 = 1,252
 Method 2 – Full/fair value method
£m
Purchase consideration 4,290
NCI (at fair value, per question) 1,366
5,656
Fair value of net identifiable net assets (4,340)
Goodwill 1,316
You can see the full value method affects both goodwill and NCI.
When NCI changes goodwill will be adjusted.
Massive Group
The two methods reconciled:
Method 1 - Method 2 – Difference
Partial Full/FV

Goodwill 1,252 1,316 64

NCI 1,302 1,366 64

Difference is attributable to NCI’s Goodwill included in

Method 2 but not in Method 1.
Non-controlling interests
Another example
NCI – both methods – a further example

• P acquired 75% of S on 1-1-X8 and paid £102,000. At the time of

acquisition retained earnings of S was £22,500.
• An impairment review shows that goodwill is not impaired.
• P values non-controlling interest at fair value and the market price of S’s
shares just before acquisition was £1.60.
The statement of financial position of P and S at P£ S£
31-12-X8
Property, plant and equipment 90 000 75 000
Shares in S 102 000 -
192 000 75 000
Current assets 78 000 52 500
Total assets 270 000 127 500
Current liabilities 15 000 15 000
Net Assets 255 000 112 500

Share capital £1 per shares 150 000 75 000

Retained earnings 105 000 37 500
Total Equity 255 000 112 500
Working one – Group structure
 Working two: net assets of subsidiary
At At reporting Post-
acquisition date acquisition
01/01/x8 31/12/x8
£ £ £
Share capital
Retained
profit/earnings
TOTAL
Working three: Goodwill – FV
Method
Goodwill separated out
Working four: Non-controlling interest (FV
Method)
Working five: Group retained earnings
Consolidated Statement of Financial Position (31-12-X8)
Using Method 2 - Full / FV Method

The P Group £ Notes

Assets
Property, plant and equipment

Current assets

Total assets

Less: Current liabilities

Net Assets

Equity
Equity attributable to the owners of P

Share capital

Retained earnings

Total equity
Using the proportionate
method
Just to see how this would work
Working three: Goodwill – Proportionate
Method
Working four: Non-controlling interest
(Proportionate Method)
Both methods reconciled

Method 1 - Method 2 – Difference

Partial Full/FV

Goodwill

NCI

Difference is attributable to NCI’s Goodwill included in

Method 2 but not in Method 1.
Consolidated statement of financial position (31-12-X8)
Using Method 1 - Proportionate / Partial Method

£
Assets
Property, plant and equipment

Current assets
Total assets
Current liabilities
Net Assets

Equity and liabilities

Equity attributable to the owners of P
Share capital
Retained earnings

Total equity and liabilities