module preparation seminar (part ii) for module a on ... · module preparation seminar (part ii)...

Module Preparation Seminar (Part II)

for

Module A on Financial Reporting

Speaker

Ms. Mabel Ho

6 November 2012

1

EXECUTIVE TRAINING COMPANY (INTERNATIONAL) LTD

Ms Mabel Ho

ETC Lecturer

ACA (UK), AICPA, CPA (Aust), FCCA, CPA (HK), Msc (Finance), Master (Tax), MBA

Extensive working experience in the financial industry

Acting as Financial Controller for listed companies – performing

strategic management work, forecasting, budgeting, complex

consolidation work and IT implementation

University lecturer for local and overseas universities

Developed unique method of teaching

Professional exam marker

Experienced notes writer

www.etctraining.com.hk

About the Lecturer

2

2

Module Preparation Seminar on Major or

Difficult Syllabus Topics (Part II)

• Business combination and consolidation of

financial statements

Module A Financial Reporting

www.etctraining.com.hk 3



In June 2011,

HKICPA issued as a “package of five” new standards

1. HKFRS 10 “Consolidated Financial Statements”

2. HKFRS 11 “Joint Arrangements”

3. HKFRS 12 “Disclosure of Interests in Other Entities”

4. HKAS 27 (2011) “Separate Financial Statements”

5. HKAS 28 (2011) “Investments in Associates and Joint Ventures”

and HKFRS 3 (revised) Business Combinations

They are applicable together. All are examinable in Module A

December 2012 Session – six month rule

4

3



Six-month rule

• A six-month rule is adopted for standards / interpretations.

• The cut-off date for new and revised standards / interpretations

examinable in the December 2012 Session is 31 May 2012.

• Please refer to the student handbook for details of the six-month

rule.

5



Effective Period of New Standards

• Effective for period beginning on or after 1 January 2013

• Earlier application is permitted

• If apply any earlier, apply all other standards at the same time

• Encourage to provide information required by HKFRS 12 earlier

• Provide some HKFRS 12 disclosures earlier does not mean early

adoption

6

4



Standards relevant to the preparation and presentation of consolidated financial statements

HKFRS 3 (revised) Business Combinations (deals with methods of accounting for business combinations and the

calculation of goodwill)

HKFRS10 Consolidated Financial Statements (applies specifically to the preparation and presentation of

consolidated financial statements for parent-subsidiary relationship and prescribes the principles of consolidations)

7



5



New Standard on Consolidation

• HKFRS 10 supersedes consolidation in HKAS 27 (Revised) and

HK(SIC) Int 12

• Because of conflict of emphasis between HKAS 27 (Revised) and

HK(SIC) Int 12

HKAS 27 (Revised) on control

HK(SIC) Int 12 on risks and rewards

• Accounting for subsidiaries, joint ventures and associates in

Separate Financial Statements in HKAS27 (2011)

9



New Standard on Consolidation

• HKFRS 10 now

Use control as a single basis for consolidation

Explicitly include de facto control

Explicitly include agent vs. principal concepts

• Three elements of control:

Power over the investee

Exposure, or rights, to variable returns from its involvement

with investee and

Ability to use its power to affect the amount of investor’s

returns

10

6





Joint Arrangements

• HKFRS 11 supersedes HKAS 31 and HK(SIC) Int 13

• HKFRS 11 addresses two aspects of HKAS 31

Structure of joint control arrangement determine accounting

treatments

Choice of different accounting treatment

• HKFRS 11 focuses on rights and obligations of arrangement,

rather than legal form

• HKFRS 11 requires equity method for joint ventures [HKAS 28

(2011)]

12

7



Chapter & Chapter Name

Main changes in 2012/13 edition

Chapter 27

Principles of consolidation

• Additional material on the disclosure

requirements in relation to subsidiaries

• Additional material on goodwill

Chapter 29

Consolidated accounts:

accounting for associates and

joint arrangements

• New material on transfers of non-current

assets between group companies and

associates of the group

• Material on disclosure requirements in

relation to associates and joint

arrangements moved from Chapter 27

MA Learning Pack –

Summary of changes 2012-13 Edition

13



Content

1. Group Accounts

2. HKFRS 10 Definition of Control

3. HKFRS 10 Consolidated Financial Statements

4. HKFRS3 (Revised) Business Combinations

5. Consolidation Theories

14

8

Group accounts are prepared which show the group

as a single economic entity:

MA – Group Accounts


SIGNIFICANT INFLUENCE = power to participate in but not control

the financial & operating policy decisions of an investee

• 20 – 50% votes

PARENT: An entity that has one or more subsidiaries

SUBSIDIARY: An entity that is

controlled by another entity

Consolidate

Control: HKFRS 3 / HKFRS 10

JOINT ARRANGEMENT: An entity in which two or more parties have joint

control

HKFRS 11 rules

Contractual arrangement HKFRS 11 /

HKAS 28 (2011)

ASSOCIATE: An entity in which the parent has significant

influence

Equity account

HKAS 28 (2011)

INVESTMENT: Asset held for accretion

of wealth

HKFRS 9 rules

Single company accounts HKFRS 9

15

Parent-Subsidiary Relationship

Parent Control Subsidiary

Subsidiary

Subsidiary

Group

Consolidation:

Process of

preparing and

presenting financial

statements of

parent and

subsidiary as if

they were one

economic entity

MA – Group Accounts


9



Content

1. Group Accounts





17

MA – HKFRS 10 Definition of Control


Power • Existing rights that give the current

ability to direct the relevant activities of the investee

• Power may be achieved through holding a majority of voting rights or by other means

Returns • Dividends • Remuneration for servicing investee’s

assets and liabilities • Fees and exposure to loss from

providing credit support. • Returns as a result of achieving

synergies by combining use of assets

Control

if the investor has • Power over the investee, and • Exposure or rights to variable returns from its involvement with the investee, and • The ability to use its power over the investee to affect the amount of returns it

receives to obtain benefits from its activities

18

10

Determination of control

MA – HKFRS 10 Definition of Control


Power – Example of Rights:

1. Rights to appoint, reassign or remove key management personnel who can direct the relevant activities

2. Rights to appoint or remove another entity that directs the relevant activities

3. Rights to direct the investee to enter or veto changes to transactions for the benefit of the investor

4. Other rights, specified in management contract

Ability rather than contractual right may also indicate POWER over investee

An investor uses POWER in the direction of relevant activities to affect returns

• from its involvement with the investee OR • even through an agent

Control Subsidiary

19



Content

1. Group Accounts





20

11

MA – HKFRS 10 Consolidated Financial Statements


Consolidated financial statements include all subsidiaries other than

those held for sale or those who operate under long term restrictions

and so are not controlled.

Exemption A parent need not prepare group accounts if: • It is itself a wholly owned subsidiary • It is partially owned and the other owners

do not object • Its securities are not publicly traded • The ultimate or intermediate parent

publishes HKFRS-compliant consolidated accounts

• Disclosures apply

Preparation • Different reporting dates –

adjustments should be made • Uniform accounting policies – if not,

disclose why. Adjustments should be made on consolidation

• Intra-group transactions are eliminated

A parent not presents consolidated financial statement must comply with HKAS 27 (2011) on separate financial statements

Parent’s account Subsidiaries are accounted for at cost or in accordance with HKFRS 9

HKFRS 9 Financial asset

21



Content

1. Group Accounts





22

12

MA – HKFRS 3 (Revised) Business Combinations


Scope of HKFRS3 (Revised)

• Second relevant standard on group accounting and provides guideline

on the measurement of net assets acquired in a business

combination, the non-controlling interest (NCI), goodwill arising

on business combination and necessary disclosures to evaluate a

business combination

• Not apply to

the formation of a joint venture

the acquisition of an asset or group of assets that does not

constitute a business (relevant standards are HKAS 16 and

HKAS 38, goodwill does not arise on such asset purchase)

a combination between entities or businesses under common

control

23



Scope of HKFRS3 (Revised)

Example of businesses under common control:

As Apex, Xero and Yoho are under the common control of Pear before and after

the business combination, this business combination is excluded from the

scope of HKFRS3 (Revised).

24

13



Definition of a Business

This determination can be complicated

If the fair value of the acquiree is concentrated in just one or a few

assets, or if there are little or no operations, for the acquiree to be

considered a business, it must have inputs and processes that make it

capable of generating a return or economic benefit for the acquirer’s

investors.

Economics benefits can be in the form of dividends, capital appreciation,

and cost reductions.

25




Under the framework, an entity determines whether acquiring a

business or assets:

1. Identifies the elements in the acquiree

• Elements may vary on industry, structure and stage of

development

26

14




2. Assesses the capability of the acquiree to produce outputs

• Development stage enterprise:

have begun planned principal activities

has employees, intellectual property, other inputs and

processes applied to inputs

is pursuing a plan to produce outputs

obtain access to customers that will purchase the outputs

27




3. Business need not include all inputs or processes if market

participants are capable of acquiring the business and produce

outputs by using their own inputs and processes (accounting, billing,

payroll & other systems are not processes to create outputs)

4. Acquirer’s intended use of the acquired assets and activities is NOT

a determining factor

5. Goodwill exists in business combination accounted for by applying

acquisition method

28

15




Example : Asset Acquisition

• Facts:

– A shipping and warehousing company (the acquiree) provides shipping and storage services to various third parties.

– A consumer retail company (the acquirer) plans to purchase several warehouses from the shipping and warehousing company and intends to use the warehouses to enhance its inventory distribution system.

– The acquiree includes only the land and warehouses. It does not include warehousing contracts with third parties, nor does it include employees, warehouse equipment, or information technology systems, such as inventory-tracking systems.

29




Example : Asset Acquisition

• Analysis:

– It is unlikely that the acquiree would be a business, but only asset acquisition.

– The acquirer will purchase only inputs (i.e., the physical assets) and no accompanying processes.

– The acquiree is missing significant inputs and processes. Without these missing elements, the acquirer does not meet the definition of a business.

30

16



Content

1. Group Accounts





31

MA – Consolidation Theories


Ownership of the combined entity involving a wholly owned subsidiary

Joint-ownership of the combined entity involving a partially owned subsidiary

Parent company’s shareholders

Parent company

Subsidiary

100% ownership

Wholly owned by the parent company’s shareholders

Parent company’s shareholders

Parent company

70% ownership

Subsidiary

Two groups of shareholders 1) The parent company’s shareholders; 2) The non-controlling shareholders of

the subsidiary

Non-controlling shareholders of a subsidiary

30% ownership in

subsidiary

32

17



• Theories relating to consolidation are critical when the percentage of

ownership in a subsidiary is less than 100%

• Termed “partially owned subsidiary”, where the remaining

percentage is owned by shareholders who are collectively referred to

as “non-controlling interest” (NCI)

Subsidiary

Parent Non-controlling interests (NCI)

90% 10%

33



Both parent and non-controlling interest have a proportionate share of the

subsidiary’s:

1. Net profit;

2. Dividend distribution;

3. Share capital

4. Retained profits and changes in equity

34

18

1. Overview of the consolidation process

2. The acquisition method

3. Determining the amount of consideration transferred

4. Recognition and measurement of identifiable assets, liabilities

and goodwill

5. Accounting for non-controlling interests under HKFRS 3

(revised)

6. Effects of amortization, depreciation and disposal of

undervalued or overvalued assets and liabilities subsequent to

acquisition

7. Goodwill impairment tests

8. Elimination of unrealized profits



[Consolidation Process]



Parent’s Financial

Statements +

Subsidiaries' Financial

Statements +/- Consolidation adjustments

and eliminations =

Consolidated financial

statements

Legal entities Economic entity

36

19


• Consolidation is the process of preparing and presenting the financial

statements of a group as an economic entity.

• No ledgers for group entity

• Consolidation worksheets are prepared to:

1. Combine parent and subsidiaries financial statements

2. Adjust or eliminate intra-group transactions and balances

3. Allocate profit to non-controlling interests

Consolidation entails an “asset substitution” - replace parent’s

investment in subsidiary with identifiable assets and liabilities of the

subsidiary with a residual asset called Goodwill.



[Consolidation Process - Overview]

1. Inter-corporate Shareholdings

• Parent : Ordinary shares held by those outside the consolidated

entity are viewed as the ordinary shares outstanding of the entire

entity.

• Wholly-owned subsidiary : Ordinary shares held entirely within

the consolidated entity are NOT shares outstanding from a

consolidated viewpoint.

Note: A company cannot report in its financial statements an

investment in itself



20


1. Inter-corporate Shareholdings

• Parent’s common stock remains as the common stock in the

consolidated balance sheet of the reporting entity.

• Parent’s retained earnings (less the unrealized intercompany

profit) remains as the only retained earnings figure in the

consolidated balance sheet.



Parent

Subsidiary

Parent’s common

stock

Consolidated Entity

Eliminate Subsidiary’s

Common stock

39


2. Intercompany Receivables and Payables • A single company cannot owe itself money, that is, a company

cannot report (in its financial statements) a receivable to itself and a payable to itself.

• Therefore, an inter-company receivable/payable is eliminated from both receivables and payables in preparing the consolidated balance sheet.



Parent

Subsidiary

Consolidated Entity

Eliminate Inter-

company

receivable/

payable

40

21


3. Inter-company Sales

• The inter-company sale should be removed from the combined

revenues because it does not represent a sale to an external

party.

• Remaining inventory must be restated to its original cost to the

consolidated entity (transferring affiliate).



Parent

Subsidiary

Consolidated Entity

Cost of

sales

41




4. Intra-group transactions are eliminated to:

• Show the financial position, performance and cash-flow of the

economic entity (not legal).

• Avoid double counting of transactions.

42

22


Example:

• Parent sold inventory to subsidiary for $2M (down-stream sale)

• The original cost of inventory is $1M

• Subsidiary eventually sold the inventory to external parties for $3M

What is the journal entry to eliminate intra-group sales transaction?



Consolidation adjustment

Dr Sale – Parent’s book 2,000,000

Cr Cost of sales – Sub’s book 2,000,000

43


Extract of consolidation worksheet

Note: Without elimination the consolidated sales and cost of sales figures

will be overstated by $2 M.



Parent's

Income

Statement

Subsidiary’s

Income

Statement

Consolidation

elimination entries

and adjustments Consol.

Income

Statement

Without

elimination Dr Cr

Sales $2,000,000 $3,000,000 2,000,000 $3,000,000 $5,000,000

Cost of

sales (1,000,000) (2,000,000) 2,000,000 (1,000,000) ($3,000,000)

Gross

profit $1,000,000 $1,000,000 $2,000,000 $2,000,000

44

23


5. Difference between Fair Value and Book Value • Fair value of the consideration given usually reflects the fair value

of the acquiree and differs from its book value.

• An acquiree’s assets and liabilities must be valued based on their acquisition-date fair values, and any excess of the consideration given over the fair values of the net assets is considered goodwill.




6. Non-Controlling interest • Shareholders of the parent are named as controlling interest.

• Shareholders of the subsidiary other than the parent are referred

as “non-controlling” shareholders. Their interests are non-controlling interests on the income and net assets of the subsidiary.

• Computation of income to the non-controlling interest: In uncomplicated situations, it is a simple proportionate share

of the subsidiary’s net income



24

[Consolidation Worksheet Example] Statement of Comprehensive Income for the year ended 31 December 20x2



Consolidation adjustment

/elimination

Consol.

Total

Prince Ltd Silver Ltd Dr Cr

Sales 5,000,000 1,900,000 6,900,000

Cost of sales -4,250,000 -1,520,000 -5,770,000

Gross profit 750,000 380,000 1,130,000

Other expenses -185,000 -155,000 7,400 -351,400

4,000

Operating profit 565,000 225,000 778,600

Dividend income 28,000 0 28,000 0

Profit before tax 593,000 225,000 778,600

Tax, at 20% -113,000 -45,000 800 -157,200

Profit after tax 480,000 180,000 621,400

Income to Non-controlling interests 33,880 -33,880

Profit after Non-controlling interests 587,520

Dividends declared -100,000 -35,000 35,000 -100,000

Profit retained 380,000 145,000 487,520

Retained earnings, 1 January 1,620,000 155,000 5,000 1,280 1,723,040

11,840

6,400

30,000

Retained earnings, 31 December 2,000,000 300,000 126,520 37,080 2,210,560

47



[Consolidation Worksheet Example] Statement of Financial Position as at 31 Dec 20x2

Prince Ltd Silver Ltd

Consol.

Total

Consolidation adjustment /elimination

Dr Cr

Fixed assets, net book value 2,200,000 326,000 20,000 12,000 2,534,000

Goodwill 74,000 22,200 51,800

Investment in Silver Ltd, at

cost 230,000 230,000 0

Other investments 120,000 120,000

Inventories 797,000 106,000 903,000

Trade and other receivables 453,000 50,000 503,000

Due from Silver Ltd 60,000 60,000 0

Cash 185,000 20,000 205,000

3,925,000 622,000 94,000 324,200 4,316,800

Share capital 1,150,000 190,000 190,000 1,150,000

Retained earnings 2,000,000 300,000 126,520 37,080 2,210,560

Non-controlling interests 1,600 55,000 107,640

7,000 30,000

2,960 33,880

320

Due to Prince Ltd 60,000 60,000

Deferred tax liability 2,400 4,000 1,600

Trade and other payables 775,000 72,000 847,000

3,925,000 622,000 390,480 160,280 4,316,800

484,480 484,480

48

25

[Consolidation Worksheet Example]

Consolidation adjustments for 20x2



(1) Elimination entry of balances at 1.1.20x1 required again in 20x2

Dr Share capital 190,000

Dr Retained earnings 5,000

Dr Fixed assets (net) 20,000

Dr Goodwill 74,000

Cr Deferred tax liability 4,000

Cr Investment in Silver Ltd 230,000

Cr Non-controlling interests 55,000

289,000 289,000

(2) Past and present impairment entries for Goodwill

Dr Opening retained earnings (80%*14,800) 11,840

Dr Non-controlling interests (20%*14,800) 2,960

Dr Impairment of goodwill (Current 20x2) 7,400

Cr Goodwill 22,200

49


What the parent pays for through investment in a subsidiary?



Share of book value of

subsidiary’s net assets on

acquisition date

+/- Share of excess fair value over book

value of identifiable assets and liabilities

(incl. zero book value intangibles and unrecognized

contingent liabilities)

+ Goodwill (an asset relates to

the subsidiary as a whole and is

non-identifiable)

Consideration transferred by

parent = Record as Investment in

Subsidiary

=

50

26


Asset substitution process in consolidation

1. Eliminate investment account in parent’s book and replace by the

book value of identifiable assets and liabilities of the subsidiary at

acquisition date.

2. Eliminate subsidiary’s share capital, pre-acquisition retained

earnings and other equity items because it is inappropriate to

include them in consolidated equity as they arose prior to the exercise

of control by the parent.

3. The differential represents a) Goodwill and b) excess or deficit of

fair value over book value of identifiable net assets of the

acquired subsidiary at acquisition date.







and goodwill


(revised)



acquisition





27

[The Acquisition Method]

• HKFRS 3 (revised) requires all business combinations to be

accounted for using the acquisition method.

• The procedures: 4-step approach



1. Identify the acquirer

2. Determine the acquisition date

3. Recognize and measure the identifiable assets acquired the liabilities assumed and any non-controlling

interest in the acquiree; and

4. Recognize and measure goodwill or a gain from a bargain purchase

Group

financial

statements

if acquire

subsidiaries

53

[The Acquisition Method]

HKFRS 3 (revised) requires the identification of the acquirer in all

circumstances

• Acquirer is the entity that obtains control (HKFRS 10 ) of another

combining entities

• In other words, a business combination is not considered to be a

merger



28





and goodwill


(revised)



acquisition





[Determine the Amount of Consideration Transferred]



Fair value of assets

transferred

+ Fair value of liabilities

incurred

+ Fair value of equity

interests issued by acquirer

Consideration transferred = + Fair value of

contingent consideration

56

29


HKFRS3 (revised) Principle: Consideration transferred in a business

combination should be measured at Fair value:

• Determined on the acquisition date

• Acquisition date is the date when the acquirer obtains control and

NOT the date when consideration is transferred




Fair value of equity interests issued is measured by:

• Market price

• If market price is not available or not reliable:

A proportion of acquirer’s fair value or proxied by the fair value

of equity interest acquired (i.e. acquiree), whichever is more

reliably measurable



30


Illustration 1:

Fair Value of Equity Issued



[Illustration 1: Fair Value of Equity Issued]

P Ltd acquires 100% of S Co through an issue of 5,000,000 shares to the

sellers of S Co.



P Ltd S Co

Number of existing shares 10,000,000 2,000,000

Number of new shares issued 5,000,000 -

Market price per share $2.00 -

Fair value of equity $24,000,000 $9,000,000

60

31

[Illustration 1: Fair Value of Equity Issued]

Q1: P Ltd’s market price is a reliable indicator

Consideration transferred = 5,000,000 shares x $ 2.00

= $10,000,000

Q2: P Ltd’s market price is not a reliable indicator; a proportional

interest in the fair value of P Ltd is a better estimate

Consideration transferred = (5,000,000/15,000,000) x $24,000,000

= $8,000,000

Q3: Fair value of S Co (acquiree) is a better estimate

Consideration transferred = $9,000,000




Contingent consideration

• Obligation (right) of the acquirer to transfer (receive) additional assets

or equity interests to (from) acquiree’s former owner if specific event

occurs

E.g. Acquirer gets a refund of a part of the consideration

transferred if the acquiree does not achieve the target profit

Fair value of the contingent consideration (refund), measured

at the acquisition date, is added to (deducted from)

consideration transferred



32


Changes in the FV of contingent consideration that the acquirer

recognizes after the acquisition date:

• result of additional information about facts and circumstances that

existed at the acquisition date, i.e. such changes are measurement

period adjustments, adjustments to be made retrospectively to

goodwill.

• Result of post-combination change after acquisition date, such as

meeting an earnings target, reaching a specified share price or

reaching a milestone on a R&D project, are not measurement period

adjustments. They are dealt with as follows:




a) Contingent consideration classified as equity shall not be re-

measured and its subsequent settlement shall be accounted for within equity.

b) Contingent consideration classified as an asset or a liability that:

1. is a financial instrument (e.g. loan notes) shall be measured at FV and account for the change under HKFRS 9

2. is in the form of cash, account for the change under HKAS 37 (Provisions, Contingent liabilities and Contingent Assets)



33


Measurement Period

• HKFRS 3 (revised) allows adjustments to be made retrospectively to

goodwill, fair value of identifiable net assets and consideration transferred: If new information about facts and circumstances existing at

acquisition date arises,

Within 1 year of acquisition date




Measurement Period

• Any change in estimate arising from new information on facts and

circumstances after the acquisition date will be recognized in the current period of change and NOT retrospectively.

• Further adjustments retrospectively after the initial accounting (after 1 year) should be recognized only to correct an error as a prior - period adjustment (HKAS 8)



34


Acquisition-Related Costs

• All acquisition-related direct and indirect costs are expensed off

• Costs of issuing debt are recognized in accordance with HKFRS 9

As yield adjustment to the cost of borrowing and are amortized

over the life of the loan

Journal entry for the payment of debt issuance cost



Dr Unamortized debt issuance costs

Cr Cash

67


Acquisition-Related Costs

• Costs of issuing equity are recognized in accordance with HKFRS 9 Deducted from equity

Journal entry to record the payment of cost of issuing equity



Dr Equity

Cr Cash

68

35





and goodwill


(revised)



acquisition





[Intangible Assets]

HKFRS3 (Revised) requires the acquirer to recognize the fair value of an

acquiree’s unrecognized identifiable asset (e.g. intangible asset) in the

combined financial statements.

• Justified by the acquisition of the subsidiary by the parent

To qualify for recognition, the intangible asset must be identifiable:

Either Separable OR must arise from Contractual or Legal rights

• E.g. assembled workforce with specialized knowledge

Fails to meet the separability criterion

• E.g. opportunity gains from an operating lease with terms favorable in

relation to current market conditions

Meets the contractual-legal criterion



36

[Contingent Liabilities & Provisions]

Contingent liabilities are recognized if they are:

• Present obligations arising from past events and

• Reliably measurable in their fair value, even if outcome is not probable

(departure from normal rules in HKAS 37)

• Contingencies must meet the definition of a liability

HKAS 37 is different from HKFRS 3 (Revised), if future outflow is less than

probable, contingent liabilities are not normally recognized in the separate

financial statement of the acquiree, but only disclosed.



[Indemnification Assets]

Contractual indemnity Provided by the sellers of the acquiree to the acquirer to make good any loss arising from contingency or an asset or a liability

• Treatment for indemnity

The acquirer has to recognize an “indemnification asset” at the same time the indemnified liability is recognized.

The indemnification asset is measured on the same basis as the indemnified asset or liability at the acquisition fair-value.

• E.g. An acquiree is exposed to a contingent liability. Based on probabilistic estimation, the FV of the contingent liability is $100,000. The seller provides a contractual guarantee to indemnify the acquirer of the loss.

In the consolidated statement of financial position, contingent liabilities and an indemnification asset of $100,000 will be recognized at fair value



37

[Deferred Tax]

The recognition of fair value differential may give rise to future tax payable or

future tax deduction

• tax effects need to be accounted for if the basis of taxation does not change in

a business combination

• i.e. If original asset is deductible based on book value, the FV differential will

give rise to a temporary taxable/deductible difference

The deferred tax benefits can be adjusted against goodwill but limited to the

measurement period. Post acquisition recognition of deferred tax impacts

statement of comprehensive income , NOT goodwill



FV > Book value of identifiable assets Deferred tax liabilities

FV < Book value of identifiable assets Deferred tax assets

FV < Book value of identifiable liabilities Deferred tax liabilities

FV > Book value of identifiable liabilities Deferred tax assets

73

[Goodwill]

A premium that a parent pays to acquire the subsidiary • Must be recognized separately as an asset • Determined as a residual

HKFRS 3 allows 2 ways of determining goodwill depending on the measurement basis for NCI at the acquisition date



38

[Goodwill]



Goodwill Fair value of consideration transferred

+

Amount of non-controlling interests

+ Fair value of the acquirer’s previously held interest (before control was achieved) in

the acquiree

Acquiree’s recognized net identifiable assets

measured in accordance with

HKFRS3


(NCI)

Measured at fair value at acquisition date (include goodwill)

Measured as a proportion of FV of identifiable net assets at acquisition date

= Less

75

[Bargain Purchase]

• Results when at the acquisition date, the

1. fair value of the consideration given by the acquirer +

2. fair value of any non-controlling interest in the acquiree +

3. fair value of acquirer’s previously held interest in the acquiree is

less than the fair value of the acquiree’s net identifiable assets

(NIA),

• if acquisition-date valuations are appropriate, the acquirer

recognizes a gain immediately at the date of acquisition

The amount of the gain must be disclosed, along with where the

gain is reported and the factors that led to it



39

[Bargain Purchase – Example]

1. AC acquires 80% of the equity interest of TC for cash of $150.

2. The net identifiable assets and liabilities acquired at acquisition date

is $200 (Assets 250- Liabilities 50).

3. The FV of the non-controlling interest in TC is $42.



[Bargain Purchase – Example]

Gain from bargain purchase:



Amount of identifiable net assets acquired 200

Less: FV of consideration transferred 150

FV of NCI 42 192

Gain on bargain purchase in AC’s book 8

Dr Asset acquired 250

Cr Cash 150

Cr Liabilities assumed 50

Cr Gain on the bargain purchase (SOCI) 8

Cr NCI (FV) 42

78

40

[Non-Controlling Interests’ Share of Goodwill]

NCI to be measured in either of two ways:



Non-controlling interests

Measured at Fair value at acquisition date (include goodwill)

(Fair value option)

Measured as a proportion of FV of

identifiable net assets at acquisition date

79




NCI measured at FV

(Fair Value Option)

NCI measured as a proportion of the

acquiree’s identifiable net assets

Book value of net assets

Fair value – Book value (Fair Value Adjustment) of net assets

Goodwill

80

41


Under the fair value option:

• 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 due to control premium paid by

parent.

• NCI comprises of 3 items.








Share of book value of net assets

Share of unamortized FV adjustment

(FV – BV)

Share of unimpaired goodwill

82

42



• 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 on consolidation (Parent & NCI)

Dr/Cr Deferred tax asset/ (liability) on fair value adjustment

Cr Investment in subsidiary

Cr Non-controlling interests (At fair value)

83


Under the 2nd option:

• NCI is a proportion of the acquiree’s identifiable net assets at fair value

• NCI comprises of 2 items:

Note: No share of goodwill by NCI






(FV – BV)

84

43


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

Dr Goodwill (Parent only)

Dr/Cr Deferred tax asset/ (liability) on FV adjustment

Cr Investment in subsidiary

Cr Non-controlling interests (NCI% x FV of identifiable net assets)

85


1. A acquires 70% of the equity interest of GC for cash of $700.

2. The net identifiable assets and liabilities acquired at acquisition date

is $740 (Assets 800- Liabilities 60).

3. The FV of the non-controlling interest in GC is $250.

What goodwill arises on acquisition and NCI interests at date of

acquisition assuming NCI is measured (a) as a proportion of the net

assets of GC (b) at FV?



44




Net assets method

FV method

Consideration 700 700

NCI (30% x $740) 222 250 (FV)

922 950

Net assets acquired (740) (740)

Goodwill 182 210

Parent’s share of goodwill 182 182

NCI’s share of goodwill Nil 28 (FV – 30% x $740)

NCI balance at acquisition 222 250 (222 + G/W 28)

87





and goodwill


(revised)



acquisition





45

[Accounting for Non-Controlling Interests]

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

Profit after tax

Dividends declared

Share capital

Retained earnings and other comprehensive income (e.g. 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

Goodwill (if the fair value alternative is adopted)

Note: There is no distinction between pre-acquisition and post-acquisition

retained earnings for NCI. NCI is entitled to the share of retained earnings of

subsidiary from incorporation.







and goodwill


(revised)



acquisition





46

[Subsequent to Acquisition]

At acquisition date, we recognize:

• Fair value of identifiable net assets,

• Intangibles, contingent liabilities, and

• Deferred tax assets or liabilities on the above




In subsequent years:

• Amortization, depreciation and cost of sales of the acquired assets

must be based on the fair value as at 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.

• E.g. When an identified asset is sold or depreciated:



(FV- BV) adjustment to expense =

FV of expense in consolidated


BV of expense in separate financial

statements +

Adjusted in consolidation worksheet

92

47


Illustration 1:

Subsequent to Acquisition



[Illustration 1: Subsequent to Acquisition]

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

acquire 80% of S Co on 1 Jan 20X2.

• Fair value of P Co’s share is $3 per share.

• Fair value of net identifiable assets is as follows:



48




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

95


Additional information:

• Contingent liability of $100,000 (law suit) was recognized as a

provision by the acquiree in Dec 20X2

• FV of NCI at acquisition date was $2,300,000

• Net profit after tax of S Co for 31 Dec 20X2 was $1,000,000

• No dividends were declared during 20X2

• Shareholders’ equity as at 31 Dec 20X2 was $5,700,000

• Tax rate 20%



49


Q1 : Prepare the consolidation adjustments for P Co for 20X2

Q2 : Perform analytical check on balance of NCI as at 31 Dec 20X2




At Acquisition Date 1 Jan 20x2



1. Consideration

transferred

= Cash consideration + Fair value of share

issued

= $6,200,000 + (1,000,000 x $3)

= $9,200,000

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

= $580,000

3. 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

98

50


At Acquisition Date 1 Jan 20x2



4. P’s share of goodwill = Consideration transferred – 80% x Fair value

of net identifiable assets, after tax

= $9,200,000 – 80% x ($7,600,000-$580,000)

= $9,200,000 – $5,616,000

= $3,584,000

5. NCI’s share of goodwill = Consideration transferred (FV) – 20% x Fair

value of net identifiable assets, after tax

= $2,300,000 – 20% x ($7,650,000-$580,000)

= $2,300,000 – $1,404,000

= $896,000

$4,480,000

99

[Illustration 1: Subsequent to Acquisition – Q1]

Consolidation adjustments for 20X2



CJE 1: Elimination of investment in S on 1 Jan 20x2

Dr Share capital 1,000,000

Dr Retained earnings 3,700,000

Dr FV differential- Leased property 1,000,000

Dr FV differential - In-process R&D 2,000,000

Dr Goodwill on consolidation 4,480,000

Cr Contingent liability (provision for lawsuit) 100,000

Cr Deferred tax liability 580,000

Cr Investment in S 9,200,000

Cr Non-controlling interests (Fair Value) 2,300,000

12,180,000 12,180,000

100

51




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

Dr Depreciation of leased property ($1,000,000/20) 50,000

Dr Amortization of in-process R&D ($2,000,000/10) 200,000

Cr Accumulated depreciation – leased property 50,000

Cr Accumulated amortization – in-process R& D 200,000

+ Dep exp: $50,000 + Amort. Exp:

$200,000 Dep. of leased

property

$200,000 ($4m/20yrs)

$200,000 Amort. of R&D $0

Based on book value

Based on FV Based on book value

Based on FV

Under dep. by $50k

Under amort. by $200k

101


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

recognition by the acquiree results in double counting; hence this

reversal entry is necessary



CJE 3: Reversal of entry relating to provision for lawsuit

Dr Provision for lawsuit 100,000

Cr Loss from lawsuit 100,000

CJE 4: Tax effects on CJE 2 & CJE 3

Dr Deferred tax liability 30,000

Cr Tax expense (tax deduction on FV adjustments) 30,000

20% * (200k +50k

-100k)

102

52




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

Dr Income to NCI (Group SOCI) 176,000

Cr NCI (Group SOFP) 176,000

Net profit after tax 1,000,000

Excess depreciation (50,000)

Excess amortization (200,000)

Reversal of loss from lawsuit 100,000

Tax effects on FV adjustments 30,000

Adjusted net profit 880,000

NCI’s share (20% x $880,000) 176,000

103




NCI balance:

NCI at acquisition date (CJE 1) at Fair Value $2,300,000

Income allocated to NCI for 20x2 (CJE 5) 176,000

NCI as at 31 Dec 20x2 $2,476,000

104

53





(FV – BV)

Share of unimpaired goodwill



$5,700,000 ($4.7m

+ $1m) x 20%

= $1,140,000

+ ($1,000,000 x 19/20 x

80% after tax x NCI

20%) + ($2,000,000 x

9/10 x 80% x 20%) =

$440,000 (after tax)

+ $896,000 = $2,476,000

105





and goodwill


(revised)



acquisition





54

[Goodwill Impairment Test]

HKAS 36: Goodwill has to be reviewed annually for impairment loss

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

CGU is the lowest level in which it has independent cash flows

and the goodwill is monitored for internal management purposes

and

Not larger than a segment determined under segment reporting

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

CGUs.



[Goodwill Impairment Test]

Steps for impairment test



1. Determine the carrying amount of the CGU

2. Determine the recoverable amount of the CGU

If carrying amount ≤ recoverable amount

If carrying amount ≥ recoverable amount

No impairment loss Allocate impairment loss

to goodwill first and balance to other net assets

3. Recoverable amount: Higher of Fair Value and Value in Use

108

55





and goodwill


(revised)



acquisition





[Elimination of Unrealized profit]

Principles Governing Elimination

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

eliminated.

• Transactions in the statement of comprehensive income between

the group companies are eliminated.

• Unrealized profit or loss included in assets are eliminated in full

(parent’s unrealized profit in downstream sale; parent’s & NCI’s

share of subsidiary’s unrealized profit in upstream sale).



56


Principles Governing Elimination

• Tax effects on unrealized profit or loss included in assets should be

adjusted according to HKAS 12 Income Taxes.

• Balances with associates (“significant influence”) are NOT

eliminated.

Associates are not part of the group




• Regardless of the parent’s percentage ownership of a subsidiary, the

full amount of any unrealized gains and losses must be

eliminated and must be excluded from consolidated net income.

• When a sale is from a parent to a subsidiary, referred to as a

downstream sale, any gain or loss on the transfer accrues to the

parent company’s stockholders.

• When the sale is from a subsidiary to its parent, an upstream sale,

any gain or loss accrues to the subsidiary’s stockholders.

• The direction of the sale determines which shareholder group absorbs

the elimination of unrealized intercompany gains and losses.



57


Intra-group Transfers of Inventory and Fixed Assets

1. If the transferred asset is an inventory:

• It should be carried at original cost and not the transferred price

• Adjustments are made to:

Eliminate the profit element

Recognize profit only when the inventory is sold to 3rd

party

2. If the transferred asset is a fixed asset:

• The asset should be carried at original cost less accumulated

depreciation

• Subsequent depreciation is based on original cost and not the

transferred price




Downstream Sale (Sales to Subsidiary)

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



Parent

Subsidiary

90 %

owned

Sales were

made from

parent to

subsidiary

Unrealized profit

resides in

Parent’s book

114

58


Upstream Sale (Sales to Parent)

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.



Parent

Subsidiary

90 %

owned

Sales were

made from

subsidiary to

parent Unrealized profit

resides in

Subsidiary’s book

115


Adjustments to Eliminate Unrealized Profit – Upstream Sale



In the current period:

Dr Sales

Cr Cost of sales (realized)

Cr Inventory (P)

In the following period (if unsold):

Dr Opening RE

Dr NCI (SOFP)

Cr Inventory (P)

In the following period (if sold):

Dr Opening RE

Dr NCI (SOFP)

Cr Cost of sales

Inter-company sales is reversed

(1) Eliminate realized cost of sales

(2) Reverse unrealized profit in inventory

Unsold % x Unrealized profit

Remove unrealized profit in inventory

Adjust cost of sales from transfer price

to original cost 116

59


Illustration 1:

Upstream and Downstream Sales



[Illustration 1: Upstream and Downstream Sales]

• P invested in 70% of shares of S • Intercompany transfers of inventory are as follows:

• Tax rate: 20% • Net profit after tax of S: $800,000 (31 Dec 20X3), $900,000 (31 Dec 20X4)



20X3 20X4

Sale of inventory from P to S (downstream sales)

Original cost of inventory

Gross profit

Percentage unsold to 3rd party at year end

$60,000

$(50,000)

$10,000

10%

4%

Sale of inventory from S to P (upstream sales)

Original cost of inventory

Gross profit

Percentage unsold to 3rd party at year end

$200,000

$(170,000)

$30,000

30%

0%

118

60


31 Dec 20X3

1) Eliminate intercompany sales and adjust unrealized profit in

inventory



Unrealized profit x

percentage unsold

Dr Sales (P’s SOCI) 60,000

Cr Cost of sales (P & S’s SOCI) 59,000

Cr Inventory (S’s SOFP)(10,000 x 10%) 1,000

(Elimination of intercompany sales and adjustment of unrealized profit of P from downstream sale)

Dr Sales (S’s SOCI) 200,000

Cr Cost of sales (P & S’s SOCI) 191,000

Cr Inventory (P’s SOFP)(30,000 x 30%) 9,000

(Elimination of intercompany sales and adjustment of unrealized profit of S from upstream sale)

119


31 Dec 20X3

2) Adjust the tax effects on unrealized profit



Unrealized profit of

P from unsold

inventory $1,000 x

20%

Unrealized profit of

S from unsold

inventory $9,000 x

20%

Dr Deferred tax asset (Group SOFP) 200

Cr Tax expense (P’s SOCI) 200

(Elimination of intercompany sales and adjustment of unrealized profit of P from downstream sale)

Dr Deferred tax asset (Group SOFP) 1,800

Cr Tax expense (S’s SOCI) 1,800

(Adjustment for tax effects on unrealized profit in inventory of

S from upstream sale)

120

61


31 Dec 20X3

3) Allocate share of S’s current year profit to NCI

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

downstream sale as profit resides in parent income





Net profit after tax of S * 800,000

Less: Unrealized profit of S from upstream sale (9,000)

Add: Tax on unrealized profit of S 1,800

Adjusted profit after tax of S 792,800

NCI’s share (30%) of S’s Net profit after tax $792,800 237,840

121


31 Dec 20X4

1) Adjust opening RE and unrealized profit in inventory



Need to adjust

NCI’s share of

unrealized profit of

S from upstream

sale

Dr Opening RE (P’s SOFP) 1,000

Cr Cost of sales 600

Cr Inventory (S’s SOFP) (10,000 x 4%) 400

(Adjustment of unrealized profit in RE of P from downstream sale in 31 Dec 20X3)

Dr Opening RE (S’s SOFP) 6,300

Dr NCI (Group SOFP) (9,000 x 30%) 2,700

Cr Cost of sales (P’s SOCI) 9,000

(Adjustment of unrealized profit in RE of S from upstream sale in 31 Dec 20X3)

122

62


31 Dec 20X4

2) Adjust the tax effect



Dr Tax expense ($9,000 x 20%) (Group’s SOCI) 1,800

Cr Opening RE ($1,800 x 70%) (S’s SOFP) 1,260

Cr NCI ($1,800 x 30%) (Group’s SOFP) 540

(Adjustment for tax effects on unrealized profit of S from upstream sale in RE)

Dr Tax expense ($600 x 20%) (Group’s SOCI) 120

Dr Deferred tax asset ($400 x 20%) on unsold inventory of S (Group’s SOFP)

80

Cr Opening RE ($1,000 x 20%) (P’s SOFP) 200

(Adjustment for tax effects on unrealized profit of P from downstream sale in RE and inventory)

123


31 Dec 20X4

3) Allocate share of S’s current year profit to NCI





Net profit after tax of S * 900,000

Add: Realized profit of S from upstream sale 9,000

Less: Tax on realized profit of S (1,800)

Adjusted S’s net profit after tax 907,200

NCI share (30%) of S’s Net profit after tax $907,200 272,160

*Note: Adjustments to current year profit: 1. Realized profit

& tax from prior years is added back

2. Unrealized profit & tax from unsold inventory of S in current year is deducted (none in this year)

124

63


Lower of cost or market

1. Assume that P parent company purchases inventory for $20,000 and

sells it to S its subsidiary for $35,000.

2. S still holds the inventory at year-end and determines that its market

value (replacement cost) is $25,000 at that time.

3. S writes down the inventory from $35,000 to its lower market value of

$25,000 at the end of the year and records the following:




The following eliminating entry is needed in the consolidation work paper :



Dr Loss on decline in value of inventory (S’s SOCI) 10,000

Cr Inventory (S’s SOFP) 10,000

Write down inventory to market value

Dr Sale (P’s SOCI) 35,000

Cr Cost of sale (P’s SOCI) 20,000

Cr Inventory (S’s SOFP) ($25,000-$20,000) 5,000

Cr Loss on decline in value of inventory (S’s SOCI) 10,000

Eliminate inter-company sales of inventory

126

64


When fixed assets (FA) are transferred at a marked-up price

• The unrealized profit must be eliminated from the carrying amount of

FA

• It is as though the transfer did not take place from the group’s

perspective



Original cost

Profit on sale

Mark up

Transfer price

Acc. Dep. Acc. Dep.

NBV NBV

Before Transfer After Transfer

127


Illustration 2:

Upstream Transfer of Fixed Assets

(Sale to Parent)



65

[Illustration 2: Upstream Transfer of Fixed Assets ]

S transfers to P

• 1 Jan 20X2 S sold equipment to P (owned 90% of S) for $360,000

• The original cost of equipment was $400,000 (10 years useful life)

• The remaining useful life is 8 years from date of transfer

• Net profit after tax of S for YE 31 Dec 20X2 : $500,000,

• Assume a tax rate of 20%



Original cost

= $400,000

Profit on sale

40,000

Transfer price

= $360,000

Acc. Dep. = $80,000

NBV = $320,000

Before Transfer After Transfer

129


31 Dec 20X2



CJE 2: Reverse of tax on S’s profit on sale

Dr Deferred tax asset (Group SOFP) 8,000

Cr Tax expense (S) $40,000 x 20% 8,000

CJE 1: Restate to original cost and accumulated depreciation and reverse S’s profit on sale

Dr Equipment (P) (400,000-360,000) 40,000

Dr Profit on Sale (S) 40,000

Cr Accumulated depreciation (P) 80,000

130

66




CJE 3: Correct P’s over-depreciation on unrealized profit included in equipment

Dr Accumulated depreciation (P) 5,000

Cr Depreciation Expense (P) 5,000

Old depreciation ($400,000/10) 40,000

New depreciation ($360,000/8) 45,000

Over-depreciation by applying New depreciation 5,000

CJE 4: Increase in P’s tax arising from correction of over-depreciation

Dr Tax expense (P) ($5,000 x 20%) 1,000

Cr Deferred tax asset (Group SOFP) 1,000

131


31 Dec 20X2

* Note: Upstream sale of FA will affect NCI’s share of profit as

unrealized profit resides in S



CJE 5: Allocation of S’s current year profit for 20x2



Net profit after tax of S 500,000

Less: Unrealized profit on sale (after-tax) (32,000)

Add: Over-depreciation (after-tax) 4,000

Adjusted net profit 472,000

NCI’s share (10%) of S’s net profit after tax $472,000 47,200

132

67

[Accounting for subsidiaries - Summary ]





Accounting for Associates [HKAS 28 (2011)] and

Joint Arrangements (HKFRS 11)

134

68

The equity method is applied to accounting for associates in the

consolidated financial statements

• It does NOT involve line by line summation of an associate’s


• Investment account is NOT eliminated, instead it comprises of:

1. Share of book value of net assets

2. Share of unamortized fair value adjustments

3. Implicit goodwill

• Dividend is a repayment of profit and NOT income under the equity

method

Transfer of assets between investor and associate

• In both upstream and downstream sales: Investor’s share of

unrealized profit arising from transfers is eliminated

MA – Accounting for Associates [HKAS 28 (2011)]


• The power to participate, but NOT to control

• Default assumption [HKAS 28 (2011)]

– Percentage ownership of ≥ 20% or more of investee’s voting rights

deemed as giving rise to “ significant influence”

• Other evidence of “significant influence”:

– Representation on the board of directors;

– Participation in policy-making processes;

– Material transactions between the investor and investee;

– Inter-change of managerial personnel; or

– Provision of essential technical information



69

Multi-level structures



P

80%

50%

X

Z

Y

50%

50%

Situation 1

P

40%

80%

A

B

C

50%

20%

Situation 2

Situation 1: P has significant influence over: 1. Y (50% direct interest) 2. Z (65% indirect

interest) 3. P has no control over

Y and Z

Situation 2: P has significant influence over: 1. A (40% direct interest) 2. C (50% direct interest) 3. B (42% indirect interest)

137

Accounting Policy for

Investments In Associates



Levels of financial reporting Accounting policy

1. Investor’s separate financial statements: legal entity

Cost or as a financial instrument

(HKFRS 9)

2. Investor’s financial statement with associates but no subsidiaries: economic entity

Equity method made in the investor’s

accounting record

3. Consolidated financial statements (with subsidiaries and associates): economic entity

Equity method made in consolidation

worksheet

138

70

1. Elimination of intra-group balances is not required

• Equity method does not entail line by line aggregation

• Perfectly offsetting items and balances are not required

2. Investment in associate is not eliminated

Investment account captures:

• Implicit goodwill

• Share of fair value of net identifiable assets at acquisition

• Share of change in post-acquisition retained earnings and

other equity

• Realization of profit through dividends





Investment in Associates

Investment in associate


Investor’s share *

(Book value of net

assets -/+ unrealized

profit/loss))

Share of unamortized FV adjustments

Investor’s share * (Unamortized balance of excess of FV over book

value of net identifiable assets at acquisition date)

Implicit goodwill

(Acquisition cost – Share of FV of net identifiable assets

at acquisition date) less impairment Loss

140

71

Illustration 1:

Amortization of FV Adjustments of

Identifiable Net Assets



[Illustration 1:

Amortization of FV Adjustments of Identifiable Net Assets]

1. I acquired 20% of A’s share on 1 Jan 20X4

2. Excess of fair value over book value of a depreciable asset at

acquisition date was $5,000,000

3. Depreciation was over remaining life of 10 years

4. Retained earnings as at acquisition date: $15,000,000; as at 1 Jan

20X5: $20,000,000

5. Net profit before tax for 20x5: $10,000,000, tax expense: $2,100,000

6. Tax rate was 20%

Prepare the equity accounting entries for the year ended 31 Dec

20X5



72

[Illustration 1:


Note: This entry capitalizes the share of past profits in the investment

account



EA 1: Share of change in retained earnings (RE) from acquisition date to beginning of 20x5

Dr Investment in associate 1,000,000

Cr Opening RE 1,000,000

RE as at 1 Jan 20X5 20,000,000

RE as at acquisition date (1 Jan 20x4) (15,000,000)

Change in RE (20x4) 5,000,000

Share of A’s post-acquisition RE (20% x $5,000,000) 1,000,000

143

[Illustration 1:


Note:

1) Any adjustments relating to associate’s asset or liabilities are made

against the investment account (a proxy for net assets) 2) This entry can be combined with the previous entry (EA 1)

3) Adjustment includes the tax effects (20%)



EA 2: Share of past cumulative depreciation on undervalued fixed assets (after-tax)

Dr Opening RE 80,000

Cr Investment in associate 80,000

20%* ($5,000,000 /

10 years)* (1-20%)

144

73

[Illustration 1:




$5,000,000 /

10 yrs

500,000 x

20%

EA 3: Share of 20x5 profit after tax of associate


Cr Share of profit of Associates 1,500,000

Net profit before tax 10,000,000

Less: excess depreciation (500,000)

Adjusted net profit before tax 9,500,000

Tax expense 2,100,000

Less: tax on excess depreciation (100,000)

Adjusted tax expense 2,000,000

Share of profit of associate [20%x (9,500,000-2,000,000)] 1,500,000

145

Impairment Test

Goodwill is not tested for impairment as a stand-alone asset

Impairment test is performed for the investment in its entirety

• Carrying amount of the investment is compared with recoverable

amount

• Recoverable amount is the higher of:

Value in use, and

Fair value less cost to sell

Impairment losses:

• Will reduce the investment account

• May attribute to book value of net assets, fair value adjustments or

implicit goodwill



74

Illustration 2:

Impairment Test



[Illustration 2: Impairment test]

1. P owned 20% of A

2. Past impairment of investment in A: $250,000

3. Current impairment: $100,000

4. Current year net profit before tax: $10,000,000

5. Tax expense: $2,100,000

Q: Prepare the equity accounting entries for the current year



75


Note:

1) This entry re-enacts past impairment losses

2) The impairment loss relates to the share owned by the investor;

hence there is no need to apply ownership percentage



EA 1: Share of past impairment loss

Dr Opening RE 250,000

Cr Investment in Associate 250,000

149


Assume impairment loss relating to goodwill is non-tax deductible Impairment of goodwill has no tax effect (HKAS12)



EA 2: Share of current profit after tax of associate


Cr Share of profit of Associates (1,900,000 - 420,000) 1,480,000

Share of profit before tax of associate 2,000,000

Less: current impairment loss (100,000)

Adjusted net profit before tax 1,900,000

Share of tax of associate 420,000

20% X

$10,000,000

20% X

$2,100,000

150

76

In both upstream & downstream sales:

Investor recognizes profit only to the extent of unrelated investor’s interest

in associate (1-X%); Investor’s share of profit arising from transfers is

eliminated (X%) against investor’s inventories (where associate is seller),

against investor’s investment (where investor is seller)



“Upstream sale”

X %

Investor

Associate

Sales

were

made

from

associate

to

investor

X %

Sales

were

made

from

investor

to

associate

“Downstream sale”

Investor

Associate

151

A Co

B Co Subsidiary

Z Co Associate (30%)

Asset transfers between a subsidiary and an associate

If a group company sells to or buys from an associate,

the group can only recognize the proportion of the unrelated interest

share of unrealized profit



77

Asset transfers between a subsidiary and an associate

Example 1: If A sells to Z

• Eliminate 30% unrealized profit, i.e. 70% of the unrealized profit

will be recognized

Example 2: If B sells to Z

• 70% of the unrealized profit will be recognized

• B’s NCI will share a proportion of 70% recognized unrealized profit

Example 3: If Z sells to B

• B’s NCI will not be affected



Illustration 3:

Downstream sales



78

[Illustration 3: Downstream sales]

1. Investor (I) owned 20% of Associate (A)

2. I sells $200,000 of inventory to A

3. The original cost of inventory is $140,000

4. 1/3 remains in A’s warehouse at the end of the year

5. A’s net profit before tax is $1,000,000 and tax expense is $200,000

6. Tax rate is 20%

Prepare the equity accounting entries for I






EA 1: Share of current profit after tax of associate

Dr Investment in associate 156,800

Cr Share of profit of associates (196,000-39,200) 156,800

Profit before tax of associate 1,000,000

Less: Unrealized profit (100%) (20,000)

Adjusted net profit before tax 980,000

I’s share of profit (20%) 196,000

Tax of associate 200,000

Less: tax on unrealized profit ($20,000 x 20%) (4,000)

Adjusted tax expense 196,000

I’s share of tax (20%) 39,200

156

79




I’s profit (at group level)

Adjusted

I’s profit (at group level)

Unadjusted

Gross profit from downstream sale

60,000 60,000

Share of A’s pre-tax profit 196,000 200,000

Profit effect 256,000 260,000

I is not able to recognize its share of unrealized profit of $4,000 ($60,000*1/3* 20%). However, I is able to recognize unrealized profit of $16,000 ($60,000*1/3*80%) relates to the unrelated investor’s share as if it had sold the inventory to unrelated investors of A.

157

Associate’s Losses Exceed Investor’s Interests

If an investor’s share of losses of an associate equals or exceeds its

interest in the associate, the investor discontinues recognizing its

share of further losses.

The interest in an associate is the carrying amount of the investment

in the associate under the equity method together with any long-term

interests that, in substance, form part of the investor’s net investment

in the associate.



80

MA – Joint Arrangements (HKFRS 11)


Joint control: contractually agreed sharing of control which exists only

when decisions about the relevant activities require the unanimous

consent of the parties sharing control

• No single party controls the arrangement

• A party with joint control can prevent any of the other parties from

controlling

• A joint arrangement even if not all parties have joint control; some

may participate but not have joint control

• Apply judgment when assessing whether a party has joint control

159



Q: A has 50% voting rights in the arrangement, B has

30% and C has 20%. Contractual arrangement specifies

that at least 75% votes are required to make decision

about relevant activities.

Ans.: A & B have joint control as decisions cannot be

made without their agreement. C is a participating party,

does not have joint control.

160

81



[Types of Joint Arrangements – HKFRS 11]

Example of Joint operation:

• Boeing builds body of the aircraft, Rolls Royce builds engines of the

aircraft. Boeing and Rolls Royce bear its own costs and take a share

of revenue from the aircraft sale.

• Need to consider the joint operators are entitled to share of assets

and liabilities of the joint arrangement but NOT share of net assets

of the joint arrangement (otherwise it is Joint Venture).

161




Example of Joint venture (JV):

• A joint venturer starts operation in a foreign country by setting up a JV

with the local government (faster route to market development)

• Entities transfer the relevant assets and liabilities to a JV in order to

combine their activities in a particular line of business.

162

82




• Joint arrangement not structured through separate vehicle is joint

operation (combine HKAS31 concepts of jointly controlled

operations and jointly controlled assets)

• Assets and liabilities held in separate vehicle can be either joint

venture or joint operation. Assess

legal form of separate vehicle

Terms of contractual arrangement and

Other facts and circumstances

163

Joint operation Joint operator should recognize: • Its assets including its share of jointly-held

assets • Its liabilities including its share of jointly-

incurred liabilities • Revenue from the sale of its share of output

from the joint operation • Its share of revenue from the sale of output

by the joint operation • Its expenses including its share of expenses

incurred jointly Treatment is applicable in both separate and consolidated accounts of the joint operator

Joint venture A joint venturer should recognize its interest in a joint venture as an investment and account for that investment using the equity method (HKAS 28)



[Accounting for joint arrangements – HKFRS11]

In separate financial statements, a joint venturer should account for its interest in a joint venture according to HKAS 27 (2011) Separate Financial Statements

164

83



[HKFRS 11 Transactions ]

Upstream transactions:

• A joint venturer sells or contributes assets to a joint venture,

only the gain relating to the interest of the other joint venturers

should be recognized,

full amount of any loss should be recognized if it shows evidence

of impairment.

165



[HKFRS 11 Transactions ]

Downstream transactions:

• A joint venturer purchases assets from a joint venture,

not recognize share of profit made by JV until he resells the assets

to an independent third party,

same for loss except if they represent an impairment loss

166

84



[HKFRS 11 Transactions – upstream sales]

A contributes inventories to a 50:50 JV, cost to A at $0.7m. Inventories are

still held by JV.

What gain or loss should be recognized by A ? [HKAS 28 (2011)]

a) If transfer @ $1m to JV

b) If transfer @ $0.5m to JV, and

167



[HKFRS 11 Transactions - upstream sales]

a) A’s profit ($1-$0.7)m = $0.3m, but only 50% realized (part attributable

to other venturer). A should recognize gain $0.15m

b) A’s loss ($0.5-$0.7)m= $0.2m of which full amount should be

recognized even though inventories not yet sold. They represent an

impairment loss (reduced NRV)

A’s separate FS

Dr Interest in JV – Inventory contribution 1,000,000

Cr Other income – gain on inventory contribution 150,000

Cr Inventory 700,000

Cr

Interest in JV – unrealized gain on inventory

contribution (eliminated against investment

under equity method)

150,000

168

85



Complex and Changes in Group Structures

169

MA – Complex and Changes in Group Structures


[Indirect Ownership Interests]

A parent has an indirect

ownership holding in a

subsidiary when equity in that

subsidiary is held through one or

more of the parent’s subsidiaries

Direct holdings

Indirect holdings

80 %

X Co

(Ultimate parent)

70 %

Y Co

(Intermediate parent)

Z Co

(Indirect Subsidiary)

Y Co’s NCI

Z Co’s NCI

20 %

30 %

14 %

56 %

In Z

X Gp.effective interest 56%

Y Co’s NCI 14%

Z’Co’s NCI 30%

Total 100%

80% x 70%

14% Indirect NCI = 20% x 70%

170

86



[Indirect Holding of Associates]

1. NO non-controlling interests in

this structure

2. P equity accounts

– 50% of S’s profit and

– 25% of A’s profit

3. Only investment in S appears on P’s

statement of financial position

50 %

P

50 %

S

A

171



[Indirect Holding of Associates]

1. S equity accounts 50% the

results of A

2. P consolidates S and S’s share

of A’s profit

3. Income to non-controlling

interests should include non-

controlling interests’ share 5%

(10% x 50%) of A’s profit

90 %

P

(Ultimate parent)

50 %

S

(Investor)

A

(Associate)

P’s NCI

10 %

172

87



[Complex Group Structure]

• P has a direct 40% holding in S2 and also controls S1 which has a

40% holding in S2. Therefore S2 is a sub-subsidiary of P.

• Group effective interest is 40% + (60% x 40%) = 64%

• NCI interest is therefore 36%

• Goodwill in S2:

• Group retained earnings include 64% of S2’s post-acquisition profits

• NCI includes 36% of S2’s post-acquisition profits

Cost of P’s investment in S2 X

60% x cost of S1’s investment in S2 X

NCI (based on 36% holding) X

Net assets of S2 (100%) (X)

X

173



[Business Combination Achieved in Stages]

Achieving control through incremental purchases

Goodwill arises on the date when control is achieved

Measurement procedures:

• Previously-held interest must be re-measured to fair value at acquisition

date when control is achieved

• Re-measurement gain or loss will be taken to profit or loss

• If the acquirer has previously recognized fair value increases of previously-

held interests in other comprehensive income

HKFRS3 requires the cumulative amount as other comprehensive income

in the equity, to be re-classified to the income statement as if the

previously-held equity interest was disposed

174

88



[Business Combination Achieved in Stages]

Goodwill

Fair value of consideration

transferred

+


+

Fair value of the acquirer’s

previously-held interest in the

acquiree

Acquiree’s

recognized net

identifiable asset

measured in

accordance with

HKFRS3 (Revised)

= Less

175

Illustration 1:

Associate become Subsidiary



89

[Illustration 1: Associate become Subsidiary]

Assume that on January 1, 20X0, S Co has $200,000 of ordinary shares

outstanding and retained earnings of $60,000.

During 20X0, 20X1, and 20X2, S Co reports the following information:

P Ltd purchases its 80% interest in S Co in several blocks, as follows:



Period Net Income Dividends Ending BV

20X0 40,000 0 300,000

20X1 50,000 30,000 320,000

20X2 75,000 40,000 350,000

Purchase date Ownership % Purchase Cost BV Premium

1/1/20X0 20 56,000 52,000 4,000

31/12/20X0 10 35,000 30,000 5,000

1/1/20X2 50 185,000

177


Assuming P Ltd has significant influence over S Co and equity account S’s profit:



20X0

Purchase shares (1.1) 56,000

Equity-account income 8,000 ($40,000 x 20%)

Purchase share (12.31) 35,000

Investment in Associate, S (30%) 99,000

20x1

Equity-account income 15,000 (50,000 x 30%)

Dividend received (9,000) (30,000 x 30%)

Investment in Associate, S (30%) 105,000

178

90


P Ltd gains control of S Co on January 1, 20X2, 1. The fair value of the 30% equity interest it already holds in S Co is

$111,000,

2. The fair value of S Co’s 20% remaining non-controlling interest is $74,000. ($111,000/30%*20%)

3. The book value of S Co as a whole on that date is $320,000.






FV of consideration exchanged for 50% interest 185,000

FV of previously held equity interest (30% interest) 111,000

FV of NCI (20%) 74,000

370,000

BV of S Co (1.1.20x2), assume FV the same (320,000)

Goodwill (Differential) 50,000

180

91


P Ltd must re-measure the equity interest it already held in S Co to its

fair value at the date of combination and recognize a gain or loss for

the difference between the fair value and its carrying amount:



FV of previously-held equity interest (30%) 111,000

Carrying amount under HKAS28 (2011) 31/12/20x1 (105,000)

Gain on disposal of investment in associate (P’s SOCI) 6,000

181


P Ltd investment account balance at 1/1/20x2:

Dr Investment in S $6,000 Cr Gain on re-measurement of investment

in S $6,000



Carrying amount 12/31/20x1 105,000

Gain on disposal of investment 6,000

50% shares acquired at 1/1/20x2 185,000

Investment in S Co (1/1/20x2) 296,000

182

92


Consolidation eliminating entries 31/12/20x2:



1. Dr Income to NCI (20%) ($75,000 x 20%) 15,000

Cr NCI (SOFP) 15,000

2. Dr Dividend Income ($40,000 x 80%) 32,000

Dr NCI (20%) ($40,000 x 20%) 8,000

Cr Dividend declared 40,000

3. Dr Share capital 200,000

Dr RE (1.1.20x2) 120,000

Dr Goodwill 50,000

Cr Investment in S Co (1.1.20x2) 296,000

Cr NCI (FV) 74,000

183

[Disposal of Subsidiaries]

a. Derecognizes the assets (including an appropriate allocation of

goodwill) and liabilities of the subsidiary at their carrying amounts

b. Derecognizes the carrying amount of any NCI (including any

components of accumulated other comprehensive income

attributable to the NCI)

c. Recognizes the fair value of the proceeds



93


d. Recognizes any retained interest in the former subsidiary at its fair

value

e. Reclassifies to income [SOCI], or transfers directly to retained

earnings if required in accordance with other HKFRS, the amounts

recognized in other comprehensive income in relation to that

subsidiary

f. Recognizes any resulting difference as a gain or loss in SOCI

attributable to the parent






94

Illustration 2:

60% Subsidiary to 40% Associate



[Illustration 2: 60% Subsidiary to 40% Associate]

Given :

1. A owns 60% of a subsidiary.

2. A disposes of 20% of the subsidiary for $200 million.

3. At the disposal date,

• the FV of A’s retained interest (40%) $300 million;

• The carrying value of former subsidiary’s identifiable net assets

$500 million

• there is no goodwill and

• NCI are valued at its proportionate share of the net assets

method



95

[Illustration 2: 60% Subsidiary to 40% Associate]



FV consideration (20%) received by A 200

FV A’s remaining holding (40%: A’s retained interest) 300

500

Less: Amounts recognized prior to disposal

Carrying value of former subsidiary’s Identifiable net asset ($500 x 60%) (300)

Cr Gain on disposal of sub (20%) 200

Gain on disposal ($200-500x20%)

100

Gain on revaluation of retained interest ($300 - $500 x 40%) 100

Gain on disposal of sub (20%) 200

189

Illustration 3:

100% Subsidiary to 60% Subsidiary



96

[Illustration 3: 100% Subsidiary to 60% Subsidiary]

Given :

1. A owned 100% of a subsidiary on its date of incorporation for $200

million.

2. A sold 40% of the subsidiary for $120 million.

3. Control is still retained (@60%)

4. At the disposal date,

• The FV of the subsidiary’s identifiable net assets were $280

million

• there is no goodwill as the subsidiary was acquired on

incorporation

• NCI are valued at its proportionate share of FV of the

subsidiary’s identifiable net assets



[Illustration 3: 100% Subsidiary to 60% Subsidiary]

A’s disposal entry: Dr cash $120 Cr Invest in sub $80 Cr gain on disposal $40

Consolidation entry: Dr Gain on disposal $40 , Dr share cap/reserve $200, Cr NCI $112

Cr Investment in sub $120 Cr Equity-controlling interest $8



A’s SOCI

FV consideration (40%) received by A 120

A’s (40%) cost of investment in subsidiary (40%x$200) (80)

Profit on sale 40

No group profit on sale as 60% control is retained.

Adjustment to A (parent)’s equity 120

FV consideration (40%) received by A (112)

Increase in NCI in net assets at date of disposal (40%x$280) 8

Adjustment to parent’s equity

192

97



193

Exam Question review


98

Dec 2011 – Case


MA – Exam Question Review

Dec 2011 – Case

Question

Global Resources Limited ('GRL'), which is a company incorporated in Hong

Kong and listed in the Growth Enterprise Market of The Stock Exchange of Hong

Kong Limited.

GRL and its subsidiaries (GRL Group) are principally engaged in the natural

resources business in the People's Republic of Bangladesh; and the provision of

medical equipment services and related accessories, and the provision of

medical research and development services in mainland China.

Now, GRL intends to disinvest its investment in the medical research and

development business.


99


Dec 2011 – Case

Question

[Asia Medical Research Limited ('AMR')]

On 1 April 20X8, GRL acquired 600,000 (60%) of the 1,000,000

ordinary shares issued by Asia Medical Research Limited ('AMR') for

$7.5 million in cash. On that date, the fair value of the net identifiable

assets of AMR was the same as their carrying amount, and the share

capital and retained earnings of AMR were $1 million and $9 million

respectively with no other components of equity.

GRL is entitled to appoint three out of the five directors on the board.

All board decisions are made by simple majority resolution.



Dec 2011 – Case

Question


On 1 April 20Y1, AMR issued 500,000 shares to a new investor, Simon

Firth Limited ('SFL'), for $8 million. As a result, GRL’s shareholdings in

AMR decreased to 40%.

In addition, SFL has the right to appoint two new directors to the board

making a total of seven directors on the board. The fair value of GRL’s

investment in AMR (previously held 60% interest) was valued at

$9.6 million on 1 April 20Y1.


100


Dec 2011 – Case

Question The draft statements of financial position of the companies at 31 March

20Y1 are:



Dec 2011 – Case

Question


a) discuss and advise, with calculations, the accounting

treatments for the investment in AMR in the consolidated

financial statements of GRL on 1 April 20Y1.

(14 marks)


101


Dec 2011 – Case

Answer (a) (subsidiary to associate)


The issue of shares by AMR to SFL has reduced GRL’s interest in AMR

to 40 per cent, i.e. less than 50 per cent. Also, GRL is entitled to appoint

only three out of the total seven seats in the board of directors. Therefore,

GRL has lost control of AMR.

Since GRL holds 20 per cent or more of the voting power of AMR, there

is a presumption that GRL has significant influence over AMR and hence

AMR should be accounted for as an associate. In this case, GRL should

stop consolidating AMR from the date that control was lost, i.e. 1 April

20Y1.



Dec 2011 – Case



Paragraph 25 of HKFRS 10 Consolidated Financial Statements states

that if a parent loses control of a subsidiary, the parent should de-

recognize the assets and liabilities of the former subsidiary from the

consolidated statement of financial position and recognize any

investment retained in the former subsidiary at its fair value when

control is lost.


102


Dec 2011 – Case



A partial disposal of the investment in AMR, as a subsidiary, but retaining

an interest as an associate creates the recognition of a gain or loss

on the entire interest. A gain or loss should be recognized on the part

that has been disposed of and a further holding gain or loss is

recognized on the investment retained, being the difference between

the fair value of the investment and the carrying amount of the

investment.



Dec 2011 – Case



On 1 April 20Y1, the carrying amounts of AMR that should be de-

recognized =

100% of the net identifiable assets of AMR = $12 million

+ goodwill $7.5m + 40% × ($1m + $9m) – $10m = $1.5 million

= $13.5 million


103


Dec 2011 – Case



GRL should de-recognize the carrying amount of any non-controlling

interests (NCI) in AMR (the former subsidiary) at the date when control is

lost (including any components of other comprehensive income

attributable to them). On 1 April 20Y1, non-controlling interest,

measured at its proportionate share of the AMR’s net identifiable assets,

should be 40% × $12 million = $4.8 million.

GRL should also recognize the fair value of the consideration received

from the transaction. However, in this case, GRL has not received any

consideration from the transaction.



Dec 2011 – Case



Any investment retained in AMR (the former subsidiary) should be

recognized at its fair value at the date when control is lost. Thus, GRL

should recognize its investment in AMR at its fair value on 1 April

20Y1, i.e. $9.6 million.

GRL should also reclassify to profit or loss, or transfer directly to

retained earnings any gain or loss previously recognized in other

comprehensive income. However, for the assets of AMR, no gain or

loss has been previously recognized in other comprehensive income.


104


Dec 2011 – Case



The resulting gain,

Investment in AMR = $9.6 million (previously held 60%)

Add Non-controlling interest = $4.8 million (previously held 40%)

Less Net identifiable assets of AMR = $12 million

Less Goodwill = $1.5 million

= $0.9 million should be recognized in profit or loss attributable to

the parent.



Dec 2011 – Case



May exclude AMR from the consolidation and prepare a terminal entry:

Dr Investment in AMR $9.6 million

Cr Investment in AMR $7.5 million

Cr Retained earnings (11m – 9m) × 60% $1.2 million

Cr Gain on disposal $0.9 million


105


Dec 2011 – Case

Question

[China Development Services Limited ('CDS')]

On 1 April 20Y0, GRL acquired 2,640,000 ordinary shares in China

Development Services Limited ('CDS') for $12 million in cash. Thus

GRL owns 2,640,000 out of the 4,000,000 shares of CDS, giving it a

66% interest.

On 1 April 20Y1, CDS issued 400,000 shares to a new investor, Michael

Sun Limited ('MSL'), for $5.5 million. As a result, GRL’s shareholdings in

CDS decreased to 60 per cent. The carrying amount of CDS’s net

identifiable assets in the consolidated financial statements of GRL, as at

31 March 20Y1, was $12.9 million.



Dec 2011 – Case

Question


Other relevant information:

• At the date of acquisition, the fair values of CDS’s assets were equal

to their carrying amounts with the exception that the fair value of

CDS’s inventory was $500,000 below its carrying amount; and it

was written down by this amount shortly after acquisition as an

impairment loss and it has not changed in its fair value since then.


106


Dec 2011 – Case

Question



• On 2 April 20Y0, GRL sold an item of plant to CDS at $2.5 million.

Its carrying amount prior to the sale was $2 million. The estimated

remaining useful life of the plant at the date of sale was five years.

GRL, AMR and CDS depreciate their property, plant and equipment

using the straight-line method.

• There were no intra-group payables or receivables at 31 March

20Y1. No dividends were paid during the year by any of the said

companies.



Dec 2011 – Case

Question



• It is the group’s policy to measure non-controlling interests at its

proportionate share of the subsidiary’s net identifiable assets at the

acquisition date. Goodwill arising from the acquisition of AMR and

CDS has not subsequently been impaired. For the assets of both

AMR and CDS, no gain or loss has been previously recognized in

other comprehensive income.


107


Dec 2011 – Case

Question


Ms Linda Ho, a director of GRL is concerned about the implications of

the above transactions and information. She wondered if it may result in

any gain or loss to be recognized and if it may make any difference in the

consolidation process.



Dec 2011 – Case

Question


[Global Resources Limited]

b) discuss and advise, with calculations, the accounting

treatments for the investment in CDS in the consolidated

financial statements of GRL on 1 April 20Y1. (10 marks)

c) prepare an annex to your memorandum showing worksheets

for the consolidated statement of financial position of GRL as at

1 April 20Y1 after considering the transactions and other

information. Ignore the deferred tax implications. (26 marks)

(Show consolidation adjustments in a worksheet with detailed

calculations of each figure, but journal entries are not required)

(14 marks)


108


Dec 2011 – Case

Answer (b) (subsidiary to subsidiary)


The issue of shares by CDS to MSL has reduced GRL’s interest in CDS

from 66 per cent to 60 per cent. Since GRL holds more than 50 per

cent of the voting power of CDS, there is a presumption that GRL has

retained control of CDS and hence CDS should remain as a subsidiary.



Dec 2011 – Case



Paragraph 23 of HKFRS 10 Consolidated Financial Statements states

that “changes in a parent’s ownership interest in a subsidiary that do not

result in a loss of control are’(i.e. transactions with owners in their

capacity as owners). accounted for as equity transactions’ This

means that no gain or loss from these changes should be recognized in

profit or loss. It also means that no change in the carrying amounts of

the subsidiary’s assets (including goodwill) or liabilities should be

recognized as a result of such transactions. This adopted approach is

consistent with the fact that non-controlling interests are treated as a

separate component of equity.


109


Dec 2011 – Case



In such circumstances, the carrying amounts of the controlling and

non-controlling interests shall be adjusted to reflect the changes in

their relative interests in the subsidiary.

Previously, the carrying amount of NCI = 34% of $12.9 million = $4.386

million. After the transaction, NCI = 40% of ($12.9 + $5.5) million =

$7.36 million. Thus, NCI increases by ($7.36 – $4.386) million = $2.974

million



Dec 2011 – Case



Any difference between the amount by which the non-controlling

interests are adjusted and the fair value of the consideration paid or

received shall be recognized directly in equity and attributed to the

owners of the parent. Thus the difference between the consideration

received ($5.5 million) and the amount that NCI is adjusted ($2.974

million), amounting to $2.526 million should be recognized directly

in parent’s equity


110


Dec 2011 – Case



The corresponding consolidation journal entry is summarized as below:

Dr Cash $5.5 million

Cr Non-controlling interest $2.974 million

Cr Equity attributable to owners of the parent $2.526 million

Alternatively:

Dr Cash $5.5 million

Dr Non-controlling interest $4.386 million

Cr Non-controlling interest $7.36 million

Cr Other components of Equity (parent ) $2.526 million



Dec 2011 – Case

Answer (c) (consolidation worksheet – SOFP) [Global Resources Limited]

Consolidated Statement of Financial Position as at 1 April 20Y1


111



Dec 2011 – Case

Answer (c) (consolidation worksheet – SOFP) [Global Resources Limited]

Consolidated Statement of Financial Position as at 1 April 20Y1

221



Dec 2011 – Case

Answer (c) (consolidation worksheet – SOFP)


Goodwill calculations (not required by the question)

Investment in AMR Investment in CDS

$’000 $’000

Purchase consideration (60%) 7,500 (66%) 12,000

NCI (10m × 40%) 4,000 (10m × 34%) 3,400

11,500 15,400

Fair value of net identifiable assets

(1m + 9m) (10,000) (4m + 6.5m – 0.5m) (10,000)

Goodwill 1,500 5,400

222

112



Dec 2011 – Case



Journal entries (not required by the question) (All figures in $’000)

(W1) Elimination of investment in CDS

Dr Share capital 4,000

Dr Retained earnings 6,500

Dr Goodwill 5,400

Cr Inventory 500

Cr Investment in CDS 12,000

Cr Non-controlling interests (NCI) 3,400 (4,000 + 6,500 - 500) × 34%

223



Dec 2011 – Case




(W2) Impairment of inventory (realized fair value loss shortly after

acquisition date, has to reverse realized loss otherwise double

counting with W1)

Dr Inventory 500

Cr Retained earnings 500

224

113



Dec 2011 – Case




(W3) Adjustment of 20Y0 unrealized profit in plant (downstream, no

effect on NCI)

Dr Retained earnings 500 (2,500 – 2,000)

Cr Plant 500

Dr Acc. depreciation 100 (500 / 5 years)

Cr Retained earnings 100

225



Dec 2011 – Case




(W4) Allocation of post-acquisition profit to NCI of CDS

Dr Retained earnings 986 (2,400 + W2 inventory 500) × 34%

Cr NCI 986

226

114

At ETC, it is our aim to encourage you. Thank you!

Website: www.etctraining.com.hk

Email: [email protected]

module preparation seminar (part ii) for module a on ... · module preparation seminar (part ii)...

Documents