Consolidation assumptions to date

1. Consolidation assumptions to date • P Ltd acquired shares of S Ltd on first day of the financial period. That first day was the day of incorporation of S Ltd • P Ltd acquired shares of S Ltd at par value of each S Ltd share. In other words, the cost of the shares in P Ltd has always been equal to the nominal value of those shares • Now consider the implications of relaxing the second of these assumptions - what accounting treatment is required if P Ltd acquires the shares in S Ltd for a consideration amounting to something other than the nominal value of the shares?

2. Goodwill terminology • FRS 10 definition of goodwill: • Cost of the acquired entity minus the aggregate of fair values of the separately identifiable net assets of the acquired entity • Identifiable net assets (FRS 7): those assets and liabilities that are capable of being disposed of or settled separately, without disposing of a business as an entity • Fair value (FRS 7): The amount at which an assets or liability could be exchanged in an arm’s length transaction between informed and willing parties, other than in a forced or liquidation sale. Refer to FRS 7 paras 9 - 22 for basis of fair values of individual assets and liabilities

3. What do we mean by ‘cost’? • SSAP9 has a definition of cost for stock valuation purposes. Similarly, for goodwill calculation purposes, FRS 7 states that the cost of acquisition is the amount of cash paid and fair value of other consideration given by the acquirer • Includes advisory fees and similar incremental costs • Includes deferred consideration and contingent consideration • Does not include internal overhead allocations • ‘Other consideration’ - refer to FRS 7 paras. 76 - 84.

4. Evaluating goodwill • Evaluating goodwill: (i) value the target business (perhaps using NPV calculations) to arrive at an amount the acquirer is willing to pay (cost) (ii) value the separable net assets (using fair value) (iii) calculate the difference • Goodwill is calculated at the DATE OF ACQUISITION

5. Accounting for purchased goodwill • FRS 10: • Capitalise as an intangible asset on the group balance sheet (amount calculated at date of acquisition) • Amortise to the profit and loss account on an annual basis over useful economic life • FRS 10 maintains there is a rebuttable presumption that useful life will not exceed 20 years • Impairment review also required on a periodic basis

6. Example • P Limited acquires 75% of ordinary shares of S Limited on 1 September 2001. • At that date, the fair value of the fixed assets of S Limited was €23,000 greater than NBV. Fair value of net current assets is the same as the book value. S Limited has not yet incorporated any revaluations. • Reserves of S Limited at 1 September 2001 were nil. • Goodwill is to be amortised over three years.

7. Nature of goodwill • There may be items of benefit to a business that are not included as assets in conventional balance sheets • The value of a business as a whole may be greater than the sum of the values of its individual net assets • The term that is attributed to the excess value is goodwill • Examples: High quality human resources, outstanding management ability, great business location, well- established customer base, technical know how, well known brand name, effective monopoly position, excellent labour relations, outstanding advertising, culture of excellence

8. Types of goodwill • Self-generated goodwill: exists in a single entity business as a result of the business being worth more as a going concern than the fair value of its assets. Self-generated goodwill IS NOT recognised as an asset on balance sheets of single entities! • Purchased goodwill: arises when one businessacquires another as a going concern. It is measured as the difference between the consideration paid for the net assets of the company acquired and the fair value of those assets. Purchased goodwill IS recognised as an intangible asset in consolidated balance sheets.

9. Goodwill terminology • FRS 10 definition of goodwill: • Cost of the acquired entity minus the aggregate of fair values of the separately identifiable net assets of the acquired entity • Identifiable net assets (FRS 7): those assets and liabilities that are capable of being disposed of or settled separately, without disposing of a business as an entity • Fair value (FRS 7): The amount at which an assets or liability could be exchanged in an arm’s length transaction between informed and willing parties, other than in a forced or liquidation sale. Refer to FRS 7 paras 9 - 22 for basis of fair values of individual assets and liabilities