HUANG HUAI UNIVERSITY FINANCIAL ACCOUNTING 2 Lecture 2 2009/10

1. HUANG HUAI UNIVERSITYFINANCIAL ACCOUNTING 2Lecture 22009/10 Consolidated Balance Sheets After the Date of Acquisition DR. AZIZ JAAFAR

2. Last lecture: • Definitions & Rules on Group accounts • Parent • Subsidiary • Group • Concept of ‘control’ • Group balance sheets on the date of acquisition • Goodwill • Minority interests • Fair Value ≠ Book Value of Assets (Revaluation)

3. Consolidated balance sheets after date of acquisition • Lecture covers: • Pre- and post-acquisition profits/losses • Inter-company balances • Unrealised profit on inter-company sales • Provision for unrealised profit affecting a minority • Uniform accounting policies

4. Pre- and post-acquisition profits • Pre-acquisition profits • Made before date parent acquired control • Represent net assets at acquisition date • Dealt with through Goodwill calculation • Post-acquisition profits • Made after date of acquisition • Include in consolidated income statement

5. Example – The Bend Group 1 January 2001 • Bend acquired 80% of the 10,000 £1 common shares in Stretch for £1.50 per share • Investment in Stretch cost £12,000 • Retained earnings were £4,000 • Fair Value of Non-current assets £600 above book value

6. Bend & Stretch balance sheets at 31 December 2001 Bend (P) Stretch (S) ASSETS Non-currents assets 26 000 12 000 Investment in Stretch 12 000 - Net current assets 13 0004 000 NET ASSETS 51 00016 000 EQUITY Common Share Capital 16 000 10 000 Retained Earnings 35 0006 000 51 00016 000

7. Steps: 1. Calculate Goodwill on consolidation: (Compare the cost of acquisition and the Fair Value of sub’s Net Assets). 2. Calculate Minority Interest 3. Group Assets aggregation 4. Group Capital and Reserves – include parent’s share capital and reserves AND parent’s share of post-acquisition profit.

8. The Bend Group Goodwill calculation

9. The Bend Group Minority Interest calculation

10. The Bend Group asset aggregation

11. The Bend Group Capital and reserves

12. The Bend Group balance sheets at 31 December 2001

13. Inter-company balances • Preferred shares held by parent • Bonds held by parent • Inter-company trading and loan balances • Inter-company dividends payable/ receivable

14. Preferred shares held by parent • Preferred shares acquired on the acquisition • Represented by net assets at date of acquisition • Dealt with through Goodwill • Preferred shares not acquired • Part of Minority interest

15. Bonds held by parent • Bonds acquired on the acquisition • Represented by net assets at date of acquisition • Dealt with through Goodwill • Bonds not acquired on the acquisition • Appear in balance sheet as long-term loan

16. Inter-company trading and loan balances • Reconcile balance in parent with subsidiary • Should be the same • Timing differences such as cash/stock in transit • Update to make balances equal • Eliminate the inter-company balances • Subsidiary as debtor in parent balance sheet; parent as creditor in subsidiary balance sheet

17. Inter-company Dividends payable/receivable • Dividend declared by subsidiary but not paid • Appear in subsidiary’s current liabilities as Dividend Payable • In Parent’s account – as Dividend Receivable (Current Assets) • In GROUP Balance sheet – cancelled off, i.e., the figure does not appear in the consolidated balance sheet.

18. Unrealised Profit on inter-company Sales • Sales transactions between parents and subsidiaries, specifically on the element of profit that has not been realised by the group if the goods have not been sold on to a third party before the year-end. • Example: Big plc. buys £2000 worth of goods for resale and sells them to Small plc. for £2700, making a profit of £700. At year-end, if Small plc. still has these goods in stock, the group has not yet made any profit on these goods and the £700 is therefore said to be unrealised. It must be removed from the group balance sheet by: Reducing the retained earnings of Big plc. by £700; Reducing the inventories of Small plc. by £700.

19. Example 2 – The Prose Group 1 January 2001 • Prose acquired in Verse • 80% of the 10,000 £1 common shares for £21,100 • 20% of Preferred shares for £2,000 • 10% of the bonds for £900 • Retained earnings were £4,000 • Fair value of non-current assets was £1,000 above BV

20. Example – The Prose Group • During 2001 • Prose sold inventory to Verse for £3,000 • This was at cost plus 25% (i.e., mark-up) • Half still in inventory at 31 December

21. Prose and Verse Balance Sheets as at 31 December 2001 – Assets Section PROSE (P) VERSE (S) ASSETS Non-current Assets (including land) 25 920 43 400 Investment in Verse 24 000 - Current Assets Inventories 9 600 4 000 Verse Current Account 8 000 Bond interest receivable 35 Other current assets 1 965 3 350 NET ASSETS 69 520 50 750

22. Prose and Verse Balance Sheets as at 31 December 2001 – Equity & Liability Section PROSE (P) VERSE (S) EQUITY AND LIABILITIES Common share capital 22 000 10 000 Additional Paid-in Capital 2 000 1 000 Preferred Shares 4 000 8 000 Retained Earnings 30 0008 500 58 000 27 500 Non-current liabilities Bonds 5 000 7 000 Current liabilities Prose Current Account 8 000 Bond interest payable 350 Other current liabilities 6 520 7 900 NET ASSETS 69 520 50 750

23. The Prose Group – Goodwill calculation

24. The Prose Group – Inter-company adjustments

25. The Prose Group – Minority interest

26. The Prose Group – Aggregate Assets

27. The Prose Group – Equity section

28. The Prose Group – Bonds

29. The Prose Group – Asset section

30. The Prose Group – Equity and liability section

31. Uniform accounting policies • Parent and subsidiary to use uniform policies • Accounts with year ends within 3 months of each other • Subject to adjusting for significant transactions

32. Purchased Goodwill/Goodwill on Consolidation • Goodwill has an objective valuation when a business is sold. • Purchased goodwill is based on transaction with third party at arm’s length • Goodwill is recognised by the acquirer as an asset from the acquisition date and is initially measured as the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities. • Purchased goodwill should be initially capitalised as assets

33. Accounting for Goodwill • A number of approaches: • Capitalisation with annual impairment (IFRS 3) • Writing off directly to reserves in the year of acquisition • Writing off directly to the income statement in the year of acquisition • Amortising the goodwill over its expected life • Permanent capitalisation: keeping the goodwill in the balance sheet unchanged (i.e., no amortisation and no impairment) • IFRS 3 prohibits the amortisation of goodwill. Instead goodwill must be tested for impairment at least annually in accordance with IAS 36 Impairment of Assets