Basic Principles of Group Accounts

1. Learning Outcomes: Demonstrate the basic principles of the acquisition method of consolidated accounts Understand the journal entries at the date of acquisition Understand the procedures to prepare the consolidated accounts Basic Principles of Group Accounts

2. Consolidated balance sheet can be prepared either: On the date the shares were acquired On the subsequent dates Basic Principles of Group Accounts

3. FRS 127 The net asset values of the subsidiary be stated at the fair values to the parent Consolidated adjustments may be necessary to revise the book values to their fair values Pre-Acquisition Adjustments

4. Example See Example 1.1 from TLT, CFS, 4th edition On 1 January 20x0, P Bhd acquired a 100% interest in S Sdn Bhd paying RM480,000 in cash and the balance by issuing 200,000 P Bhd’s RM1 ordinary shares with a market value of RM2.50 each. Also, professional fees payable to accountants, legal advisors, valuers and other consultants, which were directly attributable to the acquisition totalled RM20,000. The respective balance sheets of the two companies prior to the acquisition on the date were as follows:

5. Cont’

6. Cont’ In arriving at the purchase consideration, the buyer and seller took into account the following items: i) that the fair value of S Sdn Bhd’s properties was RM500,000 ii) S Sdn Bhd owned patents and licenses worth RM200,000 Required: Prepare a consolidated balance sheet immediately after acquisition of shares in S Sdn Bhd.

7. Purchase Method The following steps are required: • Identifying the acquirer; • Measuring the cost of business combination; and • Allocating the cost of business combination to the fair value of the net assets (including contingent liabilities) of the acquiree to determine the goodwill on consolidation, if any. Cost = cash given (if any) + fair value of consideration given + incidental cost incurred Goodwill = cost – fair value of the assets, liabilities and contingent liabilities of the acquiree

8. Cont’ Preparation of the Consolidated Balance Sheet: FRS 127 “… the financial statements of the parent and its subsidiaries is adding together line by line of items like assets, liabilities, equity, income and expenses.” The following steps are then taken: • The carrying value of the holdings’ investment in each subsidiary and the parent’s portion of equity of each subsidiary are eliminated

9. Cont’ • Minority interest in the net assets of consolidated subsidiaries is identified and shall be presented in the consolidated balance sheet separately from the shareholders’ equity • All intra group balances and transactions including income, expenses and dividends are to be eliminated

10. Solution Explanation The acquisition method of accounting for business combination requires that the fair value of the purchase consideration be allocated to the fair value of identifiable net assets with the goodwill arrived at as a balancing figure. This principle is demonstrated in the working as follows:

11. Cont’

12. Cont’ The following points in relation to the above principle should be remembered: • The shares issued by P Bhd is recorded in its accounts at the fair value and not at par value. Also cost directly attributable to the acquisition should be capitalised as part of the cost of investment in the subsidiary. Thus, P Bhd has to recorded the following journal entries: Investment in S Sdn Bhd 1,000,000 Cash Account 500,000 Share capital 200,000 Share premium 300,000

13. Cont’ • The value of the properties is to be taken in at a fair value of RM500,000. This value represents cost to the group. The surplus of RM100,000, forms part of the pre-acquisition reserves (i.e. reserves at acquisition date). • The identifiable intangibles, consisting of patents and licenses are to be taken in at their fair value. Since these intangibles are not recorded in the books of the subsidiary, a consolidation adjustment is necessary to record them in the consolidated accounts. The surplus of RM200,000 forms part of the pre-acquisition reserves (i.e. reserves at acquisition date) • The whole retained profits of S Sdn Bhd at the date of acquisition is frozen permanently and forms part of the pre-acquisition reserves

14. Solution Workings: 1. Journal entries to effect consolidation adjustments a) Properties 100,000 Patents and licenses 200,000 Revaluation reserves 300,000 (To adjust assets of subsidiary to their fair values)

15. Cont’ b) Share capital of S 400,000 Retained profits of S 200,000 Revaluation reserves 300,000 Goodwill on acquisition 100,000 Investment in S 1,000,000 (To eliminate cost of investment against net assets acquired and to recognise goodwill on acquisition)

17. Cont’ P Bhd and its subsidiary Consolidated Balance Sheet as at 1 January 20x0

18. Cont’ Note: Goodwill on acquisition in the above example could be arrived by using a T account Cost of Control Account Purchase Consideration RM’000 Net Assets Acquired RM’000 Investment in S Sdn Bhd 1’000 Share capital (per subsidiary’s book) 400 Pre-acquisition reserve from: Revaluation surplus 300 Retained profits 200 Goodwill on acquisition 100 (balancing figure) 1’000 1’000

19. Example 2 See Example 2.2 from NEJ, CFSM, 2007 C Bhd acquired 100% of the issued share capital of D Bhd on 31December 20X8 for a total consideration of RM200,000. The balance sheets of C Bhd and D Bhd as at that date are as follows:

20. Cont’

21. Cont’ C Bhd and D Bhd agreed that D Bhd’s building has a fair value of RM200,000 as at 31 December 20X8. Required: Prepare the consolidated balance sheet for C Bhd and its subsidiary as at 31 December 2008

22. Solution Workings: 1. Journal entries to effect consolidation adjustments a) Building 50,000 Revaluation reserves 50,000 (To adjust building of subsidiary to its fair values)

23. Cont’ b) Share capital of D 100,000 Retained profits of D 50,000 Revaluation reserves 50,000 Investment in D 200,000 (To eliminate cost of investment against net assets acquired)