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HUANG HUAI UNIVERSITY FINANCIAL ACCOUNTING II

Lecture 1 Consolidated Financial Statements: Rules on Group Accounts Accounting for Groups at the Date of Acquisition DR AZIZ JAAFAR. HUANG HUAI UNIVERSITY FINANCIAL ACCOUNTING II. Coverage:. Relevant International Accounting Standards Definition of a group Definition of control

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HUANG HUAI UNIVERSITY FINANCIAL ACCOUNTING II

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  1. Lecture 1 Consolidated Financial Statements: Rules on Group Accounts Accounting for Groups at the Date of Acquisition DR AZIZ JAAFAR HUANG HUAI UNIVERSITYFINANCIAL ACCOUNTING II

  2. Coverage: • Relevant International Accounting Standards • Definition of a group • Definition of control • Reasons for preparing consolidated accounts • Alternative methods of preparing consolidated accounts • Group balance sheets on the date of acquisition • Wholly Owned Subsidiary • Minority interests • Fair Value ≠ Book Value of Assets

  3. International Accounting Standards • IFRS 3 – Business Combinations • IAS 27 – Consolidated and Separate Financial Statements • IAS 28 – Investment in Associates • IAS 31 – Interests in Joint Venture

  4. Definition of a group (IFRS 3) • Group (or consolidated) financial statements are the financial statements of a set of two or more enterprises organised as an economic entity • Subsidiary – An entity that is controlled by another entity • Parent – An entity that has one or more subsidiaries • Group is defined according to concept of “control” • One enterprise controls another enterprise • Directly • Indirectly

  5. Definition of control • IFRS 3 & IAS 27 define ‘control’ • Power to govern the financial and operating policies • To obtain benefit from its activities • Control assumed if > 50% of voting rights • Control may exist where < 50%

  6. Control may exist where < 50% voting rights • Agreement with other investors gives power over > 50% • Power over financial and operating policies by an agreement • Power to appoint or remove majority of board members • Power to cast the majority of votes at a board meeting

  7. Group Structure Enterprise A 100% 25% 51% Enterpise B Enterprise C Enterprise D 100% Enterprise E

  8. Group Structure: Examples Identify in each of the following circumstances whether B is a subsidiary of A, i.e., A exercises control over B 1. A owns 40% of the voting rights of B and has an agreement with a shareholder who holds a further 15% of the voting rights that enables him to vote for these shares as well. 2. A owns 42% of the voting rights of B but also has an agreement to govern the financial and operating policies of B 3. A owns 48% of voting rights of B 4. A owns 35% of the voting rights of B and also has the power to appoint or remove five of the nine members of the board of directors. 5. A owns 33% of the voting rights of B and 100% of the voting rights of C. C also holds 20% of the voting rights in B.

  9. IAS 27 – when a subsidiary must be excluded from consolidation • Control is • temporary • acquired and held exclusively with view to sell in near future • Long-term restrictions on transfer of funds • Difficult to obtain the benefits, but no longer permitted to exclude under IAS 27

  10. Exemption from preparing Consolidated Accounts If and only if ALL of the following hold: a. The parent is itself a wholly-owned subsidiary or it is a partially owned subsidiary of another entity and its other owners, have been informed about, and do not object to, the parent not presenting group financial statement. b. Its securities are not publicly traded c. Not in the process of issuing securities in public markets d. The ultimate or intermediate parent publishes group financial statements that comply with IFRS.

  11. Reasons for preparing consolidated accounts • Prevent manipulation • (e.g., Inflating sales by selling within the group) • More meaningful (Earnings Per Share) EPS figure • Better measurement of management performance

  12. Alternative methods of preparing consolidated accounts • The purchase method • Fair value of parent company’s investment • Fair value of identifiable net assets in subsidiary • Difference is Goodwill • Pooling of interests method • Neither party is an acquirer, but • No longer permitted under IFRS 3

  13. Purchase method – Example 1: Wholly Owned Subsidiary (100%) The Rose Group 1 January 2007 Rose plc acquired 100% of 10,000 £1 common shares in Tulip plc for £1.50 per share

  14. The Rose plc and Tulip plc balance sheets on acquisition

  15. The Rose Group balance sheets on acquisition (cont.) Steps: • Calculate the goodwill for inclusion in the group accounts • Add together the assets and liabilities of the two companies for the group accounts • Calculate the consolidated share capital and reserves for the group accounts

  16. The Rose Group balance sheets on acquisition Note 1: Calculate the Goodwill for inclusion in the group accounts: The parent company’s investment 15 000 Less: The parent’s share of sub’s share capital (100% x 10 000) 10 000 The parent’s share of retained earnings (100% x 4 000) 4 00014 000 (This is equivalent to 100% share of net assets, i.e., Non-current assets 11 000 + Net Current assets 3 000) The difference is GOODWILL - for inclusion in the consolidated balance sheet 1 000

  17. The Rose Group balance sheets on acquisition Note 2: Add together the assets and liabilities of the two companies for the group accounts Non- current assets other than goodwill (20 000 + 11 000) 31 000 Goodwill ( as calculated in Note 1) 1 000 Net current assets (8 000 + 3 000) 11 000 43 000

  18. The Rose Group balance sheets on acquisition Note 3: Calculate the consolidated share capital and reserves for the group accounts: Common share capital (The parent company only) 16 000 Retained Earnings (The parent company only) 27 000 43 000

  19. The Rose Group balance sheets on acquisition

  20. Treatment of goodwill arising from consolidation • Positive goodwill • Impairment test in accordance with IAS 36 • Negative goodwill • Recognise immediately in Income Statement under IFRS 3

  21. Minority Interests • Share not held by parent (less than 50%) • Minority • All assets and liabilities controlled are included in the consolidated accounts • Minority interest = amount not owned by parent

  22. Example 2: Minority InterestsThe Bird Group 1 January 20X0 Bird acquired 80% of 10,000 £1 common shares in Flower for £1.50 per share

  23. The Bird Group

  24. Bird Group – Balance Sheet on acquisition Note 1: Calculate Goodwill The parent company’s investment in Flower 12 000 Less: The parent’s share of subsidiary’s share capital (80% x 10 000) 8 000 The parent’s share of the retained earnings (80% x 4 000 ) 3 200 (Equivalent to the shares of net assets, i.e., 80% x (10 000 + 4 000)) 11 200 The difference is GOODWILL 800

  25. Bird Group – Balance Sheet on acquisition Note 2: Calculate the minority interest The minority interest in the share cap. of Flower (20% x 10 000) 2 000 The minority interest in the retained earnings of Flower ( 20% x 4 000) 800 Minority Interest in the Net Assets of Flower 2 800 Note 3: Add together the assets and liabilities of the two companies for the group accounts. Non-current assets other than goodwill (20 000 + 11 000) 31 000 Goodwill (as calculated in Note 1) 800 Net current assets 14 000 45 800

  26. Bird Group – Balance Sheet on acquisition Note 4: Calculate the consolidated share capital and reserves for the group accounts Common share capital (The parent company only) 16 000 Retained Earnings (The parent company only) 27 000 43 000

  27. Bird Group – balance sheets on acquisition

  28. Treatment Fair value and Book value differ (IFRS 3) • Assume Flower’s non-current assets were • Book value £11,000 • Fair value £11,600 • Recognise parent’s % of revaluation • 80% of (11,600 – 11,000) = 480 • Increase non-current assets • Reduce Goodwill

  29. Fair value and Book value differ Note 1: Goodwill The parent company’s investment in Flower 12 000 Less: The parent’s share of the subsidiary’s share capital (80% x 10 000) 8 000 The parent’s share of retained earnings (80% x 4 000) 3 200 The parent’s share of the revaluation (80% x 600) 480 (Equivalent to the share of net assets) 80% x (10 000 + 4 000 + 600) 11 600 GOODWILL 320

  30. Fair value and Book value differ Note 2: Calculate the minority interest The minority interest in the share cap. of Flower (20% x 10 000) 2 000 The minority interest in the retained earnings of Flower (20% x 4 000) 800 The minority interest in the valuation (20% x 600) 120 Minority Interest in the Net Assets of Flower 2 920 Note 3: Non-current assets (20 000 + 11 000 + 600) 31 600

  31. Fair value and Book value differ

  32. How to calculate fair values • Tangible assets • FV based on market value • Depreciated replacement cost if no market value available • Intangible assets • FV based on market value • Best arm’s-length estimate if no market value

  33. How to calculate fair values (or market values) • Inventories • Finished goods • Selling price less cost of sale and reasonable profit • Work-in-progress • Selling price less cost to complete, cost of sale and reasonable profit • Raw materials • Current replacement cost

  34. How to calculate fair values • Monetary assets and liabilities • Amount to be received or disbursed • Discounted if significant • Marketable securities • Current market values • Non-marketable securities • Estimated value based on performance

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