Advanced Financial

Accounting: Chapter 3
Group Reporting II: Application of
the Acquisition Method under
IFRS 3

Tan & Lee Chapter 3 © 2009 1

Learning Objectives

1. Understand the difference between investor’s separate financial

statements and the consolidated statements;
2. Understand the consolidation process;
3. Appreciate the acquisition method and its implications;
4. Know how to determine the cost of consideration transferred;
5. Understand the identification of the acquirer;
6. Know how to recognize and measure identifiable net assets under
IFRS 3;
7. Understand the nature of goodwill;
8. Review the concept of non-controlling interests (NCI) with respect
to parent and entity theories; and
9. Know how to prepare consolidation journal entries relating to fair
value adjustment at acquisition date and subsequent years

Tan & Lee Chapter 3 © 2009 2

Content

1. Introduction
Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 3

Separate Vs Consolidated Financial
Statements
Separate financial Consolidated financial
statements statements
(Legal entity) (Economic entity)
Income recognition Dividends Share of profits
Investment in a Investment in Subsidiary:
Subsidiary carried at: • Investment is eliminated
• Cost (IAS 27) or and subsidiary’s net assets
• As a financial are added to the parent (IAS
instrument (IAS 39) 27)
Asset recognition
Investment in an Investment in an associate:
associate carried at:
• Equity method (IAS 28)
• Cost (IAS 28) or
• As a financial
instrument (IAS 39)

Tan & Lee Chapter 3 © 2009 4

Content

1. Introduction
2. Overview
Overview of
of the
the consolidation
consolidation process
process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 5

Consolidation Process

Legal entities Economic entity

Parent’s Subsidiaries' Consolidation adjustments Consolidated

Financial + Financial +/- and eliminations = financial
Statements Statements statements

• 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:
– Combine parent and subsidiaries financial statements
– Adjust or eliminate intra-group transactions and balances
– Allocate profit to non-controlling interests

Tan & Lee Chapter 3 © 2009 6

Intragroup Transactions
• Intragroup transactions are eliminated to:
– Show the financial position, performance and cashflow of the economic (not
legal) entity
– Avoid double counting of transactions

Example:
• Parent sold inventory to subsidiary for $2M
• The original cost of inventory is $1M
• Subsidiary eventually sold the inventory to external parties for $3M

Q: What is the journal entry to eliminate intragroup sales transaction?

Consolidation adjustment
Dr Sale 2,000,000
Cr Cost of sale 2,000,000

Tan & Lee Chapter 3 © 2009 7

Intragroup Transactions

Extract of consolidation worksheet

Consolidation
elimination entries
    and adjustments  

Parent's Subsidiary’s Consol.

Income Income Income Without
  Statement   Statement  Dr Cr   Statement elimination
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      
Note: Without elimination the consolidated sales and  cost
$2,000,000
of sales$2,000,000
figures
will be overstated by $2 M.

Tan & Lee Chapter 3 © 2009 8

Content

1. Introduction
2. Overview of the consolidation process
3. The
The acquisition
acquisition method
method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 9

Business Combinations

Where an acquirer
obtains control of
one or more
businesses (IFRS 3
Business App A)
combinations

Examples: IFRS 3 App B:B6

Legal merger Net assets Former
Businesses
of net assets of combining owners of a
become
of acquired entities transferred combining entity
subsidiaries of
businesses into to a newly-formed obtains control
acquirer
acquirer’s books entity of combined entity

Tan & Lee Chapter 3 © 2009 10

 The Acquisition Method

• IFRS 3 requires all business combinations to be accounted for using

the acquisition method
4-step
• The procedures:
approach:
IFRS 3:5
Identify the acquirer

Determine the acquisition date

Recognize and measure the identifiable assets acquired

Group the liabilities assumed and any non-controlling
financial interest in the acquiree; and
statements
if acquire
subsidiaries Recognize and measure goodwill or
a gain from a bargain purchase

Tan & Lee Chapter 3 © 2009 11

Identify the Acquirer

• IFRS 3 requires the identification of the acquirer in all circumstances

– Acquirer is the entity that obtains control of another combining entities
– Control is the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities

Tan & Lee Chapter 3 © 2009 12

Identify the Acquirer

Additional control criteria under IFRS 3 Appendix B

Based on consideration
Based on entity size Based on dominance
transferred
Acquirer is the entity that: Acquirer is the entity that: Acquirer is the entity:

• Transfers cash or other • Has the largest relative • Whose owners have the
assets or incurs liabilities to voting rights in a combined ability to elect, appoint or
acquire another entity entity remove a majority of
directors
 Issues shares as purchase • Holds the largest minority
consideration voting interest in the • Whose management is
combined entity (if no other dominant in the combined
 Pays a premium over the entity has significant voting entity
fair value of the equity interest)
interest •Who initiates the business
• Is relatively larger in size combination
Tan & Lee Chapter 3 © 2009 13
Identify the Acquirer

• Reverse acquisition
– Legal parent is the acquiree and legal subsidiary is the acquirer
– Often initiated by the legal subsidiary
– Has other motive of entering into such an arrangement (eg. Backdoor
listing)

• Exchange of shares in a reverse acquisition Owners of Company B

1. Company A (Legal parent) takes
over shares of Company B from (Legal subsidiary)
owners
2. Company A issues own shares
Company A to owners of Company B as
(Legal parent) purchase consideration

Company B
3. Company B has the power to govern (Legal subsidiary)
the financial and operating policies of the
legal parent
Tan & Lee Chapter 3 © 2009 14
Content

1. Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the
Determining the amount
amount of
of consideration
consideration transferred
transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 15

 Determine the Amount of Consideration
Transferred

Consideration Fair value of Fair value of

transferred =
Fair value + Fair value + equity
+ contingent
of assets of liabilities
transferred incurred interests consideration
issued by
acquirer

• Fair value of the consideration transferred:

– Determined on the acquisition date
– Acquisition date is the date when the acquirer obtains control and not
the date when consideration is transferred

Tan & Lee Chapter 3 © 2009 16

Fair Value of Assets Transferred
or Liabilities Assumed
• If assets transferred or liabilities assumed are not carried at fair
value in the acquirer’s separate financial statements:
– Remeasured gain or loss is recognized in the acquirer’s separate
financial statements
– Remeasured gain or loss is not recognized if the assets or liabilities
remain in the combined entity’s financial statements

• If transfer of monetary assets or liabilities are deferred:

– The fair value will be the present value of the future cashflows
– Eg. Future cash settlement of $1,000,000 is due 3 years later and 3%
interest is levied
Fair value = $1,000,000/ (1+0.03)^3
= $915,142

Tan & Lee Chapter 3 © 2009 17

Fair value of Equity Interests Issued
by the Acquirer
• 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, whichever is more reliably measurable

Tan & Lee Chapter 3 © 2009 18

Illustration 1:
Fair Value of Equity Issued
P Ltd acquires 100% of S Co through an issue of 5,000,000 shares
to the vendors 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

Tan & Lee Chapter 3 © 2009 19

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 is a better estimate

Consideration transferred = $9,000,000

Tan & Lee Chapter 3 © 2009 20

Fair Value of Contingent Consideration

• 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
• Eg. 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) is added to (deducted

from) consideration transferred

Tan & Lee Chapter 3 © 2009 21

Acquisition-Related Costs
• All acquisition-related costs are expensed off
• Costs of issuing debt are recognized in accordance with IAS 39
– 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
• Costs of issuing equity are recognized in accordance with IAS 32
– A reduction against equity
– Journal entry to record the payment of cost of issuing equity
Dr
Equity
Cr
Cash
Tan & Lee Chapter 3 © 2009 22
Content

1. Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition
Recognition and
and measurement
measurement of
of identifiable
identifiable assets,
assets, liabilities
liabilities and
and goodwill
goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 23

Elimination of Investment Account
What the parent is paying for

Consideration Share of book Share of

transferred value of excess of fair
Goodwill
= subsidiary’s + value over +
net assets at book value of
acquisition identifiable net
date assets
Eliminated against
subsidiary’s share
capital and pre-
acquisition retained
earnings

• Investment account is eliminated

– Substituted with subsidiary’s identifiable net assets and goodwill (residual)
– Avoid recognizing assets in two forms (investment in parent’s balance sheet and
individual assets and liabilities of the subsidiary)

Tan & Lee Chapter 3 © 2009 24

Recognition Principle

Business Combination accounted under the acquisition method

At acquisition date, the acquirer will recognize

subsidiary’s net assets at fair value
To qualify for recognition:
Identifiable net assets must meet the Identifiable net assets must be priced into
definition of an asset or a liability the consideration transferred

Rationale:
There is an effective ”purchase” of the
There has been an exchange transaction
subsidiary’s identifiable assets and
at arm-length pricing
liabilities at fair value

Tan & Lee Chapter 3 © 2009 25

Recognition Principle

Fair value At acquisition date:

differential • Fair value differential
(FV-BV) of will be recognized in
the consolidation
identifiable net worksheet
assets
In subsequent years:
•
Depreciation/amortization
/
Book value of Book value of cost of sale of asset will be
subsidiary’s subsidiary’s
identifiable net identifiable net based on the fair value
assets assets recognized at the
acquisition date
recognized in
In separate
consolidated
financial These entries have to be re-
financial
statements enacted every year until
statements
disposal of investment

Tan & Lee Chapter 3 © 2009 26

Intangible Assets

• IFRS 3 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:

Example:
• Assembled workforce with
specialized
knowledge
Or must • Fails to meet the separability
arise from criterion
contractual • Opportunity gains from an
or legal operating
rights lease in favorable market
Tan & Lee Chapter 3 © 2009 conditions 27
• Meets the contractual-legal
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
(IFRS 3:23)
• Provisions for restructuring & termination cost are recognized if they
are:

Probable
outflow of
Reliably
economic
measurable
resources

Present
constructive or
legal obligations
arising from past
events
Tan & Lee Chapter 3 © 2009 28
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 asset or liability is recognized
– The indemnification asset is measured on the same basis as the
indemnified asset or liability

• Eg. 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 balance sheet, contingent liabilities and an
indemnification asset of $100,000 will be recognized at fair value
Tan & Lee Chapter 3 © 2009 29
Deferred Tax Relating to FV Differentials
of Identifiable Assets and Liabilities
• 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 different

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

• No deferred tax liability is recognized on goodwill

Tan & Lee Chapter 3 © 2009 30

Measurement Period

• IFRS 3 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

• After 1 year, any correction of errors will be deemed as a prior -

period adjustment

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

circumstances after the acquisition date will be recognized in the
current period and not retrospectively

Tan & Lee Chapter 3 © 2009 31

Goodwill
• A premium that a parent pays to acquire the subsidiary
– Must be recognized separately as an asset
– Determined as a residual
• IFRS 3 allows 2 ways of determining goodwill:
Goodwill = Fair value of consideration transferred - Acquiree’s
+ recognized net
Amount of non-controlling interests identifiable assets
+
measured in
Fair value of the acquirer’s previously accordance with
held interest (before control was
achieved) in the acquiree IFRS 3

Amount of non- Measured at fair value at acquisition date

(include goodwill)
controlling interests

Measured as a proportion of identifiable

assets as at acquisition date

Tan & Lee Chapter 3 © 2009 32

Goodwill

Integral to the entity as

a whole, not individually
identifiable or severable
as a standalone asset

Tan & Lee Chapter 3 © 2009 33

Goodwill
• The “top-down approach” (Johnson and Petrone, 1998) results in
measurement errors in goodwill

Consideration transferred +
Overpayment for an
Amount of non-controlling interests
acquisition or
overvaluation of
consideration
transferred

Identifiable net assets

Measurement and
recognition errors

Goodwill
Above errors impact residual
goodwill
Tan & Lee Chapter 3 © 2009 34
Goodwill
• In a “bottom-up” approach (Johnson and Petrone, 1998), goodwill is substantiated
as follows:

“Going concern element” and Generated from the unique

represent the ability of an combination of the acquirer
entity to generate higher rate and acquiree or “combination
of return over its individual goodwill”
assets or “core goodwill”
Tan & Lee Chapter 3 © 2009 35
Gain From a Bargain Purchase

• A gain from bargain purchase arises when:

Fair value of consideration transferred Acquiree’s net

<
+ identifiable assets
Amount of non-controlling interests measured in
+
accordance with
Fair value of the acquirer’s previously IFRS 3
held interest in the acquiree

• The acquirer must re-assess the fair value of identifiable net assets,
consideration transferred and non-controlling interests. If there is no
measurement error:
– The gain will be recognized immediately in the income statement

Tan & Lee Chapter 3 © 2009 36

Content

1. Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests underIFRS
interest under IFRS33
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 37

Non-Controlling Interests’ Share of
Goodwill
• IFRS 3 Para 19 allows NCI to be measured in either of two ways

Non-controlling interests

Measured at Fair Measured as a

value at acquisition proportion of identifiable
date (include assets as at acquisition
goodwill) date
(Fair value option)

Tan & Lee Chapter 3 © 2009 38

Non-Controlling Interests’ Share of
Goodwill
• 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:

Non – controlling
interests

Share of book Share of Share of

value unamortized unimpaired
of net assets FV adjustment
(FV - BV) goodwill

Tan & Lee Chapter 3 © 2009 39

Non-Controlling Interests’ Share of
Goodwill
• Under the fair value option:
– 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 (Parent & NCI)
Dr/Cr Deferred tax asset/ (liability) on fair value adjustment
Cr Investment in subsidiary
Cr Non-controlling interests (At fair value)

Tan & Lee Chapter 3 © 2009 40

Non-Controlling Interests’ Share of
Goodwill
• Under the 2nd option:
– NCI is a proportion of the acquiree’s identifiable net assets
– NCI comprises of 2 items:

Non – controlling
interests

Share of
Share of book value
of net assets unamortized
of FV adjustments
(FV- BV)

Tan & Lee Chapter 3 © 2009 41

Non-Controlling Interests’ Share of
Goodwill
• 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 S subsidiary
Non-controlling interests
Cr (NCI % x FV of identifiable net assets)

Tan & Lee Chapter 3 © 2009 42

Non-Controlling Interests’ Share of
Goodwill
NCI measured as a
NCI measured at FV proportion of the
acquiree’s identifiable
net assets

Book value of net assets

Fair value – Book value of

net assets

Goodwill

Tan & Lee Chapter 3 © 2009 43

Accounting for Non-Controlling
Interests under IFRS 3
• In consolidation, non-controlling interests have a share of:
 Profit after tax
 Dividends declared
 Share capital
 Retained earnings and other comprehensive income (eg. 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)

Tan & Lee Chapter 3 © 2009 44

Reconstructing NCI on Balance Sheet

Date of Beginning of End of current

acquisition current year year

NCI have a share of NCI have a share of NCI have a share of

1. Share capital 1. Change in share capital 1. Profit after tax
2. Retained earnings 2. Change in retained 2. Current amortization of
earnings fair value differential
3. Other equity
4. Fair value differentials 3. Change in other equity 3. Current impairment of
goodwill
4. Past amortization of fair
5. Goodwill
value differential 4. Dividends as a
5. Past impairment of repayment of profits
goodwill 5. Change in other equity

Tan & Lee Chapter 3 © 2009 45

Allocation to Non-controlling Interests
1. Allocation of the change in equity from date of acquisition to the
current year
• To transfer the NCI’s share of subsidiary’s retained earnings to NCI

Dr Retained earnings (NCI % x in RE from acquisition date to

beginning of current period)
Cr NCI

2. Allocation of current profit after tax to NCI

Dr Income to NCI
Cr NCI

Tan & Lee Chapter 3 © 2009 46

Allocation to Non-controlling Interests
3. Allocation of dividends to NCI
• A realization of residual in a subsidiary
• Reduces the NCI’s stake in the net assets of the subsidiary
• Elimination of dividends as follows:

Dr Dividend income (Parent)

Dr NCI (BS)
Cr Dividends declared (Subsidiary)

4. Can NCI be a debit balance?

• If NCI’s share of losses in a subsidiary > NCI’s existing share of
subsidiary’s net assets:
• NCI will have a debit balance under IAS 27

Tan & Lee Chapter 3 © 2009 47

Analytical check on Non-controlling
Interests’ balance

NCI’s share of:

a) Book value of net assets of subsidiary at
year-end -/+ unrealized profit/loss from

=
NCI’s balance at upstream sale
year-end b) Unamortized balance of FV adjustments at
year-end
c) Unimpaired balance of goodwill at year-
end

Tan & Lee Chapter 3 © 2009 48

Content

1. Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7.
7. Effects of
Effects of amortization,
amortization, depreciation
depreciation and and disposal
disposal of
of undervalued
undervalued
or overvalued
or overvalued assets
assets and
and liabilities
liabilities subsequent
subsequent to
to acquisition
acquisition
8. Goodwill impairment tests

Tan & Lee Chapter 3 © 2009 49

In Subsequent Years
• 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
– Eg. When an identified asset is sold or depreciated:

BV of expense in (FV- BV) adjustment FV of expense

separate to expense in consolidated
financial + = financial
statements Adjusted in consolidation statements
worksheet
Tan & Lee Chapter 3 © 2009 50
Illustration 2:
Amortization of Fair Value Differentials
• P Co paid $6,200,000 and issued 1,000,000 of its own shares to
acquire 80% of S Co on 1 Jan 20X5
• Fair value of P Co’s share is $3 per share
• Fair value of net identifiable assets is as follows:
  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  
Tan & Lee Chapter 3 © 2009 51
Illustration 2:
Amortization of Fair Value Differentials
Additional information:
• Contingent liability of $100,000 was recognized as a provision by
the acquiree in Dec 20X5
• FV of NCI at acquisition date was $2,300,000
• Net profit after tax of S Co for 31 Dec 20X5 was $1,000,000
• No dividends were declared during 20X5
• Shareholders’ equity as at 31 Dec 20X5 was $5,700,000

Q1 : Prepare the consolidation adjustments for P Co for 20X5

Q2 : Perform analytical check on balance of NCI as at 31 Dec 20X5

Tan & Lee Chapter 3 © 2009 52

Illustration 2:
Amortization of Fair Value Differentials
• Consideration transferred = Cash consideration + Fair value
of share issued
= $6,200,000 + (1,000,000 x $3)
= $9,200,000

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

= $580,000

• 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

Tan & Lee Chapter 3 © 2009 53

Illustration 2:
Amortization of Fair Value Differentials
• P’s share of goodwill = Consideration transferred – 80% x Fair
value of net identifiable assets, after tax
= $9,200,000 – 80% x $7,020,000
= $9,200,000 – $5,616,000
= $3,584,000

• NCI’s share of goodwill = Consideration transferred – 20% x Fair

value of net identifiable assets, after tax
= $2,300,000 – 20% x $7,020,000
= $2,300,000 – $1,404,000
= $896,000

Tan & Lee Chapter 3 © 2009 54

Illustration 2:
Amortization of Fair Value Differentials
Consolidation adjustments for 20X5

CJE 1: Elimination of investment in S

Dr Share capital 1,000,000

Dr Retained earnings 3,700,000
Dr Leased property 1,000,000
Dr In-process R&D 2,000,000
Dr Goodwill 4,480,000
Cr Contingent liability 100,000
Cr Deferred tax liability 580,000
Cr Investment in S 9,200,000
Cr Non-controlling interests 2,300,000

Tan & Lee Chapter 3 © 2009 55

 Illustration 2:
Amortization of Fair Value Differentials
CJE 2: Depreciation and amortization of excess of FV over book value

Dr Depreciation of leased property 50,000

Dr Amortization of in-process R&D 200,000
Cr Accumulated depreciation 50,000
Cr Accumulated amortization 200,000
Under dep. by
Under amort. by
$50k
Dep exp: $200k
$50,000
Amort exp:
$200,000
Dep. of
$200,000 $200,000 Amort. of
leased R&D
property
$0
Based on Based on
Based on FV Based on FV
book value book value
Tan & Lee Chapter 3 © 2009 56
Illustration 2:
Amortization of Fair Value Differentials
CJE 3: Reversal of entry relating to provision for lawsuit

Dr Provision for lawsuit 100,000

Cr Loss from lawsuit 100,000
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 4: Tax effects on CJE 2 & CJE 3

20% * (200k
Dr Deferred tax liability 30,000 +50k -100k)

Cr Tax expense 30,000

Tan & Lee Chapter 3 © 2009 57

Illustration 2:
Amortization of Fair Value Differentials

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

Dr Income to NCI 176,000

Cr NCI 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%) 176,000

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Illustration 2:
Amortization of Fair Value Differentials
NCI balance:
NCI at acquisition date (CJE 1) $2,300,000
Income allocated to NCI for 20x5 (CJE 5)
176,000
NCI as at 31 Dec 20x5 $2,476,000

Tan & Lee Chapter 3 © 2009 59

Illustration 2:
Amortization of Fair Value Differentials
Q2 : Perform an analytical check on the balance of NCI as at 31 Dec 20X5

Non – controlling
interests

Share of book Share of Share of

value unamortized unimpaired
of net FV
assets adjustment goodwill

$5,700,000 x 20% ($1,000,000 x 19/20 x $896,000 = $2,476,000

+ 80% x 20%) +
+
= $1,140,000
($2,000,000 x 9/10 x
80% x 20%) =
$440,000
Tan & Lee Chapter 3 © 2009 60
Content

1. Introduction
2. Overview of the consolidation process
3. The acquisition method
4. Determining the amount of consideration transferred
5. Recognition and measurement of identifiable assets, liabilities
and goodwill
6. Accounting for non-controlling interests under IFRS 3
7. Effects of amortization, depreciation and disposal of undervalued
or overvalued assets and liabilities subsequent to acquisition
8.
8. Goodwill impairment
Goodwill impairment tests
tests

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Goodwill Impairment Test

• IAS 36: Goodwill has to be reviewed annually for impairment loss

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

• CGU is the lowest level at which 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

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Goodwill Impairment Test
1. Carrying amount:
– Net assets of the cash-generating unit
– It includes entity goodwill attributable to parent and NCI

2. Recoverable amount:
– Higher of FV less cost to sell (an arms-length measure), or
• Uses market based inputs in the pricing mechanism
– Value in use
• Uses internal or entity-specific input to determine the future cash flows

3. If carrying amount > recoverable amount

– Impairment loss is allocated to goodwill
– Then to other assets in proportion to their individual carrying amounts
– Impairment once made is not reversible, as it may result in the
recognition of internally-generated goodwill which is prohibited under
IAS 38

Tan & Lee Chapter 3 © 2009 63

Goodwill Impairment Test
Steps for impairment test

Determine the carrying amount of the CGU

Determine the recoverable amount of the CGU

Recoverable amount: Higher of fair value or value in use

If carrying amount ≤ If carrying amount ≥

recoverable amount recoverable amount

Allocate impairment loss

No impairment loss
to goodwill first and
balance to other net assets
Tan & Lee Chapter 3 © 2009 64
Goodwill Impairment Test
NCI as a proportion of
NCI at FV at acquisition
identifiable net asset at
date
acquisition date
Includes NCI’s share of Excludes NCI’s share of
Goodwill on consolidation
goodwill goodwill
Goodwill is allocated to Goodwill has to be grossed
cash-generating unit without up to include NCI’s share
Carrying amount of cash- further adjustment
generating unit Notionally adjusted goodwill
= Recognized goodwill/
parent’s interest
Impairment loss is shared
Impairment loss is borne
between parent and NCI on
Impairment loss only by parent as goodwill
the same basis on which
for NCI is not recognized
profit or loss is allocated

Tan & Lee Chapter 3 © 2009 65

Conclusion

• All business combinations are accounted for using the acquisition

method:
– Consideration transferred = Fair value of (assets transferred + liabilities
incurred + equity interests issued by acquirer + contingent
consideration)
– Investment account is eliminated and substituted with:
• Subsidiary’s identifiable net assets; and
• Goodwill
– Goodwill = Fair value of (consideration transferred + non-controlling
interests + acquirer’s previously held interest in the acquiree) –
Acquiree’s recognized net identifiable assets

Tan & Lee Chapter 3 © 2009 66

Conclusion

• In consolidation:
– All intragroup balances and transactions are eliminated
– Non-controlling interests have a share of:
 Profit after tax
 Dividends declared
 Share capital
 Retained earnings and other comprehensive income (eg. Revaluation
reserve) from acquisition date to current period
 Fair value differential of a subsidiary’s net assets at acquisition date
 Goodwill (if the fair value alternative is adopted)
– In the subsequent years, amortization, depreciation and cost of sales of
the acquired assets are based on fair value as at acquisition date

Tan & Lee Chapter 3 © 2009 67