Advanced Accounting I Business Combination Subsequent TO DATE OF Acquisition PDF

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Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination

Disclaimer: This handout is not meant to replace the prescribed book of the college. No part of this

handout may be reproduced or sold for personal gain without permission from the preparers but may be reproduced for academic purposes only. Special thanks are dedicated to all of the professors and students, in the UST-AMV College of Accountancy, and to God. Preparers: Edilmar R. Fontanilla, CPA Mark Stephen A. Asido , CPA Sources: IFRS 3 – Business Combination IFRS 10 – Consolidated Financial Statements IAS 39 – Financial Instruments, Recognition and Measurement IFRS 9 – Financial Instruments Intermediate Accounting vol. 2 – Empleo and Robles Advanced Accounting vol. 2 – Dayag Theory of Accounts vol. 2 - Valix UST-AMV College of Accountancy Professors

ADVANCED ACCOUNTING I – BUSINESS COMBINATION STOCK ACQUISITION – TRANSACTIONS SUBSEQUENT TO ACQUISITION KEY POINTS TO CONSIDER: 

The preparation of consolidated financial statements at the date the acquirer company (parent) acquires more than 50% of the stock of the acquired company (subsidiary) is not different when preparing consolidated financial statements subsequent to acquisition, except for the fact that there are transactions between the parent and the subsidiary occurred after the acquisition date,



which were already recorded in their books. Transactions between the two entities must eliminated when preparing consolidated financial statements because, although they are legally viewed as separate entities, they are economically viewed as one entity.



The transactions between the parent and subsidiary are eliminated only in the working papers



for consolidation purposes. Those transactions remain in their respective separate books. The parent’s control of the subsidiary due to the stock acquisition is the main reason why there are items in the separate statement of comprehensive income, which will be shared by both the controlling interest and the non-controlling interest.



If the result of the business combination is goodwill and the NCI has its share on the total goodwill (full goodwill approach), the share of the controlling and non-controlling interest for further impairment of goodwill may not be always based on the control percentage acquired



by the acquirer (parent). In intercompany profit transactions, there are two types of sale of assets, namely, upstream or downstream sales. In upstream sale, the selling affiliate is the subsidiary, while in downstream sale, the selling affiliate is the parent. It is very important to know what type of intercompany profit transactions occur between the parent and the subsidiary because it will greatly affect the consolidated net income attributable to the controlling and non-controlling interest. 

If the sale is upstream, the controlling interest will have to share in such adjustment to

If the sale is upstream, the controlling interest will have to share in such adjustment to the subsidiary’s net income equivalent to the control % of the parent because those adjustments will affect the net income of the subsidiary, of which was already shared between the controlling interest and non-controlling interest. Page 1 of 13

Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination



If the sale is downstream, only the consolidated net income attributable to the controlling interest will be affected because those items will only affect the net income of the parent.



For the preparation of the consolidated financial statements, in the working paper:  

The investment in subsidiary account of the parent is eliminated. The equity (ordinary shares, additional paid-in capital, retained earnings, etc) of the subsidiary is eliminated.



Assets and liabilities of the subsidiary are updated to their fair values less any subsequent amortization in excess of the fair value over the books, or plus the amortization of excess of book value over the fair value, if any, and if applicable.



Non-controlling interest in net assets (NCINAS) of the subsidiary is established representing the percentage of ownership of subsidiary not acquired, if the not whollyowned by parent plus the consolidated net income attributable to subsidiary, less any

dividends declared to shareholders other than the parent. 

All the of the intercompany transactions between the parent and subsidiary are eliminated because in their consolidated financial statements, they are viewed as one economic entity.



In business combination problems, the following items must be considered (and mostly asked in the problems) 

Consolidated sales



Consolidated cost of goods sold

consolidated Net income of the



Consolidated gross profit

subsidiary (NCINIS)

 

Consolidated operating expenses Consolidated dividend income



Non-controlling interest in the net assets of the subsidiary



Consolidated net income (CNI)



Consolidated



Consolidated

net



income

Non-controlling interest in the

stockholder’s

equity

attributable to parent (CNI-P)

THE CONSOLIDATED NET INCOME ATTRIBUTABLE TO PARENT AND NCI The consolidated net income of the parent includes the net income of the parent, the net income of the subsidiary from the date of acquisition, any adjustments to their net income such as adjustment for the depreciation expense previously recognized already in the books of subsidiary, all intercompany transactions that resulted to a gain or loss, or declaration of dividends, profit arising from the intercompany sale of inventories, and the impairment of goodwill that arose only from the business combination, if any. In other words, it is basically the combination of their revenues, expenses, gains, losses, and other income earned and incurred only from the unaffiliated companies and individuals. Table 2.1 –Consolidated net income attributable to controlling and non-controlling interest ITEMS IN THE INCOME STATEMENT

PARENT

NCI

Net income of the parent per books

xx

Net income of the subsidiary per books

xx

xx

(xx)

(xx)

Amortization of excess of fair over book value of assets and liabilities of subsidiary Amortization of excess of book over fair value of assets and

liabilities of subsidiary Intercompany dividends Impairment of goodwill**

xx (xx) (xx)

xx (xx) (xx) Page 2 of 13

Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination

Gain on acquisition**

xx

Unrealized (gain) / loss in the sale of plant assets (upstream)*

(xx) / xx

(xx) / xx

Realized gain / (loss) in the sale of plant assets (upstream)*

xx / (xx)

xx / (xx)

Unrealized (gain) / loss in the sale of plant assets (downstream)*

(xx) / xx

Realized gain / (loss) in the sale of plant assets (downstream)*

xx / (xx)

Unrealized profit in ending inventory (UPEI) – upstream*

(xx) / xx

Unrealized profit in ending inventory (UPEI) – downstream*

(xx) / xx

(xx)

Realized profit in the beginning inventory (RPBI) – upstream*

xx

xx

Realized profit in the beginning inventory (RPBI) – downstream*

xx

Adjusted net income for consolidated income statement

XX

XX

*not included in the quiz 5 for advanced accounting I subject **there can be only one result of the business combination. Gain on acquisition is included only in the consolidated net income in the year of acquisition only.

ITEMS IN THE CONSOLIDATED NET INCOME Net income of the parent per books- it is the net income based on the separate financial statements of the parent. Remember that this item is fully attributable to controlling interest only.

Net income of the subsidiary per books -it is the net income based on the separate financial statements of the subsidiary. For consolidation purposes, the parent has a share of the of its net income based on the percentage of ownership of stocks owned by the parent and what is attributable to subsidiary is the percentage of ownership attributable to the non-controlling interest.

Amortization of excess in fair over book value / book over fair value of assets and liabilities of the subsidiary - these items pertain to the increases or decreases in assets and liabilities of the subsidiary not recorded in the books of the subsidiary but recognized in the working paper for consolidated financial statements at the date of acquisition. In the books of the subsidiary, some of the expenses (CGS, depreciation, amortization, etc.) included in the net income of the subsidiary are based on the book values of subsidiary’s assets and liabilities. Thus, these expenses are either understated or overstated, because for consolidation purposes, these expenses must be based on their fair values relevant to the reporting period. This is the reason why there is an additional amortization for consolidation purposes. The following are the common items that are mostly revalued at the date of acquisition and how are they being amortized for consolidation: 

Depreciable assets (PPE, intangibles, investment property accounted for at cost model, leased assets) – the difference between the fair value and the book value shall be amortized based on the remaining useful life from the date of acquisition because the excess pertains to the overstatement (book over fair) or understatement (fair over book) of the depreciation expense being included in the net income of the subsidiary.

Table 2.2 – amortization of excess – depreciable assets Amortization of excess of depreciable

Working paper entries

Reason for adjustment

assets

Year of acquisition

Subsequent years

Page 3 of 13

Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination

FAIR VALUE > BOOK VALUE

Dep. Expense

xx

Accumulated dep.

Retained earnings xx

xx

Depreciation exp. xx Accumulated dep. xx

Depreciation

is

understated depreciation

because in the

books

is

recorded

based on the book value

of

depreciable

asset FAIR VALUE < BOOK VALUE

Accumulated dep.

xx

Accumulated dep.

Depreciation expense xx

xx

Depreciation

is

Depreciation expense xx

overstated

because

Retained earnings

depreciation books is

in the recorded

xx

based on the book value

of

depreciable

asset



Non-depreciable assets (land, inventories, intangibles with indefinite useful life) – the excess of the fair over book, or book over fair values shall only be amortized if already sold to the outside parties. The excess shall be considered in the consolidated net income, because when those items are already sold to the outside parties, the gain or loss (for non-depreciable non-current assets), or the cost of goods sold pertaining to the inventories revalued at the date of acquisition, are either overstated or understated, thus, amortizing these excess amounts will bring them to their correct amount for consolidated financial statements. If there is a partial sale of those assets mentioned above, the excess to be amortized must be proportionate only to the sold assets (e.g. if 20% of inventories sold during the year, 20% of the total excess must be amortized.)

Table 2.3 – amortization of excess – -non-depreciable assets Working paper entries Subsequent years (if there

Amortization of excess of inventory

Year of acquisition

are inventories already

Reason for

existing at DOA still unsold as of the end of the year of

adjustment

acquisition FAIR VALUE > BOOK VALUE

CGS xx inventory xx

Consolidated RE (pertains to last

CGS is understated, pertains to the excess

year CGS

the

portion

of acquisition

inventory existed at

(pertains to last

the date of acquisition which was already sold

xx xx

Inventory inventory xx CGS xx

to

NCI, date

Year CGS CGS FAIR VALUE < BOOK VALUE

attributable

xx

inventory CGS

of

the

xx CGS

xx

Consolidated RE

is

overstated,

xx

pertains to the excess

xx

attributable

to

the

NCI

xx

portion of the inventory existed at

Page 4 of 13

Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination

the date of acquisition which was already sold

Intercompany dividends - these arise because when the subsidiary declares a dividend, a major part of it are received by the parent company, or when there are shares of stock of the parent owned by the subsidiary, the latter as well received dividends from the parent. The controlling interest portion of the dividends declared by subsidiary is deducted from the consolidated net income attributable to the controlling interest because it was included as an income of the parent in the books. Also, retained earnings of the subsidiary is credited in the amount of dividends received by the parent from the subsidiary in the working paper because the balance of the retained earnings of the subsidiary was already affected by the subsidiary’s dividend declaration. Dividends declared for subsidiary’s other shareholders (also represented by the non-controlling interest), will be accounted for as a deduction in the NCINAS in the equity portion of the parent in the consolidated financial statements. Table 2.4 – intercompany dividends Dividends

Working paper entries

Reason for adjustment

Dividend income

xx

Dividend

NCI

xx

recorded by parent at the date of declaration of the

declared by subsidiary

RE – subsidiary

xx

income

eliminated

represents

income

subsidiary. The portion of NCI represents dividend declared by subsidiary to other shareholders. The effect of dividend declaration to the retained earnings because it must appear that the subsidiary only declares dividends to other shareholders at the date of declaration.

Impairment of goodwill - goodwill is not amortized, but is tested for impairment annually. If the parent company determined that the goodwill arising from the business combination is impaired, the impairment shall be allocated proportionately on the basis on the share of the controlling interest and the NCI on the goodwill at the date of acquisition, if the acquisition resulted in goodwill and the fair value of the NCI at the date of acquisition is based only on fair value of the NCI (given or approximated based on the cost of investment of parent), which is higher than proportionate share of NCI in the net assets of the subsidiary (minimum amount of NCI). In short, the subsidiary will only share in the impairment of goodwill if there is a part of goodwill allocated to the NCI at the date of acquisition (full goodwill approach). It must be noted, however, that if the parent already has goodwill before the date of acquisition, then its impairment is already reflected in the separate books in the parent, and is solely attributable to the controlling interest, as it arose from a different transaction before the acquisition. The following table summarizes how the goodwill will be allocated between the CI and NCI. Table 2.5 – summary of allocation of impairment goodwill between CI and NCI How NCI was measured at the date of acquisition

Allocation of goodwill

Estimated FV

Controlling and non-controlling percentage or share of CI and NCI in goodwill Page 5 of 13

Junior Philippine Institute of Accountants Discussion Review in Advanced Accounting Business Combination

Given fair value

share of CI and NCI in goodwill

Proportionate FV

Goodwill

impairment

is

fully

attributable to CI

To illustrate, PARIS CAT corporation acquired 80% of the stocks of SURFER CAT corporation for 3,500,000 on January 1, 2016. At the date of acquisition, the fair value of the net assets of Surfer cat corporation amounted to 4,000,000. During the year, goodwill is tested for impairment and PARIS CAT corporation determined it has been impaired by 27,000. Case 1: NCI is measure at fair value, no fair value of the non-controlling interest provided. In this case, NCI will be measured at its estimated fair value of 875,000, since it is higher than the proportionate fair value of NCI amounting to 800,000. The business combination resulted to a goodwill of 375,000 ((3,500,000 / 80%)-4,000,000). Also, because the estimated FV of NCI is higher than its proportionate amount, the NCI will share in the subsequent impairment of goodwill. Note that the share of CI and NCI in the goodwill is the same as the percentage of ownership controlled by the parent. Thus, if the fair value of NCI is based on estimated FV, the impairment loss to be attributable to the controlling interest is equal to the percentage of ownership of the parent. Table 2.6 – allocation of the impairment of goodwill to controlling and non-controlling interest Allocation of Goodwill to controlling and non- Working Paper Entries controlling interest DATE

OF

ACQUISITION

CI Cost

of

assets

TOTAL

3,500,000

875,000

4,375,000

(3,200,000)

(800,000)

(4,000,000)

300,000

75,000

375,000

investment FV of net

NCI

GOODWILL SUBSEQUENT

Share of controlling interest in the goodwill

TO DATE OF

impairment

ACQUISITION

Controlling interest: 27,000 x (300/375) = 21,600 Non-controlling interest 27,000 c (75/375) = 5,400

Goodwill 375,000 Investment In subsidiary NCI

300,000 75,000

Impairment loss 27,000 Goodwill

27,000

Case 2: NCI is measure at fair value; the fair value of the non-controlling interest is 750,000. In this case, the fair value of the non-controlling interest is lower than its proportionate fair value, thus, the fair value giv...