CAS Notes Module 6 - Week 7 PDF

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Corporate Accounting Systems – Module 6 Week 7 Accounting for Group Structures: Acquisition of Wholly Owned Subsidiaries

Determination of Goodwill and Gain on Bargain Purchase Acquisition analysis •

The purpose of an acquisition analysis is to compare the cost of acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at acquisition to determine whether there is: • •

•

Goodwill on acquisition (where cost of acquisition > FVINA) Recall that goodwill is an unidentifiable intangible asset that is calculated as a residual value

Also recall that: net assets = assets – liabilities = shareholders’ equity

We commonly determine the net FVINA with reference to the equity balances of the subsidiary and then adjust for specific individual asset and liability balances not at fair value. Recognition of gain on bargain purchase • • •

It is possible for a company to gain control of an entity for an amount (cost of acquisition) less than the fair value of the proportional share of the net assets acquired (acquired at a discount) Where the acquirer’s interest in the FVINA exceeds the consideration transferred, negative goodwill arises – this is referred to as a “gain on bargain purchase” The existence of a gain on bargain purchase is probably less common than goodwill on acquisition.

Eliminating Parent’s Investment in Subsidiary Accounting for the consolidation of separate legal entities Recall: The first step in consolidation process is to: • Eliminate the “pre-acquisition” equity acquired of the subsidiary against the investment account in the parent company • Where the net assets do not equal the value of the investment this will lead to a difference: - Goodwill (Cost of acquisition > FVINA) - Gain on Bargain Purchase (Cost of acquisition < FVINA) • •

Goodwill is then subject to AASB 136 impairment testing. Where there is a ‘gain on bargain purchase’, AASB 3 requires the acquirer to recognise the gain immediately as income in the profit & loss

Recall: Elimination of pre-acquisition equity • The investment account in the subsidiary will be eliminated in full against the pre-acquisition shareholders’ funds of the subsidiary • Reasons of elimination: this will avoid the double counting of assets, liabilities and shareholders’ funds of the subsidiary

Subsidiary’s assets not recorded at fair values • •

•

If a subsidiary’s assets are not recorded at fair value then adjustments will be required so that a reliable figure for goodwill (or ‘gain on bargain purchase’) can be calculated AASB 3 stipulates to either: - revalue the identifiable assets in the accounting records of the subsidiary before consolidation—all the non-current assets of the subsidiary are revalued to their fair values in the accounting records of the subsidiary, OR - recognise the necessary adjustments on consolidation (we always follow this alternative) This means that the asset values provided by the subsidiary each year from their records to the group for consolidation purposes will always be the original unadjusted values! - On consolidation each year we will first recognise the revaluation of the non-current assets in the consolidation worksheet, and then we would eliminate the investment in the subsidiary against the pre-acquisition shareholders’ funds of the subsidiary.

Adjustment on consolidation: To revalue non-current assets to fair value: Dr Non-current assets Cr Revaluation surplus Cr Deferred tax liability To then eliminate the investment in the subsidiary, as well as the revaluation reserve created in the previous entry Dr Share capital Dr Retained earnings Dr Revaluation surplus Dr Goodwill Cr Investment in subsidiary Consolidation after date of acquisition • •

Pre-acquisition shareholders’ funds of the subsidiary are eliminated on consolidation (incl. goodwill on consolidation or gain on bargain purchase, if any) In periods following acquisition the subsidiary will generate ‘post-acquisition’ profits or losses. Since these results have been generated in the period after acquisition, they should be reflected in the results of the economic entity (the group) and be included within the consolidated statements. That is, post-acquisition net profits/earnings are considered to be part of the earnings of the group....