Ch27 sm loftus 2e - solution manual PDF

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Solutions manual to accompany

Financial reporting 2nd edition by Loftus, Leo, Daniliuc, Boys, Luke, Ang and Byrnes Prepared by Sorin Daniliuc

© John Wiley & Sons Australia, Ltd 2018

Chapter 27: Consolidation: wholly owned entities

Chapter 27: Consolidation: wholly owned entities Comprehension questions 1.Briefly describe the consolidation process in the case of wholly owned entities. The consolidation process in the process through which consolidated financial statements are prepared by adding together, line by line, the financial statements of the parent and its subsidiary to some very important consolidation adjustments. First, the financial statements that are added together must be comparable. Therefore, before undertaking the consolidation process it may be necessary to make adjustments in relation to the content of the financial statements of the subsidiary. Second, as part of the consolidation process, a number of other adjustments are made to the parent’s and the subsidiary’s statements, these being expressed in the form of journal entries. A worksheet or computer spreadsheet is often used to facilitate the addition process and to make the adjustments.

2.Explain the initial adjustments that may be required before undertaking the consolidation process. Before undertaking the consolidation process it may be necessary to make adjustments in relation to the content of the financial statements of the subsidiary. •

•

If the end of a subsidiary’s reporting period does not coincide with the end of the parent’s reporting period, adjustments must be made for the effects of significant transactions and events that occur between those dates, with additional financial statements being prepared where it is practicable to do so (AASB 10/IFRS 10 paragraphs B92–B93). In most such cases, the subsidiary will prepare adjusted financial statements as at the end of the parent’s reporting period, so that adjustments are not necessary on consolidation. Where the preparation of adjusted financial statements is unduly costly, the financial statements of the subsidiary prepared at a different date from the parent may be used, subject to adjustments for significant transactions. However, as paragraph B93 states, for this to be a viable option, the difference between the ends of the reporting periods can be no longer than 3 months. Further, the length of the reporting periods, as well as any difference between the ends of the reporting periods, must be the same from period to period. The consolidated financial statements are to be prepared using uniform accounting policies for like transactions and other events in similar circumstances (AASB 10/IFRS 10 paragraph 19). Where the parent and the subsidiary used different policies, adjustments are made so that like transactions are accounted for under a uniform policy in the consolidated financial statements (normally the policy used by the parent).

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3.Explain the adjustments that may be required as part of the consolidation process. As part of the consolidation process, a number of other adjustments are made to the parent’s and the subsidiary’s statements, these being expressed in the form of journal entries. •

•

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As required by AASB 3/IFRS 3, at the acquisition date the acquirer must recognise the identifiable assets acquired and liabilities assumed of the subsidiary at fair value. Adjusting the carrying amounts of the subsidiary’s assets and liabilities to fair value and recognising any identifiable assets acquired and liabilities assumed as part of the business combination, but not recorded by the subsidiary, is a part of the consolidation process. The entries used to make these adjustments are referred to in this chapter as the business combination valuation entries. As noted in section 27.2, these adjusting entries are generally not made in the records of the subsidiary itself, but in a consolidation worksheet. Where the parent has an ownership interest (i.e. owns shares) in a subsidiary, another set of adjusting entries are made, referred to in this chapter as the pre‐acquisition entries. As noted in paragraph B86(b) of AASB 10/IFRS 10, this involves eliminating the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre‐ acquisition equity in the subsidiary. This avoids double counting of the group’s assets and equity. The name of these entries is derived from the fact that the equity of the subsidiary at the acquisition date is referred to as pre‐ acquisition equity, and it is this equity that is being eliminated. These entries are also made in the consolidation worksheet, not in the records of the subsidiary. The third set of adjustments is for transactions between the entities within the group subsequent to the acquisition date, including sales of inventories or non‐current assets. These intragroup transactions are referred to in paragraph B86(c) of AASB 10/IFRS 10. Adjustments for these transactions are discussed in detail in chapter 28.

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Chapter 27: Consolidation: wholly owned entities

4.Explain the purpose and format of the consolidated worksheet. A consolidation worksheet is often used to facilitate the consolidation process, and to make the business combination valuation and pre-acquisition entry adjustments, among other adjustments. From the worksheet, the following statements are prepared: the consolidated statement of financial position, statement of profit or loss and other comprehensive income and statement of changes in equity. Note the following points about the worksheet:  Column 1 contains the names of the accounts, as the financial statements are combined on a line-by-line basis.  Columns 2 and 3 contain the financial information for the parent and its subsidiary. This information is obtained from the financial statements of the separate legal entities. The number of columns is expanded if there are more subsidiaries within the group.  The next four columns, headed ‘Adjustments’, are used to post and reference the adjustments required in the consolidation process. These include the business combination valuation entries, pre-acquisition entries and the adjustments for intragroup transactions. These adjustments, written in the form of journal entries in the consolidation journal, are recorded in the worksheet, separately from the individual records of the parent and subsidiary, so they do not affect the individual financial statements. Where there are many adjustments, each journal entry should be numbered so that it is clear which items are being affected by a particular adjustment entry.  The right-hand column, headed ‘Group’, includes the calculated consolidated amounts for each line item, together with totals and subtotals. The figures in the ‘Group’ column provide the information for preparing the consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity and consolidated statement of financial position. These statements will not include all the line items in the consolidation worksheet. However, information for the notes to these statements is also obtained from line items in the worksheet.

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5.Explain the purpose of the acquisition analysis in the preparation of consolidated financial statements. According to AASB 3/IFRS 3 and as described in chapter 25, entities need to account for business combinations using the acquisition method. As part of the acquisition method, an acquisition analysis is conducted at acquisition date because it is necessary to recognise all the identifiable assets and liabilities of the subsidiary at fair value (including those previously not recorded by the subsidiary), and to determine whether there has been any goodwill acquired or whether a gain on bargain purchase has occurred. The acquisition analysis is considered the first step in the consolidation process as it identifies the information necessary for making both the business combination valuation and pre-acquisition entry adjustments for the consolidation worksheet. The end result of the acquisition analysis will be the determination of whether there is any goodwill acquired or gain on bargain purchase.

6.How does AASB 3/IFRS 3 Business Combinations affect the acquisition analysis? The formation of a parent–subsidiary relationship by the parent obtaining control over the subsidiary is a business combination. The parent, being the controlling entity is an acquirer, with the subsidiary being the acquiree. The acquisition analysis is then totally based on AASB 3/IFRS 3. The acquisition analysis reflects the application of the acquisition method: Step 1: Identify the acquirer – in this case, it is the parent. Step 2: Determine the acquisition date Step 3: Recognise and measure the identifiable assets acquired and the liabilities assumed at fair value. The differences between the carrying amounts and fair values of the identifiable assets, liabilities and contingent liabilities of the subsidiary are recognised via business combination valuation reserves. The effect is to recognise the assets and liabilities of the subsidiary at fair value. Step 4: Recognise and measure goodwill or a gain from a bargain purchase. The goodwill is recognised in the BCVR entries while the gain is recognised in the pre-acquisition entries.

© John Wiley and Sons Australia Ltd, 2018

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Chapter 27: Consolidation: wholly owned entities

7. At the date the parent acquires a controlling interest in a subsidiary, if the carrying amounts of the subsidiary’s assets are not equal to their fair value, explain why adjustments to these assets are required in the preparation of the consolidated financial statements. AASB 3/IFRS 3, paragraph 18, requires that identifiable assets and liabilities of the subsidiary are to be measured at fair value at acquisition date. The standard-setters believe that the fair value of the assets and liabilities provides the most relevant information to users. Even though the standard refers to an allocation of the cost of a business combination, the standard does not require the identifiable assets and liabilities acquired to be recorded at cost. The only asset acquired that is not measured at fair value is goodwill. The fair value approach is emphasised by the required accounting for any bargain purchase on combination. It is not accounted for as a reduction in the fair values of the identifiable assets and liabilities acquired such that these items are recorded at cost. Instead, the fair values are unchanged and the excess is recognised as a gain.

8. If the parent assesses that some of the subsidiary’s identifiable assets and liabilities are not recorded by the subsidiary at acquisition date, explain why adjustments to these assets and liabilities are required in the preparation of the consolidated financial statements. According to AASB 3/IFRS 3 and as described in chapter 25, entities need to account for business combinations using the acquisition method. As part of the acquisition method, an acquisition analysis is conducted at acquisition date because it is necessary to recognise all the identifiable assets and liabilities of the subsidiary at fair value (including those previously not recorded by the subsidiary).

9. Explain the purpose of the business combination valuation entries in the preparation of consolidated financial statements. The purpose of these entries is to make consolidation adjustments so that in the consolidated statement of financial position the identifiable assets, liabilities and contingent liabilities of the subsidiary are reported at fair value. This is to fulfil step 3 of the acquisition method required to account for business combinations by AASB 3/IFRS 3.

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10. Explain the purpose of the pre-acquisition entries in the preparation of consolidated financial statements. The purpose of the pre-acquisition entries is to:  prevent double counting of the assets of the economic entity  prevent double counting of the equity of the economic entity  recognise any gain on bargain purchase. A simple example such as that below could be used to illustrate these points. A Ltd has acquired all the issued shares of B Ltd for $150. The balance sheets of both companies immediately after acquisition are as follows. Share capital Reserves Shares in B Ltd Cash

$200 100 300 150 150 300

Share capital Reserves

Cash

$100 50 150 -150 150

Having acquired the shares in B Ltd, A Ltd records as an asset the investment account ‘Shares in B Ltd’ at $150. This asset represents the actual net assets of B Ltd; that is, the ownership of the shares gives A Ltd the right to the assets and liabilities of B Ltd. To include both the asset investment account ‘Shares in B Ltd’ and the assets and liabilities of B Ltd in the consolidated statement of financial position would double count the assets and liabilities of the subsidiary. On consolidation, the investment account is therefore eliminated. Similarly, A Ltd has equity of $300, which represents its net assets including the investment account, ‘Shares in B Ltd’. Because the investment in the subsidiary represents the actual net assets of B Ltd, or, in other words, the equity of the subsidiary, the equity of the parent effectively includes the equity of the subsidiary. To include both the equity of the subsidiary at acquisition date and the equity of the parent in the consolidated statement of financial position would double-count the pre-acquisition equity of the subsidiary. On consolidation, the equity of the subsidiary at acquisition date is therefore eliminated.

© John Wiley and Sons Australia Ltd, 2018

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Chapter 27: Consolidation: wholly owned entities

11. When there is a dividend payable by the subsidiary at acquisition date, under what conditions should it be taken into consideration in preparing the pre-acquisition entries? Discuss:  the difference between ex div. and cum div. acquisitions  the effects on the consolidation journal entries in the records of the parent under each circumstance. Assume for example that A Ltd acquires all the issued shares of B Ltd for $500 000 when at acquisition date B Ltd has recorded a dividend payable of $10 000. Discuss:  The effects on the acquisition analysis: - For cum div. acquisitions, the dividend payable is considered as a refund on the consideration transferred and therefore the net consideration transferred of $490 000 is used to calculate goodwill/gain on bargain purchase:  If the total shareholder’s equity of B Ltd at acquisition date was $450 000 and all its identifiable assets and liabilities were recorded at fair value, there will be a goodwill of $40 000 which will be recognised in the BCVR as part of the BCVR entries at acquisition date and every period after that. This BCVR will be eliminated in the pre-acquisition entry.  If the total shareholder’s equity of B Ltd at acquisition date was $520 000 and all its identifiable assets and liabilities were recorded at fair value, there will be a gain on bargain purchase of $30 000 which will be recognised in the pre-acquisition entries at acquisition date. In the periods after the period of acquisition, it will be taken out of the opening balance of “Retained earnings” that will be eliminated in the pre-acquisition entries. - For ex div. acquisitions, the dividend is not considered on consolidation and therefore the value of the consideration transferred used to calculate goodwill/gain on bargain purchase would be $500 000:  If the total shareholder’s equity of B Ltd at acquisition date was $450 000 and all its identifiable assets and liabilities were recorded at fair value, there will be a goodwill of $50 000 which will be recognised in the BCVR as part of the BCVR entries at acquisition date and every period after that. This BCVR will be eliminated in the pre-acquisition entry.  If the total shareholder’s equity of B Ltd at acquisition date was $520 000 and all its identifiable assets and liabilities were recorded at fair value, there will be a gain on bargain purchase of $20 000 which will be recognised in the pre-acquisition entries at acquisition date. In the periods after the period of acquisition, it will be taken out of the opening balance of “Retained earnings” that will be eliminated in the pre-acquisition entries.  Other differences in the pre-acquisition entries: - For cum div. acquisitions, the pre-acquisition entries at acquisition date will need to eliminate the dividend receivable raised by the parent and the dividend payable raised by the subsidiary as they are related to a dividend that was declared out of pre-acquisition equity; the pre-acquisition entries after the acquisition date will most likely not need to eliminate this dividend receivable and payable as the

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dividend would have been paid by the time the pre-acquisition entries need to be prepared. - For ex div. acquisitions, the pre-acquisition entries will not be further affected by this dividend.

12. Is it necessary to distinguish pre-acquisition dividends from post-acquisition dividends? Why? Discuss:  the definition of acquisition date  the meaning of pre-acquisition and post-acquisition equity  the treatment of dividends according to paragraph 38A of AASB 127/IAS 27: i.e., an entity shall recognise a dividend from a subsidiary in profit or loss i.e. as revenue – regardless of whether it is paid from pre- or post-acquisition equity. Under AASB 127/IAS 27, all dividends declared after acquisition and paid or payable by the subsidiary to a parent are recognised as revenue in the profit or loss of the parent. However, the dividends from pre-acquisition equity are, by definition, a distribution of pre-acquisition equity, which decreases the pre-acquisition equity and may reduce the value of the investment recognised by the parent. By treating those dividends as revenue, the parent may overstate its income. To reduce any risk of any possible overstatement of income by a parent, the IASB looked at the impairment testing of the investment account recorded by the parent. If the investment account decreases in value as a result of the dividends from pre-acquisition equity, an impairment loss needs to be recognised by the parent. To determine whether there is an impairment of the investment account that should be recognised as a result of dividends distribution, paragraph 12(h) of AASB 136/IAS 36 Impairment of Assets contains a scenario that may provide evidence that the impairment of the investment account occurred: for an investment in a subsidiary, joint venture or associate, the investor recognises a dividend from the investment and evidence is available that: (i) the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee’s net assets, including associated goodwill; or (ii) the dividend exceeds the total comprehensive income of the subsidiary, joint venture or associate in the period the dividend is declared. As such, the pre-acquisition dividends that cause the impairment of the investment account determine an adjustment to be posted in the pre-acquisition entries and that is to eliminate the impairment loss recognised in the individual account by the parent. This entry in the case of the pre-acquisition dividend com...