Chap.09 Guerrero Consolidated FS PDF

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Chapter 9Consolidated Financial Statement(IFRS 10)Business combination is achieved by acquisition of stock when an existing company acquires a majority or all of the stock of another existing company. The acquirer records the acquisition by debiting the Investment in Stock account for the considerat...

Description

Chapter 9

Consolidated Financial Statement (IFRS 10) Business combination is achieved by acquisition of stock when an existing company acquires a majority or all of the stock of another existing company. The acquirer records the acquisition by debiting the Investment in Stock account for the consideration given (price paid), which includes cash disbursed, the fair value of other assets given or securities issued. After the acquisition of stock a relationship exist that of parent/subsidiary relationship. The acquirer is called the parent and the acquiree is called the subsidiary. Consolidated financial statements These are the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. Consolidated financial statements are prepared when an entity controls one or more other entities. Consolidation Procedures – Basic Principles When preparing consolidated financial statements, an entity first combines the financial statements of the parent and the subsidiaries on a “line-by-line” basis by adding together like items of assets, liabilities, equity, income, and expenses. So that the consolidated financial statements present financial information about the group as that of a single economic entity, the following adjustments are made: (a) The carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity in each subsidiary are eliminated. Goodwill or gain on a bargain purchase if any is recognized. (b) Non-controlling interests in the profit or loss of consolidated subsidiaries for the reporting period are identified; and (c) Non-controlling interests in the net assets of consolidated subsidiaries are identified separately from the parent’s ownership interests in them. Non-controlling interests in the net assets of the subsidiaries consists of: I. The amount of those non-controlling interests at the date of the original combination; and II. The non-controlling interests’ share of changes in equity since the date of the combination Non-controlling interest is defined as the equity in a subsidiary not attributable directly or indirectly, to a parent. Problems involving stock investments usually involve the following: 1. Preparation of Consolidated statement of financial position at Date of Acquisition.

2. Preparation of Consolidated Financial Statements on date subsequent to acquisition. 3. Accounting for Intercompany Profits in: a. Inventories b. Plant Assets Preparation of Consolidated Statement of Financial Position at Date of Acquisition – Wholly Owned Subsidiary The following are the accounting procedures for the preparation of the consolidated statement of financial position for a parent and its wholly owned subsidiary: The amounts of the consolidated assets and liabilities (except goodwill) are the parent company’s book values and the subsidiary’s current fair values. Intercompany accounts (parent’s investment account and subsidiary’s equity accounts) are excluded (eliminated) from the consolidated statement of financial position. The book value of the net asset is adjusted to their current fair values. Goodwill is recognized in the consolidated statement of financial position, if the consideration given (price paid) exceeds the fair value of the subsidiary’s identifiable net assets. On the other hand, of the consideration given is less than the fair value of the subsidiary’s identifiable net assets, gain on acquisition (closed to parent’s retained earnings) is recognized. Preparation of Consolidated statement of financial position at Date of Acquisition – Partially Owned Subsidiary the consolidation of a parent company and its partially owned subsidiary differs from the consolidation of a wholly owned subsidiary in one major aspect – the recognition of noncontrolling interest (formerly minority interest). Non-controlling interest (NCI) represents the claims of the other stockholders other than the parent company (controlling interest) to the net income or losses and net assets of the subsidiary. Non-controlling interest is recognized only in the consolidation process. It is not a result of any business transaction or event of either the parent or the subsidiary and therefore not recorded in the books of the either the parent or the subsidiary. Measurement of Non-Controlling Interest IFRS 3 (2008) provides two options of measuring non-controlling interest in an acquiree: At fair value, or At the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets (Proportionate Method).

There is no requirement within IFRS 3 (2008) to measure non-controlling interest on a consistent basis for similar types of business combinations and therefore, an entity has a free choice between the two options for each transaction undertaken. However the fair value option is more appropriate than the non-controlling interests’ proportionate share of the acquiree’s identifiable net assets, since it results in the recognition of the non-controlling interest’s share of goodwill [IFRS 3 (2008).] For the purpose of measuring non-controlling interest at fair value, it may be possible to determine the acquisition-date fair value on the basis of active market prices of the equity shares not held by the acquirer. When the market price is not available, the acquirer should estimate the implied fair value of the non-controlling interest using other valuation techniques. The fair value of the non-controlling interest on the date of acquisition should not be less than the NCI percentage of the fair value of the net assets of the subsidiary. If this is the case the NCI should be raised to the percentage of the fair value of the net assets of the subsidiary. Goodwill or Gain on Acquisition The principal problem in the consolidation process on the date of acquisition is the measurement of goodwill or gain on acquisition when there is a non-controlling interest (NCI). IFRS 3 (2008) prescribes the following procedures: Goodwill is measured as the excess of: The aggregate of (i) the acquisition date fair value of the consideration given, (ii) the amount of NCI, and (iii) the fair value of the parent’s previously held interest in the subsidiary; over The net of the acquisition-date value of the net assets acquired. Examples 9-1 P Company acquired S Company in two stages as follows: In 2012, P Company acquired a 30% equity interest for cash consideration of P160,000 when the fair value of S Company’s identifiable net assets was P500,000. In 2013, P Company acquired a further 50% equity interest for cash consideration of P375,000. On the acquisition date, the fair value of S Company’s identifiable net assets was P600,000. The fair value of P Company’s original 30% holding was P200,000 and the fair value of the 20% non-controlling interest is assessed as P140,000. Using the two options, goodwill is calculated as follows:

Fair value of consideration

NCI @ % of net assets P375,000

NCI @ fair value P375,000

Non-controlling interests Previously-held interest Total Fair value of identifiable net assets Goodwill

120,000 200,000 695,000 600,000 P95,000

140,000 200,000 615,000 600,000 P115,000

On the other hand, gain on acquisition (bargain purchase) is recognized when the fair value of identifiable net assets is more than the aggregate of the consideration given, the noncontrolling interests and the fair value of any previously-held interest in the acquiree. The gain is to be recognized only by the acquirer (Parent). Determination and Allocation of Excess Schedule The determination and allocation of excess schedule (D&A schedule) is used to compare the company fair value with the recorded book value of the subsidiary. It also schedules the adjustments that will be made to all subsidiary accounts in the consolidated worksheet process. Examples 9-2 In January 2, 2013, P Company purchased 80% of the outstanding common stock of S Company for P1,000,000. NCI is measured at its implied fair value. S Company’s statement of financial position with the additional fair values is as follows: S Company’s Book and Estimated Fair Values January 2, 2013 Assets Cash and cash equivalents Accounts receivable Inventory Equipment (net) Total assets Liabilities and Equity Current liabilities Fair value of net assets (assets - liabilities)

Book Value P300,000 100,000 200,000 600,000 1,200,000

Fair Value P300,000 100,000 240,000 800,000 1,440,000

P200,000

P200,000 P1,240,000

The D & A schedule is presented on the next page.

Note the following features of the D & A schedule for and 80% parent ownership interest:

The “fair value of subsidiary” line contains the implied value of the entire company, the parent price paid, and the implied value of the NCI. The total stockholders’ equity of the subsidiary (the net assets of the subsidiary at book value) is allocated 80/20 to the controlling interest and NCI. The excess of fair value over book value is shown for the company, the controlling interest, and the NCI, this line means that the entire adjustment of subsidiary net assets will be P250,000. The controlling interest paid P200,000 more than the underlying book value of subsidiary net assets. All subsidiary assets and liabilities will be increased to 100% of fair value. The excess allocated to inventory and equipment is to be amortized on a date subsequent to acquisition. Determination and Allocation of Excess Schedule

Fair value of subsidiary Less book value of interest acquired: Stockholders’ equity (net assets) Interest acquired Book value Excess Allocation/adjustment: Inventory Equipment (10 years) Goodwill

Company Parent Implied Fair Value Price (80%) P1,250,000 P1,000,000 P1,000,000

P250,000

NCI Value (20%)* P250,000

P1,000,000 P1,000,000 80% 20% P800,000 P200,000 P200,000 P50,000

(40,000) (200,000) P10,000

*It is assumed that if the parent would pay P1,000,000 for an 80% interest, then the entire subsidiary company is worth P1,250,000 (P1,000,000/80%). This is called the “implied value” of the subsidiary company. Assuming this to be true, the NCI is worth 20% of the total subsidiary company value (20% x P1,250,000 = 25,000). This technique assumes that the price the parent would pay is directly proportional to the size of the interest purchased. This value should not be less than the NCI in the fair value of the identifiable net assets of the subsidiary (P1,240,000 x 20% = 248,000). Fair value analysis schedule to compare the fair value of the company acquired with the fair value of the identifiable net assets is prepared as follows:

Company fair value Fair value of net assets (excluding goodwill) Goodwill

Company Implied Parent Fair Value Price (80%) P1,250,000 P1,000,000 1,240,000 992,000 P10,000 P8,000

NCI Value (20%) P250,000 248,000 P2,000

Preparation of Consolidated Financial Statement on a Date Subsequent to Acquisition. IFRS 10 requires that all intercompany transactions must be eliminated before the preparation of consolidated financial statement. The elimination procedures to prepare consolidated financial statements on a date subsequent to acquisitions are summarized below: 1. Eliminate dividends declared by the subsidiary against dividend income and NCI share. 2. Eliminate subsidiary equity accounts against the investment account and the NCI as of the date of acquisition. 3. Allocate excess between the aggregate of NCI, price paid by the parent, and previously-held interest and the book value of the identifiable net assets of the subsidiary. This is done by adjusting the book value of the net assets to their current fair value. 4. Amortize allocated excess. 5. Recognize NCI in net income of subsidiary. In the consolidated financial statements, candidates should verify the following items: 1. 2. 3. 4. 5.

NCI in comprehensive income of subsidiary. NCI in net assets of subsidiary. Consolidated total comprehensive income attributable to parent shareholders. Consolidated retained earnings. Consolidated stockholders’ equity.

The following example will illustrate the formulas to compute the above items. Example 9-4 (Continuation of Example 9-2) Assume the following data on December 31:

Retained earnings, January 1

P Company 2012 2013 P500,000

S Company 2012 2013 P200,000

Total comprehensive income Dividends declared Amortization of allocated excess: Inventory Equipment (P200,000/10)

150,000 180,000 80,000 70,000 2012 2013 P40,000 20,000 20,000

100,000 60,000

90,000 40,000

NCI in net income of subsidiary 2012 2013 Net income – S Company P100,000 P90,000 Amortization of allocated excess (60,000) (20,000) Adjusted net income – S Company 40,000 70,000 NCI 20% 20% NCI in comprehensive income of subsidiary P8,000 P14,000 This is presented in the consolidated statement of comprehensive income. NCI in net assets of subsidiary: 2012 2013 Book value of net assets of S Company, January 2 P1,000,000 1,040,000 Increase in earnings during the year: Net income 100,000 90,000 Dividends declared (60,000) (40,000) Increase in earnings 40,000 50,000 Book value of net assets, December 31 1,040,000 1,090,000 Unamortized excess: Excess 250,000 250,000 Amortization (60,000) (80,000) Unamortized 190,000 170,000 Fair value of net assets of S Company, December 31 P1,230,000 P1,260,000 NCI 20% 20% NCI in net assets of subsidiary P246,000 P252,000 This is presented in the stockholders’ equity section of the consolidated statement of financial position. Consolidated comprehensive income attributable to parent 2012 Comprehensive income – P Company P150,000 Dividend income (80%) (48,000) Comprehensive income from own operation – P Company 102,000 Adjusted comprehensive income – S Company 40,000 Consolidated comprehensive income 142,000 NCI in comprehensive income of subsidiary (8,000) Attributable to parent shareholders P134,000 This is presented in the consolidated statement of comprehensive income. Consolidated retained earnings, December 31 2012 Retained earnings, January 1 – P Company P500,000 Consolidated comprehensive income attributable to parent 134,000 Dividends declared – P Company (80,000)

2013 P180,000 (32,000) 148,000 70,000 218,000 (14,000) P204,000 2013 P554,000 204,000 (70,000)

Consolidated retained earnings, December 31 Consolidated stockholders’ equity Common stock – P Company (assumed) APIC (assumed) Retained earnings Controlling interest NCI Stockholders’ equity

P554,000 P688,000 2012 2013 P900,000 P900,000 400,000 400,000 554,000 688,000 1,854,000 1,988,000 246,000 252,000 P2,100,000 P2,240,000

INTERCOMPANY PROFIT IN INVENTORY Intercompany profit in inventory exists when there is intercompany sale of merchandise between affiliates. Downstream intercompany sales of merchandise are those from a parent company to its subsidiary. Upstream intercompany sales are those from subsidiary to the parent company. Intercompany profit in inventories is computed by simply multiplying the inventory of the buying affiliates by the gross profit rate (based on sales) of the selling affiliate. Intercompany profit in ending inventory of the buying affiliate is unrealized until this inventory is sold to outside parties. In the following year, this unrealized profit in ending inventory will be the realized profit in beginning inventory. The following are the working paper elimination procedures when there are intercompany profits in inventory: Intercompany merchandise sales are eliminated; only the purchase and sale to outsiders should remain in the consolidated statements. The profit must be eliminated from beginning inventory of the buying affiliate by reducing the cost of goods sold and the retained earnings. The profit must be eliminated from the ending inventory of the buying affiliate both by reducing the inventory and by increasing the cost of goods sold. Unpaid intercompany trade payables/receivables resulting from intercompany merchandise sales are eliminated. In the computation of the NCI in total comprehensive income of subsidiary at the end of the year, under upstream sale, the unrealized profit in ending inventory is subtracted from the subsidiary net income while the realized profit in beginning inventory is added to arrive at the adjusted subsidiary income. The adjusted total comprehensive income is then multiplied by the NCI proportionate share to get the NCI in net income of subsidiary. If the intercompany sale is made by a parent company ( downstream) or by a wholly-owned subsidiary, there is no effect on the NCI net income, because the selling affiliate does not have NCI. In computing consolidated total comprehensive income, the intercompany profit in inventory is adjusted to the net income of the selling affiliate. INTERCOMPANY GAIN ON SALE OF PLANT ASSETS

This exists when there is intercompany sale of plant assets between affiliates. The gain on sale (selling price less book value) is considered unrealized until the plant assets is sold to outside parties or through use. The following are the working elimination procedures when there is intercompany sale of plant assets: The gain on intercompany sale of non-depreciable fixed asset (land) cannot be recognized until (if ever) the land is sold to outside parties. The gain is deducted from the land account. In the year of intercompany sale, the gain is eliminated; in later periods, retained earnings in reduced for the amount of gain. A gain on the intercompany sale of a depreciable fixed asset is eliminated in the period of sale and the net asset account restored to its book value as if no sales is made. The gain is realized over the depreciable life of the asset as a reduction from each period’s depreciation expense. To compute the comprehensive income applicable to NCI in the year of sale, under the upstream sale, the subsidiary net income is adjusted by subtracting the unrealized gain and adding the realized gain to get the adjusted net income of the subsidiary in the following year, only the realized gain is to be added to the net income of the subsidiary. In computing consolidated total comprehensive income, the total comprehensive income of the selling affiliate is adjusted for the unrealized gain on sale of plant assets.

PROBLEMS 1. On May 1,2013, Pete Corporation acquires 80% of the outstanding common stock of Sure Company for P2,800,000. Professional fees paid to effect paid to effect the combination amounts to P70,000. On the date of acquisition, the stockholders’ equity of Sure Company is as follows: Capital Stock P3,000,000 Retained earnings 437,500 On May 1, the book value of the net assets of Sure is equal to their fair values. NCI is measured at implied fair value. In the preparation of consolidated statement of financial position on May 1,2013, what is the working paper elimination entry? a. capital stock – sure P3,000,000 Retained earnings – sure 437,500 Goodwill 62,500 Investment in Sure P2,800,000 NCI 700,000 b. capital stock – sure Retained earnings – sure Goodwill Investment in Sure

2,400,000 350,000 120,000

c. . capital stock – sure Retained earnings – sure Investment in Sure

2,400,000 350,000

d. capital stock – sure Retained earnings – sure Investment in Sure NCI

P3,000,000 437,500

2,870,000

2,750,000

2,750,000 687,500

2. On May 1,2013, the separate statement of financial position of Pablo Corporation and Simon Company are as follows: Pablo Simon Cash P145,700 P15,500 Accounts receivable 120,500 35,800 Inventories 42,500 10,200 Plant assets 185,800 78,00 Total assets P494,500 P139,500 Liabilities Capital stock, P100 pa value

P110,400 200,000

P28,800 50,000

Additional paid in capital 50,000 Retained earnings 134,100 60,700 Total liabilities & P494,500 P139,500 stockholders’ equity ...