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Module 3: Basic Consolidation ProceduresMODULE 3 BASIC CONSOLIDATION PROCEDURESINTRODUCTIONPFRS 3 deals with the accounting for a business combination at the acquisition date, while PFRS 10 deals with the preparation and presentation of consolidated financial statements after the business combinatio...

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MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

MODULE 3 BASIC CONSOLIDATION PROCEDURES

INTRODUCTION PFRS 3 deals with the accounting for a business combination at the acquisition date, while PFRS 10 deals with the preparation and presentation of consolidated financial statements after the business combination.  Consolidated financial statements - "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."  Group - "a parent and its subsidiaries."  Parent - "an entity that controls one or more entities."  Subsidiary - "an entity that is controlled by another entity." (PFRS 10. Appendix A)

All parent entities are required to prepare consolidated financial statements, except as follows: 1. A parent is exempt from presenting consolidated financial statements if a. it is a subsidiary of another entity (whether wholly - owned or partially - owned) and all its other owners do not object to its non - presentation of consolidated financial statements; b. its debt or equity instruments are not traded in a public market (or being processed for such purpose); and c. its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with PFRSs.

2. Post-employment benefit plans or other long-term employee benefit plans to which PAS 19 applies.

LEARNING OUTCOME 1. State the elements of control 80

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

2. Prepare consolidated financial statements at the acquisition date. 3. Prepare consolidated financial statements at a subsequent date.

Control Control is the basis for consolidation. PFRS 10 requires an investor to determine whether it is a parent by assessing whether it controls the investee.  Control of an investee -"an investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee." (PFRS10. Appendix A)

Control exists if the investor has all of the following: a. Power over the investee; b. Exposure, or rights, to variable returns from the investee; and c. Ability to the affect returns through use of power.

Only one entity is identified to have control over an investee. If two or more investors collectively control an investee such as when they must act together to direct the investee's relevant activities, none of them individually controls the investee. Accordingly, each investor accounts for its interest in the investee in accordance with PFRS 11 Joint Arrangements, PAS 28 Investments in Associates and Joint Ventures or PFRS 9 Financial Instruments, as appropriate. Example: ABC Co. holds 70% of the voting shares of Alphabets, Inc. XYZ, Inc., the former majority owner of Alphabets, holds 10% of the voting shares of Alphabets but retains its power to appoint the majority of the board of directors of Alphabets. The other 20% is held by various shareholders holding shares of 1% or less. Decisions about the relevant activities of Alphabets require the approval of a majority of votes cast at relevant shareholders meetings - 75% of the voting rights of the investee have been cast at recent relevant shareholders' meetings. 81

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Analysis: Neither ABC Co, nor XYZ, Inc. has control over Alphabets Co.

Power An investor has power over an investee when the investor has existing rights that give it the current ability to direct the investee's relevant activities.  Relevant activities - "activities of the investee that significantly affect the investee's returns." (PFRS 10. Appendix A)

An investor's current ability to direct the investee's relevant activities is often evidenced by the investor's ability to establish and direct the investee's operating and financing policies, e.g., making operating and capital decisions, and appointing, remunerating, and terminating key management personnel. Power arises from rights and it may be obtained directly from the voting rights conferred by shareholdings. However, power may also arise from other sources, such as contractual arrangements. Examples of rights that can give an investor power: a. Voting rights (or potential voting rights); b. Rights to appoint or remove members of the investee's key management personnel or another entity that direct relevant activities of the investee; c. Rights to direct the investee to enter into transactions for t benefit of the investor; and d. Other decision-making rights that give the investor the ability to direct the investee's relevant activities. (PFRS 10)

Voting rights The investor's ability to direct the relevant activities of an investee is normally obtained through voting or similar rights.

Power with a majority of the voting rights An investor that holds more than half (51% or more) of the voting rights of an investee is presumed to have power over the investee, except when this is clearly not the case. 82

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Holding more than half of the voting rights results to power when: a. The relevant activities are directed through majority vote; or b. A majority of the members of the governing body that directs the relevant activities are appointed through majority vote.

Majority of the voting rights but no power An investor does not have power over an investee, even if he holds more than half of the voting rights, if: a. The right to direct the investee's relevant activities is conferred to a third party who is not an agent of the investor. For example, the investee's relevant activities are subject to direction by a government, court, administrator, receiver, liquidator or regulator. b. The investor's voting rights are not substantive.

Power without a majority of the voting rights An investor can have power even if he holds less than a majority of the voting rights of an investee. For example, through: a. A contractual arrangement between the investor and other vote holders; b. Rights arising from other contractual arrangements; c. The investor's voting rights, d. Potential voting rights; or e. A combination of (a) - (d).

Exposure or rights to variable returns An investor is exposed, or has a right, to variable returns if its returns from its involvement with the investee vary depending on the investee's performance.

Ability to use power to affect investors returns The investor's ability to use its power to affect its returns from the investee provides the link between power and variable returns. Only if this ability exists along with power and exposure or right to variable returns does the investor obtain control over the investee. 83

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Elements of Control

Power

Ability to affect returns

Variable returns

Control Accounting requirements

Reporting dates The financial statements of the parent and its subsidiaries used in preparing consolidated financial statements shall have the same reporting date. If the parent's and its subsidiary's reporting periods do not coincide, the subsidiary shall prepare financial statements that coincide with the parent's reporting period before consolidation subsidiary's financial If this is impracticable, the subsidiary's financial statements shall be adjusted for significant transactions and events that occur between the end of subsidiary’s reporting period that of the parent's. The difference between the parent's and subsidiary's end of reporting periods shall not exceed three months.

Uniform accounting policies Uniform accounting policies shall be used. If the subsidiary uses different accounting policies, its financial statements need to adjusted to conform to the parent's accounting policies before they are consolidated

Consolidation period

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MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Consolidation begins from the date the investor obtains control of the investee and ceases when the investor loses control of the investee. For example, if an investor obtains control of an investee on July 1, 2020, the group's consolidated financial statements for the year ended December 31, 2020 shall include only the investee's results of operations from July 1 to December 31, 2020. On the other hand, if a parent loses control over its subsidiary on September 30, 2021, the group's consolidated financial statements for the year ended December 31, 2021 shall include only the investee's results of operations from January 1 to September 30, 2021.

Measurement Income and expenses Income and expenses of the subsidiary are based on the amounts the assets and liabilities recognized in the consolidated financial statements at the acquisition date For example, depreciation expense in the consolidated financial statements is based on the related asset's acquisition - date fair value; rather than its carrying amount in the subsidiary's accounting records.

Investment in subsidiary Investments in subsidiaries are accounted for in the parent's separate financial statements either: a. at cost; b. in accordance with PFRS 9; or c. using the equity method:

Measurement at cost The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently measured at that amount, unless the investment becomes impaired.

Measurement in accordance with PFRS 9

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MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently measured at fair value.

Measurement using the equity method The investment in subsidiary is initially measured equal to the value assigned to the consideration transferred at the acquisition date and subsequently increased or decreased for the investor's share in changes in the investee's equity.

Non-controlling interests (NCI)

NCI in the net assets of the subsidiary NCI in net assets is presented in the consolidated statement financial position within equity, separately from the equity of the owners of the parent. NCI in the net assets of the subsidiary consists of: a. The amount determined at the acquisition date using PFRS 3; and b. The NCI share of changes in equity since the acquisition date.

NCI in profit or loss and comprehensive income The profit or loss and each component of other comprehensive income in the consolidated statement of profit or loss and other comprehensive income are attributed to the following: 1. Owners of the parent 2. Non-controlling interests

Total comprehensive income is attributed to the owners of the parent and to the NCI even if this results in the non - controlling interests having a deficit balance.

Preparing the Consolidated financial statements Consolidated financial statements are prepared by combining the financial statements of the parent and its subsidiaries line by line by adding together similar items of assets, liabilities, equity, income and expenses. 86

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Consolidation at date of acquisition The consolidation procedures at the acquisition date are simple because only the statements of financial position of the combining entities are consolidated. The consolidation involves the following steps: 1. Eliminate the "vestment in subsidiary" account. This requires: a. Measuring the identifiable assets acquired and liabilities assumed in the business combination at their acquisition - date fair values. b. Recognizing the goodwill from the business combination. c. Eliminating the subsidiary's pre - combination equity accounts and replacing them with the non-controlling interest.

2. Add, line by line, similar items of assets and liabilities of the combining entities. The subsidiary's assets and liabilities are included in the consolidated financial statements at 100% of their amounts irrespective of the interest acquired by the parent.

Illustration: Consolidation at acquisition date On January 1, 2020, ABC Co. (parent) acquires 80% interest in XYZ, Inc. (subsidiary). The financial statements of the combining entities immediately after the business combination are shown below: Parent

Subsidiary

Cash

10,000

5,000

Accounts receivable

30,000

12,000

Inventory

40,000

23,000

Investment in subsidiary

75,000

-

Equipment, net

180,000

40,000

Total assets

335,000

80,000

50,000

6,000

170,000

50,000

Accounts payable Share capital

87

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Share premium

65,000

-

Retained earnings

50,000

24,000

335,000

80,000

Total liabilities and equity

Additional information: 

The subsidiary's assets and liabilities are stated at acquisition - date fair values, except for the following: -

Inventory, P31,000

-

Equipment, net, P48,000



The goodwill determined using PFRS 3 is P3,000.



The NCI in the net assets of the subsidiary, also determined using PFRS 3, is P18,000.

Requirement: Prepare the consolidated statement of financial position.

Solution: Step 1: Eliminate the "Investment in subsidiary accounting: a. Measure the subsidiary's assets and liabilities at their acquisition - date fair values: b. Recognize the goodwill; and c. Replace the subsidiary's pre - combination equity accounts with the NCI in net assets.

Step 2: Add, Line by line, similar items of assets and liabilities of the combining constituents Parent

Subsidiary

Consolidated

Cash

10,000

5,000

15,000

Accounts receivable

30,000

12,000

42,000

Inventory

40,000

31,000

71,000

Investment in subsidiary Equipment, net Goodwill Total assets

180,000

40,000

228,000

3,000

3,000 359,000 88

MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

Accounts payable Share capital

50,000

6,000

56,000

170,000

50,000

170,000

Share premium

65,000

Retained earnings

50,000

NCI in Net Assets Total liabilities and equity

-

65,000 50,000

18,000

18,000 359,000

Notes:  100% of the assets and liabilities of the subsidiary are included in the consolidated financial statement even though the parent holds only 80% interest. This is an application of the following concepts: a. "Substance over form" - the consolidated financial statements report the parent's ability to control the whole of the subsidiary and not just only up to the extent of the legal percentage acquired. b. "Entity theory" - the parent and subsidiary is viewed as a single reporting entity.  The subsidiary's pre - combination equity accounts (i.e., share capital and retained earnings) are eliminated in full and replaced with the non-controlling interest account.  The share capital, share premium, and retained earnings accounts in the consolidated financial statements pertain the owners of the parent, while the non - controlling interest account pertains to the other owners of the subsidiary.  The equity structure appearing in the consolidated financial statements reflects that of a "legal entity." The group is not a legal entity, although each member of the group is a separate legal entity. Thus, the consolidated financial statement reflects the equity structure of the legal parent. The equity of the other members of the group is presented in a single line item described as non-controlling interests.

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MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

The consolidated statement of financial position is shown below: ABC Group Consolidated statement of financial position As of January 1, 2020

ASSETS Cash

15,000

Accounts receivable

42,000

Inventory

71,000

Equipment, net

228,000

Goodwill Total assets

3,000 359,000

LIABILITIES AND EQUITY Accounts payable

56,000

Total Liabilities

56,000

Share capital

170,000

Share premium

65,000

Retained earnings

50,000

Owners of parent

285,000

NCI in Net Assets

18,000

Total Equity

303,000

Total liabilities and equity

359,000

Observe that the non-controlling interest is presented within equity but separately from the equity of the owners of the parent

Traditional Accounting Method

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MA315 – Accounting for Business Combinations Module 3: Basic Consolidation Procedures

The consolidated financial statements can also be prepared by using (a) consolidation journal entries and (b) consolidation worksheet

CJE 1: To eliminate investment in subsidiary and recognize Jan 1, 2020

Inventory

8,000

Equipment

8,000

Share capital - XYZ, Inc.

50,000

Retained earnings - XYZ, Inc.

24,000

Goodwill

3,000

Investment in subsidiary

75,000

Non-controlling interest

18,000

to adjust the subsidiary's assets to acquisition - date fair value, to eliminate the investment in subsidiary and subsidiary pre - combination equity, and to recognize goodwill and non - controlling interest in the consolidated financial statements.

ABC Group Consolidated Worksheet As of January 1, 2020 ABC Co.

XYZ, Inc

Conso. Adj. Dr.

Consolidated Cr.

Cash

10,000

5,000

15,000

Accounts receivable

30,000

12,000

42,000

Inventory

40,000

23,000

Investment in subsidiary 75,000 Equipment, net

180,000

40,000

Goodwill Total assets

Accounts payable

8.000

71,000 75,000

-

8,000

228,000

3,000

3,000

335,000

80,000

359,000

50,000

6,000

56,000

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MA315 – Accounting for Busin...