Chapter 2 - Separate and Consolidated Financial Statements - Date of Acquisition Introduction In acquiring another company, the acquirer must allocate its purchase price fo the fair value of the underlying assets and fabilties acquired, Because determination of fair values often involves some degree of subjectivity, acquiring firms sometimes use their discretion fo allocate the values in such a way as fo pave the way for future growth in eamings and reported profitability. These topics are developed and illustrated fully in Chapter 1. Among the assefs that have drawr, the attention of regulators in recent years ore technology-related intangibles and in-process research and development costs because of ils doubls’ as fo ifs treatment in business combination, Recall that business combinations may be negotiated either as asset acquisitions or as stock acquisitions. In Chapter 1 the procedural focus was on business combinations arising from asset acquisitions. In those situations the acquiring company survived, and the acquired company or companies ceased to exist as separate legal entities. The focus in this chapter's on accounting practices followed if stock acquisitions, that is, when one company controls the activities of nother company through the direct or indirect ownership of some or all of its voting stock. When this occurs, the acquiring company is generally refered to as the parent and the. acquired company as a subsidiary. That hélding any remaining stock in a subsidiary is referred to 05 the non-controliing interest. Any joint relationship is termed an affiliation, and the related companies are called affiliated companies. Each of the affiliated companies continues its separate legal existence, ant the investing company canres its interest as an investment. The atfliated companies continue to account individually for their own assets and liabities, with the porent company refiecting the investment on its books in a single account, Investment in Subsidiary. This account will ulmately be eliminated in the consolidation process 40 produce a set of consolidated financial statements. However, the investment account will be maintained in the “porent" records. Thus, an important distinction is noted between the consolidated statements and the parent only records for statements in the case of stock acquisitions. The Levels of Investment (Coverage of Chapters 2 - Chapter 5) The acquisition of common stock of another company receives different accounting treatments depending on the lével of ownership and the amount of influence or control caused by the stock ownership. The ownership levels and accounting methods can be summarized as follows: LevelotQwnerhie __| _inilal Recording (Chapter 2) "| Recording of inc Passive Investment - generally | At cost including brokers’ fees. | Dividends as declared, except under 20% ownership ~ stock dividends (using Cost Model) Shategic (Active) Investment: @. Infivential - generaly | Af cost including brokers’ fees. | Ownership share of income (or fss) 20% to 50% ownership is reported. Shown os investment income on financial statements. Dividends declared are distributions of income. aready recorded: they reduce the investment account. (Equity Methoa) “Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachCHAPTER, ‘Ownership share of income fa 'b. Contoling - generally | At cost {Some adjustments are expioings ‘over 50% ownership later chapters) Accomplneg . Consolidating the subsiciay incon statement accounts with those the porent in the ‘consoidas process. (Cost Model, Method, and Fair Value Option i ir fi it licable to the common s Tc differences in reporting the income appl > ore ounod fi fopic will be discussed thoroughly In Chapters 3 to 5), consider following example based on the reported income’ of the investor and invesg {company whose shares are owned by investor): ‘Account __|Investor/Acauirer | ‘ales P_ 100,000 088: Cost of goods sold 50,000 Gross profit 50,000 Less: General/Adminisirative and selling expenses 20,000 Operating Income P_30,000 _ 8.0. Assume that the investee company paid P2,000 in cash dividends. The investor prepare the following income statements, depending on the level of ‘ownership: investor Passive investment 10% Ownership Level of Ownership Lost Mode! Soles P 100,000 Less: Cost of goods sold Geoss profit P 50,000 Less: General/Administative and seling Expenses ‘Operating income P 30,000 Dividend income (10% x P2,000 dividend) 200 Investment income (30% x P8,000 reported income) 2.400 Net income 4 P_30200 r * Consolidated netincome, Fda ‘Note: The ferm “Investor” ls used when ownership | “Aequker” more than 0% or 51% or more =P" COMMON sock (not prefened sock) i 0% or Distribution of Consolidated Net Income (NI) Controling interest in CNT {100% of investor's P30,000 + 80% of investee'sP8.000) Pp 36400} Non-controling interes in CN) (203 x P8000) ‘Consolidated Net Income With a 10% passive investment, the investor included onl dents declared by the investee as is income. With iy is Shot offs s 2.30% infuential ownership interest, #”? investor reported 30% of the investee income as a separate source of eerie ‘Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS 1 = DATE OF ACQUISITION ing it int) merges the an 80% controling interest, the investor (now termed the poret mest’ {now @ subsidiary) nominal accounts with its own amounts. Dividend and investment income no longer exist. i i fe statement of the entities. If single set of financial statements replaces the separa te parent ‘owned a 100% interest, net income would simply be reported as P38,000 (the consolidated net income). Since this is only an 80% inferest, the net income must be shown as distributed between the controlling and non-controlling interests The non-controling inferests the 20% of the subsidiary not owned by the parent. The controlling interest is the parent income, plus 80% of the subsidiary income. Acquisition of Net Assets versus Acquistion of Stock (Voting) / Equity Conceptually, a “group”, which comprises a parent and ifs subsidiaries, is a type of “business combination”. A group is a business combination in which the acquirer is a “parent” and the acquiree is a “subsidiary”, and the business combination results from the parent acquiring a controling interest in the equity (not net assets) of the subsidiary. In this business combination, both Parent and subsidiary retain their status as separate legal entities. However, from an economic Perspective, they are a single reporting entity. Two sets of financial statements must be prepared — separate financial statements for the legal entity and consolidated financial statements for the group. * Separate financial statements of the Separate Financial Statement; and Consolidated financial statements, if tt ‘accordance with PFRS 10 Consolidated Fir This is in contrast with a business com! Gssets of another entity. A business cor the purchase of net assets (not equi Subsidiary relationship. 'e legal entity in accordance with PAS 27 he legal entity is also a Parent, in inancial Statement. bination whereby an acquirer buys over the net bination such as this, which is brought about by "Y) of the other entity, does not result in a parent. In this businass combination, the | financial statements of the acqui legal and economic entities are one. The separate Ukewise, a set of c rer Provide information about the enlarged ent *onsolidated financial statements is not required, The focus of this chapter is'on the business combination in general that results to a Prcenhsubsidlary relationship which is properly termed as © Consolidation. PFRS 3 resumes that there is Presur O,dominant party in a business combination, which may be identified as an “acquirer”, Classification of Intercorporate Investment An intercorporate investment i Snother corporation. Broadly * debt securities or * equity securities - preferred ‘or common shares, is any purchase by one corporation of the securities of ‘Speaking, the investr iment may be in either:to CHAPTER, dinary shares/common stock) investments. The focus of this text is on equity (01 of another corporation can broadly, The investment of a corporation in the equity Classified as either passive or strategic: 1. A passive investment is made to earn dividen¢ trading the investment for short-term profit. 2. A strategic (active) investment is made to significantly influence or contol ig operations of the investee (acquire) corporation. ds or fo earn profs by oc Passive Investments ‘Accounting for. passive investments poses NO recorded at cost and are reported at fair market value on financial position or balance sheet. depends on how the company has elected fo classi tity makes for each separate passie particular problems. They are ina, each period's statementg The treatment of gains and losses the investment - a choice that the reporting ent equity investments when the investments is fist made. The choices available under PFRS 9, Financial Instruments, are to report the investmen| cat either: 1. Fair. value through proft or loss (FVTPL), or 2. Fair valve through other comprehensive income (FVTOC)) it an equity investment is classified as FVIPL, both: + dividends and «the change jn fair value from one period fo another are reported in the ne income section of the statement of comprehensive income (SC). it,on the other hand, an equity investment is classified as FVTOCI: «dividends from that investment are recognize in net income, but * changes in the fair value of the investment are reported as othe comprehensive income (OCI); the accumulated gains and losses are reported 5 a separate component of stockholders’ equily. The choice to classy 0 equity investment as FVTOCI is irevocable - the choice cannot be changet subsequently. Strategic (Active) Investments Strategic investments provide a strategic or long-term advantat ivi to IC fi ge by giving the inves! the obit fo either significantly influence ot control the operating or financial decors of an investee. Strategic equity investments can take several different forms depend on the investor's strategic objectives: + Controlled entities: + Subsidiaries (PAS 27 ani PFRSI0) + Structured entities (or variable interest entities) + Associated companies (PAS 28) “+ Joint ventures (PFRS 11) Gavanced Fieancial Accounting ~ A Comprehensive: Conceptual & Procedi ———SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION m Generally, investments are considered strategic if a company owns, either directly or indirectly, 20% or more of the voting shares of the investee, unless it can be clearly be demonstrated that the investments are passive, In the following sections and chapters, the focus is on the concept of “control”, which is cone of the two basis concepts that underlie Accounting for strategic investments (the other one is “significant influence”, which is not covered in this discussion). Equity Investments and Reporting Methods under PFRS . The table provides the decision rules to be followed to classify equity investments and the method of their reporting under PFRS. In the following sections, we will illustrate both consolidation and equity reporting, Sole control 2 fa Subsidiay/ |_| Consolidate following Yen Structured Entity PFRS 10 & disclose | No. followina PFRS 12 Joint control }Lyes Report share of assets; a liabilties, revenues, and Rights overincvidual YF] Joint Operation | —»| ebitis. revenues, on assets &liabilties of folowing PFRS 12 joint onangement |[ Yes No. No. ———> | _dointventure L-+[ Report using equity method following PAS 28 B disclose following Significant influence? ——>| Associate. LL» PFRS 12 Yes \ No Report as FVIPL or Pessve nvesiment >| eyroc totowing PRS 9 AS we review consolidation, itis crucial to understand that reporting is not the same os fecording, Consolidated amounts never appear on the parent company's book. feported numbers are the results of spreadsheet analysis, either computer-based or Manual, Controlled Entities There ore many ‘aspects of control that accountants must be aware of, The two general types of controlled entities are subsidiaries and structured entities or variable interest entity ~ VIE (this will be discussed on the later Part of this chapter). Subsidiaries &Y far the most common type of contolled entity is a subsidiary. A subsidiary is a Corporation (or an unincorporated entity such as a partnership or trust company) that is ‘Advanced Financial Accounting ~ A Comprehensive:CHAD Ts; at owns, usually, a majority of the |) tockholders elect a corporation's by bles the parent company to Cont, H Controlled by a parent company thi Shates/rights of the subsidiary. Since s' directors, holding most of the shares: ena ‘Composition of the subsidiary's board. The Concept of Control " Consolidation is the process of combining the assets, liabilities, Sonat Gnd coyhy of a parent and is subsidiaries as if they were one economic ent iy She On e and not legal perspective is adopted, transactions pees Companies wits economic entity and their resultant balances must be eliminated. A parent s an enfity that contals one or more subsidiaries. A group is 0 porent ag its subsigiares. PERS 10 Guidance on Control ‘An investor determines whether it is c parent by assessing or it controls one or investees. An investor considers all relevant facts and circumstances when ase control over an investee. PFRS 10 uses control as the single basis for consolidation. An investor control ¢ investee if and only if the investor has all of the following three elements of control: 1. Power over the Investée. Power is the abiity to direct those activities wis significantly affect the investee's retums. It arises from rights, which maya siaightforward (e.g. through voting rights) or complex (e.g. through one orn contractual arangements).. 2. Exposure, or tights, fo variable retums from involvement with the’ ives Retums must have the potential to vary as a result of the investee’s perfomaa and can be positive, negative or both. | 3, The ability to use power over the investee to affect the amount of the inves * retums. Power arises from rights. Such rights can be straightforward (e.g. through voting itt An investor that holds only protective rights cannot have power over an investee ord! Cannot control an investee. Power can be obfained diréctly from ownership offf mojotty of the voting rights or can be derived from other rights, such as: Rights to appoint reassign or remove key management persoanel wo diect the relevant activities; | Rais fo Gppoin or femove cnother ently that diects the relevant acl ights to ditect the investee to enter into or veto ch transactions fa benefit of the investor: and eggs | Other rights, such as those specified in a management contract, When ossessn ae eo oh sa aoe rg pater Control exists, on investor with decision making rights sol td acting as a principal or agent of other Parties. An investor M selected to @ 2! control an investee when it exercises decsion-making delegated to it. A number of factors are Considered in making this assessmer!SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS - DATE OF ACQUISITION 13, instance, the remuneration of the decision-maker is considered in determining whether itis an agent. Control as the Criterion for Consolidation ‘A subsidiary is defined as an entity that is controlled by another entity, the parent. Control is the criterion for identifying a. parent-subsidiary relationship and the basis for consolidation. The determination of whether one entity controls another is then crucial to the determination of which entities should prepare consolidated financial statements. The “Default Presumption” The presence of “control” determines the existence of a parent-subsidiary relationship. In the context of PFRS 10 the quantitative criterion of more than 50% of voting power was not mentioned but not superseded by a new rule. For practical reasons, the presumption is that ownership of more than 50% of voting power constitutes control, in thé absence of any evidence fo the contrary. However’ control also arises from many other sources: statufe, contractual ‘aangements, implicit or explicit control over the board of directors among others. ‘As PFRS 10 is based on principles rather than rules, the use of a quantitative criterion is only a guide. This is known as the “default presumption”. , Separate Financial Statements (PAS 27) PAS 27 defines separate financial statements as “those presented by a parent, an investor in an associate or a joint venturer in a joint venture in which the investments are ‘accounted for on the basis of the direct equity interest rather than on the basis of the reported results and net assets of the investees". The investor's: separate financial statements reflect the legal interest in the investment ‘and its direct benefits (dividends) rather than the larger economic entitlements (share of profits) that is brought by “control” or “significant influence" or “contractual arrangement or joint control.” ‘As economic boundaries are enlarged through “control” or “significant influence” or “contractual arrangement or joint control” that an investor possesses over the financial ‘and operating policies of subsidiaries and associates respectively, another level of reporting is required, This level of reporting is described as the consolidated financial statements that present the financidl statements of a group as those of a single economic entity. When the parent acquires a controlling interest in the subsidiary, {he parent makes an entry debiting Investment in subsidiary and crediting either cash, debt, or stock (or some combination), depending on the medium of exchange. Assume that the Acquisition relies on a cash purchase price of P500,000. The entry on the parent's books would bi Investment Cos “Advanced Flnanclal Accounting ~ A Comprehensive: Conceptual & Procedural ApproachCHAPTER 4 P "4 the parent's investment in the cite, cate saatony ond ten includes a significant moun it recorded in ai single account enlitled “Investment”. Soo eae ast continues fo keep is detalled books based on historical beet aay econ snot as curent asthe market values assessed by the paren, Mats a ey ccsulsion but they ore detaled as to classification. One way of looting ihe proces “of eonsoidating sto corsider the following: The parent's investment osset and liabiity accoun! ‘Subsidiary’s Books Parent's Books Investment Account Llabil ‘Market value Historical valve (One account Multiple accounts Valuation... Classiication From the table above, we see that neither the parent's Investment account nor subsidiary's detailed asset and liability accounts serves to provide both the valuation, and classification desired in the consolidated financial statements. The purpose of consolidated statements is to present, primarily for the benefit of the owners and creditors of the’ parent, the results of operations and the financial position of @ parent company and alll its subsidiaries as if the consolidated group were a single economic entity. Consolidated statements ignore the legal aspects of the separate entities but focus instead on theteconomic entity under the “control” of management. The presumption is that most users of financial statements prefer to evaluate the economic entity rather than the legal entity. Thus, the preparation of consolidate: cd statements is an example of focusing on substance rather than form. Investments at the Date of Acquisition The genefal principles used to fecord business combinations effected as asset ACaListions were discussed in Chapter 1. In this chapter and throughout Chapters 3, 4 and 5, we will concentrate on accounting for the Acquisition of another company's voting stock. Appendix A to th fin is chapter presents issues related to on Variable Interest Entities a) OF Structured Entities and Appendix B on deferred taxes at the date of acquisition. Recording Investment’s at Cost (Parent's Books) The basic guidelines for valuation discussed in Cha i ness combinations apply equally to the acqu pter | pertaining to bus isiion of voting stock in another company. ba ce sauce ina the stock investment is recorded at its cost as meawuted y, ur value of the consideration giv ic m i more clearly evident, given or the consideration received, whichever is Recall that the consideration give e en may consist of ties, stock of the acquiring company, an Cash,.other assets, debt secut ¥ form of asset or a ‘combination of these items. ‘Advanced Finance! Aecoutto ~ A Comprebenrive:Conaptaa & Procedural ASEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION 15 Treatment of Acquistion-related Direct Costs In the Separate Financial Statements (or Parent's Books) In acquisition of net assets discussed in Chapter | (Business Combination} wherein the basis is PFRS 3, there is no doubt that the acquisition-related direct costs are treated as expenses, The following discussion regarding the treatment of acquisition-related direct costs: in the books of parent entity, does not affect the computation of goodwill, only the manner of recording such costs in the books of the parent entity. Inthis chapter the basis is PAS 27 (2014): ©’ Before the separation of PAS 27 (2014) and PFRS 10 (2015), PFRS 27 (2008) termed as “Consolidated and Separate Financial Statements” the basis is PFRS 3, wherein ony acquisition-related costs are considered expenses. After the separation of PAS 27 “Separate Financial Statements” and PFRS 10 “Consolidated Financial Statements", there is an argument that the basis of PAS 27 is not anymore PFRS 3 and the basis for determination of “costs” will now be under the general rule of recording costs, which includes direct-acquisition costs as part of the investment acquired. On the other hand, only PERS 10 can use PFRS 3 as the bass, So, in the process of preparing the consolidated statement, the acquisition-related costs become consolidated expenses through working paper eliminating entries. The author believes that there is logic on the basis of applying the general rule in interpreting the definition of “costs” in PAS 27. Despite, the logical analysis in interpreting the general rule, the author further believes that the original treatment of acquisition-direct costs whether for business combination or separate or consolidated financial statements, will still be treated as expenses in the books of the parent entity for the following reasons: |. To capitalize the acquisition—related direct costs as part of investment seems to defeat the purpose or substance of the standard which serves as a. guide for consolidation procedures (even in some cases, stand-alone financial statement would be possible). . If the parent records the direct costs as part of Investment in subsidiary, it” may be a problem when there will be an impairment test which will reveal the costs (wherein the direct costs is already included and will be included in the impaiment) and in fact unrecoverable and there must be an impairment charge at the parent level (in which the direct costs is included 5 part of the investment fo be impaired when in the consolidated statements they are not impaired since they will be set-up as an expense), which would have the effect of bringing the parent's accounting (with the impairment of the investment including the direct costs) in line with what would later appear on the consolidated financial statements. i Advanced Financial Accounting - A Comprehensive: Conceptual & Procedural ApproachCHAPTER 2 16 ition the it is recorded at ts cash uisition, the investment Tofturae coins vied tor ne Cen acquires ol 120000 shares of the common soe, For example, ossume hol and pays acduistion fees of P30,000. STE Ev direct costs are not capitalizable, the entry to record thy . Acquistion. costs ore ; fearnert ‘on P Company's book is: Tnvesiment in Subsidiary - Cash. ion $500,000 500,000, = close to samings [acquistion-rélated expense vera somings sce ony balance shéet accounts ere being examined) : ba Cash... Record acquision elated costs 30,000 The acquisition fee would be recorded in a separate eniry as an expense oy retained earnings. “ 2. Acquisition-related direct costs are capifalizable, the entry to record the investment on P Company's book is: * Invesimentin SubSdiary.... 530,000 530,000 It should be noted again that the computation of goodwill (or bargain purchase gain) under the two assumptions above are still the same. Assume further, if P Company issues stock in the ‘Acquisition, the investment is recorded at the fair value of the stock issued, giving effect to any costs of Tegistering the stock issue, Assume that P Company issues 10,000 of its P10 par value common shares with a fair value of P13 per share for the 10,000 shares of $ Company, and that registration Costs amount to P12,000 paid in Cash. The entries to record the investment on P ‘Company's books are: ‘nvgsinient in Subsidhary, <7.-;. Sets ures 130,000 ‘Common stock (P10 par x 10,000 shares ap 100,000 Paicin copitalin excess of par [(P13-P10) x 10,000)... * 30,000 Acauiition of subsicfory 5 Paid'n capitalin excess of por CERT Rama en Rei ¥ Record acquistionselaied costs regier stocks a IFP Company paid an additional P5,000 Qs an indirect costs, the entry would be: Retained earrings (acquislion related expense ~ close To retained eamings since only balance sheet accounts are being examined) ......... 7 5, COBH es leeb sve. ” 5,000 Record acquisitionelated costs i The Acquisition Analysis (or Schedule of Determination and Allocation of Excess) As noted in paragraph 33 of PFRS 3, where the Parent exchanging its equity interests for the equity interests of the former owners of the Business combination occus by the : j Financial Accounting ~ A Comprehensive: Conceptual & Procedurl Approcch /SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION = subsidiary, the acquiition-date fair values of the acquiree's interests may be more reliably measurable than that of the acquirer's interests. The acquirer obtains control by acquiting shares {stock acquisition) in the acquire. At acquisition date, an acquisition analysis is undertaken to determine if there has been any goodwill acquired, or a bargain purchase has occurred The acquirer shall recognize goodwill as of the acquisition date, measured as the ‘excess of (I) over [ll] below." |. - the aggregate of: : . the consideration transfered measured in accordance with PFRS 3, which generally equites acquistion date fair value b. the amount of any non-controlling interest in the acquire measured in accordance with this PFRS 3; and ina business combination achieved in stages, the acquisition date fair value of the acquirer's previously held equity interest in the acquiree. Il, the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with PFRS 3. 2 Where (ll) exceeds (), PFRS 3 regards the giving rise fo a gain on a bargain purchase. The measurement of (i) had been discussed in Chapter 1. The items included within (I) _ ‘re discussed in Chapter | and in the succeeding discussions below. In Ilustration 2-1 - Illustration 2-4, because the parent acquires all the shares in the subsidiary, there is no effect due to (o} (i) and ii). Consolidation of Wholly Owned Subsidiaries There is no question of control in a wholly-owned subsidiary. Many factors have an effect on the fair value of a company and its market Per share of stock, including its asset values, its earning power, and general market conditions, When one company acquires another, the acquiree’s fair value is based on the consideration given may be equal, more than or less than the book value, In case, there will be Q difference between the fair value of the subsidiary and the book value of the acquiree's net identifiable ssefs and this is referred to in this textbook as “ALLOCATED excess”, Consolidation of Partially-Owned Subsidiaries When, a subsidiary is less than 100% owned or partially-owned, problem arses as to the determination and tecognition of goodwill and the non-controlling interests. allows goodwill and non-control esi PERS 3 wil ntrolling interests in the Icquisition date 9 ‘acquire at acqui datCHAPTER 2 18 istent with the measuremen Value Basis (consistent er rot ithe business combination), or .al Basis (of the acquiree's identifiable na ‘© Full-goodwill approach principle for other component «+ Partial-goodwill approach or Proportion assets). Full-goodwill Approach (or Falr Value Basls) fer fo this opti ferests are measured at fair value (we refe on : Mh no ion, oot attributable to non-controling interests will be recognized in the consolidated financial statements. Under the fair value basis, non-controlling Interests comprise three components: «Share of book valve of identifiable net assets of subsidiary; i © Share (fair value - book value) of identifiable net assets of subsidiary ot ‘acquisition date; and i + Share of goodwill in subsidiary at acquisition date. Under the fair value basis, non-controlling interests are determined with reference to either active market price of equity shares of the subsidiary at acquisition date or other valuation techniques mentioned in Chapter 1. Fair value per share of non-controlling interests may ciffer from fair value per share of the acquirer because a control premium may be paid by the acquirer. For example, in a takeover bid, an acquirer may pay a 20% premium over market price to gain control of the acquiree. Partial-goodwill approach. (or Proportional Basis of the Acquiree’s Identifiable Net Assets) * Under the second option where non-controlling interests are’ measured as a Proportion of the acquiree's identifiable net assets, Non-controlling interests Comprise two components as follows: : a of book value of identifiable net assets of subsidiary: and - Share {fair value — book value) of identifiable net asset: idiary at ccauisioh oak ef assets of subsidiary ai * Non-controliing interests’ share of goodwill (NCI-goodwill) i i under the second option (proportional basis). SEEM 8 fet cousbel Goodwill Iie compuation of goodwill depends onthe options mentioned above, Goodwill? Lnidentfiable ass! in which is exstence i an important motivator f nt 10 acquire a subsidiory. ion for a parer Hence, goodwill the premium that a parent pays to ‘acquire the subsidiary and should be separately ot as an asset in the consolidated financial statements. The acquirer is required to recogni i ined it i Seat es nize goodwill acquired in a business combination as a ‘Advanced Financal Accounting ~ A Comprehensive Conceptual & Procedural AnoreagySEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION ng Goodwill under PFRS 3 may be one of two values depending on the measurement basis for non-controlling interests as of acquisition date (refer to NCI discussion above). It allows two measurement bases for non-controlling interest: « ‘Option 1, if non-controlling interests are ‘measured at full-fair value, goodwill recognized in the consolidated financial statements will include non-controlling interests' share of goodwill, This is known as full-goodwill approach. © Option 2, if non-controlling interests are measured at the proportionate share of the value of the net identifiable assets acquired, non-controlling interests’ share of goodwill is not recognized under this second option under PFRS 3. This is known as partial-goodwill approach. While goodwill is measured os a residual, it should in substance be: «An expectation of future economic benefits arising from the acquisition and «An asset that is integral to the entity as a whole, which is not individually identifiable or severable as a stand-alone asset. Entity (Economic Unit) Theory Under the entity theory, non-controlling interests are deemed fo be as important as a sfakeholder of the combined entity similar to the majority shareholders. The distinction between the parent and the non-controlling interests both are both included in equity. Hence; the entity theory requires a consistent accounting treatment for both parent and non-controliing interests. Under the entity theory: «The consolidated financial statements should be prepared and presented for the benefit of both groups of equity holders. Non-controling interests ore shown as equity in the balance sheet. The accounting equation will be as follows: Consolidated equity: s (Controling and non-controling interests) = Consolidated assets — a Consolidated liabilities «The fair values of assets and liabilities of subsidiaries at the date of acquisition should be reported in ful to reflect the stakes of both parent company and non- controling shareholders. in. the net assets of the subsidiaries. A consistent ‘accounting treatment is applied to both parent's and non-controling shareholders’ interests in the net assets of a subsidiary. Hence, if the assets and liabilities of an acquired subsidiary are shown at fair values at the date of acquisition, non-controling interests are also deemed to have a share of the fair Value increment arising from the revaluation of net assets to fair value. “Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachCHAPTER } a8 | | © Goodwill is an asset of the economic unit, ‘and should be reflected in», | Intemnally generated goodwill that is not e idenced by an exchange fransockg, | is recognized in full as of the date of acquisition. | ‘ | «Net profit of the subsidiary should be reported in full os accruing fo both Maj | ‘and non-controling shareholders. Non-controlling interests’ shore of curent pro, is not shown as a deduction of profit. | Parent Theory | The parent theory focuses on the information needs of the parent -compony shareholders. Features of the parent theory are ds follows: | * The consolidated financial statements are prepared ond presertted primary ig the benefits of the parent company shareholders. The informational needs of non-controling interests are better served by the separate financial statement of the subsidiary that the consolidated financial statements. Claims by non-controling interests in the net assets of a subsidiary are shown osq separate component in the balance sheet. They are presented in a categay that is neither debt nor equity in the consolidated balance sheet, The | ‘accounting equation in the consolidated balance sheet is presented as folows: Consolidated equity + = Consolidated assets - Consolidated liabilities Non-controling interests Since the focus is on the parent's perspective, only the parent's share ofthe far values of the assets and liabilties of subsidiaries af the date of acquisition shoud be reported. There is no “purchase”. of the subsidiary by the non-controing interests. Hence, the non-controliing interests in the assets and liabiltes of ¢ subsidiary at the date of acquisition are shown at book (not fair] value. Goodwill is an asset of the porent (not the ‘economic unit) and-shoud be restricted to the parent's share. Hence, the intemally generated goodwill of 0 subsidiary that belongs fo the non-controliing shareholders of a subsidiary nol récognized Non-controliing interests’ share of current profit is shown as a deduction from Profit to show the final profit that is attributable to parent company shareholders Essentially, the differences between the two theorles are summarized as follows: ‘Atributes Parent Theory Eni Theory (PHS3)_| Fair vaue diferences in| Recognized only in respect of | Recognized In ful, refecing relation to identifiable assets | porent's share both” parent's and 00) | ‘and fobities at the date of controling interests share acquisition the fair valve adjustments Presenfaton of ron-conaling | Nelierasequlynerdebt [As par ofequly interests ‘Goodwill Goodwilis parent's asset Goodwill is an enfly set and should be recognized in ia at date of acquisition. Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION 121 Proprietary Theory : The proprietary theory is less critical to determining choice of consolidation policies. Under the proprietary theory, the parent is seen as having a direct interest in a subsidiary's assets and liabilities, This perspective results in pro-rata or proportional consolidation, whereby the parent's interest is directly multiplied fo each individual asset and liability of the subsidiary and combined with the parent's assets and liabilities. The Implicit Consolidation Theory Underlying PERS 3 Developments in accounting standards underscore: an evolutionary shift towards the Entity Theory. PFRS 3 permits the recognition of non-controlling interests’ share of goodwill Illustration 2-1 to Illustration 2-4 show different aspects of computing the fullkgoodwill (fair valve) and partial (proportionate) goodwill approach and Illustration 2-5 is in relation to bargain purchase gain. Mustration 2-1: Fair Value of Non-Controlling Interest in Subsidiary Not Given Par Company acquires 80% of Son Company for P10,000,000, canying value of Son Company's net assets at time of acquisition being P4,000,000 and fair value of these ~ net identifiable assets being P8,000,000. The following computations for goodwill and non-controlling interest under two options ‘are as follows: Proportionate Basis (Partial-goodwill Approach) * Partial-goodwill Fair valve of subsidiary (@O%): c Consideration tonsferredt Cash .......seseeseeeete + P10,000,000 (80%) Less: Book valve of stockholders’ equity net ase = Son Company: P6:000,000 X80R ss seseseeeeeseseeee 400,000 (0%) Allocated excess ‘ P 5.200.000 (g0%) Less Overlundervaluation of assets and abies: {P8,000,000 ~ 6,000,000) x 80% 1,600,000 (80%) Positive excess: Goodwil (partial. P. 3.600.000 (80%) Non-controlling interest Book Valve of stockholders’ equity of subsidiary . P 6,000,000 Agjuitments to reflec fir value (over/undervaluation of assets” ‘and libiltis):(PB,000,000 — P6,000,000) . 2,000,000 Fair valve of sockholdes' equity of sutsichry a 8,000,000 Multipied by: Non-controling interest percentage oN Non-controling interest (partial) + ginerest port) Br o6.000 | Fair Value Basis (Ful-goodwill Approach) Fullgoodwill —_°, Fair value of subsidiary (100%): Consideration transferred: Cash (P10,000,000 / 80%), 7 P 12,500,000 (1 less Sook ‘valve of stockholders’ equity (net ost] 10% Son Company: P6,000,000 x 100%... 6,000,000 Aosotd ences Pesan lon Less: Over/undervaluation of assets ond ities ; (8,000,000 ~ P6,000,000) x 1 2.000.000 Positive excess: Goodwill. te £_4.500,000 (100%) “Advanced Financial Accounting ~ A Comprehensive, Wve: Conceptual & Procedural Approachm CHAPTER A is Its which can be con | ll of P4,500,000 consists of two. parts ms Perey ct a 80%;20% ratio (unlike in Iilustration 2-2, when there willy control premium included): 73001000 Poot ig irisred on Uk good or ten Less: Contoling interes Potil-goodwil P4.50,000x80R).......-..--. 3.600000 : yodwil(P4,500,000 x 20%) ie . ‘Ada: Non-controling interest on full-goodwil (P4,500,000— 3,600,000 partial-goodil) or (P4,500.000 x 20%)". Non-controling interest (ful). i * applicable only when the far valve ‘controling interes of subsidiary is nol given & no ‘contol premium (or iscounl) included ~ refer fo tlusration 15-2. *allermat Fair value of subsidiary (100%) ......2...cccccsvne ‘Multiplied by: Non-controling interest percentage . Non-controliing interest, . *Itshould be noted that this is not an alencompassing iterative opproach, is only applicable depends if here i no control premium (or cscount) included ~reler fo llusration 15-2. Several assumptions went into the above calculation for foir value basis: * Fair Value of subsciary - itis assumed that if the parent wauld pay P10,000,000 for on ae interes, then the entre subsiciary company is worth P12,500,000 (P10,000,000/808). ths mount i refered fo as the “implied value” of the subsidiary company. Assuming ths lo be true, the non-controling interest (NCI) is worth P2,500,000 of the total ‘Subsidiary ‘company value (20% x P12,500,000).. This 12,500,000 approach assumes that the price the parent would Pay is directly Proportional fo the size of the inferest purchased. This presumption difers In the succeeding illustrations, i * Book value of the stockholders’ equity (or net assets) of subsidiary ~ P%6,000,000. This ‘mount wil be deducted to fir valve of subsidiary to determine the allocated exces * [fe over/under valuation of identifiable assets and bites (P2,000,000. This omoun! {fom the comparison of book ond foir values Al assels and bites wit be adjusted to 100% fai value regardless of the size ofthe controling interest purchasee, + Fair value of stockholders’ equity (or net assets) (8,000,000). This amount composed .of the book identifiable assets and labil 5) OF subsidiary excluding goodwill Value and ovér/undervaivation of lifes reflecting foir values of the subsidiary accounts. * Goodwill as {otal goodwil is the excess of the fair value of the subsidiary over the far ae i, Subsidiary net assets. is proportionately allocated to the controling interes ‘and NCI, ; Gan there be an Allocation of Impairment of Goodwill as to Contoling interests or Not controling Interests? Cae +f goodwill becomes impaired in a future period, thé impairment charge would be allocated to the controling interest and the NCI bosed on the percentage of to! goodwill each equly infeest received. In this case, where goodwil on the NCI Wes assumed fo be proportional fo that recorded on the controling interest the impatmet! charge would be 80/20 to the controling interest and NCI, But notin all cases that Ihe impairment is proporion to the ownership interests, it depends on how much wil he management decide on the impairment as to parent and. ‘subsidiary. “Advanced Financial Accoumting ~ A Compreheniive: Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION 13 Control Premium /Control Discount ‘A control premium is an amount that a buyer is usvally willing to pay over the current market price of a publicly traded company, This premium is usually justified by. the expected synergies, such as the expected increase in cash flow resulting from cost savings ond revenue enhancements achievable in the merger or consolidation. If the ‘consideration transfened is proportionally more than the fair Value of non- controling interests, there is a control premium. In the opposite situation, a contro! discount (which often arses in a fire sale) or discount for lack of control (sometimes called a non-controling interest discount) arises. Illustration 1-2: Fair Value of Non-Controlling Interest in Subsidiary Given with Control Premium sun Company has 40% of its shore publicly traded on an exchange. Pluto Company purchases the 60% non-publicly traded shares in one transaction, paying P6,300,000. Based on the trading price of the shares of Sun Company at the date of gaining control 4 fair valve of P4,000,000 assigned to the 40% non-controling interest (or foir value of non-controling interest), indicating that Sun Company has paid a control premium of 300,000. The fair value of Sun Company's identifiable net assets is P7,000,000 and a carrying value of P5,000,000. The following computations for goodwill and non-controling interest under three options are as follows: Proporiionate Basis (Particl-goodwill Approach) * Partial.goodwill Fair vaiue of subsidiary (60%): Consideration transferred: Cash. P 6,300,000. (60%) Less: Book value of stockholders’ equity (net assets) ~ Sun Company: P5,000,000 x 60%. 3,000,000 * (60%) Allocated exCeS.........2+++ Less: Over/undervaluation of assets and labile: (P7,000,000 - P5,000,000) x 60% e Positive excess: Goodwill (partial)... P 3,300,000 (60%) 1,200,000 (60%) B2.100.000 (60%) + _Non-controling interest Book Value of stockholders’ equity of subsidiary ...............5 5,000,000 Adjustments to reflect fair value (over/undervaluation of assets ‘and liabilities): (P7,000,000 ~ P,000,000) ... 2,000,000 Fair value of stockholders’ equity of subsidiary P 7,000,000 Multiplied by: Non-controlling interest percentage . 40%, Fair Value Basis (Full-goodwill Approach) + Full-goodwill Fai value of subsidiary (100%): Consideration transferred: Cash Fair value of NCI (given Foir value of subsidiary. P 6,300,000 (60%) 4.900.000 { 402) P 10,300,000 _ (100%) “Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachFair valve of subsidiary Less: Book value of stoc ‘Sun Company: PS:000,000 x 100% - fed EXCESS ses seressentee i eee endeuaion toes nati {P7,000,000 - P5,000,000) x 100%.» i Goodwill)... 2 itoides'equly (net ose) ice 3 P 5300000 (100%) Fae apccvsversneceratte tess Contoling interest on ful-goodwil or Pattia-goodwil.. Clon ful.goodwil 2. seneseesees ‘ing amoun! should nofbe lower compared fo fa ‘equiy of subsidiary fe. P7000,00 x 40% = P2800 ‘mount should be wed. value ofNCTor Stockholders’ (000). Otherwise, the higher Non-controlling ‘Non-controling interest (partial) “Add: Non-controliing interest on full 2,100,000 pattia-goodwl.. Non-controling interest (full in relatic i i fon 15-1. the ater led that in relation to the fist assumption made in lustrafion led computation Of NCI is not applicable, the NCI as computed using the fair vaue Stosuiony as computed above’ amounted 10 P10:300,000. the resulting goodwit 4,120,000 [P10,300,000 x 40%) does not taly with the amount of P4,000,000 as compueg above. me effect as to the amount of goodwill allocation fo the controling ang somconotng Flees wherein it does not equal fo the 60%:40% split of the total good + Since there is a control premium paid by Pluto, the goodwill attributable fo Pluto and the non-contoling interests are not proportional to each ofher. That i, if we mutfioly ful/ciy gocdwil (le. the P3,300,000) times the 60% controling interests and the 40% non Zontroling interest we would have calculated proportional goodwill of P1,980,000 ang 1,320,000, respectively. Instead, as we present in llustration 15-2, the actual amount o goodwill alocated to the controling interest is P2,100,000 and the allocation fo the no Controling interests P1,200,000. Bottom Line Analysis: The cmount of goodwill that is allocated fo the controling and non. controling interest is based on the separate fair values of each of those ownerships tha may not correspond with the proportion of the subsidiary's stock that they own. Several assumptions went into the above calculation for fair value basis: Fair value of subsidiary - this is now the sum of the price paid by the parent plus the newly esiimated fair value of the NCI. + Fair value of stockholders’ equity (or net assets) of subsidiary excluding goodwil. Tht ‘mount composed of the book value and over /undervaluation of identifiable asset and labilties reflecting far values of the subsidiary accounts. j ‘+ Goodwil - the total goodwilis the excess of the fair value of subsidiary over the fair value of subsidiary net assets, * The NCI (full) computed above shoul il ji ae jould be the same with’ the NCI given per problett + The NCI (full) can never be less than the NCI percentage of the fair valve of the stockholders’ equity of subsidiary (or net assets, in this it ah Prana his Case, it cannot be less than ‘Advanced Financial Accoumting = A Comprehensive: C aSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS = DATE OF ACQUISITION ns If goodwil becomes impaired in a future period, the impaiment charge would be allocated to the controling interest and the NCI based on the percentage of total goodwill each equity interest received. In this case, where goodwill was not proportional, anew percentage would be developed as follows: Goodwill applicable to porent.....e+esseese++ P2100,000 Goodwill applicable to NCI... seeeeee 1,200,000 26.36% oodwill. Fair Value Basis (Full-goodwill Approach). Assuming the price paid amounted to 6,294,000 which includes control premium of P294,000 with no fair value of non- controling interest given, the following computations based on this assumption are as follows: « Full-goodwill Fair value of subsidiary (100%): Consideration transferred (Pé,294,000 - P294,000)/60% P 10,000,000 - (100%) ‘Add: Control premium, oy + 224,000 Foir value of subsidiary... sau P 10,294,000 (100%) Less: Book valve of stockholders’ equly (ne ‘Sun Company: PS,000,000 x 100% . 5,000,000 (100%) located EXCESS... ..2.ses+0 Less: Over/undervoluation of assets and labilties: {P 7,000,000 - P5,000,000) x 100% . Positive excess: Goodwill (ull. P* 5,274,000 - (100%) —2.000,000 (100%) E3274000 (100%) The full = goodwill of P3,294,000 consists of two parts: FUILQOOGWI...-sesesseseseeterseeees P 3.294000 Less: Controling interest on ful-goodll or Partial-goodwil [P6,294,000 (P5,000.000 x 60% ~ (P2.000,000 x 60%] 2.094.000 NClon ful: goodWill.......ccsceieeereneess 21,200,000 Illustration 1-3:- Fair Value of Subsidiary Given On September 1, 20x4, Pare Company acquires 75% (750,000 ordinary shores) of Sore ‘Company for P7,500,000 (P10 per share). In the period around the acquisition date, Sare Company's shares are trading at about P8 per share. Pare Company pays a premium ‘over market because of the synergies it believes it will get. It therefore reasonable to conclude that the ‘fair value of Sare's as a whole may not be P10,000,000. In fact, an independent valuation shows that the value of Sore Company is P9,700,000 {fair value ‘of Sare Company). Assuming that the fair value of the net assets acquired is P8,000,000 {camying value is Pé,000,000). Proportionate Basis (Partial-goodwill Approach) + Partial-goodwill Fair valve of subsidiary (75%): Consideration transferred: Cash Sean P 7.500000 (75%) Less: Book value of stockholders’ equity (net assets) = Sare Company: Pé,000,000 x 75%. . 4,500,000 (75%) Alocated excess : } P 3000000 (75%) Less: Over/undervaluation of assets and liabil (P8,000,000 - P6,000,000) x 75% .. — 1,500,000 (75%) Positive excess: Goodwil (partial) £_1,500,000 _ (75%) “Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approachnbollng tres! Pa) ye of stockholders’ equity of subsidiory “hosel ‘Adjustments fo reflect fair value overfundervaotion 109 ‘ond fotos) 8,000,000 ~Pé,000,000) »--+018"9°" P6.000.00| . Foit valve ol stockholders’ equly of subsichay «- « easenes a Mulipled by: Non-contotinginlerest percontoge +°°""°" _ Paaitig| Non-controling interes! (parti) 2 2 Folr Value Bosis (Full-goodwill Approach) + Full-goodwill ei P 9.700.000 (100%) Fair volue of subsidiary ...-+i-e+7 3077 - Tes Book ve of stockade’ ect Inet (100%) sare Company, P6,000000 100% 3700.000 (100%) sated Excess .. veers . . ce te ucional asst na tabltos 700000 1009 | {pe.o00.000- 0200001 x 1008 «= . 000 Positive excess: Goodwil, (ful)... The full- goodwill ‘of P1,700,000 consists FURGOORWT oe Les: Contoling interest On Porto goodwill...» il. «+ Non-controling i Nor-controfing eres! [poral «=. Mor serrconkling inerst on fU-goodil (1700 00 150,000 para goodwill ie ginerest ful)... Control Achieved in Two oF ‘More Transactions-Step ‘Acquisition (Business Combination, Achieved in Stages) . inthe previous stations, the acquier acquired al isued shares of the acqbiee in he ronsaction. An allem stuaion could occur where the acauer obtained is coe ein nterest inthe acauier by acouing further shares and thereby adding fovs previouy held equiy interes, se lustration 1-4. ‘A business combination occurs when the acquirer obtains control of the acquiree. bs «at that date of the second acquisition of shares that the business combination occut this is refered fo as a business combination achieved in stages - sometimes called 0 step acquisition, Obvious, there may be a number of step purchases in the acquire? prior fo the obtaining contra. PERS 3 requies that if the acquiter holds a non-controling equity investment in the | cacquiree immediately before obtaining contol, the acquirer. An equity investment i one of the folowing categories is increased fo become a controlling inferest:c financial assef under PFRS9, an associafe under PAS 28 or a jointly under PFRS 11. The principles fo be applied are: # a business combination occurs r , enfiy contol of arother only in respect of the transaction that gives one “Advanced Fnancel Accounting ~ A Comprehensive: Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS: = DATE OF ACQUISITION 127 « the identifiable net assets of the acquiree are remeasured to their fair value on the date of acquisition i.e, the date that control passes}; * non-controlling interests are measured on the date of acquisition under one of the two options permitted by PFRS 3 [fair value basis (Option 1) or proportionate basis (option 2 abovel]; Table 2-1: Control Achieved in Two or More Transactions- Source: Deloitte PERS 9 PAS 28 / PERS 11 PAS 27 / PFRS 10 | \ ane 75%| | 75%] | = om ioe 1 1 Posive | Significant Inuence/ | Control Jolnt Cont! ! L } Ilustration 2-4: Step Acquisition: Fair value of Non-controlling Interest of the acquiree/subsidiary) and Fair valve of any previously held equity interest in the acquiree/subsidiary Pares Company acquires 15 percent of Serap Company's common stock for P500,000 cash and caries the investment as n FVTOCI investment. A few months later, Pares purchases another 60 percent of Serap Company's stock for P2,160,000. At that date, Serap Company reports identifiable assets with a book value of P3,900,000 and a fair value of P5,100,000, and it has liabilities with a book value and fair value of P1,900,000. «The fair value of the 25% non-controlling interest in Serap Company is P900,000. The following computations for goodwill and non-controlling interest'under two options are Qs follows: Proportionate Basis (Partial-goodwill Approach) Fair value of subsidiary (75%): Consideration transferred: Cash . Fair valve of previously held eauity interest in acquire P2,160,000/60% P 2,160,000 (60%) 3,600,000 x 15%... 40,000 [15%] Foir value of Subsidiary . ‘ P 2,700,000 , (75%) ~ | Less: Book valve of stockholders’ equity (net assets} ~Serap Company: {P3,900,000 - P1, 900,000) x 75% 1,500,000 (75%) Allocated excess... sees... seu,” P 1,200,000 ° (75%) Less: Over/undervaiuation of assets and iabilties: {(P5.100,000 = P,900,000) ~ (P3,900,000 - P1,900,000)] x 75% Positive excess: Goodwil (patil). ‘Advanced Financial Accounting - A Comprehenuive: Conceptual & Procedural ApproachCHAPTER 2) ga Pg ion of assels rnd tiabiltes): (P ok nave of stockholders’ aqui of sUbsCon Fratipled by; Non-coniroling interest percentage Nemcontroling interest (poral) Foie Value Basis (Ful-goodwill Approach) + Full-goodwmill For valve of subsiciary (1008: Consideration transfered: Cost aig" Foi valve of previously held equity interes ‘Acquire P2,160,000/60% = 19,600,000 x 15% - vee 540,000 ta Foir value of NCI (given) ie . =e fs Fair value of subsidiary . . abl Less: Book value of, ‘stockholders’ equity (nef asset f 100%... 2,000,000 (100%) ‘erap Company: P2,000.000x soma en Allocated Excess - Dee ifoidghansasetn tess: Over/undervaluation of assels and abies: : an {3,200,000 - P2,000,000) x 100%... Positive excess: Goodwill (full. wosentee .codwill of P400,000 consists of Ful-goodWil..-.e+-r00escnrr+ Less: Controling interest on fukgoodil Parlid-goodwill......s2++20+20+* NCI on ful-goodwil 2.2 Npnabcgies jai value of NCI OF Stockhoides’ equily of subsidy fe, ‘ths moun! sould not be lower compared fo Phpog 000% 25% = P6000). Otherwise, the higher amount should be used. Non-controlling interest ‘Non-confoling interest (partial) ‘Add: Non-contoling interest on 300,000 partial goodwil). Non-controling interest (ul i tks In general, « change in ownership leading fo a change in the nature of an investment is reported as a deemed sale of the existing investment at fair value, and as a deemed purchase of the new investment, again at fair value. Furier the new investment is reported using the appropriate reporting method - fair value, equity, or consolidation. However, differences in practice exist when accounting for a charige in the nature of an investment from passive to an investment in an ‘associate, joint venture (or joint control) or control. These differences in practice exist because PAS 28 is i silent on the riate es etiod ma acquisition. One valid practice is to follow ihe deer at fair value ay sete/perenase a ws ipproach applicable to other types of changes in the P 2,160,000 (60%) The full = lor julkgoodwil (? 400,000— Rule as a Financial Asset © an equity interest previously held by the acquit ‘ch qual ic v quire which qualified as a financial instrument under PFRS 9 is treated as if it were disposed a and reacquired at fait . nancial Accounting A Comprehensive: Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS =DATE OF ACQUISITION 2 lue on th i : xo an 'e acquisition date, depending on whether the investment (financial + Falr value through Other Cor tf mprehensive Income (FVTOCI). the temeasurement fo its acquistion-date fair value and any resulling car or loss is recognized other comprehensive income, + Fair vole through Profit and Loss (FVIPL). The rermeasurement to its aecauis lon-date fair value and any resulting gain or loss is recognized in profit Incidentally, ilustration 2-4 is an example in which an equity int. i held and qualified as FVIoci ‘investment pag remensues to : ¢ ‘and is being remeasured to its acquisition date fair valve and any diference is recognized in Other Comerehentive Income. The gain on deemed sale - OCI is computed as Fair value on previously held equily interest in acqures 2,160,000, 60% = P3,600,000 x 15%....... Less: Carrying / book value at the point controls Ochieved .. OCI Gain on remeasurement o fa valve (gain on deemed sa Because the new purchased changed the nature of the investment from Fair Value fo control, the acquiree company (Serap) has fo act as if there is a deemed sale of its existing investment in the acquirer (Pores) and a deemed purchase of its now 75% interest in Serap. Incidentally, the entry is as follows: Investment in Pores Company [Controlled Eniily - Subsidiary) 2.700.000 Investment in Pates Company (FVTOCI). Cosh. OME OLE 500,000 2,160,000 40,000 On the other hand,-if the investment. is classified as FVTPL investment, the difference which is the remeasurement gain is recognized in profit and loss account to be included in the determination of net income. As mentioned earlier of this chapter, the fair value gains and losses of FVTOCI investment can never be transferred from their separate component of equity to net income. However, the company can move the accumulated gains and losses within stockholders’ equity. That means that the company can transfer the gains and losses directly to retained earnings at any time, but not via the profit and loss section of the statement of comprehensive income. Associate E j . * an equity interest previously held in the acquire which qualified as an associate under PAS 28 or a joint venture under PFRS 11 is similarly treated. as if it were disposed of and reacquired at fair value on the acquisition date. Accordingly, it is remeasured to its acquisition date fair value, and any resulting gain or loss compared to its carrying” amount under PAS 28 or PFRS, 11 is recognized in profit or loss. ‘Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural ApproachCHAPTER 1230 Iustration 2-5: Bargain Purchase Gain ny's common stock for P75 Parlor Company acquires 75 percent of Saloon Compar interest in saloon has } book value of ps2." vorls identifiable assets “I ein: Khar the non-contoting inert noe and a fair value of P82,000. Also on that date, ;aloon repo. as liabilities with or”? Book valve of PADIND ond a far vue of POOP cand it has liabilities with a bg, Value and fair valve of P190,000. Proportionate Basis (Partial Goodwill API Partial-goodwill Fair vale of subsidiary 75%): Consideration ransfered: Com" Jers’ equily proach) Less: Book value of stockhold {net assets) - Saloon Company ; fe {p00,000 -P190.000] «75% F730 (758) Moco exces abs Less: Over/uncera {(p510.000 ~P 1905 in purchase gain (t0 Negative excess: Borgel Me eat or aouiable fo parent or = ;p400 000 ~P190.000] x 75% ‘controling 7 « Full-goodwill a Foir valve of subsidiary (100%); is ‘Consideration rarsferred: Cosh iF Savage? P 225,000 (75%) For value ‘ot non-contoling interest (aveN)”- smn (25%) Foie value of UDSCIOTY v--vsecveresseet 7 7000 (100%) tess Book votue of slocknoKden, equity. inet ossets] ~ Saloon Company: (rr 4g0,000 P1900) x ODE. vo eons * 2 (100%) Alocated excess..+ 97,000 (100%) Less: Over/undevat {(P510,000 -P 190: 110,000 (100%) Negative exces: Bargain purchase gain I controling interest or atibytable 100) + amount shoud not be iower compared fo for 7 of Stockholder equily of subsicioy ie, (P510,000- 190.000 = P320000] x 2 20000) Otherwise, the higher amount shoud De wed. n for fair value basis: Several sumptions werttinfo the above calculator sere valve of subsiciry ~ tis now the sum of the price paid b) newly estimated fair value of the NCI. Fair voue of stockholders equiy (or net ossets) of subsidiary excluding goodwill. He amount composed ofthe book valve and over/undervaluation of identifiable osselso¥ Fbitties reflecting fair values of the subsidiary accounts. Goodwil- there can be no goodwill when the price poid is less than the fair volue ot parent's share ofthe foir valve of net identifiable assets. NCI percentage of 4s, in this cose, it cannot be less y the parent plus To yates rt ne {P510,000 - P190,000) = 80,000) . som pecnee gon {gain on acquisition) - ee ferests whether under the proportior How is the NCI affected by the exisfence of a bargain purchase gain? the only gain recognized is that oppco® nate.baxs (option 2) oF fa “Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approach —SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS 131 ~ DATE OF ACQUISITION 4 PFRS 3 states that a gain on a bargain purchase can only be recogrizd by the ‘acquirer. This implies tha! only the parent's share of the:negalive goo recognized, ; Inthe rote cose that @ bargain purchase gain may are, such a goin has no, tect fon the calculation of the NCI share of equity. The NCI receives @ share of the ‘ale of he susiary, and hos no involvement with the bargain purchase gain. + It-lso implies that non-controling Interest mus! be measured at its shore of the valve of the Identiflable net assets. in effect, the parent company extension method must be used for valuing the NCI. + The subsidiary goodwil of the subsidiary may be determined by calculating the ee acquire by the Parent enfy ond hen grossing tis upto determine he goodwal fr the subsiian (as shown in the fl-goodwll approach of Huston 2-1 to 24). process not applicable for the bargain purchase gain. The gain is made by the parent paying less than the net fair value of the acquirer's share of the identifiable assets, liabilities and Contingent liabilties of the subsidiary, The standard setters adopt the view that most business combinations are an exchange of equal amounts given markets in which the parties to the business combinations are informed and wiling participants in the transaction. Therefore, the existence of a bargain purchase is expected to be an unusual or rare event. Paragraph 36 of IFRS3 requires that before a gain is recognized, the acquirer must: reassess it; * ithas correctly identified all the assets acquired and liabilities assumed; it hos conectly measured at fair value all. he assets acquired and liabilities assumed; there is non-controlling interest in the acauiree (subsidiary), if any; it is for a business combination achieved in stages, the acquirer's (parent) previously-held equity interest in the acquire; and + ithas comectly rieasured the consideration transferred. The objective here is to ensure that all the measurements at acquisition date reflect all information that aré available at that date, Noté that one effect of recognizing a bargain purchase is that th lere is no recognition of goodwil. A gain on bargain purchase and goodwill cannot be recognized in the same business combination. : Nature and Presentation of the Non-Controlling Interest (NCI) Ownership interests in a subsidiary other than the parent are refered to os the none contoling inferest. Non-conholling interest is the equity in a subsidiary not attributable, directly or indirectly, to a parent, NCI is to be identified and Presented within equit quity, separately from the parent stockholders’ equity. It is fegarded as an equity contributor t tt all its subsidiaries) rather than a liability, ne te Merde ee definition of a liability as c rained. th because the NCI does not meet the contained in the Fra resent obligation to provide e meer be a cause the group’ has no’ -CONOMiC Outflows to the NCI. : ‘Advanced Financial Accounting =A G- 132 CHAPTER 2 The NCI receives a share of consolidated equity: 4 * Aerefore © Poricipont in hy residual equity of the group. The fair value option (Option 1 - full-goodwill approach ull-fair value basis) = full. goo for non-controlng Interests brings revised PFRS 3 Closer to te cere The entty theory upholds consistency in accounting Mes meri 2 geet the combined entity, regardless of who the stakeholders Oe fed valuation model 0s embodied in i Ihe enity theory does not support o FOOTENIEG Tyne shareholders ofthe pe parent theory, which focuses on inform company. ration pri ‘ning non- controling interests! plied to determin’ 9 : shore a iedikis recognized in full forthe eng of net asset 9 Fina! of the group's: CO 4 i and foir aust 5 arate of identifiable assets ‘ond liabilities are valued in full 1 refed both parent's and non-controliing interests’ share. subsidiary is entered into by the parent and not the non. i identifiable net asset i vioRs 3 requis the fat valve OF the identifi sam peubapiety Gf acquistion to be recognized In full as if the non-contoing act Were ak0 a pay fo the acauistion- t fo recognizin er, he second alferatve permited BY rns 3 with respect sacl vewroling interests oS 0 "air valve (Option 2 - parial-goodwill approa Prenable net assets and not ful far value is a move away (or proportional basis) of from the entity theory: ‘Although the enfily the recognize, measure and. n Non-contoling Interests be a Debit Baar Car Non-controling interests’ share of losses in a subsidiary may exceed their share of the subsidiary's share capital, retained earings and other equity items. PERS 10 requires the balance under such circumstances. rnon-controlling interests to have a deficit Other Applications of the Entity Theory to Non-Controlling Interests all shareholders of the combined entity as equity holders. PRS The same accounting policy is OP ‘Although the acquistion of the tt its critics, it provides a conceptual basis tp cory Is not withoul trolling interests in a consistent framework. present non-con nce? The entity theory views 10 states that: ‘© Non-controlling interests shall be presented in the consolidated statement o ea position within equity separate from the equity of the owners Profit or loss and: each comy i fi ponent of other comprehensive oro oe owners of the parent and to the non-controlling come i ut i. one Is ibid to the owners of the parent and oe belie: even if this results in the non-controlling interes income 0® interests. 1. to the not ts having ¢ ‘Advanced ccoum = (Financial Accounting = A Comprehensive: Ce 7 ar eesSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS Spqworacounrion under the entity theory, the depreciation and amortization of fair valve differentials that affect the majority interests also apply to the non-controlling interests. Consolidated Financlal Statements (PFRS 10) the concept that drives all consolidation procedures Is that the consolidated financial statements should show only the resutts of transactions with outsiders. The effects on the accounts of transactions between the parent company and is subsidiaries or between subsidiaries should always be eliminated. The statements prepared for a parent company and its subsidiaries are called consolidated financial statements. They include the full complement of statements normally prepared for a separate entity and represent ‘essentially the sum of the assets, - ligbilfies, revenues, and expenses of the affiliates after ‘eliminating the effect of any transaction among the affliated companies. Under both PERS and US standards, a corporation's publicly fnancial statements must ro consolidated — al enties contoled by the reporting ently, including subsiciries and controlled eniiies, must, be included in the consolidated. statements, with consolidated statements, all of the assets and all of the labilfies are reported as a Sngle economic entity, s through the combined comparies were a single legal entity. However, the IASB is proposing fo exempt investment entities (that is, entities that invest solely to: obtain capital appreciation ‘and dividend income from their investment) from being required to ‘consolidated entities. Instead, investment entities will be required to teport entities that they control as FVTPL investments. Investment entities will be discussed on the latter part of this chapter. Consolidation Procedures Using the ‘Acquisition Method: General ‘Approach . Although two sets of accounts have to be prepared — the investor's separate financial statements and consolidated or group financial statements — only one set of “books” or “ledgers” has to be kept by the legal entity. There are no “ledgers” kept for the group entity. instead, consolidation worksheets are prepared at the ‘end of each reporting period, which combine the separate financial statements of a parent and its subsidiaries and include consolidation elimination entries and adjustments to remove the effects of intercompany transactions. Consolidated statements are prepared from the point of view of the shareholders of the parent company. The following items are to be noted: 1. Consolidation adds the elements on the financial statements of subsidiaries and structured entities to those of the parent. 2. On the balance sheet/statement of financial position (or SFP) there. will be no investment account for the controlled subsidiaries and structured entities (SES). Instead, the assets and abilities of the controlled entities will be added fo those of the parent to show the economic resources of the entity. “Javanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approach134 CHAPTe, 2 3. On the statement of com ci, the revenves a iprehensive income (sci), ind e; willbe the totals for each lem for Ihe parent plus the controlled entities; Py, 4, The effects of any and all intercompany transactions will be eliminateg too double-counting., form, Athough the parent ond its subs The reporting objective is substance over tt are separate legal entities and prepare separate. individual ftencil Stotement, overall economic entity is the group of companies, Indeed, conse cated sien are called group accounts, although there ‘are no formal “accounts” for the go, just consolidation working papers and financial statements. the follow the chain of steps tha, fing chapters, tf eng aps of COnsOIaHON. RMEAR I @mnenes In this Chapter and in the succ “gmeAR" steps O! may describe it as the key word s of that stands for the four steps in a typical consolidation procedures Steps i 4 Year Following Ac The RmBAR fo Consolidation at the End of the Firs lo a (Chapter 2 and nd ofthe Second Year or Later Years Following Acquistion (Choptey; 4nd 5): res to: 1 The Reliable (rellabllty) measurement step requires a. eee cost (Chapter 1) and fair value ‘adjustments (FVA) , Allocate FVA through ‘over/undervaluation of assets and liabilities This step involves determination of the fair value of subsidiay o, over/uni wn of identifiable assets and liabilities in the “schedve ¢ determination and allocation of excess. é In theory, acquliion-method of accounting combines the camying value cy parent with the fair values (at date of acquisition ofthe purchased subside on actually star's with carrying values of both compar in practice, consolidati cat the camying values and the foir vos At the date of acquisition, it is clear th relate to the same assets and liabiities. ‘As period moves on, however, ‘assets will enter and leave the balance shee! the purchased subsidiary, and the asset base will change. Therefore, broadly speaking, consolidation takes the carrying valves of bet companies and adds the fair value adjustments (FVA), i.e. the cover-untt valuation of assets and liabilities relating to each asset and liabilties. ‘A fair value adjustment which can be either a fair value increment die! undervaluation) or a fair value decrement due fo overvaluation, is the difee” between the canying valves and fair values of the acquiree's identifiable and liabilities at the date of acquisition, plus any goodwill. Specifically, the FVA is first allocated fo the various identifiable ost rs liabilities of the acquiree to the full extent of their fair value increme decrements). Any excess of the FVA affer the allocation process is allo goodwill. “Advanced FiancalAecounting~ A Comprehensive Conceptual & Procedural ApproachSEPARATE and CONSOLIDATED FINANCIAL STATEMENTS ~ DATE OF ACQUISITION 2. The Eliminate step requires to: a Identity and eliminate all intercompany transactions and balances; ond Calculate and eliminate any unrealized profits (or loss) relating to the intercompany sale of inventory (Chapter 4) and fixed assets (Chapter 5) in the current period. Calculate and recognize the profit (or loss) in the current year on the sale of inventory (Chapter 4) and fixed assets (Chapter 5) in 4d. previous petiods. go c. Ellminations and Adjustments To Prepare its consolidated financial statements, a parent will add together the financial statement amounts for itself and its controlled entities. In the process, however,. some changes to the pre-consolidation reported balances must be made, There are two types of changes that are’ made when statements are consolidated: (1) eliminations and {2) adjustments: + Ellminations are chariges that prevent certain amounts on the separate- entity statements from appearing on the consolidated statements. Eliminafions ore necessary to avoid double-counting (such as intercompany sales) and to cancel out offsetting balances (such. as intercompany receivables and payables). + Adjustments, on the other hand, are made to alter reported amounts to teflect the economic substance of transactions rather than their nominal amount. Why Eliminate the Investment Account? In the consolidation worksheet: The first intra-group or intercompany transaction that has to be eliminated is the investment by the parent in the subsidiary. Without the elimination, a double-counting of assets arises — the investment asset in the parent's balance sheet is duplicated by the individual assets and liabilities of the subsidiary acquired. By virtue of its power to govern the financial and operating policies of a subsidiary, a parent has control over the-assets and liabilities of its subsidiary, and should therefore recognize the assets and liabilities of the subsidiary on the combined balance sheet. + After eliminating the investment in a subsidiary against the capital stock, additional paid-in capital and retained earings that are outstanding at the date of acquisition, a differential remains. The difference comprises of two components which are goodwill and the excess or deficit of fair value cover book value attributable to over/under valuation of assets and liabilities. "Advanced Financ Accounting - A Comprehensive: Conceptual & Procedural Approach» 36 CHAP re, 2 In this chapter the Reliability measurement and Ellminale stop wil be int, (3, 4 ond §), we extend the REAR eo ety while in the succeeding chapters further, thus: 3. The Amortize step requites 10: ; ar amortize the EVA allocated various Identifiable Ossels and faite the over/undervalvation, relating 10 hose asses Gnd Fbites) in current and previous periods. : ee " b, Wile-off ony imoaiment of goodwal and othe inongile a ya indeterminate usetullives in the current and previous Periods, c. Fad the balance of the alocated FVA remaining unamortzed og unimpaired at the end of the current period. ling interest's (NCI) share of eamings (Chapters 3, 4, ang 4. Recagnize non-controll i ‘a. Recognize NCI share of earnings b, Calculate NCI for balance sheet purposes ©. Calculate Consolidated Retained Earnings bedded in each ilustrations belo, The steps mentioned above were oready em e Iopsis not anymore necessary for iustration Purposes. identification of such st Direct Approach versus Workpaper Approach fo Consolidation Direct Approach There are two general approaches fo preparing consofidated financial statement he Greet opproach and the worksheet approach. The direct approach prepares te cersoldated statements by seltiig up the income statement / stotement a Comprehensive income SCI and. SFP formats and computing each consoldclet , liability, revenue, and expense is separately colcucit balance directly. Each asset ‘and entered into the consolidated statement. The direct approach works from the separate-entity financial statements of the parent and the subsidiary. Workpaper Approach The alterative method is the workpaper approach. The worksheet (or spreadshee approach uses a mul-columnar worksheet to enter the trial batonces of the pat ‘nd each subsidiary, Then eliminations and adjustments are entered onto fe worksheet, and the accounts are cross-added to determine the consolidated fi balance. Which Approach to Use? The direct approach is spontaneously appealing because we are the statements and can see cleaty what is happering to the con as eliminations and adjustments are posted. When the statements to be oe ey simple, it is quite feasible to compile the consolidated statements working directly solidated stateme consolidat by the di The workpaper approach is less spontaneous, buts more methodical and keer 2 track of the eliminations and adjustments, some of which get very compicatee complex situations, therefore, accountants in practice find it easier to use 0 sie Faaned Fr Sa TA SE : —," SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS. = DATE OF ACQUISITION 37 {usualy computerized) to summarize the necessary eliminations and adjustmenis. the workshéet also provides the management trait (or audit frail) that explains how the consolidated statements were derived, In this chapter we wil ilustrate both approaches. The direct method will be presented in the first and the worksheet approach second. Both approaches yield the same result. It doesn't matter which approach is used-what is important is the result, not the method used to drive the result, The worksheet approach becomes unwieldy. to ilustrate in’ the text when. more complicated Problems are involved (even though it helps keep better track of the various adjustments and eliminations). In ater port of this chapter and in the succeeding chapters, the worksheet approach will be thoroughly illustrated. Consolidating Parent-Subsidiary Simple Illustration: Consolidated Balance Sheet at the Date of Acquisition The condensed balance sheet of a parent before setting up its subsidiary is shown below: Parent Balance Shee! December 31, 20x4 Assets: 100,000 cbiliiés and shareholders’ equity ‘Common stock. ¥ 50,000 Relained eamings. .. — $0,000 Total Libilties ang Stockholdes' Equly. 100.000 New Subsidiary Assume that the parent founded a subsidiary by investment P10,000. The separate balance sheets for each company are provided below. Notice that we introduced an “investment in subsidiary" account for P10,000 in the parent's balance sheet and a counterbalancing share capital account for P10,000 in the subsidiary’s balance sheet. From the parent's point of view, no new owner's equity was created by the formation of the subsidiary. All that happened is that one asset (cash) decreased by P10,000, while another account, investment in subsidiary, increased by the same amount of 10,000. Its total equity continued to be P100,000. Separate Balance Sheet December 31, 20x4 Parent Subsidiary Assets Cash, 90,000 10,000 Investment in: sib. 10,000 = Total Asses. : Pioo.o09 * P10.000 Liabilities and Shareholders’ reauty ‘Common stock Retained Earnings. Total Liabilities and Stockholders’ "Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approachge RR ee Direct Approach-Consolldation immediately Acquisition Both the investment in subsidiary account P10,000 in i. Welborn sheet oO the common stock account of P10,000 in the se ie ney 000 wh alin Hi cassel, a /,000, From the consolidated perspective one Se aU The sbscary comet ‘it in subsidiary, went down by P10.) i oat fo he pares Owe tock snc its chead reflected inthe pay : i psidiory immediately atte its creation, yt {oll eauity of P1000. To consolidate he WDSc Trent ri the parent, it should get back the original bal rei Balance Sheel December 31,204 Assets . Plog Cosh (P90,000 + P10.00)-. Investment in Subsichory (PI 000 10.000) Toto! Ass pastes Common stock. .:++++++ Retained earings...» Total Libiltes ond Stockholders Workpaper Approach - Consolidation Immediately ‘Acquisition the enties to efminate the investment in subsiciary account in the parent's book aq the share capital inthe subsciany's books and the parent's consolation worksheet a provided below: ‘Common stock (of subsidiary)...» . a ipsidiary (of parent) . December 1, 20x4 ‘TWial Balance ‘Adjustments Poxent Subsidiary DU/{C1) Consolidate Cosh 90,000 P10, 000 P100,00)| Investment Subsicary 10,000 » prio009) 1 Common stock (60,000). (10,000) 10,000 (soo Reicined Earnings (50,0001 Fi | pi Pa E be The consolidated balance sheet under the workpapers approach will-be identical toe balance sheet derived under the direct approach above. ‘Comprehensive illustrations: Consolidated Balance Sheet at the Date of Acquisition Consolidation procedures are affected by the parent company's ownesé percentage and by the existence of a differential between the consideroitt transfered for the investment and is underlying book value. Accordingly, cifete ilustrations are given for the following cases: 1, Consolidation of Wholly Owned Subsidiaries . Alustration 24: Date of Acquisition - 100%-Owned Subsidiary « lustration 27: Subsidiary has a Recorded Goodwill at Acquisition Date . IMlustration 2-8: Subsidiary has Recorded Dividends at Acquisition Date «illustration 2-9: Bargain Purchase Gain “Advanced Financlal Accounting ~ A Comprehensive: Gi 7 —ee SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS. DATE OF ACQUISITION 139 “DATE OP RCOUIIIION 2 2. Consolidation of Partialy-owned Subsidiaries + Mustration 2-10: 80%-Owned Subsidiary - Worksheet Preparation + llustation 2-11: Subsichary has @ Recorded Goodwill at Acquisition Date ~ Worksheet Preparation «+ Ilustration 2-12: Bargain Purchase Gain - Worksheet Preparation + Ilustration 2-13: Subsidiary has Treasury Stock + stration 2-14: Reverse Acquistion 3. Appendix + _Ilustration 2-15: Determination of Goodwill with Deferred Tax implications egordiess of percentage ownership, the procedure for consolidation using acquistion method: 1. Begins with an acquisition analysis (or schedule of determination and allocation of excess). The schedule is prepared as of the date of acquisition and supports the consolidation procedures used in all future yeors. The acquistion method of accounting for business combinations requires that o consolidated balance sheet shows the assets of tha subsidiary in the financial statements at the fair market value as of the date of acquisition. Subsidiary assets should not be consolidated-at book value if fair value as of the date of acquisition and book value are different on the acquisition date. When the fair value of the subsidiary is not equal to the underiying book value of the subsidiary's net assets, the assets and liabilties of the subsidiary must be ‘adjusted in the consolidated statements to fair value. The difference between these amounts is the allocated excess that must be ‘assigned to other subsidiary accounts in the consolidation. ie The excess represents the fotal amount of additional net upward valuations or downward valuations that must be made in the subsidiary's net assels upon consolidation. ‘Accordingly, the allocation schedule mentioned earlier is required. This schedule also ‘provides all the necessary date needed for the elimination entries in the worksheet for a consolidated balance sheet. 2. Adjusting Entries Prior fo Eliminating Entries At times, workpaper adjustments to accounting data may be needed before appropriate eliminating entries can be accomplished. The need for adjustments generally arises because of in¢ransit items where only one of the affiliates has recorded the effect of an intercompany transaction, 3. Other intercompany Balance Sheet Eliminations Up to this point we have discussed the elimination of the subsidiary equity against the related investment account, with recognition to the consolidated accounts of the non-controliing interest in equity. "Advanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approach —CHAPTER 2 Balance sheet eliminations of a variety of Intec P vsrdirongd a payables are also often required. Intercompany ir ‘be eliminated a a Not Teceivable, and interest receivable, for example verest poyable 9AM the reciprocal accounts payable, notes payable, © ie recelvabes and an tosh advances among afoed coma! COND terecode tor al tye Cat ts cid. SO, op het ce NA a ; items as i , itecompany acs le payer einted Wine Sao fe ympany- percentage of control held by the parent comp (Wholly-Owned) Consolidated Balance Sheet: The Use of Workpapers rea full set of financial statements (balance sheet, Affiliated companies should prepar hensive income; statemer ‘and comprel nt of sar ot Oe seme ea nd eaned earings): CM NOI 1 hy a WS; nancial statements). by another, however, the most relevan} stn nt tei 4 in Ren eS statements ecomtes portant with the passage of Tne and is discussed in later chapters. : 2 The consolidated balance shee! reports the sum of the assets and liabilities of a porent cand its subsidiaries as if they constituted a single company. “Assets and Kabilies ore summed in their enivety, regardless of whether the parent owns 100% oro smaler controlling interest. In he latter cose, the non-coniroling interests ae teflected as a component of owner’ pol This interest may be referred fo as either the non-controlling interest in net assets or as the non-controling interest in equity (these terms are identical), and in this textbook itis abbreviated as NCI. in'os much as the parent ond ifs subsiciories are being treated as a single ently, iminafions must be made to cancel the effects of transactions among them intercompany receivables and payables, for example, must be eliminated to avoid double counting and to avoid giving the impression that the consolidated entity owes money to itself. Likewise, any intercompany profits in assets arising from subsequent transactions must be eliminated, because an entity cannot profit on fransactions with itself. A workpapet Cee used fo summarize the effects of the various aditions, eliminations. andso Intercompany Accounts to be Eliminated E Parent's Accounts ‘Subsid roel jory’s Account Investment in Subsidiary Versus | Book valve of ockhloen' equity and overlnder valuation of assets and ih jobilties A ean oabeaeey meets Versus | intercompany payable (receivable) wate sidiary) | Versus | Advances from parent {to parent) Didendincome fda I “ Versus | Interest expense (income) Mnopotin te tetas feclared) | Versus | Dividends declared (dividends income) from subsidiary | Versus | Management fee poid fo parent "Advanced Financia! Accounting ~ A Comprehensive: Conceptual & Procedural ApproachSEPARATE nd CONSOLIDATED FINANCIAL STATEMENTS - = DATE OF ACQUISITION \ a Mustration 2-6; Date of Acquisition-100%-Owned Subsidiary Peer Company acquire’ all of Sky Company's outstanding stock on January 1, 20x4, by paying P340,000 cash, and immediately prepares a consolidated balance sheet. The separate balance sheets of the two companies immediately prepared before the consolidation with acquiree's fir value were presented as folows: PeerCo, skyCo.—_‘SkyCo. Assets Book valve Book value Far valve Cosh... 3 P 350,000 P $0,000 50,000 ‘Accounts receivable 75,000 $0,000 50.000 Inventory 100,000 60,000 75,000 land. ie 175000 40.000 100,000 Buidings and equipment (net 400000 gaog00 290.000 Total Assets f Licbilties and Stockholders’ Equity ‘Accounts payable P 100000 P 100000" =P 100,000 Bonds payable 200000 100,000 135,000 ‘Common stock, PIO par 00000, 200,000 Paid in capitalin excess of par. 30,000 20000 Retoined eamings ..... ssc 250,000 20.000 ‘Stockholders’ Equity .. PLloo.o00 _B.500,000 The resulting ownership situation can be viewed in the schedule of determination and. allocation of excess. The schedule is used to compare the company fair value with the recorded book value of the subsidiary. It also schedules the adjustment made to subsidiary accounts in the consolidated worksheet process. The schedule below is for a 100% interest, so non-controlling interest is not expected fo arise. Schedule of Determination and Allocation of Excess Date of Acquisition - January 1, 20x4 Fair value of Subsidiary (100%) ‘Consideration transfered .......... . P 340,000 Less: Book value of stockholders’ equity of Sky: Common stock (°200,000x 100%) . 200,000 Paidin capitalin excess of por (P20,000 x om . 20,000 Retcined earnings (P80,000x 100%) 30,000 300.000 Allocated excess (excess of cost over book value) P 40,000 Less: Over/under valuation of assets and liabiities: Increase in inventory (P15,000 x 100%)... .. + P 15,000 Increase in land {P60,000 x 100%)... 60,000 Decrease in buildings and equipment {P10,000 x 100%)... (10,000) Increase in bonds payable (P35 000 x 1003 Positive excess: Goodwill (excess of cost over a aig ier a ium The over/under valuation of assets and liabilities is summarized as follows: Sky Ce (Over) Under Book value Fairvalve Valuation reer. pone aT 0.000 75,000 15.000 : ke 40,000 100, Buildings ond equipment (net). sea 300,000 mio om Bonds payable é 100,000 135,000 35,000 ‘Advanced Financial Accounting ~4 Comprehensive: Conceptual d ProccdCHAPTER 2 jule: on controling interest. ine folowing features of the s isno nor 1 supsichry not OHS ON INO Woks this is 0 100% interest, there i that wil have 10 js Pao (P3000 + P0600 good ioyy account, Recall |. Recal The schedule shows. the aajuslments to ea! armerget or statutory coin _ procedure in Chapter | (Asse! ACaMS ion = a Y ded on the acauiton pa fhe entice fair valve of the su 3. oo igor ar sted on te wotksheet ot bos, the books of the acquirer, Now. to fair vove- valve, and they are only to be adjusted : ne a ote of te net se Teeny foir vlve excee’ Eb what 3 i compas vl be adjusted 10 10H se postive. crea ae bared ‘pool ‘amounting '0 000 which lidoteg balance sheet. Notice # + Because «The total agjusiment be made I Peer Company records the stock acquisition on its books with the following entry on the date of acquisition: 340,000 340,000 January 1, 204 investment ky Company +--+ "* ce h between actual-entries that are recorded in the books of It is important to aistinguls s one of the two companies ‘and workpaper-only enties. fon to record the Investment in Sty ted in the preceding sec’ ual entries, which would be recorded in the accounts of Peer ¥ eniies would already be reflected in the trial balance, which in of the workpapers presented throughout this chapter (see The entties presen Company were oc Company. These types of constitutes the frst colum Figure 2-1) The entries that we develop next, and which appear in the middle “eliminations” colunins of the workpapers, ore workpaper-only entries or eliminating entries. As such they are never posted fo the books or accounts of either company’s general ledger. the entries will need to be repeated each year in the consolidating ber of entties from prior years may be combined to the entries are being repeated each year. Consequently, process. In some cases a num simplify the process; but, in essence, Himinating entries are made fo cancel the effects of int ond ‘are made on the workpaper only. tweicempany fone On the date of acquisition, the eliminating entries consist of two: 1. iy fist enty eliminates the BOOK. VALUE of the stockholders’ equ e subsidiary with its equivalent amount against Peer's account, Sky Company" : 2 haus oe inte vest cco! villbe aftibutable fo ALLOCATED EXCES value) thi i i accounts in the consolidation, ) Tt, ube, cio, oft ae ity accounts d “investment ‘Zdeanced Financial Accounting ~ A Comprehensive: Conceptual & Procedural Approach| SEPARATE and CONSOLIDATED FINANCI | ZpaTe oF ACoUIITION Te The allocated excess represents the total amount ‘of additional net upward valvations that mus! be made in the subsiciary's net assets upon consoldation: For purposes of convenience and ilustation, this allocation is made on @ second entry. The two enhies above may be easly combined into a single compound erty. However, forlustration and clarity purposes in this book. separate entries willbe made. the schedule of determination and allocation of excess provides:complete guidance for the worksheet eliminating entries on January |, 20x4: Investment in Sky Co. minal ivesiment agar allocated excess {El Common siock—Sky Co... eer Te 200,000 ‘Additional paic.in capital ws sdeddcvsgosize 7. 20000 Retained earings ~Sky Co.......2s1es+e0+> 20,000 Investment in Sky Co... «300,000 EiminateInvesen gon book value sokolden equity of ky Co, TEJIENIOY.cccsveresreee LAN sist aie 75,000 Lond ; 40,000 Goodwill a i 10.000 Buildings and equipment . 10,000 Premium on bonds payable . ... 35,000 40,000 The separate financial statements of the two comp: the consolidated totals for the balance sheet on January 1, 20x4 are shown it lL nies, the eliminating entries, and in Figure 2- Figure 2 - 1: Worksheet for Consolidated balance Sheet, January 1, 20x4. Date of ‘Acquisition: 100%-Owned Subsidiary Eiminations % ‘Assets PeerCo,SkyCo. Dr. Ci. Consolidated Cost nas P 10.000 P 50.000 40,000 ‘Accounts receivable 75000 $0,000 1250000 c joo,000 «0.000 (2) 15.000 175.000 175,000: 40,000 .(2} 60,000, : 275000 auicings ond easioment ial. 4ooo0 300.000 * (2) 10000 690.000 Goodwil.. (2) 10.000 10.000 Investmentin Sty Co... 40.000 (1) 300,000 ate Ey ee (2) 40,000 Totol ASSES. = Pi yoo.000 500.000 ).3350000 abies and Stockholders ey "Recounts payable .. P 100,000 P100,000 200000 Bonds payable -.. «+--+ 700,000 . 100,000 300,000 Premium on bonds payable. : (2) 35,000 35,000 ‘Common stock, P10 par . ‘ 500,000 : 500,000 Common stock P10 par. ...+.+++++ 00000 (1) 200.000 Poidin copitalin excess of par...... $0,000 50,000 Paidin captain excessof par... * + 20,000 (1) 20,000 Retained earings... +». 736,000 250,000 Retained earnings. ‘ 20.000 Tolal ibis and Stockholders ot Equity ates ~ p.tononn - ps0000_p sBs000 _p 985000 _ P1335. 000 ([Biminaeirvesment agains stockholdes' equi of ky Co, 2} Biminate investment against allocated excess. 350,000 ~ P340,000 = P10.000. \dvanced Financial Accounting ~ A Comprehensive: Con AP. Aa144 CHAPTED 2 balance sheet are showin in The amounts that will appear on the consolidated it 1d 100% of the fair valves of supe a a column of Figute 2: 1. Notice the consolidates {company accounts, ‘accounts with the existing book values of paren! Soom company and SUDO Consolidated Balance Sheet anvary | ie epee | oa | ; el A a ih eorocona za ets tian : i fi te 0009 | Inventories Lond eases eer Buings and eainment (2 ; ee cot oe aaa amg [Toll Ae ey Toles ond iockhower abies B cod a gti cae 200000 | spayed ee sso Bond rn bonds OYE: 3 > _i| Tota ities ss | fot ses 2 sson| Stock PIODST.- 1 soa | corn conitalh excess of POT fetoned eigs. roa stocenaldes' Eau oe iabiesondsiocalden peri ‘Subsidiary has a Recorded Goodwill a Acquisition Date : From the pespective of its new parent, the goodwil is not considered to be Tdentifable osset at the time of the pusiness combiriation. The adjusted alloca excess or the acquisition dliferential s calculated’ sit the goodwill had been wiiten ct by the subsidiary, even though in fact this isnot the case. The adjusted allocated excess or the acquisition differential is allocated first to the fa Tree excess for identifiable net assets, and ihe the remaining balance’ goes ) goodwill. In effect, the old goodwill is ignored and the acquisition cost determines th save, any, of new goodwill at the date of acquisition. The following illustration» examine the consoldation process when the subsidiary has existing goodwill. ‘orded Goodwill Ilustration 2-7: Subsidiary has a Rec “assuming the same data in illustration consists of P240,000 cash plus 10,000 common s per share, The following costs were incurred: Indirect costs....+-+ land, Building 2-6, except that the consideration transfer hares of Peer Co. with a fair valve off is and equipment (net)........ = ed Financia ———e “Advanced Financial Accounting - A Comprehensive: Ce 7Z 4 ___—SEPARATE and CONSOLIDATED FINANCIAL STATEMENTS: = DATE OF ACQUISITION * “4s i Fieoom 100000 tends poretle \onmn "135000 Common sock. P10 par 210.000 ‘Additonal podin copie 20,000 Reloined earings s0co0 Stockholders" i The resulting ownership situation can be viewed in the schedule of determination and allocation of excess as follows: ‘Schedule of Determination and Allocation of Excess Date of Acquisition - January 1, 20x4 Fair value of Subsidiary (100%) fe aero sci P4000 ‘Common stock: 10,000 shares x P12 per share . 120,000 P 360,000 Less: Book value of stockholders’ equity of Sky: Common stock (°200,000 x 100%)...» Poe ert Paid.n copitalin excess of por (P'20,000 x 1 . Retained earings (P80,000 x 10%)...» 20.000 300,000 Allocated excess (excess of cost over book value) P 60.000 Add: Existing Goodwill of Sky Co. (P5,000 x 100%)... 0.2. 5,000 Adjusted allocated excess... age P 65,000 Less: Over/under valuation of assets and liabilities Increase ininventory(P15:000x 100%) ......-----ees-e P8000 Increase in land (P60,000 x 100%) . . 60,000 Decrease in buildings and equipment (P 10,000 x 100%) : (10,000) Increase in bonds payable (P35,000 x 100%).......... 35,000), 30,000 Positive excess: Goodwill (excess of cost over fair value] It should be noted that with the above computation, the goodwill of the subsidiary fie. the unidentifiable assets) must be added to the allocated excess, Further it is necessary to calculate the additional goodwill not recorded by the subsidiary, this being the ‘amount recognized on consolidation. The amount of unrecognized goodwill to be recognized in the eliminating entry is P30,000 [refer to {E2) below. Altematively, the unrecorded goodwill may also be comt puted by ignoring the existing goodwill in the books of the subsidiary, thus: Date of Acquistion - January 1, 20x4 (refer to previous table for detais of computation} Fair value of Subsidiary (100%) Consideration transtered.. P 360,000 Less: Book vaive of stockholders’ equly of Sky... 300,000 Allocated excess (excess of cost over book value) . Less: Over/Under valuation of assets and liabilities... Positive excess: Goodwil excess of cost over fair value) Peer Company records the stock acquisition on its books with the following entries on the date of acquisition: January 1, 20x4 (1) Investment in Sky Company... 340,000 COB Fo etesesesehedstcn 240,000 Common stock, PIO par........... 100.000 Paidin contain excess of par. 29,000 “Acquistion of Sky Company “ ‘Advanced Finance Acountng~ A Comprehensive: Conceptual & Procedural Approach fies