ADVANCED FINANCIAL

ACCOUNTING

Lecture 4
Group Reporting II&III

Angie Wang
School of Accountancy
Consolidation Process-Recap
Legal entities Economic entity

Parent’s Subsidiaries' Consolidation adjustments Consolidated

Financial + Financial +/- and eliminations
= financial
Statements Statements statements

❑Consolidation is the process of preparing and presenting the financial statements

of a group as an economic entity.
❑Consolidation worksheets are prepared to:
-Combine parent’s and subsidiaries financial statements
-Adjust or eliminate effects of intra-group transactions and balances
-Allocate profit to non-controlling interests
Consolidation Process
❑Consolidation involves adding together the financial statements of the parent
and subsidiaries and making a number of adjustments:

1. Business combination valuation entries: required to adjust the carrying amounts

of the subsidiary’s assets and liabilities to fair value

2. Pre-acquisitions entries: required to eliminate the carrying amount of the parent’s Combined:
investment in each subsidiary against the pre-acquisition equity of that subsidiary Consolidation
journal entries

3. Intragroup transactions: transactions between entities within the group

subsequent to acquisition date
 Consolidation Process
-Consolidation worksheets
❑Consolidation journals are posted into the consolidation worksheet in ‘adjustment’
columns as follows:
Add down for
Extract only Parent Subsidiary sub-totals

Purpose: to remove the parent’s investment in the subsidiary and the effect of all inter-entity
transactions so that the final column shows an ‘external view’
Consolidation Process
-Consolidation worksheets
❑Consolidation journal adjustments are ONLY prepared for the purpose of
consolidation.

❑They are posted onto the consolidation worksheet only ‒ they are NOT recorded in the
books of the parent or the subsidiary.

❑As a result, some consolidation adjustments are repeated (‘re-enact) every time
consolidated accounts are prepared.
Consolidation Process
-Business combination valuation entries
❑If the BV of subsidiary assets and liabilities differs from FV, or if a contingent liability exists,
it is necessary to make ‘business combination valuation’ adjustments. These adjustments:
-Increase or decrease subsidiary’s recorded assets and liabilities book values to fair value
-Recognise previously unrecognised assets
-Recognise subsidiary’s contingent liabilities as liabilities at fair values

❑Business Combination Valuation Reserve (BCVR) account is used to record these

adjustments.

❑The BCVR is similar to the Asset Revaluation Surplus (ARS) account

Consolidation Process
-Pre-acquisitions entries
❑Equity balances that existed in the subsidiary prior to acquisition date are referred to as
pre-acquisition equity. All movements after the date of acquisition are referred to as
post-acquisition.

❑You cannot have an investment in yourself, nor can you have equity in yourself. From a
consolidated viewpoint, these items should not exist, i.e., they must be eliminated to avoid
double counting.
Consolidation Process
-Pre-acquisitions entries
Elimination of Investment Account in a Subsidiary
Consideration Share of book value of Share of excess of fair
transferred = subsidiary’s net assets at + value over book value + Goodwill
acquisition date of identifiable net assets

Eliminated against Fair value differentials

subsidiary’s share capital
and pre-acquisition
retained earnings

Investment account is eliminated

-To ensure that the investment account must be zero
-Substituted with subsidiary’s identifiable net assets and goodwill (residual)
-Rationale: Avoid recognizing assets in two forms (investment in parent’s statement of financial
position and individual assets and liabilities of subsidiary)
Consolidation Process
-Pre-acquisitions entries
Elimination of Investment Account in a Subsidiary (Continued)

❑ Pre-acquisition retained earnings or pre-acquisition reserves of subsidiary are not included in

consolidated equity.
-Rationale: Pre-acquisition retained earnings arose prior to the exercise of control by the parent.

❑ The elimination process will result in residuals comprising of

-Goodwill; and
-Excess or deficit of fair value over book value of identifiable net assets

❑ Re-enactment of elimination of investment entry in the subsequent year (Re-enacted as long as the
investment exists)
-Rationale: The parent’s legal entity financial statements would always include investment in the
subsidiary balance as long as the investment exists.
Illustration: Elimination of Investment
Illustration
On 8 August 2010, Parent Co. bought 100% interest in subsidiary for $200,000. At the date of acquisition,
Subsidiary Co had the following:

Share capital: $50,000

Retained earnings: $30,000
Equity: $80,000

At the acquisition date, Subsidiary Co’s unrecognized intangible assets had a fair value of $50,000. Tax
rate was 20%.
Illustration: Elimination of Investment
Deferred Tax Relating to FV Differentials of Identifiable Assets and Liabilities
❑ The recognition of fair value differential may give rise to future tax payable or future tax deduction
– tax effects need to be accounted for because the basis for taxation does not change in a business combination
– i.e., The excess of fair value over book value of identifiable net assets will give rise to a taxable temporary
difference and vice versa.

FV > Book value of identifiable assets Deferred tax liabilities

FV < Book value of identifiable assets Deferred tax assets
FV < Book value of identifiable liabilities Deferred tax liabilities
FV > Book value of identifiable liabilities Deferred tax assets

❑ No deferred tax liability is recognized on goodwill as goodwill is a residual

Illustration: Elimination of Investment
Consolidation Consolidated Statement of financial
Parent Subsidiary
adjustments position
Dr Cr
Assets
Investment in
200,000 200,000 0
Subsidiary
Goodwill (Note 2) ? 80,000
Other net assets
300,000 80,000 ? ? 420,000
(Note 1)
500,000 80,000 130,000 210,000 500,000

Equity
Share capital 100,000 50,000 50,000 100,000
Retained earnings 400,000 30,000 30,000 400,000
500,000 80,000 80,000 0 500,000
210,000 210,000

Pre-acquisition
Illustration: Elimination of Investment
Note 1:
Increase in other net assets due to recognition of intangible assets 50,000

Decrease in other net assets due to recognition of deferred tax liability (10,000)

Net increase in other net assets 40,000

Note 2:
Goodwill is excess of the investment amount over the FV of identifiable net assets
Investment in Subsidiary 200,000
Book value of equity or net assets (80,000)
Fair value of intangible asset 50,000
Book value of intangible asset 0
Excess of fair value over book value 50,000
Deferred tax effects (10,000)
(40,000)
Goodwill 80,000
Illustration: Elimination of Investment
Consolidation Consolidated Statement of financial
Parent Subsidiary
adjustments position
Dr Cr
Assets
Investment in
200,000 200,000 0
Subsidiary
Goodwill (Note 2) 80,000 80,000
Other net assets
300,000 80,000 50,000 10,000 420,000
(Note 1)
500,000 80,000 130,000 210,000 500,000

Equity
Share capital 100,000 50,000 50,000 100,000
Retained earnings 400,000 30,000 30,000 400,000
500,000 80,000 80,000 0 500,000
210,000 210,000
Illustration: Elimination of Investment
Worksheet entries:
Business combination valuation entries
Dr Intangible asset 50,000
Cr Deferred tax liability 10,000
Cr Business combination valuation reserve 40,000

Dr Goodwill 80,000
Cr Business combination valuation reserve 80,000

Pre-acquisition entries
Dr Share capital 50,000
Dr Retained earnings 30,000
Dr Business combination valuation reserve 120,000
Cr Investment in Subsidiary 200,000
Illustration: Elimination of Investment
Worksheet entries (combined):
CJE1: Elimination of investment in subsidiary
Dr Share capital 50,000
Dr Retained earnings 30,000
Dr Goodwill 80,000
Dr Intangible asset 50,000
Cr Investment in Subsidiary 200,000
Cr Deferred tax liability 10,000
210,000 210,000

Re-enacting CJE

❑ Building blocks of consolidation worksheet are the legal entity financial statements
of parent and subsidiary.
❑ CJE 1 has to be re-enacted at each reporting date as long as Parent has control over
subsidiary.
❑ Each consolidation process is a fresh-start approach.
Consolidation Process
-In subsequent years
❑ In subsequent years:
– Subsequent extinguishment of assets and liabilities of subsidiary must be determined
based on the fair values at the acquisition date.
– Therefore, subsequent amortization, depreciation and cost of sales of acquired assets
are determined based on fair value as at the acquisition date.
– Elimination of consideration transferred , recognition of fair value adjustments and
amortization entries must be repeated until:
i. Date of disposal of the investment in subsidiary; or
ii. Date when control is lost
Consolidation Process
-In subsequent years
❑In subsequent years (Continued)
-Acquisition method only recognizes fair value at critical event: acquisition date
New internally-generated goodwill or subsequent appreciation in fair values are not
recognized subsequent to acquisition date.

-Since net assets are carried at book value in the separate financial statements, the subsequent
amortization/depreciation/disposal are adjusted in the consolidation worksheet.

BV of expense in (FV- BV) adjustment to FV of expense in

separate financial expense consolidated financial
statements
+ = statements

Adjusted in consolidation worksheet

Illustration 2: Re-enactment of CJE
On 1 July 20X3, P Co acquired all the share capital of S Co for £218,500. At this date, S Co’s equity
comprised: Share capital — 100,000 shares £100,000
General reserve 50,000
Retained earnings 36,000
All identifiable assets and liabilities of S Co were recorded at fair value as at 1 July 20X3 except for the
following:
Carrying amount Fair value
Inventory £27,000 £35,000
Land 75,000 90,000
Equipment (cost £100,000) 50,000 60,000

― The equipment is expected to have a further 10-year life. The tax rate is 30%.
Illustration 2: Re-enactment of CJE
Analysis of fair value differentials:
Item Fair Value Adjustment
Inventory 8,000
Land 15,000
Equipment 10,000
Total fair value adjustments (pre-tax) 33,000
Deferred tax liability 9,900
Total fair value adjustments (after-tax) 23,100

Fair value of net assets acquired = 100,000+50,000+36,000+23,100

= 209,100.

Goodwill = 218,500-209,100 = 9,400

Illustration 2: Re-enactment of CJE
Business combination valuation entries
July 1, 2013
Dr Inventory 8,000
Worksheet entries:
Cr Deferred tax liability 2,400
Cr Business combination valuation reserve 5,600

Dr Land 15,000
Cr Deferred tax liability 4,500
Cr Business combination valuation reserve 10,500

Dr Accumulated depreciation - equipment 50,000

Cr Equipment 40,000
Cr Deferred tax liability 3,000
Cr Business combination valuation reserve 7,000

Dr Goodwill 9,400
Cr Business combination valuation reserve 9,400
Illustration 2: Re-enactment of CJE
July 1, 2013
Worksheet entries:
Pre-acquisition entries
Dr Retained earnings (1/7/13) 36,000
Dr Share capital 100,000
Dr General reserve 50,000
Dr Business combination valuation reserve 32,500
Cr Investment in Subsidiary 218,500
Illustration 2: Re-enactment of CJE
July 1, 2013
Consolidation journal entries:
CJE1: Elimination of investment in subsidiary
Dr Retained earnings (1/7/13) 36,000
Dr Share capital 100,000
Dr General reserve 50,000
Dr Goodwill 9,400
Dr Inventory 8,000
Dr Land 15,000
Dr Accumulated depreciation - equipment 50,000
Cr Equipment 40,000
Cr Investment in Subsidiary 218,500
Cr Deferred tax liability (net) 9,900
268,400 268,400
Illustration 2: Re-enactment of CJE
June 30, 2014
Worksheet entries:
-newly affected by the depreciation of the equipment

Business combination valuation entries

Dr Inventory 8,000
Cr Deferred tax liability 2,400
Cr Business combination valuation reserve 5,600

Dr Land 15,000
Cr Deferred tax liability 4,500
Cr Business combination valuation reserve 10,500

Dr Goodwill 9,400
Cr Business combination valuation reserve 9,400
Illustration 2: Re-enactment of CJE
June 30, 2014
Worksheet entries (continued)
Business combination valuation entries
Dr Accumulated depreciation - equipment 50,000
Cr Equipment 40,000
Cr Deferred tax liability 3,000
Cr Business combination valuation reserve 7,000

Dr Depreciation expense 1,000

Cr Accumulated depreciation 1,000

Dr Deferred tax liability 300

Cr Income tax expense 300
Illustration 2: Re-enactment of CJE
June 30, 2014
Worksheet entries:

Pre-acquisition entries
Dr Retained earnings (1/7/13) 36,000
Dr Share capital 100,000
Dr General reserve 50,000
Dr Business combination valuation reserve 32,500
Cr Investment in Subsidiary 218,500
Illustration 2: Re-enactment of CJE
June 30, 2014
Consolidation journal entries:
CJE1: Elimination of investment in subsidiary
Dr Retained earnings (1/7/13) 36,000
Dr Share capital 100,000
Dr General reserve 50,000
Dr Goodwill 9,400
Dr Inventory 8,000
Dr Land 15,000
Dr Accumulated depreciation - equipment 50,000
Cr Equipment 40,000
Cr Investment in Subsidiary 218,500
Cr Deferred tax liability (net) 9,900
268,400 268,400
Illustration 2:
Amortization of fair value differentials
June 30, 2014
Consolidation journal entries:
CJE2: Depreciation and amortization of excess of FV over book value
Dr Depreciation of equipment 1,000
Cr Accumulated depreciation 1,000
CJE3: Tax effect on CJE 2
Dr Deferred tax liability (net) 300
Cr Income tax expense 300
Under depreciated Dep exp:
$1,000

Dep. of $5,000 $6,000

equipment

Based on
Based on FV
book value
Any questions?
Accounting for non-controlling interest
under IFRS 3
❑NCI only arises in consolidated financial statements where:
-one or more subsidiaries are not wholly owned by the parent (IFRS 10)
❑ NCI are entitled to their share of retained earnings of the subsidiary from
incorporation
-No distinction between pre-acquisition and post-acquisition retained
earnings for NCI
❑ Same applies to OCI.
-NCI collectively have a share of accumulated OCI arising from incorporate date to
the current date
❑ NCI are normally a credit balance.
-Share of residual interests in the net assets of a subsidiary
-Total equity (parent’s and NCI) = Assets - Liabilities
Illustration 3:
Non-controlling interest
― P Co paid $6,200,000 and issued 1,000,000 of its own shares to acquire 80% of S Co
on 1 Jan 20X5.
― Fair value of P Co’s share is $3 per share.
― Fair value of net identifiable assets is as follows:

Book value Fair value Remaining useful life

Leased property 4,000,000 5,000,000 20 years
In-process R&D 2,000,000 10 years
Other assets 1,900,000 1,900,000
Liabilities (1,200,000) (1,200,000)
Contingent liability (100,000)
Net assets 4,700,000 7,600,000

Share capital 1,000,000

Retained earnings 3,700,000
Shareholders’ equity 4,700,000
Illustration 3:
Non-controlling interest
Additional information:
―The contingent liability of $100,000 met the recognition criteria in IFRS 3. It was
recognized as a provision loss by the acquiree in legal entity financial statement in Dec
20X5.
―FV of NCI at acquisition date was $2,300,000.
―Net profit after tax of S Co for 31 Dec 20X5 was $1,000,000.
―No dividends were declared during 20X5.
―Shareholders’ equity as at 31 Dec 20X5 was $5,700,000.
―The tax rate was 20%.

Q : Prepare the consolidation adjustments for P Co for 20X5.

 Illustration 3:
Non-controlling interest
Consideration transferred = Cash consideration + Fair value of share issued
= $6,200,000 + (1,000,000 x $3)
= $9,200,000

Deferred tax liability = 20% x ($7,600,000 - $4,700,000)

= $580,000

Goodwill = Consideration transferred + NCI – Fair value of net identifiable assets, after-tax
= $9,200,000 + $2,300,000 – ($7,600,000 - $580,000)
= $9,200,000 + $2,300,000 – $7,020,000
= $4,480,000
 Illustration 3:
Non-controlling interest
P’s share of goodwill = Consideration transferred – 80% x Fair
value of net identifiable assets, after tax
= $9,200,000 – 80% x $7,020,000
= $9,200,000 – $5,616,000
= $3,584,000

NCI’s share of goodwill = Consideration transferred – 20% x Fair

value of net identifiable assets, after tax
= $2,300,000 – 20% x $7,020,000
= $2,300,000 – $1,404,000
= $896,000
Illustration 3:
Non-controlling interest
Consolidation adjustments for 20X5

CJE 1: Elimination of investment in Subsidiary

Dr Share capital 1,000,000

Dr Opening retained earnings 3,700,000
Dr Leased property 1,000,000
Dr In-process R&D 2,000,000
Dr Goodwill 4,480,000
Cr Contingent liability 100,000
Cr Deferred tax liability (net) 580,000
Cr Investment in S 9,200,000
Cr Non-controlling interests 2,300,000
Illustration 3:
Non-controlling interest
CJE 2: Depreciation and amortization of excess of FV over book value
Dr Depreciation of leased property 50,000
Dr Amortization of in-process R&D 200,000
Cr Accumulated depreciation 50,000
Cr Accumulated amortization 200,000

Under dep. by $50k Under amort. by

Dep exp: $200k
$50,000
Amort exp:
$200,000
Dep. of $200,000 $250,000 Amort. of
leased R&D
property
$0
Based on Based on
Based on FV Based on FV
book value book value
 Illustration 3:
Non-controlling interest
CJE 3: Reversal of entry relating to provision for loss
Effect: Increase net
earnings of the acquiree Dr Provision for loss 100,000
Cr Loss expense 100,000
Note: Contingent liability was already recognized in CJE 1. The recognition of a
provision by the acquiree in its legal entity financial statement results in double
counting; hence this reversal entry is necessary.

CJE 4: Tax effects on CJE 2 & CJE 3

Dr Deferred tax liability (net) 30,000 20% * (200k

+50k -100k)
Cr Tax expense 30,000
Illustration 3:
Non-controlling interest
CJE 5: Allocation of current year profit to non-controlling interests (NCI)

Dr Income to NCI 176,000

Cr NCI 176,000

Net profit after tax 1,000,000

Excess depreciation (50,000)
Excess amortization (200,000)
Reversal of loss from contingent liability 100,000
Tax effects on FV adjustments 30,000
Adjusted net profit 880,000
NCI’s share (20%) 176,000
Illustration 3:
Non-controlling interest
NCI balance:
NCI at acquisition date (CJE1) $2,300,000
Income allocated to NCI for 20x5 (CJE 5) 176,000
NCI as at 31 Dec 20x5 $2,476,000
For next time…
• Read McGraw Hill Ch2&4, Wiley Ch21

• No class next week!!