Corporate Reporting

2 Section A: Discuss the professional and ethical duties of the accountant Section B: Evaluate the financial reporting framework Section C: Advise on and report the financial performance of entities Section D: Prepare the financial statements of groups of entities in accordance with relevant accounting standards Section E: Explain reporting issues relating to specialised entities Section F: Discuss the implications of changes in accounting regulation on financial reporting Section G: Appraise the financial performance and position of entities Section H: Evaluate current developments Corporate Reporting

3 Section D: Financial Statements of Groups of Entities D1. Group accounting including statement of cash flows D2. Continuing and discontinued interests D3. Changes in group structures D4. Foreign transactions and entities

4  Apply the method of accounting for business combinations including complex group structures.  Apply the principles in determining the cost of a business combination.  Apply the recognition and measurement criteria for identifiable acquired assets and liabilities and goodwill including step acquisitions.  Apply and discuss the criteria used to identify a subsidiary and associate.  Determine and apply appropriate procedures to be used in preparing group financial statements.  Apply the equity method of accounting for associates.  Outline and apply the key definitions and accounting methods which relate to interests in joint ventures. Study Guide D1. Group accounting including statement of cash flows Section D: Financial Statements of Groups of Entities

5 Subsidiary formed when 1. direct control over another entity 2. control by dominant influence over another entity 3. control over potential voting rights in another entity 4. indirect control over another entity Formation of a subsidiary > 50% Voting Rights Share warrants/options/ convertible bonds/swaps etc – presently exercisable Apply and discuss the criteria used to identify a subsidiary and associate Potential voting rights:  that are currently exercisable or convertible, including potential voting rights held by another entity, are considered when assessing whether an entity has the power to govern the financial and operating policies of another entity  are relevant to the classification of an acquiree but do not affect the percentages to be used in accounting for the acquiree in consolidated FS Refer to slide no. 6 Refer to next slide no. 7 power to govern the financial and operating policies of an entity

6 What is Dominant Influence? Dominant influence is shown by Power to control Power to appoint/ remove Power to cast majority votes at meetings Power over >50% voting rights Via statute or agreement Majority of members on the board/ governing body

7 Indirect Control Parent Co Subsidiary Sub- subsidiary 80% 60% 48% Effective interest Controls

8 Associate The concept of a Group Subsidiary Parent >50% %

9 What is Significant Influence? Significant influence is shown by Presence on board of directors Participating in policy making decisions Material transactions Provision of essential technical information Or interchanging managerial personnel

10 Investing co has significant influence when 1. direct holdings over another entity 2. indirect holdings over another entity 3. holdings over potential voting rights in another entity Formation of an Associate A company can be an associate of one entity and a subsidiary of another % Voting Rights Share warrants/options / convertible bonds/swaps etc Refer to slide no. 11

11 Indirect Holdings Parent Co Subsidiary Associate 60% 30% 18% Effective interest Holds Significant influence Refer Test Yourself Page 393

12 Indentifying the acquirer: under the scope of IFRS 3R Business Combinations, one of the parties to a business combination is always identified as an acquirer who obtains control of the business of the acquiree. Ways of obtaining control by acquirer  Incurring liabilities  Transferring cash, cash equivalents or other assets  Issuing equity interests  Providing more than one type of consideration  Including by contract alone, without transferring consideration IFRS 3R prohibits the merger method. Accounting for business combination of entities or businesses under common control is excluded from its scope. Acquisition date: the date on which acquirer obtains control of the business of the acquiree. Identifying the date of acquisition is important for determining pre & post-acquisition reserves of the acquiree. Refer to Test Yourself 1 on page 393 The Acquisition Method Each business combination must be accounted for by applying the acquisition method. Following steps to be adhered:  identifying the acquirer;  determining the acquisition date;  recognising and measuring the identifiable assets acquired, the liabilities assumed and any non- controlling interest in the acquiree; and  recognising and measuring goodwill or a gain from a bargain purchase

13 Measurement of NCI (IFRS 3R) Recognition and Measurement for acquired assets & liabilities, NCI and goodwill At fair value At NCI’s proportionate share of the acquiree’s identifiable net assets measured at fair value New definition of goodwill: Goodwill is the excess of (a) over (b): a)the aggregate of: i.the consideration transferred measured in accordance with IFRS 3R; ii.the amount of any NCI in the acquiree (note the choice as to measurement of the NCI noted above); and iii.in a business combination achieved in stages the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree b)the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed in accordance with IFRS 3R If a) is less than b) a gain on bargain purchase arises – what the old standard described as negative goodwill. Refer to Example (Argo Ltd) on page 398 Gain on acquisition is recognised in profit or loss

14 Initial recognition of goodwill (IFRS 3R) Fair Value method = Full goodwill Proportionate net assets method = Partial goodwill Due to the strong disagreement of many commentators on valuation of NCI at fair value the revised IFRS 3 allowed entities to calculate goodwill by following the method in the old standard Disadvantages:  goodwill is recognised at the higher amount in the consolidated SOFP  future impairment of goodwill will also be higher  difficult to measure NCI at fair value in the absence of reliable market prices for it Advantages:  NCI will be recorded at fair value i.e. market value, if the entity is planning to buy NCI for cash there will not be much difference between the recognised value of NCI and actual cash payments. So there will be lesser change to equity on purchase of NCI Initial Recognition of Goodwill

15 Refer to Example (Gertrude Plc) on page 400 Consideration Acquirer shall re-measure acquiree’s assets & liabilities to their fair values Deferred consideration is to be paid under IFRS 3R and IAS 27 the present value of amount payable must be included in the consideration paid Contingent consideration is now recognised at fair value even if payment is not deemed to be probable at the date of acquisition Transaction costs should be expensed as they are incurred in profit or loss May include cash, assets, liabilities, ordinary or preference equity instruments, options or warrants Subsequent changes in debt contingent consideration: recognised in profit or loss (in the old standard they were set against goodwill). Consideration

16 Recognition of assets Most assets acquired at fair value, except  Deferred tax,  Pension obligation Recognition of contingent assets and contingent liabilities Under IFRS 3R, contingent assets are not recognised and contingent liabilities are measured at fair value. After the combination date, contingent liabilities are remeasured at the higher of the original amount and the amount under IAS 37. To be recognised as an actual liability the contingency must arise from a past event that can be reliably measured. Fair Value of the identifiable assets and liabilities acquired Recognition of provisions Provisions will be recognised in relation to restructuring costs. The question arises as to whether these provisions should be treated as pre or post acquisition. A restructuring provision can be recognised in a business combination (reduction in pre-acquisition profit and increase in goodwill) only when the acquiree has, at the date of acquisition, an existing liability for which there are detailed conditions in IAS 37.

17 Exchange of share-based awards Acquirer has two options for issuing replacement awards Obliged to issue replacement awards Not obliged to issue replacement awards, but issues them Any portion is treated as consideration transferred Increase in goodwill & corresponding increase in equity Not added to consideration transferred No impact either on goodwill or on equity Treated as post-acquisition expenses The consideration measured at the amount attributable to past service that the employee has provided to the acquiree If additional service conditions are imposed by the acquirer, this affects the total vesting period and, therefore, the portion of the awards that is considered pre-combination service. Exchange of share-based awards of the acquiree for the share-based awards of the acquirer is accounted for as a modification plan under IFRS 2

18 An acquirer has a maximum period of twelve months to finalise accounting for an acquisition. The measurement period or adjustment period ends when all the necessary information is gathered by the entity, subject to a period of one year from the date of acquisition, as a maximum. This means that changes in estimates of fair value can be made by adjusting goodwill for a one year period after acquisition. After that, adjustments must be made through the statement of comprehensive income. Measurement Period

19 Step acquisition - Control obtained by the acquirer in stages by successive purchases of shares of the acquiree. Step Acquisitions Gain or loss on re-measurement is recognised in profit or loss. If the acquirer holds a non-controlling equity investment in the acquiree before acquiring control, that investment is remeasured to fair value as at the date of gaining control.

20 Procedures to be used in preparing Group Financial Statements 1.Eliminate the equity of the subsidiary at acquisition. 2.NCI in the statement of financial position is made up of:  the amount of NCI at acquisition measured at: either the fair value or the NCI share of the fair value of the acquiree’s identifiable net assets at acquisition date, plus  the NCI’s share of changes in equity since the acquisition date. 3.Total comprehensive income is attributed to the owners of the parent and to the NCI Consolidation procedures including inter-company transactions between group companies

21 The extent to which NCI should bear URP in inter-company transactions – Alternatives: 1. Do not allocate URP to NCI, regardless of whether parent or subsidiary made the sale & the profit As NCI is not part of the group, it should bear no part of the URP adjustment. Because the group & NCI are included in equity, there should be no difference in treatment for controlling & non-controlling interest. The argument is that the NCI is affected only if the profit or loss of a subsidiary is affected & therefore NCI should bear its share of the URP only if a subsidiary made the sale & the profit. 2. Allocate URP to the group & NCI in proportion, regardless of whether parent or subsidiary made the sale & the profit 3. Allocate URP to the group & NCI in proportion only if the subsidiary made the sale & the profit – if the parent made the sale & the profit the whole of URP adjustment is borne by the group it is best to adopt this alternative

22 How to Account for URP? Here are some CJs (consolidation journals) First: eliminate the whole of inter-company sales/purchases: DrRevenueX Cr Cost of salesX There is no effect on consolidated gross profit. Second: calculate the URP on goods that remain in the inventory of the buying company at the year- end. Third: eliminate the whole of the URP: DrCost of salesX Cr Inventory in the statement of financial positionX Fourth: calculate the deferred tax (DT) on the URP as URP x tax rate. Tutorial note: URP adjustments on consolidation give rise to temporary differences (TDs) in consolidated accounts. This is because the SOFP carrying value of inventory reduces but there is no change in the tax base of inventory. Accordingly, a deductible TD arises and this gives rise to a DT asset that should be recognised in the consolidated accounts.

23 Fifth: account for the DT on the URP: DrDT AssetX Cr Tax charge in incomeX Sixth: refer to the accounting policy adopted in relation to URP on consolidation. Is NCI to bear its share or not? If not, allocate the profit after tax of the subsidiary to the NCI, without any adjustment: DrConsolidated incomeX Cr NCI in the statement of financial positionX If yes, allocate the profit after tax to the NCI after reducing it by the URP adjustment net of the deferred tax thereon. The reduced profit after tax is: DrConsolidated incomeX Cr NCI in the statement of financial position X Refer to Example on page 406 How to Account for URP?

24 Accounting for associates (IAS 28) The carrying value of associates in the consolidated SOFP under the equity method is calculated as: 1. either: share of equity at the reporting date (plus fair value adjustments at acquisition, where relevant) PLUS any unimpaired goodwill remaining at the end of the reporting period 2.or: cost PLUS share of post-acquisition reserves at the reporting date LESS goodwill impaired and written off since acquisition Accounting for Associates

25 If upstream Reduce profit of associate in consolidated SOCI Reduce asset in consolidated SOFP If downstream Increase cost of sales in consolidated SOCI Decrease carrying value of associate in consolidated SOFP GroupShare onlyGroupShare only Calculate URP

26 Investment in Associate Classification criteria for an Associate Accounting Consider group holdings (Holding of the parent + holdings of all subsidiaries of the parent) Exclude: holding through other associates of the parent. Assess whether the entity has significant influence The existence & effect of potential voting rights are considered while assessing the significant influence, however, in consolidated FS, only the percentage of actual holdings at the year end are considered Goodwill: relating to an associate is included in CV of the investment. The investor discontinues recognising its share of losses in associate: if investor’s share of losses of an associate > the carrying value of the investment in associate. Impairment: Associate’s share of goodwill need not be considered separately for impairment review. Impairment is dealt with under IAS 36. CV of associate includes long term interest that in substance form part of investments e.g. receivables & loans

27 Need for using coterminous year ends and uniform accounting policies when preparing consolidated financial statements is already covered in F7 Financial Reporting. Equity accounting for Associate Investment in associate is:  initially recognised at cost; and  adjusted for the post-acquisition change in the investor’s share of net assets of the investee. The SOCI includes Parent's share of the profit/loss of associate. The following are some important points.  Associate exempt from equity accounting if there is evidence that the investment is acquired and held exclusively with a view to its disposal within twelve months from acquisition and management is actively seeking a buyer.  Discontinue equity accounting from the date significant influence over an associate is lost. To be accounted in accordance with IAS 39 unless it has become a subsidiary.  In the separate financial statements of the investor, investments in associates should be accounted for either at cost or under IAS 39. Refer Example (Joyful Co) on Page 410

28 Types of Joint Venturers Joint Venturers Jointly controlled assets Jointly controlled operations Jointly controlled entities

29 Accounting … Same as associates Jointly controlled entities: two methods Line by line combined results Proportional consolidation Equity method Separate line item method

30 Complex Group Structures Vertical groupMixed group P S1 S2 70% 80% Sub-subsidiary D shaped group: parent also has a holding directly in subsidiaries P S1 S2 70% 80% 20%

31 Refer to Examples (Mixed or Diamond shaped group) on page 419 Refer to Test Yourself 3 on page 420 Refer to Test Yourself 4 on page 420 Refer to Test Yourself 5 on page 421 Refer to Self Examination Question 4 on page 433 Refer to Self Examination Question 6 on page 436 Refer to Self Examination Question 9 on page 440

32 RECAP  Apply the method of accounting for business combinations including complex group structures?  Apply the principles in determining the cost of a business combination?  Apply the recognition and measurement criteria for identifiable acquired assets and liabilities and goodwill including step acquisitions?  Apply and discuss the criteria used to identify a subsidiary and associate?  Determine and apply appropriate procedures to be used in preparing group financial statements?  Apply the equity method of accounting for associates?  Outline and apply the key definitions and accounting methods which relate to interests in joint ventures?`