HUANG HUAI UNIVERSITY FINANCIAL ACCOUNTING 2 Lecture 2 2009/10 Consolidated Balance Sheets After the Date of Acquisition DR. AZIZ JAAFAR

Last lecture: Definitions & Rules on Group accounts Parent Subsidiary Group Concept of ‘control’ Group balance sheets on the date of acquisition Goodwill Minority interests Fair Value ≠ Book Value of Assets (Revaluation)

Consolidated balance sheets after date of acquisition Lecture covers: Pre- and post-acquisition profits/losses Inter-company balances Unrealised profit on inter-company sales Provision for unrealised profit affecting a minority Uniform accounting policies

Pre- and post-acquisition profits Pre-acquisition profits Made before date parent acquired control Represent net assets at acquisition date Dealt with through Goodwill calculation Post-acquisition profits Made after date of acquisition Include in consolidated income statement

Example – The Bend Group 1 January 2001 Bend acquired 80% of the 10,000 £1 common shares in Stretch for £1.50 per share Investment in Stretch cost £12,000 Retained earnings were £4,000 Fair Value of Non-current assets £600 above book value

Bend & Stretch balance sheets at 31 December 2001 Bend (P) Stretch (S) ASSETS Non-currents assets 26 000 12 000 Investment in Stretch 12 000 - Net current assets 13 000 4 000 NET ASSETS 51 000 16 000 EQUITY Common Share Capital 16 000 10 000 Retained Earnings 35 000 6 000 51 000 16 000

Steps: 1. Calculate Goodwill on consolidation: (Compare the cost of acquisition and the Fair Value of sub’s Net Assets). 2. Calculate Minority Interest 3. Group Assets aggregation 4. Group Capital and Reserves – include parent’s share capital and reserves AND parent’s share of post-acquisition profit.

The Bend Group Goodwill calculation

The Bend Group Minority Interest calculation

The Bend Group asset aggregation

The Bend Group Capital and reserves

The Bend Group balance sheets at 31 December 2001

Inter-company balances Preferred shares held by parent Bonds held by parent Inter-company trading and loan balances Inter-company dividends payable/ receivable

Preferred shares held by parent Preferred shares acquired on the acquisition Represented by net assets at date of acquisition Dealt with through Goodwill Preferred shares not acquired Part of Minority interest

Bonds held by parent Bonds acquired on the acquisition Represented by net assets at date of acquisition Dealt with through Goodwill Bonds not acquired on the acquisition Appear in balance sheet as long-term loan

Inter-company trading and loan balances Reconcile balance in parent with subsidiary Should be the same Timing differences such as cash/stock in transit Update to make balances equal Eliminate the inter-company balances Subsidiary as debtor in parent balance sheet; parent as creditor in subsidiary balance sheet

Inter-company Dividends payable/receivable Dividend declared by subsidiary but not paid Appear in subsidiary’s current liabilities as Dividend Payable In Parent’s account – as Dividend Receivable (Current Assets) In GROUP Balance sheet – cancelled off, i.e., the figure does not appear in the consolidated balance sheet.

Unrealised Profit on inter-company Sales Sales transactions between parents and subsidiaries, specifically on the element of profit that has not been realised by the group if the goods have not been sold on to a third party before the year-end. Example: Big plc. buys £2000 worth of goods for resale and sells them to Small plc. for £2700, making a profit of £700. At year-end, if Small plc. still has these goods in stock, the group has not yet made any profit on these goods and the £700 is therefore said to be unrealised. It must be removed from the group balance sheet by: Reducing the retained earnings of Big plc. by £700; Reducing the inventories of Small plc. by £700.

Example 2 – The Prose Group 1 January 2001 Prose acquired in Verse 80% of the 10,000 £1 common shares for £21,100 20% of Preferred shares for £2,000 10% of the bonds for £900 Retained earnings were £4,000 Fair value of non-current assets was £1,000 above BV

Example – The Prose Group During 2001 Prose sold inventory to Verse for £3,000 This was at cost plus 25% (i.e., mark-up) Half still in inventory at 31 December

Prose and Verse Balance Sheets as at 31 December 2001 – Assets Section PROSE (P) VERSE (S) ASSETS Non-current Assets (including land) 25 920 43 400 Investment in Verse 24 000 - Current Assets Inventories 9 600 4 000 Verse Current Account 8 000 Bond interest receivable 35 Other current assets 1 965 3 350 NET ASSETS 69 520 50 750

Prose and Verse Balance Sheets as at 31 December 2001 – Equity & Liability Section PROSE (P) VERSE (S) EQUITY AND LIABILITIES Common share capital 22 000 10 000 Additional Paid-in Capital 2 000 1 000 Preferred Shares 4 000 8 000 Retained Earnings 30 000 8 500 58 000 27 500 Non-current liabilities Bonds 5 000 7 000 Current liabilities Prose Current Account 8 000 Bond interest payable 350 Other current liabilities 6 520 7 900 NET ASSETS 69 520 50 750

The Prose Group – Goodwill calculation

The Prose Group – Inter-company adjustments

The Prose Group – Minority interest

The Prose Group – Aggregate Assets

The Prose Group – Equity section

The Prose Group – Bonds

The Prose Group – Asset section

The Prose Group – Equity and liability section

Uniform accounting policies Parent and subsidiary to use uniform policies Accounts with year ends within 3 months of each other Subject to adjusting for significant transactions

Purchased Goodwill/ Goodwill on Consolidation Goodwill has an objective valuation when a business is sold. Purchased goodwill is based on transaction with third party at arm’s length Goodwill is recognised by the acquirer as an asset from the acquisition date and is initially measured as the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities. Purchased goodwill should be initially capitalised as assets

Accounting for Goodwill A number of approaches: Capitalisation with annual impairment (IFRS 3) Writing off directly to reserves in the year of acquisition Writing off directly to the income statement in the year of acquisition Amortising the goodwill over its expected life Permanent capitalisation: keeping the goodwill in the balance sheet unchanged (i.e., no amortisation and no impairment) IFRS 3 prohibits the amortisation of goodwill. Instead goodwill must be tested for impairment at least annually in accordance with IAS 36 Impairment of Assets