1. Applying the consolidation method controlled entities
AASB 10 requires the application of the consolidation method
Consolidation – process of preparing single set of financial statements for group of entities under control of one of those entities
Involves combining financial statements of individual entities to show financial position and performance of group as if it were single entity
Group – a parent and it’s subsidiaries
Parent – an entity that controls one or more entities
Subsidiary – an entity that is controlled by another entity

2. Applying the consolidation method
A Ltd
Parent
“control” must exist (more on this later)
B Ltd
Subsidiary
The group is referred to as the “A Ltd Group”

3. Applying the consolidation method
Consolidated financial statements are prepared by
(i) Aggregating (combining), line by line, like items of assets, liabilities, equity, income and expenses
(ii) Adjusting these combined figures for inter- group transactions between entities within the group (covered in following chapters)

4. Applying the consolidation method
Simple consolidation worksheet for the A Ltd group
A Ltd
B Ltd
Consolidation
Current assets
50 000 +
20 000 =
70 000
Non current assets
Total assets
Total liabilities
(80 000)
(30 000)
( )
Net assets

5. Control
Criterion for identifying parent-subsidiary relationship is control
Significant judgement is often required in determining whether control exists
An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee

6. Control
The following three elements are required in order for an investor to have control
1. power over the investee
2. exposure, or rights, to variable returns from its involvement with the investee
3. the ability to use its power over the investee to affect the amount of the investor’s returns.
All three elements must be present for control to exist

7. Control element 1 – Power
Power is defined as existing rights that give the current ability to direct the relevant activities.
Power arises from rights. Most rights arise from a legal contract. Examples in AASB 10 include:
Voting rights
Rights to appoint, reassign or remove members of the investee’s key management personnel
Rights to appoint or remove another entity that participates in management decisions
Rights to direct the investee to enter into, or veto any changes to, transactions that affect the investee’s returns

8. Control element 1 – Power
Rights must be substantive – the holder must have the practical ability to exercise the rights.
Judgment is required in determining whether rights are substantive. Factors to consider per AASB 10 are:
Whether the party that holds the rights would benefit from exercising the rights – eg potential voting rights;
Whether there are any barriers that prevent a holder from exercising rights.
Where multiple parties are involved, whether there is a mechanism in place to enable those parties to practically exercise the rights.

9. Control element 1 – Power
If a right is protective, then the holder does not have power.
Protective rights are designed to protect the interest of the party holding those rights without giving the party power over the entity to which the rights relate.
Example of protective rights include the following:
A lenders right to restrict a borrower from undertaking certain activities
The right of a party holding a non-controlling interest to approve various transactions
The rights of a lender to seize the assets of a borrower in the event of default.

10. Control element 1 – Power
Requires the ABILITY to direct – rather than actually directing.
The ability to direct must be current.
It must be relevant activities that are being directed, that is activities of the investee that significantly affect the investee’s returns.
Power is presumed to exist where an investor owns more than 50% of the voting rights of an entity unless there is evidence to the contrary

11. Control element 1 – Power
Voting rights of less than 50% can result in an investor having power over an investee.
The following factors need to be considered when assessing whether there is power in this case.
Dispersion of other shareholders
probability of shareholders attending meeting lessened by location and by size of share parcels
Attendance at AGMs
e.g. if only 60% of eligible votes attend meeting, 31% can control meeting
Existence of contracts
power by agreement with other investors

12. Control element 1 – Power
Problems relating to having power with less than 50% of the voting rights include:
Temporary control
eg 31% ownership can control if only 60% of eligible votes in attendance at AGM in Year 1, but not if 70% in attendance in Year 2
Friendly relationship can turn un-friendly

13. Control element 1 – Power
Who controls C Ltd?
A Ltd currently actively formulates the policies of C Ltd
B Ltd currently plays no part in the day-to-day management of C Ltd
A Ltd
B Ltd
48%
52%
C Ltd
B Ltd controls C Ltd
Even though A Ltd is currently running the day-to-day operations of C Ltd, B Ltd has the power over C Ltd. At any time that B Ltd disagrees with the management policies of A Ltd it can take control by virtue of its majority voting interests.

14. Control element 1 – Power
Does A Ltd control B Ltd?
A Ltd
20 shareholders each holding < 2% of the voting power. These shareholders rarely attend meetings and vote
45%
B Ltd
Yes.
Based on the history of AGM attendance and dispersion of shareholders it appears that A Ltd exerts power over B Ltd in spite of holding < 50% of the voting rights

15. Control element 1 – Power
Does A Ltd control B Ltd?
A Ltd
3 shareholders each holding 17% of the voting power. These shareholders regularly attend meetings and vote
49%
B Ltd
No.
Based on the history of AGM attendance and involvement of shareholders it appears that A Ltd does NOT exert control over B Ltd.

16. Control element 2 – Exposure or rights to variable returns
The second element of the control definition requires that the investor has the rights to variable returns from the investee.
Examples of returns that can exist in parent-subsidiary relationship include:
Dividends
Obtaining scarce raw materials on priority basis
Gaining access to subsidiary’s distribution network, patents
Economies of scale
Denying or regulating access to subsidiary’s assets to competitors

17. Control element 3 – Ability to use the power to affect returns
The third element requires that the parent have the ability to increase its benefits and limit its losses from the subsidiary’s activities.
Remember, all three elements must be present for control to exist.
No control = no parent-subsidiary relationship = no consolidation.

18. Preparation of consolidated financial statements
AASB 10(paragraph 4) applies to all parents unless they meet all of the following conditions:
it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners do not object to the parent not presenting consolidated financial statements;
its debt or equity instruments are not traded in a public market;
it is not required to file financial statements with a securities commission or other organisation for the purpose of issuing instruments in a public market; and
its ultimate or any intermediate parent produces consolidated financial statements available for public use and comply with AASBs.

19. Presentation of consolidated financial statements
A Limited
NCI
90%
10%
B Pty Ltd
80%
C Pty Ltd
No consolidation required for B + C sub-group if:
10% NCI shareholders in B consent;
B is unlisted - YES in this case as a Pty Ltd company;
B is not issuing instruments in a public market – YES in this case as not possible for a Pty Ltd company to do this; and
A Limited prepares compliant consolidated financial statements

20. Business combinations and consolidation
An acquirer is the combining entity that obtains control of the other combining entities in a business combination.
In most cases the parent will be the acquirer.
Exceptions arise when:
A new entity is formed, which acquires all the shares of previously existing entities (refer Fig 15.5 of text)
A reverse acquisition occurs (refer Figure 15.6 of text)

21. The consolidation process
Before consolidating, it may be necessary to adjust subsidiary’s financial statements where:
1. The subsidiary’s balance date is different to the parent’s. In such cases the subsidiary is required to prepare adjusted financial statements as at the parent’s reporting date.
2. The subsidiary’s accounting policies are different to the parent’s. In such cases the subsidiary is required to prepare adjusted accounts to ensure accounting policies consistent with the parent.
Eg- 30 June vs. 31 December
Eg- cost vs. revaluation methods of accounting for non-current assets

22. The consolidation process
Consolidation involves adding together the financial statements of the parent and subsidiaries and making a number of adjustments:
Business combination valuation entries – required to adjust the carrying amounts of the subsidiary’s assets and liabilities to fair value
Pre-acquisitions entries – required to eliminate the carrying amount of the parents investment in each subsidiary against the pre-acquisition equity of that subsidiary
Transactions between entities within the group subsequent to acquisition date (chapter 17)

23. Consolidation worksheets
Consolidation journals are posted into the consolidation worksheet in “adjustment” columns as follows:
Parent
Subsidiary
Extract only
Add down for sub-totals
All consol. journals recorded in these DR/CR columns
Where there are a large number of journals it is common to number them 1,2,3 etc.
Purpose- to remove the parent’s investment in the subsidiary and the effect of all interentity transactions so that the final column shows an “external view”

24. 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 every time consolidated accounts are prepared

25. Acquisition analysis
An acquisition analysis compares the cost of acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at acquisition to determine whether there is:
Goodwill on acquisition (where cost > FVINA)
Bargain purchase (where cost < FVINA)
Recall that goodwill is an unidentifiable intangible asset that is calculated as a residual value
Also recall that net assets = assets – liabilities = shareholders equity
NOT the book value

26. Acquisition analysis
The FVINA include all identifiable asset and liabiliites of the subsidiary as well as the fair value of any contingent liabilities the acquiree may have.
Recall that contingent liabilities are not recognised in subsidiaries balance sheet- rather they are recorded by way of note disclosure only. AASB3 requires them to be recognised on the acquisition of another business
We commonly determine the FVINA with reference to the equity balances of the subsidiary, rather than the individual asset and liability balances

27. Example – background information
Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2011 for a cash consideration of $400,000
At that time the net assets of Lotech Ltd were represented as follows: $
Share capital
300,000
Retained earnings
50,000
Net assets
350,000
Book value of identifiable net assets (BVINA)

28. Example – background information
When Hitech acquired its investment in Lotech the following information applied:
Land held by Lotech was undervalued by $10,000
A building held by Lotech was undervalued by $45,000. The building had originally cost $100,000 2 years ago and was being depreciated at 10% per year
A contingent liability relating to an unsettled legal claim with a fair value of $3,000 was recorded in the notes to Lotech’s financial statements
The tax rate is 30%

29. Acquisition analysis - no previously held equity interest$
Cost of acquisition
400,000
Book value of net assets
- Share capital
300,000
- Retained earnings
50,000
Total book value of net assets
350,000
Fair value adjustments
- After tax increase in land
7,000
- After tax increase in building
31,500
- After tax recognition of provision for legal claim
(2,100)
Total fair value adjustments
36,400
FVINA
386,400
X %age acquired
100%
Goodwill/(bargain purchase) on acquisition
13,600
BVINA A
10,000 x (1-30%) = 7,000
45,000 x (1-30%) = 31,500
(3,000) x (1-30%) = (2,100) B
A + B - 2
If +ve- goodwill
If –ve- bargain purchase
1 - 2

30. Parent has previously held equity interest
Where control is achieved in stages the previously held equity instruments in the acquiree must be adjusted to fair value prior to performing the acquisition analysis.
This will require additional entries to be made in the parents books.
Consolidation entries will remain unchanged.
Example: Hitech acquired 85% of Lotech on 30 June 2005 and the remaining 15% on 30 June 2011.

31. Worksheet entries at acquisition date -
Business combination valuation entries
If the BV of subsidiary assets and liabilities = 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 (eg internally generated intangibles); or
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

32. Worksheet entries at acquisition date -
Business combination valuation entries
While it is possible for these adjustments to be made directly in the books of the subsidiary, it is likely and common for these adjustments to be made on consolidation
In some cases, other accounting standards prevent the adjustment from being made in the subsidiaries books.
AASB 102 requires all inventory to be recorded at the lower of cost or NRV therefore where the FV of inventory is higher than the cost, such an adjustment may not be made in the subsidiaries books
AASB 138 does not allow the subsidiary to recognise internally generated goodwill.

33. Worksheet entries at acquisition date - Business combination valuation entries
Where the BCVR entry is done in the ARS account in the subsidiary’s books it is recorded in the G/L and therefore automatically carries forward to future periods once entered
BUT
Where the entry is done in the BCVR on consolidation (ie on the worksheet) it must be manually carried forward to future periods

34. BCVR adjustments at acquisition date
Land
Land is undervalued by $10,000
Accordingly, the business combination valuation adjustment required on consolidation at 30 June 2011 (the date of acquisition) is:
DR Land 10,000
CR DTL 3,000
CR BCVR 7,000
30%
70%
This entry will be posted onto the consolidation worksheet- refer slide 20 (Ref 1)

35. BCVR adjustments at acquisition date
Buildings
Buildings must be increased by $45,000.
The buildings in the statement of financial position need to change as follows
AT PRESENT REQUIRED
Buildings at cost 100,000
Accum. depreciation (20,000)
Book value ,000
In sub’s books
On consol.
125,000
125,000
of $45,000
10% depreciation p.a for 2 years
The FV of the asset is considered to be the cost of the asset to the group

36. BCVR adjustments at acquisition date
Buildings
The business combination valuation adjustments required (on consolidation) at 30 June 2011 (the date of acquisition) are:
DR Accum depreciation 20,000
CR Buildings ,000
DR Buildings 45,000
CR DTL ,500
CR BCVR ,500
30%
70%
A SINGLE JOURNAL CAN BE PREPARED AS FOLLOWS:
DR Buildings ,000
DR Accum depn 20,000
CR DTL ,500
CR BCVR ,500
Both of these journals will be posted onto the consolidation worksheet- refer slide 20 (Ref 2)

37. BCVR adjustments at acquisition date
Contingent Liability
Recognising a contingent liability for the first time will result in a liability that has a carrying amount but no tax base. Such adjustments result in a Deferred Tax Asset (DTA)
The business combination valuation adjustment required on consolidation at 30 June 2011 (the date of acquisition) in relation to the contingent liability is:
DR BCVR 2,100
DR DTA
CR Provision for legal claim 3,000
70%
30%
This entry will also be posted onto the consolidation worksheet- refer slide 20 (Ref 3)

38. BCVR adjustments at acquisition date
Goodwill
Goodwill arising on the acquisition is $13,600.
The business combination valuation adjustment required on consolidation at 30 June 2011 (the date of acquisition) in relation to the goodwill is as follows:
DR Goodwill 13,600
CR BCVR ,600
There is not tax effect arising on the recognition of goodwill as goodwill gives rise to an excluded tempreary difference
This entry will also be posted onto the consolidation worksheet- refer slide 20 (Ref 4)

39. BCVR adjustments at acquisition date
The consolidation journals will be posted onto the consolidation worksheet at 30 June 2011 (the date of acquisition) as follows: 1 2
Note consolidated balances 4 3
1, 2, 3, 4
Goodwill, provision and BCVR exist on consolidation only (NIL balance in parent & sub’s books).

40. Pre-acquisition entry at acquisition date
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
By acquiring 100% of the share capital of Lotech, Hitech effectively gained control of all of the individual assets and liabilities of Lotech. It is these balances that should be reflected in the consolidated statement of financial position

41. Pre-acquisition entry at acquisition date
The pre-acquisition entry eliminates the asset “Investment in subsidiary” (in the parent’s books) against the pre-acquisition equity (in the subsidiary’s books)
The pre-acquisition entry required in our example is:
DR Share capital 300,000
DR Retained earnings 50,000
DR BCVR ,000
CR Investment in Lotech 400,000
These figures are taken from the acquisition analysis (refer back to slide 10)

42. Pre-acquisition entry at acquisition date
Note
values
In the equity section of the statement of financial position the sub’s balances have been eliminated in full- group balances = parent’s balances

43. Acquisition analysis – other issues
Note also the impact of the following on the acquisition analysis (covered in textbook but not lecture notes):
Where subsidiary has recorded goodwill at acquisition date (p. 770)
Where subsidiary has recorded dividends at acquisition date (p.771)
Referred to as cum. divs

44. Gain on bargain purchase
A gain on bargain purchase is rare and AASB 10 recommends re-assessment and confirmation of net asset fair values before such a gain is recognised
Assume Hitech paid $360,000 for Lotech.
(Acquisition analysis on following page)
Pre-acquisition entry at 30 June 2011 is:
DR Share capital 300,000
DR Retained earnings ,000
DR BCVR ,400
CR Investment ,000
CR Gain on bargain purchase (P&L) ,400

45. Gain on bargain purchase$
Cost of acquisition
Book value of net assets
- Share capital
300,000
- Retained earnings
50,000
Total book value of net assets
350,000
Fair value (BCVR) adjustments
- After tax increase in land
7,000
- After tax increase in building
31,500
- After tax recognition of provision for legal claim
(2,100)
Total fair value adjustments
36,400
FVINA
386,400
X %age acquired
100%
Gain on bargain purchase on acquisition
360,000
No change
(26,400)
- ve therefore gain - cost < FVINA

46. Worksheet entries subsequent to acquisition date
So far, we have considered the consolidation journals required if a consolidation was being prepared on the acquisition date
How do these journals change if a consolidation is being prepared on a later date?
The business combination valuation adjustment entries may differ due to transactions and events occurring since acquisition
The pre-acquisition entry may also be affected by a number of events

47. Worksheet entries subsequent to acquisition date – BCVR - land
What if, during the year ended 30 June 2013 the land was sold for $250,000?
On sale, Lotech Ltd recognised the following journal
DR Cash 250,000
CR Gain on Sale ,000
CR Land ,000
From a group viewpoint, the Gain on sale was $40,000 (not $50,000) as the carrying value of the land on consolidation was $210,000
Lotech consol. Therefore need to decrease gain on sale on Proceeds consolidation by $10,000. Requires DR to
Book value (200) (210) debit to gain in sale account.
Profit on sale

48. Worksheet entries subsequent to acquisition date – BCVR - land
Until land is sold (30 June 2011 & 30 June 2012)
DR Land ,000
CR DTL 3,000
CR BCVR 7,000
In the year the land is sold (30 June 2013)
DR Gain on sale ,000
CR ITE ,000
CR Transfer from BCVR (R/E) 7,000
In future years (2014 >)
No BCVR entry required (no effect on retained earnings)
However, an adjustment is required to the pre-acquisition entry (refer slide 39)
B/S
B/S
P/L TT
P/L
ITE
Inventory adjustments are accounted for in a similar way to land- refer page 777 of text

49. Worksheet entries subsequent to acquisition date – BCVR - buildings
A consequential depreciation adjustment is required in relation to depreciable assets that are revalued to fair value on acquisition of a subsidiary
Required as the subsidiary is continuing to depreciate the asset based on its cost, which is lower than the fair value
From a consolidated perspective, the depreciation charge is understated
In relation to the buildings, the adjustment is calculated as shown on the following slide

50. Worksheet entries subsequent to acquisition date – BCVR - buildings
Lotech
Group
Difference
Carrying amount at date of acquisition
80,000
125,000
45,000
Remaining useful life
8 years
Annual depreciation
10,000
15,625
5,625
5,625pa additional depreciation expense required on consolidation

51. Worksheet entries subsequent to acquisition date – BCVR - buildings
On 30 June 2012 (1 year after acquisition) the original entry on slide 17 PLUS the following entries are required:
DR Depreciation expense 5,625
CR Accum depreciation 5,625
Over the next eight years we are also required to progressively reverse the DTL created with the original valuation adjustment. The following journal must also be processed on consolidation
DR DTL 1,687.5
CR ITE 1,687.5 TT
ITE

52. Worksheet entries subsequent to acquisition date – BCVR - buildings
On 30 June 2013 (two years after acquisition) the original entry on slide 17 PLUS the following entries are required:
DR Depreciation expense 5,625
DR Retained earnings 5,625
CR Accum depreciation 11,250
DR DTL 3,375
CR ITE 1,687.5
CR Retained earnings 1,687.5
2013 expense
2012 expense
2013 adj
2012 adj

53. Worksheet entries subsequent to acquisition date – BCVR - contingent liability
On 1 January 2012 the legal claim was settled for $2,000.
On settlement, Lotech Ltd will recognise the following journal
DR Expense - legal fees 2,000
CR Cash 2,000
As the liability no longer exists, it should not continue to be carried forward on consolidation. The business combination valuation adjustment must recognise the settlement and any gain/(loss) on settlement.
Liability recognised 3,000
Cost to settle ,000
Gain on settlement 1,000 - overprovision

54. Worksheet entries subsequent to acquisition date – BCVR - contingent liability
Until settlement (30 June 2011)
DR BCVR 2,100
DR DTA
CR Provision for legal claim 3,000
In the year the liability is settled (30 June 2012)
DR Transfer from BCVR 2,100
DR ITE
CR Expense – legal fees 2,000
CR Gain on settlement 1,000
In future years (2013 >)
No BCVR entry required (no effect on retained earnings)
However, an adjustment is required to the pre-acquisition entry (refer slide 39)
B/S
B/S
P/L
Remove expense in sub’s books
P/L
P/L
Overprovision

55. Worksheet entries subsequent to acquisition date – BCVR – goodwill impairment
On acquisition the balance of goodwill was $13,600
On 30 June 2012, goodwill is assessed to have a recoverable value of $13,000. The goodwill is considered to be impaired. It is therefore necessary to reduce the value of goodwill
This would be done by preparing the journal on slide 19 PLUS the following journal at 30 June 2012:
DR Impairment expense 600
CR Goodwill – accum impairment losses 600
In future years the following entry would be required:
DR Retained earnings 600
CR Goodwill – accum. Impairment losses 600
P/L
B/S

56. Changes to pre-acquisition entry
The pre-acquisition entry is required every time a consolidation is completed and does not change, except under the following circumstances
When a bonus share dividend is paid from pre-acquisition equity;
Transfers between pre-acquisition retained earnings and reserves (including BCVR, general reserve)

57. Changes to pre-acquisition entry – transfers of pre acquisition reserves
When a transfer of pre-acquisition reserves is made subsequent to acquisition a change is required to the pre-acquisition elimination entry
Consider the sale of the land in the example which was subject to a fair value adjustment
The journals on the following slide show how the sale of the land would have affected the pre-acquisition entry
Note that other types of reserve transfers (eg general reserves) are dealt with in the same way as BCVR transfers

58. Changes to pre-acquisition entry – transfers of pre-acquisition reserves
In the year the land is sold (30 June 2013)
DR Share capital 300,000
DR Retained earnings 50,000
DR BCVR ,000
CR Investment ,000
DR Transfer from BCVR(R/E) 7,000
CR BCVR ,000
In future years (2014 onwards)
DR Share capital 300,000
DR Retained earnings ,000
DR BCVR ,000
CR Investment ,000
50, ,000
50,000 – 7,000

59. Other issues Also covered in chapter 16
16.6 Revaluations in the records of the subsidiary at acquisition date
16.7 Disclosures
16.8 Reverse acquisitions