ACCT 6010 Advanced Financial Reporting
Class 3: Principles of consolidation
The University of 1
• Financial reporting for groups of companies
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• Alternate concepts of consolidation
• Definition and application of control under AASB 10
The University of 2
LS Class 2 1
Review (cont.)
Have you completed the Class 1 & Class 2 learning checklists?
The University of 3
3.1 Class overview
3.2 Requirement to prepare consolidated financial statements
3.3 Consolidation process – General principles
3.4 Consolidation process – Acquisition analysis
3.5 Consolidation process – Goodwill & gain on bargain purchase
3.6 Consolidation process – Pre-acquisition equity & investment elimination 3.7 Illustrative example: Acquisition analysis & Investment elimination
3.8 Consolidation process – Adjustments subsequent to acquisition
3.9 BlueScope: Goodwill disclosures
The University of 4
LS Class 2 2
Learning Objectives
Learning objectives
After completing this topic students should be able to
1. Explain the meaning of pre- and post-acquisition equity of the acquiree;
2. Calculate and account for goodwill or gain on bargain purchase;
3. Prepare consolidation journals relating to (i) elimination of the investment in subsidiary and pre-acquisition equity; and
(ii) impairment of goodwill.
4. Complete the consolidation worksheet;
5. Prepare a consolidated statement of profit or loss and OCI, statement of changes in equity and statement of financial position;
6. Critically evaluate the impairment and amortisation approaches to account for goodwill
The University of & Videos
– Arthur et al. Chapter 2 (all)
– AASB 3 esp. B86
– AASB 3 BC (Basis for conclusions) – AASB 124
– Supplementary readings on Reading List – Refer also to videos on Canvas:
“Measurement of Goodwill” “Components of Goodwill”
The University of
2.4.1 – 2.4.5
2.4.6- 2.5.2
2.4.6- 2.7.2
LS Class 2
1. Objective of consolidation
– The parent controls the subsidiary. Together they comprise the group
– The group is a single economic entity
– It is useful for users to have information about the assets,
liabilities, revenues, expenses and cash flows of the group.
– The accounting solution?
– Prepare financial statements from the perspective of the group (consolidated financial statements)
– Consolidation is mainly a process of aggregation
– Combining the financial statements of the parent with the
financial statements of its subsidiaries.
The University of 7
1. Objective of consolidation
But it is not that simple.
– Consolidated financial statements must only show the effects of external transactions.
– Transactions within the group are not external transactions from the perspective of the group
– We need to ‘eliminate’ those transactions (Class 4)
– Consequently, the amount of many line items in the CFS will not be equal to the total of the separate financial statements of individual entities within the group
The University of 8
LS Class 2 4
ACCT 6010 Advanced Financial Reporting
Requirement to prepare consolidated financial statements
The University of 9
2 Requirement to prepare Consolidated Financial Statements
The University of 10
LS Class 2 5
2. Requirement to prepare Consolidated Financial Statement (CFS)
AU Corporations Act 2001 (Cth)
– s 292 specifies who must prepare financial statements
– CFS may be required under the law if required by Accounting
Standards (s296).
– Most AASB standards (including AASB10) apply to reporting entities only (unless holding out statements to be general purpose financial statements).
– The Corporations Act does not specify the contents or rules governing the preparation of CFS, but requires compliance with accounting standards.
The University of 11
2. Requirement to prepare CFS (cont.)
CFS are required when:
– A parent entity exists [AASB 10.2(a)] ;
– The parent entity is a reporting entity or prepares general purpose financial statements
[AASB 10.4] ; and
– Either the parent or the group is a reporting entity, or they
both are [AASB 10 Aus4.2]
The University of 12
LS Class 2 6
2. Requirement to prepare CFS (cont.)
A parent is not required to prepare CFS
if all of the following apply:
(a) it is, itself, a wholly owned subsidiary of another parent;
(b) it’s debt is not publicly traded;
(c) It didn’t file its financial statements with a regulatory organisation (such as the ASX); and
(d) The ultimate parent produces CFS
[AASB 10.4a]
The University of 13
A Ltd Group
B Ltd Group
ACCT 6010 Advanced Financial Reporting
Consolidation process – General principles
The University of 14
LS Class 2 7
The University of 15
3. Consolidation Process
3. Consolidation process
– Record individual entities’ financial statements on a worksheet
– Prepare elimination and adjustment entries for:
– acquirer’s investment against pre-acquisition equity
(“business combination elimination”) [AASB10.B86(b)]
– intra-group transactions and balances [AASB10.B86(c)]
– Eliminations and adjustments are made using consolidated journals and a consolidated worksheet.
– Consolidation journals and worksheet DO NOT form part of the accounting records of either the parent or the subsidiary
The University of 16
LS Class 2 8
3. Consolidation Process – Worksheet
Trial bal. Income Expense Net Profit
Asset 1 Asset 2 Total Assets Liabilities
200 60 140
xxx xxx xxx
xxx xxx xxx
Eliminations & Adjustments
A Ltd Group
Vertical 100 aggregation for subtotals
200 and totals xxx
Group trial bal.
Horizontal aggregation for consol. bal.
Trial balances of A and B Ltd
The University of journal entries
3. Consolidation Process – Worksheet (cont.)
Trial bal. Income Expense Net Profit
Total Assets
Liabilities
200 60 140
xxx xxx xxx
B Ltd Eliminations & Adjustments Dr Cr
A Ltd Group
80 aggregation
for subtotals 180 and totals
xxx xxx xxx
Group trial bal.
Horizontal aggregation for individual 60 accounts.
xxx xxx xxx
Trial balances of A and B Ltd
The University of journal entries are posted here
LS Class 2 9
ACCT 6010 Advanced Financial Reporting
Consolidation process – Acquisition analysis
The University of 19
The University of 20
4. Acquisition Method
LS Class 2 10
4. Acquisition method – Acquisition analysis
We apply the requirements of AASB 3 for business combinations (AASB 3 Appenix A)
The method used is referred to as the “acquisition method”.
Step 1: Identify acquirer and acquiree
– Acquirer is the entity that obtains control of the acquiree.
– Acquiree The business or businesses that the acquirer obtains control
of in a business combination.
[AASB 3.8 & Appendix A]
Step 2: Identify acquisition date
– The date that the acquirer gains control of the acquire [AASB 3.8 &
Appendix A]
– Relevant to measurement of fair values and identification of pre- acquisition equity
The University of 21
4. Acquisition method – Acquisition analysis
Step 3: Measure:
– Consideration (C); and
– Fair value of identifiable net assets (FVINA), including some contingent liabilities at that date.
• Measuring FVINA is the focus of the next class
– IF consideration paid does not equal the fair value of identifiable net assets x ownership interest, goodwill or gain on bargain purchase arises [AASB 3.32]
Goodwill = C – FVINA * Ownership interest
The University of 22
LS Class 2 11
4 . Acquisition Method – Goodwill
– If Consideration is greater than FVINA, Goodwill arises: – Recognise as an asset; and
– Test at least annually for impairment [AASB 136.10(b)]
– If Consideration is less than FVINA (unusual), Gain on bargain purchase arises:
– Reassess asset & liability values; then
– Recognise gain as income [AASB 3.34]
In practice, it is very common for C= FVINA (G=0) ØRefer to Arthur et al. section 2.4.4
The University of 23
5. Acquisition Method – Measuring Consideration
The University of 24
LS Class 2 12
5. Acquisition method – Measuring consideration
Consideration can take the form of:
– Other assets, e.g. land (measured at fair value);
– Shares issued (measured at fair value); and/or
– Liabilities incurred by the acquirer to former owners of the acquiree (measured at fair value)
ØRefer to Arthur et al. section 2.4.1 and AASB 3.37
Contingent consideration
Any obligation to pay contingent consideration must be recognised (measured at fair value) [AASB 3.39]
The University of 25
5. Acquisition Method – Measuring FVINA
– Identify and measure the fair value of identifiable net assets and contingent liabilities of acquiree at acquisition date
– Must meet recognition criteria in the Framework
– Contingent liabilities are included in the acquisition analysis and
recognised as part of FVINA if:
(i) fair value can be measured reliably; and
(ii) it represents a present obligation of the acquiree
[AASB 3.23]
The University of 26
[AASB 3.10-11]
v LSQ 2.1 What is the difference between a contingent liability and contingent consideration?
LS Class 2 13
ACCT 6010 Advanced Financial Reporting
Consolidation process – Goodwill & Gain on bargain purchase
The University of 27
5. Acquisition Method: Goodwill or GOBP
What is the economic interpretation of this number?
– Goodwill can in part be explained by synergies.
– Goodwill could, in part, be due to overpayment ØRefer to Olante (2013)
ØRefer to video on Canvas on 6 components of goodwill
Accounting for the GOBP is controversial
– TheUS(SFAS141R)treatmentofthegainissimilar;
– Accounting vs economics: US evidence indicates that the
market does not value GOBP.
ØRefer to Comiskey et al. (2010) The University of 28
LS Class 2 14
5. Acquisition Method: Goodwill or GOBP
Case for recognising goodwill
– What does purchased goodwill represent and how can we justify debiting an asset?
– Yes, if we argue that there was an intangible asset of the subsidiary that was not previously recognized and can now be measured reliably as a consequence of a business transaction (acquisition)
– Does the market agree that the recognition of that asset reflects value?
Ø Refer Jennings et al. (1996);
• Lends support to both debiting an asset and to judgments about impairment (rather than the old accounting approach of amortization).
Ø Refer other short CFO articles
The University of 29
5. Acquisition Method: Goodwill or GOBP
Case against recognising goodwill
– Cannot be separately sold.
– What if management were bad negotiators and paid too much? – Part of goodwill could represent overpayment
ØRefer to Olante (2013)
– What would be a more appropriate classification for this Dr if
this were the case?
– Review the definition of asset again (AASB Framework).
– Does goodwill meet that definition?
The University of 30
LS Class 2 15
ACCT 6010 Advanced Financial Reporting
Consolidation process – Pre-acquisition equity
The University of 31
The University of 32
6. Pre-acquisition equity
LS Class 2 16
6. Pre-acquisition equity
– Pre-acquisition equity is the recorded & unrecorded equity (net assets) of a subsidiary at acquisition date.
– Unrecorded equity & fair value adjustments will be discussed in Class 4.
– We eliminate the investment and pre-acquisition equity on consolidation;
– Any difference is accounted for as goodwill or gain on bargain purchase
The University of 33
6. Pre-acquisition equity
If consideration > Fair value identifiable net assets
Dr Share capital
Dr Retained earnings * Dr Reserves *
Dr Goodwill
Cr Investment in subsidiary
*If the account has a debit balance we eliminate the balance by crediting the account.
The University of consideration < Fair value identifiable net assets
Dr Share capital
Dr Retained earnings * Dr Reserves
Cr Gain on bargain purchase Cr Investment in subsidiary
LS Class 2 17
ACCT 6010 Advanced Financial Reporting
Illustrative example:
Acquisition analysis
& investment elimination
The University of 35
6. Pre-acquisition equity
v Exercise:
Illustrative Example: Acquisition analysis & investment elimination - 100% interest
- Goodwill
Download template from Canvas
The University of 36
LS Class 2 18
ACCT 6010 Advanced Financial Reporting
Consolidation Process - Adjustments subsequent to acquisition
The University of 37
7. Consolidation - Subsequent to acquisition
The University of 38
LS Class 2 19
7. Consolidation - Subsequent to acquisition
A consolidation journal is used to record the adjusting
consolidation journals entries. These are posted to the worksheet
Consolidation elimination and adjustment entries are required for: – Businesscombinationeliminationentry
– Goodwill/GOBP
– Impairment of goodwill, if applicable
– Intra-entitytransactions,ifapplicable.(class4)
IMPORTANT: adjusting consolidation journals entries DO NOT form part of the accounting records of the parent or the subsidiary.
– No permanent record created
– Must be prepared each accounting period
– Some entries must be repeated (or carried forward) in subsequent
The University of 39
7. Consolidation subsequent to acquisition – Goodwill case
Business combination elimination entry:
At Acquisition
Dr Paid up capital
Dr Reserves
Dr Open. retained earnings Dr Goodwill
Cr Investment in Sub
Elimination of pre-acquisition equity and recognition of goodwill
Subsequent periods
Dr Paid up capital
Dr Reserves
Dr Open. retained earnings Dr Goodwill
Cr Investment in Sub
Elimination of pre-acquisition equity and recognition of goodwill
The University of 40
LS Class 2 20
7. Consolidation subsequent to acquisition – GOBP case
Business combination elimination entry:
At Acquisition
Dr Paid up capital
Dr Reserves
Dr Open. retained earnings
Cr Investment in Sub
Elimination of pre-acquisition equity and recognition of gain
Subsequent period
Dr Paid up capital
Dr Reserves
Dr Open. retained earnings
Cr Open. retained earnings
Cr Investment in Sub
Elimination of pre-acquisition equity and recognition of gain
The University of 41
8. Impairment of Goodwill
The University of 42
LS Class 2 21
8. Impairment of Goodwill
– AASB formerly required that purchased goodwill to be amortised over 20 years.
– Systematic, no judgment required, but arbitrary.
– AASB 136 now requires purchased goodwill to be tested annually
for impairment.
– Better matching of income and expenditure however provides management with an opportunity to manipulate profit.
– Impairment of goodwill relating to a subsidiary is one of the adjusting consolidation entries.
– Impairment vs amortisation of goodwill is controversial
The University of 43
8. Impairment of Goodwill (cont.)
Arguments against the impairment approach include:
– Some support the amortisation of goodwill as they argue that purchased goodwill is replaced by internally generated goodwill;
– Impairment testing is too complicated (amortisation is simpler);
– Others like impairment as it gives them information on whether the business combination is working as expected.
– Goodwill (as measured) is positively associated with future perfomance
ØSu and Wells (2014)
ØRefer AASB 136 BC 131A-131G for summary of the
The University of Sydney
LS Class 2 22
8. Impairment of Goodwill - example
A Ltd owns 100% of the share capital of B Ltd. Goodwill on consolidation is $500. At the end of year 1 management assess that goodwill has been impaired by $100; and at the end of year 2, goodwill is further impaired by $80.
Adjusting consolidation entry yr 1
Dr Impairment loss 100 Cr Accum impairment – Goodwill
Adjusting consolidation entry yr 2
Dr Impairment loss DrOpeningretainedearnings 100
Cr Accum impairment – Goodwill
The University of Sydney
v LSQ 2.9: What is the entry in year 3 assuming no impairment in year 3? ____________________________________________________________
ACCT 6010 Advanced Financial Reporting
Case firm:
BlueScope Steel Ltd – Goodwill disclosures
The University of 46
LS Class 2 23
9. Case firm: BlueScope Steel Ltd – Goodwill disclosures
– What is the carrying amount of goodwill?
– Is goodwill a big proportion of intangibles and total assets?
– Was any goodwill written off (impaired) in the most recent reporting period?
– What is the amount of goodwill written off in previous periods?
The University of 47
Next Week: Fair value adjustments and tax effects
- Revise revaluations and accounting for tax effects prior to watching this video
The University of 48
LS Class 2 24
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