Introduction of Group Accounts A122 1

CHAPTER 5

BUSINESS COMBINATION AND GROUP FINANCIAL STATEMENTS (MFRS 3 & MFRS 10)

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LEARNING OUTCOMES

Explain regulatory requirement for consolidation and exemption from liquidation

Explain basic structure of parent-subsidiary relationship

To record consolidation at acquisition date.

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INTRODUCTION

Business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. (MFRS 3: B5)

An acquirer might obtain control of an acquiree in a variety of ways, for example: (a) by transferring cash, cash equivalents or other assets

(including net assets that constitute a business); (b) by incurring liabilities; (c) by issuing equity interests; (d) by providing more than one type of consideration; or (e) without transferring consideration, including by

contract alone (see paragraph 43).

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INTRODUCTION

Group a parent and its subsidiaries.

Consolidated financial statements the financial statements of a group in which

the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

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REGULATORY FRAMEWORK

Companies Act 1965:

Ninth Schedule Requirements

Ninth Schedule Exemptions

MFRS 3 - Business Combinations

MFRS 10 – Consolidated Financial Statements

MFRS 127 – Separate Financial Statements

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Strd Title Effective Date

Issuance Date

MFRS 3 Business Combination

1 Jan 2012 19 Nov 2011

MFRS 127 Consolidated and Separate Financial Statements *

1 Jan 2012 19 Nov 2011

MFRS 10 Consolidated Financial Statement

1 Jan 2013 19 Nov 2011

MFRS 127 Separate Financial Statements (IAS 27 as amended by IASB in May 2011)

1 Jan 2013 19 Nov 2011

MFRS

* Will be superseded by MFRS 127 Separate Financial Statements (IAS 27 as amended by IASB in May 2011) and MFRS 10

Consolidated Financial Statements with effect from 1 Jan 20136

REGULATORY FRAMEWORK… (cont.)

Requirement to consolidation:

Company Act, 1965

Require every holding company to annex a consolidated profit and loss accounts to its profit and loss account, and a consolidated balance sheet to its balance sheet.

Parent-subsidiary relationship: Section 5 (1), Section 5 (2), Section 5 (3)

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REGULATORY FRAMEWORK (cont..)


Company Act, 1965 Prohibition on reciprocal shareholdings:

Section 17

Requirement and exemptions: Section 169 (requirements of financial

statements), Section 169(15) (present FS in AGM), Section 168 (financial year of subsidiary

companies must coincide with the financial year of holding company)

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REGULATORY FRAMEWORK (CONT..)


MFRS 10 A parent shall present consolidated

financial statements (para 4) Parent is defined as an entity that has one

or more entities.(Appendix A) Subsidiary is defined as an entity that is

controlled by another entity(Appendix A)

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MFRS 10 An investor controls an investee when it 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(para 6)

Power - existing rights that give the current ability to direct the relevant activities (Appendix A).

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Control (MFRS10 para 7):

An investor controls an investee if and only if the investor has all the following:

a) power over the investee (see para 10–14);

b) exposure, or rights, to variable returns from its involvement with the investee (see para 15 and 16);and

c) the ability to use its power over the investee to affect the amount of the investor’s returns (see para 17 and 18).

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Exemption from consolidation: MFRS 10 Para 4 (a) provides that a parent need

not present consolidated financial statement if:

i. it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners,including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;

ii. its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);

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Exemption from consolidation (cont…):

iii. it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and

iv. its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with International Financial Reporting Standards.

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BASIC PARENT-SUBSIDIARY STRUCTURE

Parent-Subsidiary Relationship (Group Structure exist): A business combination may result in a parent-

subsidiary relationship in which the acquirer is the parent and the acquiree a subsidiary of the acquirer (MFRS 3, Para 6).

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BASIC PARENT-SUBSIDIARY STRUCTURE (CONT..)

Stage/ Piecemeal Acquisition:

business combinations in which one entity obtains control of another entity but for which the date of obtaining control (ie the acquisition date) does not coincide with the date or dates of acquiring an ownership interest (ie the date or dates of exchange).

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Usefulness & Limitations of CFS

Usefullness: Management of parent Shareholder/investors of parent Long-term creditor of parent

Limitation: Non-controlling interest s/h & creditor of subsidiary LHDN CFS may not reveal some info Maybe not meaningful if dissimilar activities May mislead to unsophisticated readers.

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CONSOLIDATION AT ACQUISITION DATE

MFRS 3 (para1) specifies that all business combinations should be accounted for by applying the acquisition method.

Views a business combination from the perspective of the acquirer.

The acquirer purchases net assets and recognizes the assets acquired and liabilities and contingent liabilities assumed, including those not previously recognized by the acquiree.

The acquirer records the assets and liabilities at fair values.

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CONSOLIDATION AT ACQUISITION DATE (CONT..)

Applying the acquisition method involves the following steps:

(a) identifying the acquirer; (b) determining the acquisition date; (c) recognising and measuring the identifiable assets

acquired, the liabilities assumed and any non-controlling interest in the acquiree; and

(d) recognising and measuring goodwill or a gain from a bargain purchase.

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Identifying an acquirer The acquirer is the combining entity that obtains

control of the other combining entities or businesses.

determining the acquisition date

the date on which it obtains control of the acquiree. generally the date on which the acquirer legally

transfers the consideration, acquires the assets and assumes the liabilities of the acquiree—the closing date.

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the cost of the business combination: the fair values, at the date of exchange, of assets given,

liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree;

Acquisition-related costs are treated as acquisition expenses (MFRS 3:para 53) include finder’s fees; advisory, legal, accounting,

valuation and other professional or consulting fees; general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities.

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allocate the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed (include assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements (eg: brand name)

The difference recognised as goodwill

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Example 1 – Cost of Investment:

ABC acquired a 100% interest in the equity capital of WXY SB on 1 January 2013. The purchased consideration was satisfied as follows: An immediate cash payment of RM1,000,000 An amount of RM2,000,000 to be paid on 1 January

2013 An issue of RM1,000,000 ABC’s ordinary shares of

RM1.00 each. These shares have been valued at RM4.00 each by Merchant Bank Bhd., the advisor to the acquisition and agreed upon by the regularity authorities.

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Example (cont..)

Cost incurred that were directly attributable to the acquisition totaled RM500,000 and these have not been paid.

The cost of registration for issuing shares is RM100,000 paid by cash.

ABC’s incremental borrowing cost was 8% per annum.

Required: Calculate the cost of investment and record the related journal entry.

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Solution:

Calculation of COI: Immediate cash consideration 1,000,000PV of deferred consideration (2,000,000 /[1.08]²) 1,715,000Fair value of shares issued (1,000,000 x 4) 4,000,000

Cost of Investment 6,715,000

Journal Entry (ABC Bhd): DR Investment in Subsidiary - WXY 6,715,000

CR Cash 1,000,000CR Deferred liability 1,715,000CR Share capital, at par 1,000,000CR Share Premium 3,000,000

(to record investment in subsidiary company at cost)

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At the date of acquisition, the net asset values of the subsidiary must be stated at their fair values to the parent.

Consolidated adjustments are necessary to revise book values to the fair values. Thus, the revalued amounts of the net assets represent cost to the parent.

Pre-acquisition Adjustments parent's investment in the subsidiary (as stated by purchase

consideration) is cancelled and substituted by the underlying fair value of the net assets of the subsidiary

so that net assets of both companies are added across and presented in aggregates to avoid double-counting in the group accounts.

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Consolidation Adjustment: the investment in subsidiary account (the purchase

consideration) is cancelled against the share capital and pre-acquisition reserves of the subsidiary leaving the balanced as goodwill on acquisition.

Dr. Share Capital xx

Dr. Pre-acquisition reserves xx

Dr. Goodwill xx

Cr. Investment in Subsidiary xx


Preparing group accounts of a parent immediately after it has acquired a subsidiary (as at the date of acquisition)

Consolidation Procedure:1. the investment in subsidiary account (COI)

is cancelled against the share capital and pre-acquisition reserves of the subsidiary.

2. The financial statement of parent & subsidiaries are combined on a line-by-line basis by adding together asset, liabilities, equity, revenue & expenses.

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Consolidation issues:

Goodwill on consolidation

Revaluation of subsidiary’s assets

Non-Controlling interest

Reserves

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GOODWILL

The differences between COI, non-controlling interest (NCI) and the net fair value of the identifiable assets, liabilities and contingent liabilities(NIA) recognised in accordance with Para 36.

Goodwill = COI + NCI – FV of NIA

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GOODWILL (CONT..)

The acquirer shall, at the acquisition date:

recognise goodwill acquired in a business combination as an asset; and

initially measure that goodwill at its cost, (MFRS 3, Para. 51)

After initial recognition, the acquirer shall measure goodwill at cost less any accumulated impairment losses. (MFRS 3, Para. 54)

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Example 2:

Refer example 1, the statement of financial position of WXY SB as at 1 January 2013 was as follows:

RM ‘000Share Capital of RM1.00 each 2,000Reserves 3,000

5,000

Property, Plant & Equipment 4,000Net current assets 3,000Long term loans (2,000)

5,000

GOODWILL (CONT..)

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GOODWILL (CONT..)Example (cont..)

All items are recorded in the accounts are assumed to be recorded at fair values.

Required:

Allocate the cost of the acquisition to the identifiable net assets of WXY SB and calculate the goodwill on consolidation .Prepare consolidation journal entries at acquisition date.

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GOODWILL (CONT..)Solution:

COI, as recorded in ABC Bhd’s accounts(‘000) 6,715

Allocated to net assets (‘000):

Fair value of net assets (5,000)

Goodwill on consolidation 1,715

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GOODWILL (CONT..)

Consolidation journal entry:

DR Share Capital 2,000DR Reserves 3,000DR Goodwill on consol 1,715

CR COI 6,715(to eliminate COI and to recognize GOC)

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Gain from a bargain purchase (Negative goodwill)

If COI is less than FV of NIA the acquirer shall:

reassess the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the combination; (para 36)

recognise immediately (a gain) in profit or loss any excess remaining after that reassessment.(MFRS 3, Para 34)

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The indentifiable assets & liabilities of the acquired entity should be restated to fair value (acquisition date)

The consolidation journal entries depend on whether or not the subsiadiary has made the required adjustments in its own books.

Revaluation of Subsidiary’s Assets

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Example 3:

Refer example 1, the Balance Sheet of WXY SB as at 1 January 2013 was as follows:

RM ‘000Share Capital of RM1.00 each 2,000Reserves 3,000

5,000

Property, Plant & Equipment 4,000Net current assets 3,000Long term loans (2,000)

5,000


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Example (cont..):

Included in the fixed asset of WXY SB was a freehold property at cost of RM1,000,000. At January 1 2013, this property had an open market value of RM2,000,000.

Also, other identifiable assets (granite extraction rights) worth RM500,000 as at 1 January 2013 were not reflected in the accounts.

All other items recorded in the accounts are assumed to be recorded at fair values.

Required: Allocate the cost of the acquisition to the identifiable net assets of WXY SB and calculate the goodwill on consolidation . Show the adjustments to consolidate WXY SB.

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Solution:Book Value Fair Value Differences

Freehold property 1,000,000 2,000,000 1,000,000Intangible assets 500,000 500,000

DR Property, Plant & Equipment 1,000,000Intangible asset 500,000CR Revaluation surplus (pre-acq) 1,500,000

(to adjust book value of net assets to fair value at acquisition date)

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Solution:

COI, as recorded in ABC Bhd’s accounts 6,715,000

Allocated to NIA:

Fair value of PPE 5,000,000Fair value of granite extraction rights 500,000Net current assets 3,000,000Long term loans (2,000,000)Fair value of NIA 6,500,000

Goodwill on consolidation 215,000

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Solution:

Consolidation Journal entry:

DR Share Capital 2,000

DR Reserves 3,000

DR Revaluation surplus 1,500

DR Goodwill on consol 215

CR COI 6,715

(to eliminate COI and to recognize GOC)

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NON-CONTROLLING INTEREST

Exists when the acquirer (Parent) has less than 100% interest in subsidiary. Example: If parent acquired 70% interest in subsidiary, the NCI would be 30%.

any non-controlling interest in the acquiree is measured either: (para 19)

a) at fair value or,

b) at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

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Example 4:

Refer example 1, assuming that ABC acquired 80% interest in WXY Bhd for RM5,100,000 and fair value of the remaining 20% interest was RM1,275,000.

Required:

Prepare the relevant consolidation journal entries at acquisition date using both methods for the treatment of NCI.

NON-CONTROLLING INTEREST (cont…)

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NCI at % of net assets

NCI at fair value

COINCI (*20% x 5,000,000)

5,100,000*1,000,000

5,100,0001,275,000

FV of net identifiable assets

6,100,0005,000,000

6,375,0005,000,000

Goodwill on consolidation

1,100,000 1,375,000

Solution:


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Method: NCI at proportionate share of net assets

Dr Share capital (80% x 2,000,000) 1,600,000 Reserves (80% x 3,000,000) 2,400,000

Goodwill 1,100,000Cr COI 5,100,000

Dr Share capital (20% x 2,000,000) 400,000 Reserves (20% x 3,000,000) 600,000

Cr NCI 1,000,000


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Method: NCI at fair value:Dr Share capital (80% x 2,000,000) 1,600,000 Reserves (80% x 3,000,000) 2,400,000

Goodwill 1,100,000Cr COI

5,100,000

Dr Share capital (20% x 2,000,000) 400,000 Reserves (20% x 3,000,000) 600,000 Goodwill 275,000

Cr NCI 1,275,000


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RESERVES

Reserves could be categorized into two which are capital reserve and revenue reserve.

In preparing CFS, reserves need to be differentiated into 2, that are:

1. Pre-acquisition – arise in subsidiary’s account at the acquisition date. It is not belong to the parent. Need to be eliminated each time when preparing CFS.

2. Post-acquisition – Profit/loss earned by the subsidiary after the date of acquisition. Parent has share in this reserve as its % of ownership interest in the subsidiary.

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RESERVES (CONT..)

Example 5:

LM Bhd acquired 100% interest in MN Bhd. MN Bhd.’s equity is as follows:

Date of Acq. (T0)

RM

1 year after (T1)

RM

Share CapitalRetained EarningRevaluation Reserve

50,00020,00010,000

50,00030,00015,000

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RESERVES (CONT..)

Solution:

Pre-acquisition Reserve (RM)

Post-acquisition Reserve (RM)

Retained EarningRevaluation Reserve

20,00010,000

10,0005,000

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Example 6:

Naga Bhd acquired an 80% interest in Garuda Bhd on 31 December 2012. The acquisition was paid in cash RM300,000 and issued 600,000 new ordinary shares of Naga Bhd for RM1.50 per share with par value RM1.00.

The balance sheet of both company before the date of acquisition are as follow:

CONSOLIDATION OF ACCOUNTS

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Example 6 (cont..):

CONSOLIDATION OF ACCOUNTS (CONT..)

Naga Bhd (RM)

Garuda Bhd (RM)

Assets: Cash 460,000 70,000 Account Receivable 200,000 100,000 Inventories 180,000 120,000 Land 800,000 400,000 Building – net 900,000 600,000 Equipment – net 640,000 280,000 3,180,000 1,570,000 Equity and Liabilities: Ordinary Shares 1,800,000 600,000 Share Premium 300,000 300,000 Retained Profit 880,000 480,000 Long-term Loan - 120,000 Account Payable 200,000 70,000 3,180,000 1,570,000

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Example 6 (cont…):

All Identifiable assets and liabilities of Garuda Bhd are stated at fair value except land which was revalued at RM450,000. The non-controlling interest was fair valued at RM300,000.

REQUIRED:a) Calculate the cost of investment in Garuda Bhd

and prepare the related journal entries to record the cost of investment.

b) Prepare the consolidation journal entries as at 31 December 2012.

c) Prepare a consolidated statement of financial position as at 31 December 2012.

CONSOLIDATION OF ACCOUNTS (CONT..)

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End of the Chapter

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Documents

Introduction of Group Accounts A122 1