Webster University - Part 6

INTB 5600 – International Accounting Webster University Vienna

Spring I 2012 Part 6

20/02/2012

1

Dr. Martin Schweiger

Table of Contents

1. Determining the consolidation range

2. Steps in a business combination

3. Consolidation

4. Foreign currency effects

2

Types of investments to be considered

3

As a first step in preparing the consolidated financial statements of a reporting entity it needs to classify its shares in its investee companies or companies in which it has no shares at all but still controls in one of the above categories.

Entity type Method Standard Main criterion Outlook

Fully consolidated entity full consolidation

IAS 27 and

SIC 12 control

control criteria to be

changed by IFRS 10

Entities subject to proportionate

consolidation

proportionate

consolidation/equity method IAS 31 joint control

standard to be replaced by

IFRS 11 and proportionate

consolidation to be

abandoned

Associated companies equity method IAS 28

significant

influence -

Financial instruments amortised cost/fair value IAS 39

neither of the

above

standard to be replaced by

IFRS 9

Control concept – IAS 27 (1/3)

Definition Control under IAS 27.4 requires the following two criteria to be met: (a) the power to govern the financial and operating policies of an entity (b) in order to obtain benefits from its activities. Rebuttable control presumption (IAS 27.13): Control is presumed to exist when a parent owns, directly or indirectly (through subsidiaries) more than half of the voting power of an entity. Additional control presumptions (in cases where the investor holds half or less than half of the voting rights): • investor‘s power (over more than half of the voting rights) established through an arrangement with

another investor, • investor‘s power established through provisions in the investee company‘s bylaws enabling the investor

to govern the investee‘s financial and operating policies, • investor‘s power to appoint or remove the majority of the investee‘s board of directors, • investor‘s power through a majority of votes in the investee‘s board of directors.

4

Indirect control Entities indirectly controlled by the parent company (i.e. through controlled investee companies) need to be included in the consolidation range based on the direct ownership relationship between investee companies. Indirect voting shares in investee companies established through more than one other investee company need to be added together.

Example 1:

Parent company A owns 100 % of the voting shares in company B and 20 % in company C. Company B owns 40 % of the voting shares in company C. Assess whether company A has control over B and/or C.

Parent

company A

100% 20%

B 40% C


5

Potential voting rights

Potential voting rights need to be taken into account when determining whether an investee company is controlled by the investor or not. Potential voting rights need to be currently exercisable. Management’s intention and the parent’s financial possibilities regarding the exercising of such options granting potential voting rights are deemed irrelevant (IAS 27.14 and 27.15). Only in cases in which the potential voting rights lack economic substance can they be ignored. If regulatory approval is required to make the potential voting rights exercisable it depends on whether such approval is deemed a formality (making them currently exercisable) or not (precluding them from being considered currently exercisable).

Example 2:


Parent

company A

45% 20%

B 40% C

Example 3:

Company A and company Z each own 50 % of the voting shares in company B. A acquired a purchase option from B over 25 % of the voting shares in B for a price of EUR 15 per shares. The share price of B currently is EUR 10. The option can be exercised at any time.

A 25% option Z

50% 50%

B


6

Principal – agent relationships

Principal – agent relationships need to be reviewed for their substance. In general voting rights held under a principal – agent relationship are allocated to the principal (e.g. shares held by the agent under a trust agreement).

Example 4:

Trust company T acquired 100 % of the shares in B on behalf of A. Under the trust agreement A sets forth the rules under which T exercises voting rights in B. The trust agreement can be cancelled at any time by A. Assess whether A has control over B.

A (Principal)Trust

agreementT (Agent)

100%

B

Treasury stock Several jurisdictions’ corporate law requires the voting and dividend rights of treasury stock to remain dormant for as long as these shares are held by the entity that has issued such shares or by any of its subsidiaries. Therefore treasury stock reduce the total number of voting shares available in a company and enlarge the voting shares of its shareholders.

Example 5:

Company B is listed on a stock exchange and has repurchased 10 % of its shares. Its main shareholder, company A holds a total of 47 % of B’s shares. The remaining 43 % is free float. Assess whether A has control over B.

A Freefloat

47% 43%

B (10 % treasury

stock)

De facto control De facto control is established when an entity holds significant minority interest enabling it to control another entity without legal arrangements giving it majority voting power. In the absence of clear guidance from the IASB accounting literature suggests de facto control to be taken into account considering all relevant circumstances (KPMG, Insights into IFRS 2011/2012, p 70).

Special Purpose Entities – SIC 12

7

Definition SPEs are entities created to achieve a narrowly defined objective for the benefit of a sponsor. SIC 12 sets forth criteria which require SPEs to be consolidated by the sponsor, irrespective of the fact whether there may be any voting rights or not: (a) The SPEs activities benefit the business needs of the sponsor. (b) The sponsor has the decision-making powers to benefit from the SPEs business. (c) The sponsor receives the majority of benefits from the SPE. (d) The sponsor retains the majority of risks, benefits and ownership of residual interests.

Example 6:

Companies A and B each sell receivables to (legally independent) SPEs X and Y, providing credit enhancement. X and Y sell these receivables on to another SPE Z which issues commercial paper. A bank (M) sponsored SPE Z and provides it with additional credit enhancement (i.e. a second loss guarantee). The receivables in Z are cross-collateralised for the liability Z incurred.

A B

0% portfolio sale 0%

X Y


Z Msponsor + credit

enhancement

Control Concept – IFRS 10

8

Definition IFRS 10 defines three criteria to be met in order for an investor to have control over an investee: (a) The investor has power over the relevant activities of the investee. (b) The investor is exposed to variable returns from ist involvement with the investee. (c) The investor has the ability to use its power to affect the amount of the investor‘s returns.

Power In assessing power the investor needs to examine existing rights (other than protective rights for minority shareholders) which need to be substantial, exercisable and relating to decisions regarding the relevant activities of the investee. Relevant activities are those which significantly affect the investor‘s returns.

Variable returns Variable returns can be both positive and negative (i.e. dividends, fees, tax benefits, residual interest in the liquidation result etc.).

Link between power and variable returns

The link between power and variable returns requires the analysis of principal – agent relationships: • scope of the decision-making authority, • rights held by other parties (e.g. termination rights, limitations for the agent), • remuneration of the agent (i.e. based on his services) • exposure to variability through other interests (i.e. other directly held exposure to the investee).

Effective date IFRS 10 will be effective for business years starting on or after 1 January 2013, early adoption is permitted but requires simulatneous early application of IAS 27 (new), IAS 28 (new), IFRS 10, IFRS 11 and IFRS 12.

Joint Ventures (IAS 31) – Joint Arrangements (IFRS 11)

9

Definition IAS 31 defines a joint venture as an entity, asset or operation that is subject to (a) contractually established (b) joint control. Joint control exists when the strategic financial and operating decisions of the entity are being taken unanimously. Joint control needs to be based on a contractual arrangement.

Accounting IAS 31 permits both proportionate consolidation and equity accounting (see IAS 28) for joint ventures.

Changes through IFRS 11

IFRS 11 (Joint Arrangements) like IAS 31 requires (a) a contractual arrangement and (b) joint control over the activities. IFRS 11 distinguishes between joint operations in which the partners have joint rights in the assets and joint liabilities and joint ventures in which the partners merely hold a residual net interest. Should there be no separate vehicle then an activity is classified as a joint operation. In joint operations every party accounts for its shares in the assets and liabilities, income and expense (similar to proportionate consolidation). In joint ventures the equity method is applied (see IAS 28).

Disclosure IAS 31 holds specific disclosure requirements allowing the reader of the financial statements to identify all assets, liabilities, expenses, income and cash flows from joint ventures if proportionate consolidation is applied. The disclosure requirements to joint arrangements are set forth in a separate standard (IFRS 12).

Table of Contents



3. Consolidation


10

Business Combinations – IFRS 3 (1/5)

11

Definitions A business combination is a transaction through which an acquirer obtains control of one or more businesses. A business is defined as: (a) an integrated set of activities and assets (b) capable of being conducted and managed to provide a return to the investor.

Businesses generally consist of inputs, processes applied to those inputs and the ability to create outputs.

Example 7: Company A acquires three outlet centres in Poland together with the facility and centre management contract. The facility and centre management has operated the outlet centres for several years and has gained unique knowledge and a strong position in the market. Assess whether the acquisition is a business combination or not.

Example 8: Company A acquires a land plot adjacent to one of the outlet centres from a different vendor. It intends to enlarge the outlet centre by 10.000 sqm but still needs to apply for the are to be rezoned as well as a building permit. Assess whether the acquisition is a business combination or not.

Acquisition date The acquisition date is the date on which the acquirer obtains control of the acquiree. Should the acquisition be subject to regulatory approval then the acquisition date coincides with the date of the approval unless the approval is deemed a mere formality. From acquisition date all income, expenses and cash flows become part of the consolidated financials of the acquirer.


12

Acquirer The acquirer is the entity obtaining control over the business of the investee company. For more complex cases IFRS 3.B14s offers indicators as to who the acquirer is: (a) based on the relative size of the combining entities, (b) based on which entity pays in cash for the transaction (whereas the other might just issue shares) and (c) based on the power to determine the new management of the combined entity.

Example 9: Company A is listed on the stock exchange and acquires company B through issuing shares to the owner of company B (company Z) which in turn contributes its shares in B to A. Company Z obtains a controlling stake in A after this transaction. The basic data of both A and B are as follows: Determine the acquirer.

The above criteria need to be applied in determining who the acquirer is in a reverse acquisition. In such a transaction the legal acquirer (issuing shares) is treated as the accounting acquiree and the legal acquiree as the accounting acquirer.

Company Equity Valuation

A 50.0 100.0

B 120.0 200.0


13

Acquisition cost The acquisition cost are the fair value of the consideration transferred (IFRS 3.37). Should the payment of the consideration be deferred then the acquisition cost are discounted to their net present value. Transaction costs are expensed (IFRS 3.53), cost of issuing shares (being part of the considertaion) are subtracted from equity.

Contingent considerations (i.e. earn-out clauses in the contract) need to be taken into account as well when determining the acquisition cost of a business combination (at their fair value). The liability thus incurred is subsequently also measured at fair value.

Identifiable assets acquired and liabilities assumed

IFRS 3 requires identifiable assets acquired and liabilities assumed as part of a business combination to be recognised separately from goodwill if: (a) they meet the definition criteria for assets and liabilities of the framework and if (b) they are exchanges as part of the business combination.

Assets acquired and liabilities assumed in a business combination need to be measured at fair value unless they are deferred taxes (IAS 12), non-current assets held for sale (IFRS 5), retirement obligations (IAS 19).

Intangible assets Aside from the need to determine the fair value of intangible assets already recognised at the level of the acquiree IFRS 3 requires analysis if there are further intangible assets (previously not qualifying for recognition) which need to be recognised separately from goodwill. Unlike IAS 38 IFRS 3 does not require the probability of future economic benefits associated with the intangible asset as a recognition criterion, yet they still need to be identifiable (i.e. based on a contract or on law or separable). Such probabilities only affect the measurement (i.e. fair value) of the intangible asset identified in a business combination.


14

Contingent liabilities Unlike under IAS 37 contingent liabilities of the acquiree need to be accounted for at fair value in a business combination. The probability criterion is irrelevant for the recognition of such liability but affects its fair value.

Example 10: Company A acquires company B for a purchase price of EUR 10 mln. B‘s balance sheet before acquisition looked as follows: The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and liabilities and determine goodwill.

Indemnification Indemnification assets need to be accounted for in a business combination. They result from i.e. vendor guarantees in the acquiree’s purchase contracts.

Measurement period

IFRS 3.45 grants the acquirer a measurement period of 12 months from acquisition date during which the allocation of the cost of a business combination can be adapted insofar as this is not the result of a post-combination event. In such cases the amount of goodwill determined is adjusted accordingly (without influencing net income). After this 12 months period adjustments can only be made as corrections of errors under IAS 8.

Assets 8,000,000.0 Equity 6,500,000.0

Liabilities 1,500,000.0

Total 8,000,000.0 8,000,000.0


15

Goodwill Goodwill is the difference between the purchase price and the adjusted net assets acquired in the business combination. In case the acquirer does not acquirer 100 % in the acquiree goodwill can optionally be calculated based on the difference between the total value of the company and its remeasured equity (full goodwill method) or as the difference between the purchase price paid by the acquirer for his share and the acquiree‘s proportionate remeasured equity.

Example 11: Company A acquires 80 % of company B for a purchase price of EUR 8,5 mln. B was valued at EUR 10 mln but A was willing to pay a control premium of EUR 0,5 mln for its 80 %. B‘s balance sheet before acquisition looked as follows: The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and liabilities and determine goodwill on a proportionate basis as well as under the fair value method.

Assets 8,000,000.0 Equity 6,500,000.0


Total 8,000,000.0 8,000,000.0

Negative goodwill Should goodwill result in a negative amount a reassessment is required by IFRS 3.36 since it is generally assumed that such ‘lucky buy’ is rather rare and probably attributable to an assessment error. If the reassessment leads to the same result (i.e. a negative goodwill or ‘excess’) then the excess is accounted for as profit in net income.

Example 12: Company A acquires 100 % of the shares in company B for EUR 2 mln. B’s remeasured equity amounts to EUR 2.1 mln. Even after reassessing all assets and liabilities of B no error is detected. Calculate the excess and account for it.

Table of Contents



3. Consolidation


16

Consolidation - Technique (1/3)

17

Consolidation Consolidation is the technical process of joining the accounts of the investee companies with those of the investor eliminating ‘redundancies’ through: (a) capital consolidation, (b) debt consolidation, (c) consolidation of income and expense and (d) eliminating profits/losses from transactions within the group.

Illustrative Example 1: Company A acquires 80 % of company B for a purchase price of EUR 8,5 mln. B was valued at EUR 10 mln but A was willing to pay a control premium of EUR 0,5 mln for its 80 %. B‘s balance sheet before acquisition looked as follows: A‘s balance sheet looks as follows: The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and liabilities and determine goodwill on a proportionate basis as well as under the fair value method.

Investment 8,500,000.0 Equity 6,500,000.0


Total 8,500,000.0 8,500,000.0

A

Assets 8,000,000.0 Equity 6,500,000.0


Total 8,000,000.0 8,000,000.0

B

Consolidation – Technique (2/3)

18

Solution to Illustrative Example 1:

The revaluation follows example 10 and 11.



Total 8,500,000.0 8,500,000.0

A

Assets 10,000,000.0 Equity 8,500,000.0

Intangible 1,000,000.0 Liabilities 2,000,000.0

DTA 100,000.0 DTL 600,000.0

Total 11,100,000.0 Total 11,100,000.0

B

Assets 10,000,000.0 Equity 15,000,000.0

Investment 8,500,000.0 Liabilities 4,000,000.0

Intangible 1,000,000.0 DTL 600,000.0

DTA 100,000.0

Total 19,600,000.0 Total 19,600,000.0

A + B

Assets 10,000,000.0 Equity 6,500,000.0

Intangible 1,000,000.0 NCI 1,700,000.0

Goodwill 1,700,000.0 Liability 4,000,000.0

DTA 100,000.0 DTL 600,000.0

Total 12,800,000.0 Total 12,800,000.0

A (consolidated)

Assets Equity -8,500,000.0

Investment -8,500,000.0 Liabilities

Intangible DTL

DTA NCI 1,700,000.0

Goodwill 1,700,000.0

Total -6,800,000.0 Total -6,800,000.0

Consolidation DR CR

Equity 6,800,000.0

Investment 8,500,000.0


Equity 1,700,000.0

NCI 1,700,000.0

The balance sheets of A and B are summed up.

The capital consolidation journal entries are prepared. The ‚redundancies‘ are thus eliminated.

The result is the consolidated financial statement of position of parent company A.

Consolidation (3/3)

19

Solution to Illustrative Example 1 ctd.:

The revaluation follows example 10 and 11.



Total 8,500,000.0 8,500,000.0

A

Assets 10,000,000.0 Equity 8,500,000.0


DTA 100,000.0 DTL 600,000.0

Total 11,100,000.0 Total 11,100,000.0

B

Assets 10,000,000.0 Equity 15,000,000.0


Intangible 1,000,000.0 DTL 600,000.0

DTA 100,000.0

Total 19,600,000.0 Total 19,600,000.0

A + B The balance sheets of A and B are summed up.

The capital consolidation journal entries are prepared. The ‚redundancies‘ are thus eliminated. The full goodwill method only affects goodwill and NCI.

The result is the consolidated financial statement of position of parent company A.

DR CR

Equity 6,800,000.0



Equity 1,700,000.0

NCI 1,700,000.0

Goodwill 300,000.0

NCI 300,000.0



Intangible DTL

DTA NCI 2,000,000.0


Total -6,500,000.0 Total -6,500,000.0

Consolidation

Assets 10,000,000.0 Equity 6,500,000.0

Intangible 1,000,000.0 NCI 2,000,000.0

Goodwill 2,000,000.0 Liability 4,000,000.0

DTA 100,000.0 DTL 600,000.0

Total 13,100,000.0 Total 13,100,000.0

A (consolidated)

Indirect Non-controlling Interest (1/4)

20

Indirect NCI Indirect non-controlling interest (NCI) are encountered in multi-layer group structures with minority shareholders on various levels. It is disputed in accounting literature which percentage to use for the first time consolidation of indirect NCI.

Illustrative Example 2: Company A owns 80 % in company B which it founded together with company Z in 2011. Company A contributed EUR 8 mln and company B EUR 2 mln to B‘s equity. Later in 2011 company B acquires 60 % of company C for a consideration of EUR 5 mln. C‘s asset have a fair value of EUR 6 mln. A, B and C‘s balance sheets at the date of acquisition of C are as follows: At year end C‘s balance sheet is as follows (the increase in equity resulting from the profit from acquistion date to end of December 2011): Account for the acquisition, prepare the consolidated financial statement of position at acquisition date and for the end of 2011.



Total 8,000,000.0 8,000,000.0

A

Assets 4,000,000.0 Equity 3,000,000.0


Total 4,000,000.0 4,000,000.0

C

Assets 4,000,000.0 Equity 3,300,000.0

Liabilities 700,000.0

Total 4,000,000.0 4,000,000.0

C


Cash 5,000,000.0

Total 10,000,000.0 10,000,000.0

B


21


Assets 6,000,000.0 Equity 4,600,000.0


DTL 400,000.0

Total 6,000,000.0 6,000,000.0

C revalued DR CR

Assets 2,000,000.0

DTL 400,000.0

Equity 1,600,000.0

Assets 6,000,000.0 Equity 20,600,000.0


Cash 5,000,000.0 DTL 400,000.0

Total 24,000,000.0 24,000,000.0

A + B + C


Goodwill 2,240,000.0 NCI 3,840,000.0


Cash DTL

Total -10,760,000.0 -10,760,000.0

Consolidation

Assets 6,000,000.0 Equity 6,000,000.0

Goodwill 2,240,000.0 NCI 3,840,000.0

Cash 5,000,000.0 Liabilities 3,000,000.0

DTL 400,000.0

Total 13,240,000.0 13,240,000.0

A consolidated

DR CR

Equity 2,760,000.0



Equity 1,840,000.0

NCI 1,840,000.0

DR CR

Equity 10,000,000.0

NCI 2,000,000.0


The first two journal entries lead to C being consolidated into B, the second to B being consolidated into A. The directly held share between B and C is taken into account when calculating goodwill. This view assumes the group acquiring C rather than the shareholders of A doing so (unity theory).


22

Solution to Illustrative Example 2 ctd.: Comparison of results:

Assets 6,000,000.0 Equity 4,600,000.0


DTL 400,000.0

Total 6,000,000.0 6,000,000.0

C revalued DR CR

Assets 2,000,000.0

DTL 400,000.0

Equity 1,600,000.0

Assets 6,000,000.0 Equity 20,600,000.0


Cash 5,000,000.0 DTL 400,000.0

Total 24,000,000.0 24,000,000.0

A + B + C

The first two journal entries lead to C being consolidated into B, the second to B being consolidated into A. Only the indirect share is taken into account calculating goodwill (Investment of EUR 5.000.000 * 0.8 – Equity of EUR 4.600.000 * 0.8 * 0.6 = goodwill of EUR 1.792.000). The journal entry at the level of B corrects the NCI by the remaining investment account (EUR 1.000.000).


Goodwill 1,792,000.0 NCI 3,392,000.0


Cash DTL

Total -11,208,000.0 -11,208,000.0

Consolidation

Assets 6,000,000.0 Equity 6,000,000.0

Goodwill 1,792,000.0 NCI 3,392,000.0


DTL 400,000.0

Total 12,792,000.0 12,792,000.0

A consolidated

DR CR

Equity 2,208,000.0



Equity 2,392,000.0

NCI 2,392,000.0

DR CR

NCI 1,000,000.0


Equity 10,000,000.0

NCI 2,000,000.0


Position Full Proportionate

NCI 3,840,000.0 3,392,000.0

Goodwill 2,240,000.0 1,792,000.0


23


DR CR

Assets 2,000,000.0

DTL 400,000.0

Equity 1,600,000.0

All journal entries (revaluation and consolidation need to be carried forward (for as long as the entities are being consolidated). The profit at the end of 2011 in company C needs to be allocated to NCI (300.000 x (1 – 0.8 x 0.6) = 156.000) and the shareholders of the parent company (300.000 – 156.000 = 144.000). Both above described methods use the indirect quota for subsequent changes in the subsidiary’s equity unrelated to transactions with the shareholders.

DR CR

Equity 2,208,000.0



Equity 2,392,000.0

NCI 2,392,000.0

Assets 6,000,000.0 Equity 4,900,000.0

Liabilities 700,000.0

DTL 400,000.0

Total 6,000,000.0 6,000,000.0

C revalued

Assets 6,000,000.0 Equity 20,900,000.0


Cash 5,000,000.0 DTL 400,000.0

Total 24,000,000.0 24,000,000.0

A + B + C

Assets 0.0 Equity -14,756,000.0

Goodwill 1,792,000.0 NCI 3,548,000.0

Investment -13,000,000.0 Liabilities 0.0

Cash 0.0 DTL 0.0

Total -11,208,000.0 -11,208,000.0

Consolidation

Assets 6,000,000.0 Equity 6,144,000.0

Goodwill 1,792,000.0 NCI 3,548,000.0


DTL 400,000.0

Total 12,792,000.0 12,792,000.0

A consolidated

DR CR

Equity 10,000,000.0

NCI 2,000,000.0


Equity 156,000.0

NCI 156,000.0

Debt, Income and Expense Consolidation

24

Technique Debt, income and expense incurred from group transactions need to be eliminated in consolidated financial statements. Any differences need to be taken directly to income and will be reversed in subsequent period.

Example 11: Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In addition to the equity A granted a loan of EUR 10 mln for the acquisition of assets by B at the beginning of 2011. The loan bears 10 % interest per annum. A and B‘s financials at the end of 2011 are as follows: Prepare the year end journal entries and consolidate both companies.


IC loan 11,000,000.0

Total 13,000,000.0 13,000,000.0

A

Assets 12,000,000.0 Equity 1,000,000.0

IC loan 11,000,000.0

Total 12,000,000.0 12,000,000.0

B

Operating income 0.0

Interest income 1,000,000.0

Tax (current) -250,000.0

Net income 750,000.0

A - income statement


Interest expense -1,000,000.0

Tax (deferred) 250,000.0

Net income -750,000.0

B- income statement

Elimination of Inter-Group Profits

25

Technique Inter-group profits, resulting from transactions within the group, need to be eliminated in full.

Example 12: Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an office building (IAS 40 fair value model applied) to B at a price of EUR 5 mln. The fair value at the end of 2010 was EUR 4 mln. The fair value at the end of 2011 is EUR 4.5 mln (not yet accounted for). Prepare the year end journal entries and consolidate both companies.


Cash 750,000.0

Total 2,750,000.0 2,750,000.0

A

Assets 5,000,000.0 Equity 2,000,000.0

Debt 3,000,000.0

Total 5,000,000.0 5,000,000.0

B

Operating income 1,000,000.0

Interest income 0.0




Proportionate consolidation

26

Illustrative Example 3: Company A acquires 30 % of the shares in company B together with Y (30 %) and Z (40 %) for EUR 3 mln. A, Y and Z concluded a contract before acquiring all the shares in B to establish a joint venture, i.e. to ensure all strategic and operational decisions are sanctioned unanimously by the new shareholders. The fair value of B‘s asset is EUR 8 mln, the tax rate is 20 %. A and B‘s balance sheet at acquisition date are as follows: Prepare the consolidation journal entries and consolidate B and A using proportionate consolidation.


Total 3,000,000.0 3,000,000.0

A

Assets 5,000,000.0 Equity 5,000,000.0

Total 5,000,000.0 5,000,000.0

B


Assets 8,000,000.0 Equity 7,400,000.0

DTL 600,000.0

Total 8,000,000.0 8,000,000.0

B revalued

Assets 2,400,000.0 Equity 2,220,000.0

DTL 180,000.0

Total 2,400,000.0 2,400,000.0

B revalued (30 %)

Assets 2,400,000.0 Equity 5,220,000.0

Investment 3,000,000.0 DTL 180,000.0

Total 5,400,000.0 5,400,000.0

A + B revalued (30 %)

DR CR

Asset 3,000,000.0

Equity 2,400,000.0

DTL 600,000.0

Goodwill 780,000.0 Equity -2,220,000.0

Investment -3,000,000.0 DTL

Total -2,220,000.0 -2,220,000.0

A + B revalued (30 %) consolidation

Goodwill 780,000.0 Equity 3,000,000.0

Asset 2,400,000.0 DTL 180,000.0

Total 3,180,000.0 3,180,000.0

A consolidated

DR CR

Equity 2,220,000.0

Goodwill 780,000.0


Please note that the analogous application of the rules of IFRS 3 for acquisition accounting is disputed in accounting literature.

Table of Contents



3. Consolidation


27

Foreign Currency Translation – IAS 21

28

Definitions IAS 21.8 defines (a) functional currency as the currency of the primary economic environment of the group and (b) reporting currency as the currency in which the separate and consolidated financial statements are

presented.

The following needs to be taken into account when determining the functional currency: (a) the currency mainly influencing sales prices for goods and services, (b) the currency mainly influencing labour, material and other costs, (c) the currency in which financing is obtained and (d) the currency in which operating cash flows are obtained.

Methodology In practice most reporting entities define their subsidiaries as foreign operations (i.e. the local currency being the functional currency). All further examples will only refer to this method. Exchange rate at reporting date: assets, liabilities Average exchange rate: income, expense Historical exchange rate: equity, goodwill Please not that average exchange rate is a well accepted facilitation used instead of exchange rates at the date(s) of the transaction(s). Any difference in translating foreign operations are taken directly to other comprehensive income (currency translation reserve). Upon disposal of the subsidiary the accumulated currency translation reserve is either expensed or reclassified as income.

Translation Technique (1/2)

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Illustrative Example 4: Company A acquires 80 % of the shares in company B for EUR 9 mln. The fair value of B‘s asset is EUR 8 mln (LC 15.2 mln), the tax rate is 20 %. A (EUR) and B‘s (LC) balance sheet at acquisition date are as follows: The exchange rate at acquisition date is 1,9 (EUR 1 = LC 1,9). At year end B‘s balance sheet is as follows: The average exchange rate is 1,8, the exchange rate at year end 2.1. Prepare the consolidation journal entries and consolidate B and A.


Revaluation for acquisition accounting is done in LC.

Assets 8,000,000.0 Equity 8,000,000.0

Total 8,000,000.0 8,000,000.0

B (LC)

Assets 15,200,000.0 Equity 13,760,000.0

DTL 1,440,000.0

Total 15,200,000.0 15,200,000.0

B (LC revaluation) LC DR CR

Asset 7,200,000.0

Equity 5,760,000.0

DTL 1,440,000.0

Assets 8,000,000.0 Equity 7,242,105.3

DTL 757,894.7

Total 8,000,000.0 8,000,000.0

B (EUR revalued) B’s balance sheet is translated into EUR at acquisition date using the exchange rate of 1,9.

Assets 8,000,000.0 Equity 9,000,000.0

Goodwill 3,206,315.8 NCI 1,448,421.1

DTL 757,894.7

Total 11,206,315.8 11,206,315.8

A consolidated EUR DR CR

Equity 5,793,684.2



Equity 1,448,421.1

NCI 1,448,421.1

B is consolidated into A at acquisition date. These journal entries need to be carried forward (!).


Total 9,000,000.0 9,000,000.0

A (EUR)

Assets 7,470,000.0 Equity 8,000,000.0

Loss -530,000.0

Total 7,470,000.0 7,470,000.0

B 31 Dec. (LC)

Translation Technique (2/2)

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Revaluation journal entry is carried forward.

LC DR CR

Asset 7,200,000.0

Equity 5,760,000.0

DTL 1,440,000.0

EUR DR CR

Equity 5,793,684.2



Equity 1,448,421.1

NCI 1,448,421.1

The consolidation journal entries are carried forward.

Assets 14,670,000.0 Equity 13,760,000.0

Loss -530,000.0

DTL 1,440,000.0

Total 14,670,000.0 14,670,000.0

B 31 Dec. (LC)

The assets and the DTL are translated using the year end exchange rate, profit is translated using the average exchange rate and equity is translated using the historical exchange rate (1,9). The difference is taken to CTA

EUR DR CR

CTA 689,724.3

Equity 689,724.3

Profit 42,063.5

CTA 42,063.5

Assets 6,985,714.3 Equity 7,242,105.3

Loss -294,444.4

CTA -647,660.8

DTL 685,714.3

Total 6,985,714.3 6,985,714.3

B 31 Dec. (EUR)


Goodwill 2,654,536.3 CTA -422,247.3

Investment -9,000,000.0 Loss 58,888.9

NCI 1,260,000.0

DTL

Total -6,345,463.7 -6,345,463.7

Consolidation

EUR DR CR

NCI 58,888.9

Loss 58,888.9

NCI 129,532.2

CTA 129,532.2

Minority interest (20 %) are calculated on the loss (-294.444.4) and the CTA (-647.660.8) and allocated to NCI.

Goodwill is translated using the historic exchange rate. No minorities are taken into account since this example does not use the full goodwill method.

EUR DR CR

CTA 305,363.4

Goodwill 305,363.4Historic Y/E

Goodwill (LC) 6,092,000.0 6,092,000.0

Goodwill (EUR) 3,206,315.8 2,900,952.4

CTA -305,363.4

Assets 6,985,714.3 Equity 9,000,000.0

Goodwill 2,900,952.4 CTA -823,492.1

Loss -235,555.6

NCI 1,260,000.0

DTL 685,714.3

Total 9,886,666.7 9,886,666.7

A consolidated

Appendix B – Solutions to examples

31

Solutions to Examples (1/8)

32

Solution 1: A controls B, therefore the voting shares B holds in C are attributed to the parent company A in determining whether it directly or indirectly controls C. Together with its 20 % voting share in C parent company A controls a total of 60 % of the voting shares in C and as such needs to consolidate C.

Example 1:


Parent

company A

100% 20%

B 40% C

Example 2:


Parent

company A

45% 20%

B 40% C

Solution 2: A does not control B, therefore the voting shares B holds in C cannot be attributed to the parent company A in determining whether it directly or indirectly controls C. A thus consolidates neither of its two investee companies.


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Solution 3: Since the A‘s call option is currently exercisable the 25 % voting potential voting rights are allocated to A which thus controls 75 % of B and is required to consolidate B. The fact that the call option is currently out of the money is irrelevant.

Example 3:

Company A and company Z each own 50 % of the voting shares in company B. A acquired a purchase option from B over 25 % of the voting shares in B for a price of EUR 15 per shares. The share price of B currently is EUR 10. The option can be exercised at any time.

A 25% option Z

50% 50%

B

Example 4:

Trust company T acquired 100 % of the shares in B on behalf of A. Under the trust agreement A sets forth the rules under which T exercises voting rights in B. The trust agreement can be cancelled at any time by A. Assess whether A has control over B.

A (Principal)Trust

agreementT (Agent)

100%

B

Solution 4: T does not own the shares in B and exercise the voting rights in it on its own account but on behalf of the principal A who could at any time terminate this relationship. Therefore the voting rights in B need to be allocated to A.


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Solution 5: B‘s treasury stock reduce the voting shares outstanding to 90 %. A‘s holding 47 % of all voting shares in B therefore increases by another 5,22 % ([47 / 90 – 0,47] x 100 = 5,22) thus totalling 52,22 %. A therefore controls B.

Example 5:

Company B is listed on a stock exchange and has repurchased 10 % of its shares. Its main shareholder, company A holds a total of 47 % of B’s shares. The remaining 43 % is free float. Assess whether A has control over B.

A Freefloat

47% 43%

B (10 % treasury

stock)

Example 6:

Companies A and B each sell receivables to (legally independent) SPEs X and Y, providing credit enhancement. X and Y sell these receivables on to another SPE Z which issues commercial paper. A bank (M) sponsored SPE Z and provides it with additional credit enhancement (i.e. a second loss guarantee). The receivables in Z are cross-collateralised for the liability Z incurred.

A B


X Y


Z Msponsor + credit

enhancement

Solution 6: M needs to consolidate Z due to it absorbing losses if they occur. A consolidates X and B consolidates Y (for the same reasons).


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Solution 7: The acquisition is a business combination. The properties represent the inputs, the facility and centre management activities the processes applied thereon and the items sold the outputs.

Example 7: Company A acquires three outlet centres in Poland together with the facility and centre management contract. The facility and centre management has operated the outlet centres for several years and has gained unique knowledge and a strong position in the market. Assess whether the acquisition is a business combination or not.

Example 8: Company A acquires a land plot adjacent to one of the outlet centres from a different vendor. It intends to enlarge the outlet centre by 10.000 sqm but still needs to apply for the are to be rezoned as well as a building permit. Assess whether the acquisition is a business combination or not.

Solution 8: The acquisition is not a business combination since there are no processes (yet) applied to the input and (again yet) no outputs produced.

Example 9: Company A is listed on the stock exchange and acquires company B through issuing shares to the owner of company B (company Z) which in turn contributes its shares in B to A. Company Z obtains a controlling stake in A after this transaction. The basic data of both A and B are as follows: Determine the acquirer.

Company Equity Valuation

A 50.0 100.0

B 120.0 200.0

Solution 9: B is the accounting acquirer (and the legal acquiree) because of (a) its relative bigger size (200 : 100) and (b) due to the fact that B’s shareholder obtains control over A.


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Solution 10:

Assets and liabilities need to be adjusted to their respective fair values. The so far unrecognised intangible asset is recognised (EUR 1 mln). Since the tax bases of the various items in the balance sheet do not change deferred taxes need to be calculated on all adjustment journal entries. Goodwill is finally calculated as the difference between the purchase price and the revalued equity of the acquiree.

Example 10: Company A acquires company B for a purchase price of EUR 10 mln. B‘s balance sheet before acquisition looked as follows: The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and liabilities and determine goodwill.

Assets 8,000,000.0 Equity 6,500,000.0


Total 8,000,000.0 8,000,000.0

Assets 10,000,000.0 Equity 8,500,000.0


DTA 100,000.0 DTL 600,000.0

Total 11,100,000.0 Total 11,100,000.0

DR CR

Assets 2,000,000.0

Intangible asset 1,000,000.0

Equity 3,000,000.0

Equity 600,000.0

DTL 600,000.0

Equity 500,000.0

Liability 500,000.0

DTA 100,000.0

Equity 100,000.0

Purchase price 10,000,000.0

Equity 8,500,000.0



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Solution 11:

Only 80 % of B‘s equity is offset against the purchase price paid by the aquirer.

Example 11: Company A acquires 80 % of company B for a purchase price of EUR 8,5 mln. B was valued at EUR 10 mln but A was willing to pay a control premium of EUR 0,5 mln for its 80 %. B‘s balance sheet before acquisition looked as follows: The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and liabilities and determine goodwill on a proporationate basis as well as under the fair value method.

Assets 8,000,000.0 Equity 6,500,000.0


Total 8,000,000.0 8,000,000.0

Proportionate goodwill

Purchase price 8,500,000.0

Equity (80 %) 6,800,000.0


Full goodwill A Other Total

Purchase price 8,500,000.0 2,000,000.0 10,500,000.0

Equity (proportion) 6,800,000.0 1,700,000.0 8,500,000.0

Goodwill 1,700,000.0 300,000.0 2,000,000.0

The full goodwill method accounts for the minorities‘ share in goodwill as well. Therefore the purchase price these minorities would have paid to obtain the remaining shares needs to be reduced by the proportionate equity ‚owned‘ by these minorities. The difference is the goodwill allocated to them. In calculating the purchase price for the minorities‘ share the control premium paid by the controlling shareholder A cannot be taken into account.

Example 12: Company A acquires 100 % of the shares in company B for EUR 2 mln. B’s remeasured equity amounts to EUR 2.1 mln. Even after reassessing all assets and liabilities of B no error is detected. Calculate the excess and account for it.

Solution 12: The excess is EUR 0.1 mln (EUR 2 mln – EUR 2.1 mln) and is accounted for as profit in net income.


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Solution 11:

The group interest – and expense need to be eliminated, as well as the group debt. The consolidated group result therefore equals zero.

Example 11: Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In addition to the equity A granted a loan of EUR 10 mln for the acquisition of assets by B at the beginning of 2011. The loan bears 10 % interest per annum. A and B‘s financials at the end of 2011 are as follows: Prepare the year end journal entries and consolidate both companies.


IC loan 11,000,000.0

Total 13,000,000.0 13,000,000.0

A

Assets 12,000,000.0 Equity 1,000,000.0

IC loan 11,000,000.0

Total 12,000,000.0 12,000,000.0

B

Assets 12,000,000.0 Equity 12,000,000.0

Total 12,000,000.0 12,000,000.0

A (consolidated)


Interest income 0.0

Tax (current) 0.0

Net income 0.0

A - consolidated

DR CR

Equity 2,000,000.0


IC loan 11,000,000.0

IC loan 11,000,000.0


Interest expense 1,000,000.0







Interest expense -1,000,000.0

Tax (deferred) 250,000.0

Net income -750,000.0

B- income statement


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Solution 12:

The profit from the sales transaction needs to be eliminated (EUR 5 mln – EUR 4 mln). The taxes paid on that remain in the accounts of A. The fair value change needs to be recorded at the level of B now (EUR 4.5 mln – EUR 4 mln = EUR 1 mln). A‘s consolidated result therefore comprises the change in fair value (EUR 500.000), the deferred tax expense pertaining to that (EUR -125.000) and the income tax paid on the sales transaction of EUR -250.000).

Example 12: Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an office building (IAS 40 fair value model applied) to B at a price of EUR 5 mln. The fair value at the end of 2010 was EUR 4 mln. The fair value at the end of 2011 is EUR 4.5 mln (not yet accounted for). Prepare the year end journal entries and consolidate both companies.


Cash 750,000.0

Total 2,750,000.0 2,750,000.0

A

Assets 5,000,000.0 Equity 2,000,000.0

Debt 3,000,000.0

Total 5,000,000.0 5,000,000.0

B

Operating income 1,000,000.0

Interest income 0.0




Assets 4,500,000.0 Equity 2,125,000.0

Cash 750,000.0 Debt 3,000,000.0

DTL 125,000.0

Total 5,250,000.0 5,250,000.0

A (consolidated)

Operating income 500,000.0

Interest expense 0.0

Tax (deferred) -125,000.0


B- income statement

Operating income 500,000.0

Interest income 0.0



A - consolidated

DR CR

Equity 2,000,000.0


Sales profit 1,000,000.0

Inv. Prop. 1,000,000.0

Inv. Prop. 500,000.0

Fair value gain 500,000.0

DTE 125,000.0

DTL 125,000.0

Appendix C – Homework

40

Homework (1/2)

41

Part 1: Entity A holds 45 %, Entity C 10 % and Entity D 35 % of the voting rights in entity B. Entity B holds treasury stock representing 10 % of voting rights. Local law does not allow voting rights of treasury stock and treasury stock held by subsidiaries. Determine who holds control over B. What would change if A holds 4 % of its 45 % stake as a trustee for D? Part 2: Company A acquires 75 % of the shares in company B for EUR 7 mln. The fair value of B‘s asset is EUR 5 mln (LC 8,5 mln), the tax rate is 20 %. A (EUR) and B‘s (LC) balance sheet at acquisition date are as follows: The exchange rate at acquisition date is 1,7 (EUR 1 = LC 1,7). At year end B‘s balance sheet is as follows: The average exchange rate is 1,6, the exchange rate at year end 2.0. Prepare the consolidation journal entries and consolidate B and A. Additional homework 1: Prepare the above example and prepare it using the full goodwill method. Part 3: Company A acquires 40 % of the shares in company B together with Y (30 %) and Z (30 %) for EUR 5 mln. A, Y and Z concluded a contract before acquiring all the shares in B to establish a joint venture, i.e. to ensure all strategic and operational decisions are sanctioned unanimously by the new shareholders. The fair value of B‘s asset is EUR 7 mln, the tax rate is 20 %. A and B‘s balance sheet at acquisition date are as follows: Prepare the consolidation journal entries and consolidate B and A using proportionate consolidation.


Total 7,000,000.0 7,000,000.0

A (EUR)

Assets 5,000,000.0 Equity 5,000,000.0

Total 5,000,000.0 5,000,000.0

B (LC)

Assets 5,500,000.0 Equity 5,000,000.0

Loss 500,000.0

Total 5,500,000.0 5,500,000.0

B 31 Dec. (LC)


Total 5,000,000.0 5,000,000.0

A

Assets 4,000,000.0 Equity 4,000,000.0

Total 4,000,000.0 4,000,000.0

B

Homework (2/2)

42

Additional homework 2: Company A owns 70 % in company B which it founded together with company Z in 2011. Company A contributed EUR 7 mln and company B EUR 3 mln to B‘s equity. Later in 2011 company B acquires 55 % of company C for a consideration of EUR 6 mln. C‘s asset have a fair value of EUR 7 mln. A, B and C‘s balance sheets at the date of acquisition of C are as follows: At year end C‘s balance sheet is as follows (the increase in equity resulting from the profit from acquistion date to end of December 2011): Account for the acquisition, prepare the consolidated financial statement of position at acquisition date and for the end of 2011. Part 4: Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an industrial plant to B at a price of EUR 3 mln (paying EUR 50.000 in taxes – i.e. the tax rate of 10 %). The book value of this industrial plant in A at the end of 2010 was EUR 2,5 mln (annual depreciation of EUR 200.000). Eliminate the inter group profit and consolidate A and B.



Total 7,000,000.0 7,000,000.0

A


Cash 4,000,000.0

Total 10,000,000.0 10,000,000.0

B

Assets 3,000,000.0 Equity 2,000,000.0


Total 3,000,000.0 3,000,000.0

C

Assets 3,000,000.0 Equity 2,000,000.0

Profit 100,000.0

Debt 900,000.0

Total 3,000,000.0 3,000,000.0

C


Cash 450,000.0

Total 2,450,000.0 2,450,000.0

A

Assets 3,000,000.0 Equity 2,000,000.0

Debt 1,000,000.0

Total 3,000,000.0 3,000,000.0

B

Due date: Friday, February 24, 6 p.m.

Appendix D – Questions

43

Questions

44

125. Name the types of entities one might encounter when determining the consolidation range and elaborate on how they are accounted for. 126. Explain the control concept of IAS 27. 127. What is indirect control and which is its relevance in the context of IAS 27? 128. Explain the function of potential voting rights in the context of IAS 27. 129. Elaborate on the principal-agent problem when determining control under IAS 27 and under IFRS 10. 130. How do treasury stock influence control in the context of IAS 27. 131. Give an example for de fact control. 132. Which are the criteria for consolidating special purpose entities under SIC 12? 133. Explain the control concept in IFRS 10. 134. How are joint ventures accounted for under IAS 31? 135. How are joint arrangements accounted for under IFRS 11? 136. Define business combination and business in the context of IFRS 3. 137. Why is the acquisition date so relevant in the context of IFRS 3? 138. How is the acquirer identified in a business combination? 139. How are transaction cost accounted for in a business combination? 140. Which are the measurement criteria for intangible assets in a business combination? 141. How are contingent liabilities accounted for in a business combination? 142. Explain the purpose and function of the measurement period in IFRS 3. 143. How is goodwill determined? 144. How is a negative goodwill (excess) accounted for? 145. Name the steps in consolidating controlled subsidiaries. 146. Define functional currency and reporting currency. 147. How are foreign operations’ financials translated?

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