Advanced Financial Accounting Chapter 4 Group Reporting III

Advanced Financial Accounting: Chapter 4 Group Reporting III Tan, Lim & Lee Chapter 4 © 2015 1

Learning Objectives 1. 2. 3. 4. 5. 6. Understand the rationale for elimination of investment; Understand the concept of non-controlling interests; Appreciate the alternative measurement basis for non-controlling interests under IFRS 3; Know how to prepare consolidation journal entries relating to goodwill, depreciation and amortization of differences between book values and fair values of identifiable assets, contingent liabilities of acquired subsidiaries and non-controlling interests; Know how to prepare consolidation journal entries to allocate current and past income to non-controlling interests; and Understand the components of non-controlling interests and know how to analytically determine their balances Tan, Lim & Lee Chapter 4 © 2015 2

Content 1. Introduction 2. Elimination of the investment in a subsidiary 3. Effects of amortization, depreciation and disposal of undervalued or overvalued assets and liabilities subsequent to acquisition 4. Accounting for non-controlling interests under IFRS 3 5. Goodwill impairment tests 6. Conclusion Tan, Lim & Lee Chapter 4 © 2015 3

Introduction Recap of chapter 3 • Acquisition method: recognize and measure identifiable net assets at fair value + recognize goodwill – Recognition and measurement principles • Different forms of business combination but in substance they share common features – Acquirer who gains control of one or more businesses – Acquisition of a subsidiary = Acquisition of net assets of the acquiree Tan, Lim & Lee Chapter 4 © 2015 4

Introduction Focus of chapter 4: • Subsequent effects when identifiable net assets are consumed, extinguished or amortized. – Sale, consumption, use or settlement of the assets and liabilities of acquiree should be recorded at fair value – Test for impairment of goodwill • Subsequent effects of acquisition – Demonstrate how consolidation journal entries are passed to record the subsequent effects of acquisition • Accounting for non-controlling interests – Show the balance of the non-controlling interests can be analyzed with respect to three components – Illustrate the consolidation journal entries to recognize non-controlling interest’s share of equity • Accounting for business combinations in multiple periods – Explain the re-enactment process: involving re-enacting certain past consolidation adjusting entries. Tan, Lim & Lee Chapter 4 © 2015 5

Content 1. Introduction 2. Elimination of the investment in a subsidiary 2. Overview of the consolidation process 3. Effects of amortization, depreciation and disposal of undervalued or overvalued assets and liabilities subsequent to acquisition 4. Accounting for non-controlling interests under IFRS 3 5. Goodwill impairment tests 6. Conclusion 7. Appendix 4: Illustrations of non-controlling interests measured as a proportion of acquisition-date identifiable net assets. Tan, Lim & Lee Chapter 4 © 2015 6

Elimination of Investment Account What the parent is paying for Consideration transferred = Eliminated against subsidiary’s share capital and preacquisition retained earnings • Share of book value of subsidiary’s net assets at acquisition date + Share of excess of fair value over book value of identifiable net assets + Goodwill Investment account is eliminated – To ensure that the investment account must be zero – Substituted with subsidiary’s identifiable net assets and goodwill (residual) – Rationale: Avoid recognizing assets in two forms (investment in parent’s statement of financial position and individual assets and liabilities of subsidiary) Tan, Lim & Lee Chapter 4 © 2015 7

Elimination of Investment Account • Investment account is eliminated (Continued) – Pre-acquisition retained earnings or pre-acquisition reserves of subsidiary are not included in consolidated equity • Rationale: Pre-acquisition retained earnings arose prior to the exercise of control by parent – The elimination process will result in residuals comprising of • Goodwill; and • Excess or deficit of fair value over book value of identifiable net assets • Re-enactment of elimination of investment entry in subsequent year – Re-enacted as long as the investment exists • Rationale: parent’s legal entity financial statements would include investment in subsidiary balance Tan, Lim & Lee Chapter 4 © 2015 8

Illustration 1: Elimination of investment Illustration On 8 August 2010, Parent Co. bought 100% interest in subsidiary for $200, 000. At the date of acquisition, Subsidiary Co had the following: Share capital: Retained earnings: Equity: $50, 000 $30, 000 $80, 000 At acquisition date, Subsidiary Co unrecognized intangible assets had a fair value of $50, 000. Tax rate was 20% Tan, Lim & Lee Chapter 4 © 2015 9

Illustration 1: Elimination of investment Parent Subsidiary Consolidation adjustments Dr Consolidated Statement of financial position Cr Assets Investment in Subsidiary 200, 000 Goodwill (Note 2) 200, 000 80, 000 Other net assets (Note 1) 300, 000 80, 000 50, 000 10, 000 420, 000 500, 000 80, 000 130, 000 210, 000 500, 000 Share capital 100, 000 50, 000 Retained earnings 400, 000 30, 000 400, 000 500, 000 80, 000 0 500, 000 Equity 210, 000 Tan, Lim & Lee Chapter 4 100, 000 210, 000 © 2015 10

Illustration 1: Elimination of Investment Note 1: Increase in other net assets due to recognition of intangible assets 50, 000 Decrease in other net assets due to recognition of deferred tax liability (10, 000) Net increase in other net assets 40, 000 Note 2: Goodwill is excess of the investment amount over the FV of identifiable net assets Investment in Subsidiary 200, 000 Book value of equity or net assets (80, 000) Fair value of intangible asset Book value of intangible asset Excess of fair value over book value Deferred tax effects Goodwill Tan, Lim & Lee Chapter 4 50, 000 0 50, 000 (10, 000) (40, 000) 80, 000 © 2015 11

Illustration 1: Elimination of investment CJE 1: Elimination of investment in subsidiary Dr Share capital Dr Retained earnings Dr Goodwill Dr Intangible asset Cr Investment in Subsidiary Cr Deferred tax liability 50, 000 30, 000 80, 000 50, 000 210, 000 200, 000 10, 000 210, 000 Re-enacting CJE • Building blocks of consolidation worksheet are the legal entity financial statements of parent and subsidiary • CJE 1 has to be re-enacted at each reporting date as long as Parent has control over subsidiary • Each consolidation process is a fresh-start approach Tan, Lim & Lee Chapter 4 © 2015 12

Content 1. Introduction 2. Elimination of the investment in a subsidiary 3. Effects of amortization, depreciation and disposal of undervalued 3. Accounting for non-controlling interests under IFRS 3 or overvalued assets and liabilities subsequent to acquisition 4. Accounting for non-controlling interests under IFRS 3 5. Goodwill impairment tests 6. Conclusion Tan, Lim & Lee Chapter 4 © 2015 13

In Subsequent Years • At acquisition date, we recognize: – Fair value of identifiable net assets of acquiree as at acquisition date, – Intangibles, contingent liabilities, – Deferred tax assets or liabilities on the above; and – Goodwill as a residual • In subsequent years: – Subsequent extinguishment of assets and liabilities of subsidiary must be determined based on the fair values at acquisition date. – Therefore, subsequent amortization, depreciation and cost of sales of acquired assets are determined based on fair value as at acquisition date – Elimination of consideration transferred , recognition of fair value adjustments and amortization entries must be repeated until: i. Date of disposal of the investment in subsidiary; or ii. Date when control is lost Tan, Lim & Lee Chapter 4 © 2015 14

In Subsequent Years • In subsequent years (Continued) – Acquisition method only recognizes fair value at critical event: acquisition date • New internally-generated goodwill or subsequent appreciation in fair values are not recognized subsequent to acquisition date – Since net assets are carried at book value in the separate financial statements, the subsequent amortization/depreciation/disposal are adjusted in the consolidation worksheet BV of expense in separate financial statements Tan, Lim & Lee Chapter 4 + (FV- BV) adjustment to expense Adjusted in consolidation worksheet © 2015 = FV of expense in consolidated financial statements 15

Illustration 2: Amortization of Fair Value Differentials • P Co paid $6, 200, 000 and issued 1, 000 of its own shares to acquire 80% of S Co on 1 Jan 20 X 5 • Fair value of P Co’s share is $3 per share • Fair value of net identifiable assets is as follows: Book value Leased property In-process R&D 4, 000 Other assets Liabilities Contingent liability Remaining useful life 5, 000 20 years 2, 000 10 years 1, 900, 000 (1, 200, 000) (100, 000) Net assets 4, 700, 000 Share capital 1, 000 Retained earnings 3, 700, 000 Shareholders’ equity 4, 700, 000 Tan, Lim & Lee Chapter 4 Fair value © 2015 7, 600, 000 16

Illustration 2: Amortization of Fair Value Differentials Additional information: • Contingent liability of $100, 000 was recognized as a provision loss by the acquiree in legal entity financial statement on Dec 20 X 5 • FV of NCI at acquisition date was $2, 300, 000 • Net profit after tax of S Co for 31 Dec 20 X 5 was $1, 000 • No dividends were declared during 20 X 5 • Shareholders’ equity as at 31 Dec 20 X 5 was $5, 700, 000 Q 1 : Prepare the consolidation adjustments for P Co for 20 X 5 Q 2 : Perform analytical check on balance of NCI as at 31 Dec 20 X 5 Tan, Lim & Lee Chapter 4 © 2015 17

Illustration 2: Amortization of Fair Value Differentials • Consideration transferred = Cash consideration + Fair value of share issued = $6, 200, 000 + (1, 000 x $3) = $9, 200, 000 • Deferred tax liability = 20% x ($7, 600, 000 - $4, 700, 000) = $580, 000 • Goodwill = Consideration transferred + NCI – Fair value of net identifiable assets, after-tax = $9, 200, 000 + $2, 300, 000 – ($7, 600, 000 - $580, 000) = $4, 480, 000 Tan, Lim & Lee Chapter 4 © 2015 18

Illustration 2: Amortization of Fair Value Differentials • P’s share of goodwill = Consideration transferred – 80% x Fair value of net identifiable assets, after tax = $9, 200, 000 – 80% x $7, 020, 000 = $9, 200, 000 – $5, 616, 000 = $3, 584, 000 • NCI’s share of goodwill = Consideration transferred – 20% x Fair value of net identifiable assets, after tax = $2, 300, 000 – 20% x $7, 020, 000 = $2, 300, 000 – $1, 404, 000 = $896, 000 Tan, Lim & Lee Chapter 4 © 2015 19

Illustration 2: Amortization of Fair Value Differentials Consolidation adjustments for 20 X 5 CJE 1: Elimination of investment in Subsidiary Dr Dr Dr Cr Cr Share capital 1, 000 Opening retained earnings 3, 700, 000 Leased property 1, 000 In-process R&D 2, 000 Goodwill 4, 480, 000 Contingent liability Deferred tax liability (net) Investment in S Non-controlling interests Tan, Lim & Lee Chapter 4 © 2015 100, 000 580, 000 9, 200, 000 2, 300, 000 20

Illustration 2: Amortization of Fair Value Differentials CJE 2: Depreciation and amortization of excess of FV over book value Dr Dr Cr Depreciation of leased property Amortization of in-process R&D Accumulated depreciation Cr Accumulated amortization Under dep. by $50 k Dep. of $200, 000 leased property Based on book value Tan, Lim & Lee Chapter 4 50, 000 200, 000 Under amort. by $200 k Dep exp: $50, 000 $250, 000 200, 000 Amort exp: $200, 000 Amort. of R&D $ 0 Based on book value Based on FV © 2015 Based on FV 21

Illustration 2: Amortization of Fair Value Differentials CJE 3: Reversal of entry relating to provision for loss Dr Cr Provision for loss 100, 000 Loss expense 100, 000 Note: Contingent liability was already recognized in CJE 1. The recognition by the acquiree in its legal entity financial statement results in double counting; hence this reversal entry is necessary CJE 4: Tax effects on CJE 2 & CJE 3 Dr Deferred tax liability (net) 30, 000 Cr Tax expense Tan, Lim & Lee Chapter 4 © 2015 30, 000 20% * (200 k +50 k -100 k) 22

Illustration 2: Amortization of Fair Value Differentials CJE 5: Allocation of current year profit to non-controlling interests (NCI) Dr Cr Income to NCI 176, 000 Net profit after tax 1, 000 Excess depreciation (50, 000) Excess amortization (200, 000) Reversal of loss from contingent liability 100, 000 Tax effects on FV adjustments 30, 000 Adjusted net profit 880, 000 NCI’s share (20%) 176, 000 Tan, Lim & Lee Chapter 4 © 2015 23

Illustration 2: Amortization of Fair Value Differentials Explanatory note to CJE 5: • NCI have a share in the extinguishment of the initial FV differences and in the impairment of goodwill. • Net profit after tax represents that increase in the book value of equity of the subsidiary • Other adjustments relate to the extinguishment of the FV differentials • NCI have a share of $176, 000 of adjusted profit which represents – Increase in book value – Decrease in fair value differentials Tan, Lim & Lee Chapter 4 © 2015 24

Illustration 2: Amortization of Fair Value Differentials NCI balance: NCI at acquisition date (CJE 1) $2, 300, 000 Income allocated to NCI for 20 x 5 (CJE 5) 176, 000 NCI as at 31 Dec 20 x 5 $2, 476, 000 Tan, Lim & Lee Chapter 4 © 2015 25

Illustration 2: Amortization of Fair Value Differentials Q 2 : Perform an analytical check on the balance of NCI as at 31 Dec 20 X 5 1 st Step: reconstruct the balance of non-controlling interest as at 31 Dec 20 x 5 NCI as at acquisition date (CJE 1) Income allocated to NCI for 20 x 5 (CJE 5) NCI as at 31 December 20 x 5 Tan, Lim & Lee Chapter 4 2, 300, 000 176, 000 2, 476, 000 © 2015 26

Illustration 2: Amortization of Fair Value Differentials 2 nd step: reconcile the balance to the three components that NCI have - Non – controlling interests Share of Unamortized FV adjustment Share of book value of net assets $5, 700, 000 x 20% = $1, 140, 000 Tan, Lim & Lee Chapter 4 + ($1, 000 x 19/20 x 80% x 20%) + ($2, 000 x 9/10 x 80% x 20%) = $440, 000 © 2015 Share of unimpaired goodwill + $896, 000 = $2, 476, 000 27

Content 1. Introduction 2. Elimination of the investment in a subsidiary 3. Effects of amortization, depreciation and disposal of undervalued or overvalued assets and liabilities subsequent to acquisition 4. Accounting for non-controlling interests under IFRS 3 4. Accounting for non-controlling interest under IFRS 3 5. Goodwill impairment tests 6. Conclusion Tan, Lim & Lee Chapter 4 © 2015 28

Non-controlling interest • NCI only arises in consolidated financial statements where: – one or more subsidiaries are not wholly owned by the parent (IFRS 10) • NCI are entitled to their share of retained earnings of the subsidiary from incorporation – No distinction between pre-acquisition and post-acquisition retained earnings for NCI • Same applies to OCI – NCI collectively have a share of accumulated OCI arising from incorporate date to the current date • NCI are normally a credit balance – Share of residual interests in the net assets of a subsidiary – Total equity (parent’s and NCI) = Assets - Liabilities Tan, Lim & Lee Chapter 4 © 2015 29

Non-Controlling Interests’ Share of Goodwill • IFRS 3 Para 19 allows NCI to be measured in either of two ways Non-controlling interests Measured at Fair value at acquisition date (include goodwill) Measured as a proportion of the recognized amounts of the identifiable assets as at acquisition date “ Fair value basis” Tan, Lim & Lee Chapter 4 © 2015 30

Non-Controlling Interests’ Share of Goodwill • Under the fair value basis: – FV is determined by either the active market prices of subsidiary’s equity share at acquisition date or other valuation techniques – FV per share of NCI may differ from parent because of control premium paid by parent (e. g. 20% premium over market price to gain control) – NCI comprises of 3 items: Non – controlling interests Share of book value of net assets Tan, Lim & Lee Chapter 4 Share of unamortized FV adjustment (FV - BV) © 2015 Share of unimpaired goodwill 31

Non-Controlling Interests’ Share of Goodwill • Under the fair value option: – Journal entry to record NCI at fair value (re-enacted each year): Dr Dr Share capital of subsidiary Retained earnings at acquisition date Other equity at acquisition date FV differentials (FV- BV) Dr Dr/Cr Cr Cr Goodwill (Parent & NCI) Deferred tax asset/ (liability) on fair value adjustment Investment in subsidiary FV differentials (BV – FV) Cr Non-controlling interests (At fair value) Tan, Lim & Lee Chapter 4 © 2015 32

Non-Controlling Interests’ Share of Goodwill • Under the 2 nd option: – NCI is a proportion of the acquiree’s identifiable net assets (i. e. not full fair value) – NCI comprises of 2 items: Non – controlling interests Share of unamortized of FV adjustments (FV- BV) Share of book value of identifiable net assets Tan, Lim & Lee Chapter 4 © 2015 33

Non-Controlling Interests’ Share of Goodwill • Under the 2 nd option: – Journal entry to record NCI (re-enacted each year): Dr Dr Dr/Cr Cr Share capital of subsidiary Retained earnings at acquisition date Other equity at acquisition date FV differentials (FV – BV) Goodwill (Parent only) Deferred tax asset/ (liability) on FV adjustment FV differentials (BV – FV) Investment in S subsidiary Non-controlling interests (NCI % x FV of identifiable net assets) Tan, Lim & Lee Chapter 4 © 2015 34

Non-Controlling Interests’ Share of Goodwill NCI measured at FV NCI measured as a proportion of the acquiree’s identifiable net assets Book value of net assets Fair value – Book value of net assets Goodwill Tan, Lim & Lee Chapter 4 © 2015 35

Illustration 3: Non-Controlling Interests’ Share of Goodwill The FV of NCI that owned 10% of Subsidiary A as at 31 Dec 20 x 1(Acquisition date) was $25, 000. The financial statements of Subsidiary A as at acquisition date are as shown below. Subsidiary A had unrecognized intangible assets with fair value of $40, 000. Tax rate is 20%. Determine NCI’s good will as at acquisition date. Subsidiary A’s Statement of Financial Position as at 31 December 20 x 1: Net assets 160, 000 Equity 140, 000 Share Capital 20, 000 Retained Earnings Tan, Lim & Lee Chapter 4 160, 000 © 2015 36

Illustration 3: Non-Controlling Interests’ Share of Goodwill Fair value of NCI 25, 000 Fair value of identifiable net assets Book value of equity Fair value of intangible assets Deferred tax on intangible assets 160, 000 40, 000 (8, 000) NCI's share of FV of identifiable net assets (10%) NCI's goodwill (25, 000 - 19, 200) 192, 000 19, 200 5, 800 Under alternative basis where NCI are measured as a proportion of the recognized amounts of the identifiable assets as at acquisition date: ü NCI’s goodwill is zero ü Amount to be recognized as NCI is $19, 200 only Tan, Lim & Lee Chapter 4 © 2015 37

Accounting for Non-Controlling Interests under IFRS 3 • In consolidation, non-controlling interests have a share of: ü ü ü ü Profit after tax Dividends declared Share capital Retained earnings and other comprehensive income (eg. Revaluation reserve) at acquisition date Change in retained earnings and other comprehensive income from the date of acquisition to the current period Fair value differential of a subsidiary’s net assets at acquisition date Subsequent extinguishment of the different between the fair value and book value of identifiable net assets; and Goodwill (if the fair value alternative is adopted) Tan, Lim & Lee Chapter 4 © 2015 38

Reconstructing NCI on Statement of Financial Position Incorporation Date of acquisition date Beginning of current year End of current year NCI have a share of 1. Share capital 1. Change in share capital 1. Profit after tax 2. Retained earnings 2. 3. Other equity Change in retained earnings Current amortization of fair value differential 4. Fair value differentials 3. Change in other equity 3. 4. 5. Goodwill Past amortization of fair value differential Current impairment of goodwill 4. 5. Past impairment of goodwill Dividends as a repayment of profits 5. Change in other equity Tan, Lim & Lee Chapter 4 © 2015 39

Reconstructing NCI on Statement of Financial Position • At each reporting date, group will re-create NCI account in the consolidated financial statement by recognizing the sequential build up: – As of acquisition date – From acquisition date to beginning of the current period – During the current period • Known as the “re-enactment process” of the attribution of equity to NCI Tan, Lim & Lee Chapter 4 © 2015 40

Allocation to Non-controlling Interests 1. Allocation of the change in equity from date of acquisition to the beginning of the current period Dr Retained earnings (NCI % x in RE from acquisition date to beginning of current period) Cr NCI • No distinction between pre-acquisition or post-acquisition profits • To transfer the NCI’s share of subsidiary’s retained earnings to NCI Tan, Lim & Lee Chapter 4 © 2015 41

Allocation to Non-controlling Interests 2. Allocation of current profit after tax to NCI Dr Income to NCI Cr NCI • Attribution of profit to NCI is not expense item and should not be shown above the profit after tax line • Without attribution, retained earnings of the group would be over-stated and NCI’s share of equity would be under-stated • The same attribution principle applies to Other Comprehensive Income (OCI) – NCI are attributed their share of OCI arising during a period ü Examples: Revaluation surplus or deficit on property, PPE and intangible assets etc. Tan, Lim & Lee Chapter 4 © 2015 42

Allocation to Non-controlling Interests 3. Allocation of dividends to NCI • • • Reverses the profit and loss effects of dividends in consolidated income statement A repayment of profits by a subsidiary Reduces the NCI’s residual stake in the net assets of the subsidiary Dr Dr Cr Tan, Lim & Lee Chapter 4 Dividend income (Parent) NCI (Equity) Dividends declared (Subsidiary) © 2015 43

Can NCI be a debit balance? • IFRS 10 paragraph B 94 (Appendix B) requires NCI to have a debit balance if: – NCI share of losses > NCI existing share of the subsidiary’s share capital, retained earnings and other equity items • Departure from an earlier version of IAS 27 that requires NCI to be carried at zero balance – Losses being borne by majority shareholders unless the NCI have binding obligation to make further investments to make good the losses • Opposing views on NCI being a debit balance – Parent who has control of subsidiary should bear the responsibility of supporting an insolvent subsidiary – Limited liability argument: NCI stand to lose only their investment and have no legal obligation to bear any further losses Tan, Lim & Lee Chapter 4 © 2015 44

Can NCI be a debit balance? • IASB’s support for NCI to be a debit balance – NCI participate proportionally in the risks and rewards of a subsidiary – Limited liability argument: Parent stand to lose only their investment and have no legal obligation to bear any further losses in the absence of guarantees Tan, Lim & Lee Chapter 4 © 2015 45

Analytical check on Non-controlling Interests’ balance • If the fair value basis is adopted – NCI in a subsidiary have a share in the same three components that the parent has under the acquisition method • If NCI are recognized as proportion of FV of identifiable net assets – Only two components apply to non-controlling interests • Share of book value of net assets or shareholders’ equity of a subsidiary • Share of the balance of unamortized fair value adjustments • If NCI have both present ownership interests (e. g. ordinary shares) and potential ownership interests (e. g. options) – Only present ownership interests may be measured as a proportion of identifiable net assets Tan, Lim & Lee Chapter 4 © 2015 46

Analytical check on Non-controlling Interests’ balance NCI’s share of (NCI % multiply by): NCI’s balance at year-end = a) Book value of net assets of subsidiary at year-end +/- unrealized profit/loss from upstream sale b) Unamortized balance of FV adjustments at year-end c) Unimpaired balance of goodwill at year end ([Acquisition-date FV of NCI – NCI % x acquisition-date FV of identifiable net assets] less any cumulative impairment) Tan, Lim & Lee Chapter 4 © 2015 47

Content 1. Introduction 2. Elimination of the investment in a subsidiary 3. Effects of amortization, depreciation and disposal of undervalued or overvalued assets and liabilities subsequent to acquisition 4. Accounting for non-controlling interest under IFRS 3 5. Goodwill impairment tests 6. Conclusion Tan, Lim & Lee Chapter 4 © 2015 48

Goodwill Impairment Test • IAS 36: Goodwill has to be reviewed annually for impairment loss – Reviewed as part of a cash-generating unit (CGU) • CGU is the lowest level at which the goodwill is monitored for internal management purposes and • Not larger than a segment determined under IFRS 8 Operating Segments – Goodwill be allocated to each of the acquirer’s CGU, or group of CGUs Tan, Lim & Lee Chapter 4 © 2015 49

Goodwill Impairment Test 1. Carrying amount: – – 2. Net assets of the cash-generating unit It includes entity goodwill attribute to parent and NCI Recoverable amount: – IAS 36 allows the higher of the below two metrics to determine recoverable amount: § Higher of FV less cost to sell (an arms-length measure) § Uses market based inputs or market participants’ assumptions in the valuation process § Value-in-use (VIU) § Present value of future net cash flows § Uses internal or entity-specific input to determine the future cash flows § VIU likely to be more discretionary as assumptions about future cash flows are required Tan, Lim & Lee Chapter 4 © 2015 50

Goodwill Impairment Test 3. If carrying amount > recoverable amount – – Impairment loss is first allocated to goodwill Then to other assets in proportion to their individual carrying amounts Impairment tests to be carried out on annual basis; regardless of whether indications of impairment exists Impairment once made is not reversible, as it may result in the recognition of internally-generated goodwill which is prohibited under IAS 38 Tan, Lim & Lee Chapter 4 © 2015 51

Goodwill Impairment Test Steps for impairment test Determine the carrying amount of the CGU Determine the recoverable amount of the CGU Recoverable amount: Higher of fair value or value in use If carrying amount ≤ recoverable amount If carrying amount ≥ recoverable amount No impairment loss Allocate impairment loss to goodwill first and balance to other net assets Tan, Lim & Lee Chapter 4 © 2015 52

Goodwill Impairment Test NCI at FV at acquisition date Goodwill on consolidation Carrying amount of cashgenerating unit Impairment loss Tan, Lim & Lee Chapter 4 Includes NCI’s goodwill NCI as a proportion of identifiable net asset at acquisition date Excludes NCI’s goodwill Goodwill is allocated to cash Goodwill has to be grossed -generating unit without up to include NCI’s share further adjustment Notionally adjusted goodwill = Recognized goodwill/ parent’s interest Impairment loss is shared between parent and NCI on the same basis on which profit or loss is allocated © 2015 Impairment loss is borne only by parent as goodwill for NCI is not recognized 53

Illustration 4: Goodwill Impairment Test Company X has 80% ownership in a CGU with identifiable net assets of $6 million as at 31 Dec 20 x 1. The recoverable amount of the CGU as an entity was $5 million as at that date. Determine the impairment loss of goodwill in the CGU under two alternative measurement basis: (a) NC measured at FV at acquisition date. Goodwill recognized by CGU was $1. 2 million (b) NCI measured as a proportion of FV of identifiable net assets at acquisition date. Goodwill recognized by CGU was $1 million Tan, Lim & Lee Chapter 4 © 2015 54

Illustration 4: Goodwill Impairment Test Question (a) Goodwill Identifiable net assets Carrying amount 1, 200, 000 6, 000 Recoverable amount Total 7, 200, 000 5, 000 Impairment loss 1, 200, 000 1, 000 2, 200, 000 Impairment loss borne by Parent and NCI 1, 200, 000 1, 000 2, 200, 000 Explanatory notes: • Goodwill allocated to a CGU to enable comparison between carrying amount of all assets of the unit and recoverable amount • Goodwill attributable to NCI is included under recognized goodwill (no further adjustment is required) Tan, Lim & Lee Chapter 4 © 2015 55

Illustration 4: Goodwill Impairment Test Question (b) Carrying amount NCI's stet share of goodwill Notionally adjusted carrying amount Recoverable amount Impairment loss Goodwill 1, 000 Identifiable net assets 6, 000 250000 (20% x $1 million/0. 8) Total 7, 000 250, 000 1, 250, 000 6, 000 1, 250, 000 1, 000 7, 250, 000 5, 000 2, 250, 000 1, 000, 000 Impairment loss recognized 1000000 (80% x $1. 25 million) Explanatory notes: • Since comparison is done against the carrying amount of assets of a CGU, goodwill is regrossed under alternative (b) to show theoretical goodwill as at date of acquisition • NCI unrecognized share of goodwill is included Tan, Lim & Lee Chapter 4 © 2015 56

Conclusion • Two sets of financial statements must be presented: – Investor’s separate financial statements for the legal entity – Consolidated financial statements for group of companies • Although two sets of accounts exist, only one set of “books” has to be kept by the legal entity – Consolidation worksheets are used to prepare consolidated financial statement • Summation of line items of the financial statements of parents and subsidiaries • Incorporation of adjustments to eliminate and adjust intragroup transactions and balances • Transactions and balances in consolidated financial statement reflect group’s perspective Tan, Lim & Lee Chapter 4 © 2015 57

Conclusion • All business combinations are accounted for using the acquisition method – Entails an “asset substitution process” – Acquirer is deemed to have obtained control of all assets and liabilities of acquiree. – Acquisition date is a critical economic event (exchange of economic resources between acquirer and the former-owners) – Use of fair values to recognize assets and liabilities – Unrecognized intangible assets and contingent liabilities recognized if they meet criteria in IFRS 3 – NCI included as a component in equity Tan, Lim & Lee Chapter 4 © 2015 58

Conclusion • Under the acquisition method: – Consideration transferred = Fair value of (assets transferred + liabilities incurred + equity interests issued by acquirer + contingent consideration) – Asset substitution process: Investment account is eliminated and substituted with: • Subsidiary’s identifiable net assets; and • Goodwill – Goodwill = Fair value of (consideration transferred + non-controlling interests + acquirer’s previously held interest in the acquiree) – acquiree’s recognized net identifiable assets Tan, Lim & Lee Chapter 4 © 2015 59