MV

IFRS Business Combinations: Consolidation After Acquisition – Comprehensive Notes

Step 1: Prepare the acquisition differential schedule

  • Concept: At acquisition, record the difference between the purchase price and the BV of the subsidiary's net assets as acquisition differential (FV differences) and goodwill. This forms the basis for subsequent consolidation adjustments.
  • Key terms:
    • Purchase price: amount paid by parent for the subsidiary.
    • BV of S's net assets: book value of the subsidiary's net assets at acquisition.
    • Acquisition differential: difference between purchase price and BV of net assets, allocated to FV differences and goodwill.
    • FV differentials: adjustments to reflect fair values of identifiable assets and liabilities at acquisition.
    • Goodwill: residual amount after allocating FV differentials and NCI to the acquisition.
  • In the example, the parent acquires 80% (Purcell) of Saxton (225,000 shares) for $760,000. NCI is reported using the fair value enterprise (FVE) approach.
  • NCI at acquisition (example):
    ext{NCI at acquisition} = 225{,}000 imes 0.20 imes 4.00 = 180{,}000.
  • At acquisition, Saxton's BV of net assets = $446{,}000. Purchase price = $760{,}000. Acquisition differential total = $180{,}000. Total FV differential + BV alignment = $940{,}000 (Purchase price + NCI portion).
  • FV differentials by asset (example values):
    • Inventory: BV $273{,}000; FV $392{,}000; FV differential = +$119{,}000
    • Equipment: BV $244{,}000; FV $156{,}000; FV differential = −$88{,}000
    • Land: BV $160{,}000; FV $189{,}000; FV differential = +$29{,}000
    • Customer list: BV $105{,}000; FV $140{,}000; FV differential = +$35{,}000
    • Long-term debt: BV $875{,}000; FV $850{,}000; FV differential = −$25{,}000
    • Goodwill at acquisition: +$123{,}000 (total goodwill arising from the acquisition)
  • Summary from Step 1 (example totals):
    • FV differentials total = $106{,}400 (parent) + $16{,}600 (NCI) = $123{,}000 Goodwill (as shown in the table).
  • Note: The table in the transcript shows a detailed split of FV differentials and how they contribute to goodwill and to the NCI. The key takeaway is that the acquisition differential schedule partitions the purchase price into the BV of net assets, FV adjustments, and goodwill, with NCI at acquisition reflecting the non-controlling share of the net assets at fair value.

Step 2: Assess goodwill impairment

  • Concept: Goodwill is tested for impairment annually. Impairment occurs when fair value (FV) is less than the carrying amount (BV) of goodwill.
  • Impairment allocation: Any impairment is allocated between the parent and the NCI in proportion to their respective shares of goodwill at acquisition.
    • Impairment attributable to the parent = (goodwill allocated to parent at acquisition / total goodwill at acquisition) × goodwill impairment
    • Impairment attributable to the NCI = (goodwill allocated to NCI at acquisition / total goodwill at acquisition) × goodwill impairment
  • Example (Purcell/Saxton):
    • Goodwill at acquisition: $123{,}000
    • Year 3 impairment of Saxton's goodwill: recoverable amount leads to goodwill value down to $90{,}000
    • Impairment loss: $33{,}000 ($123{,}000 − $90{,}000)
    • Allocation:
    • Impairment attributable to the parent: ext{(106,400/123,000)} imes 33{,}000 \approx 28{,}546. (rounded)
    • Impairment attributable to NCI: ext{(16,600/123,000)} imes 33{,}000 \approx 4{,}454. (rounded)
  • Key idea: Impairment is measured against the recoverable amount and then allocated between the parent and NCI according to their acquisition-level goodwill shares.

Step 3: Analyze amortization of FV differentials

  • Concept: After acquisition, assets and liabilities of the subsidiary are to be carried in consolidation at their fair values at the acquisition date. FV differentials are amortized (or accreted) to the consolidated SCI over time according to the asset type and remaining useful life.
  • Amortization rules by asset type (typical IFRS approach):
    • Inventory: amortized in the period after acquisition when turnover occurs; usually fully amortized in first year if the inventory is sold within the period.
    • Depreciable capital assets / definite-life assets: amortize over the remaining useful life of the asset or the period to maturity for financial liabilities.
    • Land: not amortized (FV differential is generally not amortized for land, but impairments or remeasurements can occur if land is sold or impaired).
    • Intangible assets (with finite life): amortize over the remaining useful life of the asset.
    • Intangible assets not amortized (indefinite life): not amortized; subject to impairment testing.
    • Investments: amortization/impairment according to impairment indicators.
    • Long-term debt: amortized over the remaining term to maturity; interest expense is adjusted for the amortization of the FV differential related to debt.
  • How to compute amortization (general approach):
    • Start with the FV differential at acquisition for each asset.
    • Determine unamortized FV differential at the beginning of the period.
    • Determine the amortization for the current period (based on the asset's life or contractual terms).
    • Compute unamortized FV differential at end of the period = beginning balance − amortization for the period.
    • The amortization affects the SCI (e.g., higher COGS or depreciation expense) and the corresponding FV differential balance changes.
  • Example notes (Purcell/Saxton):
    • Inventory FV differential at acquisition: +$119{,}000; amortized primarily in Year 1 (full amortization of inventory FV differential in the first year after acquisition because turnover is rapid).
    • Equipment FV differential: +/− depending on the asset; amortization over the remaining useful life.
    • Land FV differential: not amortized; may affect depreciation if impairment or sale occurs.
    • Customer list FV differential: +$35,000; amortized over its finite useful life (if applicable).
    • Long-term debt FV differential: −$25,000; amortized over the remaining term to maturity.
  • Practical note: The amortization schedule is often presented as a table showing the FV differential at acquisition, accumulated amortization at the beginning of the period, current period amortization, and unamortized FV differential at end of period, with side effects on the SCI (cost of goods sold, depreciation expense, interest expense, etc.).

Step 4: Analyze intercompany transactions

  • Rationale: Post-acquisition, intercompany transactions between parent and subsidiary must be eliminated in consolidation because they pertain to an internal economic entity, not the external consolidated entity.
  • Scope of elimination:
    • Intercompany revenues and expenses (e.g., intercompany interest, management fees, rents) are offset so consolidated SCI reflects only external transactions.
    • Intercompany balances (receivables/payables, loans, dividends payable/receivable, etc.) are eliminated from assets and liabilities on consolidation.
  • Effects on consolidated statements:
    • Intercompany revenues and expenses reduce by the same amount; consolidated net income is unaffected by the intercompany transaction itself (except for intercompany dividends which affect NCI and RE as noted below).
    • Intercompany balances reduce consolidated assets and liabilities by the same amount; do not affect consolidated equity or consolidated net income.
  • Intercompany dividends specifically:
    • Dividends paid by the subsidiary to the parent are eliminated from the consolidated SCI and the equity effects are adjusted for NCI (portion attributed to NCI may reduce NCI in the SFP).
    • In the example: Saxton declares dividends during Year 3; the amount and NCI share must be eliminated (e.g., 116,000 dividends payable/receivable; 20% NCI share = 23,200; adjustments shown as 29,000 in the narrative for the NCI share of the dividend).

58.2 Consolidated statements after acquisition date

  • Post-acquisition consolidation requirements:
    • Prepare consolidated financial statements that include: Consolidated Statement of Financial Position (SFP), Consolidated Statement of Comprehensive Income (SCI), and Consolidated Statement of Changes in Equity; cash flows are also prepared if needed.
  • Key approach:
    • Begin with the parent’s and subsidiary’s separate IFRS-compliant financial statements.
    • Adjust for FV differentials identified at acquisition and subsequent amortization/impairment.
    • Eliminate intercompany transactions and balances to present a single economic entity.
  • Important contrast with pre-acquisition consolidation:
    • The subsidiary continues to maintain its own BV on its books; consolidation uses FV at acquisition for the purposes of the consolidated statements.
    • The purpose of the consolidation is to present the parent and subsidiary as if they had operated as a single entity during the reporting period.
  • Additional complexity:
    • Time elapsed since acquisition creates potential intercompany balances and profits that must be eliminated.
    • There is a continuing consideration of intercompany profits embedded in assets that may unrealize (e.g., intercompany inventory) which may require adjustments to COGS when the inventory is sold to external parties.

58.2.1 Example consolidation

  • Scenario: Purcell Inc. acquired 80% of Saxton Co. (225,000 issued shares) on Jan 1, Year 1 for $760,000 in cash. Saxton’s non-controlling interest (NCI) is measured under the fair value enterprise (FVE) approach. The period discussed is Year 3 (third year after acquisition).
  • Key balance sheet data at acquisition date (Saxton):
    • R/E = $446,000; Common stock = $251,000; BV = FV except the FV differential items below.
    • Identified FV differences at acquisition:
    • Inventory: BV $273,000; FV $392,000; FV differential = +$119,000
    • Equipment: BV $244,000; FV $156,000; FV differential = −$88,000
    • Land: BV $160,000; FV $189,000; FV differential = +$29,000
    • Customer list: BV $105,000; FV $140,000; FV differential = +$35,000
    • Long-term debt: BV $875,000; FV $850,000; FV differential = −$25,000
    • Goodwill at acquisition: +$123,000 (total Goodwill arising from acquisition)
  • Post-acquisition Year 3 data (examples):
    • Purcell’s and Saxton’s SCI (Year 3) show their respective earnings and comprehensive income; e.g., Purcell: Sales $2,484,000; COGS $1,177,200; GP $1,306,800; etc. (values from the Year 3 SCI are provided in the transcript; use as needed for consolidation calculations).
    • Year 3 R/E balances (simplified): Purcell R/E beginning and end shown; Saxton R/E beginning $851,200; R/E end $1,000+k after consolidation adjustments (depending on net income, dividends, and eliminations).
  • Additional information used in consolidation:
    • Both companies use straight-line depreciation; depreciation expense included in G&A.
    • Equipment remaining useful life on Jan 1, Year 1 was 11 years.
    • Year 3 events: Saxton sold half of a land parcel with a gain of $24,000; Saxton did not amortize the customer list (indefinite life).
    • Long-term debt matures on Dec 31, Year 10.
    • In Year 3, goodwill impairment: Goodwill in Saxton was written down to $90,000 (impairment).
    • Saxton provided $80,000 of computer programming services to Purcell in Year 3; Purcell had $5,000 still owed to Saxton at year-end; Saxton’s revenue included programming services; Purcell recorded these as G&A expenses.
    • Dividends declared by Saxton during Year 3 were not paid by year-end; dividend income is included in other income.

Step 5: Directly calculate consolidated ending retained earnings (R/E)

  • Objective: Compute the consolidated ending R/E via a three-part process:
    a) Opening consolidated R/E
    b) Consolidated net income
    c) Consolidated ending R/E
  • Practical notes:
    • Opening consolidated R/E is derived from the opening R/E balances of the parent and the subsidiary, adjusted for the effects of intercompany eliminations and FV differentials (and the NCI component).
    • Consolidated net income equals the sum of the parent’s net income and the subsidiary’s net income, adjusted for intercompany profits eliminated in Step 4.
    • Consolidated ending R/E = Opening consolidated R/E + Consolidated net income − Dividends declared by the subsidiary to external shareholders (and adjusted for NCI) + any other consolidation adjustments.
  • Special note on dividends (in the example): Saxton declared dividends during Year 3 totaling $145,000. The NCI share is $29,000 (20% of $145,000). The consolidated effect includes eliminating the subsidiary’s dividend revenue recognized by the parent and recognizing the appropriate NCI impact, with consolidated R/E adjusted by $145,000 to remove the total dividend amount from the consolidated equity base.

Step 6: Directly calculate opening NCI

  • Concept: Opening NCI reflects the non-controlling interest at the acquisition date, measured at fair value and adjusted for post-acquisition changes in the subsidiary’s equity that pertain to the NCI.
  • In the example: Opening NCI at acquisition = $180,000 (calculated as 225,000 shares × 20% × $4.00 per share).
  • The subsequent movements in NCI after acquisition flow through to the consolidated SFP and SCI via:
    • Parent net income share and subsidiary net income
    • Post-acquisition changes in the subsidiary’s equity attributable to NCI
    • Impairment allocations to NCI (from Step 2)
    • Elimination of intercompany dividends allocated to NCI (e.g., NCI’s share of dividends) as described in Step 4/Step 7.

Step 7: Prepare elimination entries

  • Purpose: Elimination entries ensure that the consolidated statements reflect the economic entity, not intercompany transactions or misstatements arising from accounting at subsidiary level.
  • Key elimination categories:
    • Adjust opening SFP accounts for FV differentials and goodwill impairment (Step 2) and amortization of FV differentials (Step 3).
    • Intercompany transactions (Step 4): eliminate intercompany revenues/expenses and intercompany balances.
    • Intercompany dividends: eliminate intercompany dividend income/expense and the related intercompany dividend receivable/payable; adjust consolidated RE and NCI accordingly.
    • Consolidated net income attributable to NCI: ensure that NCI’s share of net income is properly reflected in the equity section and does not double-count within consolidated net income.
    • Subsidiary dividends declared: adjust RE and NCI to reflect external dividends only.
  • Example eliminations from the Purcell/Saxton scenario:
    • Intercompany programming services:
    • Eliminate intercompany revenue of $80{,}000 recorded by Saxton.
    • Eliminate intercompany expense of $80{,}000 recorded by Purcell.
    • Intercompany balances:
    • Eliminate accounts receivable of $5{,}000 recorded by Saxton.
    • Eliminate accounts payable of $5{,}000 recorded by Purcell.
    • Intercompany dividends:
    • Eliminate dividends payable of $116{,}000 (Saxton’s records).
    • Eliminate dividends receivable of $116{,}000 (Purcell’s records).
    • Eliminate Purcell’s recorded dividend income of $116{,}000 from Saxton.
    • Adjust NCI via its share of the dividend: NCI is reduced by $29{,}000 (which is $145{,}000 × 20%), and consolidated RE is increased by $145{,}000 to remove the total dividend.
  • Practical consequences:
    • The elimination entries ensure that consolidated statements show only external transactions.
    • The NCI balance in the SFP reflects post-acquisition changes attributable to the non-controlling shareholders, after impairment allocations and intercompany eliminations.

Step 8: Prepare the consolidated financial statements

  • After performing the steps above, prepare:
    • Consolidated Statement of Financial Position (SFP)
    • Consolidated Statement of Comprehensive Income (SCI)
    • Consolidated Statement of Changes in Equity
  • Approach to preparation:
    • Aggregate parent and subsidiary balances, then apply the FV differential adjustments and intercompany eliminations.
    • Reconcile to the consolidated ending R/E and NCI per the calculations in Steps 5 and 6.
    • Ensure intercompany profit eliminations (Step 4) do not distort the consolidated net income attributable to the owners, or to NCI.

Additional concepts and clarifications

  • IFRS 3 framework: Business combinations, post-acquisition consolidation follows IFRS 10 and IFRS 3 principles for consolidation, with focus on FV adjustments and intercompany eliminations.
  • Reporting considerations:
    • The parent and subsidiary maintain separate accounting records post-acquisition, with consolidation adjustments applied at the group level.
    • Deferred income taxes (DIT) are ignored in the simplified example; in practice, DIT effects would be considered in consolidation when applicable.
  • NCI accounting approaches:
    • Fair Value via Equity (FVE) vs. full goodwill approach: The example uses FVE for NCI.
  • Practical implications:
    • Intercompany transactions can introduce unrealized profits in assets (e.g., intercompany inventory profits); consolidation requires eliminating those unrealized profits to avoid overstating assets and earnings.
    • The timing of amortization of FV differentials affects reported depreciation and interest expense in the SCI.
  • Formula recap (key equations):
    • NCI at acquisition: ext{NCI at acquisition} = ext{Net assets at acquisition} imes ext{NCI percentage} \, ( ext{often} \ 225{,}000 imes 0.20 imes 4.00 = 180{,}000)
    • Goodwill at acquisition: (represented as the residual goodwill arising from acquisition after FV differential allocations).
    • Impairment allocation (example):
      ext{Impairment}{P} = rac{ ext{Goodwill}{P,acq}}{ ext{Total Goodwill}{acq}} imes ext{Impairment} \ ext{Impairment}{NCI} = rac{ ext{Goodwill}{NCI,acq}}{ ext{Total Goodwill}{acq}} imes ext{Impairment}
    • Intercompany eliminations (conceptual): eliminate intercompany revenues/expenses and intercompany balances to avoid double counting; adjust for NCI and consolidated RE as described above.

Notes from the example (quick references):

  • Acquisition: Purcell acquired 80% of Saxton; Purchase price $760,000; NCI at acquisition = $180,000; Saxton net assets at acquisition BV = $446,000; FV differentials summarized above; Goodwill at acquisition = $123,000.
  • Year 3 events: Goodwill impairment of $33,000; intercompany service transactions of $80,000; intercompany balances of $5,000; dividends totaling $145,000 with NCI share $29,000; dividends payable/receivable eliminated; consolidation RE adjusted by $145,000 to remove total dividend.
  • Step 4 and Step 7 adjustments are essential to produce the consolidated statements that reflect the realities of a single economic entity rather than two legal entities operating in parallel.