CHAPTER 1: Conceptual and Case Analysis Frameworks for Financial Reporting © 2019 McGraw-Hill Education Prepared by Shannon Butler, CPA, CA Carleton University Learning Objectives LO1 Describe and apply the conceptual framework for financial reporting. Describe how accounting standards in Canada tailored to different types of organizations. LO2 LO3 Identify some of the differences between IFRS and ASPE. LO4 Analyze and interpret financial statements to assess the impact of different accounting methods on key financial statement ratios. (Appendix 1A) Apply the case analysis framework solve accounting and reporting issues. LO5 are to 2 The Conceptual Framework for Financial Reporting ➢ The Conceptual Framework for Financial reporting is a document found just prior to IFRS in Part 1 of the CPA Canada Handbook. ➢ Main items include: • • • • The objective of general-purpose financial reporting Qualitative characteristics of useful financial information Underlying assumptions Definition, recognition, and measurement of the elements of financial statements ➢ All accounting practices should be traceable back to and supported by the conceptual framework. 3 The Conceptual Framework for Financial Reporting Part 2 ➢ Professional judgement is the ability to make a decision in situations in which the answer is not clear-cut. ➢ Lots of judgement is involved when preparing financial statements. ➢ Judgment is involved when adopting accounting policies, making estimates, and writing the notes to the financial statements. ➢ Financial statements should present what really happened during the period: that is, they should tell it how it is. 4 Accounting Standards in Canada ➢ The CPA Canada Handbook contains five parts as follows: Part # Applicable To: I II III IV Publicly accountable entities Private enterprises Not-for-profit organizations Pension plans V All entities not yet using other parts Name for Standards IFRS ASPE Pre-changeover GAAP 5 GAAP for Publicly Accountable Enterprises ➢ At one time, Canada intended to harmonize its standards with those of the United States. ➢ Canadian publicly accountable enterprises have to report under IFRS. ➢ Part I of the CPA Canada Handbook contains IFRS. ➢ IFRS allows the use of fair values and optional treatments to a greater degree than pre-changeover Canadian GAAP (Part V of the CPA Canada Handbook). 6 GAAP for Private Enterprises ➢ In the 1970s there was a lot of discussion in Canada about Big GAAP versus Little GAAP, wondering if there should be different standards for big companies and little companies. ➢ Eventually the concept of Big GAAP/Little GAAP was abandoned. ➢ There were a few other approaches over time but in 2006 when the decision was made to adopt IFRS there was a task force in place to determine what private companies should do. 7 GAAP for Private Enterprises Part 2 ➢ In 2009, it was decided that private companies would have a separate part of the CPA Canada Handbook dedicated solely for them. ➢ Part II of the CPA Canada Handbook contains GAAP for private enterprises. ➢ Private enterprises can report under either IFRS or ASPE. 8 IFRS versus ASPE ➢ ASPE sometimes allows a choice between different reporting methods. ➢ Key differences between IFRSs and ASPE include: • disclosure requirements • impaired loans • revaluation and depreciation of components of property, plant and equipment • impairment losses and subsequent reversal of loss • development costs 9 IFRS versus ASPE Part 2 ➢ Key differences between IFRSs and ASPE include, continued: • post-employment benefits • Actuarial gains/losses • Income taxes • interest capitalization • Compound financial instrument • Preferred shares in tax planning arrangement • Value of conversion option for convertible bonds • Lease accounting by lessee 10 Analysis and Interpretation of Financial Statements ➢ Financial statement analysis involves reviewing, evaluating, and interpreting the company’s financial statements. ➢ Common-sized financial statements make it easier to see the relationship between financial statement items in terms of percentages. ➢ When companies in the same industry use different accounting policies, it may be necessary to adjust the financial statements of one of the companies to make the statements more comparable. 11 Analysis and Interpretation of Financial Statements Part 2 ➢ Different accounting methods have different impacts on key financial statement ratios. ➢ We will focus on the following key ratios: Ratio Current ratio Debt-to-equity ratio Return on assets Return on equity Formula Current Assets ÷ Current Liabilities Total debt ÷ Shareholders' equity Income before interest & taxes ÷ Total assets Net Income ÷ Shareholders' equity What Is Measured Liquidity Solvency Profitability of assets Profitability of owners' investment ➢ When determining the impact on ratios of changes in reporting methods, we must consider the impact on both the numerator and the denominator. 12 Appendix 1A: A Generic Approach to Case Analysis ➢ Generic Framework for Case Analysis: I II III IV V VI Determine Your Role and Requirements Identify Users and Their Needs Given the Case Environment Identify and Rank Issues Identify Viable Alternatives for Each Major Issue Analyze Alternatives Using Criteria for Resolving Communicate Practical Recommendations/Conclusions 13 I: Determine Your Role & Requirements ➢ The first step is to determine who you are in the context of the case. ➢ The key requirements are often found in the last two paragraphs of the main body of the case. 14 II: Identify Users and Their Needs Given the Case Environment ➢ Define all the other characters in the case. ➢ The other characters will be seeking your expertise in financial matters, consider their needs. ➢ When focusing your task on the user’s needs, always consider the environment in which you both operate. 15 III: Identify and Rank Issues ➢ Issues are usually ranked based on controversy, errors, and complexity. ➢ Do not rank an issue as important only because you know a lot about the subject. ➢ Rank items solely on their importance to the other characters in the case. 16 IV: Identify Viable Alternatives for Each Major Issue ➢ Very few case issues will have one correct answer. ➢ You will need to create various possible solutions to each case issue. ➢ The alternatives should be relevant and viable for the client’s unique situation. 17 V: Analyze Alternatives Using Criteria for Resolving ➢ For each issue listed on your case plan, an analysis of the previously identified alternative should be performed. ➢ This may include quantitative and or qualitative forms of analysis. 18 VI: Communicate Practical Recommendations to Users ➢ Your answer to the case should be in the form required by the question. ➢ It should provide clear, practical recommendations based on our analysis and should directly address the identified user’s needs. ➢ Your solution should demonstrate the organizational skills required of a professional person. 19 A Framework for Solving an Accounting and Financial Reporting Case I: Determine Your Role and Requirements II: Identify Users and Their Needs Given the Case Environment III: Identify and Rank Issues IV: Identify Alternatives for Each Given Issue V: Analyze Alternatives Using Criteria for Resolving VI: Communicate Practical Recommendations/ Conclusions to Information Users 20 CHAPTER 2: Investments In Equity Securities © 2019 McGraw-Hill Education Prepared by Shannon Butler, CPA, CA Carleton University Learning Objectives Describe the main changes in reporting of investments over the past 15 years. LO1 LO2 Distinguish between the various types of equity investments measured at fair value. Prepare journal entries to account for under the cost and equity methods. LO3 equity investments 2 Learning Objectives Evaluate relevant factors to determine whether investor has significant influence over an investee. LO4 an Analyze and interpret financial statements involving investments in equity securities. LO5 Identify some of the differences between IFRS ASPE for investments in equity securities. LO6 and 3 Equity Investments: The Big Picture ➢ Equity investments are investments in shares of another company. ➢ There are many different methods for reporting investments in equity securities. ➢ The methods of reporting equity investments have changed significantly over the past 15 years. 4 Equity Investments: The Big Picture ➢ There is now a trend to measure more assets at fair value on an annual basis. ➢ Prior to 2005, these investments were typically reported at some cost-based amount. ➢ IAS 39 was introduced in 2005 where for the first time it was possible to report certain investments at fair value. 5 Equity Investments: The Big Picture ➢ In 2009, IASB introduced a new accounting standard for nonstrategic investments, IFRS 9 ➢ IFRS 9 was effective for fiscal periods beginning on or after January 1, 2018. ➢ IFRS 9 requires that all nonstrategic investments be reported at fair value, including investments in private companies. 6 Equity Investments: The Big Picture ➢ In 2011, IASB introduced a new accounting standard, IFRS 13 Fair Value Measurement. ➢ IFRS 13 provides a single, unified definition of fair value and a framework for measuring it. ➢ Strategic investments are reported at values other than fair value. ➢ Non-strategic investments are reported at fair value. 7 Equity Investments: The Big Picture EXHIBIT 2.1: Reporting methods for investments in equity securities Reporting Method Reporting of Unrealized Gains/Losses Significant influence Equity method Not applicable Control Consolidation Not applicable Joint control Equity method Not applicable FVTPL (fair value through profit or loss) Fair value method In net income Other—elect FVTOCI (fair value through OCI) Fair value method In other comprehensive income Type of Investment Strategic investments: Non-strategic investments: 8 Investments Measured at Fair Value ➢ IFRS 9 deals with two types of equity investments: ➢ FVTPL: fair value through profit or loss ➢ FVTOCI: fair value through OCI 9 Investments Measured at Fair Value Fair Value Through Profit and Loss (FVTPL) Investments: ➢ Include investment held for short-term trading. ➢ Classified as current assets since they actively trade and are intended to be sold within one year. ➢ Recorded at fair value. Unrealized and realized gains and losses as well as dividends received or receivable are reported in net income. 10 Investments Measured at Fair Value Fair Value Through OCI (FVTOCI) Investments: ➢ Equity investments that are not held for short-term trading. ➢ Classified as current or noncurrent assets depending on how long management intends to hold to these shares. ➢ Unrealized gains and losses are recorded in other comprehensive income (OCI). Dividends are recorded in income. ➢ The cumulative gains or losses are cleared out of accumulated OCI and transferred directly to retained earnings. This usually occurs when the investment is sold or derecognized but could be transferred at any time. 11 Cost Method of Reporting an Equity Investment ➢ Cost method is used under IFRS in the following situations: ➢ For investments in controlled entities (Chapter 3) ➢ For a parent company’s internal accounting records prior to preparing consolidated financial statements (Chapter 5) ➢ Cost method is allowed under ASPE for equity investments that are not quoted in an active market. 12 Cost Method of Reporting an Equity Investment ➢ Under the cost method: ➢ Investment is initially recorded at cost. ➢ Investor’s share of dividends are reported in income. ➢ Impairment losses are reported in net income. ➢ When investment is sold, the realized gains or losses are reported in net income. 13 Equity Method of Reporting an Investment in an Associate ➢ Equity method applies to investments in associates, where the investee has the ability to exercise significant influence. Indications of significant influence include: ➢ Representation on board of directors. ➢ Participation in policy-making processes or decisions about dividends and distributions. ➢ Material transactions between investor and investee. ➢ Interchange of management personnel. ➢ Provision of essential technical information. 14 Equity Method of Reporting an Investment in an Associate ➢ Generally, holding between 20% and 50% of voting shares indicates the presence of significant influence, however a holding of this size does not necessarily mean that such influence exists. ➢ Determination of significant influence requires the application of judgment. ➢ When one investor has control, other investors usually do not have significant influence. 15 Equity Method Basics ➢ When an investor has less than 20% of the voting shares, it usually does not have significant influence. ➢ Income is recognized based on the income reported by the associate, and dividends are reported as a reduction of the investment account. ➢ The equity method picks up the investor’s share of the changes in the associate’s shareholders’ equity. 16 Complexities Associated with the Equity Method Accounting for other changes in associate’s equity: ➢ The investor’s statement of comprehensive income should reflect its share of the investee’s income according to its nature and the different statement classifications. ➢ The investor’s shares of income from continuing operations, discontinued operations, and other comprehensive income are reported separately. ➢ Many accounting procedures required for consolidated purposes are also required under the equity method. 17 Complexities Associated with the Equity Method Acquisition costs greater than carrying amounts: ➢ The investor’s cost is usually greater than its share of the carrying amount of the associate’s net assets. Unrealized intercompany profits: ➢ Consolidated statements should reflect only the results of transactions with outsiders. ➢ Profits from intercompany transactions must be eliminated until the assets are sold to outsiders or used in producing goods or providing services to outsiders. 18 Complexities Associated with the Equity Method Changes to and from the equity method: ➢ Changes in reporting methods are accounted for prospectively if they are changed because of a change in circumstance. Losses exceeding the balance in the investment account: ➢ If an investor guaranteed an investee’s obligations, the investor could end up reporting its investment as a liability rather than an asset. ➢ Other long-term interests in the associate may have to be written down when the associate is reporting losses. 19 Complexities Associated with the Equity Method Impairment Losses: ➢ If there is an indication that the investment may be impaired, the investment is tested for impairment. Gains and losses on sale of investments: ➢ Average cost should be used in determining any gain or loss when an investor sells part of its investment. 20 Complexities Associated with the Equity Method Held for sale: ➢ Investments in associates that meet the criteria to be classified as held for sale should be measured at the lower of carrying amount and fair value less costs of disposal, and should be reported as current assets. Presentation and disclosure requirements: ➢ The fair value of an investment in associate should be disclosed when it is readily available. 21 Analysis and Interpretation of Financial Statements ➢ See Exhibit 2.3 -- Impact of Reporting Methods on Key Financial Ratios. ➢ The FVTPL investment must be shown as a current asset, whereas the other investments could be current or noncurrent depending on management’s intentions. ➢ The FVTPL investment shows the best liquidity and profitability. 22 IFRS versus ASPE CPA Canada Handbook Part II Sections 3051 and 3856: ➢ Permits use of either equity or cost method to account for all significant influence investments that are not publicly traded on the same basis. ➢ Investments in and income from cost-accounted investments should be reported separately, net of any impairment losses which are reported in net income. ➢ Allows investors to elect to report any equity investment at fair value -- report in net income. 23 IFRS versus ASPE CPA Canada Handbook Part II Sections 3051 and 3856 continued: ➢ Prohibits use of the cost method to account for publicly traded investments, which must be reported at fair value with changes reflected in net income. ➢ Does not require amortization of the acquisition differential. ➢ Other comprehensive income does not exist under ASPE. 24 CHAPTER 3: Business Combinations © 2019 McGraw-Hill Education Prepared by Shannon Butler, CPA, CA Carleton University Learning Objectives LO1 Define a business combination, and evaluate relevant factors to determine whether control exists in a business acquisition. LO2 Describe the basic forms for achieving a business combination. LO3 Apply the acquisition method to a purchase-ofnet-assets business combination. Prepare consolidated financial statements for purchase-of-shares business combination. LO4 a 2 Learning Objectives LO5 Analyze and interpret financial statements involving business combinations. LO6 Identify some of the differences between IFRS and ASPE for business combinations. LO7 Explain a reverse takeover and its reporting implications. (Appendix 3A) 3 Introduction ➢ A business combination occurs when one company, the acquirer, obtains control of one or more businesses (IFRS 3). ➢ Reasons for business combinations include: • Defend a competitive position • Diversify into a new market and/or geographic region • Access to new customers, products or services, expertise or capabilities (eg. Technology) ➢ When a business combination occurs, consolidated financial statements are required to report the combined financial position and results of operations of the Parent and the Subsidiary. 4 Business Combinations ➢ A business combination is defined in IFRS 3 as a transaction or other events in which an acquirer obtains control of one or more businesses. ➢ There are two key aspects to this: control and businesses. ➢ A business is defined in IFRS 3 as an integrated set of activities and assets that can be conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. 5 Business Combinations ➢ A business consists of inputs and processes applied to those inputs that have the ability to create outputs. ➢ Buying a group of assets that do not constitute a business is a basket purchase, not a business combination. 6 Control – IFRS 10 How is control determined? ➢ Control is the power to direct the relevant activities of the investee. ➢ Control requires that the investor has exposure, or rights to variable returns from its involvement with the investee and has the ability to use its power over the investee to affect the amount of the investor’s returns. 7 Control – IFRS 10 ➢ Owning more than 50% of the voting shares usually, but not always, indicated control. ➢ Control can be present with less than 50% of voting shares if other factors indicate control, e.g.: ➢ Irrevocable agreement with other shareholders to convey voting rights to parent. ➢ If parent holds rights, warrants, convertible debt, or convertible preferred shares that would, if exercised or converted, give it >50% of votes. ➢ If there are contractual agreements which give control. 8 Control – IFRS 10 ➢ Deemed control if other shareholders do not actively cooperate when they exercise their votes. ➢ Example: One company may own the largest single block of shares of another company, e.g. X Company owns 40% of Y Company while the other 60% is widely held and rarely voted with the result that X has no trouble electing the majority of Y’s directors X Company could be deemed to have control in this situation as long as the other shareholders do not actively cooperate against X when they vote their shares. 9 Control – IFRS 10 ➢ Control and consolidation would cease if for example the majority of a subsidiary’s assets are seized in a receivership or bankruptcy situation. ➢ Normal business restrictions do not preclude control by the parent. 10 Control – IFRS 10 ➢ The existence of certain protective rights held by other parties does not necessarily provide those parties with control. Examples: ➢ Approval of veto rights that do not affect strategic operating and financing policies. ➢ The ability to remove the party that directs the activities of the entity in circumstances such as bankruptcy or on breach of contract by that party. ➢ Certain limitations on the operating activities of an entity, such as pricing or advertising limitations typically placed by franchisors or franchisees. 11 Control – IFRS 10 ➢ A parent can control a subsidiary, even though other parties have protective rights relating to the subsidiary. ➢ A key aspect of control is the ability to direct the activities that most significantly affect the investor’s returns. 12 Forms of Business Combinations ➢ The are three main forms of business combinations. ➢ One company can obtain control over the net assets of another company by: 1) Purchasing its net assets 2) Acquiring enough of its voting shares to control the use of its net assets, or 3) Gaining control through a contractual arrangement 13 Forms of Business Combinations ➢ Purchase of assets or net assets – When purchasing assets or net assets, the transaction is carried out with the selling company. ➢ Purchase of Shares – an alternative to the purchase of assets is for the acquirer to purchase enough voting share from the shareholders of acquiree that it can determine the acquiree’s strategic operating and financing policies. ➢ When purchasing shares, the transaction is usually consummated with the shareholders of the selling company. ➢ The acquired company make no journal entries when the acquiring company purchases shares. 14 Forms of Business Combinations ➢ Control through contractual arrangement – control can be obtained through a contractual arrangement that does not involve buying assets or shares. 15 Forms of Business Combinations ➢ All three forms of business combination result in the assets and liabilities of the companies being combined. ➢ If control is achieved with the purchase of net assets, the combining takes place in the accounting records of the acquirer. ➢ If control is achieved by purchasing shares or through contractual agreement, the combining takes place when the consolidated financial statements are prepared. 16 Forms of Business Combinations ➢ There are many different legal forms in which a business combination can be consummated. ➢ A statutory amalgamation occurs when two or more companies combine to form a single legal entity. 17 Accounting for Business Combinations under the Acquisition Method ➢ IFRS 3 outlines the accounting requirements for business combinations. The main principles are: ➢ All business combination should be accounted for by applying the ➢ ➢ ➢ ➢ ➢ acquisition method. An acquirer should be identified for all business combinations. The acquisition date is the date the acquirer obtains control of the acquiree. The acquirer should attempt to measure the fair value of the acquiree, as a whole, as of the acquisition date. The acquirer should recognize and measure the identifiable assets acquired and the liabilities assumed at fair value and report them separately from goodwill. The acquirer should recognize goodwill, if any. 18 Accounting for Business Combinations under the Acquisition Method ➢ Acquisition cost measured as the fair value of consideration given to acquire the business and is made up of the following: ➢ Any cash paid ➢ Fair Value of assets transferred by the acquirer ➢ Present value of any promises by the acquirer to pay cash in the future ➢ Fair value of any shares issued – the value of shares is based on the market price of the shares on the acquisition date ➢ Fair value of contingent consideration ➢ Acquisition cost does not include costs such as professional fees or costs of issuing shares. 19 Recognition and Measurement of Net Assets Acquired ➢ The acquirer should recognize and measure the identifiable assets and liabilities assumed at fair value and report them separately from goodwill. ➢ Identifiable assets include those with value not presently recorded by the acquiree, such as internally developed patents. ➢ Can allocate only to items that meet the definition of assets and liabilities under IASB’s Framework. For example, cannot allocate expected cost of terminating the subsidiary’s employees to a liability of the terminations have not yet occurred. In this case the termination cost would be recorded in post-acquisition expense. 20 Recognition of Goodwill ➢ Goodwill is the excess of total consideration given over the fair value of identifiable assets and liabilities. ➢ Negative goodwill could result in the reporting of a gain on purchase by the acquiring company. 21 Control through Purchase of Net Assets: Example 1 Example 1 A Company offers to buy all assets and assume all liabilities of B Corporation. The management of B Corporation accepts the offer. ➢ Assume that on January 1, Year 2, A Company pays $95,000 in cash to B Corporation for all the net assets of that company, and that no direct costs are involved. Because cash is the means of payment, A Company is the acquirer. ➢ The acquisition is allocated as per the next slide. 22 Control through Purchase of Net Assets: Example 1 Acquisition cost (cash paid) Fair value of net assets acquired Difference – goodwill page 102 $ 95,000 80,000 15,000 A Company would make the following journal entry to record the acquisition of B Corporation: Assets (in detail) Goodwill Liabilities (in detail) Cash 109,000 15,000 29,000 95,000 A COMPANY LTD. Balance Sheet January 1, Year 2 Assets (300,000 - 95,000 + 109,000) Goodwill Liabilities (120,000 + 29,000) Shareholders’ equity: Common Shares Retained earnings $314,000 15,000 $329,000 $149,000 100,000 80,000 $329,000 23 Control through Purchase of Net Assets: Example 2 ➢ Assume that on January 1, Year 2, A Company issues 4,000 common shares with a market value of $23.75 per share, to B Corporation as payment for the company’s net assets. B Corporation will be wound up after the sale of its net assets. ➢ Because the method of payment is shares, the following analysis is made to determine which company is the acquirer: Shares of A Company Group X now holds 5,000 Group Y will hold (on wind-up) 4,000 9,000 X holds 56% of A Company’s 9,000 shares therefore Group X is the Acquirer. 24 Control through Purchase of Net Assets: Example 2 Calculation of Goodwill: Acquisition cost ( 4,000 shares @ $23.75) Fair value of net assets acquired Difference – goodwill $ 95,000 80,000 15,000 A Company would make the following journal entry to record the acquisition of B Corporation’s net assets and the issuance of 4,000 common shares at fair value on January 1, Year 2 Assets (in detail) Goodwill Liabilities (in detail) Common shares error corrected A COMPANY LTD. Balance Sheet January 1, Year 2 Assets (300,000 + 109,000) Goodwill Liabilities (120,000 + 29,000) Shareholders’ equity: Common Shares (100,00 + 95,000) Retained earnings 109,000 15,000 29,000 95,000 $409,000 15,000 $424,000 $149,000 195,000 80,000 $424,000 25 Consolidated Financial Statements ➢ When an investor acquires sufficient voting shares to obtain control over the investee, a parent-subsidiary relationship is established. ➢ The investor is the parent, and the investee is the subsidiary. ➢ Usually, the companies involved continue as separate legal entities, with each maintaining separate accounting records and financial statements. However, these entities now operate as a family of companies. 26 Consolidated Financial Statements ➢ Consolidated statements consist of a balance sheet, a statement of comprehensive income, a statement of changes in equity, a cash flow statement, and the accompanying notes. ➢ The following definitions are provided in Appendix A of IFRS 10: a. Consolidated financial statements are the financial statements of a group in which the assets, liabilities, equity, income, expenses, and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. b. A Group is a parent and its subsidiaries. c. A Parent is an entity that controls one or more entities d. A Subsidiary is an entity that is controlled by another entity. e. Non-controlling interest is equity in a subsidiary not attributable, directly or indirectly, to a parent. 27 Consolidated Financial Statements ➢ IFRS 10, paragraph 4(a), states that a parent is not required to present consolidated financial statements for external reporting purposes if it meets all of the following conditions: a. Parent is itself a wholly owned subsidiary, or is a partially owned subsidiary and its owners do not object to the parent not presenting consolidated financial statements; b. Parents debt or equity instruments are not publicly traded; c. Parent has not or is not filing financial statements with a regulator for the purpose of issuing debt or equity instruments on a publicly traded market; and d. The ultimate or intermediate parent of the parent produces IFRScomplaint consolidated financial statements for public use. 28 Consolidated Financial Statements ➢ If the parent meets the conditions of IFRS 10, paragraph 4(a), it can (but does not have to) present separate financial statements in accordance with IFRS as its only financial statements to external users. ➢ It then must follow IAS 27 Separate Financial Statements, which accounts for investments in subsidiaries: a. at cost; b. in accordance with IFRS 9; or c. using the equity method as described in IAS 28. 29 Control through Purchase of Shares: Example 3 ➢ Assume that on January 1, Year 2, A Company pays $95,000 cash to the shareholders of B Corporation for all of their shares, and that no other direct costs are involved. Because cash was the means of payment, A Company is the acquirer. ➢ The financial statements of B Corporation have not been affected by this transaction because the shareholders of B, not the company itself, sold their shares. Page 109 ➢ See Exhibit 3.3 & 3.4 on the next slides 30 Exhibit 3.3 CALCULATION AND ALLOCATION OF THE ACQUISITION DIFFERENTIAL Total consideration given = cash paid by A Company $ 95,000 Less: Carrying amount of B Corporation’s net assets: Assets $88,000 Liabilities 30,000 58,000 Acquisition differential 37,000 Allocated as follows: Fair value excess Fair Value − Carrying Amount Assets 109,000 − 88,000 = $21,000 Liabilities 29,000 − 30,000 = 1,000 Balance—goodwill 22,000 $ 15,000 31 Exhibit 3.4 A COMPANY LTD. CONSOLIDATED BALANCE SHEET WORKING PAPER At January 1, Year 2 Adjustments and Eliminations A Company Assets Investment in B Corporation $205,000 B Corp. Dr. $88,000 Liabilities Common shares Retained earnings $ 21,000 $314,000 (1) _________ ________ $300,000 $88,000 $120,000 $30,000 (1) 37,000 (2) 15,000 (2) $ 95,000 37,000 15,000 $329,000 (2) 1,000 $149,000 100,000 100,000 80,000 80,000 Common shares Retained earnings Cr. 95,000 Acquisition differential Goodwill (2) Consolidated Balance Sheet 25,000 (1) 25,000 _________ 33,000 (1) 33,000 _________ ________ $300,000 $88,000 $132,000 $132,000 $329,000 32 Working Paper JE’s ➢ First remove the Investment account ➢ Dr. Common Shares 25,000 ➢ Dr Retained Earnings 33,000 ➢ Dr Acquisition Differential 37,000 ➢ Cr. Investment B Corp 95,000 ➢ Second, Adjust to fair values ➢ Dr Assets 21,000 ➢ Dr. Liabilities 1,000 ➢ Dr. Goodwill 15,000 ➢ Cr. Acq Differential 37,000 33 Control through Purchase of Net Shares: Example 3 Note the following for Exhibit 3.4: 1. A Company’s “Investment in B Corporation” balance and B Corporation’s common shares and retained earnings have been eliminated in entry (1) because they are reciprocal. 2. The acquisition differential does not appear on the consolidated balance sheet but is reallocated to the net assets of B Corporation in entry (2) 3. When we add the acquisition differential to the carrying amount of the net assets of B Corporation, the resulting amount used for the consolidation is the FV of each individual asset and liability of B Corporation. 34 Control through Purchase of Shares: Example 3 Note the following for Exhibit 3.4 continued: 4. The elimination entries are made on the working paper only and not in the books or either company. 5. The consolidated balance sheet is prepared from the amounts shown in the last column of the working paper. 6. Under the acquisition method of accounting, consolidated shareholders’ equity on acquisition date is that of the parent. 35 Control through Purchase of Shares: Example 4 ➢ Assume that on January 1, Year 2, A Company issues 4,000 common shares, with a fair value of $23.75 per share, to the shareholders of B Corporation (Group Y) for all of their shares and that there are no direct costs involved. Example 2 indicated that A Company is the acquirer. ➢ The calculation and allocation of the acquisition differential is identical to the one used in Example 3. ➢ The working paper for the preparation of the consolidated balance sheet as at January 1, Year 2 is shown next in Exhibit 3.5 36 Exhibit 3.5 A COMPANY LTD. CONSOLIDATED BALANCE SHEET WORKING PAPER At January 1, Year 2 Adjustments and Eliminations A Company Assets Investment in B Corporation B Corp. $300,000 Dr. $88,000 (2) Cr. $ 21,000 95,000 Acquisition differential (1) 37,000 Goodwill (2) 15,000 Liabilities Common shares Retained earnings $395,000 $88,000 $120,000 $30,000 Consolidated Balance Sheet $409,000 (1) $ 95,000 (2) 37,000 15,000 $424,000 (2) 1,000 $149,000 195,000 195,000 80,000 80,000 Common shares 25,000 (1) 25,000 Retained earnings 33,000 (1) 33,000 $395,000 $88,000 $132,000 $132,000 $424,000 37 The Direct Approach ➢ An alternative to the worksheet method of preparing consolidated financial statements is the Direct Approach, preparing the financial Statements directly without the use of a working paper. ➢ The basic process involved in the direct approach is as follows: ➢ Carrying amount On(parent) the date Carrying amount Acquisition + (−) = (subsidiary) differential acquisition consolidated shareholders’ + of equity = parent’s shareholders equity Consolidated amounts 38 Exhibit 3.6 – Illustration of the Direct Approach A COMPANY LTD. CONSOLIDATED BALANCE SHEET At January 1, Year 2 Assets (300,000 + 88,000 + 21,000) Goodwill (0 + 0 + 15,000) $409,000 15,000 $424,000 Liabilities (120,000 + 30,000 − 1,000) Common shares Retained earnings P 3-3, P 3-7 $149,000 195,000 80,000 $424,000 39 Reverse Takeover ➢ Occurs when one company obtains ownership of the shares of another by issuing enough voting shares as consideration that control of the combined enterprise passes to the shareholders of the acquired enterprise. i.e. 5000 shares issue 7000 so now sub has 7/12 = control ➢ In a reverse takeover, the consolidated balance sheet incorporates the carrying amount of the net assets of the deemed parent (the legal subsidiary) and the fair value of the deemed subsidiary (the legal parent). 40 Reporting Depreciable Assets ➢ There are two methods; the proportionate method, and the net method. ➢ In this textbook, we will use the net method unless otherwise indicated. ➢ Both methods report the subsidiary’s depreciable asset at fair value but report different amounts for cost and accumulated depreciation. 41 Other Consolidated Financial Statements in Year of Acquisition ➢ Consolidated net income, retained earnings, and cash flows include the subsidiary’s income and cash flows only subsequent to the date of acquisition. 42 Disclosure Requirements ➢ The acquirer must disclose information that enables users of its financial statements to evaluate the nature and financial effect of a business combination that occurs either (a) during the current reporting period or (b) after the end of the reporting period but before the financial statements are authorized for issue. 43 Disclosure Requirements ➢ IFRS 3 indicates that the acquirer shall disclose the following: a. b. c. d. The name and a description of the acquire. The acquisition date. The percentage of voting equity interests acquired. The primary reasons for the business combination and a description of how the acquirer obtained control of the acquiree. e. A qualitative description of the factors that make up the goodwill recognized. f. The acquisition-date fair value of the total consideration transferred and the acquisition-date fair value of each major class of consideration. 44 Push-Down Accounting ➢ Not permitted under IFRS but may be in the future. Permitted by GAAP for private enterprises (ASPE), with disclosures required in the first year of application. ➢ In Section 1625 in Part II of the Handbook push-down accounting is permitted when the parent owns 90% or more of a subsidiary. In these cases the parent could revalue the subsidiary’s assets and liabilities based on the parent’s acquisition cost. 45 Subsidiary Formed by Parent ➢ When a parent company sets up a subsidiary company, the preparation of the consolidated balance sheet on the date of formation of the subsidiary requires only the elimination of the parent’s investment against the subsidiary’s share capital since the subsidiary would have no retained earnings on formation. ➢ Carrying amounts = FV of the subsidiary’s net assets (no goodwill). 46 New-Entity Method ➢ An alternative to the acquisition method, called the newentity method, as been discussed in academic circles from time to time over the past 50 years. ➢ Under this method, the net assets of both the acquiring company and the acquired company are reported at their fair value. 47 Analysis and Interpretation of Financial Statements ➢ The separate entity financial statements of the parent present the investment in subsidiary as one line on the balance sheet. ➢ When the consolidated balance sheet is prepared, the investment account is replaced by the underlying assets and liabilities of the subsidiary. ➢ This gives the same results as if the investor had bought the subsidiary’s assets and liabilities directly. 48 ASPE Differences ➢ Part II of the CPA Canada Handbook outlines the main differences under ASPE: ➢ An enterprise shall make an accounting policy choice to either consolidate its subsidiaries or report its subsidiaries using either the equity method or the cost method. All subsidiaries should be reported using the same method. (Section 1591) ➢ When a subsidiary's equity securities are quoted in an active market and the parent would normally choose to use the cost method, the investment should not be reported at cost. Under such circumstances, the investment should be reported at fair value, with changes in fair value reported in net income. (Section 1591) 49 ASPE Differences ➢ Part II of the CPA Canada Handbook outlines the main differences under ASPE continued: ➢ Private companies con apply push-down accounting but must disclose the amount of the change in each major class of assets, liabilities, and shareholders’ equity in the year that push-down accounting is first applied. (Section 1625) 50 CHAPTER 4: Consolidation of Non-Wholly Owned Subsidiaries © 2019 McGraw-Hill Education Prepared by Shannon Butler, CPA, CA Carleton University Learning Objectives Define non-controlling interest and explain how measured on the consolidated balance sheet. LO1 LO2 Prepare a consolidated balance sheet using the fair value enterprise method. LO3 Prepare a consolidated balance sheet using the identifiable net assets method. LO4 Explain the concept of negative goodwill and describe how it should be treated when it arises in a business combination. it is 2 Learning Objectives LO5 Account for contingent consideration based on its classification as a liability or equity. LO6 Analyze and interpret financial statements involving consolidation of non-wholly owned subsidiaries. LO7 (Appendix 4A) Prepare a consolidated balance sheet using the working paper approach. 3 Non-Wholly Owned Subsidiaries ➢ When the parent acquires less than 100% of the shares, the parent’s own assets and liabilities and the parent’s share of the subsidiary’s assets and liabilities will be measured at carrying value and fair value, respectively, on the consolidated balance. ➢ The following example, Exhibit 4.1, will form the basis of many of the illustrations that will be used in this chapter. 4 Exhibit 4.1 BALANCE SHEET At June 29, Year 1 P Ltd. S Ltd. Carrying Amount Cash Accounts receivable Inventory Plant Patent Total assets Current liabilities Long-term debt Total liabilities Common shares Retained earnings Total liabilities and shareholders’ equity $100,000 90,000 130,000 280,000 $600,000 $ 60,000 180,000 240,000 200,000 160,000 $600,000 Carrying Amount $ 12,000 7,000 20,000 50,000 11,000 $100,000 $ 8,000 22,000 30,000 40,000 30,000 $100,000 Fair Value $ 12,000 7,000 22,000 59,000 10,000 $110,000 $ 8,000 25,000 $ 33,000 5 Non-Wholly Owned Subsidiaries ➢ The shares not acquired by the parent are owned by the other shareholders, referred to as the “non-controlling shareholders”. ➢ The value of shares held by the non-controlling shareholders appears on the balance sheet as “non-controlling interest” (NCI) 6 Non-Wholly Owned Subsidiaries ➢ Three questions arise when preparing consolidated financial statements for less-than-100% subsidiaries: 1. How should the portion of the subsidiaries net assets not acquired by the parent be valued on the consolidated financial statements? 2. How should NCI be measured? 3. How should NCI be presented? 7 Non-Wholly Owned Subsidiaries ➢ Four theories propose a solution to preparing consolidated financial statements for non-wholly subsidiaries. • • • • Proportionate consolidation method Parent Company method Identifiable net asset (INA) method Fair value enterprise (FVE) method 8 Non-Wholly Owned Subsidiaries ➢ The proportionate consolidation method used to be called the proprietary theory. ➢ The INA method used to be called the parent company extension theory and is sometimes referred to as the partial goodwill method. ➢ The FVE method used to be called the entity theory and is sometimes referred to as the full goodwill method. 9 Non-Wholly Owned Subsidiaries ➢ Each of the methods has been or is currently required by GAAP in specified situations. The following table indicates the current status and effective usage dates for these four methods: Method Status Proportionate consolidation Current GAAP for consolidating certain types of joint arrangements; was an option under GAAP prior to 2013 when consolidating joint ventures. Parent company Was GAAP for consolidating subsidiaries prior to January 1, 2011. INA An acceptable option for consolidating subsidiaries after January 1, 2011. FVE An acceptable option for consolidating subsidiaries after January 1, 2011. 10 Consolidation Methods for Valuation of Subsidiary Portion of Subsidiary Presented on Consolidated Financial Statements Proportionate Consolidation Method Parent Company Method Identifiable Net Assets Method Fair Value Enterprise Method Parent Parent Parent Parent NCI NCI NCI NCI Carrying amount of subsidiary’s net assets Fair value excess Goodwill The parent’s portion of the subsidiary’s value is fully represented under all methods. The NCI’s share varies under the four methods. 11 Consolidation Methods ➢ We will illustrate the preparation of consolidated financial statements under these methods using the following example: ➢ We will examine P Ltd. And S Ltd. Both companies have a June 30 fiscal year-end. On June 30, Year 1, S Ltd. had 10,000 shares outstanding and P Ltd. purchased 8,000 shares (80%) of S Ltd. for a total cost of $72,000. P Ltd.’s journal entry to record this purchase is as follows: Dr investment in S Ltd. Cr Cash $72,000 $72,000 12 Proportionate Consolidation Method ➢ Views the consolidated entity from the standpoint of the shareholders of the parent company. ➢ Therefore the consolidated statements do not reflect the equity of the non-controlling shareholders. ➢ The consolidated balance sheet on the date of acquisition reflects only the parent’s share of the assets and liabilities of the subsidiary, based on their fair values, and the resultant goodwill from the combination. 13 Proportionate Consolidation Method ➢ Proportionate consolidation focuses solely on the parent’s percentage interest in the subsidiary. ➢ Proportionate consolidation is not used in practice to consolidate a parent and its subsidiaries. However, it is used to report certain types of joint arrangements. 14 The Parent Company Method ➢ Similar to the proportionate consolidation method the parent company method focuses on the parent company but gives some recognition to NCI. ➢ Since the parent company method is no longer used in practice, it will not be illustrated in this textbook. 15 Fair Value Enterprise (FVE) Method ➢ Views the consolidated entity as having two distinct groups of shareholders – the controlling and non-controlling shareholders. ➢ The fair value enterprise method gives equal attention to the controlling and non-controlling shareholders. ➢ The trading price of the subsidiary’s shares or shares of a comparable company in an active market is probably the most accurate reflection of the value of the NCI. 16 Fair Value Enterprise (FVE) Method ➢ An investor typically pays a premium over the trading price of a company’s shares when acquiring sufficient shares to obtain control of the company. ➢ Discounted cash flow analysis could be used to estimate the fair value of the subsidiary. 17 Fair Value Enterprise (FVE) Method Example 1: Fair value of NCI as evidenced by market trades. ➢ P Ltd. acquires 80% of S Ltd. (8,000 of S Ltd’s shares) for $72,000 by paying $9 per share. ➢ S Ltd. shares are trading for $7.75 per share at acquisition date. 18 Fair Value Enterprise (FVE) Method ➢ Acquisition date FV is as follows: FV of controlling interest ($9 x 8,000 shares) FV of NCI ($7.75 x 2,000 shares) Total FV of S Ltd. at acquisition date $72,000 15,500 $87,500 ➢ The next slide will show the calculation of acquisition differential (exhibit 4.5) ➢ The goodwill component as a % of total value for the controlling interest is much higher than NCI when a parent pays a premium to obtain control. See Chapter 5 self-study for an example. 19 Fair Value Enterprise (FVE) Method CALCULATION OF ACQUISITION DIFFERENTIAL (FVE method—Example 1) Parent Percentage of S Ltd. Fair value at date of acquisition Carrying amount of S Ltd.’s net assets: Assets Liabilities Acquisition differential 80% $ 72,000 20% $15,500 100% $87,500 56,000 14,000 16,000 1,500 17,500 5,600 1,400 7,000 100 $10,500 70,000 FV − CA Inventory 2,000 Plant 9,000 Patent Total $100,000 (30,000) 70,000 Fair value excess: NCI (1,000) 10,000 Long-term debt −3,000 7,000 Balance—goodwill $ 10,400 $ 20 Fair Value Enterprise (FVE) Method Example 2: Fair value of NCI Implied by parent’s consideration paid. ➢ P Ltd. Acquires 80% of S Ltd. on June 30, Year 1 for $72,000 paid in cash. ➢ The following two slides Exhibit 4.6 and 4.7 reflect the calculation and allocation of acquisition differential, noncontrolling interest, and consolidated balance sheet of P Ltd. 21 Exhibit 4.6 Exhibit 4.6 CALCULATION OF ACQUISITION DIFFERENTIAL (FVE method—Example 2) Cost of 80% investment in S Ltd. $72,000 Implied value of 100% investment in S Ltd. ($72,000 ÷ 80%) $90,000 Carrying amount of S Ltd.’s net assets: Assets $100,000 Liabilities (30,000) 70,000 Implied acquisition differential Allocated: Inventory Plant Patent 20,000 (FV − CA) × 100% + 2,000 × 100% = + 2,000 + 9,000 × 100% = + 9,000 − 1,000 × 100% = − 1,000 10,000 −3,000 × 100% = −3,000 Long-term debt Balance—goodwill (a) (b) (c) 7,000 $13,000 (d) (e) Calculation of NCI Implied value of 100% investment in S Ltd. NCI ownership $90,000 20% $18,000 (f) 22 Exhibit 4.7 Exhibit 4.7 ILLUSTRATION OF THE DIRECT APPROACH (FVE method) P LTD. CONSOLIDATED BALANCE SHEET At June 30, Year 1 Cash (100,000 − 72,000* + 12,000) Accounts receivable (90,000 + 7,000) $ 40,000 97,000 Inventory (130,000 + 20,000 + [6a] 2,000) 152,000 Plant (280,000 + 50,000 + [6b] 9,000) 339,000 Patent (0 + 11,000 − [6c] 1,000) 10,000 Goodwill (0 + 0 + [6e] 13,000) 13,000 $651,000 *Cash paid by P Ltd. to acquire S Ltd. 23 Exhibit 4.7 Exhibit 4.7 continued ILLUSTRATION OF THE DIRECT APPROACH (FVE method) P LTD. CONSOLIDATED BALANCE SHEET At June 30, Year 1 Current liabilities (60,000 + 8,000) $ 68,000 Long-term debt (180,000 + 22,000 + [6d] 3,000) 205,000 Total liabilities 273,000 Shareholders’ equity: Controlling interest: Common shares 200,000 Retained earnings 160,000 360,000 Non-controlling interest [6f] 18,000 378,000 $651,000 *Cash paid by P Ltd. to acquire S Ltd. 24 Fair Value Enterprise (FVE) Method ➢ Sometimes, it is appropriate to measure NCI using the price per share paid by the parent to obtain control. ➢ The implied value assumes that the parent’s acquisition cost can be extrapolated linearly to determine the total value of the subsidiary. ➢ NCI could be valued using business valuation techniques, but this is a costly exercise. ➢ In this text, we will assume a linear relationship to calculate the value of NCI except when we are given the market price of the subsidiary’s shares help by the non-controlling shareholders. 25 Identifiable Net Assets Method ➢ Addresses concern about goodwill valuation under the fair value enterprise method. ➢ Reflects both parent’s and non-controlling interest’s share of identifiable net assets at full fair values. ➢ However only parent’s share of subsidiary’s goodwill is reflected on consolidated balance sheet. 26 Identifiable Net Assets Method ➢ NCI is calculated as follows: Carrying amount of S Ltd’s net assets: Assets Liabilities Excess of fair value over carrying amount for identifiable net assets (Exhibit 4.5) Fair value of identifiable net assets Non-controlling ownership % Non-controlling interest $100,000 (30,000) 70,000 7,000 77,000 20% $15,400 ➢ NCI is based on the fair value of identifiable assets and liabilities. ➢ See Exhibit 4.8 for Consolidated Balance Sheet 27 Bargain Purchases ➢ Negative goodwill results when the total consideration (purchase price) is less than the fair value of identifiable net assets. ➢ Often described as a bargain purchase, this can occur when share prices are depressed or subsidiary has had recent operating losses. 28 Bargain Purchases ➢ IFRS 3 requires that negative goodwill be reduced to zero by first reducing any goodwill on the subsidiary’s books, then recognizing any remaining negative goodwill as a gain. ➢ Since negative goodwill is very rare, the parent should check the valuations of the identifiable net assets before recording a gain on bargain purchase. 29 Bargain Purchases Illustration - Negative Goodwill: ➢ On June 30, year 1 P Ltd. Purchased 100% of the shares of S Ltd. For $72,000 cash. The carrying amount of S’s identifiable net assets is $70,000 and the acquisition differential is $2,000 on that date. ➢ $7,000 of the $2,000 acquisition differential is allocated to the net assets of S, leaving $5,000 negative goodwill. ➢ The calculation and amortization of the acquisition differential is shown in Exhibit 4.9 on the next slide. 30 Exhibit 4.9 CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL (Negative goodwill, wholly owned subsidiary) Cost of investment in S Ltd. $ 72,000 Carrying amount of S Ltd.’s net assets: Assets 100,000 Liabilities (30,000) Acquisition differential Allocated: 70,000 2,000 (FV − CA) Inventory + 2,000 Plant + 9,000 Patent − 1,000 10,000 Long-term debt Balance—“negative goodwill” (gain on bargain purchase) − 3,000 7,000 $ (5,000) The negative goodwill is recognized as a gain on bargain purchase 31 Negative Acquisition Differential ➢ Not the same as negative goodwill. ➢ Results when the parent’s interest in the book values of the subsidiary’s net assets exceed acquisition cost. ➢ Could result in negative goodwill if the fair values of the subsidiary’s net assets also exceed acquisition cost, otherwise will result in positive goodwill. 32 Subsidiary with Goodwill ➢ Any goodwill on the balance sheet of subsidiary on acquisition date is not carried forward to the consolidated balance sheet. ➢ That goodwill resulted from a past transaction in which the subsidiary was the acquirer in a business combination, reflecting outdated fair values of entity it acquired. ➢ The parent’s acquisition differential is now calculated as if the goodwill has been written off by the subsidiary and replaced instead by the updated fair values and goodwill of the entity the subsidiary previously acquired. 33 Subsidiary with Goodwill Example: ➢ On June 30, Year 1 P Ltd. purchased 80% of the shares of S Ltd. For $62,000 cash. The fair value of S’s identifiable net assets – which includes goodwill is $67,000 on that date. ➢ The balance sheets of both companies is shown in Exhibit 4.12 on the next slide. ➢ The calculation and amortization of the acquisition differential is shown in Exhibit 4.13 in the following slide. ➢ The consolidated balance sheet is shown in Exhibit 4.14 in the second following slide. 34 Exhibit 4.12 Exhibit 4.12 BALANCE SHEET At June 29, Year 1 P Ltd. S Ltd. Carrying Amount Cash Carrying Amount Fair Value $100,000 $ 12,000 $12,000 90,000 7,000 7,000 Inventory 130,000 20,000 22,000 Plant 280,000 50,000 59,000 Accounts receivable Goodwill 11,000 $600,000 $100,000 Current liabilities $ 60,000 $ 8,000 8,000 Long-term debt 180,000 22,000 25,000 Common shares 200,000 40,000 Retained earnings 160,000 30,000 $600,000 $100,000 35 Exhibit4.13 4. Exhibit CALCULATION AND ALLOCATION OF ACQUISITION DIFFERENTIAL (Subsidiary with goodwill) Cost of 80% investment in S Ltd. Implied value of 100% investment in S Ltd. $62,000 (62,000/0.80) $77,500 Carrying amount of net assets of S Ltd. Assets Liabilities $ 100,000 (30,000) 70,000 Deduct old goodwill of S Ltd. 11,000 (a) Adjusted net assets 59,000 Acquisition differential 18,500 Allocated: (FV − CA) Inventory +$2,000 (b) +9,000 (c) 11,000 36 Plant 4. ExhibitExhibit 4.13 continued Long-term debt −3,000 Balance—goodwill 8,000 (d) $10,500 (e) Calculation of NCI Implied value of 100% investment in S Ltd. NCI ownership $77,500 20% $15,500 (f) The subsidiary’s goodwill was revalued at the date of acquisition. It is now worth $10,500, based on the recent price paid by the parent. 37 Exhibit 4.14 ILLUSTRATION OF THE DIRECT APPROACH (Subsidiary with goodwill) P LTD. CONSOLIDATED BALANCE SHEET At June 30, Year 1 Cash (100,000 − 62,000* + 12,000) Accounts receivable (90,000 + 7,000) $ 50,000 97,000 Inventory (130,000 + 20,000 + [13b] 2,000) 152,000 Plant (280,000 + 50,000 + [13c] 9,000) 339,000 Goodwill (0 + 11,000 − [13a] 11,000 + [13e] 10,500) 10,500 $648,500 Current liabilities (60,000 + 8,000) $ 68,000 Long-term debt (180,000 + 22,000 + [13d] 3,000) 205,000 Common shares 200,000 Retained earnings 160,000 Non-controlling interest [13f] 15,500 $648,500 *Cash paid by P Ltd. to acquire S Ltd. 38 Contingent Consideration ➢ What happens when a portion of the total cost of the acquisition is variable depending on future events, so the eventual total cost is not known with certainty at the date of acquisition of the subsidiary? ➢ IFRS 3 requires the contingent consideration to be recorded at fair value at the acquisition date as part of the acquisition cost, using assumptions, probabilities, and other valuation techniques which can be subjective and require significant amount of judgment. 39 Contingent Consideration ➢ Classify contingent consideration as either liability or equity depending on its nature. ➢ If payable in cash or another asset, record as liability. Revalue liability after acquisition date as circumstances change. ➢ Record revaluation adjustment in earnings if revaluation arose as a result of events occurring after acquisition; or ➢ Adjust the purchase price if revaluation arose as a result of new information about facts and circumstances that exists as at the date of acquisition. ➢ If payable in additional shares of the parent, record as equity. Do not revalue contingent consideration classified as equity. 40 Contingent Consideration ➢ Disclosure Requirements: ➢ IFRS 3, paragraph B64, requires that a reporting entity disclose the following for each business combination in which the acquirer holds less than 100% of the equity interests in the acquiree at the acquisition date: a) The amount of the NCI in the acquiree recognized at the acquisition date and the measurement basis for that amount. b) For each NCI in an acquiree measured at fair value, the valuation techniques and key model inputs used for determining that value. 41 Analysis and Interpretation of Financial Statements ➢ The key ratios are different under different reporting methods. ➢ The value and classification of NCI is significantly different under the three methods. ➢ The classification of non-controlling interest has a big impact on the debt-to-equity ratio. ➢ See Exhibit 4.16 for impact on current and debtto-equity ratios. 42 Consolidation of Non-Wholly Owned Subsidiaries Appendix 4A ➢ Working Paper Approach - Use of the working paper ensures that the debit and credit adjustments balance each other. ➢ The working paper in Exhibit A4.1 (refer to exhibit in text for example) reflects three consolidated adjusting entries: 1. Establishes the NCI on the consolidated balance sheet and adds this additional value to the investment account, which then includes both the parent’s and NCI proportionate interest in the subsidiary. 43 Consolidation of Non-Wholly Owned Subsidiaries Appendix 4A ➢ The working paper in Exhibit A4.1 (refer to exhibit in text for example) reflects three consolidated adjusting entries continued: 2. Eliminates the investment account and the subsidiary’s shareholders’ equity accounts with the difference established as the acquisition differential. 3. Allocates the acquisition differential to revalue the identifiable net assets of the subsidiary to fair value, and establishes the resulting goodwill. 44 Consolidation of Non-Wholly Owned Subsidiaries Appendix 4A ➢ Worksheet entries are made only in the working paper; they are not entered into the accounting records of P Ltd. Or S Ltd. ➢ Exhibit A4.2 shows the preparation of the consolidated balance sheet when P Ltd. Acquires 80% of the common shares of S Ltd. For $60,000 • results in negative goodwill, reported as a gain. ➢ Exhibit A4.3 show the preparation of the consolidated balance sheet when S Ltd. has goodwill on its own balance sheet. 45 
Purchase answer to see full attachment