2016 McGraw-Hill Education

CHAPTER
5:
Consolidatio
n
Subsequent
to
Acquisition
Date

Prepared by
Shannon Butler, CPA,
Carleton University

Learning Objectives
LO1 Perform impairment tests on property, plant,
equipment, intangible assets, and goodwill.

LO2 Prepare schedules to allocate and amortize

the acquisition differential on both an annual
and a cumulative basis.

LO3 Prepare consolidated financial statements

using the entity theory subsequent to the date
of acquisition.

LO4 Prepare consolidated financial statements using

the parent company extension theory subsequent
to the date of acquisition.
2

Learning Objectives
LO5 Prepare journal entries and calculate balance
in the investment account under the equity
method.

LO6 Analyze and interpret financial statements

involving consolidations subsequent to the
date of acquisition.

LO7 (Appendix 5A) Perform impairment test for

goodwill in

complex situations.

LO8 (Appendix 5B) Prepare consolidated financial statements

subsequent to date of acquisition using the working paper
approach.
3

Methods of Accounting for an

Investment in a Subsidiary
The cost and equity methods are used in the parents
own internal records for accounting for investments in
subsidiaries.

The cost method records income when the investors

right to receive a dividend is established.

The equity method captures the investors share of any

changes to the investees shareholders equity.

The equity method captures the net effect of any

adjustments that would be made on the consolidated
financial statements.
4

Methods of Accounting for an

Investment in a Subsidiary
We must differentiate between accounting in the
internal records and reporting in the external financial
statements.

An entity could issue non-consolidated financial

statements to external users in addition to
consolidated financial statements.

Dividend income and equity method income from a

subsidiary are usually not taxable.

Consolidated net income will be the same regardless

of whether the parent used the cost method or the
equity method for its internal accounting records.
5

Consolidated Income and

Retained Earnings
The investment income from the subsidiary is replaced by
the subsidiarys revenues and expenses on a line by line
basis.

The amortization of the acquisition differential is reflected on

the consolidated financial statements, not the subsidiarys
financial statements.

The acquisition differential is amortized or written off on

consolidation as if the parent had purchased these net
assets directly.

The parents separate-entity retained earnings accounted for

under the equity method should always be equal to
consolidated retained earnings.
6

Testing Goodwill and Other

Assets for Impairment

LO1

In 2011, the impairment test for long-term

tangible and intangible assets changed with the
adoption of IFRS.

IAS 36 Impairment of Assets applies to all assets,

unless they are specifically excluded because of a
requirement in another standard.
An asset is impaired if its carrying amount exceeds its
recoverable amount.
The recoverable amount is the higher of fair value less
costs of disposal and value in use.
It is possible for an asset not to be impaired at the
subsidiary level but to be impaired at the consolidated
level.
7

Testing Goodwill and Other

Assets for Impairment

LO1

IAS 36 established different rules and procedures

for
impairment testing for each of the following types
of
assets:

Property, plant, equipment, and intangible assets with

definite useful lives.

Intangible assets with indefinite useful lives or not yet

available for use.

Cash-generating units and goodwill.

Property, Plant, Equipment and

LO1
Intangible Assets with Definite Useful
Lives
The recoverable amount needs to be determined only if
there is an indication of impairment. At a minimum the
following factors should be considered:
External Factors

Internal Factors

An assets market value has declined significantly

There is evidence of obsolescence or physical

damage of an asset.

Significant adverse changes in the technological,

market, economic, or legal environment of the
entity have occurred.

There have been significant adverse changes in

how an asset is used or expected to be used.

A significant increase in market rates of return

has occurred that will cause a reduction to value
in use

Evidence has arisen that the economic

performance of an asset is, or will be, worse than
expected

The carrying amount of the net assets of the

entity is more than its market capitalization.

The carry amount of the investment in subsidiary

in the separate-entity financial statements
exceed the carrying amounts in the consolidated
financial statements of the investees net assets,
including associated goodwill.
The dividend from the subsidiary exceeds the
total comprehensive income of the subsidiary.

Intangible Assets with

Indefinite
Useful Lives

An intangible asset that is not subject to

amortization is tested for impairment annually.

When certain criteria are met, the recoverable

amount from a preceding period can be used rather
than determining a new recoverable amount for the
current year.

LO1

10

LO1

Cash-Generating Units and

Goodwill

A business divides itself into separate cash-generating

units, each of which has cash inflows from and asset or a
group of assets that are largely independent of the cash
inflows from other assets or asset groups.

Goodwill resulting from a business combination should

be divided among each cash-generating unit that will
benefit from the goodwill.

Each unit to which goodwill is so allocated shall

represent the lowest level applicable and will not be
larger than an operating segment determined in
accordance with IFRS 8.
11

LO1

Cash-Generating Units and

Goodwill

Goodwill is allocated to cash-generating units as follows:

The total value of the subsidiary is allocated to each

cash-generating unit

The FV of the subsidiarys individual net assets is also

allocated to each cash-generating unit.

For each cash-generating unit, the allocated value is

compared with the fair value of the units identifiable net assets.

The difference = goodwill of the cash-generating unit

Sum of each cash-generating units goodwill = total acquisition

goodwill of the subsidiary

12

LO1

Cash-Generating Units and

Goodwill

The goodwill impairment test is complex and often

requires significant professional judgment.

Before goodwill impairment is tested, individual assets

should be tested for impairment and any losses
recorded.

Then the recoverable amount of each cash-generating

unit is compared to its carrying amount, including
goodwill. If recoverable amount > carrying amount
then no goodwill impairment

13

LO1

Cash-Generating Units and

Goodwill

When the carrying amount of the cash-generating

unit
goodwill exceeds the recoverable amount of the
goodwill, an impairment loss should be recognized in
an amount equal to the excess and should be
allocated to the assets of the unit in the following
order:

First, to reduce the carrying amount of any goodwill and

Second, to the other assets of the unit pro rata based on

the carrying amount of each asset

14

Reversing an ImpairmentLO1
Loss

Impairment losses on assets other than goodwill can be

reversed only to the extent of the pre-loss carrying amount of the
intangible asset.

In the first step, the entity assesses whether there are any
indications that the impairment loss either decreased or no
longer exists.

If decrease is indicated in the first step, in the second step the

recoverable amount is determined.

Impairment loss is reversed only if there has been a change in

the estimates used to determine the assets recoverable
amount, not if the present value of future cash flows has
increased solely from the passage of time.

Report reversal in net income

Allocate reversal to the assets of the cash-generating unit pro

rata
based on carrying amounts.

15

LO1

Disclosure Requirements

Extensive disclosure requirement are required for Impairment

of assets:

For each class of assets, the amount of impairment losses and

reversals of impairment losses segregated by amounts recognized in
the net income and amounts recognized in OCI

The events and circumstances that led to the recognition or reversal

of an impairment loss for individual assets, the basis of recoverable
amount, the basis used to determine fair value less costs to sell, and the
discount rate used.

For cash-generating units or indefinite-life intangible assets, the

carrying amount of goodwill and of indefinite-life intangibles allocated
to the unit, the basis of recoverable amount, description of key cash
flow projection assumptions, and the methodology to determine fair
value less cost to sell.

16

Consolidation of 100%
Owned Subsidiary

The investment account is replaced by the carrying

amount of the subsidiarys assets and liabilities plus
the acquisition differential.

LO2

Purchase price consists of carrying amount of the

subsidiary s assets and liabilities plus the acquisition
differential.

Dividends received or receivable from subsidiary are

recorded in parents income when the cost method is
used.

These dividends are eliminated on consolidation

17

Consolidation of 100%
Owned Subsidiary

LO2

The amortization and impairment of the acquisition differential

is recorded on the consolidated financial statements, in order
to match the expense to the revenue generated by the net
assets acquired. Example of amortization and impairment
schedule:

Purchase price consists of carrying value of the subsidiary s

assets and liabilities plus the acquisition differential.

Exhibit 5.4
ACQUISITION DIFFERENTIAL AMORTIZATION AND IMPAIRMENT SCHEDULE
Balance Amortization and Balance
Jan 1, Year 5 Impairment Year 5
Dec 31, Year 5
Inventory (2a) $2,000 $2,000 $ -- (a)
Goodwill (2b)
1,000
50
950
(b)
$3,000 $2,050 $950
(c)
The amortization and impairment of the acquisition differential will be reflected on
the consolidated financial statement.

18

Consolidation of 100%
Owned Subsidiary

LO2

the consolidated financial statements are prepared, account-byaccount, starting with the consolidated income statement, then
the consolidated statement of retained earnings, and finally the
consolidated balance sheet. (Exhibit 5.5 next slide)

Consolidated net income, and the consolidated balance sheet

accounts, are the same regardless of whether the parent used
equity or cost method.

Dividends on the consolidated statement of retained earnings are

the dividends of the parent.

Consolidated retained earnings reflect the cumulative effect of all

adjustments to that time.

The consolidated financial statements represents the combined

portion of parent and subsidiary as if the parent has acquired the
subsidiarys assets and liabilities directly.
19

Exhibit 5.5 Year 5, Consolidated Financial Statement (direct approach) LO2

COMPANY P - CONSOLIDATED INCOME STATEMENT
for the Year Ended December 31, Year 5

Sales (50,000 + 30,000)

$ 80,000
Cost of sales (26,500 + 14,700 + [4a] 2,000)
Goodwill impairment loss (0 + 0 + [4b] 50)
Expenses (misc.) (5,200 + 8,000)
13,200
56,450
Net Income
$ 23,550

43,200
50

COMPANY P - CONSOLIDATED STATEMENT OF RETAINED EARNINGS

for the Year Ended December 31, Year 5

Balance, January 1
Net income

$ 85,000
23,550
108,550
6,000
$102,550

Dividends
Balance, December 31

COMPANY P - CONSOLIDATED BALANCE SHEET

December 31,Year 5

Assets (misc.) (147,800 + 18,300)

Inventory (30,000 + 14,000 + [4a] 0)
Goodwill (0 + 0 + [4b0 950)

$166,100
44,000
950
$211,050

Liabilities (47,000 + 11,500)

Common shares
Retained earnings

$ 58,500
50,000
102.550
$211,050

20

LO2

Consolidation of 100% Owned

Subsidiary

When the parent uses the cost method to account for the
subsidiary, consolidated net income has to be calculated, by
converting to equity method net income since the equity
method reflects all consolidation adjustments. Example:

CALCULATION OF CONSOLIDATED NET INCOME -- Year 5

Company P net income -- cost method
$20,800
Less dividend income from Company S
2,500
Company P net income, own operations
18,300
Company S net income
$7,300
Acquisition differential amortization and impairment (4c)
(2,050)
Consolidated net income
$23,550

5,250

Since Company P owns 100% of Company S, all of the consolidated net income is
attributable to the shareholders of Company P.
This calculation starts with income under the cost method and coverts it to
consolidated net income.
21

Consolidation of 80% LO3

Owned Subsidiary Direct
Approach

It is necessary to calculate non-controlling interest that will

appear on the consolidated balance sheet.

Exhibit 5.9

COMPANY P - CALCULATION AND ALLOATION OF ACQUISITION

DIFFERENTIAL
January 1, Year 5
Cost of 80% of Company S

$15,200

Implied value of 100% of Company S

$19,000
Carrying amount of Company Ss net assets
Assets
$27,000
Liabilities (11,000)
16,000
Acquisition differential
3,000
Allocated: (FV CA)
Inventory
2,000
2,000 (a)
Balance Goodwill
$ 1,000 (b)

CALCULATION OF NON-CONTROLLING INTEREST

January 1, Year 5
Implied fair value, Company S (above) $19,000
Non-controlling interests percentage ownership
Non-controlling interest $ 3,800 (c)

20%

22

Consolidation of 80%
Owned Subsidiary

LO3

Although the parent owns < 100% of the subsidiary,

100% of the subsidiarys individual assets and
liabilities are still reported on the consolidated
balance sheet since they are controlled by the
parent.

Non-controlling interest is the balance that appears

in consolidated equity that reflects the portion of the
subsidiary that the parent does not own.

23

Consolidation of 80%
Owned Subsidiary

LO3

When the parent uses the cost method to account for the subsidiary,
consolidated net income needs to be calculated and then allocated
between parent and non-controlling shareholders.
CALCULATION OF CONSOLIDATED NET INCOME -- Year 5

Company P net income cost method (10b)

$20,300
Less: dividend income from Company S (10a)
2,000
Company P net income, own operations
18,300
Company S net income (10b) $7,300
Less: Acquisition differential amortization and impairment
5,250 (d)
Consolidated net income $23,550 (e)
Attributable to:
Shareholders of Company P
$22,500 (f)
Non-controlling interest (20% x [d] 5,250)

(2,050)

1,050 (g)

This schedule reflects 100% of the acquisition differential, which will be attributed to the
shareholders of the parent and the non-controlling interest.

24

Consolidation of 80%
Owned Subsidiary

LO3

The consolidated financial statements are prepared,

account-by-account, starting with the consolidated income
statement, and then consolidated statement of retained
earnings, and finally the consolidated balance sheet.
(Exhibit 5.12 next slide)

Consolidated net income is attributed to the controlling

shareholders and non-controlling interest.

Non-controlling interest is shown, on the balance sheet as a

component of shareholders equity. This NCI increases when
the subsidiary earns income and decreases when the
subsidiary
pays dividends
25

LO3

Exhibit 5.12 Year 5 Consolidated Financial Statements

(direct approach)
COMPANY P - CONSOLIDATED INCOME STATEMENT
for the Year Ended December 31, Year 5
Sales (50,000 + 30,000)
$ 80,000
Cost of sales (26,500 + 14,700 + [11a] 2,000)
Goodwill impairment loss (0 + 0 + [11b] 50)
Expenses (misc.) (5,200 + 8,000)
13,200
56,450
Net Income
$ 23,550
Attributable to:
Shareholders of Company P (11f)
Non-controlling interest (11g)

43,200
50

$ 22,500
1,050

COMPANY P - CONSOLIDATED STATEMENT OF RETAINED EARNINGS

for the Year Ended December 31, Year 5
Balance, January 1
Net income
Dividends
Balance, December 31

$ 85,000
22,500
107,500
6,000
$101,500

26

LO3

Exhibit 5.12 Year 5 Consolidated Financial Statements

(direct approach)
COMPANY P - CONSOLIDATED BALANCE SHEET
December 31,Year 5

Misc. Assets (151,100 + 18,300)

Inventory (30,000 + 14,000)
Goodwill (0 + 0 + (11b) 950)
$214,350

$169,400
44,000
950

Liabilities (47,000 + 11,500)

$ 58,500
Common shares
50,000
Retained earnings
101.500
Non-controlling interest (20% x [(10d) 10,000 + (10e)
10,800 + (11c) 950])
4,350
$214,350

27

LO3

Consolidation Under Equity

and Cost Method

If the parent has used the cost method to record the

subsidiary, it is necessary to calculate opening
consolidated
retained earnings.

Reflecting the cumulative increase or decrease in subsidiarys

retained earnings since acquisition.

Reflecting cumulative consolidation adjustments to that point

(e.g. Acquisition differential amortization)

When the subsidiary is less than 100% owned, it is also

necessary to calculate balance sheet NCI

See Example (Exhibit 5.14) next slide

28

LO3

Exhibit 5.14 - Consolidation in Subsequent Years

CALCULATION OF CONSOLIDATED RETAINED EARNINGS
As at January 1, Year 6
Company P retained earnings, Jan 1, Year 6 (cost method) (13c)
$ 99,300
Company S retained earnings, Jan 1, Year 6 (13c)
$10,800
Company S retained earnings, acquisition date (10c)
6,000
Increase since acquisition
4,800
Less acquisition differential amortization and impairment
to the end of Year 5 (11c)
(2,050)
2,750
(f)
Company Ps ownership percentage
80%
2,200
Consolidated retained earnings (which is equal to
Company Ps retained earnings equity method
$101,500 (g)

CALCULATION OF NON-CONTROLLING INTEREST

December 31, Year 6
Shareholders equity Company S
Common shares (13e)
Retained earnings (14a)
Unamortized acquisition differential (14a)
28,670
Non-controlling interests ownership
$ 5,734

$10,000
17,800
870
20%
(h)

29

Consolidation in Subsequent
Years

LO3

CALCULATION OF CONSOLIDATED RETAINED EARNINGS

At December 31, Year 6
Company P retained earnings, Dec 31, Year 6 $112,700
cost method (13d)
Company S retained earnings, Dec 31, Year 6 (13d) $17,800
Company S retained earnings, acquisition date (10c)
6,000
Increase since acquisition 11,800
Less acquisition differential amortization and impairment
to the end of Year 6 ([11c] 2,050 + [14a] 80) (2,130)
9,670
Company Ps ownership
80%
7,736
Consolidated retained earnings
$120,436
An alternative way to calculate NCI at the end of year 6 under the entity
theory follows:
NCI at date of acquisition (9c)
$ 3,800
Increase in Company S retained earnings, since acquisition
net of consolidation adjustments (as per (a) above)
$ 9,670
Non-controlling interests ownership
20%
1,934
NCI, end of year 6
$ 5,734

30

LO4

Parent Company Extension

Theory

If the NCI was measured based on the FV of identifiable

net assets approach i.e. The parent company
extension theory -- only the parents share of the
subsidiarys goodwill would be included on the
consolidated financial statements.

The NCIs share of the subsidiarys goodwill would be

excluded.

Goodwill and NCI are the only two accounts on the

consolidated balance sheet that would be different
under parent company extension theory compared with
entity theory.
31

Acquisition Differential
Assigned to Liabilities

Interest rate changes result in differences between

fair values and carrying amounts of liabilities
assumed in a business combination.

This difference is similar to a bond premium or

discount that must be amortized over its remaining
life.

IFRS 9 requires the use of the effective interest

method.

The effective interest method should be used to

account for financial assets and liabilities.

LO4

32

Acquisition Differential
Assigned to Liabilities

Bonds trade at a premium when the stated rate is

greater than the market rate of interest.

Under IFRS, the acquisition differential related to bonds

payable should, theoretically, be amortized using the
effective interest method.

The subsidiary amortizes the bond discount for its

separate-entity financial statements.

The straight-line and effective interest methods produce

the same results in total over the life of the bond.

LO4

33

Acquisition Differential
Assigned to Liabilities

Example: Subsidiary has outstanding 10% bonds with face

value of $100,000 maturing in 3 years. The market
interest rate is 8%. The fair value of the bonds based on
future cash flows discounted at 8% is $105,154, reflecting
a premium of $5,154 which is amortized as follows:

Period

Interest
paid

Year 2
Year 3

$10,0001

Year 4
Year 5

10,000
10,000

1
3

LO4

Amortization
Amortized
Interest
of bond
cost of
expense
premium
bonds
$8,4122

$105,154
$1,5883

8,285
8,149

$100,000 x 10% = $10,000

$10,000 - $8,412 = $1,588

1,715
1,851

103,5664
101,851
100,000

$105,154 x 8% = $8,412
4 $105,154 - $1,588 = $103,566
2

34

LO4

Intercompany Receivables
and Payables

Consolidated financial statements are designed to

reflect the results of transactions between the single
consolidated entity and those outside the entity.

All transactions between the parent and its

subsidiaries, or between the subsidiaries of a parent,
must be eliminated in the consolidation process to
reflect this single-entity concept.

This chapter focuses on the elimination of

intercompany receivables and payables.
35

Subsidiary Acquired
During the Year

The consolidated financial statements should include

only the subsidiarys net income from the date of acquisition

LO4

Example: Parent and subsidiary both have year-ends of

December 31, Year 2. parent acquired 80% of subsidiary on
September 30, Year 2, and therefore reports only the
subsidiarys net income from October 1 to December 31, Year 2.

To increase subsequent year financial statement

comparability, the consolidated financial statement footnotes
should include a pro forma consolidated income statement
prepared as if the subsidiary had been acquired at the
beginning of the year (IFRS 3)

36

LO5

Equity Method Recording

The parent can use the cost method or equity method in its
general ledger to account for an investment in a subsidiary.

Only the investors share of the investees income, dividends,

and amortization of acquisition differential are recorded in the
investors records.

The parents separate-entity net income should be equal to

consolidated net income attributable to shareholders of the
parent.

The investment account can be reconciled to the carrying

amount of the subsidiarys shareholders equity and the
unamortized acquisition differential.
37

LO5

Equity Method Recording

The investment account captures all adjustments

since the date of acquisition, whereas equity method
income captures adjustments for the current period.

The parents retained earnings under the equity

method should be equal to consolidated retained
earnings.

Investment in subsidiary and retained earnings are the

only two accounts on the separate-entity balance
sheet that would be different under the equity method
as compared with the cost method.
38

LO6

Analysis and Interpretation

of Financial Statements
Consolidated financial statements are exactly the
same and do not depend on whether the parent
uses the cost or equity method for internal record
keeping.

ROE for the parents separate entity financial

statements under the equity method should always
be equal to the ROE for the shareholders of
Company P on the consolidated consolidated
financial statements.
39

Goodwill Impairment -Appendix 5A

LO7

Goodwill is impaired when the recoverable amount

of the cash-generating unit as a whole exceeds the
carrying amount of the net assets of the cashgenerating unit as a whole.

Recoverable amount is the greater of fair value

from selling the unit today and value in use.

Value in use is the present value of future cash

flows from continuing to operate the unit.
40

Working Paper Approach for

Consolidations Subsequent to
Acquisition -- Appendix 5B

LO8

The preparation of the consolidated worksheet subsequent to

the date of acquisition starts with bringing the investment in
subsidiary account to its position at the beginning of the year
and establishing the non-controlling interest at the beginning of
the year.

Then, entries are made to eliminate the parents investment

account and the subsidiarys shareholders equity accounts and
allocate the acquisition differential at the beginning of the year.

The subsidiarys own income statement picks up the

subsidiarys income for the year.

Adjusting entries are required to amortize the acquisition

differential for the year and split the subsidiarys income and
dividend paid between the parent and non-controlling interest.

41