CHAPTER 5:

Consolidation
Subsequent to
Acquisition Date

Prepared by
Shannon Butler, CPA, CA
© 2022 McGraw Hill Limited Carleton University
 Learning Objectives, Part 1

LO1 Perform impairment tests on property, plant,

equipment, intangible assets, and goodwill.
LO2 Prepare schedules to allocate and show changes
to the acquisition differential on both an annual
and a cumulative basis.
LO3 Prepare consolidated financial statements using the fair
value enterprise method subsequent to the date of
acquisition.
LO4 Prepare consolidated financial statements using
the identifiable net assets method subsequent
to the date of acquisition.
© 2022 McGraw Hill Limited 2
 Learning Objectives, Part 2
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.

© 2022 McGraw Hill Limited 3

 Methods of Accounting for an
Investment in a Subsidiary, Part 1
 The cost and equity methods are used in the parent’s own
internal records for accounting for investments in subsidiaries.
 The cost method records income when the investor’s right to
receive a dividend is established.
 The equity method captures the investor’s share of any changes
to the investee’s shareholders’ equity.
 The equity method captures the net effect of any adjustments
that would be made on the consolidated financial statements.

© 2022 McGraw Hill Limited 4

 Methods of Accounting for an
Investment in a Subsidiary, Part 2
 We must differentiate between accounting in the internal
records and reporting in the external 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.

© 2022 McGraw Hill Limited 5

 Consolidated Income and
Retained Earnings
 The investment income from the subsidiary is replaced by the
subsidiary’s revenues and expenses on a line by line basis.
 The depletion of the acquisition differential is reflected on the
consolidated financial statements, not the subsidiary’s financial
statements.
 The acquisition differential is amortized, written down, or de-
recognized on consolidation as if the parent had purchased these
net assets directly.
 Consolidated retained earnings reflects only the parent’s share of
the combined company’s retained earnings.

© 2022 McGraw Hill Limited 6

 Testing Goodwill and Other
Assets for Impairment, Part 1
 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.

© 2022 McGraw Hill Limited 7

 Testing Goodwill and Other
Assets for Impairment, Part 2
 IAS 36 has different requirements for impairment testing for
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.

© 2022 McGraw Hill Limited 8

Property, Plant, Equipment and Intangible Assets
with Definite Useful Lives, Part 1

There is a two-step approach to determining if an impairment loss

should be reported.
 Step 1: The entity assesses whether indicators exist that an asset may be
impaired. If, in the preparer’s judgment, any such indicators exist, then
step 2 must be performed and the recoverable amount determined.

 Step 2: The recoverable amount is determined and compared with the

asset’s carrying amount.
 If the recoverable amount is greater than the carrying amount, no
impairment exists and the asset is reported at the carrying amount.
 If the recoverable amount is less than the carrying amount, impairment
exists and the asset is written down to its recoverable amount.

© 2022 McGraw Hill Limited 9

Property, Plant, Equipment and Intangible Assets
with Definite Useful Lives, Part 2
The following factors should be considered at a minimum when assessing
whether there is an indication of impairment:
External Factors Internal Factors
There is evidence of obsolescence or physical damage of
An asset’s market value has declined significantly.
an asset.
Significant adverse changes in the technological, market,
There have been significant adverse changes in how an
economic, or legal environment of the entity have
asset is used or expected to be used.
occurred.
A significant increase in market rates of return has Evidence has arisen that the economic performance of an
occurred that will cause a reduction to value in use. asset is, or will be, worse than expected.
The carrying amount of the investment in subsidiary in the
The carrying amount of the net assets of the entity is more separate-entity financial statements exceeds the carrying
than its market capitalization. amounts in the consolidated financial statements of the
investee’s net assets, including associated goodwill.
The dividend from the subsidiary exceeds the total
comprehensive income of the subsidiary.

© 2022 McGraw Hill Limited 10

 Intangible Assets with Indefinite
Useful Lives
 An intangible asset that is not subject to amortization is tested
for impairment annually (step 2).

 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.

© 2022 McGraw Hill Limited 11

 Cash-Generating Units and
Goodwill, Part 1
 A business divides itself into separate cash-generating units, each of
which has cash inflows from an 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 must represent the lowest

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

© 2022 McGraw Hill Limited 12

 Cash-Generating Units and
Goodwill, Part 2
 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 subsidiary’s 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 unit’s identifiable net assets.
 The difference = goodwill of the cash-generating unit
 Sum of each cash-generating unit’s goodwill = total acquisition
goodwill of the subsidiary.

© 2022 McGraw Hill Limited 13

 Cash-Generating Units and
Goodwill, Part 3
 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.

© 2022 McGraw Hill Limited 14

 Cash-Generating Units and
Goodwill, Part 4
 If the recoverable amount is less than the carrying amount, an
impairment loss should be recognized and should be allocated to
reduce the carrying amount of the assets in the following order:

a. First, to reduce the carrying amount of any goodwill.

b. Then to the other assets of the unit pro rata based on the carrying
amount of each asset.

© 2022 McGraw Hill Limited 15

Reversing an Impairment Loss, Part
1
 Impairment losses on assets other than goodwill can be reversed
only to the extent of the pre-loss carrying amount of the
intangible asset.

 Two step process; in step 1 the entity assesses whether there are
any indications that the impairment loss either decreased or no
longer exists.

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

recoverable amount is determined.

© 2022 McGraw Hill Limited 16

Reversing an Impairment Loss, Part
2
 An impairment loss is reversed only if there has been a change
in the estimates used to determine the asset’s recoverable
amount, not if the present value of future cash flows has
increased solely from the passage of time.

 The reversal of an impairment loss is reported in net income.

 A reversal of an impairment loss for a cash-generating unit
must be allocated to the assets of the unit pro rata with the
carrying amount of those assets.

© 2022 McGraw Hill Limited 17

 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.

© 2022 McGraw Hill Limited 18

 Consolidation of 100%
Owned Subsidiary, Part 1
 The investment account is replaced by the carrying amount of
the subsidiary’s assets and liabilities plus the acquisition
differential.
 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 parent’s income when the cost method is used.
 These dividends are eliminated on consolidation.

© 2022 McGraw Hill Limited 19

 Consolidation of 100%
Owned Subsidiary, Part 2
 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.

CHANGES TO ACQUISITION DIFFERENTIAL SCHEDULE

Balance Jan. 1, Changes in Balance Dec. 31,
Year 5 Year 5 Year 5
Inventory (2a) $2,000 $(2,000) $ (a)
Goodwill (2b) 1,000 (50) 950 (b)
$3,000 $(2,050) $950 (c)

© 2022 McGraw Hill Limited 20

 Consolidation of 100%
Owned Subsidiary, Part 3
 The consolidated financial statements are prepared, account-by-account,
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 subsidiary’s assets and
liabilities directly.

© 2022 McGraw Hill Limited 21

 Exhibit 5.5, Part 1
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 + [4a] 2,000) 43,200
Goodwill impairment loss (0 + 0 + [4b] 50) 50
Expenses (misc.) (5,200 + 8,000) 13,200
56,450
Net income $ 23,550
Consolidated net income is the same regardless of whether the parent used the cost method or the
equity method in its internal records.

© 2022 McGraw Hill Limited 22

 Exhibit 5.5, Part 2
COMPANY P
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
For the year ended December 31, Year 5
Balance, January 1 $ 85,000
Net income 23,550
108,550
Dividends 6,000
Balance, December 31 $102,550
Dividends on the consolidated statement of retained earnings are the dividends of the parent.

© 2022 McGraw Hill Limited 23

 Exhibit 5.5, Part 3
COMPANY P
CONSOLIDATED BALANCE SHEET
At December 31, Year 5
Miscellaneous assets (147,800 + 18,300) $166,100
Inventory (30,000 + 14,000 + [4a] 0) 44,000
Goodwill (0 + 0 + [4b] 950) 950
$211,050
Liabilities (47,000 + 11,500) $ 58,500
Common shares 50,000
Retained earnings 102,550
$211,050

© 2022 McGraw Hill Limited 24

 Consolidation of 100%
Owned Subsidiary, Part 4
 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

Changes in acquisition differential (4c) (2,050) 5,250

Consolidated net income $23,550

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Consolidation of 80% Owned Subsidiary –
Direct Approach, Part 1
 It is necessary to calculate non-controlling interest that will appear on the
consolidated balance sheet.
COMPANY P
CALCULATION AND ALLOCATION 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 S’s 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)

© 2022 McGraw Hill Limited 26

 Consolidation of 80% Owned Subsidiary –
Direct Approach, Part 2

The implied value of the subsidiary is derived by taking the purchase price and dividing by the
percentage ownership acquired by the parent.
CALCULATION OF NON-CONTROLLING INTEREST
January 1, Year 5
Implied fair value, Company S (above) $19,000
Non-controlling interest’s percentage ownership 20%
Non-controlling interest $ 3,800 (c)
NCI is based on the implied value of the subsidiary as a whole.

© 2022 McGraw Hill Limited 27

 Consolidation of 80% Owned
Subsidiary, Part 1
 Although the parent owns < 100% of the subsidiary, 100% of
the subsidiary’s 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.
 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.

© 2022 McGraw Hill Limited 28

 Consolidation of 80% Owned
Subsidiary, Part 2
 This schedule reflects 100% of the acquisition differential, which will be
attributed to the shareholders of the parent and the non-controlling interest.

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

Change to acquisition differential (2,050)

5,250 (d)

Consolidated net income $23,550 (e)

Attributable to:

Shareholders of Company P $22,500 (f)

Non-controlling interest (20% × [d] 5,250) 1,050 (g)

© 2022 McGraw Hill Limited 29

 Consolidation of 80% Owned
Subsidiary, Part 3
 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.

© 2022 McGraw Hill Limited 30

 Exhibit 5.12, Part 1
Year 5 Consolidated Financial Statements
(Direct approach)
COMPANY P
CONSOLIDATED INCOME STATEMENTS
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) 43,200

Goodwill impairment loss (0 + 0 + [11b] 50) 50

Expenses (miscellaneous) (5,200 + 8,000) 13,200

56,450

Net income $ 23,550

Attributable to:

Shareholders of Company P (11f) $ 22,500

Non-controlling interest (11g) 1,050

© 2022 McGraw Hill Limited 31

 Exhibit 5.12, Part 2
COMPANY P
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
For the year ended December 31, Year 5
Balance, January 1 $ 85,000
Net income 22,500
107,500
Dividends 6,000
Balance, December 31 $101,500

© 2022 McGraw Hill Limited 32

 Exhibit 5.12, Part 3
COMPANY P
CONSOLIDATED BALANCE SHEET
At December 31, Year 5
Miscellaneous assets (151,100 + 18,300) $169,400
Inventory (30,000 + 14,000) 44,000
Goodwill (0 + 0 + (11b) 950) 950
$214,350
Liabilities (47,000 + 11,500) $ 58,500
Common shares 50,000
Retained earnings 101,500
Non-controlling interest (20% × [(10d) 10,000 + (10e) 10,800 + (11c) 950]) 4,350
$214,350

© 2022 McGraw Hill Limited 33

 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 subsidiary’s
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 slides.

© 2022 McGraw Hill Limited 34

 Exhibit 5.14, Part 1
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: Changes to acquisition differential to end of Year 5 (11c) (2,050)

2,750 (f)

Company P’s ownership percentage 80%

2,200
Consolidated retained earnings (which is equal to Company P’s retained earnings
$101,500 (g)
—equity method)

© 2022 McGraw Hill Limited 35

 Exhibit 5.14, Part 2
CALCULATION OF NON-CONTROLLING INTEREST
December 31, Year 6
Shareholders’ equity—Company S:
Common shares (13e) $10,000
Retained earnings (13f) 17,800
Remaining acquisition differential (14a) 870
28,670
Non-controlling interest’s ownership 20%
$ 5,734 (h)

© 2022 McGraw Hill Limited 36

 Consolidation in Subsequent
Years, Part 1
CALCULATION OF CONSOLIDATED RETAINED EARNINGS
At December 31, Year 6

Company P retained earnings, Dec. 31, Year 6—cost method (13d) $112,700

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: changes in acquisition differential to the end of Year 6 ([11c] 2,050 + [14a] 80) (2,130)

9,670 (a)

Company P’s ownership 80% 7,736

Consolidated retained earnings $120,436

© 2022 McGraw Hill Limited 37

 Consolidation in Subsequent
Years, Part 2
 An alternative way to calculate NCI at the end of Year 6 under the
fair value enterprise method is as follows:

NCI at date of acquisition (9c) $3,800

Increase is Company S retained earnings, since acquisition net of
9,670
consolidation adjustments (as per (a) above)
Non-controlling interest’s ownership 20% 1,934
NCI, end of year 2 $5,734

© 2022 McGraw Hill Limited 38

 Identifiable Net Assets Method
 If the NCI was measured using the identifiable net assets
method, only the parent’s share of the subsidiary’s goodwill
would be included on the consolidated financial statements.

 The NCI’s share of the subsidiary’s goodwill would be excluded.

 Goodwill and NCI are the only two accounts on the consolidated
balance sheet that would be different under the identifiable net
assets method compared with the fair value enterprise method.

© 2022 McGraw Hill Limited 39

Acquisition Differential Assigned to
Liabilities, Part 1
 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.

© 2022 McGraw Hill Limited 40

Acquisition Differential Assigned to
Liabilities, Part 2
 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.

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Acquisition Differential Assigned to
Liabilities, Part 3
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 Interest Expense Amortization of Bond Premium Amortized Cost of Bonds

Year 2 $105,154

Year 3 $10,000* $8,412† $1,588§ $103,566#

Year 4 10,000 8,285 1,715 101,851

Year 5 10,000 8,149 1,851 100,000

*
$100,000 × 10% = $10,000
†
$105,154 × 8% = $8,412
§
$10,000 − $8,412 = $1,588
#
$105,154 − $1,588 = $103,566

© 2022 McGraw Hill Limited 42

 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.

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 Subsidiary Acquired During
the Year
 The consolidated financial statements should include only the
subsidiary’s net income from the date of acquisition.
 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 subsidiary’s 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)

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 Equity Method Recording, Part 1
 The parent can use the cost method or equity method in its
general ledger to account for an investment in a subsidiary.
 Only the investor’s share of the investee’s income, dividends, and
amortization of acquisition differential are recorded in the
investor’s records.
 The parent’s 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 subsidiary’s shareholders’ equity and the unamortized
acquisition differential.

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 Equity Method Recording, Part 2

 The investment account captures all adjustments since the date of

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

 The parent’s 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.

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 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 parent’s 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.

© 2022 McGraw Hill Limited 47

 Goodwill Impairment –
Appendix 5A
 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 cash-generating 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.

© 2022 McGraw Hill Limited 48