CONSOLIDATED ACCOUNT

Chapter 8 & 9

FRS 3 &127

Learning outcome
At the end of this topic, students will be able to: Explain the concept of a subsidiary and the principles of how they are accounted for

LEGAL DEFINITION OF SUBSIDIARY

Section 5 of the Companies Act 1965 defines a subsidiary company as one: a. in which the investor company i. Controls the composition of the board of directors of the investee company; or ii.Controls more than half the voting power of the investee company; or iii. Holds more than half of the issued share capital (excluding preference shares); or b. Which is a subsidiary of a subsidiary of the investor company.

EXCLUSION FROM CONSOLIDATION

Ninth schedule of the Companies Act allows parent companies from excluding certain subsidiaries from being consolidated. a. It is impracticable, the time and/or expense involved outweigh the value of such accounts to the members of the company; or b. The controlling interest in the subsidiary is temporary; or c. The subsidiary is situated outside Malaysia and conditions in the foreign country are such that the control of the subsidiary is impaired; or d. The accounts would be misleading or harmful to any member of the group; or e. The business of the subsidiary is very different from that of the parent company.

GROUP STRUCTURE
1.

Vertical Group
H Bhd 80% 80% x 60% = 48%

S
60% SS

GROUP STRUCTURE
1.

Mixed Group
H Bhd 75% 25% 25% + [75% x 40%] = 65%

S
40%

SS

Method of Accounting FRS 3

All business combination shall be accounted for by applying the Purchase Method. Application of Purchase Method

Step One : Identifying an acquirer Step two : Measuring the cost of the business combination; and Step three : Allocating at the acquisition date the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed

Step 1: Identifying the acquirer (FRS3/16-23)

An acquirer shall be identified for all business combinations. The acquirer is the combining entity that obtains control of the other combining entities or businesses

Step 1: Identifying the acquirer (FRS3/16-23)

Extract of Paragraph 20 FRS 3:

Although sometimes it may be difficult to identify an acquirer, there are usually indications that one exists. For example: if the fair value of one of the combining entities is significantly greater than that of the other combining entity, the entity with the greater fair value is likely to be the acquirer; if the business combination is effected through an exchange of voting ordinary equity instruments for cash or other assets, the entity giving up cash or other assets is likely to be the acquirer; and

Step 1: Identifying the acquirer (FRS3/16-23)

Extract of Paragraph 20 FRS 3:

Although sometimes it may be difficult to identify an acquirer, there are usually indications that one exists. For example:

if the business combination results in the management of one of the combining entities being able to dominate the selection of the management team of the resulting combined entity, the entity whose management is able so to dominate is likely to be the acquirer.

Step 1: Identifying the acquirer (FRS3/16-23)

Business combination effected through an exchange of equity interest, the entity that issues the equity interest is normally the acquirer When a new entity is formed to issued equity instruments to effect a business combination, one of the combining entities that existed before the combination shall be identified as the acquirer on the basis of the evidence available

Step 2: Cost of Business Combination (FRS3/24 - 30)

The acquirer shall measure the cost of a business combination as the aggregate of:

the fair values, at the "date of exchange", of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree; plus any cost directly attributable to the business combination (24)

Step 2: Cost of Business Combination (FRS3/24 - 30)

The "acquisition date" and "date of exchange"

The "acquisition date" is the date on which the acquirer effectively obtains control of the acquiree When this is achieved through a single exchange transaction, the "date of exchange" coincides with the acquisition date

Step 2: Cost of Business Combination (FRS3/24 - 30)

The "acquisition date" and "date of exchange"

The "acquisition date" is the date on which the acquirer effectively obtains control of the acquiree

When this is achieved in stages in stages by successive share purchases , then:

a. the cost of the combination is the aggregate cost of the individual transactions; and b. "the date of exchange" is the date of "each exchange transaction" (i.e. the date that each individual investment is recognised in the financial statements of the acquirer), whereas the acquisition date is the date on which the acquirer obtains control of the acquiree. (25) , the "date of exchange" coincides with the acquisition date

Step 2: Cost of Business Combination (FRS3/24 - 30)

The Cost of Business Combination or investments consists:

Fair value of consideration given

Assets given;

Liabilities incurred or assumed;

Equity instruments issued; plus

Any cost directly attributable to the acquisition

Step 3: Allocating at the acquisition date, the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed (IFRS3/36-50)

The acquirer shall, at the acquisition date, allocate the cost of a business combination by recognizing the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the recognition criteria at fair value at that date except:

Any difference between the cost of the business combination and the acquirer's interest in the net fair value of the identifiable asset, liabilities and contingent liabilities so recognised shall be accounted for as

Goodwill; or
"excess of acquirer's interest in the net fair value of acquiree's identifiable assets, liabilities and contingent liabilities over cost [36]

Goodwill (FRS3/51-57)

The acquirer shall, at the acquisition date:

recognize goodwill acquire in a business combination as an assets; and initially measure that goodwill at its cost, being the excess of the cost of the business combination over the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities [51]

Goodwill (FRS3/51-57)

After initial recognition:

the acquirer shall measure goodwill acquired in a business combination at cost less any accumulated impairment losses [54]

PREPARATION OF CONSOLIDATED BALANCE SHEET

Acquisition 100% or more than 50% 100% fully owned/control less than 100% not fully control share with minority interest Account cost of control, minority interest.

PREPARATION OF CONSOLIDATED BALANCE SHEET

Date of acquisition Pre acquisition reserves

Reserves that already exist in the subsidiary on the date the shares were acquired by parent. Treated as non distributable reserves by the holding company. Treated as return of capital for the holding company.

Worked example 2. page 378.

Worked example 2. page 378.

Given below are the balance sheets of two companies, H and S, as at 1.1.x3. H RM000 500,000 100,000 20,000 620,000 S RM000 200,000 150,000 20,000 370,000

Ordinary shares @RM1 each Accumulated profit Liabilities

Non current assets Current assets (other than bank) Bank

350,000 150,000 120,000

620,000

100,000 100,000 170,000

370,000

Worked example 2. page 379.

Acquires 100% on 1.1.x3. How? = new ordinary shares 200,000,000 (MV = RM1.50 each) + cash RM50,000,000. Cost of investment? = (200,000,000 x RM1.50) + RM50,000,000 = RM350,000,000 Assets acquired? 100% = 100% x 350,000,000 = RM350,000,000 Goodwill? = Cost = value assets acquired = 0

Worked example 2. page 378.

New balance sheet of both company after acquisition H RM000 700,000 100,000 100,000 20,000 920,000 Non current assets Investment in S Current assets (other than bank) Bank 350,000 350,000 150,000 70,000 S RM000 200,000 150,000 20,000 370,000 100,000 100,000 170,000

Ordinary shares @RM1 each Share premium Accumulated profit Liabilities

920,000

370,000

How to prepare Consolidated Balance sheet. Cost of investment will be eliminated to the shares and reserve acquired. all assets and liabilities will be combined.

Ordinary shares @RM1 each Share premium Accumulated profit Liabilities

H RM000 700,000 100,000 100,000 20,000 920,000

S RM000 200,000 150,000 20,000 370,000 100,000 100,000 170,000 370,000

CBS RM000 700,000 100,000 100,000 40,000 940,000 450,000 250,000 240,000 940,000

Non current assets Investment in S Current assets (other than bank) Bank

350,000 350,000 150,000 70,000 920,000

Worked example 3. page 381.

Given below are the balance sheets of two companies, H and S, as at 1.1.x1. H RM 600,000 200,000 200,000 40,000 1,040,000 Non current assets Current assets 400,000 640,000 1,040,000 S RM 200,000 40,000 60,000 30,000 330,000 170,000 160,000 330,000

Ordinary shares @RM1 each Share premium Retained earnings Liabilities

Acquires 100% on 1.1.x1. Cost of investment? = RM400,000 Assets acquired? 100% = 100% x 300,000 = RM300,000 Goodwill? = Cost - value assets acquired = RM100,000

Worked example 3. page 381.

New balance sheet of both company after acquisition
H RM 600,000 200,000 200,000 40,000 1,040,000 Non current assets Investment in S Current assets 400,000 400,000 240,000 1,040,000 S RM 200,000 40,000 60,000 30,000 330,000 170,000 160,000 330,000

Ordinary shares @RM1 each Share premium Accumulated profit Liabilities

How to prepare Consolidated Balance sheet. Cost of investment will be eliminated to the shares and reserve acquired. Any balance will be the goodwill. all assets and liabilities will be combined.

Ordinary shares @RM1 each Share premium Accumulated profit Liabilities

H RM 600,000 200,000 200,000 40,000 1,040,000

S RM 200,000 40,000 60,000 30,000 330,000 170,000 160,000 330,000

CBS RM 600,000 200,000 200,000 70,000 1,070,000 570,000 100,000 400,000 1,070,000

Non current assets Goodwill Investment in S Current assets

400,000 400,000 240,000 920,000

Minority Interest: NCI

Accounting treatment:

Option 1: at fair value of the shares held by the non controlling shareholders Option 2: equal to proportionate share of the fair value of the net assets of the subsidiary.

Method of choosen will determine the amount of goodwill recognised by parent.

Goodwill disclosed

NCI option 1: full value NCI option 2: parents share only. Worked example 5 page 386.

Post acquisition reserves

Reserves made by subsidiary after its shares are acquired by the holding. Distributable to parent company. Illustration page 391. H acquired 75% Ordinary share capital of S on 1.1.x4; (P/L account = RM10,000). On 31.12.x6; H P/L acc = RM23,000; S P/L acc = RM30,000.

Consolidated Procedures for the CBS

BS of Parent and Subsidiary are combined line by line by adding together like items of assets and liabilities. The carrying amt of Parents investment in the subsidiary and the Parents share of the equity of the subsidiary on acq date are eliminated. The minority interest in the net assets of the subsidiary are identified and presented as equity. Intra group balances and transactions are eliminated. Unrealised profit from intra-group transactions are eliminated in full.

Proforma account

Adjustment (Cost of Control) Non controlling interest (minority interest) consolidated reserves subsidiary reserves worked example 7. page 392

Preference Shares

- not calculated for control/govern the subsidiary

investment in preference shares debited to cost of control nominal values of the shares credited to cost of control & to minority interest account

Debenture and Redeemable Preference Share

- not calculated for control/govern the subsidiary

investment in debenture/Redeemable Pref share debited to cost of control nominal values of debenture/Redeemable Pref share credited to cost of control

- outstanding amt of debenture/Redeemable Pref Share not held by holding company will not treated as minority interest. Disclosed as liability in the consolidated balance sheet. Worked example 9 page 403

Tutorial Question

9.6 and 9.8 Due date:

Group 3A: 22 Sept 2011 at 10.00am Group 3B: 23 Sept 2011 at 10.00am

Fair Value Adjustment

On the date of acquisition to reflect Fair value of assets Adjust the asset account any different (surplus/deficit) will be credited/debited to asset revaluation reserve treatment same way as other pre-acquisition reserve If the assets are depreciable assets group depreciation should be based on the fair value.

Recognition of Unrecognised Assets of Subsidiary

Acquiree/subsidiary may have assets that it had not recognised as some assets Example: internally generated brand If the assets are separable and identifiable as assets recognised in the Consolidated Financial Statement

Illustration page 406

acquisition date/revaluation date = 1 Jan x4

Book Value (RM) Land 100,000 Buildings 200,000 Brand nil

Fair Value (RM) 120,000 250,000 55,000

Remaining life of building is 25 years.

Adjustment entries: If S adjust its own account

Record in Book of S

Dt Dt

Land RM20,000 Buildings RM50,000 Ct Asset revaluation reserve

RM70,000

Adjustment entries: If S adjust its own account

Record in Book of S

Brand:
S cannot recognised in its book Recognised in the consolidated financial statement

Adjustment entries: If S DOES NOT adjust its own account

Dt Dt Dt

Land RM20,000 Buildings RM50,000 Brand RM55,000 Ct Asset revaluation reserve

RM125,000

Depreciation adjustment

Depreciation will be = 250/25 =RM10,000 p.a But S Record as = 200/25 = RM8,000 p.a Make adjustment entry P/L of S RM2,000 Ct Accumulated depreciation of building

Dt

RM2,000

Example 10: Page 408

Land no depreciation involved Fair value as at 1 Jan X9 Carrying value as at 31 Dec X9 = 1 Jan X9 Increase in value RM120,000 RM100,000 RM20,000

Example 10: Page 408

Building depreciable asset Fair value as at 1 Jan X9 Carrying value as at 1 Jan X9 (given) Increase in value Depreciation adjustment: Recorded in Group 500,000/16 Recorded by S 320,000/16 Adjustment in P/L S (post reserve) RM500,000 RM320,000 RM180,000

RM31,250 20,000 11,250

Example 11: Page 412

Facts are as for Example 10 except that H acquire S on 1 January X8 Land Adjustment (non depreciable) = Same Building: Depreciation will be calculated for 2 years. Fair value as at 1 Jan X9 RM500,000 Carrying value as at 1 Jan X8 RM???????

Deprciation 1 Jan x8 31 Dec x9 = 2 years Annual depreciation x 2 years = (320,000 300,000) x 2 = 40,000 So Carrying value as at 1 Jan X8 = 300,000 = 40,000 = 340,000 Increase in value = 500,000 340,000 = RM160,000

Example 11: Page 412

Building depreciable asset Depreciation adjustment: Recorded in Group (500,000/17) x 2 Recorded by S Adjustment in P/L S (post reserve)

RM58,824 40,000 18,824

Post Acquisition Fair Value Changes

Treated accordance to FRS 116 Property, Plant and Equipment.

Asset That were Fair Valued and Subsequently disposed of

Financial Statement Subsidiary: gain or loss on the disposal will include the fair value change. Pre acquisition reserve: include the fair value change (asset is no more entity)

Example 12: page 413

Land ARR = RM500,000 Land disposed The ARR amount will be transferred to P/L of S (pre acq reserve)

Pre acquisition P/L will be increased be the ARR amount

Example 13: Page 414

Discuss on the White Board

Time Limit

FRS 3: Changes to the fair value of assets to be made within 12 months of the acquisition date. Initial goodwill will be based on provisional (estimated) amounts. Adjustments to the goodwill can be made when the actual fair value amounts are known. Must be made within 12 months See chapter 8.

Deferred Tax Implication

Surplus or Deficit on Fair Value adjustment will be subjected to Tax Tax Payable/receivable will affect the amount of goodwill Fair value surplus will reduce the goodwill deferred tax liability will increase the amount of goodwill

Example 14: Page 417

Land: non depreciable asset ARR RM2 million Deferred tax liability = RM2 million x 10% = RM200,000 Journal entries Dr Land RM2,000,000 Ct ARR Deferred Tax Liability

RM1,800,000 RM200,000

Example 14: Page 417

Plant: depreciable asset ARR RM5 million Depreciation will increased by RM5m/5 = RM1 million

Increased in expenses Reduced the profit, reduced the income tax

Deferred tax liability will be decreased. Deferred tax liability = (RM5 million x 10%) (RM1 million x 25%) = RM1,250,000

Journal entries Dr Land RM5,000,000 Ct ARR Deferred Tax Liability

RM3,750,000 RM1,250,000

INTRA-GROUP BALANCES AND TRANSACTIONS

May be presented in form of: Loans Debtors/creditors Current accounts Bill payable/receivable Interest payable/receivable Dividends payable/receivable

INTRA-GROUP BALANCES AND TRANSACTIONS

should not disclosed any intra-group mean to reporting transactions that have taken place outside the group avoids double counting of assets and liabilities

Items in Transit

cash remittance and dispatch of other assets by one party but the other party has not received them as at the balance sheet date. adjustment made in the account of the holding company. if items in transit is between two subsidiaries, the adjustment is made in the account of the company in which the item is not recorded yet. However the items will be eliminated in the CBS

Items in Transit: Example

Extract Balance sheet of H and S as at 31 Dec 2006 H Current asset Loan to S 20,000 Current liabilities Loan from H Different of RM2,000 will be cash in transit S

18,000

Items in Transit: Example

Journal entries Dt Loan from H 18,000 Cash in transit 2,000 Ct Loan to S 20,000 Extract Consolidated Balance sheet of H and its subsidiary as at 31 Dec 2006 Current asset Debtors Cash in transit Cash in bank

XXXX 2,000 XXXX

Factoring of Receivables

Receivables due from members within the group may be factored. The amount outstanding to the party outside the group is liability The unfactored amount is cancelled.

Illustration: Page 420

The Parent has lent RM100,000 to the subsidiary. However the subsidiary has remitted RM20,000 at the end of the year which the parent only received at the beginning of the year.

Journal entries: Dt Loan from Parent RM80,000 Cash in Transit 20,000 Cr Loan to subsidiary RM100,000

Illustration: Page 420

The bills payable of subsidiary of RM25,000 is due to the Parent. Parent has factored RM10,000.

Journal entries: Dt Bill payable RM15,000 Cr Bill receivable

RM15,000

Illustration: Page 420

Trade receivables of RM17,000 of the parent are receivables from the subsidiary. They include RM8,000 for inventory sent by the parent on 30 Sept x4 which was not received by the subsidiary till 11 January x5.

Journal entries: Dt Trade payables Inventory Cr Trade receivables

RM9,000 8,000 RM17,000

Current Account

Numerous inter company transactions

More convenient to operate one account named Current Account. Balances in reporting date is cancelled off: intercompany balances The differences between two account balance: cash in transit

Bills receivables/payables

Negotiable financial instruments: holder can transfer to another party

Bills are discounted Subsidiary does not owe parent on the bills discounted.

Illustration: Page 421

Bills Payable of S RM35,000 To H: RM10,000 To others: RM25,000 Group debt: RM6,000 Discounted: RM4,000

Bills Receivable of H RM35,000

From S: RM6,000 From H: RM24,000

Bills receivable and payable of RM6,000 will be cancelled: Inter company indebtedness.

Example 15

Class disscussion

Tutorial Question

9.14 and 9.15 Due date:

Group 3A: 29 Sept 2011 at 10.00am Group 3B: 30 Sept 2011 at 10.00am