GROUP OF COMPANIES - 4

Adjustments – Fair value at date of acquisition

 

 

Fair value

 

 

Is the amount for which an asset could be acquired/exchanged, liability settled between

 

knowledgeable and willing parties.

 

 

 

 

Adjustments

 

 

The fair value of the acquired subsidiary’s identifiable assets and liabilities should be

 

adjusted into the consolidated Balance Sheet at the date of acquisition.

 

 

 

 

The adjustments are necessary for some reasons of which include:-

 

 

- to avoid non-compliance with the Financial Reporting framework regulation pioneered by

 

the Professional Accountancy Bodies recognised internationally. For example, the

 

adjustments will facilitate that the value of net assets acquired by group is stated at its costs.

 

 

 

- to avoid goodwill being overstated which will occur if the net assets of the subsidiary

company is not stated at fair value at the date of acquisition.

 

 

 

 

To demonstrate this, read the example below:-

 

 

A) If no adjustments were made

 

     Purchase consideration      =          20,000

 

    Value of net assets at          =          13,000

     date of acquisition not

     at fair value                                                           

                                                            ----------

     Goodwill                                          7,000

                                                            ======

 

 

B) If adjustments were made

 

    Purchase consideration       =          20,000

 

    Value of net assets at          =          16,000

     date of acquisition

     at fair value

     (i.e. after adjustments

      were made)

                                                            ----------

                                                                4,000

                                                            ======

 

 

 

Therefore, the goodwill is overstated by 3,000 if no adjustments were made.         

 

 

 

 

Treatment of adjustments on the fair value

 

 

    Value of net assets at          =          16,000

     date of acquisition

     at fair value

     (i.e. after adjustments

      were made)

                                                            ----------

                                                                4,000

                                                            ======

 

 

 

Therefore, the goodwill is overstated by 3,000 if no adjustments were made.         

 

 

 

 

Treatment of adjustments on the fair value

 

 

The amount to be adjusted can be calculated by taking the difference between the fair value

 

and the book value of the net assets at date of acquisition.

 

 

The adjustments will be made by apportioning between the non-controlling interest and the

 

group.

 

 

Also, it is important to note that the adjustment will result to additional depreciation due to

 

there being more depreciation being charged based on fair value compared to depreciation

 

based on historical costs over the coming years in the useful life of the assets.

 

 

 

 

 

Consolidated Profit & Loss Account

 

 

Only the post-acquisition of the subsidiary’s profit & loss is to be consolidated into the profit

 

and loss account of the parent company.

 

 

 

For example

 

 

The subsidiary’s company year end is 31^st December 2013.

 

Its acquisition date is 1^st August 2013.

 

 

Its revenue and expenses to be consolidated to the parent’s profit & loss account

be on and after 1^st August 2013.

 

 

The date before 1^st August 2013 will be considered pre-acquisition date and the profit & loss

 

for such pre-acquisition period will be used to compute the goodwill at date of acquisition.

 

 

 

 

 

Suggested steps when consolidating the Profit & Loss Account

 

 

Step 1 – To establish the percentage of the equity shares of the subsidiary company acquired

 

              by the parent company.

 

 

 

Step 2 – to compute the goodwill which is the difference between the purchase consideration

 

              and the acquired net assets of the subsidiary at date of acquisition.

 

 

 

Step 3 – Cancel out intercompany items such as inter-company sales and interests payable or receivable between group of companies.

 

 

 

 

For example:-

 

 

If inter-company revenue are eliminated, the effect will be a reduction in sales and costs of

 

sales.

 

Step 4  - To eliminate the unrealised profit.

 

 

 

For example:-

 

 

As some goods are taken or bought from one group of companies by another of which have

 

not been sold out to any third party, there is this element of unrealised profit which must be

 

eliminated when producing the consolidated profit & loss account.

 

 

 

 

As mentioned earlier in our earlier accounting blog, this adjustments on unrealised profit will

 

provide a fairer value for the closing stock of the group companies as a whole.

 

 

 

This will also ensure that group companies or the consolidated profit & loss account is not

 

overstating its profit or understating its losses.

 

 

 

Step 5 – Make relevant adjustment for the depreciation as a result of the fair value adjustment.

 

 

 

Step 6 – To compute the amount of goodwill at the end of the financial year.

Step 7 – to calculate the amount of the group profit and that of the non-controlling interest.

 

GROUP OF COMPANIES - 3

Goods in transit

 

 

Goods in transit relates to goods transferred from one Group Company to another that are

 

still in transit as at the Balance Sheet date.

 

In such situation, the goods in transit must be recorded into the transferee company before

 

carrying out the inter-company balances elimination.

 

 

 

 

Examples of the adjustment

 

 

Dr. Stock Account

 

Cr. Transferor Account

 

 

 

 

Unrealised profits on unsold goods

 

 

This refers to goods transferred from one group of company to another at a profit of which

 

are unsold to a third party at the end of the financial year.

 

This unrealised profit must be eliminated. This is because such profit is not realised yet so

 

long as it remains in the group of companies. Therefore, the adjustment to eliminate the

 

unrealised profit is essential

The adjustment will eliminate the inflated consolidated retained earnings and inflated

 

consolidated closing stock.

 

 

 

 

 

 

Unrealised profit for goods transferred to subsidiary company

 

 

This means the unrealised profit is shown in the books of the parent company.

 

The retained earnings of the parent company must be reduced by the unrealised profit.

 

The consolidated stock figure should also be reduced by the unrealised profit portion.

 

 

 

Dr. Consolidated retained earnings

 

Cr. Consolidated stock

 

 

 

 

Unrealised profit for goods transferred to the parent company

 

 

This means the unrealised profit is shown in the books of the subsidiary company.

 

The relationships of the subsidiary company must be reduced by the unrealised profit.

 

The consolidated stock figure should also be reduced by the unrealised profit portion.

Dr. Consolidated retained earnings

 

Dr. Non-controlling Interest (formerly known as minority interest)

 

Cr. Consolidated Stock

 

GROUP OF COMPANIES - 2

Inter-company balances

 

 

Examples include:-

 

-          monies loan from parent company to the subsidiary company

 

-           monies loan from subsidiary company to the parent company

 

-           monies owed by the parent company to the subsidiary company as a result of goods sold to the parent company by the subsidiary company

 

-           monies owed by the subsidiary company to the parent company as a result of goods to the subsidiary company by the parent company

 

 

 

 

Consolidated Balance Sheet

 

 

It refers to both the parent’s Balance Sheet and that of the subsidiary’s Balance Sheet.

 

It is important that all inter-company balances be eliminated when the consolidated

 

Balance Sheet is prepared.

 

If no elimination is done, then the Consolidated Balance Sheet will show an inflated figure

 

for the group’s assets and liabilities.

 

If the elimination process is done, then the consolidated Balance Sheet should reflect the

 

group’s assets and liabilities fairly.

 

 

 

It is important that all inter-company balances be eliminated when the consolidated

 

Balance Sheet is prepared.

 

If no elimination is done, then the Consolidated Balance Sheet will show an inflated figure

 

for the group’s assets and liabilities.

 

If the elimination process is done, then the consolidated Balance Sheet should reflect the

 

group’s assets and liabilities fairly.

 

 

 

Example:

 

 

The trade debtors should reflect the total amount receivable by the group of companies

 

from external parties.

 

The same goes with trade creditors.

 

The trade creditors should relate to the amount payable by the group of companies to

 

external parties.

 

GROUP OF COMPANIES - 1

A group of companies will comprise of parent company and subsidiary companies.

 

A parent company is a company which has control over the operating and financing activities

 

and policies of another company or companies in a group.

 

A subsidiary company is therefore a company who’s operational and financial activities and

 

policies are under the control of another company known as the parent company.

 

 

 

 

Consolidated Balance Sheet

 

 

This is produced or prepared by combining the Balance Sheet of the parent company and the

 

Balance Sheet of the subsidiary companies.

 

The more common areas dealt with will normally comprise of the retained earnings, non-

 

controlling interest and goodwill calculation.

 

Important note: Non-controlling interest was formally known as minority interest.

 

 

 

 

Consolidated Retained Earnings

 

 

Consolidated Retained Earnings = Parent Retained Earnings +

                                                        Subsidiary post-acquisition Earnings

 

 

The above formula depicts that Consolidated Retained Earnings is derived at by adding both

 

the Parent’s Retained Earnings to the Subsidiary Post Acquisition Earnings at the date of

 

consolidation.

 

 

 

 

Non-Controlling Interest

 

 

This refers to the minority shareholders or non-controlling shareholders’ share of the

 

subsidiary’s net assets at the date of consolidation.

 

 

 

Goodwill

 

 

This refers to the purchased goodwill. This is calculated by deducting the investment cost

 

with the net assets of the acquired subsidiary.

 

There are many different approaches to calculate the net assets. However, generally the

 

approach is as follows:-

 

 

 

Example:-

 

At the date of acquisition, the net assets is arrived as follows:-

 

            Share capital                            xxx

 

Pre-acquisition

 

            Profit/Loss                              xxx

 

            Share Premium                        xxx

 

            Other Reserves                        xxx

 

                                                            -----

 

            Net Assets                               xxx

 

                                                            ===