Step three

This chapter explains how to account for acquisitions that create a group (a parent-subsidiary relationship) using the acquisition method. The focus here is on Step 3 of the acquisition method.

Learning objectives

By the end of this subchapter, you should be able to describe the components of and prepare a consolidated statement of financial position or extracts thereof, including:

• Fair value adjustments at acquisition on property, plant and equipment (excluding depreciation adjustments)

Step 3: Identifiable assets, liabilities, and NCI

Step 3 involves recognising and measuring:

1. The identifiable assets acquired and the liabilities assumed, and
2. Non-controlling interest (NCI) in the acquiree (i.e., subsidiary).

We’ll look at these separately.

Definitions

Identifiable assets acquired and liabilities assumed

Together, these are referred to as the net assets acquired. In a business combination, you identify all tangible and intangible assets and liabilities that meet the definition and recognition criteria, including items not recorded in the subsidiary’s own accounting records. Only assets and liabilities that arise from the exchange and can be reliably measured are recognised in the consolidated financial statements.

If you recall the accounting equation, we stated that by change of subject, the equation can be stated as:

$$\text{Asset}-\text{Liabilities}=\text{Equity}$$

where,

$$\text{Asset}-\text{Liabilities}=\text{Net Asset}$$

Thus,

$$\text{Net Asset}=\text{Equity}$$

Definitions

Net asset acquired

The measurement of the identifiable assets acquired and the liabilities assumed is described as the net asset acquired. In practice, you often start by adding up the subsidiary’s equity components at the acquisition date.

Net asset acquired at acquisition date can be computed as:

	$
Ordinary Shares	XXX
Retained earnings	XXX
Revaluation surplus	XXX
Share premium	XXX
Net Asset	XXX

Illustration: Computing the net assets

JB Limited acquired 150 million shares of GG Co. Limited’s 200 million equity share capital worth $100million on 1 January 20X5 for $800,000 when GG Co. Limited’s retained earnings were $750,000. JB Limited further acquired 100m shares of DBL Inc. 500million equity shares on 1 January 20X6 for $ 800,000.

Required: Calculate the net asset of the subsidiary. Suggested solution:

Do you know the answer?

Fair value adjustments at acquisition

Sometimes, before acquisition, the subsidiary’s assets or liabilities may be omitted, overstated, or understated - either due to error or because values have not been updated to reflect fair value. If that happens, the net assets acquired (and therefore equity) will also be misstated.

Definitions

Note, this is explained by the accounting equation:

Net Asset = Asset - Liabilities

• If the asset is understated, the net asset will be understated and vice versa.
• If the liability is understated, the net asset will be overstated and vice versa.

So, when you compute the net assets acquired by adding the subsidiary’s equity components, you then adjust for any under/overstatement in assets or liabilities.

Note: This syllabus limits this to adjustments arising from PPE, excluding the effect of depreciation.

Definitions

Based on this, keep in memory: “If the asset is understated, the net asset will be understated and vice versa”. Thus,

• Where an item of PPE was not recognized or undervalued on or before the acquisition date, add the amount not recognised to the equity component to ascertain the net asset acquired at the acquisition date.
• Where an item of PPE was overvalued on or before the acquisition date, subtract the amount of the overvaluation from the equity component to ascertain the net asset acquired at the acquisition date.

Illustration: Fair value adjustment

JB Limited acquired 150 million shares of GG Co. Limited’s 200 million equity share capital worth $100million on 1 January 20X5 for $800,000 when GG Co. Limited’s retained earnings were $750,000. It was noted that GG Co. Limited had a Land with a carrying amount of $5 million, which had a fair value of $6 million as at the acquisition date. The fair value difference had not yet been incorporated into the accounting records of GG Co. Limited as at the date of the acquisition.

Required: Calculate the net asset acquired. Suggested solution

Do you know the answer?

Non-controlling interest (NCI)

NCI is the equity in a subsidiary that is not attributable, directly or indirectly, to the parent. At acquisition, NCI is measured using either:

• proportionate share of the identifiable assets acquired and liabilities (i.e., net asset acquired) or
• fair value as at the date of acquisition.

Definitions

Proportionate share of net asset method

The NCI at acquisition is valued by applying the NCI % share holdings to the net asset acquired. In a typical question where the method to be used to measure the NCI is not stated, apply the proportionate share of the net asset method.

Definitions

Fair value method

Under this method, the NCI is determined based on the market value of shares held by minority shareholders. When not explicitly stated, NCI’s fair value is calculated by multiplying the current market price per share by the number of outstanding shares not under the parent company’s control. This market-based approach ensures an objective valuation of minority shareholders’ economic interest in the acquired entity.

Definitions

Subsequent measurement of NCI

At the reporting date, the NCI is reported as part of equity in the consolidated statement of financial position at its value at the reporting date. This is obtained by adding the NCI share of post-acquisition profit for the period and subtracting any impairments.

This can be presented in the form of:

	$
NCI at acquisition date	XXX
NCI Share of post-acquisition profit	XXX
NCI Share of impairment (if any)	(XXX)
NCI at Reporting	XXX

Illustration: Computation of NCI

JB Limited acquired 150 million shares of GG Co. Limited, 200 million equity share capital worth $100million on 1 January 20X5 for $800,000 when GG Co. Limited’s retained earnings were $750,000. It was noted that GG Co. Limited had a Land with a carrying amount of $5 million, which had a fair value of $6 million as at the acquisition date. The fair value difference had not yet been incorporated into the accounting records of GG Co. Limited as at the date of the acquisition.

You are required to compute the NCI at the acquisition date using:

1. Proportionate share of net asset
2. Fair value (market price of the share is $0.6)

Suggested Solution

3. NCI using the proportionate share of net assets

Do you know the answer?

1. NCI using fair value

Do you know the answer?

Let’s move on to look at the last step of the acquisition method.