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)
• Non-controlling interest measured at fair value at the acquisition date, and at the reporting date

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. Identifiable assets and liabilities that meet the Conceptual Framework definitions at the acquisition date and form part of the exchange are recognised at fair value.

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,

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

So, to find the net assets acquired, 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 of GG Co. Limited’s 200 million equity shares (share capital $100 million) on 1 January 20X5 for a consideration of $100 million, when GG Co. Limited’s retained earnings were $750,000.

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.

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.

Key relationship: since net assets = assets − liabilities, an understated asset understates net assets (and vice versa), while an understated liability overstates net assets (and vice versa). Applied to property, plant and equipment (PPE):

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

Illustration: fair value adjustment

JB Limited acquired 150 million of GG Co. Limited’s 200 million equity shares (share capital $100 million) on 1 January 20X5 for a consideration of $100 million, 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. IFRS 3 lets a group measure NCI at acquisition either at fair value or at its proportionate share of the subsidiary’s net assets, but this exam values NCI at fair value only, so that is the method this course uses.

Definitions

Fair value method

Under this method, the NCI is measured at the subsidiary’s share price at the acquisition date, multiplied by the number of shares not held by the parent. Exam questions usually give this price or the NCI fair value directly.

Definitions

Subsequent measurement of NCI

At the reporting date, the NCI is reported as part of equity in the consolidated statement of financial position. It is not remeasured to fair value: it is the NCI at acquisition plus the NCI share of the subsidiary’s post-acquisition reserves (all profits retained since the acquisition date, not only the current year’s profit).

This can be presented in the form of:

	$
NCI at acquisition date	XXX
NCI share of post-acquisition reserves	XXX
NCI at reporting	XXX

Illustration: computation of NCI

JB Limited acquired 150 million of GG Co. Limited’s 200 million equity shares (share capital $100 million) on 1 January 20X5 for a consideration of $100 million, 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 the fair value method. The market price of GG Co. Limited’s shares at the acquisition date is $0.6.

Suggested solution

Do you know the answer?

Together, the consideration transferred, the NCI at acquisition, and the net assets acquired determine goodwill (consideration + NCI at acquisition − net assets acquired). We calculate goodwill next, in Step four.