Steps one and two

This chapter explains how to account for acquisitions that create a group (a parent-subsidiary relationship) using the acquisition method. It focuses on the first two steps of the acquisition method.

Learning objectives

By the end of this subchapter, you should be able to:

• Identify subsidiaries within a group structure.
• Identify an associate within a group structure.

Before we look at consolidated financial statements in full, you need a clear understanding of how a business combination (an acquisition that creates a parent-subsidiary relationship) is accounted for under IFRS 3. Each step is explained and illustrated with examples.

Acquisition method

All business combinations (i.e., acquisitions that result in a parent-subsidiary relationship) are accounted for using the acquisition method.

Definitions

Parent

An entity that controls one or more other entities.

Subsidiary

An entity controlled by another entity (its parent).

Control

Under IFRS 10, control exists when an investor has power over an investee, is exposed to variable returns from its involvement with the investee, and has the ability to use its power to affect the amount of those returns.

Non-controlling interest (NCI)

The equity in a subsidiary not attributable, directly or indirectly, to the parent.

Associate

An entity over which the investor has significant influence. Significant influence is presumed when the investor holds 20% or more (but not more than 50%) of the voting rights.

Trade (simple) investment

A holding of less than 20% of the voting rights, where the investor has neither control nor significant influence over the investee.

The acquisition method is applied in four steps:

1. Step 1: identifying the acquirer.
2. Step 2: determining the acquisition date.
3. Step 3: recognising and measuring the identifiable assets acquired, the liabilities assumed, and any non-controlling interest (NCI) in the acquiree.
4. Step 4: recognising and measuring goodwill or a gain from a bargain purchase.

Step 1: identifying the acquirer

This step involves identifying the entity that obtains ‘control’ of the acquiree (i.e., identifying the parent and the subsidiary).

Although control can exist even when an investor holds less than 50% of the voting rights in the investee, questions in this syllabus usually identify the acquirer based on voting rights.

Some companies obtain control through gradual acquisition, but that situation is outside the scope of this syllabus.

So, the first thing to establish is the acquirer’s voting rights. This is sometimes referred to as the group structure.

Illustration: identifying an acquirer

JB Limited acquired 150 million of GG Co. Limited’s 200 million equity shares on 1 January 20X5. JB Limited further acquired 100 million of DBL Inc.'s 500 million equity shares on 1 January 20X6. Required: Calculate and explain the voting rights held by JB Limited in both companies.

Do you know the answer?

Now let’s move on to the second step in the acquisition method.

Step 2: determining the acquisition date

The acquisition date is the date on which control is obtained by the acquirer. In exam questions this is usually the date the acquirer’s holding goes above 50% of the voting rights.

This date matters because consolidation includes the acquiree’s events and transactions from the acquisition date onward.

Illustration: determining the acquisition date

Using the facts in the previous illustration, determine the acquisition date of each investment.

Do you know the answer?

Note: The other two (2) steps are covered in the next chapter.