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Separate and Consolidated

BUSINESS COMBINATION Financial Statement


(date of acquisition)
INTERCORPORATE INVESTMENT
Any purchase by one corporation of the
securities of another corporation.
Two types of intercorporate investments:
Debt securities
Equity securities
EQUITY SECURITIES
PASSIVE STRATEGIC
Dividend income/trading To obtain either control or
income significant influence
Duration Short term Long term
Example - Trading securities - Investment in Associate
- Financial assets through - Investment in Subsidiary
other comprehensive - Structured entities
income - Associated companies
- Joint ventures
PURCHASE OF NET ASSETS VS. PURCHASE OF
EQUITY
Group
Comprises a parent and its subsidiaries
A business combination in which the acquirer is a
"parent" and the acquiree is a "subsidiary", and the
business combination results from the parent
acquiring a CONTROLLING interest in the equity of
the subsidiary.
SUBSIDIARIES
The most common type of controlled entity.
A corporation (or an unincorporated entity such as a
partnership or trust company) that is controlled by a
parent company that owns, usually, a majority of the voting
shares/rights of the subsidiary.
CONTROL VERSUS SIGNIFICANT INFLUENCE
INVESTMENT IN INVESTMENT IN
ASSOCIATE SUBSIDIARY
SIGNIFICANT CONTROL
INFLUENCE
QUANTITATIVE 20% TO 50% MORE THAN 50%
THRESHOLD
CONSOLIDATED FS NONE YES
ACCOUNTING EQUITY METHOD COST METHOD
TREATMENT
FINANCIAL STATEMENTS
STOCK ACQUISITION SUBSIDIARY PARENT
SEPARATE YES YES
CONSOLIDATED NO YES

Business combination whereby an acquirer buys over the net


assets of the acquiree does not result in a parent-subsidiary
relationship, hence, only the separate financial statements of the
acquirer is prepared.
CONTROL
Control is the basis for determining which entities are
consolidated in the consolidated financial statements.
• Control of an investee – an investor controls an investee
when the investor is exposed, or has rights, to variable
returns from its involvement with the investee and has the
ability to affect those returns through its power over the
investee.
• Non-controlling interest – equity in a subsidiary not
attributable directly, or indirectly, to a parent.
GUIDANCE ON CONTROL
Only one entity shall be identified to have control over an
investee. If two or more investors collectively control an
investee, such as when they must act together to direct the
relevant activities, then none of the investors individually
controls the investee. Accordingly, each investor shall
account for its interest in the investee in accordance with
PFRS 11 Joint Arrangement, PAS 28 Investments in
Associates and Joint Ventures or PFRS 9 Financial
Instruments, as appropriate.
EXAMPLE
Abc Co. holds 70% of the voting shares of Alphabets, Inc.
XYZ, Inc., the former majority owner of Alphabets, holds 10%
of the voting shares of Alphabets but retains its power to
appoint the majority of the board of directors of Alphabets.
The other 20% is held by various shareholders holding shares
of 1% or less. Decisions about the relevant activities of
Alphabets require the approval of two-third votes cast at
relevant shareholders’ meetings – 75% of the voting rights of
the investee have been cast at recent relevant shareholders’
meetings.
GUIDANCE ON CONTROL
The presence of control over the subsidiary requires ALL
of the following:
• Power over the investee.
• Exposure, or rights, to variable returns.
• Ability to use power over the investee to affect the
amount of the investor’s returns.
CONTROL
Power over the investee
An Investor has power over an investee when the investor has existing rights
that give it the current ability to direct the investee’s relevant activities,
activities of the investee that significantly affect the investee’s returns.
Examples of decisions about relevant activities include but are not limited to:
a. Establishing operating and capital decisions of the investee, including
budgets; and
b. Appointing and remunerating an investee’s key management personnel or
service providers and terminating their services or employment.
CONTROL

Evidence that the investor has been


directing relevant activities can help
determine whether the investor has power,
but such evidence is not, in itself, conclusive
in determining whether the investor has
power over an investee.
CONTROL
VOTING RIGHTS
The investor’s ability to direct the relevant activities of an investee is normally obtained
through voting or similar rights.
Power with a majority of the voting rights
An investor that holds more than half (51% or more) of the voting rights of an investee
is presumed to have power over the investee when this is clearly not the case.
Holding more than half of the voting rights results to power when:
A. The relevant activities are directed through majority vote; or
B. A majority of the members of the governing body that directs the relevant activities
are appointed through majority vote.
CONTROL
Majority of the voting rights but no power
An investor does not have power over an investee, even if
he holds more than half of the voting rights, if:
a. The right to direct the investee’s relevant activities is
conferred to a third party who is not an agent of the
investor.
b. The investor’s voting rights are not substantive.
CONTROL
Power without a majority of the voting rights
An investor can have power even if he holds less than a majority of
the voting rights of an investee. For example, through:
a. A contractual arrangement between the investor and other vote
holders;
b. Rights arising from other contractual arrangements;
c. The inventor’s voting rights;
d. Potential voting rights; or
e. A combination of (a) to (d)
CONTROL
Contractual arrangement with other vote holders
A contractual arrangement between an investor and other
vote holders can give the investor power if the contractual
arrangement gives the investor:
The right to exercise the voting rights of other vote holders
sufficient to give the investor power; or
The right to direct how other vote holders vote to enable that
investor to make the decisions about the relevant activities.
CONTROL - EXAMPLE 1
Contractual arrangement with other vote holders
Investor A holds 40% of the voting rights of an
investee. The other 60% is held by 12 other
investors, each holding 5%. A shareholder
agreement grants investor A the right to appoint,
remove and set the remuneration of management
responsible for directing the relevant activities. To
change the agreement, a two-thirds vote of the
shareholders is required.
CONTROL - EXAMPLE 2
Rights arising from other contractual arrangements
Investor A holds 40% of the voting rights of an
investee. The remaining interest is held by thousands
of shareholders, none individually holding more than
1%. None of the shareholders has any
arrangements to consult any of the others or make
collective decisions.
CONTROL - EXAMPLE 3
Rights arising from other contractual arrangements
Investor A holds 35% of the voting rights of an investee. Three
other shareholders each hold 5% of the voting rights of the
investee. The remaining voting rights are held by numerous other
shareholders, none individually holding more than 1% of the voting
rights. None of the shareholders has arrangements to consult any
of the others or make collective decisions. Decisions about the
relevant activities of the investee require the approval of a
majority of votes cast at relevant shareholders’ meetings – 75% of
the voting rights of the investee have been cast at recent relevant
shareholders’ meetings.
CONTROL - EXAMPLE 4
Rights arising from other contractual arrangements
Investor A holds 45% of the voting rights of an
investee. Two other investors each hold 26%
of the voting rights of the investee. The
remaining voting rights are held by three other
shareholders, each holding 1%. There are no
other arrangements that affect decision-
making.
CONTROL - EXAMPLE 5
Rights arising from other contractual arrangements
Investor A holds 45% of the voting rights of an
investee. Eleven other shareholders each hold
5% of the voting rights of the investee. None
of the shareholders has contractual
arrangements to consult any of the others or
make collective decisions.
CONTROL - EXAMPLE 6
Potential voting rights
Investor A and two other investors each hold one-thirds of
the voting rights of an investee. In addition to its equity
instruments, investor A also holds debt instruments that are
convertible into ordinary shares of the investee at any time
for a fixed price that is out of the money (but not deeply
out of the money). If the debt were converted, investor A
would hold 60% of the voting rights of the investee.
CONTROL
Exposure or rights to variable returns
An investor is exposed, or has a right, to variable returns if its returns
from its involvement with the investee have the potential to vary as a
result of the investee’s performance.
Ability to use power to affect investor’s returns
The investor’s ability to use its power to affect the investor’s returns from
its involvement with the investee provides the link between power and
variable returns – only if this ability is present along with power and
exposure, or right, to variable returns does the investor obtain control
over the investee.
CONTROL

PFRS requires an investor to reassess


whether it controls an investee if facts and
circumstances indicate that there are
changes to one or more of the three
elements of control.
NON CONTROLLING INTEREST (NCI)
NCI shall be presented in the consolidated statement of
financial position within equity, separately from the equity
of the owners of the parent.
Non controlling interest in the net assets consists of:
a. The amount determined at the acquisition date using
PFRS 3
b. The NCI’s share of changes in equity since the acquisition
date.
CONSOLIDATION

The process of combining the assets,


liabilities, earnings, and cash flows of a
parent and its subsidiaries as if they were
one economic entity.
DEFAULT PRESUMPTION
Ownership of more than 50% of voting power
constitutes control, in the absence of any evidence to
the contrary.
PFRS 10 is based on principles rather than rules, the
use of a quantitative criterion is only a guide.
SEPARATE FINANCIAL STATEMENTS
PAS 27 defines separate financial statements as those
presented by a parent an investor in an associate or a
joint venture in a joint venture in which the investments
are accounted for on the basis of the direct equity
interest rather than on the basis of the reported results
and net assets of the investees.
CONSOLIDATED FINANCIAL STATEMENTS
The purpose of consolidated statements is to
present, primarily for the benefit of the owners
and creditors of the parent, the results of
operations and the financial position of a parent
company and all its subsidiaries as if the
consolidated group were a single economic entity.
EXCEPTIONS TO CONSOLIDATED FINANCIAL
STATEMENTS
An entity that is a parent shall present consolidated financial statements. This shall apply to
entities, except as follows:
a. An investment entity
b. A parent need not present consolidated financial statements if it meets all of the following:
 It is wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its
other owners, including those not object to, the parent not presenting consolidated financial
statements;
 Its debt or equity instruments are not traded in a public market
 It did not file, nor is it in the process of filing, its financial statements with securities commission
or other regulatory organization for the purpose of issuing any class of instruments in a public
market; and
 Its ultimate parent produces consolidated financial statements that are available for public use
and comply with PFRS.
INVESTMENT IN SUBSIDIARY
Transactions affecting “investment in
subsidiary” account in the parent’s books
under COST METHOD:
+ Acquisition cost

+ Acquisition-related DIRECT costs


ACQUISITION RELATED COSTS
PARENT’S CONSO FS
BOOKS
INDIRECT EXPENSED EXPENSED
DIRECT EXPENSED or EXPENSED
CAPITALIZED*
*Goodwill/Bargain purchase gain are still the same
CONSOLIDATION THEORIES
1. Entity (Economic) Theory
2. Parent Theory

PFRS3 permits the recognition of NCI’s share of


goodwill. (ENTITY THEORY)
CONSOLIDATION THEORIES
PARENT THEORY ENTITY THEORY
* Fair value differences * Fair value differences
are recognized only for are recognized for both the
parent parent and NCI
* NCI is neither a debt nor * NCI is part of equity
equity * Goodwill is the entity’s
assets and should be
* Goodwill is parent’s recognized in full
assets
CONSOLIDATION OF PARTIALLY OWNED ENTITIES
PFRS 3 allows non-controlling interest in the
acquiree at acquisition date to be measured at
either:
Full-goodwill approach or Fair value option
Partial-goodwill approach
CONSOLIDATION PROCEDURES

Acquisition analysis
Acquisition date eliminating entries
Other elimination entries
CONSOLIDATION PROCEDURES
1. Eliminate the Investment in subsidiary account. This requires:
 Measuring the identifiable assets acquired and liabilities assumed in the
business combination at their acquisition-date fair values.
 Recognizing goodwill from the business combination.
 Eliminating the subsidiary’s pre-combination equity accounts and replacing
them with the non-controlling interest.
2. Add line by line, similar items of assets and liabilities of the
combining constituents. The subsidiary’s assets and liabilities are
included in the consolidated statements at 100% of their amounts
irrespective of the interest acquired by the parent.
CONSOLIDATED FINANCIAL STATEMENTS
(ENTITY THEORY)
AT ACQUISITION DATE PARENT SUBSIDIARY
BALANCE SHEET
ASSETS @ BOOK VALUE @ FAIR VALUE (100%)
LIABILITITES @ BOOK VALUE @ FAIR VALUE (100%)
SHAREHOLDERS’EQUITY
SHARE CAPITAL 100% N/A
RETAINED 100% N/A
EARNINGS
INCOME STATEMENT 100% N/A
*After considering all elimination entries
* Non-controlling interest is recognized for partially owned subsidiaries
EFFECT OF BARGAIN PURCHASE GAIN ON NCI
PFRS 3 states that a gain on bargain purchase can only
be recognized by the acquirer. Gain HAS NO EFFECT
on the calculation of the NCI share of equity, since the
gain is made by the parent paying less than the net fair
value of the acquirer’s share of the identifiable assets,
liabilities and contingent liabilities of the subsidiary.
The NCI receives a share of the fair value of the
subsidiary, and has no involvement with the bargain
purchase gain.
DEFERRED TAXES
The acquiring firm inherits the book values of the assets
acquired for tax purposes. When the acquirer has
inherited the book values of the assets for tax purposes
but has recorded market values for reporting purposes, a
deferred tax needs to be recognized.
Under the current guidelines, the tax effects of the
difference between consolidated book values and the tax
bases must be recorded as deferred tax liabilities or
assets.
CONTROL ACHIEVED IN STAGES
A business combination occurs when the acquirer obtains control
of the acquire. It is at that date of the second acquisition of
shares that the business combination occurs: this is referred to as
a business combination achieved in stages or step acquisition.
PFRS 3 requires that if the acquirer holds a non-controlling
equity investment in the acquire immediately before obtaining
control, the acquirer. An equity investment in asset under PAS 39
(PFRS 9), an associate under PAS 28 or a jointly under PFRS 11.
CONTROL ACHIEVED IN STAGES
A change in ownership leading to a change in the nature of an investment is
reported as a deemed sale of the existing investment at fair value. According
to PFRS 9, an equity interest previously held by the acquire which qualified as
a financial instrument under PFRS9 is treated as if it were disposed of and
reacquired at fair value on the acquisition date, depending on whether the
investment (financial asset) is a:
a. Fair value through OCI – The remeasurement to its acquisition date fair
value and any resulting gain or loss is recognized in other comprehensive
income which shall be transferred directly to retained earnings at any
time.
b. Fair value through profit or loss – The remeasurement to its acquisition-date
fair value and any resulting gain or loss is recognized in profit or loss.
PUSH-DOWN ACCOUNTING
Push-down accounting refers to the practice of revaluing an acquired
subsidiary’s assets and liabilities to their fair values directly on that
subsidiary’s books at the date of acquisition.
In this practice, the revaluations are recorded once the subsidiary’s
books at the date of acquisition, and, therefore, are not made in the
consolidation working papers each time consolidated statements are
prepared. The differences between the fair values and carrying values
of the acquiree’s net assets, and Retained earnings balance at date of
acquisition are closed to Share Premium.
PUSH-DOWN ACCOUNTING
When push-down accounting is used, the subsidiary:
a. Records the goodwill arising from the business combination;
b. Records the acquisition-date fair value adjustments to its identifiable
assets and liabilities;
c. Eliminates the pre-acquisition retained earnings; and
d. The balancing figure after performing (a) to (c) is recorded in the push-
down capital account.
Push-down accounting simplifies the consolidation process because the
consolidation journal entries mainly involve only the elimination of the
investment in subsidiary.
CONSOLIDATED FINANCIAL STATEMENTS
– Subsequent to date of acquisition
CONSOLIDATION SUBSEQUENT TO DATE OF
ACQUISITION
The consolidated procedures subsequent to the acquisition
date involve the same procedures of
(a) eliminating the investment in subsidiary account and
(b) adding, line by line, similar items of assets, liabilities,
income and expenses of the parent and the subsidiary.
However, this time, we need to consider also the changes in
the subsidiary’s net assets since the acquisition date.
CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION
The Eliminating Entries
1. Date of acquisition eliminating entries
2. Amortization of excess of fair value over
3. Elimination of intercompany gains/profits or losses
4. Elimination of dividend income
5. Share of NCI in the net income (loss) of the
subsidiary
THE CONSOLIDATED RETAINED EARNINGS
Consolidated retained earnings is computed by adding the
parent’s retained earnings from its own operations (excluding
any income from consolidated subsidiaries recognized by the
parent) and the parent’s proportionate share of the net income
of each subsidiary since the date of acquisition, adjusted for
differential write-off and goodwill impairment. This is the same
approach used to compute the parent’s retained earnings when
the parent accounts for subsidiaries using the equity method on
its books.
THE NON CONTROLLING INTEREST
An entity shall attribute the profit or loss and each
component of other comprehensive income to the
owners of the parent and to the non-controlling
interests. The entity shall also attribute total
comprehensive income to the owners of the parent
and to the non-controlling interests even if this results
in the non-controlling interests having a deficit
balance.
THE NON CONTROLLING INTEREST
The balance of Non controlling interest in the shareholders’
equity after the date of acquisition is computed as the
total of the NCI recognized at acquisition date and
changes in the equity accounts of the subsidiary, which
includes the following:
Net income or net loss
Dividends paid by subsidiary
Other comprehensive income
Consolida Consolidate Non-
Share Share ted d Other controlli
CONSOLIDATED STATEMENT OF CHANGES IN
Capit Premiu Retained Comprehen ng
al m earnings sive income interest
SHAREHOLDERS’
Beginning Balance
EQUITY xxxx xxxx xxxx xxxx xxxx
Comprehensive Income:
Profit or loss
attributable to: xxxx
Controlling interest xxxx
Non-controlling interest
OCI attributable to:
Controlling interest xxxx
Non-controlling interest xxxx
Dividends paid to:
Controlling interest (xxxx)
Non-controlling interest (xxxx)
Ending balance xxxx xxxx xxxx xxxx xxxx
INTERCOMPANY TRANSACTIONS
(Intercompany sale of inventory)
Affiliated companies may make intercompany sales of inventory or
other assets.
Intercompany sales of inventory are eliminated with the objective
of eliminating the effects of intercompany sales of merchandise in
order to present consolidated balances for sales, cost of sales, and
inventory as if the intercompany sale had never occurred.
As a result, the recognition of income or loss on the intercompany
transaction, including its allocation between the noncontrolling and
controlling interest, is deferred until the profit or loss is confirmed
by sale of the merchandise to non-affiliates or to outsiders.
INTERCOMPANY TRANSACTIONS
(Intercompany sale of inventory)
Working paper procedures are designed to accomplish the following
financial reporting objectives in the consolidated financial statements:
•Consolidated sales include only sales to parties outside the affiliated
group.
•Consolidated cost of sales includes only the cost to the affiliated
group, of goods that have been sold to outside parties outside the
affiliated group.
•Consolidated inventory on the balance sheet is recorded at a value
equal to cost to the affiliated group.
INTERCOMPANY TRANSACTIONS
(Intercompany sale of depreciable assets)
A company may sell property or equipment to an affiliate for a price
that differs from its book value.
• In the year of the sale, the amount of intercompany gain (loss)
recorded by the selling affiliate must be eliminated in consolidation.
• After the sale, the purchasing affiliate will calculate depreciation on
the basis of its cost, which is the intercompany selling price.
• The depreciation recorded by the purchasing affiliate will therefore,
be excessive (deficient) from a consolidated point of view and will
also require adjustment.
INTERCOMPANY TRANSACTIONS
(Intercompany sale of depreciable assets)
From the view of the consolidated entity, the intercompany gain (loss) is considered to be
realized from the use of the property or equipment in the generation of revenue. Because
such use is measured by depreciation, the recognition of the realization of intercompany
profit (loss) is accomplished through depreciation adjustments.
In the consolidated financial statements:
• To report as gains or losses in the consolidated income statement only those that result from
the sale of depreciable property to parties outside the affiliated group.
• To present property in the consolidated balance sheet at its cost to the affiliated group.
• To present accumulated depreciation in the consolidated balance sheet based on the cost
to the affiliated group of the related assets.
• To present depreciation expense in the consolidated income statement based on the cost to
the affiliated group of the related assets.
DECONSOLIDATION AND DERECOGNITION OF
SUBSIDIARY
PFRS 10 considers that when a parent’s ownership interest in a
subsidiary decreases to the point that it no longer controls that
subsidiary, a significant event occurs.
A parent that has been including a subsidiary in its consolidated
financial statements should exclude that company from future
consolidation if the parent can no longer exercise control over it. Control
might be lost for a number of reasons, such as the parent sell some or all
of its interest in the subsidiary, the subsidiary issues additional common
stock, the parent enters into an agreement to relinquish control, or the
subsidiary comes under the control of the government or other regulator.
DECONSOLIDATION AND DERECOGNITION OF
SUBSIDIARY
If a parent loses control of a subsidiary:
1. and no longer holds an equity interest in the former subsidiary, it
recognizes a gain or loss for the difference between any proceeds
received from the event leading to loss of control, and the carrying
amount of the parent’s equity interest.
2. but maintains a non-controlling equity interest in the former subsidiary,
it must recognize in income a gain or loss for the difference, at the date
control is lost, between.
3. an interest is retained, that interest is measured at fair value, and this
is factored into the calculation of the gain or loss on disposal.
DECONSOLIDATION AND DERECOGNITION OF
SUBSIDIARY
The gain or loss on disposal is therefore calculated as follows:
Fair value of the proceeds (if any) from the transaction that resulted to the loss of
control
Add: Fair value of any retained non-controlling equity investment in the former
subsidiary, at the date control is lost.
Add: Carrying value of the non-controlling interest in the former subsidiary at the
date control is lost.
Less: Carrying value of the former subsidiary’s net assets at the date control is lost.
Add or less: Any amounts included in other components of equity, which relate to the
subsidiary, that would be required to be reclassified to profit or loss or another
component of equity if the parent had disposed of the related assets and liabilities.
DECONSOLIDATION AND DERECOGNITION OF
SUBSIDIARY
When control is lost:
1. The parent derecognizes all assets, liabilities and non-controlling
interest at their carrying amount.
2. Any retained interest in the former subsidiary is recognized at its
fair value at the date of control is lost.
3. If the loss of control of the former subsidiary involves the
distribution of equity interests to owners of the parent acting in
their capacity of owners, that distribution is recognized at the
date control is lost.
CHANGE IN OWNERSHIP – WITHOUT LOSS OF
CONTROL
Under PAS 27, changes in
ownership interest in a subsidiary
that does not result to the loss of
control are accounted for as
transfers within equity.
REVERSE ACQUISITION (TAKEOVERS)
A reverse acquisition occurs when an enterprise obtains
ownership of the shares of another enterprise but, as part of
the transaction, issued enough voting shares as consideration
that control of the combined enterprise passes to the
shareholders of the acquired enterprise. Although, legally, the
enterprise that issues the shares is regarded as the parent or
continuing enterprise, the enterprise whose former shareholders
not control the combined enterprise is treated as the acquirer
for reporting purposes.
REVERSE ACQUISITION (TAKEOVERS)
The issuing enterprise (the legal parent) is deemed
to be the acquiree and the company being
acquired in appearance (the legal subsidiary) is
deemed to have acquired control of the assets and
business of the issuing enterprise.