consolidaton entries

1Prepared by Emma Holmes

Consolidation journal adjustments are ONLY prepared for the propose of consolidation.They are posted onto the consolidation worksheet only- they are NOT recorded in the books of the parent or the subsidiary.As a result, some consolidation adjustments are repeated every time consolidated accounts are prepared.

Introduction

Consolidation journals are posted into the consolidation worksheet in adjustment columns as follows:

P Ltd.

$000 S Ltd. $000

Adjustments

Cons. Balances

DR CR Land 400 150 XX XX Invt in S Ltd 120 XX XX Receivables 200 XX XX Cash 40 20 XX 760 170 XXX Share capital 500 100 XX XX Retained earnings 160 20 XX XX Creditors 100 50 XX XX 760 170 XXX

Introduction

2Introduction

Before consolidating, it may be necessary to adjust subsidiarys financial statements where:

1. The subsidiarys balance date is different to the parents. In such cases the subsidiary is required to prepare adjusted financial statements as at the parents reporting date.

2. The subsidiarys accounting policies are different to the parents. In such cases the subsidiary is required to prepare adjusted accounts to ensure accounting policies consistent with the parent.

Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2005 for a total cash consideration of $386,400.

At that time the net assets of Lotech Ltd were represented as follows:

EXAMPLE

350,000Net assets50,000Retained earnings

300,000Share capital$

When Hitech acquired its investment in Lotech the following information applied:

Land held by Lotech was undervalued by $10,000 A building held by Lotech was undervalued by $45,000. The

building had originally cost $100,000 2 years ago and was being depreciated at 10% per year.

A contingent liability of $3,000 was recorded in the notes to Lotechs financial statements.

The tax rate is 30%

EXAMPLE continued

3Entries in the books of the parentBefore commencing consolidation, recognise that investments in subsidiaries are recorded at cost in the books of the parent as follows:

DR. Investment in subsidiary xxxCR. Cash xxx

This journal entry is NOT part of the consolidation process

For our example, the journal entry processed by Hitech Ltd would be

Acquisition AnalysisThe purpose of an acquisition analysis is to compare the cost of the acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at the date of acquisition to determine whether there is any: Goodwill on acquisition (where cost > FVINA) Excess over net assets (where cost < FVINA)

Recall that goodwill is an unidentifiable intangible asset that is calculated as a residual value.Also recall that net assets = assets liabilities = shareholders equity

Acquisition AnalysisIn our example the acquisition analysis would be prepared as follows:

Goodwill/(excess) on acquisition

X %age acquired

FVINA

Total fair value adjustments

- After tax recognition of contingent liability

- After tax increase in building

- After tax increase in land

Fair value (BCVR) adjustments

Total book value of net assets

- Retained earnings

- Share capital

Book value of net assets

Cost of acquisition

$

4Acquisition Analysis

Note also the impact of the following on the acquisition analysis (covered in textbook but not lecture notes): Where subsidiary has recorded goodwill at

acquisition date (p. 677) Where subsidiary has recorded dividends at

acquisition date (p.678)

IAS 27 requires the parent to recognise identifiable assets, liabilities and contingent liabilities of subsidiary in the consolidated accounts AT FAIR VALUE.

If the book value of subsidiary assets and liabilities = fair value, or if contingent liability exists, necessary to make business combination valuationadjustments. These adjustments increase or decrease subsidiarys assets and liabilities book values to fair

value or recognise subsidiarys contingent liabilities as liabilities (i.e. put them onto

the balance sheet) at fair valuesWhile it is possible for these adjustments to be made directly in the books of the subsidiary, it is likely and common for these adjustments to be made on consolidation

Consolidation entries at acquisition date -Business combination valuation adjustments

Either way, the valuation adjustment entry to revalue/recognise previously unrecorded identifiable assets to their fair value will take the form:

Business Combination Valuation Reserve (BCVR) is similar to Asset Revaluation ReserveNote that when depreciable assets are revalued to their fair value any accumulated depreciation recorded in the subsidiarys balance sheet must be offset against the cost of the asset being revalued.


5The valuation adjustment entry to revalue/recognise previously unrecorded liabilities and contingent liabilities to their fair value will take the form:

DR Business Combination Valuation ReserveDR Deferred Tax Asset

CR Liability/Contingent liability


LandLand is undervalued by $10,000Revaluing the asset changes the carrying amount of the asset. As the tax base stays the same such adjustments result in a Deferred Tax Liability (DTL). Accordingly, the business combination valuation adjustment required on consolidation at 30 June 2005 (the date of acquisition) is:

DR Land 10,000CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000

EXAMPLE BCVR adjustments at acquisition date

BuildingsBuildings must be increased by $45,000. This will also result in a DTLThe Buildings in the balance sheet need to change as follows

AT PRESENT REQUIREDBuildings at cost 100,000Accumulated Depreciation (20,000)Book value 80,000


6BuildingsAccordingly, the business combination evaluation adjustments required (on consolidation) at 30 June 2005 (the date of acquisition) are:


Contingent LiabilityRecognising a contingent liability for the first time will result in a liability that has a carrying amount but no tax base. Such adjustments result in a Deferred Tax Asset (DTA).

The business combination valuation adjustment required on consolidation at 30 June 2005 (the date of acquisition) in relation to the contingent liability is:


Adjustments Hitech Ltd. $000

Lotech Ltd.

$000 DR CR

Group

Land - 200 10 210 Building 100 25 125 Accumulated Depreciation - (20) 20 - Deferred Tax Asset 0.9 0.9 Investment in Lotech Ltd 386.4 - 386.4 Cash in bank 473.6 200 673.6 860 480 1,395.9 Creditors 160 130 290 Deferred Tax Liability 3 + 13.5 16.5 Contingent liability 3 3 Share capital 600 300 900 Retained earnings 100 50 150 BCVR 2.1 7 + 31.5 36.4 860 480 1,395.9


The consolidation journals will be posted onto the consolidationworksheet at 30 June 2005 (the date of acquisition) as follows:

7The rest of the consolidation process involves the elimination and adjustment of the aggregated figures, as required.The first of these is the pre-acquisition elimination entry which eliminates the asset Investment in subsidiary (in the parents books) against the shareholders equity (in the subsidiarys books) purchased by the parent .It takes the form

DR All components of subsidiary equity (eg Share Capital, Retained Earnings, ARR, etc)

DR / CR Goodwill or ExcessCR Investment in Subsidiary

Pre-acquisition elimination at acquisition date

By definition, you cannot have an investment in yourself, nor can you have equity in yourself. From a consolidated viewpoint, these items should not exist

Pre-acquisition elimination - EXAMPLE

Adjustments Hitech Ltd. $000

Lotech Ltd. $000

DR CR

Group

Land - 200 10 210Building 100 25 125Accumulated Depreciation - (20) 20 0Deferred tax asset 0.9 0.9Investment in Lotech Ltd 386.4 - 386.4Cash in bank 473.6 200 673.6 860 480 1,395.9Creditors 160 130 290Deferred Tax Liability 3 + 13.5 16.5Contingent liability 3 3Share capital 600 300 900Retained earnings 100 50 150BCVR 2.1 7 + 31.5 36.4 860 480 1,395.9

The pre-acquisition elimination entry requiredDR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400

CR Investment in Lotech 386,400

Pre-acquisition elimination no goodwill or excess

Adjustments Hitech $000

Lotech $000 DR CR

Group

Land - 200 10 210 Building 100 25 125 Accumulated Depreciation - (20) 20 0 Daferred tax asset 0.9 0.9 Investment in Lotech Ltd 386.4 - 386.4 0 Cash in bank 473.6 200 673.6 860 480 1,009.5 Creditors 160 130 290 Deferred Tax Liability 3 + 13.5 16.5 Contingent liability 3 3 Share capital 600 300 300 600 Retained earnings 100 50 50 100 BCVR 2.1 + 36.4 7 + 31.5 0 860 480 1,009.5

Note values

8Acquisition analysis - goodwill on acquisition

Assume all facts as per the previous example apply, except that Hitech paid $400,000 for Lotech. In this case the pre-acquisition analysis would be as follows:


386,400100%X %age acquired

386,400FVINA

36,400Total fair value adjustments

(2,100)- After tax recognition of contingent liability

31,500- After tax increase in building

7,000

350,000

50,000

300,000




- Retained earnings

- Share capital


Cost of acquisition

$400,000

13,600

DR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400DR Goodwill 13,600


Pre-acquisition elimination - goodwill on acquisition


Lotech $000 DR CR

Group

Land - 200 10 210Building 100 25 125Accumulated Depreciation - (20) 20 0Deferred tax asset 0.9 0.9Investment in Lotech Ltd 400 - 400 0Goodwill 13.6 13.6Cash in bank 460 200 660 860 480 1,009.5Creditors 160 130 290Deferred Tax Liability 3 + 13.5 16.5Contingent liability 3 3Share capital 600 300 300 600Retained earnings 100 50 50 100BCVR 2.1 +36.4 7 + 31.5 0 860 480 1,009.5

Note values

Acquisition analysis - excess on acquisition

IAS 27 states this would be rare and recommends re-assessment and confirmation of net asset fair values (ie check that they are correct) before an excess is recognisedAssume all facts as per the previous example apply, except that Hitech paid $360,000 for Lotech. In this case the pre-acquisition analysis would be as follows:


386,400100%X %age acquired

386,400FVINA

36,400Total fair value adjustments

(2,100)- After tax recognition of contingent liability

31,500- After tax increase in building

7,000

350,000

50,000

300,000




- Retained earnings

- Share capital


Cost of acquisition

$

9DR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400

CR Investment in Lotech 360,000CR Gain on excess (P&L) 26,400

Pre-acquisition elimination - excess on acquisition


Lotech $000 DR CR

Group

Land - 200 10 210 Building 100 25 125 Accumulated Depreciation - (20) 20 0 Deferred tax asset 0.9 0.9 Investment in Lotech Ltd 360 - 360 0 Cash in bank 500 200 700 860 480 1,035.9 Creditors 160 130 290 Deferred Tax Liability 3 + 13.5 16.5 Contingent liability 3 3 Share capital 600 300 300 600 Retained earnings 100 50 50 26.4 126.4 BCVR 2.1 + 36.4 7 + 31.5 0 860 480 1,035.9

Note values

Consolidation after acquisition date

So far, we have considered the consolidation journals required if a consolidation was being prepared on acquisition dateHow do these journals change if a consolidation is being prepared on a later date?The business combination valuation adjustment entry may differ due to transactions and events occurring since acquisitionThe pre-acquisition elimination entry may also be affected by a number of events

Consolidations after acquisition date BCVR - land

Recall, Hitech consolidation required following journal adjustment for land revaluation

DR Land 10,000CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000

What if, during the year ended 30 June 2006 the land was sold for $250,000?

10


As the Land no longer exists in Lotechs balance sheet, it cannot continue to be revalued. Instead, the business combination valuation adjustment must recognise the impact on gain on sale.On sale, Lotech Ltd recognised the following journal

From a group viewpoint, the Gain on sale was $40,000 (not $50,000) as the carrying value of the land on consolidation was $210,000.


On acquisition (30 June 2005)DR Land 10,000

CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000

In the year the Land is sold (30 June 2006)

In future years

Consolidations after acquisition date BCVR - buildings

Recall, Hitech consolidation required following journal adjustment for building revaluation DR Accumulated Depreciation 20,000

CR Buildings 20,000

DR Buildings 45,000 CR Deferred Tax Liability 13,500 CR Business Combination Valuation Reserve 31,500

How does this affect depreciation?

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At acquisition, Lotech had a building depreciating at $10,000 per year, for the next 8 years. This would take its written down value from $80,000 (as at 30 June 2005) to $0 in 8 years timeFrom a group viewpoint, however, this building was worth $125,000 as at 30 June 2005. For the building to be depreciated to $0 in 8 years time, the group will need to record depreciation of $15,625 (i.e.$125,000 / 8) per year.This is $5,625 more depreciation than Lotech is recording. Hence, if preparing consolidated accounts on 30 June 2006 (1 year after acquisition) an adjustment must be made on consolidation as follows:


Over the next 8 years we are also required to progressively reverse the DTL created with the original business combination valuation adjustment

The following journal must also be processed on consolidation

Two years after acquisition (30 June 2007) the entries required would be as follows

Consolidations after acquisition date BCVR - contingent liability

Recall, Hitech consolidation required following journal adjustment for contingent liability recognition

What if, during the year the liability was settled for $2,000?On settlement, Lotech Ltd will recognise the following journal

As the contingent liability no longer exists in Lotechs balance sheet, it should not continue to be carried forward on consolidation.The business combination valuation adjustment must recognise thesettlement and any gain/(loss) on settlement.

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Consolidations after acquisition date BCVR - contingent liability

On acquisition (30 June 2005)

DR Business Combination Valuation Reserve 2,100DR Deferred Tax Asset 900

CR Contingent liability 3,000

In the year the liability is settled (30 June 2006)

In future years

Changes to pre-acquisition elimination

The pre-acquisition elimination entry is required every time a consolidation is completed and does NOT change, except under the following circumstances

Goodwill impairment Dividends paid and payable from pre-acquisition equity Transfers to / from pre-acquisition retained earnings or

other reserves (see p.692 text)

Changes to pre-acquisition elimination goodwill impairment

In a previous example the amount paid by Hitech was $400,000, resulting in goodwill of $13,600.Assume, in a subsequent period, goodwill is assessed to have a recoverable value of $13,000. In this situation the goodwill is considered to be impaired. It is therefore necessary to reduce the value of goodwill.This would be done by preparing the following journal on consolidation:

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Changes to pre-acquisition elimination goodwill impairment

In future years, consolidation entries would be combined - with impairment expense reducing retained earnings as follows:

DR Share capital 300,000

DR BCVR 36,400DR Goodwill 13,600


Changes to pre-acquisition elimination dividends from pre-acquisition equity

Any dividend paid by a subsidiary to a parent is a transaction within the group. From the groups viewpoint, the dividend payment DOES NOT EXIST

As a result, they must be eliminated on consolidation.However, elimination entry depends upon the type of dividend (whether they are paid out of pre-acquisition or post-acquisition profits)Post acquisition dividends will be considered next.Pre-acquisition profits affect pre-acquisition elimination entries


Pre-acquisition profits- profits earned by the subsidiary prior to the subsidiary being under the control of the parent (i.ebalance of retained earnings at acquisition date)Dividends paid from pre-acquisition profits reduce the investment account and are NOT revenue to the investorAssume Lotech LTD paid a $500 dividend to Hitech out of PRE acquisition profit on 31 December 2005.Journal Entry in Lotech Journal Entry in HitechDR Dividend paid 500

CR Cash 500 NOTE the credit entry in Hitech does NOT get made to Dividend Revenue, but rather, reduces the balance of the investment (asset) account.

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In the year the pre-acquisition dividend is paid (30 June 2006)

DR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400


In future years

consolidaton entries

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