Consolidaton Entries

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<ul><li><p>1Prepared by Emma Holmes</p><p>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. </p><p>Introduction</p><p>Consolidation journals are posted into the consolidation worksheet in adjustment columns as follows:</p><p> P Ltd. </p><p>$000 S Ltd. $000 </p><p> Adjustments </p><p>Cons. Balances </p><p> 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 </p><p>Introduction</p></li><li><p>2Introduction</p><p>Before consolidating, it may be necessary to adjust subsidiarys financial statements where:</p><p>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.</p><p>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.</p><p>Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2005 for a total cash consideration of $386,400.</p><p>At that time the net assets of Lotech Ltd were represented as follows:</p><p>EXAMPLE</p><p>350,000Net assets50,000Retained earnings</p><p>300,000Share capital$</p><p>When Hitech acquired its investment in Lotech the following information applied:</p><p> Land held by Lotech was undervalued by $10,000 A building held by Lotech was undervalued by $45,000. The </p><p>building had originally cost $100,000 2 years ago and was being depreciated at 10% per year. </p><p> A contingent liability of $3,000 was recorded in the notes to Lotechs financial statements.</p><p>The tax rate is 30%</p><p>EXAMPLE continued</p></li><li><p>3Entries in the books of the parentBefore commencing consolidation, recognise that investments in subsidiaries are recorded at cost in the books of the parent as follows:</p><p>DR. Investment in subsidiary xxxCR. Cash xxx</p><p>This journal entry is NOT part of the consolidation process</p><p>For our example, the journal entry processed by Hitech Ltd would be </p><p>Acquisition AnalysisThe purpose of an acquisition analysis is to compare the cost of the acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at the date of acquisition to determine whether there is any: Goodwill on acquisition (where cost &gt; FVINA) Excess over net assets (where cost &lt; FVINA)</p><p>Recall that goodwill is an unidentifiable intangible asset that is calculated as a residual value.Also recall that net assets = assets liabilities = shareholders equity</p><p>Acquisition AnalysisIn our example the acquisition analysis would be prepared as follows:</p><p>Goodwill/(excess) on acquisition </p><p>X %age acquired</p><p>FVINA</p><p>Total fair value adjustments</p><p>- After tax recognition of contingent liability</p><p>- After tax increase in building</p><p>- After tax increase in land</p><p>Fair value (BCVR) adjustments</p><p>Total book value of net assets</p><p>- Retained earnings</p><p>- Share capital</p><p>Book value of net assets</p><p>Cost of acquisition</p><p>$</p></li><li><p>4Acquisition Analysis</p><p>Note also the impact of the following on the acquisition analysis (covered in textbook but not lecture notes): Where subsidiary has recorded goodwill at </p><p>acquisition date (p. 677) Where subsidiary has recorded dividends at </p><p>acquisition date (p.678)</p><p>IAS 27 requires the parent to recognise identifiable assets, liabilities and contingent liabilities of subsidiary in the consolidated accounts AT FAIR VALUE.</p><p>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 </p><p>value or recognise subsidiarys contingent liabilities as liabilities (i.e. put them onto </p><p>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</p><p>Consolidation entries at acquisition date -Business combination valuation adjustments</p><p>Either way, the valuation adjustment entry to revalue/recognise previously unrecorded identifiable assets to their fair value will take the form:</p><p>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.</p><p>Consolidation entries at acquisition date -Business combination valuation adjustments</p></li><li><p>5The valuation adjustment entry to revalue/recognise previously unrecorded liabilities and contingent liabilities to their fair value will take the form: </p><p>DR Business Combination Valuation ReserveDR Deferred Tax Asset</p><p>CR Liability/Contingent liability</p><p>Consolidation entries at acquisition date -Business combination valuation adjustments</p><p>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:</p><p>DR Land 10,000CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000</p><p>EXAMPLE BCVR adjustments at acquisition date</p><p>BuildingsBuildings must be increased by $45,000. This will also result in a DTLThe Buildings in the balance sheet need to change as follows</p><p>AT PRESENT REQUIREDBuildings at cost 100,000Accumulated Depreciation (20,000)Book value 80,000</p><p>EXAMPLE BCVR adjustments at acquisition date</p></li><li><p>6BuildingsAccordingly, the business combination evaluation adjustments required (on consolidation) at 30 June 2005 (the date of acquisition) are: </p><p>EXAMPLE BCVR adjustments at acquisition date</p><p>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). </p><p>The business combination valuation adjustment required on consolidation at 30 June 2005 (the date of acquisition) in relation to the contingent liability is:</p><p>EXAMPLE BCVR adjustments at acquisition date</p><p>Adjustments Hitech Ltd. $000 </p><p>Lotech Ltd. </p><p>$000 DR CR </p><p>Group </p><p>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 </p><p>EXAMPLE BCVR adjustments at acquisition date</p><p>The consolidation journals will be posted onto the consolidationworksheet at 30 June 2005 (the date of acquisition) as follows:</p></li><li><p>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</p><p>DR All components of subsidiary equity (eg Share Capital, Retained Earnings, ARR, etc)</p><p>DR / CR Goodwill or ExcessCR Investment in Subsidiary</p><p>Pre-acquisition elimination at acquisition date</p><p>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</p><p>Pre-acquisition elimination - EXAMPLE</p><p>Adjustments Hitech Ltd. $000 </p><p>Lotech Ltd. $000 </p><p>DR CR </p><p>Group</p><p>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</p><p>The pre-acquisition elimination entry requiredDR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400</p><p>CR Investment in Lotech 386,400</p><p>Pre-acquisition elimination no goodwill or excess</p><p>Adjustments Hitech $000 </p><p>Lotech $000 DR CR </p><p>Group </p><p>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 </p><p>Note values</p></li><li><p>8Acquisition analysis - goodwill on acquisition</p><p>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:</p><p>Goodwill/(excess) on acquisition </p><p>386,400100%X %age acquired</p><p>386,400FVINA</p><p>36,400Total fair value adjustments</p><p>(2,100)- After tax recognition of contingent liability</p><p>31,500- After tax increase in building</p><p>7,000</p><p>350,000</p><p>50,000</p><p>300,000</p><p>- After tax increase in land</p><p>Fair value (BCVR) adjustments</p><p>Total book value of net assets</p><p>- Retained earnings</p><p>- Share capital</p><p>Book value of net assets</p><p>Cost of acquisition</p><p>$400,000</p><p>13,600</p><p>DR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400DR Goodwill 13,600</p><p>CR Investment in Lotech 400,000</p><p>Pre-acquisition elimination - goodwill on acquisition</p><p>Adjustments Hitech $000 </p><p>Lotech $000 DR CR </p><p>Group</p><p>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</p><p>Note values</p><p>Acquisition analysis - excess on acquisition</p><p>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 $360,000 for Lotech. In this case the pre-acquisition analysis would be as follows:</p><p>Goodwill/(excess) on acquisition </p><p>386,400100%X %age acquired</p><p>386,400FVINA</p><p>36,400Total fair value adjustments</p><p>(2,100)- After tax recognition of contingent liability</p><p>31,500- After tax increase in building</p><p>7,000</p><p>350,000</p><p>50,000</p><p>300,000</p><p>- After tax increase in land</p><p>Fair value (BCVR) adjustments</p><p>Total book value of net assets</p><p>- Retained earnings</p><p>- Share capital</p><p>Book value of net assets</p><p>Cost of acquisition</p><p>$</p></li><li><p>9DR Share capital 300,000DR Retained earnings 50,000DR BCVR 36,400</p><p>CR Investment in Lotech 360,000CR Gain on excess (P&amp;L) 26,400</p><p>Pre-acquisition elimination - excess on acquisition</p><p>Adjustments Hitech $000 </p><p>Lotech $000 DR CR </p><p>Group</p><p>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 </p><p>Note values</p><p>Consolidation after acquisition date</p><p>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</p><p>Consolidations after acquisition date BCVR - land</p><p>Recall, Hitech consolidation required following journal adjustment for land revaluation</p><p>DR Land 10,000CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000</p><p>What if, during the year ended 30 June 2006 the land was sold for $250,000?</p></li><li><p>10</p><p>Consolidations after acquisition date BCVR - land</p><p>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</p><p>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.</p><p>Consolidations after acquisition date BCVR - land</p><p>On acquisition (30 June 2005)DR Land 10,000</p><p>CR Deferred Tax Liability 3,000CR Business Combination Valuation Reserve 7,000</p><p>In the year the Land is sold (30 June 2006)</p><p>In future years </p><p>Consolidations after acquisition date BCVR - buildings</p><p>Recall, Hitech consolidation required following journal adjustment for building revaluation DR Accumulated Depreciation 20,000</p><p>CR Buildings 20,000 </p><p>DR Buildings 45,000 CR Deferred Tax Liability 13,500 CR Business Combination Valuation Reserve 31,500</p><p>How does this affect depreciation?</p></li><li><p>11</p><p>Consolidations after acquisition date BCVR - buildings</p><p>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:</p><p>Consolidations after acquisition date BCVR - buildings</p><p>Over the next 8 years we are also required to progressively reverse the DTL created with the original business combination valuation adjustment</p><p>The following journal must also be processed on consolidation</p><p>Two years after acquisition (30 June 2007) the entries required would be as follows</p><p>Consolidations after acquisition date BCVR - contingent liability</p><p>Recall, Hitech consolidation required following journal adjustment for contingent liability recognition</p><p>What if, during the year the liability was settled for $2,000?On settlement, Lotech Ltd will recognise the following journal</p><p>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 adjustm...</p></li></ul>