AU: Consolidation: wholly owned entities

1.Briefly describe the consolidation process in the case of wholly owned entities.

The consolidation process in the process through which consolidated financial statements are prepared by adding together, line by line, the financial statements of the parent and its subsidiary to some very important consolidation adjustments. First, the financial statements that are added together must be comparable. Therefore, before undertaking the consolidation process it may be necessary to make adjustments in relation to the content of the financial statements of the subsidiary. Second, as part of the consolidation process, a number of other adjustments are made to the parent’s and the subsidiary’s statements, these being expressed in the form of journal entries. A worksheet or computer spreadsheet is often used to facilitate the addition process and to make the adjustments.

2.Explain the initial adjustments that may be required before undertaking the consolidation process.

Before undertaking the consolidation process it may be necessary to make adjustments in relation to the content of the financial statements of the subsidiary.

• If the end of a subsidiary’s reporting period does not coincide with the end of the parent’s reporting period, adjustments must be made for the effects of significant transactions and events that occur between those dates, with additional financial statements being prepared where it is practicable to do so (AASB 10/IFRS 10 paragraphs B92–B93). In most such cases, the subsidiary will prepare adjusted financial statements as at the end of the parent’s reporting period, so that adjustments are not necessary on consolidation. Where the preparation of adjusted financial statements is unduly costly, the financial statements of the subsidiary prepared at a different date from the parent may be used, subject to adjustments for significant transactions. However, as paragraph B93 states, for this to be a viable option, the difference between the ends of the reporting periods can be no longer than 3 months. Further, the length of the reporting periods, as well as any difference between the ends of the reporting periods, must be the same from period to period.
• The consolidated financial statements are to be prepared using uniform accounting policies for like transactions and other events in similar circumstances (AASB 10/IFRS 10 paragraph 19). Where the parent and the subsidiary used different policies, adjustments are made so that like transactions are accounted for under a uniform policy in the consolidated financial statements (normally the policy used by the parent).

3.Explain the adjustments that may be required as part of the consolidation process.

As part of the consolidation process, a number of other adjustments are made to the parent’s and the subsidiary’s statements, these being expressed in the form of journal entries.

• As required by AASB 3/IFRS 3, at the acquisition date the acquirer must recognise the identifiable assets acquired and liabilities assumed of the subsidiary at fair value. Adjusting the carrying amounts of the subsidiary’s assets and liabilities to fair value and recognising any identifiable assets acquired and liabilities assumed as part of the business combination, but not recorded by the subsidiary, is a part of the consolidation process. The entries used to make these adjustments are referred to in this chapter as the business combination valuation entries. As noted in section 27.2, these adjusting entries are generally not made in the records of the subsidiary itself, but in a consolidation worksheet.
• Where the parent has an ownership interest (i.e. owns shares) in a subsidiary, another set of adjusting entries are made, referred to in this chapter as the pre‐acquisition entries. As noted in paragraph B86(b) of AASB 10/IFRS 10, this involves eliminating the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre‐acquisition equity in the subsidiary. This avoids double counting of the group’s assets and equity. The name of these entries is derived from the fact that the equity of the subsidiary at the acquisition date is referred to as pre‐acquisition equity, and it is this equity that is being eliminated. These entries are also made in the consolidation worksheet, not in the records of the subsidiary.
• The third set of adjustments is for transactions between the entities within the group subsequent to the acquisition date, including sales of inventories or non‐current assets. These intragroup transactions are referred to in paragraph B86(c) of AASB 10/IFRS 10. Adjustments for these transactions are discussed in detail in chapter 28.

4.Explain the purpose and format of the consolidated worksheet.

A consolidation worksheet is often used to facilitate the consolidation process, and to make the business combination valuation and pre-acquisition entry adjustments, among other adjustments. From the worksheet, the following statements are prepared: the consolidated statement of financial position, statement of profit or loss and other comprehensive income and statement of changes in equity.
Note the following points about the worksheet:

• Column 1 contains the names of the accounts, as the financial statements are combined on a line-by-line basis.
• Columns 2 and 3 contain the financial information for the parent and its subsidiary. This information is obtained from the financial statements of the separate legal entities. The number of columns is expanded if there are more subsidiaries within the group.
• The next four columns, headed ‘Adjustments’, are used to post and reference the adjustments required in the consolidation process. These include the business combination valuation entries, pre-acquisition entries and the adjustments for intragroup transactions. These adjustments, written in the form of journal entries in the consolidation journal, are recorded in the worksheet, separately from the individual records of the parent and subsidiary, so they do not affect the individual financial statements. Where there are many adjustments, each journal entry should be numbered so that it is clear which items are being affected by a particular adjustment entry.
• The right-hand column, headed ‘Group’, includes the calculated consolidated amounts for each line item, together with totals and subtotals. The figures in the'Group'column provide the information for preparing the consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity and consolidated statement of financial position. These statements will not include all the line items in the consolidation worksheet. However, information for the notes to these statements is also obtained from line items in the worksheet.

5.Explain the purpose of the acquisition analysis in the preparation of consolidated financial statements.

According to AASB 3/IFRS 3 and as described in chapter 25, entities need to account for business combinations using the acquisition method. As part of the acquisition method, an acquisition analysis is conducted at acquisition date because it is necessary to recognise all the identifiable assets and liabilities of the subsidiary at fair value (including those previously not recorded by the subsidiary), and to determine whether there has been any goodwill acquired or whether a gain on bargain purchase has occurred. The acquisition analysis is considered the first step in the consolidation process as it identifies the information necessary for making both the business combination valuation and pre-acquisition entry adjustments for the consolidation worksheet. The end result of the acquisition analysis will be the determination of whether there is any goodwill acquired or gain on bargain purchase.

6.How does AASB 3/IFRS 3 Business Combinations affect the acquisition analysis?

The formation of a parent–subsidiary relationship by the parent obtaining control over the subsidiary is a business combination. The parent, being the controlling entity is an acquirer, with the subsidiary being the acquiree. The acquisition analysis is then totally based on AASB 3/IFRS 3. The acquisition analysis reflects the application of the acquisition method:
Step 1: Identify the acquirer – in this case, it is the parent.
Step 2: Determine the acquisition date
Step 3: Recognise and measure the identifiable assets acquired and the liabilities assumed at fair value. The differences between the carrying amounts and fair values of the identifiable assets, liabilities and contingent liabilities of the subsidiary are recognised via business combination valuation reserves. The effect is to recognise the assets and liabilities of the subsidiary at fair value.
Step 4: Recognise and measure goodwill or a gain from a bargain purchase. The goodwill is recognised in the BCVR entries while the gain is recognised in the pre-acquisition entries.

7.At the date the parent acquires a controlling interest in a subsidiary, if the carrying amounts of the subsidiary's assets are not equal to their fair value, explain why adjustments to these assets are required in the preparation of the consolidated financial statements.

AASB 3/IFRS 3, paragraph 18, requires that identifiable assets and liabilities of the subsidiary are to be measured at fair value at acquisition date. The standard-setters believe that the fair value of the assets and liabilities provides the most relevant information to users.
Even though the standard refers to an allocation of the cost of a business combination, the standard does not require the identifiable assets and liabilities acquired to be recorded at cost.
The only asset acquired that is not measured at fair value is goodwill.
The fair value approach is emphasised by the required accounting for any bargain purchase on combination. It is not accounted for as a reduction in the fair values of the identifiable assets and liabilities acquired such that these items are recorded at cost. Instead, the fair values are unchanged and the excess is recognised as a gain.

8.If the parent assesses that some of the subsidiary's identifiable assets and liabilities are not recorded by the subsidiary at acquisition date, explain why adjustments to these assets and liabilities are required in the preparation of the consolidated financial statements.

According to AASB 3/IFRS 3 and as described in chapter 25, entities need to account for business combinations using the acquisition method. As part of the acquisition method, an acquisition analysis is conducted at acquisition date because it is necessary to recognise all the identifiable assets and liabilities of the subsidiary at fair value (including those previously not recorded by the subsidiary).

9.Explain the purpose of the business combination valuation entries in the preparation of consolidated financial statements.

The purpose of these entries is to make consolidation adjustments so that in the consolidated statement of financial position the identifiable assets, liabilities and contingent liabilities of the subsidiary are reported at fair value. This is to fulfil step 3 of the acquisition method required to account for business combinations by AASB 3/IFRS 3.

10.Explain the purpose of the pre-acquisition entries in the preparation of consolidated financial statements.

11.When there is a dividend payable by the subsidiary at acquisition date, under what conditions should it be taken into consideration in preparing the pre-acquisition entries?

12.Is it necessary to distinguish pre-acquisition dividends from post-acquisition dividends? Why?

13.If the subsidiary has recorded goodwill in its records at acquisition date, how does this affect the acquisition analysis, the business combination valuation entries and the pre-acquisition entries?

14.Explain how the existence of a gain on bargain purchase affects the pre-acquisition entries, both in the year of acquisition and in subsequent years.

In the presence of a gain on bargain purchase, the pre-acquisition entry at acquisition date should recognise this gain as a part of the consolidated profit for the period starting at acquisition date, and not eliminate it. This is because it is considered to belong to post-acquisition equity. In subsequent periods after the acquisition date, the gain on bargain purchase is included in retained earnings (opening balance) and therefore reduces the adjustment to the opening balance of retained earnings posted in pre-acquisition entries.

15.Why are some adjustment entries in the previous period’s consolidation worksheet also made in the current period’s worksheet?

The consolidation worksheet entries do not affect the underlying financial statements or the accounts of the parent or the subsidiary. As the consolidation is done every year based on the individual financial statements or the accounts of the parent or the subsidiary, the entries in the consolidation worksheet from previous years do not carry over and they need to be repeated, sometimes exactly the same as in previous years, something with some adjustments. For example, if the last year’s profits are required to be adjusted on consolidation, then retained earnings (opening balance) will need to be adjusted in the current period. Similarly, a BCVR entry to recognise at fair value the land on hand at acquisition is made in the consolidation worksheet for each year that the land remains in the subsidiary. The entry does not change from year to year. Again the reason is that the adjustment to the carrying amount of the land is only made in a worksheet and not in the actual records of the subsidiary itself. However, the BCVR entries for non-current assets subject to depreciation need to be adjusted from year to year.

16.Explain how and why the business combination valuation entries will be adjusted in subsequent years after the acquisition date.

In any period after acquisition, business combination valuation entries are prepared for the assets and liabilities that were not recorded at fair value at acquisition date to the extent that they are still on hand with the subsidiary at the beginning of that period:

17.Explain how and why the pre-acquisition entries will be adjusted in subsequent years after the acquisition date.

There are two sets of events that can cause a change in the pre-acquisition entries after acquisition date:

18.Using an example, explain how the business combination entries affect the pre-acquisition entries, both at acquisition date and in the subsequent years.

Assume at acquisition date, the subsidiary has land recorded at a carrying amount of $10 000 and having a fair value of $15 000. The tax rate is 30%.

19.Explain the choices that may be available to revalue the identifiable assets recorded by the subsidiary at carrying amounts different from fair value at the acquisition date.

AASB 3/IFRS 3 does not discuss whether the revaluation of the assets of the subsidiary at acquisition date should be done in the consolidation worksheet or in the records of the subsidiary. Most entities will make their adjustments in the consolidation worksheet, mainly for two reasons.

20.At acquisition date, the subsidiary may have the choice to revalue (or not) in its own accounts the identifiable assets previously recorded at carrying amounts different from fair value. Discuss how the business combination entries and the pre‐acquisition entries will be affected by this choice.

If the subsidiary revalues some assets in its own accounts, an asset revaluation surplus will be recognised (and not a business combination valuation reserve) and, being part of pre‐acquisition equity, it will need to be considered when preparing the pre‐acquisition entries. As asset revaluation surplus behaves in the same manner as business combination valuation reserve, the pre‐acquisition entries will be affected if the revalued asset is derecognised, as the asset revaluation surplus will be transferred to retained earnings. Nevertheless, as the asset revaluation surplus or its transfer to retained earnings will be eliminated in pre‐acquisition entries just like the business combination valuation reserve and its transfer, the consolidated financial statements at acquisition date are the same regardless of whether revaluation occurs on consolidation or in the records of the subsidiary.