Group Financial Reporting ACF 202 PART 2 Fair value Cynthia Fortin, CPA, CMA FALL 2018

Objective Describe and explain the importance of fair valuation. We will look at fair value for each element in W3 for the calculation of goodwill.

W3 Goodwill Non-controlling interest Fair value of consideration Fair value of S’s net assets GOODWILL W3 Goodwill

P’s investment at date of acquisition IFRS 13: Fair value measurement: ‘Amount that would be received to sell an asset at market value’

Types of consideration given CASH Deferred consideration Shares Contingent consideration Interest bearing loans

How to measure consideration? CASH Share issued or share exchange Cash paid Shares issued at market value or Shares exchange ratio # P’s shares for * P’s market price * (P’s % * S’s total shares) # S’s shares

Illustration Share exchange Russia has made an acquisition of 100% of the shares in Moscow. Moscow has a share capital of 50,000 shares with a nominal value of $1 each. The consideration that Russia gave for the investment in the subsidiary included a 2 for 1 share for share exchange. The market value of Russia's shares is $3. Shares exchange ratio # P’s shares for * P’s market price * (P’s % * S’s total shares) # S’s shares 2/1 * $3 * 100% * 50000 =$300,000

Measure consideration Deferred consideration Liabilities at present value Shares at market value Contingent consideration Liabilities if settled at different amount, Difference to Income Interest bearing loans Shares if not issued No change in equity At nominal value Always at fair value

Illustration deferred consideration A liability will be paid in the future: In addition Russia will also pay cash of 80 cents per share in one year's time. Assume a relevant discount rate of 8%. We must compute the liability at present value discounting it using the 8% rate. ($0.80 per share * 100% * 50,000 shares) = $37,037 1+0.08

Exercise Let’s do Poland Russia

Non-controlling interest Fair value of consideration Fair value of S’s net assets GOODWILL

W4 Non-controlling interest (NCI) Subsidiary Voting shares Parent controls NCI is nil 100% Subsidiary Voting shares Parent controls NCI is 25% 75%

W3 Goodwill when NCI is proportionate of S's net assets NCI so far we have used a method called proportionate of S’s net assets W3 Goodwill when NCI is proportionate of S's net assets P's investment at doa ……… x Plus NCI % of W2 at doa or value given ……………………… Less W2 at doa ……………….. (x) = Goodwill at doa …………… X Less Impairment loss………… = Goodwill at yearend ……….

Examples Croatia NCI was $64m 40% OF S’S net assets $160 M = $64M Cyprus NCI $65m 25% * $260 m = $65 m Jamaica NCI $60m 20% * 300 m = $60m Whereas Tiger NCI was $50m not 40% of $300m Lion NCI was given $100m not 25% of $160m

Non Controlling Interest (NCI) When parent acquires less than 100% of S’s ordinary shares, S’s other shares are owned by external third parties called NCI which is recorded in the Group equity section. NCI at fair value is computed using the market price of S’s shares. It is usually given. So fair value of NCI at doa = Market value of S’s shares not acquired by P. Goodwill is called FULL goodwill and the impairment loss will be split between NCI in W4 and Parent Retained earnings in W5.

Goodwill Second method to record goodwill: at fair value W3 Impairment loss is split between Parent and NCI which is not the case in NCI as proportion of net assets. Goodwill

Let’s do Mount Libya Then Thames

Non-controlling interest Fair value of consideration Fair value of S’s net assets GOODWILL

Measuring S’s net assets at acquisition at fair value Parent If Fair value is higher than net assets, then a fair value adjustment is made at doa and depreciation is taken at yearend Performs a fair value exercise of S’s net assets

Measuring S’s net assets at acquisition at fair value Let’s do Malta Then Barbados Measuring S’s net assets at acquisition at fair value

Non-controlling interest Fair value of consideration Fair value of S’s net assets GOODWILL

Goodwill NCI at fair value NCI at proportionate goodwill is attributable to parent only and so is the impairment loss. goodwill is full and impairment loss is split between P and NCI.

amount is lower than the recoverable amount, no gain is recorded Goodwill is impaired when Recoverable amount Carrying amount Fair value less cost to sell Accounting records after deducting accumulated depreciation and impairment loss If the carrying amount is lower than the recoverable amount, no gain is recorded

IAS 36 does not allow goodwill impairment Goodwill impairment loss Asset written down Must be recorded IAS 36 does not allow goodwill impairment loss to be reversed

Impairment of an asset Carrying value (Assets – liabilities + goodwill) X Less recoverable amount (X) Impairment loss X Why is goodwill added to the carrying amount? Because it is inseparable from the net assets of the subsidiary. Recoverable amount: Cash generating unit is a collection of assets and liabilities that generate an independent stream of cash.

Let’s do Oman Then Singapore section 2 www. kaplanpublishing. co Let’s do Oman Then Singapore section 2 www.kaplanpublishing.co.uk/groupaccounts Dolphin Seal Sea lion Walrus

Mid-year acquisitions Assumption on Post acquisition profits When acquisition occurs during a period, assume profits accrue evenly during the period and that no dividends will have been paid by Subsidiary.

Example If S was acquired at May 1, 2014 and retained earnings at December 31, 2013 were $100m and at December 31 2014 were $148m, then to calculate retained earnings at date of acquisition: Retained earnings $100m__________$?_doa_______________$148m 2013.12.31 2014.05.01 2014.12.31 $148-100=$48 period profits 48/12 months = $4 per month From Jan. 1 to April 30 = 4 months Therefore balance of Retained Earnings as at May 1 can be $100 + 16 = $116m

What I need to know Fair value (FV) is the price to be received to sell an asset. P records the investment in the S at FV of the consideration given. FV of P’s shares issued for the investment in S will be measured at their market value. FV of deferred consideration given for the investment in S creates a liability that is measured at present value of future cash flow.

What I need to know Consideration given for the investment that is dependent on a contingency is recorded at FV and creates a provision for a liability (if cash) or and equity reserve (if settled in shares). If provision for liability for contingent consideration does not have to be paid it is derecognised and a gain recognised in income.

What i need to know FV of P’s interest bearing loan notes issued as consideration given is recorded at nominal value. NCI at acquisition can be measured at FV and goodwill will be in full. NCI at acquisition can be proportionate of S’s net assets and goodwill will be given to P only. At doa net assets of S have to be adjusted to FV

What i need to know If at year-end FV asset adjustments are depreciated, then S’s profits must be adjusted as well. Asset is impaired when the carrying value is higher than the recoverable amount. Impairment loss on full goodwill is shared between P(W5) and NCI (W4). Impairment loss on goodwill attributable to P is wholly charged against P’s profits (W5).

References Clendon, Tom (2013), “A Student's Guide to Group Accounts, 2nd Ed.”, Kaplan Publishing UK ISBN: 9780857327642 chapters 4, 5, 6, 7 and 10. Recap pp 89-90.