1. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-1 Chapter 32 Further consolidation issues IV: Accounting for changes in the degree of ownership of a subsidiary

2. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-2 Objectives of this lecture Understand how to account for incremental investments in a subsidiary Understand how to account for the disposal of a subsidiary both from the perspective of the parent entity and from the perspective of the economic entity

3. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-3 Increase in the ownership interest held in a subsidiary It is common for a parent entity to acquire additional shares in a subsidiary over time There are two general approaches that potentially could be used when accounting for increases in the ownership of a subsidiary. These two approaches have been referred to as the: 1. step-by-step method 2. single-date method

4. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-4 The step-by-step method Pursuant to the step-by-step method, which was the method required by AASB 3 until recently: –Each individual investment in the subsidiary is accounted for separately, meaning that we will have multiple consolidation elimination entries –Once control of the subsidiary is established, the consolidation worksheet entries will eliminate the various investments in the subsidiary against the parent entity’s respective share of the subsidiary’s net identifiable assets as at each of the respective investment dates (at fair value) –Because eliminations of each investment are made as at the various investment dates we need to restate the subsidiary’s assets to fair value as at each exchange date. This means that we might have numerous entries to revalue the net assets to fair value –For each investment elimination we will calculate a separate amount of goodwill. This means that the total goodwill acquired for a subsidiary could be the sum of a number of individual transaction calculations as reflected in a number of investment elimination entries

5. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-5 The single-date method By contrast, under the single-date method, goodwill would be recognised by a single consolidation journal entry at that point in time when the parent entity ultimately gains control of the subsidiary That is, the aggregate costs of the investments would be eliminated against the parent’s share of capital and reserves at the date control is ultimately established and only one amount of goodwill (or bargain gain on purchase) is calculated While the step-by-step method was the method required by AASB 3 until 2008, in 2008 AASB 3 was revised and now the requirement is that the single-date method be applied This was a major change in the accounting standard

6. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-6 The single-date method (cont.) For more background to the new requirements of AASB 127 we can refer to some of the material included within the Basis for Conclusions that accompanied the release of IAS 27. BC 41 The Board decided that after control of an entity is obtained, changes in a parent’s ownership interest that do not result in a loss of control are accounted for as equity transactions (i.e. transactions with owners in their capacity as owners). This means that no gain or loss from these changes should be recognised in profit or loss. It also means that no change in the carrying amounts of the subsidiary’s assets (including goodwill) or liabilities should be recognised as a result of such transactions BC 46 Recognising a change in any of the assets of the business, including goodwill, is inconsistent with the Board’s decision in IFRS 3 (as revised in 2008) that obtaining control in a business combination is a significant economic event. That event causes the initial recognition and measurement of all the assets acquired and liabilities assumed in the business combination.

7. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-7 The single-date method (cont.) Subsequent transactions with owners should not affect the measurement of those assets and liabilities BC 47 The parent already controls the assets of the business, although it must share the income from those assets with the non-controlling interests. By acquiring the non-controlling interests the parent is obtaining the rights to some, or all, of the income to which the non-controlling interests previously had rights. Generally, the wealth-generating ability of those assets is unaffected by the acquisition of the non-controlling interests. That is to say, the parent is not investing in more or new assets. It is acquiring more rights to the income from the assets it already controls. BC48 By acquiring some, or all, of the non-controlling interests the parent will be allocated a greater proportion of the profits or losses of the subsidiary in periods after the additional interests are acquired. The adjustment to the controlling interest will be equal to the unrecognised share of the value changes that the parent will be allocated when those value changes are recognised by the subsidiary. Failure to make that adjustment will cause the controlling interest to be overstated.

8. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-8 Applying the single-date method The non-controlling interest in share capital and reserves at the date the additional equity in a subsidiary is acquired needs to be determined No goodwill or bargain purchase on acquisition of the additional interest is recognised as this is not considered a significant economic event, as the parent already has control over the subsidiary Rather than acquiring additional assets in the controlled entity, the second share purchase is seen as a transfer of equity between owners The basis of this argument is that if the parent entity already had established control of the subsidiary (and therefore control of its assets) then it already controlled all of the assets of the subsidiary, and therefore the second transaction provided the entity with no further assets

9. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-9 Applying the single-date method (cont.) In accordance with the above perspective, paragraph 30 of AASB 127 requires the purchase of an additional ownership interest in a subsidiary, after control to be gained, to be treated as an equity transaction—that is, a transaction with owners in their capacity as owners Specifically, there is an equity transfer between the parent entity and the non-controlling interests. Paragraph 30 states: Changes in a parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions (i.e. transactions with owners in their capacity as owners)

10. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-10 Applying the single-date method (cont.) When accounting for the subsequent equity acquisition (after control had previously been established) we need to determine the non-controlling interest in the subsidiary just prior to the subsequent acquisition No goodwill or bargain purchase on acquisition of the additional equity interest is recognised as this is not considered a significant economic event

11. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-11 Applying the single-date method (cont.) We determine the non-controlling interest prior to the acquisition and then eliminate the relevant proportion. For example, if we are acquiring half of the non-controlling interests’ shareholding then we will eliminate half of the non-controlling interests’ share of capital and reserves by virtue of the following entry: Dr Share capital XXX Dr Retained earnings XXX Dr Revaluation surplus XXX Cr Reserve on acquisition of additional equity XXX Cr Investment in Subsidiary Ltd XXX The reserve arising on the acquisition of additional equity in Subsidiary Ltd (which we labelled ‘reserve on acquisition of additional equity’ in the journal entries above and which may be positive or negative) will be disclosed in consolidated equity

12. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-12 Obtaining control over an entity in which a non-controlling interest is held It is possible for an acquirer to obtain control of an acquiree in stages through successive purchases of shares. If the acquirer holds a non-controlling equity investment in the acquiree immediately prior to obtaining control, this investment must be remeasured to fair value as at the date of subsequently obtaining control and included in the calculation of goodwill Any gain or loss on the remeasurement is recognised in consolidated profit or loss

13. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-13 Example of an acquisition that results in control over a subsidiary A Ltd acquired a 15% holding in B Ltd on 1 July 2011 for $5000 cash. A Ltd made the following journal entry: Dr Investment in B Ltd 5 000 Cr Cash 5 000 On 30 June 2012, A Ltd acquired an additional 65% of the contributed capital of B Ltd for $30 355, which represents the fair value of consideration transferred. Control then vested in A Ltd The journal entry to record the additional investment in B Ltd as recorded in the accounts of A Ltd was: Dr Investment in B Ltd 30 355 Cr Cash 30 355 The fair value of the net identifiable assets of B Ltd at the acquisition date of 30 June 2012 was $35 000 and all assets were recorded at fair value in the financial statements of B Ltd The net assets of B Ltd at acquisition were represented by: Share capital 20 000 Retained earnings 15 000 35 000

14. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-14 Determining goodwill following a subsequent transaction that provides control The goodwill on acquisition date can be calculated as follows: Fair value of consideration transferred (to obtain control) 30 355 plus Amount of non-controlling interest at fair value ($30 355 + $7005) × 20/80 9 340 plus Fair value of any previously held non-controlling interest ($30 355 × 15/65) *7 005 46 700 Fair value of net identifiable assets acquired 35 000 Total goodwill on acquisition 11 700 * On 30 June 2012 the fair value of the initial 15% investment can be calculated as $30 355 × 15 ÷ 65

15. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-15 Example of an acquisition that results in control over a subsidiary (cont.) The gain on the acquisition of the additional investment in B Ltd can be determined as follows: Fair value of previously held investment at date of acquiring additional 65% investment 7 005 Carrying amount of investment 5 000 Gain on acquisition of additional investment in B Ltd 2 005 On consolidation the following entry would record the gain made on the acquisition of the additional investment in B Ltd: Dr Investment in B Ltd 2 005 Cr Gain on acquisition of investment 2 005 The above entry is consistent with the requirements of paragraph 42 of AASB 3, which requires an adjustment to any initial non-controlling investment so that it is revalued to fair value with the gain being treated as part of consolidated profit or loss The working to eliminate investment in subsidiary and recognise goodwill on acquisition date can now be made

16. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-16 Determining goodwill following a subsequent transaction that provides control 20% Non- A Ltd’s controlling B Ltd 80% interest interest Fair value of consideration transferred ($30 355 + $7005) 37 360 37 360 plus Non-controlling interest at fair value* ($37 360 × 20 ÷ 80) 9 340 46 700 Share capital 20 000 16 000 4 000 Retained earnings 15 000 12 000 3 000 Goodwill on acquisition date 11 700 9 360 2 340 Non-controlling interest on acquisition date 9 340 *We have assumed that the election has been made to value the non-controlling interest at fair value

17. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-17 Consolidation journal entries at date of acquiring a controlling interest Eliminating investment in B Ltd and recognising goodwill on acquisition Dr Share capital 16 000 Dr Retained earnings 12 000 Dr Goodwill on acquisition 9 360 Cr Investment in B Ltd 37 360 Recognising non-controlling interests and goodwill in B Dr Share capital 4 000 Dr Retained earnings 3 000 Dr Goodwill on acquisition 2 340 Cr Non-controlling interest 9 340

18. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-18 Sale of shares in a subsidiary When a parent entity sells shares in a subsidiary –profit or loss in the financial statements of the separate legal entity will be different from the profit or loss required to be shown in consolidated financial statements In the separate financial statements of the parent entity, investments in subsidiaries etc. are to be measured either: –at cost, or –in accordance with AASB 139, i.e. at fair value

19. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-19 Sale of shares in a subsidiary (cont.) From the parent’s perspective, profit or loss on sale of shares is the difference between: –carrying value of shares, and –fair value of sales proceeds Carrying value –is the amount shown in the financial statements for a particular asset or liability From group’s perspective: –consideration to be given to economic entity’s share of post-acquisition profits and reserve movements before determining profit or loss on sale of shares

20. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-20 Sale of shares in a subsidiary (cont.) When a parent entity sells shares in a subsidiary the sale may, or may not, lead to a loss of control If control is not lost then the subsidiary still forms part of the economic entity and continues to form part of the group financial statements Where changes in ownership interest in a subsidiary do not result in a loss of control, AASB 127 requires the transaction to be accounted for as a transfer within equity Where a parent entity sells some of its ownership interest but still holds control of the subsidiary, then the assets in the subsidiary that it controls do not change Where a parent entity loses control of the subsidiary, the parent entity must no longer recognise the individual assets, liabilities and equity (including any non-controlling interest) relating to that subsidiary

21. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-21 Where a sale of shares results in loss of control of a subsidiary Pursuant to paragraph 34 of AASB 127, if a parent loses control of a subsidiary then it: (a) derecognises the assets (including any goodwill) and liabilities of the subsidiary at their carrying amounts at the date when control is lost (b) derecognises the carrying amount of any non-controlling interests in the former subsidiary at the date when control is lost (including any components of other comprehensive income attributable to them) (c) recognises: (i) the fair value of the consideration received, if any, from the transaction, event or circumstances that resulted in the loss of control, and (ii) if the transaction that resulted in the loss of control involves a distribution of shares of the subsidiary to owners in their capacity as owners, that distribution

22. . Where a sale of shares results in loss of control of a subsidiary (cont.) Pursuant to paragraph 34 of AASB 127, if a parent loses control of a subsidiary then it (cont.): (d) recognises any investment retained in the former subsidiary at its fair value at the date when control is lost (e) reclassifies to profit or loss, or transfers directly to retained earnings if required in accordance with other Australian Accounting Standards, the amounts identified in paragraph 35, and (f) recognises any resulting difference as a gain or loss in profit or loss attributable to the parent Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-22

23. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-23 Calculating the profit or loss on disposal of a subsidiary (loss of control) Fair value of the proceeds (if any) from the transaction that resulted in the loss of control XXX add Fair value of any retained non-controlling equity investment in the former subsidiary, at the date control is lost XXX add Carrying value of the non-controlling interest in the former subsidiary at the date control is lost XXX less Carrying value of the former subsidiary’s net assets at the date control is lost (XXX) add/less any amount included in other components of equity that 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 (XXX) Profit or loss on disposal of subsidiary XXX

24. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-24 Worked Example 32.5—Sale of shares in a subsidiary Assume that Kanga Ltd acquires 70% of the shares in Cairns Ltd on 1 July 2010 for a cost of $1 million, being the fair value of consideration transferred. At that date the equity of Cairns Ltd is: $ Share capital 600 000 Revaluation surplus 200 000 Retained earnings 300 000 1 100 000 All assets are valued at fair value. The management of Kanga Ltd measures any non-controlling interest at the proportionate share of Cairns Ltd’s identifiable net assets (meaning that any non- controlling interest in goodwill is not recognised)

25. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-25 Worked Example 32.5—Sale of shares in a subsidiary (cont.) On 30 June 2012, Kanga Ltd sells all its shares in Cairns Ltd for $1.1 million. At the date of sale, the equity of Cairns Ltd comprised: $ Share capital 600 000 Revaluation surplus 400 000 Retained earnings 700 000 1 700 000 Included within the above retained earnings of $700 000 is a profit of $100 000 for the year to 30 June 2012 Up until 30 June 2012 total impairment losses in relation to goodwill have amounted to $46 000, evenly spread across the two years of ownership

26. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-26 Worked Example 32.5—Solution From Kanga Ltd’s individual perspective, a profit of $100 000 has been made (the shares were acquired for $1 million and sold for $1.1 million) It is necessary to know the amount of profit on sale included in Kanga Ltd’s financial statements, as this will need to be reversed as part of the consolidation process The journal entry in Kanga Ltd’s own journal (and not the consolidation worksheet) would be: Dr Cash 1 100 000 Cr Investment in Cairns Ltd 1 000 000 Cr Gain on sale of investment 100 000

27. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-27 Worked Example 32.5—Solution (cont.) 30% Non controlling Cairns Ltd interest Calculation of non-controlling interest in Cairns Ltd ($) ($) (i) Non-controlling interests at acquisition date Share capital 600 000 180 000 Revaluation surplus 200 000 60 000 Retained earnings 300 000 90 000 1 100 000 330 000 (ii) Non-controlling interest in movements in contributed equity and reserves between the date of the parent entity’s acquisition and the beginning of the current reporting period Retained earnings—since acquisition ($600 000 – $300 000) 300 000 90 000 Revaluation surplus—since acquisition ($400 000 – $200 000) 200 000 60 000 150 000 (iii) Non-controlling interest in the current period’s profit and movements in reserves in the current period Profit for the year 100 000 30 000 Non-controlling interest in Cairns Ltd at time of sale510 000

28. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-28 Worked Example 32.5—Solution (cont.) From an economic entity perspective, the calculation of the gain or loss on the disposal of Cairns Ltd is calculated as follows: $ Fair value of the proceeds from the transaction that resulted in the loss of control 1 100 000 add Fair value of any retained non-controlling investment in the former subsidiary, at the date control is lost – 1 100 000 less Carrying value of the former subsidiary’s net assets at the date control is lost (1 700 000) Carrying value of the non-controlling interest in the former subsidiary at the date control is lost 510 000 (1 190 000) (90 000) Balance of goodwill to be written off [$1.0m – ($1.1m × 0.7) – $46 000] (184 000) Loss on disposal of Cairns Ltd from group’s perspective274 000

29. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-29 Worked Example 32.5—Solution (cont.) The consolidation adjusting journal entries would be: Dr Gain on sale of investment 100 000 Dr Loss on sale of investment in Cairns Ltd 274 000 Cr Profit after tax *47 000 Cr Retained earnings **187 000 Cr Revaluation surplus 140 000 * $47 000 = share of profits derived in the 2012 reporting period less on year’s goodwill impairment loss = ($100 000 × 0.7) – $23 000 ** $187 000 = share of post acquisition movements in retained earnings to 31 March 2011 less one year’s goodwill impairment loss = ($300 000 × 0.7) – $23 000

30. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-30 Worked Example 32.5—Solution (cont.) Dr Non-controlling interest in earnings 30 000 Cr Profit after tax 30 000 (Recognising the non-controlling interest’s share of profit after tax) Because the consolidated financial statements are to show the profits of the subsidiary while it is controlled, there is a necessity to recognise the non-controlling interest in earnings This amount will be shown as a deduction in the statement of comprehensive income

31. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-31 Revenues and expenses of sold subsidiary As indicated in the previous example, where a parent sells its interest in a subsidiary it is a requirement that any profit or loss generated by the subsidiary is to be recorded in the consolidated financial statements for the period of the year during which the parent entity had control of the subsidiary. As paragraph 26 of AASB 127 states: The income and expenses of a subsidiary are included in the consolidated financial statements from the acquisition date as defined in AASB 3…. The income and expenses of a subsidiary are included in the consolidated financial statements until the date when the parent ceases to control the subsidiary

32. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-32 Consolidation adjustments As we know, in the consolidated financial statements the consolidated retained earnings will include the parent entity’s retained earnings plus its share of the subsidiaries’ post- acquisition movements in retained earnings In the period following the sale of a subsidiary the opening balance of retained earnings will be required to be equal to the closing balance as shown in the preceding period To do this, and in the case of a prior period sale of a subsidiary, it will be necessary to make a consolidation adjusting journal entry that includes the parent’s share of the post-acquisition movements in retained earnings of the former subsidiary Similarly, consolidation adjusting journal entries will be needed so that the consolidated financial statements include the parent’s share of the post-acquisition movements in other reserves of the sold subsidiary

33. . Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e 32-33 Recognition of non-controlling interests The consolidated financial statements are to include all of the revenues and expenses of the subsidiary (subject to adjustments for intragroup transactions) for the period that the parent controlled the subsidiary Because we are including all of the revenues and expenses of the sold subsidiary for the period during which the parent entity had control, we will also be required to separately disclose the non-controlling interests in the consolidated profit after tax The assets, liabilities and equity accounts of a sold subsidiary will not be shown in the consolidated financial statements