We have concluded on our requirements for consolidation, which can be summarised as follow:
- Recognizing COI, Cash or Equity transferred at legal entity level
- Determination of power and control
- Fair value adjustments and its deferred tax implications
- Calculation of Goodwill and NCI
All of the above are balance sheet focused since any profits before acquisition date does not belong to acquirer. However, any profits subsequent to acquisition date requires allocation to parent and NCI, which will involve P&L. Following is a summary of topics that will be covered for this topic:
- Consolidated Statement of Comprehensive Income
- Pre and Post acquisition reserves
- Intragroup account balances
- Unrealised Intragroup Profits and Losses
- Intragroup sale of non-depreciable assets
- Intragroup sale of stock
- Intragroup sale of depreciable assets
- Intragroup charges
- Tax effect on intragroup profits and losses
- Intragroup dividend
- Other consolidation adjustments
From here on, I will also drop the the acquirer and acquiree naming conventions, since the transaction has already gone through and the ownership has been transferred. I will address them as parent (P) or subsidiary (S). Other short forms you may encounter are Cost of Investment (COI) and Fair Value of Net Identifiable Assets (FVNIA).
Consolidated Statement of Comprehensive Income
This is an introduction on how the P&L side looks like after consolidation. We will assume no interco transactions during the year to demonstrate the most basic form. Acquisition at 60% on first day of financial year.
| P | S | DR | CR | Consol Bal. | |
| Sales | 100 | 80 | 180 | ||
| Cost of Sales | 30 | 20 | 50 | ||
| Gross Profit | 70 | 60 | 130 | ||
| Operating exp. | 20 | 30 | 50 | ||
| PBT | 50 | 30 | 80 | ||
| Tax | 15 | 10 | 25 | ||
| PAT | 35 | 20 | 55 | ||
| Other Comp. Inc | |||||
| FV Gain | 10 | 10 | 20 | ||
| Reval. Surplus | 50 | 20 | 70 | ||
| Total Comp. Inc | 60 | 30 | 90 | ||
| PAT attributable to: | |||||
| Shareholders of P (60%* 55) | 47 | ||||
| NCI (40% * 55) | 8 | ||||
| 55 | |||||
| Total Income attributable to: | |||||
| Shareholders of P (60% * (90+55) ) | 125 | ||||
| NCI (40% * (90+55) ) | 20 | ||||
| 145 |
As you can see from above, despite a 60% acquisition, consolidation of Statement of Comprehensive Income is simply an addition line by line on 100% basis. The allocation of PAT and Total Comprehensive income is only done at the last section. An important note here is that after the allocation of PAT, allocation of “Total Comprehensive Income” is next, which is actually PAT + “Other Comprehensive Income”.
Sounds easy? Your next question would then be how would that translate to Balance Sheet?
Pre and Post acquisition reserves
To answer the question immediately above, we need to understand the concept of pre and past acquisition reserves. Sometimes, its easy to mis-conceptualise pre-acquisition reserves as not belonging to Parent. That’s not true at all. In truth, the purpose of splitting pre and post acquisition reserves is to capture how much the subsidiary’s reserves was acquired upon the payment of COI (Pre-acquisition) and how much of subsdiary’s profit belonged to parent after the COI was paid (Post-acquisition). If you think of COI = Subsidiary’s Reserves + Goodwill, you will see that an acquisition is just a parent buying out the current shareholders for the reserves that belonged to them in exchange for a % of all future profits earned.
With that understanding in mind, here’s how the balance sheet looks like for a 90% acquisition which at date of acquisition, the subsidiary had a share capital of 100 and retained profit of 20.
| P | S | DR | CR | Consolidated Bal. | |
| Land | 400 | 150 | 550 | ||
| COI | 108 | – | 108 | – | |
| A/R | 200 | – | 200 | ||
| Bank | 92 | 30 | 122 | ||
| 800 | 180 | 872 | |||
| Share Capital | 500 | 100 | 90 | 500 | |
| 10 | |||||
| Retained Earnings | 200 | 30 | 18 | 209 | |
| 3 | |||||
| A/P | 100 | 50 | 150 | ||
| NCI | – | – | 13 | 13 | |
| 800 | 180 | 872 |
Breakdown of consolidation working as follows:
| Pre-acquisition | Amt | P%/NCI% | P/NCI |
| Share capital | 100 | 90% | 90 |
| 10% | 10 | ||
| Retained Earnings | 20 | 90% | 18 |
| 10% | 2 | ||
| Post-acquisition | |||
| Retained Earnings (30-20) | 10 | 90% | 9 |
| 10% | 1 | ||
| NCI’s share of Pre & Post R/E (2+1) | 3 |
If you notice the above, unlike previous blog posts for acquisition date entries, the subsidiary’s R/E does not cancel off to zero anymore. there’s a balance of 9 which is added to P’s R/E. This cements our understanding that any profits post acquisition belongs to P. Take note however, while the cancellation P’s share of R/E is a pre-acquisition figure (“18”), NCI’s share of R/E is a pre +post acquisition figure (“3”).
Take note also NCI’s figure of “13” = Share Capital at acquisition date (“10”) + R/E at acquisition date (“2”) + R/E post acquisition date (“1”). So in practice, to calculate NCI’s R/E, you can simply take all YTD R/E of 30 *10% = 3.
So since NCI is the addition of initial external shareholder interest + % of external subsequent profits, is it possible the NCI becomes a debit balance if the subsidiary is making huge losses? The answer is yes as per FRS 110.
All materials produced on this website, including this article, is based on author’s best interpretation of accepted accounting standards and his own experience. Any information bias, inaccuracies, misstatements, obsolesce are unintentional and should strictly not be held liable against the author. The author is not responsible for any losses, monetary or non-monetary, as a result of using these materials.
Derrick How 