IFRS 3, Business Combinations

In the consolidated statement of financial position the non-controlling interests would be shown as $25m.

In the above example the value of the non-controlling interests of $25m as determined by the directors of Parent is proportionate to that of Parent’s consideration ($100m x 20%/80%). This is not always (in fact rarely) the case.

Or the working can be shown as:

In the consolidated statement of financial position the non-controlling interest would be shown at its proportionate share of the subsidiary’s net assets of $15m ($75m x 20%).

The two methods are an extension of the methodology used in IAS 36, Impairment of Assets when calculating the impairment of goodwill of a cash generating unit (CGU) where there is a non-controlling interest.

EXAMPLE 2
Parent owns 80% of Subsidiary (a CGU). Its identifiable net assets at 31 March 20X0 are $500.

Scenario 1

Scenario 2

An impairment review of Subsidiary was carried out at 31 March 2010.

Required:
For scenarios 1 and 2, calculate the impairment losses and show how they would be allocated if the recoverable amount of Subsidiary at 31 March 20X0 if the impairment review concluded that the recoverable amount of Subsidiary was:

(i) $450
(ii) $550

Answer

Scenario 1
The impairment loss is $250 (700 – 450). This loss will be first applied to goodwill (eliminating it) and then to the other net assets reducing them to $450, ie equal to the recoverable amount of the CGU. The statement of financial position would now be:

Note: IFRS 3 requires that any impairment loss should be written of to the controlling and non-controlling interests on the same basis as that in which profits and losses are allocated.

With a recoverable amount of $550, the impairment loss will be $150 and applied to the goodwill reducing it to $50. The statement of financial position would now be:

Scenario 2
Where method (ii) (proportionate share of net assets) has been used to calculate goodwill and the non-controlling interests, IAS 36 requires a notional adjustment to the goodwill of Subsidiary, before being compared to the recoverable amount. This is because the recoverable amount relates to the value of Subsidiary as a whole (ie including all of its goodwill). The notional adjustment is always based on the non-controlling interest in goodwill being proportional to that of the parent.

If the goodwill of Parent is $160 and this represents 80%, then the goodwill attributable to the NCI is deemed to be $40 ($160 x 20%/80%).

In this case, because the fair value of the non-controlling interests in scenario 1 is proportional to the consideration paid by Parent, the notional adjustment leads to the same impairment losses of $250 for (i) and $150 for (ii) as under scenario 1 (see *). Applying these:

(i) the impairment loss of $250 is again applied to eliminate goodwill and the remaining $50 is applied to reduce the other net assets. The non-controlling interest will be reduced by $10 being its share (20%) of the reduction of other net assets. This gives exactly the same statement of financial position as under scenario 1.

(ii) the impairment loss of $150 would be applied to goodwill leaving the other net assets unaffected. As only Parent’s share of goodwill is recognised, only 80% of the loss is applied, giving:

From this it can be seen that the carrying amount of the CGU is now $540, which is less than the recoverable amount ($550) of the CGU. This is because the recoverable amount takes into account the unrecognised goodwill of the NCI which would be $10 (goodwill of $200 – $150 impairment) x 20%).

The problem with this methodology is that goodwill (or what is subsumed within it) is a very complex item. If asked to describe goodwill, traditional aspects such as product reputation, skilled workforce, site location, market share, and so on, all spring to mind. These are perfectly valid, but in an acquisition, goodwill may contain other factors such as a premium to acquire control, and the value of synergies (cost savings or higher profits) when the subsidiary is integrated within the rest of the group. While non-controlling interests may legitimately lay claim to their share of the more traditional aspects of goodwill, they are unlikely to benefit from the other aspects, as they relate to the ability to control the subsidiary.

*Thus, it may not be appropriate to value non-controlling interests on the same basis (proportional to) as the controlling interests (see method (i) below).

IFRS 3 illustrates the calculation of consolidated goodwill at the date of acquisition as:

Consideration paid by parent + non-controlling interest – fair value of the subsidiary’s net identifiable assets = consolidated goodwill.

The non-controlling interest in the above formula may be valued at its fair value (method (i)) or its proportionate share of the subsidiary’s net identifiable assets (method (ii)).

Subsequent to acquisition the carrying amount of the non-controlling interest (under either method) will change in proportion it is share of the post acquisition profits or losses of the subsidiary. Consolidated goodwill (under either method) will remain the same unless impaired.

The standard recognises that there may be many ways of calculating the fair value of the non-controlling interest (method (i)), one of which may be to use the market price of the subsidiary’s shares prior to the acquisition (where this exists). In the DipIFR exam this is the most common method; an alternative would be to simply give the fair value of the non-controlling interests in the question.

EXAMPLE 3
This comprehensive example is an adaptation of Question 1 a previous Financial Reporting exam, and calculates goodwill based on the fair value of the non-controlling interests (method (i) above) by valuing the non-controlling interests using the subsidiary’s share price at the date of acquisition (see note (iv) of the question).

On 1 October 20X6, Plateau acquired the following non-current investments:

Three million equity shares in Savannah by an exchange of one share in Plateau for every two shares in Savannah, plus $1.25 per acquired Savannah share in cash. The market price of each Plateau share at the date of acquisition was $6, and the market price of each Savannah share at the date of acquisition was $3.25.

Thirty per cent of the equity shares of Axle at a cost of $7.50 per share in cash.

Only the cash consideration of the above investments has been recorded by Plateau. In addition, $500,000 of professional costs relating to the acquisition of Savannah are included in the cost of the investment.

The summarised draft statements of financial position of the three companies at 30 September 20X7 are:

The following information is relevant:

(i) At the date of acquisition, Savannah had five years remaining of an agreement to supply goods to one of its major customers. Savannah believes it is highly likely that the agreement will be renewed when it expires. The directors of Plateau estimate that the value of this customer based contract has a fair value of $1m, an indefinite life, and has not suffered any impairment.

(ii) On 1 October 20X6, Plateau sold an item of plant to Savannah at its agreed fair value of $2.5m. Its carrying amount prior to the sale was $2m. The estimated remaining life of the plant at the date of sale was five years (straight-line depreciation).

(iii) During the year ended 30 September 20X7, Savannah sold goods to Plateau for $2.7m. Savannah had marked up these goods by 50% on cost. Plateau had a third of the goods still in its inventory at 30 September 20X7. There were no intra-group payables/receivables at 30 September 20X7.

(iv) At the date of acquisition the non-controlling interest in Savannah is to be valued at its fair value. For this purpose Savannah’s share price at that date can be taken to be indicative of the fair value of the shareholding of the non-controlling interest. Impairment tests on 30 September 20X7 concluded that neither consolidated goodwill nor the value of the investment in Axle had been impaired.

(v) The financial asset investments are included in Plateau’s statement of financial position (above) at their fair value on 1 October 20X6, but they have a fair value of $9m at 30 September 20X7.

(vi) No dividends were paid during the year by any of the companies.

Required:
Prepare the consolidated statement of financial position for Plateau
as at 30 September 20X7. (20 marks)

Note: From December 2019 the DipIFR exam will have 4 x 25 mark questions and will have more complexity than the above usually involving adjustments to the parents financial statements.

Tutorial note
Note (iv) may instead have said that the fair value of the NCI at the date of acquisition was $3,250,000. Alternatively, it may have said that the goodwill attributable to the NCI was $500,000. All these are different ways of giving the same information.

Answer
Consolidated statement of financial position of Plateau as at 30 September 20X7:

Workings (figures in brackets are in $000).

(i) Property, plant and equipment
The transfer of the plant creates an initial unrealised profit (URP) of $500,000. This is reduced by $100,000 for each year (straight-line depreciation over five years) of depreciation in the post-acquisition period. Thus at 30 September 20X7, the net unrealised profit is $400,000. This should be eliminated from Plateau’s retained profits and from the carrying amount of the plant.

(ii) Goodwill in Savannah

Tutorial note

The consideration given by Plateau for the shares of Savannah works out at $4.25 per share, ie consideration of $12.75m for 3 million shares. This is higher than the market price of Savannah’s shares ($3.25) before the acquisition and could be argued to be the premium paid to gain control of Savannah. This is also why it is (often) appropriate to value the NCI in Savannah shares at $3.25 each, because (by definition) the NCI does not have control.

(iii) Carrying amount of Axle at 30 September 20X7

(iv) The unrealised profit (URP) in inventory Intra-group sales are $2.7m on which Savannah made a profit of $900,000 (2,700 x 50/150). One third of these are still in the inventory of Plateau, thus there is an unrealised profit of $300,000.

(v) The 1.5 million shares issued by Plateau in the share exchange, at a value of $6 each, would be recorded as $1 per share as capital and $5 per share as premium, giving an increase in share capital of $1.5m and a share premium of $7.5m.

(vi) Consolidated retained earnings

(vii) NCI

Note that subsequent to the date of acquisition, the non-controlling interest is valued at its fair value at acquisition plus its proportionate share of Savannah’s (adjusted) post acquisition profits.

Further issues

The original question contained an impairment of goodwill; let’s say that this is $1m. IAS 36 (as amended by IFRS 3) requires a goodwill impairment of a subsidiary (if a cash generating unit) to be allocated between the parent and the non-controlling interests in on the same basis as the subsidiary’s profits and losses are allocated. Thus, of the impairment of $1m, $750,000 would be allocated to the parent (and debited to group retained earnings reducing them to $29.55m ($30,300,000 – $750,000)) and $250,000 would be allocated to the non-controlling interests, writing it down to $3.65m ($3,900,000 – $250,000). It could be argued that this requirement represents an anomaly. It can be calculated (though not done in this example) that of Savannah’s recognised goodwill (before the impairment) of $5m only $500,000 (ie 10%) relates to the non-controlling interests, but the NCI suffers 25% (its proportionate shareholding in Savannah) of the goodwill impairment. In the exam, however, you should follow the requirements of the question.

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Sai Manikanta Pedamallu

CMA (US), Dip IFRS, M.Com, M.B.A.., CSCA (USA)..,
Founder , Faculty and Financial Consultant
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