Prepared by Emma Holmes

Introduction
Consolidation journal adjustments are ONLY prepared for the propose of consolidation. They are posted onto the consolidation worksheet only- they are NOT recorded in the books of the parent or the subsidiary. As a result, some consolidation adjustments are repeated every time consolidated accounts are prepared.

Introduction
Consolidation journals are posted into the consolidation worksheet in adjustment columns as follows:
P Ltd. $000
Land Invt in S Ltd Receivables Cash 400 120 200 40 760 500 160 100 760

S Ltd. $000
150 20 170 100 20 50 170

Adjustments DR
XX XX

Cons. Balances
XX XX XX XX XXX XX XX XX XXX

CR
XX

Share capital Retained earnings Creditors

XX XX XX

Introduction
Before consolidating, it may be necessary to adjust subsidiarys financial statements where:
1. The subsidiarys balance date is different to the parents. In such cases the subsidiary is required to prepare adjusted financial statements as at the parents reporting date. 2. The subsidiarys accounting policies are different to the parents. In such cases the subsidiary is required to prepare adjusted accounts to ensure accounting policies consistent with the parent.

EXAMPLE
Hitech Ltd acquired all of the issued share capital of Lotech Ltd on 30 June 2005 for a total cash consideration of $386,400. At that time the net assets of Lotech Ltd were represented as follows: Share capital Retained earnings Net assets $ 300,000 50,000 350,000

EXAMPLE continued
When Hitech acquired its investment in Lotech the following information applied:

Land held by Lotech was undervalued by $10,000 A building held by Lotech was undervalued by $45,000. The building had originally cost $100,000 2 years ago and was being depreciated at 10% per year. A contingent liability of $3,000 was recorded in the notes to Lotechs financial statements.

The tax rate is 30%

Entries in the books of the parent

Before commencing consolidation, recognise that investments in subsidiaries are recorded at cost in the books of the parent as follows: DR. Investment in subsidiary CR. Cash xxx xxx

This journal entry is NOT part of the consolidation process For our example, the journal entry processed by Hitech Ltd would be

Acquisition Analysis
The purpose of an acquisition analysis is to compare the cost of the acquisition with the fair value of the identifiable net assets and contingent liabilities (FVINA) that exist at the date of acquisition to determine whether there is any: Goodwill on acquisition (where cost > FVINA) Excess over net assets (where cost < FVINA) Recall that goodwill is an unidentifiable intangible asset that is calculated as a residual value. Also recall that net assets = assets liabilities = shareholders equity

Acquisition Analysis
In our example the acquisition analysis would be prepared as follows:
$ Cost of acquisition Book value of net assets - Share capital - Retained earnings Total book value of net assets Fair value (BCVR) adjustments - After tax increase in land - After tax increase in building - After tax recognition of contingent liability Total fair value adjustments FVINA X %age acquired Goodwill/(excess) on acquisition

Acquisition Analysis
Note also the impact of the following on the acquisition analysis (covered in textbook but not lecture notes):
Where subsidiary has recorded goodwill at acquisition date (p. 677) Where subsidiary has recorded dividends at acquisition date (p.678)

Consolidation entries at acquisition date Business combination valuation adjustments

IAS 27 requires the parent to recognise identifiable assets, liabilities and contingent liabilities of subsidiary in the consolidated accounts AT FAIR VALUE. If the book value of subsidiary assets and liabilities = fair value, or if contingent liability exists, necessary to make business combination valuation adjustments. These adjustments increase or decrease subsidiarys assets and liabilities book values to fair value or recognise subsidiarys contingent liabilities as liabilities (i.e. put them onto the balance sheet) at fair values While it is possible for these adjustments to be made directly in the books of the subsidiary, it is likely and common for these adjustments to be made on consolidation

Consolidation entries at acquisition date Business combination valuation adjustments

Either way, the valuation adjustment entry to revalue/recognise previously unrecorded identifiable assets to their fair value will take the form:

Business Combination Valuation Reserve (BCVR) is similar to Asset Revaluation Reserve Note that when depreciable assets are revalued to their fair value any accumulated depreciation recorded in the subsidiarys balance sheet must be offset against the cost of the asset being revalued.

Consolidation entries at acquisition date Business combination valuation adjustments

The valuation adjustment entry to revalue/recognise previously unrecorded liabilities and contingent liabilities to their fair value will take the form:
DR Business Combination Valuation Reserve DR Deferred Tax Asset CR Liability/Contingent liability

EXAMPLE BCVR adjustments at acquisition date

Land
Land is undervalued by $10,000 Revaluing the asset changes the carrying amount of the asset. As the tax base stays the same such adjustments result in a Deferred Tax Liability (DTL). Accordingly, the business combination valuation adjustment required on consolidation at 30 June 2005 (the date of acquisition) is:
DR Land 10,000 CR Deferred Tax Liability CR Business Combination Valuation Reserve 3,000 7,000

EXAMPLE BCVR adjustments at acquisition date

Buildings
Buildings must be increased by $45,000. This will also result in a DTL The Buildings in the balance sheet need to change as follows
AT PRESENT REQUIRED

Buildings at cost Accumulated Depreciation Book value

100,000 (20,000) 80,000

EXAMPLE BCVR adjustments at acquisition date

Buildings Accordingly, the business combination evaluation adjustments required (on consolidation) at 30 June 2005 (the date of acquisition) are:

EXAMPLE BCVR adjustments at acquisition date

Contingent Liability Recognising a contingent liability for the first time will result in a liability that has a carrying amount but no tax base. Such adjustments result in a Deferred Tax Asset (DTA). The business combination valuation adjustment required on consolidation at 30 June 2005 (the date of acquisition) in relation to the contingent liability is:

EXAMPLE BCVR adjustments at acquisition date

The consolidation journals will be posted onto the consolidation worksheet at 30 June 2005 (the date of acquisition) as follows:
Hitech Ltd. $000 Land Building Accumulated Depreciation Deferred Tax Asset Investment in Lotech Ltd Cash in bank Creditors Deferred Tax Liability Contingent liability Share capital Retained earnings BCVR 386.4 473.6 860 160 Lotech Ltd. $000 200 100 (20) 200 480 130 3 + 13.5 3 600 100 860 300 50 2.1 480 7 + 31.5 Adjustments DR 10 25 20 0.9 CR 210 125 0.9 386.4 673.6 1,395.9 290 16.5 3 900 150 36.4 1,395.9 Group

Pre-acquisition elimination at acquisition date

The rest of the consolidation process involves the elimination and adjustment of the aggregated figures, as required. The first of these is the pre-acquisition elimination entry which eliminates the asset Investment in subsidiary (in the parents books) against the shareholders equity (in the subsidiarys books) purchased by the parent . It takes the form DR All components of subsidiary equity
(eg Share Capital, Retained Earnings, ARR, etc)

DR / CR Goodwill or Excess CR Investment in Subsidiary

Pre-acquisition elimination - EXAMPLE

By definition, you cannot have an investment in yourself, nor can you have equity in yourself. From a consolidated viewpoint, these items should not exist
Hitech Ltd. $000 Land Building Accumulated Depreciation Deferred tax asset Investment in Lotech Ltd Cash in bank Creditors Deferred Tax Liability Contingent liability Share capital Retained earnings BCVR 386.4 473.6 860 160 Lotech Ltd. $000 200 100 (20) 200 480 130 3 + 13.5 3 600 100 860 300 50 2.1 480 7 + 31.5 Adjustments DR 10 25 20 0.9 CR 210 125 0 0.9 386.4 673.6 1,395.9 290 16.5 3 900 150 36.4 1,395.9 Group

Pre-acquisition elimination no goodwill or excess

The pre-acquisition elimination entry required DR Share capital 300,000 DR Retained earnings 50,000 DR BCVR 36,400 CR Investment in Lotech
Hitech $000 Land Building Accumulated Depreciation Daferred tax asset Investment in Lotech Ltd Cash in bank Creditors Deferred Tax Liability Contingent liability Share capital Retained earnings BCVR 386.4 473.6 860 160 Lotech $000 200 100 (20) 200 480 130 Adjustments DR CR 10 25 20 0.9 386.4

386,400
Group 210 125 0 0.9 0 673.6 1,009.5 290 16.5 3 600 100 0 1,009.5

Note values

3 + 13.5 3 600 100 860 300 50 480 300 50 2.1 + 36.4

7 + 31.5

Acquisition analysis - goodwill on acquisition

Assume all facts as per the previous example apply, except that Hitech paid $400,000 for Lotech. In this case the pre-acquisition analysis would be as follows: $
Cost of acquisition Book value of net assets - Share capital - Retained earnings Total book value of net assets Fair value (BCVR) adjustments - After tax increase in land - After tax increase in building - After tax recognition of contingent liability Total fair value adjustments FVINA X %age acquired Goodwill/(excess) on acquisition 7,000 31,500 (2,100) 36,400 386,400 100% 386,400 13,600 300,000 50,000 350,000 400,000

Pre-acquisition elimination - goodwill on acquisition

DR Share capital DR Retained earnings DR BCVR DR Goodwill CR Investment in Lotech
Hitech $000 Land Building Accumulated Depreciation Deferred tax asset Investment in Lotech Ltd Goodwill Cash in bank Creditors Deferred Tax Liability Contingent liability Share capital Retained earnings BCVR 400 460 860 160 Lotech $000 200 100 (20) 13.6 200 480 130 3 + 13.5 3 600 100 860 300 50 480 300 50 2.1 +36.4 DR 10 25 20 0.9 400

300,000 50,000 36,400 13,600 400,000

Adjustments CR 210 125 0 0.9 0 13.6 660 1,009.5 290 16.5 3 600 100 0 1,009.5 Group

Note values

7 + 31.5

Acquisition analysis - excess on acquisition

IAS 27 states this would be rare and recommends re-assessment and confirmation of net asset fair values (ie check that they are correct) before an excess is recognised Assume all facts as per the previous example apply, except that Hitech paid $360,000 for Lotech. In this case the pre-acquisition analysis would be as follows:
$ Cost of acquisition Book value of net assets - Share capital - Retained earnings Total book value of net assets Fair value (BCVR) adjustments - After tax increase in land - After tax increase in building - After tax recognition of contingent liability Total fair value adjustments FVINA X %age acquired Goodwill/(excess) on acquisition 7,000 31,500 (2,100) 36,400 386,400 100% 386,400 300,000 50,000 350,000

Pre-acquisition elimination - excess on acquisition

DR Share capital DR Retained earnings DR BCVR CR Investment in Lotech CR Gain on excess (P&L)
Hitech $000 Land Building Accumulated Depreciation Deferred tax asset Investment in Lotech Ltd Cash in bank Creditors Deferred Tax Liability Contingent liability Share capital Retained earnings BCVR 360 500 860 160 Lotech $000 200 100 (20) 200 480 130 DR 10 25 20 0.9 360

300,000 50,000 36,400 360,000 26,400

Adjustments CR 210 125 0 0.9 0 700 1,035.9 290 16.5 3 600 126.4 0 1,035.9 Group

Note values

3 + 13.5 3 600 100 860 300 50 480 300 50 2.1 + 36.4 26.4 7 + 31.5

Consolidation after acquisition date

So far, we have considered the consolidation journals required if a consolidation was being prepared on acquisition date How do these journals change if a consolidation is being prepared on a later date? The business combination valuation adjustment entry may differ due to transactions and events occurring since acquisition The pre-acquisition elimination entry may also be affected by a number of events

Consolidations after acquisition date BCVR - land

Recall, Hitech consolidation required following journal adjustment for land revaluation
DR Land 10,000 CR Deferred Tax Liability 3,000 CR Business Combination Valuation Reserve 7,000

What if, during the year ended 30 June 2006 the land was sold for $250,000?

Consolidations after acquisition date BCVR - land

As the Land no longer exists in Lotechs balance sheet, it cannot continue to be revalued. Instead, the business combination valuation adjustment must recognise the impact on gain on sale. On sale, Lotech Ltd recognised the following journal

From a group viewpoint, the Gain on sale was $40,000 (not $50,000) as the carrying value of the land on consolidation was $210,000.

Consolidations after acquisition date BCVR - land

On acquisition (30 June 2005) DR Land 10,000 CR Deferred Tax Liability 3,000 CR Business Combination Valuation Reserve 7,000 In the year the Land is sold (30 June 2006)

In future years

Consolidations after acquisition date BCVR - buildings

Recall, Hitech consolidation required following journal adjustment for building revaluation
DR Accumulated Depreciation CR Buildings 20,000 20,000

DR Buildings 45,000 CR Deferred Tax Liability CR Business Combination Valuation Reserve

13,500 31,500

How does this affect depreciation?

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Consolidations after acquisition date BCVR - buildings

At acquisition, Lotech had a building depreciating at $10,000 per year, for the next 8 years. This would take its written down value from $80,000 (as at 30 June 2005) to $0 in 8 years time From a group viewpoint, however, this building was worth $125,000 as at 30 June 2005. For the building to be depreciated to $0 in 8 years time, the group will need to record depreciation of $15,625 (i.e.$125,000 / 8) per year. This is $5,625 more depreciation than Lotech is recording. Hence, if preparing consolidated accounts on 30 June 2006 (1 year after acquisition) an adjustment must be made on consolidation as follows:

Consolidations after acquisition date BCVR - buildings

Over the next 8 years we are also required to progressively reverse the DTL created with the original business combination valuation adjustment

The following journal must also be processed on consolidation

Two years after acquisition (30 June 2007) the entries required would be as follows

Consolidations after acquisition date BCVR - contingent liability

Recall, Hitech consolidation required following journal adjustment for contingent liability recognition

What if, during the year the liability was settled for $2,000? On settlement, Lotech Ltd will recognise the following journal

As the contingent liability no longer exists in Lotechs balance sheet, it should not continue to be carried forward on consolidation. The business combination valuation adjustment must recognise the settlement and any gain/(loss) on settlement.

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Consolidations after acquisition date BCVR - contingent liability

On acquisition (30 June 2005) DR Business Combination Valuation Reserve DR Deferred Tax Asset 900 CR Contingent liability In the year the liability is settled (30 June 2006) 2,100 3,000

In future years

Changes to pre-acquisition elimination

The pre-acquisition elimination entry is required every time a consolidation is completed and does NOT change, except under the following circumstances

Goodwill impairment Dividends paid and payable from pre-acquisition equity Transfers to / from pre-acquisition retained earnings or other reserves (see p.692 text)

Changes to pre-acquisition elimination goodwill impairment

In a previous example the amount paid by Hitech was $400,000, resulting in goodwill of $13,600. Assume, in a subsequent period, goodwill is assessed to have a recoverable value of $13,000. In this situation the goodwill is considered to be impaired. It is therefore necessary to reduce the value of goodwill. This would be done by preparing the following journal on consolidation:

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Changes to pre-acquisition elimination goodwill impairment

In future years, consolidation entries would be combined - with impairment expense reducing retained earnings as follows:
DR Share capital DR BCVR DR Goodwill CR Investment in Lotech 300,000 36,400 13,600 400,000

Changes to pre-acquisition elimination dividends from pre-acquisition equity

Any dividend paid by a subsidiary to a parent is a transaction within the group. From the groups viewpoint, the dividend payment DOES NOT EXIST As a result, they must be eliminated on consolidation. However, elimination entry depends upon the type of dividend (whether they are paid out of pre-acquisition or post-acquisition profits) Post acquisition dividends will be considered next. Pre-acquisition profits affect pre-acquisition elimination entries

Changes to pre-acquisition elimination dividends from pre-acquisition equity

Pre-acquisition profits- profits earned by the subsidiary prior to the subsidiary being under the control of the parent (i.e balance of retained earnings at acquisition date) Dividends paid from pre-acquisition profits reduce the investment account and are NOT revenue to the investor Assume Lotech LTD paid a $500 dividend to Hitech out of PRE acquisition profit on 31 December 2005. Journal Entry in Lotech Journal Entry in Hitech DR Dividend paid 500 CR Cash 500 NOTE the credit entry in Hitech does NOT get made to Dividend Revenue, but rather, reduces the balance of the investment (asset) account.

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Changes to pre-acquisition elimination dividends from pre-acquisition equity

In the year the pre-acquisition dividend is paid (30 June 2006)

DR Share capital 300,000 DR Retained earnings 50,000 DR BCVR 36,400 CR Investment in Lotech 386,400 In future years

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