Webster University - Part 6

INTB 5600 – International Accounting
Webster University Vienna
Spring I 2012
Part 6
20/02/2012
Dr. Martin Schweiger

1

Table of Contents

1. Determining the consolidation range

2. Steps in a business combination

3. Consolidation

4. Foreign currency effects

2

Types of investments to be considered

Entity type Method Standard Main criterion Outlook

IAS 27 and control criteria to be
Fully consolidated entity full consolidation SIC 12 control changed by IFRS 10
standard to be replaced by
IFRS 11 and proportionate
Entities subject to proportionate proportionate consolidation to be
consolidation consolidation/equity method IAS 31 joint control abandoned

significant
Associated companies equity method IAS 28 influence -

neither of the standard to be replaced by
Financial instruments amortised cost/fair value IAS 39 above IFRS 9

As a first step in preparing the consolidated financial statements of a reporting entity it needs to classify its shares in its investee
companies or companies in which it has no shares at all but still controls in one of the above categories.

3

Control concept – IAS 27 (1/3)
Definition Control under IAS 27.4 requires the following two criteria to be met:

(a) the power to govern the financial and operating policies of an entity
(b) in order to obtain benefits from its activities.

Rebuttable control presumption (IAS 27.13):
Control is presumed to exist when a parent owns, directly or indirectly (through subsidiaries) more than
half of the voting power of an entity.

Additional control presumptions (in cases where the investor holds half or less than half of the voting
rights):
• investor‘s power (over more than half of the voting rights) established through an arrangement with
another investor,
• investor‘s power established through provisions in the investee company‘s bylaws enabling the investor
to govern the investee‘s financial and operating policies,
• investor‘s power to appoint or remove the majority of the investee‘s board of directors,
• investor‘s power through a majority of votes in the investee‘s board of directors.

Indirect control Entities indirectly controlled by the parent company (i.e. through controlled investee companies) need to
be included in the consolidation range based on the direct ownership relationship between investee
companies. Indirect voting shares in investee companies established through more than one other
investee company need to be added together.

Example 1:
Parent company A owns 100 % of the voting shares in company B and 20 % in company C. Parent
Company B owns 40 % of the voting shares in company C. Assess whether company A has company A
control over B and/or C.
100% 20%

B 40% C

4

Example 2:
45% 20%

B 40% C

Potential voting Potential voting rights need to be taken into account when determining whether an investee company is
rights controlled by the investor or not. Potential voting rights need to be currently exercisable. Management’s
intention and the parent’s financial possibilities regarding the exercising of such options granting
potential voting rights are deemed irrelevant (IAS 27.14 and 27.15).

Only in cases in which the potential voting rights lack economic substance can they be ignored. If
regulatory approval is required to make the potential voting rights exercisable it depends on whether
such approval is deemed a formality (making them currently exercisable) or not (precluding them from
being considered currently exercisable).

Example 3:
Company A and company Z each own 50 % of the voting shares in company B. A acquired a
A 25% option Z
purchase option from B over 25 % of the voting shares in B for a price of EUR 15 per shares.
The share price of B currently is EUR 10. The option can be exercised at any time.
50% 50%

B

5

Principal – agent Principal – agent relationships need to be reviewed for their substance. In general voting rights held
relationships under a principal – agent relationship are allocated to the principal (e.g. shares held by the agent under a
trust agreement).

Example 4:
Trust company T acquired 100 % of the shares in B on behalf of A. Under the trust agreement Trust
A (Principal) T (Agent)
A sets forth the rules under which T exercises voting rights in B. The trust agreement can be agreement
cancelled at any time by A. Assess whether A has control over B.
100%

B

Treasury stock Several jurisdictions’ corporate law requires the voting and dividend rights of treasury stock to remain
dormant for as long as these shares are held by the entity that has issued such shares or by any of its
subsidiaries. Therefore treasury stock reduce the total number of voting shares available in a company
and enlarge the voting shares of its shareholders.

Example 5:
Company B is listed on a stock exchange and has repurchased 10 % of its shares. Its main A Freefloat
shareholder, company A holds a total of 47 % of B’s shares. The remaining 43 % is free float.
Assess whether A has control over B.
47% 43%

B
(10 % treasury
stock)

De facto control De facto control is established when an entity holds significant minority interest enabling it to control
another entity without legal arrangements giving it majority voting power. In the absence of clear
guidance from the IASB accounting literature suggests de facto control to be taken into account
considering all relevant circumstances (KPMG, Insights into IFRS 2011/2012, p 70).
6

Special Purpose Entities – SIC 12
Definition SPEs are entities created to achieve a narrowly defined objective for the benefit of a sponsor.

SIC 12 sets forth criteria which require SPEs to be consolidated by the sponsor, irrespective of the fact
whether there may be any voting rights or not:

(a) The SPEs activities benefit the business needs of the sponsor.
(b) The sponsor has the decision-making powers to benefit from the SPEs business.
(c) The sponsor receives the majority of benefits from the SPE.
(d) The sponsor retains the majority of risks, benefits and ownership of residual interests.

Example 6:
Companies A and B each sell receivables to (legally independent) SPEs A B
X and Y, providing credit enhancement. X and Y sell these receivables
on to another SPE Z which issues commercial paper. A bank (M) 0% portfolio sale 0%
sponsored SPE Z and provides it with additional credit enhancement
(i.e. a second loss guarantee). The receivables in Z are cross-
X Y
collateralised for the liability Z incurred.

0% portfolio sale 0%

sponsor + credit
Z M
enhancement

7

Control Concept – IFRS 10
Definition IFRS 10 defines three criteria to be met in order for an investor to have control over an investee:

(a) The investor has power over the relevant activities of the investee.
(b) The investor is exposed to variable returns from ist involvement with the investee.
(c) The investor has the ability to use its power to affect the amount of the investor‘s returns.

Power In assessing power the investor needs to examine existing rights (other than protective rights for minority
shareholders) which need to be substantial, exercisable and relating to decisions regarding the relevant
activities of the investee.

Relevant activities are those which significantly affect the investor‘s returns.

Variable returns Variable returns can be both positive and negative (i.e. dividends, fees, tax benefits, residual interest in
the liquidation result etc.).

Link between power The link between power and variable returns requires the analysis of principal – agent relationships:
and variable returns
• scope of the decision-making authority,
• rights held by other parties (e.g. termination rights, limitations for the agent),
• remuneration of the agent (i.e. based on his services)
• exposure to variability through other interests (i.e. other directly held exposure to the investee).

Effective date IFRS 10 will be effective for business years starting on or after 1 January 2013, early adoption is permitted
but requires simulatneous early application of IAS 27 (new), IAS 28 (new), IFRS 10, IFRS 11 and IFRS 12.

8

Joint Ventures (IAS 31) – Joint Arrangements (IFRS 11)
Definition IAS 31 defines a joint venture as an entity, asset or operation that is subject to (a) contractually
established (b) joint control.

Joint control exists when the strategic financial and operating decisions of the entity are being taken
unanimously. Joint control needs to be based on a contractual arrangement.

Accounting IAS 31 permits both proportionate consolidation and equity accounting (see IAS 28) for joint ventures.

Changes through IFRS 11 (Joint Arrangements) like IAS 31 requires (a) a contractual arrangement and (b) joint control over
IFRS 11 the activities.

IFRS 11 distinguishes between joint operations in which the partners have joint rights in the assets and
joint liabilities and joint ventures in which the partners merely hold a residual net interest. Should there
be no separate vehicle then an activity is classified as a joint operation.

In joint operations every party accounts for its shares in the assets and liabilities, income and expense
(similar to proportionate consolidation).

In joint ventures the equity method is applied (see IAS 28).

Disclosure IAS 31 holds specific disclosure requirements allowing the reader of the financial statements to identify
all assets, liabilities, expenses, income and cash flows from joint ventures if proportionate consolidation
is applied.

The disclosure requirements to joint arrangements are set forth in a separate standard (IFRS 12).

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Table of Contents



3. Consolidation


10

Business Combinations – IFRS 3 (1/5)
Definitions A business combination is a transaction through which an acquirer obtains control of one or more
businesses.

A business is defined as:

(a) an integrated set of activities and assets
(b) capable of being conducted and managed to provide a return to the investor.

Businesses generally consist of inputs, processes applied to those inputs and the ability to create outputs.

Example 7:
Company A acquires three outlet centres in Poland together with the facility and centre management contract. The facility and centre
management has operated the outlet centres for several years and has gained unique knowledge and a strong position in the market.
Assess whether the acquisition is a business combination or not.

Example 8:
Company A acquires a land plot adjacent to one of the outlet centres from a different vendor. It intends to enlarge the outlet centre by
10.000 sqm but still needs to apply for the are to be rezoned as well as a building permit. Assess whether the acquisition is a business
combination or not.

Acquisition date The acquisition date is the date on which the acquirer obtains control of the acquiree.

Should the acquisition be subject to regulatory approval then the acquisition date coincides with the date
of the approval unless the approval is deemed a mere formality.

From acquisition date all income, expenses and cash flows become part of the consolidated financials of
the acquirer.

11

Acquirer The acquirer is the entity obtaining control over the business of the investee company.

For more complex cases IFRS 3.B14s offers indicators as to who the acquirer is:

(a) based on the relative size of the combining entities,
(b) based on which entity pays in cash for the transaction (whereas the other might just issue shares) and
(c) based on the power to determine the new management of the combined entity.

The above criteria need to be applied in determining who the acquirer is in a reverse acquisition. In such
a transaction the legal acquirer (issuing shares) is treated as the accounting acquiree and the legal
acquiree as the accounting acquirer.

Example 9:
Company A is listed on the stock exchange and acquires company B through issuing shares to the owner of company B (company Z)
which in turn contributes its shares in B to A. Company Z obtains a controlling stake in A after this transaction. The basic data of both A
and B are as follows:
Company Equity Valuation
A 50.0 100.0
B 120.0 200.0
Determine the acquirer.

12

Acquisition cost The acquisition cost are the fair value of the consideration transferred (IFRS 3.37). Should the payment of
the consideration be deferred then the acquisition cost are discounted to their net present value.

Transaction costs are expensed (IFRS 3.53), cost of issuing shares (being part of the considertaion) are
subtracted from equity.

Contingent considerations (i.e. earn-out clauses in the contract) need to be taken into account as well
when determining the acquisition cost of a business combination (at their fair value). The liability thus
incurred is subsequently also measured at fair value.

Identifiable assets IFRS 3 requires identifiable assets acquired and liabilities assumed as part of a business combination to
acquired and be recognised separately from goodwill if:
liabilities assumed
(a) they meet the definition criteria for assets and liabilities of the framework and if
(b) they are exchanges as part of the business combination.

Assets acquired and liabilities assumed in a business combination need to be measured at fair value
unless they are deferred taxes (IAS 12), non-current assets held for sale (IFRS 5), retirement obligations
(IAS 19).

Intangible assets Aside from the need to determine the fair value of intangible assets already recognised at the level of the
acquiree IFRS 3 requires analysis if there are further intangible assets (previously not qualifying for
recognition) which need to be recognised separately from goodwill.

Unlike IAS 38 IFRS 3 does not require the probability of future economic benefits associated with the
intangible asset as a recognition criterion, yet they still need to be identifiable (i.e. based on a contract or
on law or separable). Such probabilities only affect the measurement (i.e. fair value) of the intangible
asset identified in a business combination.

13

Contingent liabilities Unlike under IAS 37 contingent liabilities of the acquiree need to be accounted for at fair value in a
business combination. The probability criterion is irrelevant for the recognition of such liability but affects
its fair value.

Indemnification Indemnification assets need to be accounted for in a business combination. They result from i.e. vendor
guarantees in the acquiree’s purchase contracts.

Measurement IFRS 3.45 grants the acquirer a measurement period of 12 months from acquisition date during which the
period allocation of the cost of a business combination can be adapted insofar as this is not the result of a post-
combination event.

In such cases the amount of goodwill determined is adjusted accordingly (without influencing net
income).

After this 12 months period adjustments can only be made as corrections of errors under IAS 8.

Example 10:
Company A acquires company B for a purchase price of EUR 10 mln. B‘s balance sheet before acquisition looked as follows:

Assets 8,000,000.0 Equity 6,500,000.0
Liabilities 1,500,000.0
Total 8,000,000.0 8,000,000.0

The fair value of B‘s assets amounts to EUR 10 mln, the fair value of its debt to EUR 2 mln. Furthermore a previously unrecognised
intangible asset valued at EUR 1 mln was identified. The tax rate is 20 %. Prepare the journal entries for the revaluation of B‘s assets and
liabilities and determine goodwill.

14

Goodwill Goodwill is the difference between the purchase price and the adjusted net assets acquired in the
business combination.

In case the acquirer does not acquirer 100 % in the acquiree goodwill can optionally be calculated based
on the difference between the total value of the company and its remeasured equity (full goodwill
method) or as the difference between the purchase price paid by the acquirer for his share and the
acquiree‘s proportionate remeasured equity.

Example 11:
Company A acquires 80 % of company B for a purchase price of EUR 8,5 mln. B was valued at EUR 10 mln but A was willing to pay a
control premium of EUR 0,5 mln for its 80 %. B‘s balance sheet before acquisition looked as follows:

Assets 8,000,000.0 Equity 6,500,000.0
Total 8,000,000.0 8,000,000.0

liabilities and determine goodwill on a proportionate basis as well as under the fair value method.

Negative goodwill Should goodwill result in a negative amount a reassessment is required by IFRS 3.36 since it is generally
assumed that such ‘lucky buy’ is rather rare and probably attributable to an assessment error. If the
reassessment leads to the same result (i.e. a negative goodwill or ‘excess’) then the excess is accounted
for as profit in net income.

Example 12:
Company A acquires 100 % of the shares in company B for EUR 2 mln. B’s remeasured equity amounts to EUR 2.1 mln. Even after
reassessing all assets and liabilities of B no error is detected. Calculate the excess and account for it.

15

Table of Contents



3. Consolidation


16

Consolidation - Technique (1/3)
Consolidation Consolidation is the technical process of joining the accounts of the investee companies with those of the
investor eliminating ‘redundancies’ through:

(a) capital consolidation,
(b) debt consolidation,
(c) consolidation of income and expense and
(d) eliminating profits/losses from transactions within the group.

Illustrative Example 1:
B
Assets 8,000,000.0 Equity 6,500,000.0
Total 8,000,000.0 8,000,000.0

A‘s balance sheet looks as follows:
A
Investment 8,500,000.0 Equity 6,500,000.0
Total 8,500,000.0 8,500,000.0

liabilities and determine goodwill on a proportionate basis as well as under the fair value method.

17

Consolidation – Technique (2/3)
Solution to Illustrative Example 1:
A
Total 8,500,000.0 8,500,000.0
B The revaluation follows example 10 and 11.
Assets 10,000,000.0 Equity 8,500,000.0
Intangible 1,000,000.0 Liabilities 2,000,000.0
DTA 100,000.0 DTL 600,000.0
Total 11,100,000.0 Total 11,100,000.0

A+B The balance sheets of A and B are summed up.
Assets 10,000,000.0 Equity 15,000,000.0
Investment 8,500,000.0 Liabilities 4,000,000.0
Intangible 1,000,000.0 DTL 600,000.0
DTA 100,000.0
Total 19,600,000.0 Total 19,600,000.0
Consolidation DR CR
Assets Equity -8,500,000.0 The capital consolidation journal Equity 6,800,000.0
Investment -8,500,000.0 Liabilities entries are prepared. The Investment 8,500,000.0
Intangible DTL ‚redundancies‘ are thus Goodwill 1,700,000.0
DTA NCI 1,700,000.0 eliminated. Equity 1,700,000.0
Goodwill 1,700,000.0 NCI 1,700,000.0
Total -6,800,000.0 Total -6,800,000.0

A (consolidated)
The result is the consolidated financial statement of position of parent company A.
Assets 10,000,000.0 Equity 6,500,000.0
Intangible 1,000,000.0 NCI 1,700,000.0
Goodwill 1,700,000.0 Liability 4,000,000.0
DTA 100,000.0 DTL 600,000.0
Total 12,800,000.0 Total 12,800,000.0

18

Consolidation (3/3)
Solution to Illustrative Example 1 ctd.:
A
Total 8,500,000.0 8,500,000.0
B The revaluation follows example 10 and 11.
Assets 10,000,000.0 Equity 8,500,000.0
Intangible 1,000,000.0 Liabilities 2,000,000.0
DTA 100,000.0 DTL 600,000.0
Total 11,100,000.0 Total 11,100,000.0

A+B The balance sheets of A and B are summed up.
Assets 10,000,000.0 Equity 15,000,000.0
Intangible 1,000,000.0 DTL 600,000.0
DTA 100,000.0
Total 19,600,000.0 Total 19,600,000.0
Consolidation DR CR
Assets Equity -8,500,000.0 The capital consolidation journal Equity 6,800,000.0
Investment -8,500,000.0 Liabilities entries are prepared. The Investment 8,500,000.0
Intangible DTL ‚redundancies‘ are thus eliminated. Goodwill 1,700,000.0
DTA NCI 2,000,000.0 The full goodwill method only Equity 1,700,000.0
Goodwill 2,000,000.0 affects goodwill and NCI. NCI 1,700,000.0
Total -6,500,000.0 Total -6,500,000.0 Goodwill 300,000.0
NCI 300,000.0
A (consolidated)
Assets 10,000,000.0 Equity 6,500,000.0 The result is the consolidated financial statement of position of parent company A.
Intangible 1,000,000.0 NCI 2,000,000.0
Goodwill 2,000,000.0 Liability 4,000,000.0
DTA 100,000.0 DTL 600,000.0
Total 13,100,000.0 Total 13,100,000.0

19

Indirect Non-controlling Interest (1/4)
Indirect NCI Indirect non-controlling interest (NCI) are encountered in multi-layer group structures with minority
shareholders on various levels. It is disputed in accounting literature which percentage to use for the first
time consolidation of indirect NCI.

Company A owns 80 % in company B which it founded together with company Z in 2011. Company A contributed EUR 8 mln and
company B EUR 2 mln to B‘s equity. Later in 2011 company B acquires 60 % of company C for a consideration of EUR 5 mln. C‘s asset have
a fair value of EUR 6 mln. A, B and C‘s balance sheets at the date of acquisition of C are as follows:
A
Total 8,000,000.0 8,000,000.0
B
Cash 5,000,000.0
Total 10,000,000.0 10,000,000.0
C
Assets 4,000,000.0 Equity 3,000,000.0
Total 4,000,000.0 4,000,000.0

At year end C‘s balance sheet is as follows (the increase in equity resulting from the profit from acquistion date to end of December
2011):
C
Assets 4,000,000.0 Equity 3,300,000.0
Liabilities 700,000.0
Total 4,000,000.0 4,000,000.0
Account for the acquisition, prepare the consolidated financial statement of position at acquisition date and for the end of 2011.

20

C revalued DR CR
Assets 6,000,000.0 Equity 4,600,000.0 Assets 2,000,000.0
Liabilities 1,000,000.0 DTL 400,000.0
DTL 400,000.0 Equity 1,600,000.0
Total 6,000,000.0 6,000,000.0

A+B+C
Assets 6,000,000.0 Equity 20,600,000.0
Cash 5,000,000.0 DTL 400,000.0
Total 24,000,000.0 24,000,000.0

Consolidation DR CR DR CR
Assets Equity -14,600,000.0 Equity 2,760,000.0 Equity 10,000,000.0
Goodwill 2,240,000.0 NCI 3,840,000.0 Investment 5,000,000.0 NCI 2,000,000.0
Investment -13,000,000.0 Liabilities Goodwill 2,240,000.0 Investment 8,000,000.0
Cash DTL Equity 1,840,000.0
Total -10,760,000.0 -10,760,000.0 NCI 1,840,000.0

A consolidated
The first two journal entries lead to C being consolidated into B, the second to B
Assets 6,000,000.0 Equity 6,000,000.0
Goodwill 2,240,000.0 NCI 3,840,000.0
being consolidated into A. The directly held share between B and C is taken into
Cash 5,000,000.0 Liabilities 3,000,000.0 account when calculating goodwill. This view assumes the group acquiring C rather
DTL 400,000.0 than the shareholders of A doing so (unity theory).
Total 13,240,000.0 13,240,000.0

21

C revalued DR CR
Liabilities 1,000,000.0 DTL 400,000.0
DTL 400,000.0 Equity 1,600,000.0
Total 6,000,000.0 6,000,000.0

A+B+C
Assets 6,000,000.0 Equity 20,600,000.0
Cash 5,000,000.0 DTL 400,000.0
Total 24,000,000.0 24,000,000.0

Assets Equity -14,600,000.0 Equity 2,208,000.0 NCI 1,000,000.0
Goodwill 1,792,000.0 NCI 3,392,000.0 Investment 4,000,000.0 Investment 1,000,000.0
Investment -13,000,000.0 Liabilities Goodwill 1,792,000.0 Equity 10,000,000.0
Cash DTL Equity 2,392,000.0 NCI 2,000,000.0
Total -11,208,000.0 -11,208,000.0 NCI 2,392,000.0 Investment 8,000,000.0

A consolidated
The first two journal entries lead to C being consolidated into B, the second to B
Assets 6,000,000.0 Equity 6,000,000.0
Goodwill 1,792,000.0 NCI 3,392,000.0
being consolidated into A. Only the indirect share is taken into account calculating
Cash 5,000,000.0 Liabilities 3,000,000.0 goodwill (Investment of EUR 5.000.000 * 0.8 – Equity of EUR 4.600.000 * 0.8 * 0.6
DTL 400,000.0 = goodwill of EUR 1.792.000). The journal entry at the level of B corrects the NCI by
Total 12,792,000.0 12,792,000.0 the remaining investment account (EUR 1.000.000).

Comparison of results:
Position Full Proportionate
NCI 3,840,000.0 3,392,000.0
Goodwill 2,240,000.0 1,792,000.0

22

C revalued DR CR
Liabilities 700,000.0 DTL 400,000.0
DTL 400,000.0 Equity 1,600,000.0
Total 6,000,000.0 6,000,000.0

A+B+C
Assets 6,000,000.0 Equity 20,900,000.0
Cash 5,000,000.0 DTL 400,000.0
Total 24,000,000.0 24,000,000.0

Assets 0.0 Equity -14,756,000.0 Equity 2,208,000.0 Equity 10,000,000.0
Goodwill 1,792,000.0 NCI 3,548,000.0 Investment 4,000,000.0 NCI 2,000,000.0
Investment -13,000,000.0 Liabilities 0.0 Goodwill 1,792,000.0 Investment 8,000,000.0
Cash 0.0 DTL 0.0 Equity 2,392,000.0 Equity 156,000.0
Total -11,208,000.0 -11,208,000.0 NCI 2,392,000.0 NCI 156,000.0

A consolidated
All journal entries (revaluation and consolidation need to be carried forward (for as
Assets 6,000,000.0 Equity 6,144,000.0
Goodwill 1,792,000.0 NCI 3,548,000.0
long as the entities are being consolidated). The profit at the end of 2011 in
Cash 5,000,000.0 Liabilities 2,700,000.0 company C needs to be allocated to NCI (300.000 x (1 – 0.8 x 0.6) = 156.000) and
DTL 400,000.0 the shareholders of the parent company (300.000 – 156.000 = 144.000). Both
Total 12,792,000.0 12,792,000.0 above described methods use the indirect quota for subsequent changes in the
subsidiary’s equity unrelated to transactions with the shareholders.

23

Debt, Income and Expense Consolidation
Technique Debt, income and expense incurred from group transactions need to be eliminated in consolidated
financial statements. Any differences need to be taken directly to income and will be reversed in
subsequent period.

Example 11:
Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In addition to the equity A granted a loan of
EUR 10 mln for the acquisition of assets by B at the beginning of 2011. The loan bears 10 % interest per annum. A and B‘s financials at
the end of 2011 are as follows:
A B
Investment 2,000,000.0 Equity 13,000,000.0 Assets 12,000,000.0 Equity 1,000,000.0
IC loan 11,000,000.0 IC loan 11,000,000.0
Total 13,000,000.0 13,000,000.0 Total 12,000,000.0 12,000,000.0
A - income statement B- income statement
Operating income 0.0 Operating income 0.0
Interest income 1,000,000.0 Interest expense -1,000,000.0
Tax (current) -250,000.0 Tax (deferred) 250,000.0
Net income 750,000.0 Net income -750,000.0

Prepare the year end journal entries and consolidate both companies.

24

Elimination of Inter-Group Profits
Technique Inter-group profits, resulting from transactions within the group, need to be eliminated in full.

Example 12:
Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an office building (IAS 40 fair
value model applied) to B at a price of EUR 5 mln. The fair value at the end of 2010 was EUR 4 mln. The fair value at the end of 2011 is
EUR 4.5 mln (not yet accounted for).
A B
Cash 750,000.0 Debt 3,000,000.0
Total 2,750,000.0 2,750,000.0 Total 5,000,000.0 5,000,000.0
A - income statement
Operating income 1,000,000.0
Interest income 0.0
Tax (current) -250,000.0
Net income 750,000.0


25

Proportionate consolidation
Company A acquires 30 % of the shares in company B together with Y (30 %) and Z (40 %) for EUR 3 mln. A, Y and Z concluded a contract
before acquiring all the shares in B to establish a joint venture, i.e. to ensure all strategic and operational decisions are sanctioned
unanimously by the new shareholders. The fair value of B‘s asset is EUR 8 mln, the tax rate is 20 %. A and B‘s balance sheet at acquisition
date are as follows:
A B
Total 3,000,000.0 3,000,000.0 Total 5,000,000.0 5,000,000.0
Prepare the consolidation journal entries and consolidate B and A using proportionate consolidation.

B revalued DR CR
Assets 8,000,000.0 Equity 7,400,000.0 Asset 3,000,000.0
DTL 600,000.0 Equity 2,400,000.0
Total 8,000,000.0 8,000,000.0 DTL 600,000.0
B revalued (30 %) Please note that the analogous application of the rules of IFRS 3 for acquisition
Assets 2,400,000.0 Equity 2,220,000.0
accounting is disputed in accounting literature.
DTL 180,000.0
Total 2,400,000.0 2,400,000.0
A + B revalued (30 %)
Assets 2,400,000.0 Equity 5,220,000.0
Investment 3,000,000.0 DTL 180,000.0
Total 5,400,000.0 5,400,000.0
A + B revalued (30 %) consolidation DR CR
Goodwill 780,000.0 Equity -2,220,000.0 Equity 2,220,000.0
Investment -3,000,000.0 DTL Goodwill 780,000.0
Total -2,220,000.0 -2,220,000.0 Investment 3,000,000.0
A consolidated
Goodwill 780,000.0 Equity 3,000,000.0
Asset 2,400,000.0 DTL 180,000.0
Total 3,180,000.0 3,180,000.0

26

Table of Contents



3. Consolidation


27

Foreign Currency Translation – IAS 21
Definitions IAS 21.8 defines

(a) functional currency as the currency of the primary economic environment of the group and
(b) reporting currency as the currency in which the separate and consolidated financial statements are
presented.

The following needs to be taken into account when determining the functional currency:

(a) the currency mainly influencing sales prices for goods and services,
(b) the currency mainly influencing labour, material and other costs,
(c) the currency in which financing is obtained and
(d) the currency in which operating cash flows are obtained.

Methodology In practice most reporting entities define their subsidiaries as foreign operations (i.e. the local currency
being the functional currency). All further examples will only refer to this method.

Exchange rate at reporting date: assets, liabilities
Average exchange rate: income, expense
Historical exchange rate: equity, goodwill

Please not that average exchange rate is a well accepted facilitation used instead of exchange rates at the
date(s) of the transaction(s).

Any difference in translating foreign operations are taken directly to other comprehensive income
(currency translation reserve). Upon disposal of the subsidiary the accumulated currency translation
reserve is either expensed or reclassified as income.

28

Translation Technique (1/2)
Company A acquires 80 % of the shares in company B for EUR 9 mln. The fair value of B‘s asset is EUR 8 mln (LC 15.2 mln), the tax rate is
20 %. A (EUR) and B‘s (LC) balance sheet at acquisition date are as follows:
A (EUR) B (LC)
Total 9,000,000.0 9,000,000.0 Total 8,000,000.0 8,000,000.0
The exchange rate at acquisition date is 1,9 (EUR 1 = LC 1,9).

At year end B‘s balance sheet is as follows:
B 31 Dec. (LC)
Assets 7,470,000.0 Equity 8,000,000.0
Loss -530,000.0
Total 7,470,000.0 7,470,000.0

The average exchange rate is 1,8, the exchange rate at year end 2.1. Prepare the consolidation journal entries and consolidate B and A.


B (LC revaluation) LC DR CR Revaluation for acquisition accounting
Assets 15,200,000.0 Equity 13,760,000.0 Asset 7,200,000.0
is done in LC.
DTL 1,440,000.0 Equity 5,760,000.0
Total 15,200,000.0 15,200,000.0 DTL 1,440,000.0
B (EUR revalued) B’s balance sheet is translated into EUR
Assets 8,000,000.0 Equity 7,242,105.3
at acquisition date using the exchange
DTL 757,894.7
Total 8,000,000.0 8,000,000.0 rate of 1,9.
A consolidated EUR DR CR B is consolidated into A at acquisition
Assets 8,000,000.0 Equity 9,000,000.0 Equity 5,793,684.2
date. These journal entries need to be
Goodwill 3,206,315.8 NCI 1,448,421.1 Goodwill 3,206,315.8
DTL 757,894.7 Investment 9,000,000.0 carried forward (!).
Total 11,206,315.8 11,206,315.8 Equity 1,448,421.1
NCI 1,448,421.1

29

Translation Technique (2/2)
B 31 Dec. (LC) LC DR CR Revaluation journal entry is carried
Assets 14,670,000.0 Equity 13,760,000.0 Asset 7,200,000.0 forward.
Loss -530,000.0 Equity 5,760,000.0
DTL 1,440,000.0 DTL 1,440,000.0
Total 14,670,000.0 14,670,000.0
B 31 Dec. (EUR) EUR DR CR The assets and the DTL are translated
Assets 6,985,714.3 Equity 7,242,105.3 CTA 689,724.3 using the year end exchange rate, profit
Loss -294,444.4 Equity 689,724.3 is translated using the average exchange
CTA -647,660.8 Profit 42,063.5 rate and equity is translated using the
DTL 685,714.3 CTA 42,063.5
historical exchange rate (1,9). The
Total 6,985,714.3 6,985,714.3
difference is taken to CTA
Consolidation EUR DR CR The consolidation journal entries are
Assets Equity -7,242,105.3 Equity 5,793,684.2 carried forward.
Goodwill 2,654,536.3 CTA -422,247.3 Goodwill 3,206,315.8
Investment -9,000,000.0 Loss 58,888.9 Investment 9,000,000.0
NCI 1,260,000.0 Equity 1,448,421.1
DTL NCI 1,448,421.1
Total -6,345,463.7 -6,345,463.7

EUR DR CR Minority interest (20 %) are calculated
NCI 58,888.9 on the loss (-294.444.4) and the CTA (-
Loss 58,888.9 647.660.8) and allocated to NCI.
NCI 129,532.2
CTA 129,532.2

A consolidated EUR DR CR Goodwill is translated using the historic
Assets 6,985,714.3 Equity 9,000,000.0 CTA 305,363.4 exchange rate. No minorities are taken
Goodwill 2,900,952.4 CTA -823,492.1 Goodwill 305,363.4 into account since this example does
Loss -235,555.6 Historic Y/E
Goodwill (LC) 6,092,000.0 6,092,000.0
not use the full goodwill method.
NCI 1,260,000.0
DTL 685,714.3 Goodwill (EUR) 3,206,315.8 2,900,952.4
Total 9,886,666.7 9,886,666.7 CTA -305,363.4

30

Appendix B – Solutions to examples

31

Solutions to Examples (1/8)
Example 1:
100% 20%

B 40% C

Solution 1:
A controls B, therefore the voting shares B holds in C are attributed to the parent company A in determining whether it directly or
indirectly controls C. Together with its 20 % voting share in C parent company A controls a total of 60 % of the voting shares in C and as
such needs to consolidate C.

Example 2:
45% 20%

B 40% C

Solution 2:
A does not control B, therefore the voting shares B holds in C cannot be attributed to the parent company A in determining whether it
directly or indirectly controls C. A thus consolidates neither of its two investee companies.

32

Example 3:
Company A and company Z each own 50 % of the voting shares in company B. A acquired a
A 25% option Z
purchase option from B over 25 % of the voting shares in B for a price of EUR 15 per shares.
The share price of B currently is EUR 10. The option can be exercised at any time.
50% 50%

B

Solution 3:
Since the A‘s call option is currently exercisable the 25 % voting potential voting rights are allocated to A which thus controls 75 % of B
and is required to consolidate B. The fact that the call option is currently out of the money is irrelevant.

Example 4:
Trust company T acquired 100 % of the shares in B on behalf of A. Under the trust agreement Trust
A (Principal) T (Agent)
A sets forth the rules under which T exercises voting rights in B. The trust agreement can be agreement
cancelled at any time by A. Assess whether A has control over B.
100%

B

Solution 4:
T does not own the shares in B and exercise the voting rights in it on its own account but on behalf of the principal A who could at any
time terminate this relationship. Therefore the voting rights in B need to be allocated to A.

33

Example 5:
Company B is listed on a stock exchange and has repurchased 10 % of its shares. Its main A Freefloat
shareholder, company A holds a total of 47 % of B’s shares. The remaining 43 % is free float.
Assess whether A has control over B.
47% 43%

B
(10 % treasury
stock)

Solution 5:
B‘s treasury stock reduce the voting shares outstanding to 90 %. A‘s holding 47 % of all voting shares in B therefore increases by another
5,22 % ([47 / 90 – 0,47] x 100 = 5,22) thus totalling 52,22 %. A therefore controls B.

Example 6:
Companies A and B each sell receivables to (legally independent) SPEs A B
X and Y, providing credit enhancement. X and Y sell these receivables
on to another SPE Z which issues commercial paper. A bank (M) 0% portfolio sale 0%
sponsored SPE Z and provides it with additional credit enhancement
(i.e. a second loss guarantee). The receivables in Z are cross-
X Y
collateralised for the liability Z incurred.

0% portfolio sale 0%

sponsor + credit
Z M
enhancement

Solution 6:
M needs to consolidate Z due to it absorbing losses if they occur. A consolidates X and B consolidates Y (for the same reasons).

34

Example 7:
Company A acquires three outlet centres in Poland together with the facility and centre management contract. The facility and centre
management has operated the outlet centres for several years and has gained unique knowledge and a strong position in the market.
Assess whether the acquisition is a business combination or not.

Solution 7:
The acquisition is a business combination. The properties represent the inputs, the facility and centre management activities the
processes applied thereon and the items sold the outputs.

Example 8:
Company A acquires a land plot adjacent to one of the outlet centres from a different vendor. It intends to enlarge the outlet centre by
10.000 sqm but still needs to apply for the are to be rezoned as well as a building permit. Assess whether the acquisition is a business
combination or not.

Solution 8:
The acquisition is not a business combination since there are no processes (yet) applied to the input and (again yet) no outputs
produced.

Example 9:
Company A is listed on the stock exchange and acquires company B through issuing shares to the owner of company B (company Z)
which in turn contributes its shares in B to A. Company Z obtains a controlling stake in A after this transaction. The basic data of both A
and B are as follows:
Company Equity Valuation
A 50.0 100.0
B 120.0 200.0
Determine the acquirer.

Solution 9:
B is the accounting acquirer (and the legal acquiree) because of (a) its relative bigger size (200 : 100) and (b) due to the fact that B’s
shareholder obtains control over A.
35

Example 10:
Company A acquires company B for a purchase price of EUR 10 mln. B‘s balance sheet before acquisition looked as follows:

Assets 8,000,000.0 Equity 6,500,000.0
Total 8,000,000.0 8,000,000.0

liabilities and determine goodwill.

Solution 10:

Assets 10,000,000.0 Equity 8,500,000.0 Purchase price 10,000,000.0
Intangible 1,000,000.0 Liabilities 2,000,000.0 Equity 8,500,000.0
DTA 100,000.0 DTL 600,000.0 Goodwill 1,500,000.0
Total 11,100,000.0 Total 11,100,000.0

DR CR
Assets and liabilities need to be adjusted to their respective fair values. The so far
Assets 2,000,000.0
Intangible asset 1,000,000.0
unrecognised intangible asset is recognised (EUR 1 mln). Since the tax bases of the
Equity 3,000,000.0 various items in the balance sheet do not change deferred taxes need to be
Equity 600,000.0 calculated on all adjustment journal entries.
DTL 600,000.0
Equity 500,000.0 Goodwill is finally calculated as the difference between the purchase price and the
Liability 500,000.0 revalued equity of the acquiree.
DTA 100,000.0
Equity 100,000.0

36

Example 11:

Assets 8,000,000.0 Equity 6,500,000.0
Total 8,000,000.0 8,000,000.0

liabilities and determine goodwill on a proporationate basis as well as under the fair value method.

Solution 11:
Proportionate goodwill Full goodwill A Other Total
Purchase price 8,500,000.0 Purchase price 8,500,000.0 2,000,000.0 10,500,000.0
Equity (80 %) 6,800,000.0 Equity (proportion) 6,800,000.0 1,700,000.0 8,500,000.0
Goodwill 1,700,000.0 Goodwill 1,700,000.0 300,000.0 2,000,000.0

Only 80 % of B‘s equity is offset The full goodwill method accounts for the minorities‘ share
against the purchase price paid in goodwill as well. Therefore the purchase price these
by the aquirer. minorities would have paid to obtain the remaining shares
needs to be reduced by the proportionate equity ‚owned‘ by
these minorities. The difference is the goodwill allocated to
them. In calculating the purchase price for the minorities‘
share the control premium paid by the controlling
shareholder A cannot be taken into account.

Example 12:
Company A acquires 100 % of the shares in company B for EUR 2 mln. B’s remeasured equity amounts to EUR 2.1 mln. Even after
reassessing all assets and liabilities of B no error is detected. Calculate the excess and account for it.

Solution 12:
The excess is EUR 0.1 mln (EUR 2 mln – EUR 2.1 mln) and is accounted for as profit in net income.
37

Example 11:
Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In addition to the equity A granted a loan of
EUR 10 mln for the acquisition of assets by B at the beginning of 2011. The loan bears 10 % interest per annum. A and B‘s financials at
the end of 2011 are as follows:
A B
IC loan 11,000,000.0 IC loan 11,000,000.0
Total 13,000,000.0 13,000,000.0 Total 12,000,000.0 12,000,000.0
A - income statement B- income statement
Operating income 0.0 Operating income 0.0
Interest income 1,000,000.0 Interest expense -1,000,000.0
Tax (current) -250,000.0 Tax (deferred) 250,000.0
Net income 750,000.0 Net income -750,000.0


Solution 11:
A (consolidated) A - consolidated
Assets 12,000,000.0 Equity 12,000,000.0 Operating income 0.0
Total 12,000,000.0 12,000,000.0 Interest income 0.0
Tax (current) 0.0
Net income 0.0

DR CR The group interest – and expense need to be eliminated, as well as the group debt. The
Equity 2,000,000.0
consolidated group result therefore equals zero.
Investment 2,000,000.0
IC loan 11,000,000.0
IC loan 11,000,000.0
Interest income 1,000,000.0
Interest expense 1,000,000.0

38

Example 12:
Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an office building (IAS 40 fair
value model applied) to B at a price of EUR 5 mln. The fair value at the end of 2010 was EUR 4 mln. The fair value at the end of 2011 is
EUR 4.5 mln (not yet accounted for).
A B
Cash 750,000.0 Debt 3,000,000.0
Total 2,750,000.0 2,750,000.0 Total 5,000,000.0 5,000,000.0
A - income statement
Operating income 1,000,000.0
Interest income 0.0
Tax (current) -250,000.0
Net income 750,000.0


Solution 12:
A (consolidated) B- income statement A - consolidated
Assets 4,500,000.0 Equity 2,125,000.0 Operating income 500,000.0 Operating income 500,000.0
Cash 750,000.0 Debt 3,000,000.0 Interest expense 0.0 Interest income 0.0
DTL 125,000.0 Tax (deferred) -125,000.0 Tax (current) -375,000.0
Total 5,250,000.0 5,250,000.0 Net income 375,000.0 Net income 125,000.0

DR CR The profit from the sales transaction needs to be eliminated (EUR 5 mln – EUR 4 mln). The
Equity 2,000,000.0
taxes paid on that remain in the accounts of A. The fair value change needs to be recorded
Investment 2,000,000.0
Sales profit 1,000,000.0 at the level of B now (EUR 4.5 mln – EUR 4 mln = EUR 1 mln).
Inv. Prop. 1,000,000.0
Inv. Prop. 500,000.0 A‘s consolidated result therefore comprises the change in fair value (EUR 500.000), the
Fair value gain 500,000.0 deferred tax expense pertaining to that (EUR -125.000) and the income tax paid on the
DTE 125,000.0 sales transaction of EUR -250.000).
DTL 125,000.0

39

Appendix C – Homework

40

Homework (1/2)
Part 1:
Entity A holds 45 %, Entity C 10 % and Entity D 35 % of the voting rights in entity B. Entity B holds treasury stock representing 10 % of
voting rights. Local law does not allow voting rights of treasury stock and treasury stock held by subsidiaries. Determine who holds
control over B. What would change if A holds 4 % of its 45 % stake as a trustee for D?

Part 2:
Company A acquires 75 % of the shares in company B for EUR 7 mln. The fair value of B‘s asset is EUR 5 mln (LC 8,5 mln), the tax rate is
20 %. A (EUR) and B‘s (LC) balance sheet at acquisition date are as follows:
A (EUR) B (LC)
Total 7,000,000.0 7,000,000.0 Total 5,000,000.0 5,000,000.0
The exchange rate at acquisition date is 1,7 (EUR 1 = LC 1,7).

At year end B‘s balance sheet is as follows:
B 31 Dec. (LC)
Assets 5,500,000.0 Equity 5,000,000.0
Loss 500,000.0
Total 5,500,000.0 5,500,000.0

The average exchange rate is 1,6, the exchange rate at year end 2.0. Prepare the consolidation journal entries and consolidate B and A.

Additional homework 1: Prepare the above example and prepare it using the full goodwill method.

Part 3:
Company A acquires 40 % of the shares in company B together with Y (30 %) and Z (30 %) for EUR 5 mln. A, Y and Z concluded a contract
before acquiring all the shares in B to establish a joint venture, i.e. to ensure all strategic and operational decisions are sanctioned
unanimously by the new shareholders. The fair value of B‘s asset is EUR 7 mln, the tax rate is 20 %. A and B‘s balance sheet at acquisition
date are as follows:
A B
Total 5,000,000.0 5,000,000.0 Total 4,000,000.0 4,000,000.0
Prepare the consolidation journal entries and consolidate B and A using proportionate consolidation.
41

Homework (2/2)
Additional homework 2:
Company A owns 70 % in company B which it founded together with company Z in 2011. Company A contributed EUR 7 mln and
company B EUR 3 mln to B‘s equity. Later in 2011 company B acquires 55 % of company C for a consideration of EUR 6 mln. C‘s asset have
a fair value of EUR 7 mln. A, B and C‘s balance sheets at the date of acquisition of C are as follows:
A B C
Investment 7,000,000.0 Equity 5,000,000.0 Investment 6,000,000.0 Equity 10,000,000.0 Assets 3,000,000.0 Equity 2,000,000.0
Liabilities 2,000,000.0 Cash 4,000,000.0 Liabilities 1,000,000.0
Total 7,000,000.0 7,000,000.0 Total 10,000,000.0 10,000,000.0 Total 3,000,000.0 3,000,000.0
At year end C‘s balance sheet is as follows (the increase in equity resulting from the profit from acquistion date to end of December
2011):
C
Assets 3,000,000.0 Equity 2,000,000.0
Profit 100,000.0
Debt 900,000.0
Total 3,000,000.0 3,000,000.0

Account for the acquisition, prepare the consolidated financial statement of position at acquisition date and for the end of 2011.

Part 4:
Holding company A founded the operational company B with EUR 2 mln of equity in 2010. In 2011 it sells an industrial plant to B at a
price of EUR 3 mln (paying EUR 50.000 in taxes – i.e. the tax rate of 10 %). The book value of this industrial plant in A at the end of 2010
was EUR 2,5 mln (annual depreciation of EUR 200.000).
A B
Cash 450,000.0 Debt 1,000,000.0
Total 2,450,000.0 2,450,000.0 Total 3,000,000.0 3,000,000.0

Eliminate the inter group profit and consolidate A and B.

Due date:
Friday, February 24, 6 p.m.

42

Appendix D – Questions

43

Questions
125. Name the types of entities one might encounter when determining the consolidation range and elaborate on how they are
accounted for.
126. Explain the control concept of IAS 27.
127. What is indirect control and which is its relevance in the context of IAS 27?
128. Explain the function of potential voting rights in the context of IAS 27.
129. Elaborate on the principal-agent problem when determining control under IAS 27 and under IFRS 10.
130. How do treasury stock influence control in the context of IAS 27.
131. Give an example for de fact control.
132. Which are the criteria for consolidating special purpose entities under SIC 12?
133. Explain the control concept in IFRS 10.
134. How are joint ventures accounted for under IAS 31?
135. How are joint arrangements accounted for under IFRS 11?
136. Define business combination and business in the context of IFRS 3.
137. Why is the acquisition date so relevant in the context of IFRS 3?
138. How is the acquirer identified in a business combination?
139. How are transaction cost accounted for in a business combination?
140. Which are the measurement criteria for intangible assets in a business combination?
141. How are contingent liabilities accounted for in a business combination?
142. Explain the purpose and function of the measurement period in IFRS 3.
143. How is goodwill determined?
144. How is a negative goodwill (excess) accounted for?
145. Name the steps in consolidating controlled subsidiaries.
146. Define functional currency and reporting currency.
147. How are foreign operations’ financials translated?

44

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