Business Combination and Consolidated Financial Statements

This report discusses business combination and its effects on accounting of books of holding company. It covers the two methods of takeover, purchase/acquisition and acquiring substantial interest, and their accounting treatments. It also explains the preparation of consolidated financial statements as per AASB guidelines, including the elimination of intra group transactions and unrealised profit/loss. The report includes examples and rules to follow for making consolidated balance sheet and income statement.

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Corporate Accounting

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Executive Summary
The present report is regarding business combination and its effects on the
accounting of books of the holding company. There are two company’s JKY Ltd
holding and FAB Ltd. subsidiary. JKY Ltd. wants to takeover FAB Ltd. there are two
methods of takeover by acquiring substantial interest and by purchase/ acquisition
method. They want to make the choice between the two option as if which method of
takeover is best for company’s benefit. The company entered into a transaction with
its subsidiary as its subsidiary sold inventory on profit, the accounting treatment for
the same is to eliminate all the profit. Company at the year end wants to make its
consolidated financial statements and they need to be prepared as per the
guidelines of AASB.

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Contents
Executive Summary............................................................................................................................2
Contents................................................................................................................................................3
Introduction..........................................................................................................................................4
Part A....................................................................................................................................................5
Part B....................................................................................................................................................6
Part C...................................................................................................................................................7
Conclusion...........................................................................................................................................9
References:.......................................................................................................................................10

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Introduction
This report is broadly classified into three issues and the major aim of making this
report is to get a keen knowledge of business combination. Accounting treatments
for mergers and acquisition and the preparation of consolidated financial statements
are described in this report. Business combination means when two companies are
willing to join hands together as by giving substantial control over the company to the
dominating company or by completing purchasing the business of the company for
some purchase consideration both of them has some key differences. The
accounting of both the methods is also different. The company become holding and
subsidiary if they buy controlling interest of the other company and any transactions
between holding and subsidiary company are to be eliminated in full if the company
is preparing its consolidated financial statements. The company sold goods to the
holding company accounting treatment of the same will be discussed further. The
holding company also need to prepare its consolidated financial statements for the
year end and also need to do some changes in regard to its subsidiaries.

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Part A
Business combination means one company has interest in another company that
interest can be accessed in another company either by purchasing or acquiring the
company or by taking substantial control in the working of the company. Business
combination can be between parent and target company or between holding and
subsidiary company. If the company acquires or purchases the other company then
they become parent and target company as the one which wants to acquire the other
company is called as parent company and the other is called as target company.
Similarly, if the company acquires substantial interest in other company then they
become holding and subsidiary company. There is major difference between both of
these methods of acquisition that is between purchase/ acquisition and buying
substantial interest (Wahlen et al., 2014). In purchase or acquisition the company
pays a purchase consideration for the amount of liabilities and assets of the
company taken over them as the fair value of liabilities and assets is accessed for
the same and there difference between fair value of assets and liabilities and
purchase consideration is recorded as goodwill/ capital reserve in the books of
parent company. From the date of acquisition parent company will continue to show
the liabilities and assets of the target company it its books of accounts. If company
wants to acquire substantial interest in another company then there will be a relation
of holding and subsidiary between the two companies. The holding company holds
more than 51% shareholding of the subsidiary company from its existing
shareholders. By doing, holding company will have substantial interest in the
subsidiary company and will have decision making in the matters of subsidiary
company (Van Greuning et al., 2011).

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There are two approaches of acquisition namely equity method and proportionate
consolidation method. In equity method company only invest money in another
company for some return. Both the companies will have separate books of accounts
and only the portion of investment will be shown in the books of both the companies.
In proportionate consolidation method company acquires shares of another company
from its existing shareholder to the extent that they can have substantial interest in
another company. With the help of equity method two companies can become
associates or joint venture. By buying substantial interest in another company both
the company will become holding and subsidiary of each other. Holding company
have right to take part in the decision-making process of the subsidiary company.
The difference between these two methods is majorly of controlling interest if
company wants to invest in another company then equity method is better and if
company wants to acquire substantial interest then proportionate consolidation is
better (Weil and Schipper et al., 2013).
The more perfect difference between the two is shown with the help of example:
A Ltd. wants to purchase 25% shares of B ltd. The profit of B Ltd is $ 10000 for the
period.
A ltd. will only show in its books of accounts profit up to $ 2500 ($10000*25%).
Similarly, A ltd acquired 60% shares of B Ltd. B Ltd became subsidiary of A Ltd. b
Ltd earned $10000 for the period. A Ltd will show $10000 as its own profit
In the present case company JKY Ltd wants to takeover FAB Ltd. and its directors
are confused about the type of business combination. As per one director purchase/
acquisition method is better and as per another director its better to acquire
substantial interest in FAB Ltd. both the methods have some merits and demerits if
company wants to takeover FAB Ltd as for its investment purpose then

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purchase/acquisition method is better and if company to enjoy control over the
decision making of FAB Ltd then they need to acquire substantial interest in FAB Ltd.
The company can also tax benefits if company acquires FAB Ltd as its assets will
become the assets of JKY Ltd. and company can claim depreciation tax benefit on
the same.
Part B
Holding company has to maintain its books of accounts at the end of the year as
consolidated financial statements as holding company has the compulsion to show
the cumulative books of its own and as well as of its subsidiaries. These subsidiaries
and holding company are treated as group companies. At the time of consolidation of
financial statements all the intra group balances and transaction that derive any
unrealised profit or loss are eliminated in full at the time of preparation of
consolidated financial statements. As per AASB 127 Consolidated and Separate
Financial Statements the transactions between holding and subsidiary are treated as
intra group transactions and any profit/ loss that is derived from those transactions is
called as unrealised profit/ loss. The unrealised profit/ loss is to be deducted in the
books of holding company on proportionate basis (Porter and Norton, 2012).
In the present case the subsidiary of FAB Ltd. has sold inventory at some profit. Its
directors are seeking advice as to the treatment of the same in the consolidated
financial statements. The treatment for the same will be as per AASB 127 that is if
the inventory is held in the stock at the balance sheet date then the profit that is
derived from the transaction is unrealised and need to be eliminated in the books of
the consolidated financial statements (Needles and Powers, 2010). If the inventory
that is purchased is still lying in the stock of the company then only the profit is noted
in the consolidated books of accounts of the company. Here, we assume that the

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inventory is still lying in stock so the profit that is realised from the sale of inventory
will be deducted from profit and loss of FAB Ltd. and from non-controlling interest on
pro rata basis that is the ratio of share capital.
As per AASB 10 Consolidated Financial Statements the unrealised profit/ loss from
the intra group transaction is to be removed in full form the books of accounts and
the closing inventory of the group will be recorded at cost in the consolidated
financial statements. In the present case FAB Ltd. needs to value its inventory at
cost as they need to do revaluation for inventory and need to deduct the profit figure
from the inventory (Mirza et al., 2010).
The above transaction will be further explained with the help of examples:
A ltd holds 80% interest in B ltd. B Ltd sold inventory of $ 45000 at a profit of $15000
to A Ltd.
Here we assume that the inventory that B Ltd. sold to A Ltd is still lying in the stock
of A Ltd. Further the profit of $ 15000 will be allocated between A Ltd and B ltd in the
ratio of the share of interest that is in 80:20. So, the profit is reduced by $ 12000 and
non-controlling interest is reduced by $ 3000. The inventory will be recorded in the
books at $ 30000.
A ltd holds 60% interest in B Ltd. B Ltd sold goods to A Ltd at $ 30000 and had a
loss of $5000.
Here we assume that inventory is still lying in the stock of A Ltd. Further the loss of
$5000 will be allocated between A Ltd and B Ltd in the ratio of 60:40 i.e. $3000 will
be added in the profit of A Ltd. and $2000 will be added in Non- Controlling interest.
Part C
The companies that have some holding in other companies will have to maintain
consolidated financial statements at the year end. The financial statements are to be

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organized in accordance with AASB 127 Consolidated and Separate Financial
Statements. There are some set of rules that a company needs to follow for the
making the consolidated balance sheet they are detailed in brief here under:
 The company needs to combine line by line the assets and liabilities and the
investments as well.
 The company needs to combine the profits and reserves of its subsidiaries as
well.
 The equity capital of the company is briefly categorised and non- controlling
interest also form part of the equity capital
 The carrying amount of investment is also eliminated in each of its subsidiary
 The parent’s equity holding is also eliminated from the subsidiary’s books
 The transactions between holding and subsidiary called as intra group
transactions are also removed in the consolidated financial statements and
any profit/ loss derived from intra group transaction need to be eliminated
 The financial statements of both holding and subsidiary are prepared by
following same accounting polices and any deviation from this will need a
proper disclosure in the notes to account
 The financial statements of holding and subsidiary are prepared on the same
date and if the date of presenting financial statements is not same of both the
holding and subsidiary than necessary adjustments need to be made
(Chandra, 2011).
Similarly, the income statement of the company needs to be consolidated and the
same will be prepared in accordance with AASB 127. There need to be some
adjustments for preparing the income statement as the profits are clubbed together
the accrued and outstanding expenses are shown properly. The company also need

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to show profit attributable to non- controlling interest and to the owners of the parent
in its disclosure.
The company has to prepare statement of other comprehensive income separate
from its income statement. In the statement the company has to clearly show the
allocation of comprehensive income to non- controlling interest and to owners of the
parent (Kimmel et al., 2010)
The above steps company needs to follow for making the Consolidated Financial
statements. If the company breaches in following the above rules then company will
be called by laws and will be penalised for the same. The company has the option to
deviate from the above-mentioned steps but there is need of proper disclosure for
the same in the notes to accounts of the company with proper disclosure if company
fails to do so then also penalty is imposed on the company. All the disclosure related
to financial statements of the company is made in the notes to accounts of that
company so that the reader of financial statements does not find it difficult to
understand the financial statements. The holding company also need to disclose in
its books of accounts the percentage of holding in the subsidiary (Fridson and
Alvarez, 2011).
In the present case FAB Ltd is preparing its Financial Statements in compliance with
AASB Consolidated and separate Financial statements they also need to comply
with above mentioned steps for preparing its financial statements. The non-
controlling interest is also need to be shown as a separate item in the owner’s equity
head of the balance sheet. They also need to disclose that the treatment of intra
company transactions is done in the books of accounts and also all the assumptions
relating to that is declared in the notes to accounts. The company also need to make
the statement of comprehensive income and has to show the amount allocated to

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parent and non- controlling interest. All the liabilities and assets of the subsidiaries
are also lined up with the assets and liabilities of the parent company. The
unrealised profits and losses are also need to be removed from the consolidated
financial statements. Non-Controlling interest gets effected from each and every
transaction between holding and subsidiary so there need to be proper calculation of
the non-controlling interest will due explanations for each and every adjustment. The
company needs to comply with AASB 101 presentation of financial statements which
says that each item of income statement and balance sheet needs a perfect
calculation and its precise form is disclosed in the balance sheet and income
statement the calculation regarding the same is to be shown in the notes to accounts
(Hoyle et al., 2015).

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Conclusion
To conclude this report there was a precise discussion about the methods of
business combination. The substantial interest decides the method by which one
company can acquire another company and the methods also have the major
difference that is based on the controlling interest of the acquiring company. The
company has to decide that they only want to simply acquire the company or have to
excise significant control in the decision-making process of the company. The
company has benefit if it acquires another company as they can avail depreciation
tax benefits on its assets. There was a intra group transaction between holding
company and its subsidiary company as the subsidiary sold the goods on profit to its
holding company. So, the accounting treatment for the same is that profit needs to
be eliminated in the consolidated books of accounts in proportion to the percentage
of the shareholding between holding and minority interest. At the year end the
company needs to prepare consolidated financial statements and need to do some
adjustments for recording the intra group transactions.

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References:
Chandra, P. (2011) Financial management. New York: Tata McGraw-Hill Education.
Fridson, M. S., and Alvarez, F. (2011) Financial statement analysis: a practitioner's
guide (Vol. 597). United States: John Wiley & Sons.
Hoyle, J. B., Schaefer, T., and Doupnik, T. (2015) Advanced accounting. New York:
McGraw Hill.
Kimmel, P. D., Weygandt, J. J., and Kieso, D. E. (2010) Financial accounting: tools
for business decision making. United States: John Wiley & Sons.
Mirza, A. A., Holt, G., and Orrell, M. (2010) International Financial Reporting
Standards (IFRS) Workbook and Guide: Practical Insights, Case Studies, Multiple-
choice Questions, Illustrations. United States: John Wiley & Sons.
Needles, B. E., and Powers, M. (2010) Financial accounting. United States:
Cengage Learning.
Porter, G. A., and Norton, C. L. (2012) Financial accounting: The impact on decision
makers. United States: Cengage Learning.
Van Greuning, H., Scott, D., & Terblanche, S. (2011) International financial reporting
standards: a practical guide. United States: The World Bank.
Wahlen, J. M., Baginski, S. P., and Bradshaw, M. (2014) Financial reporting,
financial statement analysis and valuation. Toronto: Nelson Education.
Weil, R. L., Schipper, K., and Francis, J. (2013) Financial accounting: an introduction
to concepts, methods and uses. United States: Cengage Learning.