Business Combination and Consolidated Financial Statements

This report emphasis on major three agendas of business combination. It discusses the consequences and impact of merger and acquisition on the business combination. The report also covers the set of rules that need to be followed for the preparation of consolidated financial statements.

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Corporate Accounting

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Executive summary:
This report emphasis on major three agendas of business combination. These
agendas are discussed further with their consequences and their impact on the
business combination. Business combination in classified as merger and acquisition
that takes place between two companies that have interest in the business of each
other. Merger is the process in which the books are being combined of the two
companies. Acquisition is the process where the pooling of interest of the two
companies takes place as they have the chance as in to whether to consolidate the
books or to make separate books of accounts. If the companies get consolidated
then they need to make consolidated financial statements at the end of the financial
year. The transactions between the companies which get polled up together will be
in the nature of consolidated transaction and transaction between the companies are
to be treated as same. The companies have the liability to present true and fair
financial statements at the year end.

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

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Introduction:
This report focuses on business combination, its scope and its effects on the holding
and subsidiaries books of accounts. Business combination is all about a mutual
agreement between two companies to join hands together to either become one
company or to work together for some common purpose. Business combination can
alternatively be called as merger or acquisition. Merger and acquisition can be done
in two ways that is by purchase/ acquisition and by taking substantial interest in the
other company. The companies that get merged will have transactions between
them that need to be accounted in the books of accounts of the holding company as
they make consolidated financial statements. All the transactions need to be properly
accounted for to get to know the true and fair position of the company’s financial
position. The consolidated financial statements have different treatments for different
transaction that need to be correctly present in the books of accounts with proper
disclosure for the same.

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Part A
When one companies combines with another company and the new organisation is
formed into the picture in place of two and both the companies works for common
objective of the organisation is called Business combination. It generally takes place
when a big company buys out minor unit or vice versa and the big company endures
to function in its name. Business combinations are done between the target
company and the parent company. If one company purchases the other company
then company becomes parent company and the acquiring company which is being
purchased by one company becomes target company. So here the parent company
becomes the acquiring company and the target company becomes the acquired
company (Van Greuninget al., 2011). In the same way, when one company is more
interested in the other company, they become the holding and subsidiary company.
The difference between the method of the acquisition is that buying substantial
interest and acquisition / purchase. In buying substantial interest method, if one
company acquires substantial interest in other company then there will be subsidiary
between the companies and relation of holding. When the holding company acquires
51% of shares of the subsidiary company then the holding company gets power of
control of the board of directors and in turn replace the required management.
Whereas in purchase/ acquisition method, one company pays the amount of the
liabilities and the assets of the other acquired company. The fair value of assets and
liabilities are accessed and the differences between purchase and fair value of asset
and liabilities are recorded as goodwill/capital reserve in the books of parent

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company. Thus, liabilities and assets of the target company are to be continued to be
shown in the books of parent company (Weil et al., 2013).
Now, we will discuss about the two main approaches of the acquisition. The two
main approaches of acquisition are proportionate consolidation method and equity
method. Equity method, it is the method when one company invest into the business
of other company for the purpose of some return and both the companies maintain
the different books of accounts and only some portion of the investments are to be
shown in the books of account. In this method both the companies can become
associates or joint venture (Fifield et al.,2011). While in proportionate consolidation
method, the one company purchase the share of another company from the current
shareholder and it gains the substantial interest in other company and by doing so
both the companies become holding and subsidiary of other. Whereas the holding
company gets the power of control of the boards of director and have rights to take
part in decision making process of subsidiary company (Robinson and Henry et al.,
2015). Therefore, the major difference between these two methods is the power of
control if one company is interested in investment purpose then the equity method
should be considered and if the company wants to buy substantial interest then
proportionate consolidation method should be considered (Edwards, 2013).
We can illustrate the above difference with the help of an example:
One company wants to purchase 30% of the shares of another company. The profit
for the year reported to be $30000.
The company will show only its share of profit in the books of accounts that is $ 9000
will be added in the company’s profit in regard to its investment
On the other hand, the same company will invest 60% in the share of the other
company and the profit for the year of that company is $40000.

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The company will report the whole profit of $40000 in the consolidate books of
accounts.
Part B
As per AASB 127 Consolidated and Separate Financial Statements all the
transaction that occur between subsidiary and its holding companies are to be
treated as intra group transaction. The intra group transactions are to be deleted in
full from the companies consolidated books of accounts (Needles and Powers,
2010). The books are to be prepared as per the requirements of AASB and the rules
and regulations of the Companies Act. Holding company has to maintain its books of
accounts and also has the compulsion to maintain group books of accounts. The
adjustments that need to be done are to be revealed in the companies notes to
accounts. Any unrealised profits and losses that occur because of intra group
transactions need to be eliminated in full from the consolidated books of accounts
(Hoyle et al., 2015). The company is legally liable to follow the above-mentioned
treatment for the intra group transaction as they will be imposed fines if they fail to do
so.
We can explain the intra group transaction with the help of an example:
AC ltd holds 80% interest in BA ltd. BA Ltd sold inventory of $ 45000 at a profit of
$15000 to AC Ltd.
Here we assume that the inventory that BA Ltd. sold to AC Ltd is still lying in the
stock of AC Ltd. Further the profit of $ 15000 will be allocated between AC Ltd and
BA 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.

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AC ltd holds 60% interest in BA Ltd. BA Ltd sold goods to AC Ltd at $ 30000 and had
a loss of $5000.
Here we make an assumption that inventory is still lying in the stock of AC Ltd.
Further the loss of $5000 will be allocated between AC Ltd and BA Ltd in the ratio of
60:40 i.e. $3000 will be added in the profit of AC Ltd. and $2000 will be added in
Non- Controlling interest.
In this case the subsidiary has sold inventory at its desirable profit. The directors of
the company are seeking advice how to treat 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. 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 (Damodaran, 2010). Here, we assume that the 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 in the
ratio of the share capital held by holding and minority interest.
Part C
The set of rules are to be followed for the preparation of the consolidated financial
statements are as follows:
 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.
 The company needs to combine the profits and reserves of its subsidiaries as
well.

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 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 company needs to combine line by line the assets and liabilities and the
investments as well (Ankarath et al., 2010).
 The parent’s equity holding is also eliminated from the subsidiary’s books.
 The carrying amount of investment is also eliminated in each of its subsidiary.
 The financial statements of both subsidiary and holding company are
prepared by following same accounting policies and any deviation from this
will need a proper disclosure in the notes to account.
 The company needs to disclose in its books of accounts all the major changes
that has been made for the preparation of consolidated financial statements.
 The costs that have no future relevance in the scope of the company are to be
noted as sunk and need to be eliminated from the books of accounts of the
company (Jones, 2011).
 The company has the liability to pay of the debt and loans of its subsidiaries at
the time of financial crises that also need to be disclosed in the books of
accounts of the company.
 The consolidated financial accounts of the company need to be properly
audited and must be attested by the authorised signatory of the company
 Th company has to adhere to all the information mentioned in the
consolidated books of accounts and the holding company will be held liable if
there is any deviation from the same will be noticed by the readers of the
financial statements (Türel, 2010).

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The company is obligatory to follow all the above-mentioned steps for making the
Consolidated Financial statements. If the company breaches in following any of the
above rules then company will be penalised for the same and will be called by laws.
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 (Judge and Pinsker, 2010). All the disclosure related to financial
statements of the company is made in the notes to accounts of that company so that
the person who reads 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.
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
 to owners of the parent.
Likewise, 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
to show profit attributable to:
 non- controlling interest
 the owners of the parent (Nobes, 2014)
this comes under the disclosure requirements of the company as the company has
the obligation to present this information in its consolidated books of accounts to

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make the financial statements presentable and as per the requirements of laws
(Epstein and Jermakowicz, 2010). The company is legally liable to follow the above-
mentioned steps for consolidation and if the company fails to do so then fines and
penalties will be imposed on the company.
In the above discussion company FAB Ltd need to prepare its financial statements
as per the requirements of AASB and also need to comply with above mentioned
steps for preparing its financial statements. The company also need to make the
statement of comprehensive income and has to show the amount allocated to 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 (Doupnik and Perera,
2011). 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 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.

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Conclusion:
The conclusion of the above discussion is that Business Combination is all about
mergers and acquisitions. The substantial interest decides the method by which one
company can attain rights in another company and the methods also variates in the
disclosure requirements. Th company needs to analyse by itself as if in which
context they want to take over the other company as if for the purpose of investment
or for the purpose of takeover. The transactions between the companies are intra
group transaction 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 completely
deleted in the consolidated books of accounts in proportion to the percentage of the
shareholding between holding and minority interest. The subsidiary and holding
company need to prepare their financial statements at the year end and the same
needs to be consolidated in the books of holding company. The company is bound to
follow all the above-mentioned requirements of consolidation else consolidation will
not be valid and company will be penalised for not adhering to the rules and
regulations.

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