Accounting Treatments in Business Combination and Consolidated Financial Statements

This report explains the accounting treatments in business combination and consolidated financial statements. It discusses the differences between equity method and consolidation accounting, and how to handle intra-group transactions. It also covers the computation of non-controlling interest. The report is relevant for accounting students studying business combination and consolidation.

COVER PAGE

EXECUTIVE SUMMARY
The main purpose of the report is to show the various accounting treatments involved in case of
business combination, consolidated financial statement. Separate and consolidated financial
statements, non-controlling interest, how the company will consider the effect of inter group and
intra group transactions. In case of inter group and intra group transactions whether profit to be
included in the books of accounts of the firm or the same will be excluded. The firm should consider
equity method of accounting or consolidation accounting treatment as a better accounting
treatment.

Contents
INTRODUCTION............................................................................................3
PART A.........................................................................................................3
Key differences between the Equity method of Accounting and
Consolidation Accounting.........................................................................3
PART B.........................................................................................................4
PART C.........................................................................................................5
Conclusion...................................................................................................7
References..................................................................................................7

INTRODUCTION
The report seeks to explain the concepts of consolidation of accounts,
presentation and computation of Non- Controlling interest, methods of
accounting for acquisition along with elimination of any intragroup
transactions for consolidation.
The report presents a brief outlay how the AASB inks out merger,
acquisition and consolidation of accounts of parents and subsidiary which
is in alignment with IFRS.
PART A
A business combination is a type of transaction in which one company
obtains the controlling power of another entity. It is a very common
method for the company to grow its operations through business
combination rather than growing through internal operations and
management. (Accounting Tools.com, 2019)
The main objective of this particular standard is to improve the reliability
and comparison of the information provided in the financials of the
company about the business combination and its effects. This standard
establishes the following principles:
 Recognition of assets acquired in the financial statements of the
company, the liabilities and any non controlling interest part in the
acquire.
 Recognition of good will value if any gained in case of business
combination
 Determination of value to be disclose in the financial statement of
the company for the end user of the firm. ( Commonwealth of
Australia , 2015)
AASB 128 Investments in Associates and Joint Ventures ,the main purpose
of this standard is to set the accounting process for investment in
associates and the application of the equity method when doing
accounting for the investment in associates and joint ventures. (jade.io,
2017)
AASB 10 Consolidated Financial Statements, the main objective of this
particular standard is to define the principles for the preparation of the
financial statements of the company when the firm controls other entities
also.
Key differences between the Equity method of Accounting and
Consolidation Accounting

The internal and general reporting of an individual company needs not to
be consolidated buy if a firm owns more than 50 percent shares of
another company the firms needs to consolidate all the accounts. The
company also has an option to choose between two methods either equity
method or cost method. If the firm is holding shares of another company
in the range of 20 and 50 percent than the firm should go for equity
method for accounting its transactions. If the firm owns more than 50
percent shares of another entity then the firm should consolidate its books
of accounts.
Consolidating the financial statement means combining the entity balance
sheet and profit and loss statement together to maker it a one
statement.In case of equity method such combination of the financial
statement is not done but it is shown as an investment in associates in
balance sheet and income received from the subsidiary in the profit and
loss statement. (McBride, 2017)
Above both the method can also be explained with an example like if
company A is holding 40 percent shares of company B and company B has
earned a profit of $ 50 million ,than the profit of $(50*40%)=$20 billion
will form part of the income statement of company A ,even though the
same amount has not been paid .
In case of consolidation accounting company, A would require to include
all the income, expenses and profit of company B together in the financial
statements. Than the company A would exclude from it the percentage of
ownership which is not owned by company A.If company A is holding 60
percent of shares in company B ,than it would report total $50 million
profit in the profit and loss statement and then one entry will be passed
labelled as minority interest that deducted the $20 million profit that it
does not own. (Kennon, 2019)
On the basis of above it can be said that consolidation method of
accounting is more complicated as compared to the equity method
accounting. In consolidation more accounting entries needs to passed and
it is more time-consuming process as compared to equity method of
accounting.
PART B
AASB 10 and AASB 127 Consolidated Financial Statements the main
objectives is the establishment of the principles for the preparation and
presentation of financial statements and this standard does not deal with
Business Combinations(AASB 3) and also any goodwill if any arise in case
Business Combination. (jade.io, 2016)

Intra group transactions are the transactions between the companies .The
transactions between the group must be definitely removed from the
consolidated accounts of the company so the profit of the company and
net income is not inflated . (Vernimmen.com, 2017)
When the intra group transactions between the two companies is
frequent, the other company is acquired because the trading is done
frequently. It became sensible to acquire that particular company so the
supply of goods become easy and secured. This type of situation lead to
difficulty in accounting treatment as each entity is a separate legal entity
and will record transactions on its own. However, when the consolidation
of accounts is done, adjustments is required to be done in order to reflect
this as single economic entity.
In case of intra group transactions there is a transaction between the
parent company and the subsidiary, so the problem which might rise
between two groups are listed here in below:
 Receivables and Payables in both the books
 Purchases and sales in both the company books.
 Unrealized profit on sale of inventory also needs to be eliminated.
In our case the CFO reported that a partially owned subsidiary provided
professional services and sold inventory to the parent company JKY Ltd at
a profit. The CFO is seeking clarification from the board in relation to
whether profit should be deducted from the subsidiary’s reported profit for
the sale of inventory and for providing the professional services to the
parent entity. In the above transaction assuming entire stock of the
company has been sold and for the same profit is also realized, then no
adjustment entry is required to be made for such unrealized profit.
If few stock has not been sold and is lying at the end of the financial year
in the books of an entity then the firm is also required to pass an
additional adjustment entry for the same ,whatever the profit component
included in the subsidiary ledger or subsidiary books of accounts need to
be erased and the stock value needs to be bought down to the original
figure of cost and an entry need to be passed in the books of accounts of
the firm. The account of the cost of sales of the subsidiary needs to be
debited and the inventory needs to be credited with the same amount.
Computation of the value of the profit which is unrealized and is lying in
the stock of the company, firstly the entity needs to properly value of
stock which is lying in the go down and relates to intra group transactions.
Accordingly profit part needs to be eliminated from the same by doing a
mark-up margin on inventory value. The taxation aspect also needs to be
taken care of as the profit will be reduced and the tax liability will also be
reduced by some value.

PART C
The term non-controlling interest is captured under AASB 127 of the
Accounting Standards issued by Australian Standard Board. The term
represents the equity portion of the subsidiary which is not under the
control of the parent either directly or indirectly through other
subsidiaries. For instance, if a company A holds 80% stake in company B
than the 20% stake which is not in control of the parent shall represent
non-controlling interest and shall be shown separately in the consolidated
Financial Statement.
Further, in terms of AASB 127, parent entity consolidates the account of
subsidiary with its books of account and presents the combined result as if
the two entities are a single economic unit. Also, in the standard control
has been defined as to govern the financial and operating activities of the
subsidiary so as to obtain a benefit.
In terms of requirement of AASB 127, a parent must consolidate and
presents the account of subsidiary every year along with its standalone
statement. The computation of preparation of consolidation of accounts
involves line by line consolidation whereby the asset of subsidiary is
added to the asset of the parent. Similar event takes place with the
liabilities whereby the liabilities of subsidiary are merged with that of
parent in order for presentation of consolidated statement.
However, there is an exception to above line by line consolidation as the
investment standing in the books of parent as on date of acquisition is
removed while consolidation and correspondingly the equity segment of
the subsidiary is eliminated to create a balance.
Apart from above, if at the date of purchase of company if the assets of
the subsidiary are revalued on account of fair value accounting, then such
fair value shall be taken into consideration for consolidation post
adjustment of any depreciation, amortisation or impairment applicable if
any. Similar is the case with the liabilities, if any liabilities which are
recognised at the date of purchase of shares of the subsidiary but were
not recorded in the books of subsidiary, the same shall be considered
while preparing the consolidated books of accounts of the company.
Also, the consolidation of books takes place post elimination of intragroup
transactions and any unrealised profits in the books of company on
account of such intragroup transaction. Further, any balance outstanding
by parent to subsidiary and vice versa shall be eliminated while
consolidating accounts.
Post above, if at the date of consolidation if the net asset of the company
exceeds the purchase consideration than the same shall be recorded as
gain on bargain purchase and shall be taken into consideration while
consolidating accounts and computing the value of NCI. However, if the
opposite happens Goodwill shall be recognised.

There are two methods of accounting of goodwill i.e. partial goodwill
method and complete goodwill method. Under the first method, goodwill
is recognised to the extent of difference between the fair value of the
asset and the purchase consideration while under full goodwill method the
goodwill is recognised at 100% and even Non-controlling interest
encompassed the fair value of Goodwill.
Post above, the computation of Non-controlling interest involves the
following elements the component of share capital contribution, retained
earnings as on date of acquisition, revaluation surplus as on date of
acquisition, any profits in proportion that have accrued post acquisition to
minority etc.
Further, the non-controlling interest does not form of equity in the
consolidated balance sheet as is represented as liability in the
consolidated balance sheet.
Let us understand the computation of non-controlling through an
example, suppose there is an entity X which acquired 80% of the stake of
Y limited for $ 200,000 while the 80% fair value of net asset as on date of
acquisition is $ 160000. Accordingly, the Goodwill shall be recognised as
$40000 in the consolidated financial statement in case of partial goodwill
method. Further, supposedly post acquisition, Y limited made a profit of $
50000 in the next year, then the value of Non-controlling Interest in the
books of the company shall be $ 40000 as on date of acquisition as
increased by $ 50000*20% = $ 10,000 representing post acquisition
profits.
Conclusion
On the basis of above, it can be understood that consolidation of accounts
is a complex process and requires a lot of precision as various nitty gritty
has to be taken into account while consolidating the accounts of
subsidiary in the books of parent and computing the non-controlling
interest. Thus, an in-depth research on the subject matter can help in
developing better knowledge of the subject matter.
References
Commonwealth of Australia , 2015. Business combinations. [Online]
Available at:

https://www.aasb.gov.au/admin/file/content105/c9/AASB3_08-15.pdf
[Accessed 27 May 2019].
Accounting Tools.com, 2019. Business Combination. [Online]
Available at:
https://www.accountingtools.com/articles/2017/5/10/business-combination
[Accessed 27 May 2019].
jade.io, 2016. Consolidated Financial Statements. [Online]
Available at: https://jade.io/j/?a=outline&id=503698
[Accessed 29 May 2019].
jade.io, 2017. Investments in Associates and Joint Ventures. [Online]
Available at: https://jade.io/j/?a=outline&id=585125
[Accessed 29 May 2019].
Kennon, J., 2019. Cost, Equity, and Consolidated Methods. [Online]
Available at: https://www.thebalance.com/cost-equity-consolidated-
methods-357583
[Accessed 29 May 2019].
McBride, C., 2017. Choosing Between Equity Method and Consolidation for
External Reporting. [Online]
Available at: https://bizfluent.com/way-7218874-consolidation-vs--equity-
method-accounting.html
[Accessed 29 May 2019].
Vernimmen.com, 2017. Definition for : Intra-group transactions. [Online]
Available at:
http://www.vernimmen.com/Practice/Glossary/definition/Intra-group
%20transactions.html
[Accessed 29 May 2019].