Corporate Takeover Decision Making and the Effects on Consolidation Accounting

This assignment explores the effects of corporate takeover decision making on consolidation accounting. It covers topics such as business combinations, acquisition accounting methods, intra-group transactions, and non-controlling interest disclosure in consolidated financial statements.

Holmes Institute
Corporate and Financial Accounting
Corporate Takeover Decision Making and the Effects on Consolidation Accounting
Name of the Student
5/26/2019

Executive Summary
The main purpose of the assignment is to extend knowledge in the area of business
combinations, the corporate group wherein multiple entity forms a single group for the
purpose of consolidation, the acquisition accounting methods, intra group transactions and its
elimination and accounting and accounting and recognition of non-controlling interest and its
disclosure in consolidated financial statement.
With reference to AASB 3: Business Combinations, AASB 128 Investments in Associates and
Joint Ventures, AASB 101 Presentation of Financial Statements and AASB 10 Consolidated
Financial Statements the accounting to be made and adjustment to be made for disclosure
and presentation of financial statements.

Table of Contents
Executive Summary....................................................................................................................2
Introduction.................................................................................................................................4
Answer to Question Part A.........................................................................................................5
Answer to Question Part B.........................................................................................................7
Answer to Question Part C.........................................................................................................9
Conclusion................................................................................................................................11
References...............................................................................................................................12

Introduction
Part A of the section addresses with reference to AASB 3: Business Combinations, AASB
128 Investments in Associates and Joint Ventures and AASB 10 Consolidated Financial
Statements, the key differences in methodology between Consolidation Accounting and
Equity Accounting and introduces us to various method of consolidation accounting.
Part B of the section addresses with reference to AASB 127 Consolidated and Separate
Financial Statements and AASB 10 Consolidated Financial Statements the key principles
which explain how intra-group transactions should be treated in consolidated financial
statement
Part C of the section addresses with reference to AASB 127 Consolidated and Separate
Financial Statements and AASB 101 Presentation of Financial Statements, the effects of the
NCI disclosure requirement as a separate item in the consolidation process.

Answer to Question Part A
As per Appendix A to AASB 3: Business Combinations, a business combination is defined as
an event or a transaction through which the acquirer obtains control over one or more
businesses, so for a business combination to happen there should be an economic
transaction between two parties through which control of the business is transferred from one
party to another party. (StuDoc, 2018)
Therefore, from the above definition, one word, which comes out very prominently, is the
word control, which has been defined in AASB 10: Consolidated Financial Statement as a
condition in which the investor has right or is exposed to variable returns from its involvement
with the entity and also has the ability to influence those returns through its power over the
entity it controls. (StuDoc, 2018)
From the above two paragraphs, we can pen down the key characteristics that determines
when we need to prepare the consolidated financial statement:
 The existence of the economic transaction between two parties
 Control
In our case, let me first let you know the 2 method of accounting in case of consolidation,
“Consolidation Accounting” and “Equity Accounting”.
Under the Consolidation accounting, the parent company presents a single financial
statement in which both the financials of parent and subsidiary are combined. Under the
equity accounting method, the parent’s financial statement has a line item for investment
made in subsidiary which represents the owned share of subsidiary’s net assets, the equity
method of accounting is also sometimes known as one line consolidation since there is only
one line representing the net assets of subsidiary. (Subbarathnam, 2016)
Choosing between the equity method and consolidation, one must see at the control one
entity have over another. If an entity owns between 20% and 50% of another entity then the
entity should use the equity method to account for the subsidiary. If an entity owns more than
50 percent of a company, the firm should consolidate the financial statements. Ownership in
stock is considered as a general rule of thumb while pinning down on the method of
accounting to be used for consolidation. (StuDoc, 2018)
In case of consolidation method, when an entity buys another entity, it needs to record series
of events like measuring any tangible or intangible assets and liabilities that were acquired,
measuring the non-controlling interest in the business acquired, measuring the consideration
paid to the other entity and measuring the goodwill or bargain purchase on the other entity.
(Wrigh, 2018)
In case of equity method, there is only one line in the purchasing entity financial statement
which represents investment made in other entity and adjusted going forward up or down to
reflect the share of net assets of the entity.

Consolidation accounting is more complicated than equity accounting since multiple journal
entries are required to eliminate the subsidiary's equity, eliminate any intercompany
transactions, and record any non-controlling interest in the subsidiary. (Pat, 2017)
Suppose we buys 28% of the stock in a $1 million company – an outflow of $280,000 is
involved. Under equity accounting, we would report the $280,000 acquisition as an
investment on the statement of financial position. When the investee company announces
results, we would report 28% of the earnings as our income. (Sherman, 2019)
If it reports $200,000 of net income for the year, we report $56,000 of the same – 28% – as
earnings on our income statement. The value of the investment asset on our balance sheet
shall also increases by $56,000. On the other hand, if the investee company reports losses,
we adjust the asset's value down to the extent of value invested. (Sherman, 2019)
If we control the other entity, we may have to draw up consolidated financial statements
under consolidation accounting. The process involves adding the subsidiary's income,
expenses and assets to our own. If, say, our company generates $150,000 in revenue and
the subsidiary brings in $60,000, we report income of $210,000. Inter group transaction,
however needs to be eliminated and balance knocked off. (Sherman, 2019)

Answer to Question Part B
Before we get into the two types of Intra group transactions to be discussed, let us first get
into the definition of the Intra group transaction or what do we mean by intra group
transaction. As per AASB 10 Consolidated Financial statement, intra group transactions are
defined as transaction between two separate legal entity and forming part of the same group
entity or economic entity. (analystbank, n.d.) So intra group transactions are transactions that
occur in the normal course of business between entities in the same group, each entity
therefore records such transactions independently in the standalone books of accounts,
however the effects of all such transactions will be included in the consolidated assets,
liabilities, income and expenses when the separate financial statements are added together
and hence there is the need to eliminate these transaction upon consolidation. (StuDoc,
2016)
As per AASB 10 Consolidated Financial statement, the full adjustment for these intra group
transaction must be given in the consolidated financial statement and proper elimination must
be done for the effect of these intra group transactions on the intra group assets, liabilities,
income and expenses. (StuDoc, 2016)
The parent and the subsidiary may well do business in the normal course of business and
trade with each other during the reporting period and the following issues needs to be dealt
with: (StuDoc, 2018)
 Receivables and payables in each books need to cancel each other
 Sales and purchase effectively need to cancel each other
 Unrealized profit on sale of inventory needs to be eliminated
In our case, a partially owned subsidiary has sold inventory to the parent company JKY Ltd at
a profit. Firstly, we will assume that the entire inventory has been sold by the parent company
and hence the effect of intra group transaction will be as follows:
1. Consolidated Sales revenue = Parent’s revenue + Subsidiary Revenue – intra group
sales made
2. Consolidated Cost of Sales = Parent’s cost of sales + Subsidiary cost of Sales – intra
group purchase
3. Receivable in subsidiary books needs to be cancelled with payable in parent books
Since, all the Inventory has been sold and profit realized, there will not be any entry or
adjustment for unrealized profit. (Kaplan Financial Limited, 2012)
Secondly, in case some of the inventory sold are lying unsold as on date of preparation of
consolidated financial statement, then in addition to the above 3 entries we will have to pass

an additional adjustment wherein, the profit element included in the subsidiary’s accounts
needs to be eliminated and inventory needs to be brought down to the actual cost value, the
entry would be: (Kaplan Financial Limited, 2012)
Debit Subsidiary cost of sales (and therefore their retained earnings in the net asset working)
Credit Group inventory
In order to find the value of unrealized profit, we need to first determine the value of closing
inventory which in lying unsold at the reporting date and relates to intra group transaction,
compute the profit mark-up or margin to calculate how much of that value represents profit
earned by the subsidiary company and then pass the above adjustment in books. The profit
element in subsidiary books relates to both the parent as well as Non-controlling interest and
hence will be reduced for computation of non-controlling interest. (Kaplan Financial Limited,
2012)
Tax effect on above transaction also needs to be eliminated since the group profit in getting
reduced due to above transaction.
The transaction pertaining to providing of professional services to parent entity is more
simpler to eliminate than the above one. Quite often in a group, one entity provides certain
services to another entity in the same group to improve synergies within the group and hence
classify as intra group transaction and would require elimination under AASB 10
Consolidated Financial statement. (Kaplan Financial Limited, 2012)
In this case, the revenue in the books of subsidiary needs to be eliminated with the cost of
service in the books of parent and hence the entry in consolidated books will be as follows:
Debit Revenue for services
Credit Expenses for services
If any balances for payables/receivables exist in books then the same must also be
eliminated on consolidation. Since the revenue of subsidiary company is getting reduced, the
non-controlling interest will also get reduced to the extent of holding of non-controlling.
(StuDoc, 2016)

Answer to Question Part C
Consolidated Financial Statements represents financial statement of the group entity in which
the assets, liabilities, equity, income and expenses of both parent companies along with its
subsidiaries are presented as those of a single economic entity. While preparing the
consolidated financial statement, two basis process needs to be adhered to: (Wikipedia,
2019)
1. Addition of line by line item of assets, liabilities, income and expenses
2. Cancellation of all intra group transactions and unrealized profits
In addition to above, investment in subsidiary, which is an asset in parent company, needs to
be cancelled by equity and reserves in subsidiary company since only the parent equity and
reserve would be presented in consolidated financial statement. However, if the parent
company holds less than 100% but above 50% in the subsidiary company then that share of
ownership which is not owned or controlled by the parent company is referred to as Non-
controlling interest (NCI). (Wikipedia, 2019)
For example, suppose that Company X acquires a controlling interest of 60 percent in
Company Y. The latter retains the remaining 40 percent of the company. On its consolidated
financial statements, Company X cannot claim the entire value of Company Y without
accounting for the 40 percent that belongs to the minority shareholders of Company Y. Thus,
company X must incorporate the impact of company Y’s minority interest on its statement of
financial position and income statements. (Simlogic, 2019)
The treatment of NCI will come into place only if the parent holds more than 50% in the
subsidiary and less than 100%. The parent may hold less than 100% but more than 50% due
to reasons like parent may want to gain control by acquiring 51% or more of the equity but
would not want to take risk of investing upto 100% of the capital and put the whole capital at
risk. Secondly, it may also be difficult for the parent to acquire 100% equity in subsidiary as
there may be some shareholders who may not want to part with their shareholding and hence
acquiring more than 51% of shareholding gives parent the control over the entity without
much risk into capital loss. (Galstyan, 2019)
When a controlling interest in subsidiary is acquired, the consolidation method of accounting
is used wherein many line items in financial statement of the parent company incorporates
the corresponding line items of the subsidiary to reflect the fictitious 100% ownership of
subsidiary company. The parent however maintains separate account in statement of
financial position and profit or loss that monitors the value of minority interest in the
subsidiary as well as profit belonging to these minority shareholders. In the consolidated
financial statement, the Minority interest is normally reported “within equity” separately from

the parent entity representing the minority share of net assets in subsidiary company and in
the consolidated income statement, minority share is recorded as a share of minority
shareholder’s profit as per AASB 127 Consolidated and Separate Financial Statements.
(Galstyan, 2019)
Before we get into the calculation of Non-controlling interest, we will have to compute
Goodwill or bargain purchase on acquisition of controlling interest in subsidiary company.
Goodwill is an intangible asset in the consolidated financial statement and arises when the
cost for purchasing the shares in subsidiary company is higher than the net fair value of
assets acquired, to put it in more simpler way:
Goodwill = Fair value of consideration transferred
+ Fair value of NCI at acquisition date
– Share capital of the subsidiary company
– share premium of subsidiary company
– Retained earnings of the subsidiary company as on acquisition date
– Fair value adjustment to assets as on acquisition date
(Wikipedia, 2019)
In our case since the assets of subsidiary were recorded at historical cost at the control date,
fair value adjustment to assets have to be made to arrive at the Goodwill and fair value of
non-controlling interest as on control date.
Now the question arises, how do we measure the non-controlling interest at acquisition date
and subsequent adjustment to the same. There are steps to identify and measure non-
controlling interest:
First is to compute the fair value of non-controlling interest on the acquisition date, which in
our case would be the book value or the net asset value of the subsidiary company plus the
fair value adjustment of assets and liabilities multiplied by the share of ownership of minority
shareholders in the subsidiary company. (Galstyan, 2019)
Second step would be to compute the net income of subsidiary company post the acquisition
of control and multiply the same by minority share of ownership to arrive at minority share of
profit and the same is disclosed separately in the income statement as a separate line item of
non-operating item under the head “net income attributable to the minority interest”, on the
consolidated income statement. (Galstyan, 2019)
The above calculated NCI is required to be reported in Equity separately from the parent’s
equity and is considered as an important item in analyzing investments. It is used in
calculation of enterprise value and is treated much like a company’s debt and added to
market capitalization to arrive at company’s enterprise value.

Conclusion
Part A introduces us to the various method of consolidation accounting and outlines the key
differences between consolidation accounting and equity accounting and how disclosure is
being made in both the sets of accounting, how control over the other entity defines the
method to be used for consolidation.
Part B introduces us to the intra group transaction of inventories and professional services
and how the same is required to be eliminated while consolidating financial statement.
Part C introduces the concept of Non-controlling interest (NCI) and how the same is
computed and disclosed in the consolidated financial statement. It states how should be
compute the NCI and disclose the same as equity separate from parent equity.

References
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Available at: https://www.quora.com/What-is-the-difference-between-consolidation-accounting-and-the-
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