Financial Accounting and Reporting 2: Power Ltd Business Combination

This report, prepared by a graduate accountant for Power Ltd, addresses key accounting issues related to business combinations and consolidations, specifically concerning the acquisition of Cargo Limited. The memorandum explores the treatment of assets and liabilities at fair value, recognition of equity accounts, and application of Australian Accounting Standards (AASB). The report delves into fair value adjustments in consolidation, the use of the business combination revaluation reserve, and the indefinite existence of equity accounts. The analysis includes discussions on contingent consideration, valuation entries, revaluation surplus, and the classification of equity or financial liability. The report concludes with a discussion on the implications of business combinations, the treatment of equity accounts, and the overall accounting treatment for the acquisition, providing a comprehensive overview of the financial accounting aspects of business combinations and consolidation.

Running head: FINANCIAL ACCOUNTING AND REPORTING 2
Financial accounting and reporting 2
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FINANCIAL ACCOUNTING AND REPORTING 2
MEMORANDUM
From: Julia Edwards ([e-mail])
Through: Graduate accountant
To: Daniel Ford
Director power limited
510 William Street
Melbourne, VIC 3000
Date: 14th May, 2019
Subject: Accounting issues: Business combination and Consolidation
Dear Daniel,
This memorandum is in response to the e mail received by you and addresses the key
accounting issues related to the business combination and consolidation in relation to the
acquisition of Cargo limited by Power Limited. The objective of writing this memorandum is
to address the accounting issues that you have pointed regarding the treatment of assets and
liabilities at the fair value and recognition of equity accounts. I would be explaining all the
issues raised by you in reference with the Australian accounting standard board which would
make it easier for you to understand the accounting treatment regarding the concerned
accounts.

FINANCIAL ACCOUNTING AND REPORTING 2
The first issue raised by you was regarding the adjustment of fair value in the
accounts of Cargo Limited or in the consolidation worksheet. The acquisition of the group of
assets or assets that does not constitute the business, in such scenario, the recognition and
identification of the individual assets acquired by the acquirer is done if the assets meet the
definition of the recognition criteria at the date of acquisition as in accordance with the
Australian accounting standard. The recognition principle as mentioned in the paragraph 10
of AASB 3 that the acquirer at the date of acquisition shall recognize the identifiable assets in
the acquiree’s account separately from the goodwill (Su and Wells 2018). In order for the
liabilities and assets to be qualified for recognition, the assumed liabilities and assets must be
a part of the acquirer and acquiree. The identifiable assets and liabilities shall be measured by
the acquirer by assuming the acquisition date fair values. Unless other measurement basis is
required by AASB, all the items of non controlling interest should be measured at the fair
value acquisition date. However, there is a limitation imposed on the recognition principles as
mentioned in the paragraph 22-31 of the AASB 3 (Bond et al. 2016). It is essential for the
acquirer to perform the valuation of the liabilities and assets if the book value of the liabilities
and assets are more than the existence of contingent liabilities. The changes in the fair value
in the event of contingent consideration should be recognized by the acquirer after the date of
acquisition.
In addition to this, the consolidation worksheet is prepared only for the purpose of
consolidation and the adjustments in the consolidation account are done every time when the
consolidation accounts are prepared. Any adjustments to the fair value are done by the
valuation of business combination and the recognition of the differences in the value of assets
and liabilities should be done by the acquisition analysis (Aasb.gov.au 2019). Thereafter, the
valuation entries of the business combination are adjusted in the worksheet of the
consolidation account.

FINANCIAL ACCOUNTING AND REPORTING 2
The next issue that you have asked to address is about the usage of the equity account
during the revaluation of the assets in the case of acquisition. The equity account that is used
in the event of revaluing the assets is the business combination revaluation reserve. In the
event of revaluation surplus which indicates an upward change in the value of capital assets is
identified in the equity account. If there is subsequent disposition of the revalued assets, then
the remaining amount of revaluation surplus is credited to the account of retained earnings of
the acquired entity (Aasb.gov.au 2019). Furthermore, the revaluation surplus should be
directly transferred to the retained earnings by the acquirer. This is done in the event when
recognition of the revaluation surplus is done in the statement of comprehensive income
which on the disposal of assets is directly transferred to the retained earnings.
Therefore, in the event of consolidation or in preparation of the consolidated financial
statements after acquisition, the revaluation of the assets and the surplus or deficit recognized
is included in the consolidated worksheet. Any upward valuation of the assets that results in
capital gain is not recorded in the income statement of consolidated entity, rather the amount
recognized as revaluation surplus is directly credited to the equity account of shareholders
which is known as revaluation surplus. The upward valuation of all the assets of company is
held in the revaluation surplus account until all the assets are disposed off. On other hand, in
the event of downward revaluation, the initial amount is not recorded in the statement of
comprehensive income and the amount is recorded in the shareholder equity as the
revaluation surplus under the comprehensive income (Dunbar and Laing 2017). Thus, there is
a decrease in the net income resulting from higher depreciation and an increase in the value
of shareholders equity due to upward valuation of the assets. Hence, in the scenario of
recognition in excess, different equity accounts should be used in relation to the liabilities
recognition.

FINANCIAL ACCOUNTING AND REPORTING 2
The third issue that is required to address is that whether the equity account would
remain existent indefinitely. The identified issue in the given case can be addressed by
referring to the applicable accounting standards. The equity account after the acquisition of
Cargo limited by Power limited public company is no longer related to the equity account
that is recognized by the acquired company itself. In order to meet the definition of the
financial instruments as equity or financial liability based on the definition in accordance
with the paragraph 11 of AASB 132 financial instruments, it is required by the acquirer to
classify the obligation for payment of contingent consideration (Gheorghe 2016).
The remeasurement of the previously held equity interest shall be done by the
acquirer at the fair value date of acquisition and the resulting loss and gain should be
recognized in the statement of comprehensive income when and as appropriate. In the case of
business combination that is affected primarily by exchanging the interest in equity, the entity
issuing the equity interests are usually the acquirer. However, in certain situation, acquire is
the issuer of equity in the event of reverse acquisition. Therefore, the new entity that is
formed after the business combination is not necessarily the acquirer and if the formation of
new entity is done for affecting the business combination, then identification of the entities
before the business combination in accordance with the AASB 3 Business combination
(Aasb.gov.au 2019). It can be observed from the analysis presented above that either the
acquirer or the acquiree can be the issue of equity depending upon the circumstances. It is
certainly possible that the two companies might opt for separation and operating as the single
entity by eliminating the affects of the business combination. Thus, the equity account cannot
remain in existence indefinitely. Moreover, the equity account in the acquisition of the Cargo
limited by Power Company is recognized by the latter company, so the acquired company’s
equity account can remain in existence only for definite period.

FINANCIAL ACCOUNTING AND REPORTING 2
The above discussion made by me has addressed all the issues raised by you. I hope
that my answer to the identified queries would assist the board members and directors in
gaining an understanding of the concepts and accounting treatment in relation to acquisition.
Regards,
Graduate accountant
Power Company limited

FINANCIAL ACCOUNTING AND REPORTING 2
Bibliography:
Aasb.gov.au. (2019). [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB9_12-14.pdf [Accessed 14 May
2019].
Aasb.gov.au. (2019). [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB3_08-15.pdf [Accessed 14 May
2019].
Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairments by
Australian firms and whether they were impacted by AASB 136. Accounting &
Finance, 56(1), pp.259-288.
Dunbar, K. and Laing, G.K., 2017. Deconstructing the Accounting Standard AASB 13 Fair
Value: Exit vs Entry Price for Assets. Journal of New Business Ideas & Trends, 15(2).
Gheorghe, H., 2016. Accounting Treatment For Commercial Discounts On Goods Purchased
For Resale. Annals-Economy Series, 2, pp.173-177.
Su, W.H. and Wells, P., 2018. Acquisition premiums and the recognition of identifiable
intangible assets in business combinations pre-and post-IFRS adoption. Accounting Research
Journal, 31(2), pp.135-156.

FINANCIAL ACCOUNTING AND REPORTING 2