Analysis of Goodwill Calculation Methods: Expander & Target

This report provides a comprehensive analysis of goodwill calculations in the context of a business combination, specifically focusing on the acquisition of Target plc by Expander plc. It explores the impact of different types of consideration, including cash, deferred consideration, and contingent shares, on goodwill valuation. The report delves into the full goodwill method, contrasting it with the proportion of net asset method (partial goodwill). It explains the treatment of non-controlling interests (NCI) under both approaches and provides detailed calculations to illustrate the differences in goodwill amounts. The report highlights the effects of each method on the balance sheet and overall financial reporting, offering valuable insights into the practical application of IFRS 3 in accounting for business combinations.

ACCOUNTING

Table of Contents
INTRODUCTION...........................................................................................................................1
a) Affects of nature of consideration on the calculation of goodwill..........................................1
b) Discussion of the concept full goodwill.................................................................................3
c) Effect of selecting the full goodwill method rather than the proportion of net asset method.3
d) Appropriate accounting policy to adopt in respect of measuring non-controlling interest at
acquisition...................................................................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7
.........................................................................................................................................................7

INTRODUCTION
IFRS 3 provides informations to improve the relevance, reliability and comparability of
data provided for business combinations like acquisitions and mergers. It also describes about
their effects on calculations of goodwill. It regulates and frames the principles on the recognition
and measurement of assets and liabilities which is acquired by parent company.
In this assignment, the present scenario's indicates that there are two companies Expander
plc and Target plc, in which Expander plc is going to acquire 70% stake in Target plc. Hence,
through this assignment, calculation of goodwill both measuring non-controlling interest and full
goodwill methods will be done.
a) Affects of nature of consideration on the calculation of goodwill
In this present scenario, consideration is given in three parts which is; Cash purchases,
acquisition through future lending of money and contingent shares (Bebbington, Unerman and
O'Dwyer, 2014). Below is the explanation of considerations with the affect on calculation of
goodwill:
NCI at %NA NCI at FV
£m £m
Consideration
Cash at acquisition 5000 5000
Deferred Consideration 992.75 992.75
Issued Expanded Shares 4900 4900
Contingent shares 4000 4000
Total Consideration 14892.75 14892.75
NCI 2058 3200
A 16950.75 18092.75
Less FV of NA
Ordinary share capital 400 400
Retained earnings 1460 1460
Fair value adjustments 5000 5000
B 6860 6860 Variation
Goodwill at acquisition(A-B) 10090.75 11232.75 1142
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Cash at acquisition: In the above calculation of total purchasing cost of 70% stake of
Target plc, cash purchases indicates instant payment of £5000 million at the time of acquiring
stakes. This consideration doesn't carry any future value or discounted value, as there's
immediate payment done by Expander plc at the time of acquiring such assets.
Issued Expander Shares: Expander plc has issued 1 shares for every 2 shares acquired
by the company. So, it has acquired 280 million shares of Target plc having value of £1 per
share. In this method, Expander has acquired the 70% stake in exchange of 140 million (280
million/2) shares having face value £35 per share. The total value of this share is around 140
million shares * £35 per share = £4900 million.
Deferred consideration for two years: In this consideration, Expander plc has promise
Target plc to pay £1100 after two years. But after discounting this amount @5% for two years,
the actual identified is £992.75 million. Deferred consideration should be measured at fair value
at the date of the acquisition, like for example it is a promise to pay an agreed sum on a
predetermined date in the future taking into account the time value of money with given
formulae:
Future value of Deferred Consideration = £1100 * (1 - 0.05)2 = £1100 * (.95)2 = £992.75
Discounting of cash payment is done to know accurate value of the investment. Because
according IFRS 3, present value should be included while calculating purchasing cost of
acquisition (IFRS 3 and IAS 27, 2009).
Contingent Shares: Contingent consideration should be measured at reasonable prices
during practical combinations and kept in mind in determining goodwill (Chaney, Faccio and
Parsley, 2011). If, after the acquisition, the number of contingency consideration changes as a
result of meeting an earnings target. The contingent shares of amount £4000 million is given.
These changes is dependent on whether the additional consideration is described as an equity or
an asset or liability.
Below is the calculation of Goodwill:
Partial Goodwill Calculation:
Amount £ Million
Cash at acquisition 5000
Deferred Consideration 992.75
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Issued Expanded Shares 4900
Contingent shares 4000
Total Consideration 14892.75
NCI 2058
A 16950.75
Less FV of NA
Ordinary share capital 400
Retained earnings 1460
Fair value adjustments 5000
B 6860
Goodwill 10090.75
In the above figure, goodwill is calculated by proportioning Non-controlling Interests at
rate of 30% from face value of assets and liabilities (Denison, 2010). Below is the effect of
considerations on goodwill calculations:
Cash Purchases: It is added to purchasing cost paid by Expander. It increases the value
of purchasing cost by £5000 million. There's no effect of future value on this consideration, as
due to instant cash payment.
Shares: The value this consideration effected the value of goodwill by increasing the cost
of purchasing by £4900 million. As the shares is issued instantly, so there will no discount rate
applicable to the value of shares.
Cash Payment after two years: This consideration has increases the value of goodwill
by £992.75. As the value of cash today is £1100, but after discounting it by 5%, its value would
be reduced and simultaneously declines the value of goodwill at a same rate.
Contingent Shares: These shares are not in real, its just depends on the probability of
occurrence of an event (DRURY, 2013). But according to IFRS 3 act, it has to included in the
calculation of acquiring cost and thus increases the value of goodwill.
b) Discussion of the concept full goodwill
In this method, goodwill is calculated by subtracting total fair value paid by company on
its acquisition and total value of acquiree identifiable net assets (Flamholtz, 2012). Full goodwill
method is mandatory and required by US GAAP and permitted as an option by IFRS.
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Many acquisitions have been made in which the acquirer receives more than 50% but less
than 100% ownership. There are two possible ways to calculate goodwill in such circumstances:
The total fair value of the company and the net worth of the worthless identities (which is the
complete good faith method) or the difference between the purchase price and the fair value of
the acquisition pure identity Qualified assets. Below is the example of full goodwill method:
Full Goodwill calculation:
Amount £ Million
Cash at acquisition 5000
Deferred Consideration 992.75
Issued Expanded Shares 4900
Contingent shares 4000
Total Consideration 14892.75
NCI 3200
A 18092.75
Less FV of NA
Ordinary share capital 400
Retained earnings 1460
Fair value adjustments 5000
B 6860
Goodwill 11232.75
In the above calculation of goodwill through full goodwill method, it could easily
differentiated between calculation method of partial goodwill and full goodwill (Godfrey, 2010).
It was found that there's £1142 million variance between two methods. It indicates that, full
goodwill method has increased the value of it by £1142 million. The full goodwill method will
increase value of net assets on the balance sheet, which means that any future damage of
goodwill will be greater.
c) Effect of selecting the full goodwill method rather than the proportion of net asset method
Proportion of net asset method is based on calculation of percentage left after acquisition,
it is also know as partial goodwill method (Hall, 2012). In the case of Expander plc, 30% is left
after acquisition and hence it will be considered for calculation of goodwill.
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Before calculating proportion of net assets, it is necessary to calculate Net assets and
liabilities of Target plc. Below is the calculation of Net assets value of Target plc:
Face value of Assets and liabilities of Target plc
Ordinary share capital 400 400
Retained earnings 1460 1460
Fair value adjustments 5000 5000
Total 6860 6860
In the above calculation, 70% of retained earnings is added with fair value of Targets net
assets because, 30% of retained earning is already included in calculations of non-controlled
interests. According to IFRS, Acquirers are necessary to value brands, licences and customer
relationships, and other intangible assets (International Financial Reporting Standards, 2008).
The basic common difference between these two methods is treatment of NCI which is
non-controlling interests (Kieso, Weygandt and Warfield, 2010). Hence, in partial goodwill
method, NCI is calculated in the following steps given below:
 Calculation of fair value of non-controlled interest (fair value of equity) This is the price
at which you can expect to sell your share in the market appropriately (Macintosh and
Quattrone, 2010). For example, Expander plc has 70% stake in Target plc, then
remaining 30% is the non-controlled interest in Target plc. The fair value of non-
controlling interest is 30% of £5000 million which is £1500 million.
 After this, Expander plc has to adjust any profit or net earnings during the year. Like for
example, Target plc has recorded £1,460 million retained earnings in acquisition year.
Hence, 30% of £1,460 million which is £438 million would be added to non-controlling
interests. Therefore the final amount would be £1,500 million + £438 million = £1938
million.
 After this, the next step is to subtract dividends paid during the year to companies
shareholders (Romney and Steinbart, 2012). As there's no such dividends paid by Target
plc, so there were no subtraction in the calculations of NCI above.
 The final face value would be recorded in the equity and shareholder portion of
consolidated balance sheet of Expander plc.
Below is the table of calculation for NCI:
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Partial good will: Amount £ Million
NCI 5000 30.00% 1500
Retained earnings 1460 30.00% 438
Total NCI 1938
Likewise there's also some steps in the method for calculation of full goodwill, these
method is explained below:
As it is given that Expander plc has acquired 70% shareholding in Target plc for
£14502.75 million. Book value of net identifiable assets of Target plc is £5000 million. The first
input requires for calculation of goodwill under full goodwill method is the fair value of Target
plc. If 70% of Target's plc is worth £14502.75 million then 100% of Target's plc worth would be
equals to £20710 million. The fair value of net identifiable assets of Target plc is equals to book
value +/- adjustments in its fair value. Hence, the fair value which is given above is £5000
million and the value of full goodwill would be (£20710 million - £5000 million = £15710
million). But the value of NCI is already given in the scenario, which is £3200 million. Therefore
this non-controlled interest value is considered for the calculation of goodwill through full
goodwill method. Some of the basic difference between both methods is given below:
 Under the full goodwill method, value of goodwill is allocated to both Expander plc and
Target plc. Company requires to use face value of subsidiaries because it includes value
of implied goodwill. So, after instant acquisition the value of non-controlled interest
would be NCI = Face value of Subsidiaries * 30%. While under Partial Goodwill method,
Expander plc's share of goodwill is considered. The NCI is still adjusted for revaluation
of Subsidiary Net assets instantly after acquisition, the formulae is NCI = Face value of
Subsidiaries Net assets * 30%.
 In full goodwill method, total value of goodwill is identified on consolidated basis while
in case of partial goodwill method, only portion of net assets of Expander is recognised
on consolidated basis. Hence, under partial goodwill, the face value of subsidiaries net
assets is to be considered in identifying Non-controlled Interests, not the total implied fair
value of subsidiaries.
Hence, it is clear that partial goodwill value is less than full goodwill, as in the calculations
of both partial and full method it is shown that full goodwill is giving the value of NCI as £3200
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million. As this would be calculated on the basis of those factors which are not mention in Assets
and liabilities side of Target plc, so it is mandatory to consider full goodwill methods for
calculating goodwill of the company.
d) Appropriate accounting policy to adopt in respect of measuring non-controlling interest at
acquisition
There are basically two ways to identify goodwill of the company, in a business
combination, Expander could calculate goodwill either by partial or full goodwill method:
Partial goodwill method: In this method, Expander would measure value of assets and
liabilities, it could only recognize these value of goodwill with controlling interest in Target plc.
Full goodwill method: This method is fundamentally same as partial method of
calculating goodwill, but there's mainly one difference which is non-controlling interests is
included in goodwill.
Both methods are advisable and the company might choose either methods depends on
different circumstances to keep consistency for every acquisition. It is also recommended to the
company, that it should calculate NCI by considering full goodwill method, because this method
recognises and allocated goodwill among Expander and Target plc both at a time.
The purchasing cost is simply based its value on market prices of the share which it
doesn't hold. When the market is not active, then it is suggested to Expander plc that it should
calculate its purchasing cost of a company to measure fair value through using other valuation
techniques such as:
 A measurement of market that contains multiple of market for traded companies and
which is comparable to Target plc.
 Valuation of income on the basis of future value analyses through discounted cash flow
analyses.
CONCLUSION
On the basis of all calculations and observations it could be concluded that IFRS 3 is
necessary to be considered, as it provides informations to improve the relevance, reliability and
comparability of data provided for business combinations like acquisitions and mergers. It also
describes about their effects on calculations of goodwill. There are basically two ways to identify
goodwill of the company in a business combination which is partial or full goodwill method. On
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the basis of all calculations and comparative analysis between these two methods, it is clear that
full goodwill method is good choice for Expander but at the same time company should consider
other alternative method also.
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