Chapter 12 Complex Groups

LEARNING OBJECTIVES 1.         Apply the method of accounting for business combinations, including complex group structures (vertical and D-shaped/mixed groups). 2.         Determine the appropriate procedures to be used in preparing group financial statements.

 

1.       Vertical Groups

1.1       Effective shareholdings

1.1.1    A vertical group arises where a subsidiary of the parent entity holds shares in a further entity such that control is achieved. The parent entity therefore controls both the subsidiary entity and, in turn, its subsidiary (often referred to as a sub-subsidiary entity). Look at the two situations:

Situation 1:	Situation 2:

In situation 1, H has an effective interest of only 72% (90% × 80%) in S2. Nevertheless, S2 is a sub-subsidiary of H because H has a controlling interest in S1 and S1 has a controlling interest in S2. As H has an effective interest in S2 of 72%, it follows that the non-controlling interest in S2 is 28%. This can be analysed as follows:

	%
Owned by outside shareholders in T	20
Owned by outside shareholders in H [(100% – 90%) × 80%]	8
Effective NCI in S2	28

In situation 2, H has an effective interest of just 42% (70% × 60%) in S2. Nevertheless, S2 is a sub-subsidiary of H because H has a controlling interest in S1 and S1 has a controlling interest in S2. As H has an effective interest in S2 of 42%, it follows that the non-controlling interest in S2 is 58%. This can be analysed as follows:

 

	%
Owned by outside shareholders in T	40
Owned by outside shareholders in H [(100% – 70%) × 60%]	18
Effective NCI in S2	58

1.2       Group reserve

1.2.1    Only the group or effective percentage of each of the reserves of the sub-subsidiary are included within group reserves. Often the only reserve will be retained earnings, but there could be others, such as revaluation reserve.

1.3       Date of acquisition

1.3.1    The date of acquisition of each subsidiary is the date on which H gains control. If S1 already held S2 when H acquired S1, treat S1 and S2 as being acquired on the same day.
1.3.2    Consider the following situations to determine when the sub-subsidiary company, S2, becomes a member of the H group:
(a)        H acquired control of S1 on 1 January 2004; S1 subsequently acquired control of another entity, S2, on 1 July 2006.

In this situation, S2 does not come under the control of H until S1 acquire shares in S2 – i.e. on 1 July 2006.

(b)        H acquired control of S1 on 1 July 2006; S1 had already acquired control of another entity, S2, on 1 January 2004.

Similarly, H cannot gain control of S2 until S1 acquires shares in S2 on 1 July 2006.

1.3.3

Example 1 – Full goodwill method

The draft statements of financial position of D, C and J, as at 31 December 2012, are as follows:   D C J   D C J Sundry assets 280 180 130 Equity capital 200 100 50         Retained earnings   100   60   30 Shares in subsidiary   120   80     Liabilities   100   100   50   400 260 130   400 260 130 You ascertain the following: (a)       D acquired 75,000 $1 shares in C on 1 January 2012 when the retained earnings of C amounted to $40,000. At that date, the fair value attributable to the non-controlling interest in C was valued at $38,000. (b)       C acquired 40,000 $1 shares in J on 30 June 2012 when the retained earnings of J amounted to $25,000; they had been $20,000 on the date of D’s acquisition of C. At that date, the fair value of the non-controlling interest in J (both direct and indirect), based on effective shareholdings, was valued at $31,000. (c)       Goodwill has suffered no impairment. Required: Produce the consolidated statement of financial position of the D group at 31 December 2012. It is group policy to use the full goodwill method. Solution: W1 Group structure   C J   Group interest 75% 60% (75% × 80%) NCI 25% 40% (25% × 80% + 20%)   100% 100%     W2 Net assets of subsidiaries at acquisition date   C J   At acq’n At acq’n   $ $ Equity capital 100,000 50,000 Reserves 40,000 25,000   140,000 75,000 W3 Goodwill A separate calculation is required to determine goodwill for each subsidiary. For the sub-subsidiary, goodwill is calculated from the perspective of the ultimate parent entity (D) rather than the immediate parent (C). Therefore, the effective cost of J is only D’s share of the amount that C paid for J, i.e. $80,000 × 75% = $60,000.   C J   $000 $000 Cost of investment 120 60 Fair value of NCI 38 31   158 91 Fair value of net assets (W2) (140) (75)   18 16 W4 Group retained earnings   D C J   $000 $000 $000 Per question 100 60 30 Less: Pre-acq. retained earnings   (40) (25)     20 5 Share of C (75% × 20) 15     Share of J (60% × 5) 3       118     Note that again, only the group or effective interest of 60% is taken of the post-acquisition retained earnings of J.   W5 Non-controlling interest   C J   $000 $000 NCI FV at acquisition 38 31 NCI share of post-acq. retained earnings (25% × 20,000 (W4)) / (40% × 5,000 (W4))   5   2 Less: NCI share of cost of investment in J (25% × 80,000)   (20)   -   23 33 Consolidated statement of financial position as at 31 December 2012     $000 Goodwill (18,000 + 16,000)   34 Sundry assets (280,000 + 180,000 + 130,000)   590 Total assets   624 Equity and liabilities     Equity capital   200 Retained earnings (W4)   118     318 Non-controlling interest (W5)   56 Total equity   374 Liabilities (100,000 + 100,000 + 50,000)   250 Total equity and liabilities   624

1.3.4

Example 2 – Proportion of net assets method

The draft statements of financial position of D, C and J, as at 31 December 2012, are as follows:   D C J   D C J Sundry assets 180 80 80 Equity capital 200 100 50 Shares in subsidiary   120   80   Retained earnings   100   60   30   300 160 80   300 160 80 You ascertain the following: (a)       C acquired 40,000 $1 shares in J on 1 January 2012 when the retained earnings of J amounted to $25,000. (b)       D acquired 75,000 $1 shares in C on 30 June 2012 when the retained earnings of C amounted to $40,000 and those of J amounted to $30,000. It is group policy to value the non-controlling interest using the proportion of net assets method. Required: Produce the consolidated statement of financial position of the D group at 31 December 2012. It is group policy to use the full goodwill method. Solution: W1 Group structure   C J   Group interest 75% 60% (75% × 80%) NCI 25% 40% (25% × 80%)   100% 100%   W2 Net assets of subsidiaries at acquisition date   C J   At acq’n At acq’n   $ $ Equity capital 100,000 50,000 Reserves 40,000 30,000   140,000 80,000 W3 Goodwill   C J   $000 $000 Cost of investment (75% × 80,000) 120 60 Fair value of NCI (25% × 140,000 (W2)) / (40% × 80,000 (W2))   35   32   155 92 Fair value of net assets (W2) (140) (80) Goodwill 15 12 W4 Group retained earnings   D C J   $000 $000 $000 Per question 100 60 30 Less: Pre-acq. retained earnings   (40) (30)     20 0 Share of C (75% × 20) 15     Share of J (60% × 0) 0       115     W5 Non-controlling interest   C J   $000 $000 NCI FV at acquisition (25% × 140,000) / (40% × 80,000)   35   32 Share of post-acq. retained earnings (25% × 20,000) / [40% × (80,000 – 80,000)]   5   0 Less: NCI share of cost of investment in J (25% × 80,000)   (20)   -   20 32 Consolidated statement of financial position as at 31 December 2012     $000 Goodwill (15,000 + 12,000) (W3)   27 Sundry assets (180,000 + 80,000 + 80,000)   340 Total assets   367 Equity and liabilities     Equity capital   200 Retained earnings (W4)   115     315 Non-controlling interest (W5)   52 Total equity   367

 

2.       Mixed (D-shaped) Groups

2.1       Definition

2.1.1    In a mixed group situation the parent entity has a direct controlling interest in at least one subsidiary. In addition, the parent entity and the subsidiary together hold a controlling interest in a further entity.

H controls 60% of S; S is therefore a subsidiary of H.
H controls 30% of T directly and another 30% indirectly via its interest in S. T is therefore a sub-subsidiary of the H group.

2.2       Date of acquisition

2.2.1    Suppose H acquired a 60% interest in S on 1 January 2012, and acquired its 30% interest on the same date. S subsequently acquired its 30% interest in T on 1 July 2012.

Initially, from 1 January 2012, H exercises significant influence over T as an associate entity. It is only from 1 July 2012 that H has access to more than 50% of the voting power in T; T is therefore consolidated into the H group accounts as a subsidiary from 1 July 2012.

Alternatively, suppose H acquired 60% interest in S on 1 January 2012, and acquired its 30% interest in T on the same date. S acquired its 30% interest in T on 1 July 2012.

Initially, from 1 January 2012, S exercises significant influence over T as an associate entity. It is only from 1 July 2012 that H has access to more than 50% of the voting power in T; T is therefore consolidated into the H group accounts from 1 July 2012.
2.2.2    Note that the definition of a mixed group does not include the situation where the parent and an associate together hold a controlling interest in a further entity. For example:

H owns 35% of S, S owns 40% of W and H owns 40% of W.

This is not a mixed group situation. Neither S nor W is a member of the H group, although S and W may both be ‘associates’ of H.

H’s interest in W might be calculated as before as (35% × 40%) + 40% = 54%. Although H has an arithmetic interest in W that is more than 50%, it does not have parent entity control of W, as it does not control S’s 40% stake in W.

2.3       Consolidation

2.3.1    The approach is similar to deal with sub-subsidiaries, i.e. an effective interest is computed and used to allocate share capital and retained earnings.
2.3.2    All consolidation workings are the same as those used in vertical group situations, with the exception of goodwill.
2.3.3    The goodwill calculation for the sub-subsidiary differs in that two elements to cost must be considered, namely:
(a)        the cost of the parent’s direct holding,
(b)        the parent’s percentage of the cost of the subsidiary’s holding (the indirect holding).

 

2.3.4

Example 3

The statements of financial position of H, S and M, as at 31 December 2012, are as follows:   H S M   $ $ $ 45,000 shares in S 72,000     16,000 shares in M 25,000     12,000 shares in M   20,000   Sundry assets 125,000 120,000 78,000   222,000 140,000 78,000         Equity share capital ($1 shares) 120,000 60,000 40,000 Retained earnings 95,000 75,000 35,000 Liabilities 7,000 5,000 3,000   222,000 140,000 78,000 All shares were acquired on 31 December 2009 when the retained earnings of S amounted to $30,000 and those of M amounted to $10,000. It is group policy to value the non-controlling interest on a proportionate basis. Required: Prepare the consolidated statement of financial position of the H group at 31 December 2012. Solution: W1 Group structure   S M   Group interest – direct 75% 40.0% (45,000/60,000) – Indirect   22.5% (75% × 30%) Total   62.5%   NCI 25% 37.5% (30% + 25% × 30%)   100% 100%   W2 Net assets of subsidiaries at acquisition date   S M   At acq’n At acq’n   $ $ Equity capital 60,000 40,000 Retained earnings 30,000 10,000   90,000 50,000 W3 Goodwill   S   M   $   $ Cost of investment 72,000 Direct 25,000     Indirect (75% × 20,000) 15,000 FV of NCI at acquisition       (25% × 90,000) 22,500 (37.5% × 50,000) 18,750   94,500   58,750 Less: FV of NA at acquisition (W2)   (90,000)     (50,000)   4,500   8,750 W4 Group retained earnings   H S M   $ $ $ Per question 95,000 75,000 35,000 Less: Pre-acq. retained earnings   (30,000) (10,000)     45,000 25,000 Share of S (75% × 45,000) 33,750     Share of M (62.5% × 25,000) 15,625       144,375     W5 Non-controlling interest   S M Total   $ $ $ NCI FV at acquisition (W3) 22,500 18,750   Share of post-acq. retained earnings (25% × 45,000) / [37.5% × 25,000]   11,250   9,375   Less: NCI share of cost of investment in M (25% × 20,000)   (5,000)   -     28,750 28,125 56,875 Consolidated statement of financial position as at 31 December 2012     $000 Goodwill (4,500 + 8,750) (W3)   13,250 Sundry assets (125,000 + 120,000 + 78,000)   323,000 Total assets   336,250 Equity and liabilities     Equity capital   120,000 Retained earnings (W4)   144,375     264,375 Non-controlling interest (W5)   56,875     321,250 Liabilities (7,000 + 5,000 + 3,000)   15,000 Total equity and liabilities   336,250

 

 

 

Question 3 The following are the summarized statements of financial position of T, S and R as at 31 December 2012.   T S R   $ $ $ Non-current assets 140,000 61,000 170,000 Investments 200,000 65,000 - Current assets 20,000 20,000 15,000   360,000 146,000 185,000         Equity share capital ($1 shares) 200,000 80,000 100,000 Retained earnings 150,000 60,000 80,000 Liabilities 10,000 6,000 5,000   360,000 146,000 185,000 On 1 January 2011, S acquired 35,000 ordinary shares in R at a cost of $65,000 when the retained earnings of R amounted to $40,000. On 1 January 2012, T acquired 64,000 shares in S at a cost of $120,000 and 40,000 shares in R at a cost 80,000. The retained earnings of S and R amounted to $50,000 and $60,000 respectively on 1 January 2012. The fair value of the NCI is S at that date was $27,000. The fair value of the whole (direct and indirect) NCI in R was $56,000. The NCI is measured using the full goodwill method. At the reporting date, goodwill has not been impaired. Required: Prepare the consolidated statement of financial position of the T group as at 31 December 2012.