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Purchases method – Subsequent adjustment to fair value and Goodwill
Extracts from FRS102 – Section 19.16-19.17 and 19.22-19.23
19.16 The acquirer’s statement of comprehensive income shall incorporate the acquiree’s profits or losses after the acquisition date by including the acquiree’s income and expenses based on the cost of the business combination to the acquirer. For example, depreciation expense included after the acquisition date in the acquirer’s statement of comprehensive income that relates to the acquiree’s depreciable assets shall be based on the fair values of those depreciable assets at the acquisition date, i.e. their cost to the acquirer.
Subsequent adjustment to fair value
19.19 If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the acquirer shall recognise in its financial statements provisional amounts for the items for which the accounting is incomplete. Within twelve months after the acquisition date, the acquirer shall retrospectively adjust the provisional amounts recognised as assets and liabilities at the acquisition date (ie account for them as if they were made at the acquisition date) to reflect new information obtained. Beyond twelve months after the acquisition date, adjustments to the initial accounting for a business combination shall be recognized only to correct a material error in accordance with Section 10 Accounting Policies, Estimates and Errors.
Goodwill
19.22 The acquirer shall, at the acquisition date:
(a) recognise goodwill acquired in a business combination as an asset; and
(b) initially measure that goodwill at its cost, being the excess of the cost of the business combination over the acquirer’s interest in the net amount of the identifiable assets, liabilities and contingent liabilities recognised and measured in accordance with paragraphs 19.15, 19.15A to 19.15C.
19.23 After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost less accumulated amortisation and accumulated impairment losses:
(a) An entity shall follow the principles in paragraphs 18.19 to 18.24 for amortisation of goodwill. Goodwill shall be considered to have a finite useful life, and shall be amortised on a systematic basis over its life. If, in exceptional cases, an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed 10 years.
(b) An entity shall follow Section 27 Impairment of Assets for recognising and measuring the impairment of goodwill.
OmniPro comment
Adjustments to fair value of identified liabilities
As per Section 19.19 adjustments to the fair value of the liabilities and assets can be made for 12 months following the date of acquisition. After this date no adjustment can be made to goodwill unless there was a material error in which case a prior year adjustment would have to be made to the consolidated financial statements.
After the 12 month period has elapsed, prior year adjustments cannot be done for changes in estimates in the fair values (it can only be done for changes in estimates within the 12 month period) other than where contingent consideration exists which was discussed above and shown in examples 6 and 7 above where any adjustments are posted to goodwill prospectively. When an acquisition occurs part way through the financial year, the 12 month period for adjustment to fair values will straddle two financial years. In this case if in the second financial year, an adjustment is required to the fair values, then a prior year adjustment will be required to restate the goodwill and fair value of assets and any depreciation impact etc. stated in the prior year i.e. it must be adjusted retrospectively. See illustration in the examples below:
Example 12: Subsequent adjustment to fair values at the acquisition date and amortisation of goodwill and fair value uplifts on acquisition
Company A acquired 100% of company B on 1 October 20X4. The year end for the financial statements is 31 December. When signing off the (consolidated where shares are acquired or entity where the net assets are acquired) financial statements, the company could not get a professional valuation for the property, plant and equipment within the time period. Therefore Company A estimated a fair value of CU100,000. Note the NBV of the PPE in the acquirees book was CU90,000 so deferred tax of CU1,000 was recognised on the uplift.
In addition Company A estimated the bad debt provision on the trade debtor balance and deemed the fair value of debtors to be CU10,000 which equaled the book value. The fair value of all assets and liabilities including the aforementioned was CU200,000. Goodwill at the date of acquisition was calculated at CU49,000. The total cost of the acquisition was CU250,000.
The useful life of goodwill was determined to be 10 years and the remaining life on the property, plant and equipment was 5 years. Assume deferred tax rate is 10%.
The profits made from 1 October to 31 December 20X4 was CU20,000.
In the 31 December 20X4 financial statements the following adjustments would be posted to the consolidated financial statements to reflect the goodwill on the acquisition date:
|
|
CU |
CU |
|
Dr Goodwill |
50,000 |
|
|
Dr Ordinary Share Capital and P&L Reserves** |
200,000 |
|
|
Cr Investment in the Parent Company Financial Statements** |
|
250,000 |
The below journal is required to recognise the deferred tax:
|
|
CU |
CU |
|
Dr Goodwill |
1,000 |
|
|
Cr Deferred Tax Liability on Fair Value Uplift above Book Value (CU10,000*10%) |
|
1,000 |
The below journal would be posted to recognise the depreciation on the uplift in PPE:
|
|
CU |
CU |
|
Dr Depreciation (CU10,000/5 years* 3/12th) |
500 |
|
|
Cr Accumulated Depreciation PPE |
|
500 |
The below journal would be posted to recognise the amortisation on goodwill:
|
|
CU |
CU |
|
Dr Amortisation |
1,225* |
|
|
Cr Accumulated Amortisation Goodwill |
|
1,225 |
*goodwill on recognition is CU50,000 less deferred tax of CU1,000=CU49,000/10yrs*3/12th being period 1 October to 31 December
**If the net assets were acquired (i.e. the trade and not the shares) the journal would be to:
|
|
CU |
CU |
|
Dr Net Assets |
200,000 |
|
|
Dr Goodwill |
50,000 |
|
|
Cr Bank |
|
250,000 |
On 1 February 20X5 (within the 12 month limit), Company A obtained the valuation for the PPE on the date of acquisition which was CU150,000. Following a review of the debtors acquired on acquisition at 31 August 20X5, evidence showed that the fair value at the date of acquisition was CU5,000 instead of the estimated CU10,000. The company is preparing the 31 December 20X5 consolidated financial statements.
Note a prior year adjustment is required here as the 12 month adjustment period straddles 2 accounting periods. The journals to be posted in the 20X4 accounts to show the prior year adjustment are:
|
|
CU |
CU |
|
Dr PPE (see note 1) |
47,500 |
|
|
Cr Debtors (see note 2) |
|
5,000 |
|
Dr Depreciation on PPE (see note 1) |
2,500 |
|
|
Cr Amortisation of Goodwill (See note 3) |
|
1,018 |
|
Cr Deferred Tax Liability (CU4,750-CU500) See note 1 and note 2 |
|
4,250 |
|
Cr Goodwill (See note 3) |
|
39,732 |
Being journal to reflect adjustment to reflect change in fair values within the 12 month period
|
Note 1: Fair value adjustment to PPE Updated fair value of PPE included in calculation of goodwill CU150,000 Initial fair value of PPE included in calculation of goodwill (CU100,000) Adjustment to be made to goodwill CU50,000 Additional depreciation that should have been charged from period 1 October to 31 December 20X4 (CU50,000/5yrs*3/12th) (CU2,500) Total adjustment to be made to PPE CU47,500 Deferred tax on net adjustment in PPE (CU47,500*10%) (CU4,750) Note 2: Fair value adjustment to debtors Updated fair value of debtors included in calculation of goodwill CU5,000 Initial fair value of debtors included in calculation of goodwill (CU10,000) Adjustment to be made to goodwill (CU5,000) Deferred tax on net adjustment in debtors (CU5,000*10%) CU500 Note 3: Adjustment to goodwill Adjustment to reflect updated PPE fair value CU50,000 Adjustment to reflect updated deferred tax (CU4,750-CU500) (CU4,250) Adjustment to reflect updated debtors fair value (CU5,000) Adjustment to goodwill cost CU40,750 Additional amortisation that should have been charged on goodwill from 1 October to 31 December 20X4 (CU40,750/10yrs useful life*3/12th) (CU1,018) Total adjustment to goodwill in 31 December 20X4 accounts – credit CU39,732 |
Note no deferred tax is recognised on goodwill as per Section 29
In the 20X5 consolidated financial statements the updated goodwill figure of CU89,750 (CU49,000+CU40,750) and PPE fair value figure of CU150,000 (CU90,000+CU10,000) will be amortised/depreciated.
Goodwill
See example 11 and 12 above which illustrates the requirements of Section 19.22 and 19.23.
Example 13: Journals to reflect the business combination
If we take example 11 above and assume only 80% of the company is acquired. The goodwill to be recognised in this instance is as follows:
Total net assets of CU748,500*80% being the % ownership= CU598,800. The total amount paid was CU1,000,000, therefore goodwill of CU393,200 should be recognised.
The journals required in the consolidated financial statements are:
|
|
CU |
CU |
|
Dr Goodwill |
401,200 |
|
|
Dr Net Assets of Company B |
748,500 |
|
|
Cr Investment in Company B in Parent Entity Balance Sheet |
|
1,000,000 |
|
Cr Non-controlling Interest (CU748,500*20%) |
|
149,700 |
Useful life of goodwill
Section 19.23 makes it clear that goodwill is considered to have a finite life. The September 2015 version of the standard specifies that where a useful life cannot be determined then a useful life should not exceed 10 years (currently 5 years in Ireland until the EU Directive 2013/34 is enacted). Where goodwill acquired prior to the transition to FRS 102 has been determined and presumably there was a basis for this as required by old GAAP, it is unlikely that this will have any impact as it will continue to be amortised over the period determined under old GAAP. However, for intangible assets acquired since the date of transition, entities will need to assess the useful economic life and if it cannot be determined a life of 10 years or less must be chosen (currently 5 years in Ireland until the EU Directive 2013/34 is enacted). This cannot be chosen as a default, instead a good effort has to be made to determine a useful life.
Where a change in useful life of goodwill is determined due to a change in estimate this should be adjusted for prospectively. See example in example 14 below.
Example 14: Revising the useful life of goodwill
In year 1 an goodwill was recognised on acquisition CU100,000. It had an estimated life of 10 years. Its estimated residual value was estimated to be nil. This useful life was assessed for indicators of change at each year end and there were no issues up to the end of year 4. At the start of year 5, due to a detailed assessment of the remaining lifes of goodwill, the useful life was reassessed at 4 years instead of 6 years at that time, the asset had a carrying amount as follows:
|
Cost |
CU100,000 |
|
Residual Value |
(-) |
|
Depreciable Amount |
CU100,000 |
|
Depreciation (100,000 / 10 yrs * 4 yrs) |
(CU40,000) |
|
Carrying Amount |
CU60,000 |
In year 5, the useful life was assessed as 4 years instead of 6 years (there were no issues with regard to impairment). Deducting amortisation charged to date of CU40,000 leaves CU60,000 to be amortised over the updated remaining useful life of 4 years. Therefore, amortisation of CU15,000 (CU60,000/4yrs) for the remaining four years. Disclosure of the change in estimate would be required in the financial statements detailing the effect on current and future years i.e. that the amortisation charge increased from CU10,000 to CU15,000 for the remaining years and the assets will be written down to nil in 4 years time as opposed to the original 6 years.
Impairment
Identifying and accounting for impairment of goodwill is dealt with by Section 27. At each reporting period goodwill should be reviewed for indicators of impairment as per Section 27. Where indicators are identified, an impairment review should be carried out. See Section 27 for further details of how this should be accounted for and how it should be carried out. Goodwill impairment cannot be reversed if the entity is a UK company which has early adopted the amendments made to FRS 102 in September 2015 as detailed in Section 27. However as the EU Directive 2013/34 has not been implemented at this date in Ireland, Republic of Ireland Companies or UK Companies who have not early adopted the September 2015 amendments to FRS 102 can currently reverse a previous impairment on goodwill.
Section 27 does not require an impairment review to be carried out for goodwill with a useful economic life of over 20 years nor does it require an impairment review to be performed the first year after acquisition. It does require an impairment review to be performed where there are indicators of impairment.
Business combination achieved in stages
Extracts from FRS102 – Section 19.11A
19.11A Where control is achieved following a series of transactions, the cost of the business combination is the aggregate of the fair values of the assets given, liabilities assumed and equity instruments issued by the acquirer at the date of each transaction in the series.
OmniPro comment
See below illustration of the above section
Example 15: Business combination achieved in stages
Company A acquired 5% of Company B for CU50,000 at the start of year 1. At the end of year 2 Company A acquired a further 30% for CU100,000 giving significant influence. At the end of year 3 a further 50% was acquired for CU110,000. At the time of the 50% acquisition the fair value of the net assets was CU200,000 which equaled the net asset value. The carrying amount of the associate holding on the consolidated balance sheet at the end of year 3 was CU170,000 being the net assets of Company B at that time (difference between CU150,000 cost and the CU170,000 is the profit share for the 3 years).
In this example we have ignored any profit earned since acquisition as an associate or amortisation of deemed goodwill when the company acquired significant influence.
Goodwill is calculated in accordance 19.11A as follows:
|
Cost of Acquisition of first 5% of Company B |
CU50,000 |
|
Cost of Acquisition of second 30% of Company B |
CU100,000 |
|
Cost of Acquisition of third 50% of Company B |
CU110,000 |
|
Total Cost of Investment on Acquiring Control |
CU260,000 |
|
Total Portion of the Fair Value of Company B Acquired on Obtaining Control at the End of Year 3 (CU200,000*(50%+30%+5%)) |
(CU170,000) |
|
Total Goodwill to be Recognised |
CU90,000 |
The journal required on acquisition of control at the end of year 3 is:
|
|
CU |
CU |
|
Dr Goodwill |
90,000 |
|
|
Dr Net Asset of Company B |
200,000 |
|
|
Dr Other Comprehensive Income |
20,000* |
|
|
Cr Associate Investment in Company B in Consolidated Balance Sheet |
|
170,000
|
|
Cr Bank |
|
110,000 |
|
Cr Non- Controlling Interest in Equity (CU200,000*15%) |
|
30,000 |
*this difference is the difference between the previous cash paid prior to obtaining control of CU150,000 and the share of the net assets at the date control is obtained of CU170,000. As it is not a profit or loss it is posted to OCI.
Accounting for changes in the parent’s ownership interest in a subsidiary that does not result in loss of control
Section 9.19 of FRS 102 states where an entity has a subsidiary and has consolidated this over the periods on the basis that it had control i.e. owned more than 50% of the voting rights but not 100% and then acquires a further amount of share capital so as to increase ownership, in the consolidated accounts of the parent company the transaction is an equity transaction. The same rule applies to disposals which do not result in a loss of control.
Example 16: Acquiring a further controlling interest
Parent A previously owned 55% of Company B which was consolidated in the financial statements. At the time of acquisition of the 55% its fair value of net assets was CU500,000 which was equal to book value. The purchase cost was CU300,000. The goodwill recognised was CU25,000 (CU500,000*55%=CU275,000-CU300,000). During the year the company acquired a further 25% from the non-controlling interest for CU220,000. The fair value of the net assets of Company B at the date of acquisition the additional 25% was CU800,000 (the NBV of the net assets was CU700,000). The carrying amount of the 45% non-controlling interest in the consolidated financial statements was CU250,000 at the date of purchase of the 25% interest.
The journals posted in the parent individual TB would be:
|
|
CU |
CU |
|
Dr Investment in Subsidiary |
220,000 |
|
|
Cr Bank |
|
220,000 |
The journals required to account for this transaction in the consolidated financial statements are:
|
|
CU |
CU |
|
Dr Equity -Profit and Loss Reserves (CU220,000-CU138,889) |
81,111 |
|
|
Dr Equity-Non Controlling Interest (CU250,000/45 being original amount owned by the minority interest *25 being the amount disposed of) |
138,889 |
|
|
Cr Investment in Subsidiary |
|
220,000 |
Being journal to reflect the acquisition as an equity transaction
Example 17: Acquiring a further controlling interest
Parent A previously owned 55% of Company B which was consolidated in the financial statements. During the year the company acquired the remaining 45% from the non-controlling interest for CU1,300,000. The non-controlling interest shown in the financial statements prior to the acquisition was CU1,000,000. The journals posted in the parent individual TB would be:
|
|
CU |
CU |
|
Dr Investment in Subsidiary |
1,300,000 |
|
|
Cr Bank |
|
1,300,000 |
The journals required to account for this transaction in the consolidated financial statements are:
|
|
CU |
CU |
|
Dr Equity -Profit and Loss Reserves (CU1,300,000 – CU1,000,000) |
300,000 |
|
|
Dr Equity-Non Controlling Interest |
1,000,000 |
|
|
Cr Investment in Subsidiary |
|
1,300,000 |
Being journal to reflect this as an equity transaction
Example 18: Disposing of controlling interest but controlling interest retained
Parent A previously owned 100% of Company B which was consolidated in the financial statements. During the year the company disposed of 25% to a third party for CU300,000. The original cost of the investment in the individual entity accounts was CU1,300,000. The net assets of the subsidiary at the date of disposal was CU800,000 plus goodwill of CU50,000 in the consolidated accounts.
The journals posted in the parent individual TB would be:
|
|
CU |
CU |
|
Dr Loss on Disposal |
25,000 |
|
|
Dr Bank |
300,000 |
|
|
Cr Investment in Subsidiary (CU1,300,000*25%) |
|
325,000 |
The journals required to account for this transaction in the consolidated financial statements are:
|
|
CU |
CU |
|
Dr Investment in Subsidiary |
300,000 |
|
|
Cr Equity -Profit and Loss Reserves (CU300,000-CU212,500) |
|
87,500 |
|
Cr Equity-Non Controlling Interest (CU850,000*25%) |
|
212,500 |
Being journal to reflect disposal as an equity transaction assuming usual goodwill journals were posted
Negative goodwill
Extracts from FRS102 – Section 19.24
19.24 If the acquirer’s interest in the net amount of the identifiable assets, liabilities and provisions for contingent liabilities recognised in accordance with paragraph 19.14 exceeds the cost of the business combination (also referred to as ‘negative goodwill’), the acquirer shall:
(a) Reassess the identification and measurement of the acquiree’s assets, liabilities and provisions for contingent liabilities and the measurement of the cost of the combination.
(b) Recognise and separately disclose the resulting excess on the face of the statement of financial position on the acquisition date, immediately below goodwill, and followed by a subtotal of the net amount of goodwill and the excess.
(c) Recognise subsequently the excess up to the fair value of non-monetary assets acquired in profit or loss in the periods in which the non-monetary assets are recovered. Any excess exceeding the fair value of non-monetary assets acquired shall be recognised in profit or loss in the periods expected to be benefited.
OmniPro comment
Section 29.24 makes it clear that it is unusual for negative goodwill to occur in an acquisition so if this occurs an entity must reassess the fair values determined for assets and liabilities to make sure the valuations are accurate. If after assessing the values no issues are found, then the negative goodwill should be recognised.
The negative goodwill is then allocated to the non-monetary items in the acquired entity (e.g. PPE, inventory, investments).
The negative goodwill should be credited to the profit and loss on a basis in which the non-monetary items are realised. Therefore where an element of the goodwill is allocated to inventory, the negative goodwill is written back to the profit and loss over the period the inventory included on the balance sheet at the date of acquisition is utilised and where it is allocated to PPE it is released over the period it is depreciated.
The non-monetary asset to which the negative goodwill attaches too should be determined based on judgement and if not easily determinable allocated pro-rata.
Example 19: Negative goodwill
Company A acquired Company B for CU200,000 when the fair value of the net assets were CU250,000. In this instance there is negative goodwill of CU50,000. Ignore deferred tax effects. Assume the acquisition occurred at the start of year 1. Assume the negative goodwill attached to the inventory at the date of acquisition and this inventory will be utilised in the Company B over two years.
After a reassessment Company A is happy that this negative goodwill exists. Therefore the acquisition journals would be:
|
|
CU |
CU |
|
Dr Net Assets |
250,000 |
|
|
Cr Goodwill |
|
50,000 |
|
Cr Investment |
|
200,000 |
The journal required at the end of year 1 to recognise the amortisation of the negative goodwill is:
|
|
CU |
CU |
|
Dr Negative Goodwill |
25,000 |
|
|
Cr Amortisation of Negative Goodwill (CU50,000/2yrs*1yr of stock disposed of) |
|
25,000 |
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