Accounting for goodwill is a key part of business combinations and is therefore regularly examined as part of the Financial Reporting (FR) exam. Goodwill arises when one entity (the parent company) gains control over another entity (the subsidiary company) and is recognised as an asset in the consolidated statement of financial position. Under IFRS 3, Business Combinations, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. Goodwill is not amortised but must be tested annually for impairment.
The calculation of goodwill is as follows:
Consideration paid | |
| Add: Non-controlling interest at acquisition | |
Less: Net assets at acquisition | |
| Goodwill at acquisition | |
Less: Impairment to date | |
Goodwill at reporting date |
In the FR exam, this can be worth many marks and contain many forms of adjustment. Each of these lines will be looked at in turn for the major elements which need to be included.
The consideration paid for a subsidiary can take many forms. The common situations arising in the FR exam are that the parent pays for the subsidiary in cash immediately, in cash payable in the future (deferred consideration), in cash payable in the future but where that payment is dependent on certain events (contingent consideration), or through an issue of its own shares to the original shareholders of the subsidiary. In addition to this, candidates will need to know the correct treatment for professional fees incurred as part of the acquisition.
Cash consideration
This is the simplest amount of consideration and represents the cash already paid by the parent as part of the acquisition. You will be told this and it will usually be included in the ‘investments’ line of the parent’s statement of financial position and simply needs to be moved into the goodwill calculation.
Deferred consideration
This is cash payable in the future and needs to be recognised initially at present value. For the FR exam, if the amount is payable in one year, the candidate will be given a discount rate (%) and be asked to calculate this. If the amount is payable in more than one year, the candidate will be given a discount factor as a decimal. The key is to initially recognise the amount payable at present value in goodwill and as a liability.
As time elapses, the discount on the liability must be unwound as the payable date approaches. The unwinding of the discount on the liability is done by increasing the liability and recording a finance cost. A key thing to note here is that goodwill is unaffected, as goodwill is only calculated at the date control is gained.
EXAMPLE 1
Laldi Co acquired control of Bidle Co on 31 March 20X6, Laldi Co’s year end. The purchase consideration included $200,000 payable on 31 March 20X7. An appropriate discount rate for use is 6%.
Required:
Calculate the amount of deferred consideration to be recognised at 31 March 20X6 and explain how the unwinding of any discount should be accounted for.
Answer
The goodwill calculation would include deferred consideration of $188,679 being $200,000 x 1/1.061. This would also be included in the consolidated statement of financial position at 31 March 20X6 as a current liability.
In the year ended 31 March 20X7, this discount of $11,321 ($188,679 x 6%) would then be unwound and recorded as a finance cost in the statement of profit or loss. The full liability of $200,000 would be settled on 31 March 20X7, consisting of the $188,679 originally recognised plus the $11,321 of finance costs.
Contingent consideration
In the FR exam, this will take the form of a future cash amount payable dependent on a set of circumstances. In accordance with IFRS 3, this must be recognised initially at fair value (which will be given in the exam). This fair value is added to the consideration as part of the goodwill calculation and recognised as a provision in liabilities in the consolidated statement of financial position.
Any subsequent movement in the potential amount payable is treated like a movement in a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Any increase or decrease in the amount payable is reflected in the liability and recorded in the parent’s statement of profit or loss. Again, it is key to note that the initial calculation of goodwill is unaffected as this is calculated on the date control is gained.
Share consideration
This is a tricky calculation but is common in the FR exam. It is likely that this amount will not yet have been recorded, testing the candidate’s knowledge of how the transaction is to be recorded. To do this, a candidate needs to work out how many shares the parent company has issued to the previous shareholders (owners) of the subsidiary as part of the acquisition. To work out the value given to the previous owners, the number of shares issued is multiplied by the parent’s share price at the date of acquisition. This full amount is then added to the consideration paid total. The amount then also needs to be added to the parent’s share capital and other components of equity (share premium) to reflect the shares issued (see Example 3 later in the article).
Acquisition costs
All acquisition costs, such as professional fees (legal fees, accountant fees etc), must be expensed in the statement of profit or loss and not included in the calculation of goodwill. Often in the FR exam this will have been recorded incorrectly, perhaps included in the statement of financial position as part of the cost of investments, and you need to make a correcting adjustment.
Under IFRS 3, the parent can choose to measure any non-controlling interest at either fair value or the proportionate share of net assets.
There are two potential ways that the fair value method will arise in the FR exam. The fair value of the non-controlling interest at acquisition may be directly given to candidates, or they may have to calculate the fair value by reference to the subsidiary’s share price. To do this, the candidate will simply have to multiply the number of shares held by the non-controlling interest by the subsidiary’s share price at the date of acquisition.
Under the proportionate share of net assets method, the value of the non-controlling interest is simpler to calculate. This is done by calculating the net assets of the subsidiary at acquisition and multiplying this by the percentage owned by the non-controlling interest.
Under the fair value method, the non-controlling interest at acquisition will be higher, meaning that the goodwill figure is higher. This is because including the non-controlling interest at fair value incorporates an element of goodwill attributable to them. Under this method the goodwill figure therefore includes elements of goodwill from both the parent and the non-controlling interest.
Including the non-controlling interest at the proportionate share of the net assets is really reflecting the lowest possible amount that can be attributed to the non-controlling interest. This method shows how much they would be due if the subsidiary company were to be closed down and all the assets sold off, incorporating no goodwill in relation to the non-controlling interest. Under the proportionate method, the goodwill figure is therefore smaller as it only includes the goodwill attributable to the parent.
At the date of acquisition, the parent company must recognise the assets and liabilities of the subsidiary at fair value. This can lead to a number of potential adjustments to the subsidiary’s assets and liabilities.
The most common situations in the FR exam are outlined below:
The final element to consider is the impairment of goodwill. Impairment arises after the acquisition and reflects some form of decline in the expected benefit to be derived from the subsidiary. As mentioned earlier, there is no amortisation of this figure, so the parent must assess each year whether there are indicators that the goodwill is impaired.
There are many indicators of impairment, ranging from loss of customers in the subsidiary to the departure of key staff or changes in technology. If an entity decides that the goodwill is impaired, it must be written down to its recoverable amount. Once goodwill is impaired, the impairment cannot be reversed.
The cumulative impairment is always deducted in full from the goodwill figure in the statement of financial position. If the non-controlling interest is recorded at fair value, then a percentage of impairment will be allocated to them (based on the percentage owned in the subsidiary), with the remainder being allocated to the group. If the non-controlling interest is held at the proportionate method, then the entire impairment is allocated to the group due to the fact that no goodwill has been attributed to the non-controlling interest.
EXAMPLE 2
Fifer Co acquired 80% of the equity shares of Grampian Co on 1 January 20X4 for $5,000,000. The fair value of Grampian Co’s net assets at the date of acquisition was $4,000,000.
At 31 December 20X4, Fifer Co has determined that goodwill is impaired by 10%.
Required:
For each of the following scenarios, calculate the value of goodwill at 31 December 20X4 and explain how the impairment loss would be allocated between the group and non-controlling interest:
Answer
1. Fair value method
| $000 | |
|---|---|
| Consideration paid | 5,000 |
Add: Non-controlling interest at acquisition | 1,000 |
| Less: Net assets at acquisition | (4,000) |
| Goodwill at acquisition | 2,000 |
| Less: impairment to date (10% x 2,000) | (200) |
| Goodwill at 31 December 20X4 | 1,800 |
The fair value method of calculating goodwill incorporates both the goodwill attributable to the group and to the non-controlling interest. Therefore, any subsequent impairment of goodwill should be allocated between the group and non-controlling interest based on the percentage ownership.
Non-controlling interest will be allocated $40,000 (20% x $200,000) of the impairment loss and the group will be allocated $160,000 (80% x $200,000).
2. Proportionate share of net assets method
| $000 | |
|---|---|
| Consideration paid | 5,000 |
Add: Non-controlling interest at acquisition | 800 |
| Less: Net assets at acquisition | (4,000) |
| Goodwill at acquisition | 1,800 |
| Less: impairment to date (10% x 1,800) | (180) |
| Goodwill at 31 December 20X4 | 1,620 |
The proportionate share of net assets method calculates the goodwill attributable to the group only. Therefore, any impairment of goodwill should only be attributed to the group and none to the non-controlling interest.
The group will be allocated the full $180,000 of impairment loss.
EXAMPLE 3
This comprehensive example is an adaptation of a previous consolidation question looking at many of the elements of goodwill outlined above. This is good practice for how a consolidated statement of financial position question might be asked, with a common format of presenting the answer. This question contains other adjustments, so it is important that you have read through other learning materials on group accounting, including associate companies, before attempting it.
On 1 October 20X6, Plateau Co acquired the following non-current investments:
The following information is relevant:
(i) At the date of acquisition, Savannah Co has an unrecognised internally generated brand name. This was deemed to have a fair value of $1m at 1 October 20X6 and has not suffered any impairment since acquisition.
(ii) On 1 October 20X6, Plateau Co sold an item of plant to Savannah Co at its agreed fair value of $2.5m. Its carrying amount prior to the sale was $2m. The estimated remaining life of the plant at the date of sale was five years (straight-line depreciation).
(iii) During the year ended 30 September 20X7, Savannah Co sold goods to Plateau Co for $2.7m. Savannah Co had marked up these goods by 50% on cost. Plateau Co had a third of the goods still in its inventory at 30 September 20X7. There were no intra-group payables/receivables at 30 September 20X7.
(iv) At the date of acquisition, the non-controlling interest in Savannah Co is to be valued at its fair value. For this purpose, Savannah Co’s share price at that date can be taken to be indicative of the fair value of the shareholding of the non-controlling interest. Impairment tests on 30 September 20X7 concluded that neither consolidated goodwill nor the value of the investment in Axle Co had been impaired.
(v) The financial asset investments are included in Plateau Co’s statement of financial position (above) at their fair value on 1 October 20X6, but they have a fair value of $9m at 30 September 20X7.
Required:
Prepare the consolidated statement of financial position for Plateau Co
as at 30 September 20X7.
Answer
Consolidated statement of financial position of Plateau Co as at 30 September 20X7 (see here).
(w1) Group structure:
Plateau Co – owned 75% of Savannah Co for 1 year
Plateau Co – owned 30% of Axle Co for 1 year
(w2) Net assets of Savannah Co:
Acquisition $000 | SFP date $000 | Post acq’n $000 |
|
Share capital | 4,000 | 4,000 | - |
| Retained earnings | 6,000 | 8,900 | 2,900 |
Fair value adjustment | 1,000 | 1,000 | - |
Excess depreciation (w7) | 100 | 100 | |
PURP on inventories (w8) | (300) | (300) |
|
| 11,000 | 13,700 | 2,700 |
(w3) Goodwill:
| $000 | |
|---|---|
| Consideration: | |
- Shares issued (3,000/2 x $6) | 9,000 |
| - Cash (3,000 x $1.25) | 3,750 |
| Non-controlling interest at acquisition (1m x $3.25) | 3,250 |
| Less: Net assets at acquisition (w2) | (11,000) |
| Goodwill at acquisition | 5,000 |
Tutorial note:
The consideration given by Plateau Co for the shares of Savannah Co works out at $4.25 per share – ie consideration of $12.75m for 3 million shares. This is higher than the market price of Savannah Co’s shares ($3.25) before the acquisition and could be argued to be the premium paid to gain control of Savannah Co. This is also why it is (often) appropriate to value the NCI in Savannah Co’s shares at $3.25 each, because (by definition) the NCI does not have control.
The 1.5 million shares issued by Plateau Co in the share exchange, at a value of $6 each, would be recorded as $1 per share as capital and $5 per share as other components of equity (share premium), giving an increase in share capital of $1.5m and a share premium of $7.5m.
(w4) Non-controlling interest:
| $000 | |
|---|---|
| Fair value at acquisition (see (w3) | 3,250 |
NCI % x S post acq’n (25% x 2,700 (w2)) | 675 |
| 3,925 |
(w5) Retained earnings:
| $000 | |
|---|---|
| Plateau Co’s retained earnings | 25,250 |
Professional fees | (500) |
P% x S post acq’n 75% x 2,700 (w2) | 2,025 |
| P% x A post acq’n 30% x (5,000 (16,000 – 11,000)) | 1,500 |
| Non-current asset PURP (w7) | (500) |
| Investment gain (9,000 – 6,500) | 2,500 |
| 30,275 |
(w6) Investment in associate:
| $000 | |
|---|---|
| Cost (4,000 x 30% x $7.50) | 9,000 |
Share post-acquisition profit (see w5) | 1,500 |
| 10,500 |
(w7) Property, plant and equipment
The transfer of the plant creates an initial unrealised profit (URP) of $500,000 being the difference between the agreed FV ($2.5m) and the carrying amount ($2m). This should be eliminated from Plateau Co’s retained earnings and from the carrying amount of the plant to restate as if the transfer had not taken place.
The carrying amount of the plant is reduced by excess depreciation of $100,000 for each year ([$2.5m/ 5years] – [$2m/ 5 years]) in the post-acquisition period. Therefore, the net adjustment in the carrying amount of property, plant and equipment is $400,000.
The excess depreciation charge should also be eliminated on consolidation and, since it will have arisen in Savannah Co’s individual accounts, the elimination of the depreciation will have the effect of increasing Savanah Co’s post-acquisition retained earnings and, consequently, the profits attributable to the non-controlling interest.
(w8) Inventory
The unrealised profit (URP) in inventory intra-group sales are $2.7m on which Savannah Co made a profit of $900,000 (2,700 x 50/150). One third of these are still in the inventory of Plateau Co, thus there is an unrealised profit of $300,000.
Tutorial note:
In this question, there is no goodwill impairment. If there had been an impairment, say of $1 million, then the full $1 million would have been deducted from goodwill. As the non-controlling interest is recorded at fair value, this impairment would have been split between the non-controlling interest and the parent based on the percentage owned. Therefore $250,000 (25% of the impairment) would be deducted from the non-controlling interest figure in equity and $750,000 (75% of the impairment) would be deducted from retained earnings in equity.
Written by a member of the FR examining team