CPA PROGRAM – PROFESSIONAL LEVEL

FINANCIAL
REPORTING

BUSINESS COMBINATIONS
AND GROUP ACCOUNTING

WORKSHOP NOTES 2014

AUTHOR: MICHAEL JONES

Published by Deakin University on behalf of CPA Australia Ltd, ABN 64 008 392 452

© CPA Australia Ltd 2014 (Edition 14a)

The contents and any information contained in this document (Information) are for general information only. They are
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CPA PROGRAM – PROFESSIONAL LEVEL

FINANCIAL
REPORTING

BUSINESS COMBINATIONS
AND GROUP ACCOUNTING

WORKSHOP NOTES 2014

AUTHOR: MICHAEL JONES

Contents
Workshop notes 1 
Objectives 2 
Workshop prerequisites 2 
Contents of the workshop 2 
Workshop Question 1 3 
Workshop Question 2 3 
Workshop Question 3 4 
Workshop Question 4 4 
Appendix: Self-study question 5 

Workshop solutions 6 
Workshop Question 1 7 
Workshop Question 2 8 
Workshop Question 3 9 
Workshop Question 4 10 
Appendix: Self-study question 12 
Workshop notes
Business Combinations and Group Accounting Workshop Notes

Objectives
At the end of this workshop, you should have:
 understood the key issues involved in consolidation accounting
 gained some additional experience in applying the requirements of IFRS 3 Business
Combinations and IFRS 10 Consolidated Financial Statements
 been able to clarify any difficulties you have experienced in studying the material provided
in Parts A and B of the Module 6 segment materials.

Workshop prerequisites
Please read both CPA 115 Financial Reporting Module 6 and the Workshop Notes. In particular,
you should have carefully worked through:
 Workshop Question 1
 Question 6.8 in the study guide
 Example 1 in the workshop slides
 Example 6.5 and Questions 6.9 and 6.10 in the study guide
 Workshop Question 2
 Example 6.6 and Question 6.11 in the study guide
 Workshop Question 3
 Workshop Question 4.

Contents of the workshop

1 Overview

2 Brief review of IFRS 3 Business Combinations:

 definition of business combination
 forms of business combinations
 overview of the acquisition method
 determination of goodwill or gain on bargain purchase
 Workshop Question 1

3 Overview of key issues in Part B of Module 6:

 defining the group
 preparation of consolidated financial statements
 disclosure requirements for consolidated financial statements

This workshop will primarily focus on the preparation of consolidated financial statements,
including the measurement of non-controlling interest.

4 Concept of the group

 identifying groups using the concept of control
 Question 6.8 of Module 6

5 Pre-acquisition elimination entry

 brief review of the consolidation process
 discussion of pre-acquisition elimination entry concept – Example 1
 discussion of revaluation of assets to fair value – Example 6.4 from Module 6
 revaluation of assets subject to depreciation – Example 6.5 and Questions 6.9 and 6.10
of Module 6
 Workshop Question 2

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

6 Intra-group transactions
 discussion of underlying concepts
 Example 6.6 and Question 6.11 of Module 6
 Workshop Question 3

7 Non-controlling interest
 concept and measurement of non-controlling interest
 Workshop Question 4

Workshop Question 1
On 1 April 20X6, H Ltd acquired a subsidiary, S Ltd. At that date, the shareholders’ equity of the
S Ltd was as follows.

$
Issued capital 100 000
Retained earnings 70 000
170 000

At the acquisition date, the identifiable net assets of S Ltd were recorded at fair value, except for
land which had a fair value of $30 000 in excess of its recorded amount.

Required
i Assume that H Ltd acquired control of S Ltd by purchasing all of its share capital for
$220 000. Determine the amount of goodwill or gain on bargain purchase involved with
this acquisition.
ii What difference would it make to your answer in (i) if the consideration transferred was
$180 000?
iii Assume that H Ltd acquired control of S Ltd by purchasing 70 per cent of the share capital
of S Ltd for $170 000. Determine the amount of goodwill or gain on bargain purchase,
assuming the non-controlling interest was measured using their proportionate share of
S Ltd’s identifiable net assets.
iv What difference would it make to the answer in (iii) if the non-controlling interest was
measured at its fair value of $70 000?

Workshop Question 2
Use the data in Workshop Question 1 and assume that the land was not revalued in the books
of S Ltd.

Required
i Prepare the pre-acquisition consolidation worksheet entry(ies) for the financial year ending
on 30 June 20X6 based on Workshop Question 1(i).
ii Prepare the pre-acquisition consolidation worksheet entry(ies) for the financial year ending
on 30 June 20X6 based on Workshop Question 1(ii).

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

Workshop Question 3
On 1 May 20X4, a subsidiary entity sold inventory to a parent entity for $90 000. The cost of the
inventory to the subsidiary entity was $60 000. The tax rate is 30 per cent.

Required
Prepare consolidation worksheet entries (including tax effect entries):
i for the financial year ending on 30 June 20X4 assuming that, by reporting date, the parent
entity had sold one-third of the inventory to parties external to the group
ii for the financial year ending on 30 June 20X5 assuming that, on reporting date, the parent
entity has one-third of the inventory still on hand (the remainder having been sold to parties
external to the group).

Workshop Question 4
Parent Ltd owns 80 per cent of the share capital of Subsidiary Ltd. During the year ended
30 June 20X2:
 Subsidiary Ltd sold inventory to Parent Ltd at a profit of $20 000
(the inventory is still on hand at 30 June 20X2)
 Parent Ltd sold plant to Subsidiary Ltd for $35 000 at a loss of $5000
 Subsidiary Ltd provided Parent Ltd with $10 000 of management services.

The plant was sold by Parent Ltd to Subsidiary Ltd on 1 July 20X1 and is depreciated on a
straight-line basis. The plant has a useful life of 7 years with a scrap value of $0 at the end of
that period.

The following figures were extracted from the consolidation worksheet for the year ended
30 June 20X2.

Parent Ltd Subsidiary Ltd

$ $
Profit for the year 200 000 100 000
Add: Opening retained earnings 30 000 20 000
230 000 120 000
Less: Dividends paid 100 000 50 000
Closing retained earnings 130 000 70 000

Assume a tax rate of 30 per cent.

Required
i Measure the non-controlling interest in the following:
 opening retained earnings
 profit for the year
 closing retained earnings.
ii Assume all of the inventory purchased by Parent Ltd from Subsidiary Ltd was sold to parties
external to the group during the financial year ending on 30 June 20X3. Moreover, assume
the following figures were extracted from the consolidation worksheet for the year ended
30 June 20X3.

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Business Combinations and Group Accounting Workshop Notes

Parent Ltd Subsidiary Ltd

$ $
Profit for the year 250 000 80 000
Add: Opening retained earnings 130 000 70 000
380 000 150 000
Less: Dividends paid 100 000 50 000
Closing retained earnings 280 000 100 000

Measure the non-controlling interest in the following:

 opening retained earnings
 profit for the year
 closing retained earnings.

Appendix: Self-study question

On 1 July 20X6, Subsidiary Ltd sold inventory to its parent entity for $80 000. The cost of the
inventory to Subsidiary Ltd was $100 000. The parent entity will use the inventory as items of
plant. It was estimated that the useful life of the plant was five years with a scrap value of $0 at
the end of that period. Assume a straight-line depreciation basis and a tax rate of 30 per cent.

Required
Prepare consolidation worksheet entries (including tax effect entries) for the financial years
ending 30 June 20X7 and 30 June 20X8 to account for this transaction from the group’s point
of view.

FINANCIAL REPORTING
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Workshop
solutions
Business Combinations and Group Accounting Workshop Notes

Workshop Question 1
i The fair value of the net assets of S Ltd at the acquisition date is determined as follows

$
Book value of net assets 170 000
Add: increase in land to fair value 30 000
Less: Deferred tax liability – revaluation of land (9 000)
Fair value of net assets of subsidiary 191 000

$
Consideration transferred 220 000
Fair value of net assets acquired 191 000
Goodwill 29 000

ii If the consideration transferred was $180 000, there would be a gain on

bargain purchase of $11 000.
$
Consideration transferred 180 000
Fair value of net assets acquired 191 000
Gain on bargain purchase 11 000

iii Goodwill is calculated as follows

$
Consideration transferred 170 000
Non-controlling interest (30% of $191 000) 57 300
227 300
Fair value of net assets acquired 191 000
Goodwill 36 300

iv Goodwill is calculated as follows

$
Consideration transferred 170 000
Non-controlling interest (fair value) 70 000
240 000
Fair value of net assets acquired 191 000
Goodwill 49 000

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

Workshop Question 2
i Using the data in Workshop Question 1(i), the consolidation worksheet entries for
30 June 20X6 would be as follows.

Debit Credit
$ $
Land 30 000
Deferred tax liability 9 000
Business combination reserve 21 000

Issued capital 100 000

Retained earnings (opening balance) 70 000
Business combination reserve 21 000
Goodwill 29 000
Investment in S Ltd 220 000

The preceding entries could be combined as follows.

Debit Credit
$ $
Issued capital 100 000
Retained earnings (opening balance) 70 000
Land 30 000
Goodwill 29 000
Deferred tax liability 9 000
Investment in S Ltd 220 000

ii Using the data in part (ii) of Workshop Question 1, the consolidation worksheet entries for
30 June 20X6 would be as follows.

Debit Credit
$ $
Land 30 000
Deferred tax liability 9 000
Business combination reserve 21 000

Issued capital 100 000

Retained earnings (opening balance) 70 000
Business combination reserve 21 000
Gain on bargain purchase 11 000
Investment in S Ltd 180 000

The preceding entries could be combined as follows.

Debit Credit
$ $
Issued capital 100 000
Retained earnings (opening balance) 70 000
Land 30 000
Deferred tax liability 9 000
Investment in S Ltd 180 000
Gain on bargain purchase 11 000

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

Workshop Question 3
i Consolidation worksheet entries for year ended 30 June 20X4.

Debit Credit
$ $
Sales1 90 000
Cost of goods sold2 70 000
Inventory3 20 000
(Sale of inventory)

Deferred tax asset4 6 000

Income tax expense5 6 000
(Tax effect of unrealised profit)

1 Intra-group sales.

2 Consists of the COGS from subsidiary to parent ($60 000) + overstatement of COGS to external
parties* ($10 000).
* When the parent entity purchased the goods from the subsidiary, it recorded the inventory at
$90 000. When one-third of the inventory was sold from the parent entity to external parties, then the
parent entity would have recorded a COGS of $30 000. However, from the group’s point of view, the
COGS should be one-third of its original cost to the group ($60 000/3 = $20 000).

3 To correct overstatement of the inventory from the group’s point of view. At 30 June 20X4, the inventory
on hand from the intra-group sale was recorded in the books of the parent entity at $60 000. From the
perspective of the group it should be recorded at $40 000 (two-thirds of its original cost to the
subsidiary of $60 000).

4 The group should record a deferred tax asset because, in a subsequent reporting period, the profit on
the inventory will be realised (when sold to external parties) but no tax will be payable by the group.
That is, the tax has been paid in the 20X4 reporting period by a member of the group (subsidiary).
Alternatively, the tax base of the inventory ($90 000) is greater than its carrying amount to the group
($70 000) and, hence, the group has a deductible temporary difference of $20 000 and this gives rise to
a deferred tax asset of $6000.

5 The reduction in the sales and COGS of the group leads to a reduction of profit of the group as
compared to that of the parent plus subsidiary. In turn, this necessitates a reduction in the income tax
expense of the group (as compared to that of the parent plus subsidiary).

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

ii Consolidation worksheet entries for year ended 30 June 20X5.

Debit Credit
$ $
Opening retained earnings1 20 000
Cost of goods sold2 10 000
Inventory3 10 000
(Unrealised profit—inventory)

Deferred tax asset4 3 000

Income tax expense5 3 000
Opening retained earnings6 6 000
(Tax effect of unrealised profit)

1 In the preceding reporting period, the unrealised profit on inventory was eliminated. The effect of this
elimination would have flowed through to (reduce) the closing retained earnings of the group. Hence
the opening retained earnings must be reduced (debited).
2 Reduction of the COGS to external parties to their cost to the group (COGS recorded by parent
= 1/3 of $90 000 = $30 000; COGS that should be recorded by the group
= 1/3 of $60 000 = $20 000).
3 To correct overstatement of inventory from the group’s point of view. One-third of the inventory is still
on hand.
4 Deferred tax asset relating to remaining unrealised profit (30% of $10 000).
1
5 As another /3 of the inventory was sold to external parties during 20X5, a further $10 000 of the initial
unrealised profit was realised by the group during this reporting period (through reduction in the
COGS). Therefore, the income tax expense of the group has to be increased (30% of $10 000),
as compared to the parent plus subsidiary.
6 In 20X4, the income tax expense of the group was reduced by $6000. The effect of this would have
flowed through to the 20X4 closing retained earnings. A reduction in income tax expense has the effect
of increasing profit after tax and, hence, increasing closing retained earnings. As a result, the 20X5
opening retained earnings has to be increased (credited) by $6000.

Workshop Question 4
i Non-controlling interest – 30 June 20X2

Non-controlling interest (NCI) in opening retained earnings

= 20% of opening retained earnings balance in financial statements of subsidiary
= 20% of $20 000
= $4 000

Non-controlling interest in profit for the year

= 20% of (Profit for the year in financial statements of subsidiary – Unrealised after tax
profits made by the subsidiary)
= 20% of (Profit for the year in the financial statements of subsidiary – Unrealised profit
on sale of inventory + Tax effect of unrealised profit)
= 20% of ($100 000 – $20 000 + $6 000)
= 20% of $86 000
= $17 200

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Business Combinations and Group Accounting Workshop Notes

Non-controlling interest in closing retained earnings

= 20% of (Closing retained earnings of subsidiary – Unrealised after tax profits made by
the subsidiary)
= 20% of (Closing retained earnings of subsidiary – Unrealised profit on sale of inventory
+ Tax effect of unrealised profit)
= 20% of ($70 000 – $20 000 + $6 000)
= 20% of $56 000
= $11 200

An alternative way of reconciling the non-controlling interest in closing retained earnings is

using the individual items making up the balance:
= NCI in opening retained earnings + NCI in profit for the year – NCI in dividends
= $4 000 + $17 200 – $10 000 (20% of $50 000)
= $11 200

ii Non-controlling interest – 30 June 20X3

Non-controlling interest in opening retained earnings

= $11 200 (as per calculation above)

Non-controlling interest in profit for the year

= 20% of (Profit for the year in the financial statements of subsidiary – Unrealised after tax
profits made by the subsidiary + Realised after tax profits of the group which were
originally made by the subsidiary)
= 20% of (Profit for the year in the financial statements of subsidiary + Realised profit on sale
of inventory – Tax effect realised profit)

= 20% of ($80 000 + $20 000 – $6 000)

= 20% of $94 000
= $18 800

Non-controlling interest in closing retained earnings

= 20% of (Closing retained earnings of subsidiary – Unrealised after tax profits of
the subsidiary)
= 20% of closing retained earnings of subsidiary*
= 20% of $100 000
= $20 000

* The unrealised profit has now been realised by the group and there are no unrealised
profits to carry forward.

An alternative way of reconciling the non-controlling interest in closing retained earnings is

using the individual items making up the balance:
= NCI in opening retained earnings + NCI in profit for year – NCI in dividends
= $11 200 + $18 800 – $10 000 (20% of $50 000)
= $20 000

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Business Combinations and Group Accounting Workshop Notes

Appendix: Self-study question

i Consolidation worksheet entries for year ended 30 June 20X7

Debit Credit
$ $
Sales1 80 000
Plant2 20 000
Cost of goods sold3 100 000
(Sale of inventory)

Income tax expense4 6 000

Deferred tax liability5 6 000
(Tax effect of unrealised loss)

Depreciation expense6 4 000

Accumulated depreciation – Plant7 4 000
(Depreciation adjustment)

Deferred tax liability8 1 200

Income tax expense9 1 200
(Tax effect of depreciation adjustment)

1 Intra-group sale.
2 Remeasures plant cost to the group, $100 000. Parent has the plant recorded in its financial statements
at $80 000.
3 Intra-group COGS. (Note: The effect of elimination entries 1 and 2 is to eliminate the loss on the sale of
the inventory recorded by Subsidiary Ltd. From the perspective of the group, this is an internal
transaction and therefore, the loss is unrealised.)
4 Entries 1 and 2 eliminate the unrealised loss. Hence, the group’s profit before tax is greater than the
sum of profit before tax of the parent entity and the subsidiary. The group’s income tax expense has to
be increased.
5 Although the income tax expense of the group increased as in (4) above, there is no current tax
payable. This is due to Subsidiary Ltd recording a loss on the sale of inventory which reduced its
tax payable. Yet in subsequent reporting periods, the parent will depreciate the plant at a lower rate
than the group. As such, the parent’s tax payable will be greater than that of the group. Hence, the
group has deferred the tax through a member of the group. Alternatively, the tax base of the plant
($80 000) is less than its carrying amount to the group ($100 000). When the group recovers the
carrying amount of the plant ($100 000), it will only receive depreciation deductions (through the parent)
of $80 000. Hence, the group has a taxable temporary difference of $20 000 and this gives rise to a
deferred tax liability of $6000.
6 Increase in depreciation expense to reflect the cost of the plant to the group. Depreciation recorded by
1 1
parent = /5 of $80 000 = $16 000, depreciation that should be recorded by the group = /5 of $100 000
= $20 000.
7 Increase in accumulated depreciation—refer to (6) above.
8 The parent entity’s lower depreciation charges (compared with the group’s) will result in a greater
amount of tax payable by that member of the group than is indicated by the profits of the group. Hence,
the deferred tax liability should be reduced (i.e. the deferred tax is now being paid through the parent).
It can be viewed that the group is recovering the book value of the plant at $20 000 per year while
receiving a tax deduction of only $16 000 ($80 000/5) per year. Hence, the group is paying the tax that
it originally deferred.
9 The increase in depreciation (see (6) above) reflects the realisation of the loss by the group. Therefore,
the income tax expense of the group has to be reduced (credited).

FINANCIAL REPORTING
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Business Combinations and Group Accounting Workshop Notes

ii Consolidation worksheet entries for year ended 30 June 20X8

Debit Credit
$ $
Plant1 20 000
Accumulated depreciation2 4 000
Opening retained earnings3 11 200
Deferred tax liability4 4 800
(20X7 carrying forward effects)

Depreciation expense5 4 000

Accumulated depreciation – Plant6 4 000
(Depreciation adjustment)

Deferred tax liability7 1 200

Income tax expense8 1 200
(Tax effect of depreciation adjustment)

1 Remeasure plant to cost to the group.

2 Carry forward of 20X7 remeasured accumulated depreciation.
3 Unrealised after-tax loss on plant = Initial unrealised after-tax loss of $14 000 ($20 000 – $6000),
less 20X7 realised after-tax loss of $2800 ($4000 – $1200) = $11 200. This entry carries forward
the effect on the 20X7 closing retained earnings.
4 Carry forward of 20X7 deferred tax liability.
5–8 See explanations (6) to (9) in answer to part (i).

FINANCIAL REPORTING
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