SEPARATE AND CONSOLIDATED FINANCIAL STATEMENTS – DATE OF

ACQUISITION
The focus of this discussion is on the business combination that results to a parent-subsidiary relationship. PFRS 3
presumes that there is a dominant party in a business combination which may be identified as the acquirer.

In the previous discussion, the procedural focus was on business combination arising from asset acquisitions. In those
situations the acquiring company survived and the acquired company ceased to exist as separate legal entities. This lesson
now will focus on the accounting practices followed in stock acquisitions, that is, when one company controls the
activities of another company through direct or indirect ownership of some or all of its voting stock.

In this business combination, both parent and subsidiary retain their status as separate legal entities. However, from an
economic perspective, they are single reporting entity. Two sets of financial statements must be prepared – separate
financial statements for the legal entity and consolidated financial statements for the group.

Subsidiary – An entity, including an unincorporated entity such as a partnership that is controlled by another entity
(known as the parent) that owns, usually, a majority of the voting shares/rights of the subsidiary.

• Once an investment ceases to fall within the definition of a subsidiary, it should be accounted for as an
associate under PAS 28 as a joint venture under PAS 31, or as an investment under PAS 39, as appropriate.

Parent – An entity that has one or more subsidiaries.

Control – The power to govern the financial and operating policies of an enterprises so as to obtain benefits from its
activities.

IDENTIFICATION OF SUBSIDIARIES
Control is presumed when the parent acquires more than half of the voting rights of the enterprise. Even when more than
half of the voting rights is not acquired, control may be evidenced by power:
➢ Over more than one half of the voting rights by virtue of an agreement with other investors; or
➢ To govern the financial and operating policies of the other enterprise under a statue or an agreement; or
➢ To appoint or remove the majority of the members of the board of directors; or
➢ To cast the majority of votes at a meeting of the board of directors.

Classification of Intercorporate Investment

Intercorporate investment – any purchase by one corporation of the securities of another corporation. It may be in
either debt securities or equity securities – preferred of common shares. However, the focus of this chapter is on equity
instruments.

Investment of a corporation (equity investments) can broadly be classified as:

1. Passive Investment – is made to earn dividends or to earn profits by actively trading investment for short-
term profit.

Passive investments are initially recorded at cost and are reported at fair market value on each period’s statement of
financial position. The treatment on gains and losses depends on how the company has elected to classify the
investment – a choice that the reporting entity makes for each separate passive equity investments when the
investments is first made. The choices available under PFRS 9, are to report the investment at either:

a. Fair value through profit or loss (FVTPL); or

b. Fair value through other comprehensive income (FVTOCI)
 If an equity investment is classified as FVTPL, both (a) dividends and (b) the change in fair value form one period to
another are reported in the net income section of the statement of comprehensive income.

If on the other hand, an equity investment is classified as FVTOCI, (a) dividends from investment are recognize in net
income, but (b) changes in the fair value of the investment are reported as other comprehensive income; the
accumulated gains and losses are reported as a separate component of stockholders’ equity. The choice to classify an
equity investment as FVTOCI is irrevocable – the choice cannot be changed subsequently.

2. Strategic Investment – is made to control or significantly influence the operations of the investee corporation.
Generally, investments are considered strategic if a company owns either directly or indirectly 20% or more of the
voting shares of the investee, unless it is clearly demonstrated that the investment are passive.

STRUCTURED ENTITIES OR VARIABLE INTEREST ENTITIES (VIEs)

Structured entity (SE) is not controlled through voting power. SE may not even be a corporation but could instead be a
partnership. An SE also can be created simply by delegating specific powers to certain individuals to act on behalf of the
sponsoring corporation – in effect, by creating sort of agency relationship with individuals instead of corporate entities.

CONCEPT OF CONTROL
Consolidation is the process of combining the assets, liabilities, earnings, and cash flows of a parent and its subsidiaries as if
they were one economic entity. Since an economic and not legal perspective is adopted, transactions between companies
within its economic entity and their resultant balances must be eliminated. A parent is an entity that controls one or more
subsidiaries. A group is a parent and all its subsidiaries.

PFRS uses control as the single basis for consolidation. An investor controls an investee if and only if the investor has all of the
following three elements of control:
1. Power over the investee. Power is the ability to direct those activities which significantly affect the investee’s
returns. It arises from rights, which may be straightforward (e.g. through voting rights) or complex (e.g. through
one or more contractual arrangements).
2. Exposure, or rights, to variable returns from involvement with the investee returns must have the potential to
vary as a result of the investee’s performance and can be positive, negative, or both.
3. The ability to use power over the investee to affect the amount of the investee’s returns.

The “Default Presumption”

The presence of “control: determines the existence of a parent-subsidiary relationship. In the context of PFRS 10 the
quantitative criterion of more than 50% of voting power was not mentioned but not superseded by a new rule. For practical
reasons, the presumption is that ownership of more than 50% of voting power constitutes control, in the absence of any
evidence to the contrary. However, control also arises from many other sources: statute, contractual agreements, implicit or
explicit control over the board of directors among others. As PFRS 10 is based on principles rather than rules, the use of a
quantitative criterion is only a guide. We term this the “default assumption” in the absence of evidence to the contrary.

“The presence of control determines the existence of a parent-subsidiary relationship”

CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

SEPARATE FINANCIAL STATEMENTS

The standard defines separate FS as those presented by a parent, an investor in an associate or a joint venture in which
the investments are accounted for on the basis of the direct equity interest rather than on the basis of the reported
results and net assets of the investee.

Recording Investment at date of acquisition (Parent’s Book)

Stock investment is recorded at its cost as measured by the fair value of the consideration given or received whichever is
more clearly evident. The subsidiary, in contrast, continues to record its detailed books based on historical book values.

Example No. 1: Assume that P Company acquires all 100,000 shares of the common stock of S Company for P5 per share.
The entry on the parent’s books would be:
Investment in Subsidiary P500,000
Cash P500,000

Treatment of Acquisition related direct costs in the separate FS

Before the separation of PAS 27 and PFRS 10 – PGFRS 27 termed as consolidated and separate FS, the basis is PFRS 3
wherein any acquisition related costs are considered expenses.

After the separation of PAS 27 and PFRS 10, there is an argument that the basis of PAS 27 is no longer PFRS 3 and the basis
of determination of costs will now be under the general rule of recording costs which includes direct acquisition costs as
part of the investment acquired.
Example No. 2: Assume that P Company acquires all 100,000 shares of the common stock of S Company for P5 per share
and pays acquisition fees of P30,000. The entry to record the acquisition-related cost following PFRS 3 on P Company’s
books is:
Retained Earnings (acquisition-related expense is close
to retained earnings since only balance sheets are
being examined) P30,000
Cash P30,000
Example No. 3: If P Company issues stock in the acquisition, the investment is recorded at the fair value of the stock
issued, giving effect to any costs of registering the stock issue. Assume that P Company issues 10,000 of its P10 par value
common shares with a fair value of P13 per share for the 10,000 shares of S Company, and that registration costs amount
to P12,000 paid in cash. The entries to record the investment on P Company’s books are:

Investment in Subsidiary P130,000

Common stock (P10 x 10,000 shares) P100,000
Paid-in capital in excess of par (P13 – P10) x 10,000) 30,000

Paid-in capital in excess of par P12,000

Cash P12,000
(To record acquisition related costs – costs to register stocks)

If P Company paid an additional P5,000 as a finder’s fee, the entry would be:
Retained Earnings (acquisition-related expense is close
to retained earnings since only balance sheets are
being examined) P5,000
Cash P5,000

CONSOLIDATED FINANCIAL STATEMENTS – The FS of a group presented as those of a single economic entity.

Presentation of Consolidated FS
A parent is required to present consolidated FS in which it consolidates its investment in subsidiaries except in one
circumstance: A parent need not present consolidated financial statements if and only if all of the following four
conditions are met:
➢ The parent is itself a wholly owned subsidiary or is a partially owned subsidiary of another entity and its other
owners including those not otherwise entitled to vote, have been informed about and do not object to, the parent
not presenting consolidated FS;
➢ The parent’s debt or equity instruments are not traded in a public market;
➢ The parent did not file, nor is it in the process of filing its FS with a securities commission or other regulatory
organization for the purpose of issuing any class of instruments in a public market; and
➢ The ultimate or any intermediate parent of the parent produces consolidated FS available for public use that
comply with IFRS.

Consolidation –is the process of combining the assets, liabilities, earnings and cash flows of parent and all its subsidiaries
as if they were one economic entity. The preparation of consolidated FS is an example of focusing on substance rather
than in form. Its purpose is to present, primarily the benefit of the owners and creditors of the parent.

ELEMENTS OF CONTROL
1. Power over the investee - Power is the ability to direct those activities which significantly affect the investee’s
returns. It arises from rights, which may be straightforward or complex.
2. Exposure or rights to variable returns – from involvement with the investee returns must have the potential to
vary as a result of the investee’s performance and can be positive, negative or both.
3. Ability to use power over the investee- to affect the amount of the investor’s returns.
CONSOLIDATION PROCEDURES USING ACQUISITION METHOD- General Approach

Although two sets of accounts have to be prepared, only one set of books or ledgers has to be kept for the group entity.
Instead, consolidation worksheets are prepared at the end of each reporting period, which combine the separate financial
statements of a parent and its subsidiaries and include consolidation elimination entries and adjustments to remove the
effects of intercompany transactions.

On the Statement of Financial Position, there will be no investment account for the controlled subsidiaries and structured
entities. Instead, the assets and liabilities of the controlled entities will be added to those of the parent to show the
economic resources of the entity.

On the Statement of Comprehensive Income, the revenues and expenses will be the totals for each item for the parent plus
the controlled entities. The effects of any and all intercompany transactions will be eliminated to avoid double-counting.

“REAR” or “MEAR” STEPS

R – EALIABILITY Measurement requires: (schedule of determination of allocated excess)
➢ Calculate cost and fair value adjustments
➢ Allocate FVA through over/undervaluation of assets and liabilities

This step involves determination of the fair value of subsidiary and over/undervaluation of identifiable assets and
liabilities in the schedule of determination and allocation of excess.

Here, consolidation takes the carrying values of both companies and adds the fair value adjustments (FVA), i.e. the over-
under valuation of assets and liabilities relating to each asset and liabilities. The FVA is the difference between the
carrying values and fair values of the acquiree’s identifiable assets and liabilities at the date of acquisition, plus any
goodwill. Specifically, the FVA is first allocated to the various identifiable assets and liabilities of the acquire to the full
extent of their fair value increments (or decrements). Any excess of the FVA after the allocation process is allocated to
goodwill.

E-LIMINATE requires:
➢ Identify and eliminate intercompany transactions and balances; and
➢ Calculate and eliminate any unrealized profits (loss) relating to the intercompany sale of inventory and fixed
assets in the current period.
➢ Calculate and recognize the profit or loss in the current year on the sale of inventory and fixed assets in the
previous periods.

The first intra-group or intercompany transaction that has to be eliminated in the consolidation worksheet is the
investment by the parent in the subsidiary. Without the elimination, a double-counting of asset arises – the
investment asset in the parent’s balance sheet is duplicated by the individual assets and liabilities of the subsidiary
acquired.

An asset substitution process takes place whereby the investment account is replaced by the identifiable assets and
liabilities of the subsidiary through the combination of the balance sheet of the subsidiary with that of the parent.
Elimination of the investment account is necessary to avoid recognizing an asset in two forms.

After eliminating the investment in a subsidiary against the capital stock, additional paid-in capital and retained
earnings that are outstanding at the date of acquisition, a differential remains. The difference comprises of two
components which are goodwill and the excess or deficit of fair value over book value attributable to over/under
valuation of assets and liabilities.
 Intercompany accounts to be eliminated:
Parent’s Account Subsidiary’s Account
Investment in Subsidiary VS Book Value of SHE and over/under valuation of
net
assets
Intercompany receivables (payable) VS Intercompany payable (receivable)
Advances to Subsidiary VS Advances from Parent
Interest Income (expense) VS Interest Expense (Income)
Dividend Income (dividends declared) VS Dividends declared
Management fee received from “S” VS Management fee paid to parent

A-MORTIZE step requires:

➢ Amortize the FVA allocated to various identifiable assets and liabilities in the current and
previous periods.
➢ Write off any impairment of goodwill and other intangible assets with indeterminate useful
lives in the current and previous periods.
➢ Find the balance of the allocated FVA remaining unamortized and unimpaired at the end of
the current period.

R-ECOGNIZE non-controlling interest share of earnings

➢ Recognize NCI share of earnings
➢ Calculate NCO for balance sheet purposes
➢ Calculate consolidated Retained earnings

Direct Approach versus Workpaper Approach to Consolidation

Direct Approach – prepares the consolidated statements by setting up the income

statement/statement of comprehensive income and Statement of financial position formats and
computing each consolidated balance directly. Each asset, liability, revenue, and expense is separately
calculated and entered into the consolidated statement. The direct approach works from the
separate-entity financial statements of the parent and the subsidiary.

Workpaper Approach – uses a multi-columnar worksheet to enter the trial balances of the parent and
each subsidiary. The eliminations and adjustments are entered onto the worksheet, and the accounts
are cross-added to determine the consolidated trial balance.

BOTH approaches yield the same result. It does not matter what approach is used-what is important is
the result, not the method used to drive the result.
Cases for Consolidation of wholly owned subsidiaries
 Non- controlling interest

IFRS 3 2008, provides two options of measuring non-controlling interest in an acquiree;

• at fair value, or
• at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets

FLOOR TEST: the amount of NCI should be equal or more than NCI @ NA @ FV

NOTE: Control Premium is included in the computation of Purchase Price and Goodwill but is
ignored in determining the Non-controlling interest.

ENTITY (ECONOMIC UNIT) THEORY

Under this theory, non-controlling interests are deemed to be as important a stakeholder of the
combined entity as are the majority shareholders. The distinction between the parent and the non-
controlling interests is unimportant – both are included in equity. Hence, the entity theory requires a
consistent accounting treatment for both parent and non-controlling interests.

Under this theory:

 The consolidated financial statements should be prepared and presented for the benefit of both
groups of equity holders.
 Non-controlling interests are shown as equity in the balance sheet. The accounting equation will
 be as follows:

Consolidated equity: Controlling and NCI = Consolidated assets – Consolidated liabilities

Parent Theory
The parent theory focuses on the information needs of the parent company shareholders. Features of
the parent theory are as follows:
 The consolidated financial statements are prepared and presented primarily for the benefits of
the parent company shareholders. The information needs of the NCI are better served by the
separate financial statements of the subsidiary that the consolidated financial statements.
 Claims by NCI in the net assets of a subsidiary are shown as a separate component in the
balance sheet.

Consolidated equity + NCI = Consolidated assets – Consolidated Liabilities.

 Only the parent’s share of the fair values of the assets and liabilities of subsidiaries at the date of
acquisition should be reported.
 Goodwill is an asset of the parent and should be restricted to the parent’s share. Hence.
Internally generated goodwill of a subsidiary that belongs to the NCI shareholders of a subsidiary
is not recognized.
 NCI interests’ share of current profit is shown as a deduction from profit to show the final profit
that is attributable to parent company shareholders.

Differences between the theories:

Attributes Parent Theory Entity Theory
Fair value differences in Recognized only in respect Recognized in full, reflecting both
relation to identifiable of parent’s share parent’s and NCI share of the fair
assets and liabilities at the value adjustments
date of acquisition
Presentation of non- Neither as equity nor debt As part of equity
controlling interests
Goodwill Goodwill is parent’s asset Goodwill is an entity asset and
should be recognized in full as at
date of acquisition

Propriety Theory

Under this theory, the parent is seen as having a direct interest in a subsidiary’s assets and
liabilities. This perspective results in pro-rata or proportional consolidation, whereby the parent’s
interest is directly multiplied to each individual asset and liability of the subsidiary and combined
in the parent’s assets and liabilities.
Push-down Accounting. Refers to the practice of revaluing an acquired subsidiary’s
assets and liabilities to their fair values directly on that subsidiary’s books at the date of
acquisition.
REVERSE ACQUISITION (TAKEOVERS)

This occurs when an enterprise obtains ownership of the shares of another enterprise but, as part
of the transaction, issues enough voting shares as consideration that control of the combined
enterprise passes to the shareholders of the acquired enterprise. Although legally, the enterprise
that issues the shares is regarded as the parent or continuing enterprise, the enterprise whose
former shareholders now control the combined enterprise treated as the acquirer for reporting
purposes. As a result, the issuing enterprise is deemed to be the acquiree and the company being
acquired in appearance is deemed to have acquired control of the assets and business of the
issuing enterprise.