Learning Outcomes
After reading this article, you will be able to explain the concept of a group as a single economic entity, assess control for consolidation under IFRS 10, and outline the acquisition method required by IFRS 3. You will understand how to determine whether an investee is a subsidiary, calculate goodwill, and apply the necessary steps for consolidating financial statements as required in the ACCA FR exam.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand the definition and identification of a subsidiary, the basis for control according to IFRS 10, and the application of the acquisition method per IFRS 3. Ensure you are able to:
- Define and explain the concept of a group as a single economic unit.
- Identify the circumstances in which consolidated financial statements are required under IFRS 10.
- Apply the criteria for control according to IFRS 10 Consolidated Financial Statements.
- Distinguish between parent and subsidiary, and assess significant influence.
- Explain and account for the acquisition method under IFRS 3, including calculation of goodwill and fair value adjustments.
- Recognise the importance of fair values for consideration, assets, and liabilities on acquisition.
- Evaluate when group financial statements are required and understand permitted exemptions.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
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Which of the following is NOT a requirement for control under IFRS 10?
- Power over the investee
- Ownership of more than 50% of voting shares
- Exposure to variable returns
- Ability to use power to affect returns
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What is the main accounting standard prescribing the acquisition method in business combinations?
- IFRS 5
- IAS 24
- IFRS 3
- IAS 16
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True or false? A parent does not have to consolidate a subsidiary if their activities are dissimilar.
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What elements are compared to determine goodwill under IFRS 3 at the acquisition date?
Introduction
Groups are presented in financial reporting as if they are a single economic entity, even though each company remains a separate legal entity. The preparation of consolidated financial statements is required so users see the combined results and financial position of the parent and its subsidiaries. Determining which companies to include and how to account for acquisitions is governed by IFRS 10 Consolidated Financial Statements and IFRS 3 Business Combinations.
Key Term: Control
Control exists when an investor is exposed, or has rights, to variable returns from its involvement with an investee and has the ability to affect those returns through its power over the investee.Key Term: Subsidiary
An entity that is controlled by another entity (the parent).Key Term: Acquisition Method
The process in IFRS 3 used to account for a business combination, requiring identification of the acquirer, measurement of consideration at fair value, recognition of acquired identifiable assets and liabilities at fair value, and calculation of goodwill.Key Term: Goodwill
The excess of the sum of the consideration transferred, the amount of any non-controlling interest, and the fair value of any previous equity interest over the acquirer's share of the fair value of the identifiable net assets at the acquisition date.
Principles of Group Accounts and Control Assessment
Identifying a Group and Assessing Control
Under IFRS 10, an entity must present consolidated accounts if it controls another entity. Control exists only if three conditions are all met:
- Power over the investee (such as voting rights, appointment of directors, or contractual arrangements),
- Exposure or rights to variable returns from involvement with the investee,
- The ability to use power to affect those returns.
Majority voting rights usually provide control but are not always essential. Contractual rights, options, or rights to appoint management can sometimes result in control, even at shareholdings below 50%. Conversely, minority protections or the requirement for unanimous consent may indicate that control does not exist even with a majority shareholding.
In group accounts, the parent company must consolidate all subsidiaries it controls unless an exemption applies according to IFRS 10 (e.g., when the parent itself is wholly owned and users are not prejudiced).
Exemptions from Consolidation
A parent need not prepare consolidated statements if all the following conditions are met:
- The parent is a wholly or partially-owned subsidiary and all other owners have agreed not to require consolidation,
- Its shares or debt are not publicly traded,
- It does not file its financial statements with a securities regulator for the purpose of issuing new instruments,
- Its ultimate parent prepares consolidated financial statements in accordance with IFRS and these are publicly available.
Dissimilar activities, poor performance, or national restrictions—by themselves—do not justify exclusion of a subsidiary from consolidation under IFRS.
The Acquisition Method under IFRS 3
When a parent obtains control of a subsidiary, IFRS 3 requires the acquisition method to be applied:
Step 1: Identify the Acquirer
Usually the entity that gains control.
Step 2: Determine the Acquisition Date
The date the acquirer obtains control.
Step 3: Recognise and Measure Identifiable Assets and Liabilities
At acquisition, all identifiable assets and liabilities of the subsidiary are recognised at their fair values in the consolidated statement of financial position.
Step 4: Recognise and Measure Consideration Transferred
All consideration provided by the parent (cash, shares issued, deferred payments, contingent consideration) must be measured at fair value at the acquisition date.
Step 5: Recognise Goodwill or Gain from Bargain Purchase
Goodwill is calculated as the excess of the consideration (plus the amount of non-controlling interest and any previous equity interest) over the group’s share of the fair value of the identifiable net assets at acquisition.
If the net assets acquired exceed the consideration (plus NCI and previous holdings), the difference is a bargain purchase and is recognised in profit or loss after reassessment.
Worked Example 1.1
Sigma Ltd acquires 80% of Pi Ltd for $800,000 cash and issues 40,000 shares with a market value of $5 per share. At the acquisition date, Pi Ltd’s identifiable net assets have a fair value of $950,000. The fair value of the non-controlling interest (NCI) in Pi Ltd is $200,000. What is the amount of goodwill?
Answer:
Total consideration = $800,000 (cash) + $200,000 (shares) = $1,000,000
Total for goodwill calc = $1,000,000 (consideration) + $200,000 (NCI) = $1,200,000
Goodwill = $1,200,000 – $950,000 (net assets at fair value) = $250,000
Fair Value Adjustments in Consolidation
For group accounts, all assets and liabilities of the acquired subsidiary are shown at their fair values at acquisition. This ensures that goodwill calculation is accurate, and future depreciation or amortisation is based on these fair values (not historical book amounts).
Contingent and deferred consideration must also be included at fair value. Incidental acquisition costs (like legal fees) are recognised as an expense in profit or loss and are not included in the cost of investment.
Worked Example 1.2
Parent Co acquires 100% of Target Co for $5,000,000 including a deferred payment of $1,000,000 due in 3 years (discounted at 8%). The fair value of net assets is $4,700,000. What is the goodwill at acquisition?
Answer:
Present value of deferred payment = $1,000,000 / (1.08)^3 ≈ $793,832
Consideration = $5,000,000 – $1,000,000 + $793,832 = $4,793,832
Goodwill = $4,793,832 (consideration) – $4,700,000 (net assets) = $93,832
Summary
Consolidated financial statements present a group as a single economic entity, requiring all subsidiaries controlled by the parent to be included. IFRS 10 defines control as power over the investee, exposure to variable returns, and the ability to use power to affect returns. IFRS 3 prescribes the acquisition method, which involves recognising the identifiable net assets at fair value, determining the fair value of consideration and non-controlling interest, and calculating goodwill. Only limited exemptions from consolidation apply, and mere differences in activities or performance do not justify exclusion.
Key Point Checklist
This article has covered the following key knowledge points:
- Explain the definition of control per IFRS 10 and its three elements
- Identify when group accounts are mandatory and when exemptions apply
- State and apply the steps of the acquisition method under IFRS 3
- Calculate goodwill using fair values of consideration, NCI, and net assets
- Recognise the requirement to adjust all assets and liabilities to fair value at acquisition
- Understand the treatment of acquisition costs and contingent consideration
Key Terms and Concepts
- Control
- Subsidiary
- Acquisition Method
- Goodwill