## **Learning Outcomes**

After reading this article, you will be able to explain why fair value adjustments are necessary when preparing consolidated financial statements in line with IFRS 10 and IFRS 3. You will understand how to determine the fair value of the subsidiary’s assets and liabilities at the acquisition date, calculate goodwill accurately, and identify the effects of these adjustments on group reserves and financial statements.

## **ACCA Financial Reporting (FR) Syllabus**

For ACCA Financial Reporting (FR), you are required to understand the treatment of fair value adjustments during the consolidation process. Specifically, revision should focus on:

- Explaining the need for fair value adjustments to assets and liabilities of a subsidiary at the acquisition date (IFRS 3, IFRS 10)
- Calculating and accounting for fair value adjustments for tangible and intangible assets, liabilities, and provisions
- Showing the impact of these adjustments on consolidated goodwill, group reserves, and non-controlling interests
- Recognising and measuring contingent liabilities and intangible assets acquired in a business combination
- Explaining how subsequent depreciation and amortisation of fair value adjustments affect group profits
- Dealing with deferred and contingent consideration as part of acquisition accounting

## **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._

1. When preparing group accounts, why must the identifiable assets and liabilities of a newly acquired subsidiary be measured at fair value at the date of acquisition?
2. If a subsidiary’s inventory is carried at \$100,000 in its own accounts but has a fair value of \$120,000 at acquisition, what adjustment is needed for consolidation?
3. How do fair value adjustments at acquisition affect goodwill and the non-controlling interest calculation in the consolidated statement of financial position?
4. State two types of assets or liabilities that might be recognized in consolidated accounts due to fair value adjustments that are not recorded in the subsidiary’s own balance sheet.

## **Introduction**

The preparation of consolidated financial statements under IFRS requires more than simply adding together the assets and liabilities of the parent and subsidiary. For consolidation to present a true and fair view, IFRS 10 and IFRS 3 require that, at acquisition, the identifiable assets and liabilities of the subsidiary are measured at their fair values, not just their book amounts. This ensures that goodwill on consolidation reflects the actual economic value acquired and that post-acquisition results are meaningfully reported.

> **Key Term: Fair value**
> The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the acquisition date.
>
> **Key Term: Acquisition date**
> The date when the parent legally obtains control over the subsidiary, which is when fair value measurement and consolidation begin.

## **Why Make Fair Value Adjustments at Acquisition?**

The main objective of consolidated financial statements is to show the economic resources controlled by the group at their current value to the group, not their historic cost to the subsidiary. Using fair values at acquisition ensures the following:

- Goodwill is measured accurately as the difference between the fair value of the consideration (plus non-controlling interest) and the fair value of acquired net assets
- All hidden value in assets (such as internally generated brands or undervalued land) is recognised
- Contingent liabilities and obligations not previously recorded by the subsidiary are properly reflected
- Users can compare the group’s financial position before and after the acquisition meaningfully

Fair value measurement also brings consistency with IFRS 3 requirements and aligns the consolidated figures with what an independent buyer would pay for the subsidiary’s net assets at the acquisition date.

## **How to Calculate Fair Value Adjustments**

Before consolidation, identify assets and liabilities in the subsidiary’s accounts that require adjustment to fair value. Key adjustment areas include:

- Non-current assets (such as property, plant and equipment)
- Inventory (if fair value exceeds carrying amount)
- Intangible assets (e.g., brands, customer lists not previously recognised)
- Provisions and contingent liabilities (such as unresolved legal claims)
- Financial assets and liabilities (adjust to market value as required)

Record these fair value adjustments in consolidation workings as if they were part of the subsidiary’s net assets as at the acquisition date. They are also reflected in the post-acquisition column and affect consolidated depreciation, amortisation, and future profit.

> **Key Term: Contingent liability**
> A possible obligation arising from past events that is only recognized at fair value in consolidation if it can be reliably measured at acquisition.
>
> **Key Term: Goodwill**
> The excess of the sum of consideration transferred and the non-controlling interest over the fair value of identifiable net assets at acquisition.

## **Impact on Goodwill and Group Figures**

The fair values of all identifiable assets and liabilities at acquisition date must be used in the calculation of group goodwill and non-controlling interest (NCI). The revised net assets (including any fair value uplift or new recognitions) typically decrease goodwill or increase it, depending on whether fair values are higher or lower than book values.

Subsequent depreciation, amortisation, or unwinding of fair value adjustments are treated as group-only adjustments and affect post-acquisition profits, group reserves, and the non-controlling interest allocation each year.

> **Key Term: Non-controlling interest (NCI)**
> The equity in a subsidiary not attributable, directly or indirectly, to the parent. For consolidation, it shares in the re-measured net assets (including fair value adjustments) at acquisition.

### **Worked Example 1.1**

On 1 January 20X1, Parent Co acquires 80% of Subsidiary Co for \$1,000,000. At acquisition, Subsidiary’s statement of financial position shows property, plant and equipment (PPE) at \$300,000 book value, but its fair value is \$400,000. Subsidiary has other net assets of \$800,000. The NCI at acquisition is valued at the proportionate share of net assets.

**Required:** Calculate consolidated goodwill at acquisition, reflecting the fair value adjustment.

> **Answer:**
> Step 1: Adjust net assets to fair value at acquisition = PPE (\$400,000) + Other net assets (\$800,000) = \$1,200,000
> Step 2: NCI at 20% = \$1,200,000 × 20% = \$240,000
> Step 3: Total deemed consideration = Consideration (\$1,000,000) + NCI (\$240,000) = \$1,240,000
> Step 4: Goodwill = Total consideration – Net assets at FV = \$1,240,000 – \$1,200,000 = \$40,000

### **Worked Example 1.2**

At acquisition, Subsidiary also has a pending legal claim for which no provision was made in the books, but Group assessors value the obligation at \$60,000. How does this affect consolidation?

> **Answer:**
>
> - The \$60,000 is included as a fair value adjustment, reducing the subsidiary's net assets at acquisition.
> - This increases calculated goodwill by \$60,000 compared to not recognising the obligation, and ensures future settlement of the claim does not reduce group post-acquisition profit.

### **Exam Warning**

> It is a frequent error to overlook depreciation or amortisation arising from fair value uplifts to items such as PPE or intangible assets. The group’s post-acquisition profits (and those used for NCI allocation) must be adjusted for the extra annual depreciation based on the higher fair value, not just the subsidiary’s own charge.

## **Effects of Fair Value Adjustments—Depreciation and Reserves**

When a fair value adjustment increases the value of depreciable assets, extra depreciation must be calculated on the fair value uplift. This additional charge reduces group profits in subsequent periods and must be split between the parent and NCI in proportion to shareholdings.

If the asset is non-depreciable (such as land), there is no ongoing adjustment, but the revised fair value forms part of group net assets for goodwill and NCI purposes.

Adjustments to inventory and contingent liabilities typically reverse within the first year after acquisition as the inventory is sold or the liability settles, with no ongoing group adjustment required.

> **Key Term: Fair value adjustment**
> The process of amending subsidiaries’ book values of assets and liabilities to reflect acquisition-date fair values in the consolidation process.

## **Summary**

Fair value adjustments at acquisition ensure that consolidated accounts reflect economic reality, supporting accurate goodwill calculation and appropriate allocation of future profits. All fair value uplifts, new asset recognitions, and contingent liabilities at acquisition are essential for correct group reporting. Ongoing effects, such as higher group depreciation or amortisation charges, must be included in post-acquisition consolidation to ensure group profits and reserves are correct.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the IFRS requirement for fair value measurement of assets and liabilities at acquisition for consolidation
- Identify which asset, liability, and contingent items may require fair value adjustment
- Calculate goodwill using acquisition-date fair values and determine the impact on NCI
- Assess the ongoing impact of fair value adjustments on group profits and reserves, especially through extra depreciation and amortisation
- Apply group-only depreciation, amortisation, and unwinding of fair value adjustments in consolidated financial statements
- Recognise that omitting fair value adjustments or failing to account for extra depreciation will make consolidated results incorrect

## **Key Terms and Concepts**

- Fair value
- Acquisition date
- Contingent liability
- Goodwill
- Non-controlling interest (NCI)
- Fair value adjustment

Principles of consolidation (IFRS 10/IFRS 3) - Fair value adjustments at acquisition