Learning Outcomes
After reading this article, you will be able to explain the main requirements for group company consolidation under IFRS 10 and IFRS 3. You should be able to identify when a parent company controls a subsidiary; calculate goodwill and non-controlling interests on acquisition, including fair value and proportion of net assets methods; and explain the purpose of these adjustments in group financial statements.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand and apply the following in relation to group accounts, goodwill, and non-controlling interests:
- When consolidated financial statements are required under IFRS 10.
- How to identify control, requiring consolidation.
- Calculation and treatment of goodwill at acquisition under IFRS 3.
- Measurement of non-controlling interests (NCI): fair value and proportion of net assets methods.
- Recognition and treatment of goodwill impairments.
- How fair values of assets and liabilities affect group statements.
- The effect of NCI policy on group reserves.
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.
- In the context of IFRS 10, which three criteria must be met for an investor to have control over an investee?
- How is goodwill calculated on the acquisition of a subsidiary under IFRS 3?
- What is the difference between measuring non-controlling interests at fair value versus at proportion of net assets?
- Explain why fair value adjustments are made to the assets and liabilities of a subsidiary at acquisition.
Introduction
Consolidated financial statements are prepared to show the financial position and performance of a group of entities as if they were a single economic unit. Under IFRS 10 and IFRS 3, this requires the parent company to replace its investment in a subsidiary with its share of that subsidiary’s actual assets and liabilities. A central part of this process is determining goodwill and non-controlling interests.
Key Term: control
The power to govern an entity’s financial and operating policies to obtain benefits from its activities, usually evidenced by holding more than 50% of voting rights plus the power to direct relevant activities.Key Term: subsidiary
An entity controlled by a parent company.Key Term: goodwill
The excess of the aggregate of the purchase consideration and non-controlling interest over the fair value of the subsidiary’s identifiable net assets at acquisition.Key Term: non-controlling interest (NCI)
The equity in a subsidiary not attributable, directly or indirectly, to a parent.Key Term: fair value adjustment
The process of restating the assets and liabilities of an acquired subsidiary to their fair values at the acquisition date, as required by IFRS 3.
The Principles of Consolidation
When is Consolidation Required?
IFRS 10 requires a parent to present consolidated financial statements when it controls another entity. Control is evidenced by:
- Power over the investee (e.g., majority of voting rights).
- Exposure, or rights, to variable returns from its involvement.
- The ability to use power to affect those returns.
The Mechanics of Consolidation
On consolidation, the parent replaces the investment in the subsidiary with its share of the subsidiary’s actual net assets. In group accounts:
- All assets and liabilities of the parent and subsidiary are combined line-by-line.
- All of the subsidiary’s equity balances are excluded except for the non-controlling interest.
A key step is to adjust the subsidiary’s net assets to fair value at acquisition to ensure the group’s consolidated position is fairly presented.
Goodwill in Consolidation
Calculation of Goodwill
Goodwill is calculated as:
Cost of investment (by parent)
- Value of NCI at acquisition
– Fair value of subsidiary’s net identifiable assets at acquisition
= Goodwill
There are two policies allowed for measuring NCI at acquisition:
- Fair value method: Measure at fair value, usually the quoted share price for NCI’s shares.
- Proportion of net assets method: Measure at NCI’s share of net assets at acquisition.
Example: Goodwill Calculation
Suppose Parent acquires 75% of Subsidiary for $6 million in cash. The fair value of NCI’s 25% is $2 million. At acquisition, the fair value of Subsidiary’s net assets is $7 million.
- Goodwill = $6m (parent) + $2m (NCI) – $7m = $1 million
If the NCI is measured just as 25% of net assets ($7m × 25% = $1.75m):
- Goodwill = $6m + $1.75m – $7m = $0.75 million
Non-controlling Interests
Measurement of NCI
NCI represents shares in a subsidiary not owned by the group. NCI is presented separately in the group statement of financial position, within equity.
- Fair value method: The NCI at acquisition is the market value of its shares, so NCI "owns" part of the goodwill.
- Proportion of net assets method: Only recognises NCI’s share of net assets, so goodwill is only the group share.
After acquisition, NCI is adjusted by its share of the subsidiary’s post-acquisition profits and any goodwill impairment (if fair value method is used).
Worked Example 1.1
A parent acquires 80% of a subsidiary for $8m. NCI’s fair value is $1.8m. At acquisition, the subsidiary's net assets are valued at $9m.
- Calculate goodwill using both NCI measurement methods.
Answer:
Fair value method:
Goodwill = $8m (parent) + $1.8m (NCI) – $9m = $0.8m
Proportion of net assets method:
NCI share of net assets: $9m × 20% = $1.8m
So calculation is the same, but in general, if NCI fair value ≠ net assets, the figure will differ.
Goodwill Impairment
Goodwill is not amortised but must be tested annually for impairment. Any impairment loss is split according to the group policy for NCI measurement:
- Fair value method: Impairment is allocated between group and NCI based on ownership %.
- Proportion of net assets method: Only group share of impairment is recognised.
Fair Value Adjustments at Acquisition
All of the subsidiary’s identifiable assets and liabilities must be restated at fair value at acquisition. This ensures that goodwill is calculated consistently and the group statement reflects the economic substance.
Common fair value adjustments include:
- Upward revaluation of PPE or inventory.
- Recognition of internally generated intangible assets if separable and reliably measurable.
Subsequent effects, such as higher depreciation on the uplift, will reduce group profits.
Worked Example 1.2
On acquisition, Parent identifies that Subsidiary's equipment has a carrying amount of $2m but a fair value of $2.4m with a remaining useful life of four years.
- Calculate the annual depreciation adjustment required for group accounts.
Answer:
Fair value uplift: $400,000.
Increased depreciation: $400,000 ÷ 4 = $100,000 per year.
The group's consolidated financial statements must add $100k/year extra depreciation and reduce group profits accordingly.
Worked Example 1.3
Parent acquires 70% of Sub for $5.6m. At acquisition, fair value of NCI is $2.2m, and the fair value of net identifiable assets is $6.9m. After one year, goodwill is found to be impaired by $300,000. Calculate goodwill and how to allocate the impairment.
Answer:
Goodwill = $5.6m (parent) + $2.2m (NCI) – $6.9m = $0.9m
If NCI is at fair value and goodwill impairment is $300,000:
Group share: $300,000 × 70% = $210,000
NCI share: $300,000 × 30% = $90,000
The group reduces its profits and the NCI balance accordingly.
Exam Warning
A common error is to use the book values of the subsidiary’s assets and liabilities in the goodwill calculation. Always adjust to fair value at acquisition for consolidated purposes.
Summary
The purpose of consolidation is to present the group as one entity. Group financial statements require:
- Identifying subsidiaries per IFRS 10 using control criteria.
- Calculating goodwill as the surplus of the consideration and NCI over the fair value of identifiable net assets at acquisition (IFRS 3).
- Recognising non-controlling interests using either fair value or proportion of net assets, affecting group reserves and goodwill.
- Adjusting subsidiary assets and liabilities to fair value at acquisition to ensure group numbers reflect economic reality.
Key Point Checklist
This article has covered the following key knowledge points:
- Explain the requirements for consolidation under IFRS 10.
- Identify and apply the definition of control for group accounts.
- Calculate goodwill at acquisition using both NCI measurement methods under IFRS 3.
- Describe how to calculate and present non-controlling interests in group accounts.
- Recognise the importance of fair value adjustments to subsidiary net assets.
- Explain the treatment of goodwill impairment in consolidated accounts.
Key Terms and Concepts
- control
- subsidiary
- goodwill
- non-controlling interest (NCI)
- fair value adjustment