FR – L2 – Q87 – Business Combinations

On 1st April 20X8, HeadSpace Plc acquired four million of the ordinary shares of Skyline Ltd, paying GH¢4.50 each. At the same time, HeadSpace Plc also purchased GH¢500,000 of Skyline Ltd 10% redeemable preference shares. At the acquisition date, the retained earnings of Skyline Ltd were GH¢8,400,000.

Reproduced below are the draft statements of financial position of the two companies at 31st March 20X9:

HeadSpace Plc GH¢’000 Skyline Ltd GH¢’000
Non-current assets
Land and buildings 22,000 12,000
Plant and equipment 20,450 10,220
Investments in Skyline Ltd:
Equity 18,000
Preference 500
Total non-current assets 60,950 22,220
Current assets
Inventories 9,850 6,590
Trade receivables 11,420 3,830
Cash at bank and in hand 490
Total assets 82,710 32,640
Equity
Ordinary shares of GH¢1 each 10,000 5,000
10% Preference shares 2,000
Retained earnings 51,840 14,580
Non-current liabilities
10% Debentures 20Y2 12,000 4,000
Current liabilities
Trade payables 6,400 4,510
Bank overdraft 570
Taxation 2,470 1,980
Total equity and liabilities 82,710 32,640

Extracts from the statement of profit or loss of Skyline Ltd, before intra-group adjustments, for the year to 31st March 20X9 are:

GH¢’000
Profit before tax 5,400
Taxation expense 1,600
3,800

The following information is relevant:
(i) Included in the land and buildings of Skyline Ltd is a large area of development land recorded at cost of GH¢5 million. Its fair value at the date Skyline Ltd was acquired was GH¢7 million and by 31st March 20X9 this had risen to GH¢8.5 million. The group valuation policy for development land is that it should be carried at fair value and not depreciated.
(ii) Also at the date of acquisition of Skyline Ltd, Skyline Ltd plant and equipment included plant that had a fair value of GH¢4 million in excess of its carrying amount. This plant had a remaining life of 5 years. The group calculates depreciation on a straight-line basis. The fair value of the other net assets of Skyline Ltd approximated to their carrying amounts.
(iii) During the year, Skyline Ltd sold goods to HeadSpace Plc for GH¢1.8 million. Skyline Ltd adds a 20% mark-up on cost to all its sales. Goods with a transfer price of GH¢450,000 were included in the inventory of HeadSpace Plc at 31st March 20X9. The balance on the current accounts of HeadSpace Plc and Skyline Ltd was GH¢240,000 on 31st March 20X9.
(iv) An impairment test carried out at 31st March 20X9 showed that the consolidated goodwill was impaired by GH¢1,488,000.
(v) Skyline Ltd had paid its preference dividends in full and ordinary dividends of GH¢500,000.

Required:
(a) Prepare the consolidated statement of financial position of HeadSpace Plc as at 31st March 20X9.

(b) Calculate the non-controlling interest in the adjusted profit of Skyline Ltd for the year to 31st March 20X9.

(c) Explain why IFRS 3 Business Combinations requires an acquirer to consolidate the fair values of the assets and liabilities of an acquired subsidiary, at the acquisition date.

(a). HeadSpace Plc Group – Consolidated statement of financial position as at 31 March 20X9

GH¢’000
Non-current assets:
Goodwill 992
Land and buildings (22,000 + 12,000 + 2,000 + 1,500) 37,500
Plant and equipment (20,450 + 10,220 + 4,000 – 800) 33,870
Current assets:
Inventories (9,850 + 6,590 – 75 (W2)) 16,365
Trade receivables (11,450 + 3,830 – 240 (W3)) 15,040
Cash at bank and in hand 490
Equity
Share capital 10,000
Revaluation (group share of post-acquisition gain (W1)) 1,200
Group retained earnings 46,265
Non-controlling interest 6,741
Non-current liabilities
10% debenture 20Y2 (12,000 + 4,000) 16,000
Current liabilities
Trade payables (6,400 + 4,510 – 240 (W3)) 10,670
Bank overdraft 570
Taxation (2,470 + 1,980) 4,450

WORKINGS
W1 Group structure
HeadSpace Ltd
(4m / 5m × 100)
80% control
20% NCI
Skyline Ltd
Date of acquisition/control: 01/04/20X7
Date of reporting: 31/03/20X8
Post-acquisition period: 1 year

W2 Net Assets

Acquisition date 01/04/20X7 GH¢’000 Reporting date 31/03/20X8 GH¢’000 Post-acquisition retained earnings GH¢’000
Ordinary Share capital 5,000 5,000
Retained earnings 8,400 14,580 6,180
Fair value of dev. Land 2,000 3,500
Fair value of plant 4,000 4,000
Fair value dep’n – plant (4,000 / 5) (800) (800)
PUP on inventory (20 / 120 × 450) (75) (75)
19,400 26,205 5,305

W3 Goodwill computation

GH¢’000
Cost of Investment 18,500
Less: Net Assets at acquisition (W2) (19,400 × 80%) (15,520)
10% Preference shares (500)
Total Goodwill 2,480
Less impairment loss (1,488)
Goodwill at consolidation 992

Note: proportionate method is required as the question is silent on fair value method.

W4 Consolidated income surplus

GH¢’000
Balance at 01/04/20X7 51,840
Goodwill impairment (1,488)
Group share of post-acquisition profit (W2) (5,305 × 80%) 4,244
At consolidation 46,265

W5 Non-Controlling interest

GH¢’000
Add: NCI’s share of post-acquisition profit (20% × 26,205) 5,241
10% Preference shares (2,000 – 500) 1,500
At consolidation 6,741

(b).

GH¢’000
Profit before tax before group adjustments 5,400
Adjustments:
Extra depreciation on fair value gain (4,000 / 5) (800)
Provision for unrealized profit (75)
Adjustment profit and tax 4,525
Taxation expenses (1,600)
2,925
10% preference dividend (150)
Total NCI 2,775
NCI (20%) 555

(c). IFRS 3 Business Combinations requires an acquirer to consolidate the fair values of the assets and liabilities of an acquired subsidiary at the acquisition date for the following reasons:

  1. True Economic Value: Fair value reflects the current market value of assets and liabilities, providing a more accurate representation of the economic resources and obligations acquired. This ensures the consolidated financial statements present a true and fair view of the group’s financial position.
  2. Consistency and Comparability: Using fair values aligns the accounting for the subsidiary’s assets and liabilities with the acquirer’s accounting policies and market-based measurement principles, enhancing consistency and comparability across the group’s financial statements.
  3. Goodwill Calculation: Fair value measurement is essential for calculating goodwill, which is the difference between the purchase consideration and the fair value of the net identifiable assets acquired. This ensures goodwill reflects the premium paid for control and synergies, not historical costs.

These principles ensure that the consolidated financial statements provide relevant and reliable information to users.