Financial Accounting and Reporting in Malaysia

Transcription

1 Financial Accounting and Reporting in Malaysia Volume 2 Fourth Edition TAN LIONG TONG Dip. Agriculture, B.S. Agribusiness, MBA, CA, CPA

2 xi TABLE OF CONTENTS About CCH...iii About the Author... iv Dedication... vi Preface...vii Index of Referenced Financial Reporting Standards... xvii CHAPTER 1 Financial Instruments Recognition and Derecognition Introduction Definitions Categories of Financial Assets Categories of Financial Liabilities Recognition Accounting for Derivative Instruments Embedded Derivatives Derecognition CHAPTER 2 Financial Instruments Measurement and Reclassification Measurement Fair Value Measurement Considerations Reclassifications Gains and Losses on Remeasurement Impairment of Financial Assets MFRS 9, Financial Instruments Classification and Measurement CHAPTER 3 Hedging and Hedge Accounting Introduction to Hedging and Hedge Accounting Identification of a Hedge Financial Accounting and Reporting in Malaysia, Volume 2

3 xii Table of Contents 3.3 Conditions for the Specified Hedge Accounting Treatments Fair Value Hedge Accounting Cash Flow Hedge Accounting Accounting for Hedges of Net Investments Assessing Hedge Effectiveness CHAPTER 4 Financial Instruments Presentation and Disclosures MFRS 132, Financial Instruments: Presentation Presentation of Liabilities and Equity Classification of Compound Instruments by the Issuer Accounting for Free Warrants with Rights Issue Treasury Shares Interest, Dividends, Losses and Gains Offsetting a Financial Asset and a Financial Liability MFRS 7, Financial Instruments: Disclosures Classes of Financial Instruments and Level of Disclosure Other Disclosures Nature and Extent of Risks Arising from Financial Instruments CHAPTER 5 Earnings Per Share Introduction The Measurement and Presentation Standards Basic Principles Basic Earnings Per Share Changes in Capital Structure Diluted Earnings Per Share Sundry Issues in EPS Calculation Disclosure Some Limitations of EPS Information CCH Asia Pte Limited

4 Table of Contents xiii CHAPTER 6 Business Combinations Introduction Identifying a Business Identifying a Business Combination Application of the Acquisition Method Business Combination Achieved in Stages Business Combination Achieved Without Transfer of Consideration Business Combination Achieved by Contract Alone Measurement Period Determining What is Part of the Business Combination Transaction Subsequent Measurement and Accounting Tax Effects Arising in a Business Combination Disclosure Requirements Reverse Acquisition Accounting CHAPTER 7 Consolidated and Separate Financial Statements Introduction Background to the Standards on Consolidation Application of MFRS Consolidation Procedures Allocating Losses to Non-controlling Interest The Separate Financial Statements of the Parent Complex Group Structures CHAPTER 8 Advanced Consolidation Principles Introduction Reduction in Stake Without Loss of Control Subsidiaries Held for Sale and Discontinued Operations Loss of Control and Derecognition of a Subsidiary Financial Accounting and Reporting in Malaysia, Volume 2

5 xiv Table of Contents 8.5 Reorganisations and Other Changes in Group Structure Reciprocal Shareholdings between Parent and Subsidiaries Mutual Holdings Amongst Subsidiaries in a Group CHAPTER 9 Joint Arrangements and Associates Summary of the Requirements of MFRS 11 and MFRS 128 (Revised) Principles of Investments in Joint Arrangements Principles of Investments in Associates The Equity Method of Accounting Transactions with an Associate or Joint Venture Goodwill and Impairment Test When the Associate or Joint Venture is a Group Separate Financial Statements of an Investor Without Subsidiaries Share of Losses in Associates and Joint Ventures Mutual Holdings of Shares Discontinuation of Equity Method of Accounting CHAPTER 10 Disclosures of Interests in Other Entities and Fair Value Measurement MFRS 12, Disclosures of Interests in Other Entities MFRS 13, Fair Value Measurement CHAPTER 11 The Effects of Changes in Foreign Exchange Rates Foreign Currency Transactions and Operations Functional Currency and Presentation Currency Reporting Foreign Currency Transactions in the Functional Currency Use of a Presentation Currency Other Than the Functional Currency CCH Asia Pte Limited

6 Table of Contents xv 11.5 Translation of Financial Statements of Foreign Operations Foreign Branches, Associates and Joint Ventures Disposal of a Foreign Operation CHAPTER 12 Consolidated Statement of Cash Flows Theoretical Considerations of Statements of Cash Flows Group Statement of Cash Flows Consolidating Separate Cash Flows of Parent and Subsidiaries Foreign Currency Cash Flows CHAPTER 13 Segment Reporting and Related Party Disclosures Introduction Statutes and Accounting Standards on Segment Information Statutes and Accounting Standards on Related Parties Principles of Segment Reporting MFRS 8, Operating Segments Principles of Related Party Disclosures CHAPTER 14 Specialised Industries in Malaysia I Accounting and Reporting by Banks and Similar Financial Institutions Accounting and Reporting by Insurance Entities Accounting and Reporting by Unit Trust Funds CHAPTER 15 Specialised Industries in Malaysia II Accounting for Plantation Operations Accounting for Aquaculture Accounting for Agriculture Financial Accounting and Reporting in Malaysia, Volume 2

7 xvi Table of Contents 15.4 Accounting Issues of Extractive Industries IC Int. 20, Stripping Costs in the Production Phase of a Surface Mine CHAPTER 16 Interim Reporting, Corporate Governance, Social and Voluntary Reporting Reasons for Interim Financial Reporting MFRS 134, Interim Financial Reporting Regulatory Requirements on Interim Reporting Corporate Governance and Reporting Corporate Social Reporting and Voluntary Disclosures Reporting of Profit Forecasts and Projections Likely Future Accounting and Reporting Practices Index CCH Asia Pte Limited

8 553 CHAPTER 7 CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS The Chapter will help you in the following areas: to understand the background to the Standards on consolidation; to understand the changes in the principles made in the new MFRS 10 and the revised MFRS 127; to be able to apply the standards prescribed in the new and the revised Standards; to be able to deal with the consolidation procedures in preparing group financial statements; and to be able to deal with consolidation of complex group structures. Financial Accounting and Reporting in Malaysia, Volume 2

9

10 Chapter 7: Consolidated and Separate Financial Statements Introduction In May 2011, the IASB simultaneously issued six IFRSs, five of which relate to consolidation and one on fair value measurement. The IFRSs related to consolidation are: IFRS 10, Consolidated Financial Statements; IFRS 11, Joint Arrangements; IFRS 12, Disclosures of Interests in Other Entities; IAS 27(r), Separate Financial Statements; and IAS 28(r), Investments in Associates and Joint Ventures. IFRS 10 replaces the consolidation part of the former IAS 27. IAS 27(r) deals only with accounting for investments in subsidiaries, joint ventures and associates in the separate financial statements of an investor (retains the part on separate financial statements in the former IAS 27). IFRS 11 supersedes the former IAS 31 on accounting for joint arrangements. Disclosure requirements on subsidiaries, joint arrangements, associates and involvement in unconsolidated structured entities are prescribed in IFRS 12. The Flowchart to the Background section of this chapter provides guidance on the application of the various IFRSs for a reporting entity s involvement with other entities. 7.2 Background to the Standards on Consolidation Reasons for Issuing IFRS 10, Consolidated Financial Statements The former IFRSs dealing with consolidation were IAS 27, Consolidated and Separate Financial Standards, and SIC 12, Consolidation Special Purpose Entities. The first version of former IAS 27 was issued by the then IASC in April 1989, subsequently revised by the IASB in December 2003 and a second revision in January In between those dates, there were also amendments for improvements, the last before the current IAS 27(r) was made in July The former SIC 12 was first issued in November 1998 by the then SIC and was subsequently amended by IFRIC in November There were some inconsistencies and conflicts when applying those two Standards. In the former IAS 27, control was defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. However, the Standard did not elaborate on the meaning of Financial Accounting and Reporting in Malaysia, Volume 2 7.2

11 556 Chapter 7: Consolidated and Separate Financial Statements power and benefits and did not explain how those two components have to be linked to constitute control. Also, the criterion of to obtain benefits tended to be interpreted as positive returns and related to ownership interest only. SIC 12, although referring to IAS 27, used a risks and rewards model to identify indicators of control in deciding whether a special purpose entity (SPE) shall be consolidated. Those indicators did not necessarily identify a control relationship. Also, SIC 12 appeared to focus primarily on vehicles that were structured to operate on auto-pilot mechanism for specific purpose. Conceptually, each of the two former IFRSs was based on a different model and this gave rise to structuring opportunities, inconsistencies and diversity in practice. The potential conflict was when an investor in applying IAS 27 might consolidate an investee that would not be consolidated in accordance with SIC 12, or not consolidate an investee that would be consolidated in accordance with SIC 12. The IASB noted the divergence in practice in the application of the former IAS 27 s control concept, for example, in the following circumstances: (a) (b) (c) when an investor controls an investee but the investor has less than a majority of the voting rights of the investee (and voting rights are clearly the basis for control); involving special purpose entities (where the notion of economic substance in SIC 12 applied); involving agency relationships; and (d) involving protective rights. The global financial crisis which started in 2007 saw the emergence of newer entities that do not take the conventional form. Assets and liabilities of reporting entities are transferred to, or securitised in, special purpose vehicles. Troubled debts of financial institutions are restructured and sold to structured entities, but a transferor-entity continues to be involved in those structured entities. Some reporting entities also provide social and financial support to troubled entities during the financial crisis although the reporting entities do not have a legal or constructive obligation to do so (they may have a reputation at stake i.e. a reputational risk rather than a financial risk). Involvement in those non-conventional entities exposes a reporting entity to risks, whether financial or reputational. The former IAS 27 and SIC 12 were unable to provide sufficient guidance on the accounting for these newer entities, resulting in many resources (assets) and claims (liabilities and equity) being unrecognised (off-balance sheet). Users, particularly existing and potential investors and lenders, have expressed concern that it has become increasingly difficult to analyse properly an entity s returns and exposure to risks when those assets and 7.2 CCH Asia Pte Limited

12 Chapter 7: Consolidated and Separate Financial Statements 557 liabilities were parked in separate vehicles. This created the need for the IASB to respond to the changing business phenomenon of structured entities. In response to the impact of the global financial crisis, the IASB was also asked to consider reputational risk as a basis in deciding whether an investor should consolidate a special purpose or structured entity which the investor has sponsored or provided financial and other support, and whether the consolidation requirements of the then current standards (IAS 27 and SIC 12) were sufficient for structured entities, as many such newer entities emerged in the current global financial crisis to cater for financial reorganisation or reengineering of troubled entities. The rationale of the single control model for consolidation in IFRS 10 is based on the view that all assets and liabilities under the control of an investor shall be consolidated, regardless of how those assets and liabilities have been structured in other entities. This change in approach is necessary to reflect properly a group s financial position (particularly its financial structure in terms of gearing) and financial performance. It would provide more useful information to users of financial statements in making economic decisions. The project on consolidation was initiated by the IASB in April 2002, the exposure draft ED 10, Consolidated Financial Statements, was issued in December 2008, and the current IFRS 10 Consolidated Financial Statements, was published in May In Malaysia, this IFRS takes the nomenclature of MFRS The Salient Features of MFRS 10 MFRS 10 requires an investor, regardless of the nature of its involvement with an entity (the investee), shall determine whether it is a parent, by assessing whether it controls the investee [MFRS 10.5]. In this new Standard, the nature of involvement need not necessarily require an investment in the investee. It may be an involvement by sponsorship, by providing financial support, including providing guarantees, or social support to another entity. MFRS 10 introduces a new single control model to identify a parentsubsidiary relationship by specifying that an investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee [MFRS 10.6]. The Control Model In this new control model, an investor controls an investee if, and only if, the investor has all of the following three elements: (a) power over the investee (the Power); Financial Accounting and Reporting in Malaysia, Volume 2 7.2

13 558 Chapter 7: Consolidated and Separate Financial Statements (b) (c) exposure, or rights, to variable returns from its involvement with the investee (the Returns); and the ability to use its power over the investee to affect the amount of the investor s returns (the Link between Power and Returns). [MFRS 10.7] The diagram below depicts the new control model. POWER LINK RETURNS In this single control model, power is not defined as a legal or contractual right to direct relevant activities, but is based on the ability to direct relevant activities unilaterally. The consolidation model is not a quantitative model (based on risks and rewards) but a qualitative model (based on power, returns and a link between the two elements). The control model is built on the principles (of three elements) rather than on bright lines. As such, the application of this model will require judgements, by considering the relevant facts and circumstances in making consolidation decisions. In the IASB view, this consolidation model will better reflect the economic substance of relationships with other entities. The Power Element An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, i.e. the activities that significantly affect the investee s returns [MFRS 10.10]. Power can arise from voting rights (such as by holding equity instruments) or contractual arrangements, or a combination of both. An investor can have the power even if its rights to direct have yet to be exercised (a passive parent). Similarly, an investor can have the power even if other parties have existing rights, to participate in the direction of the relevant activities or hold protective rights, including special rights, to veto certain decisions. Protective rights held by other parties may restrict but do not preclude an investor from having the power to direct. The Returns Element The Standard clarifies that an investor must be exposed, or have rights, to variable returns from its involvement with an investee to control the investee. The former FRS 127 used the term to obtain benefits from its activities, which might imply only positive returns. In this MFRS, the returns must have the potential to vary as a result of the investee s performance and can be only positive, only negative, or wholly positive and negative [MFRS 10.15]. Thus, returns include not only dividends and other distributions from holding equity instruments in the investee, but may also include upfront fees, access 7.2 CCH Asia Pte Limited

14 Chapter 7: Consolidated and Separate Financial Statements 559 to cash, servicing fee, returns not available to non-controlling interest, cost savings, etc. For example, an investor may transfer a loan receivable to a structured entity and receives a servicing fee for managing the loan receivable. Similarly, a property developer may transfer a land to a special purpose vehicle and receives income from the land development, even though it may hold little or no equity interest in the special purpose vehicle. The Link Element An investor must not only have power over an investee and exposure or rights to variable returns from its involvement with the investee. It must also have the ability to use its power over the investee to affect its return from its involvement with the investee [MFRS 10.17]. In other words, there must be a link between the two components of power and returns. For example, if an investor is the majority shareholder of an investee, it receives the most dividends (returns) but if the investor does not have the power to direct the relevant activities (for example, due to a contractual arrangement), the investee is not a subsidiary of the investor. Similarly, an entity may have decision-making rights delegated to it when acting as an agent, but it does not have exposure or rights to variable returns, and accordingly, it does not control the investee. For example, a fund manager of a unit trust fund may have decision-making rights with respect to investments of the fund, but it does not have the ability to direct the relevant activities (buying or selling investments) unilaterally and it is neither exposed nor have rights to variable returns. It receives a fee acting as an agent of the unit holders of the fund Application of the Control Model (a) (b) (c) The IFRS sets out the requirements on how to apply this control model in: circumstances when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of the voting rights, and in circumstances involving potential voting rights; circumstances when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements (for example, in determining control of a structured entity); in circumstances involving agency relationships; and (d) in circumstances when the investor has control over specified assets (a silo) of an investee. Financial Accounting and Reporting in Malaysia, Volume 2 7.2

15 560 Chapter 7: Consolidated and Separate Financial Statements Control by Voting Rights If the relevant activities of an investee are directed through voting rights, an investor considers whether it has the current ability, through voting or similar rights, to direct the relevant activities. MFRS 10 retains the presumption in the former FRS 127 that an investor who can exercise more than a majority of the voting rights has control of the investee (unless circumstances indicate otherwise). The more than a majority criterion can be attained by holding, directly or indirectly, more than half the voting equity instruments of an investee, or by holding voting equity instruments and having contractual arrangements with other investors. For example, an investor owns 40% equity shares of an investee. It enters into an arrangement with another shareholder of the investee to have the power to exercise the other shareholder s 11% voting rights. In this case, the investor s own shareholdings and the arrangement with the other shareholder give it the current ability to exercise more than a majority of the voting rights in the investee. When no party holds a majority of the voting rights in an investee, and voting rights are clearly the only basis for assessment (in the absence of any additional arrangements altering decision-making), the assessment of control will focus on which party, if any, is able to exercise voting rights sufficient to direct the relevant activities of the investee unilaterally [MFRS 10.B41]. When assessing whether an investor s voting rights are sufficient to give it power, an investor considers all facts and circumstances, such as: (a) the size of its holding of voting rights relative to the size and dispersion of holdings of other vote holders; (b) potential voting rights, regardless of whether they are currently exercisable or not (the former IAS 27 required that the potential voting rights must be currently exercisable); and (c) rights from contractual arrangements. The MFRS clarifies that when the direction of the relevant activities is determined by a majority vote and an investor holds significantly more voting rights than any other vote holders or organised group of vote holders, and the other shareholdings are widely dispersed, it may be clear, after considering the relevant facts and circumstances alone, that the investor has power over the investee [MFRS 10.B43]. For example, an investor can have the power to direct the relevant activities of a public listed company if the investor is the dominant shareholder who holds voting rights and all the other shareholders with voting rights are widely dispersed and are not organised in such a way that they actively cooperate when they exercise their votes so as to have more voting power than the investor. In such a case, the investor, being the dominant shareholder, is said to have de facto control over the investee. This dominant shareholder concept was implicit in the former FRS CCH Asia Pte Limited

16 Chapter 7: Consolidated and Separate Financial Statements 561 Control by Contractual Arrangements When an investee is designed or structured in a manner that voting rights relate to administrative tasks only but the relevant activities are directed by contractual arrangements, the assessment of control would need to consider those contractual arrangements to decide who is able to direct the relevant activities. For more complex cases of contractual arrangements (for example, when assessing control of structured entities or special purpose entities), it may be necessary to consider many or all of the following factors to determine whether an investor controls an investee: (a) (b) (c) what the relevant activities are, and how decisions about those activities are made; whether the rights of the investor give it the current ability to direct those activities; whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and (d) whether the investor has the ability to use its power over the investee to affect the amount of the investor s returns. This assessment should include the consideration of risks that the investee was designed to create, the risks it was designed to pass on to the parties involved in the transaction, and whether the investor is exposed to some, or all of those risks. The investor should consider the decisions made at the investee s inception as part of its design, including call rights, put rights or liquidation rights. If these contractual arrangements involve activities that are closely related to the investee, then they are, in substance, an integral part of the investee s relevant activities. The investee may be designed so that the direction of its activities and its returns are predetermined unless, and until, those particular circumstances arise or events occur. In this case, only the decisions about the investee s activities when those circumstances or events occur, can significantly affect its returns, and are thus considered as relevant activities. Being involved in the design of an investee, although not sufficient, may indicate that the investor had the opportunity to obtain rights that are sufficient to give it power over the investee. Similarly, an investor s explicit or implicit commitment to ensure that an investee continues to operate as designed, may increase the investor s exposure to the variability of returns and thus the likelihood that it has power. The commitment alone, however, neither give an investor power nor does it prevents another party from having power. Financial Accounting and Reporting in Malaysia, Volume 2 7.2

17 562 Chapter 7: Consolidated and Separate Financial Statements Agency Relationships An investor needs to assess whether its relationship with other parties is such that those other parties are acting on the investor s behalf i.e. they are de facto agents. A party is a de facto agent when the investor has, or those that direct the activities of the investee have, the ability to direct that party to act on the investor s behalf. Thus, an investor can control an investee by appointing agents to act on its behalf. But if the investor is acting only as an agent, it does not control the investee. The MFRS provides examples of such other parties that, by the nature of their relationship, may act as de facto agents of the investor, and these include the investor s related parties, a party that received its interest in the investee as a contribution or loan from the investor; a party that cannot finance its operations without subordinated financial support from the investor; an investee for which the majority of the members of its governing body or for which its key management personnel is the same as that of the investor; and a party that has a close business relationship with the investor, such as the relationship between a professional service provider and one of its significant clients. Control Over Specified Assets (A Silo) Sometimes, an investor may only have power over specified assets (or over a portion) of an investee. In such cases, the IFRS requires that the investor shall treat the portion of that investee as a separate entity if and only if the following condition is satisfied: Specified assets of the investee (and related credit enhancements, if any) are the only source of payments for specified liabilities of, or specified other interests in, the investee. Parties other than those with the specified liabilities do not have rights or obligations related to the specified assets or to residual cash flows from those assets. In substance, none of the returns from the specified assets can be used by the remaining investee and none of the liabilities of the deemed separate entity are payable from the assets of the remaining investee. Thus, in substance all of the assets, liabilities and equity of that deemed separate entity are economically ringed-fenced from the overall investee. Such a deemed separate entity is often called a silo. If an investor controls a silo in an investee, it consolidates a portion of an investee as a separate entity. Other parties exclude that portion of the investee when assessing control of, and in consolidating the investee. 7.2 CCH Asia Pte Limited

18 Chapter 7: Consolidated and Separate Financial Statements 563 Reassessment of Control The MFRS requires that an investor shall reassess whether it controls an investee only if facts and circumstances indicate that there are changes to one or more of the three elements of control. A change in power over an investee can occur when there are changes to decision-making rights, for example, when the relevant activities are no longer directed through voting rights, but instead by other agreements, such as a contract, that give another party or parties the current ability to direct the relevant activities. An investor may also gain or lose power over an investee without the investor being involved in that event. For example, an investor can gain power over an investee because decision-making rights held by another party or parties that previously prevented the investor from controlling an investee have lapsed. Changes to exposure, or rights, to variable returns from its involvement may also cause an investor to lose control of an investee, for example when the investor ceases to be entitled to receive returns or to be exposed to obligations, such as when a contract to receive performance-related fees is terminated Other Requirements of MFRS 10 The requirements for consolidation and the consolidation procedures of the former FRS 127 remain unchanged in MFRS 10. The disclosure requirements of the former FRS 127 are dealt with in the new MFRS Implications of MFRS 10 on Practice MFRS 10 may bring about fundamental changes to the current practice of some reporting entities. It is not just about learning and understanding the MFRS as the new requirements may require changes in the accounting processes and procedures of a reporting entity. Contractual arrangements with other parties would need to be reassessed to determine whether voting rights are transferred to an investor, whether an investor holds special rights by statute (such as when a golden share owned by a government is passed to the investor for control of an investee), or whether an investor controls an investee by a contract with a major shareholder. A reporting entity would also need to reassess its involvement with all other entities, regardless of whether they are the conventional type or the structured type, and determine the nature of the relationship. Applying the new control model might result in some subsidiaries consolidated under the former FRS 127 failing the control test, and thus requiring deconsolidation. Financial Accounting and Reporting in Malaysia, Volume 2 7.2

19 564 Chapter 7: Consolidated and Separate Financial Statements The new control model would more probably result in some investees not consolidated under the former FRS 127 meeting the control test, and henceforth shall be consolidated. For example, the requirements on the dominant shareholder concept may result in some investees previously treated as associates becoming subsidiaries under the new control model. Even if a reporting entity is a passive investor (i.e. have yet to exercise its voting rights) in such investee, the investor would still need to test whether it would have that current and practical ability to direct the relevant activities of the investee if it wants to do so. A reporting entity would also need to reassess its involvement in structured entities (SEs) as the scope is wider than the guidance on special purpose entities (SPEs) in SIC 12. The conditions for SPEs in SIC 12 were narrowly focussed on vehicles established for specific purposes. The requirement on SEs in MFRS 10 applies to any entity that is not managed by the traditional means. These may include vehicles created for transfers of assets and liabilities, entities that an investor sponsors or provides financial (including guarantees) and other support, and involvement in clubs, trusts and nonprofit organisations. Although the control model is premised on the three elements of power, returns and link between power and returns, a reporting entity needs to consider all relevant facts and circumstances. Significant judgements are required in deciding whether a reporting entity has the power to direct and generate returns when the voting rights held are less than a majority, or when the power to direct the relevant activities are based on contractual arrangements. (a) (b) (c) The changes in accounting will probably be in the following four situations: some current subsidiaries may fail the control test and thus require deconsolidation; some current investees may meet the control test and thus require consolidation; structured entities that an investor controls shall henceforth be consolidated; and (d) silos (ringed-fenced assets, liabilities and equity) that an investor controls shall henceforth be consolidated. 7.2 CCH Asia Pte Limited

20 Chapter 7: Consolidated and Separate Financial Statements 565 Appendix: A Decision Flowchart for Involvement with Other Entities An investor shall assess its involvement with each other entity Has control? Yes Apply MFRS 10, consolidate investee No Has joint control? Yes Joint operation? Apply MFRS 11, account for assets, liabilities, revenues & expenses directly No Has significant influence? Yes Joint venture? Apply MFRS 128, equity accounting No Hold equity and debt instruments? Unconsolidated structured entity Apply MFRS 132, MFRS 139 and MFRS 7 Apply MFRS 12 for disclosures 7.3 Application of MFRS The Main Principles of MFRS 10 There are no changes to the consolidation requirements and the consolidation procedures in the new MFRS 10. The main principles, which are the same as those in the original FRS 127 (2008), are summarised as follows: (a) Changes in the parent s ownership interest that do not result in the loss of control of a subsidiary shall be accounted for as transactions with Financial Accounting and Reporting in Malaysia, Volume 2 7.3

21 566 Chapter 7: Consolidated and Separate Financial Statements (b) (c) equity holders in their capacity as equity holders. Consequently, such changes would not result in a gain or loss being recognised in profit or loss. For example, if a parent lists its wholly-owned subsidiary in a stock exchange and the parent s equity stake after the listing is diluted to 60%, the decrease in stake of 40% is treated as an equity transaction (rather than as a deemed disposal under the former practice) with the gain or loss recognised directly in equity. The new MFRS specifies how an entity measures a gain or loss arising on loss of control of a subsidiary, and it requires that any such gain or loss to be recognised in profit or loss. The gain or loss arising on loss of control includes the parent s share of post-acquisition gains or losses of the subsidiary that were previously recognised in other comprehensive income (and deferred in equity). In other words, the parent s share of any post-acquisition fair value reserve, exchange reserve and hedged reserve, shall be reclassified to profit or loss as part of the gain or loss arising on loss of control. The new MFRS requires that any remaining non-controlling equity investment in a former subsidiary shall be remeasured to its fair value in the consolidated financial statements on the date control of it is lost. For example, if the remaining equity stake becomes an investment in an associate, that stake shall be measured to fair value at the date control is lost and the difference between fair value and carrying amount is included in the calculation of the gain or loss arising on loss of control. (d) The new MFRS also provides guidance on determining when two or more transactions or arrangements that result in a loss of control of a subsidiary shall be treated as a single transaction. For example, when a disposal arrangement has been structured in a series of transactions to nullify the impact on profit or loss, those series of transactions shall be accounted as a single transaction to reflect the economic substance of the arrangement as a whole. (e) The new MFRS requires that losses applicable to the non-controlling interest shall be allocated to the non-controlling interest, even if this results in a deficit to the amount of the non-controlling interest. Any guarantees or other support arrangements from the controlling and noncontrolling interests shall be accounted for separately. The previous FRS 127 did not permit allocation of losses to non-controlling interest that was in excess of their capital contribution except when non-controlling shareholders have given a guarantee to share losses in excess of their capital contribution. 7.3 CCH Asia Pte Limited

22 Chapter 7: Consolidated and Separate Financial Statements Objective The objective of MFRS 10 remains the same as the original FRS 127 in that it establishes principles for the preparation and presentation of consolidated financial statements when an entity controls one or more other entities. To meet the objective, the MFRS: (a) (b) (c) requires an entity (the parent) that controls one or more other entities (subsidiaries) to present consolidated financial statements; defines the principle of control and establishes control as the basis for consolidation; sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee; and (d) sets out the accounting requirements for the preparation of consolidated financial statements Scope The Standard requires that an entity that is a parent shall present consolidated financial statements. This MFRS applies to all entities except for: (a) a parent need not present consolidated financial statements if it meets all of the following conditions: (i) it is 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 financial statements; (ii) its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional market); (iii) it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and (iv) its ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with MFRSs [MFRS 10.4]. In practice, this exemption is normally only availed when the parent is itself a wholly-owned subsidiary of another parent (i.e. its immediate parent). This is because there is no other shareholder, other than its immediate parent, and the shareholders of its immediate parent would be better served by consolidating at the immediate parent s level. For a Financial Accounting and Reporting in Malaysia, Volume 2 7.3

23 568 Chapter 7: Consolidated and Separate Financial Statements (b) partially-owned subsidiary, it may be practicable to avail the exemption if there are only a few non-controlling shareholders (for example, corporate minority shareholders) and consent has been obtained from them for not presenting consolidated financial statements. It shall be noted that in some jurisdictions, the local laws permit the exemption only if the intermediate or ultimate parent is incorporated in that local jurisdiction. Thus, for a wholly-owned parent that is a subsidiary of another parent incorporated outside that jurisdiction, the exemption does not apply. It must produce consolidated financial statements in that local jurisdiction. post-employment benefit plans or other long-term employee benefit plans to which MFRS 119, Employee Benefits applies Scope of Consolidated Financial Statements There is no change made to the scope of consolidation in the former FRS 127 as the MFRS continues to require that consolidated financial statements shall include all subsidiaries of the parent. The exceptions in some past standards, which required that a subsidiary shall be excluded from consolidation on the grounds of temporary control and severe restrictions, have been removed in the former FRS 127. The Standard clarifies that if a subsidiary is acquired exclusively with the view to disposal within 12 months, it shall be consolidated, and then presented as non-current assets held for sale and discontinued operation when the criteria of MFRS 5, Non-Current Assets Held for Sale and Discontinued Operations, are met. Similarly, a subsidiary is not excluded from consolidation because its business activities are dissimilar from those of the other entities within the group. The Standard clarifies that relevant information is provided by consolidating such subsidiaries and disclosing additional information in the consolidated financial statements about the different business activities in accordance with MFRS 8, Operating Segments. A subsidiary is also not excluded from consolidation on the ground that it operates under conditions of severe long-term restrictions in its ability to transfer funds to the parent. So long as control continues to exist, the subsidiary shall be consolidated although additional information may be disclosed about the long-term restrictions. Similarly, non-controlling interests and other parties may hold protective rights in a subsidiary that limit, but do not preclude, the parent from exercising its power to direct the activities of the subsidiary. For example, a non-controlling shareholder may hold veto power for approval of capital expenditure of a subsidiary but this is not sufficient to preclude the parent from controlling the subsidiary. 7.3 CCH Asia Pte Limited

24 Chapter 7: Consolidated and Separate Financial Statements 569 It has been argued that for venture capital entities and mutual funds, the main purpose of their investments in subsidiaries is to achieve wealth or value creation for those investments. Thus, some commentators have suggested that the investments in subsidiaries made by such entities should be measured on the fair value model (for example, in accordance with MFRS 9), rather than by consolidation. The revised Standard clarifies that a subsidiary is not excluded from consolidation simply because the investor is a venture capital organisation, mutual fund, unit trust or similar entity. Note that in August 2011, the IASB issued Exposure Draft ED/2011/4 Investment Entities, to propose exemption for such investment entities from the consolidation requirement of IFRS 10 provided their investments in subsidiaries are measured at fair value through profit or loss. Thus, for a subsidiary to be excluded from consolidation, the parent must have lost control. A parent loses control when it loses the power to direct the relevant activities of the investee or when it ceases to be exposed, or have rights, to variable returns from the investee. For example, when shares in a subsidiary are disposed and the parent loses control. Also, the loss of control can occur with or without a change in absolute or relative ownership levels. It could occur, for example, when a subsidiary is subject to control of a government, court, administrator or regulator. It could also occur as a result of a contractual agreement. For example, an agreement that previously allowed the entity to gain control in an investee but is not renewed on expiry of the agreement Definitions In general, consolidated financial statements shall be presented when there is a group of entities under the control of a parent. A group is defined in the Standard as a parent and its subsidiaries. There must therefore be a parent-subsidiary relationship for a group to exist. The test of the existence of a parent-subsidiary relationship rests on the criterion of control. A subsidiary is defined as an entity that is controlled by another entity. It shall be emphasised that as control is the central criterion, it need not necessarily be accompanied by an ownership interest in an investee, to qualify the latter to be a subsidiary. The IFRS defines control of an investee as an investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. In a parent-subsidiary relationship, control is exercised with benefits and risks attached, and this will normally (though not necessarily) arise if the investor has substantial ownership interest at stake. Thus, when an entity has the power to direct the relevant activities and policies of another entity Financial Accounting and Reporting in Malaysia, Volume 2 7.3

25 570 Chapter 7: Consolidated and Separate Financial Statements purely by virtue of a management contract, there are no risks or benefits attached to the exercise of power (apart from perhaps an agreed management fee for acting as an agent), and accordingly, no parent-subsidiary relationship arises. The control exercised by the parent must also be a unilateral or sole control, which is the power to direct the relevant activities and policies of the investee without having to make reference to, or to seek the concurrence of, another third party, or to share control with another party. In some situations, benefits and risks can arise in arrangements other than the holding of ownership interest, such as in the case of an entity s involvement in a structured entity and the entity holds little or no equity interest in the structured entity. The most commonly used test of a parent-subsidiary relationship is the more than 50 per cent ownership interest. In the case of a subsidiary company, this interest is satisfied if the parent holds 50% plus one more share of the subsidiary company. Note that it is not necessary for the parent to own directly, more than 50% of the equity share capital of another company for the existence of a parent-subsidiary relationship. Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than one half of the voting rights of an entity unless, in exceptional circumstances, it can be clearly demonstrated that such ownership does not constitute control. In other words, when a group as a whole owns more than 50% of the equity share capital, control is generally presumed. An investor may sometimes hold more than 50% ownership interest in an investee but does not have unilateral control. Such is the case when a local investor may have entered into a joint venture agreement with a foreign partner to set up a joint venture company. The local investor may hold more than 50% ownership interest in the joint venture company, but if the agreement provides for a joint control, the joint venture company is not a subsidiary of the local investor because it does not have unilateral control. An investor may hold more than 50% ownership interest in an investee, but if it has entered into an agreement with another investor that provides the other investor veto rights to all strategic decisions that affect the relevant activities of the investee, the investor has no unilateral power. However, if the other investor only holds veto rights to some strategic decisions (protective rights), they do not preclude the investor from having the power to direct the relevant activities of the investee. Control may exist in certain circumstances, even when the more than 50% equity interest is not met. This may arise when: (a) the power to direct is obtained by operation of law or by agreement with other investors; 7.3 CCH Asia Pte Limited

26 Chapter 7: Consolidated and Separate Financial Statements 571 (b) (c) the investor is the single largest shareholder and the other shareholders are thinly spread out among many investors (the dominant shareholder concept); the investor holds potential voting rights that enable it to have the current ability to direct the relevant activities of an investee; and (d) by contractual arrangement, such as control of a structured entity Control by Operation of Law or by Agreement with Other Investors The following group structures illustrate how control exists when the equity interest is not more than 50% but the power to direct is obtained by operation of law or by agreement with other investors that allows the investor to have more than a majority of the voting rights. P Bhd 40% Control by law P Bhd Agreement Mr. X 40% 11% S Bhd P Bhd owns 40% equity shares in S Bhd and controls it by operation of law. S Bhd Agreement with Mr. X allows P Bhd to control 51% of the voting rights in S Bhd Control by Holding Sufficient Voting Rights The following cases illustrate how to assess whether an investor has sufficient voting rights to have the power to direct the relevant activities of an investee (i.e. the application of the dominant shareholder concept). Example 1 (Cases on Investor s Voting Rights that are 50% or less) Case 1 Entity P holds 40% of the ordinary shares of Entity Q. The next two largest shareholdings of Entity Q are 10% and 5% respectively and the remaining ordinary shares are held by thousands of shareholders, none individually more than 1%. None of the shareholders has any arrangement to consult each other or to make collective decisions. In this case, on the basis of the absolute size of its holding and the relative size of the holdings of other shareholders, Entity P has sufficient dominant voting rights to meet the power criterion without the need to consider any other evidence of power. Financial Accounting and Reporting in Malaysia, Volume 2 7.3

27 572 Chapter 7: Consolidated and Separate Financial Statements Case 2 Entity P holds 30% of the ordinary shares of Entity Q and seven other shareholders each hold 10% of the ordinary shares of Entity Q. A shareholder agreement between Entity P and all the other shareholders grants Entity P the right to appoint, remove and set the compensation of management responsible for the relevant activities of Entity Q. However, Entity P has yet to exercise this right and chooses to remain as a passive investor. In this case, considering the absolute size of its holding and the relative size of the other shareholdings alone is not conclusive to determine that Entity P has rights sufficient to give it power over Entity Q. However, the fact that Entity P has the contractual right to appoint, remove and set the compensation of key management is sufficient to conclude that Entity P has power. The fact that Entity P has not exercised this right yet or the likelihood of it exercising this right should not be considered when assessing if it has the power. Case 3 Entity P holds 40% of the ordinary shares of Entity Q. Three other investors each hold 20% of the ordinary shares of Entity Q. Entity P has two representations on the board of directors of Entity Q whilst the other three investors each have one representation. There are no other arrangements that affect decision-making policies of Entity Q. In this case, considering the absolute size of Entity P s voting right and its relative size to the other three shareholdings is sufficient to conclude that Entity P does not have power over Entity Q. This is because only three other investors would need to cooperate to be able to prevent Entity P from controlling Entity Q unilaterally. Case 4 Entity P holds 40% of the ordinary shares of Entity Q. Twelve other investors each hold 5% of the ordinary shares of Entity Q. None of the other shareholders has any contractual arrangement to consult each other or to make collective decisions. In this case, considering the absolute size of Entity P s holding and the relative size of the other shareholdings alone is not conclusive to determine if Entity P has rights sufficient to give it power over Entity Q. Additional facts and circumstances that indicate that Entity P has, or does not have power should be considered Potential Voting Rights An entity may hold warrants, share options or convertible securities that are exercisable or convertible into ordinary shares, or other similar 7.3 CCH Asia Pte Limited

28 Chapter 7: Consolidated and Separate Financial Statements 573 instruments that have the potential, if exercised or converted, to give the entity voting power or reduce another party s voting power over the financial and operating policies of another entity (potential voting rights). The IFRS requires that the existence and effects of potential voting rights, including potential voting rights held by another entity, are considered when assessing whether an entity has the power to direct the relevant activities of an investee. In assessing whether potential voting rights contribute to control, the entity examines all facts and circumstances (including the terms of the exercise of the potential voting rights and any other contractual arrangements whether considered individually or in combination) that affect potential voting rights, except the intention of management and the financial ability to exercise or convert. The condition of currently exercisable in the former FRS 127 has been removed. Example 2 X Bhd and Y Bhd each holds a 30% interest in the 100 million ordinary shares of S Bhd. The remaining shareholders are spread out evenly among the public investors. X Bhd also holds 50 million warrants of S Bhd, which are exercisable into 50 million new ordinary shares of S Bhd. In this case, if X Bhd were to exercise the warrants it holds in S Bhd, its effective ownership in S Bhd would be [30m + 50m]/[100m + 50m] = 53.3%. This would give X Bhd a voting power of more than half. Thus, with the potential voting rights and considering all other relevant factors, it is probable that X Bhd would have control of S Bhd, and should therefore treat S Bhd as a subsidiary. Example 3 (Cases on Potential Voting Rights) Case 1 Potential voting rights that are not substantive Entity A and Entity B currently hold 60% and 40% respectively of the voting ordinary shares of Entity C. However, Entity B has a call option to acquire half of Entity A s voting ordinary shares of Entity C. The option is exercisable at any time in the next three years at a fixed price that is deeply out of the money (and is expected to remain so for that three-year period). Entity A has been exercising its votes and is actively directing the relevant activities of Entity C. In this case, Entity A is more likely to meet the power criterion because it has the current ability to direct the relevant activities of Entity C. Although Entity B has a current exercisable call option to purchase additional voting rights that if exercised would give it a majority of the voting rights in Entity C, the terms and conditions associated with the option (the fact that the option is deeply out of the money and likely to remain so in the next three years) are such that the option is not considered to be substantive. Financial Accounting and Reporting in Malaysia, Volume 2 7.3

29 574 Chapter 7: Consolidated and Separate Financial Statements Case 2 Potential voting rights that are substantive Entity O has three shareholders, Entity L, Entity M and Entity N, each holding one third of the ordinary shares of Entity O. Entity L also holds convertible loanstocks of Entity O which are exercisable at a fixed conversion price at any time in the next two years. If exercised, Entity L would have a majority of the voting rights in Entity O. The conversion option in the loanstocks is currently out of the money (but not deeply out of the money). In this case, Entity L is likely to have the power because it holds voting rights in the investee together with rights to obtain voting rights, to give it the current ability to direct the relevant activities of Entity O. The potential voting rights in this case is substantive. However, to conclude whether Entity L has power over the investee, it needs to consider additional evidence, such as whether it can appoint or approve the investee s key management personnel, whether it can direct the investee to enter into, or can veto any changes to, significant transactions that affect its returns, whether it can dominate the nomination process of electing members of the investee s governing body or whether the key management personnel or board members are its related parties Control of Structured Entities A structured entity is defined in the MFRS as an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. Features or attributes of a structured entity may include some or all of the following: (a) (b) (c) restricted activities. a narrow and well-defined objective, such as to effect a tax-efficient lease, carry out research and development activities, provide a source of capital or funding to an entity or provide investment opportunities for investors by passing risks and rewards associated with the assets of the structured entity to investors. insufficient equity to permit the structured entity to finance its activities without subordinated financial support. (d) Financing in the form of multiple contractually linked instruments to investors that create concentrations of credit or other risks (tranches). (a) (b) (c) Examples of structured entities are: Securitisation vehicles; Asset-backed financings Some investment funds 7.3 CCH Asia Pte Limited

30 Chapter 7: Consolidated and Separate Financial Statements 575 An investor needs to assess its involvement with a structured entity to determine whether it has the power to direct the relevant activities and is exposed, or have rights, to variable returns of the structured entity. If its involvement meets the control model, it shall treat the structured entity as its subsidiary. Otherwise the investee is treated as an unconsolidated structured entity and the disclosure requirements of MFRS 12 would apply. Example 4 On 1 January 20x0 Setia Bhd, a property development company, creates Damai Trust for the sole purpose of developing a shopping complex that will be leased to Jusco Bhd. The cost to develop the shopping complex, including land cost, is estimated at RM500 million. To provide the necessary financing for the development of the shopping complex, two banks are invited to each take up a 40% stake in the equity of Damai Trust and the balance of the 20% stake will be invested by Setia Bhd. For its 20% stake, Setia Bhd will transfer its land to Damai Trust and undertake the entire development of the shopping complex. Damai Trust will then enter into an operating lease arrangement whereby upon completion, the shopping complex will be leased to Jusco Bhd for a lease period of 20 years at a minimum lease payment of RM50 million per year. The lease payments received in each year, after deducting operating expenses of Damai Trust, will be paid out as dividends to the stakeholders (the bankers and Setia Bhd). The governing board of Damai Trust will consist of representations from the two bankers and Setia Bhd but its functions are limited to ensuring that the payments for development are in accordance with the stage of development, the lease arrangement with Jusco Bhd is set out properly, and the approval of the annual dividends to the stakeholders. At the end of year 20, the shopping complex will be taken over by Setia Bhd. Damai Trust will be dissolved and the initial capital provided by the bankers will be returned to them. Required Explain whether Setia Bhd should consolidate the financial statements of Damai Trust. Solution 4 Although Setia Bhd only holds a 20% stake in the equity of Damai Trust, the substance of the arrangement is that Damai Trust is a structured entity that is controlled by Setia Bhd. Accordingly, Setia Bhd should consolidate the financial statements of Damai Trust. Damai Trust operates on an autopilot mechanism whereby its policies are predetermined. The control is evident because Setia Bhd is the creator of the Trust and it derives economic benefits directly by transferring its land and undertaking the entire development activities of the shopping complex and receiving dividend distribution from its 20% equity stake in the Trust. Furthermore, it bears the residual or ownership risk in that at the end of year 20, the initial capital provided by the bankers must be returned in their entirety (a form of guarantee for return of capital) even if the market value of the shopping complex were to fall substantially below the capital provided by the bankers. Financial Accounting and Reporting in Malaysia, Volume 2 7.3

31 576 Chapter 7: Consolidated and Separate Financial Statements Requirement for Group Accounts In general, when a group exists, the Standard requires that the parent must, in addition to its own separate financial statements, prepare a set of group financial statements comprising itself and all its subsidiaries. Note that the parent s separate financial statements would normally record its investments in subsidiaries based on the cost principle, and hence would only account for dividends received and receivable from its subsidiaries. This cost basis of accounting for subsidiaries is not an appropriate measure of the group s performance and financial position because the dividends recognised may bear little relationship to the performance of the subsidiaries. Furthermore, it does not indicate the extent of financial resources (assets and liabilities) controlled by the parent. Thus, without presenting group accounts, it can be argued that the parent s separate financial statements would not reflect a true and fair view of the operations and financial position of a parent and its subsidiaries. The objective of the group financial statements is designed for shareholders of the parent in particular and the users of accounts in general. Shareholders and users are usually concerned with and need to be informed about the performance, financial position and changes in financial position of the group as a whole. Thus, group financial statements are presented to reflect financial information of the group as a whole, as if the group is a single entity although separate legal entities exist for entities within the group Basic Concepts of Group Accounts Group accounts are usually prepared in the form of consolidated financial statements which treat the parent and its subsidiaries as a single economic unit. Consolidation is basically a method of accounting under which the information contained in the separate financial statements of a parent and its subsidiaries is presented as though for a single entity. The consolidated financial statements record the results and assets and liabilities of the entities which comprise a group, aggregated on the basis that those entities all form part of a single economic unit. The views of consolidation differ and these can affect the way certain items are treated in the consolidated accounts. One such view is based on the proprietary concept which stresses on ownership interest rather than control. This concept assumes that the shareholders of the parent are the only relevant users and that they are interested solely in the equity shares that they owned. Accordingly, only the proportionate interest of the parent in the assets, liabilities, revenues and expenses of partly-owned subsidiaries would be added to the consolidated accounts (proportionate consolidation). 7.3 CCH Asia Pte Limited

32 Chapter 7: Consolidated and Separate Financial Statements 577 An opposing view to consolidation is based on the entity concept which stresses on common control regardless of ownership. This concept, though focussing on the group itself as being a single entity, does not make a distinction between the different shareholders in the entities that comprise a group. Interest of shareholders of the parent is not separately identified. Controlling and non-controlling shareholders are all treated as shareholders within the group s economic entity. In practice, consolidated financial statements are prepared on the basis of a combination of the two concepts. The proprietary concept alone does not provide sufficient relevant information for the parent s shareholders as it undermines the economic resources controlled by the group. On the other hand, the entity concept alone does not make a distinction between interests of the shareholders of the parent and the non-controlling shareholders of the subsidiaries in the group. Such a distinction is generally considered as important to the group parent s investors as they need information not only on the group as a whole, but also on the distinction between what they own and what others own. In its deliberation on this subject of consolidation, the IASB considered the following bases for consolidation: (a) (b) (c) the controlling entity model, where the consolidated financial statements comprise the controlling entity and other entities under its control; the common control model, where the combined financial statements comprise entities under the control of the same controlling entity or body; and the risks and rewards model, where two entities are included in the consolidated financial statements when the activities of one entity affect the wealth of the residual shareholders (or residual claimants) of the other entity. The IASB rejected the risks and rewards model as a basis for consolidation on the grounds that it is not conceptually robust. The IASB observed that there are occasions when the combined financial statements and therefore the application of the common control model, would provide useful information to users of financial statements. However, it concluded that the IFRS should use the controlling entity model as the primary basis of consolidation. MFRS 10 defines consolidated financial statements as the financial statements of a group in which the assets, liabilities, equity, income and expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. In other words, the net assets and results of all entities that comprise a group are first aggregated using the entity concept, on the basis that those entities all from part of a single economic entity. The results and net assets aggregated are then allocated to interests Financial Accounting and Reporting in Malaysia, Volume 2 7.3

33 578 Chapter 7: Consolidated and Separate Financial Statements of non-controlling shareholders leaving the balances as attributable to the shareholders or owners of the parent entity (the proprietary concept is applied within the entity concept to separate the results and net assets). 7.4 Consolidation Procedures The Standard explains that in preparing consolidated financial statements, an entity combines the financial statements of the parent and its subsidiaries, line by line by adding together the items of assets, liabilities, equity, income and expenses. In order that the consolidated financial statements present financial information about the group as that of a single economic entity, the following steps are then taken: (a) (b) (c) the carrying amount of the parent s investment in each subsidiary and the parent s portion of the equity of each subsidiary are eliminated (see MFRS 3, which describes the treatment for the resultant goodwill); non-controlling interests in the profit or loss and other comprehensive income of consolidated subsidiaries for the reporting period are identified; and non-controlling interests in the net assets of consolidated subsidiaries are identified separately from the parent s ownership interests in them. Non-controlling interests in the net assets consist of: (i) the amount of those non-controlling interests at the date of the original combination calculated in accordance with MFRS 3; and (ii) the non-controlling interests share of changes in equity since the date of the combination. The profit or loss, other comprehensive income and the net assets allocated to the parent and non-controlling interests shall be based on the present ownership interests and do not reflect possible exercise or conversion of potential voting rights. For example, assume that the present ownership interests of the parent and non-controlling interests are 60% and 40% respectively. The exercise or conversion of potential ordinary shares would change their ownership interests to 80% and 20% respectively. The allocation of the current period profit, other comprehensive income and net assets should be based on the present 60% and 40% ownership interests. The Standard further requires that non-controlling interests shall be presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. As non-controlling interests represent equity not held by the parent, they would include ordinary equity shares, preference shares that are classified as equity and other components of equity (such as share option reserves) not attributable to the parent. 7.4 CCH Asia Pte Limited

34 Chapter 7: Consolidated and Separate Financial Statements Other Intragroup Balances Apart from the investment in equity shares of a subsidiary, other intragroup balances may include investment in preference shares, intragroup bond holdings, intragroup loans and advances, intragroup group current accounts (such as amount due from or due to a subsidiary), intragroup dividend receivable and payable, and intragroup bills receivable and bills payable. In accordance with the concept that all entities in a group are a single economic entity, all intragroup balances must be eliminated on consolidation. The elimination of intragroup loans and advances, current accounts and dividend is usually a straightforward procedure of reversing entries at the consolidation level. In practice, the intragroup current accounts often to not agree, either due to items in transit and/or errors in recording. In principle, the current accounts should be adjusted for these items and/or errors before they are eliminated on consolidation. If a partly-owned subsidiary has declared a dividend, the parent s share of that dividend is eliminated in the consolidated statement of financial position. The portion of that dividend payable to non-controlling interest is not eliminated but included in other payables. If a parent has provided a financial guarantee to a lender for a loan taken by its subsidiary, the financial guarantee is disclosed as a contingent liability in its separate financial statements. On consolidation, this contingent liability must be eliminated as the loan taken by the subsidiary would be included in the consolidated statement of financial position Preference Shares in a Subsidiary A subsidiary may have issued redeemable preference shares or nonredeemable preference shares that are classified as financial liabilities. To the extent that the preference shares are held by the parent, they shall be eliminated with the parent s investment on consolidation as they represent intragroup balances. The balance of the preference shares not held by the parent shall remain as financial liabilities in the consolidated statement of financial position. If a subsidiary has preference shares that are classified as equity, the extent of the preference shares not held by the parent is classified as non-controlling interests. The Standard clarifies that if a subsidiary has outstanding cumulative preference shares that are classified as equity and are held by non-controlling interests, the parent computes its share of profit or loss after adjusting for the dividends on such shares, whether or not dividends have been declared. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

35 580 Chapter 7: Consolidated and Separate Financial Statements Example 5 On 1 January 20x1, Happy Bhd acquired 75% of the ordinary shares and 30% of the preference shares of Lucky Bhd. The preference shares are classified as equity and they carry a cumulative preference dividend of 10% per year. The payment of dividend is discretionary and conditional on the company achieving sufficient profits in each year. However, dividends on ordinary shares can only be paid after all arrears of preference dividends have been paid. For the year ended 31 December 20x4, Lucky Bhd reported a profit after tax of RM70 million. Its equity consists of the following components: Required (a) (b) Cumulative preference shares of RM1 each 100,000 Ordinary shares of RM1 each 200,000 Retained profits brought forward 80,000 Profit after tax for the year 20x4 70, ,000 Compute the amount of profit for the year that shall be allocated to noncontrolling interests; and Determine the amount of non-controlling interest that shall be shown in the financial position. Solution 5 (a) Allocation of profit for the year Total Profit after tax 70,000 Noncontrolling Interest Parent 10% preference dividend (10,000) 7,000 3,000 Profit after preference dividend 60,000 15,000 45,000 Allocation of profit 70,000 22,000 48, CCH Asia Pte Limited

36 Chapter 7: Consolidated and Separate Financial Statements 581 (b) Non-controlling interest in financial position Total Noncontrolling Interest Parent Preference shares 100,000 70,000 30,000 Ordinary shares 200,000 50, ,000 Retained profits brought forward 80,000 20,000 60,000 Profit for the year 70,000 22,000 48, , , , Intragroup Bond Holdings Whilst the Companies Act, 1965 prohibits reciprocal shareholdings between a parent company and its subsidiary companies, there is no such equivalent restriction on intragroup bond holdings. Thus, companies in a group may hold bonds of the parent or any of its subsidiaries. Also, a company may retire its own bonds by purchasing them in the open market. Bonds, which are commonly called loan stocks or debentures in Malaysia, are debt instruments, which the issuer must recognise as a long-term financial liability in its financial position. The financial liability is normally carried at the amortised cost basis in accordance with MFRS 139, Financial Instruments: Recognition and Measurement. The liability instrument gives rise to interest expense, which may consist of the coupon interest rate plus accretion of bond discount, and less amortisation of bond premium. Under the amortised cost basis, the effective interest expense recognised would be equal to the effective market interest rate prevailing at the time of the bond issue (i.e. a historical interest rate) When an entity purchases a bond of its affiliate (which can be any other entity in the group), the entity needs to account for the bond as an investment. The investment in bond is a financial asset, which in accordance with MFRS 139, shall be classified as either: (i) held-to-maturity (HTM) investment, (ii) available-for-sale (AFS) investment, or (iii) investment at fair value through profit or loss. When classified as a HTM investment, the bond would be measured at amortised cost using effective interest basis, wherein the initial cost of the investment is adjusted for amortisation of bond premium or accretion of bond discount. Its interest income may thus consist of coupon interest rate plus accretion of bond discount, and less amortisation of bond premium, to provide an effective yield based on the market interest rate Financial Accounting and Reporting in Malaysia, Volume 2 7.4

37 582 Chapter 7: Consolidated and Separate Financial Statements prevailing at the time the investment was made (i.e. a historical interest rate). If the bond is classified as an AFS investment, the interest income shall continue to be based on the effective interest but changes in market or fair value of the bond shall be taken directly to equity (for example, fair value reserve). Similarly, if the bond is classified as at fair value through profit or loss, the interest income is also based on interest received, but the changes in market or fair value are recognised as gains or losses in the income statement. The basic principle of eliminating all intragroup balances and transactions remains the same for intragroup bond holdings. On consolidation, an adjustment is required to eliminate the purchaser s investment in bond account with the issuer s bond liability account, leaving only bonds held by third parties as bond liability in the consolidated financial position. Similarly, an adjustment is required to eliminate the purchaser s interest income with the issuer s interest expense, with the resulting net interest expense attributable to bonds held by third parties being reflected in the consolidated income statement. Inter-company Bonds Purchased as at the Date of the Issue Where the intragroup bonds are purchased directly from the issuer at the date of the issue, there is usually no complication in the elimination process if both the issuer and the purchaser apply the amortised cost basis. This is because the purchase price of the investment in bond will be equal to the issue price of the bond liability. No difference will arise in the elimination process as at the date of the issue and subsequently, because the intragroup bond accounts will offset each other exactly. Conceptually then, the portion of the bond purchased by any company within the group as at the date of the issue, reduces the extent of the bond liability of the consolidated entity. For example, if a parent issues a RM50 million bond, and out of this amount, RM20 million is purchased by its subsidiaries, effectively then, the group has raised a bond liability of only RM30 million. Thus, in the case where the bonds are purchased at the date of the issue, the price paid by the purchaser for the bonds will be equal to the fair value of the bond of the issuer. On consolidation, the investment in bonds of the purchaser will cancel out the fair value of the bonds of the issuer, and no difference on consolidation will arise. Similarly, the interest expense (coupon interest plus accretion of discount minus amortisation of premium) of the issuer should cancel out the interest income of the purchaser. 7.4 CCH Asia Pte Limited

38 Chapter 7: Consolidated and Separate Financial Statements 583 Example 6 P Bhd owns a 75% interest in the equity capital of S Bhd. On 1 January 20x7, S Bhd issued a RM100,000,000 unsecured bond that carries a coupon interest rate of 6% per annum. The bond was issued at RM per unit of RM1,000 nominal value. The effective market interest rate for similar risk class bonds at issue date was 10%. Interest is payable annually on 31 December. The bond is fully redeemable at its nominal value after five years. P Bhd acquired 40% of the total bond issue of S Bhd. Both P Bhd and S Bhd use the amortised cost method to carry the bond in the accounts. Required (i) (ii) For the financial year ended 31 December 20x7: Explain how S Bhd should account for the bond issue and the interest expense; Explain how P Bhd should account for its investment in the bond of S Bhd; and (iii) Explain the consolidation adjustments required at the P Bhd group level. Solution 6 (i) (ii) On 1 January 20x7, S Bhd should record the issuance of the bond as follows: RM Dr Bank account 84,850,000 Dr Bond discount contra to bond account 15,150,000 Cr Bond account nominal value 100,000,000 On 31 December 20x7, S Bhd should recognise the interest expense, as follows: RM Dr Interest expense 10% x 84,850,000 8,485,000 Cr Bank account coupon interest 6,000,000 Cr Bond discount - amortisation 2,485,000 At 31 December 20x7, the carrying value of the bond liability in the accounts of S Bhd would be = RM100,000,000 RM12,665,000 = RM87,335,000. On 1 January 20x7, P Bhd should record its investment in the bond of S Bhd as follows: RM Dr HTM investment in bond of S Bhd 33,940,000 Cr Bank account (40m x.8485) 33,940,000 On 31 December 20x7, P Bhd should recognise the interest income as follows: RM Dr Bank account - coupon interest 6% x 40m 2,400,000 Dr HTM investment in bond of S Bhd - accretion 994,000 Cr Effective interest income (10% x 33,940,000) 3,394,000 RM RM RM RM Financial Accounting and Reporting in Malaysia, Volume 2 7.4

39 584 Chapter 7: Consolidated and Separate Financial Statements At 31 December 20x7, the carrying value of P Bhd s HTM investment in bond is thus = RM33,940, ,000 = RM34,934,000. (iii) On consolidation of P Bhd and S Bhd, the following adjustments are required to eliminate the intergroup bond holding in the financial position and the intergroup income and expense: RM Dr Bond account of S Bhd 40,000,000 Cr Bond discount of S Bhd 5,066,000 Cr HTM investment in Bond of S Bhd 34,934,000 The net carrying amount of the bond liability as at 31 December 20x7 in the consolidated financial position will be RM52,401,000 (i.e. nominal value of RM60,000,000 less bond discount of RM7,599,000). RM Dr Effective interest income of P Bhd 3,394,000 Cr Effective interest expense 3,394,000 The net interest expense in the consolidated profit and loss account will be RM5,091,000 (i.e. coupon interest expense of RM3,600,000 plus amortisation of bond discount of RM1,491,000). Note that when transaction costs are involved, the intragroup bond accounts may not offset each other exactly. Based on FRS 139, transaction costs are included in the initial measurement of a financial asset or a financial liability (except when a financial instrument is measured at fair value through profit or loss, in which case, the transaction costs shall be expensed). To the issuer, the transaction costs would include underwriting fees and other charges incurred in the issue. Inclusion of the transaction costs thus reduces the carrying amount of the liability on its initial measurement. To the purchaser, transaction costs are mostly commissions paid to brokers. Inclusion of the transaction costs thus increases the carrying amount of the asset on initial measurement. For example, an intragroup bond floated in the market at RM10,000,000 is carried in the issuer s book at RM9,800,000 net of underwriting fee. The same bond is carried in the purchaser s book at RM10,080,000 inclusive of dealers or brokers commissions. When eliminating the intragroup bond on consolidation, a debit difference of RM280,000 would arise. From the viewpoint of the consolidated entity, such intragroup bond does not exist. Accordingly, the debit difference shall be expensed in the consolidated income statement. If the purchaser of an intragroup bond treats it as an AFS investment, the change in fair value of the bond that is taken to other comprehensive income in its individual accounts shall be reversed on consolidation. For example, an intragroup bond in the issuer s books is carried at amortised cost of RM9,500,000. In the books of the purchaser, the bond is treated as an RM RM 7.4 CCH Asia Pte Limited

40 Chapter 7: Consolidated and Separate Financial Statements 585 AFS investment and carried at fair value of RM10,100,000 with RM600,000 credited to other comprehensive income and retained in a fair value reserve. On consolidation, the fair value change recognised in the other comprehensive income shall be reversed before the intragroup bond is eliminated. Similarly, if the purchaser of an intragroup bond treats it as at fair value through profit or loss, the change in fair value that is recognised as gain or loss in its income statement shall be reversed on consolidation. Inter-company Bonds Purchased from Market After Issue Date In the case where the intragroup bonds are purchased in the open market from third parties after their issuance date, the purchase price of the bonds may differ from the carrying amount of the bond liability account because market interest rate could have changed since the issuance date. For example, if the market interest rate goes up after the date of the issue, the market value of the bond would decrease. Conversely, a decrease in market interest rate would have the opposite effect on the market price of the bond. Thus, when the investment account and the bond liability account are compared, a difference will arise in the elimination process depending upon the price paid for the bond and the carrying amount of the bold liability. A debit difference will arise in the elimination process if the price paid for the bond is more than its corresponding carrying amount in the books of the issuer, and conversely, a credit difference will result in the elimination process if the price paid for the bond is less than its corresponding carrying amount. For example, assume that an issuer s bond has a carrying value of RM900 per unit of RM1,000 nominal value. If an affiliated company purchased the bond in the open market at a price of RM950 per unit, then on consolidation a debit difference of RM50 per unit will arise when the cost of investment in bond is cancelled with the corresponding carrying value of the bond. Conversely, if the affiliated company had purchased the bond at a market price of RM800 per unit, a credit difference of RM100 per unit will arise in the consolidation adjustment. The issue centres on the appropriate accounting treatment for the debit or credit difference arising in the elimination process. When an affiliate s bonds are purchased in the open market, the bonds are viewed as having been constructively retired from the viewpoint of the consolidated entity. Thus, the accounting for this constructive retirement of the bonds is the same as the accounting treatment accorded if an entity were to buy back its own bonds in the open market. MFRS 132, Financial Instruments: Presentation, requires that any gain or loss arising from an instrument classified as a financial liability should be reported as a gain or loss in the income statement. Note that the term constructive is used, which means that the intragroup bonds are viewed as having been retired from the Financial Accounting and Reporting in Malaysia, Volume 2 7.4

41 586 Chapter 7: Consolidated and Separate Financial Statements viewpoint of the consolidated entity only, but legally the total bonds are still outstanding insofar as the issuer is concerned. Whilst there is a general agreement on the recognition of the gain or loss on a constructive retirement of intragroup bonds in the consolidated income statement, there is no general consensus on how the gain or loss should be allocated between the majority (parent) and non-controlling interests. Past practices in the USA suggested at least four alternative treatments: (1) that the entire gain or loss is assigned to the purchasing company; (2) that the entire gain or loss is assigned to the parent company, (3) that the gain or loss is allocated ratably between the purchasing company and the issuing company; and (4) that the entire gain or loss is assigned to the issuing company. Assigning the entire gain or loss to the purchasing company appears to be inconsistent with the principle that a gain or loss cannot arise when the investment is first acquired. In other words, the purchasing company records the investment in bonds at its fair value at the date of purchase, and thus no gain or loss can possibly arise in its accounts at that date. Accordingly, the consolidation adjustment should not result in the gain or loss being allocated entirely to the purchasing company. For example, if the purchasing company is a parent, allocating the entire gain to the parent would result in the non-controlling interest? in the subsidiary? not having a share of that gain. Conversely, if the purchasing company is a partlyowned subsidiary, allocating the entire gain to the subsidiary would result in the non-controlling interest in that subsidiary having a share of that gain. This would over-state the non-controlling interest s share of net assets in that subsidiary. Assigning the entire gain or loss to the parent company (regardless of whether it is the issuer or the purchaser of the intragroup bonds) is often argued on the grounds of practical expediency although this treatment is not supported with any theoretical merits. Allocating the gain or loss ratably between the purchasing company and the issuing company is supported, on the grounds that it is consistent with the allocation of unrealised profits or losses to parent and non-controlling interests arising on other intragroup transactions. The practical difficulty of this treatment is in deciding on the ratable allocation, such as, should it be allocated equally or should it be based on the ownership interests of the parent and non-controlling shareholders. Assigning the entire gain or loss to the issuing company is based on the notion that a constructive retirement of a bond from the group s viewpoint is similar, in substance, to an actual retirement of the bond. Thus, if the issuing company were to actually retire its bond by a repurchase in the open 7.4 CCH Asia Pte Limited

42 Chapter 7: Consolidated and Separate Financial Statements 587 market, the entire gain or loss would have been recognised in its income statement. The current thinking on fair value accounting for financial instruments would appear to lend further support to this treatment. If all financial assets and liabilities, including bonds, are carried at their fair values, any changes in fair values would be recognised as gains or losses in income. Thus, the issuing entity would recognise any change in the market value of its bond in the income statement. Since its bond is marked to market value, any purchase by its affiliate would also be at the market value, and thus no further gain or loss will arise on the constructive retirement in the consolidation adjustment. The author considers this treatment to be the most appropriate in the light of the current developments in accounting for financial instruments. When the gain or loss is attributed to the issuing entity, in the calculation of the non-controlling interest s share of profit for a period, the gain or loss is attributable to them only if the subsidiary is the issuing entity. In this case, a ratable portion of the gain or loss recognised at the group level shall be included in the calculation of the non-controlling interest s share of profit. In the case when the bond is issued by the parent, the gain or loss is attributed to the parent only (as if the parent itself had repurchased the bond or had fair valued the bond), and thus not included in the calculation of the noncontrolling interest s share of profit. Example 7 Papa Bhd acquired a 60% interest in the equity capital of Mama Bhd on 1 January 20x1 for a consideration of RM20,000,000. At acquisition date, the retained profits of Mama Bhd were RM10,000,000. On 1 January 20x4, Mama Bhd issued RM20,000,000 6% unsecured 5-year bond at a discount and received a net proceed of RM16,970,000. The market interest rate at the time of issue was 10%. The bond is carried at the amortised cost basis using the effective interest rate of 10% in its accounts. On 1 January 20x6, Papa Bhd purchased 50% of Mama Bhd s outstanding bond in the open market at a market price of RM7,757,600. On this date, the carrying value of the total bond in the accounts of Mama Bhd was RM18,013,600. On this date, the market interest rate of Mama Bhd s bond was quoted at 16%. Papa Bhd accounts for the bond as HTM investment and carries the bond at the amortised cost method using the effective interest rate of 16%. The summarised accounts of the two companies for the year ended 31 December 20x6 are as follows: Financial Accounting and Reporting in Malaysia, Volume 2 7.4

43 588 Chapter 7: Consolidated and Separate Financial Statements Statements of Comprehensive Income & Retained Profits Papa Bhd Mama Bhd Operating profit 10,600 8,600 Add: Bond interest receivable 600 Accretion of bond discount 1,241 Less: Bond interest payable (1,200) Amortisation of bond discount (601) Profit before taxation 12,441 6,799 Taxation (3,961) (2,299) Profit after taxation and retained 8,480 4,500 Retained profits brought forward 11,520 17,500 Retained profits carried forward 20,000 22,000 Statements of Financial Position Papa Bhd Mama Bhd Share capital of RM1 each 40,000 20,000 Retained profits 20,000 22,000 8% unsecured bonds - nominal value 20,000 Investment in Mama Bhd: - bond discount (1,385) 60,000 60,615 12,000,000 shares of Mama Bhd, at cost 20,000 10,000,000 units of Mama Bhd s bond - Cost adjusted for accretion of bond discount 8,999 Sundry net assets 31,001 60,615 60,000 60,615 Required (a) As at the date of the purchase of the intragroup bond by Papa Bhd, calculate the gain or loss on constructive retirement of the bond. (b) Prepare the consolidated accounts of Papa Bhd for the financial year of 20x CCH Asia Pte Limited

44 Chapter 7: Consolidated and Separate Financial Statements 589 Solution 7 (a) Constructive gain or loss: Cost of investment in bond 7,757.6 Share of carrying value of bond at 1 January 20x6 50% x 18,013,600 9,006.8 Credit difference being gain on constructive retirement 1,249.2 (b) Papa Bhd Consolidated Statement of Comprehensive Income & Retained Profits For the year ended 31 December 20x6 PapaBhd Mama Bhd Adjustments Group Operating profit 10,600 8,600 19,200 Gain on constructive retirementof Mama Bhd s bond 1,249 1,249 Interest income receivable 600 (600) Accretion of bond discount 1,241 (1,241) Interest expense payable (1,200) 600 (600) Amortisation of bond discount (601) 301 (300) Profit before taxation 12,441 8,048 (940) 19,549 Less: Taxation (3,961) (2,299) (6,260) Profit after taxation 8,480 5,749 (940) 13,289 Non-controlling interest (2,300) 376 (1,924) Retained profit for the year 8,480 3,449 (564) 11,365 Retained profits brought forward 11,520 4,500 16,020 Retained profits carried forward 20,000 7,949 (564) 27,385 Financial Accounting and Reporting in Malaysia, Volume 2 7.4

45 590 Chapter 7: Consolidated and Separate Financial Statements Consolidated Statement of Financial Position As at 31 December 20x6 Share capital of RM each 40,000 Retained profits 27,385 67,385 Non-controlling interest 40% (42, , ) + 1,333 18,257 8% Unsecured bond Nominal value 10,000 Unamortised bond discount (693) 9,307 94,949 Goodwill on combination (20,000/.60-30,000) 3,333 Sundry net assets (31, ,615) 91, Intragroup Transactions and Unrealised Profits 94,949 Many types of intragroup transactions can arise in a group. The more common types are as follows: (i) sale of inventories between entities in a group; (ii) sale or transfer of property, plant and equipment; (iii) intragroup loans that give rise to interest income and interest expense; and (iv) management fees charged by the parent. In accordance with the view that a group of companies is a single economic entity, the effects of all such intragroup transactions in a group must be eliminated as the group cannot possibly trade and make profits from itself. The Standard requires that intragroup balances, transactions, income and expenses shall be eliminated in full. Consequently, unrealised profits and losses resulting from intragroup transactions that are included in the carrying amount of assets, such as inventories and property, plant and equipment, are eliminated in full. Intragroup losses may indicate an impairment that requires recognition in the consolidated financial statements. The Standard s requirement for full elimination reflects that fact that an intragroup transaction is a control issue, i.e., the transaction can be made without reference to any external third party. The non-controlling shareholders are treated as internal to the group for the purpose of the elimination of unrealised profits or losses, and it is thus not sufficient to 7.4 CCH Asia Pte Limited

46 Chapter 7: Consolidated and Separate Financial Statements 591 adjust only for that portion of the transaction that relates to the controlling interest. Adjustments for the whole transaction and the full amount of any unrealised profit or loss shall be made and allocated suitably between the controlling interest and the non-controlling interest. Note that legally, the profits or losses are realised in the accounts of the selling company and are therefore subject to tax. Thus, when the full unrealised profits or losses are eliminated on consolidation, their related tax effects must also be recognised and carried forward until the profits or losses are realised. The Standard requires that temporary differences that arise from the elimination of unrealised profits or losses resulting from intragroup transactions be dealt with in accordance with MFRS 112, Income Taxes. Intragroup Sale of Inventories The consolidation adjustments to eliminate intragroup sales and unrealised profits are as follows: Dr Sales (of seller) Cr Purchases (of buyer) to eliminate intragroup sales. Dr Closing inventories in the trading account Cr Closing inventories in the financial position to eliminate the unrealised profit in closing inventories carried forward. Dr Deferred taxation in the financial position Cr Taxation expense in the income statement to account for the tax effect of the profit deferred. In general, it is presumed that the profits eliminated on consolidation are realised on the first-in-first-out basis, unless the inventories are carried on the specific identification costing method. In other words, any unrealised profit in the current year is assumed to be fully realised in the following year, unless evidence indicates otherwise. The consolidation adjustment to account for this subsequent realisation is as follows: Dr Opening retained profits Dr Taxation expense Cr Opening inventories in the trading account to reinstate unrealised profit brought forward and to account for its subsequent realisation. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

47 592 Chapter 7: Consolidated and Separate Financial Statements Example 8 P Bhd is a parent company with a few subsidiaries. The following intragroup sales were recorded for the financial years ended 31 December 20x6 and 20x7 respectively: (i) (ii) Year 20x6: Intragroup sales at invoice prices amounted to RM2,000,000 of which RM800,000 remained in the closing inventories of the buying companies. Year 20x7: Intragroup sales at invoice prices amounted to RM3,200,000 of which RM1,200,000 remained in the closing inventories of the buying companies. The profit element on intragroup sales to the selling companies was at 20% of the invoice prices. Income tax rate was at 25% for both financial years. Required Show the consolidation adjustments to eliminate the intragroup transactions and unrealised profits for both financial years 20x6 and 20x7. Solution 8 Year 20x6: (i) Dr Sales (of sellers) RM2,000,000 Cr Purchases (of buyers) to eliminate intragroup sales. (ii) Dr Closing inventories in the trading account Cr Closing inventories in the financial position RM160,000 RM2,000,000 RM160,000 to eliminate unrealised profit in closing inventories carried forward. (iii) Dr Deferred tax liability in the financial position RM40,000 Cr Taxation expense in the income statement to account for the related tax effect of the profit eliminated. Year 20x7: (i) Dr Opening retained profits Dr Taxation expense Cr Opening inventories in the trading account RM120,000 RM40,000 to reinstate opening retained profits and to account for the realisation of the profit deferred in the prior year. (ii) Dr Sales (of sellers) Cr Purchases (of buyers) to eliminate intragroup sales. (iii) Dr Closing inventories in the trading account Cr Closing inventories in the financial position RM3,200,000 RM240,000 to eliminate unrealised profit in closing profit carried forward. (iv) Dr Deferred tax liability in the financial position RM60,000 Cr Taxation expense in the income statement to account for the related tax effect of the profit eliminated. RM40,000 RM160,000 RM3,200,000 RM240,000 RM60, CCH Asia Pte Limited

48 Chapter 7: Consolidated and Separate Financial Statements Effects of the Elimination on Non-Controlling Interests In the Example above, we have specifically ignored the directions of the intragroup sales by not identifying the selling companies or the buying companies. This is because the consolidation adjustments for eliminating intragroup sales and unrealised profits are the same regardless of the directions of the intragroup sales. In allocating the group s profits and net assets to non-controlling interests, the resulting unrealised profits or losses shall be allocated to non-controlling interests based on their respective interests in the subsidiaries that have recorded the unrealised profits or losses. Thus, it is only in the calculation of the non-controlling interest s share of profit and net assets that the directions of the intragroup sales matter and should be identified correctly. When the sales are downstream (i.e. sales by a parent to its subsidiaries), the profits are recorded by the parent. The amounts of the subsidiaries profits are not affected by the elimination of the unrealised profits. Accordingly, no adjustment shall be made in the calculation of non-controlling interest s share of profit and net assets in the consolidated accounts. When the sales are upstream (i.e. sales by subsidiaries to their parent) or horizontal (i.e. sales amongst subsidiaries in a group), the profits are recorded by the selling subsidiaries. Accordingly, when the full unrealised profits are eliminated on consolidation, the non-controlling interests shall be allocated for their share of the unrealised profits. In other words, the noncontrolling interests share of profits in the consolidated accounts shall be based on the subsidiaries profits that have been realised in transactions with parties external to the group. Thus, in both upstream and horizontal sales, the non-controlling interests share of profits shall becalculated as follows: NCIs percent holding in the selling subsidiary X Subsidiary s profit after tax + Unrealised profit brought forward Unrealised profit carried forward Example 9 On 1 January 20x6, H Bhd acquired a 60% interest in the equity capital of S Bhd for a cash consideration of RM12,000,000. On this date the retained profits of S Bhd were RM6,000,000. The net assets of S Bhd at the acquisition date were stated in the accounts at their fair value of RM14,000,000. Based on an income approach, the fair value of S Bhd as a whole was measured at RM20,000,000 at the acquisition date. The summarised accounts of the two companies for the year ended 31 December 20x7 are as follows: Financial Accounting and Reporting in Malaysia, Volume 2 7.4

49 594 Chapter 7: Consolidated and Separate Financial Statements Statements of Comprehensive Income & Retained Profits H Bhd S Bhd Sales 24,000 12,000 Cost of sales: Opening inventories (8,000) (5,000) Purchases (18,000) (9,000) Closing inventories 10,000 6,000 (16,000) (8,000) Gross profit 8,000 4,000 Expenses (2,000) (1,000) Profit before taxation 6,000 3,000 Tax expense (1,800) (900) Profit after taxation 4,200 2,100 Retained profits brought forward 10,800 8,900 Retained profits carried forward 15,000 11,000 Statements of Financial Position H Bhd S Bhd Share capital of RM1 each 22,000 8,000 Retained profits 15,000 11,000 Total liabilities 14,000 8,000 51,000 27,000 Property, plant and equipment 21,000 17,000 Investment in S Bhd 12,000 Current assets: Inventories 10,000 6,000 Other current assets 8,000 4,000 51,000 27,000 Additional information: (a) (b) During the year ended 31 December 20x7, S Bhd sold goods to H Bhd for invoices totalling RM3,000,000. Of these sales, RM800,000 remained in the closing inventories of B Bhd at 31 December 20x7. The corresponding intragroup sales and closing inventories for the 20x6 financial year were RM2,000,000 and RM500,000 respectively. The profit margin to S Bhd was 25% on selling prices. The group carries goodwill on combination at cost less accumulated impairment losses. Income tax rate is 30% for both financial years. Non-controlling interest is measured at acquisition-date fair value. 7.4 CCH Asia Pte Limited

50 Chapter 7: Consolidated and Separate Financial Statements 595 Required (i) (ii) Show the consolidation adjustments and eliminations required to prepare the consolidated accounts for the 20x7 financial year; and Using a consolidated worksheet, derived the group accounts for the 20x7 financial year. Solution 9 (i) Consolidation adjustments and eliminations: (a) Dr Goodwill on combination (20,000 14,000) 6,000 Cr Revaluation reserve 6,000 to recognise goodwill on combination. (b) Dr Share capital of S Bhd 4,800 Dr Revaluation reserve goodwill 3,600 Dr Pre-acquisition profits 3,600 Cr Investment in S Bhd 12,000 to eliminate cost of investment. (c) Dr Share capital of S Bhd 3,200 Dr Revaluation reserve - goodwill 2,400 Dr Retained profits brought forward 3,560 Cr Non-controlling interest in financial position 9,160 to allocate opening net assets and goodwill to NCI. (d) Dr Retained profits brought forward 52.5 Dr Non-controlling interest in financial position 35.0 Dr Tax expense 37.5 Cr Opening inventories in profit or loss 125 to restate unrealised profit in opening inventories. (e) Dr Sales 3,000 Cr Purchases 3,000 to eliminate intragroup sales for the year. (f) Dr Closing inventories in financial position 200 Dr Deferred tax in financial position 60 Cr Closing inventories in profit or loss 200 Cr Tax expense in profit or loss 60 to eliminate unrealised profit in closing inventories. (g) Dr Non-controlling interest in profit or loss 819 Cr Non-controlling interest in financial position 819 to allocate profit to NCI (2, ) x 40%. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

51 596 Chapter 7: Consolidated and Separate Financial Statements (ii) Consolidation worksheet H Bhd Consol. Adjustments S Bhd (Dr) Cr H Group Sales 24,000 12,000 (3,000)e 33,000 Cost of sales Opening inventories (8,000) (5,000) 125d (12,875) Purchases (18,000) (9,000) 3,000e (24,000) Closing inventories 10,000 6,000 (200)f 15,800 (16,000) (8,000) (21,705) Gross profit 8,000 4,000 11,925 Expenses (2,000) (1,000) (3,000) Profit before taxation 6,000 3,000 8,925 Tax expense (1,800) (900) (37.5)d 60f (2,677.5) Profit after taxation 4,200 2,100 6,247.5 Non-controlling interest (819)g (819) Profit attributable to owners 4,200 2,100 5,428.5 Retained profits b/forward 10,800 8,900 (3,600)b 12,487.5 (3,560)c (52.5)d Retained profits c/forward 15,000 11,000 17,916 Share capital 22,000 8,000 (4,800)b 22,000 (3,200)c Revaluation reserve (3,600)b (2,400)c Non-controlling interest (35)d 9,160c 6,000a 9, g Total liabilities 14,000 8,000 (60)f 21,940 Total Equity and Liabilities 51,000 27,000 71,800 Property, plant and equipment (21,000) (17,000) (38,000) Goodwill on combination (6,000)a (6,000) Investment in S Bhd (12,000) 12,000b Inventories (10,000) (6,000) 200f (15,800) Other current assets (8,000) (4,000) (12,000) Total Assets (51,000) (27,000 (31,364) 31,364 (71,800) 7.4 CCH Asia Pte Limited

52 Chapter 7: Consolidated and Separate Financial Statements 597 Workings: (i) Proof of non-controlling interest: Net assets of S Bhd 19,000 Goodwill on combination 6,000 Unrealised profits carried forward (140) 24,860 Non-controlling interest at 40% 9,944 (ii) Proof of consolidated retained profits: Parent s retained profits 15,000 Share of post-acquisition profits of S Bhd 60% x 5,000 3,000 Share of unrealised profits carried forward (84) 17, Intragroup Sale or Transfer of Property, Plant and Equipment The principle of full elimination of intragroup transactions and unrealised profits or losses is also applicable in an intragroup sale or transfer of property, plant and equipment. In the year of the sale or transfer, an adjustment is required to eliminate the gain or loss on the transfer and to restate the carrying amount of the item of property, plant and equipment to cost or book value. For example, if the transfer of an item of property, plant and equipment results in a profit to the transferor, the consolidation adjustment would be as follows: Dr Gain on sale of property, plant and equipment Cr Property, plant and equipment, at cost After the sale, the purchasing company will calculate depreciation on the basis of its purchased price. The depreciation recorded by the purchasing company will be excessive from the group s viewpoint and accordingly must be corrected on consolidation. From the group s viewpoint, the intragroup profit or loss is considered to be realised as a consequence of the use of the property, plant and equipment in the generation of revenue. As usage of a property, plant and equipment is measured by depreciation, the recognition of the realisation of the intragroup profit or loss is accomplished through the depreciation adjustments over the remaining useful life of the property, plant and equipment transferred. As in the case of intragroup sale of inventories, the direction of the transfer of a property, plant and equipment matters only in the calculation of the non-controlling interest s share of profit and net assets. In the case of a Financial Accounting and Reporting in Malaysia, Volume 2 7.4

53 598 Chapter 7: Consolidated and Separate Financial Statements downstream transfer (i.e. sale or transfer by the parent to its subsidiary), no modification in the calculation of non-controlling interests share of profits and net assets shall be made. However, in the case of an upstream transfer (i.e. sale or transfer by the subsidiary to its parent) or a horizontal transfer (i.e. sale or transfer by one subsidiary to a fellow subsidiary in the group), modifications are required in the calculation of non-controlling interests. The non-controlling interests share of profit in the selling subsidiary shall be as follows: In the year of sale or transfer: NCIs percent holding in the selling subsidiary X Subsidiary s profit after tax Full unrealised profit + Depreciation adjustment In the subsequent years and over the remaining useful life: NCIs percent holding in the selling subsidiary X Subsidiary s profit after tax + Depreciation adjustment Example 10 On 1 January 20x1, Anak Bhd transferred machinery with a net book value of RM400,000 to its parent company, Bapa Bhd. The transfer price was RM800,000 and the machine had a remaining useful life of 4 years as at the date of the transfer. Depreciation is calculated on the straight line method. Bapa Bhd holds a 75% equity interest in Anak Bhd. Assume that Anak Bhd s profit after tax for each year in the 20x1 20x4 period is RM1,000,000. Income tax rate is 25%. Required (a) (b) Show the consolidation adjustments required in respect of the above intragroup transfer of property, plant and equipment; and Calculate the non-controlling interest s share of profit in each year. Solution 10 (a) Consolidation adjustments: RM Year 20x1: Dr Gain on sale of property, plant and equipment 400,000 RM Cr Property, plant and equipment, at cost 400,000 to eliminate gain on sale of property, plant and equipment and to restate carrying amount of property, plant and equipment. 7.4 CCH Asia Pte Limited

54 Chapter 7: Consolidated and Separate Financial Statements 599 Dr Deferred tax asset in the financial position 100,000 Cr Deferred tax income in profit or loss 100,000 to recognise deferred tax asset of unrealised profit Dr Accumulated depreciation in the financial position 100,000 Cr Depreciation expense in profit or loss 100,000 to correct for the depreciation over-provided. Dr Deferred tax expense 25,000 Cr Deferred tax asset in the financial position 25,000 to account for the reversal of deferred tax asset. Year 20x2: Dr Opening retained profits 225,000 Dr Deferred tax asset in the financial position 75,000 Dr Accumulated depreciation in the financial position 100,000 Cr Property, plant and equipment, at cost 400,000 to restate opening balances relating to transfer of property, plant and equipment. Dr Accumulated depreciation in the financial position 100,000 Cr Depreciation expense in the income statement 100,000 to correct for depreciation over-provided. Dr Deferred tax expense 25,000 Cr Deferred tax asset in the financial position 25,000 to account for the reversal of deferred tax asset. Year 20x3: Dr Opening retained profits 150,000 Dr Deferred tax asset in the financial position 50,000 Dr Accumulated depreciation in the financial position 200,000 Cr Property, plant and equipment, at cost 400,000 to restate opening balances relating to transfer of property, plant and equipment. Dr Accumulated depreciation in the financial position 100,000 Cr Depreciation expense in the income statement 100,000 to correct for depreciation over-provided. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

55 600 Chapter 7: Consolidated and Separate Financial Statements Dr Deferred tax expense 25,000 Cr Deferred tax asset in the financial position 25,000 to account for the reversal of deferred tax asset. Year 20x4: Dr Opening retained profits 75,000 Dr Deferred tax asset in the financial position 25,000 Dr Accumulated depreciation in the financial position 300,000 Cr Property, plant and equipment, at cost 400,000 to restate opening balances relating to transfer of property, plant and equipment. Dr Accumulated depreciation in the financial position 100,000 Cr Depreciation expense in the income statement 100,000 to correct for depreciation over-provided. Dr Deferred tax expense 25,000 Cr Deferred tax asset in the financial position 25,000 to account for the reversal of deferred tax asset. Note that by the end of 20x4, the machine would be fully depreciated and the intragroup profit would be fully realised. In year 20x5 and subsequent years, if the machine continues to be in use, then the opening adjustment would be as follows: Dr Accumulated depreciation in the financial position Cr Property, plant and equipment, at cost Summary of Adjustments RM400,000 RM400,000 Year Unrealised profit Tax effect Depreciation Adjustment Tax effect Unrealised profit c/ forward RM RM RM RM RM 20x1 (400) (25) (225) 20x2 100 (25) (150) 20x3 100 (25) (75) 20x4 100 (25) (400) (100) 7.4 CCH Asia Pte Limited

56 Chapter 7: Consolidated and Separate Financial Statements 601 (b) Non-controlling interest s share of profit: 20x1 20x2 20x3 20x4 Subsidiary s profit after tax 1,000 1,000 1,000 1,000 Less: Unrealised profit (300) Add: Depreciation adjustment Adjusted profit after tax 775 1,075 1,075 1,075 Non-controlling interest at 25% Other Intragroup Transactions Other intragroup transactions may include interest on loans and advances, intragroup rental charges, and management and other fees charged by the parent company. These intragroup profit and loss items must also be eliminated on consolidation by reversing the entries made by the respective companies to the transactions. The consolidation adjustments can be summarised as follows: Dr Interest income of the lending affiliate Cr Interest expense of the borrowing affiliate to eliminate intragroup interest income and interest expense. Dr Rental income of the owner Cr Rental expense of the tenant to eliminate intragroup rental income and expense. Dr Management (or any other) fee income Cr Management (or any other) fee expense to eliminate intragroup management (or any other) fee income and expense. Note that if these transactions give rise to receivables and payables in the financial positions of the companies in the group, the receivables and payables shall also be eliminated on consolidation as they are effectively intragroup balances. Also note that in the consolidation adjustments above, the issue of unrealised profit does not arise. In other words, they are realised transactions and thus the adjustments have no net effect on the group s profit or loss (because elimination of an income item is matched by an elimination of the corresponding expense item). Thus, irrespective of the directions of the transactions, non-controlling interest shall not be adjusted for the effects of such eliminations. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

57 602 Chapter 7: Consolidated and Separate Financial Statements Intragroup Dividends Dividends paid or payable by a subsidiary are received or receivable by its parent. From the group s viewpoint, there is no change in the amount of group s profit, because such intragroup dividends merely represent shifting of profits from one location (the paying subsidiary) to another location (the receiving parent) but all within the boundary of the single economic entity. Thus, on consolidation, dividend income received/receivable by the parent shall be eliminated against dividends paid/declared by the subsidiary in the consolidated retained profits. Similarly, any dividend receivable by the parent shall be cancelled against the dividend payable of the subsidiary in the consolidated statement of financial position. Note that in the consolidated statement of financial position, the dividend payable reflected under current liabilities shall strictly be the dividend payable of the parent which, when approved in a shareholders general meeting, are legally payable to the shareholders of the parent. Thus, any dividend payable of the subsidiary that is attributable to non-controlling interests, which is not eliminated, is normally classified under other payables. The consolidation adjustments are as follows: Dr Dividend income of the parent Cr Dividend paid/payable of the subsidiary to eliminate intragroup dividend in profit or loss. Dr Non-controlling interest in the financial position Cr Dividend paid/payable of the subsidiary to charge non-controlling interests for their share of the subsidiary s dividends. Dr Dividend payable in the subsidiary s financial position Cr Dividends receivable in the parent s financial position Cr Other payables non-controlling interests share of dividend payable to eliminate intragroup dividend in the financial position Dividend Income in the Separate Financial Statements of the Parent When a parent receives dividends from its subsidiaries, the issue that arises is whether the entire amount received can be recognised as income in profit or loss (as a return on investment), or a portion thereof should be regarded as return of investment (credited to the cost of investment). On a year to year basis, the identification of dividend as to income or return of investment to the parent shall not normally pose a problem. Most dividends paid or declared by subsidiaries would be regarded as income by the parent, unless in the rare circumstance where the amount of the dividend 7.4 CCH Asia Pte Limited

58 Chapter 7: Consolidated and Separate Financial Statements 603 paid or declared by a subsidiary is so large that it utilises part, or all, of the pre-acquisition profits (in which case, the portion which relates to the preacquisition profit shall be regarded as a return of investment). The identification of dividend as to income or return of investment can be an accounting issue in the year when the acquisition takes place. This issue can become complicated when there are both interim and final dividends paid and declared respectively by the subsidiary. If dividends are paid or declared by the subsidiary after the acquisition date, in principle, the dividends received by the parent should be analysed and split into their respective pre-acquisition and post-acquisition portions in the separate financial statements of the parent, with the pre-acquisition portion deducted against the cost of investment, and the post-acquisition portion recognised in profit or loss. However, in practice, it is often difficult and arbitrary to split up the dividends into income and return of investment. Furthermore, it may be argued that the entire dividends received have been declared out of postacquisition profits of the subsidiary, so long as they are sufficient to cover the dividends paid. In May 2008, the IASB issued an amendment to IAS 27 to address this issue. The amendment deleted reference to the cost method and the requirement that the dividend received by the parent be analysed into the pre-acquisition and post-acquisition portions, has been removed. It prescribes that an entity shall recognise a dividend from a subsidiary, joint venture or an associate in profit or loss in its separate financial statements when its right to receive the dividend is established [IAS 27.12] Dividend Received and Impairment Test Concerns were expressed that removing the definition of the cost method in MFRS 127 and treating all dividend received as income could lead to the investment in a subsidiary being overstated in the separate financial statements of the parent. To overcome this potential conflict, a consequential amendment was made to MFRS 136, Impairment of Assets, on the specific indicators of impairment for the investment when a dividend is recognised. Thus, impairment test in this regard is only required for an investment in a subsidiary, joint venture or an associate, when an investor recognises a dividend from the investment and evidence is available that: (a) (b) the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee s net assets, including associated goodwill; or the dividend exceeds the total comprehensive income of the subsidiary, joint venture or associate in the period the dividend is declared [MFRS (h)]. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

59 604 Chapter 7: Consolidated and Separate Financial Statements Example 11 On 1 January 20x1, Hati Bhd acquired a 100% interest in the equity capital of Sagu Bhd paying a consideration of RM400 million. On the acquisition date, the net assets of Sagu Bhd, stated at their fair value, were RM300 million (consisting of share capital of RM100m and retained profits of RM200 million). For the current year ended 31 December 20x1, the total comprehensive income of Sagu Bhd was RM100 million (consisting of profit of RM40 million and revaluation surplus of RM60 million). Sagu Bhd declared and paid a dividend of RM200 million to its parent. Required Explain the accounting requirements in the above case. Solution 11 In the separate financial statements of Hati Bhd, the cost of investment in Sagu Bhd is recorded at RM400 million. A goodwill on combination of RM100 million arises on consolidation. Hati Bhd shall recognise the RM200 million dividend as income when it has been appropriately authorised i.e. when its right to receive dividend has been established, such as when the dividend is approved in a shareholders meeting. The payment of dividend by the subsidiary triggers an indication of impairment of the investment (either the carrying amount of investment being higher than the carrying amounts of the net assets and goodwill in the consolidated financial statements, or the total dividend being higher than the total comprehensive income for the year). Thus, Hati Bhd shall perform an impairment test as follows: RM m RM m Carrying amount of investment in separate financial statements 400 Carrying amounts in the consolidated financial statements: Net assets: Share capital 100 Pre-acquisition profits 200 Total comprehensive income for the year 100 Dividends paid (200) 200 Goodwill on combination ( ) Impairment loss in profit or loss CCH Asia Pte Limited

60 Chapter 7: Consolidated and Separate Financial Statements 605 In its separate financial statements, Hati Bhd shall recognise an impairment loss of RM100 million in profit or loss and reduce the cost of investment in Sagu Bhd by the same amount. In the consolidated financial statements, the dividend paid is RM100 million more than the total comprehensive income for the year. This shall be treated as being paid out of the pre-acquisition profit. Thus, on consolidation, the goodwill remains the same as shown by the analysis below: RM m Original cost of investment 400 Less: Impairment loss (100) Revised carrying amount 300 Dividends paid (200) Net assets: Share capital 100 Balance in pre-acquisition profits ( ) 100 Adjusted net assets 200 Goodwill on combination 100 Example 12 (A Comprehensive Case) On 1 January 20x1, Harta Bhd acquired a 75% interest in the equity capital of Setia Bhd for a cash consideration of RM10 million. On this date, the net assets of Setia Bhd were stated in the accounts at fair value of RM12 million and the balance in the retained profits was RM2 million. On this date, the fair value of Setia Bhd as a whole was RM13 million. The summarised accounts of the two companies for the year ended 31 December 20x4 were as follows: Statements of Comprehensive Income & Retained Profits Harta Bhd Setia Bhd Revenue 25,000 18,000 Cost of sales (15,000) (9,200) Gross profit 10,000 8,800 Dividend income 1,575 Interest income 160 Rental income 120 Management fee 60 Expenses (5,400) (4,200) Financial Accounting and Reporting in Malaysia, Volume 2 7.4

61 606 Chapter 7: Consolidated and Separate Financial Statements Profit before taxation 6,515 4,600 Taxation (1,482) (1,380) Profit after taxation 5,033 3,220 Dividend payable (2,500) (2,100) Retained profit for the year 2,533 1,120 Retained profits brought forward 6,227 5,360 Retained profits carried forward 8,760 6,480 Statements of Financial Position Harta Bhd Setia Bhd Share capital of RM1 each 20,000 10,000 Retained profits 8,760 6,480 Loan from Harta Bhd 2,000 Deferred taxes 2,000 1,000 Trade payables (3,135) (2,420) Taxation (2,200) (1,600) Dividend payable (2,500) (2,100) 38,595 25,600 Property, plant and equipment 18,580 17,970 Investment in Setia Bhd, at cost 10,000 Loan to Setia Bhd 2,000 Inventories 4,300 3,500 Trade receivables 2,000 2,500 Dividend receivable 1,575 Bank account 140 1,630 38,595 25,600 Additional information: (a) (b) During the year ended 31 December 20x4, Harta Bhd sold goods to Setia Bhd for invoices totalling RM2,000,000. Of this amount, RM500,000 remained in the closing inventories of Setia Bhd at year end. The corresponding closing stock amount in the prior year was RM800,000. The profit margin to Harta Bhd was 20% on selling price. In the prior year 20x3, Setia Bhd completed the construction of a warehouse at a cost of RM1,000,000 for the use of Harta Bhd. The transfer price was RM2,000,000 and this amount was recorded as a property, plant and equipment by Harta Bhd. The warehouse was depreciated at 10% per annum straight line basis in accordance with the group s policy, charging a full year s depreciation in the year of purchase. 7.4 CCH Asia Pte Limited

62 Chapter 7: Consolidated and Separate Financial Statements 607 (c) Harta Bhd provided a loan of RM2 million to Setia Bhd at an interest rate of 8% per annum. Harta Bhd also let out one of its buildings to Setia Bhd charging a monthly rental of RM10,000. Also, Harta Bhd provided management services to Setia Bhd and the agreed management fee was RM60,000 per annum. (d) Assume an income tax rate of 25%. Non-controlling interest is measured at acquisition-date fair value. Required (i) (ii) Calculate the goodwill on combination and show the allocation of goodwill to parent and non-controlling interest Show the consolidation adjustments required to prepare the group accounts of Harta Bhd. (iii) Using a consolidation worksheet, derive the group accounts of Harta Bhd. Solution 12 (i) (ii) Goodwill on consolidation: Aggregate of: Consideration transferred 10,000 Non-controlling interest at fair value (25% x 13,000) 3,250 13,250 Fair value of identifiable net assets 12,000 Goodwill on combination 1,250 Allocated to: Parent (10,000 75% x 12,000) 1,000 Non-controlling interest 250 Consolidation adjustments: Permanent adjustment 1,250 (a) Dr Goodwill on combination 1,250 Cr Revaluation reserve 1,250 to recognise goodwill on combination. (b) Dr Share capital of Setia Bhd 7,500 Dr Revaluation reserve goodwill 1,000 Dr Pre-acquisition profits 1,500 Cr Investment in Setia Bhd 10,000 to eliminate cost of investment. Financial Accounting and Reporting in Malaysia, Volume 2 7.4

63 608 Chapter 7: Consolidated and Separate Financial Statements Opening adjustments (c) Dr Share capital of Setia Bhd 2,500 Dr Revaluation reserve goodwill 250 Dr Retained profits brought forward 1,340 Cr Non-controlling interest in financial position 4,090 to restate NCI s share of opening net assets and goodwill. (d) Dr Retained profits brought forward 120 Dr Deferred tax expense 40 Cr Cost of sales 160 to restate unrealised profit in opening inventories. (e) Dr Retained profits brought forward 506 Dr Non-controlling interest in financial position 169 Dr Deferred taxes in financial position 225 Dr Accumulated depreciation of PPE 100 Cr Property, plant and equipment, at cost 1,000 to restate opening balances relating to transfer of warehouse. Current year adjustments (f) Dr Revenue of Harta Bhd 2,000 Cr Cost of sales of Setia Bhd 2,000 to eliminate intragroup sales. (g) Dr Cost of sales of Setia Bhd 100 Cr Inventories in financial position 100 Dr Deferred taxes in financial position 25 Cr Deferred tax income in profit or loss 25 to eliminate unrealised profit in closing inventories. (h) Dr Accumulated depreciation in financial position 100 Cr Depreciation expense 100 Dr Deferred tax expense 25 Cr Deferred taxes in financial position 25 to correct for the depreciation over-provided. (i) Dr Non-controlling interest in profit or loss 824 Cr Dividend payable in equity 525 Cr Non-controlling interest in financial position 299 to allocate current year profit to NCI. (j) Dr Dividend income of parent 1,575 Cr Dividend payable in equity 1,575 to eliminate intragroup dividend. 7.4 CCH Asia Pte Limited

64 Chapter 7: Consolidated and Separate Financial Statements 609 (k) Dr Dividend payable in financial position 2,100 Cr Dividend receivable of parent 1,575 Cr Other payables 525 to eliminate intragroup balances. (l) Dr Interest income 160 Dr Rental income 120 Dr Management fee 60 Cr Expenses of subsidiary 340 to eliminate intragroup income and expenses. (m) Dr Loan from Harta 2,000 Cr Loan to Setia 2,000 to eliminate intragroup loan. (iii) Consolidation Worksheet: Harta Bhd Setia Bhd Revenue 25,000 18,000 (2,000)f 41,000 Cost of sales (15,000) (9,200) (100)g 160d (22,140) (Dr) Cr Group 2,000f Gross profit 10,000 8,800 18,860 Dividend income 1,575 (1,575)j Interest income 160 (160)l Rental income 120 (120)l Management fee 60 (60)l Expenses (5,400) (4,200) 100h (9,160) 340l Profit before tax 6,515 4,600 9,700 Tax expense (1,482) (1,380) (40)d 25g (2,902) (25)h Profit after tax 5,033 3,220 6,798 Non-controlling interest (824)i (824) Attributable to owners 5,974 Retained profits b/ 6,227 5,360 (1,500)b 8,121 forward (1,340)c (120)d (506)e Dividend payable (2,500) (2,100) 525i 1,575j (2,500) Financial Accounting and Reporting in Malaysia, Volume 2 7.4

65 610 Chapter 7: Consolidated and Separate Financial Statements Retained profits c/ forward 8,760 6,480 11,595 Share capital 20,000 10,000 (7,500)b 20,000 (2,500)c Revaluation (1,000)b Non-controlling interest (250)c (169)e 4,090c 1,250a 4, i Loan from Harta 2,000 (2,000)m Deferred taxes 2,000 1,000 (225)e 25h 2,775 (25)g Trade payables 3,135 2,420 5,555 Other payables 525k 525 Taxation 2,200 1,600 3,800 Dividend payable 2,500 2,100 (2,100)k 2,500 Total Equity and Liabilities 38,595 25,600 50,970 Property, plant and equipment (18,580) (17,970) (100)e 1,000e (35,750) (100)h (1,250)a (1,250) Goodwill on combination Investment in Setia (10,000) 10,000b Loan to Setia (2,000) 2,000m Inventories (4,300) (3,500) 100g (7,700) Trade receivables (2,000) (2,500) (4,500) Dividend receivable (1,575) 1,575k Bank (140) (1,630) (1,770) Total Assets (38,595) (25,600) (25,589) 25,589 (50,970) Proof of Non-controlling Interest: Sundry net assets 16,480 Less: Unrealised profit on upstream transfer (1, ) x.75 (600) Adjusted net assets 15,880 Non-controlling interest s share of net assets 25% 3,970 Goodwill allocated to non-controlling interest 250 Closing non-controlling interest in financial position 4, CCH Asia Pte Limited

66 Chapter 7: Consolidated and Separate Financial Statements Subsidiary that has a Different Reporting Date MFRS 10 generally requires that the financial statements of the parent and its subsidiaries used in the preparation of the consolidated financial statements shall have the same reporting date. When the end of the reporting period of a parent is different from that of a subsidiary, the subsidiary prepares, for consolidation purposes, additional financial statements as of the same date as the financial statements of the parent unless it is impracticable to do so [MFRS 10.B92]. If impracticable to do so, the MFRS permits consolidation of a subsidiary s financial statements with a different reporting date, provided that the difference between reporting dates of the parent and any of its subsidiaries shall be no more than 3 months. For example, if the financial year ended of a parent is 31 December 20x6, it may consolidate the accounts of a subsidiary with a financial year ended 30 September 20x6 or with a financial year ended 31 March 20x7 or any financial year ended in between those dates. However, the Standard requires that appropriate adjustments shall be made for the effects of significant transactions or events that occur between those dates, and the date of the parent s financial statements [see MFRS 10.B93]. In practice, one way of consolidating the financial statements of a subsidiary with a different reporting date is to adjust the subsidiary s financial statements (for purpose of the consolidation only) so that its revised financial statements have a financial year that coincides with the year end of the parent. For this purpose, management accounts for the period of the difference in dates may be required to make those adjustments. The alternative way is to consolidate the subsidiary s accounts as they stand, and adjust only for the effects of significant events or transactions that occurred in the period of the difference in dates. Irrespective of which way the financial statements of the subsidiary are to be consolidated, it is important that the length of the reporting period and any difference in reporting dates shall be the same from period to period. Example 13 Ajex Bhd prepares its financial statements to 31 December each year. Baja Bhd prepares its financial statements to 30 September each year. On 1 January 20x7, Ajex Bhd acquired a 100% interest in the equity capital of Baja Bhd. Ajex Bhd is in the process of preparing its consolidated financial statements for the year ended 31 December 20x7 and the summarised individual financial statements are as follows: Financial Accounting and Reporting in Malaysia, Volume 2 7.4

67 612 Chapter 7: Consolidated and Separate Financial Statements Statement of Comprehensive Income and Retained Profits Ajex Bhd Baja Bhd Year ended 31/12/20x7 Year ended 30/09/20x7 Profit before taxation 20,000 12,000 Taxation (6,000) (3,600) Profit after taxation 14,000 8,400 Retained profits brought forward 26,000 12,600 Retained profits carried forward 40,000 21,000 Statements of Financial Position Ajex Bhd As at 31/12/20x7 Baja Bhd As at 30/09/20x7 Share capital of RM1.00 each 100,000 40,000 Retained profits 40,000 21, ,000 61,000 Investment in Baja Bhd 60,000 Sundry net assets 80,000 61, ,000 61,000 The profits of Baja Bhd accrued evenly in the financial year ended 30 September 20x7. The management accounts of Baja Bhd showed a profit before tax of RM4,500,000 for the first quarter of its 20x8 financial year. Required (a) (b) Explain how the financial statements of Baja Bhd may be consolidated for the financial year ended 31 December 20x7 and prepare the consolidated financial statements for the 20x7 financial year; and Suppose the profit for the first quarter of Baja s 20x8 financial year included an exceptional gain of RM2,000,000 on sale of a property, prepare the consolidated financial statements of Ajex Bhd for the year ended 31 December 20x7, by adjusting for the effects of significant items. 7.4 CCH Asia Pte Limited

68 Chapter 7: Consolidated and Separate Financial Statements 613 Solution 13 (a) The first way to consolidate the financial statements of Baja Bhd is to adjust its financial statements (for consolidation only) so that its year end coincides with the year end of Ajex Bhd. In this case, the profit for the first quarter of its 20x7 financial year (i.e. the 1 October 20x6-31 December 20x6 period) shall be deducted while the profit of the first quarter of its 20x8 financial year (i.e. the 1 October 20x7-31 December 20x7 period) shall be added. For the financial position, however, the assets and liabilities at 30 September 20x7 shall be adjusted individually for their movements to 31 December 20x7 so that their net increase is equal to the net profit of the first quarter of the 20x8 financial year. In practice, the financial position as at 31 December 20x7 based on management accounts may also be used for this purpose. Consolidated Statement of Comprehensive Income & Retained Profits Profit before taxation For the year ended 31 December 20x7 Ajex Bhd 20,000 Baja Bhd [12,000 3, ,500] 13,500 Less: Taxation Ajex Bhd 6,000 Baja Bhd [3, ,350] 4,050 33,500 10,050 Profit after taxation 23,450 Retained profits brought forward 26,000 Retained profits carried forward 49,450 Consolidated Statement of Financial Position As at 31 December 20x7 Share capital of RM1.00 each 100,000 Retained profits 49, ,450 Goodwill arising on consolidation (W.1) 5,300 Sundry net assets (80, ,000) 141,000 Increase in net asset of Baja to x7 3, , ,450 Financial Accounting and Reporting in Malaysia, Volume 2 7.4

69 614 Chapter 7: Consolidated and Separate Financial Statements W.1. Goodwill on combination Investment in Baja 60,000 Net assets acquired: Share capital 40,000 Retained profits brought forward 12,600 Pre-acquisition profit (8,400/4) 2,100 54,700 Goodwill on combination 5,300 The other way is to consolidate the financial statements of Baja Bhd as they stand. The results of Baja Bhd would be included in the consolidated statement of comprehensive income with effect from 1 January 20x7 to 30 September 20x7. The effects would be as follows: Consolidated Statement of Comprehensive Income & Retained Profits For the year ended 31 December 20x7 Profit before taxation [20, ,000 3,000] 29,000 Less: Taxation [6, , ] 8,700 Profit after taxation 20,300 Retained profits brought forward 26,000 Retained profits carried forward 46,300 Consolidated Statement of Financial Position As at 31 December 20x7 Share capital of RM1.00 each 100,000 Retained profits 46, ,300 Goodwill on combination 5,300 Sundry net assets [80, ,000] 141, ,300 (b) Using the first way, the effect of any significant item would have been included in the adjustment and therefore consolidated in the group accounts. Under the second way, the accounts shall be adjusted for the exceptional gain arising on the sale of the property as follows: 7.4 CCH Asia Pte Limited

70 Chapter 7: Consolidated and Separate Financial Statements 615 Consolidated Statement of Comprehensive Income and Retained Profits For the year ended 31 December 20x7 Profit before taxation [20, ,000 3,000] 28,000 Gain on sale of property 2,000 Profit before taxation 30,000 Less: Taxation [6, , ] 8,700 Profit after taxation 22,300 Retained profits brought forward 26,000 Retained profits carried forward 48,300 Consolidated Statement of Financial Position As at 31 December 20x7 Share capital of RM1.00 each 100,000 Retained profits 48, ,300 Goodwill arising on consolidation 5,300 Sundry net assets [80, ,000] 141,000 Increase in net asset of exceptional gain 2, Uniform Accounting Policies 143, ,300 In general, Standard requires that consolidated financial statements shall be prepared using uniform accounting policies for like transactions and other events in similar circumstances [MFRS 10.19]. Thus, all entities in the group shall ideally use the same accounting policies for like transactions and other events. For example, on the measurement of property, plant and equipment, if the group uses the revaluation model, then all entities in the group shall use the same revaluation model to measure their property, plant and equipment. Sometimes due to statutory or other regulatory requirements, a subsidiary may have to adopt an accounting policy (or policies) that is (are) different from those used by other entities in the group. In such cases and for the purpose of consolidation, appropriate adjustments shall be made to the financial statements of the subsidiary to align its policies to those used in the consolidated financial statements [see MFRS 10.B87]. For example, a foreign subsidiary may have used the cost model to measure its biological assets because the jurisdiction in which it operates has not adopted MFRS 141, Financial Accounting and Reporting in Malaysia, Volume 2 7.4

71 616 Chapter 7: Consolidated and Separate Financial Statements Agriculture. If the parent and its other subsidiaries all use the fair value model for biological assets in accordance with MFRS 141, the biological assets of that foreign subsidiary shall be adjusted from the cost model to the fair value model before they can be included in the consolidated financial statements of the parent. 7.5 Allocating Losses to Non-controlling Interest Unlike the previous FRS 127 (2005) which did not allow a debit noncontrolling interest, MFRS 10 requires that profit or loss and each component of other comprehensive income are attributed to the owners of the parent and to the non-controlling interests. If the parent and the non-controlling interest have entered into an arrangement that determines the attribution of profit or loss and other comprehensive income, the attribution shall be based on the terms of the arrangement. The effect of this requirement is that the total comprehensive income is attributed to the owners of the parent and to the non-controlling interests even if this results in the non-controlling interest having a deficit balance. Note that as long as the parent still controls the subsidiary, it must continue to consolidate the losses of the subsidiary, even if the losses exceed the capital, or the subsidiary has negative net assets. In the case when a loss-making subsidiary is technically insolvent, the losses applicable to noncontrolling interest in the subsidiary would exceed the non-controlling interest in the equity of the subsidiary. The previous FRS 127 (2005) required that in such cases, the excess, and any further losses applicable to the minority, are allocated against the majority interest except to the extent that the minority has a binding obligation and is able to make an additional investment to cover the losses. The previous FRS 127 generally did not permit a debit noncontrolling interest in the statement of financial position. However, MFRS 10 requires that the full loss shall be allocated to non-controlling interest even if it results in a deficit to non-controlling interest. The revised Standard clarifies that allocation of losses to both the controlling and non-controlling interests is to reflect their participation proportionally in the risks and rewards of their respective investments in the subsidiary. Note that this change in treatment is a consequence of treating noncontrolling interests as a component of equity of the group. Carrying a debit non-controlling interests does not imply that there is a legal obligation on the part of the non-controlling interests to make good their share of losses. If there are guarantees or other support arrangements from the controlling and non-controlling interests, they shall be accounted for separately. 7.5 CCH Asia Pte Limited

72 Chapter 7: Consolidated and Separate Financial Statements 617 Example 14 Abu Bhd acquired an 80% equity interest in Bakar Bhd and a 75% equity interest in Cumi Bhd when the accumulated losses of Bakar Bhd were RM2,000,000 and the retained profits of Cumi Bhd were RM1,000,000. On the acquisition date, the net assets of Bakar Bhd and Cumi Bhd were valued at RM8,000,000 and RM11,000,000 respectively. However, based on an income approach, the fair values of Bakar Bhd and Cumi Bhd were measured independently at RM10,000,000 and RM15,000,000 respectively. The summarised accounts for the three companies for the year ended 31 December 20x8 are as follows: Statements of Financial Position as at 31 December 20x8 Abu Bhd Bakar Bhd Cumi Bhd Sundry net assets/(liabilities) 20,100 14,000 (5,000) Investments, at costs 8,000,000 shares in Bakar 8,000 7,500,000 shares in Cumi 11,250 39,350 14,000 (5,000) Share capital of RM1 each 20,000 10,000 10,000 Retained profits / (losses) 19,350 4,000 (15,000) 39,350 14,000 (5,000) Statements of Comprehensive Income & Retained Profits for the year ended 31 December 20x8 Abu Bhd Bakar Bhd Cumi Bhd Operating profit / (loss) 8,000 2,000 (12,000) Taxation (2,000) (800) Profit / (loss) after tax 6,000 1,200 (12,000) Dividends (1,000) Retained profit / (loss) for the year 5,000 1,200 (12,000) Retained profits / (losses) brought forward 14,350 2,800 (3,000) Retained profits / (losses) carried forward 19,350 4,000 (15,000) Abu Bhd carries goodwill on acquisition at cost less accumulated impairment losses. Each of the subsidiary forms a gash-generating unit for the purpose of impairment testing. Goodwill on acquisition has been allocated to each cashgenerating unit at the acquisition date. In the prior years, no impairment loss was recognised as the recoverable amounts of the subsidiaries then exceeded their respectively carrying amounts. Financial Accounting and Reporting in Malaysia, Volume 2 7.5

73 618 Chapter 7: Consolidated and Separate Financial Statements In the current year, it considers the losses in Cumi Bhd to be permanent and performs an impairment test. An external party had made an offer and is willing to pay RM1 to acquire the entire share capital of Cumi Bhd. Based on management s budgeted cash flows, the value in use is determined at nil amount. Non-controlling interest is measured at acquisition-date fair value. Required (a) (b) (c) Determine the goodwill on combination and allocate the goodwill to the noncontrolling interest and the parent; Calculate the impairment loss required in the separate and consolidated financial statements; and Using a consolidation worksheet, derive the group accounts of Abu Bhd and its subsidiaries for the year ended 31 December 20x8. Solution 14 (a) (b) Goodwill on combination Aggregate of: Bakar Cumi Consideration transferred 8,000 11,250 Non-controlling interest at fair value 2,000 3,750 Fair value as a whole 10,000 15,000 Fair value of identifiable net assets 8,000 11,000 Goodwill on combination 2,000 4,000 Allocated to: Parent 1,600 3,000 Non-controlling interest 400 1,000 Impairment loss 2,000 4,000 Company Group Carrying amount of investment/goodwill 11,250 4,000 Recoverable amount Impairment loss required 11,250 4,000 In the separate financial statements of the Parent, the impairment loss relates to the write-off of the investment whilst in the consolidated financial statements, the impairment loss relates to the write-off of the goodwill on combination. 7.5 CCH Asia Pte Limited

74 Chapter 7: Consolidated and Separate Financial Statements 619 (c) Consolidation Worksheet: Abu Bakar Cumi Consol. adjustments (Dr) (Cr) Group Profit/(loss) before tax 8,000 2,000 (12,000) (2,000) Impairment loss (11,250) (4,000)j 11,250i (4,000) Profit/(loss) before tax (3,250) 2,000 (12,000) (6,000) Taxation (2,000) (800) (2,800) Profit/(loss) after tax (5,250) 1,200 (12,000) (8,800) Non-controlling interests (240)d 3,000h 3,760 1,000k Profit to owners of parent (5,250) 1,200 (12,000) (5,040) Retained profits b/f 14,350 2,800 (3,000) (560)c 1,600b 15,190 (750)f 750g Dividends paid (1,000) (1,000) Retained profits c/f 8,100 4,000 (15,000) 9,150 Share capital 20,000 10,000 10,000 (8,000)b 20,000 Revaluation Non-controlling interests (2,000)c (7,500)f (2,500)g (1,600)b (400)c (3,000)f (1,000)g (3,000)h 2,000a 4,000e 2,960c 240d 2,750g (1,000)k (1,250) Total equity 28,100 14,000 (5,000) 31,100 3,200 Sundry net assets (20,100) (14,000) 5,000 (29,100) Goodwill on combination (2,000)a (2,000) (4,000)e 4,000j Investment in Bakar (8,000) 8,000b Investment in Cumi (11,250)f 11,250f Total net assets (28,100) (14,000) 5,000 (52,800) 52,800 (31.100) Financial Accounting and Reporting in Malaysia, Volume 2 7.5

75 620 Chapter 7: Consolidated and Separate Financial Statements The consolidation adjustments are as follows: For Bakar Bhd: (a) Dr Goodwill on combination 2,000 Cr Revaluation reserve 2,000 to recognise goodwill on combination.. (b) Dr Share capital of Bakar 8,000 Dr Revaluation reserve goodwill 1,600 Cr Pre-acquisition loss 1,600 Cr Investment in Bakar 8,000 to eliminate cost of investment. (c) Dr Share capital of Bakar 2,000 Dr Revaluation reserve goodwill 400 Dr Retained profits brought forward 560 Cr Non-controlling interest 2,960 to opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in profit or loss 240 Cr Non-controlling interest in financial position 240 to allocate profit to NCI. For Cumi Bhd (e) Dr Goodwill on combination 4,000 Cr Revaluation reserve 4,000 to recognise goodwill on combination. (f) Dr Share capital of Cumi 7,500 Dr Revaluation reserve goodwill 3,000 Dr Pre-acquisition profits of Cumi 750 Cr Investment in Cumi 11,250 to eliminate cost of investment. (g) Dr Share capital of Cumi 2,500 Dr Revaluation reserve goodwill 1,000 Cr Retained losses brought forward 750 Cr Non-controlling interest in financial position 2,750 to restate opening NCI s share of net assets and goodwill. (h) Dr Non-controlling interest in financial position 3,000 Cr Non-controlling interest in profit or loss 3,000 to allocate current year loss to NCI. 7.5 CCH Asia Pte Limited

76 Chapter 7: Consolidated and Separate Financial Statements 621 (i) Dr Investment in Cumi Bhd 11,250 Cr Impairment loss of Parent 11,250 to restate investment and reverse parent s impairment loss. (j) Dr Goodwill impairment loss in profit or loss 4,000 Cr Goodwill on combination 4,000 to recognise goodwill impairment loss. (k) Dr Non-controlling interest in financial position 1,000 Cr Non-controlling interest in profit or loss 1,000 to allocate goodwill write-off to NCI. The consolidated financial statements are presented as follows: Statement of Comprehensive Income For the year ended 31 December 20x8 Operating loss before impairment of goodwill (2,000) Goodwill impairment loss (4,000) Loss before taxation (6,000) Less: Tax expense (2,800) Loss for the year (8,800) Attributable to: Owners of the parent (5,040) Non-controlling interests (3,760) Movements in Retained Profits and Non-controlling Interests: Retained Profits (8,800) Non-controlling Interests Balance at 1 January 20x8 15,190 5,710 Loss for the year (5,040) (3,760) Dividends paid (1,000) Balance at 31 December 20x8 9,150 1,950 Financial Accounting and Reporting in Malaysia, Volume 2 7.5

77 622 Chapter 7: Consolidated and Separate Financial Statements Consolidated Statement of Financial Position As at 31 December 20x8 Goodwill on combination 2,000 Sundry net assets 29,100 31,100 Share capital of RM1 each 20,000 Retained profits 9,150 Equity attributable to owners of the parent 29,150 Non-controlling interests 1,950 Workings 1. Proof of Non-Controlling Interest: 31,100 Bakar Cumi Sundry net assets / (liabilities) 14,000 (5,000) Goodwill on combination 2,000 Total net assets & goodwill 16,000 (5,000) Non-controlling interest 20% 25% NCI s share or net assets / (liabilities) 3,200 (1,250) 2. Proof of Consolidated Retained Profits Group Parent s separate profit 8,100 Share of post-acquisition profits in Bakar 80% x 6,000 4,800 Share of post-acquisition losses in Cumi 75% x (16,000) (12,000) Add: Impairment loss in separate financial statements of parent 11,250 Less: Share of goodwill written off (3,000) Consolidated retained profits 9,150 When losses of an insolvent subsidiary are consolidated in full, any subsequent disposal of that subsidiary would result in a reversal or deconsolidation of those losses. Therefore, a gain would arise on disposal even if the subsidiary were sold for a nil consideration. 7.5 CCH Asia Pte Limited

78 Chapter 7: Consolidated and Separate Financial Statements 623 Example 15 On 1 January 20x6, A Bhd and B Bhd establish C Bhd. A Bhd s stake in C Bhd is 60% and has control of the latter. C Bhd reports losses since its incorporation. In order for C Bhd to continue its operations, A Bhd and B Bhd have entered into an agreement with bankers to guarantee all losses of C Bhd, where B Bhd would inject further cash into C Bhd for up to 20% of any net deficit in the shareholders equity and the balance made good by A Bhd. The draft summarised financial statements of A Bhd and C Bhd for the current financial year ended 31 December 20x9 are as follows: Statements of Comprehensive Income and Retained Profits A Bhd C Bhd RM m RM m Profit / (loss) before tax 200 (100) Taxation (52) Profit / (loss) after tax 148 (100) Retained profits / (losses) brought forward 152 (150) Recoverable from shareholders 150 Retained profits / (losses) carried forward 300 (100) Statements of Financial Position A Bhd C Bhd RM m RM m Share capital of RM1 each Retained profit / (losses) 300 (100) Payable to Cumi Bhd Investment in Cumi Bhd, at cost 60 Recoverable from shareholders 150 Sundry net assets / (liabilities) 860 (150) 920 Additional information: (a) (b) The accounts of A Bhd have not recognised any impairment loss on the investment in C Bhd. The bankers have demanded that A Bhd and B Bhd should immediately inject cash into C Bhd to clear the deficit in shareholders equity. Required (a) Prepare the consolidated financial statements of A Bhd for the financial year ended 31 December 20x9; Financial Accounting and Reporting in Malaysia, Volume 2 7.5

79 624 Chapter 7: Consolidated and Separate Financial Statements (b) Suppose on 31 December 20x9, A Bhd and B Bhd sell their stakes in C Bhd for RM1 each to a third party (the RM1 consideration is for the purpose of legalising the agreement of sale). The agreement provides that both A Bhd and B Bhd would not have to make good their share of the net deficit in C Bhd. Calculate the gain or loss on disposal and prepare the primary financial statements of A Bhd. Solution 15 (a) Consolidated Statement of Comprehensive Income For the year ended 31 December 20x9 RM m Profit before tax ( ) 100 Taxation (52) Profit after tax 48 Attributable to: Non-controlling interest 40% x (100) (40) Shareholders of the parent company Movements in Retained Profits and Non-controlling Interest Retained Non-controlling profits interest RM m RM m Balance brought forward [152 60% (150)] 62 (20) Profit / (loss) for the year 88 (40) Balance before contribution 150 (60) Contribution by shareholders (ratio of 8:2) Dilution on contribution (30) 30 Balance carried forward 240 Consolidated Statement of Financial Position As at 31 December 20x9 RM m Share capital of RM1 each 500 Retained profits (300 60% x 100) Non-controlling interests 40% x nil Total equity 740 Amount recoverable from non-controlling interest 30 Sundry net assets ( ) CCH Asia Pte Limited

80 Chapter 7: Consolidated and Separate Financial Statements 625 (c) Gain or loss on disposal RM m Consideration receivable Share of sundry net liabilities 90% x 150m (90) Gain on disposal 90 Alternative calculation: RM m Consideration receivable Carrying value of investment (60) Impairment loss in separate financial statements (60) Post-acquisition losses deconsolidated: (60% x 250) 150 Gain on disposal in primary financial statements 90 Primary Statement of Comprehensive Income RM m Profit before tax ( ) 100 Gain on deconsolidation of subsidiary disposed Taxation (52) Profit after tax 138 Attributable to: Non-controlling interests (40) Shareholders of the parent company Movements in Retained Profits and Non-controlling Interest Retained profits Non-controlling interest RM m RM m Balance brought forward 62 (20) Profit / (loss) for the year 178 (40) 240 (60) Deconsolidation of subsidiary disposed Balance carried forward 360 Primary Statement of Financial Position RM m Share capital of RM1 each 500 Retained profits ( ) Sundry net assets 860 Financial Accounting and Reporting in Malaysia, Volume 2 7.5

81 626 Chapter 7: Consolidated and Separate Financial Statements 7.6 The Separate Financial Statements of a Parent The revised MFRS 127, Separate Financial Statements, deals only with the accounting requirements in the separate financial statements of a parent or an investor for its investments in subsidiaries, joint ventures and associates. Separate financial statements are those presented by a parent (i.e. an investor with control of a subsidiary), or investor with joint control of, or significant influence over, an investee, in which the investment is accounted for at cost or in accordance with MFRS 9, Financial Instruments (i.e. 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 investees). The Standard does not mandate which entity shall produce separate financial statements. Thus, the presentation of separate financial statements is either required by law or regulation (mandatory), or by election (voluntary). In many jurisdictions, a parent company is required by law to produce its separate financial statements (company accounts) in addition to its consolidated financial statements (group accounts) When an entity prepares separate financial statements it shall account for investments in subsidiaries, joint ventures and associates either: (a) at cost, or (b) in accordance with MFRS 9 [MFRS ]. The same accounting shall be applied for each category of investment. For example, if the cost basis is applied to a subsidiary, then all investments in subsidiaries shall be measured on the same cost basis. Investments accounted for at cost shall be accounted for in accordance with MFRS 5 Non-current Assets Held for Sale and Discontinued Operations, when they are classified as held for sale (or included in a disposal group that is classified as held for sale). The measurement of investments accounted for in accordance with MFRS 9 is not changed in such circumstances [MFRS ]. The implication of this requirement is that if a subsidiary, measured at cost, is classified as held for sale, it must be tested for impairment loss under MFRS 5. For example, if the cost carrying amount of the investment is RM10 million and the parent expects to sell the investment for RM8 million (its fair value less costs to sell), an impairment loss of RM2 million is recognised in profit or loss when the investment is classified as held for sale (even though the disposal is not yet complete). Had the investment been measured at fair value, the impairment loss of RM2 million would have been recognised in profit or loss by the changes in the fair value measurement. If an entity elects to account for those investments in accordance with MFRS 9, Financial Instruments, the investments shall be measured at fair value through profit or loss (the option of fair value through other 7.6 CCH Asia Pte Limited

82 Chapter 7: Consolidated and Separate Financial Statements 627 comprehensive income is no longer relevant as the category of available-forsale financial assets has been removed in MFRS 9). The revised MFRS 128 permits certain types of entities, such as mutual funds and venture capital entities, to account for their investments in joint ventures and associates at fair value rather than based on share of profits. If any such entities elect this fair value option, the investments in joint ventures and associates that are accounted for in accordance with MFRS 9 in the consolidated financial statements shall be accounted for in the same way in the investor s separate financial statements [MFRS ] Valuation of Subsidiaries in the Separate Financial Statements of the Parent If investments in subsidiaries are accounted for in accordance with MFRS 9, they shall be measured at fair value with changes in fair value recognised in profit or loss. Under MFRS 13, Fair Value Measurement, the fair value of investments shall be based on the market prices of the investments if they are available. Otherwise, the fair value may be determined using a valuation technique, such as the P/E ratio valuation method or the discounted cash flow (DCF) method. If the fair value measurement principle is applied to investments in subsidiaries, it could potentially lead to the reserves in the separate financial statements of the parent being larger than the group reserves. For example, when the market price of an investment in a subsidiary is greater than the carrying value per ordinary share, the retained profits in the separate financial statements would be more than the consolidated retained profits at the group level. Example 16 P Bhd paid RM1,000,000 to acquire a wholly owned subsidiary, S Bhd on 1 January 20x1. The net assets of S Bhd on acquisition date were RM1,000,000 (consisting of share capital of RM500,000 and retained profits of RM500,000). As at 31 December 20x5, the retained profits of S Bhd were RM1,500,000. P Bhd accounts for the investment in S Bhd at fair value through profit or loss. As at 31 December 20x5, the fair value of its investment in the subsidiary was determined using the P/E ratio valuation method at RM3,000,000. On 1 January 20x6, S Bhd paid a dividend of RM1,000,000 to the parent company. Required (a) (b) Explain how the fair value shall be incorporated in the separate financial statements of P Bhd and show the journal entry required; and Show the journal entry required in the financial statements of P Bhd in respect of the dividend paid by S Bhd. Financial Accounting and Reporting in Malaysia, Volume 2 7.6

83 628 Chapter 7: Consolidated and Separate Financial Statements Solution 16 (a) (b) The fair value of S Bhd at the valuation date was RM3,000,000. Upon valuing the investment, a gain of RM2,000,000 arose. Thus, P Bhd shall account for the fair value gain as follows: Dr Investment in subsidiary Cr Fair value gain in profit or loss RM2,000,000 to incorporate fair value gain of investment in a subsidiary. RM2,000,000 The carrying amount of the investment after incorporating the fair value gain would be RM3,000,000, which is RM1,000,000 higher than the net tangible assets of the subsidiary. Note that the corresponding post-acquisition profits consolidated in the group accounts are RM1,000,000, which is lower than the gain recognised in the separate financial statements of the parent. On receipt of the dividend from the subsidiary, the following journal entry shall be made: Dr Cash account Cr Dividend income in profit or loss to record dividend received as income. RM1,000,000 RM1,000,000 When the investment in a subsidiary is carried at fair value in the parent s accounts, the resulting fair value gain and the corresponding increase in the carrying amount of investment shall be reversed upon consolidation, so that there is no effect at the group level. If, however, the fair value gain had been utilised by the parent for bonus issue of shares, there has in effect been a permanent freezing of the subsidiary s post-acquisition profits. Accordingly, the reversal of the increase in the carrying value of the investment shall be made against the post-acquisition profits of the subsidiary. As in past practices of using revaluation reserve for bonus shares, it appears that there is no legal restriction on the use of fair value gain for bonus shares. However, the author cautions the use of this fair value gain for bonus shares as it may potentially lead to a deficit in the post-acquisition reserve at the group level. Example 17 Assume the same case facts as in the Example above. The financial positions as at 31 December 20x5 are as follows: 7.6 CCH Asia Pte Limited

84 Chapter 7: Consolidated and Separate Financial Statements 629 P Bhd S Bhd Share capital 2, Retained profits 1,500 (i) Fair value gain 2,000 (ii) Other profits 2,000 6,000 2,000 Investment in S Bhd, at fair value 3,000 Sundry net assets 3,000 2,000 5,000 2,000 Required (i) (ii) Show the consolidation adjustments required and prepare the consolidated financial statements of P Bhd for the 20x5 financial year; Prepare the consolidated financial statements immediately after the payment of dividend on 1 January 20x6; and (iii) Suppose P Bhd had on 31 December 20x5 issued bonus shares by capitalising all the fair value gain, show the consolidation adjustments and prepare the consolidated financial statements of P Bhd for the 20x5 financial year. Solution 17 Consolidation adjustments: (a) Dr Fair value reserve 2,000 Cr Investment in subsidiary 2,000 to reverse fair value gain on consolidation. (b) Dr Share capital of S Bhd 500 Dr Pre-acquisition profits 500 Cr Investment in subsidiary 1,000 to eliminate cost of investment against net assets acquired. P Bhd S Bhd Consolidation Group adjustments (Dr) Cr Share capital 2, (500)b 2,000 Fair value gain 2,000 (2,000)a Other retained profits 2,000 1,500 (500)b 3,000 6,000 2,000 5,000 Investment in S Bhd (3,000) 2,000(a) 1,000(b) Sundry net assets (3,000) (2,000) (5,000) (6,000) 2,000 (3,000) 3,000 5,000 Financial Accounting and Reporting in Malaysia, Volume 2 7.6

85 630 Chapter 7: Consolidated and Separate Financial Statements (ii) Consolidated financial position on 1 January 20x6 P Bhd S Bhd Consolidation Group adjustments (Dr) Cr Share capital 2, (500) 2,000 Fair value gain 2,000 (2,000) Other retained profits 3, (500) 3,000 7,000 1,000 5,000 Investment in subsidiary (3,000) 3,000 Sundry net assets (4,000) (1,000) (5,000) (7,000) (1,000) (3,000) 3,000 (5,000) Note that there is no consequential effect of the dividend payment by S Bhd to P Bhd as the group retained profits remain at RM3,000,000. Consolidation adjustments: Dr Share capital of S Bhd 500 Dr Pre-acquisition profits 500 Dr Fair value reserve of parent 2,000 Cr Investment in subsidiary 3,000 to eliminate cost of investment against net assets acquired. (iii) Fair value reserve capitalised as bonus shares P Bhd S Bhd Consolidation Group adjustments (Dr) Cr Share capital 4, (500)a 4,000 Retained profits 2,000 1,500 (500)a (2,000)b 1,000 6,000 2,000 5,000 Investment in S Bhd (3,000) 1,000(a) 2,000(b) Sundry net assets (3,000) (2,000) (5,000) (6,000) (2,000) (3,000) 3,000 5,000 Note that in this case, RM2,000,000 post-acquisition profits are deemed capitalised for the bonus issue of shares. 7.6 CCH Asia Pte Limited

86 Chapter 7: Consolidated and Separate Financial Statements 631 Consolidation adjustments: (a) Dr Share capital of S Bhd 500 Dr Pre-acquisition profit 500 Cr Investment in S Bhd 1,000 to eliminate the original cost of investment. (b) Dr Post-acquisition profits 2,000 Cr Investment in S Bhd 2,000 to eliminate balance of cost of investment When the New Holding Company is the Parent of the Entity A limited guidance is provided in MFRS 127 on the measurement of the cost of investment in a subsidiary when a parent (the original parent) reorganises its group structure by establishing a new entity to be its parent (the new parent). The Standard clarifies that when a parent reorganises the structure of its group, by establishing a new entity as its parent in a manner that satisfies the following criteria: (a) (b) (c) the new parent obtains control of the original parent by issuing equity instruments in exchange for existing equity instruments of the original parent; the assets and liabilities of the new group and the original group are the same immediately before and after the reorganisation; and the owners of the original parent before the reorganisation have the same absolute and relative interests in the net assets of the original group and the new group immediately before, and after, the reorganisation and the new parent accounts for its investment in the original parent under the cost method in its separate financial statements, the new parent shall measure cost at the carrying amount of its share of the equity items in the separate financial statements of the original parent, at the date of the reorganization [MFRS ]. Similarly, a stand-alone entity that is not a parent might establish a new entity as its parent in a manner that satisfies the criteria above. The requirements in MFRS apply equally to such reorganisations [MFRS ]. The requirement to measure the cost of investment at net assets value (i.e. based on the share of the equity items), rather than at fair value is to prevent recognition of an inherent goodwill of the original parent or the stand-alone entity. Financial Accounting and Reporting in Malaysia, Volume 2 7.6

87 632 Chapter 7: Consolidated and Separate Financial Statements For example, a stand-alone entity has a net assets value of RM100 million (share capital of RM40 million and reserves of RM60 million). The fair value of the entity based on the P/E ratio method of valuation is RM200 million. The entity establishes a new holding company to be its parent. The new parent issues equity shares to the original owners of the stand-alone entity in exchange for existing equity shares of the stand-alone entity. The analysis below shows the difference on consolidation if the new parent records the cost of investment at: (i) net asset value and (ii) at fair value: (i) At NAV (ii) Fair Value RM m RM m Cost of investment Share of net assets: Share capital (40) (40) Pre-acquisition reserve (60) (60) Goodwill on combination 100 Notice that if the fair value basis of measurement were to be allowed, it would have resulted in recognising a goodwill on combination of RM100 million. This would have been an equivalent of capitalising the inherent goodwill of the stand-alone entity. Example 18 On 1 January 20x1, Q Bhd acquired a 75% equity interest R Bhd for a consideration of RM225 million. On this date the net assets of R Bhd, measured at fair value, were RM200 million. The fair value of R Bhd on the acquisition date was RM300 million. The summarised statements of financial position of Q Bhd, R Bhd and the Q Group at 31 December 20x5 are as follows: Q Bhd R Bhd Q Group RM m RM m RM m Share capital Retained profits Non-controlling interest ,175 Investment in R Bhd, at cost 225 Goodwill on combination 100 Sundry net assets , , CCH Asia Pte Limited

88 Chapter 7: Consolidated and Separate Financial Statements 633 On 1 January 20x6, Q Bhd reorganises its group structure by establishing a new holding company, P Bhd, as its parent. For this reorganisation, P Bhd, issues its equity shares to the original shareholders of Q Bhd in exchange for the existing equity shares of Q Bhd. P Bhd accounts for its investment in Q Bhd under the cost method in accordance with FRS 127. The fair value of Q Bhd s ordinary shares, based on its quoted market price on 1 January 20x6, is RM5 per share (total fair value of RM1.5 billion). P Bhd assumes the listing status of Q Bhd after the reorganisation. Required (a) (b) Explain how P Bhd shall account for its investment in Q Bhd in its separate financial statements; and Prepare the consolidated financial position of the new P Group immediately after the reorganisation. Solution 18 (a) (b) In this group reorganisation, P Bhd is the new holding company formed to be the parent of the Q Group. In substance, there has been no change to the ownership structure or the assets and liabilities immediately before and after the reorganisation. Thus, in accordance with MFRS , P Bhd shall record its investment in Q Bhd based on the carrying amount of its share of the equity items shown in the separate financial statements of Q Bhd i.e. at its net assets value of RM800 million. Consequently no additional goodwill would arise in this group reorganisation. Note that if P Bhd had recorded its investment in Q Bhd based on the fair value of the ordinary shares of Q Bhd, it would have resulted in an additional goodwill of RM700 million in this group reorganisation. This would not have reflected fairly the substance of the group reorganisation (it would have been the equivalent of recognising an inherent goodwill, which is against the current MFRSs). P Group - Consolidated Statement of Financial Position (Immediately After) P Bhd RM m Q Bhd RM m R Bhd RM m (Dr) RM m (Cr) RM m P Group RM m Share capital (300)a 800 (75)c (25)d Retained profits (500)a 225 (75)c (100)d Revaluation (75)c 100b (25)d NCI ,175 Financial Accounting and Reporting in Malaysia, Volume 2 7.6

89 634 Chapter 7: Consolidated and Separate Financial Statements Investment in Q (800) 800a Investment in R (225) 225c Goodwill (100)b (100) Sundry net assets (575) (500) (1,075) (800) (800) (500) (1,275) 1,275 (1,175) The consolidation adjustments are as follows: RM m (a) Dr Share capital of Q Bhd 300 Dr Retained profits of Q Bhd (pre-acquisition) 500 RM m Cr Investment in Q Bhd 800 to eliminate investment in Q Bhd. (b) Dr Goodwill on combination 100 Cr Revaluation reserve goodwill 100 to recognise goodwill on combination. (c) Dr Share capital of R Bhd 75 Dr Pre-acquisition of R Bhd 75 Dr Revaluation reserve goodwill 75 Cr Investment in R Bhd 225 to eliminate investment in R Bhd. (d) Dr Share capital of R Bhd 25 Dr Retained profits of R Bhd 100 Dr Revaluation reserve goodwill 25 Cr NCI in financial position 150 to allocate net assets to NCI When the New Holding Company is an Intermediate Parent of the Group Some group reorganisations may involve a parent (ultimate parent) establishing a new subsidiary as the holding company (intermediate parent) of other subsidiaries in the group. Although the guidance in MFRS relates to reorganisations that establish a new ultimate parent, the same accounting requirements apply when an intermediate parent is established. In the Basis for Conclusion to the Amendment of IAS 27 issued in May 2008, the IASB clarifies that the requirements IAS apply to the following types of reorganisations when they satisfied the criteria specified in the amendment: (a) reorganisations in which the new parent does not acquire all of the equity instruments of the original parent. For example, a new parent 7.6 CCH Asia Pte Limited

90 Chapter 7: Consolidated and Separate Financial Statements 635 (b) (c) might issue equity instruments in exchange for ordinary shares of the original parent, but not acquire the preference shares of the original parent. In addition, a new parent might obtain control of the original parent, but not acquire all of the ordinary shares of the original parent. the establishment of an intermediate parent within a group, as well as the establishment of a new ultimate parent of a group. reorganisations in which an entity that is not a parent establishes a new entity as its parent. (IAS 27.BC66N) The IASB further clarifies that the amendment focuses on the measurement of one asset the new parent s investment in the original parent, in the new parent s separate financial statements. It does not apply to the measurement of any other assets or liabilities in the separate financial statements of either the original parent or the new parent, or in the consolidated financial statements (IAS 27.BC66O). Thus, the requirements apply only when the criteria in those paragraphs are satisfied. They do not apply to other types of reorganisations or for other business combinations under common control. Example 19 P Bhd acquired a 75% interest in the equity capital of T Bhd on 1 January 20x3 for a consideration of RM15,000,000. On this date, the net assets of T Bhd were stated in the accounts at their fair value. The share capital and retained profits of T Bhd on this date were RM8,000,000 and RM4,000,000 respectively. The statements of financial position of the two companies as at 31 December 20x7 are as follows: P Bhd T Bhd Share capital of RM1 each 40,000 8,000 Retained profits 30,000 10,000 70,000 18,000 Investment in T Bhd, at cost 15,000 Sundry net assets 55,000 18,000 50,000 18,000 On 31 December 20x7, P Bhd formed a new company, S Bhd to take over T Bhd. For this take-over, T Bhd was valued independently at RM30,000,000. S Bhd issued 18,000,000 shares of RM1 each to the existing shareholders of T Bhd in proportion to their respective ownership interests. This group reorganisation has not been reflected in the statements of financial position above. Financial Accounting and Reporting in Malaysia, Volume 2 7.6

91 636 Chapter 7: Consolidated and Separate Financial Statements Required Prepare the consolidated statement of financial position of P Bhd as at 31 December 20x7 after the completion of the group reorganisation. Solution 19 The original goodwill on combination is calculated as follows: Consideration transferred 15,000 NCI at acquisition-date fair value (15,000/.75) x 25% 5,000 Aggregate 20,000 Fair value of identifiable net assets (8, ,000) 12,000 Goodwill on combination 8,000 After the reorganisation, the effective ownerships of the parent and the NCI would be as follows: S Bhd T Bhd Parent direct 75% indirect 75% x 100% 75% NCI direct 25% indirect 25% x 100% 25% 100% 100% The parent s and NCI s ownership interests in T Bhd remain unchanged at 75% and 25% respectively (albeit indirectly). In the separate financial statements of S Bhd, it shall measure the cost of investment at the net asset value of RM18,000,000 rather than at fair value. However, in the separate financial statements of P Bhd, it records the consideration received, i.e., the investment in S Bhd, at fair value of RM22,500,000, derecognises its investment in T Bhd and recognise a gain on disposal of RM7,500,000 In the group accounts of S Bhd (the sub-group), it may consolidate the accounts of T Bhd using the normal consolidation procedures and the elimination would be as follows: Consideration transferred 18,000 Net assets acquired 18,000 Goodwill on combination nil 7.6 CCH Asia Pte Limited

92 Chapter 7: Consolidated and Separate Financial Statements 637 If the stage-by-stage method is applied, the second stage consolidation procedures would be as follows: P Bhd S Group (Dr) Share capital 40,000 18,000 (13,500)c (4,500)d Cr P Group 40,000 Retained profits 30,000 4,500c 34,500 Gain on disposal 7,500 (7,500)b Revaluation reserve (6,000)c (2,000)d 8,000a NCI 6,500d 6,500 77,500 18,000 81,000 Investment in S Bhd (22,500) 7,500b 15,000c Goodwill (8,000)a (8,000) Sundry net assets (55,000) (18,000) (73,000) The consolidation adjustments are: (77,500) (18,000) (41,500) 41,500 (81,000) (a) Dr Goodwill on combination 8,000 Cr Revaluation reserve 8,000 to recognise the original goodwill on combination. (b) Dr Parent s gain on disposal 7,500 Cr Investment in S Bhd 7,500 to eliminate parent s gain on disposal (c) Dr Share capital of S Bhd 13,500 Dr Revaluation reserve goodwill 6,000 Cr Retained profits of T Bhd 4,500 Cr Investment in S Bhd 15,000 to eliminate investment in S Bhd and restore the group s retained profits. (d) Dr Share capital of S Bhd 4,500 Dr Revaluation reserve 2,000 Cr NCI in financial position 6,500 to allocate net assets and goodwill to NCI. Financial Accounting and Reporting in Malaysia, Volume 2 7.6

93 638 Chapter 7: Consolidated and Separate Financial Statements If the one-stage method is applied, the consolidation procedures would be as follows: P Bhd S Bhd T Bhd (Dr) Share capital 40,000 18,000 8,000 (6,000)b Revaluation (2,000)c (13,500)d (4,500)e (2,000)c (6,000)d Retained profits 30,000 10,000 (7,500)b Cr P Group 40,000 8,000a 4,500d 34,500 (2,500)c Gain on disposal 7,500 (7,500)d NCI (4,500)b 6,500c 6,500 4,500e 77,500 18,000 18,000 81,000 Investment in S (22,500) 22,500d Investment in T (18,000) 18,000b Goodwill (8,000)a (8,000) Sundry net assets (55,000) (18,000) (73,000) (77,500) (18,000) (18,000) (64,000) 64,000 (81,000) The consolidation adjustments are: (a) Dr Goodwill on combination 8,000 Cr Revaluation reserve goodwill 8,000 to recognise goodwill on combination. (b) Dr Share capital of T Bhd 6,000 Dr Retained profits of T Bhd 7,500 Dr NCI in financial position 4,500 Cr Investment in T Bhd 18,000 to eliminate investment in T Bhd (c) Dr Share capital of T Bhd 2,000 Dr Retained profits of T Bhd 2,500 Dr Revaluation reserve goodwill 2,000 Cr NCI in financial position 6,500 to allocate net assets and goodwill to NCI. 7.6 CCH Asia Pte Limited

94 Chapter 7: Consolidated and Separate Financial Statements 639 (d) Dr Share capital of S Bhd 13,500 Dr Revaluation reserve goodwill 6,000 Dr Parent s gain on disposal 7,500 Cr Retained profits of T Bhd 4,500 Cr Investment in S Bhd 22,500 to eliminate investment in T Bhd. (e) Dr Share capital of S Bhd 4,500 Cr NCI in financial position 4,500 to allocate net assets to NCI When a Parent accounts for its Investments in Subsidiaries at Fair Value The requirements of MFRS to use the net assets value to measure the cost of investment in a subsidiary apply only if the new parent uses the cost method in its separate financial statements. They do not apply if the new parent uses the fair value method and account for its investments in subsidiaries at fair value, in accordance with MFRS 9, Financial Instruments. Thus, if the fair value method is applied, the new parent records the cost of investment in the original parent at its fair value initially, and subsequently accounts for the changes in fair value of the investment through profit or loss in accordance with MFRS 9. MFRS 127 does not deal with the consequential treatment at the consolidation level when the fair value method is applied in a group reorganisation. As mentioned earlier, when the new parent records the investment in the original parent at its fair value, it would create an additional goodwill at the consolidation level. The issue is whether or not this additional goodwill can be recognised. In the author s view, this would tantamount to recognising an inherent goodwill in a group reorganisation. Thus, to avoid capitalising an inherent goodwill at the group level, the fair value measurement recognised in the separate financial statements of the new parent is reversed to book value on consolidation, in the same manner as fair value changes of the investment in the separate financial statements are reversed on consolidation. 7.7 Complex Group Structures Indirect Interests Where the parent s interest in a subsidiary is held indirectly via one or more other subsidiaries, an indirect subsidiary is said to exist, insofar as Financial Accounting and Reporting in Malaysia, Volume 2 7.7

95 640 Chapter 7: Consolidated and Separate Financial Statements the parent is concerned. The following structures illustrate such indirect interests. H Bhd 60% H Bhd 80% 60% S Bhd 60% P Bhd Q Bhd 30% 30% T Bhd S Bhd T Bhd Parent s interest-direct 60% indirect 60%x 60% 36% NCI direct 40% 40% indirect 40%x 60% 24% 100% 100% R Bhd P Bhd Q Bhd R Bhd Parent s interest direct 80% 60% indirect 80x30+60x30 42% NCI direct 20% 40% 40% indirect 20x30+40x30 18% 100% 100% 100% The consolidation principles are the same regardless of whether the interest in a subsidiary is held directly by the parent, or indirectly, through one or more subsidiaries. The consolidated financial statements would present revenue, expenses, assets, liabilities and equity of all companies in a group as a single entity. However, the amount recognised for goodwill on combination in the parent s group accounts would depend on its policy for measuring noncontrolling interests at the acquisition date. If non-controlling interests are measured at their acquisition-date fair value, the goodwill on combination would include a portion attributable to non-controlling interest. The goodwill as a whole is recognised for each subsidiary, regardless of whether it is a direct subsidiary or an indirect subsidiary. If non-controlling interests are measured based on their proportionate share of net assets at the acquisition date, then the goodwill on combination shall reflect only the parent s effective ownership interest in the indirect subsidiary so that no goodwill will be attributable to non-controlling interest, whether directly or indirectly. Thus, the goodwill that shall be recognised in the parent s group accounts shall relate only to the extent of its effective ownership in each subsidiary, so as to reflect its purchase, directly or indirectly, in each subsidiary. 7.7 CCH Asia Pte Limited

96 Chapter 7: Consolidated and Separate Financial Statements 641 In practice, where a sub-group exists in a group structure, more than one set of group accounts must be prepared if the immediate parent is not wholly owned by the ultimate parent. Insofar as the consolidation of the ultimate parent s group accounts is concerned, it can be accomplished either by: (i) the stage by stage (commonly called multiple stage) consolidation method; or (ii) the one stage (commonly called the short cut technique) consolidation method. Under the multiple-stage method, the sub-group accounts at the lowest tier of the vertical group structure are prepared first, and subsequently, the consolidation is repeated by progressing stage by stage upward until it reaches the highest tier of the ultimate parent s group accounts. If goodwill on combination is attributed to non-controlling interests, the goodwill in the consolidated accounts of a sub-group will be added on to the goodwill at the ultimate group level without any further adjustment. However, if no goodwill is attributed to non-controlling interests, then at each subsequent consolidation stage, any goodwill attributable to the indirect non-controlling interest is excluded by debiting the non-controlling interest in the consolidated financial position and crediting the goodwill account. Under the one-stage method, consolidation adjustments are made by reference to the ultimate parent s effective ownership interests in the indirect subsidiaries. In matching the cost of investment with the ultimate parent s effective share of net assets in each indirect subsidiary, the portion of the cost that is attributable to minorities in the immediate parent is excluded and charged to the non-controlling interest account. This exclusion of the portion of cost of investment attributable to non-controlling interest is necessary, if the goodwill on consolidation is to reflect only the ultimate parent s proportionate share. Example 20 Ultimate Bhd acquired a 60% interest in the equity capital of Immediate Bhd on 1 January 20x1 when the net assets of the latter, stated at their fair value, were RM300 million (consisting of share capital of RM200 million and pre-acquisition profits of RM100 million). On 1 January 20x2, Immediate Bhd acquired a 75% interest in the equity capital of Subsist Bhd and the net assets of the latter, stated at their fair value were RM300 million (consisting of share capital of RM100 million and pre-acquisition profits of RM200 million). The draft accounts of the three companies for the year ended 31 December 20x2 are as follows: Financial Accounting and Reporting in Malaysia, Volume 2 7.7

97 642 Chapter 7: Consolidated and Separate Financial Statements Statements of Financial Position Ultimate Bhd RM m Immediate Bhd RM m Subsist Bhd RM m Share capital of RM 1 each Retained profits Sundry net assets Investment in Immediate Bhd 300 Investment in Subsist Bhd Statement of Comprehensive Income & Retained Profits Ultimate Bhd RM m Immediate Bhd RM m Subsist Bhd RM m Profit before taxation Taxation (80) (70) (80) Profit after taxation and retained Retained profits brought forward Retained profits carried forward Goodwill on acquisition is carried at cost less accumulated impairment losses. Required (a) (b) If non-controlling interests are measured at acquisition-date fair value, prepare the consolidated financial statements of Ultimate Bhd using the: (i) (ii) two-stage method; and one-stage method. If non-controlling interests are measured based on their proportionate share of net assets at the acquisition date, prepare the consolidated financial statements of Ultimate Bhd using the: (i) (ii) Solution 20 (a) two-stage method; and one-stage method Non-controlling interests measured at acquisition-date fair value: The goodwill on combination is determined as follows: 7.7 CCH Asia Pte Limited

98 Chapter 7: Consolidated and Separate Financial Statements 643 (i) (ii) RM m Immediate Bhd and Subsist Bhd Consideration transferred 300 Non-controlling interest (300/.75) x 25% Fair value of identifiable net assets 300 Goodwill on combination 100 Ultimate Bhd and Immediate Bhd Consideration transferred 300 Non-controlling interest (300/.60) x 40% Fair value of identifiable net assets 300 Goodwill on combination 200 Total goodwill on combination 300 Two-stage Consolidation Stage 1 Immediate Subsist RM m RM m RM m RM m RM m Profit before tax Tax expense (70) (80) (150) Profit after tax Non-controlling interest (25) d (25) Attributable to owners Retained profits b/ (150) b forward (50) c 200 Retained profits c/ forward Share capital (75) b (Dr) Cr Immediate group (25) c 200 Revaluation reserve (75) b 100 a (25) c Non-controlling 100 c interest 25 d 125 Total equity Financial Accounting and Reporting in Malaysia, Volume 2 7.7

99 644 Chapter 7: Consolidated and Separate Financial Statements Sundry net assets (200) (400) (600) Goodwill on combination (100) a (100) Investment in Subsist (300) 300 b Total net assets (500) (400) (525) 525 (700) Consolidation adjustments: RM m (a) Dr Goodwill on combination 100 RM m Cr Revaluation reserve 100 to recognise goodwill on combination. (b) Dr Share capital of Subsist Bhd 75 Dr Revaluation reserve goodwill 75 Dr Pre-acquisition profits 150 Cr Investment in Subsist Bhd 300 to eliminate cost of investment. (c) Dr Share capital of Subsist Bhd 25 Dr Revaluation reserve goodwill 25 Dr Pre-acquisition profits 50 Cr Non-controlling interest in financial position 100 to recognise NCI at acquisition-date fair value. (d) Dr Non-controlling interest in profit or loss 25 Stage 2 Cr Non-controlling interest in financial position 25 to allocate current year profit to NCI. Ultimate Immediate group (Dr) Cr Ultimate group RM m RM m RM m RM m RM m Profit before tax Tax expense (80) (150) (230) Profit after tax Non-controlling interest (25) (70) d (95) Attributable to owners Retained profits b/ (60) b 160 forward (80) c Retained profits c/ forward CCH Asia Pte Limited

100 Chapter 7: Consolidated and Separate Financial Statements 645 Share capital (120) b (80) c Revaluation reserve (120) b Non-controlling interest (80) c c a 70 d ,200 Sundry net assets (300) (600) (900) Goodwill on combination (100) (200) a (300) Investment in Immediate (300) 300 b Consolidation adjustments: (600) (700) (810) (810) (1,200) RM m (a) Dr Goodwill on combination 200 RM m Cr Revaluation reserve 200 to recognise goodwill on combination. (b) Dr Share capital of Immediate 120 Dr Revaluation reserve goodwill 120 Dr Pre-acquisition profits 60 Cr Investment in Immediate 300 to eliminate cost of investment. (c) Dr Share capital of Immediate 80 Dr Revaluation reserve goodwill 80 Dr Retained profits brought forward 80 Cr Non-controlling interest in financial position 240 to allocate opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in profit of loss 70 Cr Non-controlling interest in financial position 70 to allocate current year profit to NCI (40% x 175) Financial Accounting and Reporting in Malaysia, Volume 2 7.7

101 646 Chapter 7: Consolidated and Separate Financial Statements One-stage Consolidation The effective ownership: Immediate Subsist Parent s interest direct 60% indirect.60 x 75% 45% Non-controlling interest direct 40% 25% indirect.40 x 75% 30% 100% 100% Consolidation Worksheet Ultimate Immediate Subsist (Dr) Cr Ultimate Group RM m RM m RM m RM m RM m RM m Profit before tax Tax expense (80) (70) (80) (230) Profit after tax Non-controlling interest (40) d (55) h Attributable to owners Retained profits b/ (60) b 160 forward (80) c (90) f (110) g Retained profits c/ forward Share capital (120) b 400 (80) c (45) f (55) g Revaluation reserve (120) b (80) c (45) f (55) g 200 a 100 e Non-controlling interest (120) f 240 c 40 d 220 g 55 h Total equity ,200 (95) CCH Asia Pte Limited

102 Chapter 7: Consolidated and Separate Financial Statements 647 Sundry net assets (300) (200) (400) (900) Goodwill on (200) a (300) combination (100) e Investment in (300) 300 b Immediate Investment in Subsist (300) 300 f Total net assets (600) (500) (400) (1,455) 1,455 (1,200) Proof of NCI: Immediate Subsist Total NCI RM m RM m RM m Owners equity Less: Investment in Subsist (300) Sundry net assets Goodwill on combination Net assets and goodwill NCI % 40% 55% NCI s share The consolidation adjustments: RM m (a) Dr Goodwill on combination 200 RM m Cr Revaluation reserve 200 to recognise goodwill on combination. (b) Dr Share capital of Immediate 120 Dr Revaluation reserve goodwill 120 Dr Pre-acquisition profits 60 Cr Investment in Immediate 300 to eliminate cost of investment. (c) Dr Share capital of Immediate 80 Dr Revaluation reserve goodwill 80 Dr Retained profits brought forward 80 Cr Non-controlling interest in financial position 240 to allocate opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in profit or loss 40 Cr Non-controlling interest in financial position 40 to allocate current year profit to NCI. (e) Dr Goodwill on combination 100 Cr Revaluation reserve 100 to recognise goodwill on combination. Financial Accounting and Reporting in Malaysia, Volume 2 7.7

103 648 Chapter 7: Consolidated and Separate Financial Statements (f) Dr Share capital of Subsist 45 Dr Revaluation reserve goodwill 45 Dr Pre-acquisition profit 90 D r Non-controlling interest in financial position (40% x 300) 120 Cr Investment in Subsist 300 to eliminate cost of investment. (g) Dr Share capital of Subsist 55 Dr Revaluation reserve goodwill 55 Dr Retained profits brought forward 110 Cr Non-controlling interest in financial position 220 to allocate net assets and goodwill to NCI. (h) Dr Non-controlling interest in profit or loss 55 Cr Non-controlling interest in financial position 55 to allocate current year profit to NCI. (b) Non-controlling Interests Measured based on Proportionate Share of Net Assets The goodwill on combination is determined as follows: (i) (ii) Immediate Bhd and Subsist Bhd: Aggregate of: RM m Consideration transferred 300 Non-controlling interest 25% x Fair value of identifiable net assets 300 Goodwill on combination parent only 75 Ultimate Bhd and Immediate Bhd: Aggregate of: Consideration transferred 300 Non-controlling interest 40% x Fair value of identifiable net assets 300 Goodwill on combination parent 120 Part of the goodwill on combination in the sub-group belongs to the noncontrolling interest in Immediate Bhd. Therefore, the goodwill that should be recognised in the Ultimate group accounts is calculated as follows: 7.7 CCH Asia Pte Limited

104 Chapter 7: Consolidated and Separate Financial Statements 649 RM m Goodwill on combination of Immediate 120 Parent s share of goodwill on combination of Subsist 60% x Goodwill on combination 165 (i) Two-stage Consolidation Stage 1 Immediate Subsist (Dr) Cr Immediate group RM m RM m RM m RM m RM m Profit before tax Tax expense (70) (80) (150) Profit after tax Non-controlling interest (25) d (25) Attributable to owners Retained profits b/ (150) b 200 forward (50) c Retained profits c/ forward Share capital (75) b 200 (25) c Revaluation (75) b 75 a Non-controlling 75 c 100 interest 25 d Total equity Sundry net assets (200) (400) (600) Goodwill on combination (75) a (75) Investment in Subsist (300) 300 b Total net assets (500) (400) (475) 475 (675) The consolidation adjustments are: RM m (a) Dr Goodwill on combination 75 RM m Cr Revaluation reserve 75 to recognise goodwill on combination. (b) Dr Share capital of Subsist 75 Dr Revaluation reserve goodwill 75 Financial Accounting and Reporting in Malaysia, Volume 2 7.7

105 650 Chapter 7: Consolidated and Separate Financial Statements Dr Pre-acquisition profits 150 Cr Investment in Subsist 300 to eliminate cost of investment. (c) Dr Share capital of Subsist 25 Dr Pre-acquisition profits 50 Cr Non-controlling interest in financial position 75 to allocate acquisition-date net assets to NCI. (d) Dr Non-controlling interest in profit or loss 25 Cr Non-controlling interest in financial position 25 to allocate current year profit to NCI. Stage 2 Ultimate Immediate group (Dr) Cr Ultimate group RM m RM m RM m RM m RM m Profit before tax Tax expense (80) (150) (230) Profit after tax Non-controlling interest (25) (70) e (95) Attributable to owners Retained profits b/ (60) b 160 forward (80) c Retained profits c/ forward Share capital (120) b 400 (80) c Revaluation reserve (120) b 120 a Non-controlling 100 (30) d 160 c 300 interest 70 e Total equity ,065 Sundry net assets (300) (600) (900) Goodwill on combination (75) (120) a 30 d (165) Investment in Immediate (300) 300 b Total net assets (600) (675) (680) 680 (1,065) 7.7 CCH Asia Pte Limited

106 Chapter 7: Consolidated and Separate Financial Statements 651 The consolidation adjustments: RM m RM m (a) Dr Goodwill on combination 120 Cr Revaluation reserve 120 to recognise goodwill on combination. (b) Dr Share capital of Immediate 120 Dr Revaluation reserve goodwill 120 Dr Pre-acquisition profits 60 Cr Investment in Immediate 300 to eliminate cost of investment. (c) Dr Share capital of Immediate 80 Dr Retained profits brought forward 80 Cr Non-controlling interest in financial position 160 to allocate opening net assets to NCI. (d) Dr Non-controlling interest in financial position 30 Cr Goodwill on combination 30 to eliminate goodwill of sub-group attributable to NCI. (e) Dr Non-controlling interest in profit or loss 70 Cr Non-controlling interest in financial position 70 to allocate current year profit to NCI. (ii) One-stage Consolidation Ultimate Immediate Subsist (DR) Cr Ultimate group RM m RM m RM m RM m RM m RM m Profit before tax Tax expense (80) (70) (80) (230) Profit after tax Non-controlling interest (40) d (55) h Attributable to owners Retained profits (60) b 160 b/forward (80) c (90) f (110)g Retained profits c/forward (95) Financial Accounting and Reporting in Malaysia, Volume 2 7.7

107 652 Chapter 7: Consolidated and Separate Financial Statements Share capital (120) b (80) c (45) f (55) g Revaluation reserve Non-controlling interest (120) b (45) f 120 a 45 e (120) f 160 c 40 d 165 g 55 h Total equity , Sundry net assets Goodwill on combination (300) (200) (400) (900) (120) a (45) e (165) Investment in Immediate (300) 300 b Investment in Subsist (300) 300 f Total net assets (600) (500) (400) (1,185) 1,185 (1,065) Proof of NCI: Immediate Subsist Total NCI RM m RM m RM m Owners equity Less: Investment in Subsist (300) Sundry net assets NCI % 40% 55% NCI s share of sundry net assets The consolidation adjustments: RM m RM m (a) Dr Goodwill on combination 120 Cr Revaluation reserve 120 to recognise goodwill on combination. 7.7 CCH Asia Pte Limited

108 Chapter 7: Consolidated and Separate Financial Statements 653 (b) Dr Share capital of Immediate 120 Dr Revaluation reserve goodwill 120 Dr Pre-acquisition profits 60 Cr Investment in Immediate 300 to eliminate cost of investment. (c) Dr Share capital of Immediate 80 Dr Retained profits brought forward 80 Cr Non-controlling interest in financial position 160 to allocate opening net assets to NCI. (d) Dr Non-controlling interest in profit or loss 40 Cr Non-controlling interest in financial position 40 to allocate current year profit to NCI. (e) Dr Goodwill on combination 45 Cr Revaluation reserve 45 to recognise goodwill on combination. (f) Dr Share capital of Subsist 45 Dr Revaluation reserve goodwill 45 Dr Pre-acquisition profits 90 Dr Non-controlling interest in financial position 120 Cr Investment in Subsist 300 to eliminate cost of investment. (g) Dr Share capital of Subsist 55 Dr Pre-acquisition profits 110 Cr Non-controlling interest in financial position 165 to allocate acquisition-date net assets to NCI. (h) Dr Non-controlling interest in profit or loss 55 Cr Non-controlling interest in financial position 55 to allocate current year profit to NCI. Financial Accounting and Reporting in Malaysia, Volume 2 7.7

109 654 Chapter 7: Consolidated and Separate Financial Statements Direct and Indirect Interests in a Subsidiary A parent and its subsidiary may both hold shares in another subsidiary. Examples of such interests are shown in the group structures below. Group Structure A Group Structure B P Bhd P Bhd 75% 15% 60% 30% Q Bhd 60% R Bhd S Bhd 30% T Bhd Q Bhd R Bhd Parent s interest - direct 75% 15% indirect 75 x 60 45% NCI direct 25% 25% indirect 25 x 60 15% 100% 100% S Bhd T Bhd Parent s interest direct 60% 30% indirect 60 x 30 18% NCI direct 40% 40% indirect 40 x 30 12% 100% 100% In applying MFRS 3, the critical criterion for the consolidation of the group structures above is the control criterion that determines when an acquisition occurs. For example, in the Group Structure A above, if Q Bhd with its 60% ownership already controls R Bhd at the acquisition date, the additional 15% direct investment made by P Bhd in R Bhd on a later date shall be treated as an equity transaction in accordance with MFRS 3. Conversely, if P Bhd s 15% direct investment in R Bhd was purchased on an earlier date (and treated as an AFS investment), a remeasurement of the investment to fair value is required and changes in fair value, including those previously recognised in other comprehensive income, shall be reclassified to profit or loss on the date when Q Bhd acquires R Bhd. In the Group Structure B above, a step-acquisition occurs if P Bhd s 30% stake and S Bhd s 30% stake in T Bhd are purchased on different dates. In this case, it is necessary to fair value the carrying amount of the earlier 30% purchased stake on the date when an acquisition occurs (i.e. the date the later 30% purchased stake occurs). In accordance with MFRS 3, a change in the fair value is recognised in profit or loss on that date when the acquisition occurs. 7.7 CCH Asia Pte Limited

110 Chapter 7: Consolidated and Separate Financial Statements 655 The consolidation technique for direct and indirect interests is exactly the same as the technique used for consolidating indirect interest in a subsidiary. The important point to consider is whether or not goodwill on combination is attributable to non-controlling interest, and this is an issue of accounting policy choice. Example 21 On 1 January 20x1, X Bhd acquired a 60% interest in the equity capital of Y Bhd paying a consideration of RM8 million, which reflected 60% of the fair value of Y Bhd. On this date, the pre-acquisition profits of Y Bhd were RM2 million. On the same date, X Bhd purchased a 30% interest in the equity capital of Z Bhd, paying a consideration of RM4.7 million. The pre-acquisition profits of Z Bhd on that date were RM4 million. X Bhd was represented on the Board of Directors of Z Bhd and treated the investment as an associate. On 1 January 20x2 of the current financial year, Y Bhd acquired a 40% interest in the equity capital of Z Bhd, paying a consideration of RM7.4 million. The retained profits of Z Bhd on that date were RM6,000,000. On that date, the X Group assumed control of Z Bhd. The fair value of the ordinary shares of Z Bhd on acquisition date was determined at RM1.85 per share The draft financial positions of the three companies as at 31 December 20x2 were as follows: X Bhd Y Bhd Z Bhd Share capital of RM1 each 20,000 10,000 10,000 Retained profits 10,000 5,000 8,000 30,000 15,000 18,000 Investment in Y Bhd 8,000 Investment in Z Bhd 4,700 7,400 Sundry net assets 17,300 7,600 18,000 Required (a) (b) Calculate the goodwill on combination 30,000 15,000 18,000 Using a consolidation worksheet, derived the consolidated statement of financial position of X Bhd as at 31 December 20x2. Financial Accounting and Reporting in Malaysia, Volume 2 7.7

111 656 Chapter 7: Consolidated and Separate Financial Statements Solution 21 (a) Goodwill on combination: (i) Acquisition of Y Bhd Aggregate of: Consideration transferred 8,000 No n-controlling interest at acquisition-date fair value (8,000/.60) x 40% 5,333 Fair value of Y Bhd as a whole 13,333 Fair value of identifiable net assets (10, ,000) 12,000 Goodwill on combination 1,333 Allocated to parent (60%) 800 Allocated to non-controlling interest (40%) 533 1,333 (ii) Acquisition of Z Bhd Aggregate of: Consideration transferred 7,400 No n-controlling interest at acquisition-date fair value (3,000 x RM1.85) 5,550 Fair value of previously held stake (3,000 x RM1.85) 5,550 Fair value of Z Bhd as a whole 18,500 Fair value of identifiable net assets (10, ,000) 16,000 Goodwill on combination 2,500 Allocated to parent (54%) 1,350 Allocated to non-controlling interest (44%) 1,150 2,500 Gain on remeasurement of previously held stake: Cost of investment in Z Bhd 4,700 Share of post-acquisition profit (6,000 4,000) x 30% 600 Carrying amount at date of control 5,300 Fair value of previously held stake 5,550 Gain on remeasurement CCH Asia Pte Limited

112 Chapter 7: Consolidated and Separate Financial Statements 657 Consolidation Worksheet: X Bhd Y Bhd Z Bhd (Dr) Share capital 20,000 10,000 10,000 (6,000) b (4,000) c (5,400) g (4,600) h Retained profits 10,000 5,000 8,000 (1,200) b (2,000) c (3,240) g (3,680) h Revaluation reserve (800) b Non-controlling interest (533) c (1,350) g Cr 600 e 250 f 1,333 a 2,500 d (1,150) h (2,960) g 6,533 c X Group 20,000 13,730 9,430 h Total Equity 30,000 15,000 18,000 46,733 13,003 Investment in Y Bhd (8,000) 8,000 b Investment in Z Bhd (4,700) (7,400) (600) e 12,950 g Goodwill on combination (250) f (1,333) a (3,833) (2,500) d Sundry net assets (17,300) (7,600) (18,000) (42,900) Total Net Assets (30,000) (15,000) (18,000) (41,596) 41,596 (46,733) Proof of NCI: Y Bhd Z Bhd Total NCI Owners equity 15,000 18,000 Less: Investment in Z ltd (7,400) Sundry net assets 7,600 18,000 Goodwill on combination 1,333 2,500 Total sundry net assets and goodwill 8,933 20,500 Effective NCI% 40% 46% NCI share 3,573 9,430 13,003 Financial Accounting and Reporting in Malaysia, Volume 2 7.7

113 658 Chapter 7: Consolidated and Separate Financial Statements The consolidation adjustments: (a) Dr Goodwill on combination 1,333 Cr Revaluation reserve 1,333 to recognise goodwill on combination. (b) Dr Share capital of Y Bhd 6,000 Dr Revaluation reserve goodwill 800 Dr Pre-acquisition profit 1,200 Cr Investment in Y Bhd 8,000 to eliminate cost of investment. (c) Dr Share capital of Y Bhd 4,000 Dr Revaluation reserve goodwill 533 Dr Retained profits 2,000 Cr Non-controlling interest 6,533 to allocate net assets and goodwill to NCI. (d) Dr Goodwill on combination 2,500 Cr Revaluation reserve 2,500 to recognise goodwill on combination. (e) Dr Investment in Z Bhd 600 Cr Retained profits b/forward 600 to restate opening retained profits of former associate. (f) Dr Investment in Z Bhd 250 Cr Gain on remeasurement 250 to recognise gain on remeasurement of previously held stake. (g) Dr Share capital of Z Bhd (54% x 10,000) 5,400 Dr Revaluation reserve goodwill 1,350 Dr Pre-acquisition profit (54% x 6,000) 3,240 D r Non-controlling interest in financial position (40% x 7,400) 2,960 Cr Investments in Z Bhd 12,950 to eliminate cost of investment. (h) Dr Share capital of Z Bhd (46% x 10,000) 4,600 Dr Revaluation reserve goodwill 1,150 Dr Retained profits 3,680 Cr Non-controlling interest in financial position 9,430 to allocate net assets and goodwill to NCI. 7.7 CCH Asia Pte Limited

114 Chapter 7: Consolidated and Separate Financial Statements 659 Example 22 U Bhd acquired a 75% interest in the equity capital of M Bhd on 1 January 20x1 for a consideration of RM53,500,000. On this date the share premium and retained profits of M Bhd were RM10,000,000 and RM8,000,000 respectively. On the same day, M Bhd acquired a 60% interest in the equity capital of S Bhd for a consideration of RM23,600,000. The share premium and retained profits of S Bhd on this date were RM5,000,000 and RM6,000,000 respectively. On 1 January 20x2, the beginning of the current year ended 31 December 20x2, U Bhd acquired a 20% interest in the equity capital of S Bhd for a consideration of RM8,080,000. The summarised accounts of the three companies for the current year ended 31 December 20x2 are as follows: Statements of Comprehensive Income U Bhd M Bhd S Bhd Revenue 80,000 60,000 40,000 Expenses (60,000) (48,000) (32,000) Profit before taxation 20,000 12,000 8,000 Taxation (6,000) (3,600) (2,400) Profit after taxation 14,000 8,400 5,600 Retained profits brought forward 36,000 14,600 10,400 Retained profits carried forward 50,000 23,000 16,000 Statements of Financial Position U Bhd M Bhd S Bhd Share capital of RM1 each 80,000 40,000 20,000 Share premium account 40,000 10,000 5,000 Retained profits 50,000 23,000 16,000 Long-term loans 40,000 20,000 15,000 Current liabilities (39,000) (30,000) (11,000) 249, ,000 67,000 Property, plant and equipment 118,420 54,400 41,000 Investment, at cost: 30,000,000 shares of M Bhd 53,500 4,000,000 shares of S Bhd 8,080 12,000,000 shares of S Bhd 23,600 Current assets 69,000 45,000 26, , ,000 67,000 Financial Accounting and Reporting in Malaysia, Volume 2 7.7

115 660 Chapter 7: Consolidated and Separate Financial Statements At the acquisition dates of M Bhd and S Bhd, their net assets were stated in the accounts at fair values. There were no intragroup transactions during the year ended 31 December 20x2. At the respective acquisition dates, the considerations paid by the parents are based on the fair values of the subsidiaries as a whole. Noncontrolling interests are measured at acquisition-date fair value. Required (a) (b) Using the two-stage method, firstly, prepare the consolidated accounts of sub-group M Bhd and then prepare the consolidated accounts of the ultimate group U Bhd. Using the one-stage method, prepare the consolidated accounts of the ultimate group U Bhd. Solution 22 (a) Goodwill on combination (i) (ii) M Bhd and S Bhd: Consideration transferred 23,600 Non-controlling interest at acquisition date fair value (23,600/.6) x 40% 15,733 Fair value of S Bhd as a whole 39,333 Fair value of identifiable net assets (20, , ,000) 31,000 Goodwill on combination 8,333 Allocated to Parent (60%) 5,000 Allocated to non-controlling interest 3,333 U Bhd and M Bhd: 8,333 Consideration transferred 53,500 Non-controlling interest at acquisition-date fair value (53,500/.75) x 25% 17,833 Fair value of M Bhd as a whole 71,833 Fair value of identifiable net assets (40, , ,000) 58,000 Goodwill on combination 13,333 Allocated to Parent (75%) 10,000 Non-controlling interest (25%) 3,333 13, CCH Asia Pte Limited

116 Chapter 7: Consolidated and Separate Financial Statements 661 (iii) Change in stake as equity transaction: Net assets of S Bhd on 1 January 20x2 (20, , ,400) 35,400 Goodwill on combination W(i) 8,333 Total net assets and goodwill 43,733 Purchase of 20% additional stake 20% Increase in share of net assets and goodwill 8,747 Cost of additional 20% stake 8,080 Accretion of net asset and goodwill adjusted to equity 667 Two-stage Consolidation Stage 1 M Bhd and S Bhd M Bhd S Bhd (Dr) Cr M Group Revenue 60,000 40, ,000 Expenses (48,000) (32,000) (80,000) Profit before tax 12,000 8,000 20,000 Tax expense (3,600) (2,400) (6,000) Profit after tax 8,400 5,600 14,000 Non-controlling interest (2,240) d (2,240) Attributable to owners 8,400 5,600 11,760 Retained profits b/forward 14,600 10,400 (3,600) b 17,240 (4,160) c Retained profits c/forward 23,000 16,000 29,000 Share capital 40,000 20,000 (12,000 b 40,000 (8,000) c Share premium 10,000 5,000 (3,000) b 10,000 (2,000) c Revaluation reserve (5,000) b 8,333 a (3,333) c Non-controlling interest 17,493 c 19,733 2,240 d Long-term loans 20,000 15,000 35,000 Current liabilities 30,000 11,000 41,000 Total Equity & Liabilities 123,000 67, ,733 Property, plant & equipment (54,400) (41,000) (95,400) Goodwill on combination (8,333) a (8,333) Investment in S Bhd (23,600) 23,600 b Current assets (45,000) (26,000) (71,000) Total Assets (123,000) (67,000) (51,667) 51,667 (174,733) Financial Accounting and Reporting in Malaysia, Volume 2 7.7

117 662 Chapter 7: Consolidated and Separate Financial Statements Consolidation adjustments: (a) Dr Goodwill on combination 8,333 Cr Revaluation reserve 8,333 to recognise goodwill on combination. (b) Dr Share capital of S Bhd 12,000 Dr Share premium of S Bhd 3,000 Dr Revaluation reserve goodwill 5,000 Dr Pre-acquisition profits 3,600 Cr Investment in S Bhd 23,600 to eliminate cost of investment. (c) Dr Share capital of S Bhd 8,000 Dr Share premium of S Bhd 2,000 Dr Revaluation reserve goodwill 3,333 Dr Retained profits brought forward 4,160 Cr Non-controlling interest in financial position 17,493 to allocate opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in profit or loss 2,240 Cr Non-controlling interest in financial position 2,240 to allocate current year profit to NCI. Stage 2 U Bhd and M Group U Bhd M Group (Dr) Cr U Group Revenue 80, , ,000 Expenses (60,000) (80,000) (140,000) Profit before tax 20,000 20,000 40,000 Tax expense (6,000) (6,000) (12,000) Profit after tax 14,000 14,000 28,000 Non-controlling interest (2,240) (1,820) e (4,060) Attributable to owners 14,000 11,760 23,940 Retained profits b/forward 36,000 17,240 (6,000) b 42,930 (4,310) c Accretion on change in stake 667 d 667 Retained profits c/forward 50,000 29,000 67, CCH Asia Pte Limited

118 Chapter 7: Consolidated and Separate Financial Statements 663 Share capital 80,000 40,000 (30,000) b (10,000) c Share premium 40,000 10,000 (7,500) b Revaluation reserve (2,500) c (10,000) b (3,333) c Non-controlling interest 19,733 (8,747) d 20,143 c 80,000 40,000 13,333 a 32,950 1,820 e Long-term loans 40,000 35,000 75,000 Current liabilities 39,000 41,000 80,000 Total Equity & Liabilities 249, , ,487 Property, plant & equipment (118,420) (95,400) (213,820) Goodwill on combination (8,333) (13,333) a (21,667) Investment in M Bhd (53,500) 53,500 b Investment in S Bhd (8,080) 8,080 d Current assets (69,000) (71,000) (140,000) Total Assets (249,000) (174,733) (97,543) 97,543 (357,487) The consolidation adjustments: (a) Dr Goodwill on combination 13,333 Cr Revaluation reserve 13,333 to recognise goodwill on combination. (b) Dr Share capital of M Bhd 30,000 Dr Share premium of M Bhd 7,500 Dr Revaluation reserve goodwill 10,000 Dr Pre-acquisition profits 6,000 Cr Investment in M Bhd 53,500 to eliminate cost of investment. (c) Dr Share capital of M Bhd 10,000 Dr Share premium of M Bhd 2,500 Dr Revaluation reserve goodwill 3,333 Dr Retained profits brought forward 4,310 Cr Non-controlling interest in financial position 20,143 to allocate opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in financial position 8,747 Cr Accretion on change in stake 667 Cr Investment in S Bhd 8,080 to recognise accretion on change in stake. Financial Accounting and Reporting in Malaysia, Volume 2 7.7

119 664 Chapter 7: Consolidated and Separate Financial Statements (e) Dr Non-controlling interest in profit or loss 1,820 Cr Non-controlling interest in financial position 1,820 to allocate balance of current year profit to NCI. [calculated at 25% x 11,760 ½ x 2,240 = 1,820] One-stage Consolidation U Bhd M Bhd S Bhd Revenue 80,000 60,000 40, ,000 Expenses (60,000) (48,000) (32,000) (140,000) Profit before tax 20,000 12,000 8,000 40,000 Tax expense (6,000) (3,600) (2,400) (12,000) Profit after tax 14,000 8,400 5,600 28,000 Non-controlling (2,100) d (4,060) interest (1,960) i Attributable to owners 14,000 8,400 5,600 23,940 Retained profit 36,000 14,600 10,400 (6,000) b 42,930 b/f (3,650) c (Dr) (2,700) f Cr U Group (5,720) g Change in stake 667 h 667 Retained profits c/f 50,000 23,000 16,000 67,537 Share capital 80,000 40,000 20,000 (30,000) b (10,000) c (9,000) f (11,000) g Share premium 40,000 10,000 5,000 (7,500) b Revaluation (2,500) c (2,250) f (2,750) g (10,000) b (3,333) c (3,750) f (4,583) g 13,333 a 8,333 e 40, CCH Asia Pte Limited

120 Chapter 7: Consolidated and Separate Financial Statements 665 Non-controlling interest (5,900) f (8,747) h 19,483 c 2,100 d 24,053 g 1,960 i 32,950 Long-term loans 40,000 20,000 15,000 75,000 Current liabilities 39,000 30,000 11,000 80,000 Total Equity & Liabilities 249, ,000 67, ,847 Prop, plant & equipment (118,420) (54,400) (41,000) (213,820) Goodwill on comb. (13,333) a (8,333) e (21,667) Investment in M Bhd (53,500) 53,500 b Investment in (8,080) (23,600) 23,600 f S Bhd 8,080 h Current assets (69,000) (45,000) (26,000) (140,000) Total Assets (249,000) (123,000) (67,000) (155,110) 155,110 (375,487) Proof of NCI M Bhd S Bhd Total NCI Owners equity 73,000 41,000 Less: Investment in S Bhd (23,600) Sundry net assets 49,400 41,000 Goodwill on combination 13,333 8,333 Net assets and goodwill 62,733 49,333 Effective NCI % 25% 35% NCI s share 15,683 17,267 32,950 The consolidation adjustments: (a) Dr Goodwill on combination 13,333 Cr Revaluation reserve 13,333 to recognise goodwill on combination. (b) Dr Share capital of M Bhd 30,000 Dr Share premium of M Bhd 7,500 Dr Revaluation reserve goodwill 10,000 Dr Pre-acquisition profits 6,000 Cr Investment in M Bhd 53,500 to eliminate cost of investment. Financial Accounting and Reporting in Malaysia, Volume 2 7.7

121 666 Chapter 7: Consolidated and Separate Financial Statements (c) Dr Share capital of M Bhd 10,000 Dr Share premium of M Bhd 2,500 Dr Revaluation reserve goodwill 3,333 Dr Retained profits brought forward 3,650 Cr Non-controlling interest in financial position 19,483 to allocate opening net assets and goodwill to NCI. (d) Dr Non-controlling interest in profit or loss 2,100 Cr Non-controlling interest in financial position 2,100 to allocate current year profit to NCI. (e) Dr Goodwill on combination 8,333 Cr Revaluation reserve 8,333 to recognise goodwill on combination. (f) Dr Share capital of S Bhd (45% x 20,000) 9,000 Dr Share premium of S Bhd (45% x 5,000) 2,250 Dr Revaluation reserve goodwill (5,000x75%) 3,750 Dr Pre-acquisition profit (45% x 6,000) 2,700 Dr NCI in financial position 25% x 23,600 5,900 Cr Investment in S Bhd 23,600 to eliminate cost of investment. (g) Dr Share capital of S Bhd 11,000 Dr Share premium of S Bhd 2,750 Dr Revaluation reserve goodwill 4,583 Dr Retained profits brought forward 5,720 Cr Non-controlling interest in financial position 24,053 to allocate opening net assets and goodwill to NCI. (h) Dr Non-controlling interest in financial position 8,747 Cr Accretion on change in stake 667 Cr Investment in S Bhd 8,080 to recognise accretion on change in stake. (i) Dr Non-controlling interest in profit or loss 1,960 Cr Non-controlling interest in financial position 1,960 to allocate current year profit to NCI. 7.7 CCH Asia Pte Limited