Accounting for goodwill is a key technical skill for business combinations and is, therefore, regularly examined as part of the Financial Reporting (FR) exam. Goodwill arises when one entity (the parent company) gains control over another entity (the subsidiary company) and it is recognised as an asset only in the consolidated statement of financial position (CSFP). Under IFRS 3 Business Combinations, goodwill is an asset in the CSFP representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. Goodwill is not amortised but must be tested annually for impairment.

The calculation of goodwill is as follows:

In the FR exam, this calculation may contain many complexities. Each of these line items will be addressed in turn.

1. Consideration paid

The common situations arising in the FR exam are:

• payment in cash, immediately
• cash, payable in the future (deferred payment)
• cash payable in the future but where that payment is dependent on certain events (contingent consideration), and/ or
• an issue of the acquiring company’s (the parent’s) own shares to the original shareholders of the acquired company (the subsidiary).

In addition to this, candidates will need to know the correct treatment for professional fees incurred as part of the acquisition.

Cash consideration
This is the simplest element of consideration and represents the cash paid immediately by the parent as part of the acquisition. You will be told this and it will usually be included in the ‘investments’ line of the parent’s individual statement of financial position; and needs to be included in the goodwill calculation.

Deferred consideration
This is cash payable in the future and needs to be recognised, initially, at its present value. For the FR exam, if the amount is payable in one year, you will be given a discount rate (%) and be asked to calculate this. If the amount is payable in more than one year, you will be given a cumulative discount factor (to three decimal places). The key is to initially recognise the amount payable at present value in goodwill and as a corresponding liability on the CSFP.

As time elapses, the discount on the liability must be ‘unwound’ as the settlement date approaches. The unwinding of the discount on the liability increases both the ‘liability for deferred payment’ on the and ‘interest expenses on unwinding of discounts’. A key thing to note here is that goodwill is unaffected by unwinding the discount as goodwill is only calculated at the date of acquisition.

EXAMPLE 1
Laldi Co acquired control of Bidle Co on 31 March 20X6, Laldi Co’s year end. The consideration paid included $200,000 payable on 31 March 20X7. The discount rate is 6%.

Required:
Calculate the amount of deferred consideration to be recognised at 31 March 20X6 and explain how the unwinding of any discount should be accounted for.

Answer
The goodwill calculation will include deferred consideration of $188,679 ($200,000 ÷ 1.06^{1 year}). This will also be included in the CSFP at 31 March 20X6 as a current liability (as it is due in 12 months’ time).

In the year ended 31 March 20X7, this discount of $11,321 ($188,679 × 6%) would then be unwound and recorded as ‘interest expenses on unwinding of discounts’ in the parent’s individual statement of profit or loss (which is consolidated into the group). The full liability of $200,000 would be settled on 31 March 20X7, consisting of the $188,679 originally recognised plus the $11,321 of interest expenses.

Contingent consideration
In the FR exam, this will take the form of a future cash amount payable dependent on a set of circumstances. In accordance with IFRS 3, this must be recognised initially at its fair value (which will be given in the exam). This fair value is added to the consideration as part of the goodwill calculation and recognised as a current or non-current provision in liabilities in the CSFP.

Any subsequent movement in the potential amount payable is treated as a movement in a provision in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Any increase or decrease in the amount payable is reflected in the liability and recorded in the parent’s individual statement of profit or loss. Again, it is key to note that the initial calculation of goodwill is unaffected as this is calculated at the date of acquisition.

Share consideration
This is common in the FR exam. It is likely that this amount will not yet have been recorded, testing the candidate’s knowledge of how the transaction is to be recorded. To do this, a candidate needs to work out how many shares the parent company has issued to the previous shareholders (owners) of the subsidiary as part of the acquisition. To work out the value given to the previous owners, the number of shares issued is multiplied by the parent’s share price at the date of acquisition. This full amount is then added to the consideration paid total. The amount then also needs to be added to the parent’s individual share capital and other components of equity (share premium) to reflect the shares issued (see Example 3 later in the article).

Acquisition costs
All acquisition costs, such as professional fees (legal fees, accountant fees etc), must be expensed in the parent’s individual statement of profit or loss and not included in the calculation of goodwill. Occasionally, in the FR exam, this will have been recorded incorrectly, perhaps included in the statement of financial position as part of the cost of investments and you need to make a correcting adjustment.

2. Non-controlling interests

Under IFRS 3, the parent can choose to measure any non-controlling interests (NCI) at the date of acquisition at either fair value or the proportionate share of net assets. Both methods are examinable.

There are two potential ways that the fair value method will arise in the FR exam. The fair value of the NCI at acquisition may be directly given to candidates or they may have to calculate the fair value by reference to the subsidiary’s share price. To do this, the candidate will have to multiply the number of shares held by the NCI by the subsidiary’s share price at the date of acquisition.

Under the proportionate share of net assets method, the NCI is calculated as the fair value of net assets of the subsidiary at acquisition multiplied by the percentage owned by the NCI.

Under the fair value method, the NCI at acquisition will be higher, meaning that the goodwill amount is higher. This is because including the NCI at fair value incorporates an element of goodwill attributable to them. Under this method, the goodwill figure includes elements of goodwill from both the parent and the NCI.

Including the NCI at the proportionate share of the net assets reflects the lowest possible amount that can be attributed to the NCI. This method shows how much they would be due if the subsidiary company was no longer a going concern and all the assets realised at their carrying amounts, incorporating no goodwill in relation to the NCI. Under the proportionate method, the goodwill amount is, therefore, smaller as it only includes the goodwill attributable to the parent.

3. Net assets at acquisition

At the date of acquisition, the parent company must recognise the assets and liabilities of the subsidiary at fair value. This can lead to a number of potential adjustments to the subsidiary’s assets and liabilities. This is covered in detail in the this technical article.

4. Goodwill impairment losses

The final element to consider is the impairment of goodwill. Impairment arises after the acquisition and reflects some form of decline in the expected benefit to be derived from the subsidiary. As mentioned earlier, there is no amortisation of this figure and so the parent must assess each year whether there are indicators that the goodwill is impaired.

There are many indicators of impairment, ranging from loss of customers in the subsidiary to the departure of key staff or changes in technology. If an entity decides that the goodwill is impaired, it must be written down to its recoverable amount. Once goodwill is impaired, the impairment cannot be reversed.

The cumulative impairment is always deducted, in full, from the goodwill figure in the CSFP. If the NCI were initially measured at fair value, then a percentage of impairment will be allocated to them (based on the percentage owned in the subsidiary), with the remainder being allocated to the group. If the NCI were initially measured at their share of net assets, then the entire impairment is allocated to the group, due to the fact that no goodwill has been attributed to the NCI.

EXAMPLE 2
Fifer Co acquired 80% of the ordinary (equity) shares of Grampian Co on 1 January 20X4 for $5m. The fair value of Grampian Co’s net assets at the date of acquisition was $4m.

At 31 December 20X4, due to unexpected market factors, Fifer Co has determined that goodwill is impaired by 10%.

Required:
For each of the following scenarios, calculate the value of goodwill at 31 December 20X4 and explain how the impairment loss would be allocated between the group and NCI:

1. NCI are valued at its fair value of $1,000,000, and
2. NCI are valued as a proportionate share of net assets.

Answer

1. Fair value method

The fair value method of calculating NCI incorporates both the goodwill attributable to the group and to the NCI. Therefore, any subsequent impairment of goodwill should be allocated between the group and NCI based on the percentage ownership.

NCI will be allocated $40,000 (20% × $200,000) of the impairment loss and the group will be allocated $160,000 (80% × $200,000).

2. Proportionate share of net assets method

The proportionate share of net assets method calculates the goodwill attributable to the group only. Therefore, any impairment of goodwill should only be attributed to the group and none to the NCI.

The $180,000 impairment loss relates to the group only.

EXAMPLE 3
This comprehensive example is an adaptation of a previous consolidation question looking at many of the elements of goodwill outlined above. This is good practice for how a CSFP question might be asked, with a common format of presenting the answer. This question contains other adjustments, so it is important that you have read through other learning materials on group accounting, including associate companies, before attempting it.

On 1 October 20X6, Plateau Co acquired two non-current investments:

3 million $1.00 ordinary (equity) shares in Savannah Co by an exchange of one share in Plateau Co for every two shares in Savannah Co, plus $1.25 per acquired Savannah Co share in cash. The share price of each Plateau Co share at the date of acquisition was $6.00 and the share price of each Savannah Co share at the date of acquisition was $3.25. At 1 October 20X6, Savannah Co had retained earnings of $6m.

30% of the $1.00 ordinary (equity) shares of Axle Co, at a cost of $7.50 per share in cash. At this date, Axle Co had retained earnings of $11m.

Only the cash consideration of the above investments has been recorded by Plateau Co. In addition, $500,000 of professional costs relating to the acquisition of Savannah Co are included in the cost of the investment.

The summarised, draft statements of financial position of the three companies at 30 September 20X7 are shown below.

Additional information

(i) At the date of acquisition, Savannah Co has an unrecognised internally generated brand. This was deemed to have a fair value of $1m at 1 October 20X6 and has not been impaired.

(ii) On 1 October 20X6, Plateau Co sold an item of plant to Savannah Co for $2.5m. Its carrying amount prior to the sale was $2m. The estimated remaining life of the plant at the date of sale was five years and straight-line depreciation is applied.

(iii) During the year ended 30 September 20X7, Savannah Co sold goods to Plateau Co for $2.7m. Savannah Co had marked up these goods by 50%. Plateau Co had a third of the goods still in its inventories at 30 September 20X7.

(iv) At the date of acquisition, the NCI in Savannah Co were measured at fair value. Savannah Co’s share price at that date was used for the fair value measurement.

(v) Other financial assets of $6.5m are at their fair value on 1 October 20X6, but they have a fair value of $9m at 30 September 20X7.

Required:
Prepare the Plateau group’s consolidated statement of financial position as at 30 September 20X7.

Answer
Consolidated statement of financial position of Plateau Co as at 30 September 20X7.

(w1) Group structure:
Plateau Co has owned 75% of Savannah Co and 30% of Axle Co for one year.

(w2) Net assets of Savannah Co

(w3) Goodwill:

Tutorial note:
The consideration given by Plateau Co for the shares of Savannah Co works out at $4.25 per share – ie consideration of $12.75m for 3 million shares. This is higher than the market price of Savannah Co’s shares ($3.25) before the acquisition and could be argued to be the premium paid to gain control of Savannah Co. This is also why it is (often) appropriate to value the NCI in Savannah Co’s shares at $3.25 each, because (by definition) the NCI does not have control.

The 1.5 million shares issued by Plateau Co in the share exchange, at a value of $6.00 each, would be recorded as $1.00 per share as capital and $5.00 per share as other components of equity (share premium), giving an increase in share capital of $1.5m and a share premium of $7.5m.

(w4) Non-controlling interests:

(w5) Retained earnings:

(w6) Investment in associate:

(w7) Property, plant and equipment 
The transfer of the plant creates an initial unrealised profit (URP) of $500,000 being the difference between the agreed FV ($2.5m) and the carrying amount ($2m). This should be eliminated from Plateau Co’s retained earnings and from the carrying amount of the plant to restate as if the transfer had not taken place.

The carrying amount of the plant is reduced by excess depreciation of $100,000 for each year ([$2.5m ÷ 5years] – [$2m ÷ 5 years]) in the post-acquisition period. Therefore, the net adjustment in the carrying amount of property, plant and equipment is $400,000.

The excess depreciation charge should also be eliminated on consolidation and, since it will have arisen in Savannah Co’s individual accounts, the elimination of the depreciation will have the effect of increasing Savanah Co’s post-acquisition retained earnings and, consequently, the profits attributable to the non-controlling interest.

(w8) Inventory
The URP in inventory intra-group sales are $2.7m on which Savannah Co made a profit of $900,000 ($2.7m × [50% ÷ 150%]). One third of these are still in the inventory of Plateau Co, thus there is an unrealised profit of $300,000.

Tutorial note:
In this question, there is no goodwill impairment. If there had been an impairment of, for example, $1m, then the full $1m would have been deducted from goodwill. As the NCI are initially measured at fair value, this impairment would have been split between the NCI and the parent based on the percentage owned. Therefore, $250,000 (25% of the impairment) would be deducted from the NCI and $750,000 (75% of the impairment) would be deducted from retained earnings (ie the group share).

Written by a member of the FR examining team