Question

Peach acquired 75% of the equity share of Strawberry on 1 July 2008 when the balance on Strawberry’s accumulated profits was $300,000. Peach made an immediate cash payment of $500,000 and agreed to pay a further $200,000 on 1 July 2011. Peach also incurred $15,000 of legal fees in respect of the acquisition. Currently, Peach has recorded the cost of the investment as the cash paid plus the legal fees, but has yet to record the deferred consideration. An interest rate of 6% is to be used for discounting purposes.

The statements of financial position of the two entities as at 30 June 2009 are:

Peach Strawberry $000’s $000’s Non-current assets Tangible 1,465 1,220 Investments 515 -

Current Assets 420 280 2,400 1,500

Equity share capital 750 500 Accumulated 590 420 profits

Non-current 800 400 liabilities

Current liabilities 260 180 2,400 1,500

At the date of acquisition, the fair value of the non-controlling interest in Strawberry was determined to be $220,000. It is Peach’s policy to measure goodwill arising on acquisition under the gross goodwill method. As at 30 June 2009, it was determined that gross goodwill should be impaired by $8,000.

Requirement Prepare the consolidated statement financial position of the Peach Group as at 30 June 2009.

Answer

Consolidated statement of financial position as at 30 June 2009 Calculation $000’s Non-current assets Goodwill (W3) 80 Tangible (1,465+1,220) 2,685

Current Assets (420+280) 700 3,465

Equity share 750 capital Accumulated (W5) 649 profits Non-controlling (W4) 248 interests

Non-current (800+400+168(W3) 1,378 liabilities + 10(W6))

Current liabilities (260+180) 440 3,465

Workings W1 Group structure

On 1 July 2008 (one year ago) Peach acquired 75% of Strawberry. The workings below show the difference in share capital and profits between those dates.

W2 Net assets of Strawberry Acquisition Reporting date $000’s $000’s Share capital 500 500 Accumulated 300 420 profits 800 920

The increase in net assets of $120,000 ($920,000 - $820,000) represents the post acquisition profits of Strawberry.

W3 Goodwill $’000s Cost of Investment Cash 500 Deferred consideration, discounted (200 x 168 to present value 0.840) 668 Fair value of non-controlling interest 220 (NCI) at acquisition 100% of Strawberry’s net assets at (800) acquisition Gross goodwill at acquisition 88 Impairment (8) Gross goodwill at reporting date 80

The discount factor of 0.840 applied to the deferred consideration is taken from discount tables, where the interest rate is 6% and the future cash flow will be in three years' time.

The deferred consideration has not yet been recorded by Peach and so as well as including it in the above cost of investment (as a debit entry) it will need to be recorded as a non-current liability (a credit entry). Since the reporting date is one year after acquisition, the discounting will need unwinding for one year – see W6.

The legal fees of $15,000 should not have been capitalised by Peach and so are not included in the above cost of investment. They should have been charged to profits and so are deducted from accumulated profits in W5 below.

Alternatively, the gross goodwill could have been calculated as: $’000s Cost of investment Cash 500 Deferred consideration, (200 x 168 discounted to present value 0.840) 668 Peach’s share of Strawberry’s (75% x (600) net assets at acquisition 800) Peach’s share of goodwill 68 Fair value of NCI at 220 acquisition NCI’s share of Strawberry’s (25% x (200) net assets at acquisition 800) NCI’s share of goodwill 20 Gross goodwill at acquisition 88 Impairment (8) Gross goodwill at reporting 80 date

W4 Non-controlling interests at reporting date $’000s Fair value at acquisition 220 NCI’s share of Strawberry’s post (25% x 120) 30 acquisition profits NCI’s share of impairment loss (25% x 8) (2) 248

Alternatively, the NCI’s could have been calculated as: $’000s NCI’s share of Strawberry’s net (25% x 920) 230 assets at reporting date NCI’s share of goodwill (W3) 20 NCI’s share of impairment loss (25% x 8) (2) 248

W5 Accumulated profits $’000s Peach’s accumulated profits 590 Legal fees to be expensed (15) Finance cost on unwinding of (W6) (10) deferred consideration Peach’s share of Strawberry’s post (75% x 120) 90 acquisition profits Peach’s share of impairment loss (75% x 8) (6) 649

W6 Deferred consideration At 1 July 2008, the date of acquisition, the deferred consideration is recorded at its present value of $168,000. As time passes, the present value will increase at the rate of 6% a year. At the reporting date, which is one year after acquisition, the present value of the liability will have increased by: 6% x 168,000 = 10,000 (rounded)

The increase of $10,000 will be recorded in Peach’s books as a finance cost (a debit entry) and so will reduce Peach’s profits as shown in W5 above and will be recorded as an increase in the non-current liability (a credit entry) as shown on the face of the consolidated statement of financial position.