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Once an entity obtains a significant influence (as per Ind-As-28) or Joint control (as per Ind-As-111 to fall under JV) then Equity accounting needs to be applied. There are some events when the entity subsequently acquires/ controls (control as defined in Ind-As-110) these equity accounted investments and become Parent for these entities, and requires to account for these step acquisitions (i.e. from Associate/JV to Subsidiary).
There are some notable significant points where an existing equity accounted Investment will become a subsidiary which have been summarized below after we will have a look at how this accounting will work by using an example with Journal Entries.
Firstly,
Let’s have related references from the standard which deals with these kinds of accounting situations –
Ind-As 103 – Business Combination
Para -41– An acquirer sometimes obtains control of an acquiree in which it held an equity interest
immediately before the acquisition date. For example, on 31 December 20X1, Entity A holds a 35 per cent non-controlling equity interest in Entity B. On that date, Entity A purchases an additional 40 per cent interest in Entity B, which gives it control of Entity B. This Ind AS refers to such a transaction as a business combination achieved in stages, sometimes also referred to as a step acquisition.
Para- 42– In a business combination achieved in stages, the acquirer shall remeasure its previously
held equity interest in the acquiree at its acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss or other comprehensive income, as appropriate. In prior reporting periods, the acquirer may have recognised changes in the value of its equity interest in the acquiree in other comprehensive income. If so, the amount that was recognised in other comprehensive income shall be recognised on the same basis as would be required if the acquirer had disposed directly of the previously held equity interest.
Now,
Let’s take an example to have a practical insight about the concept as mentioned above.
Example –
Company A has purchased an Investment in Company B on 1.04.2015 by taking its 35% of ordinary shares for an amount of INR 75,000 and classified this investment as an Associate (by establishing facts of significant influence). At the end of the year, Company A has bought additional 65% shares and take full control over the Company B by paying a cash amount of INR 425,000.
During the year 2015-2016, Company A has got below share of profit in Company B as on 31.03.2016 –
Share of profit of B for Company A | |
Portion- Profit & Loss | 10,000 |
Portion-FX losses through OCI | 2,000 |
Portion-Revaluation on Property-OCI | 1,000 |
Equity accounted balance of for Company A as on 31.03.2016 will be calculated as below-
Equity accounted interest | 88,000 |
(75,000+10,000+2,000+1,000) |
Fair value of the shares held i.e. 35% and overall Fair value of business has been given as below-
Fair Value of 35% previously held share | 115,000 |
Fair value of total assets/ liab. | 510,000 |
Now, since control has been established on 31.03.2016, a Goodwill will be calculated as per para 42 of Ind-As 103 (mentioned above) –
Goodwill Calculation: | |
Cash paid for the 65% additional intt. | 425,000 |
Fair value of previously held shares | 115,000 |
Total value of deal (paid+ re-valued) | 540,000 |
Total fair value of assets/ Liab | 510,000 |
Difference being GOODWILL | 30,000 |
As per the standard, all previously held share of investment will be fair valued and resultant gain/ loss will be transferred to PL of the year when such control has been established which has been calculated as below –
Gain on previously held shares : | |
Fair value of previously held shares | 115,000 |
Equity accounted interest | 88,000 |
Difference | 27,000 |
Add : | |
Portion-FX losses through OCI | 2,000 |
Total Gain to credit into PL | 29,000 |
Now,
Let’s have a Journal Entry for the transaction which has happened based on the calculations (as above)-
Journal Entry (to record Step acquisition) | ||
Company A books | ||
Total net assets (acquired) | 510,000 | |
Goodwill | 30,000 | (refer working) |
Portion-FX losses through OCI | 2,000 | (recycle to PL) |
Portion-Revaluation on Property-OCI | 1,000 | (non-recycle to PL) |
To Cash | 425,000 | |
To Equity accounted interest | 88,000 | |
To Retained Earning | 1,000 | |
To Gain on previously held share | 29,000 | |
Total Journal | 543,000 | 543,000 |
Significant changes/ notes on the step acquisition-
- One can clearly see that, a gain/loss will be credited/ debited to the PL in the year when such step acquisition takes place which can substantially affect the profitability of the business/KPI,
- FX losses in this example are considered as exchange difference while converting functional currency to presentation currency which will be reclassified into PL in the year of disposal (which is the date of acquisition),
- Revaluation of property (part of OCI) will never be re-classified into PL and hence it has been adjusted towards retained earnings,
- If there is any Minority Interest then fair value of that share will be calculated (given by a valuer) and accordingly Goodwill will be calculated (either partial or full),
- If you read the example carefully and assume that there is no such OCI related items then, simply your gain amount will be INR 27,000 in place of INR 29,000 which is because of additional INR 2,000 reclassified to PL (Fx losses entry) and INR 1,000 which was related to revaluation will never affect this gain calculation, further the Goodwill calculation will remain same no matter if there is any item related to OCI or not (refer example calculations)
This example is to provide an overall understanding and resulting effects of this step acquisition accounting and provide its significance over profits of the year in which such transactions takes place.
A reader will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at [email protected] or Whatsapp +91-9634706933)
Sir can you please comment: when a parent acquires for eg 70% stake in a co it becomes its subsidiary, further when the subsidiary buy 60% stake in another co. (let’s say C), C becomes a chain holding of parent. Sir in this case effective holding of Parent is 42% (70% of 60), and consequently entity C is an associate of Parent. Sir how will be record this – as per IND As 110 (consolidation perspective) or as per IND AS 28 (equity method)
DEAR SIR,
idk if this is proper time to ask this question as you have posted this article in 2017, in IND AS 28, as per equity method it allows to adjust carrying amount of investment by asso’s share of profit & OCI adjustments only, so indirectly it says we cant revalue the carrying amount of previous holding by calculating fair value of previous holding while recognizing new holding.
*Equity method*
10 Under the equity method, on initial recognition the investment in an
associate or a joint venture is recognised at cost, and the carrying
amount is increased or decreased to recognise the investor’s share of
the profit or loss of the investee after the date of acquisition. The
investor’s share of the investee’s profit or loss is recognised in the
investor’s profit or loss. Distributions received from an investee reduce
the carrying amount of the investment. Adjustments to the carrying
amount may also be necessary for changes in the investor’s
proportionate interest in the investee arising from changes in the
investee’s other comprehensive income. Such changes include those
arising from the revaluation of property, plant and equipment and from
foreign exchange translation differences. The investor’s share of those
changes is recognised in the investor’s other comprehensive income
(see Ind AS 1, Presentation of Financial Statements).
Dear Sir, Kindly ask anything related to accounting aspects..thanks
Yes, You are right Amit, and hence all those who will be acting as auditor or those acting as client will not need to be sure about the proper compliance of these standards..
As per a news from ET, there is a clear indication from regulators also that the compliance of these new accounting standards (INd-AS) will be ensured by them and scrutiny might be started…
Dear Sir, can you pl. suggest the prescribed procedure for payment of Purchase Consideration by a USA base Co.for purchase of 100% Equity Shares of an Indian Company, by issuing its own shares of U.S. Co. to the Individual Share holders of the acquired Indian Co.May pl. include the FEMA / RBI procedural requirements.