44 Study notes

Paper F2

ManagementFinancial

By Katy Hibbert, financial reporting subject matter specialist at BPP Learning Media

Even the best-prepared students sometimes falter when tackling step acquisitions because they see them as too tough. But adopting a step-by-step approach should help to overcome the fear factor

Since the introduction of the current syllabus in May 2010, step acquisitions – also called piecemeal acquisitions or, more formally, “business combi nations achieved in stages” – have been exam-ined four times. It’s clear that there is no

escaping them. Step acquisitions were examined most recently

in question 6(a) of the November 2011 Financial Management paper, which can be downloaded from bit.ly/J9siiY. Let’s attempt to answer it using a methodical, six-step approach.

Step 1. The requirementRead it. This may sound obvious, but students often don’t. And don’t just read it; think about it. The requirement is as follows: “Prepare the consolidated statement of comprehensive income for the BH Group for the year ended 31 March 2011. Round all figures to the nearest $000 (18 marks).”

Now, think about it. You have already studied basic statements of comprehensive income for the F1 paper and you know that these are usually easier to deal with than statements of financial position. So, if the F2 examiner is asking you for one, there must be a twist: generally, a disposal or step acqui-sition. Sure enough, a quick glance at note 1 in the “Additional information” section of the question confirms that the BH Group is acquiring control of NJ in two stages: 25 per cent and then a further 40 per cent, giving a 65 per cent stake.

When there are three companies in a consolida-tion question, the third is generally an associate or a sub-subsidiary. If MK were a sub-subsidiary, it would be acquired by NJ, rather than the parent company, BH. Look out for the words “significant influence”, which signal the existence of an asso-ciate. Note that the examiner is not trying to catch you out – there will always be clues in the question pointing you in the right direction.

Step 2. Group structure and timelineDon’t omit this stage in your rush to get consolidat-ing, because you’re more likely to make errors if you do. Once the group structure and the timeline are in place, much of the number-crunching will be easier. These don’t have to be works of art, but they need to be clear (see diagrams below). They give information about the percentage holding, the status and the dates from which to consolidate and equity account. Specifically, NJ is a subsidiary for only 3/12 of the year. This 3/12 will be applied to items in the state-ment of consolidated income (SOCI) on a line-by-line basis. MK is an associate for 6/12 of the year. This 6/12 will be applied to the share of profit and the share of other comprehensive income for the year when equity accounting in the consolidation.

During your F1 studies you probably found the SOCI easier to deal with than the statement of financial position. This may well be no longer true at F2 level. In this question, for example, you have a lot of time-apportioning to do, because you are concerned with what happens during the year, rather than the position at the year end.

Step 3. Pro formasNow you need to draw up a pro forma for the con-solidated SOCI (see bottom of page 46). You will

Working 1: group structure and timeline diagrams

BH

NJ MK

1.9.02: 25% (financial asset) 1.10.10: 40% (associate)

1.1.11: 40% (part-year (mid-year acquisition: piecemeal acquisition) equity account 6/12)

65% (sub for 3/12)

PAR (1.1.11) = $526,000

1.4.10 1.10.10 1.1.11 31.3.11

3/12 (35% NCI) NJ consolidate

MK equity account 6/12

46

Further reading CIMA Official Study Text – Financial Management (2011-12 edition), CIMA Publishing, 2011.

Paper F2Financial Management

Study notes

require additional lines for “Profit on derecognition of financial asset” because, as you can see from the group structure diagram, an accounting boundary has been crossed. When this happens, you need to revalue the investment.

You will also need a caption entitled “Available-for-sale reclassification adjustment”. This is because available-for-sale financial assets are valued at fair value through other comprehensive income. When these are sold, the revaluation gains are reclassified from other comprehensive income to profit or loss.

Some of the figures can be taken from the ques-tion, or be worked out on a line-by-line basis, but others will require separate workings.

You also need to set up pro forma workings to be filled in later. Although a goodwill working is usu-ally associated with the consolidated statement of

financial position, it may also be required for the SOCI where, as in this case, there’s a change in own-ership, or where the goodwill is impaired. As this is a step acqui sition, your goodwill working will include a calc ulation of the profit on derecognition of the available-for-sale financial asset. You will also know from having determined the group structure that there is an associate, and the question tells you that there are dividends and some intra-group trading.

Leave plenty of space in your pro forma workings for adjustments – e.g. for impairment of goodwill or provision for unrealised profit. At this point they should look something like the following:

BH GROUP’s CONsOLIDATED sTATEMENT OF COMPREHENsIVE INCOME FOR THE yEAR ENDED 31 MARCH 2011

$000Revenue

Cost of sales

Gross profit

Administrative expenses

Distribution costs

Investment income

Finance costs

Profit on derecognition of financial asset (working 3)

Share of profit of associate (working 4)

Profit before tax

Income tax expense

Profit for the year

Other comprehensive income

Revaluation of property, plant and equipment

Available-for-sale reclassification adjustment (working 3)

Tax effect of other comprehensive income

Share of other comprehensive income of associate

Other comprehensive income for the year, net of tax

Total comprehensive income for the year

Profit attributable to:

Owners of the parent

Non-controlling interests (working 2)

Total comprehensive income attributable to:

Owners of the parent

Non-controlling interests (working 2)

Working 2: non-controlling interest (NJ) Profit for Total comp year ($000) income ($000)Per question

NCI share x 35% x 35%Note: you can insert the NCI percentage here because you have derived it from working 1.

Working 3: goodwill (NJ) ($000) ($000)Consideration transferred (for 40% on 1.1.11)Non-controlling interests (at fair value)Fair value of previously held equity interestFair value of net assets at acquisition: Share capital Retained earnings (per question)Impairment Profit on derecognition of financial asset (inv in NJ) ($000)Fair value at 1.1.11Carrying value at 1.1.11

Reclassification of previous revaluation gains (remove from other comprehensive income)Total profit to be recognised in P/L (separate line of face of statement of comprehensive income)

Working 4: investment in associate (MK) ($000)Cost of associateShare of post-acquisition reserves of associate

Impairment loss

Working 5: intra-group trading

Working 6: intra-group dividend income

Study notes 47

CIMA corporate centre 26 Chapter Street,London SW1P 4NP T: +44 (0)20 8849 2251E: cima.contact@ cimaglobal.comwww.cimaglobal.comCIMA Australia 5 Hunter Street, Sydney, NSW 2000T: +61 (0)2 9376 9902E: sydney@cimaglobal.comCIMA Bangladesh Suite 309, RM Center, (3rd Floor), 101 Gulshan Avenue, Dhaka-1212T: +8802 881 5724E: zareef.matin@ cimaglobal.comCIMA Botswana Plot 50374 , Block 3, 1st Floor, Southern Wing, Fairgrounds Financial Centre, GaboroneT: +267 395 2362E: gaborone@cimaglobal.comCIMA China: head officeUnit 1508A, 15th Floor, Azia Center, 1233 Lujiazui Ring Road, Pudong, Shanghai 200120T: +86 (0)21 6160 1558E: infochina@cimaglobal.comCIMA China: BeijingC 201, 2/F Landmark Tower 2, 8 North Dongsanhuan Road,Beijing 100004

T: +86 (0)10 6590 0751 E: beijing@cimaglobal.comCIMA China: ChongqingRoom 1202, Metropolitan Plaza, 68 Zou Rong Road, Yuzhong District, Chongqing 400010T: +86 (0)23 6371 3538 E: infochina@cimaglobal.comCIMA China: Shenzhen16/F, CITIC City Plaza,Shennan Road Central, Shenzhen 518031T: +86 (0)755 3330 5151 E: shenzhen@cimaglobal.comCIMA Ghana3rd Floor, Ayele Building,IPS/Attraco Road,Madina, AccraT: +233 (0)30 250 3407E: accra@cimaglobal.comCIMA Hong KongSuite 2005, 20th Floor, Tower One, Times Square, 1 Matheson Street, Causeway Bay, Hong KongT: +852 (0)2511 2003E: hongkong@cimaglobal.comCIMA India Unit 1-A-1, 3rd Floor, Vibgyor Towers, C-62, G Block, Bandra Kurla Complex, Bandra (East), Mumbai 400051T: +91 22 4237 0100E: india@cimaglobal.com

CIMA Ireland5th Floor, Block E, Iveagh Court, Harcourt Road, Dublin 2T: +353 (0)1 643 0400E: cima.ireland@ cimaglobal.comCIMA Malaysia: head office CIMA Malaysia, Lots 1.03b & 1.05, Level 1, KPMG Tower, 8 First Avenue, Bandar Utama, 47800 Petaling Jaya, Selangor Darul EhsanT: +60 (0)3 77 230230E: kualalumpur@ cimaglobal.comCIMA Malaysia: SarawakSublot 315, 1st Floor, 21 Jalan Bukit Mata, 93100 Kuching, Sarawak T: +6082 233136E: doreen.tan@cimaglobal.com CIMA Malaysia: PenangSuite 12-04A, 12th Floor, Menara Boustead Penang,39 Jalan Sultan Ahmad Shah, 10050 PenangT: +60 (0)4 226 7488E: penang@cimaglobal.comCIMA Middle EastOffice E01, 1st Floor, Block 3,PO Box 502221, Dubai Knowledge Village, Al Sofouh Road, Dubai, United Arab EmiratesT: +9714 434 7370E: middleeast@cimaglobal.com

CIMA NigeriaLandmark Virtual Office, 5th Floor, Mulliner Towers, 39 Alfred Rewane Road, Ikoyi, LagosT: +234 1 463 8353 (ext 518)E: lagos@cimaglobal.comCIMA Pakistan 201, 2nd Floor, Business Arcade, Plot 27-A, Block 6, PECHS, Shahra-e-faisal, KarachiT: +92 21 3432 2387E: pakistan@cimaglobal.comCIMA Pakistan: Islamabad1st Floor, Rehman Chambers,Fazal-e-Haq Road, Blue Area, IslamabadT: + 92 51 260 5701-6CIMA Pakistan: LahoreFlat 1, 2, 1st Floor, Front Block 3, Awami Complex at 1-4, Usman Block, New Garden Town, LahoreT: +92 42 3594 0311-16CIMA PolandWarsaw Financial Centre , Floor 11, ul Emilii Plater 53,00-113 Warsaw T: +48 22 528 6651E: poland@cimaglobal.comCIMA RussiaOffice 4009, 4th floor,Zemlyanoj Val 9, Moscow 105064 T: +7495 967 9328E: russia@cimaglobal.com

CIMA Singapore3 Phillip Street, Commerce Point, Level 19, Singapore 048693T: +65 68248252E: singapore@cimaglobal.comCIMA South Africa 1st Floor, 198 Oxford Road, Illovo 2196T: +27 11 788 8723 E: johannesburg@ cimaglobal.comCIMA Sri Lanka356 Elvitigala, Mawatha,Colombo 05T: +94 (0)11 250 3880E: colombo@cimaglobal.comCIMA Sri Lanka: Kandy229 Peradeniya Road, KandyT: +94 (0)81 222 7883E: kandy@cimaglobal.comCIMA UK 26 Chapter Street, London SW1P 4NP T: +44 (0)20 8849 2251E: cima.contact@ cimaglobal.comCIMA Zambia6053 Sibweni Road,Northmead, LusakaT: +260 1 290219E: lusaka@cimaglobal.comCIMA Zimbabwe6th Floor Michael House, 62 Nelson Mandela Ave, HarareT: +263 4 708600E: harare@cimaglobal.com

GLOBAL CONTACT DETAILs

Although any workings that are clear are accep-table, students who have the BPP study text are advised to follow the process that it specifies.

Step 4. DownloadingWork methodically down the income statement, transferring figures to either the pro forma or the workings as necessary. Put all of BH’s and 3/12 of NJ’s income/expenses in brackets on the face of the pro forma, ready for any adjustments you need to make.

Don’t make the mistake of including only 65 per cent of NJ’s income and expenses. Candidates do this all too often. The fact that NJ is not wholly owned is dealt with in the working for non-controlling inter-est. BH does not own all of NJ, but it controls NJ. Control results in the full consolidation of NJ’s income and expenses (and assets and liabilities in the statement of financial position), with a separate working for non-controlling interest.

At this stage you should download from the ques-tion 3/12 of NJ’s profit for the year and total compre-hensive income to the non-controlling interest working. Look at working 2 of the final answer on page 48 to see the neatest way to present this.

You will be picking up some easy marks here for basic consolidation aspects, so don’t let the fact that this is a step acquisition deter you.

Step 5. AdjustmentsRead the additional information given in the ques-tion again and attempt the adjustments required:l Goodwill. See working 3 of the final answer on page 48. Remember to include the fair value of the previ-ously held equity interest, which is given in the ques-tion, along with the fair value of the non-controlling interest. The goodwill impairment can now be cal-culated and transferred to administrative expenses on the SOCI, and also to working 2. Note that, because the non-controlling interest is at fair value, some of the goodwill is attributable to the non-controlling interest and has also suffered impairment.l Profit on derecognition of financial asset. See working 3 of the final answer on page 48. Transfer this figure to the SOCI.l Non-controlling interest. Insert the goodwill impairment. This working is nearly complete, apart from the provision for unrealised profit. Be aware that a provision for unrealised profit will not be included in the non-controlling interest if the profit is made by the parent. In this question it is made by the partly owned subsidiary.l Intra-group trading and dividends. See workings 5 and 6 on page 48. The results of working 5 are transferred to the SOCI and to the non-controlling interest working, which can now be completed.

48

Paper F2Financial Management

Study notes

l Associate. The associate’s share of profit is worked out easily on the face of the SOCI, but remember to time-apportion. The associate is impaired and work-ing 4 shows how this is calculated.

If you can, add across to show that you have under-stood any adjustments – e.g. non-controlling interest. This is less important for items that don’t need adjust-ing, but, then again, those items won’t take long.

Step 6. Ownership reconciliationThe last stage involves apportioning profit and total comprehensive income for the year between the parent and the non-controlling interest. This is straightforward: take the figures from working 2 and find the parent’s share as a balancing figure.

Working 2: non-controlling interest (NJ) Profit for Total comp year ($000) income ($000)Per question: 440 x 3/12 110 464 x 3/12 116Impairment of goodwill (working 3) (16) (16)Provision for unrealised profit (working 5) (20) (20) 74 80NCI share x 35% x 35% 26 28 Working 3: goodwill (NJ) ($000) ($000)Consideration transferred (for 40% on 1.1.11) 680Non-controlling interests (at fair value) 581Fair value of previously held equity interest 425Fair value of net assets at acquisition: Share capital 1,000 Retained earnings (per question) 526 (1,526) 160Impairment: 10% x 160 (add to admin expenses) (16) 144 Profit on derecognition of financial asset ($000)Fair value at 1.1.11 425Carrying value at 1.1.11 (assume this has not been revalued since 31 March 2010 – i.e. revalued only at year end) (400) 25Reclassification of previous revaluation gains (remove from other comprehensive income): 400 – 300 100Total profit to be recognised in P/L (separate line of SOCI) 125

Working 4: investment in associate (MK) ($000)Cost of associate 334Share of post-acquisition reserves of MK: [{370 x 6/12} – 80] x 40% 42 376Impairment loss: 10% x 376 (38) 338

Working 5: intra-group tradingNJ (in Jan 2011 – i.e. when NJ was a 65% subsidiary) BH (parent).Cancel intra-group revenue and cost of sales of $200,000 (all in post-acquisition period, so there’s no need to pro-rate). Provision for unrealised profit = $200,000 x 1/2 in inventories x 20/100 margin = $20,000. Increase NJ’s cost of sales (and, as the subsidiary is the seller, adjust non-controlling interest).

Working 6: intra-group dividend incomeOn 31.3.11 MK pays BH a dividend of $80,000 x 40% = $32,000. This must be can-celled from “investment income”, as it’s in the group accounts. The group share of MK’s profit is included instead.

BH GROUP’s CONsOLIDATED sTATEMENT OF COMPREHENsIVE INCOME FOR THE yEAR ENDED 31 MARCH 2011

$000Revenue: 3,360 + [3/12 x 3,240] – 200 3,970

Cost of sales: 1,800 + [3/12 x 1,860] – 200 + 20 (2,085)

Gross profit 1,885

Administrative expenses: 380 + [3/12 x 340] + 16 (481)

Distribution costs: 400 + [3/12 x 300] (475)

Investment income: 80 – 32 48

Finance costs: 180 + [3/12 x 140] (215)

Profit on derecognition of financial asset (working 3) 125

Share of profit of associate: [6/12 x 350 x 40%] – 38 32

Profit before tax 919

Income tax expense: 200 + [3/12 x 160] (240)

Profit for the year 679

Other comprehensive income

Revaluation of PPE: 70 + [3/12 x 40] 80

Available-for-sale reclassification adjustment (working 3) (100)

Tax effect of OCI: 50 + [3/12 x 16] (54)

Share of OCI of associate: 20 x 6/12 x 40% 4

Other comprehensive income for the year, net of tax (70)

Total comprehensive income for the year 609

Profit attributable to:

Owners of the parent 653

Non-controlling interests (working 2) 26

679

Total comprehensive income attributable to:

Owners of the parent 581

Non-controlling interests (working 2) 28

609