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Solution
Corporate and Financial Accounting
Corporate Takeover Decision Making and the
Effects on Consolidation Accounting
Contents
Executive Summary:
The
purpose of this literature is to identify the best possible financial method
for two companies JSK LTD and FAB LTD who are thinking to collaborate with each
other combining their efforts towards the greater goals. In this research,
different financial analysis is done with the examples to show which method of
acquisition is appropriate for the firms. Secondly, the report shows how the
businesses can combine their financial statements in the most organized and
convincing manner. It has been seen that how the holding company will react to
intra-group transactions and how these extended activities will be show in the
consolidated financial statements so to show the exact performance of both
companies and whether the acquisition is going beneficial for the parent or
not.
Introduction:
In
this report we undergoing Scenario analysis as being a non-executive director
of JSK LTD I have been handled with the task to make a company plan of takeover
of a small company FAB LTD. For this I
am assigned to cover what will be the most suitable business combination for
clients, what will be the investment criteria in the new setup and how
consolidated financial statements would work. Each point will be explained one
by one. The Suggested acquisition strategy will be acquiring of shares of FAB
LTD by the JKY LTD. Let’s see the strategy from all different angles to
conclude its feasibility with the company.
Business combination: A business combination is a
transaction in which the acquirer obtains the control of another business. The
acquirer is usual a large business as compared to the one acquired. It allows
the company to grow in size and diversify their activities with additional set
of resources. When there is a business consolidation, the acquirer reports
consolidated results that combine its own financial statements with those of
the “acquire”. In the business combinations, the working of the acquire ad
their personal dealing with the customers are not entered as goodwill (Australian Government accounting standards board,
2015) .
The Acquirer lets the “acquire” to stay independent in certain aspects. For
example, JKY LTD obtained the control of FAB LTD in a business combination on
31st December 20X4. FAB LTD does business with its customers solely
through the purchase and sale orders on 60% criteria. As most of these
customers are recurrent this contractual criteria will be treated as an
intangible asset separate from the goodwill provided its fair value be measured
reliably.
Investments in Associations
and Joint ventures: A
method in which companies operate in the form of Joint venture or associated
with each other through shares purchase technique and account for investments
by using the equity method. In this case, an investor which is JSK LTD will
have significant influence on associate company “FAB LTD”. This influence will
equip the JSK LTD with significant power allowing him to participate and have a
dominant say in the financial and operating policy decisions of the investee.
As in our case of subsidiary method as a joint venture if the company sustain
20% or more power of voting of the investee it is presumed to bear a significant
influence.
For
example, JSK LTD acquires a 20% ownership interest in FAB LTD on 30th
June 20X8 for CU 3500000 cash. At this date the fair value of FAB LTD is CU10,
000,000 and the carrying amount of assets is CU8, 000,000. FAB LTD has no
contingent liabilities at this time as illustrated in balance sheet.
During
the year end 31st Dec 20X1, the FAB LTD reports a profit of CU
6,000,000 but does not pay any dividends. In addition to that the fair value of
FAB LTD land increases by CU3,000,000 to CU11,00,000 while the amount
recognized in this aspect that is U6,000,000 remains unchanged as reflected in
balance sheet.
Calculating
the goodwill of JSK LTD in this respect will be as follows, (note that
calculating will be done on the basis of fair value)
Analysis:
The JSK LTD will have significant influence on FAB LTD if it keep acquiring the
shares of the company and will lead the company to work within its own designed
operational model to control finances.
Consolidated financial statements:
Now up
till now it can be clear that it is the “Subsidiary strategy” that is feasible
to adopted in which the JSK LTD will acquire the shares of the FAB LTD. It is
safe to understand the concept of consolidated financial statements and how
they work in this scenario with examples. The two firms by now agreed upon a
strategy in which FAB LTD is the associate over which JSK LTD has a greater
influence. Consolidated financial statements are the collective representation
of financial statements in which the assets, liabilities, income, equity, cash
flows and expenses of the parent (JSK) and its subsidiary (FAB) are presented
as a single economic entity (Australian Accounting Standards
Board, 2018) .
For
example: JSK LTD is a holding company with 10,000 shares and FAB LTD has 6,000
shares. Assume JSK acquires 4,000 shares of FAB LTD. Now we calculate how the
scenario works with assumption based values. The left over shares of FAB LTD
will be 2,000. This will make FAB LTD as the subsidiary of JSK LTD.
Steps
involved in preparation of Consolidated Balance Sheet”
Step
1: Computation of holding-Minority ratio
Step
2: Ascertaining Capital Profits
Step
3: Commutation of Reserve Profits
Step
4: Computation of Minority Interest
Step
5: Computation of Goodwill
Explanation
through Balance sheet
|
LIABILITIES
|
ASSETS
|
|||||
|
JSK LTD
|
FAB LTD
|
JSK LTD
|
FAB LTD
|
|||
|
H.
|
S.
|
H.
|
S.
|
|||
|
Share Capital (shares of Rs.10 each)
|
250,000
|
60,000
|
Land & Buildings
|
200,000
|
40,000
|
|
|
General Reserve
|
75,000
|
30,000
|
Investment (4,000
shares in S LTD)
|
50,000
|
0
|
|
|
Profit and Loss account
|
50,000
|
40,000
|
Stock
|
40,000
|
25,000
|
|
|
Creditors
|
35,000
|
10,000
|
Debtors
|
42,000
|
20,000
|
|
|
0
|
0
|
Bank Balance
|
78,000
|
55,000
|
||
|
0
|
0
|
0
|
0
|
|||
|
410,000
|
140,000
|
410,000
|
140,000
|
|||
On the
basis of this balance sheet, the required data for consolidated financial
statement of both companies will be calculated.
Total
shares for Subsidiary company= 60,000 /10 =6,000 shares
Shares
acquired by holding company= 4,000
Shares
left by general public (minority share) = 6,000 – 4,000 = 2,000
Holding and Minority ratio = 2:1
Calculation
of step 2 & step 3
For
these step it is important to note the date of acquisition both opening and
closing date.
Date
of acquisition: 30-6-2004
For
example at the date of acquisition by JSK LTD of its holdings of 4,000 shares
in FAB LTD, the latter company had undistributed profits and reserves amounting
to 25,000 and 20,000 respectively.
|
Computation of Capital Profits
|
||
|
FAB LTD
|
JSK LTD
|
|
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S.com
|
H.comp
|
|
|
General Reserves, Capital Reserve, P&L a/c, and other
reserves of subsidiary co. on the date of purchase of shares
|
30,000
|
|
|
40,000
|
||
|
70,000
|
||
|
At the time of acquisition
GR & P/L accounts
|
25,000
|
|
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20,000
|
||
|
CAPITAL PROFIT
|
45,000
|
|
|
CAPITAL PROFIT divided according to minority ratio (2:1)
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45,000x1/3=15,000
|
45,000x2/3 =30,000
|
|
70,000-45,000
|
||
|
REVENUE PROFIT
|
25000
|
|
|
REVENUE PROFIT divided according to minority ratio (2:1)
|
25,000x2/3= 16,667
|
25,000x1/3= 8,333
|
Step
4:
|
Computation of minority share
|
|
|
FAB LTD
|
|
|
S.com
|
|
|
Face value of minority share (2,000x10)
|
20,000
|
|
Minority share of Capital Profit
|
15,000
|
|
8,333
|
|
|
Total Minority interest
|
43,333
|
Step
5:
|
Computation of Goodwill
|
|||
|
JSK LTD
|
|||
|
H
|
|||
|
Amount Paid by the JSK for shares in FAB
|
50,000
|
||
|
JSK capital loss
|
40,000
|
||
|
90,000
|
|||
|
Liabilities
|
|||
|
Face value of shared Capital
|
40,000
|
||
|
JSK share of Capital
Profit
|
30,000
|
||
|
JSK share of bonus shares (if any)
|
0
|
||
|
JSK share of dividends
paid out of CP
|
0
|
||
|
70,000
|
|||
|
Goodwill
|
20,000
|
Capital Reserve
|
-
|
Consolidated
financial statement
|
Consolidated Balance sheet of JSK LTD and its subsidiary FAB LTD
as on 30.06.2004
|
|||
|
Equity & Liabilities
|
|||
|
1. shareholders’ funds
|
|||
|
share capital
|
250,000
|
||
|
Reserves and Surplus
|
161,667
|
||
|
2. Minority interest
|
43,333
|
||
|
3. Current liabilities
|
|||
|
Creditors
|
45,000
|
||
|
500,000
|
|||
|
Assets
|
|||
|
1. Non-current assets
|
|||
|
tangible assets
|
240000
|
||
|
intangible assets (Goodwill)
|
20,000
|
||
|
2. Current assets
|
260000
|
||
|
520000
|
|||
This
has been the example to show how consolidated statements in the case of
subsidiary method will work.
Part 2
As
being directed by the board meeting I am directed with the task to provide the
solution for a problem in which a partially owned subsidiary provides
professional services and sells inventory to the parent company at a profit.
The decision is to seek clarification whether profits should be deducted from
the subsidiary profits for sales of inventory or what. These come as
intra-group transactions which involves two companies of the same group (that
is related in business theme). As occurring in this case in which one unity of
entity is involved in transaction with the other unit of the same entity which
occurs for a variety of reasons. The major reason is the normal business
relationship that exists between two entities in which both units (parent and
subsidiary) work collaboratively to achieve desired combined profits and
competitive advantage. In case of calculations as gathering from the data represented
in financial consolidated files. If the subsidiary is selling to the parent
(JSK) the sale to the parent will be recorded at full price and full cost will
be included in the subsidiaries profit. In this case, subsidiaries profit will
be reduced on the consolidation which will equally reduce the share of profit
of the subsidiary that is related to the NCI. Such transaction greatly affects
the collective account for example current period sales of inventory affect
sales and the cost of sales accounts whereas the prior period sales of
inventory affect retained earnings. If the transactions are not correctly
placed where they are supposed to be this will show inappropriate conclusions.
EXAMPLE
|
JSK LTD
|
FAB LTD
|
|
|
Property, Plant & Equipment
|
180,000
|
155,000
|
|
Investment in 100,000 Ordinary
shares in JSK
|
108,000
|
|
|
Inventories
|
40,000
|
30,000
|
|
Debtors
|
12,000
|
20,000
|
|
Bank
|
10,000
|
15,000
|
|
350,000
|
220,000
|
|
|
Equity:
|
||
|
200,000
|
150,000
|
|
|
Retained Profit
|
100,000
|
48,000
|
|
Creditors
|
50,000
|
22,000
|
|
350,000
|
220,000
|
Through
this model we can identify the Non-controlling interest account (account that
includes the intra-group transactions) (McGraw Hill, 2015) . The non-controlling
interest can be calculates as follows through steps. The first step involves
the calculation of retained profits. Through them NCI will be calculated with
the provided information in which lets suppose JSK acquired 100,000 ordinary shares
of FAB LTD when the retained profits of JSK had a credit balance of 12,000.
Through the year, FAB TLD sold inventory to JSK costing 50,000 with the goods
at a cost of plus 25%. 20,000 worth of these goods still remain in closing
inventories of JSK LTD. As shown below non-controlling interest is not only
calculated but is also represented in that in consolidated financial statements
Adjustment
Profit and loss JSK LTD
Balance 48000
URP 4000
B/c 44,000
Retained profit to NCI 2/3x44,
000= 14,667
|
Non-Controlling Interest (1/3)
|
|||||
|
CSOFP
|
64,667
|
OS
|
50,000
|
||
|
Retained Profit
|
14,667
|
||||
|
64,667
|
|
64,667
|
|||
Part 3:
After thorough
analysis and calculation of NCI this part involves the designing of entire
consolidated financial statement of two holding JSK LTD company and the other
FAB LTD. In this part it will show where exactly NIC has to be placed. NCI
takes the place in the equity section of two company’s final financial
statement. Analyzing NCI it is the equity in a subsidiary that is
non-attributable directly or indirectly to the parent. They are shown in
separately from the parent’s ownership interest in the equity section. If the
subsidiary FAB LTD has outstanding preference shares that are classified as
equity and are held by NCI, the parent computes its shares of Profit and loss
after adjusting the dividends on such shares along with calculating the other
vested transactions. With regards to the changes as long as the parent’s
ownership and influence in a subsidiary is not hurting and there is no danger
of loss of control at the parents side the NCI adjustments will be accounted
for as equity transactions. So in such circumstances the carrying amounts of
the controlling and non-controlling interest shall be adjusted to reflect the
changes in their relative interest in the subsidiary FAB LTD. In consolidated
financial statement preparation, financial statement of the parent and
subsidiaries are done line by line as shown below. If in case the parent
company losses its control onto the subsidiary then it start derecognizing the
carrying amount of any non-controlling interests in the former subsidiary at
the date when control is lost.
Consolidated Retained Profit
|
Consolidated Retained
Profit
|
|||||
|
JSK LTD
|
FAB LTD
|
JSK LTD
|
FAB LTD
|
||
|
COC
|
8,000
|
Balance
|
100,000
|
48,000
|
|
|
NCI
|
14,667
|
||||
|
Unrealized Profit
|
|
4,000
|
|||
|
Balance c/f
|
100,000
|
21,333
|
|||
|
100,000
|
48,000
|
100,000
|
48,000
|
||
Consolidated financial statement
with NCI
|
|
|
|
Consolidated Statement of Financial Position as
|
|
|
Non-Current Asset:
|
|
|
Property, Plant & Equipment (PPE)
|
335,000
|
|
|
|
|
Current Asset:
|
|
|
Inventory
|
66,000
|
|
Debtors
|
32,000
|
|
Bank
|
25,000
|
|
|
|
|
458,000
|
|
|
|
|
|
Equity:
|
|
|
Ordinary Shares
|
200,000
|
|
Retained Profit
|
121,333
|
|
Creditors
|
72,000
|
|
Non-Controlling Interest
|
64,667
|
|
|
|
|
458,000
|
|
From
the above data, it can see that it is done in accordance with the AASB 127 that
accounts the investor which in case in JSK LTD to account for its investments
using the equity method (made in accordance with AASB 128). The results are
determined after the statements solely on the basis of the present ownership
interest of the holding company and what economic, social and financial
benefits it is gaining from the acquisition decision. The report clearly makes
it easy to understand that how companies should act in case of different
decisions. Showing NCI in separate column serves well the requirement by the
AASB 127 to show individual reports separately. So all the reserves that are
the result of some discretionary transfers must be calculated within the equity
portion for example Capital realization reserves. Disclosing such individual
reserves in the notes rather than on the face of the statements of changes in
equity reduces clutter and makes the statement more readable and understanding
towards both the parties indulged together in diversified business
activities. The reconciliation of
changes if any happen must also be shown separately in the comprehensive mode
of financial statement. This information may be either represented in the notes
in header or footer or in the statement of changes in equity.
Conclusion:
The
research shows that there are clear profits if the JSK LTD uses consolidated
financial accounts method in order to work with the FAB LTD. This method will
allow both the companies to identify their profits before and after the
acquisition data and become more aligned to each other goal. From the report
different adjustments of financial transactions have been calculated as shown
in the consolidated statements. The purpose of the report is to analyze
different financial decisions through the eyes of CFO and how we can make the
difference for the companies in helping them to make informed decisions.
Bibliography
Australian
Accounting Standards Board, 2018. Consolidated Financial Statements. Compiled
AASB Standard-AASB 10, 20 April.
Australian Government accounting
standards board, 2015. Business Combinations. AASB Standard-Federal
Register of Legislative Instruments , August.
McGraw Hill, 2015. ACCOUNTING FOR
INTRAGROUP TRANSACTIONS-CHAPTER 25.
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