I have written a few articles about it, including:
Today, I’d like to go beyond basics and clarify what happens when a group changes its composition.
In other words – what happens when an investor decides to acquire more shares or as opposite, dispose of some shares in its existing investment.
It’s very hard to name and count all the ways of changing group’s composition. Here, I tried to outline just a few of them -let’s call them “basic”.
Having that said, there’s a number of tweaks and twists and you need to consider and evaluate each situation very carefully to select the most appropriate accounting treatment.
The ONE THING to remember
When an investor purchases new shares or sells some share in the same investee, then the principal question is:
How does the relationship between an acquirer (e.g. parent) and an acquiree (e.g. subsidiary) change?
In other words, what is the relationship before change and what will it be afterwards?
Let me explain.
There are 4 different types of relationships between investors and investees:
- Control, as defined by IFRS 10;
- Significant influence, as defined by IAS 28
- Joint control as defined by IFRS 11
- None of the above – in this case, an interest in an investee is considered a financial instrument under IAS 39/IFRS 9.
For the simplicity, let’s not deal with joint control here, but in most cases, when joint control is involved in the change, the accounting treatment is the same as for significant influence.
Also, in this article, I focus on groups with control only – either when control is acquired, maintained or lost. In the future, I will write up something specifically for significant influence, too.
Let’s explain what we should do when an investor purchases more shares, or sells some shares in the same investment.
Purchasing more shares
When an investor acquires more shares in its investee, then there are a few ways how control may change:
- No relation increases to control (e.g. 15% share is increased to 70% share);
- Significant influence increases to control (e.g. 25% share is increased to 70% share); or
- Existing control is maintained while new shares are acquired (e.g. 55% share is increased to 70% share).
Let me remind you that the share amount is just an indicator and in practice, control can be achieved in a different way, for example contractually without changing the shares.
Let’s take a look at the accounting treatment.
No relation -> control
When an investor acquires control in its investment with no significant influence, then in fact, a subsidiary is acquired and you need to consolidate.
The principal questions are:
- What to do with a previous investment?
- How to calculate goodwill?
#1 What to do with a previous investment?
You simply dispose it off and derecognize it from the financial statements.
I know, I know – the rules for derecognition of financial instrument are not met here. But, this is only a “deemed disposal” and you will re-recognize the same investment together with new shares.
You need to calculate investor’s gain (or loss) from deemed disposal (fair value less carrying amount) and recognize it in profit or loss.
Then, right after you do it, you recognize your previous investment back at fair value, together with your new investment.
#2 How to calculate goodwill?
As you know by now, goodwill is calculated as:
- Fair value of consideration transferred, plus
- Non-controlling interest in an acquiree, plus
- Fair value of previously held interest when acquisition happens in stages , less
- Net assets in an acquiree.
Therefore, you simply include the fair value of previously held interest in the calculation of goodwill and then you consolidate as usual.
But, to make it clear, let’s illustrate it on a simple example.
Example: No relation -> control
ABC holds 10% share in DEF and it acquires another 50% in DEF on 30 June 20X1. At this date, control is achieved. The financials on 30 June 20X1 are as follows:
- Carrying amount of 10% share in ABC’s books: CU 1 000
- Fair value of 10% share: CU 1 300
- Cost of 50% share that ABC actually paid: CU 6 700
- DEF’s net assets: CU 11 000
First, let’s calculate gain on a deemed disposal:
Debit Financial investments: CU 300
Credit P/L – Gain on a deemed disposal: CU 300
Then, we can calculate goodwill:
- Fair value of consideration paid for 50% share: CU 6 700
- Fair value of previously held interest: CU 1 300
- Non-controlling interest (CU 11 000*40%): CU 4 400
- Less DEF’s net assets: CU 11 000
- Goodwill: CU 1 400
Then you can go ahead and consolidate – here’s my article with a basic consolidation example.
Significant influence -> control
When an investor acquires control in its associate (with significant influence), then an associate ceases to exist and subsidiary is acquired.
The accounting treatment is exactly the same as shown above. You need to:
- Derecognize an associate and calculate investor’s gain on a deemed disposal; and
- Recognize a subsidiary and start consolidating.
Both steps are identical as above. Derecognition of an associate is not a big issue as an associate is shown as a single line item exactly as a financial investment above.
Control is retained with more shares acquired
When an investor has already controlled an investment before acquiring an additional share, then an accounting treatment is totally different from previous two situations.
Because, an investor does NOT acquire a subsidiary with an additional purchase.
As a result, you should NOT derecognize previously held investment with profit or loss on a deemed disposal.
What happens here instead is that an investor buys a greater percentage of ownership of subsidiary’s net assets.
Therefore, you need to adjust parent’s equity to show there was a transfer between owners.
By purchasing additional share, a non-controlling interest decreases because it is sold to a parent.
Also, there might be some transfer between non-controlling interest and retained earnings to reflect the changes in fair value over time (at the date of additional acquisition versus date of the first acquisition).
Disposing of some (or all of) shares
When an investor sells shares in its subsidiary over which control is exercised, then there are a few ways how control may change:
- Control is lost and significant influence is acquired (e.g. 70% share is decreased to 25% share);
- Control is lost and no significant influence is acquired (e.g. 70% share is decreased to 15% share); or
- Existing control is maintained while some shares are sold (e.g. 70% share is decreased to 55% share).
Be careful here, because in reality, an investor does not need to sell anything to dispose of her subsidiary. In other words, a subsidiary can be disposed of by other ways, for example:
- Another investor exercises its options to get shares in a subsidiary (as a result, parent’s share is reduced);
- A subsidiary issues shares to third parties,
- A new contract transfers control from a parent to someone else.
In these situations, control is lost and subsidiary is disposed of. This is called “a deemed disposal” and you must be extremely watchful what’s happening around you, because sometimes a subsidiary can be disposed of without a parent even noticing (OK, that would be an extreme case, but still possible).
In principle, the accounting for these situations is very similar as written above, just the other way round. What really matters here is whether control is lost or retained.
Let me sum it up.
Control is lost
When control is lost, then an investor (or a parent) disposes of its subsidiary and stops applying the full consolidation method.
You need to take 2 steps:
- The first step is to calculate gain or loss from disposal of investment, in both parent’s separate financial statements and consolidated financial statements (yes, these 2 numbers are different).
- The second step depends on what share or interest in an investment is retained:
- If all investment is disposed of, then there’s no second step
- If an associate is acquired (e.g. 70% share decreases to 25% share), then the remaining investment is recognized at fair value at the date of disposal, and from that date, an equity method is applied;
- If an investment with no significant influence is retained (e.g. 70% share decreases to 15% share), then an investor must classify the financial asset and continue measuring and recognizing it in line with IFRS 9.
Control is retained
When an investor decreases its share, but retains control (e.g. 70% share decreases to 55% share), the situation is pretty different.
You need to continue consolidating, because you still have a subsidiary.
Also, despite disposing of some shares, you do NOT calculate any gain from disposal.
Instead, this is accounted for as an equity transaction – that is, as a transaction between the owners of a subsidiary. More precisely, you should adjust only a non-controlling interest and retained earnings within equity. Assets and liabilities remain untouched.
How do we present comparative information?
To finish this article, I’d like to make a note about comparatives.
Very often I get one and the same question:
“We acquired/sold a subsidiary during 20X2, should we restate the comparative numbers for 20X1, too?”
The answer is NO.
The reason is that here, you did not change any accounting policy that would require a restatement.
Instead, acquiring or selling a subsidiary is a new event occurring in the current reporting period, but not in the past. Therefore, it’s totally OK to present comparatives as they are. You are only reflecting a fact that your group looked differently in the comparative reporting period.
In this article, I tried to outline the basic ideas around the changes in the groups, without aiming at providing an exhaustive and complete explanation – that would take me a book! Please feel free to share this article with your friends who can benefit. Thank you!