Consolidation Expanded

Setting up and consolidating a subsidiary

At the beginning of period one, XYZ decided to establish a new subsidiary. After it sold some securities, it registered ABC as separate legal entity and transferred it startup capital.

XYZ liquidated a portion of the investment portfolio where it keeps excess cash:

Cash		10,000
	Investments		10,000

Before and after.

XYZ	Before	After
Cash	1,000	11,000
Receivables	5,000	5,000
Inventory	10,000	10,000
Accruals	1,000	1,000
Current assets	17,000	27,000
Financial assets: Investments	18,000	8,000
Property plant and equipment	35,000	35,000
Intangible assets	30,000	30,000
Total assets	100,000	100,000

Payables	5,000	5,000
Loans	20,000	20,000
Total Liabilities	25,000	25,000
Paid in capital	50,000	50,000
Retained earnings	25,000	25,000
Total equity	75,000	75,000
Liabilities and equity	100,000	100,000

Financial assets: InterCo: Equity: ABC		10,000
	Cash		10,000

ABC used the funds to buy a distribution license and initial inventory for 3,000 and 1,500 respectively. During the period, it also bought equipment, furniture and fixtures from various vendors for 5,500. At the end of the period, consolidated financial statements were prepared.

Receipt of startup funds:
Cash		10,000
	Paid in capital		10,000

Expenditure of startup funds:
Inventory		1,500
License		3,000
Equipment, Furniture and fixtures		5,500
	Cash		10,000

As no transactions between XYZ and ABC occurred, the only item to be eliminated was the InterCo investment.

XYZ		ABC		Adj.	XYZ / ABC
Cash	1,000	Cash			1,000
Receivables	5,000	Receivables			5,000
Inventory	10,000	Inventory	1,500		11,500
Accruals	1,000	Accruals			1,000
Current assets	17,000	Current assets	1,500		18,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	100,000	Total assets	10,000		100,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(75,000)	Total equity	(10,000)		(75,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(100,000)

Once the adjustment had been made, consolidated financial statements could be prepared.

XYZ / ABC
Cash	1,000
Receivables	5,000
Inventory	11,500
Accruals	1,000
Current assets	18,500
Financial assets: Investments	8,000
Property plant and equipment	40,500
Intangible assets	33,000
Total assets	100,000

Payables	5,000
Loans	20,000
Total Liabilities	25,000
Paid in capital	50,000
Retained earnings	25,000
Total equity	75,000
Liabilities and equity	100,000

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000
Cash		3,000
	Receivables		3,000

ABC
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

To improve readability, the transactions are presented in aggregate.

As no transactions between XYZ and ABC occurred, the only item to be eliminated was the InterCo investment.

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Cash	19,000	Cash	1,000		20,000
Receivables	2,000	Receivables			2,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	22,500	Current assets	2,500		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	105,500	Total assets	11,000		106,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(1,000)		(31,500)
Total equity	(80,500)	Total equity	(11,000)		(81,500)
Liabilities and equity	(105,500)	Liabilities and equity	(11,000)		(106,500)

Once the adjustment was made, consolidated financial statements could be prepared.

XYZ / ABC
Revenue	23,000
Cost of sales	11,000
Gross profit	12,000
Administrative expenses	5,500
Net income	6,500

Cash	20,000
Receivables	2,000
Inventory	2,000
Accruals	1,000
Current assets	25,000
Financial assets: Investments	8,000
Property plant and equipment	40,500
Intangible assets	33,000
Total assets	106,500

Payables	5,000
Loans	20,000
Total Liabilities	25,000
Paid in capital	50,000
Retained earnings	31,500
Total equity	81,500
Liabilities and equity	106,500

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		22,000
	Cash		22,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

As transactions between XYZ and ABC had occurred, they had to be eliminated.

Consolidation involves combining non-InterCo and eliminating InterCo items.

As outlined in IFRS 10.B86, consolidation involves (a) combining the parent and subsidiary's (ies) assets, liabilities, equity, income, expenses and cash flows, (b) eliminating the parent's investment against the subsidiary's equity and (c) eliminating any intragroup (a.k.a. InterCo) assets and liabilities, equity, income, expenses and cash flows not forgetting that "profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full."

While not semantically accurate, the term InterCo is used considerably more in practice than the term intragroup even by professional organizations that should know better.

Rather than swimming against this tide, this site refers to these items as InterCo, just like everyone else.

While not identical, ASC 810-10-45-1 specifies that consolidation involves eliminating intra-entity balances and transactions including any open account balances, security holdings, sales and purchases, interest, dividends, etc. Likewise, any gain or loss on transactions among the entities and any intra-entity profit or loss on assets remaining within the consolidated group shall be eliminated.

The simplest way to make sure all InterCo items have been identified and eliminated is comparing financial results including InterCo items with those excluding them.

To improve readability, the differences on sub-total and total lines are not shown.

	Including InterCo transactions			Excluding InterCo transactions			Difference
	XYZ	ABC	XYZ + ABC	XYZ	ABC	XYZ + ABC
Revenue	(41,700)	(5,000)	(46,700)	(40,000)	(5,000)	(45,000)	1,700
Cost of sales	20,750	2,500	23,250	20,000	2,500	22,500	(750)
Gross profit	(20,950)	(2,500)	(23,450)	(20,000)	(2,500)	(22,500)
Administrative expenses	5,000	500	5,500	5,000	500	5,500
Net income	(15,950)	(2,000)	(17,950)	(15,000)	(2,000)	(17,000)

Cash	2,000	3,000	5,000	2,000	3,000	5,000
Receivables	8,700		8,700	7,000		7,000	(1,700)
Inventory	4,750	3,200	7,950	5,500	1,500	7,000	(950)
Accruals	1,000		1,000	1,000		1,000
Current assets	16,450	6,200	22,650	15,500	4,500	20,000
Financial assets: Investments	30,000		30,000	30,000		30,000
Financial assets: InterCo: Equity: ABC	10,000			10,000
Property plant and equipment	35,000	5,500	40,500	35,000	5,500	40,500
Financial assets: InterCo: Equity: ABC	30,000	3,000	33,000	30,000	3,000	33,000
Total assets	121,450	14,700	126,150	120,500	13,000	123,500

Payables	(5,000)	(1,700)	(6,700)	(5,000)		(5,000)	1,700
Loans	(20,000)		(20,000)	(20,000)		(20,000)
Total Liabilities	(25,000)	(1,700)	(26,700)	(25,000)		(25,000)
Paid in capital (XYZ)	(50,000)	(10,000)	(50,000)	(50,000)	(10,000)	(50,000)
Retained earnings (XYZ)	(46,450)	(3,000)	(49,450)	(45,500)	(3,000)	(48,500)
Total equity	(96,450)	(13,000)	(99,450)	(95,500)	(13,000)	(98,500)
Liabilities and equity	(121,450)	(14,700)	(126,150)	(120,500)	(13,000)	(123,500)

Note: the best way to make sure all InterCo items are easily identifiable is to use a CAO that keeps them completely segregated, even if this seems strange to some people.

This approach is especially useful at helping identify InterCo balances hiding in inventory or PP&E where separate InterCo accounts are (unlike for revenue, expenses, receivables or payables) rarely set up.

Separate InterCo accounts are commonly set up for loans, receivables, payables and similar balance sheet items. They are rarely used in inventory, PP&E and other non-monetary items even though it could be done.

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	2,000	Cash	3,000		5,000
Receivables	7,000	Receivables			7,000
A/R (InterCo)	1,700			(1,700)
Inventory	5,500	Inventory	1,500		7,000
Inventory (InterCo)	(750)			750
		Inventory (InterCo)	1,700	(1,700)
Accruals	1,000	Accruals			1,000
Current assets	16,450	Current assets	6,200		20,000
Financial assets: Investments	30,000	Financial assets: Investments			30,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	121,450	Total assets	14,700		123,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(96,450)	Total equity	(13,000)		(98,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(123,500)

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	2,000	Cash	3,000		5,000
Receivables	7,000	Receivables			7,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	16,450	Current assets	6,200		20,000
Financial assets: Investments	30,000	Financial assets: Investments			30,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	121,450	Total assets	14,700		123,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(96,450)	Total equity	(13,000)		(98,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(123,500)

InterCo Revenue - InterCo COS = InterCo Profit.

As stated in IAS 10.B86.c ... profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full ...

While ASC 810-10-45-1 is not as specific, it does state:... consolidated financial statements ... shall not include gain or loss on transactions among the entities in the consolidated group. Accordingly, any intra-entity profit or loss on assets remaining within the consolidated group [like inventory] shall be eliminated...

Consequently, consolidated revenue was reduced by 1,700, consolidated cost of sales by 750 and the remaining 950, the intra-entity profit that had been recognized in inventory, was deducted from inventory.

Note: eliminating InterCo Revenue and InterCo COS decrease InterCo Profit, which is carried over into consolidated retained earnings. Consequently, an adjustment to retained earnings does not appear in the adjustments column.

Once all the InterCo balances had been eliminated, consolidated financial statements could be prepared.

XYZ / ABC
Revenue	45,000
Cost of sales	22,500
Gross profit	22,500
Administrative expenses	5,500
Net income	17,000

Cash	5,000
Receivables	7,000
Inventory	7,000
Accruals	1,000
Current assets	20,000
Financial assets: Investments	30,000
Property plant and equipment	40,500
Intangible assets	33,000
Total assets	123,500

Payables	5,000
Loans	20,000
Total Liabilities	25,000
Paid in capital	50,000
Retained earnings	48,500
Total equity	98,500
Liabilities and equity	123,500

In addition, XYZ and ABC could have also prepared individual financial statements.

XYZ		ABC
Revenue	41,700	Revenue	5,000
Cost of sales	20,750	Cost of sales	2,500
Gross profit	20,950	Gross profit	2,500
Administrative expenses	5,000	Administrative expenses	500
Net income	15,950	Net income	2,000

Cash	2,000	Cash	3,000
Receivables	8,700	Receivables
Inventory	4,750	Inventory	3,200
Accruals	1,000	Accruals
Current assets	16,450	Current assets	6,200
Financial assets: Investments	40,000	Financial assets: Investments
Property plant and equipment	35,000	Property plant and equipment	5,500
Intangible assets	30,000	Intangible assets	3,000
Total assets	121,450	Total assets	14,700

Payables	5,000	Payables	1,700
Loans	20,000	Loans
Total Liabilities	25,000	Total Liabilities	1,700
Paid in capital (XYZ)	50,000	Paid in capital (ABC)	10,000
Retained earnings (XYZ)	46,450	Retained earnings (ABC)	3,000
Total equity	96,450	Total equity	13,000
Liabilities and equity	121,450	Liabilities and equity	14,700

Setting up and consolidating a subsidiary: debt, equity, interest & dividends

At the beginning of period one, XYZ set up a new subsidiary investing 5,000 and loaning 5,000. The annual interest rate on the loan was 10%.

Financial assets: InterCo: Equity: ABC		5,000
Financial assets: InterCo: Loan: ABC		5,000
	Cash		5,000

Inventory		1,500
License		3,000
Equipment, Furniture		5,500
	Cash		10,000

To improve readability, no interest was accrued in period one.

As no transactions between XYZ and ABC occurred, only the InterCo investment and loan were eliminated.

XYZ		ABC		Adj.	XYZ / ABC
Cash	1,000	Cash			1,000
Receivables	5,000	Receivables			5,000
Inventory	10,000	Inventory	1,500		11,500
Accruals	1,000	Accruals			1,000
Current assets	17,000	Current assets	1,500		18,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Debt: ABC	5,000			(5,000)
Financial assets: InterCo: Equity: ABC	5,000			(5,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	100,000	Total assets	10,000		100,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
		Loans: InterCo: XYZ	(5,000)	5,000
Total Liabilities	(25,000)	Total Liabilities	(5,000)		(25,000)
Paid in capital (XYZ)	(50,000)	Paid in capital (ABC)	(5,000)	5,000	(50,000)
Retained earnings (XYZ)	(25,000)	Retained earnings (ABC)			(25,000)
Total equity	(75,000)	Total equity	(5,000)		(75,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(100,000)

In period two, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000
Cash		3,000
	Receivables		3,000

ABC
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
Financial assets: InterCo: Debt: ABC		500
	Interest (InterCo)		500

ABC
Interest (InterCo)		500
	Loans: InterCo (XYZ)		500

To improve readability, the transactions are presented in aggregate.

In addition to the investment and loan, InterCo interest was also eliminated.

While not semantically accurate, the term InterCo is used considerably more in practice than the term intragroup even by professional organizations that should know better.

Rather than swimming against this tide, this site refers to these items as InterCo, just like everyone else.

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Interest revenue (InterCo)	(500)			500
		Interest expense (InterCo)	500	(500)
Net income	(6,000)	Net income	(500)		(6,500)

Cash	19,000	Cash	1,000		20,000
Receivables	2,000	Receivables			2,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	22,500	Current assets	2,500		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Debt: ABC	5,500			(5,500)
Financial assets: InterCo: Equity: ABC	5,000			(5,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	106,000	Total assets	11,000		106,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
		Loans: InterCo: XYZ	(5,500)	5,500
Total Liabilities	(25,000)	Total Liabilities	(5,500)		(25,000)
Paid in capital (XYZ)	(50,000)	Paid in capital (ABC)	(5,000)	5,000	(50,000)
Retained earnings (XYZ)	(31,000)	Retained earnings (ABC)	(500)		(31,500)
Total equity	(81,000)	Total equity	(5,500)		(81,500)
Liabilities and equity	(106,000)	Liabilities and equity	(11,000)		(106,500)

Instead of letting it compound, ABC could have paid out the interest.

XYZ
Cash		500
	Interest (InterCo)		500

ABC
Interest (InterCo)		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Interest revenue (InterCo)	(500)			500
		Interest expense (InterCo)	500	(500)
Net income	(6,000)	Net income	(500)		(6,500)

Cash	19,500	Cash	500		20,000
Receivables	2,000	Receivables			2,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	23,000	Current assets	2,000		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Debt: ABC	5,000			(5,000)
Financial assets: InterCo: Equity: ABC	5,000			(5,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	106,000	Total assets	10,500		106,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
		Loans: InterCo: XYZ	(5,000)	5,000
Total Liabilities	(25,000)	Total Liabilities	(5,000)		(25,000)
Paid in capital (XYZ)	(50,000)	Paid in capital (ABC)	(5,000)	5,000	(50,000)
Retained earnings (XYZ)	(31,000)	Retained earnings (ABC)	(500)		(31,500)
Total equity	(81,000)	Total equity	(5,500)		(81,500)
Liabilities and equity	(106,000)	Liabilities and equity	(10,500)		(106,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		22,000
	Cash		22,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

ABC also borrowed 5,000 to acquire additional equipment. During the period, it paid 50 in interest on this loan.

ABC
Property plant and equipment		5,000
	Loan		5,000
Interest expense		50
	Cash		50

Between themselves

XYZ
A/R (InterCo)		1,700
	Revenue (InterCo)		1,700
COS (InterCo)		750
	Inventory		750
Financial assets: InterCo: Debt: ABC		500
	Interest revenue (InterCo)		500
Cash		1,200
	InterCompany dividend (ABC)		1,200

ABC
Inventory		1,700
	A/P (Interco)		1,700
Interest expense (InterCo)		500
	Loans: InterCompany (XYZ)		500
Retained earnings (dividends ABC)		1,200
	Cash		1,200

As transactions between XYZ and ABC occurred, they had to be eliminated.

While not semantically accurate, the term InterCo is used considerably more in practice than the term intragroup even by professional organizations that should know better.

Rather than swimming against this tide, this site refers to these items as InterCo, just like everyone else.

A supplemental discussion of how to identify the necessary adjustments is included in the first illustration.

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Interest revenue (InterCo)	(500)			500
		Interest expense	50		50
		Interest expense (InterCo)	500	(500)
Dividend (InterCo)	(1,200)			1,200
Net income	(17,650)	Net income	(1,450)		(16,950)

Cash	3,200	Cash	1,750		4,950
Receivables	7,000	Receivables			7,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	17,650	Current assets	4,950		19,950
Financial assets: Investments	30,000	Financial assets			30,000
Financial assets: InterCo: Debt: ABC	6,000			(6,000)
Financial assets: InterCo: Equity: ABC	5,000			(5,000)
Property plant and equipment	35,000	Property plant and equipment	10,500		45,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	123,650	Total assets	18,450		128,450

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans	(5,000)		(25,000)
		Loans: InterCo: XYZ	(6,000)	6,000
Total Liabilities	(25,000)	Total Liabilities	(12,700)		(30,000)
Paid in capital (XYZ)	(50,000)	Paid in capital (ABC)	(5,000)	5,000	(50,000)
Retained earnings (XYZ)	(48,650)	Retained earnings (ABC)	(750)		(48,450)
Total equity	(98,650)	Total equity	(5,750)		(98,450)
Liabilities and equity	(123,650)	Liabilities and equity	(18,450)		(128,450)

As the dividend was not ABC's expense, it was, unlike the Interco interest which was ABC's expense, eliminated with a single adjustment, which is why the adjustments column does not zero out.

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Business combination

At end beginning of period one, XYZ acquired ABC paying its previous owners 10,000 in cash and consolidated financial statements were prepared.

Important: for the sake of simplicity, this illustration assumes the book value of ABC's assets equaled their fair value.

In most cases, this is not true. The following examples thus illustrate more realistic scenarios.

A discussion of how to determine the fair value of an acquired entity's assets is provided at Non-Current Assets / Acquired in business combination.

Pre-acquisition XYZ		Pre-acquisition ABC		Adj.	Post acquisition ABC
Cash	18,000	Cash	200		200
Receivables	5,000	Receivables	300		300
Inventory	3,000	Inventory	1,000		1,000
Accruals	1,000	Accruals
Current assets	27,000	Current assets	1,500		1,500
Financial assets: Investments	8,000	Financial assets
Property plant and equipment	35,000	Property plant and equipment	5,500		5,500
Intangible assets	30,000	Intangible assets	3,000		3,000
Total assets	100,000	Total assets	10,000		10,000

Payables	(5,000)	Payables
Loans	(20,000)	Loans
Total Liabilities	(25,000)	Total Liabilities
Paid in capital	(50,000)	Paid in capital	(8,500)	(1,500)	(10,000)
Retained earnings	(25,000)	Retained earnings	(1,500)	1,500
Total equity	(75,000)	Total equity	(10,000)		(10,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(10,000)

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

Financial assets: InterCo: Equity: ABC		10,000
	Cash		10,000

XYZ		ABC		Adj.	XYZ / ABC
Cash	8,000	Cash	200		8,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	17,000	Current assets	1,500		18,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	100,000	Total assets	10,000		100,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(75,000)	Total equity	(10,000)		(75,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(100,000)

Share swap

Same facts except, instead of cash, XYZ paid for the acquisition with its own shares.

XYZ		ABC		Adj.	XYZ / ABC
Cash	18,000	Cash	200		18,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	27,000	Current assets	1,500		28,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	110,000	Total assets	10,000		110,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(60,000)	Paid in capital	(10,000)	10,000	(60,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(85,000)	Total equity	(10,000)		(85,000)
Liabilities and equity	(110,000)	Liabilities and equity	(10,000)		(110,000)

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Cash	16,000	Cash	1,000		17,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	22,500	Current assets	2,500		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	105,500	Total assets	11,000		106,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(1,000)		(31,500)
Total equity	(80,500)	Total equity	(11,000)		(81,500)
Liabilities and equity	(105,500)	Liabilities and equity	(11,000)		(106,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	5,000	Cash	3,000		8,000
Receivables	10,000	Receivables			10,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	22,450	Current assets	6,200		26,000
Financial assets: Investments	24,000	Financial assets			24,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	121,450	Total assets	14,700		123,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(96,450)	Total equity	(13,000)		(98,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(123,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Business combination with goodwill

At end beginning of period one, XYZ acquired ABC paying its previous owners 10,000 in cash. After it adjusted ABC's assets to reflect acquisition date fair value and recognized goodwill , consolidated financial statements were prepared.

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

Financial assets: InterCo: Equity: ABC		10,000
	Cash		10,000

Pre-acquisition XYZ		Pre-acquisition ABC		Adj.	Post acquisition ABC
Cash	18,000	Cash	200		200
Receivables	5,000	Receivables	300		300
Inventory	3,000	Inventory	1,000		1,000
Accruals	1,000	Accruals
Current assets	27,000	Current assets	1,500		1,500
Financial assets: Investments	8,000	Financial assets
Property plant and equipment	35,000	Property plant and equipment	4,500	1,000	5,500
Intangible assets	30,000	Intangible assets	1,000	1,000	2,000
		Goodwill		1,000	1,000
Total assets	100,000	Total assets	7,000		10,000

Payables	(5,000)	Payables
Loans	(20,000)	Loans
Total Liabilities	(25,000)	Total Liabilities
Paid in capital	(50,000)	Paid in capital	(5,500)	(4,500)	(10,000)
Retained earnings	(25,000)	Retained earnings	(1,500)	1,500
Total equity	(75,000)	Total equity	(7,000)		(10,000)
Liabilities and equity	(100,000)	Liabilities and equity	(7,000)		(10,000)

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

The 10,000 investment by XYZ increased ABC's paid in capital by 3,000, reflecting both the fair value adjustments to ABC’s fixed assets and the recognition of goodwill.

ABC's pre-acquisition retained earnings of 1,500 was eliminated.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

To save space, the adjustment and elimination are aggregated.

XYZ		ABC		Adj.	XYZ / ABC
Cash	8,000	Cash	200		8,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	17,000	Current assets	1,500		18,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	1,000		1,000
Total assets	100,000	Total assets	10,000		100,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(75,000)	Total equity	(10,000)		(75,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(100,000)

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Cash	16,000	Cash	1,000		17,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	22,500	Current assets	2,500		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	1,000		1,000
Total assets	105,500	Total assets	11,000		106,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(1,000)		(31,500)
Total equity	(80,500)	Total equity	(11,000)		(81,500)
Liabilities and equity	(105,500)	Liabilities and equity	(11,000)		(106,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	5,000	Cash	3,000		8,000
Receivables	10,000	Receivables			10,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	22,450	Current assets	6,200		26,000
Financial assets: Investments	24,000	Financial assets			24,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
Goodwill		Goodwill	1,000		1,000
Total assets	121,450	Total assets	14,700		123,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(96,450)	Total equity	(13,000)		(98,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(123,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Business combination with goodwill and assumed liabilities

At end beginning of period one, XYZ acquired ABC paying its previous owners 10,000 in cash and assuming 1,000 in liabilities. After it adjusted ABC's assets to reflect acquisition date fair value, recognized goodwill and the assumed liabilities, consolidated financial statements were prepared.

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

Financial assets: InterCo: Equity: ABC		10,000
	Cash		10,000

Pre-acquisition XYZ		Pre-acquisition ABC		Adj.	Post acquisition ABC
Cash	18,000	Cash	200		200
Receivables	5,000	Receivables	300		300
Inventory	3,000	Inventory	1,000		1,000
Accruals	1,000	Accruals
Current assets	27,000	Current assets	1,500		1,500
Financial assets: Investments	8,000	Financial assets
Property plant and equipment	35,000	Property plant and equipment	4,500	1,000	5,500
Intangible assets	30,000	Intangible assets	1,000	1,000	2,000
		Goodwill		2,000	2,000
Total assets	100,000	Total assets	7,000		11,000

Payables	(5,000)	Payables	(250)		(250)
Loans	(20,000)	Loans	(750)		(750)
Total Liabilities	(25,000)	Total Liabilities	(1,000)		(1,000)
Paid in capital	(50,000)	Paid in capital	(4,500)	(5,500)	(10,000)
Retained earnings	(25,000)	Retained earnings	(1,500)	1,500
Total equity	(75,000)	Total equity	(6,000)		(10,000)
Liabilities and equity	(100,000)	Liabilities and equity	(7,000)		(11,000)

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

The 10,000 investment by XYZ increased ABC's paid in capital by 4,000, reflecting the fair value adjustments to ABC’s fixed assets, and the recognition of goodwill and the assumed liabilities.

ABC's retained earnings of 1,500 was also eliminated.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

To save space, the adjustment and elimination are aggregated.

XYZ		ABC		Adj.	XYZ / ABC
Cash	8,000	Cash	200		8,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	17,000	Current assets	1,500		18,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	2,000		2,000
Total assets	100,000	Total assets	11,000		101,000

Payables	(5,000)	Payables	(250)		(5,250)
Loans	(20,000)	Loans	(750)		(20,750)
Total Liabilities	(25,000)	Total Liabilities	(1,000)		(26,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(75,000)	Total equity	(10,000)		(75,000)
Liabilities and equity	(100,000)	Liabilities and equity	(11,000)		(101,000)

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Cash	16,000	Cash	1,000		17,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	22,500	Current assets	2,500		25,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	2,000		2,000
Total assets	105,500	Total assets	12,000		107,500

Payables	(5,000)	Payables	(250)		(5,250)
Loans	(20,000)	Loans	(750)		(20,750)
Total Liabilities	(25,000)	Total Liabilities	(1,000)		(26,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(1,000)		(31,500)
Total equity	(80,500)	Total equity	(11,000)		(81,500)
Liabilities and equity	(105,500)	Liabilities and equity	(12,000)		(107,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	5,000	Cash	3,000		8,000
Receivables	10,000	Receivables			10,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	22,450	Current assets	6,200		26,000
Financial assets: Investments	24,000	Financial assets			24,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	2,000		2,000
Total assets	121,450	Total assets	15,700		124,500

Payables	(5,000)	Payables	(250)		(5,250)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans	(750)		(20,750)
Total Liabilities	(25,000)	Total Liabilities	(2,700)		(26,000)
Paid in capital	(50,000)	Paid in capital	(10,000)	10,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(96,450)	Total equity	(13,000)		(98,500)
Liabilities and equity	(121,450)	Liabilities and equity	(15,700)		(124,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Business combination with goodwill, share swap

At end beginning of period one, XYZ acquired ABC exchanging 1,000 of its shares for 5,000 ABC shares (its entire float). The market price of XYZ's shares was 10 per share. After it adjusted ABC's assets to reflect acquisition date fair value and recognized goodwill, consolidated financial statements were prepared.

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

Financial assets: InterCo: Equity: ABC		10,000
	Paid in capital		10,000

XYZ financed the transaction by issuing new shares.

A discussion how to determine the fair value shares is provided at Non-Current Assets / Goodwill.

Pre-acquisition XYZ		Pre-acquisition ABC		Adj.	Post acquisition ABC
Cash	1,000	Cash	200		200
Receivables	5,000	Receivables	300		300
Inventory	3,000	Inventory	1,000		1,000
Accruals	1,000	Accruals
Current assets	10,000	Current assets	1,500		1,500
Financial assets: Investments	1,000	Financial assets
Property plant and equipment	50,000	Property plant and equipment	4,500	1,000	5,500
Intangible assets	39,000	Intangible assets	1,000	1,000	2,000
		Goodwill		1,000	1,000
Total assets	100,000	Total assets	7,000		10,000

Payables	(5,000)	Payables
Loans	(20,000)	Loans
Total Liabilities	(25,000)	Total Liabilities
Paid in capital	(50,000)	Paid in capital	(5,500)	(4,500)	(10,000)
Retained earnings	(25,000)	Retained earnings	(1,500)	1,500
Total equity	(75,000)	Total equity	(7,000)		(10,000)
Liabilities and equity	(100,000)	Liabilities and equity	(7,000)		(10,000)

An illustration of how goodwill is determined is provided on the Non-Current Assets / Goodwill page.

The 10,000 investment by XYZ increased ABC's paid in capital by 3,000, reflecting both the fair value adjustments to ABC’s fixed assets and recognition of goodwill.

ABC's pre-acquisition retained earnings of 1,500 was eliminated.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

To save space, the adjustment and elimination are aggregated.

XYZ		ABC		Adj.	XYZ / ABC
Cash	1,000	Cash	200		1,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	10,000	Current assets	1,500		11,500
Financial assets: Investments	1,000	Financial assets			1,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	50,000	Property plant and equipment	5,500		55,500
Intangible assets	39,000	Intangible assets	2,000		41,000
		Goodwill	1,000		1,000
Total assets	110,000	Total assets	10,000		110,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(60,000)	Paid in capital	(10,000)	10,000	(60,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
Total equity	(85,000)	Total equity	(10,000)		(85,000)
Liabilities and equity	(110,000)	Liabilities and equity	(10,000)		(110,000)

An illustration of how goodwill is determined is provided at Non-Current Assets / Goodwill.

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Cash	9,000	Cash	1,000		10,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	15,500	Current assets	2,500		18,000
Financial assets: Investments	1,000	Financial assets			1,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	50,000	Property plant and equipment	5,500		55,500
Intangible assets	39,000	Intangible assets	2,000		41,000
		Goodwill	1,000		1,000
Total assets	115,500	Total assets	11,000		116,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(60,000)	Paid in capital	(10,000)	10,000	(60,000)
Retained earnings	(30,500)	Retained earnings	(1,000)		(31,500)
Total equity	(90,500)	Total equity	(11,000)		(91,500)
Liabilities and equity	(115,500)	Liabilities and equity	(11,000)		(116,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		38,000
Receivables		2,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Cash	1,000	Cash	3,000		4,000
Receivables	7,000	Receivables			7,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	15,450	Current assets	6,200		19,000
Financial assets: Investments	17,000	Financial assets			17,000
Financial assets: InterCo: Equity: ABC	10,000			(10,000)
Property plant and equipment	50,000	Property plant and equipment	5,500		55,500
Intangible assets	39,000	Intangible assets	2,000		41,000
		Goodwill	1,000		1,000
Total assets	131,450	Total assets	14,700		133,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(60,000)	Paid in capital	(10,000)	10,000	(60,000)
Retained earnings	(46,450)	Retained earnings	(3,000)		(48,500)
Total equity	(106,450)	Total equity	(13,000)		(108,500)
Liabilities and equity	(131,450)	Liabilities and equity	(14,700)		(133,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Non-controlling interest

At end beginning of period one, XYZ offered each of ABC's five owners 2,000 in cash for their share. Four accepted. Nevertheless, as XYZ gained power | control over ABC, consolidated financial statements were prepared.

Financial assets: InterCo: Equity: ABC		8,000
	Cash		8,000

Under in IFRS, consolidated is required if an investor has power over an investee.

IFRS guidance for how investments should be treated is relatively involved and spread over several standards.

In summary:

Step 1: investor evaluates interest in investee
	Step 1.A: investor has power (to direct relevant activities) over investee (IFRS 10.7.a)	Yes	Step 1.A.i
		No	Step 3
	Step 1.A.i: investor is (IFRS 10.18)	Principal	Step 1.B
		Agent	Stop: no consolidation
	Step 1.B: investor has exposure / right to variable returns (IFRS 10.7.b)	Yes	Step 1.C
		No	Step 3
	Step 1.C: investor has ability to use power to effect returns (IFRS 10.7.c)	Yes	Control confirmed: Step 2
		No	Step 3

Step 2: investor determines if control is shared
A third party (unrelated to investor) shares control (IFRS 11.4)	Yes	Step 3 (IFRS 11.7)
	No	Stop: consolidation (IFRS 10.19 / IFRS 12)

Step 3: investor evaluates joint control
	Joint control is contractually agreed (IFRS 11.7)	Yes	Joint arrangement: Step 4
		No	Significant influence (20% + ownership) exists (IFRS 11.25)	Yes	Stop: equity method (IAS 28.16 / IFRS 12)
				No	Step 7

Step 4: investor evaluates structure of joint arrangement
	Joint arrangement structured as separate vehicle (IFRS 11.B16)	Yes	Right to assets and obligations for liabilities (IFRS 11.15)	Joint operation: Step 5
			Right to net assets only (IFRS 11.16)	Joint venture: Step 6
		No	Joint operation: Step 5

Step 5: investor selects accounting policy for joint operation
	Joint control	Yes	Stop: share of assets, liabilities, revenue and expenses (formerly: proportional consolidation) (IFRS 11.20 / IFRS 12)
		No	Right to assets and obligations for liabilities (IFRS 11.23)	Yes	Stop: share of assets, liabilities, revenue and expenses
				No	Step 7

Step 6: investor selects accounting policy for joint venture
	Joint control	Yes	Stop: equity method
		No	Significant influence (IFRS 11.25)	Yes	Stop: equity method
				No	Step 7

Step 7: investor evaluates structured entity
	Investee is a structured entity (IFRS 12.6.d.ii)	Yes	Stop: fair value (IFRS 9 / IAS 39) and disclosure (IFRS 12)
		No	Stop: fair value (IFRS 9 / IAS 39)

Supplemental step: separate (individual) financial Statements
	The investor decides to publish separate financial statements	Yes	Apply IAS 27
		No	Do not apply IAS 27

Under US GAAP, consolidation is required if an investor controls an investee.

While US GAAP's guidance is also spread over several topics, it is fairly straight forward.

As a rule of thumb, an investor consolidates if it controls an investee (owns over 50%), uses the equity method if it has significant influence (owns 20% or more) and treats the investment as passive (ASC 321) in other situations.

The first paragraph of ASC 810-10-25 states (edited): ... consolidation is appropriate if a reporting entity has a controlling financial interest in another entity ... The usual condition for a controlling financial interest is ownership of a majority (> 50% not ≥ 50%) voting interest... .

The remainder of the topic discusses situations where a majority voting interest may not lead to consolidation.

It is important to remember that subsection ASC 810-10-15-13 to 17D (variable interest entities) is designed to make the Enron like structuring of investments with the intent to avoid disclosing risky endeavors impossible. In the same vein, ASC 810-10-15-18 to 22 covers the consolidation of entities controlled by contract.

Consequently, the > 50% threshold is not a bright line in any, but the plain vanilla scenarios illustrated in this example.

As outlined in ASC 323-10-15-8, an investment (direct or indirect) of 20% or more indicates the investor has significant influence. However, ASC 323-10-15-10 also outlines various facts and circumstances where a 20% or greater stake does not bring this influence.

Therefore, assuming XYZ intended to operate ABC without regard to the views of the minority investor, applying ASC 323-10-15-10.c (assuming the investor was required apply US GAAP) would obviate the investor of the need to use the equity method.

Important: for the sake of simplicity, this illustration assumes the book value of ABC's assets equaled their fair value.

In most cases, this is not true. The next example thus illustrates more realistic scenario.

An discussion of how to determine the fair value of an acquired entity's assets is provided at Non-Current Assets / Acquired in business combination.

Pre-acquisition XYZ		Pre-acquisition ABC		Adj.	Post acquisition ABC
Cash	18,000	Cash	200		200
Receivables	5,000	Receivables	300		300
Inventory	3,000	Inventory	1,000		1,000
Accruals	1,000	Accruals
Current assets	27,000	Current assets	1,500		1,500
Financial assets: Investments	8,000	Financial assets
Property plant and equipment	35,000	Property plant and equipment	5,500		5,500
Intangible assets	30,000	Intangible assets	3,000		3,000
Total assets	100,000	Total assets	10,000		10,000

Payables	(5,000)	Payables
Loans	(20,000)	Loans
Total Liabilities	(25,000)	Total Liabilities
Paid in capital	(50,000)	Paid in capital	(8,500)	500	(8,000)
Retained earnings	(25,000)	Retained earnings	(1,500)	1,500
		Minority interest		(1,700)	(1,700)
		Minority interest retained earnings		(300)	(300)
Total equity	(75,000)	Total equity	(10,000)		(10,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(10,000)

XYZ's share of ABC's equity was 8,000. The remainder was reclassified as a non-controlling interest.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

Note: unlike the previous illustrations, where XYZ could eliminate the entire R/E balance, here it had to retain the portion (300 = 1,500 x 20%) associated with the non-controlling interest.

As outlined in IFRS 3.19, a non-controlling (a.k.a. minority) interest may be measured at (a) its acquisition date fair value or (b) a proportionate share in the acquiree’s net assets, in that IFRS 3.B44 gives the acquirer the choice.

Since it was the simpler option, XYZ applied IFRS 3.19.b.

In contrast, ASC 805-20-30-1 does not give a choice. It requires the NCI to be measured at fair value.

Thus, rather than simply recognizing the NCI at 20% or 10,000, XYZ had to determine what the NCI was actually worth.

To do so, XYZ considered that, since ABC was not a traded entity, a valuation technique was, as outlined in ASC 805-20-30-1, appropriate.

Fortunately, after examining ABC's accounts, XYZ determined the book value of its assets (ABC had no liabilities) equaled their fair value. It also determined that the holder of the NCI, with a 20% stake, had not controlled ABC before the acquisition, so there was no control premium (ASC 805-20-30-8) to consider.

It thus concluded the NCI was worth 2,000 (in the following illustration, book value and fair value do not equal).

Note: as the portion of equity associated with the minority interest had no characteristics of a liability (ASC 810-10-45-17), the SEC’s guidance on "mezzanine equity" (ASC 480-10-S99-3A), was not applicable.

ABC's minority shareholders retained 20% of ABC's pre-acquisition capital or 2,000 on total.

Of that total, 300 (1,500 x 20%) was their share in ABC's pre-acquisition retained earnings.

XYZ		ABC		Adj.	XYZ / ABC
Cash	10,000	Cash	200		10,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	19,000	Current assets	1,500		20,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	100,000	Total assets	10,000		102,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
		Minority interest	(1,700)		(1,700)
		Minority interest retained earnings	(300)		(300)
Total equity	(75,000)	Total equity	(10,000)		(77,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(102,000)

Share swap

Instead of paying cash, XYZ acquired ABC exchanging 800 of its shares for 4,000 ABC shares (80% of its float). The market price of XYZ's shares was 10 per share.

XYZ		ABC		Adj.	XYZ / ABC
Cash	18,000	Cash	200		18,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	27,000	Current assets	1,500		28,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	108,000	Total assets	10,000		110,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(58,000)	Paid in capital	(8,000)	8,000	(58,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
		Minority interest	(1,700)		(1,700)
		Minority interest retained earnings	(300)		(300)
Total equity	(83,000)	Total equity	(10,000)		(85,000)
Liabilities and equity	(108,000)	Liabilities and equity	(10,000)		(110,000)

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Net income attributable to parent		Net income attributable to parent	(800)		(6,300)
Net income attributable to minority owner		Net income attributable to minority owner	(200)		(200)

Cash	18,000	Cash	1,000		19,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	24,500	Current assets	2,500		27,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	105,500	Total assets	11,000		108,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(800)		(31,300)
		Minority interest	(1,700)		(1,700)
		Minority interest retained earnings	(500)		(500)
Total equity	(80,500)	Total equity	(11,000)		(83,500)
Liabilities and equity	(105,500)	Liabilities and equity	(11,000)		(108,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Net income attributable to parent		Net income attributable to parent	(1,600)		(16,600)
Net income attributable to minority owner		Net income attributable to minority owner	(400)		(400)

Cash	7,000	Cash	3,000		10,000
Receivables	10,000	Receivables			10,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	24,450	Current assets	6,200		28,000
Financial assets: Investments	24,000	Financial assets			24,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	3,000		33,000
Total assets	121,450	Total assets	14,700		125,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(2,400)		(47,900)
		Minority interest	(1,700)		(1,700)
		Minority interest retained earnings	(900)		(900)
Total equity	(96,450)	Total equity	(13,000)		(100,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(125,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Non-controlling interest with goodwill

At end beginning of period one, XYZ acquired 80% of ABC's outstanding shares for 8,000. The remainder continued to trade. After determining the fair value of ABC's assets and the NCI, consolidated financial statements were prepared.

Pre-acquisition XYZ

Pre-acquisition ABC

Adj.

Post acquisition ABC

Cash

18,000

Cash

200

Receivables

5,000

Receivables

300

Inventory

3,000

Inventory

1,000

Accruals

1,000

Accruals

Current assets

27,000

Current assets

1,500

Financial assets: Investments

8,000

Financial assets

Property plant and equipment

35,000

Property plant and equipment

4,500

1,000

5,500

Intangible assets

30,000

Intangible assets

1,000

2,000

Goodwill

1,000

Total assets

100,000

Total assets

7,000

10,000

As outlined in IFRS 3.32 | ASC 805-30-30-1, goodwill is the difference between:

A:	Acquisition price of a business (ABC)
	Purchase price			8,000
	Non-controlling interest			2,000
B:	A business’s net assets	Pre-acquisition book value	Adjustment	Post-acquisition fair value
	Current assets	1,500	N/A	(1,500)
	Property plant and equipment	4,500	1,000	(5,500)
	Intangible assets	1,000	1,000	(2,000)
	Goodwill			1,000

As outlined in IFRS 3.32.a | ASC 805-30-30-1.a, the acquisition price comprises:

the fair value of the consideration transferred to the acquiree's previous owners
any non-controlling interest remaining with the acquiree's former owners
if acquired in stages, any previously held equity interest

As the consideration transferred was cash, determining its fair value was straight forward.

A discussion of fair value for non-cash consideration is available at: Non-Current Assets / Goodwill.

Note: as XYZ did not acquire ABC in stages, iii was not applicable.

As outlined in IFRS 3.32.a | ASC 805-30-30-1.a, the acquisition price comprises:

the fair value of the consideration transferred to the acquiree's previous owners
any non-controlling interest remaining with the acquiree's former owners
if acquired in stages, any previously held equity interest

While determining a purchase price is generally straight forward, the NCI can be more involved.

But not in this situation

Under IFRS 3.19, the NCI is measured at either (a) fair value or (b) a proportionate share of (net) assets.

Since the remainder of ABC's shares continued to trade, XYZ simply went in order and measured the NCI at its fair value which was equal to its market price on the date of the acquisition.

Various jurisdictions have various requirements and thresholds applicable to tenders, mergers, takeovers, stakebuilding, squeeze-outs, etc.

This illustration assumes ABC's jurisdiction did not require XYZ to acquire a 100% stake to complete the takeover.

From a US GAAP perspective, XYZ did not even need to decide since, under ASC 805-20-30-7, fair value is the only option.

Note: when considering if it was necessary to adjust the NCI to reflect the absence of a control premium (IFRS 3.B45 | ASC 805-20-30-8), XYZ concluded, as acquisition had been announced well before the acquisition-date, the market had priced this in.

Note: as XYZ did not acquire ABC in stages, iii was not applicable.

Also note: as the portion of equity associated with the minority interest had no characteristics of a liability (ASC 810-10-45-17), the SEC’s guidance on "mezzanine equity" (ASC 480-10-S99-3A), was not applicable.

As ABC had no liabilities, net assets = total assets.

As in this illustration, book value of current assets is often equal to their fair value so need not be adjusted.

See: Non-Current Assets / Acquired in business combination.

An illustration of how to determine the fair value of an acquiree’s PP&E is available at:

Non-Current Assets / Acquired in business combination

An illustration of how to determine the fair value of an acquiree’s intangible assets is available at:

Non-Current Assets / Acquired in business combination

Payables

(5,000)

Payables

Loans

(20,000)

Loans

Total Liabilities

(25,000)

Total Liabilities

Paid in capital

(50,000)

Paid in capital

(6,000)

(2,000)

(8,000)

Retained earnings

(25,000)

Retained earnings

(1,000)

1,000

Minority interest

(1,800)

Minority interest retained earnings

(200)

Total equity

(75,000)

Total equity

(7,000)

(10,000)

Liabilities and equity

(100,000)

Liabilities and equity

(7,000)

(10,000)

After the 3,000 fair value adjustment to ABC's assets and elimination of 80% of ABC's pre-acquisition retained earnings, XYZ's share in ABC had a value of 8,000.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

Note: unlike earlier illustrations, where XYZ could eliminate the entire R/E balance, here it had to retain the portion (200 = 1,000 x 20%) associated with the non-controlling interest.

After the 3,000 fair value adjustment to ABC's assets, ABC's minority shareholder’s share in ABC had a value of 2,000.

Of that amount, 200 was associated with their 20% stake in ABC's pre-acquisition retained earnings, which was not affected by the adjustment.

As the minority share of ABC's pre-acquisition retained earnings was 200 (1,000 x 20%), this amount was carried over.

If the NCI is traded, measuring its fair value (as illustrated above) is straight forward.

However, if it remains private hands, not so much.

This is because, in the absence of a market price, "other valuation techniques" (IFRS 13.B44 | 805-20-30-7) come into play.

Not only will this be more work, but will probably yield a different result.

Pre-acquisition XYZ

Pre-acquisition ABC

Adj.

Post acquisition ABC

Cash

18,000

Cash

200

Receivables

5,000

Receivables

300

Inventory

3,000

Inventory

1,000

Accruals

1,000

Accruals

Current assets

27,000

Current assets

1,500

Financial assets: Investments

8,000

Financial assets

Property plant and equipment

35,000

Property plant and equipment

4,500

1,000

5,500

Intangible assets

30,000

Intangible assets

1,000

2,000

Goodwill

Total assets

100,000

Total assets

7,000

9,000

As outlined in IFRS 3.32 | ASC 805-30-30-1, goodwill is the difference between:

A:	Acquisition price of a business (ABC)
	Purchase price			8,000
	Non-controlling interest			1,000
B:	A business’s net assets	Pre-acquisition book value	Adjustment	Post-acquisition fair value
	Current assets	1,500	N/A	(1,500)
	Property plant and equipment	4,500	1,000	(5,500)
	Intangible assets	1,000	1,000	(2,000)
	Goodwill			0

As outlined in IFRS 3.32.a | ASC 805-30-30-1.a, the acquisition price comprises:

the fair value of the consideration transferred to the acquiree's previous owners
any non-controlling interest remaining with the acquiree's former owners
if acquired in stages, any previously held equity interest

As the consideration transferred was cash, determining its fair value was straight forward.

A discussion of fair value for non-cash consideration is available at: Non-Current Assets / Goodwill.

Note: as XYZ did not acquire ABC in stages, iii was not applicable.

As outlined in IFRS 3.32.a | ASC 805-30-30-1.a, the acquisition price comprises:

the fair value of the consideration transferred to the acquiree's previous owners
any non-controlling interest remaining with the acquiree's former owners
if acquired in stages, any previously held equity interest

While determining a purchase price is generally straight forward, the NCI can be more involved.

As allowed under IFRS 3.19.a | required under ASC 805-20-30-1, XYZ measured the NCI at fair value.

To keep it simple, it assumed the absence of a control premium implied a fair value where no goodwill needed to be recognized. As there was no market price to support a different conclusion, XYZ's independent auditor accepted this (conservative) approach.

While there is, contrary to popular belief, no conservative principal, avoiding excessive valuation of assets, especially goodwill, is not something most auditors object to.

A discussion of why it is reasonable to minimize goodwill is provided at: Non-Current Assets / Acquired in business combination.

Rather than trying to keep it simple (above), XYZ decided to apply the guidance more rigorously.

US GAAP

Under ASC 805-20-30-1 and 7, the NCI must always be measured at fair value.

As ABC's shares were not traded, a quoted price in an active market, the easiest and most reliable way to determine fair value, was not available.

As a result, XYZ had to resort to "other valuation techniques."

To summarize, applying these techniques involves first determining the fair value of an acquiree’s net assets so a portion can be attributed to the NCI's share in these assets (IFRS 13.B3 | ASC 820-10-55-3 provide additional guidance on the valuation premise to be used in such a situation).

See fair value / expected present value for a summary fair value using valuations techniques.

See Non-Current Assets / Acquired in business combination for discussion of multi-period excess earnings, the valuation technique most suited to determining the fair value of a business and hence a minority shareholder's interest in that business.

Fortunately, since the fair of net assets is determined during the acquisition anyway, this step did not need to be repeated.

Second, it also involves estimating an acquiree’s future profits so a portion of (the present value of) these can be attributed to the NCI.

This is more involved and comparable to how excess future earnings are used to measure the fair value of stand-alone assets such as patents, copyrights or unpatented technology acquired in business combinations.

The difference, as the acquiree is a business not a stand-alone asset, it involves evaluating not only the future profitability of the business. But, and this is the kicker, not from the perspective of the acquirer from that of the holders of the NCI.

As outlined in IFRS 13.B13 | ASC 820-10-55-5, the fair value of an asset determined using a present value technique captures valuation elements from the perspective of market participant.

As, in this instance the market participant is the minority owner, this implies the acquiror must evaluate how the minority owner(s) feels about not being able to control the entity and incorporate these feeling into the estimate of how they would value their share.

For completeness, the valuation elements discussed in IFRS 13.B13 | ASC 820-10-55-5 are:

An estimate of future cash flows
Expectations about possible variations in the amount and timing of those cash flows
The time value of money (a.k.a. risk-free rate)
The price for bearing the uncertainty inherent in the cash flows (a.k.a. risk premium)
Other factors that market participants would take into account (e.g. the absence of a control premium)
Risk of bankruptcy

Note: item f. discusses the nonperformance (a.k.a. default) risk of a liability.

As applied to the issue at hand, this would translate into bankruptcy risk.

These holders not only consider the potential profitability of acquiree, but also how being controlled by a separate company, presumably interested in maximizing its own profits, will influence that profitability (a.k.a. absence of a control premium: ASC 805-20-30-8 | IFRS B45).

Conclusion

After applying the guidance to the facts, XYZ arrived at a valuation where no goodwill was recognized.

IFRS

Like US GAAP, IFRS 3.19.a allows fair value, so the above approach can be used.

In addition, an acquirer may measure the NCI at a proportionate share of net assets (IFRS 3.19.b).

Note: this guidance only applies to those components of the non-controlling interests that represent present ownership interests and entitle their holders to a proportionate share of the acquiree’s net assets in the event of liquidation. All other components of non-controlling interests are measured at their acquisition-date fair values (unless another measurement basis is required by a different standard).

After considering that the proportionate share [(1,500 + 5,500 + 2,000) x 20% = 1,800] not only differed from fair value, but would result in goodwill recognition, XYZ elected apply IFRS 3.19.a.

Note: as XYZ did not acquire ABC in stages, iii was not applicable.

As ABC had no liabilities, net assets = total assets.

As in this illustration, book value of current assets is often equal to their fair value so need not be adjusted.

See: Non-Current Assets / Acquired in business combination.

An illustration of how to determine the fair value of an acquiree’s PP&E is available at:

Non-Current Assets / Acquired in business combination

An illustration of how to determine the fair value of an acquiree’s intangible assets is available at:

Non-Current Assets / Acquired in business combination

Payables

(5,000)

Payables

Loans

(20,000)

Loans

Total Liabilities

(25,000)

Total Liabilities

Paid in capital

(50,000)

Paid in capital

(6,000)

(2,000)

(8,000)

Retained earnings

(25,000)

Retained earnings

(1,000)

1,000

Minority interest

(800)

Minority interest retained earnings

(200)

Total equity

(75,000)

Total equity

(7,000)

(9,000)

Liabilities and equity

(100,000)

Liabilities and equity

(7,000)

(9,000)

After the 2,000 fair value adjustment to ABC's assets and elimination of 80% of ABC's pre-acquisition retained earnings, XYZ's share in ABC had a value of 8,000 as previously.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

After the 2,000 fair value adjustment to ABC's assets, ABC's minority shareholder’s share in ABC had a value of only 1,000 (as discussed above).

However, their share of ABC's pre-acquisition retained earnings, determined by their 20% share of ABC's equity, remained unchanged at 200.

7,000 x 20% = 1,400, 1,400 + 600 = 2,000 of that 2,000, 200 (1,000 x 20%) is carried over as retained earnings. The remainder as the NCI\s share on paid in capital.

As the minority share of ABC's pre-acquisition retained earnings was 200 (1,000 x 20%), this amount was carried over.

XYZ		ABC		Adj.	XYZ / ABC
Cash	10,000	Cash	200		10,200
Receivables	5,000	Receivables	300		5,300
Inventory	3,000	Inventory	1,000		4,000
Accruals	1,000	Accruals			1,000
Current assets	19,000	Current assets	1,500		20,500
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	1,000		1,000
Total assets	100,000	Total assets	10,000		102,000

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(25,000)	Retained earnings			(25,000)
		Minority interest	(1,800)		(1,800)
		Minority interest retained earnings	(200)		(200)
Total equity	(75,000)	Total equity	(10,000)		(77,000)
Liabilities and equity	(100,000)	Liabilities and equity	(10,000)		(102,000)

In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ
Inventory		7,000
	Cash		7,000
Cash		20,000
	Revenue		20,000
Cost of sales		9,500
	Inventory		9,500
Administrative expenses		5,000
	Cash		5,000

ABC
Cash		300
	Receivables		300
Inventory		500
	Cash		500
Cash		3,000
	Revenue		3,000
Cost of sales		1,500
	Inventory		1,500
Administrative expenses		500
	Cash		500

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(20,000)	Revenue	(3,000)		(23,000)
Cost of sales	9,500	Cost of sales	1,500		11,000
Gross profit	(10,500)	Gross profit	(1,500)		(12,000)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(5,500)	Net income	(1,000)		(6,500)

Net income attributable to parent		Net income attributable to parent	(800)		(6,300)
Net income attributable to minority owner		Net income attributable to minority owner	(200)		(200)

Cash	18,000	Cash	1,000		19,000
Receivables	5,000	Receivables			5,000
Inventory	500	Inventory	1,500		2,000
Accruals	1,000	Accruals			1,000
Current assets	24,500	Current assets	2,500		27,000
Financial assets: Investments	8,000	Financial assets			8,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	1,000		1,000
Total assets	105,500	Total assets	11,000		108,500

Payables	(5,000)	Payables			(5,000)
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities			(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(30,500)	Retained earnings	(800)		(31,300)
		Minority interest	(1800)		(1,800)
		Minority interest retained earnings	(400)		(400)
Total equity	(80,500)	Total equity	(11,000)		(83,500)
Liabilities and equity	(105,500)	Liabilities and equity	(11,000)		(108,500)

In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ
Inventory		25,000
	Cash		25,000
Cash		35,000
Receivables		5,000
	Revenue		40,000
Cost of sales		20,000
	Inventory		20,000
Administrative expenses		5,000
	Cash		5,000
Financial assets		16,000
	Cash		16,000

ABC
Inventory		2,500
	Cash		2,500
Cash		5,000
	Revenue		5,000
Cost of sales		2,500
	Inventory		2,500
Administrative expenses		500
	Cash		500

Between themselves

XYZ
A/R (Interco)		1,700
	Revenue (Interco)		1,700
COS (Interco)		750
	Inventory		750

ABC
Inventory		1,700
	A/P (Interco)		1,700

XYZ		ABC		Adj.	XYZ / ABC
Revenue	(40,000)	Revenue	(5,000)		(45,000)
Revenue (InterCo)	(1,700)			1,700
Cost of sales	20,000	Cost of sales	2,500		22,500
COS (InterCo)	750			(750)
Gross profit	(20,950)	Gross profit	(2,500)		(22,500)
Administrative expenses	5,000	Administrative expenses	500		5,500
Net income	(15,950)	Net income	(2,000)		(17,000)

Net income attributable to parent		Net income attributable to parent	(1,600)		(16,600)
Net income attributable to minority owner		Net income attributable to minority owner	(400)		(400)

Cash	7,000	Cash	3,000		10,000
Receivables	10,000	Receivables			10,000
A/R (InterCo)	1,700			(1,700)
Inventory	4,750	Inventory	3,200	(950)	7,000
Accruals	1,000	Accruals			1,000
Current assets	24,450	Current assets	6,200		28,000
Financial assets: Investments	24,000	Financial assets			24,000
Financial assets: InterCo: Equity: ABC	8,000			(8,000)
Property plant and equipment	35,000	Property plant and equipment	5,500		40,500
Intangible assets	30,000	Intangible assets	2,000		32,000
		Goodwill	1,000		1,000
Total assets	121,450	Total assets	14,700		125,500

Payables	(5,000)	Payables			(5,000)
		A/P (InterCo)	(1,700)	1,700
Loans	(20,000)	Loans			(20,000)
Total Liabilities	(25,000)	Total Liabilities	(1,700)		(25,000)
Paid in capital	(50,000)	Paid in capital	(8,000)	8,000	(50,000)
Retained earnings	(46,450)	Retained earnings	(2,400)		(47,900)
		Minority interest	(1,800)		(1,800)
		Minority interest retained earnings	(800)		(800)
Total equity	(96,450)	Total equity	(13,000)		(100,500)
Liabilities and equity	(121,450)	Liabilities and equity	(14,700)		(125,500)

A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

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