CHAPTER 5

Consolidation Subsequent to Acquisition Date

Advanced Financial Accounting — Study Notes

Learning Objectives

LO1 Perform impairment tests on PP&E, intangible assets, and goodwill

Prepare schedules to allocate and show changes to the acquisition differential (annual
LO2
& cumulative)
Prepare consolidated financial statements using the fair value enterprise method
LO3
subsequent to acquisition
Prepare consolidated financial statements using the identifiable net assets method
LO4
subsequent to acquisition
Prepare journal entries and calculate the balance in the investment account under the
LO5
equity method
Analyze and interpret financial statements involving consolidations subsequent to
LO6
acquisition
LO7 (Appendix 5A) Perform impairment test for goodwill in complex situations
(Appendix 5B) Prepare consolidated financial statements using the working paper
LO8
approach

1. Introduction
This chapter extends consolidation from the acquisition date (Chapters 3 & 4) to subsequent fiscal
year-ends. The acquisition differential must be depleted/tested for impairment each year, and the
consolidated income statement, retained earnings statement, and balance sheet must be prepared.

★ Core Concept: The acquisition differential must be depleted and tested for impairment
when preparing consolidated financial statements subsequent to the date of acquisition.
2. Methods of Accounting for an Investment in a Subsidiary
After acquisition, a parent chooses between two methods in its own internal records for accounting for
its subsidiary investment:

Feature Cost Method Equity Method

Income recognition When dividend is declared (right to Parent's share of subsidiary's net
receive) income each period

Investment account Remains at original cost (only Adjusted each period for share of
adjusted for impairment) income, dividends, and OCI

Complexity Simple — usually one entry per More complex — multiple entries
year required

Use case Most common for internal records Used when entity wants to capture
subsidiary income without
consolidating

IFRS reference IAS 27 (separate entity statements) IAS 28 (associates and

subsidiaries)

★ Key Rule: Consolidated net income will be the SAME whether the parent used the cost
method or the equity method in its internal records — the final consolidated statements are
identical.

2.1 The Cost Method

The investment is initially recorded at cost. Income from the subsidiary is recognized in net income only
when the investor's right to receive a dividend is established (usually when declared).

Investment recorded at cost; income recognized when dividends

Cost Method declared. Only entry typically made each year: debit Dividend
Receivable / credit Dividend Income.

• Investment account stays at original cost (unless impaired)

• If subsidiary's net income is high but no dividends are paid, parent records NO income
• Occasional impairment loss entry may also be required

2.2 The Equity Method

Defined by IAS 28: investment initially recognized at cost, then adjusted for the post-acquisition change
in the investor's share of net assets of the investee.

Investment adjusted each period for: (1) investor's share of profit/loss,

Equity Method (2) dividends received (reduce carrying amount), and (3) share of other
comprehensive income (OCI).
The equity method captures the net effect of any adjustments that would be made on the consolidated
financial statements. If used fully and correctly:
• Parent's net income under equity method = consolidated net income attributable to parent's
shareholders
• Parent's retained earnings under equity method = consolidated retained earnings
• Difference: consolidated statements show subsidiary's values line-by-line; equity method shows
net amount on one line (investment in subsidiary)

★ Tax Note: Dividend income and equity method income are usually NOT taxable to the
investor because tax was assessed at the investee level. CRA is indifferent to which method
is used on separate-entity statements.

2.3 Three Sets of Records / Statements

There are three distinct sets of records to keep in mind:

Set # Entity Description

Parent Parent's internal general ledger. Investment in subsidiary recorded

1 using cost or equity method.

Subsidiary Subsidiary's own internal general ledger. Shows subsidiary's

2 assets, liabilities, revenues, and expenses.

Consolidated Combined statements prepared for external users (the large circle
3 containing both). Eliminates investment account and intercompany
transactions.

3. Consolidated Income & Retained Earnings Statements

The consolidated statement of comprehensive income is prepared by combining, on an item-by-item
basis, the revenues, expenses, and OCI of parent and subsidiary. The parent's investment income from
the subsidiary does NOT appear; instead it is replaced by the subsidiary's actual revenues and
expenses.

3.1 Formula for Consolidated Net Income

Consolidated Net Income (any fiscal period)

Parent net income (own operations, excl. investment income) $ XXX
+ Net income of the subsidiary XXX
+/- Change in the acquisition differential (XXX)
─────
= Consolidated net income $ XXX
 Attributable to:
Shareholders of parent company $ XXX
Noncontrolling interest (NCI) XXX

The 'change in the acquisition differential' is subtracted when it decreases (amortization, impairment)
and added when it increases.

3.2 Acquisition Differential — Depletion Rules

The acquisition differential is allocated to identifiable assets/liabilities at acquisition. It must
subsequently be:

Asset Type Treatment of Differential Where Reflected

PP&E / intangibles with finite Amortized over useful life Depreciation/amortization

life expense on consolidated income
statement

Inventory Derecognized (expensed) when Cost of goods sold on

sold consolidated income statement

Land Not amortized; written down only Impairment loss or gain/loss on

if impaired or derecognized sale
when sold

Goodwill / indefinite-life NOT amortized; tested for Impairment loss on consolidated

intangibles impairment annually (or when income statement
indicators exist)

★ Important: The depletion of the acquisition differential is reflected on the

CONSOLIDATED financial statements — NOT on the subsidiary's own financial statements.

3.3 Consolidated Retained Earnings

• On the date of acquisition: consolidated retained earnings = parent's retained earnings ONLY
• Subsequent to acquisition: reflects the parent's shareholders' share of the combined entity's
operations
• NCI's share is tracked in a separate NCI account within shareholders' equity on the consolidated
balance sheet
• Dividends paid by a subsidiary to the parent are ELIMINATED (intercompany transaction — no
net change to consolidated entity)
• Only dividends declared by the parent to its outside shareholders reduce consolidated retained
earnings
4. Testing Goodwill and Other Assets for Impairment (LO1)
Governed by IAS 36 Impairment of Assets. An asset is impaired if its carrying amount exceeds its
recoverable amount.

4.1 Key Definitions

The amount by which the carrying amount of an asset (or CGU)

Impairment Loss exceeds its recoverable amount. Reported in net income (unless
revaluation model applies).

Recoverable The HIGHER of: (1) Fair Value Less Costs of Disposal (FVLCD), and
Amount (2) Value in Use (VIU).

Fair Value Price that would be received to sell an asset in an orderly transaction
(FVLCD) at the measurement date (exit price), less disposal costs.

Present value of future cash flows expected from the asset or group of
Value in Use (VIU)
assets (including disposal).

Smallest identifiable group of assets that generates cash inflows

Cash-Generating
largely independent of other assets. Used when cash flows cannot be
Unit (CGU)
associated with a single asset.

★ Note: It is possible for an asset NOT to be impaired at the subsidiary level but to BE
impaired at the consolidated level, because fair values on the consolidated statements are
often higher due to the acquisition differential.

4.2 Three Categories Under IAS 36

Category 1: PP&E and Intangibles with Definite Useful Lives

• Tested for impairment only when there are indicators that impairment may exist (two-step
approach)
• Step 1: Assess whether indicators exist at each reporting date
• Step 2: If indicators exist, determine recoverable amount and compare to carrying amount
• If carrying amount > recoverable amount → record impairment loss

Category 2: Intangible Assets with Indefinite Useful Lives (or Not Yet Available for Use)
• Must be tested for impairment ANNUALLY, regardless of whether indicators exist
• Also tested whenever there is an indication of possible impairment
 • Example: brand names, mastheads, customer lists with no foreseeable end

Category 3: Cash-Generating Units (CGUs) and Goodwill

• Goodwill must be allocated to CGUs (or groups of CGUs) at acquisition
• Each CGU with allocated goodwill is tested ANNUALLY for impairment

Goodwill Impairment Test

Recoverable amount of CGU $ XXX
Less: Carrying amount of CGU (including allocated goodwill) (XXX)
─────
If negative → Impairment loss $ XXX

Allocation of impairment loss (in order):

1. First reduce goodwill allocated to the CGU to zero
2. Then reduce other assets of the CGU pro rata

• Goodwill impairment losses are NEVER reversed in a subsequent period

• Impairment losses on other assets CAN be reversed if circumstances change (IAS 36)

5. Consolidation — Fair Value Enterprise Method (LO2 & LO3)

Under the fair value enterprise method, NCI is measured at its fair value at the date of acquisition (i.e.,
a proportionate share of the total enterprise value, not just identifiable net assets). This means goodwill
includes both the parent's and the NCI's share.

5.1 Acquisition Differential Schedule

An annual schedule tracks the allocation and depletion of the acquisition differential. It has two parts:
an annual schedule and a cumulative schedule.

Structure of Acquisition Differential Schedule

Balance Annual Cumulative
at Acq. Change Balance
─────────────────────────────────────────────────────────────
Inventory X,XXX (X,XXX) 0 [sold]
Equipment (net, 5-yr life) X,XXX (XXX) (XXX)
Patent (10-yr life) X,XXX (XXX) (XXX)
Land X,XXX 0 X,XXX
Goodwill X,XXX impair? X,XXX
─────────────────────────────────────────────────────────────
Total acquisition diff. X,XXX (X,XXX) X,XXX

• The 'Annual Change' column flows through to reduce consolidated net income each year
 • The 'Cumulative Balance' shows the remaining unamortized/unimpaired differential still on the
consolidated balance sheet

5.2 100%-Owned Subsidiary — Direct Approach (Year 5 Example)

Steps for preparing consolidated statements in Year 5 (end of first year after acquisition):

1. Calculate consolidated net income using the formula (parent own ops + subsidiary net income +/-
acquisition differential changes)
2. Prepare the consolidated retained earnings statement (opening balance + net income attributable
to parent − dividends declared by parent)
3. Combine the balance sheets of parent and subsidiary, line by line, substituting fair values for
items in the acquisition differential, and eliminating the investment account against subsidiary
equity
4. Add remaining unamortized acquisition differential items to the relevant asset/liability lines on the
consolidated balance sheet
5. Present NCI (if applicable) as a separate component of equity

5.3 80%-Owned Subsidiary — Direct Approach (LO3)

When parent owns less than 100%, a Noncontrolling Interest (NCI) appears on the consolidated
balance sheet and income statement.

NCI Calculation — Fair Value Enterprise Method

NCI at acquisition (fair value) $ XXX
+ NCI's share of subsidiary net income (each year) XXX
− NCI's share of dividends paid by subsidiary (XXX)
+/− NCI's share of acquisition differential changes (XXX)
─────
= NCI balance at end of period $ XXX

★ NCI Income: NCI's share of consolidated net income = NCI% × (subsidiary net income
+/- NCI's share of acquisition differential changes).

6. Consolidation — Identifiable Net Assets Method (LO4)

Under the identifiable net assets (INA) method, NCI is measured at its proportionate share of the
subsidiary's identifiable net assets (fair value) at acquisition — NOT at full fair value. This means
goodwill belongs entirely to the parent; the NCI does not get a share of goodwill.

Item Fair Value Enterprise Method INA Method

NCI measurement at Fair value of NCI (includes NCI's NCI% × fair value of identifiable
acquisition share of goodwill) net assets (NO goodwill share)
 Goodwill Reflects 100% of goodwill (parent Only the parent's portion of
+ NCI portions) goodwill

NCI on balance sheet Larger (includes NCI's goodwill Smaller (excludes NCI's goodwill
share) share)

Impairment of goodwill Allocated between parent and Only allocated to parent (NCI has
NCI no goodwill)

Consolidated net income SAME under both methods SAME under both methods
attributable to parent

7. Equity Method — Journal Entries (LO5)

When the parent uses the equity method in its own internal records, it makes the following entries each
period:

Event Journal Entry

Subsidiary earns net income Dr. Investment in Subsidiary Cr. Equity Method
Income (% ownership × subsidiary net income)

Subsidiary declares/pays Dr. Dividends Receivable / Cash Cr. Investment

dividend in Subsidiary (% ownership × dividend declared)

Amortization of acquisition Dr. Equity Method Income Cr. Investment in

differential (annual) Subsidiary (parent's % × annual depletion of
acquisition diff.)

Impairment of goodwill Dr. Equity Method Income (or Impairment Loss)

Cr. Investment in Subsidiary (parent's % ×
impairment amount)

Subsidiary has OCI Dr./Cr. Investment in Subsidiary Cr./Dr. OCI —

Equity Method Investee (% ownership × subsidiary
OCI)

★ Verification: Under the equity method, the balance in the investment account at any date
equals: [original cost] + [cumulative equity method income] − [cumulative dividends received]
+/− [cumulative OCI adjustments] − [cumulative acquisition differential depletion].

8. Key Terms Quick Reference

Term Definition

Acquisition Differential Excess of purchase price over the book value of the subsidiary's net
assets; allocated to identifiable assets/liabilities at FV, with remainder
as goodwill
Noncontrolling Interest Portion of the subsidiary's equity not owned by the parent; presented
(NCI) as a separate component of consolidated equity

Cost Method Parent records investment at cost; income recognized when dividends
declared by subsidiary

Equity Method Investment adjusted each period for parent's share of subsidiary's net
income, dividends, OCI, and acquisition differential changes

IAS 36 IFRS standard governing impairment of assets; requires annual

impairment test for goodwill and indefinite-life intangibles

CGU Cash-Generating Unit; smallest identifiable group of assets generating

largely independent cash inflows; used for impairment testing

FVLCD Fair Value Less Costs of Disposal; one of two measures used to
determine recoverable amount

VIU Value in Use; present value of future cash flows expected from an
asset or CGU

Recoverable Amount Higher of FVLCD and VIU; carrying amount must not exceed this

Fair Value Enterprise NCI measured at full fair value at acquisition (includes NCI's share of
Method goodwill)

INA Method Identifiable Net Assets method; NCI measured at NCI% × fair value of
identifiable net assets (no goodwill for NCI)

Separate-Entity Nonconsolidated financial statements of the parent alone (required for

Statements tax purposes in Canada)

9. Exam Tips & Common Pitfalls

❌ Common Mistakes ✓ Correct Approach

Forgetting to subtract the annual depletion of the Always prepare the acquisition differential
acquisition differential from consolidated net schedule first and identify the annual change
income column

Including subsidiary dividends paid to parent in Eliminate all intercompany dividends — they
consolidated statements cancel out within the consolidated entity

Confusing NCI on income statement vs. balance NCI on income statement = NCI% × subsidiary
sheet net income (+/- NCI's share of acq. diff. changes).
NCI on balance sheet is a cumulative running
total

Amortizing goodwill under IFRS Goodwill is NEVER amortized under IFRS (IAS
36) — it is tested for impairment annually

Reversing a goodwill impairment loss Goodwill impairment losses are NEVER reversed
— all other assets can be reversed if conditions
improve

Thinking consolidated net income differs between The final consolidated statements are IDENTICAL
cost and equity method regardless of which method parent uses internally
Chapter 5 — Consolidation Subsequent to Acquisition Date | Study Notes