- This topic has 7 replies, 2 voices, and was last updated 8 years ago by
.
- Posts
The parent’s acquired 75% of the sub’s 80M $1 shares on 1 January 2016. It paid $3.50 per share and agreed to pay a further $108M on 1 Jan 2017. The cost of capital is 8%. What is the total consideration?
The answer
80M shares x 75% x $3.50 =$210 M
Deferred consideration:108 x 1/1.08 =$100 M
Total consideration =$310 MI have certain issues specially to understand the logic of certain workings.
-Why the DC has been discounted? What’s the logic?
-Why the total consideration is $310 M and not $318 M(210M +108 M)?, because after-all, the parent has acquired 75% of the sub but also has to pay $108 M. This $108 M is a form of ‘debt’ which the parent has to give.-$8 m is charged as finance cost. Could you explain how; I mean the logic of it?
Thanks in advance.‘Why the DC has been discounted? What’s the logic?” Because whenever a payment (or receipt) is deferred, we need to discount it to arrive at its present value
Incidentally, when we unroll the discount, that amount unrolled is debited to finance costs and NOT to goodwill. And this comes up in practically every F7 exam, so get used to it!
“because after-all, the parent has acquired 75% of the sub but also has to pay $108 M. This $108 M is a form of ‘debt’ which the parent has to give.” – we’re looking at the fair value of the newly acquired subsidiary’s net assets and we’re also considering the fair value / present value of the amount to be paid
Of course the parent will have to pay $108 million next year but the present value of that amount is $100 million
When we unroll that discounted payment we Dr Finance Costs and Cr the Obligation to Pay account
That leaves the Obligation account at $108 million and now we pay that amount in cash
“$8 m is charged as finance cost. Could you explain how; I mean the logic of it?” – I believe the combination of the replies to your two earlier queries has answered this
OK?
I have got your point but not fully.
I do have understand the logic behind “discounting” but still finding some difficulties to understand why do we need to DR finance cost; more precisely where does this $8m come from and why do we need to DR it?In addition, when you say ” Cr the Obligation to Pay account”, what do you mean and what is the figure for it?
Thanks.
$108 payable in 1 year’s time has a present value of 108 x 1/1.08 = 100
So that 100 is the amount that is credited to the obligation account and debited to the account that measures the cost of acquisition – and eventually balances off to give the goodwill figure
And then, when we unroll it after 1 year, we debit finance costs and credit the obligation to pay account with 8% of that present value = 8% of 100 = 8 … and that’s where the 8 comes from
I hope that that is better for you!
1.When you say, “we unroll it” or ” unroll that discounted payment”, what do you mean by that?
Imagine a carpet that is laid out and the very end of the carpet is three years away and represents an amount to be paid right at the end of that three years
But I want to know what amount TODAY represents that amount payable in three years, so I apply discounted cash flow techniques to that three-years-away amount and roll it backwards to arrive at the today value.
In effect, I’m rolling up that carpet from three years away to get to today’s value
Then, over the next three years I’m going to unroll it …
… and that’s what is meant by unrolling the discount
I’m assuming that this is you just being a bit rusty over an F2 topic but if it’s all Greek to you (apologies to our Greek students) then I suggest that you listen to John’s F2 lectures covering the topic of discounted cash flows
OK?
Got the point now. Thanks.
One last thing, In working 3, do we need to reduce the parent retained earnings by $8m?
- The topic ‘consolidated financial statement’ is closed to new replies.