how to account for unwinding of discount amount

Hi

Let’s assume that the company’s cost of capital is 10% and that the deferred consideration of $15,000 is the actual amount payable in 3 years’ time

The present value of that $15,000 discounted at the rate of 10% is $11,270

That figure is calculated by successively dividing $15,000 by 1.1 ie by (1 plus the cost of capital expressed as a percentage)

15,000 / 1.1 = 13,636
13,636 / 1.1 = 12,397
12,397 / 1.1 = 11,270

So, in working W2, goodwill, the present value of $15,000 payable in 3 years’ time is $

At 1 July, 2011, 6 months after the takeover, we need to unroll that discounted value and debit finance charges in the statement of profit or loss , credit the long term liability on the statement of financial position

The amount by which the $11,270 is unrolled is 11,270 * 10% * 6/12

That works out to be $563.5

You ask about the consideration as at 1 July, 2012

The value of the consideration will not change after you have calculated it as at date of acquisition. It will have been recorded in the goodwill calculation at a value of $11,270 and that’s the figure it will stay at (together with the $20,000 cash payment on the date of acquisition)

Does that sort it out for you

Well, having unrolled for half a year to July 2011, you’re now in the position for next year 2012 to unroll for the full year ie 10% x 11,270 + 563.5

That gives, for the year 2012, the amount of 1,183 interest (unrolled discount)

Debit finance costs, credit long term liability (because it’s still more than 12 months to payment date)

Is that better?

You’re very welcome

It’s a cost associated with the borrowing of money

The parent, at date of acquisition, says “We’ll pay you but you’re going to have to wait for a couple of years” So, yes, there is an obligation, but the parent is making the former members of the subsidiary “lend” that money to the parent

So we find the present value of how much we are going to have to pay in 2 years’ time, record that as the obligation and then unroll that discount which is, in effect, the “loan” interest accruing on the present value of the obligation

Logical enough?

“since it is charged already as finance cost which reduces the profit of the parent already” – where has it been charged already?

I don’t see it! In fact, I don’t believe that, in the example you quote, the parent has even recorded to present value of the obligation, let alone the unrolled discount.

Tell me exactly where I can find that unrolled interest, please

If you’re doing a consolidation question that requires a statement of financial position AND a statement of profit or loss, you need mentally to separate the two exercises

When preparing workings for the statement of financial position, working W3 will need to include an adjustment because (typically) the company will not have accounted for the unrolled discount. In double entry terms you will need to debit retained earnings and credit the loan account

Whoa! Where’s this “Retained Earnings” T account? There isn’t one. On the statement of financial position, the retained earnings figure represents the accumulated retained profits since the company was born. Well, if there’s not a “Retained Earnings” T account, where are we going to put that debit from the previous paragraph?

Ah! Here’s where we can put it. When we’re drawing up the statement of profit or loss, there’s an item called “Finance Charges” and we can put our debit entry in there.

That has the EFFECT of debiting / reducing retained earnings because it’s an additional expense that was previously unrecorded

Is that better?

You’re welcome

‘For your reference please check question number 32 of Mock Exam in 2016 BPP’s revision kit.’

I don’t have this material

Yes, we always (it’s a strange example that doesn’t) deduct the finance cost from the parent’s retained earnings

” why cant we set it off as it is a receivable for the subsidiary?”

Oh dear! You really are confused aren’t you!

From whom are we buying all these shares in the subsidiary?

Answer me that, first, if you will

So why do you think it will be shown as a receivable in the subsidiary?

Absolutely correct!

Imagine that you own shares in BP plc and I want to buy your shares

If I offer to pay you $4 per share and you agree to sell them to me at $4 per share …. where is BP’s involvement?

The only time they are involved is when the transfer is registered from your name into mine and it probably isn’t BP themselves that record that transfer! It will be someone like Lloyds Bank Registrars

BP have NO INTEREST whatsoever in the small shareholders like you and me and their only interest in the 4 or 5 BIG shareholders is the fact that they need to keep these institutional investors happy

“So whatever the parent is investing in the subsidiary it aint going to the subsidiary at all?”

Correctamundo!

OK?

You’re welcome