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how to account for unwinding of discount amount

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FR Exams › how to account for unwinding of discount amount

  • This topic has 25 replies, 6 voices, and was last updated 8 years ago by MikeLittle.
Viewing 25 posts - 1 through 25 (of 26 total)
1 2 →
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  • September 11, 2014 at 10:20 pm #194698
    Aleem
    Member
    • Topics: 16
    • Replies: 89
    • ☆☆

    Hello!
    I am conceptually confused with the treatment of unwinding of discount.
    please help me with the following example:

    P CO acquired 80% shares of S CO on 1/Jan/2011.
    cost of investment:
    cash =20 000
    deferred consideration= 15 000 payable after 3 years
    reporting date: 1/July/2012

    so what will be the unwinding of discount amount and considration amount on 1/July/2012?
    thank you for your time! 🙂

    September 12, 2014 at 7:13 am #194710
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    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

    September 12, 2014 at 2:21 pm #194779
    Aleem
    Member
    • Topics: 16
    • Replies: 89
    • ☆☆

    Thanks Sir!
    You do have sorted out the main issue,
    but there is one little thing I want to ask.

    When you unrolled the discounted amount you chose 1 july 2011
    whereas the reporting date was 1 july 2012 (which is 1 year + 6 months after the acquisition date).
    so what is the logic behind it?

    September 12, 2014 at 9:22 pm #194818
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    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?

    September 13, 2014 at 5:29 pm #194884
    Aleem
    Member
    • Topics: 16
    • Replies: 89
    • ☆☆

    Yes that makes me understood better.
    Thank you for the help! 🙂

    September 13, 2014 at 9:29 pm #194898
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    You’re very welcome

    February 18, 2016 at 6:15 am #300909
    Ibrahim
    Member
    • Topics: 41
    • Replies: 79
    • ☆☆

    Hi Mike I understood the arithmetic of unrolled discount but why it must be charged to finance cost, credit long term liability, charge in w3 in Parent co. what i want to know is just the logic behind it i know how to deal with it arithmetically. pls explain to me with example
    thanks as always

    February 18, 2016 at 7:27 am #300924
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    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?

    February 18, 2016 at 8:48 am #300938
    Ibrahim
    Member
    • Topics: 41
    • Replies: 79
    • ☆☆

    yes i understood that unrolled discount is in effect, the “loan” interest accruing on the present value of the obligation as you explained but i don t get the logic of it being charged on ret. earning in w3 of the parent since it is charged already as finance cost which reduces the profit of the parent already. is that not double charging? thanks

    February 18, 2016 at 1:58 pm #301000
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    “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

    February 18, 2016 at 3:55 pm #301043
    Ibrahim
    Member
    • Topics: 41
    • Replies: 79
    • ☆☆

    sorry,I am not referring to this question but what i mean is, when we unroll the discounted value and debit finance charges in the statement of profit or loss , credit the long term liability on the statement of financial position. do we still need to debit ret earning wit the amount in w3 (from parent co.) while doing CS of FP question. if yes what is the logic. thanks and bear with me.

    February 18, 2016 at 4:19 pm #301050
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    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?

    February 18, 2016 at 8:12 pm #301079
    Ibrahim
    Member
    • Topics: 41
    • Replies: 79
    • ☆☆

    much better, it is indeed true that “mothers give their babies T account not blanket or bottles” mike little.
    your quotation somewhere. thanks indeed.

    February 19, 2016 at 8:20 am #301125
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    You’re welcome

    September 4, 2016 at 6:00 pm #337736
    shadlinsky90
    Member
    • Topics: 1
    • Replies: 1
    • ☆

    Hey Mike,

    While consolidating SOFP of parent and subsidiary do we always subtract finance cost of deferred consideration which is a loan note from retained earnings of Parent Co. ?
    Almost in all past papers the procedure is to deduct Finance Costs from Parents Retained Earnings while consolidating group balance sheets. Yet in a very recent mock exam I have encountered a situation where finance cost is not charged at all.
    For your reference please check question number 32 of Mock Exam in 2016 BPP’s revision kit.

    Thanks!

    September 4, 2016 at 7:24 pm #337755
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    ‘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

    October 5, 2016 at 1:02 pm #342449
    saadiy
    Member
    • Topics: 0
    • Replies: 6
    • ☆

    Hi mike
    One thing is really confusing me. Why do we include deffered consideration as a liability in sofp I mean why cant we set it off as it is a receivable for the subsidiary?
    This is really confusing me.
    Thanks.

    October 5, 2016 at 2:35 pm #342462
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    ” 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

    October 5, 2016 at 2:48 pm #342468
    saadiy
    Member
    • Topics: 0
    • Replies: 6
    • ☆

    Umm we are buying the from the shareholders of the subsidiary

    October 5, 2016 at 8:19 pm #342489
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

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

    October 6, 2016 at 11:03 am #342537
    saadiy
    Member
    • Topics: 0
    • Replies: 6
    • ☆

    Because its the subsidiary’s shares after all.
    So whatever the parent is investing in the subsidiary it aint going to the subsidiary at all?

    October 6, 2016 at 2:40 pm #342551
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    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?

    October 6, 2016 at 5:22 pm #342567
    saadiy
    Member
    • Topics: 0
    • Replies: 6
    • ☆

    Absolutely perfect! Thank you so much!!!! This was really confusing me. You crystal cleared it to me
    Thanks alot!!!!

    October 6, 2016 at 6:13 pm #342570
    MikeLittle
    Keymaster
    • Topics: 27
    • Replies: 23315
    • ☆☆☆☆☆

    You’re welcome

    May 30, 2017 at 7:24 am #388904
    tshahjabin
    Participant
    • Topics: 0
    • Replies: 1
    • ☆

    Hi Mike !! Debiting the finance cost (For unwinding the discount for deferred payment) automatically reduces the R/E. right? We don’t need to separately debit/reduce R/e in the CSPF ?

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