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

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?

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?

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

You're very welcome

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

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?

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

"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

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.

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?

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

You're welcome

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!

'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

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.

" 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

Umm we are buying the from the shareholders of the subsidiary

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

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?

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?

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

You're welcome

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 ?

The double entry is: Dr Finance costs (say) $30 Cr Loan payable $30 Now that debit to Finance Costs works its way through to the parent company's statement of profit or loss account which itself is an integral element of the parent's retained earnings "We don’t need to separately debit/reduce R/e in the CSPF" When you make the $30 adjustment, in a question asking for statement of financial position, the adjustment will feature in working W3, Consolidated Retained Earnings, in the parent's column If the question is asking for statement of profit or loss, that $30 is added to the parent's finance costs when you are adding across the various expenses of the parent and the subsidiary Is that clearer?