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Hi, stacie here.
“On 1 June 2010, Robby acquired 80% of the equity interests of Hail. The purchase consideration comprised cash of $ 50 mil. Robby has treated the investment in Hail at fair value through other comprehensive income (OCI).”
The investment has been carried at $ 55 mil in Robby financial statements.
Examiner’s answer :-
On consolidation, there will be a reversal of the fair value adjustments to the investments held at fair value through profit and loss.What is the reason for the reversal ?
On 1 June 2009, Robby acquired 5% of the ordinary shares of Zinc. Robby had treated this investment at fair value through profit and loss in the financial statements to 31 May 2011.
The investments has been carried at $19 mil in Robby’s financial statements.
On 1 Dec 2011, Robby acquired a further 55% of the ordinary shares of Zinc and gained control of the company.
The consideration for the acquisitions for the 5% is $2 mil, and for the 55% is $16 mil.
At 1 December 2011, the fair value of the equity interest in Zinc held by Robby before the business combination was $5 mil.
Examiner’s answer :-
Consideration :1 June 2009 : 2 mil
1 June 2011 : 16 milIncrease in fair value to 31 May 2011 : 1 mil
Investment in Zinc in Robby’s fin stm : 19 milIncrease in fair value of equity interest : 2 mil (5-2-1)
Fair value of consideration : 21 milWhat made me confused was, why we reversed the fair value for investment in Hail but not for investment in Zinc when calculating goodwill ?
And for investment in Zinc, can i do it this way ?
Cost of investment : 18 mil (19-1) 1 is the fair value adjustment
Since control is gained on the second acquisition, the 5% investment has to be fair valued to the date of the second acquisition on 1 December 2011.
The initial investment of 5% is $2 mil, therefore the fair value adjustments will be $3 mil (5- initial cost of investment of 2).
As a result, the fair value of consideration will be $18 mil + fair value adjustments $3 mil.
Isn’t this also made up to fair value of consideration of $21 mil ?
And if the fair value adjustments of $1 mil is to be adjusted upon calculating goodwill, is it to be deducted from post acquisition profits of Robby ?
Need clarification on this. Thanks..!
Hi – is the first adjustment because we’ve elected to hold at “fair value through comprehensive income” and that’s also the reason why we’re NOT going to reverse that one!
Dangerous to arrive at fair value simply by taking an apportioned calculation. The 55% will be worth rather more that the equivalent 5%. Why? Because you’re buying not just 55 % of the shares but you’ve also just acquired CONTROL over another subsidiary
It’s not sensible to value an acquisition of 55% at an amount which represents 11 times the value of a 5% holding. The reason is that, with the 55% acquisition, we are acquiring not simply 55% of the fair valued net assets. We are, in addition, buying CONTROL and that surely is a valuable commodity.
Now, turn the emphasis round – is it fair to value a 5% existing interest as 1 / 11 of the cost of a 55% acquisition? No!
Hi Mike, i think perhaps you misunderstood my question.
My question was, why when we calculate the goodwill of Hail, we take the historical cost of $50 mil, but not $55 mil ? Why should we reversed out the $5 mil from other comprehensive income ?
And when we calculate the goodwill for Zinc, why we are not taking its historical cost of $18 mil, but rather use $19 mil ? Why we need to reversed out the fair value for Hail from OCI, but not required to reversed out the $1 mil from retained earnings ? Examiner uses $19 mil to calculate, that’s why he derived at a $2 mil for increase in fair value later. If i use historical cost to calculate goodwill, isn’t it a $3 mil for the increase in fair value ?
So sorry, but please assist.
OK Stacie, we’re not getting anywhere with this. Can you give me a reference to a question number – hopefully in a Kaplan exam kit?
Hi Mike, i do not have a Kaplan exam kit with me here…Is there any other way you can assist me ? This has been killing me…!
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