In the group accounts we have looked at so far the cost of shares acquired by the parent company has always been equal to the nominal value of those shares. This is seldom the case in practice and we must now consider some more complicated examples. To begin with, we will examine the entries made by the parent company on its own balance sheet when it acquired shares.
Suppose when the directors of X company agree to pay for 120000$ for a 100% investment in A limited they must believe that, in addition to its tangible assets 80000$, ABC limited must also have intangible assets worth 40000$. This amount of 40000$ paid over and above the value of the tangible assets acquired is called goodwill arising on consolidation (sometimes it called premium on acquisition).
When a company X limited wishes to purchase shares in a company Y limited it must it must pay the previous owners of those shares. The most obvious form of payment would be in cash. Suppose X purchases all 40000$ 1 shares in Y and pays 60000$ cash to the previous share holders in consideration. The entries in X books would be:
Debit – Investment in Y at cost 60000$
Credit – Bank 60000$
However, the previous shareholders might be prepared to asset some other firm of consideration. For example they might accept an agreed number of shares in X limited. X limited would then issue new shares in the agreed number and allot them to the former shareholders of s Y limited. This kind of deal might be attractive to X since it avoids the need for a heavy cash outlay. The former shareholders of Y would return and indirect interests in that companies profitability via their new holding in its parent company.
Goodwill and Acquisition Profits
Assuming instead that S company has earned profits of 8000$ in the period before acquisition, its balance sheet just before the purchase would like as follows.
Net tangible assets 40000$
Share capital 40000$
If H now purchases all the shares in S company it will acquire net tangible assets worth 48000$ (share capital + reserves) at a cost of 60000$. Clearly in this case S intangible assets (goodwill) are being valued at 12000$ by the parent company must be incorporated in the cancellation process so as to arrive at a figure for goodwill arising on consolidation. In other words, not only S shares capital, but also its acquisition reserves, must be cancelled against the asset “investment in S limited” in the accounts of parent company. The unconcealed balance of 12000$ appears in the consolidated balance sheet.
The consequence of this is that any acquisition reserves of a subsidiary company are not aggregated with the parent companies reserves in the consolidated balance sheet. The figure of consolidated reserves comprises the reserves of the parent company plus the post-acquisition reserves only of subsidiary companies. The post-acquisition reserves are simply reserves not less reserves at acquisition.