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Goodwill resulting from consolidation

In the group accounts that we have analyzed so far, the cost of the shares acquired by the parent company has always been equal to the nominal value of those shares. In practice, this rarely happens and now we must consider some more complicated examples. To begin, we will examine the entries made by the parent company on its own balance sheet when it acquired shares.

Suppose that when the directors of Company X agree to pay $ 120,000 for a 100% investment in A limited, they must believe that, in addition to its tangible assets of $ 80,000, ABC Limited must also have intangible assets worth $ 40,000. This amount of $ 40,000 paid in excess of the value of the tangible assets acquired is called goodwill arising on consolidation (sometimes called the acquisition premium).

When a limited company X wants to buy shares in a limited company Y, it must pay the previous owners of those shares. The most obvious form of payment would be cash. Suppose X buys all of the $ 40,000 1 shares in Y and pays $ 60,000 in cash to the previous shareholders under consideration. The entries in books X would be:

Debit – Investment in Y at a cost of $ 60,000

Credit – Bank $ 60,000

However, previous shareholders may be willing to activate some other significant company. For example, they could accept an agreed number of shares in X limited. X limited would then issue new shares in the agreed number and allocate them to the former shareholders of s Y limited. This type of deal can be attractive to X as it avoids the need for large cash outlays. The former shareholders of Y would once again have indirect interests in the profitability of the companies through their new participation in their parent company.

Acquisition and capital gains

Assuming instead that Company S made a profit of $ 8,000 in the period before the acquisition, its balance just before the purchase would be as follows.

Net tangible assets $ 40,000

Share capital $ 40,000

Reserves $ 8,000

If H now buys all the shares of company S, he will acquire $ 48,000 worth of net tangible assets (equity + reserves) at a cost of $ 60,000. Clearly, in this case, the intangible assets (goodwill) are being valued at $ 12,000 by the parent company and must be incorporated into the cancellation process to arrive at a capital gain figure arising on consolidation. In other words, not only the capital stock of S, but also its acquisition reserves, must be written off against the asset “investment in S limited” in the accounts of the parent company. The undisclosed balance of $ 12,000 appears on the consolidated balance sheet.

The consequence of this is that the reserves for the acquisition of a subsidiary are not aggregated with the reserves of the parent companies in the consolidated balance sheet. The consolidated reserves figure includes the reserves of the parent company plus the reserves after the acquisition of the subsidiaries only. Post-acquisition reserves are simply reserves, not less reserves at the time of acquisition.

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