Question

Mensa Ltd has acquired all the shares of Careers Ltd. The accountant for Mensa Ltd, having studied the requirements of AASB 3/IFRS 3 Business Combinations, realises that all the identifiable assets and liabilities of Careers Ltd must be recognised in the consolidated financial statements at fair value. Although she understands the need to revalue items recorded by the subsidiary at carrying amounts different from fair value and to recognise previously unrecorded assets or liabilities at fair value, she is unsure of a number of matters associated with accounting for these assets and liabilities. She has approached you and asked for your advice.

Required

Write a report for the accountant at Mensa Ltd advising on the following issues:

1. Should the adjustments to fair value be made in the consolidation worksheet or in the accounts of Careers Ltd?

2. What equity accounts should be used when revaluing or recognising assets and liabilities?

3. Do these equity accounts remain in existence indefinitely, since they do not seem to be related to the equity accounts recognised by Careers Ltd itself?

Answer 1

1. From the point of view of AASB 3/IFRS 3, there is no specification on where the adjustments are to made.

However if the assets of the Careers Ltd(Subsidiary) are adjusted to fair value in the accounts of the Careers Ltd itself, then this amounts to adoption of the revaluation model by Careers Ltd and all the regulations in AASB 116/IAS 16 and AASB 138/IAS 38 apply. In particular, the assets must be continuously adjusted to reflect current fair values.

If, on the other hand, the adjustments are made in the consolidation worksheet, this is a recognition on consolidation of the cost of the assets to the group entity rather than an adoption of the revaluation model. Hence the recognition of the Careers Ltd’s assets at fair value is to measure cost to the acquirer. Therefore, there is no need to make subsequent adjustments to the assets when the fair values change.

Note also that some assets cannot be revalued at fair value in the individual accounts of a subsidiary (e.g. inventories).

2. The accounting standards do not specify the name of the equity account to be raised on valuation of the assets and liabilities of the subsidiary. Hence, an asset revaluation reserve account could be used for the assets.

Practically, many use "Business Combination Valuation Reserve (BCV Reserve)" because adjustments are made to both assets and liabilities and the BCV Reserve is then a generic account for all asset and liability adjustments arising as a result of such business combination. It is not appropriate to use income for liabilities as the recognition of equity for both assets and liabilities does not affect current period profit or loss. There is no gain by the acquirer on recognition of assets or liabilities not recognised by the subsidiary.

3. The BCV Reserve remains in existence while the underlying assets and liabilities remain unsold, unconsumed or unsettled.

The asset revaluation reserves under the revaluation model are never required to be transferred to retained earnings. This is a normal practice and is allowed under AASB 116. So, the BCV Reserves could remain indefinitely.

However, the extra benefits/expenses resulting from using the assets or settling the liabilities will flow into the subsidiary’s retained earnings account. Hence the group recognises the net benefits in the BCV Reserve while the subsidiary recognises them in Retained Earnings. This situation requires an adjustment in the consolidation worksheet every year while such a difference in equity classification occurs. If on consolidation, as the assets are used up or sold and the liabilities settled, the BCV Reserve is transferred to Retained Earnings, no subsequent consolidation adjustment is required.