Question

Ifrs 3 Business combinations permits non-controlling interests at the date of acquisition to be values by one of two methods:

(1) at its proportionate share of the subsidiary's identifiable net assets; or

(2) at its fair value (usually determined by the directors of the parent)

Required:

Explain the difference that the accounting treatment of these alternative methods could have on the consolidated financial statements.

Answer 1

Proportionate share of net assets method

The NCI is valued at its proportionate share of fair value of it's net assets at acquisition and subsequently the NCI's share of post acquisition profits is added to it.

Since the NCI is valued at it's proportionate share the goodwill includes parent's share of goodwill only (Partial goodwill method) and any impairment of goodwill needs to be deducted from goodwill by the parent's share of impairment only and the same balance would need to be charged to consolidated retained earnings. The NCI would need no adjustment.

Fair value method

The NCI is valued at fair value at acquisition. Subsequently the NCI's share of post acquisition profits is added to it.

Since the NCI is valued at it's fair value, the goodwill disclosed in the parent company's financial position includes the entire goodwill of the subsidiary (Full goodwill) and any subsequent impairment of goodwill needs to be deducted entirely from the goodwill balance. The parent's share of impairment would need to be charged to retained earnings and the NCI's share of impairment would be deducted from the fair value of NCI.

Understanding the difference between these two methods is very important in learning consolidation. So, please do let me know for any clarifications in the comments below. Please give an upvote if you liked my answer.

Effects of Financial statements:

Statement of financial position:

Goodwill: Goodwill will be higher in the fair value method as the NCI's share of goodwill is also included in it. In the proportionate share method only the parent's share of goodwill is disclosed.
NCI: NCI value will be higher in fair value method by the same amount as goodwill as it also includes NCI's goodwill and not just it's share of fair value of net assets. In proportionate share method NCI does not include it's share of goodwill value.
Impairment: In fair value method subsequent impairment of goodwill will reduce goodwill by a higher amount (But the parent's share only is charged to Income statement, the NCI's share is used to reduce NCI. In proportionate share method only the parent's share is charged to reduce goodwill as NCI's share of goodwill was never recognized in goodwill balance and in NCI balance in the first place.

There is no effect of this method on income statement or cash flow.