|
Query No. 24
Subject:
Treatment of goodwill (arising on consolidation) and reserve arising on revaluation of the properties of the
subsidiary in the consolidated financial statements pursuant to testing of impairment as per AS 28. 1
A. Facts of the Case
1. A private limited company (hereinafter referred to as the ‘parent’) incorporated under the Companies Act, 1956, acquired 90% equity in another company (hereinafter referred to as the ‘subsidiary’) on September 30, 2006.
2. The querist has stated that at the time of acquisition, the fixed assets of the ‘subsidiary’ and its subsidiaries were not revalued (although the book value of some of the fixed assets was far lower than their fair value) (emphasis supplied by the querist). The difference in the carrying value of net assets as per the newly acquired subsidiary’s financials on the date of acquisition and acquisition price, which was substantial, was recognised as goodwill in the consolidated financial statements (CFS) of the parent company. The acquisition was thus, recorded as below in the CFS of the parent company:
(In Rs. Lakh)
Bank -750
Land +100
Goodwill +500
Building +100
Net Current Assets +50
3. The subsidiary, subsequently, on March 31, 2008, revalued certain class of the fixed assets (primarily land and building) to reflect the true and fair view of such fixed assets and a revaluation reserve for the differential amount was created in the books of the subsidiary. The querist has stated that the accounting treatment of revaluation has been done as per Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’. The depreciation over the revalued amount will be charged against the revaluation reserve and will not be debited to the profit and loss account of the subsidiary. The effect of the revaluation was also considered for the purpose of consolidation in the CFS of the parent company to represent the true financial position of the group assets.
4. As per the querist, the revaluation of such assets was done by professional valuer who provided valuation to the management with fair value as at two dates, viz., (a) as at the date of acquisition (September 2006) and (b) as on 31st March, 2008. The professional valuer, in his report, has revalued the net value of land and building as below:
(In Rs. Lakh)
Land As at Sep. 30, 2006 300
As at March 31, 2008 450
Building As at Sep. 30, 2006 150
As at March 31, 2008 200
5. The parent company has a policy of testing the goodwill for impairment arising on consolidation, which represents the difference between the amount paid for acquisition of controlling stake and the net carrying value of assets as per subsidiary’s financial statements on the date of such acquisition. As on 31st March, 2008, it carried out impairment analysis of the cash-generating unit (CGU) consisting of the subsidiary company as a whole, and finds that:
(i) There is no impairment of goodwill in case no entries relating to revaluation of assets are passed.
(ii) There is no impairment of goodwill even in case the entries relating to revaluation of land and building to the extent of the post-acquisition appreciation in value are passed in the financials.
(iii) There is slight impairment of goodwill post-acquisition in case the entries relating to revaluation of land and building to the full extent (including appreciation gains related to pre-acquisition period) are passed in the financials.
The net present value (NPV) of the cash flows representing ‘value in use’ from the CGU is lesser than the carrying amount of goodwill and other assets (including revalued assets), leading to impairment. The querist has also stated that there is no impairment loss in the subsidiary as a whole as the subsidiary does not have goodwill in its balance sheet. The loss is arising only in the consolidated financial statements of the parent company.
Auditor’s analysis and suggestion
6. The querist has stated that the statutory auditors of the parent company have opined that the fixed assets have been revalued as at March 31, 2008 and such revaluation complies with Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which, inter alia, states as below:
“27. When a fixed asset is revalued in financial statements, an entire class of assets should be revalued, or the selection of assets for revaluation should be made on a systematic basis. This basis should be disclosed.
28. The revaluation in financial statements of a class of assets should not result in the net book value of that class being greater than the recoverable amount of assets of that class.”
The auditors are of the view that paragraphs 58 and 59 (reproduced below) of Accounting Standard (AS) 28, ‘Impairment of Assets’, do not apply to the case in true sense as there is no impairment loss:
“58. An impairment loss should be recognised as an expense in the statement of profit and loss immediately, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Accounting for Fixed Assets), in which case any impairment loss of a revalued asset should be treated as a revaluation decrease under that Accounting Standard.
59. An impairment loss on a revalued asset is recognised as an expense in the statement of profit and loss. However, an impairment loss on a revalued asset is recognised directly against any revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount held in the revaluation surplus for that same asset.”
The auditors are further of the view that the revaluation of land and building and to the extent that revaluation gain is identified with the pre-acquisition period, the goodwill amount should be reduced so as to reflect true and fair view. According to them, in case the company recognises the revaluation reserve and also keeps the goodwill in the books (to the extent it related to revaluation gain relating to pre-acquisition period), it would lead to financials of the company not reflecting the true and fair view.
7. As per the querist, the company is of the view that paragraph 14 of Accounting Standard (AS) 21, ‘Consolidated Financial Statements’, clearly and unambiguously states as follows:
“14. The parent’s portion of equity in a subsidiary, at the date on which investment is made, is determined on the basis of information contained in the financial statements of the subsidiary as on the date of investment. … ”
Thus, the querist has stated that, under AS 21, the measurement of goodwill (or capital reserve, as the case may be) at the date of acquisition of a subsidiary is based on the carrying amount of the subsidiary’s assets and liabilities as per the books of account of the subsidiary as at the date of acquisition (emphasis supplied by the querist).
8. The querist has stated that as per the auditor, the goodwill of Rs. 500 lakh appearing in the consolidated financial statements actually comprises three elements:
(In Rs. Lakh)
(a) Difference between book value and fair value of land on the date of acquisition 200
(b) Difference between the book value and fair value of buildings 50
(c) ‘True’ goodwill (balancing figure) 250
Thus, on recognition of revaluation gain as on March 31, 2008, the company must reduce its goodwill and revaluation reserve to the extent of Rs. 250 lakh, so that true and fair view is not impaired and the net worth of the group is correctly stated. Based on this, the various assets and goodwill will appear as under in the CFS:
(In Rs. Lakh)
Goodwill 250
Land 450
Building 200
Other net current assets 50
Revaluation reserve 200
9. Auditors have also opined that the excerpts from AS 21 and AS 28 reproduced above need to be construed and read in a manner so as to reflect a fair presentation of the underlying economic position as well as resources of the group.
10. The auditors have also suggested another methodology where, in their opinion, to ensure that true and fair view of the financials of the group is correctly stated, the increase in the value of land and building should not be recognised to the extent this belongs to pre-acquisition period. In such a case, the various assets and goodwill will appear as under in CFS:
(In Rs. Lakh)
Goodwill 500
Land 250
Building 150
Other net current assets 50
Revaluation reserve 200
11. The company (parent) is, however, of the view that keeping in view the given accounting guidance, the various assets and goodwill in the CFS should be reflected as below:
(In Rs. Lakh)
Goodwill 500
Land 450
Building 200
Other net current assets 50
Revaluation reserve 450
As soon as the group recognises the goodwill and the revaluation gains (leading to an increase in the carrying value of the assets of CGU), as per above, given the ‘value in use’ of CGU, in the view of the querist, there is an impairment of goodwill to the extent of 100 and thus, following additional entry may be passed:
Profit & Loss Account Dr. 100
To Goodwill 100
12. Notwithstanding the above economic arguments, the company feels that treatment at paragraph 7 above is inconsistent with AS 21 which requires the differences between book values and fair values of recognised assets and liabilities of a subsidiary as at the date of acquisition to be merged into a single figure of goodwill (goodwill would also include unrecognised assets and liabilities of subsidiary and any true goodwill). However, the company does recognise the fact that what auditor is saying makes economic sense as prima facie some of the revaluation has arisen from and belongs to the pre-acquisition period.
B. Query
13. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the parent company should revalue the figures of fixed assets of the aforesaid subsidiary in the CFS of the company, considering that the revaluation increase up to the date of acquisition (September 2006) is already included in goodwill appearing in consolidated balance sheet (as per paragraph 10 above).
(ii) Whether the parent company would be justified in setting off the goodwill arising on consolidation as on date of acquisition with the increase in the fair value of land and building on the same date in the consolidated books of account as at March 31, 2008, as suggested by the auditors in paragraph 8 above.
(iii) Whether the parent company should revalue the figures of fixed assets of the aforesaid subsidiary in the CFS of the company, considering the revaluation increase up to 31st March, 2008, and reflect the corresponding revaluation reserve, keeping the goodwill appearing in consolidated balance sheet on the date of acquisition intact (as per paragraph 11 above). Further, whether the parent company should reflect the impairment of goodwill through profit and loss account.
C. Points considered by the Committee
14. The Committee, while answering, has considered only the issues raised in paragraph 13 above and has not examined any other issue that may arise from the Facts of the Case, such as, appropriateness of the revaluation of assets and accounting thereof in the books of the subsidiary, accounting for depreciation on the revalued assets, whether or not the goodwill arising on consolidation should be amortised, etc. Further, the Committee has not gone into the computation/determination of specific amounts of the various items, such as, goodwill, land and buildings, etc., that should appear in the financial statements. The Committee has also not examined the appropriateness of considering the whole subsidiary as a CGU and presumes that the company has correctly identified the subsidiary as a whole, as a CGU. The Committee also presumes that the amount of goodwill in the CFS has been arrived at by the parent company correctly in accordance with the Accounting Standard (AS) 21, ‘Consolidated Financial Statements’.
15. As far as recognition of goodwill arising on consolidation is concerned, the Committee notes paragraph 14 of AS 21 as reproduced in paragraph 7 above and paragraph 13 thereof as reproduced below:
“13. In preparing consolidated financial statements, the financial statements of the parent and its subsidiaries should be combined on a line by line basis by adding together like items of assets, liabilities, income and expenses. In order that the consolidated financial statements present financial information about the group as that of a single enterprise, the following steps should be taken:
(a) the cost to the parent of its investment in each subsidiary and the parent’s portion of equity of each subsidiary, at the date on which investment in each subsidiary is made, should be eliminated;
(b) any excess of the cost to the parent of its investment in a subsidiary over the parent’s portion of equity of the subsidiary, at the date on which investment in the subsidiary is made, should be described as goodwill to be recognised as an asset in the consolidated financial statements;
(c) when the cost to the parent of its investment in a subsidiary is less than the parent’s portion of equity of the subsidiary, at the date on which investment in the subsidiary is made, the difference should be treated as a capital reserve in the consolidated financial statements;
…
Where the carrying amount of the investment in the subsidiary is different from its cost, the carrying amount is considered for the purpose of above computations.”
Thus, any excess of the cost to the parent of its investment in subsidiary over the parent’s portion of equity determined on the basis of the carrying amount of assets and liabilities in the financial statements of the subsidiary as on the date of acquisition of equity interest in the subsidiary is recognised as goodwill in the consolidated financial statements. Accordingly, the Committee is of the view that goodwill as on the date of consolidation is determined on the basis of the carrying amount of assets and liabilities appearing in the financial statements of the subsidiary as on the date of acquisition and the same cannot be adjusted against the revaluation increase on account of increase in fair value of assets upto the date of acquisition not recognised in the financial statements as being argued in the Facts of the Case.
16. As far as impairment of goodwill in the consolidated financial statements is concerned, the Committee notes that AS 28 requires impairment of goodwill to be tested as part of impairment testing of the cash-generating unit(s) to which it relates. In this connection, the Committee notes the following paragraphs from AS 28:
“79. Goodwill arising on acquisition represents a payment made by an acquirer in anticipation of future economic benefits. The future economic benefits may result from synergy between the identifiable assets acquired or from assets that individually do not qualify for recognition in the financial statements. Goodwill does not generate cash flows independently from other assets or groups of assets and, therefore, the recoverable amount of goodwill as an individual asset cannot be determined. As a consequence, if there is an indication that goodwill may be impaired, recoverable amount is determined for the cash-generating unit to which goodwill belongs. This amount is then compared to the carrying amount of this cash-generating unit and any impairment loss is recognised in accordance with paragraph 87.”
“87. An impairment loss should be recognised for a cash-generating unit if, and only if, its recoverable amount is less than its carrying amount. The impairment loss should be allocated to reduce the carrying amount of the assets of the unit in the following order:
(a) first, to goodwill allocated to the cash-generating unit (if any); and
(b) then, to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit.
These reductions in carrying amounts should be treated as impairment losses on individual assets and recognised in accordance with paragraph 58.”
“58. An impairment loss should be recognised as an expense in the statement of profit and loss immediately, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Accounting for Fixed Assets), in which case any impairment loss of a revalued asset should be treated as a revaluation decrease under that Accounting Standard.”
On the basis of the above, the Committee is of the view that since as per the facts of the case supplied by the querist, the goodwill appearing in the consolidated financial statements is allocated to the subsidiary as a whole forming a CGU, the carrying amount of the cash-generating unit including goodwill, should be compared with the recoverable amount of that unit, and then, the impairment loss, if any, should be allocated to reduce the carrying amount of the goodwill and the balance, if any, to other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit. In case the asset to which the impairment loss has been allocated is carried at a revalued amount, to that extent, the impairment loss should be treated as a revaluation decrease and the balance, if any, should be recognised as an expense in the statement of profit and loss.
D. Opinion
17. On the basis of the above and subject to paragraph 14 above, the Committee is of the following opinion on the issues raised by the querist in paragraph 13:
(i) The parent company should give full effect of the revaluation made by the subsidiary in the consolidated financial statements. It should not, on its own, revalue the figures of the fixed assets of the subsidiary in the consolidated financial statements on the ground that the revaluation increase upto the date of acquisition is already included in goodwill appearing in consolidated financial statements as stated by the querist in paragraph 10 above.
(ii) No, the goodwill arising on consolidation as on the date of acquisition cannot be adjusted for the increase in the fair value of land and building on the date of acquisition in the consolidated financial statements as at March 31, 2008, as suggested by the auditors in paragraph 8 above.
(iii) The parent company should give full effect of the revaluation made by the subsidiary upto the date of consolidation in the consolidated financial statements reflecting the corresponding revaluation reserve. Impairment of goodwill should be accounted for as discussed in paragraph 16 above.
1Opinion finalised by the Committee on 15.12.2009 |