Question 19.6 Business combination valuation entries, pre-acquisition entries
On 1 July 2016, Mutt Ltd acquired all the issued shares of Jeff Ltd for $174 800. At this date the
equity of Jeff Ltd consisted of share capital of $80 000 and retained earnings of $68 800. All the
identifiable assets and liabilities of Jeff Ltd were recorded at amounts equal to fair value except for:
Carrying amount Fair value
Patent $60 000 $72 000
Plant (net of $40 000 depreciation) 40 000 48 000
Inventory 21 600 28 000
The patent was considered to have an indefinite life. It was calculated that the plant had a
further life of 10 years, and was depreciated on a straight-line basis. All the inventory was sold
by 30 June 2017. In June 2017, Jeff Ltd conducted an impairment test on the patent, as it was
considered to have an indefinite life, and the goodwill. As a result, the goodwill was considered
to be impaired by $1200.
In May 2017, Jeff Ltd transferred $20 000 from the retained earnings on hand at 1 July 2016
to a general reserve. The tax rate is 30%.
Required
Prepare the consolidation worksheet adjustments entries at 1 July 2016 and 30 June 2017.
At 1 July 2016:
Net fair value of identifiable assets
and liabilities of Jeff Ltd = ($80 000 + $68 800) (equity)
+$6 400 (1 – 30%) (inventory)
+ $12 000 (1 – 30%) (patent)
+ $8 000 (1 – 30%) (plant)
= $167 280
Consideration transferred = $174 800
Goodwill = $7 520
Worksheet entries at 1 July 2016
Business combination valuation entries
Inventory Dr 6 400
Deferred tax liability Cr 1 920
Business combination valuation reserve Cr 4 480
Patent Dr 12 000
Deferred tax liability Cr 3 600
Business combination valuation reserve Cr 8 400
*Accumulated depreciation - equipment Dr 40 000
Equipment Cr 32 000
Deferred tax liability Cr 2 400
Business combination valuation reserve Cr 5 600
*refer to end of solution for an alternative to this journal entry
Goodwill Dr 7 520
Business combination valuation reserve Cr 7 520
- Pre-acquisition entries
Retained earnings (1/7/16) Dr 68 800
Share capital Dr 80 000
Business combination valuation reserve Dr 26 000
Shares in Jeff Ltd Cr 174 800
Worksheet entries at 30 June 2017
Business combination valuation entries
The entries at 1 July 2013 are affected by:
- the sale of the inventory
- the depreciation of the plant
- the impairment of the goodwill
Cost of sales Dr 6 400
Income tax expense Cr 1 920
Transfer from business combination
valuation reserve Cr 4 480
Patent Dr 12 000
Deferred tax liability Cr 3 600
Business combination valuation reserve Cr 8 400
Accumulated depreciation - equipment Dr 40 000
Equipment Cr 32 000
Deferred tax liability Cr 2 400
Business combination valuation reserve Cr 5 600
Depreciation expense Dr 800
Accumulated depreciation Cr 800
(10% x $8 000)
Deferred tax liability Dr 240
Income tax expense Cr 240
(30% x $1 000)
Goodwill Dr 7 520
Business combination valuation reserve Cr 7 520
Impairment loss – goodwill Dr 1 200
Accum. impairment losses – goodwill Cr 1 200
Pre-acquisition entries
The pre-acquisition entries are affected by:
- transfer from business combination valuation reserve
Retained earnings (1/7/16) Dr 68 800
Share capital Dr 80 000
Business combination valuation reserve Dr 26 000
Shares in Jeff Ltd Cr 174 800
General reserve Dr 12 000
Transfer to general reserve Cr 12 000
Transfer from business comb. valuation reserve Dr 4 480
Business combination valuation reserve Cr 4 480
*Alternative BCVR entry for Equipment
Accumulated depreciation - equipment Dr 40 000
Equipment Cr 40 000
Equipment Dr 8 000
Deferred tax liability Cr 2 400
Business combination valuation reserve Cr 5 600
The above BCVR entry demonstrates the 2 steps for the recognition of a change in fair value on consolidation.
- Write back all of the accumulated depreciation for the asset at date of aqusition.
- Recognise the increase/decrease to the asset’s fair value with the tax effect.
NB: From these 2 journal entries it is easier to see that the depreciation adjustments then required at the end of each year for consolidation purposes are based on the $8 000 increase to fair value. That is, the additional amount of the asset that needs to be depreciated.
In this question….$8,000 / 10years = $800 per year.
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