Mid-Year Acquisition with Fair Value Uplift and Intra-Group Inventory
On 1 July 20X4, Pine plc acquired 80% of Sycamore Ltd for £10 million cash. At acquisition, Sycamore’s share capital was £2 million and retained earnings £3 million. A building with a remaining life of five years had a fair value £1 million above carrying amount. Pine elected to measure non-controlling interest at fair value, £2.8 million. Sycamore’s profit for the year ended 31 December 20X4 was £2.4 million, earned evenly. During the post-acquisition period, Sycamore sold goods to Pine for £1.2 million at a 25% gross margin; half of those goods remained in Pine’s inventory at year end. Pine’s own retained earnings at 31 December 20X4 were £8 million. Pine uses the acquisition method under IFRS 3 and prepares consolidated financial statements.
1. Calculate goodwill at acquisition under IFRS 3 and explain the effect of measuring NCI at fair value rather than at the proportionate share of net assets.
Read the worked answer
Goodwill calculation. Consideration = £10.0m. NCI at fair value = £2.8m. Fair value of identifiable net assets = share capital £2.0m + retained earnings £3.0m + building fair value uplift £1.0m = £6.0m.
Goodwill = £10.0m + £2.8m − £6.0m = £6.8m.
Alternative proportionate NCI. NCI would be 20% × £6.0m = £1.2m, giving goodwill of £10.0m + £1.2m − £6.0m = £5.2m. The £1.6m difference is the NCI share of goodwill recognised under the full-goodwill method.
Why it matters. Measuring NCI at fair value recognises goodwill attributable to both owners and NCI. It increases NCI and goodwill by £1.6m at acquisition, with no immediate profit effect. Future goodwill impairment is allocated between owners and NCI, so reported profit attributable to owners can differ between the two methods. It also affects gearing and return-on-equity ratios because both goodwill and NCI are larger. The choice is an accounting policy election for each business combination, not a free choice by management.
2. Compute consolidated retained earnings attributable to the owners of Pine and the NCI at 31 December 20X4.
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Post-acquisition profit. Sycamore earned £2.4m evenly over the year, so the post-acquisition amount is £2.4m × 6/12 = £1.2m.
Fair value depreciation. The £1.0m building uplift is depreciated over five years: £1.0m/5 = £0.2m per year, or £0.1m for six months. Reduce post-acquisition profit by £0.1m.
Unrealised profit. Sycamore sold goods for £1.2m at a 25% margin, so total profit was £300,000. Half the goods remain in Pine’s inventory, so unrealised profit = £300,000 × 1/2 = £150,000. Eliminate this from inventory and profit.
Adjusted post-acquisition profit = £1.2m − £0.1m − £0.15m = £0.95m.
Group retained earnings = Pine’s £8.0m + Pine’s share of adjusted post-acquisition profit (80% × £0.95m = £0.76m) = £8.76m.
NCI = NCI at acquisition £2.8m + NCI share of adjusted post-acquisition profit (20% × £0.95m = £0.19m) = £2.99m.
If proportionate NCI had been elected, NCI would be £1.2m + £0.19m = £1.39m.
3. Explain how the intra-group sale and the fair value uplift affect the consolidation, and whether the building adjustment affects goodwill after acquisition.
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The intra-group sale must be eliminated in full: remove £1.2m from revenue and £1.2m from cost of sales. Only half the goods remain in inventory, so £150,000 of profit is unrealised and must be removed from inventory and from group profit. Because the selling company is the subsidiary, the elimination reduces Sycamore’s post-acquisition profit and therefore reduces both group retained earnings and NCI by their respective shares. The remaining half of the goods has been sold outside the group, so that profit is realised and is not eliminated.
The fair value uplift is recognised at acquisition as part of the identifiable net assets, which reduces goodwill at the acquisition date. After acquisition, the additional depreciation of £0.1m for the six-month period reduces consolidated profit and therefore group retained earnings and NCI. It does not change goodwill, except through any goodwill impairment test. The uplift is not remeasured each year; it is depreciated over the remaining useful life. Consolidation adjustments should also consider deferred tax if the building uplift would create a taxable temporary difference, which would further adjust goodwill and post-acquisition profit.