b)
NZ IFRS 3 Business Combinations requires the purchase consideration for an acquired entity to
be allocated to the fair value of the assets, liabilities and contingent liabilities acquired
(henceforth referred to as net assets and ignoring contingent liabilities) with any residue being
allocated to goodwill. This also means that those net assets will be recorded at fair value in the
consolidated statement of financial position. This is entirely consistent with the way other net
assets are recorded when first transacted (i.e. the initial cost of an asset is normally its fair value).
The purpose of this process is that it ensures that individual assets and liabilities are correctly
classified (and valued) in the consolidated statement of financial position. Whilst this may sound
obvious, consider what would happen if say a property had a carrying amount of $5 million, but
a fair value of $7 million at the date it was acquired. If the carrying amount rather than the fair
value was used in the consolidation it would mean that tangible assets (property, plant and
equipment) would be understated by $2 million and intangible assets (goodwill) would be
overstated by the same amount (note: in the consolidated statement of financial position of
Plateau the opposite effect would occur as the fair value of Savannah’s land is below its carrying
amount at the date of acquisition). There could also be a ‘knock on’ effect with incorrect
depreciation charges in the years following an acquisition and incorrect calculation of any
goodwill impairment. Thus the use of carrying amounts rather than fair values would not give a
‘faithful representation’ as required by the Framework.
The assistant’s comment regarding the inconsistency of value models in the consolidated
statement of financial position is a fair point, but it is really a deficiency of the historical cost
concept rather than a flawed consolidation technique. Indeed the fair values of the subsidiary’s
net assets are the historical costs to the parent. To overcome much of the inconsistency, there
would be nothing to prevent the parent company from applying the revaluation model to its
property, plant and equipment.
NZ IFRS 3 Business Combinations requires the purchase consideration for an acquired entity to
be allocated to the fair value of the assets, liabilities and contingent liabilities acquired
(henceforth referred to as net assets and ignoring contingent liabilities) with any residue being
allocated to goodwill. This also means that those net assets will be recorded at fair value in the
consolidated statement of financial position. This is entirely consistent with the way other net
assets are recorded when first transacted (i.e. the initial cost of an asset is normally its fair value).
The purpose of this process is that it ensures that individual assets and liabilities are correctly
classified (and valued) in the consolidated statement of financial position. Whilst this may sound
obvious, consider what would happen if say a property had a carrying amount of $5 million, but
a fair value of $7 million at the date it was acquired. If the carrying amount rather than the fair
value was used in the consolidation it would mean that tangible assets (property, plant and
equipment) would be understated by $2 million and intangible assets (goodwill) would be
overstated by the same amount (note: in the consolidated statement of financial position of
Plateau the opposite effect would occur as the fair value of Savannah’s land is below its carrying
amount at the date of acquisition). There could also be a ‘knock on’ effect with incorrect
depreciation charges in the years following an acquisition and incorrect calculation of any
goodwill impairment. Thus the use of carrying amounts rather than fair values would not give a
‘faithful representation’ as required by the Framework.
The assistant’s comment regarding the inconsistency of value models in the consolidated
statement of financial position is a fair point, but it is really a deficiency of the historical cost
concept rather than a flawed consolidation technique. Indeed the fair values of the subsidiary’s
net assets are the historical costs to the parent. To overcome much of the inconsistency, there
would be nothing to prevent the parent company from applying the revaluation model to its
property, plant and equipment.
