As my knowledge of how to do consolidations is but a distant memory, I would be grateful for advice on a particular issue.
During the year the holding company acquired the shares in an existing trading company. The subsidiary had bought a freehold property 12 years ago, which it had revalued in its own accounts, so there is a significant revaluation reserve in the subsidiary. I can just about remember that the goodwill arising on consolidation is the price paid by the holding company for the shares less the net assets of the subsidiary, i.e: share capital and retained profits.
But what to do with the revaluation reserve?
- If we leave it out of the goodwill calculation, the subsidiary's net assets will effectively be valued at cost, the goodwill on consolidation will therefore be much greater and the revaluation reserve will come through into the consolidated accounts.
- If we include it in the calculation, the subsidiary's net assets will be acquired at their current value (which seems more logical), the goodwill premium on consolidation will be lower (which seems more realistic) and there will be no revaluation reserve in the consolidated accounts.
Second question. The subsidiary is releasing its revaluation reserve in line with the depreciation of the revalued property. If we go for option 2, will we have increasing goodwill each year or a negative revaluation reserve in the consolidated accounts?
My head is in a spin! Any help would be greatly appreciated.
Replies (5)
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Assuming that the book values of the net assets of the subsidiary on acquisition are equal to their fair value (which is another story - but is the basis on which you appear to be proceeding) then the goodwill arising on consolidation is precisely what you say it is - with the proviso that net assets are not necessarily equal to share capital plus retained profits, especially when there is a revaluation reserve!
So option 2 is correct.
As to your second question, as under Option 2 you are ignoring the revaluation reserve (effectively treating it as a part of the undifferentiated pre-acquisition reserves) the annual revaluation reserve transfers are just ignored. I don't see how they can have the effect you suggest.
Sorry I assumed the revaluation reserve reduction was a transfer in the reserves note, not a credit to the P&L. The way to deal with that in the consolidation schedules is to remove the revaluation reserve credit from the consolidated P&L. Does that make sense?
So on consolidation your just reverse it because it is a nothing adjustment - a transfer between two accounts that are separate in the subsidiary but combined in the consolidated figures.