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Goodwill Arising from the Acquisition of Foreign Subsidiaries

Date of Acquisition

When a over the acquirer’s interest in the fair value of identifiable net assets of the acquired
company acquires a controlling equity interest in another company, the excess of the
purchase price company is recognize as goodwill on consolidation. In the context of the
acquisition of a foreign company, the issue arises as to whether goodwill is an asset of the
acquired company or an asset in the acquirer’s books. If it is an asset of the acquired subsidiary,
the goodwill is a foreign asset which should be translated in the same manner as any other
asset of the acquired subsidiary , which may give rise to a translation difference . However, if it
is treated as an asset in the acquirer's book there is no need for transaction.

PAS 21 paragraph 47 states "Any goodwill arising on acquisition of a foreign operation and any
fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition
of that foreign operation shall be treated as an assets and liabilities of foreign operation "Thus
they shall be express in the functional currency of the foreign operation ( meaning their
functional currency is the LCU)and shall be translated at the "current/ closing rate"

llustration 21-3" Translation of goodwill and Fair Value Differential Under PAS 21

Espenilla Corporation , whose functional currency is the Philippine peso acquired the entire
common stock of Elirie Company , a Japanese company on December 31 20x4 at a cost of
2,000,000 . At the date of acquisition, Elirie Company's paid up capital and retained earnings
were 3,000,000 yen and 500,000 yen respectively. The asset and liabilities of elirie company at
the date of acquisition by Espenilla Corporation approximately their fair values except for a
buiding that was under valued by 100 000 yen . Deferred tax liability on the undervalued
building was 20,000 yen. The exchange rate on December 31 20x4 was P.50 = 1 yen.

The resulting ownership situation can be viewed in the schedule of determination and
allocation of excess. Goodwill in pesos on the date of acquisition is computed as follows :
 Fair value of subsidiary (100%)
Consolidation transferred:
Cash 2,000,000
Less: Book value of stockholder’s equity of
Common stock (3,000,000 yen x P.50x 100%)) P 1,500,000
Retained earnings (500,000 yen x P.50x 100%)) 250,000 1,750,000
Allocated excess 250,000
Less; over or under valuation of assets and liabilities
Increase in building (100,000 yen xP.50x 100%) P 50,000
Increased in deferred tax liability on building
(20,000 yen xP.50x100%) (10,000) 40,000
Positive excess: goodwill ( excess of cost over fair value ) P 210,000
Goodwill in yen : (P210,000 x 1 yen / p . 50)

It should be noted than on the date of acquisition (December 31, 20x4) " goodwill arising on the
acquisition of a foreign operator and any fair value adjustment to the carrying amounts of
assets and liabilities arising on the acquisition of that foreign shall be treated as an assets and
liabilities of the foreign operation ." Thus they shall be express in the functional currency of the
foreign operations ( meaning their functional currency is the LCU) and shall be translated at the
currency / closing rate ."

The following consolidation journal entries are recorded in the workpaper in pesos :

Consolidation workpaper -First year after acquisition

The schedule of determination and allocation of excess presented above provides complete
guidance for the worksheet eliminating entries on Dcember 31 20x4:

(E1) Common stock –Elirie Co. 1,500,000

Retained earnings 250,000
Investment in son co. 1,750,000
( to eliminate intercompany investment and equity account
of subsidiary in date of acquisition and establish non controlling interest )

(E2) Building 50,000

Goodwill 210,000
Deffered tax liability 10,000
Investment in Elirie Co. 250,000
(To allocate excess of cost over book value of identifiable assets acquired ,
with remainder to goodwill )
Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to
the carrying amount of the asset and liabilities arising on the acquisition of that foreign
operations. They shall be expressed in the functional currency of the foreign operation and shall
be translated at the current / closing rate.

Assumed that the building is depreciated on the straight line basis over a period of 25 years .
The exchange rate on December31 20x5 was 1 yen =0.45 and the average rate for 20x5 was 1
yen = 0.48

The accounting treatment under translation (current closing rate method) and re
measurement method) are as follows:

Current closing rate method

Under the current/ closing rate method ( the functional currency of Elirie Company is the yen

On goodwill :
Goodwill on December 31 20x5 (420,000 yen xP.50/ yen) P210,000
Goodwill on December 31 20x4 (420,000 yen xP.50/ yen) 189,000
Translation adjustments loss on goodwill P21,000

On the fair value differential (after tax)

Undervalued building on December 31, 20x4
(1000 yen x P.50/YEN X80% (net at tax) P40,000
Less: depreciation expense 4,000 x .48 x 80% ( net at tax) (1,536)
Undervalued building net on 12/31 20x4 38,464
Undervalued building net on 12/31 20x5
(96,000 yen x .45 x 80% ( net of tax ) 34,560
Translation adjustments loss on undervalued building (OIC) (P 3,904)

Accordingly, goodwill has to be measure in the functional currency of the foreign operation. If
the functional currency of the foreign operation is the local currency, the goodwill on
acquisition is to be translated at the current closing rate.

In the consolidated financial statement any goodwill arising on the acquisition of a foreign
operation should be treated as an asset of the foreign operation. The goodwill should therefore
be expressed in functional currency of the foreign operation and translated at the current/
closing rate of the date of each statement of financial position .The same treatment is required
of any fair value adjustments to the carrying amounts of assets and liabilities arising on the
acquisition of a foreign operation. In both cases, exchange differences are recognized in other
comprehensive income, rather than as part of the profit or loss for the period.

If the subsidiary is partially owned, non controlling interest will be allocated a share of the
transaction adjustments and the foreign currency translation reserves (FCTR) from the
translation workpaper.

Remeasurement or Temporal Method

On the other hand, if the functional currency of the foreign operation is the parent’s currency
(or the presentation currency- function currency of Elirie Company is the peso), goodwill and
fair value differentials on acquisition is treated as a non-monetary asset and measured at the
exchange rate of the date of acquisition ( historical or actual rate) of the foreign operation.
Since both are translated at historical rates, the translation adjustment is zero.

Foreign Operations in a Hyperinflationary Environment

The hallmark of a hyperinflationary economy is rampant and continuing inflation over a number
of years resulting in a massive loss of purchasing power. PAS 29 Financial Reporting in
Hyperinflationary Economies lists a number of indicators of a hyperinflationary economy. These
indicators include:

 An inflation rate of 100% or more over a period of three years;

 Interest rates, wages and prices that are linked to a price index;
 Price that are quoted in a stable currency;
 Sales and purchases on credit take place at prices that compensate for the expected
loss of purchasing power during the credit period, even if the period is short; and
 A general population that prefers to keep its wealth in non-monetary assets or in a
relatively stable foreign currency.

PSA 29 consider that in a hyperinflationary economy, financial statements which are not
restated (adjusted for inflation) are not useful as the loss of purchasing power at a rapid rate
results in a misleading comparison of “amounts from transactions and other events that have
occurred at different times, even within the accounting period.

Where the functional currency of a foreign operation is the currency of a hyperinflationary

economy, PSA 21 requires a restate-then-translate approach in translating the financial
statements of the foreign operation.

It should be noted that PAS 29 paragraph 8 states “the financial statements of an entity whose
functional currency is the currency of a hyperinflationary economy , whether they are based on
a historical approach or a current cost approach, shall be stated in terms of the measuring unit
current at the balance sheet.”

Restatement of Financial Statement

The basic principle in PAS 29 is that the financial statements of an entity that reports in the
currency of a hyperinflationary economy should be stated in terms of the measuring unit
current at the balance sheet date. Comprehensive figures for prior period(s) should be restated
into the same current measuring unit.

Historical Cost Financial Statements

Restatements are made by applying a general price index.

1. Monetary items are not restated that are already stated at the measuring unit at the
balance sheet date are not restated.
2. Assets and liabilities linked by agreement to changes in prices should be adjusted in
accordance with the agreement.
3. All other assets and liabilities are non-monetary. Some non-monetary items are carried
at amounts current at the balance sheet date, such as net realizable value and market
value, so they are not restated. All other non-monetary assets and liabilities are
restated.
4. All items in the income statement are expressed in terms of the measuring unit current
at the balance sheet date. Therefore, all amounts need to be restated by applying the
change in the general price index from the dates when the items of income and
expenses were initially recorded in the financial statements.
5. Any gain or loss on the restatement of non- monetary items is included in the income
statement. It is a requirement to disclose separately this net gain or loss.

The standard does not establish an absolute rate at which hyperinflation is deemed to arise –
but allows judgement as to when restatement of financial statements becomes necessary.

When the economy ceases to be hyperinflationary and an enterprise discontinues the

preparation and presentation of financial statements in accordance with PAS29, it should treat
the amounts expressed in the measuring unit current at the end of the previous reporting
period as the basis for the carrying amount in its subsequent financial statements.

Functional Currency is the Currency of a Hyperinflationary Economy

For an entity whose functional currency is the currency of a hyperinflationary economy, and for
which the comparatives amounts are translated into the currency of a different
hyperinflationary shall be translated into a different presentation currency using the following
procedures.

a. All account (i.e. assets, liabilities, equity items income and expenses, including
comparatives) shall be translated at the current/closing rate at the date of the most
recent balance sheet (i.e. last years comparatives, as adjusted for subsequent changes in
the price level, are translated at this year’s closing rate, except that
b. When amounts are translated into the currency of a non-hyperinflationary economy,
comparative amount S shall be those that were presented in the prior year financial
statements (i.e. not adjusted for subsequent changes in the price level or subsequent
changes in exchange rates).