Group reorganisations and impairment
Topco has two directly held subsidiaries, Tradeco and Shellco. It acquired Shellco for £30 million and immediately thereafter transferred all of its trade and assets to its fellow subsidiary Tradeco for book value of £10 million with the proceeds being left outstanding on intercompany account. Shellco now has net assets of £10 million (its intercompany receivable) but a carrying value in Topco of £30 million. On the other hand, the value of Tradeco has been enhanced by its purchase of the business at an undervalue.
In our view, there are two acceptable ways in which Tradeco may account for this. The cost of the investment in Tradeco’s individual financial statements may be the fair value of the cash given as consideration, i.e. £10 million. Alternatively, it is the fair value of the cash given as consideration (£10 million), together with a deemed capital contribution received from Topco for the difference up to the fair value of the business of Shellco of £20 million, which will be recognised in equity, giving a total consideration of £30 million.
The capital contribution measured under the second method represents the value distributed by Shellco to its parent Topco and thence to Tradeco. Meanwhile Topco could record a transfer of £20 million from the carrying value of Shellco to the carrying value of Topco.
If there is an intermediate holding company between Topco and Shellco but all other facts remain the same, then it would appear that an impairment ought to be made against the carrying value of Shellco in its immediate parent, which will be treated as an expense or as a distribution, depending on the policy adopted by the entity and the relevant facts and circumstances. The argument against impairment would still apply in Topco.