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TOPIC 2

: PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS

Standards covered
IFRS 3 – Business Combinations
IAS 27 Consolidated & Separate Financial Statements
IAS 28 – Investment in Associated Company
The concept of groups
What is a group?
A parent undertaking and its subsidiary undertakings
...



If one company owns more than 50% of the ordinary shares of another company
this will give the first company control of the second company
...
The first company is the parent and the second company is the
subsidiary
...
e
...


Group Accounts
The key principle underlying group accounts is the need to reflect the economic
substance of the relationship
...

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The objective of consolidated financial statements is to show the position of the group as
if it were a single economic entity therefore
...




All the income and expenses of P and S are included in the consolidated income
statement
...


The best way of showing the results of the group is to imagine that all transactions
of the group had been carried out by a single equivalent company and to prepare a
statement of financial position/balance sheet, an income statement and statement
showing other comprehensive income for that company such statements are called
consolidated financial statements
...

1
...

2
...

3
...

Each company in a group prepares its own accounting records and annual financial
statements in the usual way
...


Purpose of consolidated accounts
1
...


2
...


3
...


4
...


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IAS 27 definitions
-

Subsidiary: an entity that is controlled by another entity (parent)
...
Control is usually based on ownership of
more than 50% of voting power but other forms of control are possible
...



When the parent company has power to govern financial and operating policies of
the entity under a statute or an agreement
...




The parent has power to appoint or remove the majority of the members of the
Board of Directors
...


Circumstances where it is permitted not to consolidate a subsidiary
...
If an investor does not have effective control over an investee,
then the investee cannot be classified as a subsidiary
...
This may occur in practice where a foreign subsidiary
is subject to interference by the relevant government perhaps taking the form of
blocking remittances back to the parent
...

(2)

Subsidiary held for resale: if on acquisition a subsidiary meets the criteria to be
classified as held for sale in accordance with IFRS 5, then it must still be included

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in consolidation but accounted for in accordance with IFRS 5
...

This might occur when a parent has acquired a group with one or more
subsidiaries that do not fit into its long term strategic plans and are therefore
likely to be sold
...

Reasons for wanting to exclude consolidation of a subsidiary by Directors
...


Note: The above reasons are not permitted by IFRSs
...

However IAS 27 has never permitted exclusion on these grounds because it feels
that differing activity problems are overcome by the provision of segmental
information

Further points to note in consolidation:


Uniform accounting policies:

All group companies should have the same

accounting policies, if a group member uses different accounting policies its
financial statements must be adjusted to achieve consistency before they are
consolidated
...
K
...
e
...

A group cannot trade with itself nor can it make a profit out of itself
...


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CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(Balance Sheet)
Principles of Consolidated Statement of Financial Position (Balance Sheet)
...

Intra group items are excluded e
...
receivables and payables shown in the consolidated
statement of financial position only include amounts owed from/to third parties
...

The cost of the investment in S is effectively cancelled with the ordinary share
capital and reserves of the subsidiary
...

-

The net assets of the whole group (P + S)
...

The retained profits comprising profits made by the group i
...
(all of Ps historical
profits plus profits made by S post acquisition)
...
000
...
K
...


Good will on acquisition
In the previous example, the cost of the shares in S was $ 50
...

Equally the net assets of S were $ 50
...
This is not always the case
...
The difference
is good will
...

Good will on acquisition is calculated by comparing the value of the subsidiary acquired
to its net assets
...

(1) The value of the part acquired by the parent
...

There are 2 methods in which good will may now be calculated following the update to
IFRS 3
...

(2) Full good will method
(1)

Partial good will (old method)
Cost of investment
Less: share of the subsidiary net assets acquired
Good will on consolidation parents share only

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XX
(XX)
XXX

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(2)

Full good will method (new method)
Cost of investment
Less: percentage share of net assets acquired at acquisition date
Good will - parents share

Fair value of NCI at acquisition
Less NCI percentage share of net assets at acquisition

X
(X)
XX

XX
(XX)

Good will –NCI

XX

Total good will

XXX

This method is referred to as full good will method as it results in 100% of the good will
being shown in the group statement of financial position that belonging to the
shareholders of the parent and that belonging to the non controlling interest
...

Cost of investment (value of acquired part)

XX

Non controlling interest (value of part not acquired)

XX
X

Less: Net assets of the subsidiary

(X)

Good will

XX

Positive good will – is presented as a non current asset on the face of consolidated
statement of financial position and is subject to impairment reviews to assess whether its
value has fallen
...
78
...
At this date the net assets of Craig were Shs
...
000
...

(ii)
If the NCI is valued using the full good will method and the Fair Value
(FV) of the NCI on the acquisition date is Shs
...
000
...
K
...

You need to use a set of standard workings
...
1: Establish the group structure
P
Date of acquisition ie
...


S

W
...
3: Determine the Good will on Acquisition
Cost of investment (purchase consideration)
Less: percentage share of net asset @ acquisition date
Good will on acquisition (parents share)
FV of NCI @ acquisition
X
Less NCI percentage of subsidiary net assets @ acquisition (X)
Good will – NCI share
Total good will

W
...
K
...
5: Group retained earnings
P’s retained earnings 100%

X

S: group share of post acquisition retained earnings

X

Less: impairments of good will to date

(X)
XX

Example: Consolidated statement of financial position
...
The statement of financial
position of two companies at 31 Dec 2007 are as follows
...
000

8
...
000

-

97
...
000

24
...
000

32
...
000
30
...
000

10
...
000
15
...
000
295
...


17
...
000

Capital and reserves
Share capital
Retained earnings

Current liabilities

Required: Prepare a consolidated statement of financial position for Austin for the
year ended 31 Dec 2007
...
K
...

They are capitalized at the date of acquisition by including them in the good will
calculation
...
They are included in group reserves
...

Pre-acquisition reserves – existed at the date of acquisition
...

Only the group share of post acquisition reserves of the subsidiary is included in the
group statement of financial position
...

Derek
Non current assets
Tangible assets
Investments
Shares in Clive
Current assets

Clive

75
...
000

27
...
000
214
...
000

33
...
000

Capital and reserves
Share capital
Share premium
Retained earnings

80
...
000
20
...
000
40
...
000
140
...
000
Current liabilities
176
...
000
316
...
000
Derek acquired all of the share capital of Clive one year ago
...
2000= on the day of acquisition and no impairment of good will has
taken place since acquisition
...


Non controlling interest (NCI)
In some situations a parent may not own all the shares in the subsidiary e
...
if P owns
only 80% of the ordinary shares of S there is a non controlling interest of 20%
...
K
...

Accounting treatment of NCI
As P controls S
-

In the consolidated statement of financial position include all of the net assets of
S
...
4)
...


Illustration 1 :
Draft balance sheet of Piper and Swans on 31 Dec
...

Piper
Non current assets
Investment in Swans at cost
Current assets

Swans

90

100

110

-

50
250

30
130

Equity & Liabilities
Ordinary share Capital

100

100

Retained earnings

120

20

Current Liabilities

30

10

Piper had bought 80% of the ordinary shares of Swans on 1st Jan 2011 when the retained
profits of Swans were shs 10 /=
...

Required: Prepare a consolidated statement of financial position as at 31 Dec 2011
assuming that Piper group values the NCI using the proportion of net assets
method
...
K
...

Dickens
Jones
Non current assets
Tangible assets
85
...
000
Investments
Shares in Jones
60
...
000
Current assets
160
...
000
305
...
000
Capital and reserves
Called up share capital
65
...
000
Share premium
35
...
000
Retained earnings
70
...
000
170
...
000
Current liabilities
135
...
000
305
...
000
=======
======
Dickens acquired its 80% holding in Jones on 1st Jan 2008 when Jones retained earnings
stood at 20
...
On this date the fair value of the 20% non controlling shareholding in
Jones was shs 12
...
There has been no impairment of good will since acquisition
...

Required: Prepare a consolidated statement of financial position of Dickens as at
31st Dec 2008
...







Current accounts between P and S
...

Unrealized profit on sales of non current assets
...

Dividends and loan interest
...

A payables (current) account in the other company’s SFP
...
They are
therefore cancelled (contra’d) against each other on consolidation
...
K
...

The usual rules are as follows:
(1)

If the goods or cash are in transit between P and S make the adjusting entry to the
statement of financial position of the recipient
...

(ii) Goods in transit adjusting entry:
Dr inventory
Cr payables current account
...




Once in agreement, the current accounts may be contra’d and cancelled as part of
the process of cross casting the assets and liabilities
...


Good will
IFRS 3 business combinations
IFRS revised governs accounting for all business combinations other than joint ventures
...

Good will is calculated as the excess of the consideration transferred and amount of any
non controlling interest over the net of the acquisition date identifiable assets acquired
and liabilities assumed
...

Tested annually for impairment
...


Negative good will
-

Arises where the cost of the investment is less than the value of net assets
purchased
...
K
...

It arises due to a misstatement of the fair values of assets and liabilities and the
standard requires that the calculation is reviewed
...


Illustration
Statement of financial position at 31 Dec 2009
...
000

20
...
000

Non current assets

Current assets

5
...
000

50
...
000

10
...
000

Equity and liabilities
Capital and reserves
Called up share capital (Shs
...
000

-

Retained earnings

6
...
000

21
...
000

20
...
000

9
...
000

50
...
000

Non current liabilities
8% loan notes
Current liabilities

On 1st Jan 2003 Faye acquired 3
...
At that date the balance on Garbo
retained earnings was 8
...
= and the fair value of the non controlling interest was
Shs
...
500
...
1
...

Required: Prepare a consolidated statement of financial position of Faye at 31st Dec
2009 assuming that it is a group practice to value the NCI using the full good will
method
...
K
...
The adjustments required will
be
Dr: Consolidated Retained Earnings
Cr: Group Inventory
b) If the seller is the subsidiary the profit element is included in the subsidiary
company accounts and relates partly to the group and partly to NCI(if any) the
adjustments required will be
Dr: Consolidated Retained Earnings with Group %ge share
Dr: Non Controlling Interest with NCI %ge share
Cr: Group Inventory (whole total of URP)
Example:
Suppose P owns 90% of S
...
At year
end the closing inventory of P includes $ 8000 of goods at invoice value acquired
originally from S
...
K
...
two years ago o 1st Jan 20X2 when the
retained earnings of S stood at shs 5000
SOFP at year end of 31st Dec 20X3 are as follows
P

S

100

30

Non Current Assets
Property, plant & Equipment
Investment

34
134

Current Assets
Inventory

90

20

Receivables

110

25

Bank

10

210

5

50

344

80

Share Capital

15

5

Retained Earnings

159

31

Non Current Liabilities

120

16

Current Liabilities

50

28

344

80

Additional Information:
S transferred goods to P at a transfer price of shs 18,000/= and a markup of 50%
...
The current account in the parent &
subsidiary stood at shs 22,000/= on that day
...
K
...
In separate years transfers are
a) From H to S shs 20,000, Mark up 25% half of the good are still in inventory
b) From S to H shs 150,000
...
K
...


Significant influence is the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control over those policies
...
Conversely it is presumed that a holding of
less than20% does not give significant influence, unless such influence can be clearly
demonstrated
...

The carrying amount of the investment is adjusted in each period by the group share of
the profit of the associate less any impairment losses
...


The effect of this is that the consolidated statement of financial position includes;
-

100%, of the assets and liabilities of the parent and subsidiary company on a line
by line basis
...


The consolidated income statement includes;
-

100% of the incomes and expenses of the parent and subsidiary company on a
line by line basis
...


Note: In order to equity account, the parent company must already be producing
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consolidated financial statements (i
...
it must already have at least one subsidiary)
...

Unrealized profits on trading between the group and associate must be eliminated to the
extent of the investor’s interest (i
...
% age owned by the parent)

Other disclosures
Notes to the consolidated financial statements should disclose;
-

The fair value of investments in associates for which there are published price
quotations
...


Associates in the consolidated statement of financial position
Preparing the CSFP including an associate
The CSFP is prepared on a normal line-by-line basis following the acquisition method for
the parent and subsidiary
...

$000
Parents share of associates net assets at reporting date (W2)
X
Carrying Goodwill/Premium (W3)
X_
X_
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Standard workings
The calculations for an associate (A) can be incorporated into standard CSFP workings as
follows
...
K
...
V of NCI @ acquisition

X
X

Less:
NCI % of subs net assets at acquisition

_(X)_

Goodwill – NCI share

X_

Total Goodwill on acquisition

X

Less impairment

(X)_

Carrying Goodwill

(X)_

W4 Non Controlling Interest (old method)
Parents share of subs net assets at reporting date

X

or;
Non-controlling interest (new method)
Parents share of subs net assets at reporting date

X

NCI share of Goodwill

X_
X_

(W5) Group retained earning
$
Preserves (100%)

X

S – group share of post-acquisition reserves

X

A – group share of post-acquisition reserves

X

Less: Impairment losses to date (S + A) (W3)

X_
X_

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(W6) Investment in associated company
Cost of investment
Post-acquisition profits (W5)
Less Impairment

or;
Parents share of Assets NA @ reporting date
Carrying Goodwill

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$
X
X
X_
X_

X
X_
X_

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Below are the statements of financial position of three companies as at
31 December 20X9
Dipsy
$000

LaaLaa
$000

Po
$000

1,120

980

840

644

-

-

224
_____
1,988

_____
980

_____
840

Inventory

380

640

190

Receivables

190

310

100

35
_____
605
_____

58
_____
1,008
_____

46
_____
336
_____

2,593
_____

1,988
_____

1,176
_____

$ 1 ordinary shares

1,120

840

560

Retained earnings

1,232
_____
2,352

602
_____
1,442

448
_____
1,008

150

480

136

91
_____
241
_____

66
_____
546
_____

32
_____
168
_____

2,593

1,988

1,176

Non-current assets:
Tangible assets
Investments
672
...
000 shares in Po

Current assets:

Cash

Equity and liabilities
Capital and reserves

Current liabilities:
Trade payables
Taxation

You are also given the following information:
(1) Dipsy acquired its shares in LaaLaa on 1 January 20X9 when LaaLaa had
retained losses of $56,000
...
K
...

(3) An impairment test at the year end shows that goodwill for LaaLaa remains
unimpaired and the investment in Po by $2,800
...
The fair
value on 1 January 20X9 was $157,000
...


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PRINCIPLES OF CONSOLIDATED INCOME STATEMENT
Basic Principle:
The consolidated income statement shows the profit generated by all resources disclosed
in the related consolidated statement of financial position that is the net assets of the
parent Co (P) and its subsidiaries (S)

The consolidated income statement follows these basic principles


From revenue to profit after tax include all of P’s income plus all of S’s income
and expenses (reflecting control of S)



After the profit after tax deduct share of profits due to the non controlling
interest (to reflect ownership)

The mechanics of consolidation
As with the SOFP it is common to use a standard set of workings when producing a
consolidated income statement as below,


Consolidation schedule



Group structure diagram



Net assets of subsidiary at acquisition (required for goodwill calculation)
...


Example
The draft income statements of P and S for the year 30th Nov 2010 are given below
P ($)
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S ($)
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Revenue

8500

2200

Cost of sales and expenses

(7650)

(1980)

Income tax

(400)

(100)

Profit after tax

450

120

Required
Prepare a consolidated income statement for P and its subsidiaries for the year
ended 30th Nov 2010
...

Sales and purchases
Such trading will be included in the sales revenue of one Group Company and the
purchases of another
...




Consolidated cost of sales = P’s + S’s C
...
S – Intra group sales
...

The adjustment for unrealized profit should be shown as an increase to cost of sales in the
seller’s column in the consolidation schedule
...
K
...
5 million on 31 December 20X1 for 80% of London’s ordinary share
capital of $800,000
...




Good will impairments at 1 January 20X5 amounted to $152,000
...
The profit element
included in London’s closing inventory was $30,000
...
Not all of
the goods had been sold externally by the year end
...




The figure for investment income in Paris’s income statement comprises the parent
company’s share of the subsidiary’s total dividend for the year
...


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Illustration 2
On 1 January 20X9 Zebedee acquired 60% of the ordinary shares of Xavier for the year
ended 31 December 20X9
$000
$000
Sales revenue
1,260
520
Cost of sales
(420)
(210)
___
___
Gross profit
840
310
Distribution costs
(180)
(60)
Administration expenses
(120)
(90)
___
___
Profit from operations
540
160
Investment income from Xavier
36
___
___
Profit before taxation
576
160
Taxation
(130)
(26)
___
___
Profit after taxation
446
134
During the year ended 31 December 20X9 Zebedee had sold $84,000 worth of goods to
Xavier
...

Prepare the consolidated income statement to incorporate Zebedee and Xavier for
the year ended 31 December 20X9
...

Both the loan and loan interest must be excluded from the consolidated results
...


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Mid – year acquisitions
Mid – year acquisition procedure
If a subsidiary is acquired part way through the year then the subsidiary’s results should
only be consolidated from the date of acquisition that is, the date on which control is
obtained
...




Time apportionment of the results of S in the year of acquisition
...




After time – apportioning S’s results, deduction of post acquisition intra – group
items as normal
...

The profits of both companies are deemed to accrue evenly over the year
...

Ignore goodwill
...
K
...
The issued share capital of flower is 100,000 $1 ordinary shares
...

Income statement for the year ended 31 December 20X7

Sales revenue
Cost of sales

Operating costs
Operating profit
Interest payable
Profit before tax
Tax
Profit after tax

Smiths
$000
600
(360)
___
2
(93)
___
147
___
147
(50)
___
97

Flowers
$000
300
(140)
___
(45)
___
115
(3)
___
112
(32)
___
80

The following additional information is relevant
(1) During the year flowers sold goods to Smiths for $20,000, making a mark-up of the
third
...

(2) Goodwill has been subject to an impairment review at the end of each year since
acquisition
...
The
current impairment is to be recognized as an operating cost
...


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