OVERVIEW
Objective
¾
To explain the accounting treatment of subsidiaries in consolidated statement of comprehensive income.TREATMENT OF GOODWILL INTRODUCTION
MID-YEAR ACQUISITIONS INTER-COMPANY
TRANSACTIONS AND UNREALISED PROFIT
¾ Income generation ¾ Control and ownership
¾ Dividends
¾ Inter-company items
¾ Inclusion of subsidiary’s results
¾ Dividends from subsidiary acquired mid-year ENTITLEMENT OF
NON-CONTROLLING INTEREST
¾ IAS 1 ¾ Basics
1
INTRODUCTION
1.1
Income generation
¾
The statement of comprehensive income shows the income generated by resources (= net assets in the statement of financial position): Parent’s own statement of comprehensive income includes dividend income from subsidiary.
The consolidated statement of comprehensive income shows the income generated by the group’s resources (= net assets in consolidated statement of financial
position).
¾
The consolidated statement of comprehensive income is prepared on a basis consistent with that used in the preparation of the consolidated statement of financial position.1.2
Control and ownership
Consolidated statement of comprehensive income
$
Revenue X
[Parent + Subsidiary (100%) – intercompany items]
↓ ___ ↓
Profit after tax (CONTROL) ___X
OWNERSHIP
Equity shareholders of the parent X
Non-controlling interests
( % × subsidiary’s profit after tax) X ___
Profit for the period X
___
¾
This reflects the profit or loss section of the statement of comprehensive income, any other gains or losses for the period will be included within other comprehensive income. This session will focus upon the profit or loss component of the statement of comprehensive income.¾
The profit or loss shows the income generated from net assets under parent’s control.¾
In the profit or loss dividends from subsidiary are replaced by parent’s share ofsubsidiary’s income and expenses (100%) line-by-line, as far as profit after tax.
Commentary
For example, for interest paid by subsidiary to parent, cancel interest payable in subsidiary’s profit or loss against interest receivable in parent’s profit or loss.
2
INTER-COMPANY TRANSACTIONS AND UNREALISED
PROFIT
2.1
Dividends
¾
Dividends from subsidiary to parent are inter-company items: Cancel parent’s dividend income from subsidiary against subsidiary’s dividends paid and proposed.
This “leaves” the non-controlling interests’ share of subsidiary’s dividends.
¾
Non-controlling interest in subsidiary in profit or loss is calculated on profit after tax(before dividends), and therefore includes the non-controlling interest’s share of subsidiary’s
dividends and retained profits.
Commentary
In short, simply ignore dividends from subsidiary on consolidation.
¾
In profit or loss dividend income is from trade investments only. Any dividends paid or proposed will be dealt with in the statement of changes in equity.2.2
Inter-company items
2.2.1
Trading
¾
Inter-company trading will be included in the revenue of one group company and the purchases of another. Such inter company items must be cancelled out on consolidation (single entity concept) by taking the following steps: add across parent and subsidiary revenue and cost of sales;
deduct value of inter-company sales from revenue and cost of sales.
Commentary
This adjustment has no effect on profit and hence will have no effect on the non-controlling interest share of profit.
¾
The adjustment will be made as a consolidation adjustment against the profits of the selling company.¾
Steps to set up the provision for unrealised profit. Calculate the amount of inventory remaining at the year end. Calculate the inter-company profit included in it.
Make a provision against the inventory to reduce it to cost to the group (or net realisable value if lower).
Example 1
Whales owns 75% of Porpoise. The trading account for each company for the year ended 31 March 2008 is as follows:
Whales Porpoise
$ $
Revenue 120,000 70,000
Cost of sales (80,000) (50,000)
_______ _______
Gross profit _______ 40,000 20,000
_______ During the year Porpoise made sales to Whales amounting to $30,000. $15,000 of these sales were in inventory at the year end. Profit made on the year end inventory items amounted to $2,000.
Required:
Calculate group revenue, cost of sales and gross profit.
Solution
Seller adjustment
Whales Porpoise Adjustment Consolidated
$ $ $ $
Revenue
Cost of sales – per question
– unrealised profit _______ _______ _______ _______ Gross profit
_______ _______ _______ _______
Non-controlling interest
2.2.3
Unrealised profit in opening inventory
¾
Last years closing inventory will become this years opening inventory, and so any adjustments made in the previous year in terms of the unrealised profit will be reversed in the current year, on the presumption that the inventory has been sold on in the current period.¾
Therefore any unrealised profit in the opening inventory will be deducted from the costs of the original selling company, thereby increasing the profits for the current year.¾
All we are doing with unrealised profit is shifting the period in which the profit isrecognised, delaying the recognition of the profit by the group until the goods have been sold outside of the group.
¾
This adjustment only ever impacts on the gross profit calculation, never the statement of financial position.2.2.4
Non-current asset transfers
¾
The consolidated statement of comprehensive income should include depreciation of current assets based on cost to group and should exclude profit/loss onnon-current asset transfers between group members. This is consistent with treatment in the consolidated statement of financial position.
Eliminate profit or loss on transfer and adjust depreciation in full (control). These adjustments are made in full against the consolidated figures.
Illustration 1
Parent owns 80% of subsidiary. Parent transferred a non-current asset to subsidiary on 1 January 2007 at a value of $15,000. The asset originally cost Parent $2012,000 and depreciation to the date of transfer was $8,0004,800.. The asset had a useful life of 5 years when originally acquired, with a residual value of zero. The useful life at the date of transfer remains at 3 years.Both companies depreciate their assets at 20% per annum on cost, making a A full year’s depreciation charge is made in the year of acquisition and none in the year of disposal. Total depreciation for 2007 was $700,000 for parent and $500,000 for subsidiary.
Required:
Solution
Parent Subsidiary Adjustment Consolidated
$ $ $
Per question 700,000 500,000 1,200,000
Asset unrealised profit
[15,000 – (20,000 – 8,000)] 3,000 3,000
Depreciation adjustment
(15,000 / 3 years) – 4,000 (1,000) (1,000)
_________ 1,202,,000 _________
↑
This would be part of the profit after tax of subsidiary and would therefore be shared with the non-controlling interest
3
ENTITLEMENT OF THE NON-CONTROLLING INTEREST
3.1
Basics
¾
The non-controlling interests’ share of subsidiary’s profit after tax must be shown, leaving group profit remaining.Example 2
Pathfinder owns 75% of Sultan . Statements of comprehensive income for the two companies for the year ending 30 September 2008 are as follows:
Pathfinder Sultan
$ $
Revenue 100,000 50,000
Cost of sales (60,000) (30,000)
_______ _______
Gross profit 40,000 20,000
Expenses (20,000) (10,000)
_______ _______
Profit for the period 20,000 10,000
_______ _______ During the year, Pathfinder sold goods to Sultan for $20,000, at a gross profit margin of 40%. Half of the goods remained in inventory at the year-end.
Required:
Proforma solution
Consolidated statement of comprehensive income for the year ended 30 September 2008
$ Revenue
Cost of sales _______
Gross profit
Expenses _______
Profit
_______ Non-controlling interests (W3)
Equity shareholders of the parent (balance)
_______
Profit for the period _______
WORKINGS
(1) Group structure
Pathfinder
75%
Sultan
(2) Consolidation schedule
Pathfinder Sultan AdjustmentConsolidated
$ $ $ $ Revenue
Cost of sales
Expenses
_______ Profit
_______
(3) Non-controlling interests
(4) Unrealised profit
% $
Selling price Cost
____ _______ $ Gross profit
____ _______ _______
4
MID-YEAR ACQUISITIONS
4.1
Inclusion of subsidiary’s results
¾
Group accounts only include subsidiary from date of acquisition, i.e. when control is gained. If subsidiary is acquired mid-year: Consolidate subsidiary from date of acquisition;
Identify net assets at date of acquisition for goodwill (see consolidated statement of financial position notes);
Assume revenue and expenses accrue evenly over the year (unless contrary is indicated). Therefore time-apportion totals for revenue and costs, then deduct inter-company items.
Example 3
Parent acquired 75% of subsidiary on 1 April 2007. Extracts from the companies’ statements of comprehensive income for the year ended 31 December 2007 are:
Parent Subsidiary
$ $
Revenue 100,000 75,000
Cost of sales (70,000) (60,000)
_______ _______
Gross profit 30,000 15,000
_______ _______
Since acquisition, parent has made sales to subsidiary of $15,000. None of these goods remain in inventories at the year end.
Required:
Solution
Consolidated statement of comprehensive income for the year ending 31 December 2007
9/12
Parent Subsidiary Adjustment Consolidated
$ $ $ $
Revenue Cost of sales
_______ _______ _______ _______
Gross profit _______ _______ _______ _______
4.2
Dividends from subsidiary acquired mid-year
¾
In calculating net assets at acquisition, assume profit after tax (i.e. before dividends) accrues evenly over year, unless contrary is indicated.5
TREATMENT OF GOODWILL
¾
IFRS 3 rules that goodwill arising on acquisition must be capitalised and tested annually for impairment. Any fall in value is recognised as an expense and charged to profit or loss in the period.¾
Any excess of the fair value of the assets and liabilities acquired over the cost of the acquisition is credited to profit or loss immediately.6
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
6.1
IAS 1
¾
IAS 1 requires a statement of changes in equity to be included in a set of financial statements, whether they are from a single entity perspective or that of a group.¾
The statement will reconcile how the equity position has changed during the period. The consolidated statement will look at the movements from the point of the group, only changes in the parents share capital position will be included in the consolidated statement. The statement may include some of the following: Opening balances
Cumulative effect of changes in accounting policy and prior period errors Profit for the year
Ordinary dividends (parent plus non-controlling interest share of subsidiary) Issue of shares
Equity component of convertible bond
Example 4
The draft accounts of two companies at 31 March 2008 were as follows:
Statement of financial position
Hamble Group Jemima $ $
Investment in Jemima at cost 3,440 –
Sundry assets 36,450 6,500
_______ _______ 39,890 6,500 _______ _______
Share capital ($1 ordinary shares) 20,000 3,000
Retained earnings 19,890 3,500
_______ _______ 39,890 6,500 _______ _______
Statement of comprehensive income
Hamble Group Jemima $ $
Profit before tax 12,950 3,800
Tax (5,400) (2,150)
_______ _______
Profit after tax 7,550 1,650
Retained earnings b/d 12,340 1,850
_______ _______
Retained earnings c/f 19,890 3,500
_______ _______ Hamble and Jemima are both incorporated enterprises.
Hamble had acquired 90% of Jemima, on 1 April 2006, when the reserves of Jemima were $700. Goodwill of $110 arose on the acquisition. An impairment loss of $20 was recognised in the previous years accounts, and an impairment loss of $25 is to be recognised in the current years accounts.
Required:
Solution
(1) Consolidated retained earnings 1 April 2007
$ Hamble Group
Jemima
Less Goodwill _______
_______
(2) Consolidated retained earnings 31 March 2008
$ Hamble Group
Jemima
Less Goodwill _______
_______
Consolidated statement of financial position as at 31 March 2008
$ Goodwill
Sundry assets _______
_______
Share capital Retained earnings Non-controlling interest
_______
_______
Consolidated statement of comprehensive income for the year ended 31 March 2008
Hamble Jemima Consolidated
$ $ $
Profit before taxation Goodwill
Taxation
_______ _______ _______
Profit after taxation _______
Non-controlling interests
Consolidated statement of changes in equity for year ended 31 March 2008
Share Retained Total Non-controlling Total
capital earnings interest Equity
$ $ $ $ $
At 1 April 2007 Profit for year
——— ——— ——— ——— ———
At 31 March 2008
——— ——— ——— ——— ———
FOCUS
You should now be able to:
¾
account for the effects of intra-group trading;¾
prepare a consolidated statement of comprehensive income for a simple group, dealing with an acquisition in the period and non-controlling interest;¾
account for the effects of intra-group trading and other transactions including: unrealised profits in inventory and non-current assets;
intra-group loans and interest and other intra-group charges; and intra-group dividends;
EXAMPLE SOLUTIONS
Solution 1
Seller adjustment
Whales Porpoise Adjustment Consolidated
$ $ $ $
Revenue 120,000 70,000 (30,000) 160,000
Cost of sales – per question (80,000) (50,000) 30,000
– unrealised profit (2,000) (102,000)
_______ _______ _______ _______
Gross profit 40,000 18,000 58,000
_______ _______ _______ _______
Non-controlling interest (25% × 18,000) (4,500)
_______
Solution 2
Consolidated statement of comprehensive income for the year ended 30 September 2008
$Revenue 130,000
Cost of sales (74,000)
_______
Gross profit 56,000
Expenses (30,000)
_______
Profit 26,000
Non-controlling interests (W3) (2,500) _______
Profit for the period 23,500
_______ WORKINGS
(a) (1) Group structure
Pathfinder
75%
(2) Consolidation schedule
Pathfinder Sultan Adjustment Consolidated
$ $ $ $
Revenue 100,000 50,000 (20,000) 130,000
Cost of sales – per question (60,000) (30,000) 20,000 – unrealised profit (W4) (4,000) (74,000)
Expenses (20,000) (10,000) (30,000)
_______
Profit 26,000
_______
(3) Non-controlling interests
$ Sultan 10,000 (W2) × 25% = 2,500
_______
(4) Unrealised profit
% $
Selling price 100 20,000
Cost (60) (12,000)
____ ______ $
Gross profit 40 8,000 ×½ = 4,000
____ ______ _____
Solution 3
Consolidated statement of comprehensive income for the year ending 31 December 2007
9/12
Parent Subsidiary Adjustment Consolidated
$ $ $ $
Revenue 100,000 56,250 (15,000) 141,250
Cost of sales (70,000) (45,000) 15,000 (100,000)
_______ _______ _______ _______
Gross profit 30,000 11,250 – 41,250
_______ _______ _______ _______
Solution 4
(1) Consolidated retained earnings 1 April 2007
$
Hamble Group 12,340
Jemima 90% (1,850 – 700) 1,035
Less Goodwill (20)
(2) Consolidated retained earnings 31 March 2008
$
Hamble Group 19,890
Jemima 90% (3,500 – 700) 2,520 Less Goodwill (20 + 25) (45)
_______ 22,365 _______
Consolidated statement of financial position as at 31 March 2008
$
Goodwill (110 – 45) 65
Sundry assets (36,450 + 6,500) 42,950
_______ 43,015 _______
Share capital 20,000
Retained earnings 22,365
Non-controlling interest (6,500 × 10%) 650
_______ 43,015 _______
Consolidated statement of comprehensive income for the year ended 31 March 2008
Hamble Jemima Consolidated
$ $ $
Profit before taxation 12,950 3,800 16,750
Goodwill (25)
Taxation (5,400) (2,150) (7,550)
_______ _______ _______
Profit after taxation 7,550 1,650 9,175
_______
Non-controlling interests (1,650 × 10%) 165
Equity shareholders of the parent 9,010
_______
Profit for the financial year 9,175
_______
Consolidated statement of changes in equity for year ended 31 March 2008
Share Retained Total Non-controlling Total
capital earnings interest Equity
$ $ $ $ $
At 1 April 2007 20,000 13,353 33,353 485 33,838
Profit for year 9,013 9,013 165 9,178
——— ——— ——— ——— ———
Commentary
