Consolidation of Accounts

Advanced Financial Accounting Chapter 5 – Consolidation accounts

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Advanced Financial Accounting Chapter 5 – Consolidation accounts What is consolidated accounts? A group exists if a dominant company (holding company or parent undertaking) controls another company know as the subsidiary undertaking. Group accounts extend the reporting entity, the holding company or parent company to include other entities that are subject to its control and influence. This involves treating the net assets and activities of subsidaries held by the holding company as if they were part of the holding company’s own new assets and activities. The overall aim is to present the results of the group as if they were those of a single entity. According to FRS2, the purpose of consolidated financial statements is to present financial information about a parent undertaking and its subsidiary undertaking as a single economic entity to show the economic resources controlled by the group. What is a subsidiary? Under the Companies Act 1989, a subsidiary undertaking is one in which the parent: • Has a majority of voting rights, • Is a member and can appoint or remove a majority of the board, • Is a member and controls alone a majority of voting rights by agreement with

other members, • Has the right to exercise a dominant influence through the Memorandum and

Articles or a control contract; • Has a participating interest and either actually exercises a dominant influence

over it or manages both on a unified basis. Prepare a consolidate accounts Goodwill Purchases goodwill is the difference between the cost of an acquired entity and the aggregate of the fair values of an entity’s identifiable assets and liabilities (Capital). Goodwill is calculated through: Cost of investment xxx Less: Shareholders’ funds at the date of acquisition

Share capital xx Pre-acquisition retained earnings xx xx

Goodwill arising on acquisition xxx Balance of the goodwill account: Goodwill arising on acquisition xxx Less: Amortisation of goodwill (from acquisition to now) xx Balance of goodwill xxx



Retained earnings The retained earnings or reserves of a group is: Parent company’s retained profit + Parent company’s share of post acquisition profit Consolidated retained earnings is calculated through: Parent company’s balance xxx Group’s share of post acquisition profit xx Less: Goodwill written off xx xxx Minority interests In a situation where the holding company acquires less than 100 per cent, say 75 per cent of the issued ordinary shares and therefore owns 75 per cent of the net assets, the practice is to include all resources that are under the control of the directors of the holding company in the consolidated accounts. The shares and reserves that have not been acquired by the holding company, ie the 25 per cent, are transferred to a separate liability heading called the minority interest to indicate the amount that does not belong to the holding company. Minority is calculated by: Shareholders’ funds at balance sheet date * percentage not acquired Financed by A consolidate accounts is financed by: Share capital (Parent company’s) + Profit and loss (Parent’s P/L + post-acquisition profit) + Minority interest (at balance sheet date) Calculation of goodwill on consolidation or cost of control There are several cases for acquisition of subsidiaries, these include:

• Acquisition at balance sheet date • Acquisition before the balance sheet date • Acquisition involving pre-acquisition loss • Acquisition involving minority interest • Acquisition of subsidiary during the year

Refer to the background information below, and find out the following for each of the cases, at 31 December 2000:

a) Goodwill arising on consolidation b) Consolidated retained earnings c) Balance sheet



The balance sheet of Alpha Ltd and Beta Ltd on 31 December 2000 were as follows: Alpha Ltd Beta Ltd $ $ Fixed assets Tangible 500,000 90,000 Investments 70,000 shares in Beta Ltd 190,000 - 690,000 90,000 Net current assets 30,000 40,000 720,000 130,000 Capital and reserves Called-up share capital 550,000 70,000 Profit and loss account 170,000 60,000 720,000 130,000 Different cases of acquisitions: Acquisition date Retained profit at the time

of acquisition % holding

Case 1 31 Dec 2000 $60,000 100 Case 2 1 Jan 2000 $30,000 100 Case 3 1 Aug 2000 $40,000 100 Case 4 1 Jan 2000 -$20,000 100 Case 5 1 Jan 2000 $30,000 80 Case 6 1 Aug 2000 $40,000 80 Case 7 1 Jan 1998 -$20,000 80 Consolidation adjustments There always transactions between companies in the same group. These inter-company transactions should be eliminated when group accounts are prepared. The main problem is how to account for the unrealised profit on goods transferred by one group company to the other. If goods transferred from one group to the other at a profit remain unsold at the end of the financial year, the unrealized profit will e eliminated on consolidation. The main consolidation adjustments are:

• Profit on unsold stock • Inter-company balances • Items in transit • Transfer of fixed assets • Fair value of fixed assets



Profit on unsold stock Profit on unsold stock may happen in both goods transferred from and to parent company to subsidiary. If the goods are transferred from parent company: Dr consolidated retained earnings account Cr consolidated stock figure If the goods are transferred from subsidiary to parent company Dr consolidated retained earnings Dr minority interest (with the minority’s share of the unrealised profit) Cr consolidated stock (with the total amount of unrealised profit) Inter-company balances All inter-company balances should be eliminated (delete through offsetting each other) when preparing the consolidated balance sheet. These balances may arise from loan between the parent and subsidiary companies, dividend proposed by the subsidiary, and goods purchases from subsidiary. Items in transit This refers to cash and goods transferred from one group company to the other but are in transit at the balance sheet date. Goods and cash in transit would cause the inter-company balances to differ. If this happens, we need to debit the items in transit (cash or goods) account and credit the transferor (which send the cash/goods) company’s account in the books of the transferee (which receive the cash/goods). Example Alpha is the parent company of Beta Ltd. At 31 December 2000, the following balances appeared in the balance sheets of the two companies. Alpha Beta $ $ Beta Ltd – debtor 15,000 Alpha Ltd – creditor 12,000 The difference in the two balances is due to cash transferred by Beta Ltd (transferor) to Alpha Ltd (transferee), which was in transit at the balance sheet date. Required Explain the consolidation adjustments required. Transfer of fixed assets Transfer of fixed assets from the subsidiary to parent company or vice versa would give rise to inter-company adjustments if the transfer is made at a price other than the book value or the cost of the fixed asset. The unrealized profit would have to be eliminated.



The unrealized profit of the asset is calculated by: Written down value based on selling price – written down value based on cost. If the transfer is from parent company to subsidiary, the unrealized profit is to be eliminated from the group’s retained earnings. While if the transfer is from subsidiary to parent company, it is to be eliminated from both retained earnings and minority interest as well. Example Alpha Ltd acquired 90 percent of the voting shares of Beta Ltd on 1 January 1999. On the 1 Jul, Beta bought machinery from Alpha. This machinery was manufactured by Alpha for $100,000 and sold to Beta at a profit of 20 percent on the selling price. Beta which still owned the machinery at 31 December 1999, wrote off depreciation at the rate of 10 percent on cost, charging a full year’s depreciation in 1999. Required Explain the adjustments required for consolidation purpose. Fair value of fixed assets If the fair value of the fixed assets at the date of acquisition is different from the book value, the fixed assets need to be revaluated to reflect the revaluation surplus. The revaluation reserve is a pre-acquisition reserve and should affect the goodwill computation. Dr Tangible fixed assets Cr Revaluation reserve However, the additional depreciation that charged for the revaluation is a post-acquisition expenses, therefore it is to be deducted from the post-acquisition profit when calculating both consolidated retained earnings and minority interest. Negative Goodwill Negative goodwill is to be recognized in the profit and loss account over the period (number of years) in which the non-monetary assets (stocks and tangible fixed assets) acquired by the parent company are recovered (selling of stock and depreciation of fixed assets). Example: Negative goodwill: $15,000 Fixed assets (at date of acquisition): $90,000 Stocks (at date of acquisition): $70,000 Stocks were sold during the year, and depreciation charged on the fixed assets amounted $10,000. Required Calculate the goodwill written back to profit and loss account.



Exercises Exercise 5.1



Exercise 5.2



Exercise 5.3



Exercise 5.4



Exercise 5.5



Exercise 5.6



Exercise 5.7

Consolidation of Accounts

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