ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing
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Chapter 18: Consolidated accounts
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6.2 Consolidated income statement: the basic rules
A consolidated income statement brings together the sales revenue, income and
expenses of the parent and the sales revenue, income and expenses of its
subsidiaries.
The basic principle can be illustrated with a simple example. In the example below,
the subsidiary is 100% owned by the parent, and the acquisition did not occur in the
current year.
Example
Entity P owns 100% of the equity capital of Entity S, and has owned the shares for
several years. In the year just ended, the income statement of each entity was as
follows.
EntityP EntityS
$ $
Revenue 500,000 250,000
Costofsales (200,000) (80,000)
–
––––––
–
––––––
Grossprofit 300,000 170,000
Otherincome 25,000 6,000
Distributioncosts (70,000) (60,000)
Administrativeexpenses (90,000) (50,000)
Otherexpenses (30,000) (18,000)
Financecosts (15,000) (8,000)
–
––––––
–
––––––
Profitbeforetax 120,000 40,000
Incometaxexpense (45,000) (16,000)
–
––––––
–
––––––
Profitfortheperiod 75,000 24,000
–
––––––
–
––––––
In this situation, the figures for the parent and subsidiary are added together to
produce the consolidated income statement.
PGroup
Consolidatedincomestatementfortheyear
$
Revenue(500,000+250,000) 750,000
Costofsales(200,000+80,000) (280,000)
–
––––––
Grossprofit 470,000
Otherincome(25,000+6,000) 31,000
Distributioncosts(70,000+60,000) (130,000)
Administrativeexpenses(90,000+50,000) (140,000)
Otherexpenses(30,000+18,000) (48,000)
Financecosts(15,000+8,000) (23,000)
–
––––––
Profitbeforetax 160,000
Incometaxexpense(45,000+16,000) (61,000)
–
––––––
Profitfortheperiod 99,000
–
––––––
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6.3 Pre- and post-acquisition profits
When a parent acquires a subsidiary during a financial year, the profits of the
subsidiary have to be divided into pre-acquisition and post-acquisition profits.
The pre-acquisition profit is used to calculate the goodwill.
The post-acquisition profit (or loss) is included in the consolidated profit for the
year.
Unless you are given information that suggests an alternative assumption is
appropriate, you should assume that in the year of acquisition, the profits of the
subsidiary occur at an even rate throughout the course of the year. The division of
the annual profit of the subsidiary into pre-acquisition and post-acquisition
elements can be done on a time basis.
Example
Entity P acquired 100% of the equity shares of Entity S at a cost of $750,000 on 1
October Year 2, when the net assets of Entity S were $600,000. Entity P prepares its
financial statements to 31 December each year. The income statement for each entity
for the year to 31 December Year 2 was as follows.
EntityP EntityS
$ $
Revenue 400,000 260,000
Costofsales (200,000) (60,000)
–
––––––
–
––––––
Grossprofit 200,000 200,000
Otherincome 20,000‐
Distributioncosts (50,000) (30,000)
Administrativeexpenses (60,000) (80,000)
Otherexpenses (20,000) (10,000)
Financecosts (10,000) (5,000)
–
––––––
–
––––––
Profitbeforetax 80,000 75,000
Incometaxexpense (30,000) (15,000)
–
––––––
–
––––––
Profitfortheperiod 50,000 60,000
–
––––––
–
––––––
Required
Prepare a consolidated income statement for the year to 31 December Year 2,
assuming there is no impairment of goodwill during the year.
Answer
The acquisition date was 1 October. This means that 9/12 or 75% of the subsidiary’s
profit for the year is pre-acquisition profit and 3/12 or 25% is post-acquisition profit.
The post-acquisition profit of the subsidiary for the year is therefore 3/12 × $60,000
= $15,000.
Chapter 18: Consolidated accounts
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EntityP EntityS(25%) Consolidated
$ $ $
Revenue 400,000 65,000 465,000
Costofsales (200,000) (15,000) (215,000)
–
––––––
–
––––– –––––––
Grossprofit 200,000 50,000 250,000
Otherincome 20,000 – 20,000
Distributioncosts (50,000) (7,500) (57,500)
Administrativeexpenses (60,000) (20,000) (80,000)
Otherexpenses (20,000) (2,500) (22,500)
Financecosts (10,000) (1,250) (11,250)
–
––––––
–
–––––– –––––––
Profitbeforetax 80,000 18,750 98,750
Incometaxexpense (30,000) (3,750) (33,750)
–
––––––
–
–––––– ––––––
–
Profitfortheperiod 50,000 15,000 65,000
–
––––––
–
–––––– –––––––
6.4 Non-controlling interest in the consolidated income statement
When there is a non-controlling interest (minority interest) in a subsidiary, the
consolidated income statement should show:
the post-acquisition profit for the year for the group as a whole, including all the
post-acquisition profit of the subsidiary, and
the amount of this total profit that that is attributable to the parent’s equity
shareholders and the amount that is attributable to the non-controlling interest
in the subsidiary.
For the purpose of preparing the consolidated income statement, all the pre-
acquisition profits of the subsidiary are excluded. When the financial statements
include a separate consolidated income statement, the final lines of the consolidated
income statement should therefore be as follows:
Profit for the period X
–
––
Attributable to:
Owners of the parent Y
Non-controlling interest Z
–
––––––––
Y + Z = X
–
––––––––
Example
Entity P acquired 300,000 shares in Entity S on 1 August Year 2. The total net assets
of Entity S at 1 January Year 2 were $1,310,000.
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The statement of financial position of entity S at 31 December Year 2 was as follows:
EntityS
Statementoffinancialpositionasat31DecemberYear2
$000
Property,plantandmachinery 1,200
Currentassets 550
–
––––
1,750
–
––––
Equityandliabilities
Equitysharesof$1each 500
Sharepremium 300
Retainedearnings 600
–
––––
1,400
Liabilities 350
–
––––
1,750
–
––––
There has been no dividend payment by S in the year. The profit after tax of Entity P
for the year was $250,000. There has been no impairment of goodwill.
Required
Calculate the consolidated profit for the year to 31 December Year 2, and the
allocation of this profit between the equity holders of the parent and the non-
controlling interest in S.
Answer
Step 1. Establish the percentage share in the subsidiary of the parent P and the non-
controlling interest.
%
Parentshare:(300,000/500,000)×100% 60
Non‐controllinginterest:(200,000/500,000)×100% 40
–
––
100
–
––
Step 2. Establish the post-acquisition profit of the subsidiary.
Since there has been no dividend payment, the annual profit for the subsidiary can
be calculated as the difference between the net assets of Entity S at the end of the
year and the net assets at the beginning of the year.
$
Netassetsofsubsidiaryat31DecemberYear2(1,750–350) 1,400,000
Netassetsofsubsidiaryat1JanuaryYear2 1,310,000
––––––––
Profitfortheyearaftertax 90,000
––––––––
Post‐acquisitionprofit(5months,therefore5/12×$90,000) 37,500
Chapter 18: Consolidated accounts
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Step 3. Allocate the subsidiary’s post-acquisition profit between the parent’s equity
shareholders and the non-controlling interest in Entity S.
$
Post‐acquisitionprofit(5months,therefore5/12×$90,000) 37,500
––––––
ParentPshare:60%×$37,500 22,500
Non‐controllinginterest:40%×$37,500 15,000
Step 4. Calculate the profit for the year for the group as a whole, and separate into
the parent’s share and the non-controlling interest.
$
ProfitfortheyearofEntityP 250,000
Post‐acquisitionprofitofsubsidiaryS 37,500
–––––––
Consolidatedprofitfortheyear 287,500
–––––––
Attributableto:
Ownersoftheparent(250,000+22,500) 272,500
Non‐controllinginterest 15,000
–––––––
287,500
–––––––
6.5 Impairment of goodwill and consolidated profit
There may be other adjustments to the consolidated profit or loss for the year. One
such adjustment is impairment to goodwill. When purchased goodwill is impaired,
the impairment does not affect the individual financial statements of the parent
company or the subsidiary. The effect of the impairment applies exclusively to the
consolidated statement of financial position and the consolidated income statement.
If goodwill is impaired:
it is written down in value in the consolidated statement of financial position,
and
the amount of the write-down is charged as an expense in the consolidated
income statement (normally in administrative expenses).
When non-controlling interests are valued at their proportionate share of the net
assets of the subsidiary, a write-down in goodwill affects the parent entity only, not
the non-controlling interest. It should therefore be deducted from the profit
attributable to the owners of the parent.
Example
Assume that the same situation applies as in the previous example, with the
following additional information:
The purchase cost of the 300,000 shares in the subsidiary was $900,000.
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At 31 December Year 2, it is assessed that there has been impairment of
goodwill, and the value of the goodwill is now just $70,000.
The goodwill at acquisition can be calculated on the assumption that the profit of
the subsidiary in Year 2 ($90,000 in total) accrued at an even rate through the year.
$
Netassetsofthesubsidiaryat31DecemberYear2 1,400,000
Minuspost‐acquisitionprofit(seeabove) (37,500)
––––––––
Netassetsofthesubsidiaryatacquisitiondate 1,362,500
––––––––
Parent’sshare(60%) 817,500
Costofacquisition 900,000
––––––––
Goodwillatacquisition 82,500
––––––––
$
Goodwillatacquisition(1AugustYear2) 82,500
Goodwillat31DecemberYear2 70,000
––––––
Impairmentintheyear 12,500
––––––
The summarised consolidated income statement for the P Group for the year to 31
December Year 2 will be:
$
ProfitfortheyearofentityP 250,000
Post‐acquisitionprofitofsubsidiaryS 37,500
Impairmentofgoodwill (12,500)
–––––––
Profitfortheyear 275,000
–––––––
Attributableto:
Ownersoftheparent(250,000+22,500–12,500) 260,000
Non‐controllinginterest 15,000
–––––––
275,000
–––––––
Note
When non-controlling interests are valued using the fair value method, a write-
down in goodwill affects both the parent entity and the non-controlling interests.
The impairment reduces total consolidated profit for the period, and this
impairment loss can be apportioned between profit attributable to the owners of the
parent and profit attributable to the NCI.
Chapter 18: Consolidated accounts
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6.6 Fair value adjustments
If assets of the subsidiary are re-valued adjusted to their fair values, this will affect
the consolidated statement of comprehensive income.
If a non-current asset is revalued upwards, the depreciation expense is increased
from the time of the revaluation.
The gain on revaluation is included in other comprehensive income for the
period, in the consolidated statement of comprehensive income. This gain can be
divided between the non-controlling interest and the interest of the owners of
the parent company.
The total comprehensive income for the year will include the gain on
revaluation, which must be analysed between the income attributable to owners
of the parent and the income attributable to the non-controlling interest.
Example
Entity P acquired 80% of the shares of Entity S on 1 January Year 1.
At 1 January Year 1 the fair values of S’s plant and equipment exceeded their book
value by $200,000. They had a remaining useful life of 5 years at this date.
At 31 December Year 1, some property of Entity S was revalued upwards by
$600,000. The rate of tax is 25%.
S also had a long-term loan of $500,000 which was repayable on 31 December Year
5. The loan is interest free, but the interest rate on a similar borrowing would be
10%.
The book values of the other assets and liabilities of S were approximately equal to
their fair values at 1 January Year 1.
Several adjustments are made to the consolidated statement of comprehensive
income for Year 1:
Property, plant and equipment increases by $200,000 at the acquisition date for
items that have a remaining useful life of 5 years. Assuming straight-line
depreciation, there is an additional depreciation expense of $40,000 (200,000/5)
in Year 1. This is included either in cost of sales or in administrative expenses for
Entity S, depending on the nature of the assets that have been revalued, and will
also be included in the consolidated profit or loss for the year.
At 1 January Year 1 the long-term loan is discounted to $310,500 (500,000 ×
0.621). At 31 December Year 1 the long-term loan is discounted to $341,500
(500,000 × 0.683). During Year 1 the discount unwinds by $31,000 (341,500 –
310,500). Therefore there is an additional finance cost of $31,000 in the reported
profit or loss of Entity S, which represents the amount by which present value of
the loan has increased during the year. This will also be included in the
consolidated profit or loss for the year.
The revaluation gain is $600,000 and the related tax is $150,000. The revaluation
reserve of Entity S is increased by $450,000. The after-tax gain of $450,000 in
included in other comprehensive income for the year (for both Entity S and in
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the consolidated statement of comprehensive income.). In the consolidated
accounts, 80% of this income ($360,000) is attributable to owners of the parent
and 20% ($90,000) is attributable to the non-controlling interests.
6.7 Accounting for deferred consideration
Whenever some of the consideration for an acquisition is deferred by more than one
year, it should be valued at present value at the date of acquisition. The present
value of deferred consideration is the amount payable in the future, discounted at
the company’s cost of capital.
In calculating the purchase consideration, the deferred consideration should be
taken at its present value, not the actual future amount payable.
In each subsequent year, there is a finance charge for the deferred acquisition,
which is included in finance costs in the consolidated income statement.
This finance charge is added to the deferred consideration, which is a liability in
the consolidated statement of financial position.
The finance charge is the accumulated balance of the deferred consideration at
the beginning of the year multiplied by the cost of capital.
Example
Hole acquired 80% of the shares of Sole on 1 July Year 5 when the net assets of Sole
were $16 million. The purchase consideration was an immediate payment of $14
million plus a further $3.63 million payable two years after the acquisition.
The company’s cost of capital is 10%. Its financial year ends on 30 June.
The parent company’s attributable goodwill is calculated as follows:
$
Immediatepayment 14,000,000
Deferredpayment:prsentvalue=$3.63million×1/(1.10)
2
3,000,000
–––––––––
17,000,000
Netassetsacquired=80%×$16million 12,800,000
–––––––––
Goodwillattributabletoparent 4,200,000
–––––––––
At the acquisition date, the consolidated statement of financial position includes a
liability for the deferred consideration of $3,000,000.
Year to 30 June Year 6
Finance charge (consolidated income statement) = 10% × $3,000,000 = $300,000.
Total deferred consideration at 30 June Year 5 = $3,000,000 + $300,000 = $3,300,000.
This is a liability in the consolidated statement of financial position.
Year to 30 June Year 7
Finance charge (consolidated income statement) = 10% × $3,300,000 = $330,000.
Total deferred consideration at 30 June Year 6, before the payment is actually made
= $3,300,000 + $330,000 = $3,630,000 (= amount actually payable).
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Paper F7 (INT)
Financial reporting
CHAPTER
19
Consolidated accounts:
intra-group adjustments
Contents
1 Intra-group transactions
2 Intra-group sales and intra-group balances
3 Unrealised profit in inventory
4 Transfers of non-current assets
5 Intra-group loans and interest
6 Intra-group dividends
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Intra-group transactions
Types of intra-group transaction
The need to eliminate intra-group transactions on consolidation
1 Intra-group transactions
1.1 Types of intra-group transaction
In many groups, business and financial transactions take place between entities
within the group. These ‘intra-group’ transactions might be:
the sale of goods or services between the parent and a subsidiary, or between
two subsidiaries in the group
transfers of non-current assets between the parent and a subsidiary, or between
two subsidiaries in the group
the payment of dividends by a subsidiary to the parent (or by one subsidiary to
another subsidiary)
loans by one entity in the group to another, and the payment of interest on intra-
group loans.
1.2 The need to eliminate intra-group transactions on consolidation
Intra-group transactions should be eliminated on consolidation. In other words, the
effects of intra-group transactions must be removed from the financial statements
on consolidation.
The purpose of consolidated accounts is to show the financial position and the
financial performance of the group as a whole, as if it is a single operating unit. If
intra-group transactions are included in the consolidated financial statements, the
statements will show too many assets, liabilities, income and expenses for the group
as a single operating unit.
IAS27 therefore states:
Intra-group balances and transactions, including income, expenses and
dividends, must be eliminated in full.
Profits or losses resulting from intra-group transactions that are recognised in
inventory or non-current assets must be eliminated in full.
Example
Suppose that a parent P lends $50,000 to its subsidiary S.
In the statement of financial position of P, there will be a non-current asset of
$50,000.
In the statement of financial position of the subsidiary S, there will be a long-
term liability of $50,000 for the loan.