ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing
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Chapter 19: Consolidated accounts: intra-group adjustments
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reduce the consolidated cost of goods sold by the intra group-sales (R) minus the
amount of unrealised profit in the closing inventory (P).
$
Revenue from intra-group sales R
Unrealised profit in closing inventory of intra-group sales P
––––––
Reduction in consolidated cost of goods sold (R – P)
––––––
This has the effect of reducing the consolidated profit for the year by the unrealised
profit in the closing inventory. (This is because consolidated revenue is reduced by
R and the cost of goods sold is reduced by a smaller amount, (R – P).)
Example
The revenue and cost of goods sold for a parent entity P and its 100%-owned
subsidiary S are shown below, for the year to 31 December Year 6.
P S
$000 $000
Revenue 750 500
Costofgoodssold 300 200
–
––
–
––
Grossprofit 450 300
–
––
–
––
The subsidiary S made sales of $100,000 to P during the year. Of these sales, $30,000
is still held as inventory by P at the year-end. The mark-up on goods sold by S to P
is 150% of cost.
Required
Calculate the revenue and cost of goods sold for the consolidated income statement.
Answer
The closing inventory of P that was purchased from S is carried in the accounts of P
at $30,000. However, the unrealised profit must be eliminated.
When unrealised profit is stated as a percentage mark-up on cost, it is calculated as:
100%)+%up‐(Mark
%up‐Mark
valueSalesprofitUnrealised ×=
In this example, the unrealised profit in the inventory is:
000,18$
100)+(150
150
000,30$ =×
Consolidated revenue is reduced by the total amount of intra-group sales, $100,000.
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The consolidated cost of goods sold is reduced by the total intra-group sales minus
the unrealised profit in the inventory. It is therefore reduced by $100,000 – $18,000 =
$82,000.
PGroup
Consolidatedincomestatementfortheyearto31DecemberYear6
$000
Revenue(750+500–100) 1,150
Costofgoodssold(300+200–82) 418
–––––
Grossprofit(450+300–18) 732
–––––
In the consolidated statement of financial position, the unrealised profit should be
deducted from the inventory, and the inventory should be valued at $12,000 (=
$30,000 – $18,000).
3.3 Unrealised profit: partly-owned subsidiary
When there is unrealised profit in closing inventory within a group, and the
inventory has been sold or purchased by a partly-owned subsidiary, the entire
unrealised profit should be eliminated from the inventory value.
If the goods have been sold by the parent (P) to the subsidiary (S) then the profit has
been made in P’s books and the group consolidated retained profits are charged
with the amount of the unrealised profit in the same way as when S is a wholly-
owned subsidiary.
However if S is not a wholly-owned subsidiary, i.e. there is a non-controlling
interest, and S has sold the goods to P then normal practice is to charge the non-
controlling interest with its share of the unrealised profit.
The approach to consolidation is illustrated by the following example.
Example
The statements of financial position of P and S at 31 December Year 7 are shown
below.
P S
Assets $ $
Property,plantandequipment 400,000 300,000
InvestmentinS 270,000‐
–
–––––– –––––––
670,000 300,000
Currentassets
Receivables:BalanceonaccountwithP‐10,000
Othercurrentassets 40,000 80,000
–
–––––– –––––––
Totalassets 710,000 390,000
–
–––––– –––––––
Chapter 19: Consolidated accounts: intra-group adjustments
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Equityandliabilities
Sharecapital:equityshares$0.25 150,000 100,000
Retainedearnings 490,000 270,000
–
–––––– –––––––
640,000 370,000
Liabilities
Payables:BalanceonaccountwithS 10,000‐
Otherliabilities 60,000 20,000
–
–––––– –––––––
Totalequityandliabilities 710,000 390,000
–
–––––– –––––––
P acquired 320,000 shares in S when the net assets of S were $250,000. The
accounting policy of P is to value non-controlling interests in S at a proportionate
amount of net identifiable assets.
The valuation of goodwill at the beginning of the year was $60,000 but an
impairment review at the end of Year 7 has found that the goodwill is now worth
only $45,000.
During the year S sold goods to P at a standard mark-up of 50% on cost for $160,000
and at the end of the year $24,000 of this was still held as inventory by P.
The recorded revenue and profit after tax of P and S for the year to 31 December
Year 7 were:
P S
$ $
Revenue 600,000 480,000
Profitaftertax 50,000 40,000
Required
(a) Prepare a consolidated statement of financial position as at 31 December Year
7.
(b) Calculate the revenue and the profit after tax for the year that will be reported
in the consolidated statement of comprehensive income/consolidated income
statement.
Answer
Step 1. Calculate the parent company share and the non-controlling interest share in
the subsidiary, as a percentage.
The number of shares issued by S is $100,000/$0.25 per share = 400,000 shares.
%
Parent’sshare:(320,000/400,000)×100% 80
Non‐controllinginterest:(80,000/400,000)×100% 20
–
––
100
–
––
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Step 2. Calculate the net assets of S at acquisition and at the end of the reporting
period (31 December Year 7).
At this stage, make any fair value adjustments, or adjustments for unrealised profit.
By adjusting for unrealised profit at this stage and charging it to the retained
earnings of the subsidiary, we make sure that the non-controlling interests will bear
their share (in Step 4) and the parent will bear its share (in Step 5).
At31
December
Year7
At
acquisition
Post
acquisition
$
Equityshares 100,000 100,000‐
Retainedearnings(=$270,000minus
unrealisedprofitof$8,000
(seeworking)) 262,000 150,000 112,000
–
––––––
–
––––––
362,000 250,000
–
––––––
–
––––––
Working
The unrealised profit in the inventory is: $24,000 × 50/(50 + 100) = $8,000.
The inventory of S must be reduced from $80,000 to $72,000, to eliminate the
unrealised profit.
Step 3. Calculate the goodwill at acquisition.
$
Costoftheacquisition 270,000
Parent’sshareofthesubsidiary’snetassetsatacquisition
(=80%(Step1)×$250,000(Step2)) (200,000)
––––––––
Goodwill 70,000
Minusimpairmenttodate (25,000)
––––––––
Balancecarriedforward 45,000
––––––––
Step 4. Calculate the non-controlling interest.
Non-controlling interest share of net assets of the subsidiary at 31 December Year 7
(the end of the reporting period)
= 20% (Step 1) × $362,000 (Step 2) = $72,400.
Step 5. Calculate consolidated retained earnings.
$
Parent’sretainedearnings 490,000
Parent’sshareofsubsidiary’spost‐acquisitionprofits
(80%(Step1)×$112,000(Step2))
89,600
Minusimpairedgoodwillsinceacquisition(Step3) (25,000)
–
––––––
Consolidatedretainedearnings 554,600
–
––––––
Chapter 19: Consolidated accounts: intra-group adjustments
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Consolidated statement of financial position
The consolidated statement of financial position is now constructed as follows.
PGroup
Consolidatedstatementoffinancialpositionat31DecemberYear7
Assets $
Property,plantandequipment(400,000+300,000) 700,000
Goodwill(Step3) 45,000
–––––––
745,000
Currentassets(40,000+72,000) 112,000
–––––––
Totalassets 857,000
–––––––
Equityandliabilities
Equityattributabletoowersoftheparent
Sharecapital:equityshares$1 150,000
Retainedearnings(Step5) 554,600
–––––––
704,600
Non‐controllinginterests(Step4) 72,400
–––––––
Totalequity 777,000
Liabilities(60,000+20,000) 80,000
–––––––
Totalequityandliabilities 857,000
–––––––
Consolidated revenue and consolidated profit for the year
The consolidated revenue excludes the intra-group sales of $160,000.
PGroup
Summaryconsolidatedincomestatement
fortheyearto31DecemberYear7
$
Revenue(600+480–160)
920,000
–––––––
ProfitofS 40,000
Unrealisedprofitininventory (8,000)
–––––––
ProfitofSminusinventoryadjustment 32,000
–––––––
Parent’sshareofSprofitlessinventoryadjustment(80%) 25,600
ProfitfortheyearofP 50,000
Goodwillimpairmentfortheyear(60,000–
45,000) (15,000)
–––––––
Consolidatedprofit:parent’sshare 60,600
–––––––
Non-controlling interest share in profit of subsidiary, less inventory adjustment:
20% × $32,000 = $6,400.
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Total consolidated profit for the year = $60,600 + $6,400 = $67,000.
Check:
$
ProfitofP 50,000
ProfitofS 40,000
Eliminateunrealisedprofit (8,000)
Goodwillimpairmentintheyear (15,000)
––––––
Totalconsolidatedprofitfortheyear 67,000
––––––
Chapter 19: Consolidated accounts: intra-group adjustments
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Transfers of non-current assets
The nature of the problem
Dealing with a transfer to or from a partly owned subsidiary
4 Transfers of non-current assets
4.1 The nature of the problem
A parent can sell a non-current asset to a subsidiary or vice-versa. This creates
similar problems to intra-group sales of goods.
Example
P owns 100% of S. At the beginning of Year 1 P buys a machine for $80,000 and
immediately sells it to S for $100,000. The group depreciates plant over five years
using the straight line method. (Residual value = $0.)
When the consolidated financial statements for Year 1 are prepared there are two
problems:
P has made a profit of $20,000, but from the point of view of the group, this is
unrealised.
During Year 1, S has charged depreciation on the machine. This has been based
on the machine’s cost to S, not its original cost to the group.
Both the unrealised profit and the excess depreciation must be eliminated from the
consolidated financial statements.
Step 1. Calculate the cost and accumulated depreciation on the machine: (a) as it is
included in the statement of financial position of S at the end of Year 1; and (b) as it
would have been included in the statement of financial position of P at the same
date if the transfer had never occurred.
Instatement
offinancial
p
ositionofS
Ingroup
statementof
financial
p
osition Difference
$ $ $
Cost 100,000 80,000 20,000
Accumulateddepreciation(1/5cost) (20,000) (16,000) (4,000)
–
–––––
–
––––– ––––––
Netbookvalue 80,000 64,000 16,000
–
–––––
–
––––– ––––––
Step 2. Adjust the consolidated statement of financial position
Unrealised profit
The cost of non-current assets is reduced from its transfer value to the original
cost to the group.
Debit (= reduce) Consolidated retained earnings $20,000
Cr edit (= reduce) Non-current assets: Cost $20,000
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Excess depreciation
The accumulated depreciation on the asset is reduced by the amount of the
excess depreciation.
Debit (= reduce) Non-current assets: Accumulated depreciation $4,000
Cr edit (= increase) Consolidated retained earnings $4,000
These two adjustments have the effect of reducing the net book value of the machine
to the amount at which it would have been stated had the transfer not occurred.
Instatementof
financial
positionofS Adjustment
Consolidated
statementof
financial
position
$ $ $
Cost 100,000 20,000 80,000
Accumulateddepreciation
(1/5cost)
(20,000) (4,000) (16,000)
–
–––––
–
––––– ––––––
Netbookvalue 80,000 16,000 64,000
–
–––––
–
––––– ––––––
4.2 Dealing with a transfer to or from a partly-owned subsidiary
Where a non-current asset is transferred to or from a partly owned subsidiary,
either the adjustment for unrealised profit or the adjustment to reverse the excess
depreciation must be shared between the group (consolidated retained earnings)
and the non-controlling interests.
Suppose that in the example above the facts are exactly as before, except that P now
owns only 80% of S.
Transfer from parent to subsidiary
The parent has made the unrealised profit, so 100% of this adjustment goes to
reduce (debit) consolidated retained earnings and the carrying value of the non-
current asset, as before.
Debit Consolidated retained earnings $20,000
Credit Non-current assets: Cost $20,000
The subsidiary has suffered the excess depreciation, so this adjustment is shared
between consolidated retained earnings and non-controlling interests.
Debit Non-current assets: Accumulated depreciation $4,000
Credit Consolidated retained earnings (80%) $3,200
Credit Non-controlling interests (20%) $800
Chapter 19: Consolidated accounts: intra-group adjustments
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Transfer from subsidiary to parent
Here, the subsidiary has made the unrealised profit, so the adjustment is shared
between consolidated retained earnings and non-controlling interests.
Debit Consolidated retained earnings (80%) $16,000
Debit Minority interests (20%) $4,000
Credit Non-current assets: Cost $20,000
The parent has suffered the excess depreciation, so 100% of this adjustment goes
to increase (credit) consolidated retained earnings.
Debit Non-current assets: Accumulated depreciation $4,000
Credit Consolidated retained earnings $4,000
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Intra-group loans and interest
Intra-group loans
Intra group interest
Non-controlling interests and intra-group loans
Preference shares in a subsidiary
5 Intra-group loans and interest
It is quite common for group entities to lend money to other group entities, and to
charge interest on the loan.
5.1 Intra-group loans
If one group entity makes a loan to another group entity, the asset of the lender is
matched by the liability of the borrower, and the asset and liability should both be
eliminated on consolidation.
For example, if a parent lends $100,000 to a subsidiary, the loan will be excluded
from both long-term assets and long-term liabilities of the group on consolidation.
Any non-controlling interests in the subsidiary will be calculated by taking the loan
into account as a liability when calculating the net assets of the subsidiary.
5.2 Intra-group interest
When one group entity makes a loan to another group entity, there may be accrued
interest payable in the statement of financial position of the borrower at the year-
end. This should be matched by interest receivable by the lender. The current
liability (interest payable) and the current asset (interest receivable) should therefore
be self-cancelling on consolidation, and both the asset and the liability should be
excluded from the consolidated statement of financial position.
(Note: If one of the entities has failed to record the accrued interest in its accounts,
you should correct this omission and record the transaction in the accounts of the
entity where it is missing. Having recorded the missing transaction, you can then
cancel the matching asset and liability.)
5.3 Non-controlling interests and intra-group loans
The non-controlling interest in the equity of a subsidiary and the subsidiary’s profit
for the year are calculated on the assumption that the non-controlling interest is the
relevant proportion of:
the subsidiary’s net assets including the intra-group loan as an asset or liability,
and
the subsidiary’s profit for the year including the interest as an expense or as
income, depending on whether the subsidiary is the borrower or the lender.