ACCA P2 (INT) Corporate Reporting - Study text

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Chapter 4: Group financial statements

Step 1

Calculate the group share (parent company share) and the NCI share of the equity

of the subsidiary.

Parent’sshare

NCI 20

100

Step 2

Calculate the net assets of S at acquisition and at the balance sheet date.

Atendofcurrent

reportingperiod

At

acquisition

Post

acquisition



Equityshares 100,000

100,000 ‐

Accumulatedprofits

270,000

150,000 120,000

370,000

250,000 

Step 3

Calculate the goodwill.

$

Costoftheacquisition

260,000

Parent’sshareofsubsidiary’snetassetsatacquisition

(80%(Step1)×$250,000(Step2))



200,000

Goodwill(attributabletoownersofparent)

60,000

Step 4

Calculate the non-controlling interest.

NCI share of net assets of the subsidiary at the end of the reporting period

= 20% (Step 1) × $370,000 (Step2) = $74,000

Step 5

Calculate consolidated accumulated profits.

$

Parent’saccumulatedprofits

450,000

Parent’sshareofsubsidiary’spost‐acquisitionprofts

(80%(Step1)×$120,000(Step2))



96,000

Consolidatedaccumulatedprofits

546,000

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Consolidated statement of financial position

The consolidated statement of financial position is prepared as follows:

ConsolidatedstatementoffinancialpositionofParentGroup

Assets

$

Property,plantandequipment(400,000+300,000) 700,000

Goodwill(Step3)

60,000

760,000

Currentassets(40,000+10,000cashintransit+65,000) 115,000

Totalassets

875,000



Equityandliabilities 

Equity



Sharecapital:equityshares$1

150,000

Accumulatedprofits(Step5)

546,000

Equityattributabletoequityholdersoftheparent

696,000

Non‐controllinginterest(Step4) 74,000

Totalequity

770,000

Liabilities(85,000+20,000) 105,000

Totalequityandliabilities

875,000

4.5 Unrealised profit in inventory

When entities within a group trade with each other, the selling entity makes a profit

on the goods that it sells. Provided that all the goods are eventually sold outside the

group, the internal profit does not matter for consolidation, because the revenue of

the selling entity is a cost of sale for the buying entity. The matching revenue and

cost of sale are both deducted from consolidated revenue and cost of goods sold, as

described earlier, and the gross profit on consolidation is not affected.

A different situation arises, however, when some of the inventory sold by one group

entity to another group entity is still held as inventory by the buying entity at the

end of the reporting period.

When intra-group sales are still held as inventory:

 the entity that made the sale has recorded a profit on the sale, but

 this profit is included within the inventory valuation of the entity that made the

purchase, because inventory is valued at the purchase cost to the buying entity.

The inventory is still held within the group, so the group as a unit has not made an

external sale. The profit made by the selling entity is included in the cost of the

Chapter 4: Group financial statements

closing inventory of the buying entity. The profit on the sale of this inventory must

be eliminated on consolidation. It is unrealised profit.

Unrealised profit: 100%-owned subsidiary

The following rules should be applied for a 100%-owned subsidiary:

Unrealised profit is eliminated from the consolidated statement of financial

position by:

 reducing the consolidated accumulated profit by the amount of the unrealised

profit, and

 reducing the valuation of the inventory by the amount of the unrealised profit.

In consolidated profit and loss (statement of comprehensive income):

 reduce consolidated revenue by the amount of the intra-group sales (R)

 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.

$000

Revenue 800

300

Costofgoodssold

600

200

Grossprofit

200

100

The subsidiary S made sales of $50,000 to P during the year. Of these sales, $20,000

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 inclusion in consolidated profit and

loss.

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

Answer

The closing inventory of P that was purchased from S is carried in the accounts of P

at $20,000. 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

valueSales=profit Unrealised ×

In this example, the unrealised profit in the inventory is:

$12,000=

100)+(150

150

$20,000 ×

Consolidated revenue is reduced by the total amount of intra-group sales, $50,000.

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 $50,000 – $12,000 =

$38,000.

PGroup

Extractfromconsolidatedstatementofcomprehensiveincome

fortheyearto31DecemberYear6

$000

Revenue(800+300–50) 1,050

Costofgoodssold(600+200–38)

762

Grossprofit(200+100–12)

288

In the consolidated statement of financial position, the unrealised profit should be

deducted from the inventory, and the inventory should be valued at $8,000 ($20,000

– $12,000).

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.

Normal practice is to charge the non-controlling interest with its share of the

unrealised profit.

4.6 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.

Chapter 4: Group financial statements

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 interest in the subsidiary will be calculated taking the loan

into account in calculating the net assets of the subsidiary.

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.)

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.

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Accounting for associates and joint ventures

 Definition of associate and joint venture

 Methods of accounting for associates and joint ventures

 Accounting for investments in associates: equity method

 Accounting for interests in joint ventures

 Accounting for jointly-controlled entities

5 Accounting for associates and joint ventures

5.1 Definition of associate and joint venture

In consolidated accounts, subsidiaries are accounted for by the ‘purchase method’ or

‘acquisition method’. The principle underlying the purchase method is that

subsidiaries are under the control of the parent entity; therefore it is appropriate to

present financial statements for the parent and its subsidiaries as if the group were a

single operating entity and single economic entity.

Consolidation using the purchase method is not required where there is an

investment in shares of another company, but the investment does not give control.

If an entity owns a fairly small interest in the equity shares of another company,

and the investment is long-term:

 the shares are shown in the statement of financial position as long-term assets

(an investment) and valued in accordance with IAS 39

 any dividends received for the shares are included in profit or loss for the year

as other income.

Some investments in the equity shares of another company are fairly substantial

without giving control. They are more than simple small investments, because the

entity owning the shares has a reasonable degree of influence through the size of its

shareholding. However, the investment does not give control; therefore it cannot be

treated as a subsidiary.

These fairly substantial investments are accounted for as an investment in an

associate entity or as an investment in a joint venture. The accounting standards that

apply are as follows:

 IAS 28 Investments in associates deals with accounting for associates

 IAS 31 Interests in joint ventures deals with accounting for joint ventures.

Definition of an associate

An associate is defined by IAS 28 as: ‘an entity… over which the investor has

significant influence… that is neither a subsidiary nor an interest in a joint venture.’

Chapter 4: Group financial statements

Significant influence is defined as the power to participate in the financial and

operating policy decisions of the entity, but is not control or joint control.

 IAS 28 states that if an entity holds 20% or more of the voting power (equity) of

another entity, it is presumed that significant influence exists, and the

investment should be treated as an associate.

 If an entity owns less than 20% of the equity of another entity, the normal

presumption is that significant influence does not exist.

Holding 20% to 50% of the equity of another entity therefore means as a general rule

that significant influence exists, but not control; therefore the investment is treated

as an associate, provided that it is not a joint venture.

The ‘20% or more’ rule is a general guideline, however, and IAS 28 states more

specifically how significant influence arises. The existence of significant influence is

usually evidenced in one or more of the following ways:

 representation on the board of directors

 participation in policy-making processes, including participation in decisions

about distributions (dividends)

 material transactions between the two entities

 an interchange of management personnel between the two entities

 the provision of essential technical information by one entity to the other.

An entity loses significant influence when it loses the ability to participate in

financial and operating policy decisions of the entity in which it has invested (the

‘investee ‘ entity). This might occur, for example, if the investee becomes subject to

the control of a government, a court or a regulator. Alternatively, influence might be

lost if an entity holds 25% of the equity in another company but the other 75% of the

equity is acquired by a single purchaser who therefore gains control.

Definition of a joint venture

A joint venture is defined by IAS 31 as: ‘a contractual arrangement whereby two or

more parties undertake an economic activity that is subject to joint control.’

Joint control is defined as ‘the contractually agreed sharing of control over an

economic entity.’ Joint control only exists when the strategic financial and operating

decisions relating to the economic activity require the unanimous consent of the

entities sharing control (the joint venturers).

Joint control is the key factor in deciding whether a joint venture exists. The

following characteristics are common to all types of joint venture:

 two or more joint venturers are bound by a contractual arrangement (usually in

writing); and

 the contractual arrangement establishes joint control.

Paper P2: Corporate Reporting (International)

IAS 31 identifies three broad types of joint venture:

 jointly-controlled operations

 jointly-controlled assets

 jointly-controlled entities.

Jointly-controlled operations

In a jointly-controlled operation, each joint venture partner:

 uses its own property, plant and equipment

 carries its own inventory

 incurs its own expenses and liabilities

 raises its own finance, which represents its own obligations.

The contractual agreement between the joint venturers usually provides a means by

which revenue from the joint venture activities and any expenses incurred in

common are shared among the venturers.

IAS 31 gives an example of a jointly-controlled operation. This is a consortium of

separate companies that form a venture to manufacture, market and distribute a

particular product, such as an aircraft. Each of the venturers makes a different part

of the aircraft. Each venturer:

 bears its own costs and

 receives a share of the revenue in accordance with a predetermined contractual

agreement.

Jointly-controlled assets

Some joint ventures involve the joint control and joint ownership of some assets that

are acquired for the joint venture and used specifically for the purpose of the joint

venture.

The venturers do not form a separate entity that owns the assets. They own a

percentage of the assets themselves. Each venturer may take a share of the output

from the assets and bear an agreed share of the expenses of operating the assets.

IAS 31 gives as an example an oil pipeline that might be jointly-owned by several oil

production companies.

Jointly-controlled entities

A jointly-controlled entity involves setting up a separate entity such as a company,

with its own equity, assets and liabilities. Each joint venturer owns an agreed share

of the equity of this entity and is entitled to a share of the profits and distributions

(dividends).

The proportion of the equity owned by each joint venturer can vary. A jointly-

controlled entity differs from a subsidiary because there is joint control, not control

Chapter 4: Group financial statements

by a majority owner of the equity. Similarly, it differs from an associate because

there is joint control, rather than significant influence.

IAS 28 gives as an example an entity setting up business in a foreign country in

conjunction with the government or a government agency of that country. A

separate entity is established, and the two joint venturers share joint control.

5.2 Methods of accounting for associates and joint ventures

IAS 28 states that associates must be accounted for in consolidated financial

statements using the equity method of accounting. This rule applies whether or not

the entity also has subsidiaries and prepares consolidated financial statements.

The only exceptions to the requirement to use the equity method to account for

investments in associates are:

 when the reporting entity presents separate financial statements in accordance

with IAS 27, or

 when the associate is acquired and held with a view to disposal within 12

months of acquisition.

IAS 31 states that the method of accounting for joint ventures will depend on what

type of joint venture it is.

5.3 Accounting for investments in associates: equity method

The main features of the equity accounting method are as follows:

Statement of financial position: investment in the associate

In the statement of financial position of the reporting entity (the investor), an

investment in an associate is valued at:

 cost

 plus the investor’s share of the retained post-acquisition profits of the associate

(or minus the investor’s share of any post-acquisition losses)

 minus any impairment in the value of the investment since acquisition.

There is no separately-recognised goodwill on acquisition of an investment in an

associate. However, the investment in the associate should be subject to an annual

impairment review in accordance with IAS 36. Any impairment in the investment is

deducted from the carrying value of the investment in the statement of financial

position (and deducted from the reporting entity’s accumulated profits).

Statement of financial position: accumulated profits

The accumulated profits of the reporting entity, or the consolidated accumulated

reserves when consolidated accounts are prepared, should include:

 the investor’s share of the post-acquisition retained profits of the associate,

 minus any impairment in the value of the investment since acquisition.

Paper P2: Corporate Reporting (International)

Statement of comprehensive income

In the statement of comprehensive income, there should be a separate line for:

 ‘Share of profits of associate’ in the profit and loss section of the statement

 ‘Share of other comprehensive income of associates’ in the ‘other comprehensive

income’ section of the statement.

The share of the profits of the associate for inclusion in profit or loss is the reporting

entity’s share of the associate’s profits after tax. If the associate has partly-owned

subsidiaries, the reporting entity’s share of the profits of the associate is the share of

the associate’s after-tax profits attributable to equity holders of the associate..



Example

Entity P acquired 30% of the equity shares in Entity A during Year 1 at a cost of

$147,000 when the fair value of the net assets of Entity A was $350,000. Since that

time, the investment in the associate has been impaired by $18,000.

Since acquisition of the investment, there has been no change in the issued share

capital of Entity A, nor in its share premium reserve or revaluation reserve. At 31

December Year 5, the net assets of Entity A were $600,000.

In the year to 31 December Year 5, the profits of Entity A after tax were $80,000.

Required

What figures would be included for the associate in the financial statements of

Entity P for the year to 31 December Year 5?



Answer

It is presumed that the investment in Entity A is an investment in an associate.

Retainedpost‐acquisitionprofitsofEntityA

$

Netassetsoftheassociateat31DecemberYear5

600,000

NetassetsofEntityAatdateofacquisitionofshares (350,000)



––––––––––––––––––––

Retainedpost‐acquisitionprofitsofEntityA

250,000

––––––––––––––––––––



Theshare‘owned’byEntityPis30%×$250,000

=$75,000

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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