ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)
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Chapter 4: Group financial statements
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In the statement of financial position, the investment in the associate is as follows:
$
Investmentatcost
147,000
Investor’sshareofpost‐acquisitionprofitsofA 75,000
Minus:Accumulatedimpairmentintheinvestment
(18,000)
–––––––––––––––––––
Investmentintheassociate
204,000
–––––––––––––––––––
Alternatively this can be calculated as:
$
Investor’sshareofnetassetsatendofreportingperiod:
(600,000×30%) 180,000
Goodwill(147,000–(350,000×30%))
42,000
Lessimpairment
(18,000)
–––––––––––––––––––
Investmentintheassociate
204,000
–––––––––––––––––––
The accumulated profits will include:
$
Investor’sshareofpost‐acquisitionprofitsofA
75,000
Minus:Accumulatedimpairmentintheinvestment (18,000)
–––––––––––––––––––
57,000
–––––––––––––––––––
In the statement of comprehensive income, the share of the associate’s after-tax
profit for the year is shown on a separate line in the profit or loss section of the
statement:
Share of profits of associate (30% × $80,000): $24,000.
Trading with an associate: unrealised profit in closing inventory
When the investor entity (or a subsidiary) trades with an associate:
the investor entity might owe money to the associate at the end of the reporting
period, or be owed money by the associate
closing inventory might be held by the investor entity or by the associate that
includes some unrealised profit on sales between the investor entity and the
associate (in the same way that there might be unrealised profit in inventory
sold between a parent and a subsidiary).
The accounting rules for dealing with these items for associates are different from
the rules for subsidiaries.
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Inter-entity balances. Any amount owed by the investor entity to the associate or
owed by the associate to the investor entity should be included in the current
liabilities or current assets in the statement of financial position of the investor entity
(and in its consolidated statement of financial position, if it prepares consolidated
accounts). In other words, inter-entity balances are not self-cancelling.
Unrealised inter-group profit. However, any unrealised profit in closing inventory
must be removed.
If the unrealised profit is held in inventory of the investor/reporting entity, the
inventory should be reduced in value by the amount of the unrealised profit
If the unrealised profit is held in inventory of the associate, the investment in the
associate should be reduced by the investor’s share (reporting entity’s share) of
the unrealised profit.
In both cases, there should also be a reduction in the post-acquisition profits of the
associate, and the investor entity’s share of those profits (as reported in profit or
loss). This will reduce the accumulated profits in the statement of financial position.
Example
Entity P acquired 40% of the equity shares of Entity A several years ago. The cost of
the investment was $205,000. There has been no impairment in the investment.
Entity P’s share of the post-acquisition retained profits of Entity A was $90,000 as at
31 December Year 5. In the year to 31 December Year 6, the reported profits after tax
of Entity A were $50,000.
In the year to 31 December Year 6, Entity P sold $200,000 of goods to Entity A, and
the mark-up was 100% on cost. Of these goods, $30,000 were still held as inventory
by Entity A at the year-end.
The unrealised profit on this inventory is $30,000 × (100/200) = $15,000. Entity P’s
share of this unrealised profit is (40%) $6,000.
The unrealised profits are in inventory held by the associate; therefore the
investment in the associate is reduced by the investor company’s share of the
unrealised profit. The investment in the associate at 31 December Year 6 is as
follows:
$
Costoftheinvestment
205,000
EntityP’sshareofpost‐acquisitionprofitsofEntityA
[$90,000+(40%×$50,000)]
110,000
Minus:EntityP’sshareofunrealisedprofitininventory
(6,000)
Minus:Accumulatedimpairmentintheinvestment
(0)
–––––––––––––––––––
309,000
–––––––––––––––––––
Chapter 4: Group financial statements
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The share of the profits of Entity A reported in the profit or loss of Entity P for the
year to 31 December Year 6 is after deducting its share of the unrealised profit:
= (40% × $50,000) – $6,000 = $14,000.
This will also be included within the accumulated profits in the statement of
financial position of Entity P as at 31 December Year 6.
The reasons for the use of the equity method
The equity method is used to represent the nature of the relationship between an
investor and an associate.
The equity method reflects the investor’s significant influence. This is less than
control, but more than just the right to receive dividends that a simple investment
would give.
Consolidated financial statements include 100% of a subsidiary’s assets and
liabilities, because these are controlled by the parent, even if the parent owns less
than 100% of the equity shares. Consolidation would not be an appropriate way of
accounting for an associate.
Under the equity method:
the investor’s share of the associate’s assets, liabilities, profits and losses is
included in the investor’s financial statements; this represents significant
influence
the investor’s share of the associate is shown on one line in profit or loss, one
line in other comprehensive income and one line in the statement of financial
position, making it clear that the associate is separate from the main group (a
single economic entity).
Disadvantages of the equity method
The equity method has some important disadvantages for users of the financial
statements.
Because only the investor’s share of the net assets is shown, information about
individual assets and liabilities can be hidden. For example, if an associate has
significant borrowings or other liabilities, this is not obvious to a user of the
investor’s financial statements.
In the same way, the equity method does not provide any information about the
components that make up an associate’s profit for the period.
5.4 Accounting for interests in joint ventures
The method of accounting for an interest in a joint venture depends on what type of
joint venture it is.
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Accounting for a jointly-controlled operation
When an entity has an interest in a jointly-controlled operation, it should recognise
the following in its financial statements:
the assets that it controls and the liabilities that it incurs
the expenses that it incurs, and
its share of the income that it earns from sales by the joint venture.
Example
Entity X and Entity Y undertake a joint venture. Each entity undertakes to bear its
own expenses, but to share revenues from sales by the joint venture 50:50.
During the first year of the operation, Entity X made sales of $420,000 and Entity Y
made sales of $370,000. Costs incurred by Entity X were $280,000 and by Entity Y
were $290,000.
To finance the operation, Entity X took out a bank loan of $40,000.
Profit or loss of Entity X
Since each joint venturer bears all its own expenses, the profit or loss of Entity X will
include:
$
Shareofsales:$(420,000+370,000)×50%
395,000
Owncosts 280,000
Profit
115,000
The sales reported by each joint venturer are 50% of the total sales of the joint
venture, in accordance with the joint venture agreement. The reported sales are not
the sales actually made by the entity: for example the reported sales of Entity X are
not $420,000.
Since Entity X made more sales than Entity Y, the joint venture agreement will
provide for a payment by Entity X to Entity Y, to equalise their actual revenues.
Extracts from statement of financial position, Entity X
The statement of financial position of Entity X will include:
$
Liabilities
Bankloan 40,000
PayabletoEntityY(seebelow)
25,000
Chapter 4: Group financial statements
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Workings
JointventurewithY:currentaccount
$
$
Sales(50%share) 395,000
Cash(ownsales) 420,000
Balance(payabletoY) 25,000
420,000
420,000
Balance(payabletoY)
Accounting for jointly-controlled assets
When an entity has an interest in jointly-controlled assets, it should recognise the
following in its financial statements:
Its share of the jointly-controlled assets, classified according to the nature of the
assets. For example, a joint share of an oil pipeline would be included in
property, plant and equipment in the statement of financial position
Any liabilities that it has incurred
Its share of any liabilities incurred jointly with the other joint venturers
Its income from the sale (or use of) its share of the output of the joint venture,
together with its share of any expenses incurred by the joint venture
Any expenses that it has incurred in respect of its interest in the joint venture.
These assets, liabilities, income and expenses are recognised in the financial
statements of the venturer. This means that no adjustments are needed on
consolidation for these items, when the venturer prepares consolidated financial
statements.
Example
On 1 January 20X7, Entity B and Entity C entered into a joint venture to purchase
and operate an oil pipeline. Both entities would contribute equally to the purchase
cost of $20 million. Entity C was responsible for carrying out all maintenance work
on the pipeline, but maintenance expenses were to be shared between B and C in the
ratio 40%: 60%.
In order to pay for the pipeline, the joint venturers obtained a joint loan of
$20,000,000 from a bank. Interest of $1,500,000 was paid for the year on 31 December
by Entity B.
Both entities would use the pipeline for their own operations, but any income from
third parties would be shared 50%: 50%.
The pipeline has an estimated useful life of 20 years and no residual value. Both
entities apply this depreciation policy to the asset. A full year’s depreciation will be
charged in 20X7.
During the year to 31 December 20X7, maintenance and running expenses were
$1,200,000 and income from third parties was $900,000. All this income was paid to
Entity C by the third parties.
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Required
Show the relevant figures that would be recognised in the financial statements of
Entity B and Entity C for the year to 31 December 20X7.
Answer
Total
amount
InEntityB
financial
statements
InEntityC
financial
statements
$ $ $
Jointly‐controlledassets
Property,plantandequipment
Cost 20,000,000 10,000,000 10,000,000
Accumulateddepreciation
1,000,000 500,000 500,000
–
––––––––––––––––––––––
–
–
––––––––––––––––––––––
–
–––––––––––––––––––––––
–
19,000,000 9,500,000 9,500,000
–
––––––––––––––––––––––
–
–
––––––––––––––––––––––
–
–––––––––––––––––––––––
–
Shareofliabilitiesincurred
Bankloan 20,000,000 10,000,000 10,000,000
Current:accountwithB(owedtoB)–seeworkings 720,000
Current:accountwithC(owedbyC)–seeworkings
720,000
Shareofexpenses
Depreciation(50:50) 1,000,000 500,000 500,000
Maintenancecosts(40:60)
1,200,000 480,000 720,000
Interestonloan(50:50)
1,500,000 750,000 750,000
Workings
IntheaccountsofB
JointventurewithC:currentaccount
$
$
Revenuereceivablefrom
C
450,000
Maintenancecosts
(payabletoC) 480,000
InterestpayablebyC 750,000
Balance(payablebyC) 720,000
1,200,000
1,200,000
Balanceb/d 720,000
Chapter 4: Group financial statements
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IntheaccountsofC
JointventurewithB:currentaccount
$
$
Maintenancecosts 480,000
InterestpayabletoB 750,000
(payablebyB)
RevenuepayabletoB 450,000
Balance(payabletoB) 720,000
1,200,000
1,200,000
Balanceb/d 720,000
5.5 Accounting for jointly-controlled entities
IAS 31 requires that an entity should disclose its interest in a jointly-controlled
entity using either:
the proportionate consolidation method, or
the equity method of accounting. This is exactly the same as accounting for
investments in associates.
Proportionate consolidation is described below.
Proportionate consolidation
Proportionate consolidation is a method of accounting in which the financial
statements of a joint venturer recognise:
in its statement of financial position (or consolidated statement of financial
position)
— its proportionate share of the assets it controls jointly, and
— its proportionate share of the liabilities for which it is jointly responsible
in its statement of comprehensive income (or consolidated statement of
comprehensive income), its proportionate share of the income and expenses of
the jointly-controlled entity
Two methods of presentation
Proportionate consolidation can be presented in either of two ways. Both ways are
permitted by IAS 31.
Method 1
A joint venturer may combine its share of the assets, liabilities, income and expenses
of the jointly-controlled entity with similar items, line by line, in its financial
statements.
For example, in its statement of financial position it may combine its share of the
joint venture’s inventory with its own inventory, and combine its share of the
property, plant and equipment of the joint venture with its own property, plant and
equipment.
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Method 2
Alternatively, a joint venturer may include separate line items for its share of the
assets, liabilities, income and expenses of the jointly-controlled entity.
For example, in its statement of financial position it may show its share of a current
asset of the jointly-controlled asset on a separate line as part of current assets.
Similarly it may show its share of the property, plant and equipment of the joint
venture in a separate line as part of property, plant and equipment.
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Paper P2 (INT)
Corporate Reporting
CHAPTER
5
Group financial statements:
complex groups
Contents
1 The nature of complex groups
2 Calculating parent entity holdings and non-
controlling interests
3 Identifying the date of acquisition
4 Calculating the non-controlling interest and
goodwill: indirect holdings
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The nature of complex groups
Complex group structures
Checking the status of investments
Consolidation in practice and consolidation in the examination
Problem areas with complex groups
1 The nature of complex groups
1.1 Complex group structures
In a simple group, a parent owns one or more subsidiaries and possibly also has an
associate or joint venture.
Parent/holding
company
Subsidiary 1 Subsidiary 2 Subsidiary 3 Subsidiary 4 Associate
A more complex group may be one of the following two types:
A ‘vertical group’ in which the parent company or holding company (H) owns a
subsidiary (S) and the subsidiary owns its own subsidiary (T)
A ‘mixed group’, in which the parent company (H) owns shares in two companies.
It owns more than 50% in one of these companies (S), but less than 50% in the other
company (T). However, company S also owns shares in T, and the combined
shareholding of H and S in company T, taken together, exceeds 50%. (Note that
mixed groups are sometimes called D-shaped groups due to the shape of the group
structure.)
These two types of group are illustrated in the diagrams below. The percentage
shareholdings are included for illustrative purposes, but these percentages will be
used in the examples and explanations that follow.