Consolidated Accounts (Group Accounts) These notes are for those studying financial accounting and reporting at an introductory

level. All initial examples will include the preparation of Consolidated Balance Sheets of the holding company (parent) plus a subsidiary or subsidiaries. A simple group Income Statement will also be prepared. The acquisition method of consolidation will be used. As far as the balance sheet is concerned we will examine: i) The cancellation processes that are required for the acquisition method of consolidation including intercompany trading. Part cancellation, where the holding company may buy the `goodwill` of the subsidiary, where less than 100% of the subsidiary voting shares have been acquired, which raises the issue of the noncontrolling (minority interest) shareholders.

ii)

Rationale for Group Accounting There are many reasons why one company (a parent undertaking) might wish to acquire control of another (a subsidiary undertaking). These might include commercial objectives such as to gain access to market share, to curtail competition, to acquire new products or services, acquire new resources such as fixed assets, research and development assets, to acquire the services of skilled staff, to gain access to finance, for taxation reasons or to diversify risk. There have, though, been notable examples of `asset stripping` whereby an acquired company is subsequently dismantled and its assets sold. An acquisition strategy can represent a speedier means of achieving expansion than traditional `internal development` methods. This can often be `cost-effective` - particularly where a parent undertaking has sufficient `strength` within its balance sheet to effect a purchase of a subsidiary undertaking by issuing its own new shares to the subsidiarys shareholders as a form of consideration. Irrespective of the reasoning for and the methodology of acquisitions, a considerable issue is the nature of the published information that is made available for parent undertaking shareholders. If one considers that with international conglomerates the parent company invests in the shares of many different subsidiary undertakings, in diverse markets in widely disparate geographical locations. By buying shares in the parent undertaking, a shareholder shares the rewards or failures of the parent undertaking and every subsidiary undertaking within the group. Remember that the parents investment entitles it to the dividends and the potential capital growth of each of the subsidiaries in the group. Whilst this is itself begs the question how useful are group accounts in analysing performance in such circumstances?, nevertheless as a shareholder of the parent company, one would not be expected, nor would it be possible, to interpret the financial performance of each of numerous individual subsidiary undertakings which, together with the parent undertaking, make up the group. An important point, not always stressed in texts, is that the parent undertaking earns its profits (or suffers) by virtue of the performance of itself and the subsidiary undertakings. Profits of subsidiary undertakings are reflected by payments of dividends to the parent undertaking, whilst the success of the overall group is reflected to a great extent in the payment of dividends by the parent undertaking to its own shareholders. This in turn impacts on the value of the group as reflected in the share price and the associated yields to shareholders. Thus, the only practical way to interpret the performance of such combinations is to prepare consolidated (group) accounts.

Content of Group accounts It is important to understand that group accounts are a combination of the accounts of all those entities within the group. The individual units are separate legal entities, but the group has no separate legal existence - it exists for accounting purposes. There is no obligation of a parent undertaking, for example, for the solvency or otherwise of a subsidiary, unless specific guarantees are given to that effect. In the UK, the Companies Acts require group accounts to be prepared where a company is a parent undertaking at the end of its financial year and where it is not itself a wholly owned subsidiary undertaking of another UK incorporated company. The preparation of the group accounts is also governed by International Accounting Standards, particularly: IAS 1 Presentation of Financial Statement IFRS 3 Business Combinations IAS 27 Consolidation and Separate Financial Statements IAS 28 Investments in Associates, and IAS 31 Interests in joint ventures.

It is not necessary for you, at this stage, to understand the full requirements of all the regulatory framework. The detailed regulations change from time to time as IFRSs and IASs are updated, but for the time being it is sufficient to be aware of the following: IAS 27 sets out the various definitions for Parent, Subsidiary and Control. It indicates that when preparing group accounts, where possible the same accounting dates should be used. It is also important that common accounting policies (as per all IFRSs and IASs) are applied for all parties to the consolidation. Intra-group transactions are eliminated from the process. IFRS 3, which has recently (2008) been revised, is a major standard to consider when preparing group accounts. It is vital that all transactions are recorded at fair value (which is the amount by which an asset or liability is valued by knowledgeable, willing parties in an arms length transaction). A recent innovation here has been the option to value goodwill using a full goodwill method. It is not necessary to consider this aspect of group accounts for purposes of this course. A change in terminology has been agreed. The term Minority Interest will now be replaced by NonControlling Interest For purposes of these notes please assume that the key requirements of the regulatory framework are applied, in the examples except that published account formats (as required by IAS 1) are not being utilised. At this level of study we will be concerned with producing a simple draft group balance sheet and Income Statement only. In advanced studies you would need to be able to understand complex groups including the group cash flow statement. The following examples will progressively develop your skills of Consolidation. You will need to learn the rules rather mechanistically at first. A parent company called Hold Plc has made an investment in the ordinary (voting) share capital of a Subsidiary called Sub Ltd. Where voting rights are acquired, generally speaking anything beyond 50% of the voting shares gives control to the parent. The voting shares not held by the Parent are owned by the Non-Controlling Interest (Minority Interest) Shareholders. In the accounts of the Parent the investment is shown as a non-current (fixed) asset. The investment actually pays for a share of the net assets of the subsidiary. Another way of looking at the net assets is that it is the same as the ordinary shares and reserves of the subsidiary at acquisition date. It is very important to remember this.

Basic Consolidated Accounting Procedures Case 1: It is 31 March 19X4 and Hold plc has just acquired 100% of the Ordinary Shares of Sub Ltd for 70,000. On the date of the acquisition the net assets of Sub Ltd were 70,000 and the accounts of the two companies were as follows: You should also assume that the current assets of Hold Ltd include 14,000 due from Sub Ltd and that the Current Liabilities of Sub Ltd include 14,000 owing to Hold Ltd. The consolidated (group) position is as follows; Balance Sheets of Hold plc and its Subsidiary as at 31 March 19X4 Hold plc 000 100 70* 170 Sub Ltd 000 50 50 50 (20) (10) 160 (20) 140 100 40 140 30 80 (10) 70 50* 20* 70 126 (106) 20 170 (30) 140 100 40 140 3 4 Group 000 150 Note 1 2

000 Fixed Assets Investment in Sub Ltd at cost Current Assets Current Liabilities Net current assets \ (liabilities) Long Term Loans Net Assets Ordinary Share Capital Retained Profits Shareholders Capital Employed 90 (100)

000

000

6 7

* Note that in this example the Investment by Hold in Sub exactly equals the book value of Subs shares and reserves at acquisition. The first rule of group accounts is that, on consolidation, equal and opposites, (marked * above) are cancelled out. Other balance sheet items are combined but the inter-company balances, are removed from the Consolidated Balance Sheet. Note also that you will never see the information in the above format in group accounts. The cases are presented in this manner for learning purposes only. Notes: 1 100 + 50 = 150 2 Cancelled out, 0 3 90 + 50 - 14 = 126 4 100 + 20 - 14 = 106 5 20 + 10 = 30 Notes Continued: 6 Hold only (always the case). Shares of Sub, 50, are cancelled out 7 Hold only (in this case). Reserves of Sub, as existed at acquisition date, 20, are cancelled out.

Case 2: It is 31 March 19X4 and Hold plc has just acquired 100% of the Ordinary Shares of Sub Ltd for 85,000. On the date of the acquisition the accounts of the two companies and the consolidated position were as follows. Balance Sheets of Hold plc and its Subsidiary as at 31 March 19X4 Hold plc 000 100 185 Goodwill on acquisition Current Assets Current Liabilities Net current assets \ (liabilities) Long Term Loans Net Assets Financed By: Ordinary Share Capital Retained Profits Shareholders Capital Employed 100 55 155 50* 20* 70 100 55 155 90 (100) (10) 175 (20) 155 50 (20) 30 80 (10) 70 Sub Ltd 000 50 50 15 140 (120) 20 185 (30) 155 Group 000 150

000 Fixed Assets Investment in Sub at cost 85*

000

000

* Note that in this example the Investment by Hold in Sub is 15 larger than the book value of Subs shares and reserves (net assets) at acquisition. This means that Hold has paid 15,000 more than the fair value of the net assets of Sub Ltd. It has purchased Goodwill. This is known as Goodwill on acquisition. Note that in this case there are no inter-company debtors and creditors. It is normal for businesses to write off (amortise) the goodwill acquired over a number of years. For the time being, though, we will continue to carry goodwill in consolidated balance sheets at its original acquisition value.

Case 3: It is 31 March 19X4 and Hold plc has just acquired 100% of the Ordinary Shares of Sub Ltd for 60. On the date of the acquisition the accounts of the two companies and the consolidated position were as follows. All amounts are in 000: Balance Sheets of Hold plc and its Subsidiary as at 31 March 19X4 Hold plc 000 100 60* 160 Sub Ltd 000 50 50 50 (20) 15 175 (20) 155 30 80 (10) 70 165 (120) 45 195 (30) 165 Group 000 150 . 150 Note

000 Fixed Assets Investment in Sub at cost Current Assets Current Liabilities Net current assets Long Term Loans Net Assets Financed By: Ordinary Share Capital Retained Profits Shareholders Capital Employed 115 (100)

000

000

100 55 155

50* 20* 70

100 65 165

* Note that in this example the Investment by Hold in Sub is 10 smaller than the book value of Subs shares and reserves at acquisition. This creates negative goodwill arising on consolidation. Note again that in this case there are no inter-company debtors and creditors. Note: 1. The treatment of negative goodwill is tricky, but it cannot be shown as a negative asset. Instead the 10 has to be recognised in the group retained profits. 55 + 10 = 65

Case 4: Let us now assume that Hold had paid 85 for 60% of the Shares and reserves (net assets) of Sub Ltd instead of 100%. On the date of the acquisition the accounts of the two companies and the consolidated position were as follows. All amounts are in 000: Balance Sheets of Hold plc and its Subsidiary as at 31 March 19X4 Hold plc Sub Ltd 000 000 000 000 000 100 50 85* 185 50 43 90 (100) (10) 175 (20) 155 100 55 155 50 (20) 30 80 (10) 70 50* 20* 70 140 (120) 20 213 (30) 183 100 55 28 183

Fixed Assets Investment in Sub at cost Goodwill on acquisition Current Assets Current Liabilities Net current assets \ (liabilities) Long Term Loans Net Assets Financed By: Ordinary Share Capital Retained Profits Non-Controlling Interests of Sub Ltd Shareholders Capital Employed

Group 000 150

* Note that in this example the Investment by Hold in Sub is 43 larger than the book value of Subs shares and reserves at acquisition. This is because the 85 investment now purchases (60% x 70 = 42) of Subs shares and reserves (or net assets). The remaining 40% of the shares and reserves of Sub Ltd belong to the Non- Controlling Interest (Minority Interest) Shareholders of Sub Ltd. At Balance Sheet date, the Non-Controlling (Minority) Interests in Sub Ltd are shown in the Consolidated Balance Sheet as (40% x 70 = 28). When calculation the non-controlling interest you should always start with the latest balance sheet figures for the Shares and Reserves of each subsidiary. You then apply the non-group shareholding percentage to this figure. The above presentation indicates that 28,000 of the subsidiarys net assets are financed by outside (non group) shareholders, that is, Non-Controlling Interest Shareholders.

Now attempt the following simple case:

Case 5: Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 18 100 S Ltd 000 100

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

20 (10) 10 128 (28) 100 80 20 100

30 (20) 10 110 (10) 100 50 50 100

Ordinary Share Capital 1 Shares Profit and Loss Reserve

H acquired 80% of S Ltds net assets when Ss shares stood at 50 and its profit and loss reserve at 50. Amounts are in 000's Any positive Goodwill is carried in the balance sheet, negative goodwill is transferred to the group profit and loss reserves. Required: Prepare the group balance sheet as at 31 December 20X9

Use the pro-forma overleaf:

Consolidated balance sheet of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 18 100 20 (10) 10 128 (28) 100 80 20 100 Non-Controlling Interests 50 50 100 30 (20) 10 110 (10) 100 S Ltd 000 100 Group 000 Note

000 Fixed assets Investment by H in S Goodwill on acquisition Current Assets Current Liabilities Net current assets Long Term Loans

000

000

000

Ordinary Share Capital 1 Shares Profit and Loss Reserve

Consolidated balance sheet of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 18 100 20 (10) 10 128 (28) 100 80 20 100 30 (20) 10 110 (10) 100 50 50 100 S Ltd 000 100 Group 000 118 20 50 (30) 20 158 (38) 120 80 20 100 20 120 Note

000 Fixed assets Investment by H in S Goodwill on acquisition Current Assets Current Liabilities Net current assets Long Term Loans

000

000

1 2 3 4

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests Notes 1 2 3 4 5 6 7 8

6 7 8

H + S = 18 + 100 = 118 100 paid to acquire 80% x (50 + 50) = 100 paid to acquire 80 = 20 Goodwill H + S = 20 + 30 = 50 H + S = 10 + 20 = 30 H + S = 28 + 10 = 38 H only, 80 H + 100% of S post acquisition = 20 + 0 = 20 20% x 100 = 20

We will now consider what happens in the consolidation process where the subsidiary increases its profit and loss reserve in the period beyond acquisition date by the Parent. Consider the following example. Case 6: Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 18 100 S Ltd 000 100

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

20 (10) 10 128 (28) 100 80 20 100

30 (20) 10 110 (10) 100 50 50* 100

Profit and Loss Reserve

H acquired 80% of S Ltds net assets for 100,000 some time ago when Ss shares stood at 50,000 and its profit and loss reserve at 40,000 Any positive Goodwill is carried in the balance sheet, negative goodwill is transferred to the group profit and loss reserves. Required: Prepare the group balance sheet as at 31 December 20X9 NB in this case the profit and loss reserve at acquisition date was 40. By consolidation date this has increased to 50* The impact of this small change to the case requires care with: the goodwill calculation and a revised treatment for the consolidated reserves in the balance sheet.

10

Goodwill Calculation In this case, H has paid For 80% of (50 + 40) = 80% x 90 = Goodwill on acquisition Consolidated Reserves

000 100 72 28

The rule to apply for group reserves is that the consolidated figure includes all Hs reserves plus Hs share of any reserves of S Ltd which have been earned SINCE acquisition. That means that the slightly more complete rule for calculating consolidated reserves is: Holding Company (H), plus Hs share of Subsidiary post acquisition profits. Post acquisition profits As indicated above, these are the profits earned by S since acquisition. The quickest way to establish post acquisition profits of S is to locate the very latest profit and loss reserve figure at consolidation date (latest balance sheet) and then deduct the profit and loss reserve which existed at acquisition date. The technical term for the profit and loss reserve which exists at acquisition date is pre-acquisition profits. In the above example, post acquisition profits are 50 40 = 10. Hs share of Ss post acquisition profits is 80% x 10 = 8

11

Consolidated balance sheet of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 18 100 20 (10) 10 128 (28) 100 80 20 100 30 (20) 10 110 (10) 100 50 50 100 S Ltd 000 100 Group 000 118 28 50 (30) 20 166 (38) 128 80 28 108 20 128 Note

000 Fixed assets Investment by H in S Goodwill on acquisition Current Assets Current Liabilities Net current assets Long Term Loans

000

000

1 2 3 4

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests Notes 1 2 3 4 5 6 7 8

6 7 8

H + S = 18 + 100 = 118 100 paid to acquire 80% x (50 + 40) = 100 paid to acquire 72 = 28 Goodwill H + S = 20 + 30 = 50 H + S = 10 + 20 = 30 H + S = 28 + 10 = 38 H only, 80 H + 80% of S post acquisition = 20 + 80% x (50 - 40) = 20 + 8 = 28 20% x 100 = 20

Now consider another case.

12

Case 7: Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 267 51 S Ltd 000 200

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

120 (90) 30 348 (48) 300 180 120 300

140 (60) 80 280 (180) 100 50 50* 100

Ordinary Share Capital 1 Shares Profit and Loss Reserve

H acquired 60% of S Ltds net assets for 51,000 one year ago when Ss shares stood at 50,000 and its profit and loss reserve at 10,000 The current assets of H include 35,000 owing from S and the current liabilities of S include 35,000 owing to H. Any positive Goodwill arising on consolidation is amortised over its useful life, in this case considered to be five years. Negative goodwill, if any, is transferred to group profit and loss reserves. Required: Prepare the group balance sheet as at 31 December 20X9 NB In this case you will find that Goodwill on acquisition calculates at 15,000. Amortising (writing off) over 5 years means an annual goodwill amortisation amount of 3,000. The impact of this transaction on group accounts would be to reduce the balance sheet figure for goodwill from 15,000 to 12,000 and also group reserves will be reduced by 3,000 to reflect the amortisation of goodwill which would have been charged as an expense in the income statement.

13

Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9

000 Fixed Assets Investment by H in S Goodwill on Consolidation Current Assets Current Liabilities 120 90

H plc 000 267 51 318

000

S Ltd 000 200

000

Group 000 467 12 479

Note 1 2 3 4

140 60 30 348 48 300 180 120 300 80 280 180 100 50 50 100

225 115 110 589 228 361 180 141 40 361

Long Term Loans

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

6 7 8

Notes: 1 2 H + S = 267 + 200 = For an acquisition costing H acquired 60% of S, 60% x 60 = Goodwill acquired Amortised for 1 year Carrying value in Group balance sheet H + S Inter-Company = 120 + 140 - 35 = H + S Inter-Company = 90 + 60 - 35 = H + S = 48 + 180 = H only H + 60% x post acquisition profit of S minus 1 years amortization = 120 + (60% x (50 - 10) - 3 = 120 + 24 - 3 = 40% x Shareholders funds of S = 40% x 100 = 467 51 36 15 amortised over 5 years = 3 per annum 3 12 225 115 228 180 141 40

3 4 5 6 7 8

14

Now consider a very small change to the case 7 scenario. Acquisition of S by H is now TWO years ago. Case 8: Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 267 51 S Ltd 000 200

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

120 (90) 30 348 (48) 300 180 120 300

140 (60) 80 280 (180) 100 50 50* 100

Ordinary Share Capital 1 Shares Profit and Loss Reserve

H acquired 60% of S Ltds net assets for 51,000 two years ago when Ss shares stood at 50,000 and its profit and loss reserve at 10,000 The current assets of H include 35,000 owing from S and the current liabilities of S include 35,000 owing to H. Any positive Goodwill arising on consolidation is amortised over its useful life, in this case considered to be five years. Negative goodwill, if any, is transferred to group profit and loss reserves. Required: Prepare the group balance sheet as at 31 December 20X9 NB As with case 7 you will find that Goodwill on acquisition calculates at 15,000. Amortising (writing off) over 5 years means an annual goodwill amortisation amount of 3,000. But acquisition was two years ago which means that the group accounts will have reflected two years of amortisation of goodwill. The impact of this transaction on group accounts would be to reduce the balance sheet figure for goodwill from 15,000 to 9,000 and also group reserves will be reduced by 6,000 to reflect the amortisation of goodwill which would have been charged as an expense in the income statement for two years.

15

Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9

000 Fixed Assets Investment by H in S Goodwill on Consolidation Current Assets Current Liabilities 120 90

H plc 000 267 51 318

000

S Ltd 000 200

000

Group 000 467 9 476

Note 1 2 3 4

140 60 30 348 48 300 180 120 300 80 280 180 100 50 50 100

225 115 110 586 228 358 180 138 40 358

Long Term Loans

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

6 7 8

Notes: 3 4 H + S = 267 + 200 = For an acquisition costing H acquired 60% of S, 60% x 60 = Goodwill acquired Amortised for 2 years Carrying value in Group balance sheet H + S Inter-Company = 120 + 140 - 35 = H + S Inter-Company = 90 + 60 - 35 = H + S = 48 + 180 = H only H + 60% x post acquisition profit of S minus 2 years amortization = 120 + (60% x (50 - 10) - 6 = 120 + 24 - 6 = 40% x Shareholders funds of S = 40% x 100 = 467 51 36 15 amortised over 5 years = 3 per annum 6 9 225 115 228 180 138 40

3 4 5 6 7 8

16

Finally please attempt the final balance sheet case (number 9) for yourselves: Case 9: Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 H plc 000 263 55 S Ltd 000 200

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

120 (90) 30 348 (48) 300 180 120 300

140 (60) 80 280 (180) 100 50 50* 100

Ordinary Share Capital 1 Shares Profit and Loss Reserve

H acquired 75% of S Ltds net assets for 55,000 two years ago when Ss shares stood at 50,000 and its profit and loss reserve at 10,000 The current assets of H include 26,000 owing from S and the current liabilities of S include 26,000 owing to H. Any positive Goodwill arising on consolidation is amortised over its useful life, in this case considered to be ten years. Negative goodwill, if any, is transferred to group profit and loss reserves. Required: Prepare the group balance sheet as at 31 December 20X9

17

Draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9
H plc 000 263 55 318 Current Assets Current Liabilities 120 90 30 348 48 300 180 120 300 140 60 80 280 180 100 50 50 100 234 124 110 581 228 353 180 148 25 353 S Ltd 000 200 Group 000 463 8 471

000 Fixed Assets Investment by H in S Goodwill on Consolidation

000

000

Note 1 2 3 4

Long Term Loans

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

6 7 8

Notes: 5 6 H + S = 263 + 200 = For an acquisition costing H acquired 75% of S, 75% x 60 = Goodwill acquired Amortised for 2 years Carrying value in Group balance sheet H + S Inter-Company = 120 + 140 - 26 = H + S Inter-Company = 90 + 60 - 26 = H + S = 48 + 180 = H only H + 75% x post acquisition profit of S minus 2 years amortisation = 120 + (75% x (50 - 10) - 2 = 120 + 30 - 2 = 25% x Shareholders funds of S = 25% x 100 = 463 55 45 10 amortised over 10 years = 1 per annum 2 8 234 124 228 180 148 25

3 4 5 6 7 8

18

The Consolidated Income Statement In this section we need to be aware of some transaction which might well happen between companies within a group. At this basic level we will consider just two items: Inter-company sales \ purchases Dividends

Inter-company (IC) Sales and Purchases Where the Holding Company Sells to the Subsidiary (or vice versa) the transaction might (or might not) be done at a profit to the selling company. For group Income Statement purposes inter-company sales and purchases are ignored for purposes of group sales and group purchases. Remember if S sells goods worth 10 then H buys goods worth 10. If, however, any stocks are in hand at the end of the year which emanate from inter-company transactions, then if there is any profit within those stocks then the profit would have to be eliminated from group stock figures. Such transactions will not feature in these notes. Any outstanding amounts at the year end in respect of inter-company debtors and creditors are dealt with in the balance sheet as you have already seen. Dividends As we have already seen the Holding Company is entitled to its share of any dividends paid by the Subsidiary companies. When it comes to dealing with dividends received within the group income statement we must only incorporate dividends received from outside the group. Hence the dividend received by H from S is not included in the group accounts. In terms of Dividends payable, the rule to adopt is that we include Dividends paid by the parent only. Other Items within the Group Income Statement: There will be an extra operating cost in respect of the amortisation of goodwill in subsidiaries. There is also the matter of profit attributable to Non-controlling (Minority) Interests. Non-Controlling (Minority) Interests These stakeholders are entitled to the non-group percentage of profits after taxation of each subsidiary. So if the Parent holds 80% of the subsidiary shares and the Subsidiary earns 45,000 after tax, then the Non-controlling shareholders are entitled to 20% x 45,000 = 9,000 of the after-tax profit. This is shown as a deduction from group profit after tax.

19

Consolidation Rules At a basic level there are a small number of rules which, if applied consistently will enable you to produce a simple consolidated income statement. Item Sales Cost of Sales Operating expenses Amortisation of goodwill in Subsidiary Financing Costs Taxation Inter-company dividend received by H Non-Controlling Interest (Minority Interest) Ordinary Dividend paid Retained Profit Brought Forward Retained Profit Carried Forward Consolidation treatment H + S minus any inter-company (IC) sales. Assume that there are no stocks from inter-company sales at the year end. H + S minus any inter-company (IC) purchases H+ S As calculated for annual amortisation undertaken in group balance sheet H+ S H+ S Ignore Profit after tax of Subsidiary x non-group shareholding percentage. This is deducted from the group income statement. H only H + Hs share of S Post-acquisition retained profit brought forward, minus goodwill amortised to date H + Hs share of S Post-acquisition retained profit carried forward, minus goodwill amortised to date

Please Note: These transactions will be calculated using the internally produced accounts. You will not necessarily see all these figures in the published group accounts. The information from case 9, above, has been supplemented to provide individual income statement accounts for H and S for the year to 31 December 20X9

20

Case 9 continued. The following are the draft Income Statements for H plc and S Ltd for the year ended 31 December 20X9

000 Sales Cost of Sales Gross Profit Operating Expenses Amortisation of goodwill in S Ltd Operating profit Financing Costs Profit before Tax Taxation Profit after Tax Inter Company Dividends received Non Controlling Interests Group profit for year Dividends paid Retained profit for year Retained profit brought forward Retained profit carried forward

H plc 000 350 210 140 35 105 5 100 20 80 3 83

000

S Ltd 000 230 138 92 23 69 22 47 7 40

9 74 46 120

4 36 14 50

21

As before, the draft balance sheets of H plc and its subsidiary S Ltd as at 31 December 20X9 are H plc 000 263 55 S Ltd 000 200

000 Fixed assets Investment by H in S Current Assets Current Liabilities Net current assets Long Term Loans

000

120 (90) 30 348 (48) 300 180 120 300

140 (60) 80 280 (180) 100 50 50 100

Ordinary Share Capital 1 Shares Profit and Loss Reserve

H acquired 75% of S Ltds net assets for 55,000 two years ago when Ss shares stood at 50,000 and its profit and loss reserve at 10,000 Inter-company (IC) sales from S Ltd to H plc during the year were 150,000. There were no unsold stocks in relation to these transactions at the year end. The current assets of S include 26,000 owing from H and the current liabilities of H include 26,000 owing to S. Any positive Goodwill arising on consolidation is amortised over its useful life, in this case considered to be ten years. Negative goodwill, if any, is transferred to group profit and loss reserves.

Required: Prepare the group Income statement for the year ended 31 December 20X9 and a Group balance sheet as at that date.

22

Solution: Group Income Statement for H plc and S Ltd for year ended 31 December 20X9

000 Sales Cost of Sales Gross Profit Operating Expenses Amortisation of goodwill in S Ltd Operating profit Financing Costs Profit before Tax Taxation Profit after Tax Inter Company Dividends received Non Controlling Interests Group profit for year Dividends paid Retained profit for year Retained profit brought forward Retained profit carried forward

H plc 000 350 210 140 35 105 5 100 20 80 3 83

000

S Ltd 000 230 138 92 23 69 22 47 7 40

000

Group 000 430 198 232 59 173 27 146 27 119

Note 1 2 3 4 5 6 7

58 1

9 74 46 120

4 36 14 50

10 109 9 100 48 148

8 9 10 11

23

Group Balance Sheet of H plc and S Ltd as at 31 December 20X9

000 Fixed Assets Investment by H in S Goodwill on Consolidation Current Assets Current Liabilities 120 90

H plc 000 263 55 318

000

S Ltd 000 200

000

Group 000 463 8 471

Note 12 13 14 15

140 60 30 348 48 300 180 120 300 80 280 180 100 50 50 100

234 124 110 581 228 353 180 148 25 353

Long Term Loans

16

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

17 11 18

Notes: 1 2 3 4 H + S IC = 350 + 230 - 150 = H + S IC =210 + 138 - 150 = H + S = 35 + 23 = For an acquisition costing H acquired 75% of S, 75% x 60 = Goodwill acquired Amortised over 10 years = 5 H + S = 5 + 22 =

000 430 198 58 55 45 10 1 27

24

6 7 8 9 10

H + S = 20 + 7 = From outside group only = 25% x 40 = H plc only H S, 75% x (14 - 10) = 75% x 4 1 year amortisation

000 27 0 10 9 46 3 49 1 48 120 30 150 2 148 463 55 45 10 amortised over 10 years = 1 per annum 2 8 234 124 228 180 25

11

H S, 75% x (50 - 10) = 75% x 40 2 years amortisation

12 13

H + S = 263 + 200 = For an acquisition costing H acquired 75% of S, 75% x 60 = Goodwill acquired Amortised for 2 years Carrying value in Group balance sheet H + S Inter-Company = 120 + 140 - 26 = H + S Inter-Company = 90 + 60 - 26 = H + S = 48 + 180 = H only 25% x Shareholders funds of S = 25% x 100 =

14 15 16 17 18

25

Now attempt the final case for this level of study. Case 10 The following are the draft Income and Expenditure accounts of H plc and S Ltd for the period to 31 December 20X9:

000 Sales Cost of Sales Gross Profit Operating Expenses Amortisation of goodwill in S Ltd Operating profit Financing Costs Profit before Tax Taxation Profit after Tax Inter Company Dividends received Non Controlling Interests Group profit for year Dividends paid Retained profit for year Retained profit brought forward Retained profit carried forward

H plc 000 500 300 200 50 150 5 145 30 115 4 119

000

S Ltd 000 300 180 120 30 90 22 68 18 50

50 69 46 115

5 45 19 64

26

The following are the draft Balance Sheets of H plc and S Ltd as at 31 December 20X9:

000 Fixed Assets Investment by H in S Goodwill on Consolidation Current Assets Current Liabilities 120 90

H plc 000 263 100 363

000

S Ltd 000 264

140 60 30 393 48 345 230 115 345 80 344 180 164 100 64 164

Long Term Loans

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

Note: H acquired 80% of S Ltds net assets for 100,000 one year ago when Ss shares stood at 100,000 and its profit and loss reserve at 19,000 Inter-company (IC) sales from S Ltd to H plc during the year were 175,000. There were no unsold stocks in relation to these transactions at the year end. The current assets of S include 32,000 owing from H and the current liabilities of H include 32,000 owing to S. Any positive Goodwill arising on consolidation is amortised over its useful life, in this case considered to be five years. Negative goodwill, if any, is transferred to group profit and loss reserves. Required: Prepare the group Income statement for the year ended 31 December 20X9 and a Group balance sheet as at that date. Please show calculations to the nearest 1,000

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Solution: Group Income and Expenditure accounts of H plc and S Ltd for the period to 31 December 20X9:

000 Sales Cost of Sales Gross Profit Operating Expenses Amortisation of goodwill in S Ltd Operating profit Financing Costs Profit before Tax Taxation Profit after Tax Inter Company Dividends received Non Controlling Interests Group profit for year Dividends paid Retained profit for year Retained profit brought forward Retained profit carried forward

H plc 000 500 300 200 50 150 5 145 30 115 4 119

000

S Ltd 000 300 180 120 30 90 22 68 18 50

000

Group 000 625 305 320 81 239 27 212 48 164

Note 1 2 3 4 5 6 7

80 1

50 69 46 115

5 45 19 64

10 154 50 104 46 150

8 9 10 11

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Group Balance Sheet as at 31 December 20X9

000 Fixed Assets Investment by H in S Goodwill on Consolidation Current Assets Current Liabilities 120 90

H plc 000 263 100 363

000

S Ltd 000 264

000

Group 000 527 4 531

Note 12 13 14 15

140 60 30 393 48 345 230 115 345 80 344 180 164 100 64 164

228 118 110 641 228 413 230 150 33 413

Long Term Loans

16

Ordinary Share Capital 1 Shares Profit and Loss Reserve Non-Controlling Interests

17 11 18

Notes: 1 2 3 4 H + S IC = 500 + 300 - 175 = H + S IC =300 + 180 - 175 = H + S = 50 + 30 = For an acquisition costing H acquired 80% of S, 80% x 119 = Goodwill acquired Amortised over 5 years = 5 H + S = 5 + 22 =

000 625 305 80 100 95 5 1 27

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6 7 8 9 10

H + S = 30 + 18 = From outside group only = 20% x 50 = H plc only H S, 80% x (19 - 19) = 80% x 0 No amortisation

000 48 0 10 50 46 0 46 0 46 115 36 151 1 150 527 100 95 5 amortised over 5 years = 1 per annum 1 4 228 118 228 230 33

11

H S, 80% x (64 - 19) = 80% x 45 1 years amortisation

12 13

H + S = 263 + 264 = For an acquisition costing H acquired 80% of S, 80% x 119 = Goodwill acquired Amortised for 1 year Carrying value in Group balance sheet H + S Inter-Company = 120 + 140 - 32 = H + S Inter-Company = 90 + 60 - 32 = H + S = 48 + 180 = H only 20% x Shareholders funds of S = 20% x 164 =

14 15 16 17 18

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