1

Principles of consolidated
financial statements

1 The concept of group accounts

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 What is a group?

If one company owns more than 50% of the ordinary shares of another
company:

• this will usually give the first company ‘control’ of the second company
• the first company (the parent company, P) has enough voting power to
appoint all the directors of the second company (the subsidiary company,
S)
• P is, in effect, able to manage S as if it were merely a department of P,
rather than a separate entity
• in strict legal terms P and S remain distinct, but in economic substance
they can be regarded as a single unit (a ‘group’).

Expandable text - Group concept

Group accounts

The key principle underlying group accounts is the need to reflect the
economic substance of the relationship.

• P is an individual legal entity.

• S is an individual legal entity.
P controls S and therefore they form a single economic entity – the Group.

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 • subsidiary – an entity that is controlled by another entity (known as the
parent)
• control – the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities.
Requirements for consolidated financial statements

IAS 27 outlines the circumstances in which a group is required to prepare

consolidated financial statements.  

Consolidated financial statements should be prepared when the parent

company has control over the subsidiary.  Control is usually established based
on ownership of more than 50% of voting power, but other forms of control are
possible.

IAS 27 gives four other situations in which control exists – when the parent has
power:

• over more than half the voting rights by virtue of an agreement with other
investors
• to govern the financial and operating policies of the entity under a statute
or an agreement
• to appoint or remove the majority of the members of the board of directors
• to cast the majority of votes at a meeting of the board of directors.

Example 1 - Control
(i) Hercules purchases 6,000 A ordinary shares.
(ii) Hercules purchases 10,000 B and 4,000 A ordinary shares.
(i) Hercules has purchased 6,000 of the 10,000 voting A shares but no non-voting B
shares.

It is the voting shares that give Hercules the influence in Samson. With 60% of the
voting shares Hercules should control Samson. Samson should therefore be treated
as a subsidiary.
(ii) Hercules has purchased 4,000 of the 10,000 voting A shares and 10,000 non-voting B
shares.

As Hercules has less than 50% of the voting share this time it probably will not be able
to control Samson. Samson will not be a subsidiary.

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 Exemption from preparation of group financial statements

A parent need not present consolidated financial statements if and only if:

• the parent itself is a wholly owned subsidiary or a partially-owned

subsidiary and its owners, (including those not otherwise entitled to vote)
have been informed about and do not object to the parent not preparing
consolidated financial statements.
• the parent's debt or equity instruments are not traded in a public market.
• the parent did not file its financial statements with a securities commission
or other regulatory organisation.
• the ultimate or any immediate parent of the parent produces.

Expandable text - Reasons for wanting to exclude a subsidiary

• poor performance of the subsidiary

• poor financial position of the subsidiary
• differing activities of the subsidiary from the rest of the group.

Consolidated statement of
financial position
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 1 Principles of the consolidated statement of financial position

Basic principle

The basic principle of a consolidated statement of financial position is that it

shows all assets and liabilities of the parent and subsidiary.

Intra-group items are excluded, e.g. receivables and payables shown in the
consolidated statement of financial position only include amounts owed from/to
third parties.

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 Method of preparing a consolidated statement of financial position
(1) The investment in the subsidiary (S) shown in the parent’s (P’s) statement
of financial position is replaced by the net assets of S.
(2) The cost of the investment in S is effectively cancelled with the ordinary
share capital and reserves of the subsidiary
This leaves a consolidated statement of financial position showing:

• the net assets of the whole group (P + S)

• the share capital of the group which always equals the share capital of P
only and
• the retained profits, comprising profits made by the group (i.e. all of P’s
historical profits + profits made by S post-acquisition).

Example 1 - Principles of the consolidated SFP

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 P
$000
Non-current assets 60
Investment in S at cost 50
Current assets 40
___
150
___
Ordinary share capital ($1 shares) 100
Retained earnings 30
Current liabilities 20
___
150
___
(1) The balance on ‘investment in subsidiary account’ in P’s accounts will be replaced by
the underlying assets and liabilities which the investment represents, i.e. the assets
and liabilities of S.
(2) The cost of the investment in the subsidiary is effectively cancelled with the ordinary
share capital and reserves of S. This is normally achieved in consolidation workings
(discussed in more detail below). However, in this simple case, it can be seen that the
relevant figures are equal and opposite ($50,000), and therefore cancel directly.
• the net assets of the whole group (P + S)
• the share capital of the group, which equals the share capital of P only – $100,000
• retained earnings comprising profits made by the group. Here this will only include the
$30,000 retained earnings of the parent company. S is purchased on the reporting
date, therefore there are no post-acquisition earnings to include in the group amount.

Non-current assets $(60,000 + 50,000)

Current assets $(40,000 + 40,000)

Share capital ($1 ordinary shares)

Retained earnings
Current liabilities $(20,000 + 40,000)

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 The mechanics of consolidation

A standard group accounting question will provide the accounts of P and the
accounts of S and will require the preparation of consolidated accounts.

The best approach is to use a set of standard workings.

(W1) Establish the group structure

(W2) Net assets of subsidiary

At date of acquisition At the reporting date

$ $
Share capital X X
Reserves:
Share premium X X
Retained earnings X X
–– ––
X X
–– ––

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 (W3) Goodwill

  $
 
X
Parent holding (investment) at fair value
NCI value at acquisition (*)   X
    —
    X
Less:    

Fair value of net assets at acquisition (W2)   (X)

    —
Goodwill  on acquisition   X
   
Impairment   (X)
    —
X
Carrying Goodwill   —
 

If fair value method adopted, NCI value = fair value of NCI's holding at
(* acquisition (number of shares NCI own × subsidiary share price). 
)
(* If proportion of net assets method adopted, NCI value = NCI % × fair value of net assets at acquisition (from
W2).
)
 

(W4) Non controlling interest

   
NCI value at acquisition (as in W3) X
NCI share of post-acquisition reserves (W2) X
NCI share of impairment (fair value method only) (X)
  —
  X
  —

Expandable text - Goodwill

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 $
Cost of investment (= value of the subsidiary) X
Net assets of subsidiary (X)
___
Goodwill X
• The value of the part acquired by the parent
• The value of the part not acquired by the parent, known as the non-controlling interest
(i) Proportion of net assets method (as seen in consolidation workings).
(ii) Fair value method (as seen in consolidation workings).

Example 2 - Goodwill
(i) if the NCI is valued using the proportion of net assets method
(ii) if the NCI is valued using the fair value method and the fair value of the NCI on the
acquisition date is $19,000?
 
Solution 

(i)
Parent holding (investment) at fair value  
NCI value at acquisition  
(20% × $85,000)
   
   
Less:   
Fair value of net assets at acquisition  
   
Goodwill on acquisition  
   
   
(ii)  
Parent holding (investment) at fair value  
NCI value at acquisition  
   
   
Less:  
Fair value of net assets at acquisition  
   
Goodwill on acquisition  
   

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 Expandable text - IFRS 3 Business Combinations

• Capitalised as an intangible non-current asset.

• Tested annually for possible impairments.
• Amortisation of goodwill is not permitted by the standard.
• Arises where the cost of the investment is less than the value of net assets
purchased.
• IFRS 3 does not refer to this as negative goodwill (instead it is referred to as a bargain
purchase), however this is the commonly used term.
• Most likely reason for this to arise is a misstatement of the fair values of assets and
liabilities and accordingly the standard requires that the calculation is reviewed.
• After such a review, any negative goodwill remaining is credited directly to the income
statement.

Expandable text - Pre- and post acquisition reserves

• those reserves of S which existed at the date of acquisition by P (pre-acquisition

reserves) and
• the increase in the reserves of S which arose after acquisition by P (post-acquisition
reserves).

Example 3 - Pre- and post-acquisition reserves

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 Derek
$
Non-current assets:
   Property, plant & equipment 75,000
   Investments
   Shares in Clive 27,000
–––––––
102,000
Current assets 214,000
–––––––
316,000
–––––––

Equity:
   Share capital 80,000
   Share premium 20,000
   Retained earnings 40,000
–––––––
140,000
–––––––
Current liabilities 176,000
–––––––
316,000
–––––––

Non-current assets:
   Goodwill (W3)
   PPE $(75,000 + 11,000)
Current assets $(214,000 + 33,000)

Share capital (Derek only)

Share premium (Derek only)
Group retained earnings (W5)

Current liabilities $(176,000 + 25,000)

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 Expandable text - Non-controlling interests

• in the consolidated statement of financial position, include all of the net assets of S (to
show control).
• ‘give back’ the net assets of S which belong to the non-controlling interest within the
equity section of the consolidated statement of financial position (calculated in W4).

Test your understanding 1

Draft SFPs of Piper and Swans on 31 December 20X1 are as follows.

Piper
$000
Property, plant & equipment 90
Investment in Swans at cost 110
Current assets 50
––––
250
––––
Equity and liabilities
Equity
Ordinary share capital $1 100
Retained earnings 120
–––
220
–––
Current liabilities 30
–––
250
–––
Piper had bought 80% of the ordinary shares of Swans on 1 January 20X1 when the
retained profits of Swans were $15,000. No impairment of goodwill has occurred to date.

Prepare a consolidated statement of financial position as at 31 December 20X1,

assuming that the Piper group values the non-controlling interest using the
proportion of net assets method.

Test your understanding 1

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 Show Answer

Piper consolidated statement of financial position as at 31 December 20X1

Non-current assets:
Goodwill (W3)
PPE $(90,000 + 100,000)

Current assets $(50,000 + 30,000)

Total assets

Equity:
Ordinary share capital $1 (100% P only)
Retained earnings (W5)

Non-controlling interest (W4)

Current liabilities $(30,000 + 10,000)

Total equity and liabilities

At date of
acquisition reporting

$000
Ordinary share capital 100
Retained earnings 15
___
115
___
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 Test your understanding 2

The following SFPs have been prepared at 31 December 20X8.

Dickens
$
Non-current assets:
Property, plant & equipment 85,000
Investments:
Shares in Jones 60,000
––––––
145,000
Current assets 160,000
––––––
305,000
––––––
Equity:
Ordinary $1 shares 65,000
Share premium 35,000
Retained earnings 70,000
––––––
170,000
Current liabilities 135,000
––––––
305,000
––––––
Dickens acquired its 80% holding in Jones on 1 January 20X8, when Jones’ retained
earnings stood at $20,000.On this date, the fair value of the 20% non-controlling
shareholding in Jones was $12,500.

The Dickens Group uses the fair value method to value the non-controlling interest

Prepare the consolidated statement of financial position of Dickens as at 31

December 20X8.

Test your understanding 2

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 Solution
Show Answer

Non-current assets
Goodwill (W3)
PPE 
(85,000 + 18,000)
Current assets
(160,000 + 84,000)

Equity  

Share capital
Share premium
Group retained earnings (W5)
Non-controlling interest (W4)

Current liabilities
(135,000 + 47,000)

At date of acquisition At reporting date

Share capital 20,000 20,000
Share premium 10,000 10,000
Retained earnings 20,000 25,000
______ ______
Net assets 50,000 55,000
______ ______
60,000
Parent holding (investment) at fair value
NCI value at acquisition 12,500
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 2 Fair values

Fair value of consideration and net assets

To ensure that an accurate figure is calculated for goodwill:

• the consideration paid for a subsidiary must be accounted for at fair value
• the subsidiary’s identifiable assets and liabilities acquired must be
accounted for at their fair values.

The fair value of assets and liabilities is defined in IFRS 3 (and several other
IFRSs) as ‘the amount for which an asset could be exchanged or a liability
settled between knowledgeable, willing parties in an arm’s length transaction’.

Expandable text - Fair values

• the cost of the investment in its own statement of financial position

• the amount to be allocated between the identifiable net assets of the subsidiary, the
non-controlling interest and goodwill in the consolidated financial statements.
• Consolidated accounts are prepared from the perspective of the group, rather than
from the perspectives of the individual companies. The book values of the subsidiary’s
assets and liabilities are largely irrelevant, because the consolidated accounts must
reflect their cost to the group (i.e. to the parent), not their original cost to the
subsidiary. The cost to the group is their fair value at the date of acquisition.
• Purchased goodwill is the difference between the value of an acquired entity and the
aggregate of the fair values of that entity’s identifiable assets and liabilities. If fair
values are not used, the value of goodwill will be meaningless.
• Changes resulting from the acquirer’s intentions or future actions.
• Changes resulting from post-acquisition events.
• Provisions for future operating losses or reorganisation costs incurred as a result of
the acquisition.

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 Deferred and contingent consideration

In some situations not all of the purchase consideration is paid at the date of
the acquisition, instead a part of the payment is deferred until a later date –
deferred consideration.

• Deferred consideration should be measured at fair value at the date of the

acquisition (i.e. a promise to pay an agreed sum on a predetermined date
in the future taking into account the time value of money).
• The fair value of any deferred consideration is calculated by discounting
the amounts payable to present value at acquisition.
• Any contingent consideration should always be included as long as it can
be measured reliably.  This will be indicated where relevant in an exam
question.  (A contingent consideration is an agreement to settle in the
future provided certain conditions attached to the agreement are met.
These conditions vary depending on the terms of the settlement).
There are two ways to discount the deferred amount to fair value at the
acquisition date:

(1) The examiner gives you the present value of the payment based on a given
cost of capital.

For example, $1 receivable in three years time based on a cost of capital of

10% = $0.75
(2) Use the interest rate given and apply the discount fraction where r is the
interest rate and n the number of years to settlement

1
––––––
(1 + r ) n
Each year the discount is then "unwound".  This increases the deferred liability
each year (to increase to future cash liability) and the discount is treated as a
finance cost.

Expandable text - Contingent consideration

Share exchange

Often the parent company will issue shares in its own company in return for
the shares acquired in the subsidiary.  The share price at acquisition should be
used to record the cost of the shares at fair value.

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 Example 4 - Cost of investment
(i) Calculate the cost of investment and show the journals to record it in Jack's accounts.
(ii) Show how the discount would be unwound.
(i) Cost of investment

Deferred cash (at present value)

    $0.75 × ($1 × 24m)
Shares exchange
    (24m × 2/3) × $2

Cost of investment in subsidiary

Dr
Cr Non-current liabilities - deferred consideration
Cr Share capital (16 million shares issued × $1 nominal value)
Cr Share premium (16 million shares issued × $1 premium
element)
(ii) Unwinding the discount
Finance cost
Dr
Cr Non-current liabilities - deferred consideration

Test your understanding 3

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 Cost of investment

Statements of Financial Position of P and S as at 30 June 20X8 are given below:

  P    
  $    
   
Property, plant & equipment 15,000
Investments 5,000
     
Current assets 7,500
  ––––––
  27,500
  ––––––
     
Share capital $1 6,000
Share premium 4,000
Retained earnings 12,500
  ––––––
  22,500
   
Non-current liabilities 1,000
     
Current liabilities 4,000
  ––––––
  27,500
  ––––––
P acquired 60% of S on 1 July 20X7 when the retained earnings of S were $5,800. P paid
$5,000 in cash.  P also issued 2 $1 shares for every 5 acquired in S and agreed to pay a
further $2,000 in 3 years time. The market value of P’s shares at 1 July 20X7 was $1.80. P
has only recorded the cash paid in respect of the investment in S. Current interest rates
are 6%.

The P group uses the fair value method to value the non-controlling interests.  At the date
of acquisition the fair value of the non-controlling interest was $5,750.

Required:

Prepare the consolidated Statement of Financial Position of P group as at 30 June

20X8.

Test your understanding 3

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 Show Answer

Non-current assets
Goodwill (W3)
Property, plant & equip (15,000 + 9,500)
Investments (5,000 – 5,000)
Current Assets (7,500 + 5,000)
 
 
 

Share capital (6,000 + 1,200)

Share premium (4,000 + 960)
Retained earnings (W5)
Non-controlling Interest (W4)
 
 

Non-current liabilities (1,000 + 500 + 1,680 +101)

Current liabilities (4,000 + 1,800)
 
 
 

  @ acq'n @ rep date

Share capital 5,000
Retained earnings 5,800
  ––––––
  10,800
  ––––––
 

Parent holding (investment) at fair value:

Cash paid
Share exchange
(60% × 5,000 × 2/5 × $1.80)
Deferred consideration
(2,000 × 1/1.063)
  ––––––
 

NCI value at acquisition

  ––––––
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 Fair value of net assets acquired

IFRS 3 revised requires that the subsidiary’s assets and liabilities are recorded
at their fair value for the purposes of the calculation of goodwill and production
of consolidated accounts.

Adjustments will therefore be required where the subsidiary’s accounts

themselves do not reflect fair value.

How to include fair values in consolidation workings

(1) Adjust both columns of W2 to bring the net assets
to fair value at acquisition and reporting date.

This will ensure that the fair value of net assets is

carried through to the goodwill and non-controlling
interest calculations.

At acquisition At reporting date

$000 $000
Ordinary share capital + X X
reserves
Fair value adjustments X X
  ___ ___
X X
___ ___
(2) At the reporting date make the adjustment on the face of the SFP when
adding across assets and liabilities.

Test your understanding 4

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 Hazelnut acquired 80% of the share capital of Peppermint two years ago, when the
reserves of Peppermint stood at $125,000. Hazelnut paid initial cash consideration of $1
million. Additionally Hazelnut issued 200,000 shares with a nominal value of $1 and a
current market value of $1.80. It was also agreed that Hazelnut would pay a further
$500,000 in three years’ time. Current interest rates are 10% pa. The appropriate discount
factor for $1 receivable three years from now is 0.751. The shares and deferred
consideration have not yet been recorded.

Below are the statements of financial position of Hazelnut and Peppermint as at 31

December 20X4:
Hazelnut Peppermint
$000
Investment in Peppermint at cost 1,000
Property, plant & equipment 5,500
Current assets:
Inventory 550
Receivables 400
Cash 200
–––––
7,650
–––––
Share capital 2,000
Retained earnings 1,400
–––––
3,400
Non-current liabilities 3,000
Current liabilities 1,250
–––––
7,650
–––––
At acquisition the fair values of Peppermint’s plant exceeded its book value by $200,000.
The plant had a remaining useful life of five years at this date.

For many years Peppermint has been selling some of its products under the brand name
of ‘Spearmint’. At the date of acquisition the directors of Hazelnut valued this brand at
$250,000 with a remaining life of 10 years. The brand is not included in Peppermint’s
statement of financial position.

The consolidated goodwill has been impaired by $258,000.

The Hazelnut Group values the non-controlling interest using the fair value method. At the
date of acquisition the fair value of the 20% non-controlling interest was $380,000
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 Expandable text - Uniform accounting policies
(1) adjusting the relevant asset or liability balance in the subsidiary’s individual statement
of financial position prior to adding across on a line by line basis, and
(2) adjusting W2 to reflect the impact of the different policy on the subsidiary’s net assets.

3 Intra-group trading

Types of intra-group trading

P and S may well trade with each other leading to the following potential
problem areas:

• current accounts between P and S   

• loans held by one company in the other
• dividends and loan interest.
• unrealised profits on sales of inventory    
• unrealised profits on sales of non-current assets

Current accounts

If P and S trade with each other then this will probably be done on credit
leading to:

• a receivables (current) account in one company’s SFP

• a payables (current) account in the other company’s SFP.
These are amounts owing within the group rather than outside the group and
therefore they must not appear in the consolidated statement of financial
position.

They are therefore cancelled (contra’d) against each other on consolidation.

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 Cash/goods in transit

At the year end, current accounts may not agree, owing to the existence of in-
transit items such as goods or cash.

The usual rules are as follows:

• If the goods or cash are in transit between P and S, make the adjusting
entry to the statement of financial position of the recipient:
– cash in transit adjusting entry is:
– Dr Cash in transit
– Cr Receivables current account
– goods in transit adjusting entry is:
– Dr Inventory
– Cr Payables current account
this adjustment is for the purpose of consolidation only.

• Once in agreement, the current accounts may be contra’d and cancelled as

part of the process of cross casting the assets and liabilities.
• This means that reconciled current account balance amounts are removed
from both receivables and payables in the consolidated statement of
financial position .

Example 5 - Inter-company current accounts

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 Plant
$000
Property, plant & equipment 100
Investment in S at cost 180
Current assets
Inventory 30
Trade receivables 20
Cash 10
___
340

Equity and liabilities

Share capital: Ordinary $1 shares 200
Share premium 10
Retained earnings 40
___
250
Non-current liabilities:
10% loan notes 65
Current liabilities 25
___
340
• Plant bought 80,000 shares in Shrub in 20X1 when Shrub’s reserves included a share
premium of $30,000 and retained profits of $5,000.
• Plant's accounts show $6,000 owing to Shrub; Shrub's accounts show $8,000 owed
by Plant. The difference is explained as cash in transit.
• No impairment of goodwill has occurred to date.
• Plant uses the proportion of net assets method to value the non-controlling interest.
$000
Assets
Non-current assets:
Intangible assets – goodwill (W3)
Property, plant & equipment 
(100 + 140)

Current assets:
Inventory $(30 + 35) 65
Trade receivables
(20 + 10 - 2 (CIT) – 6 (inter-co)) 22
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 Show Answer

Non-current assets
Goodwill (W3)
Land (4,500 + 2,500 + 1,250)
Plant & equipment (2,400 + 1,750 + 500 – 300)
Investments (8,000 – 3,500 – (60% × 500))
 
 
Current Assets

Inventory
(3,200 + 900)
Receivables
(1,400 + 650 - 100 (CIT) - 400 (inter-co))
Bank (600 + 150 + 100 (CIT))
 
 
 
 
 

Equity
Share capital
Retained earnings (W5)
Non-controlling Interest (W4)
 
 
 
Non-current liabilities (4,000 + 500 – (60% × 500))
Current liabilities (2,800 + 1,300 - 400)
 
 
 

  @Acq'n

Share capital 1,000

Retained earnings 1,150
FV Adj Land (3,750 – 2,500) 1,250
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 4 Unrealised profit

Profits made by members of a group on transactions with other group

members are:

• recognised in the accounts of the individual companies concerned, but

• in terms of the group as a whole, such profits are unrealised and must be
eliminated from the consolidated accounts.
Unrealised profit may arise within a group scenario on:

• inventory where companies trade with each other

• non-current assets where one group company has transferred an asset to
another.

Intra-group trading and unrealised profit in inventory

When one group company sells goods to another a number of adjustments

may be needed.

• Current accounts must be cancelled (see earlier in this chapter).

• Where goods are still held by a group company, any unrealised profit must
be cancelled.
• Inventory must be included at original cost to the group (i.e. cost to the
company which then sold it).

Expandable text - PURP

(1) The profit made by Pineapple is unrealised.  The profit will only become realised when
sold on to a third party customer.
(2) The value in Satsuma’s inventory ($500) is not the cost of the inventory to the group
(cost to the group was the purchase price of the goods from the external third party
supplier i.e. $400).  

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 Adjustments for unrealised profit in inventory

The process to adjust is:

(1) Determine the value of closing inventory included in an individual

company’s accounts which has been purchased from another company in
the group.
(2) Use mark-up or margin to calculate how much of that value represents
profit earned by the selling company.
(3) Make the adjustments. These will depend on who the seller is.
If the seller is the parent company, the profit element is included in the
holding company’s accounts and relates entirely to the group.

Adjustment required:

Dr Group retained earnings (deduct the profit in W5)

Cr Group inventory

If the seller is the subsidiary, the profit element is included in the subsidiary
company’s accounts and relates partly to the group, partly to non-controlling
interests (if any).

Adjustment required:

Dr Subsidiary retained earnings (deduct the profit in W2 - at reporting date)

Cr Group inventory

Test your understanding 6

29 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Health (H) bought 90% of the equity share capital of Safety (S), two years ago on 1
January 20X2 when the retained earnings of Safety stood at $5,000. Statements of
financial position at the year end of 31 December 20X3 are as follows:

Health Safety
$000 $000 $000
Non-current assets:
Property, plant & equipment 100
Investment in Safety at cost 34
––––
134

Current assets:
Inventory 90 20
Receivables 110 25
Bank 10 5
–––– ––––
210
––––
344
––––
       

Equity:
Share capital 15
Retained earnings 159
––––
174
Non-current liabilities 120
Current liabilities 50
––––
344
––––
Safety transferred goods to Health at a transfer price of $18,000 at a mark-up of 50%.
Two-thirds remained in inventory at the year end. The current account in Health and
Safety stood at $22,000 on that day. Goodwill has suffered an impairment of $10,000.

The Health group uses the fair value method to value the non-controlling interest.
value of the non-controlling interest at acquisition was $4,000

Prepare the consolidated statement of financial position at 31/12/X3.

30 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Non-current assets

If one group member sells non-current assets to another group member

adjustments must be made to recreate the situation that would have existed if
the sale had not occurred:

• There would have been no profit on the sale.

• Depreciation would have been based on the original cost of the asset to
the group.

Expandable text - NCA PURP

Adjustments for unrealised profit in non-current assets

The easiest way to calculate the adjustment required is to compare the

carrying value (CV) of the asset now with the CV that it would have been held
at had the transfer never occurred:

X
CV at reporting date with transfer
CV at reporting date without transfer (X)
–––
Adjustment required X
The calculated amount should be:

(1) deducted when adding across P’s non-current assets + S’s non-current
assets
(2) deducted in the retained earnings of the seller (W2 if the seller is the
subsidiary; W5 if it is the parent company).

Example 7 - Unrealised profit in NCA

31 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 NBV Before NBV After
Solution
Transfer Transfer
$ $
Cost 10,000
Depreciation (3 yrs) (6,000)
–––––
Carrying value 4,000 6,000
Depreciation (2,000) (3,000)
––––– –––––
Carrying value 2,000 3,000

Dr Consolidated retained earnings (W5)

Cr Property, plant and equipment

5 Mid-year acquisitions

Calculation of reserves at date of acquisition

If a parent company acquires a subsidiary mid-year, the net assets at the date
of acquisition must be calculated based on the net assets at the start of the
subsidiary's financial year plus the profits of up to the date of acquisition.

To calculate this it is normally assumed that S’s profit after tax accrues evenly
over time.

Test your understanding 7

32 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Consolidated Statement of Financial Position

On 1 May 2007 Karl bought 60% of Susan paying $76,000 cash. The summarised
Statements of Financial Position for the two companies as at 30 November 2007 are:

  Karl    
  $    
   
Non-current assets
Property, plant & equipment 138,000
Investments 98,000
     
Current assets
Inventory 15,000
Receivables 19,000
Cash 2,000
  ––––––
  272,000
  ––––––
     
Share capital 50,000

Retained earnings 189,000

  ––––––
  239,000

Non-current liabilities
8% Loan notes -
     
Current liabilities 33,000
  ––––––
  272,000
  ––––––
The following information is relevant:

(1) The inventory of Susan includes $8,000 of goods purchased from Karl at cost plus
25%.
(2) On 1 June 2007 Susan transferred an item of plant to Karl for $15,000.  Its carrying
amount at that date was $10,000.  The asset had a remaining useful economic life of
5 years.
(3) The Karl Group values the non-controlling interest using the fair value method. At the
date of acquisition the fair value of the 40% non-controlling interest was $50,000.
(4) An impairment loss of $1,000 is to be charged against goodwill at the year-end.
(5) Susan earned a profit of $9,000 in the year ended 30 November 2007.
(6) The loan note in Susan’s books represents monies borrowed from Karl during the
year.  All of the loan note interest has been accounted for.
33 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T
Consolidated income statement

1 Principles of the consolidated income statement

Basic principle

The consolidated income statement shows the profit generated by all

resources disclosed in the related consolidated statement of financial position,
i.e. the net assets of the parent company (P) and its subsidiary (S).

The consolidated income statement follows these basic principles:

• From revenue to profit for the year include all of P’s income and expenses
plus all of S’s income and expenses (reflecting control of S).
• After profit for the year show split of profit between amounts attributable to
the parent's shareholders and the non-controlling interest (to reflect
ownership).

34 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 The mechanics of consolidation

As with the statement of financial position, it is common to use standard

workings when producing a consolidated income statement:

• group structure diagram

• net assets of subsidiary at acquisition (required for goodwill calculation - if
asked to calculate)    
• goodwill calculation (if asked to calculate goodwill or if you are required to
calculate an impairment that is to be charged to profits (see below))
• non-controlling interest (NCI) share of profit (see below)

Non-controlling interest

This is calculated as:

NCI % × subsidiary’s profit after tax X

Less:
NCI % × fair value depreciation (X)
NCI % × PURP (sub = seller only) (X)
NCI % × impairment (fair value method) (X)
  –––––
  X
  –––––

2 Intra-company trading

Sales and purchases

The effect of intra-group trading must be eliminated from the consolidated

income statement.

Such trading will be included in the sales revenue of one group company and
the purchases of another.

• Consolidated sales revenue = P’s revenue + S’s revenue – intra-group

sales.
• Consolidated cost of sales   = P’s COS + S’s COS – intra-group sales.

35 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Provision for unrealised profit

Inventory

If any goods sold intra-group are included in closing inventory, their value must
be adjusted to the lower of cost and net realisable value (NRV) to the group
(as in the CSFP).

The adjustment for unrealised profit should be shown as an increase to cost of

sales (return inventory back to true cost to group and eliminate unrealised
profit).

Expandable text - Unrealised profit in inventory

• A buys an inventory item for $60

• A sells it to B for $80, B being a member of the same group as A
• B still holds the item at the reporting date, then the income statements of the two
companies will include, in respect of these events:
A
$
Sales revenue 80
Cost of sales (60)
___
Profit 20
___
(1) eliminate sales of $80 in A's books and purchases of $80 in B's books
(2) cancel the unrealised profit of $20 in A (the seller's) books.
A
$
Sales revenue 80
Cost of sales (60)
__
Gross profit (and other subtotals) 20
__

Sales revenue
Cost of sales

Gross profit (and other subtotals)

36 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Example 2 - Unrealised profit in CIS

37 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Zebedee
$000
Revenue 1,260
Cost of sales (420)
–––––
Gross profit 840
Distribution costs (180)
Administration expenses (120)
–––––
Profit from operations 540
Investment income from Xavier 36
–––––
Profit before taxation 576
Taxation (130)
–––––
Profit for the year 446

Revenue
(1,260 + 520 - 84)
Cost of sales
(420 + 210 - 84 + 12)

Gross profit
Distribution costs
(180 + 60)
Administrative expenses
(120 + 90)

Profit from operations

Taxation
(130 + 26)

Profit for the year

Amount attributable to:
Equity holders of the parent (532 – NCI)
Non-controlling interests (W3)

38 (W2) Unrealised profit

Prepared by in inventory
Baravuga Zefania {B.com-Udsm} CPA-T
 Transfers of non-current assets

If one group company sells a non-current asset to another group company the
following adjustments are needed in the income statement to account for the
unrealised profit and the additional depreciation.

• Any profit or loss arising on the transfer must be removed from the
consolidated income statement.
• The depreciation charge must be adjusted so that it is based on the cost of
the asset to the group.

Expandable text - Unrealised profit on non-current assets

• any remaining unrealised profit or loss arising on the transfer is eliminated

• the asset’s cost and accumulated depreciation are adjusted so that they are based on
the cost of the asset to the group.

3 Other CIS adjustments

Impairment of goodwill

Once any impairment has been identified during the year, the charge for the
year will be passed through the consolidated income statement. This will
usually be through operating expenses, however always follow instructions
from the examiner.

If non-controlling interests have been valued at fair value, a portion of the

impairment expense must be removed from the non-controlling interest's share
of profit.

39 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Fair values

If a depreciating non-current asset of the subsidiary has been revalued as part

of a fair value exercise when calculating goodwill, this will result in an
adjustment to the consolidated income statement.

The subsidiary's own income statement will include depreciation based on the
value the asset is held at in the subsidiary's own SFP.

The consolidated income statement must include a depreciation charge based

on the fair value of the asset, included in the consolidated SFP.

Extra depreciation must therefore be calculated and charged to an appropriate

cost category (usually in line with examiner requirements).

Test your understanding 1

40 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Set out below are the draft income statements of Smiths and its subsidiary company
Flowers for the year ended 31 December 20X7.

On 1 January 20X6 Smiths purchased 75,000 ordinary shares in Flowers from an issued
share capital of 100,000 $1 ordinary shares.

Income statements for the year ended 31 December 20X7

Smiths
$000
Revenue 600
Cost of sales (360)
––––
Gross profit 240
Operating expenses (93)
––––
Profit from operations 147
Finance costs
––––
Profit before tax 147
Tax (50)
––––
Profit for the year 97
The following additional information is relevant:

(1) During the year Flowers sold goods to Smiths for $20,000, making a mark-up of one
third. Only 20% of these goods were sold before the end of the year, the rest were still
in inventory.
(2) Goodwill has been subject to an impairment review at the end of each year since
acquisition and the review at the end of this year revealed another impairment of
$5,000. The current impairment is to be recognised as an operating cost.
(3) At the date of acquisition a fair value adjustment was made and this has resulted in an
additional depreciation charge for the current year of $15,000.  It is group policy that
all depreciation is charged to cost of sales.
(4) Smiths values the non-controlling interests using the fair value method. 
Prepare the consolidated income statement for the year ended 31 December 20X7.

Test your understanding 1

41 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Solution
Hide Answer

Smiths consolidated income statement for the year ended 31 December 20X7

Revenue
(600 + 300 - 20)
Cost of sales
(360 + 140 - 20 + 4 (W2) + 15 (fv dep'n))

Gross profit
Operating expenses
(93 + 45 + 5 (impairment))

Profit from operations

Finance costs

Profit before tax

Tax
(50 + 32)

Profit for the year

 

Attributable to:
Non-controlling interest (W3)
Group (168 – 17.75)
 
 
 

Workings

(W1) Group structure

(W2) Unrealised profit

42 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Test your understanding 2

Given below are the income statements for Paris and its subsidiary London for the year
ended 31 December 20X5.

Paris
$000
Revenue 3,200
Cost of sales (2,200)
–––––
Gross profit 1,000
Distribution costs (160)
Administrative expenses (400)
–––––
Profit from operations 440
Investment income 160
–––––
Profit before tax 600
Taxation (400)
–––––
Profit for the year 200
Additional information:

• Paris paid $1.5 million on 31 December 20X1 for 80% of London’s 800,000 ordinary
shares.
• Goodwill impairments at 1 January 20X5 amounted to $152,000. A further impairment
of $40,000 was found to be necessary at the year end. Impairments are included
within administrative expenses.
• Paris made sales to London, at a selling price of $600,000 during the year. Not all of
the goods had been sold externally by the year end. The profit element included in
London’s closing inventory was $30,000.
• Fair value depreciation for the current year amounted to $10,000.  All depreciation
should be charged to cost of sales.
• London paid an interim dividend during the year of $200,000.
• Paris values the non-controlling interests using the fair value method.
Prepare a consolidated income statement for the year ended 31 December 20X5 for
the Paris group.

43 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 4 Mid-year acquisitions

Mid-year acquisition procedure

If a subsidiary is acquired part way through the year, then the subsidiary’s
results should only be consolidated from the date of acquisition, i.e. the date
on which control is obtained.

In practice this will require:

• Identification of the net assets of S at the date of acquisition in order to

calculate goodwill.
• Time apportionment of the results of S in the year of acquisition. For this
purpose, unless indicated otherwise, assume that revenue and expenses
accrue evenly.
• After time-apportioning S’s results, deduction of post acquisition intra-group
items as normal.

Example 3 - Mid-year acquisition

44 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Ethos
$000
Revenue 303,600
Cost of sales (143,800)
_______
Gross profit 159,800
Operating expenses (71,200)
_______
Profit from operations 88,600
Investment income 2,800
_______
Profit before tax 91,400
Taxation (46,200)
_______
Profit for the year 45,200

Revenue
(303,600 + (217,700 × 4/12))
Cost of sales
(143,800 + (102,200 × 4/12))

Gross profit
Operating expenses
(71,200 + (51,300 × 4/12))

Profit from operations

Investment income
(2,800 + (1,200 × 4/12))

Profit before tax

Income tax
(46,200 + (32,600 × 4/12))

Profit for the year

Amount attributable to:
Equity holders of the parent
Non-controlling interest (25% × ($32,800 × 4/12)

Test your understanding 3

45 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 P bought 70% of S on 1 July 20X6. The following are the Income Statements of P and S
for the year ended 31 March 20X7:

  P    
  $    
Revenue 31,200
Cost of sales (17,800)
––––––
Gross profit 13,400
Operating expenses (8,500)
––––––
Profit from operations 4,900
Investment Income 2,000
  ––––––
Profit before tax 6,900
Tax (2,100)
  ––––––
Profit for the year 4,800
––––––
The following information is available:

(1) On 1 July 20X6, an item of plant in the books of S had a fair value of $5,000 in excess
of its carrying value.  At this time, the plant had a remaining life of 10 years.
Depreciation is charged to cost of sales.
(2) During the post-acquisition period S sold goods to P for $4,400.  Of this amount, $500
was included in the inventory of P at the year-end.  S earns a 35% margin on its sales.
(3) Goodwill amounting to $800 arose on the acquisition of S, which had been measured
using the fair value method.  Goodwill is to be impaired by 10% at the year-end.
Impairment losses should be charged to operating expenses.
(4) S paid a dividend of $500 on 1 January 20X7.
Required:

Prepare the consolidated income statement for the year ended 31 March 20X7.

Test your understanding 3

46 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Hide Answer

Consolidated Income Statement for the year ended 31 March 20X7

Revenue (31,200 + (9/12 × 10,400) – 4,400 (W4))

Cost of Sales (17,800 + (9/12 × 5,600) + 375 (W3) – 4,400 (W4)
+ 175 (W4))
 

Gross profit
Operating expenses (8,500 + (9/12 × 3,200) + 80 (W5))
 

Profit from operations

Investment Income (2,000 – 350 (W6))
 

Profit before tax

Tax (2,100 + (9/12 × 500)
 

Profit for the year

 

Attributable to:
NCI (W2)
Group
 
 
 

(W1) Group structure

(W2) Non-controlling Interests

NCI share of sub's profit for the year

(30% × (9/12 ×  $1,100)
Less:
NCI share of fair value depreciation
(30% × $375 (W3))
47 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T
 Associates

1 IAS 28 Investments in associates

Definition of an associate

IAS 28 defines an associate as:

An entity over which the investor has significant influence and that is neither a
subsidiary nor an interest in joint venture.

48 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Significant influence is the power to participate in the financial and operating
policy decisions of the investee but is not control or joint control over those
policies.

Significant influence is assumed with a shareholding of 20% to 50%.

Principles of equity accounting and reasoning behind it

Equity accounting is a method of accounting whereby the investment is initially

recorded at cost and adjusted thereafter for the post-acquisition change in the
investor’s share of net assets of the associate.

The effect of this is that the consolidated statement of financial position

includes:

• 100% of the assets and liabilities of the parent and subsidiary company on
a line by line basis
• an ‘investments in associates’ line within non-current assets which includes
the group share of the assets and liabilities of any associate.
The consolidated income statement includes:

• 100% of the income and expenses of the parent and subsidiary company
on a line by line basis
• one line ‘share of profit of associates’ which includes the group share of
any associate’s profit after tax.
Note: in order to equity account, the parent company must already be
producing consolidated financial statements (i.e. it must already have at least
one subsidiary).

Expandable text - IAS 28 Investments in Associates

• the investment is classified as held for sale in accordance with IFRS 5 or

• the parent is exempted from having to prepare consolidated accounts on the grounds
that it is itself a wholly, or partially, owned subsidiary of another company (IAS 27).

2 Associates in the consolidated statement of financial position

49 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Preparing the CSFP including an associate

The CSFP is prepared on a normal line-by-line basis following the acquisition

method for the parent and subsidiary.

The associate is included as a non-current asset investment calculated as:

$000
Cost of investment X
Share of post acquisition profits X
Less: impairment losses (X)
Less: PURP (P = seller) (X)
___
X
___
The group share of the associate’s post acquisition profits or losses and the
impairment of goodwill will also be included in the group retained earnings
calculation.

50 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Standard workings

The calculations for an associate (A) can be incorporated into standard CSFP
workings as follows.

(W1) Group structure

(W2) Net assets of subsidiary

At date of acquisition At reporting date
$ $
Share capital X X
Retained earnings X X
___ ___
X X
___ ___

(W3) Goodwill – subsidiary

X
Parent holding (investment) at fair value
NCI value at acquisition X
  — 
  X
Less:  

Fair value of net assets at acquisition (W2) (X)

   —
Goodwill at acquisition X
Impairment (X)
   —
Carrying goodwill X
   —
 

(W4) Non controlling interest (NCI)

   

NCI value at acquisition (as in W3) X

51 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 NCI share of subsidiary post-acquisiton reserves (W2) X
NCI share of impairment (W3) (fair value method only) (X)
  —
  X
  —

(W5) Group retained earnings

Parent retained earnings (100%)

Group % of sub's post-acquisition retained earnings
Group % of assoc post-acquisition retained earnings
Less: Impairment losses to date (S + A) (W3)
 
 

(W6) Investment in associate company

  $
Cost of investment X
Post-acquisition profits (W5) X
Less: impairment X
Less PURP (P = seller) X
  —
  X
  —

Example 1 - Associates in CSFP

52 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Dipsy Laa Laa
$000 $000
Non-current assets:
Property, plant & equipment 1,120 980
Investments
672,000 shares in LaaLaa 644 -
168,000 shares in Po 224 -
––––––– –––––––
1,988 980
       
Current assets:
Inventory 380 640
Receivables 190 310
Bank 35 58
––––––– –––––––
605 1,008
––––––– –––––––
2,593 1,988
––––––– –––––––
       
Equity
$1 ordinary shares 1,120 840
Retained earnings 1,232 602
––––––– –––––––
2,352 1,442
Current liabilities:
Trade payables 150 480
Taxation 91 66
––––––– –––––––
241 546
––––––– –––––––
2,593 1,988
––––––– –––––––
(1) Dipsy acquired its shares in Laa Laa on 1 January 20X9 when LaaLaa had retained
losses of $56,000.
(2) Dipsy acquired its shares in Po on 1 January 20X9 when Po had retained earnings of
$140,000.
(3) An impairment test at the year end shows that goodwill for Laa Laa remains
unimpaired but the investment in Po has impaired by $2,800.
(4) The Dipsy Group values the non-controlling interest using the fair value method. The
fair value on 1 January 20X9 was $160,000.
53 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T
 Fair values and the associate

If the fair value of the associate’s net assets at acquisition are materially
different from their book value the net assets should be adjusted in the same
way as for a subsidiary.

Balances with the associate

Generally the associate is considered to be outside the group. Therefore

balances between group companies and the associate will remain in the
consolidated statement of financial position.

If a group company trades with the associate, the resulting payables and
receivables will remain in the consolidated statement of financial position.

Unrealised profit in inventory

Unrealised profits on trading between group and associate must be eliminated

to the extent of the investor's interest (i.e. % owned by parent).

Adjustment must be made for unrealised profit in inventory as follows.

(1) Determine the value of closing inventory which is the result of a sale to or
from the associate.
(2) Use mark-up/margin to calculate the profit earned by the selling company.
(3) Make the required adjustments. These will depend upon who the seller is:
Parent company selling to associate — the profit element is included in the
parent company’s accounts and associate holds the inventory.

Dr Group retained earnings (W5)

Cr Investment in associate (W6)

Associate selling to parent company— the profit element is included in the

associate company’s accounts and the parent holds the inventory.

Dr Group retained earnings (W5)

Cr Group inventory

Test your understanding 1

54 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 Below are the statements of financial position of three entities as at 30 September 20X8

  P S
  $000 $000
Non-current assets  

Property, plant and equipment 14,000 7,500

Investments 10,000
  ––––– –––––
  24,000 7,500
   
Current assets 6,000 3,000
  ––––– –––––
  30,000 10,500
  ––––– –––––
Equity  

Share capital ($1 ordinary shares) 10,000 1,000

Retained earnings 7,500 5,500
  ––––– –––––
  17,500 6,500
   
Non-current liabilities 8,000 1,250
   
Current liabilities 4,500 2,750
  ––––– –––––
  30,000 10,500
  ––––– –––––
Further information:

• P acquired 75% of the equity share capital of S several years ago, paying $5 million in
cash.  At this time the balance on S's retained earnings was $3 million.
• P acquired 30% of the equity share capital of A on 1 October 20X6, paying $750,000 in
cash.  At 1 October 20X6 the balance on A's retained earnings was $1.5 million.
• During the year, P sold goods to A for $1 million at a mark up of 25%.  At the year-end,
A still held one quarter of these goods in inventory.
• As a result of this trading, P was owed $250,000 by A at the reporting date.  
agrees with the amount included in A's trade payables.
• At 30 September 20X8, it was determined that the investment in the associate was
impaired by $35,000.
• Non-controlling interests are valued using the fair value method.  The fair value of the
non-controlling interest at the date of acquisition was $1.6 million.
Required:

Prepare the consolidated statement of financial position of the P group as at 30 September

20X8.

55 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

 3 Associates in the consolidated income statement

Equity accounting

The equity method of accounting requires that the consolidated income

statement:

• does not include dividends from the associate

• instead includes group share of the associate’s profit after tax less any
impairment of the associate in the year (included below group profit from
operations).

Trading with the associate

Generally the associate is considered to be outside the group.

Therefore any sales or purchases between group companies and the

associate are not normally eliminated and will remain part of the consolidated
figures in the income statement.

It is normal practice to instead adjust for the unrealised profit in inventory.

Dividends from associates

Dividends from associates are excluded from the consolidated income

statement; the group share of the associate’s profit is included instead.

Example 2 - Associates in CIS

56 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

   P S
  $000 $000
Revenue 8,000 4,500
Operating expenses (4,750) (2,700)
  ––––– –––––

Profit from operations 3,250 1,800

Finance costs (750) (100)
  ––––– –––––

Profit before tax 2,500 1,700

Tax (700) (500)
  ––––– –––––
Profit for the year 1,800 1,200
  ––––– –––––

• P acquired 80% of S several years ago.    

• P acquired 30% of the equity share capital of A on 1 October 20X6.    
• During the year, P sold goods to A for $1 million at a mark-up of 25%.  At the year-
end, A still held one quarter of these goods in inventory.    
• At 30 September 20X8, it was determined that the investment in the associate was
impaired by $35,000, of which $20,000 related to the current year.
 

Revenue
(8,000 + 4,500)
Operating expenses
(4,750 + 2,700 + 15 (W2))
 
Profit from operations
Share of associate:
((30% × 600) - 20 impairment)
Finance costs
(750 + 100)
 

Profit before tax

Taxation
(700 + 500)
 
Profit for the year
 

Profit on sale:
(25 / 125 × $1,000 )
Profit in inventory
(1/4 × $200)
PURP
(30% × $50)

57 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T

58 Prepared by Baravuga Zefania {B.com-Udsm} CPA-T