Financial Accounting II

ACC 302
3 units
B.S . OLAWOYIN
Department of Management and Accounting
Faculty of Administration
MODULE 2

Consolidation of Balance Sheets for Direct

Subsidiaries
Learning objectives
At the end of this module, you should be able to:

• Explain the nature of goodwill on acquisition

and its treatment
• Describe the basic mechanics for putting
together the consolidated statements of
financial position, including entries for
goodwill and minority interest.
Goodwill on acquisition
• It makes quite a business sense to assume that a company (holding) will seek
to assume the control of another (subsidiary) if doing so, will, to a large extent
improve the financial position of the shareholders of the holding company.

• In other words, a holding company will only seek to control a profitable

subsidiary. Therefore, it will ordinarily be willing to pay a “premium” later
“Goodwill” in order to achieve this feat.

• Goodwill on acquisition therefore is the premium or excess value (money)

paid over the actual worth of the net assets so acquired: Net assets is the
excess of total tangible assets over external liabilities.

• If a holding company pays N18,000 to acquire 100% a subsidiary whose total

assets were N15,000, and only external liability of N2,000 i.e. net assets of
N13,000; then the amount paid for Goodwill is (N18,000 – N13,000) or
N5,000.
Goodwill on acquisition (contd)
• This goodwill of N5,000 will appear in the
consolidated balance sheet i.e. consolidated
statement of financial position.
• If the holding company had acquired only 75% of
the subsidiary and had paid the same amount, then
it is purchasing 75% of net assets (N13,000) for
N18,000. The goodwill on acquisition in that
circumstance is N18,000 + N9,750 which is N8,250.
• In rare cases of the amount paid being less than the
value of net assets acquired, it is treated as a capital
reserve.
Minority Interest
• Where the acquisition is not total i.e. not 100%; then there
exists a minority interest in the subsidiary company. Minority
interest must be properly computed and taken care of both in
the consolidated balance sheets and the consolidated income
statements.

• For the purposes of consolidated statements of financial position

(Balance sheet), minority interest is the percentage of minority
shareholding multiplied by ALL items of shareholders’ fund.

• Shareholders’ fund comprises of the share capital, capital and

revenue reserves, retained earnings (i.e. profit and loss account
balances).
Illustration 1

Big Ltd and Small Ltd have the following financial

positions on 31st Dec 2014.
• Big Ltd
N N
•
Capital 200,000 Fixed Assets 80,000

Reserves 25,000 Debtors 35,000

Profit & Loss 30,000 Stock 80,000

Creditors 45,000 Bank 105,000

300,000 300,000
Small LTD
N N
Share Capital 50,000 -
Profit & loss 18,000 Debtors 15,000
Stock 48,000
Creditors 22,000 Bank 27,000
90,000 90,000

Big Ltd then moves to acquire 100% the shares of small Ltd on 31/12/14 paying the
shareholders N80,000 immediately, after the arrangement is perfected, the balance
sheet of Big Ltd becomes
Big LtD
N N
Capital 200,000 Fixed Assets 80,000
Reserves 25,000 Investment in 80,000
small Ltd
Profit & loss 30,000 Debtors 35,000
Creditors 45,000 Stock 80,000
Bank 25,000
300,000 300,000

Note: The only new entry in the Balance sheet of Big Ltd is the entry for its investment
in small Ltd, which it had financed using its bank balance. You can see the bank
balance of Big Ltd dropping from N105,000 to N25,000.
Conclusion
• This is the only way by which Big Ltd could acquire small Ltd in the circumstance. It
couldn’t have issued its own shares in exchange. That will amount to ABSORPTION
which is a different thing entirely from creating a holding-subsidiary relationship.
Small Ltd: What happens?
• The Balance Sheet of small Ltd remains unchanged. The company’s books are
unaffected. The payment of N80,000 goes to individual shareholders of small Ltd in
their private capacities, who merely collected cash and relinquish their share
certificates to directors of Big Ltd.
• The directors of Big Ltd will now move to have the register of shareholders of small
Ltd amended to reflect the name of new owners (Big Ltd).
The Consolidation
• Even before any fresh trading takes place, the directors of Big Ltd will wish to
inform shareholders of Big Ltd that they have taken a major investment decision on
their behalf by making their company (Big Ltd) a holding company of another (Small
Ltd).
• Thus 2 separate Balance Sheets will be presented; (i) that of Big Ltd (alone) and
as shown before and (ii) that of Big Ltd consolidated with small Ltd.
Steps
(i) Compute goodwill (if any)
(ii) Add items of assets (Other than value of investments) on line by line basis.
(iii) Also add liability items (other than the holding company’s share of the
subsidiaries shareholder fund) on line by line basis.

Following the Steps:

i) Net assets of small Ltd
Total assets = N90,000
less: External liability (creditors) = N22,000
N68,000
Amount paid N80,000
:. Goodwill N12,000
Big Ltd & Small Ltd
Consolidated Statement of Financial Position as at 31/12/14

N N
Share capital 200,000 Goodwill 12,000
Reserves 25,000 Fixed assets 80,000
Profit & Loss 30,000 Debtors 50,000
Creditors 67,000 Stock 128,000
Bank 52,000
322,000 322,000

Notes: Step (ii): items added line by line

Step (iii): Liability items also added line by line.
Conclusion
• General: Asset item (investment in subsidiary)
has cancelled out the liability items
(shareholders fund of subsidiary) through a
process called the computation of cost of
control. This is the same process (in accounting
method) that gives the value of goodwill.
Illustration 2
Accounting for Minority Interest
• Let us assume Big Ltd acquired only 75% of the shares of
small Ltd and still paid N80,000 for them. Minority interest
in small Ltd is 25%.
• By so doing, it is paying N80,000 for 75% of net assets
(N68,000).
• The Goodwill now is N80,000 – N51,000 = N29,000.
• Minority interest is simply: Percentage multiplied by
shareholders fund
• 25% of capital = N12,500
• 25% of P & L = N 4,500
• Total = N17,000
Consolidated Balance Sheet

N N
Share capital 200,000 Goodwill 29,000
Reserves 25,000 Fixed assets 80,000
Profit & loss 30,000 Debtors 50,000
Minority in SLtd 17,000 Stock 128,000
Creditors 67,000 Bank 52,000
339,000 339,000
SUMMARY
i) Computation of goodwill is KEY in any consolidation
process. The value of goodwill arising remains the same
irrespective of the year after acquisition that it is computed. It
may get impaired over time but whatever remains of its value
must always be part of consolidated balance sheet.
ii) Minority interest is a liability to the Group. It is computed at
any point in time as the percentage of minority shareholding
multiplied by each and every item of shareholders fund in the
subsidiary own balance sheet.
Exercise
• To be submitted not later than 3 weeks into
the Semester.
• The Balance sheets of Jingo Ltd and Bingo
Ltd are as follows:
 N N
Ordinary 500,000 Fixed 125,000
share Assets
Capital of
N1 each

Capital 60,000 Investment 96,000

reserve in Bingo
Ltd (60%)
Profit/Loss 40,000 Stock 150,000

Creditors 36,000 Debtors 86,000

Accruals 14,000 Bank 193,000
650,000 650,000
Bingo Ltd

Prepare consolidated statement of financial position on the date of acquisition

which is 31/12/15
References and Further Readings
• Business Accounting vol. II (International
Students’ Edition) by Frank wood & Allan
Sangster.