consolidated accounts

Consolidated Accounts

How can a company be a holding one?

• Controls the composition of the board of director

• Controls more than half of the voting power

• holds more than half of the issued share capital (ordinary shares)

Why do companies want to be a holding one? Any benefits?

• Increase in revenue (improvement in marketing, reduction of competition, gain in monopoly power, etc)

• Cost reduction (purchase in bulk and discount obtained)

Why are consolidated accounts needed?

• Present group’s financial position and operating results

• Required by the Companies ordinance

• eliminate inter-group transactions (over / under estimate net profit)

Parent + holding = a group=one single economic entity

Under what occasions, will a subsidiary be excluded from the consolidation?

• Control of parent over subsidiary is temporary (subsequent disposal in the near future)

• subsidiary operate under severe long-term restriction (unable to transfer funds to the parent)

Cost of control AccountCost of Control

$ $Investment in Subsidiary X Ordinary shares X

(S x %)Pre GR X(S x %)Pre NP X(S x %)GW (Bal Fig) X

%=% of Ordinary shares held by parent

S=Subsidiary

Consolidated Profit or Loss

Consolidated profit and loss$ $

cost of control (pre profit) X NP of parent (100%) X(S's pre*%) NP of subsidiary (100%) XMinority Interest X Deprecation over-provided X(A+B+C)*%Goodwill amortised X(Bal Fig x 1/amortisation period)URP on stock XURP on fixes assets XBalance to consolidated balance sheetX

Minority Interest

Minority Interest$ $

Balance to consolidated B/S Ordinary share in S X(S*%)GR (S*%) XP&L (S*%) X

%=% of ordinary shares held by MI

Negative GoodwillCost of Control

$ $Investment in Subsidiary X Ordinary shares XGW (Bal Fig) X (S x %)

Pre GR X(S x %)Pre NP X(S x %)

Dr. Negative Goodwill

Cr.P&L

Show in brackets in B/S

RevaluationCost of Control

$ $Investment in Subsidiary X Ordinary shares X

(S x %)Pre GR X(S x %)Pre NP X(S x %)Pre RR X(X*%)

RR GW MI PFD

Past paper 2004-I-1bIn January 2003, Lemon Ltd loaned $10000000 for ten months to

John, a shareholder of Tea Ltd. John pledged his investment, which represents 60% of the ordinary capital of Tea Ltd, as security for the loan. When the loan is matured, he was unable to repay the debt and transferred the title of the shares to Lemon Ltd. Lemon Ltd tried to find a buyer for these shares but failed. At its year end on 31 Dec 2003, Lemon Ltd was still holding the shares. The shares were ultimately sold in Feb 2004.

With respect to Lemon Ltd’s shareholding in Tea Ltd, explain whether Lemon Ltd is required to prepare consolidated financial statement as at 31 Dec 2003.

Answer

• Lemon Ltd does not acquire the investment for long term purpose. Control in intended to be temporary because the 60% of ordinary share capital is acquired and held with a view to its subsequent disposal in the near future. Despite its majority shareholding in Tea Ltd, Lemon Ltd is not required to prepare the consolidated financial statement.

2005Past Paper-I-1

• (iii) For the purpose of acquisition, a fixed asset of Leaf Ltd (subsidiary) was revalued from $2000000 to $2500000. The revaluation was not recorded in the books of Leaf Ltd. Leaf Ltd had been providing depreciation at a rate of 10% per annum on the net book value of fixed assets.

Adjustment

Cost of ControlPre: RR (500000*%)

Dep over provided:(2500000-2000000)*10%=50000

Dr.Provision of Depreciation

Cr.P&L

Debentures and Preference Shares of Subsidiaries

A company will be deemed to be a subsidiary of another company if latter holds more than half of the issued ordinary share capital of the subsidiary.

The % of controlling interest is determined by the amount of ordinary shares held instead of preference shares.

MI only consists of reserves, ordinary shares and preference shares held by the outside shareholders.In determining whether acompany is a subsidiary, the holding of its debentures is irrelevant.

Points to be noted:

*debentures should be disclosed as liabilities in the consolidated balance sheet.

• If the purchase price of debentures > the nominal value, the premium should : Dr consolidated reservesCr cost of control

• If the purchase price of debentures < the nominal value, the discount should : Dr cost of control Cr consolidated reserves

ExampleH Ltd. had acquired 70% ordinary shares and debentures of S Ltd on 31/12/2003.

H S

Investment is S Ltd

700 ordinary shares 990

800 debentures 780

Share capital

Ordinary shares of $1 each 1000

10% debentures 1000

$ $Cost of share ordinary 990 70% of share capial 700Cost of debentures 780

80% of debentures 800Capital reserve on 20Acq. of debentures

cost of control

consolidated balance sheet of H and S as at December 2003( extract)

Long term liab.

10% Debentures 200 *debentures (ONLY S)

capital reserve 20

Proposed dividendIf the dividend is paid by the subsidiary :

•The dividend must be accounted for as payables in the subsidiary’s accounts

•The dividend must be accounted for as receivables in the parent’s accounts

•The intra – group dividend will be set off in the consolidated

account so that only the dividend payable to outsiders will remain

Unrealised Profit(URP)

• In the preparation of consolidated balancesheet, we should eliminate the intra-group unrealized profit at the end of the financial year.

Consolidated Balance Sheet as at 31 December 2003Fixed assets [H + S(**the change of depreciation , unrealised profit ]

goodwill ( cost - accumulated amortization) / negative goodwill

current assets

inventories (H + S - goods in transit - unrealized profit)

trade receivables ( H + S - intra-group balances)

Bank ( H + S + cash in transit)

less : Current Liab.

trade payables ( H + S - intra-group balances)

less : long-term Liab.

Debentures (H + 30% S)(assume the holding company holds 70% of the debentures of the subsidiary)

Financed by:

Share Capital

ordinary ( H ONLY )

preference (H ONLY)

Reserves

P & L { H + (post acquisition reserve of S - inderprovision of

depreciation on revalued assets) X 80% - any change in income )

other reserves ( H + prost acquisition reserve of S - inderprovision of

depreciation on revalued assets) X 80%***assume the holding company holds only 80% of the ordinary share capital

Minority Interest (20 % of ord. Share , 20 % reserves , 40 % of the

preference shares)***assume the holding company holds 60% of the preference share capital

How to share the URP?• There are 2 methods to share the URP

• The first method:Minority interests are to share any unrealised profit or losses (together with any related depreciation adjustment) arising from sales of assets by the subsidiary to the parent according to their proportion of shareholding

•Parent shares 80% of the URP MI share 20% of the URP

• The second method:The group also adopts the policy that the unrealised arising from intra-group transaction have to be eliminated in full and shared between the parent and the minority interests according to their respective shareholdings.

The parent bear all of the URP

Dividend and Bonus issue

Dividend

• From pre-acquistion profitsDr Consolidated P & LCr Investment in subsidiary

• From post-acquistion profitsNo adjustment is needed

Bonus issue

• From pre-acquistion profitsThere is no change in the consolidated balance sheet

• From post acquisition profitsDr post-acquisition profits Cr Capital reserve

Sample paper

• On 1/1/2000, Sally Ltd transferred an item of plant to Henry Ltd for $120000.The item was acquired on 1/1/1998 at a cost if $150000. It had an estimated useful life of 5 years with no residual value. After the item was taken over by Henry Ltd, it was estimated that it still had a useful life of 3 years with no residual value.

Adjustment

• We need to prepare the consolidated B/S as at 31 December 2001

• So, there have some adjustment in “retained Profit”

• The value of the plant on 1/1/2000 = $90000• But Sally Ltd transferred the plant to Henry Ltd

for $120000• So, the URP is $30000• But this event happened in the previous year, so

we need to correct the RETAINED PROFIT.

•Dr Retained Profit 30000•Cr Plant 30000

The entry should be made

Adjustment

• Also, depreciation is overstated by 10000

• (150000/5 – 120000 / 3 = 10000)

•For 2000 : Dr provision for dep. 10000

• Cr retained profit 10000

•For 2001 : Dr provision for dep. 10000

• Cr profit & loss 10000

2004 Examination report

• Points to be noted :

“Minority Interests“ should be separately disclosed after “shareholders fund”, and not together with other liabilities or reserves.

2004 Examination report ( contin )

• Since the company’s policy was that minority interests would not share any unrealised profits and losses arising from downstream sales of assets, the amounts unrealised profit on fixed asset and the excess depreciation written back were to be adjusted in consolidated P&L account balance.

• The amount of unrealised profit on inventories arose form sales and hence was to be shared between the group and the MI in the ratio 8:2

• ase 2: The subsidiary issues both ordinary and preference share capital

(*** In this case, the MI includes the minority preference shareholders’ interest in the preference dividends and the minority ordinary shareholders’ interest in the remaining profits.)

2005 past paper• The date of acquistion : 1/1/2003

• We need to prepare the balance sheet as at 31/12/2004

• Goodwill arising on consolidation is to be written off as an administrative expense over 5 years on a straight line basis.

**We need to calculate two years’ amortisation on goodwill and write off the current year amortisation as an administrative expense.

Consolidated Income Statement

$50028022020042040602030010290122782116241

H = Holding company S = SubsidiaryI = Inter-company transactions* It is assumed that the holding company owns 70% of the ordinary shares of the subsidiary.

Proposed Dividend (H only)Transfer to Reserves ( H + 70% * Post-acqusition reserves)Profits Retained for the Period

Taxation (H + S)Profit after TaxMinority InterestProfit attributable to the Group

Consolidated Income Statement

Finance Costs (H + S - I)Profit before Tax

Turnover (H + S- Inter-company sales)Cost of Sales (H + S - Inter-company sales + URP in inventories)Gross Profit (H + S - URP in inventories)Investment Income ( H + S - Inter-company dividends)

Administrative Expenses (H + S - I)Selling and Distribution Expenese( H + S - I)

(A)

(B)

(C)

(D)(E)

Inter-company Sales• Since inter-company sales do not constitute

any sakes nor cost of sales from the viewpoint of the whole group, they should therefore be eliminated as follows:

Dr Consolidated Sales ↓

With the selling price of inter-company sales

Cr Consolidated Cost of Sales ↓

***Inter-company sales are eliminated by reducing both the consolidated sales and the consolidated cost of sales.

Part (A)

• When the H Ltd. sells goods costing $100 to S Ltd. for $120, the unsold inventories of subsidiary would be recorded at $120 in S Ltd.’s balance sheet. However, the unsold inventories should be valued at cost of $100 and the unrealized profit should be provided as follows:

Dr Consolidated Cost of Sales $20

Cr Consolidated Inventories $20

URP on unsold stock is eliminated by increasing the consolidated Cost of Sales and reducing the consolidated Inventories.

Please remember that, if all the goods from inter-company sales have been sold, no adjustment is needed for the unrealized profit.

As a result, the Consolidated Income Statement should be shown as follows:

$500280220

Cost of Sales(H+S-Inter-company sales+URP in inventories)

Turnover(H+S-Inter-company sales)

Gross Profit (H + S - URP in inventories)

Inter-company DividendsInter-company dividends should be treated as follows:• The inter-company dividends should be eliminated in

the consolidated accounts.

Part (B)

$500280220200420

Turnover (H + S- Inter-company sales)Cost of Sales (H + S - Inter-company sales + URP in inventories)Gross Profit (H + S - URP in inventories)

Investment Income ( H + S - Inter-company dividends)

However, we should first ensure that the dividends receivable from subsidiaries have been Cr to the P/L account of H Ltd. before we

do the elimination.

Minority Interest

• If the holding company does not own 100% of the shares of the subsidiary, some of the subsidiary’s profit after tax belongs to the minority shareholders.

Part (C)

The amount will be calculated as follows:

Case 1: The subsidiary issues only ordinary share capital

Minority Interest

= Profit after tax of subsidiary * (1 – Percentage of ordinary shares held)

• Case 2: The subsidiary issues both ordinary and preference share capital

(*** In this case, the MI includes the minority preference shareholders’ interest in the preference dividends and the minority ordinary shareholders’ interest in the remaining profits.)

Minority Interest

= (1 – Percentage of preference shares held) * Preference dividends + (Profit after tax of subsidiary – Preference dividends) * ( 1 – Percentage of ordinary shares held)

Example for Case 2• H Ltd. owns 70% of the issued ordinary share capital and 80%

of the issued preference share capital of its subsidiary.

(1-* % of pref. Shares held)* Pref. Divd.+(PAT of S – Pref. Divd)*(1-% of Ord. Shares held)

H Ltd. S Ltd.

$ $

8,000 2,0001,280 220

PAT 6,720 1,780400

1,500 1,0005,220 380

$

10,0001,5008,500

494Profit Attributable to the Group 8,006

1,5006,506

Proposed Pref. Divd.Proposed Ord. Divd.Retained Profits for the Year

Extracted Consolidated Income Statement

Proposed Dividend (holding company only)Retained Profits for the Year

Minority Interest

Profit before TaxTaxationProfit after Tax

(1-0.8)*400+(1780- 400)*(1-0.7)

Proposed Dividend

• Inter-company dividends do not represent investment income of the group from outsiders, therefore they should be eliminated in the consolidated income statement.

• Since MI has already been excluded in arriving at the profit attributable to the group, there is no need to disclose how many dividends should be distributed from the MI.

Part (D)

Only the dividends paid and proposed by the holding company should be shown.

Transfer of Reserves

• Only the transfer of reserves of the holding company and the share of post-acquisition transfers of the group should be shown in the consolidated P&L.

Part (E)

•Pre-acquisition transfers are capital in nature, therefore they must be excluded.If the subsidiary is acquired

part way through an accounting period, the transfer of reserves should be apportioned on a time basis.

Example of Transfer of Reserves

• H Ltd. Bought 80% of the issued ordinary shares of S Ltd. On 1 April 2003. On 31 Dec. 2003, the directors of H Ltd. And S Ltd. Resolved to transfer $4000 and $1000 to the general reserve respectively.

•Transfer to General Reserve ($4000 + $1000 * 80% *9/12)

= $ 4,600

Past-paper - 2004-I-1(B)

• Points to be noted:

• (B) You are required to prepare for the group of Michael Ltd :

(b) a statement showing the calculation of consolidated profit and loss account balance as at 31 Dec 2003.

Past Paper –2005-I-1(A)• As at 31 Dec. 2004, Big Ltd owns 400 000 8% preference shares

and 220 000 ordinary shares in Small Ltd as an investment. Small Ltd has an issued share capital of 600 000 8% preference shares of $0.5 each fully paid and 500 000 ordinary shares of $1 each fully paid.

•Required:•With respect to Big Ltd’s shareholding in Small Ltd, explain whether Big Ltd is required to prepare consolidated financial statement as at 31 Dec 2004.

•Points to be noted:•Some candidates did not differentiate the holding of preference shares from that of ordinary shares and wrongly counted the majority holding of preference shares as an indication of control. Others mistakenly calculated the percentage of shareholding by grouping the two types of shares.

Past Paper – 2005-I-1(B)

• Points to be noted:• Some candidates were not familiar with the adjustments

relating to intra-group transactions.• Some of them did not adjust the cost of goods sold with the

cost of unsold stock.• Performance for the consolidated income statement was

proved weak.• Intra-group debenture interest was generally not excluded

and this resulted in an overstatement of financial expenses. • The amount of retained profit brought forward should have

been reduced by the amounts of goodwill amortization and depreciation adjustment for 2003.

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Consolidated Accounts

*END*

URP : stock• During the year 2004, goods at invoiced

value of $30000 were sold by H To S.1/3 of these goods remained unsold at the year end. H sell good at a mark-up of 25%

•ANSWER:•The cost : 30000/1.25 = 24000•The extra amount : 30000 – 24000 = 6000•The URP : 6000 x 1/3 = 2000•URP = 2000

URP : Debtor

• At the balance sheet date S owes H $20000

$ H $ Scurrent assets trade receivables ( H + S - intra-group balances) 120

less : Current Liab.trade payables ( H + S - intra-group balances) 90

Consolidated Balance Sheet as at 31 December 2003

100

70

URP : depreciation• On 1/1/2003, S transferred a machine to H for $120000. Thi

s item was acquired on 1/1/2002 at a cost of $100000. It had an estimated useful life of 5 years with no residual value. After the item was taken over by H, it still had an estimated useful life of 4 years with no residual value.

• Original dep: 120k / 5yrs = 24k • The dep charged after revaluation : 100k / 4yrs = 25k• URP : 100k –(120k – 24k)= 4k• Dep : overcharged 25k – 24k=1k

H S adjustment consolidatedFixed assets 360 240 (-40+4) 564

balance sheet