CHAPTER 21

BASIS CONSOLIDATED ACCOUNTS

1 WHAT ARE CONSOLIDATED ACCOUNT?

IAS 27 Consolidated Financial Statements and Accounting for Investments is Subsidiaries requires a parent company to prepare consolidated accounts incorporating the results of the whole group.

Consolidated accounts :the name given to the accounting techniques which seek to reflect the true position, as regards both profits and assets, when one company controls another. They consist of:

---A consolidated balance sheet, in which all assets and liabilities of group undertakings are aggregated, and

---A consolidated income statement aggregating the profits and losses of all group undertakings.

For Paper 1.1 we are concerned only with the consolidated balance sheet.

Parent company A company which is controlled by a parent company.

Group of companies. Apparent company plus its subsidiaries.

Group of companies. A company plus its subsidiaries. Minority interest. If the subsidiary is not wholly owne

d by the parent, the ‘outside’ interest is referred to as the ‘minority interest’

2 THE BASIC BALANCE SHEET CONSOLIDATION PROCEDURE

Preparing a consolidated balance sheet really means' adding together’ the two balance sheets. The investment in the subsidiary is replaced by the underlying net assets of the subsidiary.

ExampleExample P was incorporated on 1January 20X1.On

1January 20X3 it acquired 100% of the ordinary shares in S which was incorporated on the day. Five years later, on 31 December 20X7,the balance sheets of the two companies were as follows:

P S $ $ Non-current assets 10000 5000 Investment in S:5000$1 shares 5000 Net current assets 5000 3000 20000 8000 Share capital :ordinary shares of

$1 each 10000 5000

Accumulated profits 10000 3000

20000 8000

Prepare a consolidated balance sheet at 31 December 20X7 for P

and its subsidiary

Solution In adding together the two balance sheets the $5000 investment is

S appearing in the P balance sheet is cancelled by the $5000 share capital in the balance sheet of S

P and its subsidiaryConsolidated balance sheet as at 31December 20X7

$ Non- current assets 15000 Net current assets 8000 23000 Share capital 10000 Accumulated profits 13000 23000

The $3000 increase in value of the assets since acquisition is represented by the $3000 post-acquisition reserves of S, which are combined with those of P in the consolidated balance sheet.

The share capital of the subsidiary company never appears as part of the figure of the share capital in the consolidated balance sheet.

Goodwill on consolidation

---Goodwill :the difference between the cost of an entity and the fair values of that entity’s net assets.

---If the parent pays more for the investment in the subsidiary than the value of the subsidiary’s net assets, the difference represents the amount paid for the unrecorded goodwill in the subsidiary.

---Our approach is to calculate the net value of the subsidiary's assets on the date it was acquired, which of course is equal to its share capital and accumulated reserves as on that date. We compare this with the amount paid by the parent company, and the difference represents goodwill.

Say P had $6000 for the shares.

Balance sheets at 31 December 20X7 P S $ $ Tangible non-current assets 10000 5000 Investment in S:5000 $1 shares 6000 Net current assets 4000 3000 20000 8000 Share capital :ordinary shares of $1 each 10000 5000 Accumulated profits 10000 3000 20000 8000

Goodwill workingGoodwill working $ $ Cost of investment is S 6000

Share of net assets acquired Share capital 5000 Accumulated profits (at acquisition) nil 5000 P’s interest 100% 5000 Goodwill on acquisition $1000

Amortization of goodwill

---Goodwill must be amortized (depreciated) over its estimated economic life, through the income statement.

---If we assume a life of ten years for this goodwill, and it was acquired five years ago(1 January 20X3) the consolidated balance sheet at 31December 20X7 will be as follows:

P and its subsidiaryP and its subsidiaryConsolidated balance sheet as at 31 December 20X7Consolidated balance sheet as at 31 December 20X7

$ $ Non-current assets: Goodwill 1000 Less: amortisation (5year) 500 500 Tangible non- assets 15000 15500 Net current assets 7000 22500 Share capital-ordinary shares of $1 each 10000

Accumulated profits(10000+3000-500) 12500 22500

---The amortization through the income statement at $100 per year has reduced the accumulated profit balance)

Minority interests

---As long as the parent owns more than 50%mthe company is a subsidiary

---If the parent company owns ,say 80%of the ordinary share capital, the holders of the remaining 20% are referred to as the ‘minority', or ‘minority interest’.

---Total assets and liabilities are shown exactly as before ,but a new item representing the /minority interest’ must be introduced into the bottom half of the consolidated balance sheet.

---The minority interest can be calculated by taking the appropriate percentage of the net assets at the balance sheet date, but net assets will again equal share capital plus reserves and it is convenient to calculate the minority interest by dividend up the share capital reserves.

Say P had paid $4800 for 80% of the share capital of S

Balance sheets at 31 December 20X7

P S

$ $

Non-current assets 10000 5000

Investment in S:4000$ shares 4800

Net current assets 5200 3000

20000 8000

Share capital:ordinary shares of $1 each 10000 5000

Accumulated profits 10000 3000

20000 8000

Before calculating the minority interest, let us calculate the goodwill in this example.

Goodwill working

Cost of investment is S $ $

Share of net assets acquired: 4800

Share capital 5000

Accumulated profits (as before) nil

5000

P’s interest 80% 4000

Goodwill on acquisition 800

The minority interest is calculated as at the current balance sheet date and not as at acquisition

Minority interest working

$ $

Net assets of at the balance sheet date

Share capital 5000

Accumulated profits 3000

8000

Minority interest 20% 1600

P and its subsidiaryconsolidated balance sheet as at 31 December 20X7

Non-current assets $ $

Goodwill at cost 800

Amortisation 400 400

Tangible non-current assets 15000

15400

Net current assets 8200

23600

Share capital-ordinary shares of $1 each 10000

Accumulated profits 12000

10000+(80%*3000)-400 22000

Minority interest 1600

Pre-acquisition profit

---In the examples so far, the subsidiary was acquired at its formation. It had no chance to trade and earn profits before the acquisition

---If a subsidiary is acquired after its formation and has accumulated some retained profit, only the post-acquisition profit may be combined with the parent’s accumulated profits. The pre-acquisition portion represents assets at the date of acquisition, and so must form part of the calculation of goodwill.

Example

Q acquired 80% of the share capital of T on 1January 20X1 for $10000,when the accumulated profits of T amounted to $4000.At 31 December 20X3,the companies’ balance sheets were as follows:

Balance sheets at 31 December 20X3

Q T

$ $

Non-current assets 8000 11000

Investment in T at cost 10000

Net current assets 4000 3000

22000 14000

Ordinary share capital (shares of $1 each) 10000 5000

Accumulated profits 12000 9000

22000 14000

Goodwill is to be amortized on the straight line basis over five years.

STEP 1 GOODWILL WORKING

$ $

Cost of investment in T 10000

Share if net assets acquired:

Share capital 5000

Accumulated profits 4000

9000

Q’s interest 80% 7200

Goodwill on acquisition 2800

Amortisation3*20%=60%*$2800 1680

Balance at 31December 20X3 1120

STEP 2 MINORITY INTEREST WORKING

$ $

Net assets of T at the balance sheet date

Share capital 5000

Accumulated profits 9000

14000

Minority interest20% 2800

STEP 3 POST-ACQUISITION PROFIT WORKING

$

Q: all 12000

T: 80%*(9000-4000) 4000

16000

Amortization of goodwill per working 1 (1680)

14320

Q and its subsidiaryconsolidated balance sheet as a 31 December 20X3

$

Non- current assets(8000+11000) 19000

Goodwill (Working 1) 1120

Net current assets 7000

27120

Share capital 10000

Accumulated profits (Working 3) 14320

24320

Minority interest (Working 2) 2800

27120

Companies are required to prepare consolidated financial statements if they own more than 50% of another company or control it in some other way.

Subsidiaries may be excluded from consolidation in some circumstance:

---Severe long –term restrictions on control

---Investment held for resale

A group may be exempted from the requirement to prepare consolidated financial statements if:

---Parent is w wholly-owned subsidiary of another

company

---Parent is a virtually wholly-owned subsidiary of

another company and minority have agreed that

consolidated financial statements are not required by

them.