Consolidated Statement of Financial Position Adjustments
Consolidated Statement of Financial Position Adjustments
Consolidated Statement of Financial Position Adjustments
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').
Definitions
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
1
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.
Subsidiary exclusion
(2) The cost of the investment in S is effectively cancelled with the ordinary
share capital and reserves of the subsidiary.
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Illustration 1: Simple CSFP
Solution
Approach
(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.
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purchased on the reporting date, therefore there are no post-acquisition
earnings to include in the group amount.
A standard group accounting question will provide the accounts of P and the
accounts of S and will require the preparation of consolidated accounts.
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(W1) Establish the group structure
(W3) Goodwill
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(W4) Non-controlling interest
Goodwill
Goodwill on acquisition
In example 1 the cost of the shares in S was $50,000. Equally the net assets of
S were $50,000. This is not always the case.
The value of a company will normally exceed the value of its net assets. The
difference is goodwill. This goodwill represents assets not shown in the
statement of financial position of the acquired company such as the reputation
of the business.
Where less than 100% of the subsidiary is acquired, the value of the subsidiary
comprises two elements:
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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). Not
examinable
Illustration 2: Goodwill
Solution
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IFRS 3 Business Combinations
IFRS 3 revised governs accounting for all business combinations other than
joint ventures and a number of other unusual arrangements.
Treatment of goodwill
Positive goodwill
Negative goodwill
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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.
They are capitalized at the date of acquisition by including them in the goodwill
calculation.
Group reserves
When looking at the reserves of S at the year end, e.g. revaluation reserve, a
distinction must be made between:
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Illustration 3: Pre- and post-acquisition reserves
The following statements of financial position were extracted from the books of
two companies at 31 December 20X9.
Derek acquired all of the share capital of Clive one year ago. The retained
earnings of Clive stood at $2,000 on the day of acquisition. Goodwill is
calculated using the fair value method. There has been no impairment of
goodwill since acquisition.
Required:
Solution
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(W1) Establish the group structure
(W3) Goodwill
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(W4) NCI
Non-controlling interests
In some situations, a parent may not own all of the shares in the subsidiary,
e.g. if P owns only 80% of the ordinary shares of S, there is a non-controlling
interest of 20%.
As P Controls S:
The D Group uses the fair value method to value the non-controlling interest.
SUGGESTED SOLUTION
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(W1) Group structure
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(W3) Goodwill
2 Fair values
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the consideration paid for a subsidiary must be accounted for at fair
value
the subsidiary’ 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.
Fair values
Identifiable assets and liabilities recognised in the accounts are those of the
acquired entity that existed at the date of acquisition.
Assets and liabilities are measured at fair values reflecting conditions at the
date of acquisition.
The following do not affect fair values at the date of acquisition and are
therefore dealt with as post-acquisition items.
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.
(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.
(2) At the reporting date make the adjustment on the face of the SFP when
adding across assets and liabilities.
Hazelnut acquired 80% of the share capital of Peppermint twoyears ago, when
the reserves of Peppermint stood at $125,000. Hazelnutpaid initial cash
consideration of $1 million.
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At acquisition the fair values of Peppermint’s plant exceeded itsbook value by
$200,000. The fair value of the 20% non-controllinginterest was $380,000
SUGGESTED SOLUTION
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Workings
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(W3) Goodwill
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3 Intra-group trading
P and S may well trade with each other leading to the following potential
problem areas:
Current accounts
If P and S trade with each other then this will probably be done on credit
leading to:
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.
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.
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 and cancelled as
part of the process of cross casting the assets and liabilities.
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This means that reconciled current account balance amounts are
removed from both receivables and payables in the consolidated
statement of financial position.
P acquired 75% of S on 1 July 20X5 when the balance on S’s retained earnings
was $1,150. P paid $3,500 for its investment in the share capital of S.
The P group uses the fair value method to value the non-controlling interest
which was $1,100.
Required:
SUGGESTED SOLUTION
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Workings
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(W2) Net assets
(W3) Goodwill
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4 Unrealised profit
When one group company sells goods to another a number of adjustments may
be needed.
PURP
Where goods have been sold by one group company to another at a profit and
some of these goods are still in the purchaser’s inventory at the year end, then
the profit loading on these goods is unrealised from the viewpoint of the group
as a whole.
This is because we are treating the group as if it is a single entity. No one can
make a profit by trading with himself. Until the goods are sold to an outside
party there is no realized profit from the group perspective.
For example, if Pineapple purchased goods for $400 and then sold these goods
onto Satsuma during the year for $500, Pineapple would record a profit of $100
in their own individual financial statements. The statement of financial position
of Satsuma will include closing inventory at the cost to Satsuma i.e. $500.
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This situation results in two problems within the group:
(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).
An adjustment will need to be made so that the single entity concept can be
upheld i.e. The group should report external profits, external assets and
external liabilities only.
(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:
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:
Cr Group inventory
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Test your understanding 4
H bought 90% of the equity share capital of S, two years ago on 1January 20X2
when the retained earnings of S stood at $5,000. Statements of financial
position at the year end of 31 December 20X3 are as follows:
The H group uses the fair value method to value the non-controlling interest.
The fair value of the non-controlling interest at acquisition was $4,000
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SUGGESTED SOLUTION
Workings
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(W2) Net assets
(W3) Goodwill
(W6) PURP
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5 Mid-year acquisitions
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.
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On 1 May 2007 K bought 60% of S paying $76,000 cash. The summarized
Statements of Financial Position for the two companies as at 30November 2007
are:
(1) The inventory of S includes $8,000 of goods purchased from Kat cost plus
25%.
(2) The K Group values thenon-controlling interest using the fair value method.
At the date ofacquisition the fair value of the 40% non-controlling interest
was$50,000.
Required:
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SUGGESTED SOLUTION
Workings
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(W2) Net assets
(W3) Goodwill
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(W5) Group retained earnings
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