Semester 2 Week 6 PP (Group Accounting 1)

Question 1

What is a group?

Answer 1

In simple terms a group is a company owned by another company.

Question 2

Group example:

Hughes owns 100% of Sharp Ltd. What does this make Sharp Ltd and Hughes?

Answer 2

Hughes will recognise as a non-current asset an investment in Sharp.

Question 3

Why does being a parent company matter?

Answer 3

As Hughes owns 100% of the shares in sharp this means they have 100% of the votes. Therefore they can:
Remove, appoint or replace any director of Sharp.
Pass any motion in Sharp.
Make Sharp pay or not pay a dividend.
Make Sharp borrow money.
Use Sharp’s assets.
Hughes therefore control Sharp.

Question 4

Why do companies make groups?

Answer 4

Companies organise themselves into groups for various reasons:
Organisational – especially if large operations in a number of countries.
Tax reasons.
Vertical integration – e.g. a supermarket also owning farms.

Question 5

What are groups required to do?

Answer 5

Companies are required to prepare group accounts including all the companies they control.
We’ll be looking at the process of doing this over the next few weeks.
This process is called group accounting – also called consolidation or acquisition accounting. A company is required to consolidate, or prepare group accounts for all companies under its control.
The most common form of control is that you own over 50% of the shares.
In real life, however, there can be varying ways to gain control.

Question 6

What ways can control be obtained?

Answer 6

Control could also be obtained in more complex ways such as:
The right to appoint directors.
The right to veto key decisions.
Economic dominance (for example being the only customer).
Control of the company’s finances.

Question 7

How are group accounts prepared?

Answer 7

Group accounts are prepared under what is called the single entity approach.
This essentially combines all the companies in the group and treats them as if they were a single entity – or just one company.

Question 8

Loggerhead Ltd acquires 100% of the shares in Hawksbill on 1/1/X2 for £15,000, when Hawksbill had retained earnings of £9,000. Both companies have a 31 December year end.
The statement of financial position for both companies as at 31/12/X2.

Answer 8

Let’s add them together as the first step to creating the Loggerhead Group. The P&L would also be added together but we’ll look more at this in subsequent weeks.

£,000 Loggerhead Group
PPE 19,000
Investment in Hawksbill 15,000
Current assets 11,000
Total assets 45,000
Share capital (£1 ord) 6,000
Retained earnings 32,000
Current liabilities 7,000
Total equity and liabilities 45,000

Adjustments:

The PPE is fine, Loggerhead controls Hawksbill therefore the combined PPE of both companies should be recognised in the group accounts.
Other things are fine in individual accounts but would need adjusted for when we prepare group accounts.
For example the investment will need adjusted – you can’t hold an investment in yourself!
We therefore need adjustments to:
Remove the investment in ourselves
Remove the share capital we own in ourselves
Remove any retained earnings earned before Hawksbill was bought over
We do this in step 2
Step 2:
Assets
Remove investment of £15,000,000
Equity
Reduce share capital by £2,000,000
Reduce retained earnings by £9,000,000
That doesn’t balance – assets go down by £15,000,000 but equity only goes down by £11,000,000.

To get the answer to this question we have to go back to our accounting equation.
Remember equity = assets – liabilities
At the point of takeover Hawksbill had total equity of £11,000,000 (£9,000,000 RE + £2,000,000 SC)
It was therefore effectively “worth” £11,000,000 in terms of net assets.
But Loggerhead was willing to pay £15,000,000 – why?
When acquiring Hawksbill, Loggerhead is not just acquiring the assets on the statement of financial position, but also assets that would not be included in the statement of financial position.
For example, the trading history of Hawksbill, the market position, the reputation etc.
We call this goodwill. Goodwill is therefore what a buyer is willing to pay over and above the asset value of a company.
In the example we’ve just looked at Hawksbill had a net asset value of £11,000,000 but Loggerhead was willing to pay £15,000,000 for them.
In this case, therefore, we would have goodwill of £15,000,000 - £11,000,000 = £4,000,000
Goodwill is recorded as a non-current asset in the SFP.
Assets
Remove investment of £15,000,000
Create goodwill of £4,000,000
Equity
Reduce share capital by £2,000,000
Reduce retained earnings by £9,000,000
The consolidation spreadsheet is essentially split into three sections.
The furthest left is simply the parent company and subsidiary(ies) added together.
The middle section is the adjustments.
The furthest right section is the final adjusted figures.

Let’s do this for the Loggerhead Group….
(Note you don’t need to do the journals).

£,000 Loggerhead Adjustment Final
Group
PPE 19,000 19,000
Investment in Hawksbill 15,000 -15,000 -
Goodwill +4,000 4,000
Current assets 11,000 11,000
Total assets 45,000 34,000
Share capital (£1 ord) 6,000 -2,000 4,000
Retained earnings 32,000 -9,000 23,000
Current liabilities 7,000 7,000
Total equity and liabilities 45,000 34,000

£,000 Loggerhead Group
PPE 19,000
Goodwill 4,000
Current assets 11,000
Total assets 34,000
Share capital (£1 ord) 4,000
Retained earnings 23,000
Current liabilities 7,000
Total equity and liabilities 34,000