Week 9 - Consolidation Financial Statements Flashcards
What is a group structure?
Parent/ holding company -> subsidiary company
What is control?
The power to govern the financial and operating policies.
When is control presumed?
When P owns more than 50% of the voting rights of S.
If less than 50% is owned, how may control still exist?
▪ power over more than 50% of the voting rights of S through an agreement
▪ power to govern the financial and operating policies of S under an agreement
▪ power to appoint or remove the majority of the members of the Board of Directors (BOD)
▪ power to cast the majority of votes at a meeting of the BOD
What are the principles of consolidation in the SOFP?
All P’s and S’s assets and liabilities
are added together 100% line by line. Even though the Subsidiary may not be 100% owned by the
Parent company, all the assets and
liabilities (=net assets) are added
together in full (the same principle
applies to Consolidated Income
Statement).
What is the reasoning behind the principle of consolidation in the SOFP?
Substance over form: Strictly, the P company and the S company are two separate entities, but we prepare the group accounts as if
they were a single entity. Shareholders of the parent company can appreciate the total
resources that are controlled.
What are the principles of consolidation when combining the share capital of the group?
Share capital of the group is that of
the Parent only. Parent’s investment
in the Subsidiary is cancelled out
with share capital and pre-acquisition profits of the Subsidiary.
What is the reasoning behind the principle of consolidation when combining the share capital of the group?
This elimination avoids double
counting that would otherwise
result on the consolidated SOFP –
that is counting the asset
“Investment in subsidiary” (in
Parent’s SOFP) and the assets and
liabilities on the Subsidiary’s SOFP.
What do you calculate on the consolidation at the date of acquisition?
- Goodwill
- Non-controlling interest (or minority interest)
- Revaluation adjustment
What do you calculate on the consolidation after acquisition?
- Post acquisition profits
- Inter-company balances
- Unrealized profit on inter-company sales (PUP)
- Differences in accounting policies (APadj)
What is goodwill?
Goodwill is the difference between the purchase consideration for an entity (price paid to acquire it) and the sum of the fair value of its net assets.
When does goodwill occur?
arises when P pays more than the fair value of the net assets of S because S has higher earning power than its industry peers due to its:
▪ Workforce in place (e.g. competent management, technological and innovative skills, sound financial management)
▪ Cost synergies
▪ Sales synergies, technological and innovative skills
How is goodwill calculated?
Goodwill at acquisition = Cost of investment – Parent’s share of acquired net assets [at FV]
Where is goodwill recognised in the consolidated SOFP?
Goodwill is recognised as an asset in the consolidated SOFP.
How is goodwill at the reporting date calculated and how is it updated each year?
Goodwill is subject to an annual impairment review and where it has been impaired must be written down. Therefore, goodwill at reporting date:
Goodwill at reporting date = Goodwill at acquisition date - Accumulated impairment losses.
What is non-controlling interest?
A non-controlling interest is an ownership position in which a shareholder owns less than 50% of outstanding shares and has no control over decisions.
What is the principle of consolidation when calculating Non Controlling Interest?
Where the Parent has not acquired 100% of the ordinary shares in the Subsidiary, there will be shares in the Subsidiary that are owned by external third parties = non-controlling interest (NCI). NCI is included as part of equity on the SOFP.
Note: a line item also appears on the consolidated income statement below net income, which represents net income attributable to the non-controlling interest.
What is the reasoning behind the principle of consolidation in NCI?
While the shareholders of the parent company control the group, the group is considered to be partly owned by non-controlling shareholders. So on the SOFP NCI are treated as co-owners of the
subsidiary.
How do you calculate NCI?
NCI = NCI % x Net assets of S at the balance sheet date
How do you calculate goodwill in the presence of NCI?
Goodwill = Purchase price – % of shares owned * fair value of S’s net assets
What is the principle of consolidation in fair value adjustments?
All subsidiary’s assets acquired and
liabilities assumed are measured at
acquisition-date fair value.
On acquisition the identifiable assets of the subsidiary are recognized separately from goodwill (even if they have not been
recognized as an asset in the subsidiary’s individual SOFP).
As a result, it is possible for customer lists and brand names of the subsidiary to be recognized as intangible assets in the group accounts.
What is the reasoning behind the principle of consolidation in fair value adjustments?
If a parent company was to buy an
individual asset from the subsidiary, say an item of property, this would be done at whatever the market price of the asset is, irrespective of its carrying amount in the selling entity’s SOFP. This same principle is
applied to the acquisition of the entire entity.
A further justification for recognising subsidiary’s net assets at fair value is to ensure the correct measurement of goodwill!
How is revaluation adjustment calculated?
S’ assets need to be revalued before being included on the consolidated
balance sheet
Revaluation Adjustment = S’s fair value of assets − S’s book value assets
What are the steps to preparing a consolidated financial statement?
- Determine goodwill
- Determine NCI
- Add the assets and liabilities of the two companies to obtain the consolidated balance sheet.
