Week 9 - Consolidation Financial Statements

Question 1

What is a group structure?

Answer 1

Parent/ holding company -> subsidiary company

Question 2

What is control?

Answer 2

The power to govern the financial and operating policies.

Question 3

When is control presumed?

Answer 3

When P owns more than 50% of the voting rights of S.

Question 4

If less than 50% is owned, how may control still exist?

Answer 4

▪ 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

Question 5

What are the principles of consolidation in the SOFP?

Answer 5

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).

Question 6

What is the reasoning behind the principle of consolidation in the SOFP?

Answer 6

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.

Question 7

What are the principles of consolidation when combining the share capital of the group?

Answer 7

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.

Question 8

What is the reasoning behind the principle of consolidation when combining the share capital of the group?

Answer 8

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.

Question 9

What do you calculate on the consolidation at the date of acquisition?

Answer 9

1. Goodwill
2. Non-controlling interest (or minority interest)
3. Revaluation adjustment

Question 10

What do you calculate on the consolidation after acquisition?

Answer 10

1. Post acquisition profits
2. Inter-company balances
3. Unrealized profit on inter-company sales (PUP)
4. Differences in accounting policies (APadj)

Question 11

What is goodwill?

Answer 11

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.

Question 12

When does goodwill occur?

Answer 12

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

Question 13

How is goodwill calculated?

Answer 13

Goodwill at acquisition = Cost of investment – Parent’s share of acquired net assets [at FV]

Question 14

Where is goodwill recognised in the consolidated SOFP?

Answer 14

Goodwill is recognised as an asset in the consolidated SOFP.

Question 15

How is goodwill at the reporting date calculated and how is it updated each year?

Answer 15

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.

Question 16

What is non-controlling interest?

Answer 16

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.

Question 17

What is the principle of consolidation when calculating Non Controlling Interest?

Answer 17

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.

Question 18

What is the reasoning behind the principle of consolidation in NCI?

Answer 18

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.

Question 19

How do you calculate NCI?

Answer 19

NCI = NCI % x Net assets of S at the balance sheet date

Question 20

How do you calculate goodwill in the presence of NCI?

Answer 20

Goodwill = Purchase price – % of shares owned * fair value of S’s net assets

Question 21

What is the principle of consolidation in fair value adjustments?

Answer 21

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.

Question 22

What is the reasoning behind the principle of consolidation in fair value adjustments?

Answer 22

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!

Question 23

How is revaluation adjustment calculated?

Answer 23

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

Question 24

What are the steps to preparing a consolidated financial statement?

Answer 24

1. Determine goodwill
2. Determine NCI
3. Add the assets and liabilities of the two companies to obtain the consolidated balance sheet.

Question 25

How do you calculate NCI at acquisition?

Answer 25

NCI at acquisition = NCI’s share of Subsidiary’s net assets [at FV]

Question 26

How do you deal with intercompany payables/ receivables?
E.g. Parent has been selling goods to the subsidiary and at the year end £200 is still owed.

Answer 26

Parent: Receivable £200
Subsidiary: Payable £200
Both balances have to be eliminated in the consolidated SOFP:
Dr Trade payables £200
Cr Trade receivables £200

Question 27

How to deal with intercompany cash in transit?
E.g. Green transferred £115,000 to Club on 31 March 2019 which was not recorded by Club until April 2019 (reporting date = 31 March).

Answer 27

Green (already recorded):
Dr Payables 115,000
Cr Cash 115,000

Club (adjustment required):
Dr Cash 115,000
Cr Receivables 115,000

The cash that is in transit has to be included in group accounts!

Question 28

What is done with intercompany loans and loan interest?

Answer 28

They are cancelled out on consollidation.

(see week 9 page 68)

Question 29

What is unrealised profit and when does it arise?

Answer 29

Unrealised profits arise when the parent/subsidiary sell goods at above cost prices AND these goods are still held in inventory at year end.
You need to reduce (Cr) inventory with the unrealised profit AND reduce (Dr)
retained earnings as follows:

Question 30

When dealing with unrealised profit - what do you do if the sale is from P —> S?

Answer 30

1. Deduct Provision for
   Unrealised profit (PURP)
   from group’s inventory
   (this reduces inventory to
   the amount of cost to
   group)
2. Deduct the PURP from
   group’s retained earnings

CBS Inventory. (decrease)
CBS RE (decrease)

Question 31

When dealing with unrealised profit - what do you do if the sale is from S —> P?

Answer 31

1. Deduct PURP from group’s
   inventory (this reduces
   inventory to the amount of
   cost to group)
2. Deduct P’s % from group’s
   retained earnings and NCI’s %
   from NCI

CBS Inventory - decrease
CBS RE (P% x PURP) - decrease
CBS NCI (NCI% x PURP) - decrease

Question 32

When do you do adjustments in inter-company sales?

Answer 32

Only if the inventory has not been sold. If it has been sold to the outside world no adjustments are needed.

Question 33

What does mark-up mean?

Answer 33

It means you have marked up the price. Say you manufactured something for £100 and you sell it for £120.

Question 34

How do you calculate the PURP?

Answer 34

Unsold inventory x (mark-up ÷ (100+mark-up))
OR
Unsold inventory x (margin ÷ 100)

Question 35

How do you convert between mark-up and margin?

Answer 35

Markup = Margin / (1 – Margin)

Margin = Markup / (1+ Markup)

Question 36

What is the case of consolidated financial statements?

Answer 36

If P and S use different accounting policies (e.g. straight line vs. reducing balance depreciation), S needs to adjust its accounts as if it had always followed the accounting policies of P.