Financial Position

Chapter 19 Consolidated Statement of Financial Position with Consolidated Adjustments

1. Objectives

1.1       Account for the effects of intra-group trading in the statement of financial position.
1.2       Explain why it is necessary to use fair values when preparing consolidated financial statements.
1.3       Account for the effects of fair values adjustments in consolidation.
1.4       Account for the effects of mid-year acquisition of subsidiary.

Organigramma

2. Intra-group Trading

2.1       Parent (P) and subsidiary (S) may well trade with each other leading to the following potential problem areas:
(a)        Current account between parent and subsidiary
(b)        Loans held by one company in the other
(c)        Dividends and loan interest
(d)        Unrealised profits on sales of inventory
(e)        Unrealised profits on sales of non-current assets

(A) Current accounts

2.2 At the year end, current accounts may not agree, owing to the existence of in-transit items such as goods or cash.

2.3

Cash or goods in transit

The usual rules are as follows:
(a) 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:
Dr Cash in transit
Cr Current account

Goods in transit:
Dr Inventory
Cr Current account

This adjustment is for the purpose of consolidation only.
(b) Once in agreement, the current accounts may be contra and cancelled as part of the process of cross casting the assets and liabilities.
(c) This means that reconciled current account balance amounts are removed from both receivables and payables in the consolidated statement of financial position.

2.4

Example 1 – Intercompany current accounts

Below are the statements of financial position of H Ltd and S Ltd as at 31 December 2010:

	H Ltd	S Ltd
Non-current assets	$000	$000
Property, plant and equipment	100	140
Investments in S at cost	180	-
	280	140
Current assets
Inventory	30	35
Trade receivables	20	10
Cash	10	5
Total assets	340	190

Equity and liabilities
Equity
Share capital	200	100
Share premium	10	30
Retained earnings	40	20
	250	150
Non-current liabilities
10% loan notes	65	-
Current liabilities	25	40
Total equity and liabilities	340	190

Notes:
1.         H Ltd bought 80,000 shares in S Ltd in 2010 when S Ltd’s reserves included a share premium of $30,000 and retained profits of $5,000.
2.         H Ltd’s accounts show $6,000 owing to S Ltd; S Ltd’s accounts show $8,000 owed by H Ltd. The difference is explained as cash in transit.
3.         No impairment of goodwill has occurred to date.
4.         H Ltd uses the proportion of net assets method to value the non-controlling interest.

Required:

Prepare the consolidated statement of financial position of H Ltd as at 31 December 2010.

Solution:

W1 Shareholdings in S Ltd.

	%
Group	80
Non-controlling interest	20
	100

W2 Cash in transit
The $2,000 cash in transit should be adjusted for in S Ltd’s accounts prior to consolidation. The outstanding intercompany balance requiring cancelling is therefore $6,000.

Consolidated adjustment:	Dr ($)	Cr ($)
Cash in transit	2,000
Current account		2,000

W3 Net asset of S Ltd

	At date of acquisition	At the reporting date
	$000	$000
Share capital	100	100
Share premium	30	30
Retained earnings	5	20
Net assets	135	150

W4 Calculation of Goodwill

	$000
Parent holding (investment) at fair value	180
NCI value at acquisition (20% x 135 (W2))	27
	207
Less: Fair value of net assets at acquisition (W2)	(135)
Goodwill on acquisition	72

W5 Non-controlling interest

	$000
NCI value at acquisition (W3)	27
NCI share of post acquisition reserves [20% x (20 – 5)]	3
	30

W6 Group retained earnings

	$000
H Ltd	40
S Ltd: 80% x (20 – 5)	12
	52

Consolidated statement of financial position as at 31 December 2010

Non-current assets		$000
Goodwill (W4)		72
Property, plant and equipment (100 + 140)		240
		312
Current assets
Inventory (30 + 35)		65
Trade receivables (20 + 10 – 2 – 6 (W2))		22
Cash (10 + 5 + 2 (W2))		17
Total assets		416

Equity and liabilities
Equity
Share capital		200
Share premium		10
Retained earnings		52
		262
Non-controlling interest (W5)		30
		292
Non-current liabilities
10% loan notes		65
Current liabilities
Payables (25 + 40 – 6 (W2))		59
Total equity and liabilities		416

(B) Unrealised profit in inventory

2.5 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 unrealized 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.

2.6

Adjustments for unrealized profit in inventory

The process to adjust is:
(a)        Determine the value of closing inventory included in an individual company’s accounts which has been purchased from another company in the group.
(b)        Use mark-up or margin to calculate how much of that value represents profit earned by the selling company.
(c)        Make the adjustments. These will depend on who the seller is.
1.      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:
Dr Group retained earnings (deduct the profit in W6)
Cr Group inventory

2. 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.

Adjustments required:
Dr Subsidiary retained earnings (deduct the profit in W3 – at reporting date)
Cr Group inventory

2.7

Exercise 1 – Unrealised profit in inventory

H Ltd bought 90% of the equity share capital of S Ltd, two years ago on 1 January 2009 when the retained earnings of S Ltd stood at $5,000. Statements of financial position at the year end of 31 December 2010 as follows:

	H Ltd	S Ltd
Non-current assets	$000	$000
Property, plant and equipment	100	30
Investments in S at cost	34	-
	134	30
Current assets
Inventory	90	20
Trade receivables	110	25
Bank	10	5
Total assets	344	80

Equity and liabilities
Equity
Share capital	15	5
Retained earnings	159	31
	174	36
Non-current liabilities	120	28
Current liabilities	50	16
Total equity and liabilities	344	80

S Ltd transferred goods to H Ltd at a transfer price of $18,000 at a mark-up of 50%. Two-thirds remained in inventory at the year end. The current account in H Ltd and S Ltd stood at $22,000 on that day. Goodwill has suffered an impairment of $10,000.

H Ltd uses the fair value method to value the non-controlling interest. The fair value of the non-controlling interest at acquisition was $4,000.

Required:

Prepare the consolidated statement of financial position of H Ltd as at 31 December 2010.

(C) Unrealised profit in sale of non-current assets

2.8       If one group member sells non-current assets to another group member, adjustments must be made to recreate the situation that would have existed if the sale had not occurred:
(a)        There would have been no profit on the sale.
(b)        Depreciation would have been based on the original cost of the asset to the group.

2.9

Adjustments for unrealized profit in sale of non-current assets

Two consolidation adjustments will usually be needed to achieve this.
(a) An adjustment to alter retained earnings and non-current assets cost so as to remove any element of unrealized profit or loss. This is similar to the adjustment required in respect of unrealized profit in inventory.
(b) An adjustment to alter retained earnings and accumulated depreciation is made so that consolidated depreciation is based on the asset’s cost to the group.

In practice, these steps are combined so that the retained earnings of the entity making the unrealized profit are debited with the unrealized profit less the additional depreciation.

The double entry is as follows
1. Sale by parent

Dr Group retained earnings (deduct the profit in W6)
Cr Non-current assets

2. Sale by subsidiary

Dr Group retained earnings (deduct the profit in W3 at reporting date)
Dr Non-controlling interest
Cr Non-current assets

2.10

Example 2 – Unrealised profit in non-current asset

H Ltd transfers an item of plant to its subsidiary (S Ltd) for $6,000 at the start of 2010. The plant originally cost of $10,000 and had an original useful economic life of 5 years when purchased 3 years ago. The useful economic life of the asset has not changed as a result of the transfer.

Required:

Calculate the unrealized profit on the transaction at the end of the year of transfer (2010).

Solution:

	NBV before transfer	NBV after transfer	Difference
	$	$	$
Cost	10,000
Depreciation (3 yrs)	(6,000)
Carrying value	4,000	6,000	2,000
Depreciation	(2,000)	(3,000)	(1,000)
Carrying value	2,000	3,000	1,000

The overall adjustment would be $1,000 at the reporting date. To adjust the accounts:

Consolidation adjustment:	Dr ($)	Cr ($)
Consolidated retained earnings (W6)	1,000
Property, plant and equipment		1,000

(D) Dividends paid by subsidiary

2.11     When a subsidiary company pays a dividend during the year the accounting treatment is not difficult. Suppose S Ltd, a 60% subsidiary of H Ltd, pays a dividend of $1,000 on the last day of its accounting period. Its total reserves before paying the dividend stood at $5,000.
(a)        $400 of the dividend is paid to non-controlling shareholders. The cash leaves the group and will not appear anywhere in the consolidated statement of financial position.
(b)       The parent company receives $600 of the dividend, debiting cash and crediting profit or loss. This will be cancelled on consolidation.
(c)        The remaining balance of retained earnings in S Co's statement of financial position ($4,000) will be consolidated in the normal way. The group's share (60% × $4,000 = $2,400) will be included in group retained earnings in the statement of financial position; the non-controlling interest share (40% × $4,000 = $1,600) is credited to the non-controlling interest account in the statement of financial position.

(E) Intra-group lending

2.12 As a result of intra-group lending one group company will show a loan in their statement of financial position and another group company will show an investment (or receivable).
2.13 On consolidation these should be eliminated against each other and are therefore not added across to form part of group borrowings or group investments.

3. Dividends and Pre-acquisition Profits

3.1 The parent company, as a member of the subsidiary, is entitled to its share of the dividends paid but it is necessary to decide whether or not these dividends come out of the pre-acquisition profits of the subsidiary.
3.2 If the dividend is paid from pre-acquisition profits, the double entry is being as follows:

Dr Cash
Cr Investment in subsidiary

In other words, it reduces the cost of the parent company’s investment.

3.3

Example 3 – Dividends paid from pre-acquisition of the subsidiary

P acquires a 60% interest in S on 1 September 2010. S's year end is 31 December. On 10 January 2011 S pays a dividend of $10,000 in respect of 2010. P's share of the dividend is $6,000. However, as it relates to the year of acquisition, $2,000 (6,000 × 4/12) is treated as being from post-acquisition profits and $4,000 (6,000 × 8/12) is treated as being from pre-acquisition profits.

Why do we make this distinction? If we consider the situation of a holding company deciding whether to invest in a subsidiary, we can see the significance of a dividend paid from pre-acquisition profits. If the prospective subsidiary's financial statements disclose that it proposes to pay a dividend in the near future, the prospective holding company knows that if it invests in the shares some of its investment will be returned to it very soon. Also, a dividend paid out of pre-acquisition profits cannot be regarded as a return on the company's investment because it relates to the period before the investment was made. So we treat it as what it effectively is – a reduction in the cost of the investment.

To continue the example, it assumes that P has paid $175,000 for its 60% shareholding in S. At the date of acquisition S had share capital of $100,000 and retained earnings of $70,000.

In 2011 S pays a $10,000 dividend of which P receives $6,000. $4,000 is deemed to be from pre-acquisition profits. The goodwill calculation at 31 December 2011 is as follows:

	$	$
Consideration transferred		175,000
Less: pre-acquisition dividend		(4,000)
		171,000
Net assets acquired:
Share capital	100,000
Retained earnings	70,000
	170,000
Group share (60%)		(102,000)
Goodwill		69,000

4. Mid-year Acquisitions

4.1 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.
4.2 To calculate this it is normally assumed that subsidiary’s profit after tax accrues evenly over time.

4.3

Example 4 – Mid-year acquisition

On 1 May 2010 H Ltd bought 60% of S Ltd paying $76,000 cash. The summarized statements of financial position for the two companies as at 30 November 2010 are:

	H Ltd	S Ltd
Non-current assets	$	$
Property, plant and equipment	138,000	115,000
Investments	98,000	-
	236,000	115,000
Current assets
Inventory	15,000	17,000
Trade receivables	19,000	20,000
Bank	2,000	-
Total assets	272,000	152,000

Equity and liabilities
Equity
Share capital	50,000	40,000
Retained earnings	189,000	69,000
	239,000	109,000
Non-current liabilities
8% Loan notes	-	20,000
Current liabilities	33,000	23,000
Total equity and liabilities	272,000	152,000

The following information is relevant:

(1)       The inventory of S Ltd includes $8,000 of goods purchased from H Ltd at cost plus 25%.
(2)       On 1 June 2010 S Ltd transferred an item of plant to H Ltd for $15,000. Its carrying amount at that date was $10,000. The asset had a remaining useful economic life of 5 years.
(3)       The H Group values the non-controlling interest using the fair value method. At the date of acquisition the fair value of the 40% non-controlling interest was $50,000.
(4)       An impairment loss of $1,000 is to be charged against goodwill at the year-end.
(5)       S Ltd earned a profit of $9,000 in the year ended 30 November 2010.
(6)       The loan note in S Ltd’s books represents monies borrowed from H Ltd during the year. All of the loan note interest has been accounted for.
(7)       Included in H Ltd’s receivables is $4,000 relating to inventory sold to S Ltd during the year. S Ltd raised a cheque for $2,500 and sent it to H Ltd on 29 November 2010. H Ltd did not receive this cheque until 4 December 2010.

Required:

Prepare the consolidated statement of financial position of H Ltd as at 30 November 2010.

Solution:

W1 Shareholdings in S Ltd.

	%
Group (acquired 7 months)	60
Non-controlling interest	40
	100

W2 Unrealised profit in inventory
= $8,000 x 25/125 = $1,600

Consolidated adjustment:	Dr ($)	Cr ($)
Group retained earnings	1,600
Group inventory		1,600

W3 Transfer of plant from S Ltd to H Ltd
Unrealised profit = 15,000 – 10,000 = $5,000

Excessive depreciation = (15,000 – 10,000) / 5 years x 6/12 = $500

Net unrealized profit = 5,000 – 500 = $4,500

Consolidated adjustment:	Dr ($)	Cr ($)
Group retained earnings (4,500 x 60%)	2,700
Non-controlling interest (4,500 x 40%)	1,800
Group property, plant and equipment		4,500

W4 Impairment of goodwill

Consolidated adjustment:	Dr ($)	Cr ($)
Group retained earnings (1,000 x 60%)	600
Non-controlling interest (1,000 x 40%)	400
Goodwill		1,000

W5 Loan note of S Ltd

Consolidated adjustment:	Dr ($)	Cr ($)
8% Loan notes (S Ltd)	20,000
Investment (H Ltd)		20,000

W6 Cash in transit

Consolidated adjustment:	Dr ($)	Cr ($)
Cash in transit	2,500
Receivables (H Ltd)		2,500
Payables (S Ltd)	1,500
Receivables (H Ltd)		1,500

W7 Net asset of S Ltd

	At date of acquisition	At the reporting date
	$	$
Share capital	40,000	40,000
Retained earnings	63,750	69,000
Unrealised profit in plant (W3)		(4,500)
	103,750	104,500

Pre-acquisition profit = 60,000 + 9,000 x 5/12 = 63,750.

W8 Goodwill

	$
Parent holding (investment) at fair value	76,000
NCI value at acquisition	50,000
	126,000
Less: Fair value of net assets at acquisition (W7)	(103,750)
Goodwill on acquisition	22,250
Less: Impairment of goodwill	(1,000)
Carrying amount	21,250

W9 Non-controlling interest

	$
NCI value at acquisition (W8)	50,000
NCI share of post acquisition reserves [40% x (104,500 – 103,750)]	300
Less: NCI share of impairment (W4)	(400)
	49,900

W10 Group retained earnings

	$
H Ltd	189,000
S Ltd: [60% x (104,500 – 103,750)]	450
Impairment of goodwill (W4)	(600)
	187,250

Consolidated statement of financial positions as at 30 November 2010

		S Ltd
Non-current assets		$
Goodwill (W8)		21,250
Property, plant and equipment (138,000 + 115,000 – 4,500 (W3))		248,500
Investments (98,000 – 76,000 – 20,000 (W5))		2,000
		271,750
Current assets
Inventory (15,000 + 17,000 – 1,600 (W2))		30,400
Trade receivables (19,000 + 20,000 – 2,500 – 1,500 (W6))		35,000
Bank (2,000 + 2,500 (W6))		4,500
Total assets		341,650

Equity and liabilities
Equity
Share capital		50,000
Retained earnings (W10)		187,250
		237,250
Non-controlling interest (W9)		49,900
		287,150
Non-current liabilities
8% Loan notes (20,000 – 20,000)		-
Current liabilities (33,000 + 23,000 – 1,500 (W6))		54,500
Total equity and liabilities		341,650

Source: https://hkiaatevening.yolasite.com/resources/F7Notes/Chapter19-ConSFPAdj.doc

Web site to visit: https://hkiaatevening.yolasite.com

Author of the text: indicated on the source document of the above text

If you are the author of the text above and you not agree to share your knowledge for teaching, research, scholarship (for fair use as indicated in the United States copyrigh low) please send us an e-mail and we will remove your text quickly. Fair use is a limitation and exception to the exclusive right granted by copyright law to the author of a creative work. In United States copyright law, fair use is a doctrine that permits limited use of copyrighted material without acquiring permission from the rights holders. Examples of fair use include commentary, search engines, criticism, news reporting, research, teaching, library archiving and scholarship. It provides for the legal, unlicensed citation or incorporation of copyrighted material in another author's work under a four-factor balancing test. (source: http://en.wikipedia.org/wiki/Fair_use)

The information of medicine and health contained in the site are of a general nature and purpose which is purely informative and for this reason may not replace in any case, the council of a doctor or a qualified entity legally to the profession.

Financial Position

The texts are the property of their respective authors and we thank them for giving us the opportunity to share for free to students, teachers and users of the Web their texts will used only for illustrative educational and scientific purposes only.

All the information in our site are given for nonprofit educational purposes