IFRS 9 Financial Instruments s1

for Accounting Professionals

CONSOLIDATION PART 2

2011 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng CONSOLIDATION PART 2

IFRS WORKBOOKS (1 million downloaded)

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Robin Joyce Professor of the Chair of International Banking and Finance Financial University under the Government of the Russian Federation

Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Updated

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 2 CONTENTS (ii) determining the acquisition date;

1. Consolidation Introduction 3 (iii) recognising and measuring the identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree; 2. Definitions 4 and

3. Intra Group Trading 5 (iv) recognising and measuring goodwill or a gain from a bargain purchase. 4. Dividends Paid out of Pre-Acquisition Profits 13 5. Dividends Paid out of Post-Acquisition Profits 15 Before commencing a consolidation, the accountant should have the full financial statements of the parent and subsidiaries produced 6. Intra-Group Asset Sales 18 as of the same date, and using the same accounting policies.

7. Vertically Integrated Groups 20 Where possible, all subsidiary year-ends must be the same as the 8. Consolidated Income Statements 21 parent undertaking. 9. Multiple Choice Questions 24 Under IFRS 10, the maximum permitted difference is 3 months. Adjustment should be made for any significant differences created 10. Exercise Questions 25 by any subsidiary having a different accounting date. 11. Solutions 37 The length of reporting periods, and any difference in the reporting dates, should be consistent from period to period. This will make the corresponding figures from previous accounting periods more 1. Consolidation Introduction easily comparable.

Aim Transactions and balances between group undertakings should be l reconciled and listed. The aim of this workbook is to assist in understanding consolidation methodology for IFRS. Where an undertaking has been purchased or sold, the financial Approach statements at the time of acquisition or sale should be on hand. Spreadsheets are ideal for producing consolidated balance sheets To consolidate a business combination requires: and income statements, although bespoke consolidated software is available. (i) identifying the acquirer; http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 3 At a practical level, to ensure consistency of treatment, a Group, or business combination consolidation pack is prepared for each group company detailing Two or more companies where one company controls the other(s). standard adjustments, reconciliation’s, forms, and spreadsheets. Consolidated accounts will be required if one business controls This makes assembly of the final group reports much simpler and another, whatever are the means of control. reduces the possibilities of different interpretations by the financial controllers of each group company. Dissimilar business activities must be consolidated, if they controlled by the parent undertaking. Other Workbooks Consolidation 1 and 3 concentrate on practical consolidation and Control dealing with Associates and Joint Ventures. Control is the power to govern the financial and operating policies of an undertaking to obtain benefits. The IFRS 3 workbook concentrates on that standard which provides guidance on specific points, such as the purchase of Indications of control are: companies in stages, loss of control but retention of an associate and reverse takeovers.  Ownership of more than 50% of the voting rights.

IAS 27 has been replaced by IFRS 10 for consolidated financial  Effective control over more than 50% of the voting rights. For statements. IFRS 11 has replaced IAS 31. The new standards are example, a husband owns 30% and a wife owns 40%. As effective from 2013. they are connected parties, they can exercise control over The earlier standards can be used until then. the subsidiary.

2. Definitions  Controlling the composition of the board of directors. For example if A controls B and B controls C, the A controls C. Undertaking An undertaking is any business, either incorporated or Minority Interest (now called non-controlling interests) unincorporated. Minority interest is the part of the net assets of a subsidiary attributable to others outside the group. Parent (now called controlling interests) A parent is an undertaking that controls another undertaking. Fair value The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction Subsidiary between market participants at the measurement A subsidiary is an undertaking that is controlled by another. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 4 date. (IFRS 13) 3. Intra Group Trading Example 1 Monetary assets Parent Balance Sheet Monetary assets are money held, assets receivable, and liabilities payable, in cash or cash equivalents. Assets Liabilities Cash 400 Accounts payable 800 Uniting of Interests Accounts receivable 1000 Accruals Uniting (or pooling) of interests was an alternative method of Investments 200 Shareholders’ Funds 400 consolidation. It reflects the merger of two, or more, interests, Fixed Assets 100 Profit and loss 500 where no undertaking can be identified as the acquirer. Account IFRS 3 eliminated this method as an option for acquisitions. 1700 1700

Associate An undertaking in which the parent has significant influence, but is The parent buys 100% of the subsidiary. It pays 270 cash. neither its subsidiary, nor part of a joint venture of the parent. Then, the parent loans 100 to the subsidiary. Indications of significant influence are: Subsidiary Balance Sheet

 Ownership of 20-50% of the voting shares Assets Liabilities Cash 20 Accounts 300  Representation on the Board of Directors payable Accounts receivable 400 Joint Venture Investments 100 Fixed Assets 50 Shareholders’ 270 A joint venture is an undertaking subject to the joint control of two or Funds more enterprises. The joint control is usually governed by a contract 570 570 between the parties. Parent Balance Sheet (after acquisition & loan Intra Group Trading transaction) When the parent trades with a subsidiary, the parent’s balance sheet shows an asset/liability, and an equal, but opposite, Assets Liabilities asset/liability is shown in the balance sheet of the subsidiary. Cash 30 Accounts payable 800 Accounts receivable 1000 On consolidation, these always cancel each other out. Investments 200 Accruals 400 Investment in S 270 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 5 Loan to subsidiary 100 2000 2000 Fixed Assets 100 Shareholders’ 500 Funds 1700 1700 Note: Cash= 30+120=150 Investments= (470-270)+100 =300 Note: Cash= 400-270-100=30 The loan has been eliminated on consolidation.

Subsidiary Balance Sheet All transactions between parent and subsidiary are accounted for through the subsidiary account (in the parent’s books) and the Assets Liabilities parent account (in the subsidiaries books). Cash 120 Accounts 300 These accounts are always equal and opposite, and cancel out on payable consolidation. Accounts 400 Loan from 100 receivable Parent In the next example, the subsidiary is 100% owned and cost 270 Investments 100 cash. Fixed Assets 50 Shareholders’ 270 Funds The parent buys an investment security for 100 from a subsidiary 670 670 that paid 90 for it. No cash has been transferred between the companies to settle this transaction at the balance sheet date. Note: Cash= 20+100=120 The subsidiary shows 100 owing from the parent company and a The asset in the parent balance sheet is equal, but opposite, to the profit of 10 from the sale of the investment. liability in the subsidiary balance sheet.

Group Balance Sheet Example 2 Intra Group Profit:

Assets Liabilities Parent Balance Sheet (after acquisition) Cash 150 Accounts 1100 payable Assets Liabilities Accounts receivable 1400 Cash 30 Accounts 800 Investments 300 Accruals 400 payable Fixed Assets 150 Shareholders’ 500 Accounts receivable 1000 Funds Investments 200 Accruals 300 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 6 Investment in subsidiary 270 Cr Investments 90 Fixed Assets 100 Shareholders’ 500 Funds The Parent’s Balance Sheet shows an increase in investments of 1600 1600 100 and 100 owing to the subsidiary.

Subsidiary Balance Sheet (before transaction) Parent Balance Sheet (after transaction)

Assets Liabilities Assets Liabilities Cash 20 Accounts 300 Cash 30 Accounts payable 800 payable Accounts receivable 1000 Accounts receivable 400 Investments 300 Accruals 300 Investments 100 Investment in Subsidiary 270 Subsidiary account 100 Fixed Assets 50 Shareholders’ 270 Fixed Assets 100 Shareholders’ 500 Funds Funds 570 570 1700 1700

Note: All investments are stated at cost Note: Investments= 200+100=300

Subsidiary Balance Sheet (after transaction) The profit is not realised as far as the group is concerned so it has to be eliminated on consolidation. Assets Liabilities Cash 20 Accounts 300 payable Accounts 400 receivable Group Balance Sheet Investments 10 Assets Liabilities Parent account 100 Shareholders’ 270 Cash 50 Accounts 1100 Funds payable Fixed Assets 50 Profit 10 Accounts 1400 580 580 receivable Investments 300 Accruals 300 Fixed Assets 150 Shareholders’ 500 Notes: Funds Dr Parent account 100 1900 1900 Cr Profit 10 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 7 Note: Investments= 300-10+10=300

Details of the bookkeeping are on the next page:

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 8 Derivation of Group Parent Subsidiary Adjustments Total Figures Dr Cr Dr Cr Dr Cr Dr Cr Assets Cash 30 20 50 Accounts receivable 1000 400 1400 Investments 300 10 10 300 Investment in S 270 270 Parent Subsidiary 100 100 Fixed Assets 100 50 150

Liabilities Accounts payable 800 300 1100 Accruals 300 300

Shareholders’ Funds 500 280 280 500

TOTAL 1700 1700 580 580 280 280 1900 1900

The adjustment eliminates the investment in subsidiary, and the 10 profit created by the intra group transaction.

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 9 Example 3 Realised Intra Group Profits Subsidiary Balance Sheet (same as in the previous example) The parent buys a security for 100 from a subsidiary that paid 90 for it, as in the previous example. Assets Liabilities Cash 20 Accounts 300 Next the parent sold the investments to another client, outside the payable group, for 120. Accounts 400 receivable This means that the group profit on the transaction is Investments 10 120-90=30. Parent account 100 Shareholders’ 270 Funds This profit is realised, as it has been sold outside the group. Fixed Assets 50 Retained Earnings 10 20 of the profit is found in the parent and 10 in the subsidiary. 580 580

In this example, the subsidiary is 100% owned, and cost 270 cash, Then the parent sells the investment to a third party for 120 cash. as in the previous example. The Balance sheets are stated after both acquisition of subsidiary and the intra group purchase of the In this case, all of the profit is realised as the investment has been investment, but before sale outside the group. sold outside the group. Note that even if the subsidiary is only partly-owned, Parent Balance Sheet (same as in the previous all unrealised profit is fully eliminated on consolidation. example) Parent Balance Sheet (after Sale)

Assets Liabilities Assets Liabilities Cash 30 Accounts 800 Cash 150 Accounts 800 payable payable Accounts 1000 Accounts 1000 Accruals 300 receivable receivable Investments 300 Accruals 300 Investments 200 Subsidiary a/c 100 Investment in 270 Subsidiary 100 Investment in S 270 Shareholders’ 500 subsidiary account Funds Fixed Assets 100 Shareholders’ 500 Fixed Assets 100 Retained 20 Funds Earnings 1700 1700 1720 1720

Notes: http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 10 Cash= 30+120=150 Investments= 300-100=200

The profit is now realised by the group. In the following examples, I/B refers to Income Statement and The retained earning is the profit on sale attributable to the parent. Balance Sheet (SFP).

Group Balance Sheet (after sale) EXAMPLE 1. – partly-owned subsidiaries

Assets Liabilities Cash 170 Accounts 1100 P has a subsidiary S, of which it owns 70%. At the balance payable sheet date S has inventories that it bought from P at a cost Accounts 1400 of 100. P made a profit of 20 on the sale. receivable Investments 210 Accruals 300 As the profit was earned by the parent, all the profit is Fixed Assets 150 Shareholders’ 500 eliminated. (There is no impact on minority interests.) Funds Retained 30 I/B DR CR Earnings Revenue I 100 1930 1930 Cost of sales I 80 Inventory B 20 Notes: Reduction of group sales, cost of Cash= 150+20=170 sales and profit in P’s inventory Accounts Receivable= 1000+400= 1400 Investments= 200+10=210 Accounts payable= 800+300= 1100 EXAMPLE 2. – partly-owned subsidiaries Retained Earnings= 10+20=30 This is the parent’s profit on sale (20) and the post acquisition profit of the subsidiary (10). P has a subsidiary S, of which it owns 70%. At the balance sheet date P has inventories that it bought from S at a cost of 100. S made a profit of 20 on the sale.

I/B DR CR Intra-group profits – partly-owned subsidiaries and associates Revenue I 100 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 11 Cost of sales I 80 EXAMPLE 4. - associates Inventory B 20 Reduction of group sales, cost of sales and profit in P’s inventory P has an associate A, of which it owns 20%. At the balance Minority interests (balance sheet) B 6 sheet date P has inventories that it bought from A at a cost (30%*20) of 100. A made a profit of 25 on the sale. Minority interests (income statement) I 6 Reducing the profit related to minority interests I/B DR CR Share of income of associates I 5 EXAMPLE 3. - associates Investment in associate (20%*25) B 5 Reduction of group net income, and investment in associate P has an associate A, of which it owns 20%. At the balance sheet date A has inventories that it bought from P at a cost of 100. P made a profit of 25 on the sale. EXAMPLE - Associates and extent of inter-group elimination

Undertaking C is a 20% investor in an associate, undertaking D. As the profit was earned by the parent, the parent’s share of (see Consolidation Book 3 for accounting for associates) profit is eliminated. I/B DR CR During the year, undertaking C entered into the following Revenue (20%*100) I 20 transactions with undertaking D: Cost of sales I 15 Investment in associate (20%*25) B 5 - sale of inventory with a cost price of £100 for £200. The stock has Reduction of group sales, cost of not been sold by undertaking A at year end; and sales and investment in associate - providing management services to undertaking D and invoicing £200 for these services.

How should undertaking C account for the revenue arising from the sale of inventory and management services?

Many of the procedures appropriate to the application of the equity method are similar to the consolidation procedures. Unrealised profits and losses arising from downstream transactions http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 12 are eliminated to the extent that the investor is transacting with Undertaking E must therefore continue to eliminate the intra-group itself. While the inventory remains on the associate’s balance sheet, balances between F and the rest of the group in accordance with the associate will not be recording an expense in its income the normal consolidation requirements, and present the disposal statement. group excluding the eliminated balances.

Therefore a consolidation entry, reducing the revenue arising from The net assets of F should be presented as held for sale, excluding the sale of the inventory by £40 (£200 x 20%), is required to the intra-group balances. However, E should disclose any material eliminate the unrealised portion of the gain made in undertaking C. intra-group balances, currently eliminated on consolidation that will be disposed of, and should disclose any relevant impact such The revenue arising from the management services would not be balances may have on F’s fair value less costs to sell. adjusted, as the management services cost is realised in the associate. As undertaking D is equity- accounted for, £40 (£200 x 4. Dividends Paid out of Pre-Acquisition Profits 20%) - representing the portion of the cost relating to undertaking C - will be reflected in the consolidated financial statements of ‘Pre-acquisition’ dividends undertaking C; no further elimination entry is therefore required. During the year, a subsidiary pays a dividend to its parent in excess of its post-acquisition reserves. The parent has early adopted the EXAMPLE - Discontinued operations and intra-group balances recent amendment to IAS 27 (now IFRS 10).

Group E plans to sell one of its subsidiaries F. F meets the criteria How does the parent account for the dividend paid out of pre- in IFRS 5 to be classified as a disposal group held for sale and also acquisition profits? to be presented as discontinued. IFRS 5 requires that operations classified as held for sale are measured at the lower of carrying Dividends paid from pre-acquisition profits of a subsidiary are now value and fair value less costs to sell. recognised in profit or loss and are no longer recognised as a deduction from the investment in subsidiary. The net assets of F to be sold include various trading balances with other members of group E. However, if there is evidence of impairment, this could trigger an impairment test in terms of IAS 36, Impairment of Assets. Should these intra-group balances form part of the fair value less cost to sell of F that would be presented separately as discontinued Triggers include: in the consolidated financial statements of E? a) if the carrying amount of the investment in the subsidiary IFRS 5 does not provide guidance on the treatment of intra-group exceeds the carrying amount in the consolidated financial balances within disposal groups classified as held for sale. It does statements of the subsidiary’s net assets, including the associated not provide any relief from the requirement to apply IFRS 10. goodwill; and http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 13 b) if the dividend exceeds the total comprehensive income of the Assets Liabilities subsidiary in the period the dividend is declared. Cash 100 Accounts 800 payable Example 4 Accounts 1000 Accruals 300 Parent Balance Sheet (pre-acquisition) receivable Investments 200 Assets Liabilities Investment in S 300 Shareholders’ 500 Cash 400 Accounts 800 Funds payable Fixed Assets 100 Retained 100 Accounts 1000 Earnings receivable 1700 1700 Investments 200 Accruals 300 Fixed Assets 100 Shareholders’ 500 Funds S pays a dividend of 30, all out of pre-acquisition profits. The Retained 100 parent in its own accounts does treats this as investment income, Earnings but the value of S has fallen to 270. 1700 1700 Therefore, the investment in S has been impaired and reduced in value by 30. The impairment is recorded in the Income Statement, Subsidiary Balance Sheet (pre-acquisition) eliminating the benefit of the dividend.

Assets Liabilities The only benefit to the parent is that it receives 30 in cash. Cash 50 Accounts 300 payable Accounts 400 So, in the Parent Balance Sheet the net cost of S is reduced from receivable 300 to (300-30)=270, and cash increased from 100 to 130. Investments 100 Share Capital 270 Fixed Assets 50 Retained 30 Earnings 600 600 Subsidiary Balance Sheet(after dividend payment) The parent buys 100% of the subsidiary for 300. Assets Liabilities Parent Balance Sheet (post-acquisition) Cash 20 Accounts 300 payable http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 14 Accounts 400 receivable receivable Investments 300 Shareholders’ 500 Investments 100 Share Capital 270 Funds Fixed Assets 50 Retained 0 Fixed Assets 150 Retained 100 Earnings Earnings 570 570 2000 2000

Parent Balance Sheet (after dividend received) Notes: Cash= 20+130=150 Assets Liabilities Accounts receivable= 400+1000=1400 Cash 130 Accounts 800 Investments= 100+200=300 payable Fixed Assets= 50+100=150 Accounts 1000 Accounts payable= 300+800=1100 receivable Investments 200 Accruals 300 5. Dividends Paid out of Post-Acquisition Profits Investment in S* 270 Shareholders’ 500 Funds Dividends paid out of post-acquisition profits are income in the Fixed Assets 100 Retained 100 income statement of Parent and an expense for Subsidiary. Post- Earnings** acquisition profits may be considered to be group profits, as they 1700 1700 are made after the subsidiary becomes a member of the group.

* After recording an impairment of 30 (300-30) On consolidation these cancel out (dividends received = ** 100 + 30 dividends received – 30 impairment charge = 100 dividends paid).

Example 5 Minority Interest and Dividends Paid from Consolidated Balance Sheet Pre- and Post- Acquisition Profits

Assets Liabilities Cash 150 Accounts 1100 Parent Balance Sheet (before acquisition of payable subsidiary) Accounts 1400 Accruals 300 Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 15 Cash 400 Accounts 800 payable Inventory 1000 Accruals 300 S pays a dividend of 30, all out of pre-acquisition profits. Investments 200 Share Capital 500 Fixed Assets 100 Retained 100 P owns 60% of S. P receives a dividend of 18 (60% of 30), paid out Earnings of pre-acquisition profits. 1700 1700 On consolidation this is treated as a return of capital (purchase price) but in the parent balance sheet it is treated as investment income.

So, the net investment cost of S is reduced from 300 to 282 (300- Subsidiary Balance Sheet (before acquisition) 18) – an impairment. Assets Liabilities Cash 50 Accounts 300 S’s retained earnings are reduced from 30 to 0. payable Inventory 400 The remaining 12 of dividend will be paid to the minority interest Investments 100 Share Capital 270 and reduces the value of the minority interest in the consolidated Fixed Assets 50 Retained 30 balance sheet. Earnings 600 600

The parent buys 60% of the subsidiary for 300 cash.

Parent Balance Sheet (after acquisition) Assets Liabilities Cash 100 Accounts 800 Subsidiary Balance Sheet (after dividend payment) payable Inventory 1000 Assets Liabilities Investments 200 Accruals 300 Cash 20 Accounts 300 Investment in S 300 Share Capital 500 payable Fixed Assets 100 Retained 100 Inventory 400 Earnings Investments 100 Share Capital 270 1700 1700 Fixed Assets 50 Retained 0 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 16 Earnings Inventory= 1000+400=1400 570 570 Investments= 200+100=300 Goodwill= P has paid 300 for 60% of the assets of S (60% of (270+30) = 180) Parent Balance Sheet (after receipt of dividend) so goodwill= 300-180=120 Accounts payable= 800+300=1100 Assets Liabilities Minority Interest= 40%of 300 less dividend of 12= 108 Cash 118 Accounts 800 payable The subsidiary then makes a profit of 100, (post-acquisition profits) Inventory 1000 Accruals 300 which it pays out as a cash dividend. The parent company’s Investments 200 Share Capital 500 balance sheet had not changed since receiving the first dividend. S investment 282 Fixed Assets 100 Retained 100 Parent Balance Sheet Earnings 1700 1700 Assets Liabilities Cash 178 Accounts 800 payable Consolidated Balance Sheet Inventory 1000 Investments 200 Accruals 300 Assets Liabilities S investment 300 Cash 138 Accounts 1100 Fixed Assets 100 Share Capital 500 payable Retained 178 Inventory 1400 Earnings Investments 300 Accruals 300 1760 1760

Minority Interest 108 Notes: Fixed Assets 150 Share Capital 500 Cash (plus dividend)= 118+60%(100)=178 Goodwill 120 Retained 100 Retained Earnings= 118+60%(100)=178 Earnings Subsidiary Balance Sheet (after 2nd dividend 2108 2108 payment- no change. All profits paid out in dividends)

Notes Assets Liabilities Cash= 118+20=138 Cash 20 Accounts 300 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 17 payable Example 6 Inventory 400 Parent Balance Sheet (before acquisition) Investments 100 Share Capital 270 Fixed Assets 50 Retained 0 Assets Liabilities Earnings Cash 300 Accounts 800 570 570 payable Inventory 1000 The dividend of 100 of post-acquisition profits is spilt between Investments 200 Accruals 300 the parent (60) and minority interests (40). Fixed Assets 100 Shareholders’ 500 As it is paid in cash, no change is made to minority interests in the Funds consolidated balance sheet. 1600 1600 Consolidated Balance Sheet

Assets Liabilities Subsidiary Balance Sheet (before acquisition) Cash 198 Accounts 1100 payable Assets Liabilities Inventory 1400 Cash 20 Accounts payable 300 Investments 300 Accruals 300 Inventory 400 Minority Interest 108 Investments 100 Fixed Assets 150 Share Capital 500 Fixed Assets 50 Shareholders’ 270 Goodwill 120 Retained 160 Funds Earnings 570 570 2168 2168 P buys 100% of S for 270 Cash. Notes: Retained earnings= 178-18(dividend from pre-acquisition)= 160 P sells a fixed asset to S for cash. All post acquisition profits paid as cash dividend Details of the asset are: Cost 20 6. Intra-Group Asset Sales Net Book Value at date of sale 5 Sale Price 12 Profit=7 (12-5) Parent Balance Sheet (after sale of asset and S Any profits or losses, on the sale of assets to other group members, purchase) must be cancelled out on consolidation. Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 18 Cash 42 Accounts 800 Funds payable Fixed Assets 150 Profit 0 Inventory 1000 1900 1900 Investments 200 Accruals 300 S investment 270 Shareholders’ 500 Funds Notes: Cash= 42+8=50 Fixed Assets 95 Profit on asset 7 Inventory= 1000+400=1400 sale Investments= (470-270)+100=300 1607 1607 Fixed Assets= 95+62-7=150 Accounts Payable= 800+300=1100 Notes: Shareholders’Funds= (507-7)+(270-270)= 500 Cash= 300-270+12=42 Fixed Assets= 100-5=95 Subsidiary Balance Sheet (after purchase of asset)

Assets Liabilities Cash 8 Accounts 300 payable Inventory 400 Investments 100 Fixed Assets 62 Shareholders’ 270 Funds 7. Vertically Integrated Groups 570 570 Parent Notes: owns 70% of S1 Cash= 20-12=8 Fixed Assets= 50+12=62 S1 owns 60% of S2

Consolidated Balance Sheet P owns (60% of 70%) = 42% of S2, but since P controls S1 and it in Assets Liabilities turn controls S2, P effectively controls S2 and its results should be Cash 50 Accounts 1100 consolidated with P. payable Inventory 1400 Accruals 300 So a subsidiary is consolidated if the parent holding is greater than Investments 300 Shareholders’ 500 50%, or if the parent has effective control through a subsidiary. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 19 Example 7 Assets Liabilities Cash 10 Accounts 300 Parent Balance Sheet(before acquisition) payable Inventory 300 Assets Liabilities Investments 80 Cash 300 Accounts 800 Fixed Assets 30 Shareholders’ 120 payable Funds Inventory 1000 420 420 Investments 200 Accruals 300 Fixed Assets 100 Shareholders’ 500 Funds 1600 1600

Parent buys 60% of Subsidiary 1 for 200, and pays cash.

Consolidated Balance Sheet - S1 Group Subsidiary 1 Balance Sheet (before acquisition) Assets Liabilities Assets Liabilities Cash 30 Accounts 700 Cash 120 Accounts 400 payable payable Inventory 700 Inventory 400 Investments 180 Investments 100 Fixed Assets 80 Minority Interest 36 Fixed Assets 50 Shareholders’ 270 Goodwill 16 Shareholders’ 270 Funds Funds 670 670 1006 1006

Subsidiary 1 buys 70% of Subsidiary 2 for 100, and pays cash. Notes: Cash= (120-100)+10=30 Subsidiary 2 Balance Sheet (before acquisition) Inventory= 400+300=700 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 20 Investments= 100+80=180 Fixed Assets= 50+30 = 80 In practice, there are common adjustments that need to be made to Goodwill= 100 – (70% of 120)=16 eliminate inter-company income, expenses, profits, dividends etc. Accounts Payable= 400+300=700 Minority Interest = 30% of 120=36 Also, retained profits must be split into pre- and post-acquisition, as in prior examples. Consolidated Balance Sheet - P Group

Assets Liabilities Cash 130 Accounts 1500 payable Inventory 1700 Investments 380 Accruals 300 Fixed Assets 180 Minority Interest 144 Goodwill 54 Shareholders’ 500 Funds 2444 2444

Notes: Cash= (300-200)+30=130 Inventory= 1000+700=1700 Investments= 200+180=380 Fixed Assets= 100+80 Goodwill= 38+16=54 200-(60%of 270)=38 Accounts= 800+700=1500 Minority Interest= (40% of 270)+36=144

8. Consolidated Income Statements

In theory, the income statement of a 100% owned subsidiary can be added directly to the income statement of the parent to give a consolidated result. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 21 Example 8

In the following example, Intra Group transactions need to be eliminated. They are: Sales / Purchases 600 Distribution recharge/distribution cost 220 Finance recharge/finance cost 60

The impact of these adjustments is to reduce sales and cost of sales. Recharges at cost have no overall impact, unless the recharge and the cost appear on different lines in the financial statements. If a subsidiary is sold during the period, the consolidated income statements should only include the subsidiary’s figures up to the date of disposal. Parent Company Subsidiary Adjustments Consolidated Income Income Income Statement Statement Statement DR CR DR CR DR CR DR CR

Sales 16000 5000 600 20400

Cost of Sales 7500 2400 600 9300 Distribution Costs 1800 500 220 220 2300 Administrative Expenses 3200 1000 4200 Finance Costs 1100 800 60 60 1900

Profit before tax 2400 300 2700 16000 16000 5000 5000 880 880 20400 20400 . http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 22 In the next example, the subsidiary was bought halfway through the accounting period.

The subsidiary’s accounts cover the entire period, so the adjustments represent the elimination of pre-acquisition profits.

No inter-company sales, nor recharges, were made.

Parent Company Subsidiary Adjustments Consolidated Income (Pre- Income Statement Statement Acquisition) Income Statement DR CR DR CR DR CR DR CR

Sales 16000 9000 4740 20260

Cost of Sales 7500 4300 2160 9640 Distribution Costs 1800 800 430 2170 Administrative Expenses 3200 1800 920 4080 Finance Costs 1100 700 375 1425

Profit before tax 2400 1400 855 2945

16000 16000 9000 9000 4740 4740 20260 20260

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 23 9. Multiple Choice Questions 1) Not be included. 2) Include the subsidiary’s figures up to the date of disposal. Choose the correct answer: 3) Show pre-disposal and post-disposal results separately.

1. In the consolidated accounts, Profit on Intra Group Asset Sales:

1) Must be capitalised and depreciated over the life of the asset. 2) Must be shown separately. 3) Must be eliminated.

2. If a parent company has only a minority of an undertaking’s shares, but has effective control through a subsidiary, the correct consolidation of the undertaking treatment is:

1) Joint venture. 2) Associate. 3) Subsidiary.

3. The income statement of a 100% owned subsidiary can be added, without adjustment, to the income statement of the parent to give a consolidated result. This is,

1) Generally true. 2) Generally false.

4. Retained profits must be:

1) Analysed by subsidiary. 2) Split into pre- and post-acquisition profits.

5. If a subsidiary is sold during the period, the consolidated income statements should: http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 24 The parent buys 100% of the subsidiary. It pays 400 cash. 10. Exercise Questions Instructions: In each of the following examples complete the blank Then, the parent loans 200 to the subsidiary. boxes with your own figures. Parent Balance Sheet (after acquisition & loan transaction) 1. Intra Group Trading Company: Loan from parent Assets Liabilities Parent Balance Sheet (before acquisition) Cash 200 Accounts 800 payable Assets Liabilities Accounts 600 Cash 800 Accounts payable 800 receivable Accounts 600 Accruals 400 Investments 200 Accruals 400 receivable Investment in S 400 Investments 200 Shareholders’ 500 Loan to subsidiary 200 Funds Fixed Assets 100 Shareholders’ 500 Fixed Assets 100 Profit and loss Funds Account 1700 1700 1700 1700 Subsidiary Balance Sheet (after acquisition & loan transaction) Subsidiary Balance Sheet (before acquisition) Assets Liabilities Assets Liabilities Cash Accounts Cash 20 Accounts 170 payable payable Accounts Loan from Accounts 400 receivable Parent receivable Investments Investments 100 Fixed Assets Shareholders’ Fixed Assets 50 Shareholders’ 400 Funds Funds 570 570 Group Balance Sheet

Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 25 Cash Accounts Cash 20 Accounts 70 payable payable Accounts Accounts 400 receivable receivable Investments Accruals Investments 100 Fixed Assets Shareholders’ Fixed Assets 50 Shareholders’ 500 Funds Funds 570 570

2. Intra Group Trading: Buying an asset (investment) In this example, the subsidiary is 100% owned and cost 500 cash. Parent Balance Sheet (before acquisition) The parent buys an investment security for 200 from a subsidiary Assets Liabilities that cost 90. Cash 900 Accounts payable 600 Accounts 400 So the subsidiary makes a profit of 110 but the group profit is zero receivable as no group profit is made until the sale is made outside the group. Investments 200 Accruals 300 Fixed Assets 100 Shareholders’ 700 Funds No money has been transferred between the companies to Profit and loss settle this transaction at the balance sheet date. Account 1600 1600

Subsidiary Balance Sheet (before acquisition)

Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 26 Assets Liabilities Parent Balance Sheet (after acquisition and purchase transaction) Cash Accounts payable Assets Liabilities Accounts Cash 400 Accounts 600 receivable payable Investments Accruals Accounts 400 Fixed Assets Shareholders’ receivable Funds Investments 400 Accruals 300 Investment in 500 Subsidiary 200 Subsidiary account Fixed Assets 100 Shareholders’ 700 Funds 1800 1800

Subsidiary Balance Sheet (after acquisition and purchase)

Assets Liabilities Cash Accounts payable Accounts receivable Investments Parent account Shareholders’ Funds Fixed Assets Profit

Group Balance Sheet http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 27 3. Intra Group Trading: Buying securities more than book the securities to another company, outside the group, for 300 value and sold outside the group at a profit. cash. Parent Balance Sheet (after acquisition and purchase) Parent Balance Sheet (before acquisition) Assets Liabilities Assets Liabilities Cash Accounts Cash 900 Accounts 600 payable payable Accounts Accruals Accounts 400 Accruals receivable receivable Investments Subsidiary a/c Investments 200 Shareholders’ 300 Funds Investment in S Shareholders’ Fixed Assets 100 Profit and loss 700 Funds Account Fixed Assets Retained 1600 1600 Earnings

Subsidiary Balance Sheet (before acquisition) Subsidiary Balance Sheet (after acquisition) Assets Liabilities Cash 20 Accounts 70 Assets Liabilities payable Cash Accounts Accounts receivable 400 payable Investments 100 Accounts Fixed Assets 50 Shareholders’ 500 receivable Funds Investments 570 570 Fixed Assets Shareholders’ Funds

The parent buys the subsidiary for 500. The parent buys securities from the subsidiary for 200 that Group Balance Sheet cost 90. No cash is paid by the parent. Next the parent sold on http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 28 Assets Liabilities Accounts receivable 400 Cash Accounts Investments 100 Shareholders’ 400 payable Funds Accounts Accruals Fixed Assets 50 Retained profit 100 receivable 600 600 Investments Shareholders’ Funds Fixed Assets Retained The parent buys 100% of the subsidiary for 500 and S pays a Earnings dividend of 40, all out of pre-acquisition profits.

Subsidiary Balance Sheet (after dividend payment)

4. Dividends Paid by subsidiary from Pre-Acquisition Profits Assets Liabilities Cash 10 Accounts 100 Parent Balance Sheet (before acquisition) payable Accounts 400 Assets Liabilities receivable Cash 600 Accounts 800 Investments 100 Share Capital 400 payable Fixed Assets 50 Retained 60 Accounts 800 Accruals 100 Earnings receivable 560 560 Investments 200 Shareholders’ 300 Funds Fixed Assets 100 Retained 500 Earnings 1700 1700

Subsidiary Balance Sheet (before acquisition)

Assets Liabilities Cash 50 Accounts 100 payable http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 29 Parent Balance Sheet (after acquisition) Assets Liabilities Cash Accounts Assets Liabilities payable Cash 100 Accounts 800 Accounts Accruals payable receivable Accounts 800 Investments Shareholders’ receivable Funds Investments 200 Accruals 100 Fixed Assets Retained Investment in S 500 Shareholders’ 300 Earnings Funds Fixed Assets 100 Retained 500 Earnings 1700 1700 Dividends paid out of pre-acquisition profits are treated as income (eliminated by an impairment charge of the same amount, though they are a return of cash to the parent of part Parent Balance Sheet (after acquisition and receipt of of the price paid and so reduce the cash outflow. dividend) Example 5 Dividends Paid by subsidiary from Post-Acquisition Assets Liabilities Profits Cash Accounts payable The parent had bought 75% of the subsidiary for 700. The net Accounts Accruals assets of the subsidiary were worth 800 at the date of receivable acquisition. Investments Investment in S Shareholders’ Funds Fixed Assets Retained Earnings

Parent Balance Sheet (after acquisition)

Assets Liabilities Consolidated Balance Sheet http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 30 Cash 0 Accounts 800 Cash Accounts payable payable Inventory 1000 Accruals 300 Inventory Accruals Investments 100 Investments Minority Interest S investment 700 Share Capital 750 Fixed Assets Share Capital Fixed Assets 100 Retained 50 Goodwill Retained Earnings Earnings 1900 1900

6. Intra-Group Asset Sales Subsidiary Balance Sheet (after acquisition but before dividend) Parent Balance Sheet (before acquisition) Assets Liabilities Cash 320 Accounts payable 400 Assets Liabilities Inventory 400 Cash 300 Accounts 800 Investments 100 Share Capital 800 payable Fixed Assets 680 Post-Acquisition 300 Inventory 1000 profits Investments 200 Accruals 300 1500 1500 Fixed Assets 100 Shareholders’ 500 Funds 1600 1600 A dividend of 200 is paid entirely out of post acquisition profits.

The dividend is paid in cash and spilt between the parent (75%) and minority interests (25%).

Post acquisition profits of 100 remain in the subsidiary, 75 attributable to the parent and 25% attributable to minority interests. Subsidiary Balance Sheet (before acquisition)

Consolidated Balance Sheet Assets Liabilities Cash 80 Accounts 320 Assets Liabilities payable http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 31 Inventory 340 Funds Investments 100 Fixed Assets 150 Profit Fixed Assets 50 Shareholders’ 250 1920 1920 Funds 570 570 Subsidiary Balance Sheet(after purchase of asset)

Assets Liabilities The Parent buys 100% of S for 250 Cash. Cash Accounts payable Inventory The parent then sells a fixed asset to S for cash. The asset cost the Investments parent 30 and the Net Book Value at date of sale is10. Fixed Assets The asset is sold for 25 giving a profit of 15 to P.

Parent Balance Sheet (after sale of asset and S purchase) Consolidated Balance Sheet

Assets Liabilities Assets Liabilities Cash Accounts Cash Accounts payable payable Inventory Accruals Inventory Accruals Investments S Investments Shareholders’ Investment Shareholders’ Funds Funds Fixed Assets Profit Fixed Assets Profit from sale

7. Vertical Integration and Minority Interest Consolidated Balance Sheet Parent Balance Sheet Assets Liabilities Cash 130 Accounts 1120 Assets Liabilities payable Cash 1000 Accounts 500 Inventory 1340 Accruals 300 payable Investments 300 Shareholders’ 500 Inventory 300 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 32 Investments 200 Accruals 300 Subsidiary 1 buys 80% of Subsidiary 2 for 190, and pays cash. Fixed Assets 100 Shareholders’ 800 Funds Subsidiary 2 Balance Sheet 1600 1600 Assets Liabilities Cash 10 Accounts 220 Parent buys 75% of Subsidiary1 for 350 cash. payable Inventory 300 Investments 80 Subsidiary 1 Balance Sheet Fixed Assets 30 Shareholders’ 200 Funds Assets Liabilities 420 420 Cash 400 Accounts 270 payable Inventory 120 Investments 100 Consolidated Balance Sheet - S1 Group Fixed Assets 50 Shareholders’ 400 Funds Assets Liabilities 670 670 Cash Accounts payable Inventory Investments Fixed Assets Minority Interest Goodwill Shareholders’ Funds

Consolidated Balance Sheet - P Group http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 33 Assets Liabilities Cash Accounts payable Inventory Investments Accruals Fixed Assets Minority Interest Goodwill Shareholders’ Funds

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 34 8.Adjustments to the Income Statement Intra Group transactions need to be eliminated. Only transactions outside the group should be reflected in the consolidated statement.

Group transactions are: 1. Sales by Parent to Subsidiary - 2000 on which the Parent made a profit of 500. The cost of sales was 1300 and distribution was 200. 2. Finance charges were incurred by the Parent on behalf of the Subsidiary of 200

Parent Company Subsidiary Adjustments Consolidated

Income Income Income Statement Statement Statement DR CR DR CR DR CR DR CR

Sales 16000 5000

Cost of Sales 7500 2400 Distribution Costs 1800 500 Administrative Expenses 3200 1000 Finance Costs 1100 800

Profit before tax 2400 300

16000 16000 5000 5000

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 35 9. Acquisition part way through the accounting period The parent acquired the subsidiary halfway through the accounting period.

The subsidiary’s financial statements cover the entire period, so the adjustments represent the elimination of pre-acquisition profits.

Assume that exactly half of the subsidiary’s results occurred before the acquisition.

Income Income (Pre- Income Statement Statement Acquisition) Statement DR CR DR CR DR CR DR CR

Sales 16000 9000

Cost of Sales 7500 4300 Distribution Costs 1800 800 Administrative Expenses 3200 1800 Finance Costs 1100 700

Profit before tax 2400 1400

16000 16000 9000 9000

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 36 11. Solutions Assets Liabilities Cash 20 Accounts 170 Answers to Multiple Choice Questions: payable Accounts 400 1. 3) receivable Investments 100 2. 3) Fixed Assets 50 Shareholders’ 400 3. 2) Funds 570 570 4. 2) 5. 2) The parent buys 100% of the subsidiary. It pays 400 cash. 1. Intra Group Trading Company: Loan from parent Then, the parent loans 200 to the subsidiary.

Parent Balance Sheet (before acquisition) Parent Balance Sheet (after acquisition & loan transaction) Assets Liabilities Cash 800 Accounts payable 800 Assets Liabilities Accounts 600 Accruals 400 Cash 200 Accounts 800 receivable payable Investments 200 Shareholders’ 500 Accounts 600 Funds receivable Fixed Assets 100 Profit and loss Investments 200 Accruals 400 Account Investment in S 400 1700 1700 Loan to subsidiary 200 Fixed Assets 100 Shareholders’ 500 Funds 1700 1700

Subsidiary Balance Sheet (after acquisition & loan transaction) Subsidiary Balance Sheet (before acquisition) http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 37 Assets Liabilities Accounts 400 Accruals 300 Cash 220 Accounts 170 receivable payable Investments 200 Shareholders’ 700 Accounts 400 Loan from 200 Funds receivable Parent Fixed Assets 100 Profit and loss 0 Investments 100 1600 1600 Fixed Assets 50 Shareholders’ 400 Funds 770 770 Subsidiary Balance Sheet (before acquisition)

Assets Liabilities Group Balance Sheet Cash 20 Accounts 70 payable Assets Liabilities Accounts 400 Cash 420 Accounts payable 970 receivable Accounts 1000 Investments 100 receivable Fixed Assets 50 Shareholders’ 500 Investments 300 Accruals 400 Funds Fixed Assets 150 Shareholders’ 500 570 570 Funds 1870 1870 In this example, the subsidiary is 100% owned and cost 500 cash.

The parent buys an investment security for 200 from a subsidiary Cash (P200+S220)=420 A/R (P600+S400)=1000 that cost 90. So the subsidiary makes a profit of 110 but the group Investments (P200+S100)=300 profit is zero as no group profit is made until the sale is made outside the group. FA (P100+S50)=150 A/P (P800+S170)=970 No money has been transferred between the companies to settle 2. Intra Group Trading: Buying an asset (investment) this transaction at the balance sheet date. Parent Balance Sheet (before acquisition) Parent Balance Sheet (after acquisition and Assets Liabilities purchase transaction) Cash 900 Accounts 600 payable Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 38 Cash 400 Accounts 600 Fixed Assets 150 Shareholders’ 700 payable Funds Accounts 400 1670 1670 receivable Investments 400 Accruals 300 Investment in S 500 Subsidiary 200 account Cash (P400+S20)=420 A/R (P400+S400)=800 Fixed Assets 100 Shareholders’ 700 Investments (P400+S10-110)=300 Funds FA (P100+S50)=150 A/P (P600+S70)=670 1800 1800

Subsidiary Balance Sheet (after acquisition and purchase transaction)

Assets Liabilities Cash 20 Accounts 70 payable Accounts 400 receivable Investments 10 Parent account 200 Shareholders’ 500 Funds Fixed Assets 50 Profit 110 680 680

Group Balance Sheet

Assets Liabilities Cash 420 Accounts 670 payable Accounts 800 receivable Investments 300 Accruals 300 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 39 3. Intra Group Trading: Buying an asset (securities) It is Next the parent sold on the investments to another client, outside bought for more than book value and sold outside the group at the group, for 300 cash. The net profit to the group is 210 (300-90). a profit. For consolidation all inter company transactions must be eliminated. No profit is made until a sale is made outside the group. Parent Balance Sheet (before acquisition) Parent Balance Sheet (after acquisition and purchase)

Assets Liabilities Assets Liabilities Cash 900 Accounts 600 Cash 400 Accounts 600 payable payable Accounts 400 Accruals Accounts 400 Accruals 0 receivable receivable Investments 200 Shareholders’ 300 Investments 400 Subsidiary a/c 200 Funds Investment in S 500 Shareholders’ 300 Fixed Assets 100 Retained 700 Funds Earnings Fixed Assets 100 Retained 700 1600 1600 Earnings 1800 1800 Cash (900-500)= 400 Subsidiary Balance Sheet (before acquisition) Investments (200+200)= 400 Investments in S (0+500)= 500 Assets Liabilities Cash 20 Accounts 70 payable Accounts receivable 400 Investments 100 Fixed Assets 50 Shareholders’ 500 Funds 570 570

The Parent buys 100% of the Subsidiary for cash of 500. The parent buys from a subsidiary, a security for 200 that cost 90. No settlement takes place. Subsidiary Balance Sheet (after acquisition and sale) http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 40 Assets Liabilities Retained earnings (P700+(P300-P200)+(S200-S90))=910 Cash 20 Accounts 70 Example 4 Dividends Paid by subsidiary from Pre-Acquisition payable Profits Accounts 400 receivable Parent Balance Sheet (before acquisition) Parent a/c 200 Investments 10 Shareholders’ 500 Funds Assets Liabilities Fixed Assets 50 Retained 110 Cash 600 Accounts 800 Earnings payable 680 680 Accounts 800 Accruals 100 receivable Investments = 100-90 = 10 Investments 200 Shareholders’ 300 Retained earnings = 0+(200-90) = 110 Funds Fixed Assets 100 Retained 500 Group Balance Sheet Earnings 1700 1700 Assets Liabilities Cash 720 Accounts 670 payable Subsidiary Balance Sheet (before acquisition) Accounts 800 Accruals 0 receivable Assets Liabilities Investments 210 Shareholders’ 300 Cash 50 Accounts 100 Funds payable Fixed Assets 150 Retained 910 Accounts receivable 400 Earnings Investments 100 Shareholders’ 400 1880 1880 Funds Fixed Assets 50 Retained profit 100 600 600

Cash (P400+S20+P300)=720 A/R (P400+S400)=800 The parent buys 100% of the subsidiary for 500 and S pays a cash Investments (P400-P200+S10)=210 FA (P100+S50)=150 dividend of 40, all out of pre-acquisition profits. A/P (P600+S70)=670 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 41 Dividends paid out of pre-acquisition profits are treated as income Cash 150 Accounts 900 though they are matched by an impairment charge. They reduce payable the cash cost of the investment in the Subsidiary. Accounts 1200 Accruals 100 Parent Balance Sheet (after acquisition and receipt of receivable dividend) Investments 300 Shareholders’ 300 Funds Assets Liabilities Fixed Assets 150 Retained 500 Cash 140 Accounts 800 Earnings payable 1800 1800 Accounts 800 receivable Investments 200 Accruals 100 Investment in S 460 Shareholders’ 300 Cash (P140+S10)=150 A/R (P800+S400)=1200 Funds Investments (P200+S100)=300 FA (P100+S50)=150 Fixed Assets 100 Retained 500 A/P (P800+S100)=900 SF 500. Earnings 1700 1700

Subsidiary Balance Sheet (after dividend payment)

Assets Liabilities Cash 10 Accounts 100 payable Accounts 400 receivable Investments 100 Share Capital 400 Fixed Assets 50 Retained 60 Earnings 560 560

Consolidated Balance Sheet

Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 42 Example 5 Dividends Paid by subsidiary from Post-Acquisition Profits Post acquisition profits of 100 remain in the subsidiary, 75% The parent has bought 75% of the subsidiary for 700. The net attributable to the parent and 25% attributable to minority interests. assets of the subsidiary were worth 800 at the date of acquisition.

Parent Balance Sheet (after acquisition but before Parent Balance Sheet (after acquisition, after dividend) dividend)

Assets Liabilities Assets Liabilities Cash 0 Accounts 800 Cash 150 Accounts 800 payable payable Inventory 1000 Accruals 300 Inventory 1000 Accruals 300 Investments 100 Investments 100 S investment 700 Share Capital 750 S investment 700 Share Capital 750 Fixed Assets 100 Retained 50 Fixed Assets 100 Retained 200 Earnings Earnings 1900 1900 2050 2050

Subsidiary Balance Sheet (after acquisition but Subsidiary Balance Sheet (after acquisition, after before dividend) dividend)

Assets Liabilities Assets Liabilities Cash 320 Accounts payable 400 Cash 120 Accounts payable 400 Inventory 400 Inventory 400 Investments 100 Share Capital 800 Investments 100 Share Capital 800 Fixed Assets 680 Post-Acquisition 300 Fixed Assets 680 Post-Acquisition 100 profits profits 1500 1500 1300 1300

A dividend of 200 is paid entirely out of post acquisition profits. Consolidated Balance Sheet The dividend is paid in cash and spilt between the parent (75%) and minority interests (25%). Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 43 Cash 270 Accounts 1200 Cash 300 Accounts 800 payable payable Inventory 1400 Accruals 300 Inventory 1000 Investments 200 Minority Interest 225 Investments 200 Accruals 300 Fixed Assets 780 Share Capital 750 Fixed Assets 100 Shareholders’ 500 Goodwill 100 Retained 275 Funds Earnings 1600 1600 2750 2750

Subsidiary Balance Sheet (before acquisition) Cash (P0+150)+S320-200)=270 – The 200 is the dividend paid by S and 150 is received by P. Goodwill (75%x800)-700=100 – Calculated from Cost 700 less 75% Assets Liabilities of the net assets of S. Cash 80 Accounts 320 payable Minority Interest 25%(800+100)=225 – Minority interest is 25% Inventory 340 (Share capital + Retained Earnings- in this case, post acquisition Investments 100 profits ). Fixed Assets 50 Shareholders’ 250 Funds Retained Earnings (P50+150)+(S75%x100)=275 570 570 – Retained earning of P + only 75% of post acquisition profits of S. The parent buys 100% of S for 250 Cash.

The parent then sells a fixed asset to S for cash.

The asset cost the parent 30 and the Net Book Value at date of 6. Asset Sales within the Group sale is10. The asset is sold for 25 giving a profit of 15 to P. Parent Balance Sheet (after sale of asset and S Parent Balance Sheet (before acquisition) purchase)

Assets Liabilities Assets Liabilities http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 44 Cash 75 Accounts 800 Inventory 1340 Accruals 300 payable Investments 300 Shareholders’ 500 Inventory 1000 Accruals 300 Funds Investments S 250 Fixed Assets 150 Profit 0 Investment 200 Shareholders’ 500 1920 1920 Funds Fixed Assets 90 Profit from sale 15 1615 1615 Cash P75+S55=130 Fixed Assets P(100-10)+ S(75-15)=150 – Inter company profit of 15 Subsidiary Balance Sheet(after purchase of asset) must be eliminated Profit – There is no profit as far as the group is concerned. Assets Liabilities 7. Vertical Integration and Minority Interest Cash 55 Accounts 320 payable Subsidiary 1 Balance Sheet Inventory 340 Investments 100 Assets Liabilities Fixed Assets 75 Shareholders’ 250 Cash 400 Accounts 270 Funds payable 570 570 Inventory 120 Investments 100 Fixed Assets 50 Shareholders’ 400 Cash (80-25)Fixed Assets (50+25)=75 Funds 670 670

Subsidiary 1 buys 80% of Subsidiary 2 for 190, and pays cash.

Subsidiary 2 Balance Sheet Consolidated Balance Sheet Assets Liabilities Assets Liabilities Cash 10 Accounts 220 Cash 130 Accounts 1120 payable payable Inventory 300 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 45 Investments 80 Fixed Assets 30 Shareholders’ 200 Assets Liabilities Funds Cash 870 Accounts 990 420 420 payable Inventory 720 Consolidated Balance Sheet - S1/S2 Group Investments 380 Accruals 300 Fixed Assets 180 Minority Interest 120 Assets Liabilities Goodwill 60 Shareholders’ 800 Cash 220 Accounts 490 Funds payable 2210 2210 Inventory 420 Investments 180 Fixed Assets 80 Minority Interest 20 Cash P(1000-350)+S1/S2(220)=870 Goodwill 10 Shareholders’ 400 Funds Goodwill P(350-300)+ S1/S2(10)=60 910 910 Minority Interest P(25% of 400)+S1/S2(20)=120

Parent Balance Sheet

Assets Liabilities Cash 1000 Accounts 500 payable Inventory 300 Investments 200 Accruals 300 Fixed Assets 100 Shareholders’ 800 Funds 1600 1600

Parent buys 75% of Subsidiary 1 for 350 cash.

The P group balance sheet is constructed by combining the P balance sheet with that of the S1/S2 group

Consolidated Balance Sheet - P Group http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 46 8.Adjustments to the Income Statement Intra Group transactions need to be eliminated. Only transactions outside the group should be reflected in the consolidated statement. In this example the Parent owns 100% of Subsidiary

Group transactions are: 3. 1. Sales by Parent to Subsidiary - 2000 on which the Parent made a profit of 500. The cost of sales was 1300 and distribution was 200. The goods are unsold by the subsidiary at the reporting date. 2. Finance charges were incurred by the Parent on behalf of the Subsidiary of 200. As there is no net effect to the group, no entry is made for these finance charges. In addition to the adjustments to the income statement, In the group balance sheet would require that the inventory value is reduced by 500 for unrealised profit.

Required: Complete the Adjustment and Consolidated columns

Income Income Income Statement Statement Statement DR CR DR CR DR CR DR CR

Sales 16000 5000 2000 19000

Cost of Sales 7500 2400 1300 8600 I Distribution Costs 1800 500 200 2100 Administrative Expenses 3200 1000 4200 Finance Costs 1100 800 1900

16000 16000 5000 5000 2000 2000 19000 19000

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng CONSOLIDATION PART 2

9. Acquisition part way through the accounting period -IFRS News -Accounting Solutions The parent acquired the subsidiary halfway through the accounting period.

The subsidiary’s financial statements cover the entire period, so the adjustments represent the elimination of pre-acquisition profits.

Required: Complete the Adjustment and Consolidated columns

Income Income (Pre- Income Statement Statement Acquisition) Statement DR CR DR CR DR CR DR CR

Sales 16000 9000 4500 20500

Cost of Sales 7500 4300 2150 9650 Distribution Costs 1800 800 400 2200 Administrative Expenses 3200 1800 900 4100 Finance Costs 1100 700 350 1450

16000 16000 9000 9000 4500 4500 20500 20500

Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:

-Applying IFRS http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 48