GROUP FINANCIAL STATEMENTS
(CONSOLIDATION)
Definitions
• A parent is an entity that controls another
entity
• A subsidiary is an entity that is controlled by
another entity
• Control is the power to govern the financial
and operating policies of an entity so as to
obtain benefits from its activities.
• A group - Parent Company & Subsidiaries
Why consolidated group accounts?
• To show a clearer picture of the position and
profitability of a parent company and its
subsidiaries after properly making the
necessary adjustments for inter-company
dealing and transactions.
• To show how the management of the parent
company was able to utilize the assets at its
disposal to generate profit.
Why consolidated group accounts
cont…..
• Attempt to show the financial position and
earnings of a company – as if the parent
company. bought assets of the subsidiary
instead of buying the share capital.
Problems of consolidated accounts
• The loss of one company in the group might
be masked by the profits in others
• The group as a whole is not liable for the
debts of any individual group company
• The group appears to be highly geared than
their constituent companies
Control
• Is presumed when one entity acquires more
than one-half of another entity's voting rights,
unless it can be demonstrated that such
ownership does not constitute control
Control cont…..
Even if one of the entity does not acquire more
than one-half of the voting rights of another
entity, it might have obtained control of that
other entity if, as a result of the combination, it
obtains:
power over more than one-half of the voting
rights of the other entity by virtue of an
agreement with other investors; or
Control cont…..
 power to govern the financial and operating
policies of the other entity under a statute or an
agreement; or
 power to appoint or remove the majority of the
members of the board of directors or equivalent
governing body of the other entity; or
 Power to cast the majority of votes at meetings of
the board of directors or equivalent governing
body of the other entity.
Exemption from presenting
Consolidated financial
the parent is itself a wholly-owned subsidiary, or
is a partially owned subsidiary of another entity
and its other owners, including those not
otherwise entitled to vote, have been informed
about, and do not object to, the parent not
presenting consolidated financial statements;
the parent's debt or equity instruments are not
traded in a public market (a domestic or foreign
stock exchange or an over-the-counter market,
including local and regional markets);
Exemption from presenting
Consolidated financial cont…
the parent did not file, nor is it in the process of
filing, its financial statements with a securities
commission or other regulatory organization for
the purpose of issuing any class of instruments in
a public market; and
the ultimate or any intermediate parent of the
parent produces consolidated financial
statements available for public use that comply
with International Financial Reporting Standards
Group Structure
• Direct Subsidiary
H
70%
S
S is a subsidiary of H since 70% of its shares are
owned by H. The effective interest of H is also 70%
Group Structure cont….
• Indirect Subsidiary
a) Case A
H
80%
S1
70%
S2
Group Structure cont….
• S1 = Direct subsidiary of H
• S2 = Indirect subsidiary of H
S2
Controlling % = 80% of 70%
Effective Interest% = 56% (70% x 80%)
Group Structure cont….
b)Case B
H
60%
S1
70%
S2
Group Structure cont….
• H controls 70% of S2
• Effective interest is 60% x 70% = 42%
• Note that even though in Case B, the effective
interest % is only 42%, S2 is still a subsidiary of
H.
Group Structure cont….
• Mixed Group
•
•
H
20%
70%
S1
S2
40%
Group Structure cont….
S1 is a subsidiary of H
Question:
Is S2 a subsidiary of H?
Group Structure cont….
• Answer
S2 is a subsidiary of H, because H & S1 together owns 60%
of S2 (H can order S1 to vote in a certain way, therefore
they control the 40% shares in S2 through S1. 40% + 20%
of direct ownership comes to 60%).
However, Effective interest is
• Direct –
20%
• Indirect 70% x 40% - 28%
48%
Group Structure cont….
• Note that unless otherwise stated, H will be
required to consolidate the accounts of S2
even though its effective interest is less than
50%. H in collaboration with S1 (controlled by
H) have a majority voting on how S2 should be
run.
BASIC CONSOLIDATION TECHNIQUES
• The principle of commercial substance over
legal form is applied(substance over form)
i.e individual assets and liabilities are combined
because they are under the control of the
parent company
Consolidated Statement of Financial
Position
• Control is reflected by all of the assets and
liabilities of the subsidiary
• The actual ownership of the shares in the
subsidiary are reflected in an adjustment for
Non Controlling Interest in the equity section
of consolidated statement of financial position
Consolidated Statement of Financial
Position
• Step 1: Establish group structure
• Step 2:Determine net assets of subsidiary(at
the date of acquisition)
• Step 3: Determine goodwill on acquisition
• Step 4: Calculate Non Controlling Interest
• Step 5: Compute consolidated retained
earnings
Step 1: Establish group structure
• Is determined by considering ordinary shares
acquired by the parent company ONLY
• Preference shares, bonds and debentures are
not considered to determine group structure
Step 2:Determine net assets of
subsidiary(at the date of acquisition)
Recall the accounting equation:
•
A
= L + C + Reserves
•
A - L
=
C +
Reserves
Net assets =
C + Reserves
Step 2:Determine net assets of
subsidiary(at the date of acquisition)
cont…
• Reserves should be split between preacqusition reserves and post acquisition
reserves
Pre-acquisition profits/reserve represents the
net assets at the time of acquisition. To Parent
Company, this is not profit, but it is capital
Post-acquisition profits are included in the
Consolidated Profit & Loss account
Step 2:Determine net assets of
subsidiary(at the date of acquisition)
cont…
Dividends declared by subsidiary out of the preacquisition profits represent a return of capital
(not income) to parent company
Dividends declared by subsidiary out of the
post-acquisition profits represent income to
parent company
Step 3: Determine goodwill on
acquisition
Goodwill is computed by comparing
• Cost of Investment (Purchase price), and
• Net assets(at the time of acquisition)
Goodwill= Cost of Investment – Net Assets
N.B If Cost of Investment is LESS than Net
Assets of subsidiary acquired at the date of
acquisition = Negative goodwill
Example 1
Statement of Financial Positions
H Ltd
•
•
•
•
•
•
•
•
S Ltd
Assets
Investments in S Ltd
51,000
49,000
100,000
52,000
- 52,000
Ord Share Capital
Reserves
70,000
30,000
100,000
40,000
12,000
52,000
Example 1 cont…
H acquired ALL shares in S Ltd at a cost of 49,000
when S Ltd reserves were 4,000.
Determine goodwill on acquisition
Example 1 cont…
Since Net assets at time of acquisition, OSC +
pre- acquisition reserves = 44,000
• Goodwill is 49,000 – (40,000 + 4000) = 5,000
• Consolidated reserves now include those of
the H Ltd and profits made in the subsidiary
after acquisition (post-acquisition profits) =
30,000 + 8,000.
Step 4: Calculate Non Controlling
Interest
• Non controlling Interest account is credited
with their share of net assets at the date of
the Statement of Financial Position. That is,
no attempt is made to distinguish pre and
post acquisition reserves for the Non
controlling interest.
Step 5: Compute consolidated
retained earnings
• Only parent share of subsidiary’s postacquisition reserves goes to the Consolidated
reserves account to be combined with parent
company’s reserves to get total reserves to
appear in the Consolidated Statement of
Financial Position.
Intra-group transactions
a) Dividends from subsidiaries
Post-Acquisition Dividends
When dividend is declared/paid by subsidiary,
the subsidiary will
Dr. Reserves
Cr. Proposed dividends/Cash if paid
Intra-group transactions cont…
Entry in the Parent Company books.
Dr. Dividend receivable/Cash if received
Cr. Reserves
Intra-group transactions cont…
Treatment in preparing group accounts
The treatment depends on whether the
dividends have already been paid or not
If Paid
No action is required.
Intra-group transactions cont…
• If NOT PAID
, We need to ask ourselves a question
“has the Parent Company taken credit of (i.e,
recognized or recorded) the proposed
dividends in its books”?
If the answer is YES, then offset the intercompany indebtedness arising out of the
dividends payable by the subsidiary to the
Parent Company.
Intra-group transactions cont…
If the answer is NO, then the Parent Company
will need to first recognize the dividends as
follows:
Dr. Dividends receivable
Cr. Reserves
Intra-group transactions cont…
• For consolidation purposes, the intercompany indebtedness will need to be
eliminated. That means, in the consolidated
accounts, dividends payable (i.e., proposed
dividends) should only include the amount
payable to outside parties, that is, the amount
payable to Non controlling shareholders ONLY.
Intra-group transactions cont…
Pre-Acquisition Dividends
Dividends declared by subsidiary out of the preacquisition profits represent a return of capital
(not income) to parent company
Accounting entry required in parent company
Dr Cash/Dividend receivable(if not paid)
Cr Cost of investment
Intra-group transactions cont…
In Subsidiary,
Dr Pre-acquisition reserves
Cr Dividends payable
For consolidation purposes, “New” preacquisition profits will now be: pre-acquisition
profits at the time of acquisition minus
dividends out of those profits.
Intra-group transactions cont…
Note that Goodwill will not change. Why?
Because on one hand the cost of investment has
gone down by H’s share of the pre-acquisition
dividend, and on the other hand the net assets
acquired (or pre-acquisition reserves) will have
gone down by the same amount.
Inter company trading of stock
Adjustment entry for goods in transit should be
made as follows.
• If it involves the Parent Company, goods in
transit should be included in the Parent Company
books.
• If it involves two subsidiaries, the subsidiary to
which goods are headed should record the goods
in transit in its books. The resulting equal
balances in the trade debtors and trade creditors
will then be cancelled
Unrealized profit
• For consolidated accounts purposes, a
provision for unrealized stocks should be
made as follows:
Dr. Consolidated Reserve xx
Cr. Consolidated Stocks
xx
This is for wholly owned subsidiary
Unrealized profit
• For partly owned subsidiary
• Dr Consolidated retained earnings(Share of
parent) -say 90%
• Dr Non controlling interest -say 10%
Cr Consolidated inventory
Example
• P owns 90% of S. During the year S sells goods
to P at cost plus 25%.At the year end the
closing stock of P includes 8,000,000 of goods
at invoice value acquired from S. What are
consolidation adjustments needed?
INTER-COMPANY SALE OF NON
CURRENT ASSETS
• The selling company will record any gain or
loss and delete the asset (cost and applicable
accumulated depreciation) from its books
• The price paid will normally be the cost at
which the buying company will record the
asset in its book and depreciation will be
based on this figure
INTER-COMPANY SALE OF NON
CURRENT ASSETS
Important things to note:
• The cost of the asset in the consolidated
Statement of Financial Position should be that
incurred by the first owner in the group
• The depreciation expense and accumulated
depreciation should be based on the cost in (i)
above as if the sale had not taken place.
INTER-COMPANY SALE OF NON
CURRENT ASSETS
• Sale by parent
Dr Consolidated R/E
XX
Cr Non current assets
xx
• Sale by subsidiary
Dr Consolidated R/E(Group’s share of S)
XX
Dr Non Controlling Interest(NCI’s share of S) XX
Cr Non current assets
xx
Example
• Suppose that during the year the parent (P
ltd) sold a machine to subsidiary B (B Ltd) for
shs 570,000. Suppose further that the
machine was bought by A Ltd for shs 700,000
and had an accumulated depreciation of shs
252,000. Depreciation in the group is 20% on
book value. What consolidation adjustment
would be required?
Solution
• The gain on sale of shs 122,000 should be
cancelled since this is not considered a sale
from the point of view of the group. The shs
122,000 should be deducted from the group
profits.
Dr Consolidated Reserve
122,000
Cr Non current assets
122,000
Solution
• The overcharge in depreciation should be
added back to the group profits. It is found by
taking a difference between
– The depreciation recorded in B Ltd of shs 114,000,
and
– Depreciation recomputed taking shs 448,000 as
the book value, i.e., 448,000 x 20% = 89,600
– Group profit should be revised upward by shs
24,400.
Solution
• The consolidated Statement of Financial
Position should report the asset at the book
value as would have been reported if the sale
had not taken place, i.e., 448,000 – 89,600 =
358,400.
Example 3
Patel Ltd acquired 80% of the ordinary shares of
Shamo Ltd on 31st December 2004 for Tshs 20
million. On that date, Shamo Ltd financial
statements showed a share premium of TZS
4,000,000, share capital of TZS 10,000,000 and
Revenue Reserves of TZS 15,000,000.
On 1st February 2005,Shamo Ltd declared dividend
of Tshs 5,000,000 out of pre-acquisition profit.
Example 2 cont….
Required:
a. Compute goodwill or negative goodwill on
acquisition
b. Determine Non-Controlling interest and
consolidated reserve on 31 December 2005 if
on that date retained earnings for Shamo Ltd
and Patel Ltd were Tshs 18,000,000 and Tshs
31,000,000 respectively.