F7

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3 Designed to give you the knowledge and application of: D1. The concept and principles of a group D2. The concept of consolidated financial statements D3. Preparation of consolidated financial statements including an associate Section D: Business combination

4 Learning Outcomes D3: Preparation of consolidated financial statements including an associate  Preparation of consolidated statement of financial position for a simple group.  Preparation of consolidated income statement and statement of comprehensive income for s simple group.  Account for the effects in the financial statements of intra-group trading.  Account for the effects of fair value adjustments (including their effect on consolidated goodwill) to: i.depreciating and non-depreciating non-current assets ii.inventory iii.monetary liabilities iv.assets and liabilities not included in the subsidiary’s own statement of financial position, including contingent assets and liabilities.  Account for goodwill impairment.  Associate and equity accounting  Preparation of consolidated financial statements to include a single subsidiary and an associate.

5 How to prepare a CSOFP Represents the difference between:  the value of a business as a going concern and  the sum of the values of its net assets taken individually Add together like items of assets, liabilities, income and expenses of parent and subsidiary Cr P’s investment in S (P’s books) Dr share capital S (S’s books) Eliminate intra group balances/ transactions Calculate Goodwill

6 S Co 100% Non-controlling Interest 80% by P ? What if there is a partial acquisition??? Non-controlling interest Example P company pays $8000 to buy 80% shares in S company

7 Measurement of Non-controlling interest Non-controlling Interest in the acquiree can be measured at :  Fair Value  At the Non-controlling interest’s proportionate share of the acquiree’s identifiable net assets

8 Calculating Goodwill Fair Value of Consideration paidX Fair Value of NCIX (A) Total X Less: (B) Fair value of Net assets acquired (represented by) Share Capital (X) Retained Earnings (X)(X) Goodwill/(Gain on bargain purchase) XX If A > B = Goodwill If B > A = Negative goodwill (Gain on bargain purchase)

9 Pre and post acquisition reserves Pre Acquisition reserves = Reserves held by S on the date of acquisition Everything after this date is post- acquisition - so P must be given its share of these profits Goodwill calculation (date of acquisition)$ Fair value of Consideration paidX Add: Fair alue of NCIX TotalX Less: Fair value of Net assets acquired (represented by): Share capitalX Retained earningsX GoodwillX This is S’s pre-acquisition reserves

10 Accounting treatment for subsidiary’s profits Pre-acquisition profits Post-acquisition profits Non-controlling share Parent share Non-controlling share Parent share Added to Non-controlling interest, except where fair value option is used considered while determining goodwill Added to Non-controlling interest Added to accumulated reserves Accounting treatment for Pre and post acquisition reserves

11 Proforma of Consolidated retained earnings ParentSubsidiaryAssociate According to questionxxx Less: Pre- acquisition(x) Post-acquisition profitxx Less: FV adjustments (from date of acquisition to date of reporting) (x) Less: Unrealised profit adjustments(x) Balancexxx Add: share of Subsidiary (%)x Add: share of Associate (%)x To consolidated SOFPx

12 Proforma - Non-controlling interest of subsidiary$ Fair value of the non-controlling shares at the date of acquisition X Post-acquisition reserves (non-controlling share)X TotalX Proforma of Non-controlling interest

13 How to prepare a CSOCI with a non-controlling interest Add remaining consolidated (post acquisition) profit for the year to b/f reserves - Gives c/f reserves of P & S P’s share of pre acquisition reserves – transfer to goodwill calculation NCI’s share of pre/post acquisition reserves & c/f reserves – transfer to NCI in CSOFP Add together like items in individual SOCI of P and S up to “profit after tax for year” Split b/f reserves of S into: pre and post acquisition reserves Deduct non controlling interest’s share of S profit: NCI% x PAT

14 Humpty Co bought 80% of the shares of its subsidiary Dumpty Co on1/1/20X5. The statements of comprehensive income of Humpty Co and Dumpty Co for the year to 31 December 20X5 are: The entire profits for the year have been earned in the post-acquisition period only. Prepare a consolidated statement of comprehensive income for the group. Example Humpty $ Dumpty $ Turnover94,50042,000 Cost of sales(47,750)(17,750) Gross profit46,75024,250 Administrative expenses(28,150)(6,250) Profit before taxation18,60018,000 Taxation(6,200)(6,000) Profit after taxation12,40012,000 Reserves brought forward48,52018,000 Reserves carried forward60,92030,000

15 Answer Consolidated SOCI (Income statement) for the year to 31 Consolidated SOCI (Income statement) for the year to 31 December 20X5 December 20X5 $ 136,500 Cost of sales(47, ,750)(65,500) Gross profit71,000 Administrative expenses (28, ,250)(34,400) Turnover (94, ,000)36,600 Taxation(6, ,000)(12,200) Profit after taxation24,400 Share of non-controlling interest (W1)2,400 Group profit for the year22,000 Reserves brought forward (Humpty)48,520 Reserves carried forward70,520 Continued…

16 Workings W1Share of NCI in post-acquisition profits: Post-acquisition profits of Dumpty12,000 Non-Controlling interest at 20% 2,400 W2The brought forward reserves of Dumpty are not reflected in the consolidated SOCI (income statement). Continued…

17 Remove intra-group sales and purchases Account for unrealised profit if goods still in inventory: cost of sales will be increased If sale was from S to P, NCI share must be adjusted Intra group transactions : SOCI and SOFP

18 Unrealised profits in Inventory $2,000 x ½ Unrealised Profit in Black Inc’s books $1,000 Should be removed on consolidation Black Inc is the parent of Red Inc. The total sales of Black Inc for the year to 31 December 20X6 include a sale of $10,000 to Red Inc of that 50% are still in stock. There is an in-built profit of $2,000 in this sale. Continued…

19 Sale - from Black to Red $10,000 Actual cost to Black $8,000 Unrealised profit $2,000 Dr Group retained earnings (P’s reserves) $1,000 Cr Group Inventory $1,000 Being URP eliminated from inventory Profit not realised from P’s perspective Unrealised profit in inventory… parent to subsidiary Continued…

20 Removing unrealised profits in inventory In the above example of Black Inc and Red Inc, if we do not deduct the URP of $1,000 from inventory, then the figure of inventory that is reflected in the consolidated SOFP (balance sheet) is: Consolidated FS $ 36,500 Otherwise shows an inflated and misleading picture… Deducted $1,000 unrealised profit Black IncRed Inc $ Inventory25,00012,500 Individual FS

21 Sale of goods from subsidiary to Parent… Example Perfect Co buys goods costing $10,000 for $20,000 from its 75% subsidiary Semi-perfect Co on 29 December 20X6. All these goods form part of the inventory of Perfect Co as at 31 December 20X6.This means that the individual financial statements of Semi-perfect Co for the year to 31 December 20X6 include this intra-group profit of $10,000. However the group has not earned this profit and so this URP of $10,000 should be deducted from the total retained earnings of the group.

22 DrGroup total retained earnings (Parent’s share) $7,500 DrGroup total retained earnings (NCI’s share) $2,500 Cr Group inventory $10,000 Being URP eliminated from inventory Profit not realised from P’s or NCI’s perspective Sale - from S to P $20,000 (P owns 75% of S) Actual cost to S $10,000 Unrealised profit In S $10,000 P’s share of S’s profit – 75% NCI’s share of S’s profit – 25% Continued…

23 Selective Co General Co $40,000 Unrealised Profit in Selective’s books Should be removed on consolidation NBV car – group $200,000 Unrealised profits in non-current assets On 1 January 20X6 Selective Inc sells a car to its subsidiary General Inc for $240,000 at a profit of $40,000. From a group perspective, how much should the car be in the consolidated accounts?

24 Sale - from P to S $240,000 Actual cost In P $200,000 Unrealised profit $40,000 Dr Group retained earnings (P’s reserves) $40,000 Cr Car in Group SOFP $40,000 Being URP eliminated from non-current assets, from a group perspective Profit not realised from Parent’s perspective URP on NCA – P to S…

25 Sale of non current assets S to P… Sale - from S to P $240,000 Actual cost In subsidiary $200,000 Unrealised profit In subsidiary $40,000 P’s share of S’s profit – e.g. 80% NCI'S share of S’s profit – e.g. 20% Dr Group retained earnings (80%) $32,000 Dr Non-controlling Interest (20%)$ 8,000 Cr Car in Selective $40,000 Being URP eliminated from inventory Profit not realised from P’s or NCI'S perspective

26 NCA – complicating matters… Car is in General Inc at $240,000 Depreciation – charged on this amount: Excess depreciation from a consolidated perspective! Depreciation charged by parent: 240,000/5 = 48,000 Depreciation charged by subsidiary would have been: 200,000/5 = 40,000 Excess depreciation: 48,000 – 40,000 = 8,000 Dr Accumulated depreciation $8,000 Cr Group retained earnings $8,000 Being the excess depreciation on the car sold intra-group On 1 January 20X6 Selective Inc sells a car to its subsidiary General Inc for $240,000 at a profit of $40,000. The car was being depreciated over 8 years and had 5 years remaining when sold. Refer to Example on 542