Gary Leung www.garyleung.hk ACCA Paper P2 (HKG) Corporate Reporting- Consolidated Financial Statements (Complex) 7 Sept. 2012 Gary Leung www.garyleung.hk ACCA P2- Dec 2012 1

Contents Type of Structure Status of investments Techniques Timing of acquisitions ACCA P2- Dec 2012 2

Type of Structure A subsidiary is a company controlled by another. In practice this control might be achieved through complicated chains of control. Two common type of structure Vertical group Mixed group (“D” shaped groups) ACCA P2- Dec 2012

Vertical group P 70% P controls T through its control of S S 60% SS is the subsidiary of P SS SS can be referred to as a sub-subsidiary or indirect subsidiary ACCA P2- Dec 2012

Status of investments Status is always based on control P 70% P owns 70% of S and therefore controls it. S 60% S owns 60% of SS and SS P controls SS by controlling ∴ SS is a subsidiary ACCA P2- Dec 2012

Status of investments Effective interest in the sub-subsidiary SS is In the above illustration P effectively owns Effective interest 70% × 60% = 42% of SS. NCI (100% - 42%) = 58% This is a useful tool to bring to the consolidation but it is irrelevant in deciding the status of the investment. ACCA P2- Dec 2012

Techniques 2 possible approaches (direct or indirect) to consolidations involving sub. subsidiaries. Indirect approach (2 stages) 1. Consolidate SS into S to give the S group accounts. 2. Consolidate the S group into P. − This technique is too slow for exam purposes when it comes to dealing with sub subsidiaries. Always use the direct method. − But it must be used to consolidate sub associates. 3. In practice, consolidated accounts for complex groups are prepared in indirect approach. ACCA P2- Dec 2012

Techniques Direct Approach Carry out the consolidation using the effective rate. P P 70% 70% × 60% S = 42% 60% SS SS In effect we have changed to P P 70% 70% 42% S 60% S SS (as a subsidiary) SS ACCA P2- Dec 2012

Direct Approach- Technique Step 1 Calculate the effective holding. Step 2 Consolidate as normal subject to 2 important points Dividends are paid to real shareholders not effective shareholders. Cost of investment in the sub subsidiary [i.e. that appears in the main subsidiary’s accounts] is split: P’s share is used to calculate goodwill Cost of investment of S in SS A Less: cost of indirect non-controlling interest in SS (X)# Cost of parent ‘s investment in SS B # cost of investment of S in SS X % share from S by P the balance (A – B= X) is reduced the non-controlling interest. (i.e. cost of indirect non-controlling interest in SS) Step 3 Proceed with the consolidation as normal. ACCA P2- Dec 2012

Illustration 1 Statements of financial position as at 31 December 2011 P S T $ $ $ Cost of investment in S 700 in T 450 Other assets 1,100 900 600 1,800 1,350 600 Share capital 200 100 100 Retained earnings 1,600 1,250 500 Further information (a) P bought 70% of S two years ago when S’s retained earnings stood at $500 Later (1 year ago) S bought 60% of T when T’s retained earnings were $200. (b) The non-controlling interest is valued at their proportionate share of the subsidiary’s identifiable net assets. (c) Goodwill to the extent of $112 has been impaired in respect of the holding in S and by $37.8 in respect of the holding in T. Required: Prepare the consolidated statement of financial position of the P group as at 31 December 2011. ACCA P2- Dec 2012

Illustration 1 Consolidated statement of financial position as at 31 December 2011 $ Assets Goodwill (168 + 151.2) 319.2 Other Assets(1,100 + 900 + 600) 2,600.0 2,919.2 Share capital 200 Retained earnings 2,101.2 Non-controlling interest 618 ACCA P2- Dec 2012

Illustration 1 (W1) Group structure P P 70% S 42% NCI 58% 60% T T (W2) Net assets summary S Ltd At At consolidation acquisition Share capital 100 100 Retained earnings per Q 1,250 500 1,350 600 T Ltd per Q 500 200 600 300 ACCA P2- Dec 2012

Illustration 1 (W3) Goodwill Cost $ $ Investment in S 700 Investment in T 450 Less: indirect holding adjustments ( 450X 30%) (135) Share of net assets 70% × 600 (W3) (420) 42% × 300 (W3) (126) ------- ------- 280 189 -------- ------- Asset (balance) 168 151.2 Impaired (given) 112 37.8 (W4) Non-controlling interest $ In S 30% × 1,350 (W2) 405 In T 58% × 600 (W2) 348 S Inc’s non-controlling share of cost of investment in T (30% × 450) (135) ____ 618 ACCA P2- Dec 2012

Illustration 1 Consolidated retained earnings All of P 1,600 Share of S 70% (1,250 − 500) (W2) 525 Share of T 42% (500 − 200) (W2) 126 Goodwill (112 + 37.8)(W3) (149.8) _______ 2,101.2 ACCA P2- Dec 2012

Illustration 2 –full goodwill method The following are the statement of financial position at 31 December 2011 G Ltd A Ltd B Ltd 45,000 shares in A Ltd 65,000 30,000 shares in B Ltd 55,000 Other net assets 80,000 33,000 75,000 145,000 88,000 75,000 Share capital ($1 shares) 100,000 60,000 50,000 Retained earnings 45,000 28,000 25,000 The inter-company shareholdings were acquired on 1 Jan 2011 when the retained earnings were 10,000 and 8,000 of A Ltd and B Ltd respectively. At that date, the fair value of the non-controlling interest in A was $20,000. The fair value of the total non-controlling interest (direct and indirect) in B was $50,000. Required: Prepare the consolidated statement of financial position, assuming any goodwill has been fully impaired. It is group policy to value the non-controlling interest using the full goodwill method. ACCA P2- Dec 2012

Illustration 2 Consolidated statements of financial position as at 31 December 2011. Other net assets 188,000 Share capital 100,000 Retained earnings 39,938 NCI 48,062 188,000 ACCA P2- Dec 2012

Illustration 2 Working 1 G: G 75%, NCI 25% A: A 60%, NCI 40% B: Effective shares = 75% X 60% = 45% NCI effective shares = 100% - 45% = 55% Or 40% directly + 25% X 60% = 55% indirectly. ACCA P2- Dec 2012

Illustration 2 2) Net assets working Acquisition Balance sheet date A Ltd Share capital 60,000 60,000 P&L 10,000 28,000 70,000 88,000 B Ltd Share capital 50,000 50,000 P&L 8,000 25,000 58,000 75,000 18 ACCA P2- Dec 2012

Illustration 2 3) Working Goodwill A Ltd Purchase consideration 65,000 NCI 20,000 Less: Net assets (70,000) Goodwill 15,000 Breakdown of Goodwill Parent (65,000 – 75% x 70,000) 12,500 NCI ( 20,000 – 25% X 70,000) 2,500 B Ltd Purchase consideration 55,000 Less: indirect holding adjustment (55,000 X 25%) (13,750) NCI 50,000 Less: Net assets (58,000) Goodwill 33,250 Parent (41,250 – 58,000 X 45%) 15,150 NCI ( 50,000 – 58,000 X 55%) 18,100 19 ACCA P2- Dec 2012

Illustration 2 3) NCI working A Ltd 25% X 88,000 22,000 Less: NCI of A’s investment in B Ltd (55,000 X 25%) (13,750) B Ltd 55% X 75,000 41,250 NCI –Goodwill A 2,500 NCI – Goodwill B 18,100 70,100 Less: impairment of Goodwill A (15,000 X 25% ) (3,750) B (33,250 X 55% ) (18,288) 48,062 20 ACCA P2- Dec 2012

Illustration 2 W4) Retained Earnings Retained Earnings of G 45,000 Group share of post-acq. Profits A ( 18,000 X 75%) 13,500 B (17,00 X 45%) 7,650 Goodwill written off A ( 15,000 X 75%) (11,250) B ( 33,250 X 45%) (14,962) 39,938 ACCA P2- Dec 2012

Mixed group structures A 60% B 25% 30% C ACCA P2- Dec 2012

Mixed group structures Effective interest of C as follows: A’s direct interest in C 25% A’s indirect interest (via B) ( 60% X 30%) 18% A’s effective interest in C 43% NCI 57% ACCA P2- Dec 2012

Illustration 3 The statements of financial position of three companies are as follows: Alpha Beta Gamma $000 $000 $000 Investments 400 120 Assets 1,000 680 350 1,400 800 350 Share capital ($1) 200 100 50 Accumulated profits 800 500 200 1,000 600 250 Liabilities 400 300 100 1,400 800 350 ACCA P2- Dec 2012

Illustration 3 Alpha acquired a 80% shareholding in Beta for consideration of $350,000 Beta acquired a 60% shareholding in Gamma for consideration of $120,000 Alpha acquired a 20% shareholding in Gamma for consideration of $50,000 All the investments were made at the same date. At the date of acquisition the carrying values of the assets and liabilities were the same as the fair values. Details of the accumulated profits and the fair value of the effective NCI at acquisition are as follows: $000 Beta Gamma Beta Gamma Acc. Profits 200 75 Fair value of the effective NCI 90 50 Alpha has a policy of always calculating goodwill at Full, the impairment reviews reveal no impairment losses are to be recorded. No shares have been issued since the date of acquisition. Required Prepare the consolidated statement of financial position of the Alpha Group. ACCA P2- Dec 2012

Illustration 3 W1) Group structure Alpha 80% Beta NCI 20% Alpha 68% Gamma NCI 32% Alpha’s effective interest in Gamma Alpha’s direct interest in Gamma 20% Alpha’s indirect interest in Gamma ( 80% X 60%) 48% Alpha’s effective interest in Gamma 68% Effective NCI in Gamma 32% ACCA P2- Dec 2012

Illustration 3 W2) indirect holding adjustment There will be an indirect holding adjustment in respect of Beta’s investment in Gamma The NCI in Beta Beta’s cost of investment in Gamma 20% X $120,000 = $24,000 ACCA P2- Dec 2012

Illustration 3 W3) Net assets Beta Gamma DOA Y.E. DOA Y.E. $000 $000 $000 $000 Share capital 100 100 50 50 Acc. Profits 200 500 75 200 300 600 125 250 The post acquisition profit of Beta is $300,000 ($600,000 - $300,000) The post acquisition profits of Gamma is $125,000 ($250,000 – 125,000) ACCA P2- Dec 2012

Illustration 3 Beta’s gross goodwill $000 Cost of the investment 350 Fair value of the NCI at DOA 90 Less: net assets at DOA (300) Goodwill 140 Gamma’s gross goodwill Cost of the investment by Alpha 50 Cost of the investment by Beta 120 Less: the indirect holding adjustment (24) Fair value of the NCI at DOA 50 Less: net assets at DOA 125 Goodwill 71 ACCA P2- Dec 2012

Illustration 3 216 W4) NCI $000 Fair value of Beta at acquisition 90 Fair value of Gamma at acquisition 50 Less: the indirect holdings adjustments (24) Plus: the NCI% of Beta’s post acq. Profits ( 20% X 300) 60 Plus: the NCI% of Gamma’s post acq. Profits ( 32% X 125) 40 216 ACCA P2- Dec 2012

Illustration 3 W5) Accumulated profits $000 Parent’s accumulated profits 800 Plus the parent’s % of Beta’s post acquisition profits (80% X 300) 240 Plus the parent’s % of Gamma’s post acquisition profits (68% X 125) 85 1,125 ACCA P2- Dec 2012

Illustration 3 Alpha Group statement of financial position $000 Goodwill 211 Assets (1,000+ 680+ 350) 2,030 2,241 Share capital ($1) 200 Accumulated profits 1,125 NCI 216 Equity 1,541 Liabilities (400+ 200+ 100) 700 2,241 ACCA P2- Dec 2012

Timing of acquisitions What is the date of acquisition of the sub - subsidiary? This is important for deciding reserves of the date of acquisition. For the calculation of pre- and post-acquisition profits of SS Ltd. The date the SS Ltd comes under the control of the P Ltd is either: 1) The date P acquired S if S already holds shares in SS, or 2) If S acquires shares in SS later, then that later date. ACCA P2- Dec 2012

Illustration 4 P bought 80% of S at 31 March 2010. S bought 60% of T on 14 July 2011 Date of acquisition of T = 14 July 2011. ACCA P2- Dec 2012

Illustration 5 P bought 80% of S at 31 March 2010. S already owned 60% of T at 31 March 2009. Date of acquisition of T = 31 March 2010. ACCA P2- Dec 2012

Consolidated Statement of profit or loss and other comprehensive income These present no real problem. Calculate the effective rate and consolidate as normal. There is one complication. If the sub subsidiary has declared a dividend and the main subsidiary has accounted for its share through profit or loss this will be part of the subsidiary’s profit before tax. It must be eliminated (as a consolidation adjustment) during the non-controlling interest calculation. ACCA P2- Dec 2012

Illustration 6 P S T Consolidated Operating profit 1,200 600 500 2,300 Dividend receivable from T − 120* − − ____ ____ ____ ____ 1,200 720 500 2,300 Taxation (400) (250) (100) (750) PAT 800 470 400 1,550 Non-controlling interest (W) (278) 800 470 400 1,272 Extract from SOCIE Dividends (300) (200) *(200) (300) ACCA P2- Dec 2012

Illustration 6 P P 80% S 48% 60% NCI = 52% T T Non-controlling interest In S 20% × (470 − 120) 70 In T 52% ×400 208 ____ 278 ACCA P2- Dec 2012