CONSOLIDATED STATEMENT OF FINANCIAL POSITION CHAPTER 27 CONSOLIDATED STATEMENT OF FINANCIAL POSITION

27.1 INTRODUCTION Companies frequently acquire controlling interests in other companies Although the parent company has control over the assets and liabilities of the subsidiary, the members of the parent company do not clearly see the value which the subsidiary is having on the net assets of the group For this reason, all holding companies are generally required to prepare separate company and consolidated FS The consolidated financial statements attempt to show the position and earnings of the group However, it is important to remember that consolidation is an accounting technique; legally this ‘single entity’ does not exist

27.2 IDENTIFYING THE GROUP STRUCTURE i.e. Based upon the number of ordinary shares held P Limited purchased 60,000 shares in S Limited for €20,000. The ordinary share capital of S Limited is 100,000 shares at €1 each. Requirement How should S Limited be treated by P Limited? Solution 1. P is obviously the parent company 2. Percentage holding S Limited Group (60,000/100,000 shares) 60% Non-controlling interests 40% 100% As P Limited has > 50% (presumed control) of the shareholding of S Limited, S Limited is treated as a subsidiary.

See Chapter 27, Example 27.2: My first consolidated statement of financial position Note: This example ignores goodwill (See Section 27.3), pre-acquisition reserves (See Section 27.4) and NCI (See Section 27.5).

27.3 PREMIUM ON ACQUISITION Goodwill = the future economic benefits that are not capable of being individually identified and separately recognised Goodwill = consideration paid by parent + NCI – FV of the subsidiary’s identifiable net assets  Purchase price > value of underlying net assets = premium on acquisition (i.e. Positive goodwill) Purchase price < value of underlying net assets = gain on bargain purchase (i.e. Negative goodwill) If the difference is positive, the acquirer should recognise the goodwill as an asset If the difference is negative, the resulting gain is recognised as a bargain purchase in arriving at profit or loss for the period in the SPLOCI

Example 27.3: Positive goodwill P Limited acquired all the shares in S Limited [therefore no non-controlling interest] for €50,000 at the date of incorporation [therefore no pre-acquisition retained earnings] of S Limited. At 31 December 2012 the SFP showed: P Limited S Limited € ASSETS Sundry net assets [abbreviated format for simplicity] 110,000 200,000 Investment in S Limited [i.e. the cost] 50,000 - 160,000 EQUITY Ordinary share capital 80,000 40,000 Revenue reserves In preparing the consolidated SFP as at 31 December 2012: (a) net assets of S Limited at the date of acquisition were represented by share capital of €40,000 and the revenue reserves of €Nil*; (b) cost of investment was €50,000.

Example 27.3: Positive goodwill *Note that the reserves at the date of acquisition were €Nil because the shares were purchased at the date of incorporation of S Limited. Goodwill: € Consideration paid by parent 50,000 + non-controlling interest [n/a – 100% acquisition] - – FV of the subsidiary’s net identifiable assets (40,000) Premium on acquisition [positive goodwill] 10,000 See full solution to Example 27.3 on pages 571-574.

27.4 PRE-ACQUISITION PROFITS So far the issue of pre-acquisition reserves has been ignored (i.e.) P Limited acquired its interest at the date of incorporation of S Limited and accordingly the net assets of S Limited at the date of acquisition were represented by the share capital of S Limited since no reserves exist at date of incorporation This is now developed by introducing pre-acquisition reserves

Example 27.4: Pre-acquisition profits P Limited acquired all of the shares of S Limited after one year’s trading when its reserves were €20,000 [i.e. pre-acquisition]. The statements of financial position of the two companies at 31 December 2012 were as follows: P Limited S Limited € Assets Sundry net assets 90,000 200,000 Investment in S Limited 70,000 - 160,000 Equity Ordinary share capital 80,000 40,000 Revenue reserves In this situation, the net assets of S Limited at the date of acquisition were represented by the share capital plus reserves of S Limited at that date. It is both these amounts that are cancelled against the cost of investment in preparing the consolidated statement of financial position.

Example 27.4: Pre-acquisition profits First, calculate the goodwill/discount on acquisition: Goodwill: € Consideration paid by parent 70,000 + non-controlling interest [n/a as 100% acquisition] - − fair value of the subsidiary’s net identifiable assets [Share capital + reserves] (60,000) Premium on acquisition [positive goodwill] 10,000 See full solution to Example 27.4 on pages 574-576 – pay particular attention to the share capital and retained earnings figures.

27.5 NON-CONTROLLING INTERESTS Until now, the parent has acquired 100% of the subsidiary’s shares – this assumption is now relaxed NCI = the portion of the net results and net assets of a subsidiary attributable to interests not owned directly or indirectly by the parent See Chapter 26, Section 26.4 – IFRS 3 has an explicit option on a transaction-by-transaction basis to measure NCI at the date of acquisition at either: fair value (new method) e.g. if available, share price of NCI equity shares; or using other valuation techniques if not publicly traded or NCI’s proportionate share of the net identifiable assets of the entity acquired (old method)

NCI – old and new methods If old method used for NCI at acquisition – goodwill relates to the parent’s share only If new method used for NCI at acquisition – goodwill represents that of both the parent and NCI

Example 27.5: Non-controlling interests P Limited acquired 80% [therefore NCI = 20%] of the ordinary share capital of S Limited for €56,000 [see ‘Investment in S Limited’ below] when S Limited reserves were €20,000 [i.e. pre-acquisition]. The SFP at 31 December 2012 showed: P Limited S Limited € ASSETS Sundry net assets 104,000 200,000 Investment in S Limited 56,000 - 160,000 EQUITY Ordinary share capital 80,000 40,000 Revenue reserves

Example 27.5: Non-controlling interests Assume that the proportionate share method equates to the fair value method when measuring NCI at the date of acquisition: i.e. 20% of (€40,000 + €20,000) = €12,000. [Note: Pre- and post-acquisition reserves distinction does not apply to NCI.] The goodwill/discount on acquisition is: € Consideration paid by parent 56,000 + non-controlling interest 12,000 – FV of the subsidiary’s net identifiable assets (60,000) Premium on acquisition [positive goodwill] 8,000 The NCI in S Limited at 31 December 2012 [the reporting date]: i.e. 20% of €200,000 = €40,000. See full solution to Example 27.5 on pages 577-580 – pay particular attention to the OSC, RE and NCI figures.

Example 27.6: Gain from a bargain purchase Consolidated Statement of Financial Position as at 31 December 2012 P Limited S Limited € Assets Sundry net assets 102,000 74,000 Investment in S Limited 43,000 - 145,000 Equity Share capital (€1 shares) 100,000 50,000 Revenue reserves 45,000 24,000 P Limited acquired 37,500 shares [37,500/50,000 = 75%, therefore NCI = 25%] in S Limited at a cost of €43,000 [see ‘Investment in S Limited’ above] when S Limited’s revenue reserves were €10,000 [i.e. pre-acquisition]. Requirement Prepare the consolidated SFP as at 31 December 2012.

Example 27.6: Gain from a bargain purchase Cost of Control Account € Cost of shares held 43,000 Share capital – S 50,000 NCI (at acquisition date) 15,000 Goodwill 2,000 Revenue reserves – S 10,000 60,000 The negative goodwill of €2,000 is credited to revenue reserves (IFRS 3). Non-controlling Interest Account (at reporting date) Balance c/d 18,500 12,500 - (25% x €24,000) 6,000 Consolidated Revenue Reserves Account CoC account (75% × € 10,000) 7,500 P Limited 45,000 Non-controlling interest S Limited 24,000 57,500 Negative goodwill 71,000 Balance b/d

Example 27.6: Gain from a bargain purchase Consolidated Statement of Financial Position as at 31 December 2012 P Limited S Limited Consol. Adjs. Group SFP € Sundry net assets 102,000 74,000 - 176,000 Shares in S Limited 43,000 [see cost of control account] (43,000) 145,000 (43,000) Ordinary share capital 100,000 50,000 (50,000) [P only] 100,000 Revenue reserves 45,000 24,000 (11,500) 57,500 Non-controlling interest [€74,000 x 25%] 18,500 18,500 See full solution to Example 27.6 on pages 581-582.

27.6 PROPOSED DIVIDENDS No entitlement to ordinary dividends until they are approved at the AGM Dividends declared after the reporting date should not be recognised as liabilities unless there ‘is a legal obligation’ to receive the dividend (IAS 10 Events after the Reporting Date – See Chapter 15)

Incorrect proposed dividends Where S Limited, has ‘incorrectly’ accrued a proposed dividend in its FS and P Limited has not taken credit for its share of that dividend: DR Current liabilities – S CR Retained earnings – S   Where S Limited has ‘incorrectly’ accrued a proposed dividend in its FS and P Limited has taken credit for its share of that dividend: DR Investment income – P CR Receivables – P

Legitimately accrued dividends In the case of proposed dividends that have been ‘legitimately’ accrued, steps must be made to ensure that the: (a) parent’s share of the proposed dividend of the subsidiary is not included in the group SFP as it represents an inter-company liability and only the amount due to the NCI is accrued; (b) correct reserves figure of the subsidiary is used for the purposes of calculating NCI. If a subsidiary has legitimately accrued proposed dividends at the year-end, it is important to ascertain whether the parent has taken credit for its share or not.

Example 27.7: Parent has taken credit P Limited owns 80% of the ordinary shares of S Limited, a company that has legitimately accrued a proposed dividend at the reporting date. However, P Limited has taken credit for its share of that dividend. Extracts from Statements of Financial Position as at 31 December 2012 P Limited S Limited Current Assets € Dividends receivable 40,000 - Current Liabilities Proposed ordinary dividends 100,000 50,000 The proposed dividends were approved by the shareholders prior to 31 December 2012. Solution 80% of S Limited’s dividend (€40,000) is owed to P Limited and should be eliminated on consolidation. The remainder of S Limited’s dividend is due to the NCI (€10,000) and should be disclosed in the consolidated SFP under current liabilities along with the proposed dividend of P Limited. Journal Adjustment: Jnl 1 DR Proposed dividends CR Dividends receivable To cancel the intragroup dividend See full solution to Example 27.7 on pages 583-584.

Example 27.8: Parent has not taken credit P Limited owns 80% of the ordinary shares of S Limited, a company that has legitimately accrued a proposed dividend at the reporting date. However, P Limited has not taken credit for its share of that dividend. Extracts from Statements of Financial Position as at 31 December 2012 P Limited S Limited Current Liabilities € Proposed ordinary dividends 100,000 50,000 The proposed dividends were approved by the shareholders prior to 31 December 2012. Solution Bring in the dividend receivable into P Limited’s accounts; Cancel the inter-group dividend; and The remainder of S Limited’s dividend is due to the NCI. Journal Adjustments: Jnl 1 DR Dividends receivable 40,000 CR P Limited - SPLOCI Jnl 2 DR Proposed dividends CR Dividends receivable See full solution to Example 27.8 on pages 584-585.

27.7 DIVIDENDS OUT OF PRE-ACQUISITION PROFITS When P acquires S, company law dictates that the reserves of S at the date of acquisition are ‘frozen’ (i.e.) if a dividend is paid by S out of pre-acquisition profits, it cannot be recognised as income in the books of P Traditionally, under accounting standards this was also the case, with P reducing the cost of the investment in S by the dividend received (i.e. the dividend was deemed to be a refund of part of the investment) However, IAS 27 Separate Financial Statements states that an entity shall recognise a dividend from a subsidiary, jointly controlled entity or associate in arriving at profit or loss in its separate FS when its right to receive the dividend is established Therefore, from an IAS/IFRS perspective, this effectively removes the pre/post-acquisition distinction with respect to dividends paid by a subsidiary as IAS 27 allows an entity to recognise a dividend paid from pre-acquisition profits from a subsidiary in arriving at profit or loss in its separate FS (albeit this is at variance with company law).

Example 27.9: Dividends paid out of pre-acquisition profits On 3 September 2012 Christy Limited purchased 75% of the ordinary share capital of Voyage Limited for €1,635,000 when the issued ordinary share capital of Voyage Limited was €750,000 and the retained earnings were €1,200,000. At the date of acquisition, the fair value of the net assets of Voyage Limited was the same as their book value. In December 2012, Voyage Limited paid a dividend of €75,000 out of profits in existence at 3 September 2012. Requirement Show the calculation of goodwill under company law and extant IASs/IFRSs.

Example 27.9: Dividends paid out of pre-acquisition profits Under Company Law: The dividend is treated as a partial return of the cost of the investment in Voyage Limited. The investment in Voyage Limited is credited with the dividend received and the retained earnings of Voyage Limited at the date of acquisition are reduced by the total dividend paid.   € Cost of investment 1,635,000 Less pre-acquisition dividend received (€75,000 x 75%) (56,250) 1,578,750 FV of net assets at acquisition date: Ordinary share capital 750,000 Retained earnings 1,200,000 Less pre-acquisition dividend (75,000) 1,875,000 Christy Limited’s share at 75% 1,406,250 Goodwill 172,500

Example 27.9: Dividends paid out of pre-acquisition profits Under Extant IASs/IFRSs: Christy Limited can include the dividend paid out of pre-acquisition profits in arriving at profit or loss in its SPLOCI, with the goodwill being calculated as if it was paid out of post-acquisition retained earnings.   € Cost of investment 1,635,000 Fair value of net assets at acquisition date: Ordinary share capital 750,000 Retained earnings 1,200,000 1,950,000 Christy Limited’s share at 75% 1,462,500 Goodwill 172,500 See also Chapter 27, Example 27.10

27.8 INTER-COMPANY BALANCES Consolidated FS should present the FS of the parent and its subsidiaries as if they were the financial statements of a single entity Particular items that often require cancellation as part of this process are: Loans Current accounts (Example 27.11) Debentures (Example 27.12) Bills of exchange (Example 27.13) In simple terms, this requires cancelling the credit balance of one company against the debit balance of the other, thereby eliminating both balances in the consolidated FS In practice, the balances usually do not agree and they must be reconciled first before being cancelled/eliminated

Example 27.11: Eliminating current accounts Current accounts in the books of: P Limited – with S Limited – €1,490 (debit) S Limited – with P Limited – €740 (credit) At year end there were in transit: Goods – from P Limited to S Limited – €500 Cash – from S Limited to P Limited – €250 Current Account in Books of P Limited   € Balance b/d 1,490 Goods in transit 500 Cash in transit 250 ____ Balance c/d 740 The goods and cash in transit will be incorporated in the consolidated SFP. The current account balance of €740 will be cancelled on consolidation against the equivalent balance in S.

Example 27.12: Inter-company balances S Limited has €15,000 of 5% debentures, of which P Limited holds €10,000 and outsiders hold €5,000. The payables of S Limited amount to €25,000, of which €900 represents debenture interest payable, while receivables of P Limited amount to €30,000 of which €600 represents debenture interest receivable. In addition, the receivables of S Limited amount to €35,000 and payables of P Limited amount to €27,000. Requirement Show the balances that should appear in the consolidated SFP for: 6% Debentures; Receivables; and Payables.  Solution P Limited S Limited Consolidation Consolidated   Adjustment SFP € DR/(CR) Invest in debentures 10,000 - (10,000) 6% debentures (15,000) (5,000) Payables (27,000) (25,000) (600) (51,400) Receivables 30,000 35,000 64,400

27.9 UNREALISED PROFIT ON THE INTRAGROUP TRANSFER OF ASSETS Inventory – eliminate any unrealised profit from inventory remaining unsold at the reporting date P sells to S DR Consol. RE (P) CR Inventory S sells to P DR Consol. RE (Group %) DR NCI% CR Inventory Non-current assets – check which company sold the asset and whether depreciation should be adjusted

Example 27.14: Inventory profit At the reporting date, S Limited’s inventory includes €3,200 of goods at invoice price bought from P Limited. P Limited adds 331/3% to cost. P Limited owns 80% of S Limited.   Therefore S Limited’s inventory should be recorded at its original cost to P (the group). The unrealised profit is €3,200 × 331/3 = €800 1331/3 DR Consolidated RE €800 CR Inventory €800

Example 27.15: From parent to subsidiary During the year P Limited (which owns 80% of the ordinary share capital of S Limited) sold to S Limited a tangible non-current asset for €30,000. The asset had been bought by P Limited on the first day of the current year for €24,000 and had thus not been depreciated by P Limited. Depreciation is provided within the group at 10% per annum on a straight-line basis. The journal adjustments would be as follows:   € DR Consolidated Reserves 6,000 CR Tangible non-current assets Being the elimination of unrealised profit on inter-group transfer of non-current assets. DR Tangible non-current assets – Accum. depreciation 600 CR Reserves S Being the correction of accumulated depreciation on assets transferred to group companies (10% x 6,000).

Example 27.16: From subsidiary to parent On 1.1.10, S Limited sold a tangible non-current asset for €100,000 to P Limited. The asset cost S Limited €50,000 on 1.1.X1. Depreciation is charged by the group at 10% per annum on a straight-line basis. P Limited owns 75% of S Limited. The current year-end is 31.12.12.   € Cost to the group 1.1.08 50,000 Depreciation 2008 (5,000) 2009 NBV at date of transfer 1.1.10 40,000 Value transferred 100,000 Unrealised profit 60,000 DR Consolidated reserves (group share) (€60,000 x 75%) €45,000 DR Non-controlling interest (NCI share) (€60,000 x 25%) €15,000 CR Tangible non-current asset – cost €60,000 Being the elimination of the unrealised tangible non-current asset profit.

Example 27.16: From subsidiary to parent An adjustment is also required to correct three years of over-depreciation in the books of P Limited.   € 100,000 x 10% x 3 years 30,000 Correct depreciation, i.e. based on cost to the group 50,000 x 10% x 3 years 15,000 DR Tangible Non-current asset – Depreciation €15,000 CR Consolidated Reserves As there has been over-depreciation charged by P, tangible non-current assets are valued too low.

27.10 REVALUATION OF TANGIBLE NON-CURRENT ASSETS In most cases, on acquisition of a subsidiary, the assets of the subsidiary would have been revalued for the purpose of determining the purchase price. This revaluation should be preferably recorded by the subsidiary in its own separate accounts. Failing this, the revaluation should be made as a consolidation adjustment as follows: DR Non-current assets CR Cost of control account (group’s share) CR NCI (their share) Where a consolidation adjustment is made, depreciation should also be adjusted appropriately if the net assets revalued include any tangible non-current assets. This adjustment should be debited to the subsidiary company’s reserves. The NCI should then be charged with their share of the adjustment, while the remainder should be charged against post acquisition reserves.  See Chapter 27, Example 27.17

Finally, See Chapter 27, Example 27 Finally, See Chapter 27, Example 27.18: Consolidated statement of financial position