Chapter 35

An introduction to consolidated financial statements

Learning objectives

After reading this chapter you should be able to:

1 explain the meaning of the key terms and concepts listed at the end of the chapter; 2 describe the regulatory requirements of the Companies Acts and IFRS 3 with regard to consolidated financial statements; 3 explain the nature of goodwill on acquisition and describe the provisions of IFRS 3 concerning its accounting treatment;

4 prepare consolidated statements of financial position, including the entries for goodwill and minority interests; 5 prepare consolidated income statements, including the entries for minority interests and simple examples of intragroup sales.

Introduction

Throughout this book there are several exercises containing investments, listed or otherwise. The reader should, therefore, by this point be accustomed to the idea that one company may own shares in another company. Where these shares are held on a longterm basis, they are shown as a non-current asset in the final financial statements of the company that owns the shares. They are usually described as Investment in subsidiaries. This chapter is also concerned with investments that are held on a long-term basis, but deals with the situation where the parent company owns a relatively large number of shares in another company; more precisely, usually in excess of 50 per cent of the other companys issued equity share capital, or even all its shares, both of which are said to constitute control of one company by another. The company that owns the shares is referred to as the parent (or holding) company. The company whose shares are owned is referred to as a subsidiary of the parent company. When this situation arises these two companies are said to constitute a group. Thus, a group exists when a parent company has one or more subsidiaries. Where the parent company owns all the issued equity share

capital of a subsidiary it is referred to as a wholly owned subsidiary. If the parent company owns more than 50 per cent but less than 100 per cent of the issued equity share capital of a subsidiary it is referred to as a partially owned or partly owned subsidiary. Where a group exists, the law requires consolidated (also known as group) financial statements to be prepared. In simple terms, consolidated financial statements are a combination of the final financial statements of a parent company with those of its subsidiary (or subsidiaries). Thus, where a group exists, a separate set of financial statements must be prepared for each of the following: 1 the parent company; 2 one for each subsidiary; and 3 consolidated financial statements of the parent company and its subsidiary (or subsidiaries). The latter will be included in the annual report of the parent company, along with its own financial statements.

Learning Activity 35.1

Examine Viridian Group plcs financial statements. Note how details are provided for both the group and the parent company separately.

Identifying business combinations

Consolidated financial statements are governed by the Companies Act 20061 as well as IFRS 3 Business combinations2, issued by the IASB and applicable from March 2004 and IAS 27 Consolidated and separate financial statements3. When two or more separate entities come together to form one reporting entity this is known as a business combination (IFRS 3). In most instances one company gains control (the acquiring company). In these instances consolidated financial statements are required to be prepared. IFRS 3 defines a group as a parent and all its subsidiaries. Wherein a parent is defined as an entity that has one, or more subsidiaries and a subsidiary is defined as an entity, including an unincorporated entity such as a partnership, that is controlled by another entity (the parent). In short, a group may include bodies other than limited companies. However, for simplicity, this chapter is confined to entities that are limited companies, and where there is only one subsidiary. The rules relating to whether a group exists (and thus whether consolidated financial statements must be prepared) are rather complex, in order to avoid companies circumventing the law. They focus on what constitutes a subsidiary. In the introduction a subsidiary was defined in simple terms as being a company where more than 50 per cent of its issued equity share capital is owned by another company. To be more accurate this refers to the companys voting shares. Moreover, this is only meant to be indicative of the main criterion of what constitutes a parentsubsidiary relationship, namely where one entity exercises control over another entity.

Thus, according to IFRS 3 an entity is the parent of another subsidiary if any of the following apply. a It holds power over more than 50 per cent of the voting rights of the entity with the agreement of other investor; b It has the power to govern the financial and operating policies of the other entity under a stature or an agreement; c It has the power to appoint or remove the majority of the members of the board of directors, or equivalent governing body of the other entity; or d It has the power to cast the majority of votes at meetings of the board of directors or equivalent governing body of the other entity. Control is defined in IFRS 3 as the power to govern the financial and operating policies of an entity so as to benefit from its activities. The Companies Act and IFRS 3 require that parent entities provide financial information about the economic activities of their groups by preparing consolidated financial statements. These are defined in IAS 27 as the financial statements of a group presented as those of a single entity. Preparing group financial statements involves a process of adjusting and combining financial information from the individual financial statements of a parent and its subsidiaries to prepare consolidated financial statements that present financial information for the whole group as a single economic entity. There is one final key term that needs to be explained at this point. As mentioned earlier, some subsidiaries may be only partially owned by a parent company. This means

that a minority of its shares are owned by other organisations and/or individuals who also have a financial interest in the entity. These are thus referred to as minority interests. The minority interest is defined in IFRS 3 as that portion of the profit or loss and net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent (discussed in more detail later). Minority interests are also referred to as non-controlling interests.

Goodwill on acquisition

When one company buys another company (by purchasing its shares), the price paid is usually greater than the value of its net assets. The excess of the purchase price over the value of its net assets relates to the cost of goodwill. In other words, when a parent company acquires a subsidiary this usually gives rise to what is referred to as goodwill on acquisition, or more accurately, purchased goodwill. This is defined in IFRS 3 as the difference between the cost of an acquired entity and the aggregate of the fair values of that entitys identifiable assets, liabilities and contingent liabilities. The purchased goodwill is calculated in precisely the manner explicit in its definition. This has to be reflected in the consolidated statement of financial position as shown in the next section. There are complex rules about what constitutes the fair values of an acquired entitys identifiable assets and liabilities. These are too advanced for an introductory textbook, and it is sufficient at this stage to point out that book values are not usually fair values.

However, for the sake of simplicity, this chapter assumes that the book values are fair values. Goodwill was dealt with in detail in Chapter 28 on changes in partnerships. Students following a syllabus that does not include changes in partnerships, but does include goodwill, are advised to read the two sections entitled the nature of goodwill and the recognition of goodwill in financial statements at this point, if they have not already done so. The most relevant aspect of the latter is that IFRS 3 requires goodwill to be capitalised as an intangible asset and impaired to fair value when/if it diminishes in value (It cannot be revalued upwards). The recommended accounting treatment can be found in Viridian Group plcs financial statements.

Viridian Group plc

Accounting policies

(Note this is just an extract. The accounting policy states how the group determines fair value and how they deal with goodwill on the sale of a subsidiary. This is deemed to be beyond the scope of this text, so is not presented here)

Goodwill Goodwill arising on consolidation represents the excess of the cost of acquisition over the fair value of the identifiable net assets of a subsidiary at the date of acquisition. Goodwill

is recognised as an asset and reviewed for impairment annually. ..

Goodwill is stated at cost less any impairment in value.

The value of goodwill in some instances can be very material and very difficult to value correctly. For example:

Real life example

In May 2000 Cap Gemini purchased Ernst and Youngs consulting practice for $11.3 billion. At the time Ernst and Young had valued the business at $4.745 billion.

The difference would be accounted for as goodwill.

The consolidated statement of financial position

As explained earlier, the statement of financial position of the parent company will normally contain only one entry relating to its subsidiary: the cost of the investment in its subsidiary. That is, the price paid to acquire the shares of the subsidiary. This is shown under the heading of non-current asset: investment in subsidiary. It does not change as a

result of consolidation. The consolidated statement of financial position is part of a separate set of consolidated financial statements. The main objective of consolidated statements of financial position is to provide information about the groups financial position to the equity shareholders of the parent company. The consolidated statement of financial position is prepared by aggregating on a line-by-line basis all the assets and liabilities of the parent company with those of its subsidiary. The result is a statement of financial position containing the assets and liabilities of the two entities as if they were owned by a single economic entity. A working ledger account, the cost of control account is usually established when preparing group financial statements. It is used to eliminate the ledger account balances that are not simply combined. The balance on this account is goodwill on acquisition. The cost of the investment in the subsidiary and the equity that is taken over at the date of the business combination are transferred to this account. A simple illustration is given in Example 35.1.

Example 35.1
The following are the statements of financial position of Parent plc and Subsidiary Ltd. as at 31 December 20X1:

Parent plc ASSETS Non-current assets Property, plant and equipment Investment in Subsidiary Ltd. 3,400 900 million

Subsidiary Ltd million

600

4,300 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities Total equity and liabilities 3,000 1,700 4,700 200 4,900 600 4,900

600 400 1,000

500 300 800 200 1,000

Parent plc purchased all the equity shares of Subsidiary Ltd. on the 31 December 20X1. The assets and liabilities of Subsidiary Ltd. are shown in its financial statements at what are agreed to be appropriate fair values.

Required Prepare a consolidated statement of financial position as at 31 December 20X1.

Workings Cost of control account 20X1 31 Dec Details Inv in Subsidiary Ltd. m 900 20X1 31 Dec Details 100% Share capital 100% Retained earnings Goodwill 900 m 500 300 100 900

To check. Purchased goodwill = the price paid less the net assets taken over = 900m

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(1,000m 200m) = 100m

Parent Group Consolidated statement of financial position as at 31 December 20X1 ASSETS Non-current assets Property, plant and equipment (3,400 + 600) Goodwill 4,000 100 4,100 Current assets (600 + 400) Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities (200 + 200) Total equity and liabilities 3,000 1,700 4,700 400 5,100 1,000 5,100 m

Notice that only the assets and liabilities of each entity are aggregated. The share capital and retained earnings are not aggregated. The share capital and retained earnings of the subsidiary do not appear on the consolidated statement of financial position. Many authors explain the reason for this as being because the consolidation process simply

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replaces the investment in the subsidiary shown in the parent companys statement of financial position with the net assets of the subsidiary (and any goodwill). This is true in an accounting sense, but students should remember that the statement of financial position of the parent company does not change as a result of consolidation. A more meaningful way of explaining the exclusion of the subsidiarys capital and reserves perhaps lies in the nature and function of consolidated financial statements. The consolidated statement of financial position is meant to relate to a single economic entity. The net assets of that entity belong to the equity shareholders of the parent company. Thus, only their equity interests are shown on the statement of financial position. As a single economic entity the subsidiary, its shares and its shareholder(s) simply do not exist. Thus, the share capital and reserves of the subsidiary do not appear in the consolidated statement of financial position. There is, however, a much more important legal reason why the reserves of the subsidiary do not appear in the consolidated statement of financial position. This is because they arose prior to its acquisition by the parent company, which is why they are referred to as pre-acquisition reserves. The rest of this chapter focuses on post-acquisition revenue reserves/retained earnings. However, before moving on it is important to appreciate that the above discussion relating to the treatment of pre-acquisition reserves applies to all reservesboth revenue and capital. That is, any retained earnings, share premium account and/or revaluation reserve in the financial statements of the subsidiary which arose prior to acquisition must not be included in the consolidated statement of financial position.

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This brings us to the next important point in consolidated statements of financial position. Whereas pre-acquisition reserves of a subsidiary are not included in a consolidated statement of financial position, post-acquisition reserves are included. This is because they are generated after acquisition and are represented by an increase in the net assets of the subsidiary. Therefore, they belong to the equity shareholders of the parent company (this assumes that all of the share capital is taken over by the parent company. If the parent company only takes over 70% of the equity shares then it will be entitled to 70% of the profits made post-acquisition (discussed later)). In other terms, post-acquisition reserves constitute an increase in the value of the parent companys investment in its subsidiary. The workings for the consolidated reserves are easier to understand if the transactions are shown in the ledger accounts. This is illustrated in Example 35.2, which is a continuation of Example 35.1.

Example 35.2

During the year ended 31 December 20X2, Parent plc made a profit of 750 million, and Subsidiary Ltd. made a profit of 250 million. This has resulted in an equivalent increase in their net current assets and reserves as shown below in their statement of financial positions as at 31 December 20X2.

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Parent plc ASSETS Non-current assets Property, plant and equipment Investment in Subsidiary Ltd. 3,400 900 4,300 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities Total equity and liabilities 3,000 2,450 5,450 200 5,650 1,350 5,650 million

Subsidiary Ltd. million

600 600 650 1,250

500 550 1,050 200 1,250

Goodwill on acquisition is considered to have lost 5 million in value over the first year. Required Prepare a consolidated statement of financial position as at 31 December 20X2.

Workings Reserves (Subsidiary Ltd.) 20X1 31 Dec 20X2 31 Dec Consolidated reserves 250 Details Cost of control m 300 20X1 31 Dec 20X2 31 Dec Profit for the year* 250 Details Bal b/d m 300

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*The profit for the year is the movement in reserves. The statement of financial position for 20X2 states that the total reserves in the subsidiary is 550 million, and the statement of financial position for 20X1 states that total reserves was 300 million. The difference 250 million must have been the profit for the year. The profit for the year postacquisition goes to the group, as it is entitled to 100% of it.

Reserves (Parent plc) 20X1 31 Dec 20X2 31 Dec Consolidated reserves 750 Details Consolidated reserves m 1,700 20X1 31 Dec 20X2 31 Dec Profit for the year 750 Details Bal b/d m 1,700

*The profit for the year is the movement in reserves. The statement of financial position for 20X2 states that the total reserves in the subsidiary is 2,450 million, and the statement of financial position for 20X1 states that total reserves was 1,700 million. The difference 750 million must have been the profit for the year. All of the profits of the parent are the groups.

The only group specific adjustment is the impairment of goodwill by 5 million. The double entry for this will be:
Debit Debit: Income statement group (hence retained earnings) Credit: Goodwill account Being the impairment of goodwill by 5 million in the year ended 31 December 20X2 5 million 5 million Credit

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Consolidated reserves 20X2 31 Dec Details Goodwill impairment m 5 20X2 1 Jan 31 Dec 31 Dec Balance c/d 2,695 2,700 20X3 1 Jan Balance b/d 2,695 Details Reserves (Parent plc) Reserves (Subsidiary Ltd.) Reserves (Parent plc) m 1,700 250 750 2,700

Parent Group Consolidated statement of financial position as at 31 December 20X2 ASSETS Non-current assets Property, plant and equipment (3,400 + 600) Goodwill (100 5) 4,000 95 4,095 Current assets (1,350 + 650) Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities (200 + 200) Total equity and liabilities 3,000 2,695 5,695 400 6,095 2,000 6,095 m

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Minority interests
So far in this section it has been assumed that the subsidiary is wholly owned. As has already been mentioned, a subsidiary may be partially owned by its parent company, in which case there will be a minority interest, as defined earlier. What needs to be explained at this stage is why minority interests appear in consolidated statements of financial position. The reason is essentially that one of the basic underlying principles of consolidation is that consolidated financial statements are prepared on the basis that the parent and subsidiary are a single economic entity. That is, all the assets and liabilities of the parent and subsidiary are aggregated without regard to the proportion of the subsidiarys voting shares that are owned by the parent. However, it must be recognised that a proportion of these net assets is owned/financed by the other (minority) shareholders. This is achieved by entering the value of the minority interest on the consolidated statement of financial position as a part of the groups capital. The movement in minority interests is best explained using a ledger account. At this stage, when consolidating, it is recommended that the subsidiarys equity accounts and two group ledger accounts are opened, the cost of control and minority interests. This is illustrated in Examples 35.3 and 35.4. The latter is a continuation of the former.

Example 35.3

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The following are the statements of financial position of Holding plc and Subsidy Ltd. as at 30 June 20X1:
Holding plc ASSETS Non-current assets Property, plant and equipment Investment in Subsidy Ltd. 3,760 540 4,300 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities Total equity and liabilities 3,000 1,700 4,700 200 4,900 500 300 800 200 1,000 600 4,900 600 600 400 1,000 million Subsidy Ltd. million

Holding plc purchased 60 per cent of the equity shares of Subsidy Ltd. on 30 June 20X1 at a price of 540 million. The assets and liabilities of Subsidy Ltd. are shown in its financial statements at what are agreed to be appropriate fair values.

Required Prepare a consolidated statement of financial position as at 30 June 20X1.

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Workings Cost of control account 20X1 31 Dec Details Inv. in Subsidy Ltd. m 540 20X1 31 Dec Details 60% Share capital 60% Retained earnings Goodwill 540 m 300 180 60 540

Subsidy Ltd. reserves 20X1 31 Dec 31 Dec Details Cost of control (60%) Minority interests (40%) m 180 120 300 300 20X1 31 Dec Details Balance b/d m 300

Subsidy Ltd. Share capital 20X1 31 Dec 31 Dec Details Cost of control (60%) Minority interests (40%) m 300 200 500 500 20X1 31 Dec Details Balance b/d m 500

Minority interests 20X1 Details m 20X1 31 Dec 31 Dec Balance c/d 320 320 20X2 1 Jan Balance b/d 320 31 Dec Details Reserves Subsidy (40%) Share capital: Subsidy (40%) m 120 200 320

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Holding group Consolidated statement of financial position as at 31 December 20X2 ASSETS Non-current assets Property, plant and equipment (3,760 + 600) Goodwill 4,360 60 4,420 Current assets (600 + 400) Total assets EQUITY AND LIABILITIES Equity attributable to owners of the parent Equity share capital Retained earnings 3,000 1,700 4,700 Non-controlling interests Total equity Current liabilities (200 + 200) Total equity and liabilities 320 5,020 400 5,420 1,000 5,420 m

Example 35.4

During the year ended 30 June 20X2, Holding plc made a profit of 750 million, and

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Subsidy Ltd. made a profit of 250 million. This has resulted in an equivalent increase in their net current assets and reserves as shown below in their statement of financial positions as at 30 June 20X2.

Holding plc ASSETS Non-current assets Property, plant and equipment Investment in Subsidy Ltd. 3,760 540 4,300 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Retained earnings Total equity Current liabilities Total equity and liabilities 3,000 2,450 5,450 200 5,650 1,350 5,650 million

Subsidy Ltd. million

600 600 650 1,250

500 550 1,050 200 1,250

Goodwill on acquisition is considered to have lost 3 million in value over the first year.

Required Prepare a consolidated statement of financial position as at 30 June 20X2.

Workings

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Subsidy Ltd. reserves 20X1 31 Dec 31 Dec Details Cost of control (60%) Minority interests (40%) m 180 120 300 20X2 31 Dec 31 Dec Consolidated reserves (60%) Minority interests (40%) 150 100 250 250 20X2 31 Dec Profit for the year 250 300 20X1 31 Dec Details Balance b/d m 300

Reserves (Holding plc) 20X1 31 Dec 20X2 31 Dec Consolidated reserves 750 2,450 Details Consolidated reserves m 1,700 20X1 31 Dec 20X2 31 Dec Profit for the year 750 2,450 Details Bal b/d m 1,700

Consolidated reserves 20X2 31 Dec Details Goodwill impairment m 3 20X2 1 Jan 31 Dec 31 Dec Balance c/d 2,597 2,600 20X3 1 Jan Balance b/d 2,597 Details Reserves (Parent plc) Profit (Subsidy Ltd.) 60% Profit (Holding plc) 100% m 1,700 150 750 2,600

Minority interests 20X1 Details m 20X1 31 Dec Details Reserves Subsidy (40%) m 120

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31 Dec

Balance c/d

320 320

31 Dec

Share capital: Subsidy (40%)

200 320

20X2

20X2 1 Jan Balance b/d Profit in year subsidy (40%) 320 100 420 20X3 1 Dec Balance b/d 420

31 Dec

Balance c/d

420 420

31 Dec

Holding group Consolidated statement of financial position as at 30 June 20X2 ASSETS Non-current assets Property, plant and equipment (3,760 + 600) Goodwill (60 - 3) 4,360 57 4,417 Current assets (1,350 + 650) Total assets EQUITY AND LIABILITIES Equity attributable to owners of the parent Equity share capital Retained earnings 3,000 2,597 5,597 Non-controlling interests Total equity Current liabilities (200 + 200) 420 6,017 400 2,000 6,417 m

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Total equity and liabilities

6,417

The consolidated income statement

The income statement of a parent company will normally contain only one entry relating to its subsidiarythe dividends received from the subsidiary. This is referred to in published financial statements as income from shares in subsidiaries. It does not change as a result of consolidation. The consolidated income statement is part of a separate set of consolidated financial statements. The main objective of consolidated income statements is to provide information about the groups financial performance to the equity shareholders of the parent company. The principles of preparing a consolidated income statement are much the same as those relating to the consolidated statement of financial position. That is, most of the items in the parent companys income statement are aggregated on a line-by-line basis with those in the subsidiary companys income statement. However, there are complications arising from what are referred to as intragroup transactions and items. These take two main forms, intragroup sales and the dividends paid to the parent company by its subsidiary. Since the consolidated income statement is intended to reflect the trading activities of the group as a single economic entity, these must be eliminated. In arithmetic terms, they cancel each other out. This is illustrated in

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Example 35.5.

Example 35.5

The following are the income statements of Parent plc and Subsidiary Ltd. for the year ended 31 December 20X2:
Parent plc Subsidiary Ltd. million Turnover Cost of sales Gross profit Distribution costs Administrative expenses Dividends from Subsidiary Ltd. Profit before taxation Income tax Profit for the year 10,050 (6,700) 3,350 (550) (350) 150 2,600 (1,200) 1,400 million 3,300 (2,200) 1,100 (275) (125) 700 (300) 400

Parent plc acquired all the equity shares of Subsidiary Ltd. on the 31 December 20X1. During the year Parent plc sold goods for 50 million, to Subsidiary Ltd. who has sold them all to third parties during the year. Parent plc paid a dividend of 650 million during the year and Subsidiary Ltd. paid a dividend during the year of 150 million.

Required

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Prepare a consolidated income statement for the year ended 31 December 20X2.

Parent group Consolidated income statement for the year ended 31 December 20X2 m Turnover (10,050 50 + 3,300) Cost of sales (6,700 + 2,200 50) Gross profit Distribution costs (550 + 275) Administrative expenses (350 + 125) Profit before taxation Income tax (1,200 + 300) Profit for the year 13,300 (8,850) 4,450 (825) (475) 3,150 (1,500) 1,650

Any impairment of goodwill on acquisition would also have to be entered in the consolidated income statement. Using the data in Example 35.2, this will reduce the profit by 5 million. The Parent group consolidated statement of financial position will be as shown in Example 35.2. The figure for reserves on this consolidated statement of financial position would be computed as follows:
m Balance at 31 Dec 20X1 (given on the consolidated statement of financial position in Example 35.1) Profit for the year (1,650 5) Dividends paid Balance at 31 Dec 20X2 1,700 1,645 (650) 2,695

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Minority interest

As already discussed, a subsidiary may be only partially owned by its parent company, in which case there will be a minority interest, as defined earlier. The minority interest will not only be reflected in the consolidated statement of financial position, but also appear in the consolidated income statement. The reason is essentially that one of the basic underlying principles of consolidation is that consolidated financial statements are prepared on the basis that the parent and subsidiary are a single economic entity. That is, the revenue and costs of the parent and subsidiary are aggregated without regard to the proportion of the subsidiarys voting shares that are owned by the parent. However, it must be recognised that a proportion of the profit (or loss) of the subsidiary belongs to the other (minority) shareholders. Therefore, the group profit for the year is analysed into profit attributable to the owners of the parent and profit attributable to non-controlling interests (i.e. minority interests). This is illustrated in Example 35.6.

Example 35.6

The following are the income statements of Holding plc and Subsidy Ltd. for the year ended 30 June 20X2:
Holding plc Subsidy Ltd.

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million Turnover Cost of sales Gross profit Distribution costs Administrative expenses Dividends from Subsidiary Ltd. Profit before taxation Income tax Profit for the year 10,050 (6,700) 3,350 (550) (290) 90 2,600 (1,200) 1,400

million 3,300 (2,200) 1,100 (275) (125) 700 (300) 400

Holding plc acquired 60 per cent of the equity shares of Subsidy Ltd. on 30 June 20X1. Holding plc paid a dividend of 650 million during the year and Subsidy Ltd. paid a dividend during the year of 150 million.

Required Prepare a consolidated income statement for the year ended 30 June 20X2.

Workings Minority interest = 40 per cent = 400m 160m

Holding Group Consolidated income statement for the year ended 30 June 20X2 m Turnover (10,050 + 3,300) Cost of sales (6,700 + 2,200) 13,350 (8,900)

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Gross profit Distribution costs (550 + 275) Administrative expenses (290 + 125) Profit before taxation Income tax (1,200 + 300) Profit for the year

4,450 (825) (415) 3,210 (1,500) 1,710

Profit attributable to: Owners of the parent Non-controlling interests 1,550 160 1,710

Notice that the profit for the year in the consolidated income statement that is attributable to the equity holders of the parent company equals the profit for the year of the parent/holding company plus its share of the profit for the year of the subsidiary, less the dividend received from the subsidiary. That is, in the above example 1,400m + (60 per cent 400m) - 90= 1,550 m. Any impairment of goodwill on acquisition would also have to be entered in the consolidated income statement. Using the data in Example 35.4, this will reduce the group profit/retained profit by 3 million. The Holding group consolidated statement of financial position will be as shown in Example 35.4. The figure for reserves on this consolidated statement of financial position would be computed as follows:

m Balance at 30 June 20X1 (given on the consolidated

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statement of financial position in Example 35.3) Retained earnings for the financial year (1,550 3) Dividend paid Balance at 30 June 20X2

1,700 1,547 (650) 2,597

The figure for minority interest on this consolidated statement of financial position can also be computed as follows:
m Balance at 30 June 20X1 (given on the consolidated statement of financial position in Example 35.3) Minority interest in consolidated income statement 320 160 480 Dividends paid to minority shareholders (150 90) or (40% 150) Balance at 30 June 20X2 (60) 420

This increase in the minority interest on the consolidated statement of financial position of 160m 60m = 100m is their share of the profit less the dividends paid to them from their share of the profit. Those students who conceptualise the preparation of the consolidated income statement as an arithmetic combination of the income statements of the parent and subsidiary may have observed that 100m was in a sense lost in the process. It has now reappeared as the increase in minority interest in the consolidated statement of financial position.

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Learning Activity 35.2

Visit the website of a large listed/quoted public limited company that has a subsidiary whose shares are also listed, and find their latest annual report and financial statements. Examine the contents of the income statement, statement of financial position and notes to the financial statements, paying particular attention to the items relating to goodwill and minority interests.

Summary

The Companies Act 2006 as well as IFRS 3 and IAS 27 require the preparation of consolidated financial statements where a group exists. A group is defined as a parent and all its subsidiaries. There are detailed legal regulations regarding when a parent subsidiary relationship exists. The main criteria include: where the parent holds over at least 50%, or has influence over at least 50% of the voting rights in the subsidiary; or has the power to govern the financial or operating policies of the subsidiary either under statute or by an agreement; or has the power to appoint or remove the majority of the board of directors; or has to power to cast a majority of votes at board meetings. Control refers to the power that a parent has to govern the operating and financial policies of the subsidiary so as to have benefits from its activities. Consolidated financial statements are defined in IFRS 3 as the financial statements of

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a group presented as those of a single economic entity. Consolidation is the process of adjusting and combining financial information from the individual financial statements of a parent and its subsidiaries to prepare consolidated financial statements that present financial information for the group as a single economic entity. Consolidated financial statements include a consolidated income statement and a consolidated statement of financial position. These are prepared by aggregating on a lineby-line basis most of the items in the parents financial statements with those in the subsidiaries financial statements while at the same time eliminating certain intra-group items, referred to above as adjustments. The process of consolidation usually gives rise to goodwill on acquisition. This must be accounted for in accordance with IFRS 3 (i.e. impaired), which refers to it as purchased goodwill. Where a subsidiary is only partially owned by the parent, the process of consolidation also gives rise to minority interests in both the consolidated income statement and the consolidated statement of financial position. A minority interest is defined in IAS 27 as that portion of the profit or loss and net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent. The group profit for the year is analysed into profit attributable to the owners of the parent and profit attributable to non-controlling interests (i.e. minority interests). The minority interest is also shown in the consolidated statement of financial position as part of the groups overall equity capital, and represents their share of the subsidiarys net assets.

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Key terms and concepts

Consolidated financial statements Control Cost of control Group Minority interest Non-controlling interests Parent Pre-acquisition reserves Post-acquisition reserves Purchased goodwill Subsidiary

References
1. Companies Act (2006), HM Stationery Office. 2. International Accounting Standards Board, (2008), International Financial Reporting Standard 3 Business Combinations, (IASB). 3. International Accounting Standards Board, (2008), International Accounting Standard 27 Consolidated and Separate Financial Statements, (IASB).

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Review questions
35.1 Define each of the following in accordance with the Companies Act 2006, IFRS 3 Business Combinations (IASB, 2008) and International Accounting Standard 27 Consolidated and Separate Financial Statements (2008): a a group; b a subsidiary; c consolidated financial statements; d consolidation. 35.2 Describe fully the provisions of IFRS 3 with regard to what constitutes a parent and a subsidiary. 35.3 a Explain the nature of goodwill arising on the acquisition of a subsidiary and how

it is measured. b Describe the requirements of IFRS 3 Business Combinations (IASB, 2008) with regard to the accounting treatment of purchased goodwill. 35.4 a Explain the objective(s) of consolidated financial statements.

b Describe in general terms the principles of consolidation. 35.5 Parhold plc has bought for cash of 12 million all the voting shares of Subsid plc, whose net assets have been valued at 10 million. Describe how this transaction would affect:

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a the statement of financial position of Parhold plc; and b the statement of financial position of Parhold Group, given that Subsid plc is the only subsidiary. You need only describe the effects on these statements of financial position on the date of acquisition of Subsids shares. 35.6 Given the circumstances in Question 35.5 above, describe how this relationship between Parhold plc and Subsid plc would affect the following at the end of the first accounting year after acquisition: a the financial statements of Subsid plc; b the financial statements of Parhold plc; and c the consolidated financial statements of Parhold Group. 35.7 a Define a minority interest in accordance with International Accounting Standard

27 Consolidated and Separate Financial Statements (2008). b Explain why minority interests arise in consolidated financial statements in the context of the principles of consolidation. c Describe the effects of a minority interest on the consolidated financial statements.

Exercises

35.8 Level II

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At 1 January 20X0 H Ltd. acquired 80 per cent of the share capital of S for 160,000. At that date the share capital of S consisted of 100,000 equity shares of 1 each and its reserves totalled 40,000. Goodwill on acquisition of subsidiaries was impaired by 15,000 in 20X0, 10,000 in 20X1 and 3,800 in 20X2. In the consolidated statement of financial position of H and its subsidiary S at 31 December 20X2 the amount appearing for goodwill should be:

a b c d

16,000; 19,200; 28,800; or 4,000? (ACCA)

35.9 Level II At 1 January 20X0 H Ltd. acquired 60 per cent of the share capital of S for 180,000. At that date the share capital of S consisted of 200,000 shares of 50p each. The reserves of H and S are stated below:
At 1 Jan 20X0 H S 280,000 50,000 At 31 Dec 20X2 340,000 180,000

In the consolidated statement of financial position of H and its subsidiary S at 31 December 20X2, what amount should appear for the minority interest in S?

a b

92,000; 280,000;

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c d

152,000; 112,000. (ACCA)

35.10 Level II H Ltd. acquired 75 per cent of the share capital of S for 280,000 on 1 January 20W6. Goodwill arising on consolidation has been fully impaired. Details of the share capital and retained earnings of S are as follows:
At 1 January 20W6 Share capital Retained earnings 200,000 120,000 At 31 December 20X2 200,000 180,000

At 31 December 20X2 the retained earnings of H amounted to 480,000. What figure should appear in the consolidated statement of financial position of H and S for the retained earnings at 31 December 20X2?

a b c d

530,000; 525,000; 485,000; 575,000. (ACCA)

35.11 Level II

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Statements of financial position for A plc and B plc as at 31 December 20X0 ASSETS Non-current assets Property, plant and equipment A plc 000 1,000 1,000 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Revaluation reserve Retained earnings Total equity Non-current liabilities Long-term loan 450 90 1,200 400 1,600 150 40 10 200 1,450 2,450 B plc 000 200 200 290 490

Current liabilities Total liabilities Total equity and liabilities

400 850 2,450

200 290 490

Other information: A plc purchased 100% of the equity shares of B plc for 300,000

Required

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a Prepare As statement of financial position after the purchase (assume the purchase was made in cash). b Prepare the statement of financial position for the group after the acquisition.

35.12

Level II

Using the information from 35.11 Assume that in this scenario A plc 80% of equity shares of B plc for 240

Required a Prepare As statement of financial position after the purchase (assume the purchase was made in cash). b Prepare the statement of financial position for the group after the acquisition.

35.13

Level II

Using the information from 35.11 Assume that in this scenario A plc 80% of equity shares of B plc for 140

Required

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a Prepare As statement of financial position after the purchase (assume the purchase was made in cash). b Prepare the statement of financial position for the group after the acquisition.

35.14

Level II

The following are the statements of financial position of Gold plc and Silver plc as at 1 January 20X1:
Gold plc ASSETS Non-current assets Property, plant and equipment Investment in Silver plc 13,600 3,600 17,200 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Share premium Revaluation reserve Retained earnings Total equity Current liabilities Total equity and liabilities 5,000 4,000 3,000 6,800 18,800 400 19,200 1,000 800 200 1,200 3,200 300 3,500 2,000 19,200 2,500 2,500 1,000 3,500 000 Silver plc 000

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Gold plc purchased all the equity shares of Silver plc on 1 January 20X1. The assets and liabilities of Silver plc are shown in its financial statements at what are agreed to be appropriate fair values.

Required Prepare a consolidated statement of financial position as at 1 January 20X1.

35.15

Level II

(This is a continuation of Exercise 35.11.) The following are the income statements and statements of financial position of Gold plc and Silver plc for the year ended 31 December 20X1:

Income statements

Gold plc 000

Silver plc 000 6,600 (4,400) 2,200 (550) (250) 1,400 (600)

Turnover Cost of sales Gross profit Distribution costs Administrative expenses Dividends from Silver plc Profit before taxation Income tax

20,100 (13,400) 6,700 (1,100) (700) 300 5,200 (2,400)

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Profit for the year

2,800

800

Gold plc ASSETS Non-current assets Property, plant and equipment Investment in Silver plc 13,600 3,600 17,200 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Share premium Revaluation reserve Retained earnings Total equity Current liabilities Total equity and liabilities 5,000 4,000 3,000 8,300 20,300 400 20,700 3,500 20,700 000

Silver plc 000

2,500 2,500 1,500 4,000

1,000 800 200 1,700 3,700 300 4,000

Other information Gold plc paid a dividend of 1,300,000 during the year and Silver plc paid a dividend of 300,000 during the year.

Required Prepare a consolidated income statement for the year and a consolidated statement

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of financial position as at 31 December 20X1. Goodwill has not diminished in value.

35.16

Level II

The following are the statements of financial positions of Wood plc and Stone plc as at 1 May 20X1:

Wood plc ASSETS Non-current assets Property, plant and equipment Investment in Stone plc 10,000 4,800 14,800 Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Share premium Revaluation reserve Retained earnings Total equity Current liabilities Total equity and liabilities 6,000 4,500 2,500 5,300 18,300 500 18,800 4,000 18,800 000

Stone plc 000

3,000 3,000 2,500 5,500

1,500 750 650 2,100 5,000 500 5,500

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Wood plc purchased 80 per cent of the equity shares of Stone plc on 1 May 20X1 at a price of 4,800,000. The assets and liabilities of Stone plc are shown in its financial statements at what are agreed to be appropriate fair values.

Required Prepare a consolidated statement of financial position as at 1 May 20X1.

35.17

Level II

(This is a continuation of Exercise 35.13.)

The following are the income statements and statements of financial position of Wood plc and Stone plc for the year ended 30 April 20X2:

Income statements

Wood plc 000

Stone plc 000 3,400 (2,300) 1,100 (225) (275)

Turnover Cost of sales Gross profit Distribution costs Administrative expenses

15,680 (9,840) 5,840 (725) (875)

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Dividends from Stone plc Profit before taxation Income tax Profit for the year

160 4,400 (1,800) 2,600

600 (150) 450

Statements of financial position ASSETS Non-current assets Property, plant and equipment Investment in Stone plc

Wood plc 000

Stone plc 000

10,000 4,800 14,800

3,000 3,000 2,500 5,500

Current assets Total assets EQUITY AND LIABILITIES Equity Equity share capital Share premium Revaluation reserve Retained earnings Total equity Current liabilities Total equity and liabilities

5,000 19,800

6,000 4,500 2,500 6,400 19,400 400 19,800

1,500 750 650 2,350 5,250 250 5,500

Other information Wood plc paid a dividend of 1,500,000 during the year and Stone plc paid a dividend of 200,000 during the year.

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Required

Prepare a consolidated income statement for the year and a consolidated statement of financial position as at 30 April 20X2. Goodwill has not diminished in value.

35.18

Level II

P buys 70% of the shares of S on 31 Dec 20X0. The statements of financial position of the two companies on 31 December 20X1 are as follows:
P: Statement of financial position as at 31 Dec 20X1 ASSETS Non-current assets Property, plant and equipment Investment in S Ltd 39,000 7,800 46,800 Current assets Total assets EQUITY AND LIABILITIES Equity Share capital Retained earnings Profit for 20X1 General reserve Total equity 4,800 9,200 14,000 5,000 69,000 50,000 22,200 69,000 Current assets Total assets EQUITY AND LIABILITIES Equity Share capital Retained earnings Loss for 20X1 General reserve Total equity 1,700 (400) 1,300 2,000 13,300 10,000 8,400 4,900 13,300 S: Statement of financial position as at 31 Dec 20X1 ASSETS Non-current assets Property, plant and equipment 8,400

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Required Prepare the consolidated statement of financial position at 31 December 20X1 assuming goodwill is impaired during the year to half of its original value.

35.19 Level II Fresh Ltd. acquired 80% of Stale Ltd. on 1 January 20X1, when the balance on Fresh Ltd.s retained earnings was 160,000 and the balance on Stale Ltd.s retained earnings was 100,000. There have been no share issues since this date by either company. Both companies adopt a policy of not paying any dividends.

Summary statement of financial position for both companies as at 31 December 20X1

Fresh Ltd. ASSETS Sundry net assets Investment in Stale Total assets EQUITY Equity share capital Share premium Retained earnings Total equity 80,000 70,000 194,000 344,000 80,000 20,000 120,000 220,000 144,000 200,000 344,000 220,000 220,000 Stale Ltd.

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Additional information

At the end of the year, the directors conduct an impairment review and conclude that the value of goodwill is now 20,000.

Required

a) Calculate the goodwill on consolidation (all workings must be shown). b) Prepare the consolidated statement of financial position as at 31 December 20X1.

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