Before attempting the following question, please read the Study Notes article by Sally Baker in the January/February edition of Financial Management.

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1 Model answer F2: changes in group structure Before attempting the following question, please read the tudy Notes article by ally Baker in the January/February edition of Financial Management. Question Below are the summarised financial statements of three entities, P, and for the year ended 31 December INCOME TATEMENT P evenue 85,000 60,000 50,000 Operating expenses (60,000) (45,000) (40,000) Operating profit 25,000 15,000 10,000 Tax (5,000) (5,000) (2,000) Profit for the year 20,000 10,000 8,000 TATEMENT OF FINANCIAL POITION P AET Non-current assets 300, , ,000 Investment in 150, Investment in 70, , , ,000 Current assets 80,000 50,000 25,000 Total assets 600, , ,000 EQUITY AND LIABILITIE Equity hare capital 1 shares 100,000 80,000 50,000 etained earnings 380, ,000 50, , , ,000 Non-current liabilities 50,000 20,000 10,000 Current liabilities 70,000 40,000 15,000 Total liabilities 120,000 60,000 25,000 Total equity and liabilities 600, , , On 1 January 2006, P acquired 80% of the equity share capital of for 140,000. At the same date it acquired 75% of the equity share capital of at a cost of 70,000. At this time the balances on the retained earnings of and and the fair value of noncontrolling interests were as follows: etained earnings 75,000 30,000 Fair value of non-controlling interests 35,000 22, It is P s policy to measure goodwill gross and so to record NCIs at fair value at acquisition. Neither the goodwill of or have suffered any impairment since acquisition.

2 3. On 1 July 2009 P acquired a further 5% of the equity shares of for 10,000. This additional investment is recorded in P s books at its cost. 4. On 1 October 2009, P disposed of 50% of s equity shares for cash proceeds of 90,000. At this time, it was determined that the fair value of the remaining interest was 25,000. P has not yet recorded this disposal in its individual financial statements. 5. It may be assumed that profits accrue evenly over the year and that no dividends were paid during the year. equirement Prepare the consolidated income statement and consolidated statement of financial position of the P group for the year ended 31 December Answer Consolidated income statement evenue (85,000+60,000+(9/12x50,000)) 182,500 Operating expenses (60,000+45,000+(9/12x40,000)) (135,000) Operating profit 47,500 Gain on disposal of subsidiary W7 31,500 hare of profit of associate (25% x 3/12 x 8,000) (W8) 500 Profit before tax 79,500 Income tax expense (5,000+5,000+(9/12 x 2,000)) (11,500) Profit for the year 68,000 Attributable to: Parent shareholders Balance 64,750 NCI shareholders W4 3,250 68,000 Consolidated statement of financial position Assets Non-current assets (300, ,000) 500,000 Goodwill W3 20,000 Investment in associate W8 25,500 Current assets (80,000+50,000+90,000) (W7) 220,000 Total assets 765,500 Equity hare capital 1 shares 100,000 etained earnings W5 454, ,000 Non-controlling interests W4 31,500 Total 585,500 Non-current liabilities (50,000+20,000) 70,000 Current liabilities (70,000+40,000) 110,000

3 Total equity & liabilities 765,500 Workings W1 Group tructure P 80% 1 Jan 06 75% 1 Jan 06 +5% 1 July 09-50% 1 Oct 09 85% 25% tep acquisition educes NCI Disposal Control is lost ub all year ub for 9 months 20% NCI for 6 months Associate for 3 months 15% NCI for 6 months W2 Net Assets Acquisition tep acquisition eporting date hare capital 80,000 80,000 80,000 etained earnings 75, , , , , ,000 The net assets of are also calculated at the date of the step acquisition in order to calculate the NCI balance at this date. In turn, this is used to calculate the difference between the cash paid and the reduction in NCI which is taken to equity (W6). made a profit of 10,000 during the year of which 6/12 x 10,000 = 5,000 relates to the period after the step acquisition. Therefore the balance on retained earnings at the date of the step acquisition is the closing balance of 110,000 less 5,000 = 105,000. s post acquisition profits are 185, ,000 = 30,000 while it is an 80% sub and 190, ,000 = 5,000 while it is an 85% sub. Acquisition Disposal ep Date hare capital 50,000 50,000 50,000 etained earnings 30,000 48,000 50,000 80,000 98, ,000 The net assets of are calculated at the date of disposal as this will be required for calculating the gain arising on disposal (W7).

4 made a profit of 8,000 during the year of which 3/12 x 8,000 = 2,000 relates to the period after the disposal. Therefore the balance on retained earnings at the date of disposal is the closing balance of 50,000 less 2,000 = 48,000. s post acquisition profits are 98,000-80,000 = 18,000 while it is a subsidiary and 100,000-98,000 = 2,000 while it is an associate. W3 Goodwill Goodwill is calculated at the date that control is achieved which is 1 January 2006 for both and. The goodwill of will be recognised in the CFP as is still a subsidiary at the year end. The goodwill of will be taken to the gain on disposal calculation (W7). Cost of investment 140,000 70,000 Fair value of NCI s 35,000 22, % of sub s net assets at acquisition (155,000) (80,000) Gross goodwill 20,000 12,000 An alternative goodwill calculation would be: Cost of investment 140,000 70,000 Parent s % of net assets at acquisition (80% x 155,000) (124,000) (75% x 80,000) (60,000) Parent s goodwill 16,000 10,000 Fair value of NCIs 35,000 22,000 NCI% of net assets at acquisition (20% x 155,000) (31,000) (25% x 80,000) (20,000) NCI s goodwill 4,000 2,000 Gross goodwill 20,000 12,000 W4 Non-controlling interests Non controlling interests are only relevant at the year end for since is no longer a subsidiary. When calculating this figure, it is important that the NCIs owned 20% of up to the date of the step acquisition and only 15% thereafter. For consolidated statement of financial position Fair value at acquisition 35,000 hare of post acquisition profits (20% x 30,000) (W2) 6,000 (15% x 5,000) (W2) 750 eduction in NCI on step acquisition (W6) (10,250) 31,500 An alternative calculation would be: hare of net assets at reporting date (15% x 190,000) 28,500 NCI s share of goodwill At acquisition per W3 4,000

5 eduction on step acquisition (5/20 x 4,000) (1,000) 3,000 31,500 emember for the consolidated income statement that was a subsidiary for the first nine months of the year. It is therefore necessary to include its share of profits for this period. For consolidated income statement NCI s share of s profits for year 20% x 10,000 x 6/12 1,000 15% x 10,000 x 6/ NCI s share of s profits for year 25% x 8,000 x 9/12 1,500 3,250 W5 etained earnings P 380,000 (80% x 30,000) (W2) 24,000 (85% x 5,000) 4,250 Increase to equity on step acquisition W6 250 (75% x 18,000) (W2) 13,500 (25% x 2,000) (W2) 500 Gain on disposal W7 31, ,000 W6 tep acquisition The step acquisition represents a transaction between shareholders and so a difference between the cash paid by P and the reduction in the NCI s is recorded in equity: Consideration paid by P 10,000 Transfer to reduce the NCI (5/20 x 41,000) 10,250 Increase to equity is recorded as an increase in equity since effectively P has acquired the NCI shareholding at a discount and so gained. NCIs immediately before the step acquisition were: Fair value of NCIs at acquisition 35,000 NCI% of post acquisition profits (20% x 30,000) (W2) 6,000 41,000 Or alternatively: NCI% of net assets at date of step acquisition (20% x 185,000) (W2) 37,000 NCI s goodwill W3 alternative 4,000 41,000

6 W7 Gain on disposal ince by disposing of shares on 1 October 2009, P loses control of, it is necessary to calculate the gain arising on disposal for inclusion in the consolidated income statement so also in consolidated retained earnings: Proceeds 90,000 Fair value of residual 25% interest 25,000 Less carrying value of subsidiary Net assets at disposal (W2) 98,000 Goodwill at disposal (W3) 12,000 NCI s at disposal (below) (26,500) (83,500) Gain on disposal 31,500 ince P has not recorded the disposal in its individual financial statements, the cash proceeds have not yet been recorded. It will therefore need to be recorded in current assets on the consolidation process. NCIs at the date of disposal would be: Fair value of NCIs at acquisition 22,000 NCI% of post acquisition profits (25% x 18,000) (W2) 4,500 26,500 Or alternatively: NCI% of net assets at date of disposal (25% x 98,000) (W2) 24,500 NCI s goodwill W3 alternative 2,000 26,500 W8 Investment in associate At the reporting date, the 25% investment in would be assumed to give P significant influence and so must be equity accounted. The cost of the investment is the fair value of 25,000 as at 1 October This will be increased by the year end by 25% of s post acquisition profits: Cost of investment 25,000 hare of post acquisition profits (25% x 2,000) (W2) ,500 The share of post acquisition profits are also recognised in the consolidated income statement as 'hare of profit of associate'.