(F1) Intra-Group Accounting (continued) Following on from the initial article published in Velocity and extended web version of that article, Cathy Sibley will now work through a detailed example of how to tackle an exam question on this topic. The group question of a paper can be one of the most straightforward if you are structured in the way you approach the answer. Here, we work through a typical consolidation question to gain that structured approach. Below is question 4 from the May 2012 exam paper which we will work through as if we were in the exam. Start by reading the question through carefully. Question 4 The draft statements of financial position at 31 March 2012 and statements of comprehensive income for the year ended 31 March 2012 for three entities, Loch, River and Stream are given below: Statements of Financial Position as at 31 March 2012: Notes Loch River Stream Non-current Assets Property, plant and equipment (iv) 1,193 767 670 Investments: Loan to River (iii) 300 0 0 156,000 Ordinary shares in (vi) 223 0 0 Stream at cost 1,716 767 670 Current Assets Inventory (vii) 1,107 320 87 Trade receivables 1,320 570 90 Current a/c with River (viii) 101 0 0 Cash and cash equivalents 62 58 14 2,590 948 191 Total Assets 4,306 1,715 861 Equity and Liabilities Equity shares of $1 each 3,500 600 520 Retained earnings 413 385 125 3,913 985 645 Non-current liabilities Loan from Loch (iii) 0 300 0 Current liabilities Trade payables 393 340 216 Loan interest payable (ix) 0 15 0 Current a/c with Loch (viii) 0 75 0 393 430 216 Total Equity and Liabilities 4,306 1,715 861 1
Statements of Comprehensive Income for the year ended 31 March 2012 River Stream Loch Revenue 1,500 693 227 Cost of sales (865) (308) (84) Gross profit 635 385 143 Expenses (124) (70) (35) 511 315 108 Finance cost (80) (40) (12) 431 275 96 Income tax expense (118) (20) (16) Profit for the year 313 255 80 Additional information: (i) Loch holds shares in two other entities, River and Stream. (ii) Loch acquired all of River s equity shares on 1 April 2011 in a share for share exchange. The agreed purchase consideration was $950,000, however Loch has not yet recorded the acquisition in its accounting records. On the 1 April 2011 Loch s shares had a market value of $2.00 each. River s retained earnings were $130,000 on 1 April 2011. (iii) On 1 April 2011 Loch advanced River a 10 year loan of $300,000. (iv) The fair value of River s property, plant and equipment on 1 April 2011 exceeded its carrying value by $144,000. The excess of fair value over carrying value was attributed to buildings owned by River. At the date of acquisition these buildings had a remaining useful life of 12 years. Loch s accounting policy is to depreciate buildings using the straight line basis with no residual value. (v) Loch carried out an impairment review of the goodwill arising on acquisition of River and found that as at 31 March 2012 the goodwill had been impaired by $20,000. (vi) Loch purchased its shareholding in Stream on 1 April 2011 for $223,000 when Stream s retained earnings were $45,000. The fair value of Stream s net assets was the same as its carrying value at that date. Loch exercises significant influence over all aspects of Stream s financial and operating policies. (vii) Loch occasionally trades with River. During September 2011 Loch sold River goods for $220,000. Loch uses a mark-up of 50% on cost. At 31 March 2012 all the goods remained in River s closing inventory. (viii) River posted a cheque to Loch for $26,000 on 29 March 2012 which did not arrive until 7 April 2012. (ix) At 31 March 2012 $15,000 loan interest was due and had not been paid. River had accrued the loan interest due at the year end but Loch had not accrued any interest income. Required: (a) Prepare the journal entry to record the purchase of River in Loch s accounting records. (3 marks) 2
(b) Prepare the consolidated statement of comprehensive income for Loch for the year ended 31 March 2012 AND a consolidated statement of financial position for Loch as at 31 March 2012, in accordance with the requirements of International Financial Reporting Standards. (22 marks) Notes to the financial statements are not required, but all workings must be clearly shown. (Total for Question Four = 25 marks) Having read the question let s answer part a) before we get lost in the calculations and consolidation. (a) Prepare the journal entry to record the purchase of River in Loch s accounting records. Using note (ii) ii) Loch acquired all of River s equity shares on 1 April 2011 in a share for share exchange. The agreed purchase consideration was $950,000, however Loch has not yet recorded the acquisition in its accounting records. On the 1 April 2011 Loch s shares had a market value of $2.00 each. River s retained earnings were $130,000 on 1 April 2011. In a share for share exchange the parent company issues brand new shares to the shareholders of the subsidiary in return for their shares in the subsidiary they swap shares. Loch has paid $950,000 to acquire the equity shares in River. Each Loch share is worth $2 so Loch must have issued 475,000 new shares ($950,000 $2) in order to acquire River. The shares must be recorded at nominal value with any balance being recorded in share premium. (a) Consideration for River paid in shares: Journal Dr Investment in River $950,000 (per note ii) Cr Equity shares $475,000 (nominal value) Cr Share premium $475,000 (balance) The investment value will then be used in the goodwill calculation later but make sure you record the extra shares. You can write these on your question to remind yourself to include them later. Remember only the share capital of the parent is included in the consolidated statement of financial position. Notes Loch River Stream Non current assets Investments: Shares in River +950 Equity and Liabilities Equity shares of $1 each 3,500 +475 SP 475 600 520 Retained earnings 413 385 125 3,913 985 645 Now let s establish the relationship between the three companies based on the investments made. 3
Using note i) again we see that River is a wholly owned subsidiary as all of the equity shares were acquired and therefore control was obtained on 1 April 2011. For Stream we need to use note vi) (vi) Loch purchased its shareholding in Stream on 1 April 2011 for $223,000 when Stream s retained earnings were $45,000. The fair value of Stream s net assets was the same as its carrying value at that date. Loch exercises significant influence over all aspects of Stream s financial and operating policies. We also see in the statement of financial position Non-current Assets Investments: 156,000 Ordinary shares in Stream at cost Notes Loch River Stream (vi) 223 0 0 Equity and Liabilities Equity shares of $1 each 3,500 600 520 When you compare the number of shares purchased to the number in existence we can calculate the percentage acquired: 156,000 520,000 = 30% The fact that we have 30% ie greater than 20%, of the shares of Stream combined with the statement - Loch exercises significant influence over all aspects of Stream s financial and operating policies tells us that Stream is an associate. The group structure now looks like this: (W1) Group structure 1.4.11 100% Loch 1.4.11 Stream River 30% Our first calculation for the subsidiary will be goodwill at acquisition which will include the concept of fair values discussed in a previous article. From the question we need notes iv) and v) (iv) The fair value of River s property, plant and equipment on 1 April 2011 exceeded its carrying value by $144,000. The excess of fair value over carrying value was attributed to buildings owned by River. At the date of acquisition these buildings had a remaining useful life of 12 years. Loch s accounting policy is to depreciate buildings using the straight line basis with no residual value. (v) Loch carried out an impairment review of the goodwill arising on acquisition of River and found that as at 31 March 2012 the goodwill had been impaired by $20,000. 4
Start with the simple numbers that make up net assets - share capital and reserves from the question itself. (W2) Net assets of River Acquisition SFP $ 000 $ 000 Equity shares 600 Retained earnings 385 These numbers are simply copied from the statement of financial position of River. Next we think about the date of acquisition. The share capital of the subsidiary will never change in your questions so you are safe to copy the same share capital figure across to the acquisition column automatically. The retained earnings at acquisition is given to you back in note ii) - River s retained earnings were $130,000 on 1 April 2011. (W2) Net assets of River Acquisition SFP $ $ Equity shares 600 600 Retained earnings 130 385 Now for the fair value adjustment. (iv) The fair value of River s property, plant and equipment on 1 April 2011 exceeded its carrying value by $144,000. The excess of fair value over carrying value was attributed to buildings owned by River. At the date of acquisition these buildings had a remaining useful life of 12 years. Loch s accounting policy is to depreciate buildings using the straight line basis with no residual value. Start by adding the excess fair value onto the net assets at the date of acquisition (W2) Net assets of River Acquisition SFP $ 000 $ 000 Equity shares 600 600 Retained earnings 130 385 Fair Value adj: Buildings 144 As long as there is nothing to say the building has been sold before the reporting date the adjustment must be repeated at the end of the year also. Once the cost of the building to the group has been established at acquisition this value must be used in all consolidation calculations and the consolidated statement of financial position itself. 5
(W2) Net assets of River Acquisition SFP $ 000 $ 000 Equity shares 600 600 Retained earnings 130 385 Fair Value adj: Buildings 144 144 Note iv) also gives you the depreciation policy of the group and the remaining useful life of the buildings. So far only the carrying value of the buildings has been depreciated. We must depreciate the excess fair value in line with group policy for the exact period between the date of acquisition 1 April 2011 and the reporting date 31 March 2012 one full year. (W2) Net assets of River Acquisition SFP $ 000 $ 000 Equity shares 600 600 Retained earnings 130 385 Fair Value adj: Buildings 144 144 Depn (144 12 years) x 1 year - (12) Any adjustment made to the SFP column must also be put through the consolidated statement of financial position so these two adjustments can be written on your question to remind you. Notes Loch River Stream Consol. Adj. Non-current Assets Property, plant and equipment (iv) 1,193 767 670 +144-12 The extra depreciation for the year must also be included in the statement of comprehensive income. Loch River Stream Consol. Adj Revenue 1,500 693 227 Cost of sales (865) (308) (84) +12 Gross profit 635 385 143 By adding the Consol. Adj. heading we are reminding ourselves that we are not adjusting the figures of River but are adjusting the group overall. Now total the net assets working ready for use in the goodwill and retained earnings calculations. 6
(W2) Net assets of River Acquisition SFP $ 000 $ 000 Equity shares 600 600 Retained earnings 130 385 Fair Value adj: Buildings 144 144 Depn (144 12 years) x 1 year - (12) 874 1,117 We can now use the acquisition column to help us calculate goodwill as follows: (W3) Goodwill $ 000 Cost of investment 950 Fair value of net assets acquired W2 (874) Goodwill at acquisition 76 The cost of investment of $950,000 that we recorded with the journal in part a) is cancelled and replaced with this goodwill figure. Loch River Stream Consol. Adj. Non-current Assets Investments: Shares in River +950 - - -950 Although goodwill is an intangible asset it is never amortised, only impaired. The value of the impairment will be given to you in the question. In this case in note v) (v) Loch carried out an impairment review of the goodwill arising on acquisition of River and found that as at 31 March 2012 the goodwill had been impaired by $20,000. To record the impairment we must: Dr Impairment expense in the SOCI $20,000 Cr Goodwill $20,000 $ 000 Cost of investment 950 Fair value of net assets acquired W2 (874) Goodwill at acquisition 76 Less impairment to date (20) Goodwill at 31 March 2012 56 Adjust the statement of comprehensive income to show the impairment as an expense. 7
Loch River Stream Consol. Adj Expenses 124 70 35 +20 Continuing with the subsidiary for the time being there are a number of intra group trading adjustments to be done from notes vii), viii) and ix). (vii) Loch occasionally trades with River. During September 2011 Loch sold River goods for $220,000. Loch uses a mark-up of 50% on cost. At 31 March 2012 all the goods remained in River s closing inventory. (viii) River posted a cheque to Loch for $26,000 on 29 March 2012 which did not arrive until 7 April 2012. (ix) At 31 March 2012 $15,000 loan interest was due and had not been paid. River had accrued the loan interest due at the year end but Loch had not accrued any interest income. (W4) Intra group trading (vii) Loch occasionally trades with River. During September 2011 Loch sold River goods for $220,000. Loch uses a mark-up of 50% on cost. At 31 March 2012 all the goods remained in River s closing inventory. As in the intra group adjustments article we have two considerations here. The sale and purchase between group companies must be cancelled and the unrealised profit in inventory dealt with. Start with the sale and purchase cancellation Dr Group revenue $220,000 Cr Group cost of sales $220,000 Update your question for these adjustments Loch River Stream Consol. Adj Revenue 1,500 693 227-220 Cost of sales (865) (308) (84) +12-220 Gross profit 635 385 143 All of these goods remain in inventory at the end of the year so the full $220,000 will be used in the PUP calculation. $220,000 x 50 = $73,000 (rounded down) 150 Closing inventory must now be reduced to cost to the group which means adjusting closing inventory in both cost of sales and current assets. 8
Dr Group cost of sales $73,000 Cr Group current assets - inventory $73,000 Loch River Stream Consol. Adj Revenue 1,500 693 227-220 Cost of sales (865) (308) (84) +12-220 +73 Gross profit 635 385 143 Loch River Stream Consol, Adj Current Assets Inventory 1,107 320 87-73 (viii) River posted a cheque to Loch for $26,000 on 29 March 2012 which did not arrive until 7 April 2012. You can see from the statements of financial position that the current accounts differ by $26,000 exactly which is of course the cash in transit. We must reinstate the cash balance and cancel the current account balances before consolidating. Dr Group cash and cash equivalents $26,000 Dr Current account with Loch $75,000 Cr Current account with River $111,000 Loch River Stream Consol, Adj Current Assets Current a/c with River 101 0 0-101 Cash and cash equivalents 62 58 14 +26 Current liabilities Current a/c with Loch 0 75 0-75 (ix) At 31 March 2012 $15,000 loan interest was due and had not been paid. River had accrued the loan interest due at the year end but Loch had not accrued any interest income. Start by accruing the interest receivable by Loch in its own books rather than as a group adjustment. Dr Receivables interest due SFP $15,000 Cr Interest receivable SOCI $15,000 Loch River Stream Current Assets Trade receivables 1320 570 90 Loan interest receivable - +15* - - 9
SOCI River Stream Loch Interest receivable - +15* - - Remember whatever updates the SOCI during the year will also update retained earnings. Loch River Stream Equity and Liabilities Equity shares of $1 each 3,500 600 520 Retained earnings 413 +15* 385 125 This puts in place the receivable so you can cancel it against the payable in the books of River. Dr Group loan interest payable SFP $15,000 Cr Group receivables interest due SFP $15,000 The need to show the receivable is cancelled and the payable in the SFP is also cancelled in full. Loch River Stream Consol, Adj Current Assets Trade receivables 1320 570 90 Loan interest receivable - +15* - - -15 Current liabilities Loan interest payable 0 15 0-15 In the same way that the receivable and payable are cancelled in the statement of financial position the interest income and cost must cancelled in the statement of comprehensive income. Dr Group interest receivable SOCI $15,000 Cr Group finance cost SOCI $15,000 Statements of Comprehensive Income for the year ended 31 March 2012 Loch River Stream Consol. Adj Interest receivable - +15* - - -15 Finance cost 80 40 12-15 *Notice that the adjustment for the interest due to Loch has been added next to the figures of Loch itself as these are bookkeeping entries in Loch as an individual company rather than consolidation adjustments. Overall loan interest receivable in the statement of financial position and the statement of comprehensive income both cancel in full. Finally, if we are dealing with interest receivable and payable there must be a loan that creates this! Cancel the inter company loan within the statements of financial position. Dr Loan from Loch $300,000 Cr Loan to River $300,000 10
Loch River Stream Consol. Adj. Non-current Assets Investments: Loan to River 300 0 0-300 Non-current liabilities Loan from Loch 0 300 0-300 Now let s turn our attention to the associate. The associate is not controlled by the group instead the group exercises significant influence over the associate. Therefore, we must use a different method of consolidation to reflect this difference in influence- the equity method. This is applied as follows: (W5) Investment in associate Cost of investment Add group share of post acquisition profits Investment at 31 March 2012 $,000 X X X The information we need is found in the statement of financial position and note vi) Loch River Stream Equity and Liabilities Equity shares of $1 each 3,500 600 520 Retained earnings 413 385 125 (vi) Loch purchased its shareholding in Stream on 1 April 2011 for $223,000 when Stream s retained earnings were $45,000. The fair value of Stream s net assets was the same as its carrying value at that date. Loch exercises significant influence over all aspects of Stream s financial and operating policies. $,000 Cost of investment 223 Add group share of post acquisition profits 30% x (125 per SFP 45 at acqn) 24 Investment at 31 March 2012 247 The investment figure of $223,000 in the statement of financial position of Loch will now be cancelled and replaced with the Investment in associate figure. Non-current Assets Investments: 156,000 Ordinary shares in Stream at cost Loch River Stream Consol. Adj. 223 0 0-223 For the SOCI we take a share of the associates profit after tax and include it as an investment income type item below operating profit see the consolidated statement of comprehensive income statement below. 11
We can now combine all three entities in retained earnings for the group based on ownership by the group. (W6) Group retained earnings $ 000 100% Loch X 100% River post acquisition profits X 30% Stream post acquisition profits X Less impairment to date (X) Less PUP (X) Loch s reserves are simply slotted in from the statement of financial position but remember the adjustment you made for interest receivable of $15,000 earlier. Stream should include the same amount that we calculated for the investment in associate figure in working 5. For River we have two options that give the same result. 1. Calculate post acquisition profits in the same way that you did for the associate. Then go through the workings looking for any adjustments that would update the profit of the subsidiary in this case the extra depreciation on the fair value adjustment. $ 000 100% x (385 from SFP 130 at acqn) 255 Less extra depreciation on fair value adj. W2 (12) 243 2. Use W2 as a short cut. As share capital never changes in your questions the movement in net assets will be the movement in retained earnings including any adjustments such as depreciation. $ 000 100% x (1117 874) W2 243 Overall the working would look like this: $ 000 100% Loch 413 Add Interest receivable W4 15 100% River post acquisition profits 243 30% Stream post acquisition profits 24 Less impairment to date W3 (20) Less PUP W4 (73) 602 The final stage of the process is to consolidate the statement of financial position and statement of comprehensive income. The parent and subsidiary are added together 100% line by line making any adjustments (SHOWN IN RED) that we have dealt with previously in our workings. 12
If you have updated your question for all the adjustments done within the working above the final line by line consolidation should be quick and simple. To ensure you have all the adjustments your question should now look like this: Statements of Financial Position as at 31 March 2012: Loch River Stream Consol. Adj. Non-current Assets Property, plant and equipment 1,193 767 670 +144-12 Investments: Shares in River +950-950 Loan to River 300 0 0-300 156,000 Ordinary shares in 223 0 0-223 Stream at cost 1,716 767 670 Current Assets Inventory 1,107 320 87-73 Trade receivables 1,320 570 90 Loan interest receivable +15-15 Current a/c with River 101 0 0-101 Cash and cash equivalents 62 58 14 +26 2,590 948 191 Total Assets 4,306 1,715 861 Equity and Liabilities Equity shares of $1 each 3,500 +475 SP 475 600 520 Retained earnings 413 +15 385 125 3,913 985 645 Non-current liabilities Loan from Loch 0 300 0-300 Current liabilities Trade payables 393 340 216 Loan interest payable 0 15 0-15 Current a/c with Loch 0 75 0-75 393 430 216 Total Equity and Liabilities 4,306 1,715 861 Statements of Comprehensive Income for the year ended 31 March 2012 River Stream Loch Consol. Adj. Revenue 1,500 693 227-220 Cost of sales (865) (308) (84) +12-220+73 Gross profit 635 385 143 Expenses (124) (70) (35) +20 13
511 315 108 Interest receivable +15-15 Finance cost (80) (40) (12) -15 431 275 96 Income tax expense (118) (20) (16) Profit for the year 313 255 80 Your final answer will be as follows: Loch Group - Consolidated Statement of Financial Position as at 31 March 2012 $000 $000 Non-Current Assets Property, plant and equipment (1,193+767+144-12) 2,092 Goodwill W3 56 Investment in associate W5 247 2,395 Current Assets Inventory (1107+320-73) 1,354 Trade receivables (1,320 + 570) 1,890 Cash and cash equivalents (62+58+26) 146 3,390 Total assets 5,785 Equity and Liabilities Equity Shares (3500+475) 3,975 Share premium 475 Retained Earnings 602 5,052 Current Liabilities Trade payables (393+340) 733 5,785 Loch Group Consolidated Statement of Comprehensive Income for year ended 31 March 2012 $ 000 Revenue(1500+693-220) 1,973 Cost of sales (865+308+12-220+73) (1,038) Gross profit 935 Expenses (124+70+20) (214) Profit from operations 721 Share of profit of associated entity (30% x 80) 24 Interest receivable (15-15) - Finance cost (80+40-15) (105) Profit before tax 640 Income tax expense (118+20) (138) Profit for the year 502 14
This technique shows all the workings being completed first and the consolidation done at the end whilst utilising the question as part of your workings. An alternative approach would be to complete the basic consolidated financial statements after the group structure so rather than writing adjustments on the question to consolidate later you write the adjustments directly in your answer. As long as you show all your workings clearly either approach will work. 15