Consolidations 1 Introduction and consolidated statement of financial position*

Investments3 Types1. Small - 50% sharesAccounting TreatmentTrade Investment shown at cost or Fair Value

Associate - equity account

Subsidiary consolidation or single entity method

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Group accounts aim to recognise the difference and account for them in the most useful way for shareholders*

Simple ExampleSuppose H has the following statement of Financial Position at 1st January 20X0

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Non Current Assets6,000Current Assets5,00011,000

Ordinary Share Capital5,000Retained Profits5,00010,000Current Liabilities1,00011,000

The Directors of H decide to acquire the business of S for 1,100

At that date, S had the following assets and liabilities

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Non Current Assets650

Current Assets400

Current Liabilities50

Why has H paid more than the value of the net assets?Paid 1,100

Net assets worth 1,000

GOODWILL IS THE DIFFERENCE BETWEEN THE CONSIDERATION AND THE NET ASSETS ACQUIRED*Difference = 100 is GOODWILL

What is the status of S?*SSole TraderCompanyUnincorporatedIncorporatedH acquires title to the net assets of SH acquires title to the shares in S

Accounting is different in each of these situations*

AssumptionsH doesnt trade

S does trade and makes a profit of 500 in 20X0600 in 20X1*

S is incorporated (company)H has acquired the shares in S

The 2 companies maintain their separate identities. S Ltd will still exist as a separate entity and will still prepare its own accounts*

S is unincorporated (sole trader)H does not hold shares in S but the individual assets and liabilitiesOnly ONE Statement of Financial Position is required Just H, as all Ss assets are now owned by H*

Compare the 2 Statements of Financial PositionDifference is due to the legal status of S*

Compare the 2 Statements of Financial Position*SSole TraderCompanyUnincorporatedIncorporatedCan see how the directors of H have managed their investmentInvestment shown at costNo change year on yearNo indication of future value in the investment

The previous situation does not seem fair and it could lead to companies hiding information

Law (CA 2006) and Accounting Standards therefore say that if one company (H) takes over another company (S) In addition to preparing its own accounts, H must also prepare group or consolidated accounts*

Consolidated AccountsShow the assets and liabilities of any companies taken overShow the profits of any companies taken over*This is the same as if the company was an unincorporated businessKnown as the SINGLE ENTITY METHOD ie all the companies are treated as a single entity

What is a subsidiary?A company controlled by another company

Control may be because:The parent owns the majority of the voting rights (usually by owning more than half the ordinary shares) The parent can appoint a majority of the directorsThe parent can exercise dominant influence*

What are consolidated accounts?Present the results of the group as if it were one single entity (substance over form)All the transactions of a subsidiary are under the control of the parentAll results are the responsibility of the parentThe shareholders of the parent company need to be fully informed about all the actions of the directors, including their management of subsidiaries*

A simple consolidationH has bought 100% of SThe investment of H and the share capital of S need to be cancelled out.All other assets and liabilities are added togetherShare capital is only HS has been owned since incorporation so all retained earnings are post-acquisition and are includedRetained earnings are therefore*

Example 1Example 1*

HS000000Non-current AssetsFreehold land150 50Plant 80120Investment100-Current AssetsInventory 6040Receivables12030Cash 1020520260Equity1 Ordinary shares200100Retained earnings170 80370180Non-current liabilities10% debentures-10Current LiabilitiesTrade payables11060Corporation tax 4010520260

Subsidiaries not fully ownedWhat if a company only purchases 70% of the shares in another company?

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H LtdS LtdNon Current AssetsProperty, Plant and Equipment1,000Investment in S7007001,000

Share Capital7001000

One Year Later*

HS

Non Current Assets1,200

Investment in S700

7001,200

Share Capital and Reserves

Share Capital7001,000Retained Profits2007001,200

*Intra Group Balances

HS000000Non current AssetsPPE10080Investment80-Current Assets--Receivable from S8-Other current assets11240300120EquityOrdinary shares of 1200100Retained earnings4010Current liabilitiesSundry602Payable to H-8300120

Example 2 cancellation of internal itemsThe investment consists of 80,000 ordinary shares in S, at cost. The capital was purchased at par when the subsidiary was incorporated.Intra group balances must always be cancelled*

Other intra group balancesDividends if the holding company has shares in the subsidiary, when the subsidiary pays dividends, then a proportion of them will be paid to the Holding company.At the year end the subsidiary may have an outstanding dividend payable. The holding company would show this as a dividend receivableThese are intra group balances and must cancel out*

Consolidations 1Consolidations 1*Consolidations 1Consolidations 1*Consolidations 1Substance over form legally 2 separate entities, but the commercial reality is that H controls S

Consolidations 1*