1. Financial Statements 2 Consolidations 2 – more complex statements of financial position 1

2. Goodwill Arises when shares are purchased for more than their nominal value Usually happens after the subsidiary has been trading for some years prior to the takeover by the parent, and has built up some retained earnings Calculate goodwill on acquisition Include in consolidated retained earnings only the share of the subsidiary’s earnings since acquisition 2

3. Example 8 Calculate percentage shareholding: 30,000/40,000 = NCI = Non-controlling interest Consolidated retained earnings H S 3

4. Example 8 Goodwill Investment in sub at cost Net assets of sub at acquisition Represented by: Share capital Retained earnings x 75 % Goodwill 4

5. Example 8 Consolidated statement of financial position as at 31.12.09 £000 Non Current Assets PPE (75 + 60)135 Intangible assets W4 Current Assets (85 + 40)125 Current Liabilities (50 + 20)(70) 202.5 Equity £1 ordinary shares Retained earnings W3 Non-controlling interest W2 202.5 5

6. Example 8a amended The share premium account will always be a pre-acquisition reserve Non-controlling interest becomes 6

7. Example 8a amended Goodwill becomes Investment in sub at cost50 Net assets of sub at acquisition Represented by: Share capital40 Share premium Retained earnings10 x 75 % Goodwill 7

8. Example 8a amended Consolidated statement of financial position as at 31.12.09 £000 Non Current Assets PPE (75 + 60)135 Intangible assets W4 Current Assets (85 + 40 +14)139 Current Liabilities (50 + 20)(70) 206 Equity £1 ordinary shares100 Retained earnings W3 Non-controlling interest W2 206 8

9. Example 8b amended Goodwill and consolidated reserves go down by the amount of the impairment 9

10. Example 8b amended Consolidated statement of financial position as at 31.12.09 £000 Non Current Assets PPE (75 + 60)135 Intangible assets W4 Current Assets (85 + 40)125 Current Liabilities (50 + 20)(70) 200 Equity £1 ordinary shares100 Retained earnings W3 Non-controlling interest W2 20 200 10

11. Unrealised profit Consolidated accounts show the affairs of the group as if it were a single entity. Groups frequently transfer inventory between group companies allowing the seller to make a profit. This causes problems in the group accounts if any of these goods are left in inventory at the year end. The company holding the inventory will correctly show it in its own statement of financial position at its cost (what it paid for it). The selling company will correctly record a profit on the sale of those goods. 11

12. Unrealised profit The consolidated statement of financial position needs to show it at cost to the group. The consolidated retained earnings must exclude the unrealised profit. This will require a consolidation adjustment, working out a provision for unrealised profit which is then deducted from the inventory figure. Consolidated retained earnings and non-controlling interest may also be affected 12

13. Unrealised profit Gross margin is a profit calculated as a percentage of selling price. E.g. included in S Ltd’s inventory at the year end is £40 purchased from H. H made a margin of 25% on the sale. The profit included in H’s profits and the inventory of S is £40 x 25% = £10. This must be deducted from H’s profits and the inventory of S 13

14. Unrealised profit Mark-up is the profit based on the cost E.g included in H Ltd’s inventory at the year end is £40 purchased from S. S charged a mark up of 25% on the sale. £40 is the selling price. It represents 125% of the cost. The profit is therefore 40 x 25/125 = 8 In this case S made the profit. Reducing S’s retained earnings affects the consolidated retained earnings and the non-controlling interest. 14

15. Cash in transit Intra-group trading is normally accounted for in a current account between the companies as part of their receivables or payables as appropriate. At the year end the outstanding receivable in one company’s statement of financial position should equal the payable in the other’s and just cancel out on consolidation If they not equal, the difference is normally cash in transit. 15

16. Example 9 Current accounts H receivables are £15; S payables are £12 – S has sent a cheque to H for £3 and has deducted this from it’s cash at bank figure – H has not yet received it, so they are showing the amount as still due from S – £3 cash is still owned by the group, but is not showing in either company’s SFP – Cancel the current accounts and add £3 to cash at bank 16

17. Example 9 Provision for unrealised profit on inventory Mark up is cost plus one third (33.33%), or selling price is 133.33% of cost Selling price is £20 so profit is H is the selling company so adjust against H’s retained earnings, and reduce inventory 17

18. Example 9 Goodwill Investment in sub at cost Net assets of sub at acquisition Represented by: Share capital Share premium Retained earnings Goodwill 18

19. Example 9 Non-controlling interest Retained earnings H Less: provision for unrealised profit S 19

20. Example 9 Consolidated statement of financial position Non current assets Freehold land (150+50)200 Plant(80+120)200 Goodwill Current Assets Inventory (60+40 Receivables (120+40 Cash(10+30 20

21. Example 9 Current Liabilities Trade payables (110+60 Corporation tax(40+10) (50) Non current liabilities 10% debentures (10) 481 Equity Ordinary shares 200 Retained earnings Non-controlling interest 481 21

22. Example 9 amended PUP is NCI Consolidated retained earnings H S 22

23. Example 9 amended Consolidated statement of financial position Non current assets Freehold land (150+50)200 Plant(80+120)200 Goodwill Current Assets Inventory (60+40 Receivables (120+40-15)145 Cash(10+30+3) 43 23

24. Example 9 amended Current Liabilities Trade payables (110+60-12)(158) Corporation tax(40+10) (50) Non current liabilities 10% debentures (10) 484 Equity Ordinary shares 200 Retained earnings Non-controlling interest 484 24

25. Example 10 Calculate percentage shareholding: NCI = Non-controlling interest Consolidated retained earnings H S Goodwill impairment 25

26. Example 10 Goodwill Investment in sub at cost Net assets of sub at acquisition Represented by: Share capital Share premium Retained earnings Fair value adj x 75 % Goodwill Impairment 26

27. Example 10 Consolidated statement of financial position as at 31.12.09 £000 Non Current Assets PPE (75 + 60 Intangible assets W4 Current Assets (85 + 50)135 Current Liabilities (50 + 20)(70) 212 Equity £1 ordinary shares 80 Share Premium 30 Retained earnings W3 Non-controlling interest W2 212 27