AC506 lecture 7

1. AC506 lecture 7 • Pre-acquisition reserves • Consolidated profit and loss account

2. Pre- and post-acquisition reserves • When a parent acquires a subsidiary during the financial period or at a date subsequent to the date of incorporation of the subsidiary (when the subsidiary has accumulated reserves), for consolidation purposes it is necessary to distinguish between pre-acquisition and post-acquisition reserves

3. Example • P Ltd purchased 80% of the equity share capital of S Ltd at a cost of €9,600 on 1 January 2000. At that date, the revenue reserves of S Ltd amounted to €2,000 • Prepare the consolidated balance sheet as at 31 December 2000

4. Consolidated Profit and Loss • Previously dealt with profit and loss implications of associates and JVs • Consolidation of profit and loss account of parent and subsidiaries follow same logic as balance sheet - parent plus group share of subsidiaries. Eliminate intra-group items.

5. Standard P&L adjustments • Intra-group turnover • Intra-group stock • Intra-group charges • Minority interest • Dividend shuffle and holding company dividend • Retained profit brought forward

6. Example • Apple Limited acquired the following in 1987: • 90,000 of 100,000 issued €1 ordinary shares in Pear Limited • 180,000 of 200,000 issued €1 ordinary shares in Plum Limited • 20,000 of 100,000 issued 1% €1 preference shares in Plum Limited • Apple controls all the operating and policy decisions in both Pear and Plum • The reserves balances of Pear Limited and Plum Limited at the date of acquisition were €1,600 dr and €5,800 cr respectively • Prepare consolidated profit and loss account for the Apple Group

7. Intra-group turnover • During the financial year, Apple sold goods to Plum for €48,000. => Intragroup sales and purchases amounts to be eliminated • Of these, Plum holds stock costing Plum €2,700 at year-end. • Unrealised profit to be eliminated from cost of sales and stock asset • Apple makes a 20% gross profit based on cost on all intra group sales. => Amount to be eliminated = 2,700/6 = €450

8. Intra-group charges • Included in Pear’s administrative expenses is a holding company management charge of €2,000. This has been recognised in the books of Apple as management fee income. • Eliminate all management charges, interest on loans, debenture interest charged by one group company to another.

9. Minority interest • Although Apple has control over the activities of the companies in the group, it does not have legal title to 100% of the shares and consequently to 100% of the profits. • We must calculate and show the amount attributable to the minority interest =>Minority interest of Pear is 10% of the ordinary shares; and =>Minority interest of Plum is 10% of the ordinary shares and 80% of the preference shares

10. Intragroup dividends • Once minority interest has been deducted from total profit, all amounts in the consolidated profit and loss account are group share only => net of minority interest • Apple has included dividend income in its sundry income • Eliminate from Apple income and corresponding dividend payments in Pear and Plum. Note there is no change to the profit retained by the group as a result of the intragroup elimination

11. Reserves brought forward • Pear €1,600 dr • Plum €5,800 cr • Exclude pre-acquisition reserves (Adjust 1) • Include group share of post-acquisition reserves only (Adjust 2)