Financial Statements 2

1. Financial Statements 2 Consolidations 1 – Introduction and consolidated statement of financial position

2. What is a group? • Parent company • Subsidiary companies Parent Subsidiary Subsidiary

3. 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 directors • The parent can exercise dominant interest

4. 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 parent • All results are the responsibility of the parent • The shareholders of the parent company need to be fully informed about all the actions of the directors, including their management of subsidiaries

5. The acquisition method • Add together similar items in the parent and subsidiary accounts • Cancel inter-company transactions and balances • Allow for any non-controlling interest • Account for goodwill

6. Top part of the statement of financial position • This is the operational assets and liabilities of the group. These are always under the full control of the group so 100% of parent and subsidiary are added • Any inter-company balances are cancelled out • Goodwill on acquisition is included as an intangible non-current asset

7. Bottom part of the SFP • This represents ownership • Share capital is always just the parent company • Each reserve is: • 100% of parent company • Share of subsidiary’s post-acquisition reserve

8. Example 1 – a simple consolidation • H has bought 100% of S • The investment of H and the share capital of S need to be cancelled out. • All other assets and liabilities are added together • Share capital is only H • S has been owned since incorporation so all retained earnings are post-acquisition and are included • Retained earnings are therefore

9. Example 1 – consolidated statement of financial position of H Ltd £000 £000 Non Current Assets Equity Freehold land Ordinary shares Plant Retained Profits 450 Current Assets Inventory Receivables Cash Current Liabilities Trade creditors Corporation tax Non current liabilities 10% debentures 450

10. Example 2 – cancellation of internal items • H has bought 100% of S share capital and some debentures • Investment 1 of H and the share capital of S need to be cancelled out. • Investment 2 and the debentures of S need to be cancelled. NB H owns 60,000, not all of them. • Dividend receivable by H needs to be cancelled with the dividend payable of S • Inter-company balances must always be cancelled

11. Example 2 – consolidated statement of financial position of H Ltd £000 £000 Non current assets Equity PPE 380 Ordinary shares Retained Profit Current Assets 580 Other 390 Current liabilities Dividends payable Other creditors (140) Non current liabilities £1 8% debentures 580

12. Example 3 – non-controlling interest • Less than 100% of S is owned by H – S owns 80,000 out of 100,000 shares so owns 80%. The non-controlling shareholders own 20% • H still controls 100% of the assets and liabilities of S • Top part of SFP reflects control – add 100% of S to H

13. Example 3 – non-controlling interest • Bottom part of SFP reflects ownership • SC is H only • Retained earnings is H plus share of post-acquisition earnings of S: • Non-controlling interest shows the amount owned by the non-controlling shareholders: shareholders’ funds of S times the non-controlling share:

14. Example 3 – consolidated statement of financial position of H Ltd £000 Non current Assets PPE 180 Current assets 160 Current liabilities (70) 270 Equity Ordinary shares Retained Profit Non-controlling interest 270

15. Example 4 • As example 3 plus • Cancel inter-company balance: Dividend payable by S x H share The remaining dividend is due to the NCI so remains as a liability

16. Example 4 – consolidated statement of financial position of H Ltd £000 Non current Assets PPE 180 Current Assets Other current assets 152 Current liabilities Sundry (60) Dividends payable 270 Equity Ordinary shares of £1 Retained Profit Non-controlling interest 270

17. Example 5 – Preference share capital with non-controlling interest • Calculate percentage interest in ordinary shares and preference shares • Voting rights attach only to ordinary shares • Retained earnings all belong to the ordinary shareholders • Preference shareholders are only interested in the preference share capital • NCI is in both the preference and ordinary shares

18. Example 5 – Workings • W1 percentage shareholdings: • Ordinary shares 30,000/40,000 = • NCI in ordinary shares = • Preference shares 18,000/20,000 = • NCI in preference shares = • W2 Non-controlling interest • Prefs • Ords • W3 Retained earnings • H • S

19. Example 5 – consolidated statement of financial position of H Ltd £000 Non-current Assets PPE 110 Current Assets 130 Current Liabilities (60) 180 Equity Ordinary shares of £1 Retained Profit Non-controlling interest 180

20. Example 6 • Calculate percentage interests in prefs and ord shares • Cancel inter-company dividends • Calculate non-controlling interests • Calculate retained earnings

21. Example 6 – workings • W1 percentage shareholdings: • Ordinary shares 70,000/100,000 = • NCI in ordinary shares = • Preference shares 36,000/60,000 = • NCI in preference shares = • W2 Non-controlling interest • Prefs • Ords

22. Example 6 – workings • W3 Inter-company dividend • Pref • Ord • Retained earnings • H • S

23. Example 6 – consolidated statement of financial position of H Ltd £000 Non current Assets PPE 370 Current Assets Other 200 Current Liabilities Dividend payable -ordinary -preference Other (110) 410 Equity Ordinary shares 250 Retained Profit Non-controlling interest 410

24. Summary • Calculate percentage shareholdings • Calculate NCI as % x net assets of S • Calculate retained earnings as H plus % share of post-acquisition earnings of S • Add together parent and subsidiary • Cancel inter-company balances such as debentures, dividends • Consolidated SC is always only H