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Financial Statements 2

Financial Statements 2. Consolidations 2 – more complex statements of financial position. Goodwill. Arises when shares are purchased for more than their nominal value

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Financial Statements 2

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

  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

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

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

  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

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

  7. Example 8a amended • Goodwill becomes Investment in sub at cost 50 Net assets of sub at acquisition Represented by: Share capital 40 Share premium Retained earnings 10 x 75 % Goodwill

  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 shares 100 Retained earnings W3 Non-controlling interest W2 206

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

  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 shares 100 Retained earnings W3 Non-controlling interest W2 20 200

  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.

  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

  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

  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.

  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.

  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

  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

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

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

  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

  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

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

  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

  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

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

  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

  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

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