Group accounts

A parent that controls another company (a subsidiary) must prepare consolidated accounts that show the group as a single business (IFRS 10). Control usually comes from owning more than 50% of the voting shares.

How consolidation works

1. Add together 100% of the parent’s and subsidiary’s assets, liabilities, income and expenses, line by line, even if the parent owns less than 100%.
2. Take out the parent’s “investment in subsidiary” (the amount it paid for its shares) and put goodwill in its place. If both stayed in, the subsidiary would be counted twice: once as the investment, and again as its assets and liabilities added line by line.
3. Show the share of the subsidiary owned by other shareholders as non-controlling interest (NCI), within equity.
4. Cancel anything between group companies: intra-group balances, sales and unrealised profit.

Goodwill (IFRS 3)

Goodwill is the extra paid for a business on top of what its separate assets are worth. It is the value of things you can’t list individually, such as its customers, reputation and staff.

What the words mean:

• Consideration: what the parent gave to buy the shares, usually cash, but it can be the parent’s own shares.
• Fair value: what something would sell for today between willing buyers and sellers. It can be different from the figure in the subsidiary’s books.
• Fair value of NCI: what the shares owned by the outside shareholders are worth at the date of purchase. The exam question will give you this figure.
• Net assets: assets minus liabilities. This equals share capital plus reserves (such as retained earnings).
• At acquisition: on the day the parent took control.

Example: P pays £400,000 for 75% of S. The NCI is worth £120,000. S’s net assets are worth £440,000. Goodwill = 400,000 + 120,000 − 440,000 = £80,000.

Goodwill is not amortised (spread as an expense over its life). Instead it is tested for impairment every year: if it is now worth less, the loss is written off (IAS 36).

Group retained earnings and NCI

Only profits the subsidiary makes after the acquisition belong to the group. Profits it made before were already there when the parent bought it, so they were part of what the parent paid for. These are called pre-acquisition profits, and they go into the goodwill working, not into group retained earnings.

Post-acquisition profit = the subsidiary’s retained earnings now − its retained earnings at acquisition.

Unrealised profit (PURP)

If one group company sells goods to another at a profit and some are still in stock at the year end, the group hasn’t made that profit yet. Remove it from inventory and from profit.

With a mark-up on cost of m%, profit = selling price × m / (100 + m). With a margin of g%, profit = selling price × g%.

• Mark-up is profit as a percentage of cost. Cost £100, 25% mark-up, so you sell for £125.
• Margin is profit as a percentage of the selling price. Sell for £125 with £25 profit, so the margin is 20%.

Example: S sells goods to P for £12,000 at a mark-up of 25% on cost. At the year end, P still has half of them.

Reduce group inventory by £1,200 and group profit by £1,200. Because S made the sale, the NCI takes its share of the £1,200 reduction too. The other half of the goods has been sold outside the group, so that profit is real and stays in.

Associates (IAS 28)

If the investor has significant influence but not control, usually 20% to 50% of the voting shares, the investment is an associate. It isn’t consolidated line by line. It is shown as one line using the equity method: cost plus the investor’s share of profits since acquisition.

Example: P buys 30% of A for £100,000. Since then, A has made £40,000 profit. Investment in associate = 100,000 + (30% × 40,000) = £112,000. P’s profit or loss shows one line, “Share of profit of associate”, of £12,000.

This takes the three standard workings in the order you would do them in an exam: goodwill first, then group retained earnings, then NCI.

P buys 80% of S for £500,000. The fair value of the NCI at acquisition is £110,000. At acquisition S had share capital of £200,000 and retained earnings of £300,000 (fair value = book value). At the year end S’s retained earnings are £380,000, and P’s are £900,000.

Net assets at acquisition are share capital plus retained earnings on that day, because net assets always equal equity.

Post-acquisition profit in S = 380,000 − 300,000 = £80,000. P owns 80%, so the group gets £64,000 of it. The outside shareholders own 20%, so the NCI gets £16,000.