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The Review of Financial and Accounting Studies ISSN 1450-2812 Issue 1 (2011) EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/REFAS.

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A New Approach to the Preparation of Consolidated Financial Statements of Group Companies


A. Seetharaman Professor, SP Jain Center of Management, Singapore E-mail: seetha.raman@spjain.org M. Krishna Moorthy Lecturer, Universiti Tunku Abdul Rahman, Perak Campus, Malaysia E-mail: krishnam@utar.edu.my A. S. Saravanan Lecturer, Multimedia University, Cyberjaya, Malaysia E-mail: a.s.saravanan@mmu.edu.my Abstract The treatment of accounts relating to holding companies occupies a predominant portion of any text book on corporate accounting or advanced financial accounting. This is due to too many journal entries, ledger accounts, work sheet and working notes besides final presentation of Consolidated Balance Sheet in the prescribed published format. A new method of preparation of consolidated financial statements of group companies is introduced in this article. Normally consolidated financial statements are prepared under traditional method by using journal entries, ledger accounts, work sheet and working notes to arrive an ultimate answer of Consolidated Balance Sheet in the prescribed format stipulated by accounting regulators. This process involves considerable amount of paper work, too much professional labour and duplication of time and effort. By conducting class room experiment among the under graduate and post graduate accounting students for the last three years, the author introduces a new method known as Accounting Equation Method. Under this method, the calculation is made very simple by taking only 20 minutes as against 50 minutes under traditional method.

1. Introduction
The 20th century saw a sea of change in the corporate structure. Corporations have grown globally. Expansion and increase of wealth through acquisition of subsidiary, foreign collaboration has become common. A fact of modern society is the conglomerate which is involved in many industries usually series of interlocking of companies. Another name for conglomerate is Group companies which is holding company and its subsidiaries.

2. Acquisition
An acquisition occurs when an entity acquires the control of another entity. The investor which controls another entity is known as the holding company while the company invested in is known as the subsidiary. A holding company together with subsidiary will form a group. The definition of

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control is that the holding company is able to exercise the majority of the voting rights at the Annual General Meeting (AGM) whereby it will be able to elect the majority of the members of the board of directors. These directors determine the financial and operating policies of the company. The usual way to acquire control of another company is by acquiring more than one half of the voting power in the investee company. A subsidiary company is defined as a company in which the majority of the shares are owned by another corporation; another corporation controls the composition of the board; or has the power to cast more than half of the votes. In determining a holding company, the accounting standard IAS 27 stresses that control rather than ownership is the key. The corporation exerting the control is a holding company.

3. Preparation of Consolidated Balance Sheet


The most exciting and perhaps the most complicated area of corporate accounting is the recording and reporting the activities of a group of companies. IAS 27 defines consolidated statements as the financial statements of a group presented as those of a single entity or single enterprise. IAS 27 deals with preparation and presentation of consolidated financial statements reporting the financial position, results of operations and cash flows of a group of enterprises under the control of the parent. All these financial statements are pro-forma accounts. Although parent company compiles the consolidated accounts, these accounts are neither prepared in the parent company books nor in the subsidiary books. They are merely memorandum accounts to facilitate to disclose the group accounts. All double entry rules apply in these proforma or memorandum accounts. Hence, some of the accounts appearing in the individual books of parent and subsidiary will be duplicated in the work sheet to facilitate consolidation.

4. The principle of cancellation


The consolidation of financial statements basically involves summing up the amounts for various financial statement items across the separate company statements. The accountant must adjust the amounts resulting from the summation, in order to eliminate double-counting resulting from intercompany transactions. The various final accounts of the holding company and its subsidiary undertakings have to be brought together and consolidated into one set of accounts for the whole of the group as one unit. Some items in one of the original sets of accounts will also be found to refer to exactly the same transactions in one of the other sets of original final accounts. Some common examples of elimination of double counting of same transactions are as followsAn item which is a debtor in one balance sheet may be shown as a creditor in another balance sheet. If P Ltd had sold goods to S Ltd, its subsidiary, but S Ltd had not yet paid for them, then the item would be shown as a debtor in the balance sheet of P Ltd and as a creditor in the balance sheet of S Ltd. Sales by one of the group companies to another company in the group will appear as sales in one company's accounts and purchases in another company's accounts. Shares bought in one of the subsidiary undertakings by the parent undertaking will be shown as an investment on the assets side of the parent undertaking's balance sheet. In the balance sheet of the subsidiary, exactly those same shares will be shown as issued share capital. Intra-group loans. This is when S LTD borrows money from H LTD. Loan from H LTD would appear in the balance sheet of S LTD. And as Loan to S LTD in the balance sheet of H LTD. Therefore, these two items will cancel out each other and will not appear in the consolidated balance sheet. Current accounts are maintained both by H LTD and by S LTD to record intra-group transaction. Instead of showing H LTD as a debtor and S LTD as creditors, current account here serves as a debtors or creditors. Thus, current accounts are eliminated from the consolidated balance sheets. However, the

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two current accounts sometimes may not show equal amounts. This is often due to two items, namely goods in transit and cash in transit. Note that transit means on the way. Bills of exchange. Intra group bills of exchange which are disclosed in the individual balance sheets of H LTD and S LTD must be eliminated and not shown in the consolidated balance sheet since they represent inter-company indebtedness. However, bills of exchange relating to outsiders and intra group bills that have been discounted must be shown in the consolidated balance sheet. Dividends paid by a subsidiary undertaking to its parent undertaking will be shown as paid dividends in the final accounts of the subsidiary, and as dividends received in the final accounts of the parent undertaking.

5. Preparation of Consolidated Balance Sheet


The popular method of preparing the consolidated balance sheet is the traditional method. Traditional method consists of using the following: Journal entries Ledger accounts Worksheet Lengthy calculations showing the details of goodwill and minority interest Consolidated Balance Sheet in prescribe formats However, another method known as the Accounting Equation Method will be introduced here. The following will discuss about the nature or characteristics of the two methods respectively.

6. Traditional Method of Using Journal, Ledger and Work Sheets


As stated above, the traditional method consists of using journal entries, ledger accounts (T- accounts) and work sheets to record, adjust and eliminate transactions. This will be supplemented by worksheet with adjustment in debit credit columns. Journal is an accounting record in which transactions are initially recorded in chronological order. Thus, the journal is referred to as the book of original entry. For each transaction the journal shows the debit and credit effects on specific accounts. Typically a journal has spaces for dates, account titles and explanations, references, and two columns to show monetary value namely debit and credit. Ledger is referred to the entire group of T- accounts maintained by a company. It keeps in one place where all the information about changes in specific account balances. The ledger should be arranged in statement order beginning with the balance sheet accounts. First in order are the assets, followed by liability accounts, owners equity consisting of share capital, share premium, reserves, retain earnings and profit and loss accounts, revenues, and expenses. Each account is numbered for easier identification. Worksheet is introduced to record the elimination and adjustment. By using work sheet, the elimination of investment account against shareholders fund is easily made. However, when the consolidation involves more complicated adjustments, for example, when the investment account and the shareholders funds are not equal, it is necessary to prepare some working paper which shows how the elimination or adjustment are calculated. Although any working paper which explains the derivation of the figure in the consolidated statement is acceptable, experiences has shown that multi column with debit credit elimination is complex. The use of traditional method consumes substantial amount of time in the recording process of journalizing (the entering of transaction data in the journal) and posting (the procedure of transferring journal entries to the ledger accounts). Transactions are initially recorded in chronological order in a journal before being transferred to the ledger accounts. In some circumstances, an entry will involve three or more accounts, and it is known as compound entry. Hence, there is a possibility of error occurrence if any accounts are omitted or over stated or under stated.. Besides, worksheets will very quickly become complicated document when too many debits and credits being used. The use of

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journals, ledgers and worksheets involves considerable amount of paper work and duplication of time, energy and money. Hence, there is a proposal for a simpler and effective approach to this most complicated consolidation.

7. Accounting Equation Method- A New Approach


Accounting equation can be used to make adjustment on financial position for both holdings and subsidiaries companies. Accounting equation is the most basic tool of accounting presenting resources of the business and claims to those resources. The accounting equation method uses a columnar accounts to record transactions involving plus (+) and minus (-) adjustments. The formula of an accounting equation is as follows: Assets = Liabilities + Shareholders equity Thus, this relationship refers basic accounting equation. Assets must equal the sum of liabilities and shareholders equity. Asset appears on left-hand side of the equation. The legal and economic claims against the asset- liabilities and owners equity - appear on right hand - side of the equation. Assets An increase in asset is represented by plus and its decrease is represented by minus. Liabilities and Shareholders Equity An increase in liabilities and owner equity is represented by plus and their decrease is represented by minus. Here, the shareholders equity includes share premium, reserves, retain earnings and profits. Accounting equation is used to Record and Analyse the transactions in tabular columns to determine the nature and effect of each transaction on asset, liability and owners equity Keep the accounting equation always in balance Ensure that change in asset will require a change in other asset or in liability or owners equity. (In other words, a plus in asset will require a minus in other asset or a plus in liability or owners equity and vice versa) Ensure that a change in liability will require a change in other liabilities or owners equity or in an asset. (In other words, a plus in a liability will require a minus in other liability or owners equity or a plus in assets and vice versa) Accounting equation method helps to organize accounting data systematically. It aids in preparing the financial statements, recording the adjustment entries and closing the accounts. By listing all the accounts and their unadjusted balances, it helps the accountant to identify the accounts needing adjustments. Although, its not essential, the accounting equation method is helpful because it brings together in one place the effects of all the transactions of a particular period. The accounting equation method aids the closing process by listing the adjusted balances of all the accounts. It also helps the accountant to discover potential errors. The accounting equation method is not part of the ledger or the journal, nor is it a financial statement. Therefore, it is not part of the formal accounting system. Instead, it is a summary device or a proforma statement that exists for the accountants convenience. Throughout this article, accounting equation method is used as a comparison with traditional method. This is a situation where the consolidated entity does not have its own set of journals and ledgers. The eliminations to remove inter-company transactions typically appear on a consolidated worksheet, not in the records of any of the companies in the consolidated entity. The accountant prepares the consolidated profit and loss account, and consolidated balance sheet directly from the worksheet.

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8. Traditional Method of Preparing Consolidation Accounts


In consolidated accounts, accounting equation method simply replaces the voluminous journal entries, T- ledgers, worksheet with debit credits columns and working notes. This can very well be seen by working out any illustration under both traditional method and accounting equation method. For this purpose, two illustrations are presented here to cover both simple consolidation and complicated consolidation. Illustration 1 Given below are the balance sheets of Henry Ltd and its 80% owned subsidiary Scooby Ltd as at 31.12.98. Henry acquired the ordinary shares of Scooby on 1.1.98 when the profit and loss account of Scooby had a credit balance of $45,000. Debtors of Henry include $30,000 due from Scooby. Bills payable of Scooby of $45,000 were drawn in favour of Henry. Henry had discounted $24,000 of these bills. Scooby had remitted $9,000 on account of the loan from Henry. Henry received the remittance on 2.1.x9. The goodwill is impaired and its value as at stands at Rs18, 000.

Henry $ ASSETS Investment in 240,000 Ordinary shares of Scooby at cost Fixed assets Stock-in-trade Debtors Bills receivable Loan to Scooby Bank LIABILITIES Ordinary shares of $1/- each Profit and loss account Creditors Bills payable Loan from Henry 300,000 1,500,000 150,000 90,000 60,000 90,000 60,000 2,250,000 1,800,00 360,000 60,000 30,000 2,250,000

Scooby $

600,000 60,000 15,000 30,000 6,000 711,000 300,000 165,000 90,000 75,000 81,0000 711,000

Required The consolidated balance sheet of the group as at 31-12 -1998. Workings under Traditional Method using Journals and Ledgers:
Henry 80% Minority Shareholders 20%

Ordinary shares of Scooby

Cancellation of inter-company balances: Debtors of Henry of $30,000 are cancelled against creditors of Scooby. Bills receivable of Henry to the amount of $21,000(i.e. the bills drawn by Henry and accepted by Scooby of $45,000 less bills discounted of $24,000) to be cancelled against bills receivable of Scooby. A note to denote the bills discounted of $24,000 to be appended to the consolidated balance sheet. Loan to Scooby to be adjusted for remittance in transit of $9,000. The amount owing of $81,000 to be cancelled against loan from Henry.

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies Journal Entries
Debit 240,000 36,000 24,000 60,000 33,000 93,000 6,000 6,000 30,000 30,000 21,000 21,000 81,000 9,000 90,000 Credit

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a)

b)

c) d) e) f)

Ordinary Shares in Scooby (80%) P & L Account in Scooby (80% of Pre Acq) Goodwill on Consolidation Investment in Scooby Ordinary Shares in Scooby (20%) P & L Account in Scooby (20%) Minority Interest Consolidate P & L Account Goodwill on Consolidation (impairment) Creditors Scooby Debtors Henry Bills payable Bills receivable Loan from Henry Cash in transit Loan to Scooby

300,000

Ledger Accounts
Investment in Scooby (80%) $ 300,000 Ordinary shares of Scooby Profit and loss of Scooby Goodwill on consolidation 300,000 Goodwill Investment $ 24,000 Consolidated profit and loss account (impairment) To CBS $ 6,000

Balance

$ 240,000 36,000 24,000 300,000

24,000 Minority Interest (20%) To CBS $ 93,000 93,000 Consolidated Profit and Loss Account $ 6,000 Balance b/d of Henry 450,000 Profit and loss of Scooby 456,000
Profit and Loss Account of Scooby $ 36,000 Balance b/d 96,000

18,000 24,000

Ordinary shares of Scooby Profit and loss of Scooby

$ 60,000 33,000 93,000

Goodwill on impairment To CBS

$ 360,000 96,000 456,000

To Investment ($45,000x80%) To consolidated profit and loss account ($165,000 $45,000) x80%) Minority interest ($165,000 x 20%)

$ 165,000

33,000 165,000 165,000

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Consolidation Work Sheet Henry Scooby $000 $000

Adjustments Debit Credit $000 $000 a300

CBS $000

Assets Investment in 240,000 Ordinary shares of Scooby at cost Fixed assets Stock in trade Debtors Bills receivable Loan to Scooby Bank Goodwill on Consolidation Total Liabilities Ordinary shares Profit and loss account

300 1500 150 90 60 90 60 2250 1800 360 600 60 15 30 6 711 300 165 f9 a24 33 a240 b60 a36 b33 c6 d30 e21 81

d30 e21 f90 c6 447

2100 210 75 69 75 18 2547 1800 450

Creditors Bills payable Loan from Henry Minority interest Total Grand Total of Debit Credit Adjustments

60 30

90 75

120 84 f81 b60 b33 93 540 93 2547

2250

711

507 540

Consolidated Balance sheet of Henry and of its subsidiary Scooby as at 31.12.98 $ $ Goodwill on consolidation 18,000 Fixed assets 2,100,000 2,118,000 Current assets Stock 210,000 Debtors 75,000 Bills receivable 66,000 Cash bank and in transit 75,000 426,000 Less Current liabilities Creditors 120,000 Bills payable 81,000 201,000 225,000 2,343,000 Financed by: Ordinary shares of $1/-each 1,800,000 Consolidated profit and loss account 450,000 2,250,000 Minority shareholders interest 93,000 2,343,000

Notes to the accounts: (1) Henry holds 80% of the issued ordinary share capital of Scooby as from 1.1.98. (2) Henry has a contingent liability of $24,000 on bills discounted.

9. Simpler Method of Accounting Equation in Preparing Consolidation Accounts


Now, accounting equation method is used to prepare consolidated statement. For this purpose it is necessary to consider the basic concepts of acquisition accounting for groups. Under the acquisition method, the balance sheet of the Scooby (subsidiary) should be restructured to make a distinction between Pre-Acquisition and Post- Acquisition profit. Hence the profit and loss account of Scooby should be split into P&L Pre-Acquisition and P&L Post-Acquisition. The cost of investment in the ordinary shares of the subsidiary is matched against fair value of net assets of the subsidiary (Share capital and Pre-Acquisition profits) on the date of acquisition. The difference between the two amounts

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is treated as Goodwill on consolidation. There is a remarkable amount of savings in space, time, effort, and concentration. Summary of Steps under Accounting Equation Method Post the balance sheets of both holding and subsidiary in a columnar statement. Restructure the Balance Sheet of the Subsidiary by splitting the Profit and Loss account in to Pre Acquisition P & L Account and Post Acquisition P & L Account. Adjust the Investment Account in holding company against the share capital and pre-acquisition profits and reserves of the subsidiary to the extent of controlling interest. Treat the difference between two amounts as goodwill on consolidation. Create Minority Interest Account by transferring minority portion of share capital, profit and reserves (Both pre and post acquisition profits) Eliminate inter company balances Provide for impairment by reducing both Goodwill and Profit & Loss Eliminate the undiscounted portion of bills of exchange involving inter company transactions Now, the same illustration which involves so many journal, ledger and work sheet entries in five pages is presented simply in one page under Accounting Equation Method. Consolidation Under Accounting Equation Method Figures in 000)
Assets Inves- Fixed Stock Deb- Bills tment Asset In tors Rec Trade Balance Sheet Henry 300 1500 150 90 60 Ltd Balance Sheet Scooby 600 60 15 30 Ltd Adjustment of 80% -300 control in Scooby and creation of Good will Minority Interest @ 20% Eliminate debtors due -30 from Scooby Eliminate loan to Scooby and Create Cash in Transit Impairment of Goodwill at current value at 18 (24-18) Undiscounted Bills of -21 S Total 0 2100 210 75 69 Grand Total Assets Details of Transaction I Liabilities Loan Bank Cash Good Ordinary P&L P&L Bills Loan Credi Minority to S in will Shares Pre Post Pay,e from tors Interest Transit Acq Acq Henry 90 60 1800 360 30 60 6 +24 300 -240 45 -36 120 75 81 90

-60

-9

-24 -30

+93

-90

+9

-81

-6

-6

-21 0 66 9 2547 18 1800 0 Liabilities 450 84 0 120 93 2547

Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.

Consolidated Balance sheet of Henry and of its subsidiary Scooby as at 31.12.98 $ $ Goodwill on consolidation 18,000 Fixed assets 2,100,000 2,118,000 Current assets Stock 210,000 Debtors 75,000 Bills receivable 66,000 Cash bank and in transit 75,000

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Less Current liabilities Creditors Bills payable

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426,000 120,000 81,000 201,000

225,000 2,343,000 1,800,000 450,000 2,250,000 93,000 2,343,000

Financed by: Ordinary shares of $1/-each Consolidated profit and loss account Minority shareholders interest Notes to the accounts: (1) Henry holds 80% of the issued ordinary share capital of Scooby as from 1.1.98. (2) Henry has a contingent liability of $24,000 on bills discounted.

Illustration 2 Given below are the balance sheets of Harrison Ltd, Steven Ltd and Robert Ltd. 31. 12. X8 Harrison Ltd has acquired 450,000 ordinary shares of Steven Ltd. On 1.1.x3 when the profit and loss account of Steven Ltd. had a balance of $ 60,000. Subsequently, on 1.1.x4 Steven Ltd. acquired 240,000 ordinary shares of Robert Ltd. and the balance in the profit and loss account of Robert Ltd. on that date was $ 30,000.
Harrison Ltd. $ 1,500,000 300,000 1,800,000 540,000 1,260,000 1,800,000 300,000 540,000 840,000 480,000 480,000 Steven Ltd. $ 600,000 240,000 840,000 Robert Ltd. $ 300,000 180,000 480,000

Ordinary shares of $1/- each Profit and Loss account Investment in subsidiaries at cost Ordinary shares in Steven Ltd. Ordinary shares in Robert Ltd. Sundry assets

Required You are required to prepare the consolidated balance sheet as at 31.12.x8. Answer Multi stage method First Stage - Preparation of consolidated accounts for sub-groups Steven Ltd. and Robert Ltd. Journal Entries (Fig in 000)
Debit 240 24 36 60 60 36 36 Credit

a)

b) c)

Ordinary Shares (80% of Roberts shares) P & L A/C (80% of Pre Acquisition Profits) Goodwill on Consolidation Investment in Robert Ordinary Shares (20% of Robert shares) Minority Interest P & L A/C (20% of Profit) Minority Interest

300

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies Ledger Accounts
Investment in Robert Ltd Balance $ 300,000 Ordinary shares in Robert Ltd. Profit and Loss of Robert Ltd. Goodwill on consolidation $ 240,000 24,000 36,000 300,000

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300,000 Minority Interest To CBS $ 96,000 96,000 Consolidated Profit and Loss Account $ 360,000 Profit and Loss balance of Steven Ltd. Robert Ltd. 360,000 Profit and Loss Account of Robert Ltd. $ 24,000 Balance b/d 36,000 120,000 180,000 Worksheet Steven Robert $000 Liabilities Ordinary shares Profit and loss Minority Interest Total Assets Investment in Robert Sundry assets Goodwill Total Grand Total of Debit Credit Adjustment 840 480 360 600 240 $000 300 180 Ordinary shares. Profit and Loss.

$ 60,000 36,000 96,000

$ 240,000 120,000 360,000

To CBS

Investment in Robert Consolidated profit and loss Account Minority interest

$ 180,000

180,000

Adjustments Debit Credit $000 $000 a240 b60 a24 c36 b60 c36 96

CBS $000 600 360

96 1056

300 540 840

a300 480 480 a36 36 396 300 396 1020 36 1056

Consolidated Balance Sheet of Steven Ltd. and of its subsidiary Robert Ltd. as at 31.12.x8 $ $ Sundry assets 1,020,000 Goodwill on Consolidation 36,000 1,056,000 Ordinary shares of $1/-each 600,000 Consolidated profit and loss account 360,000 960,000 Minority shareholders interest 96,000 1,056,000

Second Stage - Preparation of consolidated accounts of Harrison Ltd. and the sub-group Steven Ltd & Robert Ltd.

82 Journal Entries (Fig in 000)

A. Seetharaman, M. Krishna Moorthy and A. S. Saravanan

a)

b) c)

Ordinary Shares (75% of Stevens) P & L A/C (75% of Pre Acq profits of 60) Goodwill on Consolidation Investment in Stevens Ordinary Shares (25% of Stevens) Minority Interest P & L A/C (25% of both Post and pre acq profits) Minority Interest

Debit 450 45 45 150

Credit

540 150 90 90

Ledger Accounts
Investment in Steven Ltd Balance $ 540,000 Ordinary shares of Steven Ltd. Profit and Loss of Steven Ltd. Goodwill on consolidation $ 450,000 45,000 45,000 540,000

540,000 Minority Interest To CBS $ 240,000 240,000 Consolidated Profit and Loss Account $ 525,000 Profit and Loss Balance of Harrison Ltd. Steven Ltd. (CPL) 525,000 Consolidated Profit and Loss of Group Steven Ltd. $ 45,000 Balance as per CBS of Steven Ltd. 225,000 Ordinary shares of Steven Ltd. Profit and Loss of Steven Ltd.

$ 150,000 90,000 240,000

$ 300,000 225,000 525,000

To CBS

Investment in Stevens 75% x $60,000 Consolidated profit and Loss account 75% x ($360,000 $60,000) Minority Interest 25% x $360,000

$ 360,000

90,000 360,000 Consolidation Worksheet Harrison CBS Steven & Robert $000 $000 600 360 96 1800 540 1056 735 360,000

Adjustments Debit $000 a450 b150 a45 c90 b150 c90 240 a540 Credit $000

CBS

$000 1500 525

Liabilities Ordinary shares Profit and loss Minority Interest Total Assets Investment in Steven

1500 300

336 2361

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies


Sundry assets Goodwill Total Grand Total of Debit Credit Adjustment 1260 1800 1020 36 1056 a45 45 780 2280 81 2361

83

540 780

Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Sundry assets 2,280,000 Goodwill on consolidation ($36,000 + $ 45,000) 81,000 2,361,000 Ordinary shares of $1/-each 1,500,000 Consolidated profit and loss account 525,000 2,025,000 Minority interest ($ 96,000 + $ 240,000) 336,000 2,361,000

Now, the same illustration which involves so many journal, ledger and work sheet entries in five pages is presented simply in one page under Accounting Equation Method. Illustration -2 Multistage Method (Fig 000) Important Points: 1. Consolidate S with SS and then consolidate H with S and SS subgroup H holds 80% control in S. S holds 75% control in SS. The effective interest of H over SS is 60% (80%x75%) First Stage: Consolidation of S with SS Assets Liabilities
Details of Transaction First Stage Balance Sheet S Balance Sheet SS Adjustment of 80% of Control interest in SS With Creation of Goodwill Mino.Interest @ 20% Grand Total -S and SS Second Stage: Cons of H with S and SS Group Balance Sheet H Adj. Of 75% Control in S By H & creation of Goodwill Minority Interest @ 25% Total Investm ent In SS 300 -300 Investm ent In S Sundry Assets Good Will Total Assets Ordina ry Shares 600 300 -240 P&L A/c Pre Acq 60 30 -24 P&L A/c Post Acq 180 150 Minorit y Interest Total Liabiliti es

540 480 +36

-60 0 1020 36 1056 600

-6 60

-30 300

+96 96 1056

540 -540

1260 +45

1500 -450

300 -45

-150 0 0 2280 81 2361 1500

-15 0

-75 525

+240 336 2361

Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.

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Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Sundry assets 2,280,000 Goodwill on consolidation ($36,000 + $ 45,000) 81,000 2,361,000 Ordinary shares of $1/-each 1,500,000 Consolidated profit and loss account 525,000 2,025,000 Minority interest ($ 96,000 + $ 240,000) 336,000 2,361,000

Single Stage Method Step 1 Determine the Effective interest of the ultimate holding companys interest in the various subsidiaries. Step 2 Open one Investment Account Debit with: Holding companys interest in the subsidiary and the holding companys interest in the subsidiarys investment in the sub subsidiary. Credit with: The holding companys interest in the share capital and pre-acquisition reserves of the subsidiary and sub subsidiary. Step 3 Open one minority shareholders account: Debit with: The minority shareholders interest in the investment in the sub subsidiary. Credit with: The minority shareholders interest in the capital and reserves of the subsidiary and sub subsidiary. Answer The holding company holds 75% of the issued ordinary share capital of Steven Ltd. Steven Ltd. holds 80% interest in Robert Ltd. Therefore, Steven Ltd. has an indirect interest of 75% of 80% = 60% interest in Robert Ltd. Journal Entries (Fig in 000)
Debit 450 45 45 150 15 45 210 180 18 27 75 300 120 12 60 192 Credit

a)

b)

c)

d)

Ordinary Shares (75%of Stevens - 600) P & L A/C (75% of Stevens Pre Acq Profits) Goodwill on Consolidation Investment in Stevens Ordinary Shares (25% of Stevens 600) P & L A/C (25% of Stevens Pre Acq Profits -60) P & L A/C (25% of Stevens Post Acq Profits -180) Minority Interest in Stevens Ordinary Shares (60% = 80% of 75% = of Robert 300) P & L A/C (60% of Robert Pre Acq profits 30) Goodwill on Consolidation Minority Interest Investment in Robert Ordinary Shares (40% of Robert 300) P & L A/C (40% of Pre Acq Profits -30) P & L A/C (40% of Post Acq Profits 150) Minority Interest in Robert Investment in Stevens Ltd

540

Balance

$ 540,000

Ordinary shares in Stevens 75%

$ 450,000

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies


P & L A/C (75% of Pre Acq Profits) Goodwill on Consolidation 540,000 Investment in Robert Ltd Balance $ 300,000 Ordinary Shares 60% of Robert (80%of75%) 300,000) P & L A/C (60% 0f Pre Acq Profits) Goodwill on Consolidation Minority Interest (25% of 300) $ 180,000 18,000 27.000 75,000 300,000 45,000 45,000 540,000

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300,000 Minority Interest Investments in Robert Ltd 25% $300,000 To CBS $ 75,000 327,000 Ordinary shares of Stevens Ltd Ordinary Shares of Robert Ltd Profit and Loss of Steven Ltd. (15+60) Profit and Loss of Robert Ltd. (12+60)

$ 150,000 120,000 60,000 72,000 402,000

402,000 Consolidated profit and Loss Account $ 525,000 Balance Of Harrison Ltd. Steven Ltd. Robert Ltd. 525,000 Profit and Loss Account Steven Ltd $ 45,000 Balance B/d 135,000 60,000 240,000 Profit and Loss Account Robert Ltd. $ 18,000 Balance B/d 90,000 72,000 180,000

$ 300,000 135,000 90,000 525,000

To CBS

Cost control - 75% x $60,000 CPL - 75% x ($240,000 $ 60,000) MI - 25% x $240,000

$ 240,000

240,000

Cost control - 60% x $30,000 CPL - 60% x ($180,000 $ 30,000) MI - 40% x $180,000

$ 180,000

180,000

Consolidation Work Sheet Harrison Steven Robert $000 Liabilities Ordinary shares 1500 $000 600 $000 300

Adjustments Debit Credit $000 $000 a450 b150 c180 d120 a45 b60 c18 d72 c75 b210 d192

CBS $000 1500

Profit and loss

300

240

180

525

Minority Interest

327

86
Total Assets Investments Sundry assets Goodwill on Consolidation Stevens Robert Total Grand Total of Debit Credit Adjustment

A. Seetharaman, M. Krishna Moorthy and A. S. Saravanan


1800 540 1260 840 300 540 480 a45 c27 72 1242 480 1170 402 a540 a300 2280 72 840 1242 2352 2352

1800

840

480

Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Ordinary shares of $1/- each 1,500,000 Consolidated profit and loss 525,000 Capital and reserves 2,025,000 Minority shareholders interest 327,000 2,352,000 Goodwill on consolidation 72,000 Sundry assets 2,280,000 2,352,000

Note:

The goodwill on consolidation and minority shareholders interest differ between the two methods. The difference is $9,000. In the single stage method the minority shareholders interest in the goodwill in the sub subsidiary is allocated to them. The minority shareholders of Steven Ltd. have a 25% interest in the goodwill of Robert Ltd. $36,000 x 25% = $9,000.

Now, the same illustration which involves so many journal, ledger and work sheet entries in five pages is presented simply in one page under Accounting Equation Method. Illustration 2 - Single Stage Method Important Points (Fig in 000) Investment by S in SS consists of both H share and minority share in 75:25 ratio
Details of Transaction Assets Invest Invest ment ment In In S SS 540 300 - 540 Sundry Assets Good will I Total Assets Ordina ry Shares 1500 600 300 -450 P&L A/c Pre Acq Liabilities P&L Minorit A/c y Post Interest Acq 300 180 150 Total Liabilit ies

Balance Sheet H Balance Sheet S Balance Sheet SS Adj. Of 75% control in S By H with Goodwill Minority Interest 25% Hs Interest in the investment Of SS 75% and its effective interest In SS shares and pre acq. Profits only 60% (80%x75%) Minority Interest in Investment of SS 25% Minority Interest in shares and profits of SS (100%-60%) 40%(effective) Grand Total

1260 540 480 +45

60 30 -45

-150 -225 +27 -180 (60%)

-15 -18 (60%)

-45

+210

-75

-75

-120

-12

-60

+192

2280

72

2352

1500

525

327

2352

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies

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Please note the differences between multistage and single stage method in calculation of goodwill and minority interest. The difference is RM 9000. In single stage method, the minority interest in the goodwill in SS is allocated to them. The minority shareholders have a 25% interest in the goodwill of SS = 36000 x25% = 9000. A Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.
Consolidated Balance sheet Of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Ordinary shares of $1/- each 1,500,000 Consolidated profit and loss 525,000 Capital and reserves 2,025,000 Minority shareholders interest 327,000 2,352,000 Goodwill on consolidation 72,000 Sundry assets 2,280,000 2,352,000

10. Traditional Accounting System versus New Accounting Equation Method


Traditional Accounting System with journal and ledger It is very complicated compare to the new accounting system because all journal entries, ledger and balance sheet need to be opened individually. It is difficult for users who do not have accounting knowledge to understand the debit credit transaction. New Accounting Equation Method It is easy to prepare because it combined all journal entries, ledger, and balance sheet in one stroke. It helps new user of the financial statements who does not have accounting knowledge to understand the companys financial statement easily. The accounting equation method can show all the companys transaction in an easy, simpler and clear way to the user. The accounting equation method (new accounting system) is less time consuming as all transaction will be drawn in just one worksheet. Error that occurs in the financial statement can be easily detected by the accountant as all the business transactions are shown in one worksheet only. Thus, this can decrease the risk of mistake in the financial statement that will mislead the users. Furthermore this can increase the credibility of the financial statement to the public. Errors can be easily corrected. The accountants just need to correct the mistake in the accounting equation only.

The old accounting system with journal and ledger entries consumed more time and space as journal entries will be recorded in journal book and ledger entries will be recorded in ledger book. Errors are hard to detect and to do this is time consuming as each transactions in the entry need to be thoroughly checked. This is because the accountant need to check each and every one of the transactions to identify if there is any wrong double entry. In this old accounting system errors are hard to correct. Accountants need to correct mistakes from the beginning (journal entry) to the Balance Sheet. This is a very messy job. Higher cost will be accrued, as more staff is required to prepare the full sets of accounts. For example, one employee will prepare the trade debtors account; one will prepare the trade creditors accounts etc. The author experimented this traditional system with a sample of 100 students who took average of 55 minutes to complete the illustration 2.

The company can reduce the cost in preparing a full set of accounts. This is because the company can just employ a few staff in preparing the financial statement. The author experimented the Accounting Equation Method with a sample of 100 students who took only average of 25 minutes to complete the illustration 2.

11. Treatment of Goodwill


Now, the treatment of goodwill differs from country to country. Standards are set and based on impairment method.

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A. Seetharaman, M. Krishna Moorthy and A. S. Saravanan

12. Conclusion
The doublze entry system is based on recording the transaction value in debits and credits. The dual effect of each transaction is recorded in appropriate accounts. The basic accounting equation ie., Assets = Liabilities + Owners equity, must be equal. In the technology era efficient and effective accounting information systems are based on certain principles like cost effectiveness, usefulness and flexibility that is the future needs. When the world is using computerised system, why still need manual accounting system in preparing the accounts including consolidation of group financial statements. To understand what computerised accounting system do, still we need to understand how manual accounting systems work. The traditional accounting system of consolidation of group accounts, by using various T accounts and journals, involve time, cost, risk and errors. To achieve the goal of cost effectiveness, usefulness, flexibility, timeliness and above all to understand by non accounting personals in preparation of group financial statements the new accounting method in preparing the group consolidated financial statements called New Accounting Equation Method on consolidation can be used, which is very simple to follow since it is based on arithmetic equation of plus and minus. This can be achieved by employing fewer accounting employees, at lesser cost and produce the required group financial statements on time.