You are on page 1of 7

F1: preparing

consolidated financial
statements
Velocity August 2010

This article explains how to prepare basic consolidated financial


statements for a group with one subsidiary. Its the second in a twopart series by the F1 examiner.
Consolidated financial statements were not examined at the equivalent
level in the old syllabus. They have now been included in F1 as an
introduction to consolidated financial statements in preparation for the F2
exam.
The F1 syllabus excludes non-controlling interests, all subsidiaries must
be 100% owned by the parent entity. Questions could include one or
more subsidiaries. The syllabus includes associated entities but we will
not be able to consider them in this article.
The F1 syllabus specifies that you should be able to prepare a
consolidated statement of financial position and a consolidated
statement of comprehensive income for a group in relatively
straightforward circumstances. Questions could be set requiring either
one of these consolidated statements or both of them.

Preparing consolidated financial statements


IAS 27 Consolidated and separate financial statements defines a
subsidiary as an entity that is controlled by another entity. An entity has
control if it has the ability to direct the operating and financial policies of
another with a view to gaining economic benefit. If an entity owns 100%
of another entity it will usually have control.
When preparing consolidated financial statements:
1.
2.
3.

We are replacing the cost of the investment in the holding entitys accounts with the fair value of the assets and
liabilities of the subsidiary.
Goodwill is likely to arise on acquisition. Shares purchased at the market price may not reflect the fair value of the
assets and liabilities of the subsidiary. Any difference between the amount paid and the value of the assets is
goodwill.
There must be no double counting. All items that relate to transfers within the group must be eliminated on
consolidation.

Pre-acquisition and post-acquisition reserves


When preparing consolidated financial statements it is important to
distinguish between pre-acquisition reserves and post-acquisition
reserves. Pre-acquisition reserves are retained profits and other
reserves that exist in a subsidiarys statement of financial position at the
date of acquisition. Pre-acquisition reserves are capitalised at the date of
acquisition by including in the goodwill calculation. They must not be
included in the consolidated income statement or consolidated statement
of financial position.
Profits/losses (including unrealised gains and losses) made after
acquisition that are shown in the subsidiary reserves can be included in
the consolidated statement of comprehensive income and in reserves in
the consolidated statement of financial position.
Intra-group activities
The impact of any intra-group activities must be cancelled out in the
consolidated financial statements.
1.
2.
3.

Inter-entity trading. Sales and purchases figures need to be adjusted on the income statement to remove double
counting of the sales. Any goods in closing inventory at the year end will include unrealised profit in the inventory
value, this must be removed.
Current accounts should be reconciled, making adjustments for any items in transit and then cancelled out on
consolidation.
Intra/inter-group dividends received are cancelled on consolidation against dividends paid.

Consolidated financial statements use the same underlying format as


single entity financial statements, so you do not need to learn new
formats for consolidated financial statements.
Consolidated financial statement preparation - checklist
1.
2.
3.
4.
5.

Calculate group holdings and establish the status of each entity in the question (subsidiary, associate or
investment), W1
Establish fair value of assets acquired and calculate net assets of the subsidiary, W2
Calculate goodwill arising on acquisition, W3
Adjust for any intra-group activities, W4
Calculate balance carried forward on consolidated retained earnings, W5

6.
7.

Calculate balance carried forward on consolidated reserves, W6


Prepare consolidated financial statements, statement of financial position and/or consolidated statement of
comprehensive income.

Now, let us use this approach in answering a typical question. X holds


shares in Y. On 1 April 2006 X purchased 600,000 shares in Y at a cost
of $1.60 per share. The fair value of Ys tangible assets at 1 April 2006
was $126,000 more than book value. The retained profits of Y at 1 April
2006 were $120,000. The excess of fair value over book value was
attributed to buildings held by Y. At 1 April 2006 the buildings had an
estimated remaining useful life of 21 years. The draft summarised
financial statements for the two entities as at 31 March 2010 are given
below:
Summarised statement of financial position at 31 March 2010
X

Y
$000

$000

Property, plant and equipment

1,210

700

Investment in Y at cost

960

Non-current assets

2,170

700

Current assets
Sundry

1,780

Current a/c with Y Ltd

80

Total assets

620

1,860

620

4,030

1,320

Equity and reserves


Equity shares of $1 each

2,000

600

Retained earnings

400

300

2,400

900

Current liabilities

Trade payables

1,630

Current a/c with X plc

360
60

1,630
4,030

420
1,320

Summarised statement of comprehensive income for the year


ended 31 March 2010
X

$000

$000

Revenue

910

390

Cost of sales

(461)

(171)

449

219

Other income - dividends received

50

Expenses

(110)

(43)

389

176

(30)

(22)

359

154

Taxation

(43)

(12)

Profit for the year

316

142

Finance cost

Additional information:
(i) Y paid an interim dividend of $50,000 on 31 December 2009
(ii) Y sent a cheque for 20,000 to X on 30 March 2010
(iii) X occasionally trades with Y. In November 2009 X sold Y goods for
$90,000. X uses a mark up of 50% on cost. On 31 March 2010 Y had not
paid for the goods and they were all still in Ys closing inventory.
Required
Prepare a consolidated, summarised statement of comprehensive
income for the year ended 31 March 2010 and a consolidated statement
of financial position for the X group of entities as at 31 March 2010.
Solution
All figures are in $000

Workings (following the checklist above)


Note: Narrative and journal entries are shown here to aid understanding
of the process of consolidation; they are not required in an exam answer.
1) Calculate group holdings:
Xs holding in Y is 600,000 shares out of 600,000, therefore treat Y as a
wholly owned subsidiary of X.
2) Fair value of net assets of Y at acquisition
Fair value of the net assets is the same as the total of share capital plus
all pre-acquisition reserves. As buildings are revalued upwards at
acquisition it will create a revaluation reserve at the date of acquisition.
This must be treated as a pre-acquisition reserve and included in the fair
value of net assets at acquisition.
Shares 600
Retained earnings at 1 April 2006 120
Fair value adjustment 126
Total 846
The fair value of the buildings increased by 126 and has a useful life of
21 years. Assuming straight line depreciation with no residual value, that
is, 126/21=6. Y was purchased four years ago, so the amount of extra
depreciation since acquisition is 6 x 4 = 24.
Debit Credit
Consolidated retained earnings 24
Property, plant and equipment 24
3) Goodwill - Y
Cost of shares acquired 960
Fair value of net assets acquired (W2) 846
Goodwill 114
4) Intra/inter-group activities
(i) Current accounts Debit Credit
Y sent a cheque to X. When this is received and banked it will increase
bank balance and reduce the current account. Entries are:
Sundry current assets (bank) 20
Current account with Y 20
Now the current accounts agree, so cancel current accounts on
consolidation and ignore in the consolidated financial statements.
Current account with X 60
Current account with Y 60

The only item appearing in the consolidated statements is the


adjustment to bank of 20.
(ii) Intra-group trading
As the mark up is given in the question we will have to convert it to the
selling price margin.
Mark up on cost 50% = 33% margin on selling price.
Selling price 90; unrealised profit = 90 x 33% = 30
As all the goods are in closing inventory we need to cancel the
unrealised profit of 30 from closing inventory in both the statement of
comprehensive income and the statement of financial position.
Debit Credit
Consolidated revenue 90
Consolidated cost of sales 90
Consolidated cost of sales 30
Consolidated sundry current assets (inventory) 30
(iii) Interim dividend paid by Y
Cancel the other income item in X against the dividend paid by Y. Then
ignore in the financial statements as it has no effect. Note that the
dividend paid by Y would be shown in its statement of changes in equity.
5) Consolidated retained earnings
Make sure that you collect all the adjustments above that effect the postacquisition profit of the group.
Balance - X, from question 400
Y group share of post acquisition profits (300 120) 180
Deduct post-acquisition increase in depreciation due to fair value
adjustment (W2) (24)
Cancel unrealised profit in inventory (4ii) (30)
Total 526
7) Prepare consolidated financial statements
The first part is to add together the parent and its subsidiary amounts for
each line of the statements. The only exceptions to this are share
capital, where you put in the parent entitys share capital on its own and
retained earnings where you use the figure calculated in W5. In the
statements below the figures from the question are shown first, then the
adjustments from the workings are shown with workings reference.
X group consolidated statement of comprehensive income
$000
Revenue (910+390-90 [w4ii]) 1,210

Cost of sales (461+171-90 [w4ii] +30 [w4ii] +24 [w2]) 596 614
Expenses (110+43) (153)
461
Finance cost (30+22) (52)
409
Taxation (43+12) (55)
Profit for the year 354
X group - consolidated statement of financial position as at 31
March 2010
$000
Non-current assets
Goodwill [W3] 114
Property, plant and equipment
(1210+700+126 [w2] -24 [w2]) 2,012
2,126
Current assets
Sundry assets
(1,780+620-30 [w4ii] +20 [w4i]) 2,390
4,516
Equity and reserves
Ordinary shares 2,000
Retained earnings [W5] 526
2,526
Current liabilities
Trade payables
(1,630+360) 1,990
4,516
Conclusion
If you follow this approach to the preparation of consolidated financial
statements you should have no problem with the F1 questions and will
be well prepared for the consolidated financial statements on F2.