Accounting for Groups of Companies

Introduction A group is formed when one company acquires a controlling interest in one or more
companies. This chapter of the workbook focuses on the preparation of consolidated profit and
loss accounts and balance sheets.
Learning targets By the end of this chapter you should be able to:
prepare consolidated balance sheets • prepare consolidated profit and loss accounts.
........
6.1 Definition of key terms
Consolidation is the process of aggregating the amounts shown in the individual accounts of the
parent company and its subsidiaries on a line by line basis and making appropriate adjustments
such as unrealised profit on inter-company transactions and elimination of inter-company
balances.
A group is made up of the parent company and its subsidiaries.
A parent company is the firm that controls the operating and financial policies of the other firms
in the group.
A subsidiary is a company controlled by the parent company,
6.2 Consolidated balance sheets
A consolidated balance sheet is prepared by combining information recorded within the
individual balance sheets of the parent and the subsidiary companies.
The main calculations required are normally in respect of: goodwill consolidated retained
earnings minority interest.

Chapter 6: Accounting for Groups of Companies

6.3 Goodwill
Purchased goodwill is the difference between the cost of investment and the aggregate of the fair
value of the acquired entity's identifiable assets and liabilities (net assets) at the date of
acquisition.
Net assets at the date of acquisition are calculated as follows:
XXX
XXX
Ordinary share capital Pre-acquisition profit/(loss) Share premium Other pre-acquisition reserves
Net assets at the date of acquisition
XXX XXX
XXX
Positive goodwill arises if the cost of investment is greater than the fair value of the net assets of
the acquired entity. Negative goodwill, on the other hand, arises when the cost of investment is
lower than the fair value of the net assets of the acquired entity.
6.4 Consolidated retained earnings
Consolidated retained earnings are the total of the retained earnings of the parent entity and the
group's share of the post-acquisition earnings of the subsidiary. Post-acquisition earnings of the
subsidiary are the retained earnings of the subsidiary at the date of consolidation, less retained
earnings at the date of acquisition.
6.5 Minority interest
Minority interest is the minority shareholders' share of the net assets of the subsidiary at the date
of consolidation.
Example 1
X plc paid $270,000 to acquire 100% of the ordinary shares of Y Ltd on 31 December 20X6. Y
Ltd's retained earnings at the date of acquisition were £150 000. The balance sheets of the two
companies at the close of business on 31 December 20X7 were as follows:
Capital and reserves
X plc
Y Ltd
of
650,000
50,000
Ordinary shares of £1 each Reserves Share premium Revaluation reserve Retained earnings
30,000
100,000
40,000 100,000
190,000
240,000 890,000
220,000 270,000
Required Calculate the following: (a) Goodwill at the date of acquisition. (b) Consolidated
retained earnings at 31 December 20X7.

Pearson LCCI Accounting: Level 3

Solution
270,000
(a) Goodwill
Cost of investment Share capital Share premium Pre-acquisition earnings
50,000 30,000 150,000 230,000
Group's share (100% X 230,000) Goodwill
230,000 40,000
100,000
(b) Consolidated retained earnings
Parent company's balance Parent's share of post-acquisition earnings
(100% X (190,000 – 150,000)
40,000 140,000
Example 2
X plc paid £250,000 to acquire 70% of the ordinary shares of Y Ltd on 31 December 20X6. Y
Ltd's retained earnings at the date of acquisition were £120,000. The balance sheets of the two
companies at the close of business on 31 December 20X7 were as follows:
Capital and reserves
X plc
Y Ltd
650,000
50,000
Ordinary shares of £1 each Reserves Share premium Revaluation reserve Retained earnings
30,000
100,000 40,000 110,000
190,000
220,000 270,000
900,000
Required Calculate the following amounts: (a) Goodwill at the date of acquisition. (b)
Consolidated retained earnings at 31 December 20X7. (c) Minority interest at 31 December
20X7.

Chapter 6: Accounting for Groups of Companies

Solution
250,000
(a) Goodwill
Cost of investment Share capital Share premium Pre-acquisition reserves
50,000 30,000 120,000 200,000
Group's share (70% x 200,000) Goodwill
140,000 110,000
110,000
(b) Consolidated retained earnings
Parent company's balance Parent's share of post-acquisition
earnings (70% X (190,000 – 120,000)
49,000 159,000
(c) Minority interest
Share capital Share premium Pre-acquisition earnings Post-acquisition earnings
(190,000 – 120,000)
50,000 30,000 120,000
70,000 270,000
Minority interest (30% x 270,000)
81,000
Example 3
X plc paid £180,000 to acquire 90% of the ordinary shares of Y Ltd on 31 December 20X6. Y
Ltd had a debit balance of £40,000 on its retained earnings account and a credit balance of
£20,000 on its revaluation reserve at the date of acquisition. The balance sheets of the two
companies at the close of business on 31 December 20X7 were as follows:
Capital and reserves
X plc
Y Ltd
650,000
50,000
Ordinary shares of £1 each Reserves Share premium Revaluation reserve Retained earnings
100,000 40,000 90,000
30,000 20,000 10,000
230,000 880,000
60,000 110,000
Hint: a debit balance on the retained earnings account is an accumulated loss.
Required Calculate the following: (a) Goodwill at the date of acquisition. (b) Consolidated
retained earnings at 31 December 20X7. (c) Minority interest at 31 December 20X7.

Pearson LCCI Accounting: Level 3

Solution
180,000
(a) Goodwill
Cost of investment Share capital Share premium Revaluation reserve Pre-acquisition reserves
50,000 30,000 20,000 (40,000) 60,000
Group's share (90% x 60,000) Goodwill
54,000 126,000
90,000
(b) Consolidated retained earnings
Parent company's balance Parent's share of post-acquisition
earnings 90% x (40,000 + 10,000)
45,000 135,000
(c) Minority interest
Share capital Share premium Revaluation reserve Pre-acquisition earnings Post-acquisition
earnings
(40,000 + 10,000)
50,000 30,000 20,000 (40,000)
50,000 110,000
Minority interest (10% X 110,000)
11,000
Example 4
X plc paid £160,000 to acquire 60% of the ordinary shares of Y Ltd on 31 December 20X5. Y
Ltd had a credit balance of £30,000 on its retained earnings account and a credit balance of
£10,000 on its revaluation reserve at the date of acquisition. Goodwill arising on acquisition is
amortised on a straight-line basis over a period of five years. The balance sheets of the two
companies at the close of business on 31 December 20X7 were as follows:
Capital and reserves
X plc
Y Ltd
650,000
50,000
Ordinary shares of £1 each Reserves Share premium Revaluation reserve Retained earnings
100,000 40,000 80,000
60,000 10,000 (20,000)
220,000 870,000
50,000 100,000
Required Calculate the following: (a) Goodwill at 31 December 20X7. (b) Consolidated retained
earnings.
(c) Minority interest.
Chapter 6: Accounting for Groups of Companies
Solution
160,000
(a) Goodwill
Cost of investment Share capital
50,000 Share premium
60,000 Revaluation reserve
10,000 Pre-acquisition reserves
30,000
150,000 Group's share (60% X 150,000) Goodwill at the date of acquisition Goodwill amortised
(70,000 = 5 x 2) Goodwill at 31 December 20X7
90,000 70,000 28,000 42,000
80,000
(b) Consolidated retained earnings
Parent company's balance Group's share of post-acquisition earnings
(60% X (-30,000 – 20,000))
30,000 50,000 28,000 22,000
Less goodwill amortised
(c) Minority interest
Share capital Share premium Revaluation reserve Pre-acquisition earnings Post-acquisition
earnings
50,000 60,000 10,000 30,000 (50,000) 100,000
Minority interest (40% x 100,000)
40,000
Exercise 6.1
On 1 January 20X7, Donna plc issued 10,000 of its ordinary shares to acquire 45,000 of the
issued ordinary shares of Tron plc. The retained earnings of Tron plc on 1 January 20X7 were
£7,000. Donna plc's shares were traded at £5 per share on 1 January 20X7. Tron plc's shares
were traded at £0.50 per share on the same date. Donna plc is yet to record the acquisition of the
shares in Tron plc in its books. At 31 December 20X7, the individual company balance sheets
were as follows:
Donna plc Tron plc
350,000
30,000
Fixed assets Investment in Tron plc Net current assets
60,000 410,000
50,000 80,000
Share capital (Ordinary shares of £0.50 each) Share premium Retained earnings
300,000 100,000
10,000 410,000
30,000
3,000 47,000 80,000

Pearson LCCI Accounting: Level 3

D
.
Goodwill is amortised on a straight-line basis over a period of five years.
Required (a) Prepare journal entries to record the acquisition of shares in Tron plc in
the books of Donna plc. (b) Calculate the following amounts:
(i) Goodwill at the date of acquisition. (ii) Goodwill at 31 December 2007. (iii) Consolidated
retained earnings at 31 December 20X7.
(iv) Minority interest at 31 December 20X7. (c) Prepare a consolidated balance sheet for the
Donna plc group as at
31 December 20X7.
Solution
Dr
(a) The acquisition has to be recorded at the fair value of the consideration
given. The shares will therefore be recorded at the fair value of (10,000 x 5) = £50,000 The
entries are:
Cr Debit Investment in Tron plc (10,000 x 5) 50,000 Credit Ordinary share capital (10,000 x
0.50)
5,000 Credit Share premium
45,000 Calculate the number of equity shares issued by Tron plc: 30,000
- = 60,000 shares 0.5
45,000 X 100 Calculate the percentage acquired: -
=75%
60,000 So, the percentage held by the minority shareholders in Tron plc is 25%.
50,000
(b) Goodwill at date of acquisition
Cost of investment Share capital Share premium Pre-acquisition reserves
30,000 3,000 7,000 40,000
Group's share (75% x 40,000) Goodwill at the date of acquisition
30,000 20,000
Goodwill at 31 December 20X7 Goodwill at the date of acquisition Less amortisation of
goodwill (20,000 = 5 x 1)
20,000
4,000 16,000
10,000
Consolidated retained earnings Parent company's balance Parent's share of post-acquisition
earnings
(75% X (47,000 – 7,000) Less goodwill amortised
30,000 (4,000) 36,000

Chapter 6: Accounting for Groups of Companies

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Minority interest Share capital Share premium Pre-acquisition profit Post-acquisition earnings
30,000 3,000 7,000 40,000 80,000
20,000
Minority interest (25% x 80,000) (c) Consolidated balance sheet
Goodwill Fixed assets (350,000 + 30,000) Net current assets
Share capital Share premium Retained earnings
16,000 380,000 110,000 506,000 305,000 145,000
36,000 486,000
20,000 506,000
Minority interest
6.6 Consolidation adjustments 6.6.1 Inter-company balances
Inter-company balances may arise from the following:
the parent company lends money to a subsidiary or vice versa • the parent company owes the
subsidiary for goods sold by the subsidiary to
the parent on credit or vice versa a dividend proposed by the subsidiary may be recorded as a
liability in the balance sheet of the subsidiary and an asset in the balance sheet of the parent
company.
All inter-company balances have to be eliminated when the consolidated balance sheet is
prepared. The consolidated balance sheet relates to the group (parent and subsidiary). Hence, any
debtors and creditors reported on the balance sheet should relate to amounts receivable by the
combined entity (group) from external parties payable by the combined entity to parties external
to the group. Failure to eliminate inter-company balances will result in the group's assets and
liabilities being inflated.