CIMA-F2-Consolidated Financial Statements

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CIMA-F2-Consolidated Financial Statements

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CIMA-F2-Consolidated Financial Statements

  1. 1. KAPP Edge Solutions Pvt. Ltd. FINANCIAL MANAGEMENT-F2 CONSOLIDATED FINANCIAL STATEMENT
  2. 2. KAPP Edge Solutions Pvt. Ltd. What is a group? A group is where one parent company (holding company) control one or more companies (subsidiary company) by way of Dominant influence or Participating interest. IAS 27 consolidated and separate financial statements IAS 27 has two objectives: (1) Preparation and presentation of consolidated financial statements for a group of entities under the control of a parent; and (2) In accounting for investments in subsidiaries, jointly controlled entities and associates in the separate individual (non-consolidated) financial statements. IAS 27 specifically does not allow the following reasons as exemptions: Different nature of business Severe long-term restrictions IAS 27 states that the investment in the subsidiary must be shown in the statement of financial of the parent company’s separate financial statement either: (i) At cost or (ii) Using IAS 39 financial instruments - recognition and measurement . General provisions of IAS 27 for consolidation Accounting policies Accounting period and dates Date of acquisition or disposal. Inter company transactions Non controlling interest - minority interest CONSOLIDATED STATEMENT OF FINANCIAL POSITION A company which has a subsidiary on the last day of its accounting period must prepare consolidated financial statements in addition to its own individual accounts.
  3. 3. KAPP Edge Solutions Pvt. Ltd. Consolidation involves the replacement of cost of investment in the parent’s accounts by what it actually represents i.e: Parent’s share of the net assets of the subsidiary as at the end of the reporting period; AND Any remaining element of the goodwill which the parent paid for at the date of acquisition. In addition to this, the reserves of the parent must be credited with the parent’s share of the subsidiary’s post-acquisition reserves so that the accounts balance. Goodwill Goodwill is the difference between the value of the business taken as a whole and the fair value of its separate net assets. Note The idea is that when a company buys an interest in another it will pay a price that reflects both the assets it buys and the goodwill. It can be calculated as: GOODWILL = COST less: SHARE OF NET ASSETS Consolidation
  4. 4. KAPP Edge Solutions Pvt. Ltd. ↓ ↓ Parent Subsidiary Net assets X X X + Issued capital X X = X Reserves X X X X X X = = = + CONSOLIDATION ADJUSTMENTS INDIVIDUAL COMPANY ADJUSTMENTS Consolidated statement of financial position Overview of the technique Individual company adjustments In exam questions the statements of financial position initially provided will be incorrect/deficient, the must be corrected before the consolidation can proceed. The approach may be broadly represented as follows
  5. 5. KAPP Edge Solutions Pvt. Ltd. Consolidation adjustments Two types Major Inter- company adjustmen ts adjustmen ts *Consolidated reserves *Goodwill * Inventory * Non-current asset transfers *Non-controlling interests Those that “drive” the * Inter company balances double entry: * Unrealised profit
  6. 6. KAPP Edge Solutions Pvt. Ltd. Inter-company balances Consolidation represents the position and performance of a group of companies as if they were a single entity. ̈If the members of the group trade with each other (as is likely) a receivable in one set of accounts will be balanced out by a payable in another. When statements of financial position are combined on consolidation these amounts are cancelled out against each other in the group accounts. Adjustments Illustration Parent owns 80% of Subsidiary. Parent sells goods to Subsidiary. At the end of the reporting period the accounts of the two entities contain inter-company balances (also called intra-group). These amounts are contained in accounts that are often described as Current accounts in the receivables and payables sections of the appropriate statement of financial position . As far as the individual entities are concerned it is quite correct that the balances appear in this way as they represent amounts that will be received by/ paid to the separate entities. Parent Subsidiary Receivables Amount receivable from Subsidiary 1,000 Payables Amount payable to Parent 1,000 Usually the assets and the liabilities of the group are a straightforward cross cast of the individual items in the accounts of the parent company and its subsidiaries. If this occurred in respect of inter-company amounts the financial statements of the group would end up showing cash owed from and to itself. This would clearly be misleading.
  7. 7. KAPP Edge Solutions Pvt. Ltd. To avoid this, the inter-company amounts are cancelled on consolidation. Parent Subsidiary Consolidated statement of financial position Receivables Dr Cr Amount receivable from Subsidiary 1000 1000 - Payables Amount payable to Parent 1,000 1,000 - Adjustments on consolidation Unrealised profit Inter-company balances are cancelled on consolidation. The main reason for these arising is intercompany (or intra- group) trading. If a member of a group sells inventory to another member of the group and that inventory is still held by the buying company at the end of the reporting period: ̌ The company that made the sale will show profit in its own accounts. This is correct from the individual company’s viewpoint. However, this profit will not have been realised from the group’s perspective. ̌ The company that made the purchase will record the inventory at cost to itself. This is also correct from the individual company view. However consolidation of this value will result in the inclusion in the financial statements of a figure which is not at cost to the group. ̈ IAS 27 Consolidated and Separate Financial Statements rules that “… resulting unrealised profits shall be eliminated in full.” This implies that the unrealised profit is eliminated from the inventory value. However, the Standard does not rule on the other side of the entry. There are two possibilities. (1) The whole amount of the unrealised profit adjustment is “suffered” by the parent company’s shareholders: ̌ Reduce the inventory value in the consolidated statement of financial position and profit or loss. ̌ Treat the adjustment as a consolidation adjustment.
  8. 8. KAPP Edge Solutions Pvt. Ltd. The reduction of closing inventory in the consolidated statement of comprehensive income would reduce the profit for the year and hence the retained earnings figure at the bottom of the statement of financial position. The direction of the sale (Parent to Subsidiary or Subsidiary to Parent) would be irrelevant. (2) Share the adjustment between the parent company’s shareholders and the non-controlling interest as appropriate: ̌ Reduce the inventory value in the consolidated statement of financial position and statement of comprehensive income and then give the non-controlling interest their share. ̌ This is easily achieved by making an adjustment in the books of the group company that made the sale to the other group company (i.e. seller adjustment), as a consolidation adjustment. ̌ The direction of sale is now important. Inventory ̈ One group company may sell inventory to another at a profit. ̌ Inventories in the statement of financial position are valued at lower of cost and net realisable value (NRV). In the consolidated statement of financial position, where the group is reflected as a single entity, inventories must be at lower of cost and NRV to the group. ̌ The group needs to eliminate profit made by the selling company if inventory is still held by the group at the end of the reporting period, as the group has not yet realised this profit. ̌ Applying single entity concept, group has bought and is holding inventory. ̈ There are two ways in which the unrealised profit can be eliminated from the consolidated financial statements: ̌ as a parent adjustment against group totals after the subsidiaries’financial statements have been consolidated with the parent; or ̌ as an adjustment by the seller before consolidation .
  9. 9. KAPP Edge Solutions Pvt. Ltd. Parent adjustment ̈ Adjustments: ̌ Consolidated inventory in the statement of financial position; and ̌ Consolidated closing inventory in the statement of comprehensive income (and therefore retained earnings). Seller adjustment ̈ Adjustments from seller perspective: ̌ Inventory in the statement of financial position ; ̌ Closing inventory in the statement of comprehensive income Non-current asset transfers ̈ In accordance with the single entity concept the group accounts should reflect the non-current assets at the amount they would have been stated at had the transfer not been made. ̈ On an intra-group transfer a profit/loss may have been recognised by the selling company. This must be removed on consolidation. ̈ The buying company will include the asset at cost (which is different to cost to the group) and will depreciate the asset. The charge for the year will be different to what it would have been if no transfer had occurred. ̈ Summary of adjustments needed: ̌ Remove profit ̌ Correct the depreciation charge The unrealised profit will be in the accounts of the selling company and the depreciation adjustment will be made in the accounts of the company buying the asset. Approach ̈ Construct a working, which shows the figures in the accounts, and what would be in the accounts with no transfer.
  10. 10. KAPP Edge Solutions Pvt. Ltd. FURTHER ADJUSTMENTS Adjustments Consolidation problems are usually tackled in two stages: Stage 1 Process the individual company adjustments. Stage 2 Do the consolidation. Items not accounted for Dividends payable If draft statements of financial position of group companies have not yet recognised dividends declared before the year end closing adjustments will need to be made before consolidation Process adjustments to finalise individual statements of financial position before consolidation In books of proposing company Dr Retained earnings (in statement of changes in equity) X Cr Current liabilities – dividends payable X (with dividend payable.) If the subsidiary is declaring the dividend, the parent will receive its share. This dividend now represents reserves-in- transit. The parent must record its dividend receivable. Dr Dividend receivable X Cr Profit or loss X (with share of dividend receivable from the subsidiary.) The dividend receivable and liability are inter-company balances and must be cancelled.
  11. 11. KAPP Edge Solutions Pvt. Ltd. Consolidated statement of financial position will reflect in liabilities: • Parent’s dividends payable; • Non-controlling interests’share of the subsidiary’s dividends payable. Dividends paid out of pre-acquisition profits Goodwill is the difference between: The net assets of the subsidiary at the date of acquisition (as represented by issued capital and reserves); and The cost of shares acquired. A dividend declared out of pre-acquisition profits represents a distribution of the assets at acquisition. The parent is therefore realising part of its investment (i.e. the assets in which it invested). Crediting such dividends to “Cost of investment” in the parent’s books will reduce goodwill. Group accounting policy adjustments IAS 27 states that the accounts of subsidiaries are to be drawn up according to the same accounting policies as the holding company. If this is not the case then the accounts of the subsidiary may have to be restated in line with the group policy. Such a requirement is rare in practice because a situation that required it would by definition be contrary to the IAS. It might be needed in the cases of: Mid year acquisition – where the parent has not yet imposed its policies on the subsidiary; or Where the subsidiary was foreign and was following local GAAP.
  12. 12. KAPP Edge Solutions Pvt. Ltd. Goodwill Definition IFRS 3 defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised”. In essence it is the difference between the cost of the acquisition and the acquirer’s interest in the fair value of its identifiable assets acquired and liabilities assumed as at the date of the exchange transaction. This is reflected in consolidation workings as: $ Cost (the value of the part of the business owned) X Acquirer’s share of the fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary as at the date of acquisition (X) ____ X ____ As a result of the revisions to IFRS 3, issued in 2008, the non-controlling interests’share of goodwill may be recognised as part of the acquisition process. The option to measure non-controlling interests is allowed on a transaction-by- transaction basis. As a result of this change in the possible measurement of both goodwill and non-controlling interests IFRS 3 specifies the goodwill calculation as follows: $ Acquisition date fair value of the consideration transferred X Amount of any non-controlling interests in the entity acquired X Less: Acquisition date amounts of identifiable assets acquired and liabilities assumed measured in accordance with IFRS 3 (X) ____ Goodwill X ____ If the subsidiary has not reflected fair values in its accounts, this must be done before consolidating.
  13. 13. KAPP Edge Solutions Pvt. Ltd. Cost of acquisition – Fair value of purchase consideration An acquisition is accounted for at its cost. Cost is: Amount of cash or cash equivalents paid; and The fair value of the other purchase consideration given. Any costs directly associated with the acquisition of the subsidiary are to be expensed through profit or loss as a period costs. Deferred consideration Deferred consideration – cost of the acquisition is the present value of the consideration, taking into account any premium or discount likely to be incurred in settlement (and not the nominal value of the payable). Contingent consideration When a business combination agreement provides for an adjustment to the cost, contingent on future events, the acquirer includes the acquisition date fair value of the contingent consideration in the calculation of the consideration paid. If the contingent settlement is to be in cash, then a liability will be recognised. If settlement is to be through the issue of further equity instruments, then the credit entry will be to equity. Any non-measurement period changes to the contingent consideration recognised will be accounted for in accordance with the relevant IFRS and will not impact upon the original calculation of goodwill. Recognition Introduction The identifiable assets and liabilities acquired are recognised separately as at the date of acquisition (and therefore feature in the calculation of goodwill). This may mean that some assets, especially intangible assets, will be recognised in the consolidated statement of financial position that were not recognised in the subsidiary’s single entity statement of financial position. Any future costs that the acquirer expects to incur in respect of plans to restructure the subsidiary must not be recognised as a provision at the acquisition date. They will be treated as a post-acquisition cost.
  14. 14. KAPP Edge Solutions Pvt. Ltd. Contingent liabilities of the acquiree IAS 37 Provisions, Contingent Liabilities and Contingent Assets does not require contingent liabilities to be recognised in the financial statements. However, if a contingent liability of the subsidiary has arisen due to a present obligation that has not been recognised (because an outflow of economic benefits is not probable) IFRS 3 requires this present obligation to be recognised in the consolidated financial statements as long as its fair value can be measured reliably. This will mean that some contingent liabilities will be recognised in the consolidated statement of financial position that were not recognised in the single entity’s statement of financial position. Measurement All assets and liabilities of the subsidiary that are recognised in the consolidated statement of financial position are measured at their acquisition date fair values. The non-controlling interests of the subsidiary are measured at either: fair value; or the non-controlling interests’proportionate share of the subsidiary’s identifiable net assets. Exceptions to recognition and measurement principles Exceptions to both recognition and measurement principles Deferred taxes are recognised and measured in accordance with IAS 12. Employee benefits are recognised and measured in accordance with IAS 19. Any indemnification assets (e.g. a guarantee given by the seller against a future event or contingency) are recognised and measured using the same principles of recognition and measurement as for the item that is being indemnified.
  15. 15. KAPP Edge Solutions Pvt. Ltd. Fair values – general guidance Marketable securities – current market values. Non-marketable securities – estimated values that take account of price earnings ratios, dividend yields and expected growth rates of comparable securities of entities with similar characteristics. Receivables – at the present values of the amounts to be received, determined at appropriate current interest rates, less allowances for uncollectibility and collection costs, if necessary Inventories : finished goods and merchandise at selling price less: costs of disposal; and a reasonable profit allowance for the acquirer’s selling effort (based on profit for similar items); work in progress at selling price of finished goods less: costs to complete; costs of disposal; and a reasonable profit allowance for the completing and selling effort (based on profit for similar finished goods; and raw materials at current replacement costs. Land and buildings – at their current market value. Plant and equipment – at market value normally determined by appraisal. .
  16. 16. KAPP Edge Solutions Pvt. Ltd. Intangible assets – at fair value determined: by reference to an active market; if no active market exists at an amount that the entity would have paid for the asset in an arm’s length transaction between knowledgeable and willing parties based on the best information available Defined benefit plans assets or liabilities at present value of the defined benefit obligation less the fair value of the plans assets. Tax assets and liabilities – at the amount of the tax benefit arising from tax losses or the taxes payable in respect of the profit or loss, assessed from the perspective of the combined entity or group resulting from the acquisition. The tax recognised will be after allowing for the effects of fair valuing the assets, liabilities and contingent liabilities of the acquiree. The amount recognised is not discounted. Accounts and notes payable – long-term debt, liabilities, accruals and other claims payable at the present values of amounts to be disbursed in meeting the liability determined at appropriate current interest rates. Onerous contracts and other identifiable liabilities of the acquiree – at the present values of amounts to be disbursed in meeting the obligation determined at appropriate current interest rates. Contingent Liabilities of the acquiree will be valued at the amounts third parties would charge to take them over. The amount reflects all expectations about future cash flows.
  17. 17. KAPP Edge Solutions Pvt. Ltd. Accounting for the revaluation in the accounts of subsidiaries If the subsidiary has not reflected fair values in its accounts, this must be done before consolidating. For a revaluation upwards create a revaluation surplus in net assets working (fair value less book value of net assets at acquisition) at acquisition and the end of the reporting period . For a revaluation downwards create a provision against retained earnings in net assets working (book value less fair value of net assets at acquisition) at acquisition and the end of the reporting period . Goodwill in the subsidiary’s statement of financial position is not part of identifiable assets and liabilities acquired. If the subsidiary’s own statement of financial position at acquisition includes goodwill, this must be written off. Reduce retained earnings at acquisition and the end of the reporting period by goodwill in the subsidiary’s statement of financial position at acquisition. Do this in the net assets working. IFRS 3 refers to this as “allocation of the cost of acquisition”. IFRS 3 requires the whole revaluation to be reflected in the consolidated group accounts. The non- controlling interests balance will reflect their share of the revaluation.
  18. 18. KAPP Edge Solutions Pvt. Ltd. Accounting for goodwill Goodwill Goodwill reflects the future economic benefits arising from assets that are not capable of being identified individually or recognised separately. It is initially measured at cost, being the excess of the cost of the acquisition over the acquirer’s interest in the fair value of the identifiable assets, and liabilities acquired as at the date of the acquisition. It is recognised as an asset. Subsequent to initial recognition goodwill is carried at cost less any accumulated impairment losses. Goodwill is tested annually for impairment; any loss is expensed to profit or loss. Bargain purchases If on initial measurement the fair value of the acquiree’s net assets exceeds the cost of acquisition , then the acquirer reassesses: the value of net assets acquired; that all relevant assets and liabilities have been identified; and that the cost of the combination has been correctly measured. If there still remains an excess after the reassessment then that excess is recognised immediately in profit or loss. This excess (gain) could have arisen due to: future costs not being reflected in the acquisition process; measurement of items not at fair value, if required by another standard, such as deferred tax being undiscounted; bargain purchase. known within the “measurement period”.
  19. 19. KAPP Edge Solutions Pvt. Ltd. Measurement period The measurement period is the period after the acquisition date during which the parent may adjust the provisional amounts recognised in respect of the acquisition of a subsidiary. The measurement period cannot exceed one year after the acquisition date. Subsequent adjustments Any other adjustments are treated in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. An error in acquisition values is treated retrospectively. A change in estimate is treated prospectively. Impairment of goodwill General Goodwill on acquisition must be allocated to a cash generating unit (CGU) that benefits from the acquisition. A CGU need not necessarily be a unit of the subsidiary acquired; it could be a unit of the parent or another subsidiary in the group. The unit must be at least that of an operating segment (as defined under IFRS 8 Operating Segments), that is, a distinguishable component. Each CGU must be tested annually for impairment. The test must be carried out at the same time each year, but does not have to be carried out at the year end. Partially-owned subsidiary Any goodwill in a partially-owned subsidiary, where the amount of the non-controlling interest’s share of goodwill has not been recognised, must be grossed up to include the non-controlling interests’share of goodwill for the purposes of the impairment test. Any impairment is firstly allocated against this grossed up goodwill figure. Any impairment in excess of this grossed up goodwill is then allocated against the remaining assets of the CGU on a pro-rata basis.
  20. 20. KAPP Edge Solutions Pvt. Ltd. At acquisition X X ______ ______ X X X X X X NON-CONTROLLING INTERESTS GOODWILL ×% × Net asset at end of Cost X acquisition (X) X _____ _____ _____ acquisition profits Goodwill adjustment (X) (X) Adjustments (X) X × x% Subsidiary share of post _____ All of Parent per Q X acquired Share net assets x% × Net assets at CONSOLIDATED RETAINED EARNINGS ______ ______ the reporting period Fair value reserve ______ ______ per Q X X Adjustments (X) At balance sheet date Issued capital Retained earnings
  21. 21. KAPP Edge Solutions Pvt. Ltd. KAPPEDGE SOLUTIONS PVT. LTD. CIMAAPPROVED LEARNING PARTNER WWW.ONLINEGLOBALCAREER.COM

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