Consolidated Income Statement • CIS is the combination of the operation of the individual subsidiaries and parent company • Items of income and expenses disclosed in the CIS are the those transactions between the group and third parties (entities outside the group • All intra-group transactions are cancelled
Cont. • Accounting Technique • CIS combines similar items such as sales, income and expenses on a line by line basis regardless of the fact that the subsidiary is being consolidated may not be owned 100% by the parent company. • The portion belongs to minority shareholders will be disclosed separately in the income statement • Any appropriation of profits (e.g. dividends, transfer to reserves) will be disclosed in the statement of changes in equity
Example See Example 1 from JL & TLL, C&G A&R, 6th edition On 1.1.X3 H acquired 75% of the issued ordinary share capital of S of 40 million shares of RM1 each. On that date the reserves of S consisted of share premium of RM20 million and retained profits of RM10 million Given are the incomes statements of H and its subsidiary S for the year ended 31.12.X5
Solution Workings: 1. Revenue (turnover) Aggregate sales of the H company and those of the subsidiary 2. Cost of sales The aggregate sales of the H company and those of the subsidiary 3. Operating expenses The aggregate expenses of the H company and those of the subsidiary
Solution 4. Investment income It will comprise dividends and interest and other income excluding dividends and interest received/receivables from subsidiaries. Dividend from subsidiary is not disclosed 2. Taxation Combine total of H company and those of the subsidiary 3. Profit attributable to MI Profit after tax of S x MI (%)
Cont’ H and its subsidiary Consolidated Income Statement For the year ended 31.12.X5
Cont’ Extract of the Statement of Changes in Equity For the Year Ended 31.12.X5
Inter-Company Transactions • Closely related to inter-company balances are inter-company transactions which may result in profits or losses. • Examples of transactions • Inter-company sales of stocks • Inter-company dividends • Inter-company loans giving rise to interest receivable and payable • Management fees charged by parent company • Inter-company sale of stock by one company and treated as PPE by another member company
Cont. The Principle • In the single entity concept, the effects of such inter-company transactions in a group must be eliminated as the group (as one entity) cannot possibly trade and make profit from itself. • FRS 127 prescribes that “intra-group balances and intra-group transactions and resulting unrealized profits should be eliminated in full”.
Sales of Stocks Consolidation adjustment Inter-company profits or losses arise when inventories are sold at price other than costs to the selling company within the group. Profits are realized only when purchased inventories from a member company were sold off to an outside party. Adjustment for unrealized profits is only required in the trading inventories purchased from a member still remain unsold on the balance sheet date.
Cont. The unrealized profitsof the inventories unsold are to be eliminated in full and value of the inventories reduced to cost (to the group). If it is down stream sales i.e. parent selling to the subsidiary, the unrealized profit will be adjusted fully in the accounts of the parent. If the sales are up stream sales, i.e. sales by the subsidiary to the parent, the unrealized profit adjustment is made in the accounts of the subsidiary.
Illustration 1 – At Cost During 20X7 S Bhd sold goods worth RM80,000 (at cost) to P Bhd (upstream sale). S Bhd is wholly owned by P Bhd. On 31 December 20X7, RM20,000 out of the purchase amount by P Bhd is still in ending inventory. Assume the selected figures for the year ending 31 December 20X7 before adjustments as shown in the consolidated worksheet are as follows:
Cont. Required: Show the journal entry to eliminate the inter-company transactions from sale of goods and show the effect in the consolidated worksheet for the year 20X7. (Ignore tax effect).
Solution Since the sale of goods was made at cost, no unrealized profit has been arisen as the sale was effectively a transfer of asset (i.e. inventory or may be other assets) from the premise of S Bhd to the premise of P Bhd. The only adjusting entry required on consolidation is the elimination of inter-company sales and purchases. Journal entry: (a) Sales (S) RM80,000 Purchases (P) RM80,000
Cont. After the adjustment, the balance in the sales and purchases figures only shows transactions with outside parties. The endinginventory figures need not be adjusted as the purchasing company (i.e. P Bhd) has recorded in its books at cost of purchase(i.e. no unrealized profit embedded in the inventory figure) The adjusting entry shows that sale and the corresponding cost of sales (i.e. purchases) were eliminated on consolidation
Illustration 2 – Above Cost P Bhd acquired 100% interest in S Bhd. In 20X8, S Bhd sold inventories to P Bhd up to RM440,000, after 10% markup. Assumes that P Bhd sold ¾ of inventories in 20X8. (Ignore tax effect)
Solution Explanation: Cost of inventories to S Bhd would be: RM400,000 = (100/110 x RM440,000) Profit for S Bhd = RM40,000 If P Bhd sells all inventories to external party in 20X8 at RM500,000, then no consolidated journal entry is required. Profit has been realised.
Cont. Profit for group: Sales RM500,000 Cost (400,000) Profit 100,000* Note: Profit of RM100,000 is recorded in S Bhd at RM40,000 and P Bhd RM60,000.
Cont. When P Bhd sold only ¾ of inventories, there is unrealized profit in the group’s inventories. This unrealized profit needed to be eliminated to record the inventories at cost together with inter-company sales of inventories. Journal entry on 31/12/20X8 (a) elimination of inter-company sales Sales (S) 440,000 Purchases (P) 440,000
Cont. (b) elimination of unrealized profit in ending inventories Ending inventories (IS - COGS) (S) 10,000 Inventories (BS) (P) 10,000 (1/4 x RM40,000 = RM10,000)
Illustration 3 – Above Cost Assume the facts are in Illustration 1 except that the profit was made at 20% of invoice price (RM80,000).
Solution Explanation: Since the sale of goods was made at 20% of invoice price, the seller (S Bhd) would have recorded an unrealized profit of RM16,000 (RM80,000 x 20%) on the transaction date. Note that RM20,000 of the purchased inventories are still in the ending inventory at 31.12.20X7. Thus, RM20,000 ending inventory would comprised ofcost (RM16,000) and unrealized profit (RM4,000 = RM20,000 x 20%).
Cont. Journal entry on 31/12/20X7 (a) elimination of inter-company sales Sales (S) 80,000 Purchases (P) 80,000
Cont. (b) elimination of unrealized profit in ending inventory Ending inventory (IS - COGS) (S) 4,000 Inventory (BS) (P) 4,000 If the entity accounts for deferred tax then the tax effect on unrealized profits must also be eliminated as follows: (c) Deferred tax (BS) 1,120 Taxation expense 1,120
Unrealized Profit – Opening Inventory An unrealized profits embedded in the ending inventory will be carried over to the period as an opening inventory embedded with unrealized profits. An unrealized profit in the opening inventory would normally be converted into realized profit by the end of the year when the inventory is sold to outside parties. Unrealized profit in the opening inventory needed to be eliminated on consolidation.
Illustration 4 The ending inventory in 20X7 becomes the opening inventory of 20X8. In the P Bhd’s book the retained profit b/f and the opening inventory is embedded with unrealized profit (RM4,000) carried forward from 20X7. Therefore, on consolidation in 20X7 the brought forward retained profits and the opening inventory containing profit transfer of RM4,000 must be eliminated. Journal entry Opening retained profits (P) RM4,000 Opening inventory (IS - COGS) RM4,000
Sales of Stocks – Minority Interest If it is down stream sales i.e. parent selling to the subsidiary, the profits are recorded by the parent. Any unrealized profit will be adjusted fully in the accounts of the parent.No adjustment is necessary in the calculation of MI in the CSI and CBS. If the sales are up stream sales, i.e. sales by the subsidiary to the parent or horizontal sales, i.e. sales among subsidiaries in a group, profits are recorded by the selling subsidiaries. The unrealized profit adjustment is made in the accounts of the subsidiary. When the full unrealized profits are eliminated on consolidation, MI should be allocated for their share of unrealized profits.
Sales of Stocks – Minority Interest MI share of the profits in the CSI should be based on the subsidiaries’ profits that have been realized. Calculation: Subsidiary’s after tax profit + unrealized profit b/f (net of tax if applicable) - unrealized profit c/f (net of tax if applicable) MI’s percent holding in subsidiary X
Illustration 5 Assume S Bhd (80% owned subsidiary) reported a net profit after tax of RM57,600. At the end of previous year and end of the current year it had sold inventory to the parent at 20% of invoice price. Computed unrealized profit in opening inventory and ending inventory were RM6,000 and RM4,000 respectively. Determine the realized profit to be shared between the parent and minority interest.
Solution 1. Compute adjusted current profit RM S Bhd profit after tax 57,600 + unrealized profit b/f (in opening inventory) 6,000 - unrealized profit c/f (in ending inventory) (4,000) Adjusted S Bhd’s current profit 59,600
Cont. 2. Compute the MI’s share in adjusted current profit The share of realized profits in S Bhd consisting: RM P Bhd – (80% x RM59,600) 47,680 MI – (20% x RM59,600) 11,920 59,600
Example 6 See Example 2.3 – CFS, TLT, 5th edition, p.68. On January 20X1, Parent Bhd acquired a 60% interest in the equity capital of Son Sdn Bhd for a cash consideration of RM6,000,000. On this date, the retained profits of Son Sdn Bhd were RM3,000,000. The draft accounts of the two companies for the year ended 31 December 20X4 were as follows:
Cont. Additional Information: a) Included in the property, plant and equipment of Sons Sdn Bhd was a freehold land at cost of Rm1,000,000. At acquisition date, this land was assessed to have a fair value of RM3,000,000. No adjustment had been made in the accounts to reflect the fair value. b) During 20X4, Sons Sdn Bhd sold goods to Parent Bhd for invoices totaling RM2,000,000. Of this amount, RM500,000 remained in the closing stock of the Parent Bhd at 31 December 20X4. The corresponding inter-company sales and closing stock figures for the 20X3 financial year were RM3,000,000 and RM800,000 respectively. The profit margin to Sons Sdn Bhd was 25% on selling price.
Cont. c) The group treats goodwill on acquisition as a permanent item and does not account for deferred tax. Required: Prepare consolidated income statement, consolidated retained profits and consolidated balance sheet of Parent Bhd for 20X4. Also show the movements in the group retained profits.
Solution Consolidated journal entries required on 31 December 20X4 a) Freehold land 2,000 Revaluation reserves 2,000 (To adjust assets of subsidiary to their fair values) b) Share capital (.6 x 4,000,000) 2,400 Retained profits (pre) (.6x3,000,000) 1,800 Revaluation reserves (.6 x 2,000,000) 1,200 Goodwill on acquisition 600 Investment in S 6,000 (To eliminate cost of investment against net assets acquired and to recognise goodwill on acquisition)
Cont’ c) Share capital (.4 x 4,000,000) 1,600 Revaluation reserves (.4 x 2,000,000) 800 Retained profits (W2) 1,920 Minority Interest (BS) 4,320 (To record MI for it’s share in the opening net assets) d) Profit after tax (MI in net income) (W1) 430 (40% x RM1,075,000 net of adjustment) Minority Interest (BS) 430 (to record MI’s share in net income
Cont’ e) Sales (Son Sdn Bhd) 2,000 Purchases (Parent Bhd) 2,000 (To eliminate inter-company sales of stock) f) Ending Stock (COGS – IS) 125 Stock (BS) 125 (to eliminate unrealized profit c/f in ending stock – 25% x RM500,000)
Cont’ g) Retained profit b/f (Opening) 200 COGS (Opening stock - IS) 200 (To reinstate unrealized profit of opening stock and to account for its realization in the current year)
Cont’ Workings: MI’s share in net assets of Sons Sdn Bhd W1 Calculation of MI’s share in Net Income RM Profit after tax/Net income 1,000 + unrealized profit in opening stock 200 - Unrealized profit in closing stock (125) 1,075 Share of MI in current net income (RM1,075,000 x 40%) 430
Cont’ W2 Calculation of MI’s share in Retained Profits RM Retained profits (pre.)(.4 x RM3, 000,000) 1,200 Retained profits (post) [.4 x (RM3, 000,000 – RM200,000) 720 1,920
Cont’ Remember: Computation and Adjustments required in an upstream sales of stock 1. Unrealized profit in stock b/f Reinstate opening stock figure by: Add the unrealized profit to opening stock – reducing COGS (expense) or credit COGS) Reduce by debiting retained profit b/f by the amount of unrealized profit in opening stock Refer to transaction (g) in example 6
Cont’ 2. Unrealized profit in stock c/f Eliminate unrealized profit in closing stock by: Debiting COGS or reduce ending stock in income by the amount of unrealized profit in closing stock Credit ending stock (BS) Refer to transaction (f) in example 6