General comments
Part (a) was a consolidated balance sheet question, featuring one subsidiary and one associate.
Adjustments were typical of this type of question and included a fair value adjustment on acquisition, intra-group balances and transactions and impairment write-downs. Part (b) tested an understanding of the concepts underlying the preparation of consolidated financial statements: namely the single entity concept and control versus ownership.
York plc
(a) Consolidated balance sheet as at 31 March 2008
£ £
Assets
Non-current assets
Property, plant and equipment (3,963,900 + 1,686,900) 5,650,800
Intangibles (W3) 192,000
Investments in associates (W7) 261,920
6,104,720 Current assets
Inventories (860,000 + 650,000 – 35,000 (W6) – 30,000 x 40% (W6))
1,463,000
Trade and other receivables (730,000 + 540,000 – 210,000 (W6))
1,060,000
Cash and cash equivalents (29,600 + 15,500) 45,100
2,568,100
Total assets 8,672,820
Equity and liabilities Capital and reserves
Ordinary share capital 2,000,000
Share premium account 1,000,000
Retained earnings (W5) 3,424,060
Attributable to the equity holders of York plc 6,424,060
Minority interest (W4) 414,160
Equity 6,838,220
Current liabilities
Trade and other payables (878,000 + 546,600 – 210,000 (W6))
1,214,600
Taxation (380,000 + 240,000) 620,000
1,834,600
Total equity and liabilities 8,672,820
Workings
(1) Group structure
(2) Net assets – Ripon Ltd
Balance sheet date
Acquisition Post acq
£ £ £
Share capital 1,000,000 1,000,000 -
Share premium 500,000 500,000 -
Retained earnings
Per Q 625,800 (215,000)
PURP (W6) (35,000) -
Amortisation adj – intangible 30,000 - 835,800
FV adj – intangible (50,000) (50,000) -
2,070,800 1,235,000 835,800
(3) Goodwill – Ripon Ltd
£ Cost of investment ((1,000,000 x £1.20) + 400,000) 1,600,000
Less Share of FV of net assets acquired (1,235,000 (W2) x 80%) (988,000)
612,000 Impairments to date (400,000 + 20,000) (420,000)
192,000 800
1,000
York plc
Ripon Ltd
200 500
Beverley Ltd
= 80%
= 40%
(4) Minority interest – Ripon Ltd
£ Share of net assets (2,070,800 (W2) x 20%) 414,160 (5) Retained earnings
York plc 3,175,500
Ripon Ltd (835,800 (W2) x 80%) 668,640
Beverley Ltd ((210,800 – 56,000 – 30,000 (W6)) x 40%)) 49,920 Less Impairments to date (420,000 (W3) + 50,000) (470,000) 3,424,060 (6) PURP
Ripon Ltd Beverley Ltd
% £ £
SP (210,000/180,000 x ½) 150 105,000 90,000
Cost (140,000/120,000 x ½) (100) (70,000) (60,000)
GP 50 35,000 30,000
(7) Investments in associates – Beverley Ltd
£
Cost (200,000 x £1.25) 250,000
Add: Share of post acquisition increase in net assets ((210,800 – 56,000)) x 40%))
61,920
Less: Impairment to date (50,000)
261,920 Note: Candidates who correctly calculated a discount on acquisition of the
associate of £12,400 and dealt with it appropriately were also given credit.
Candidates were clearly very well prepared for this question and generally scored highly. Almost all candidates demonstrated a sound technique and most dealt easily with the required adjustments. Errors included the following:
• Failing to adjust both receivables and payables for the invoice value of the sale of goods from the subsidiary to the parent, with a number of candidates making the adjustment at cost.
• Calculating unrealised profit based on the full invoice value, as opposed to only half of that value, when the question clearly stated that only half of the goods remained in year-end inventory.
• Taking the cost figures given in the question for the intra-group sale as being the selling price of the goods and hence calculating an incorrect provision for unrealised profit.
• Treating the pre-acquisition loss of the subsidiary as a pre-acquisition profit.
• Failing to include the share premium account correctly in the net assets table for the subsidiary.
• Not adjusting for the accumulated impairments in the group retained earnings working, instead adjusting only for the impairments which had arisen during the current year.
• Pleasingly, many candidates correctly adjusted for the group share of the provision for unrealised profit arising on goods sold by the associate to the parent against retained earnings and inventory, but many also made an adjustment against the carrying amount of the associate. Others
calculated an initial post-acquisition profit figure for the associate less a 40% share of the provision for unrealised profit but then adjusted that total by 40%, consequently scaling down the provision for unrealised profit twice.
• Only a minority of candidates correctly dealt with the goodwill in the subsidiary’s own books.
Others took £20,000 out of the subsidiary’s net assets at both acquisition and at the balance sheet date (instead of £50,000 out at acquisition and £20,000 at the balance sheet date) and some were clearly confused between this goodwill and that arising on consolidation.
• When calculating the cost of investment in the subsidiary a significant number of candidates failed to allow for an issue price of £1.20 per share, as given in the question, and instead assumed that the shares were issued at par.
A number of candidates failed to provide workings for assets and liabilities on the face of the consolidated balance sheet. Where these balance sheet figures were incorrect no partial marks could then be awarded.
Candidates must show their workings in all cases so that partial credit can be given.
A number of candidates also failed to complete the consolidated balance sheet, but rather abbreviated line items and/or included partial workings, which were not totalled, although this had improved since a similar question was last set. As the question required the preparation of a consolidated balance sheet,
candidates are expected to complete all additions and present a complete balance sheet. Very few candidates gained the presentation marks which were available for clearly disclosing the minority interest as a separate component of equity.
Total possible marks Maximum full marks
21 21
(b) Concepts underlying preparation of consolidated financial statements
Group accounts are prepared on the basis that the group is a single entity (single entity concept). This reflects the substance of the group arrangement.
For example, in the consolidation of the York plc group, all assets and liabilities are added together, as if the group were a single entity (so, for example, trade receivables of £730,000 and £540,000 are added).
However, the single entity concept also means that any intra-group transactions and balances need to be eliminated, as otherwise items would be double counted in the context of the group as a single entity.
Hence, because Ripon Ltd has sold goods for £210,000 to York plc, that amount needs to be subtracted from York plc’s cost of sales and from Ripon plc’s revenue as if the group were a single entity that transaction would not have occurred. That adjustment cannot be seen in the context of the preparation of a consolidated balance sheet, though it would be seen in the preparation of a
consolidated income statement.
In the context of the consolidated balance sheet any related intra-group balances need to be
eliminated. This amount is included in York plc’s trade payables and Ripon Ltd’s trade receivables as this amount is unpaid at the year end. It needs to be eliminated from both.
Any profit made between parent and subsidiary companies also needs to be eliminated where that profit has not yet been realised outside the group. So, for the £210,000 intra-group sale, because half of these goods have not yet been sold outside the group, inventory needs to be reduced by the profit on half that amount, otherwise inventory will be overstated from the point of view of the group as a whole. The adjustment effectively brings inventory back down to what it would have been stated at if the intra-group sale has never taken place.
The other principle underlying the preparation of consolidated financial statements is the distinction between control and ownership. Control is reflected by including all of the subsidiary’s assets, liabilities, income and expenses in the consolidated financial statements, even where the parent does not own 100% of that subsidiary. So, for York plc, 100% of Ripon Ltd’s inventories of £650,000 are added in even though, in effect, York plc only owns 80% of those inventories.
Ownership is then reflected by showing that part of the subsidiary’s net assets and results included in the consolidation, which is not owned by the parent, as a minority interest. York plc’s consolidated balance sheet shows a minority interest of £414,160, representing that part of Ripon Ltd not owned by York plc.
Where an investor (York plc) does not have control but does have significant influence over an investee (Beverley Ltd), line-by-line consolidation is not appropriate, because York plc cannot determine Beverley Ltd’s assets and liabilities. But because York plc has this influence, it should be accountable for the total investment in Beverley Ltd, ie cost plus share of post-acquisition retained earnings (the latter are added to group earnings).
As with previous papers, the quality of written answers was disappointing. In common with the other written part of this paper, some candidates made no attempt at this part.
Whilst most candidates were able to pick up marks for referring to the single entity concept and substance over form few got beyond this. Almost no candidates scored 5 or even 4 marks on this part of the question, in spite of the number of marks available. Many wasted time discussing the techniques used for consolidating financial statements and/or the factors which might indicate control or significant influence. A number thought the question was about the qualitative characteristics of financial information and based their answer around those or discussed the advantages of consolidated financial statements. Although some of these approaches enabled candidates to pick up the odd extra mark scores were generally low.
Very few candidates related their answer to York plc as specified in the requirement.