December 2012 1 (F1 ) Calculating PUP
Continuing from the article in the December 2012 issue of Velocity , we can now look at calculating a figure for PUP and how to adjust it.
STEP 1 Calculate the PUP
up
Mark
up
Mark
inventory
unsold
100
OR100
arg in
M
inventory
unsold
STEP 2 Make the adjustment
Seller Buyer Cancel profit Reduce inventory to cost to the group Example:
Summarised statements of financial position for the year to 31 December 2012
Mark Sam
$ $
Non Current Assets
Tangible 3,600 2,000 Investment in Sam 3,200 - Current Assets Inventory 1,400 1,200 Receivables 800 700 Bank 600 500 9,600 4,400 Share Capital $1 2,000 800 Retained earnings 3,300 1,600 Current liabilities 4,400 2,000 9,600 4,400
1) Mark purchased 100% of the ordinary shares of Sam for $3,200 two years ago when Sam’s retained earnings showed a balance of $800.
2) Mark and Sam traded with each other during the year. At the end of the year Sam owed Mark $100. This is included in both sets of individual company figures. Also included in the inventory of Sam was $120 of goods purchased from Mark at mark up on cost of 25%.
December 2012 2 Reading note 2 gives rise to two issues:
The need to cancel balances between group companies as discussed in the previous article, - “At the end of the year Sam owed Mark $100. This is included in both sets of individual company figures.” and
The need for a PUP adjustment – “Also included in the inventory of Sam was $120 of goods purchased from Mark at mark up on cost of 25%.”
Let’s start with the $100 balance between the two companies.
Remember we talked about a school with class rooms that had desks and how moving the desks from classroom to classroom would affect each classroom but not the school overall?? Here we have that concept again.
Sam owes Mark $100 which ultimately will be settled. When the cash moves between the two companies each one is individually affected but the Group position remains the same- $100 simply moving from one company to another without increasing or reducing the groups’ assets and liabilities.
The adjustment is:
Dr Group payables $100 Cr Group receivables $100
Adjust this on the face of your question as soon as you read it to remind you to do this later.
Mark Sam Adjustments
$ $
Non Current Assets
Tangible 3,600 2,000 Investment in Susan 3,200 - Current Assets Inventory 1,400 1,200 Receivables 800 700 -100 Bank 600 500 9,600 4,400 Share Capital $1 2,000 800 Retained earnings 6,200 3,400 Current liabilities 400 200 -100 9,600 4,400
In making the adjustment on the right hand side of the question you are simply updating group totals rather than adjusting an individual company. It’s a fact that $100 will neither be received into the group or $100 paid outside the group so both receivables and payables are overstated by $100 from the group point of view. When you consolidated your answer it will simply look like this:
December 2012 3
$
Receivables (800+700 -100) 1,400
Payables (400+200 -100) 500
Note: these balances between group companies may be recorded as current account balances between group companies and shown separately from day to day payables and receivables. See cash in transit below.
Next the PUP adjustment itself. STEP 1 Calculate the PUP
up
Mark
up
Mark
inventory
unsold
100
100
25
25
120
= PUP $24STEP 2 Make the adjustment
Mark Sam
Cancel profit Reduce inventory to cost to the group Ask yourself two questions:
1. How much of Marks profit goes into the group in the Retained Earnings calculation? 2. How much of Sam’s inventory will be included in total group inventory?
The answer to both these questions should be - ALL OF IT or 100%. If that’s the way its included then that’s the way it should be cancelled.
Dr Group RE 100% of PUP Cr Group inventory 100% of PUP Your question now looks like this:
Mark Sam Adjustments
$ $
Non Current Assets
Tangible 3,600 2,000 Investment in Susan 3,200 - Current Assets Inventory 1,400 1,200 -24 Receivables 800 700 -100 Bank 600 500 9,600 4,400 Share Capital $1 2,000 800
December 2012 4
Retained earnings 6,200 -24* 3,400
Current liabilities 400 200 -100
9,600 4,400
*The adjustment to RE is recorded next to the parent as that is the only figure you include from the question for RE in the retained earnings working.
When you consolidate your answer it will simply look like this: Consolidated Statement of Financial Position Extract...
Current assets $
Inventory (1,400 +1,200 -24) 2,576
Your retained earnings working would show:
100% Marks’ retained earnings 6,200
100% Sam post acquisition reserves (not calculated for this eg) Less PUP (24)
Now, what happens if the transaction were the other way round and Sam had sold to Mark? The calculation for PUP is always exactly the same.
25
100
25
120
= PUP $24The adjustment however may be different
Sam Mark
Cancel profit Reduce inventory to cost to the group Ask yourself the same two questions:
1. How much of Sam’s profit goes into the group in the RE calculation? 2. How much of Marks’s inventory will be included in total group inventory? As F1 only includes 100% subsidiaries the answer is again – all of it or 100%.
Note: In the future when studying F2 the parent will acquire less than 100% so the adjustment will be different.
Extract from November 2011 question 4.
The Draft summarised Statement of Financial Position at 30 September 2011 for PH and its 100% subsidiary SU are given below:
December 2012 5 PH $000 SU $000 Current Assets Inventory 10,160 14,410
Current account with SU 10,000
Trade receivables 21,400 13,200
Cash and cash equivalents 1,260 3,600
42,820 31,210
Additional information:
PH occasionally trades with SU. In September 2011 PH sold SU goods for $4,800,000. PH uses a mark-up of one third on cost. On 30 September 2011 all the goods were included in SU’s closing inventory.
An important word here is ‘ALL’ – “ ....all the goods were included in SU’s closing inventory.” This means that the full amount of $4,800,000 is to be used in the calculation for PUP.
3
.
33
100
3
.
33
000
,
800
,
4
= 1,200,000Consolidated Statement of Financial Position Extract... $’000 Current assets
Inventory (10,160+14,410 – 1,200) 23,370
Your retained earnings working would show:
100% PH retained earnings X
100% SU post acquisition reserves X
Less PUP (1,200)
Extract from March 2012 question 4.
The draft statements of financial position at 31 January 2012 and statements of comprehensive income for the year ended 31 January 2012 for Tree and its 100% subsidiary Branch are given below: Statements of Financial Position at 31 January 2012
Tree Branch
$000 $000
Current Assets
Inventory 1,360 411
Current account with Branch 123 -
December 2012 6
Cash and cash equivalents 47 75
3,070 1,220
Additional information
Tree occasionally trades with Branch. During September 2011 Tree sold Branch goods for $180,000. Tree uses a mark up of fifty percent on cost. By 31 January 2012 Branch had sold one third of the goods, $120,000 being included in Branch’s closing inventory
In this example $180,000 of goods were sold between group companies in total but only $120,000 remain in inventory at the year end. There will be a cancellation of sales and purchases of $180,000 in the comprehensive income statement but the PUP figure will be based on the remaining inventory of $120,000 only.
50
100
50
000
,
120
= 40,000Consolidated Statement of Financial Position Extract... $’000 Current assets
Inventory (1,360+441 – 40) 1,761
Your retained earnings working would show:
100% Tree retained earnings X
100% Branch post acquisition reserves X Less PUP (40)
Loans, investments and interest.
It is not just goods and asset transactions that give rise to intra group adjustments. A parent may loan its subsidiary money – often at a reduced interest rate. For example let’s say a parent lends $100,000 to its subsidiary at a rate of interest of 10% per annum.
In the books of the Parent: In the books of the Subsidiary: Dr Investment $100,000 Dr Bank $100,000
Cr Bank $100,000 Cr Loan $100,000
Looking at the journals in the individual companies you can see the movement of cash being recorded but as you now know this will not affect the group position overall.
December 2012 7
Dr Group loans $100,000
Cr Group investments $100,000
Although the interest rate may be lower than the market rate it is still interest paid and received between group companies. In this case $10,000 interest will be received by the parent and paid by the subsidiary each year.
In the books of the Parent: In the books of the Subsidiary:
Dr Bank $10,000 Dr Finance cost $10,000
Cr Investment income $10,000 Cr Bank $10,000
The movement of cash is seen again but the group does not receive cash in or pay cash out overall. The investment income and the finance cost must be cancelled in the comprehensive income statement when it is consolidated.
Dr Group investment income $10,000 Cr Group finance cost $10,000
Cash in transit
Not all transactions are timed perfectly to coincide with year ends and months ends. As a result adjustments may be required.
Common examples of such an adjustment would be cash in transit relating to receivables and payables or current accounts and cash in transit relating to loans between group companies. For example: Nathan has a subsidiary Hayley. The two companies regularly trade and both have a year end 31 March 2012. On 31 March 2012 Nathan sent a cheque to Hayley to clear an outstanding liability of $1,000. Hayley did not receive the cheque until 6 April 2012.
$1,000 Group $1,000 Nathan Pays Hayley $1,000 Dr Payable with Hayley Cr Bank
Payable is cleared
Hayley Does not receive the cheque until after the year end. At 31.3.12 the receivable $1,000 still exists
December 2012 8
From the above you can see that $1,000 has left Nathan but not yet made it to Hayley. The key thing however is that the cash has not left the group. Neither company is showing the cash in their books so it must be adjusted from the group point of view.
The other consideration is that there is an intra group receivable balance of $1,000 sitting in the books of Hayley without a corresponding payable to cancel it against. Overall we need to reinstate the cash and cancel the receivable. This can be done as follows:
Dr Group Bank $1,000
Cr Group receivables $1,000
Not all cash in transit transactions settle a balance in full. For example Extract from November 2011 question 4.
The Draft summarised Statement of Financial Position at 30 September 2011 for PH and its subsidiary SU are given below:
Statements of Financial Position at 30 September 2011 PH $000 SU $000 Current Assets Inventory 10,160 14,410
Current account with SU 10,000
Trade receivables 21,400 13,200
Cash and cash equivalents 1,260 3,600
42,820 31,210
Current liabilities
Trade payables 12,600 5,400
Current account with PH 7,200
12,600 12,600
Additional information:
SU posted a cheque to PH for $2,800,000 on 29 September 2011 which did not arrive until 7 October 2011.
As you can see from the statement of financial position extracts the difference between the
amounts being shown as owed to them in PH’s books and owed by them in SU’s book is $2,800,000. This is of course due to the cheque sent by SU on 29 September 2011.
We now have three things to adjust – reinstate the cash of $2,800,000, cancel the current account receivable of $10,000,000 and cancel the current account payable of $7,200,000. This can be done as follows:
Dr Group bank 2,800,000
Dr Current account with PH 7,200,000
December 2012 9 Transfer of non-current assets at a profit.
As well as buying and selling goods for resale Group companies may also sell each other non-current assets.
Extract from September 2012 question 4.
The draft statements of financial position at 31 March 2012 and statements of comprehensive income for the year ended 31 March 2012 for Wood and its 100% subsidiary Plank are given below:
Statements of Financial Position at 31 March 2012 (Extract)
Wood Plank
$000 $000 $000 $000
Non-current Assets
Property, plant and equipment 11,820 7,240
Statements of Comprehensive Income for the year ended 31 March 2012 (Extract)
Plank Bush $000 $000 Revenue 15,500 6,900 Cost of sales (8,700) (3,080) Gross profit 6,800 3,820 Additional information:
Wood sold a piece of machinery to Plank on 30 September 2011 for $95,000. The machinery had previously been used in Wood’s business and had been included in Wood’s property, plant and equipment at a carrying value of $75,000. The machinery had a remaining useful life of ten years at 30 September 2011. Machinery enters the group at cost for $20
As with inventory the machinery must be recorded at cost to the group and not include any profit made between the two group companies. The transfer of the machinery must be done at carrying
Group Sold for $95,000 Wood Depreciates the machinery to leave a carrying value of $75,000. Plank Buys the machinery for $95,000 (cost) & depreciates it.
December 2012 10
value to the group with no profit recognised. The profit of $20,000 ($95,000 - $75,000) must be cancelled as follows:
Dr Profit on disposal in the comprehensive income statement* $20,000
Cr Property, plant and equipment $20,000
This adjustment will of course have an impact on group retained earnings too – reducing retained earnings. In addition to cancelling the profit on the transaction there is an additional consideration – depreciation.
The machinery must be depreciated based on cost to the group – in this case carrying value of $75,000. Plank is depreciating the asset at the price it paid of $95,000 which results in higher depreciation:
($95,000 ÷ 10 years) – ($75,000 ÷ 10 years) = $2,000 extra depreciation per year as a result of the transfer.
This increase in depreciation must be cancelled as follows:
Dr Property, plant and equipment (accumulated depn) $2,000 Cr Depreciation expense* (Retained earnings) $2,000
*As the asset transferred is machinery its depreciation and therefore profit on disposal would have been included in cost of sales. This is where the adjustments must be made.
These adjustments will be included in your answer:
Consolidated Statement of Financial Position at 31 March 2012 - Extract
Non-current Assets $’000 Property, plant and equipment (11,820 + 7,240 – 20 + 2) 19,042
Consolidated Statement of Comprehensive Income for the year ended 31 March 2012 - Extract $’000
Revenue
Cost of sales (8,700 + 3,080 + 20 - 2) (11,798) _______ Gross profit
Your retained earnings working would show:
100% Wood retained earnings X 100% Plank post acquisition reserves X
ADD back extra depreciation on machinery transfer 2 DEDUCT profit on machinery sale (20)
