Consolidation

The Review of Financial and Accounting Studies ISSN 1450-2812 Issue 1 (2011) © EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/REFAS.htm

A New Approach to the Preparation of Consolidated Financial

Statements of Group Companies

A. Seetharaman Professor, SP Jain Center of Management, Singapore

E-mail: [email protected]

M. Krishna Moorthy Lecturer, Universiti Tunku Abdul Rahman, Perak Campus, Malaysia


A. S. Saravanan Lecturer, Multimedia University, Cyberjaya, Malaysia


Abstract

The treatment of accounts relating to holding companies occupies a predominant portion of any text book on corporate accounting or advanced financial accounting. This is due to too many journal entries, ledger accounts, work sheet and working notes besides final presentation of Consolidated Balance Sheet in the prescribed published format. A new method of preparation of consolidated financial statements of group companies is introduced in this article. Normally consolidated financial statements are prepared under traditional method by using journal entries, ledger accounts, work sheet and working notes to arrive an ultimate answer of Consolidated Balance Sheet in the prescribed format stipulated by accounting regulators. This process involves considerable amount of paper work, too much professional labour and duplication of time and effort. By conducting class room experiment among the under graduate and post graduate accounting students for the last three years, the author introduces a new method known as “ Accounting Equation Method”. Under this method, the calculation is made very simple by taking only 20 minutes as against 50 minutes under traditional method.

1. Introduction The 20th century saw a sea of change in the corporate structure. Corporations have grown globally. Expansion and increase of wealth through acquisition of subsidiary, foreign collaboration has become common. A fact of modern society is the conglomerate which is involved in many industries usually series of interlocking of companies. Another name for conglomerate is ‘Group’ companies which is holding company and its subsidiaries. 2. Acquisition An acquisition occurs when an entity acquires the control of another entity. The investor which controls another entity is known as the holding company while the company invested in is known as the subsidiary. A holding company together with subsidiary will form a group. The definition of

A New Approach to the Preparation of Consolidated Financial Statements of Group Companies 73

control is that the holding company is able to exercise the majority of the voting rights at the Annual General Meeting (AGM) whereby it will be able to elect the majority of the members of the board of directors. These directors determine the financial and operating policies of the company. The usual way to acquire control of another company is by acquiring more than one half of the voting power in the investee company.

A subsidiary company is defined as a company in which the majority of the shares are owned by another corporation; another corporation controls the composition of the board; or has the power to cast more than half of the votes. In determining a holding company, the accounting standard IAS 27 stresses that control rather than ownership is the key. The corporation exerting the control is a holding company. 3. Preparation of Consolidated Balance Sheet The most exciting and perhaps the most complicated area of corporate accounting is the recording and reporting the activities of a group of companies. IAS 27 defines consolidated statements as the financial statements of a group presented as those of a single entity or single enterprise. IAS 27 deals with preparation and presentation of consolidated financial statements reporting the financial position, results of operations and cash flows of a group of enterprises under the control of the parent. All these financial statements are pro-forma accounts. Although parent company compiles the consolidated accounts, these accounts are neither prepared in the parent company books nor in the subsidiary books. They are merely memorandum accounts to facilitate to disclose the group accounts. All double entry rules apply in these proforma or memorandum accounts. Hence, some of the accounts appearing in the individual books of parent and subsidiary will be duplicated in the work sheet to facilitate consolidation. 4. The principle of cancellation The consolidation of financial statements basically involves summing up the amounts for various financial statement items across the separate company statements. The accountant must adjust the amounts resulting from the summation, in order to eliminate double-counting resulting from inter-company transactions.

The various final accounts of the holding company and its subsidiary undertakings have to be brought together and consolidated into one set of accounts for the whole of the group as one unit. Some items in one of the original sets of accounts will also be found to refer to exactly the same transactions in one of the other sets of original final accounts.

Some common examples of elimination of double counting of same transactions are as follows- An item which is a debtor in one balance sheet may be shown as a creditor in another balance sheet. If P Ltd had sold goods to S Ltd, its subsidiary, but S Ltd had not yet paid for them, then the item would be shown as a debtor in the balance sheet of P Ltd and as a creditor in the balance sheet of S Ltd. Sales by one of the group companies to another company in the group will appear as sales in one company's accounts and purchases in another company's accounts. Shares bought in one of the subsidiary undertakings by the parent undertaking will be shown as an investment on the assets side of the parent undertaking's balance sheet. In the balance sheet of the subsidiary, exactly those same shares will be shown as issued share capital. Intra-group loans. This is when S LTD borrows money from H LTD. “Loan from H LTD” would appear in the balance sheet of S LTD. And as “Loan to S LTD” in the balance sheet of H LTD. Therefore, these two items will cancel out each other and will not appear in the consolidated balance sheet. Current accounts are maintained both by H LTD and by S LTD to record intra-group transaction. Instead of showing H LTD as a debtor and S LTD as creditors, current account here serves as a debtors or creditors. Thus, current accounts are eliminated from the consolidated balance sheets. However, the

74 A. Seetharaman, M. Krishna Moorthy and A. S. Saravanan

two current accounts sometimes may not show equal amounts. This is often due to two items, namely goods in transit and cash in transit. Note that transit means on the way. Bills of exchange. Intra group bills of exchange which are disclosed in the individual balance sheets of H LTD and S LTD must be eliminated and not shown in the consolidated balance sheet since they represent inter-company indebtedness. However, bills of exchange relating to outsiders and intra group bills that have been discounted must be shown in the consolidated balance sheet. Dividends paid by a subsidiary undertaking to its parent undertaking will be shown as paid dividends in the final accounts of the subsidiary, and as dividends received in the final accounts of the parent undertaking. 5. Preparation of Consolidated Balance Sheet The popular method of preparing the consolidated balance sheet is the traditional method. Traditional method consists of using the following: Journal entries Ledger accounts Worksheet Lengthy calculations showing the details of goodwill and minority interest Consolidated Balance Sheet in prescribe formats

However, another method known as the Accounting Equation Method will be introduced here. The following will discuss about the nature or characteristics of the two methods respectively. 6. Traditional Method of Using Journal, Ledger and Work Sheets As stated above, the traditional method consists of using journal entries, ledger accounts (T- accounts) and work sheets to record, adjust and eliminate transactions. This will be supplemented by worksheet with adjustment in debit credit columns. Journal is an accounting record in which transactions are initially recorded in chronological order. Thus, the journal is referred to as the book of original entry. For each transaction the journal shows the debit and credit effects on specific accounts. Typically a journal has spaces for dates, account titles and explanations, references, and two columns to show monetary value namely debit and credit.

Ledger is referred to the entire group of T- accounts maintained by a company. It keeps in one place where all the information about changes in specific account balances. The ledger should be arranged in statement order beginning with the balance sheet accounts. First in order are the assets, followed by liability accounts, owner’s equity consisting of share capital, share premium, reserves, retain earnings and profit and loss accounts, revenues, and expenses. Each account is numbered for easier identification.

Worksheet is introduced to record the elimination and adjustment. By using work sheet, the elimination of investment account against shareholder’s fund is easily made. However, when the consolidation involves more complicated adjustments, for example, when the investment account and the shareholders funds are not equal, it is necessary to prepare some working paper which shows how the elimination or adjustment are calculated. Although any working paper which explains the derivation of the figure in the consolidated statement is acceptable, experiences has shown that multi column with debit credit elimination is complex.

The use of traditional method consumes substantial amount of time in the recording process of journalizing (the entering of transaction data in the journal) and posting (the procedure of transferring journal entries to the ledger accounts). Transactions are initially recorded in chronological order in a journal before being transferred to the ledger accounts. In some circumstances, an entry will involve three or more accounts, and it is known as compound entry. Hence, there is a possibility of error occurrence if any accounts are omitted or over stated or under stated.. Besides, worksheets will very quickly become complicated document when too many debits and credits being used. The use of


journals, ledgers and worksheets involves considerable amount of paper work and duplication of time, energy and money. Hence, there is a proposal for a simpler and effective approach to this most complicated consolidation. 7. Accounting Equation Method- A New Approach Accounting equation can be used to make adjustment on financial position for both holdings and subsidiaries companies. Accounting equation is the most basic tool of accounting presenting resources of the business and claims to those resources.

The accounting equation method uses a columnar accounts to record transactions involving plus (+) and minus (-) adjustments. The formula of an accounting equation is as follows:

Assets = Liabilities + Shareholders’ equity Thus, this relationship refers basic accounting equation. Assets must equal the sum of liabilities

and shareholders equity. Asset appears on left-hand side of the equation. The legal and economic claims against the asset- liabilities and owners’ equity - appear on right hand - side of the equation. Assets

An increase in asset is represented by plus and its decrease is represented by minus. Liabilities and Shareholders Equity

An increase in liabilities and owner equity is represented by plus and their decrease is represented by minus. Here, the shareholders equity includes share premium, reserves, retain earnings and profits.

Accounting equation is used to – Record and Analyse the transactions in tabular columns to determine the nature and effect of each transaction on asset, liability and owners equity Keep the accounting equation always in balance Ensure that change in asset will require a change in other asset or in liability or owners equity. (In other words, a plus in asset will require a minus in other asset or a plus in liability or owners equity and vice versa) Ensure that a change in liability will require a change in other liabilities or owners equity or in an asset. (In other words, a plus in a liability will require a minus in other liability or owners equity or a plus in assets and vice versa)

Accounting equation method helps to organize accounting data systematically. It aids in preparing the financial statements, recording the adjustment entries and closing the accounts. By listing all the accounts and their unadjusted balances, it helps the accountant to identify the accounts needing adjustments. Although, it’s not essential, the accounting equation method is helpful because it brings together in one place the effects of all the transactions of a particular period. The accounting equation method aids the closing process by listing the adjusted balances of all the accounts. It also helps the accountant to discover potential errors.

The accounting equation method is not part of the ledger or the journal, nor is it a financial statement. Therefore, it is not part of the formal accounting system. Instead, it is a summary device or a proforma statement that exists for the accountant’s convenience.

Throughout this article, accounting equation method is used as a comparison with traditional method. This is a situation where the consolidated entity does not have its own set of journals and ledgers. The eliminations to remove inter-company transactions typically appear on a consolidated worksheet, not in the records of any of the companies in the consolidated entity. The accountant prepares the consolidated profit and loss account, and consolidated balance sheet directly from the worksheet.


8. Traditional Method of Preparing Consolidation Accounts In consolidated accounts, accounting equation method simply replaces the voluminous journal entries, T- ledgers, worksheet with debit credits columns and working notes.

This can very well be seen by working out any illustration under both traditional method and accounting equation method. For this purpose, two illustrations are presented here to cover both simple consolidation and complicated consolidation. Illustration 1

Given below are the balance sheets of Henry Ltd and its 80% owned subsidiary Scooby Ltd as at 31.12.98. Henry acquired the ordinary shares of Scooby on 1.1.98 when the profit and loss account of Scooby had a credit balance of $45,000. Debtors of Henry include $30,000 due from Scooby. Bills payable of Scooby of $45,000 were drawn in favour of Henry. Henry had discounted $24,000 of these bills. Scooby had remitted $9,000 on account of the loan from Henry. Henry received the remittance on 2.1.x9. The goodwill is impaired and its value as at stands at Rs18, 000.

Henry $

Scooby $

ASSETS Investment in 240,000 Ordinary shares of Scooby at cost

300,000

Fixed assets 1,500,000 600,000 Stock-in-trade 150,000 60,000 Debtors 90,000 15,000 Bills receivable 60,000 30,000 Loan to Scooby 90,000 Bank 60,000 6,000 2,250,000 711,000 LIABILITIES Ordinary shares of $1/- each 1,800,00 300,000 Profit and loss account 360,000 165,000 Creditors 60,000 90,000 Bills payable 30,000 75,000 Loan from Henry 81,0000 2,250,000 711,000

Required

The consolidated balance sheet of the group as at 31-12 -1998. Workings under Traditional Method using Journals and Ledgers:

Henry Minority Shareholders Ordinary shares of Scooby 80% 20%

Cancellation of inter-company balances: Debtors of Henry of $30,000 are cancelled against creditors of Scooby. Bills receivable of Henry to the amount of $21,000(i.e. the bills drawn by Henry and accepted by Scooby of $45,000 less bills discounted of $24,000) to be cancelled against bills receivable of Scooby. A note to denote the bills discounted of $24,000 to be appended to the consolidated balance sheet. Loan to Scooby to be adjusted for remittance in transit of $9,000. The amount owing of $81,000 to be cancelled against loan from Henry.


Journal Entries

Debit Credit

a) Ordinary Shares in Scooby (80%) 240,000 P & L Account in Scooby (80% of Pre Acq) 36,000 Goodwill on Consolidation 24,000 Investment in Scooby 300,000

b) Ordinary Shares in Scooby (20%) 60,000 P & L Account in Scooby (20%) 33,000 Minority Interest 93,000

c) Consolidate P & L Account 6,000 Goodwill on Consolidation (impairment) 6,000

d) Creditors – Scooby 30,000 Debtors – Henry 30,000

e) Bills payable 21,000 Bills receivable 21,000

f) Loan from ‘Henry’ 81,000 Cash in transit 9,000 Loan to ‘Scooby’ 90,000

Ledger Accounts

Investment in Scooby (80%)

$ $ Balance 300,000 Ordinary shares of Scooby 240,000 Profit and loss of Scooby 36,000 Goodwill on consolidation 24,000 300,000 300,000

Goodwill

$ $ Investment 24,000 Consolidated profit 6,000 and loss account

(impairment)

To CBS 18,000 24,000 24,000

Minority Interest (20%)

$ $ To CBS 93,000 Ordinary shares of Scooby 60,000 Profit and loss of Scooby 33,000 93,000 93,000

Consolidated Profit and Loss Account

$ $ Goodwill on impairment 6,000 Balance b/d of Henry 360,000 To CBS 450,000 Profit and loss of Scooby 96,000 456,000 456,000

Profit and Loss Account of Scooby

$ $ To Investment 36,000 Balance b/d 165,000 ($45,000x80%) To consolidated profit and loss account

96,000

($165,000 – $45,000) x80%) Minority interest 33,000 ($165,000 x 20%) 165,000 165,000


Consolidation Work Sheet

Henry Scooby Adjustments CBS Debit Credit $’000 $’000 $’000 $’000 $’000 Assets Investment in 240,000 Ordinary shares of 300 a300 Scooby at cost Fixed assets 1500 600 2100 Stock – in – trade 150 60 210 Debtors 90 15 d30 75 Bills receivable 60 30 e21 69 Loan to Scooby 90 f90 Bank 60 6 f9 75 Goodwill on Consolidation a24 c6 18 Total 2250 711 33 447 2547 Liabilities Ordinary shares 1800 300 a240 1800 b60 Profit and loss account 360 165 a36 450 b33 c6 Creditors 60 90 d30 120 Bills payable 30 75 e21 84 Loan from Henry 81 f81 Minority interest b60 93 b33 Total 2250 711 507 93 2547 Grand Total of Debit Credit Adjustments 540 540

Consolidated Balance sheet of Henry and of its subsidiary Scooby as at 31.12.98

$ $ Goodwill on consolidation 18,000 Fixed assets 2,100,000 2,118,000 Current assets Stock 210,000 Debtors 75,000 Bills receivable 66,000 Cash bank and in transit 75,000 426,000 Less Current liabilities Creditors 120,000 Bills payable 81,000 201,000 225,000 2,343,000 Financed by: Ordinary shares of $1/-each 1,800,000 Consolidated profit and loss account 450,000 2,250,000 Minority shareholders’ interest 93,000 2,343,000

Notes to the accounts: (1) Henry holds 80% of the issued ordinary share capital of Scooby as from 1.1.98. (2) Henry has a contingent liability of $24,000 on bills discounted. 9. Simpler Method of Accounting Equation in Preparing Consolidation Accounts Now, accounting equation method is used to prepare consolidated statement. For this purpose it is necessary to consider the basic concepts of acquisition accounting for groups. Under the acquisition method, the balance sheet of the Scooby (subsidiary) should be restructured to make a distinction between Pre-Acquisition and Post- Acquisition profit. Hence the profit and loss account of Scooby should be split into P&L Pre-Acquisition and P&L Post-Acquisition. The cost of investment in the ordinary shares of the subsidiary is matched against fair value of net assets of the subsidiary (Share capital and Pre-Acquisition profits) on the date of acquisition. The difference between the two amounts


is treated as Goodwill on consolidation. There is a remarkable amount of savings in space, time, effort, and concentration. Summary of Steps under Accounting Equation Method

Post the balance sheets of both holding and subsidiary in a columnar statement. Restructure the Balance Sheet of the Subsidiary by splitting the Profit and Loss account in to Pre Acquisition P & L Account and Post Acquisition P & L Account. Adjust the Investment Account in holding company against the share capital and pre-acquisition profits and reserves of the subsidiary to the extent of controlling interest. Treat the difference between two amounts as goodwill on consolidation. Create Minority Interest Account by transferring minority portion of share capital, profit and reserves (Both pre and post acquisition profits) Eliminate inter company balances Provide for impairment by reducing both Goodwill and Profit & Loss Eliminate the undiscounted portion of bills of exchange involving inter company transactions

Now, the same illustration which involves so many journal, ledger and work sheet entries in five pages is presented simply in one page under Accounting Equation Method. Consolidation Under Accounting Equation Method Figures in ‘000)

Assets I Liabilities Details of Transaction

Inves- tment

Fixed Asset

Stock In

Trade

Deb- tors

BillsRec

Loanto S

Bank Cashin

Transit

Goodwill

OrdinaryShares

P&LPreAcq

P&L Post Acq

Bills Pay,e

Loanfrom

Henry

Creditors

MinorityInterest

Balance Sheet Henry Ltd

300 1500 150 90 60 90 60 1800 360 30 60

Balance Sheet Scooby Ltd

600 60 15 30 6 300 45 120 75 81 90

Adjustment of 80% control in Scooby and creation of Good will

-300 +24 -240 -36

Minority Interest @ 20%

-60 -9 -24 +93

Eliminate debtors due from Scooby

-30 -30

Eliminate loan to Scooby and Create Cash in Transit

-90 +9 -81

Impairment of Goodwill at current value at 18 (24-18)

-6 -6

Undiscounted Bills of S

-21 -21

Total 0 2100 210 75 69 0 66 9 18 1800 0 450 84 0 120 93 Grand Total Assets 2547 Liabilities 2547

Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.

Consolidated Balance sheet of Henry and of its subsidiary Scooby as at 31.12.98 $ $ Goodwill on consolidation 18,000 Fixed assets 2,100,000 2,118,000 Current assets Stock 210,000 Debtors 75,000 Bills receivable 66,000 Cash bank and in transit 75,000


426,000 Less Current liabilities Creditors 120,000 Bills payable 81,000 201,000 225,000 2,343,000 Financed by: Ordinary shares of $1/-each 1,800,000 Consolidated profit and loss account 450,000 2,250,000 Minority shareholders’ interest 93,000 2,343,000

Notes to the accounts: (1) Henry holds 80% of the issued ordinary share capital of Scooby as from 1.1.98. (2) Henry has a contingent liability of $24,000 on bills discounted. Illustration 2

Given below are the balance sheets of Harrison Ltd, Steven Ltd and Robert Ltd. 31. 12. X8 Harrison Ltd has acquired 450,000 ordinary shares of Steven Ltd. On 1.1.x3 when the profit and loss account of Steven Ltd. had a balance of $ 60,000. Subsequently, on 1.1.x4 Steven Ltd. acquired 240,000 ordinary shares of Robert Ltd. and the balance in the profit and loss account of Robert Ltd. on that date was $ 30,000. …

Harrison Ltd. Steven Ltd. Robert Ltd. $ $ $ Ordinary shares of $1/- each 1,500,000 600,000 300,000 Profit and Loss account 300,000 240,000 180,000 1,800,000 840,000 480,000 Investment in subsidiaries at cost Ordinary shares in Steven Ltd. 540,000 Ordinary shares in Robert Ltd. 300,000 Sundry assets 1,260,000 540,000 480,000 1,800,000 840,000 480,000

Required

You are required to prepare the consolidated balance sheet as at 31.12.x8.

Answer Multi – stage method

First Stage - Preparation of consolidated accounts for sub-groups Steven Ltd. and Robert Ltd.

Journal Entries (Fig in ‘000)

Debit Credit

a) Ordinary Shares (80% of Robert’s shares) 240 P & L A/C (80% of Pre Acquisition Profits) 24 Goodwill on Consolidation 36 Investment in Robert 300

b) Ordinary Shares (20% of Robert shares) 60 Minority Interest 60

c) P & L A/C (20% of Profit) 36 Minority Interest 36


Ledger Accounts

Investment in Robert Ltd

$ $ Balance 300,000 Ordinary shares in Robert Ltd. 240,000 Profit and Loss of Robert Ltd. 24,000 Goodwill on consolidation 36,000 300,000 300,000

Minority Interest

$ $ To CBS 96,000 Ordinary shares. 60,000 Profit and Loss. 36,000 96,000 96,000


$ $ To CBS 360,000 Profit and Loss balance of Steven Ltd. 240,000 Robert Ltd. 120,000 360,000 360,000

Profit and Loss Account of Robert Ltd.

$ $ Investment in Robert 24,000 Balance b/d 180,000 Consolidated profit and loss 36,000 Account Minority interest 120,000 180,000 180,000

Worksheet

Adjustments Steven Robert Debit Credit

CBS

$’000 $’000 $’000 $’000 $’000 Liabilities Ordinary shares 600 300 a240 600 b60 Profit and loss 240 180 a24 360 c36 Minority Interest b60 c36 96 Total 840 480 360 96 1056 Assets Investment in Robert 300 a300 Sundry assets 540 480 1020 Goodwill a36 36 Total 840 480 36 300 1056 Grand Total of Debit Credit Adjustment 396 396

Consolidated Balance Sheet of Steven Ltd. and of its subsidiary Robert Ltd. as at 31.12.x8

$ $ Sundry assets 1,020,000 Goodwill on Consolidation 36,000 1,056,000 Ordinary shares of $1/-each 600,000 Consolidated profit and loss account 360,000 960,000 Minority shareholders’ interest 96,000 1,056,000

Second Stage - Preparation of consolidated accounts of Harrison Ltd. and the sub-group Steven

Ltd & Robert Ltd.


Journal Entries (Fig in ‘000)

Debit Credit

a) Ordinary Shares (75% of Stevens) 450 P & L A/C (75% of Pre Acq profits of 60) 45 Goodwill on Consolidation 45 Investment in Stevens 540

b) Ordinary Shares (25% of Stevens) 150 Minority Interest 150

c) P & L A/C (25% of both Post and pre acq profits) 90 Minority Interest 90

Ledger Accounts

Investment in Steven Ltd

$ $ Balance 540,000 Ordinary shares of Steven Ltd. 450,000 Profit and Loss of Steven Ltd. 45,000 Goodwill on consolidation 45,000 540,000 540,000

Minority Interest

$ $ To CBS 240,000 Ordinary shares of Steven Ltd. 150,000 Profit and Loss of Steven Ltd. 90,000 240,000 240,000


$ $ To CBS 525,000 Profit and Loss Balance of Harrison Ltd. 300,000 Steven Ltd. (CPL) 225,000 525,000 525,000

Consolidated Profit and Loss of Group Steven Ltd.

$ $ Investment in Stevens 45,000 Balance as per CBS of Steven

Ltd. 360,000

75% x $60,000 Consolidated profit and 225,000 Loss account 75% x ($360,000 – $60,000) Minority Interest 90,000 25% x $360,000 360,000 360,000

Consolidation Worksheet

CBS Steven& Robert

Adjustments Harrison

Debit Credit

CBS

$’000 $’000 $’000 $’000 $’000 Liabilities Ordinary shares 1500 600 a450 1500 b150 Profit and loss 300 360 a45 525 c90 Minority Interest 96 b150 c90 336 Total 1800 1056 735 240 2361 Assets Investment in Steven 540 a540


Sundry assets 1260 1020 2280 Goodwill 36 a45 81 Total 1800 1056 45 540 2361 Grand Total of Debit Credit Adjustment 780 780

Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8

$ $ Sundry assets 2,280,000 Goodwill on consolidation ($36,000 + $ 45,000) 81,000 2,361,000 Ordinary shares of $1/-each 1,500,000 Consolidated profit and loss account 525,000 2,025,000 Minority interest ($ 96,000 + $ 240,000) 336,000 2,361,000

Now, the same illustration which involves so many journal, ledger and work sheet entries in

five pages is presented simply in one page under Accounting Equation Method. Illustration -2– Multistage Method (Fig’ 000)

Important Points: 1. Consolidate S with SS and then consolidate H with S and SS subgroup H holds 80% control in S. S holds 75% control in SS. The effective interest of H over SS is 60% (80%x75%)

First Stage: Consolidation of S with SS Assets Liabilities

Details of Transaction First

Stage

Investment

In SS

Investment In S

SundryAssets

Good Will

Total Assets

Ordinary

Shares

P&L A/c

Pre Acq

P&L A/c Post Acq

Minority

Interest

Total Liabiliti

es

Balance Sheet S 300 540 600 60 180 Balance Sheet SS 480 300 30 150 Adjustment of 80% of Control interest in SS With Creation of Goodwill

-300 +36 -240 -24

Mino.Interest @ 20%

-60 -6 -30 +96

Grand Total -S and SS

0 1020 36 1056 600 60 300 96 1056

Second Stage: Cons of H with S and SS Group

Balance Sheet H 540 1260 1500 300 Adj. Of 75% Control in S By H & creation of Goodwill

-540 +45 -450 -45

Minority Interest @ 25%

-150 -15 -75 +240

Total 0 0 2280 81 2361 1500 0 525 336 2361

Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.


Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Sundry assets 2,280,000 Goodwill on consolidation ($36,000 + $ 45,000) 81,000 2,361,000 Ordinary shares of $1/-each 1,500,000 Consolidated profit and loss account 525,000 2,025,000 Minority interest ($ 96,000 + $ 240,000) 336,000 2,361,000

Single Stage Method

Step 1 Determine the Effective interest of the ultimate holding company’s interest in the various subsidiaries.

Step 2 Open one Investment Account Debit with: Holding company’s interest in the subsidiary and the holding company’s interest in the

subsidiary’s investment in the sub – subsidiary. Credit with: The holding company’s interest in the share capital and pre-acquisition reserves of the

subsidiary and sub – subsidiary. Step 3 Open one minority shareholders’ account: Debit with: The minority shareholders’ interest in the investment in the sub – subsidiary. Credit with: The minority shareholders’ interest in the capital and reserves of the subsidiary and sub –

subsidiary. Answer

The holding company holds 75% of the issued ordinary share capital of Steven Ltd. Steven Ltd. holds 80% interest in Robert Ltd. Therefore, Steven Ltd. has an indirect interest of 75% of 80% = 60% interest in Robert Ltd. Journal Entries (Fig in ‘000)

Debit Credit

a) Ordinary Shares (75%of Stevens - 600) 450 P & L A/C (75% of Stevens Pre Acq Profits) 45 Goodwill on Consolidation 45 Investment in Stevens 540

b) Ordinary Shares (25% of Stevens – 600) 150 P & L A/C (25% of Stevens Pre Acq Profits -60) 15 P & L A/C (25% of Stevens Post Acq Profits -180) 45 Minority Interest in Stevens 210

c) Ordinary Shares (60% = 80% of 75% = of Robert 300) 180 P & L A/C (60% of Robert Pre Acq profits – 30) 18 Goodwill on Consolidation 27 Minority Interest 75 Investment in Robert 300

d) Ordinary Shares (40% of Robert 300) 120 P & L A/C (40% of Pre Acq Profits -30) 12 P & L A/C (40% of Post Acq Profits – 150) 60 Minority Interest in Robert 192

Investment in Stevens Ltd

$ $ Balance 540,000 Ordinary shares in Stevens 75% 450,000


P & L A/C (75% of Pre Acq Profits)

45,000

Goodwill on Consolidation 45,000 540,000 540,000

Investment in Robert Ltd

$ $ Balance 300,000 Ordinary Shares 60% of Robert 180,000 (80%of75%) 300,000) P & L A/C (60% 0f Pre Acq

Profits) 18,000

Goodwill on Consolidation 27.000 Minority Interest (25% of 300) 75,000 300,000 300,000

Minority Interest

$ $ Investments in Robert Ltd 75,000 Ordinary shares of Stevens Ltd 150,000 25% $300,000 Ordinary Shares of Robert Ltd 120,000 To CBS 327,000 Profit and Loss of Steven Ltd. 60,000 (15+60) Profit and Loss of Robert Ltd. 72,000 (12+60) 402,000 402,000

Consolidated profit and Loss Account

$ $ To CBS 525,000 Balance Of Harrison Ltd. 300,000 Steven Ltd. 135,000 Robert Ltd. 90,000 525,000 525,000

Profit and Loss Account Steven Ltd

$ $ Cost control - 75% x $60,000 45,000 Balance B/d 240,000 CPL - 75% x ($240,000 – $ 60,000)

135,000

MI - 25% x $240,000 60,000 240,000 240,000

Profit and Loss Account Robert Ltd.

$ $ Cost control - 60% x $30,000 18,000 Balance B/d 180,000 CPL - 60% x ($180,000 – $ 30,000)

90,000

MI - 40% x $180,000 72,000 180,000 180,000

Consolidation Work Sheet Adjustments Harrison Steven Robert

Debit Credit CBS

$’000 $’000 $’000 $’000 $’000 $’000 Liabilities Ordinary shares 1500 600 300 a450 1500 b150 c180 d120 Profit and loss 300 240 180 a45 525 b60 c18 d72 Minority Interest b210 c75 d192 327


Total 1800 840 480 1170 402 2352 Assets Investments 540 300 a540 a300 Sundry assets 1260 540 480 2280 Goodwill on Consolidation Stevens a45 72 Robert c27 Total 1800 840 480 72 840 2352 Grand Total of Debit Credit Adjustment 1242 1242

Consolidated Balance sheet of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8

$ $ Ordinary shares of $1/- each 1,500,000 Consolidated profit and loss 525,000 Capital and reserves 2,025,000 Minority shareholders’ interest 327,000 2,352,000 Goodwill on consolidation 72,000 Sundry assets 2,280,000 2,352,000

Note: The goodwill on consolidation and minority shareholders’ interest differ between the two methods. The difference is $9,000. In the single – stage method the minority shareholders’ interest in the goodwill in the sub – subsidiary is allocated to them. The minority shareholders of Steven Ltd. have a 25% interest in the goodwill of Robert Ltd. – $36,000 x 25% = $9,000.

Now, the same illustration which involves so many journal, ledger and work sheet entries in

five pages is presented simply in one page under Accounting Equation Method. Illustration 2 - Single Stage Method

Important Points (Fig in ‘000) Investment by S in SS consists of both H share and minority share in 75:25 ratio

Assets I Liabilities Details of

Transaction Investment

In SS

Investment In S

SundryAssets

Good will

Total Assets

Ordinary

Shares

P&L A/c Pre

Acq

P&L A/c Post Acq

Minority

Interest

Total Liabilit

ies

Balance Sheet H 540 1260 1500 300 Balance Sheet S 300 540 600 60 180 Balance Sheet SS 480 300 30 150 Adj. Of 75% control in S By H with Goodwill

- 540 +45 -450 -45

Minority Interest 25%

-150 -15 -45 +210

H’s Interest in the investment Of SS 75% and its effective interest In SS shares and pre acq. Profits only 60% (80%x75%)

-225 +27 -180 (60%)

-18 (60%)

Minority Interest in Investment of SS 25%

-75 -75

Minority Interest in shares and profits of SS (100%-60%) 40%(effective)

-120 -12 -60 +192

Grand Total 0 0 2280 72 2352 1500 0 525 327 2352


Please note the differences between multistage and single stage method in calculation of goodwill and minority interest. The difference is RM 9000. In single stage method, the minority interest in the goodwill in SS is allocated to them. The minority shareholders have a 25% interest in the goodwill of SS = 36000 x25% = 9000.

A Consolidated Balance Sheet is prepared in the prescribed format which is as follows. It is evident from this presentation that answer is same for both methods.

Consolidated Balance sheet Of Harrison Ltd. and of its subsidiaries Steven Ltd. and Robert Ltd. as at 31.12.x8 $ $ Ordinary shares of $1/- each 1,500,000 Consolidated profit and loss 525,000 Capital and reserves 2,025,000 Minority shareholders’ interest 327,000 2,352,000 Goodwill on consolidation 72,000 Sundry assets 2,280,000 2,352,000

10. Traditional Accounting System versus New Accounting Equation Method

Traditional Accounting System with journal and ledger New Accounting Equation Method It is very complicated compare to the new accounting system because all journal entries, ledger and balance sheet need to be opened individually.

It is easy to prepare because it combined all journal entries, ledger, and balance sheet in one stroke.

It is difficult for users who do not have accounting knowledge to understand the debit credit transaction.

It helps new user of the financial statements who does not have accounting knowledge to understand the company’s financial statement easily. The accounting equation method can show all the company’s transaction in an easy, simpler and clear way to the user.

The old accounting system with journal and ledger entries consumed more time and space as journal entries will be recorded in journal book and ledger entries will be recorded in ledger book.

The accounting equation method (new accounting system) is less time consuming as all transaction will be drawn in just one worksheet.

Errors are hard to detect and to do this is time consuming as each transactions in the entry need to be thoroughly checked. This is because the accountant need to check each and every one of the transactions to identify if there is any wrong double entry.

Error that occurs in the financial statement can be easily detected by the accountant as all the business transactions are shown in one worksheet only. Thus, this can decrease the risk of mistake in the financial statement that will mislead the users. Furthermore this can increase the credibility of the financial statement to the public.

In this old accounting system errors are hard to correct. Accountants need to correct mistakes from the beginning (journal entry) to the Balance Sheet. This is a very messy job.

Errors can be easily corrected. The accountants just need to correct the mistake in the accounting equation only.

Higher cost will be accrued, as more staff is required to prepare the full sets of accounts. For example, one employee will prepare the trade debtors account; one will prepare the trade creditors accounts etc.

The company can reduce the cost in preparing a full set of accounts. This is because the company can just employ a few staff in preparing the financial statement.

The author experimented this traditional system with a sample of 100 students who took average of 55 minutes to complete the illustration 2.

The author experimented the Accounting Equation Method with a sample of 100 students who took only average of 25 minutes to complete the illustration 2.

11. Treatment of Goodwill Now, the treatment of goodwill differs from country to country. Standards are set and based on impairment method.


12. Conclusion The doublze entry system is based on recording the transaction value in debits and credits. The dual effect of each transaction is recorded in appropriate accounts. The basic accounting equation ie., Assets = Liabilities + Owners equity, must be equal. In the technology era efficient and effective accounting information systems are based on certain principles like cost effectiveness, usefulness and flexibility that is the future needs. When the world is using computerised system, why still need manual accounting system in preparing the accounts including consolidation of group financial statements. To understand what computerised accounting system do, still we need to understand how manual accounting systems work. The traditional accounting system of consolidation of group accounts, by using various ‘T’ accounts and journals, involve time, cost, risk and errors. To achieve the goal of cost effectiveness, usefulness, flexibility, timeliness and above all to understand by non accounting personals in preparation of group financial statements the new accounting method in preparing the group consolidated financial statements called “ New Accounting Equation Method” on consolidation can be used, which is very simple to follow since it is based on arithmetic equation of plus and minus. This can be achieved by employing fewer accounting employees, at lesser cost and produce the required group financial statements on time.

Documents

Consolidation