Semester 2 Week 8 PP (Group Accounting 3) Flashcards
Sandeep Plc. is the 100% owner of Chisolm Ltd.
Sandeep buys goods for £100,000 from a third party.
They then sell them to Chisolm for £140,000 and record £40,000 of profit. Chisolm records the £140,000 as a cost, then sell the goods back to Sandeep for £190,000 recording £50,000 of profit.
Sandeep records the £190,000 as a cost, then sells the goods back to Chisolm for £210,000 recording £20,000 of profit.
Chisolm records the £210,000 as a cost, then sells them to Sandeep for £240,000 recording £30,000 of profit. Sandeep holds these goods at the year end.
So by the year end, the goods that were purchased for £100,000 by Sandeep are still held by Sandeep.
Sandeep has a total profit of £60,000 recognised from these goods.
Chisolm has a total profit of £80,000 recognised from these goods.
Does this seem right?
Clearly not!
Otherwise companies could make a fortune simply by passing the same goods back and forward between themselves.
What is the difference between individual accounts and group accounts?
Individual accounts show the position of an individual company.
Group accounts show the position of the overall group.
Remember in group accounts we adopt the single entity approach.
This treats the group as if it was just one singe entity or company.
This can mean that what is a valid transaction from an individual company point of view is not from a group point of view.
Swan Ltd. acquires Puffin Ltd. on 1 July 20X4, for £15,000,000 when retained earnings were £9,000,000.
Swan Ltd. had a new facility installed in the year and used some of Puffin’s staff to assist with labour.
At the year end Swan still owes Puffin £500,000 for this work.
Cost of investment 15,000
Share capital 1,000
Retained earnings 9,000
Net assets on acquisition 10,000
Goodwill 5,000
Internal indebtedness:
Swan will have a payable of £500,000 in its accounts for the amount owed to Puffin.
Puffin will have a receivable of £500,000 due from Swan.
When the financial statements have been added together this will show a payable £500,000 due from us to us and a receivable of £500,000 due to us from us.
They, therefore, must be removed.
What would the SFP be?
Note we are remove £500,000 from both assets and liabilities.
No – group companies buy and sell items from each other all the time.
For both Goose and Gander these are completely normal transactions. They have bought/sold something from another company.
Let’s consider a group point of view.
No.
Goose would recognise a profit of £500 (£1,500 sale less £1,000 cost).
Gander would recognise a profit of £300 (£1,800 sale less £1,500 cost).
Upon consolidation this would be added together therefore a profit of £800 would be recognised.
This is accurate as from a group point of view the profit was £800.
The goods were bought externally to the group for £1,000 and sold externally to the group for £1,800.
Therefore the group made a profit of £800.
How many group companies it passed through on the way is pretty irrelevant.
Goose will be recognising a profit of £500.
Gander will be recognising inventories of £1,500 (lower of cost and NRV = cost of £1,500).
Therefore adding the accounts together will give us:
Profit of £500
Inventories of £1,500
But from a group point of view.
The goods were bought for £1,000 and are still held within the group.
We can’t make a profit off ourselves.
Therefore we need to do an adjustment to reduce inventories to £1,000 and remove the profit we made from ourselves.
The profit we make from ourselves is called unrealised profit.
Reduce inventories by £500
Reduce retained earnings (to remove the profit) by £500
What is Margin?
If we were told that there were goods that had cost 400 and were sold at a 20% margin, the profit would be:
(400/80) x 20 = 100
What is Markup?
If we were told that there were goods that had cost 400 and were sold at a 20% markup, the profit would be:
(400/100) x 20 = 80
Blackbird Ltd. owns 100% of Crow Ltd.
During the year Crow sold goods for £15,000 to Blackbird, Crow made a margin of 20% on this sale.
At the year end 50% of these goods remain in stock.
Steps:
1. Calculate the total profit.
2. Calculate how much of this is unrealised.
3. Prepare the adjustment.
- £15,000 with a gross margin of 20%
= total profit of 20% x £15,000 = £3,000
- But remember we only adjust for the unrealised element.
As half the goods have been sold half of the profit is unrealised =
50% x £3,000 = £1,500
- Reduce inventories by 1,500
Reduce retained earnings by 1,500
Rose Ltd. acquires 100% of Thorn Ltd. on 1 July 20X5 for £14 million cash. The statements of financial position for both companies as at 30 June 20X6 are given on the following slide.
At the point of acquisition Thorn had retained earnings of £9,500,000.
The fair value of the assets at acquisition was as listed except for PPE with a remaining useful life 10 years which is considered to have a fair value of £500,000 in excess of its carrying amount.
During the year Thorn sold goods to Rose for £6,000,000. The mark-up on this transaction is 50%. 90% of these goods had been sold by the year end.
At 30/6/X6 goodwill was considered to be impaired by 50%.
Add the financial statements together – just like before.
£,000 Rose group
PPE 28,200
Investment in Thorn 14,000
Inventories 3,500
Other current assets 7,000
Total assets 52,700
Share capital (£1 ord) 6,000
Retained earnings 41,700
Current liabilities 5,000
Total equity and liabilities 52,700
Now adjust for the fair value items.
At acq Change At consolidation PPE +500 Take to goodwill
Cost of investment 14,000
Share capital 1,000
Retained earnings 9,500
Fair value adjustment 500
Net assets on acquisition 11,000
Goodwill 3,000
We are told there is impairment of 50%
Cost of investment 14,000
Share capital 1,000
Retained earnings 9,500
Fair value adjustment 500
Net assets on acquisition 11,000
Goodwill 3,000
Impairment (1,500)
Goodwill at year end 1,500
Now, the internal trading.
£6,000,000 with a gross markup of 50%
= total profit of (6,000,000/150) x 50 = 2,000,000
But remember we only adjust for the unrealised element.
As 90% of the goods have been sold 10% of the profit is unrealised =
10% x £2,000,000 = £200,000
Reduce inventories by 200
Reduce retained earnings by 200
We deal with the change by the year end
The depreciation of the non-current assets is 500/10 years = 50
At acq Change At consolidation
PPE +500 -50 +450
Take to goodwill Take to retained earnings
Final SFP
£,000 Rose Group
PPE 28,650
Goodwill 1,500
Inventories 3,300
Other current assets 7,000
Total assets 40,450
Share capital (£1 ord) 5,000
Retained earnings 30,450
Current liabilities 5,000
Total equity and liabilities 40,450
