Chapter 20 Consolidated Income Statement

1.       Objectives

1.1       Prepare a consolidated income statement for a simple group and a non-controlling interest.
1.2       Account for the effects of intra-group trading in the income statement.
1.3       Prepare a consolidated income statement for a simple group with an acquisition in the period and non-controlling interest.
1.4       Account for impairment of goodwill.

2.       Basic Principles

2.1

The mechanics of consolidation

The consolidated income statement follows the following basic principles: (a)        From revenue to profit for the year include all of parent company’s (P) income and expenses plus all of subsidiary’s (S) income and expenses (reflecting control of S). (b)        After profit for the year show split of profit between amounts attributable to the parent’s shareholders and the non-controlling interest (to reflect ownership).

2.2

Example 1

The income statements of H Ltd and S Ltd for the year ended 31 December 2010 are given below:   H Ltd S Ltd   $ $ Turnover 300,000 180,000 Cost of sales (120,000) (60,000) Gross profit 180,000 120,000 Administrative, selling and distribution expenses (90,000) (60,000) Profit before taxation 90,000 60,000 Taxation (14,000) (10,000) Profit for the year 76,000 50,000 H Ltd acquired 80% of the ordinary share capital of S Ltd on 1 January 2010. Required: Prepare the consolidated income statement of H Ltd for the year ended 31 December 2010. Solution: Consolidated income statement for the year ended 31 December 2010.     Workings   $ $ Turnover 480,000 (300,000 + 180,000) Cost of sales (180,000) (120,000 + 60,000) Gross profit 300,000   Administrative, selling and distribution expenses   (150,000)   (90,000 + 60,000) Profit before tax 150,000   Taxation (24,000) (14,000 + 10,000) Profit for the year 126,000         Attributable to:     Group (126,000 – NCI) 116,000   Non-controlling interest (50,000 x 20%) 10,000     126,000

 

3.       Intra-group Transactions

(A)       Dividends

3.1       Although it is proper for the holding company to take credit of the dividends received and receivable from the subsidiary, the inter-company dividends do not constitute income of the group and, thus, should not be included in the consolidated income statement.
3.2       In arriving at the profit attributable to the group, the non-controlling interest in the profits of the subsidiaries is excluded. Hence, no account needs to be taken of how much of the non-controlling interest is distributed as dividends.

3.3

Example 2

The income statements for H Ltd and S Ltd for the year ended 31 December 2010 are shown below. H Ltd acquired 75% of the ordinary share capital of S Ltd several years ago.   H Ltd S Ltd   $000 $000 Turnover 2,400 800 Cost of sales and expenses (2,160) (720) Trading profit 240 80 Investment income: Dividend received from S 1.5 - Profit before tax 241.5 80 Tax (115) (38) Profit for the year 126.5 42 Required: Prepare the consolidated income statement of H Ltd for the year ended 31 December 2010. Solution: Consolidated income statement for the year ended 31 December 2010.       $ Turnover (2,400 + 800) 3,200 Cost of sales and expenses (2,160 + 720) (2,880) Profit before tax 320 Tax (115 + 38) (153) Profit for the year 167     Attributable to:   Group (167 – NCI) 156.5 Non-controlling interest (42 x 25%) 10.5   167

 

(B)       Interest

3.4       If there is a loan outstanding between group companies the effect of any loan interest received and paid must be eliminated from the consolidated income statement.
3.5       The relevant amount of interest should be deducted from group investment income and group finance costs.

(C)       Unrealised profit in inventory

3.6       If any goods sold intra-group are included in closing inventory, their value must be adjusted to the lower of cost and net realizable value (NRV) to the group.
3.7       The adjustment for unrealized profit should be shown as an increase to cost of sales (return inventory back to true cost to group and eliminate unrealized profit).

 

3.8

Example 3

On 1 January 2010 H Ltd acquired 60% of the ordinary shares of S Ltd. The following income statements have been produced by H Ltd and S Ltd for the year ended 31 December 2010.   H Ltd S Ltd   $000 $000 Turnover 1,260 520 Cost of sales (420) (210) Gross profit 840 310 Distribution costs (180) (60) Administration expenses (120) (90) Profit from operations 540 160 Investment income from S Ltd 36 - Profit before taxation 576 160 Taxation (130) (26) Profit for the year 446 134 During the year ended 31 December 2010 H Ltd had sold $84,000 worth of goods to S Ltd. These goods had cost H Ltd $56,000. On 31 December 2010 S Ltd still had $36,000 worth of these goods in inventories. Required: Prepare the consolidated income statement of H Ltd for the year ended 31 December 2010. Solution: Consolidated income statement for the year ended 31 December 2010.       $000 Turnover (1,260 + 520 – 84) 1,696 Cost of sales (420 + 210 – 84 + 12) (558) Gross profit 1,138 Distribution costs (180 + 60) (240) Administrative expenses (120 + 90) (210) Profit from operations 688 Taxation (130 + 26) (156) Profit for the year 532     Attributable to:   Group (532 – NCI) 478.4 Non-controlling interest (134 x 40%) 53.6   532

 

(D)       Transfers of non-current assets

3.9       If one group company sells a non-current asset to another group company, the following adjustments are needed in the income statement to account for the unrealized profit and the additional depreciation.
(a)        Any profit or loss arising on the transfer must be removed from the consolidated income statement.
(b)        The depreciation charge must be adjusted so that it is based on the cost of the asset to the group.

(E)       Impairment of goodwill

3.10     Once any impairment has been identified during the year, the charge for the year will be passed through the consolidated income statement. This will usually be through operating expenses, however always follow instructions from the examiner.
3.11     If non-controlling interests have been valued at fair value, a portion of the impairment expense must be removed from the non-controlling interest’s share of profit.

(F)       Fair values

3.12     If a depreciating non-current asset of the subsidiary has been revalued as part of a fair value exercise when calculating goodwill, this will result in an adjustment to the consolidated income statement.
3.13     The consolidated income statement must include a depreciation charge based on the fair value of the asset, extra depreciation must therefore be calculated and charged to an appropriate cost category (usually in line with examiner requirements).

 

 

3.14

Example 4

Set out below are the draft income statements of H Ltd and its subsidiary company, S Ltd, for the year ended 31 December 2010. On 1 January 2009 H Ltd purchased 75,000 ordinary shares in S Ltd from an issued share capital of 100,000 $1 ordinary shares. Income statements for the year ended 31 December 2010   H Ltd S Ltd   $000 $000 Turnover 600 300 Cost of sales (360) (140) Gross profit 240 160 Operating expenses (93) (45) Profit from operations 147 115 Finance costs - (3) Profit before tax 147 112 Taxation (50) (32) Profit for the year 97 80 The following additional information is relevant: 1.         During the year S Ltd sold goods to H Ltd for $20,000, making a mark-up of one third. Only 20% of these goods were sold before the end of the year, the rest were still in inventory. 2.         Goodwill has been subject to an impairment review at the end of each year since acquisition and the review at the end of this year revealed another impairment of $5,000. The current impairment is to be recognized as an operating cost. 3.         At the date of acquisition a fair value adjustment was made and this has resulted in an additional depreciation charge for the current year of $15,000. It is group policy that all depreciation is charged to cost of sales. 4.         H Ltd values the non-controlling interests using the fair value method. Required: Prepare the consolidated income statement of H Ltd for the year ended 31 December 2010. Solution: Consolidated income statement for the year ended 31 December 2010.   $000 Turnover (600 + 300 – 20) 880 Cost of sales (360 + 140 – 20 + 4 + 15 (fair value depn)) (499) Gross profit 381 Operating expenses (93 + 45 + 5 (impairment)) (143) Profit from operations 238 Finance costs (3) Profit before tax 235 Tax (50 + 32) (82) Profit for the year 153     Attributable to:   Group (168 – 17.75) 139 Non-controlling interest (W2) 14   153 W1 Unrealised profit in inventory $000 = 80% x $20 x 33/133 4 W2 Non-controlling interest $000 NCI share of subsidiary’s profit for the year ($80 x 25%) 20 Less:   NCI share of unrealized profit (25% x $4) (1.00) NCI share of impairment (25% x $5) (1.25) NCI share of fair value depreciation (25% x $15) (3.75)   14.00

 

 

 

 

4.         Mid-year Acquisitions

4.1       If a subsidiary is acquired part way through the year, then the subsidiary’s results should only be consolidated from the date of acquisition, i.e. the date on which control is obtained.

4.2

Treatment of mid-year acquisition

In practice this will require: (a)        Identification of the net assets of S at the date of acquisition in order to calculate goodwill. (b)        Time apportionment of the results of S in the year of acquisition. For this purpose, unless indicated otherwise, assume that revenue and expenses accrue evenly. (c)        After time-apportioning S’s results, deduction of post acquisition intra-group items as normal.

4.3

Example 5

The following income statements were prepared for the year ended 31 March 2011. Income statements for the year ended 31 March 2011   H Ltd S Ltd   $000 $000 Turnover 303,600 217,700 Cost of sales (143,800) (102,200) Gross profit 159,800 115,500 Operating expenses (71,200) (51,300) Profit from operations 88,600 64,200 Investment income 2,800 1,200 Profit before tax 91,400 65,400 Taxation (46,200) (32,600) Profit for the year 45,200 32,800 On 30 November 2011 H Ltd acquired 75% of the issued ordinary capital of S Ltd. No dividends were paid by either company during the year. The investment income is from quoted investments and has been correctly accounted for. The profits of both companies are deemed to accrue evenly over the year. Required: Prepare the consolidated income statement of H Ltd for the year ended 31 March 2010. Solution: Consolidated income statement for the year ended 31 March 2011.   $000 Turnover (303,600 + (217,700 x 4/12)) 376,167 Cost of sales (143,800 + (102,200 x 4/12)) (177,867) Gross profit 198,300 Operating expenses (71,200 + (51,300 x 4/12)) (88,300) Profit from operations 110,000 Investment income (2,800 + (1,200 x 4/12)) 3,200 Profit before tax 113,200 Tax (46,200 + (32,600 x 4/12)) (57,067) Profit for the year 56,133     Attributable to:   Group (56,133 – NCI) 53,400 Non-controlling interest (25% x (32,800 x 4/12)) 2,733   56,133

 

Examination Style Questions

Question 1
Given below are the income statements for H Ltd and its subsidiary S Ltd for the year ended 31 December 2010.

	H Ltd	S Ltd
	$000	$000
Turnover	3,200	2,560
Cost of sales	(2,200)	(1,480)
Gross profit	1,000	1,080
Distribution costs	(160)	(120)
Administrative expenses	(400)	(80)
Profit from operations	440	880
Investment income	160	-
Profit before tax	600	880
Taxation	(400)	(480)
Profit for the year	200	400

Additional information:

1.      H Ltd paid $1.5 million on 31 December 2006 for 80% of S Ltd’s 800,000 ordinary shares.
2.      Goodwill impairments at 1 January 2010 amounted to $152,000. A further impairment of $40,000 was found to be necessary at the year end. Impairments are included within administrative expenses.
3.      H Ltd made sales to S Ltd, at a selling price of $600,000 during the year. Not all of the goods had been sold externally by the year end. The profit element included in S Ltd’s closing inventory was $30,000.
4.      Fair value depreciation for the current year amounted to $10,000. All depreciation should be charged to cost of sales.
5.      S Ltd paid an interim dividend during the year of $200,000.
6.      H Ltd values the non-controlling interests using the fair value method.

Required:

Prepare a consolidated income statement for the year ended 31 December 2010 for the H Group.

Question 2
H bought 70% of S on 1 July 2010. The following are the income statements of H and S for the year ended 31 March 2011.

	H Ltd	S Ltd
	$	$
Revenue	31,200	10,400
Cost of sales	(17,800)	(5,600)
Gross profit	13,400	4,800
Operating expenses	(8,500)	(3,200)
Profit from operations	4,900	1,600
Investment income	2,000	-
Profit before tax	6,900	1,600
Tax	(2,100)	(500)
Profit for the year	4,800	1,100

The following information is available:

1.       On 1 July 2010, an item of plant in the books of S had a fair value of $5,000 in excess of its carrying value. At this time, the plant had a remaining life of 10 years. Depreciation is charged to costs of sales.
2.       During the post-acquisition period S sold goods to P for $4,400. Of this amount, $500 was included in the inventory of H at the year-end. S earns a 35% margin on its sales.
3.       Goodwill amounting to $800 arose on the acquisition of S, which had been measured using the fair value method. Goodwill is to be impaired by 10% at the year-end. Impairment losses should be charged to operating expenses.
4.       S paid a dividend of $500 on 1 January 2011.

Required:

Prepare the consolidated income statement for the year ended 31 March 2011.