EACC3708

LEARING UNIT 11
·

GROUP STATEMENTS

PART A
At the end of this learning unit, a student should be able to:
• Identify when investment in another company will be classified as an investment in a
subsidiary
• Prepare Pro-forma consolidation journals and consolidated financial statements for a wholly-
owned subsidiary at the date of acquisition.
• Prepare Pro-forma consolidation journals and consolidated financial statements for a partly
owned subsidiary at the date of acquisition.
• Prepare Pro-forma consolidation journals and consolidated financial statements for a wholly-
owned subsidiary at a date after acquisition.
• Prepare Pro-forma consolidation journals and consolidated financial statements for a partly
owned subsidiary at a date after acquisition.

PART B
At the end of this learning unit, a student should be able to:
• Demonstrate an understanding of when to prepare separate/ individual and consolidated
financial statements (all based on IAS 1 - the overall considerations for the presentation of
financial statements).
• Prepare Pro-forma consolidation journals and consolidated financial statements for a group
with a wholly-owned subsidiary at a date after acquisition.
• Prepare Pro-forma consolidation journals and consolidated financial statements for a group
with a partly owned subsidiary at a date after acquisition
• Prepare Pro-forma consolidation journals to eliminate intercompany balances and
transactions and account for that in the consolidated financial statements for the group.
• To account for deferred tax on intercompany transactions where applicable.
• Prepare Pro-forma consolidation journals to revalue a non-depreciable non-current asset at
acquisition and prepare the consolidated financial statements for the group.
• Prepare Pro-forma consolidation journals and consolidated financial statements for the
group where a subsidiary has preference shares in issue.
• Prepare Pro-forma consolidation journals and consolidated financial statements for a
horizontal group.
• Prepare Pro-forma consolidation journals and consolidated financial statements when a
subsidiary was acquired during the year.
 INTRODUCTION

Consolidated Financial Statements

• IAS 27 outlines the requirements for the preparation and presentation of consolidated financial
statements, providing guidance on the scope and principles of consolidation. It is the process
of combining financial statements of a parent company and its subsidiaries to present a single
set of financial statements
• It also addresses the preparation of separate financial statements, defining the criteria for their
presentation when an entity is exempt from preparing consolidated financial statements.
• The standard focuses on the concept of control and the determination of whether an entity
controls another entity. This helps students understand the fundamental principle of control
and its significance in the context of financial reporting

Examples of Group companies

Most of the companies you have seen are probably familiar to you;

Did you know that some of the companies you buy from are actually part of a bigger group of
companies owned by a company referred to as the “holding company” or “parent company”.
For Example, The TFG Group includes:
• The parent company ‐ Foschini Group Ltd (TFG); and
• Different companies, that sell to different clients– @home; Sportscene; Markham, etc.
• Each retail store may prepare its own financial statements and be registered as a separate
company, although it is owned by the parent company (TFG).

m
A company may decide to grow by:

• physically expanding, e.g., to a different region, or

• expanding within its own supply chain, by buying or getting the control of a supplier or
customer or getting control over a competitor. Control over a supplier can ease the access to
resources and the control over a customer and competitor can expand the company’s market
share.
The company can buy all the assets and liabilities of the other entity, or they can gain control over
the other entity by buying for example the majority of the equity shares of the entity.

Subsidiary companies
• When a company acquire the control over another company, the company becomes the
parent company and the company that is controlled is the subsidiary. Each company still
prepare its own separate financial statements.
• In terms of IFRS 9 ‐ The shareholders of the parent company will see the investment in the
subsidiary as a line item (Investment in shares) on the separate financial statements of the
parent company. If the parent is in control of the subsidiary, the shareholders of both
companies may be interested in the financial performance and position of the group as a
whole.
• In terms of IFRS 10.19 –If the parent controls the subsidiary, group financial statements/
consolidated financial statements will be a requirement to be prepared to give the
shareholders of the complete picture of the group
The emergence of group entities
Why do entities do business as a group of companies? It could be for various reasons:
• Investing in competitors or suppliers in order to manage risks and gain easier access to
resources;
• Reduction of costs through economies of scale; and
• All this to gain more profits and market share.

Group companies that resulted from a company that is acquired by another (not organic growth)
are accounted for using IFRS 3 Business Combinations.

DEFINITIONS AS PER THE COMPANY’S ACT

Group: Consists of a parent and its subsidiaries.

~ Y
A Holding Company / Parent / Investor: Subsidiary/Investee:
in relation to a subsidiary is defined as a juristic An entity controlled by another entity
person (or undertaking) that controls the subsidiary. (known as the parent).
A company will be a holding company if any of the
following applies: Y
• It has the ability to directly or indirectly exercise, Control:
or control the exercise of a majority of the An investor controls an investee when
general voting rights at a general meeting; or the investor has:
• It has the right to appoint or elect, or control the • power over the investee;
appointment or election of directors of that • exposure or has rights to variable
company who would have a majority of the returns from its involvement with the
votes at a board meeting; or investee; and
• All the general voting rights associated with the • The ability to use power over
issued securities of the company are held and investee to affect the amount of the
controlled by the persons contemplated above. investor’s returns.

CONTROL IS ESSENTIAL. Therefore, to

Holding Company/Parent/Investor ‐ example
determine if there is a group, the
A parent company is a company that owns the
investor/parent will assess whether they
controlling interest in another company. A parent
control the entity. IF there is control, then
doesn’t have to own 100% of the equity shares of
consolidated financial statements shall
the subsidiary. It only has to own the controlling
be prepared.
interest.
Parent company = Famous Brands Group
Subsidiaries = Wimpy/Steers/ etc.
Control vs ownership
• P Ltd only owns 51% of the net assets of S Ltd, although P Ltd only owns
51% interest, 100% of the net assets are consolidated. This is because of
the “control” principle.
• P Ltd controls 100% of the net assets of S Ltd.

Where control was obtained through majority voting rights, always assume the parent determines the
relevant activities and therefore has control and has to prepare consolidated financial statements.

Types of group structures

Consolidation
• Broadly explained, it is a process of reporting separate entities (parent and subsidiary) as a
single economic entity. Because the consolidated financial statements are a combination of
the financial statements of more than one entity, it may also be referred to as ‘group’ financial
statements.
• Consolidated financial statements does not replace the original financial statements of the
parent and their respective subsidiaries
• Consolidated financial statements are for REPORTING PURPOSES only
• The individual entities continue their operations (as individual companies)
• They still compile their own INDEPENTENT Stand alone financial statements, regardless of the
consolidated financial statements compiled

Non‐controlling interests (NCI) :

• Note that NCI is only relevant where the parent company does not own 100% of the equity
shares of the subsidiary company (Partially‐owned).
• The NCI are the owners who do not have a controlling interest in an entity;
• The non‐controlling interests in a subsidiary represent the residual interest in the net assets of
subsidiaries held by some other owners (not the parent) of the subsidiaries within a group. NCI
is classified as equity.

Note that P Ltd (parent) 75%

+ Other shareholders 25% (NCI)
=100% ownership in S Ltd (subsidiary).
 SECTION 1

Basic of consolidation at
acquisition date

Chapter 3
Lecture 1 2
+

↓
“Wholly-owned” Subsidiary

D
means; 100% ownership by the
parent. Therefore there is no NCI

“Partially-owned” subsidiary means;

Less < than 100% ownership by the
parent. Therefore, there is NCI
portion to account for.
BASIC CONSOLIDATION TECHNIQUES

A. Eliminate Common Items

An important intra-entity relationship between the respective financial statements of a parent and
subsidiary is that which exists between the investment in the subsidiary in the statement of
financial position of the parent and the parent’s portion of the equity of the statement of financial
position of the subsidiary. Since this investment account in the parent’s records (an asset) is
merely a claim against the net assets of the subsidiary as represented by its equity, the two items
are the obverse sides or mirror images of the same item and must be eliminated in the new
reporting entity, i.e. the group. In branch accounts, the investment account in the records of the
head office (the branch account) is replaced on consolidation of the records of the head office
and branch, by the net assets of the branch. In a similar manner, the account for the investment
in a subsidiary in the parent’s records is in effect replaced on consolidation by the appropriate
portion of the interest of the parent in the net assets of the subsidiary.
 CONSOLIDATION METHOD

The consolidated statements consist of five components:

• a consolidated statement of financial position at the end of the reporting period;
• a consolidated statement of profit or loss and other comprehensive income for the period;
• a consolidated statement of changes in equity for the period;
• a consolidated statement of cash flows for the period; and
• the notes, comprising a summary of significant accounting policies and other explanatory
information (IAS 1.10).

2. Pro forma journals

• Pro forma journals are prepared to eliminate the effect of internal transactions between the
parent and the subsidiary.
• Pro forma journals are not recognised in the individual records of either entity.
• Such journals may affect the trial balances of any of the entities involved.
• Such journal entries form part of the working papers or calculations related to consolidations.
• NB! The pro forma journals are never recognised in either of the individual accounting records
of the parent or the subsidiary and because of this, such pro forma journals need to be re-
written every year on consolidation of the group financial statements.

SFP OF WHOLLY-OWNED SUBSIDIARY

a) Interest aquired At Fair Value

where the shares in a wholly-owned subsidiary are acquired by the parent at a consideration equal
to the fair value of the net assets (being assets less liabilities which is the equity of the entity) on
the last day of the reporting period as it appears in the accounting records of the subsidiary. Such
an acquisition is referred to as an acquisition of shares at the fair value of the identifiable assets
and liabilities of the acquiree;
b) Interest acquired at a premium (Goodwill)

where the shares in a wholly-owned subsidiary are acquired by the parent at a premium
(therefore a consideration higher than the fair value of the identifiable assets and liabilities of the
acquiree) on the first day of the reporting period; and

Accounting Treatment
• In the case of a wholly-owned subsidiary, the parent (acquirer) shall recognise goodwill as of
the acquisition date, measured as the excess of the consideration transferred (at fair value)
over the net of the identifiable assets acquired and the liabilities assumed and the contingent
liabilities, based on acquisition-date fair values, i.e. the equity of the subsidiary (IFRS 3.32 –
adopted for a wholly-owned subsidiary).
• After initial recognition, the goodwill acquired in a business combination shall be measured
at cost less any accumulated impairment losses. Goodwill may not be amortised. Instead, it
shall be tested for impairment annually, or more frequently if events or changes in
circumstances indicate that it might be impaired in accordance with IAS 36 Impairment of
Assets (IAS 36.10) (see paragraph 6.7).
c) Interest acquired at a discount (GAIN ON BARGAIN PURCHASE)

where the shares in a wholly-owned subsidiary are acquired by the parent at a discount
(therefore for less than the fair value of the identifiable assets and liabilities of the acquiree) on
the first day of the reporting period.
SFP OF PARTIALLY-OWNED SUBSIDIARY

Non-Controlling Interest (NCI)

Where the parent does not acquire the entire issued share
capital of a subsidiary, the owners other than the parent (and
its subsidiaries and their nominees) are referred to as the non-
controlling interests (NCI). In the past, the term “minority
interest” was used for this category of owners, but the change
in terminology reflects the fact that the owner of a minority
interest in an entity might control that entity and conversely,
that the owners of a majority interest might not control the
entity, as discussed in chapter 1. Non-controlling interests
(NCI) are therefore defined as the equity in a subsidiary not
attributable, directly or indirectly, to the parent

NCI - TWO OPTIONS:

PROPORTIONATE SHARE AT FAIR VALUE

ab
Interest acquired Goodwill: + Goodwill: d Gain from a bargain
at FV of identifiable Interest acquired at Interest acquired at purchase:
net assets a premium a premium Interest acquired at a
discount

a) At fair value (proportionate share)

b) At a premium - goodwill (proportionate share)
c) At a premium - goodwill (fair value)
d) At a discount- gain on bargain purchase (proportionate share)
 SECTION 2

Consolidation after acquistion

date

Chapter 4
Lecture 3 + 4

b
INTRODUCTION

Consolidation after acquisition date

Distributable profits of an acquired subsidiary in the hands of the group
• Any profits that were earned before the acquisition date, called pre- acquisition profits, are not
distributable in the hands of the group (Not to be consolidated)
• Any profit of the subsidiary arising in the period since acquisition by the parent is distributable
profit from the point of view of the group and is disclosed as such in the consolidated financial
statements.

As consolidation takes place at a date after the parent acquired the interest in the wholly-owned
subsidiary, the full set of financial statements have to be consolidated, namely;
• The statements of financial position,
• The statements of profit or loss and other comprehensive income;
• The statements of changes in equity of the parent and the subsidiary and
• The consolidated statement of cash-flows. (N/A for this year).
 INTRAGROUP DIVIDEND

• IFRS 10 requires that all intragroup transactions shall be eliminated on consolidation (P and
S are seen as one economic entity).You can't pay yourself a dividend and recognise income
from yourself.
• Intragroup transactions includes intragroup dividends (i.e Dividends paid by the subsidiary to
the parent)
• The parent company recognise dividends received (income) in their separate books and the
subsidiary recognise dividends paid (equity).
• Dividends represents a distribution of a portion of the company’s profits to its shareholders
in proportion to their shareholding.
• It is important to remember that a dividend is a distribution to the owners of the company
and not an expense; therefore it is included in the statement of changes in equity.

• When a dividend is proposed it implies that the directors of a company calculated a dividend
& made a suggestion in their [Link] however, must still be authorised by resolution of
board of directors. Before this authorisation, there is no dividend recognised or presented in
the statement of changes in equity.
• Dividends are normally declared from retained earnings (even though they may be distributed
from any reserve). NB! A dividend is recognised when the dividend is declared (if no further
approval is required).

EXAMPLE
Suppose that the board of directors of S Ltd declared a dividend of R10 000 on 1 March 20.29 in
respect of the reporting period ended 31 December 20.28 and paid the dividend on 15 March
20.29. S Ltd will process the following journal in its individual records on 1 March 20.29:

• If a dividend is declared after the

reporting period, but before the
financial statements are authorised for
issue, the dividend may not be
recognised as a liability at the end of
the reporting period.
• Instead they are disclosed only in the
notes to the financial statements in
accordance with IAS 1.
• S Ltd will only recognise the dividend
relating to the 20.28 reporting period in
the 20.29 reporting period, as no
liability existed at 31 December 20.28
to pay a dividend.

• The shareholders of a company will in

turn recognise the dividend in their
individual records at the date when
the other company’s board of
directors approved the dividend.
• Dividends received are recognised as
income in the reporting period in
which the shareholder becomes
entitled to the dividend (when the right
to receive the dividend has been
established).
• This means that P Ltd becomes
entitled to the dividend income on 1
March 20.29.
SOLUTION & NOTES
• On consolidation the effect of the transaction above must be eliminated.
• The distribution of a dividend by a wholly-owned subsidiary out of profit after acquisition is, in
truth, from the point of view of the group, only a transfer of a portion of the retained earnings
of the subsidiary to the retained earnings of the parent: that is why it is merely eliminated as an
intragroup transaction and the amounts disclosed in the consolidated statement of financial
position are not affected at all by the transaction.
• The pro forma journal that should be taken into account on consolidation to recognise the
elimination is as follows:

WHOLLY-OWNED SUBSIDIARY

The basic consolidation procedures consist of the following:

• elimination of common items;
• elimination of intragroup items (such as dividends);
• consolidation of remaining non-common items on a line-by-line basis.

a) At fair value: AT COST

-
a) At fair value: AT FV

nee
a) At a premium (GOODWILL)
a) At a discount (GAIN ON BARGAIN PURCHASE)
PARTIAL-OWNED SUBSIDIARY

a) At fair value (proportionate share)

b) At a premium (at fair value)
SUBSIDIARY WITH A MARK-TO-MARKET RESERVE
 SECTION 3

Intergroup Transacions
(without tax)

Chapter 5
Lecture 5 + 6

The one SELLING the inventory

or assets is ALWAYS the one
whose profit is AFFECTED!!!

(section 3)
(section 3)

The following intragroup transactions will be explained in this document:

1. Elimination of intragroup loans. (See example 1.1 – 1.4 and refer to Journal 10)
2. Elimination of intragroup current accounts. (See example 2.1 – 2.2)
3. Elimination of intragroup dividends. (See example 3 and refer to Journal 7)
4. Elimination of intragroup profit in relation to intercompany sale of inventory. (See example
4.1 – 4.4 and refer to Journals 3, 4 and 5)
5. Elimination of intragroup profit in relation to intercompany sale of assets (for example
equipment, vehicles etc.) (See example 5.1 – 5.3 and refer to Journals 8 and 9)
2020 – Test 5 – adjusted for no tax

QUESTION 1 (30 marks; 45 minutes)

The Recovery Ltd group (‘Recovery group’) comprises of Recovery Ltd (‘Recovery’) and Speedi Ltd
(‘Speedi’). Both companies are in the clothing manufacturing industry.
Provided below are the condensed financial statements of Recovery and Speedi, for the year ended
31 August 20.20:

STATEMENTS OF FINANCIAL POSITION AT 31 AUGUST 20.20

Recovery Speedi
ASSETS Rand Rand
Property, plant and equipment 223 742 244 882
Investment in Speedi at cost 313 652 -
Investment in Speedi: Loan 13 600 -
Inventory 104 385 241 671
Trade receivables 198 654 194 300
Cash and cash equivalents 66 662 -
Total assets 920 695 680 853

EQUITY AND LIABILITIES

Ordinary share capital 438 333 326 100
Retained earnings 332 362 294 153
Loan from Recovery - 13 600
Trade payables 150 000 25 000
Bank overdraft - 22 000
Total equity and liabilities 920 695 920 695

STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 31 AUGUST 20.20

Recovery Speedi
Rand Rand
Revenue 725 636 288 563
Cost of sales (609 553) (187 600)
Gross Profit 116 083 100 963
Other income (including dividends received) 144 560 58 620
Other expenses (38 900) (12 566)
Profit before tax 221 743 147 017

Page 3 of 42
AN EXTRACT OF THE STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 AUGUST 20.20
Retained earnings
Recovery Speedi
Rand Rand
Balance at 31 August 20.19 145 219 160 135
Profit before tax 211 743 147 017
Ordinary dividends declared and paid (34 600) (12 999)
Balance at 31 August 20.20 332 362 294 153

Investment in Speedi:
1. On 3 September 20.18, Recovery acquired 93 917 of the 130 440 ordinary shares issued by
Speedi for R313 652. On 3 September 20.18, Speedi’s equity consisted of:
Rand
Retained earnings (credit balance) 23 200
Share capital 326 100

2. Recovery elected to measure any non-controlling interests at fair value at the acquisition date. The
fair value of the non-controlling interest of Speedi amounted to R91 000 at the acquisition date.

3. Assume that the identifiable assets acquired and the liabilities assumed of Speedi at the acquisition
date, are shown at their acquisition-date fair values, as determined in terms of IFRS 3.

4. On 1 July 20.20, Speedi borrowed R13 600 from Recovery. The loan is repayable in three equal
payments from 30 June 20.21. The loan bears interest at 9% per annum, payable annually in arrears.
The interest accrued on 31 August is included in the trade payables and trade receivable accounts of each
respective company. The interest income and finance cost is reconised in other income and other
expenses of each respective company.

5. Since the acquisition date, Recovery purchases all its inventories from Speedi. Speedi sells
inventories to Recovery at cost price plus 25%. Total sales of inventories from Speedi to Recovery
for the year ended 31 August 20.20 amounted to R166 123. Recovery’s opening inventory on 1
September 20.19 amounted to R37 500.

6. On 1 March 20.19 Recovery sold equipment to Speedi at a profit of R32 600. Recovery did not
hold the equipment as trading stock. The equipment was not sold for a price higher than the
original cost to Speedi. Speedi will be using the equipment to manufacture trousers.

Both companies depreciate equipment according to the straight-line method. On 1 March 20.19,
the remaining useful life of the equipment was estimated to be 10 years with no residual value.

7. Recovery did not sign a guarantee to allow an offset to cover Speedi’s bank overdraft.

8. The group accountant prepared the following pro forma journal entry for the year-ended 31 August
20.20. It can be assumed that this journal entry is correct:
Debit Credit
Rand Rand
Loan from Recovery (S) (SFP) 13 600
Investment in Speedi: Loan (P) (SFP) 13 600
(Elimination of intragroup loan)
Page 4 of 42
Additional information:
• Assume that all items of income and expenditure have been correctly accounted for in determining
profit before tax for all the companies in the group, unless otherwise stated.
• Recovery recognised the investment in its subsidiary in its separate financial records at cost.
• All dividends received, paid, or declared have been correctly accounted for in all companies’
individual financial statements.
• Since incorporation, the share capital of Recovery and Speedi remained unchanged.
• There was no impairment of any goodwill.
• Assume a normal tax rate of 27% for all periods. Ignore all other taxes.

QUESTION 1 REQUIRED:
Marks
(a) Prepare the abridged consolidated statement of profit or loss and other
13
comprehensive income of the Recovery group for the year ended 31 August
20.20.
(b) Prepare the consolidated statement of changes in equity for the Recovery group
for the year ended 31 August 20.20. Prepare ONLY the following columns:
• Retained earnings 10
• Non-controlling interest (NCI)
Do not show any other columns (Share capital and the Total equity).
(c) Prepare the assets portion (non-current and current) of the consolidated
statement of financial position of the Recovery group for the year ended 31 7
August 20.20. You ONLY need to prepare it up to the total assets.
TOTAL MARKS 30
You have to comply with the IFRS Accounting Standards. Assume that all current IFRSs have always
been in existence. Clearly show all calculations and work to the nearest Rand. Assume all items and
amounts to be material unless the contrary is clearly evident from the information given. Comparative
amounts are not required.

Page 5 of 42
[Link] OF INTRAGROUP LOANS

With intragroup loans, the following needs to be eliminated namely:

• The loan between the parent and subsidiary AND;
• The interest received and interest paid between the parent and subsidiary AND;
• The interest receivable and interest receivable between the parent and subsidiary (Only if the
interest has not yet been paid / received between the parent and the subsidiary)
Application of the intracompany loan principle on Test 5 – 2020

STATEMENTS OF FINANCIAL POSITION AT 31 AUGUST 20.20

Recovery Speedi
ASSETS Rand Rand
Property, plant and equipment 223 742 244 882
Investment in Speedi at cost 313 652 -
Investment in Speedi: Loan 13 600 -
Inventory 104 385 241 671
Trade receivables 198 654 194 300
Cash and cash equivalents 66 662 -
Total assets 920 695 680 853

EQUITY AND LIABILITIES

Ordinary share capital 438 333 326 100
Retained earnings 332 362 294 153
Loan from Recovery - 13 600
Trade payables 150 000 25 000
Bank overdraft - 22 000
Total equity and liabilities 920 695 920 695

The pro forma journal entries regarding the intragroup loan will be as follows:

Debit Credit
Rand Rand
Loan from Recovery Ltd (S) (SFP) 13 600
Investment in Speedi Ltd: Loan (P) (SFP) 13 600
(Elimination of intragroup loan)
Other income (Interest received) (P) (P/L) (13 600 x 9% x 2 / 12) 204
Other expenses (Interest paid) (S) (P/L) 204
(Elimination of intragroup loan)
Trade payables (Interest payable) (S) (SFP) (13 600 x 9% x 2/12) 204
Trade receivables (Interest receivable) (P) (SFP) 204
Elimination of intragroup interest still receivable / payable

Page 14 of 42
2. ELIMINATION OF INTRAGROUP CURRENT ACCOUNTS

With intragroup current accounts, the following needs to be eliminated namely:

• The current accounts between the parent and subsidiary.
3. ELIMINATION OF INTRAGROUP DIVIDENDS
Application of the intracompany dividend received / paid principle on Test 5 – 2020

STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 31 AUGUST 20.20

Recovery Speedi
Rand Rand
Revenue 725 636 288 563
Cost of sales (609 553) (187 600)
Gross Profit 116 083 100 963
Other income (including dividends received) 144 560 58 620
Other expenses (38 900) (12 566)
Profit before tax 221 743 147 017

AN EXTRACT OF THE STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED

31 AUGUST 20.20
Retained earnings
Recovery Speedi
Rand Rand
Balance at 31 August 20.19 145 219 160 135
Profit before tax 211 743 147 017
Ordinary dividends declared and paid (34 600) (12 999)
Balance at 31 August 20.20 332 362 294 153

Debit Credit
Rand Rand
Ordinary dividend received (P) (P/L) (12 999 x 73%) 9 359
Non-controlling interest (SCE) (P/L) (12 999 x 27%) 3 640
Ordinary dividends paid (S) (SCE) 12 999
(Elimination of intercompany dividend)

Always ask yourself:

1. What is the % that the parent owes of the subsidiary (Recovery owes 73% of Speedi),
2. What is the NCI % (NCI: 100% – 73% = 27%),
3. Is the dividend still payable to the Parent (No – No further pro forma journals are
required).

Page 21 of 42
4. ELIMINATION OF INTRAGROUP PROFIT IN RELATION TO
INTERCOMPANY SALE OF INVENTORY

You should know the following two methods of how the amount of unrealised profit can be
accounted for:
• Mark-up on cost (“Cost + profit %”)
• Gross profit margin
 - VERY IMPORTANT RULE NB!!!:

 If the subsidiary SELLS goods to the parent

Then the subsidiary makes the unrealised profit!!!!

 If the parent SELLS goods to the subsidiary

Then the parent makes the unrealised profit!!!!

- NB!! 3 Stages of Inventory:

1. Total sales for the year between P & S: Adjust with total sales figure.
2. Opening inventory – If sales occurred in prior years: Adjust with unrealised profit.
3. Closing inventory – Adjust with unrealised profit.
The pro forma journals will be as follows:

If the PARENT buys inventory from the subsidiary If the SUBSIDIARY buys inventory from the parent

Thus: P = Buyer Thus: P = Seller (P makes the profit)

S = Seller (S makes the profit) S = Buyer

The following pro forma journals will be prepared: The following pro forma journals will be prepared:
Debit Credit Debit Credit
Rand Rand Rand Rand
Sales (S) (P/L) XXX Sales (P) (P/L) XXX
Cost of sales (P) (P/L) XXX Cost of sales (S) (P/L) XXX

Elimination of intragroup sales Elimination of intragroup sales

For OPENING inventory, the following

For OPENING inventory, the following journal:
journal: Retained earnings (P) (SFP) XXX
Retained earnings (S) (SFP) XXX Cost of sales (P) (P/L) XXX
Cost of sales (S) (P/L) XXX
Realisation of unrealised profit of prior year
Realisation of unrealised profit of prior year

For CLOSING inventory, the following

For CLOSING inventory, the following journal:
journal: Cost of sales (P) (P/L) XXX
Cost of sales (S) (P/L) XXX Inventory (S) (SFP) XXX
Inventory (P) (SFP) XXX
Elimination of unrealised profit in closing
Elimination of unrealised profit in closing inventory
inventory

Page 24 of 42
Example 4.1: Subsidiary sold to the parent (Mark-up on cost)

Assume the following information:

 P = Parent
 S = Subsidiary
 Current financial year = 1 March 2020 till 28 February 20.21

P Ltd purchased inventory from S Ltd at cost plus 25%. During the year the total intracompany sales
amounted to R100 000. The inventory on hand in the records of P Ltd at the end of the financial
years were as follows:

20.20 = R20 000

20.21 = R30 000

Solution:

Lecturer note: Remember, the one who is selling is always the one whose profit is affected.

Always ask yourself:

1. Who is the seller and who is the buyer?
• S = seller
• P = buyer
2. Mark-up on cost is used. Thus: Rxxx X 25/125

The pro forma journal entries will be as follows:

Debit Credit
Rand Rand
Sales (S) (P/L) (Amount is always given) 100 000
Cost of sales (P) (P/L) 100 000
Elimination of intragroup sales

Lecturer note:
We need to eliminate all intragroup transactions. The group is regarded as one economic entity. As the
single entity will not enter into transactions with itself, we should eliminate any sales between companies
in the group. Therefore, we need to eliminate the intragroup sales of R100 000. When these sales took
place, the parent credited sales as it sold these goods. The subsidiary debited their inventory with the
purchase. We assume the subsidiary sold this inventory and therefore had already affected cost of sales.
To eliminate the intragroup sales, we will debit the sales of the parent with R100 000, and subtracting the
amount from sales. We will credit the cost of sales of the subsidiary and thus decreasing cost of sales.

Debit Credit
Rand Rand
Retained earnings (S) (SFP) (R20 000 x 25/125) 4 000
Cost of sales (S) (P/L) 4 000
Realisation of unrealised profit of prior year (opening inventory)

Page 25 of 42
Lecturer note:
On consolidation, we have to repeat all the entries annually because we combine the individual
companies' financial records annually and these current record does not contain the consolidation entries
of the previous year. If profit was affected in the previous year, we need to adjust the retained earnings
in the current year. Therefore, the cost of sales of R4 000 that would have been debited in the previous
year, will be debited against the retained earnings in the current year. Remember an adjustment against
profit or loss in a previous year will affect the opening balance of the current year.

Due to the general view that the operating cycle of entities is normally a year, we assume that the parent
actually sold this inventory to outside parties within a year, therefore the profit is realised. Therefore, we
credit cost of sales in the subsidiary to increase the profit again. Crediting the cost of sales implies that
the cost of sales decreases, so the R 4 000 is subtracted from cost of sales in the statements.

Debit Credit
Rand Rand
Cost of sales (S) (P/L) (R30 000 x 25/125) 6 000
Inventory (P) (SFP) 6 000
Elimination of unrealised profit in closing inventory

Lecturer note:
The subsidiary sells inventory to the parent at a profit of 25%. Both the parents’ inventory left at year end,
and the subsidiaries’ profit includes this intragroup profit. Since we evaluate the companies as a single
entity, we need to eliminate the intragroup profit (unrealised profit) as it was profit earned from within the
group but had not yet been realised outside the group.

At year end, the parent has inventory obtained from the subsidiary in its financial records amounting
to R30 000. The subsidiary made a profit of 25%. To calculate the unrealised profit portion, we have to
recognise that the R30 000 already includes 25% profit, which makes it 125%. We calculate the profit of
25% as follows: R30 000 x 25 /125 = R6 000.

To eliminate the unrealised profit, the parent has to subtract the R6 000 from its closing inventory in the
statement of financial position. We therefore credit inventory to decrease it. We should also decrease the
subsidiaries’ profit by debiting cost of sales. Profit decreases when we debit cost of sales, but the R6 000
is added to cost of sales.

Page 26 of 42
 Application of the intracompany inventory sales principle on Test 5 – 2020

Since the acquisition date, Recovery purchases all its inventories from Speedi. Speedi sells
inventories to Recovery at cost price plus 25%. Total sales of inventories from Speedi to Recovery
for the year ended 31 August 20.20 amounted to R166 123. Recovery’s opening inventory on
1 September 20.19 amounted to R37 500.

Where is the closing inventory on 30 August 20.20?

Remember, in the information given, it is mentioned that Recovery purchased ALL its inventory from
Speedi. Therefore the amount of inventory in the statement of financial position will be where the
unrealised profit must be eliminated.

AN EXTRACT OF THE STATEMENTS OF FINANCIAL POSITION AT 31 AUGUST 20.20

Recovery Speedi
ASSETS Rand Rand
Property, plant and equipment 223 742 244 882
Investment in Speedi at cost 313 652 -
Investment in Speedi: Loan 13 600 -
Inventory 104 385 241 671
Trade receivables 198 654 194 300
Cash and cash equivalents 66 662 -
Total assets 920 695 680 853

Lecturer note: Remember, the one who is selling is always the one whose profit is affected.

1. Who is the seller and who is the buyer?

• Speedi = seller – this means Speedi's profit must be adjusted. Therefore, the journal
must also be reflected in the analysis.
• Recovery = buyer
2. Mark-up on cost is used. Thus: Rxxx X 25/125

The pro forma journal entries to:

1. Correct the opening balance of retained earnings at the beginning of 20.20;

2. Eliminate the intracompany transaction; and
3. Eliminate the unrealised profit

Debit Credit
Rand Rand
Retained earnings-beginning of year (S) (SCE) 7,500
Cost of Sales (S) (P/L) (37 500 x 25/125) 7,500
(Adjustment to ensure that the consolidated retained earnings at the beginning of 20.20 are in agreement
with the consolidated retained earnings at the end of 20.19)

Page 27 of 42
 Revenue (S) (P/L) 16,123
Cost of Sales (P) (P/L) 166,123
(Elimination of intragroup sales)

Cost of Sales (S) (P/L) (104 385 x 25 / 125) 20,877

Inventory (P) (SFP) 20,877
(Elimination of unrealised intercompany profit included in inventories of P Ltd at
year-end)

Remember: Speedi = seller – this means Speedi's profit must be adjusted. Therefore the journal must also be
reflected in the analysis and in the financial statements.

Analysis of the shareholders' interest of Speedi Ltd

Total Speedi Ltd
72% SINCE NCI
ORDINARY SHARES AT RE 28%
At date of acquisition
Share capital 326,100 234,792 91,308
Retained earnings 23,200 16,704 6,496
349,300 251,496 - 97,804
Goodwill/(Gain) from bargain purchase 55,352 62,156 (6,804)
Investment in S Ltd 313,652 91,000
Since acquisition
· To beginning of current year
Retained earnings 129,435 93,193 36,242
127,242

· Current year
Profit for the year (SPL) 133,640 96,221 37,419
(147,017+7,500(JNL3)-20 877(JNL5))
Ordinary dividends (12,999) (9,359) (3,640)

654,728 180,055 161,021

Page 28 of 42
 Example 4.2: Subsidiary sold to the parent (Mark-up on cost)

Assume the following information:

 Pie Ltd = Parent
 Sweetie Ltd = Subsidiary
 Current financial year = 1 January 20.20 till 31 December 20.20

Pie Ltd bought some of its inventory from Sweetie Ltd at cost plus 20%. The total intracompany
sales for the year amounted to R250 000. On 31 December 20.19 Pie Ltd had R52 000 of these
goods in inventory and R65 000 on 31 December 20.20.

Solution:

Lecturer note: Remember, the one who is selling is always the one whose profit is affected.

Always ask yourself:

1. Who is the seller and who is the buyer?
• Sweetie Ltd = seller
• Pie Ltd = buyer
2. Mark-up on cost is used. Thus: Rxxx X 20/120

The pro forma journal entries will be as follows:

Debit Credit
Rand Rand
Sales (Sweetie) (P/L) (Amount is always given) 250 000
Cost of sales (Pie) (P/L) 250 000
Elimination of intragroup sales
Retained earnings (Sweetie) (SFP) (R52 000 x 20/120) 8 667
Cost of sales (Sweetie) (P/L) 8 667
Realisation of unrealised profit of prior year (opening inventory)
Cost of sales (Sweetie) (P/L) (R65 000 x 20/120) 10 833
Inventory (Pie) (SFP) 10 833
Elimination of unrealised profit in closing inventory

Remember: If the parent is the seller, the pro forma journal entries are only accounted for in the financial
statements and not in the analysis, because the profit of the subsidiary is not affected.

Page 29 of 42
Example 4.3: Parent sold to the subsidiary (Gross profit margin)

Assume the following information:

 Hinderland = Parent
 Senwest = Subsidiary
 Current financial year = 1 January 20.20 till 31 December 20.20

Senwest bought some of its inventory from Hinderland at a gross profit margin of 35% (profit on
the selling price). The total intracompany sales for the year amounted to R1 050 000. On
31 December 20.20, Senwest had R595 000 of these goods in inventory and R675 000 at
31 December 20.19. It was, however, noted that a freight of goods at a selling price of R75 000
was dispatched by Hinderland to Senwest on 30 December 20.20 and the freight, including
appropriate documentation only, arrived on 5 January 20.21 on which date the transaction was
only processed by Senwest staff.

Solution:

Lecturer note: Remember, the one who is selling is always the one whose profit is affected.

Always ask yourself:

1. Who is the seller and who is the buyer?
• Hinderland = seller
• Senwest = buyer
2. Gross profit margin is used. Thus: Rxxx X 35% (or 35 / 100)

The pro forma journal entries will be as follows:

Debit Credit
Rand Rand
Sales (Hinderland) (P/L) (Amount is always given) 1 050 000
Cost of sales (Senwest) (P/L) 1 050 000
Elimination of intragroup sales
Retained earnings (Hinderland) (SFP) (R675 000 x 35%) 236 250
Cost of sales (Hinderland) (P/L) 236 250
Realisation of unrealised profit of prior year (opening inventory)
Cost of sales (Hinderland) (P/L) ([R595 000 + R75 000] x 35%) 234 500
Inventory (Senwest) (SFP) 234 500
Elimination of unrealised profit in closing inventory

Page 30 of 42
Example 4.4: Subsidiary sold to the parent (Mark-up on cost)

Assume the following information:

 Handy Ltd = Parent
 Andy Ltd = Subsidiary
 Current financial year = 1 January 20.21 till 31 December 20.21

Handy has been purchasing inventory from Andy since the date of acquisition. The inventory on
hand in Handy’s financial records at 31 December 20.21 relating to inventory purchased from
Andy, amounted to R85 500 (31 December 20.20: R47 500). The total intergroup sales amounted
to R225 000 for the year. Andy sells inventory to Handy at mark-up on cost of 10%.

Solution:

Lecturer note: Remember, the one who is selling is always the one whose profit is affected.

Always ask yourself:

1. Who is the seller and who is the buyer?
• Andy Ltd = seller
• Handy Ltd = buyer
2. Mark-up on cost is used. Thus: Rxxx X 10/110

The pro forma journal entries will be as follows:

Debit Credit
Rand Rand
Sales (Andy) (P/L) (Amount is always given) 225 000
Cost of sales (Handy) (P/L) 225 000
Elimination of intragroup sales
Retained earnings (Andy) (SFP) (R47 500 x 10/110) 4 318
Cost of sales (Andy) (P/L) 4 318
Realisation of unrealised profit of prior year (opening inventory)
Cost of sales (Andy) (P/L) (R85 500 x 10/110) 7 773
Inventory (Handy) (SFP) 7 773
Elimination of unrealised profit in closing inventory

Page 31 of 42
5. ELIMINATION OF INTRAGROUP PROFIT IN RELATION TO
INTRACOMPANY SALE OF ASSETS
 Application of the intracompany sales of an asset principle on Test 5 – 2020

On 1 March 20.19 Recovery sold equipment to Speedi at a profit of R32 600. Recovery did not hold
the equipment as trading stock. The equipment was not sold for a price higher than the original cost
to Speedi. Speedi will be using the equipment to manufacture trousers.

Both companies depreciate equipment according to the straight-line method. On 1 March 20.19,
the remaining useful life of the equipment was estimated to be 10 years with no residual value.

Beginning

purchase financial

Unknown 1 March 20.19 1 September 20.19 31 August 20.20

Diff = 6 months

Debit Credit
Rand Rand
Retained earnings (P)(SCE) (balancing amount) 30 970
Accumulated depreciation:Equipment (S) (SFP)
(32 600 /10 years x 6 x 12 months) 1 630
Equipment (S) (SFP) 32 600
(Elimination of the unrealised intragroup profit included in the
equipment of company on 31/08/20.19)

Accumulated depreciation:Equipment (S) (SFP) 3 260

Depreciation (P) [Cost of Sales]( 32 600 / 10 ) (P/L) 3 260
(Recording of the portion of the unrealised intercompany
profit realised in 20.20)

Remember the parent made the profit, therefore the analysis of the subsidiary is not adjusted.

RECOVERY GROUP LTD

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AT 31 AUGUST 20.20
Rand
ASSETS
Non-current assets
Property, plant and equipment (223 742 (100% P)+ 244 882 (100% S) – 32 600 + 3 260
440 914
+ 1 630)

Page 41 of 42
 RECOVERY GROUP LTD
AN EXTRACT OF THE CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE
YEAR ENDED 31 AUGUST 20.20
Rand

Revenue (725 636 + 288 563- 166 123) 848 076

Cost of sales (609 553 + 187 600 – 166 123 + 20 877 – 7 500 – 3 260) (641 147)

RECOVERY GROUP LTD

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 AUGUST 20.20

Retained
earnings
Rand
Balance at 31 Aug 20.19 207,442

RE opening balance: [145 219 (100% P)+160 135 (100% S) -23 200 (At acquisition RE ) - 36 242 (NCI since
acquisition at beginning of the current year) – 7 500 (Correction of PY unrrealised profit of inventory) –
30 970(Correction of RE opening balance of PY unrealised profit on asset sold)

Page 42 of 42
SUMMARY - ELIMINATION OF INTERGROUP PROFITS

Elimination of intragroup transactions Elimination of intragroup transactions

Formula/
ratio % Amount
Cost 100 Cost
Unrealised
Profit 50 profit ?? (30 000 x 50 /150)
Selling price 150 Selling pric 30,000 (given)

If adjust profit/equity of S - also adjust NCI

P sold inventory to (80%) S S (80%) sold inventory to P (S made profit with the transaction)
Sales 100,000 Sales 100,000
Profit (100 000 x 50/150) 50% on cost Profit 50% on cost
Tax rate 27% Tax rate 27%
Year 1: Debit Credit Year 1: Debit Credit
Sales Sales (P/L) 100,000 Sales Sales (P/L) 100,000
Cost of Sales (P/L) 100,000 Cost of Sales (P/L) 100,000

Closing Cost of Sales (P/L) 10,000 Closing Cost of Sales (P/L) 10,000
inventory Inventory (SFP) 10,000 inventory Inventory (SFP) 10,000
R30 000 (30 000 x 50 /150) R30 000
Deferred tax (SFP) 2,700 Deferred tax (SFP) 2,700
Income tax expense (P/L) 2,700 Income tax expense (P/L) 2,700
(10 000 x 27%)
Year 2: Debit Credit Year 2: Debit Credit
Opening Retained earnings (SCE) 7,300 Opening Retained earnings (SCE) 7,300
inventory Deferred tax (SFP) 2,700 inventory Deferred tax (SFP) 2,700
Cost of Sales (P/L) 10,000 Cost of Sales (P/L) 10,000

Income tax expense (P/L) 2,700 Income tax expense (P/L) 2,700
Deferred tax (SFP) 2,700 Deferred tax (SFP) 2,700

If adjust profit/equity of S - also adjust NCI

Elimination of intragroup transactions Elimination of intragroup transactions

If adjust profit/equity of S - also adjust NCI
P sold equipment to (80%) S S (80%) sold equipment to P
Profit 25,000 Profit 25,000
Remaining useful life: straight-line 10 Remaining useful life: straight-line 10
Tax rate 27% Tax rate 27%
Year 1: Debit Credit Year 1: Debit Credit
Sales Profit sale of asset (P/L) 25,000 Sales Profit sale of asset (P/L) 25,000
Equipment (SFP) 25,000 Equipment (SFP) 25,000

Deferred tax (SFP) 6,750 Deferred tax 6,750

Income tax expense (P/L) 6,750 Income tax expense (P/L) 6,750

Deprec. Accumulated deprec.(SFP) 2,500 Deprec. Accumulated deprec. 2,500

Depreciation (P/L) 2,500 Depreciation (P/L) 2,500
(25 000 / 10 years)
Income tax expense (P/L) 675 Income tax expense (P/L) (S) 675
Deferred tax (SFP) 675 Deferred tax 675

Year 2: Debit Credit Year 2: Debit Credit

Opening Retained earnings (SCE) 16,425 Opening Retained earnings (SCE) 16,425
balance Deferred tax (SFP) 6,075 balance Deferred tax (SFP) 6,075
Accumulated deprec.(SFP) 2,500 Accumulated deprec. (SFP) 2,500
Equipment (SFP) 25,000 Equipment (SFP) 25,000

Deprec. Accumulated deprec.(SFP) 2,500 Deprec. Accumulated deprec. (SFP) 2,500

Depreciation (P/L) 2,500 Depreciation ((P/L) 2,500

Income tax expense (P/L) 675 Income tax expense (P/L) 675
Deferred tax (SFP) 675 Deferred tax 675

If adjust profit/equity of S - also adjust NCI

 SECTION 4

Intergroup Transacions with

tax and deferred tax
implications
Chapter 5
Lecture 7 - 9

INVENTORY SOLD AS INVENTORY

EQUIPMENT SOLD AS INVENTORY
INVENTORY SOLD AS EQUIPMENT
EQUIPMENT SOLD AS EQUIPMENT
SUBSEQUENT SALE OF PPE
Remember the principle when PPE is sold in a group:
• The group will only realise the intragroup profit/loss once the group realises the economic
benefits associated with the asset, for PPE the group realises the economic benefits of the
asset over its useful life.
• However: When the PPE is sold to a third party BEFORE the end of its useful life, the group will
realise all the economic benefits of the asset at once. Due to this, any unrealised profit/loss will
realise at the date of sale of the PPE to a third party.
 SECTION 5

Sundry aspects of groups

statements (Only Preference
shares)
Chapter 6
Lecture 10 + 11

PREFERENCE SHARES

Preference shares can only exist when another class of shares, generally ordinary shares, exists, in
comparison to which the preference shares enjoy certain preferential rights. These preferential
rights can be summarised as follows:

(a) Preferential rights in respect of dividends

This right is normally expressed as a percentage of the value of the share, for example 9%
preference shares. If the preference shares are cumulative (see (c) below), ordinary owners may
not receive a dividend in the current reporting period unless a preference dividend is declared.

(b) Preferential rights in respect of repayment of capital

Unless an express provision exists in the articles of the company to the effect that
preference shares also enjoy preference to repayment of capital on liquidation, they share
pro rata in such repayment with the ordinary shares.

(e) Voting rights

Normally do not carry a vote, except while the preference dividend or a redemption instalment
(see below) is in arrears and remains unpaid

LIABILITY VS EQUITY

Per IAS 32.15 an issuer of a financial instrument should, on initial recognition, classify the
instrument as a financial liability or an equity instrument in accordance with the substance of the
contractual arrangement and the definitions of a financial liability and an equity instrument
A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.

A financial liability is any liability that is a contractual obligation:

• to deliver cash or another financial asset to another entity; or

• to exchange financial assets or financial liabilities with another entity under conditions that
are potentially unfavourable to the entity; or
• a contract that will be settled in the entity’s own equity instruments and is:
• a non-derivative, for which the entity is or may be obliged to deliver a variable number of
the entity’s own equity instruments; or
• a derivative that will or may be settled other than by the exchange of a fixed amount of
cash or another financial asset for a fixed amount of the entity’s own equity instruments.
For this purpose, the entity’s own equity instruments do not include instruments that are
themselves contracts for the future receipt or delivery of the entity’s own equity
instruments.

A financial instrument that falls into this category is classified as a financial liability and is
accounted for in terms of IAS 39 Financial Instruments: Presentation. Such investments in
preferences shares are not consolidated. Furthermore, if the preference share is classified as a
financial liability, the related dividends are regarded as interest and thus classified as an expense in
profit or loss. Such dividends therefore also have no effect on the consolidation process.

An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting the liabilities.

When the definition of a financial liability is analysed, it becomes clear that the essence of the
classification depends on whether the issuer of the instrument has a contractual obligation:
• to deliver cash or another financial instrument to the holder of the instrument; or
• to exchange financial assets and liabilities with other entities under conditions that would be
potentially unfavourable to the issuer.

Furthermore, it is important to determine whether the issuer has an unconditional right to avoid
delivering cash or another financial asset to settle an obligation, i.e.:
• if an entity does not have an unconditional right to avoid delivering cash or another financial
asset to settle a contractual obligation, the obligation meets the definition of a financial liability
(IAS 32.19); therefore
• if an entity does have an unconditional right to avoid delivering cash or another financial asset to
settle a contractual obligation, the obligation meets the definition of an equity instrument.

In all other instances preference shares are assumed to be non-redeemable and are therefore
regarded as equity instruments for the purposes of this work. Furthermore, such an investment
in the preference shares of a subsidiary is regarded as being part of the net investment in the
subsidiary as a whole, because of the equity nature of the preference shares. Investments in
preference shares are consolidated in terms of IFRS 10 in the same manner as ordinary shares.
Consolidation procedures where the capital of the subsidiary includes preference shares
If the share capital of a subsidiary consists of more than one class of shares, the total owner’s
equity must be allocated between the different classes of capital in accordance with the
particular rights attached to each. The purpose of such allocation is to:
• identify the equity of the subsidiary attributable to the total investment of the parent; and
• determine the total interest of the non-controlling interests (where applicable).

If the non-controlling interests in the acquiree are not entitled on liquidation of the acquiree to a
proportionate share of the acquiree’s net assets then the non-controlling interests shall be
measured at their acquisition-date fair values (IFRS 3.19). If the non-controlling interests include
preference shares then the measurement of the preference share capital will be determined as
follows:
• the acquiree has issued preference shares and the preference shares give their holders a right
to a preferential dividend in priority to the payment of any dividend to the holders of ordinary
shares and the preference shareholders are only entitled to receive a repayment of the nominal
value of the preference share upon liquidation of the acquiree. In this situation, the acquirer
measures the preference shares at their acquisition-date fair value,
• the acquiree has issued preference shares and the preference shares give their holders a right
to a preferential dividend in priority to the payment of any dividend to the holders of ordinary
shares and the preference shareholders are entitled to receive a proportionate share of the net
assets available for distribution upon liquidation of the acquiree. In this situation, the acquirer
measures the preference shares at their acquisition-date fair value or at their proportionate
share in the acquiree’s recognised identifiable net assets. This will be in accordance with the
method elected by the parent for the measuring of the non-controlling interests at acquisition
date.
·

·
TREATMENT OF PREFERENCE DIVIDENDS

Situations to be considered
IAS 27.12 determines that an entity shall recognise a dividend from a subsidiary in profit or loss in
the entity’s separate financial statements when the entity’s right to receive the dividend is
established. When such a dividend is recognised in terms of IAS 27 and evidence is available that
the carrying amount of the investment in the separate financial statements exceeds the carrying
amount in the consolidated financial statements of the investee’s net assets, including associated
goodwill, or the dividend exceeds the total comprehensive income of the subsidiary in the period
in which the dividend is declared, an impairment test needs to be done in terms of IAS 36.12(h)
and
.9 Impairment of Assets. This impairment test is done for the first dividend received after
acquisition. It may also be necessary to perform an impairment test in any year in which the
dividends received from the subsidiary for that year exceed the parents'
share of the total comprehensive income for that year.

In the treatment of the preference dividends of subsidiaries, the following circumstances will be
considered:
• preference dividends outstanding at the end of the reporting period;
• accrued preference dividends on acquisition of a subsidiary; and
• preference dividends in arrears.

Preference dividends outstanding at the end of the reporting period

As has already been stated, the preference dividend of a subsidiary must, for consolidation
purposes, be treated as if it is an expense (like interest on a loan) which accrues on a time-
proportion basis. When regarded in this way, this dividend represents a charge against income,
and must be brought into account before the profit attributable to the owners of both the non-
controlling interests as well as the parent is determined
 SECTION 6

Consolidation of Complex
groups (only horizontal groups)

Chapter 7
Lecture 12

Introduction
A group consists of a parent which is not itself a full subsidiary, and all such companies which are
its subsidiaries. A parent (P Ltd) can have more than one subsidiary, whilst a subsidiary (S Ltd)
could also be the parent of another entity (SS Ltd). SS Ltd is known as the sub-subsidiary of the
ultimate parent (P Ltd).
A parent, together with its subsidiaries and sub-subsidiaries (if any), forms a group of entities.
Note that a sub-subsidiary is legally considered to be a subsidiary of the ultimate parent. This
arises from the definition of a subsidiary as stated in chapter 1.
A simple group is a group consisting of a parent and a single subsidiary, whilst there is more than
one subsidiary in a complex group. Complex groups can, according to the structure of the
controlling equity shareholding, be divided into horizontal, vertical and mixed groups.

Horizontal Groups

Basic consolidation procedures

In a horizontal group, the parent itself is the only entity in the group holding shares in two or more
subsidiaries. (Note that in Figure 1, control is exercised in only one direction.) In the case of a
horizontal group, the consolidation process is thus like the process applied in the case of a simple
group, where the parent owns the controlling interest in only a single subsidiary. The interests of
the subsidiaries in a horizontal group must be separately analysed. It does not matter which
subsidiary is analysed first
 SECTION 7

Interim acquisition

Chapter 8
Lecture 13 + 14

Interim acquisition of an interest in a subsidiary

In the preceding chapters, the acquisition date of an interest in a subsidiary by the parent was
consistently taken to be the first day of the subsidiary’s relevant reporting period. The purchase of
an interest in a subsidiary at a date that is later than the first day of the subsidiary’s current
reporting period is known as an “interim acquisitionof an interest in a subsidiary”. In the event of
an interim acquisition, the profit or loss for the year of the specific reporting period during which
the interest was acquired must be allocated between pre-acquisition and post-acquisition profit
and losses. The same applies to items of other comprehensive income and movements in equity
(such as dividends declared). If it is feasible, financial statements of the subsidiary must be drawn
up at the acquisition date of the interest in the subsidiary concerned. Should this be done, the
consolidation process would not differ materially from a case in which the interest is acquired at
the beginning of the reporting period.
IFRS 10 Consolidated Financial Statements requires that the income, expenses, and items of
other comprehensive income of a subsidiary are only included in the consolidated financial
statements from the effective acquisition date (i.e. from the date the parent obtained control over
the subsidiary).

ALLOCATION OF SFP AND OCI IN THE SCE

If financial statements were not drawn up at the acquisition date of the interest in the subsidiary
concerned, it is necessary to allocate all the line items in the profit or loss, other comprehensive
income and movements in the equity of the subsidiary for the relevant period concerned with
reference to the available information. The profit or loss for any reporting period of the subsidiary
will, if it is not practicable to apportion it with reference to the facts, be treated as if it accrued
from day to day during the year and be apportioned accordingly.
Allocation of income and expense items
Income and expense must be examined individually in order to determine the basis on which
each item should be apportioned between the period before acquisition and the period post
acquisition. This is needed to ensure that only post-acquisition items are included in the group’s
consolidated financial statements, with pre-acquisition items being eliminated at acquisition.

Certain items, such as depreciation, rates, other fixed costs, etc., normally accumulate from day
to day. Other items, such as gains or losses on the sale of property, plant and equipment or
investments, may be realised at a definite time, while other items may accrue during the
respective periods at differing rates or tariffs.
For example:
• Gross profit may accrue at an increasing rate as a result of an increase in sales or in the profit
margin.
• Directors’ remuneration may change as a result of new appointments.
• Salaries and wages are allocated on a time basis, but this may change due to new
appointments or resignations.
• Fair value adjustments on investment properties are allocated to the period when the
investment property was adjusted to fair value. It would need to be fairly valued at the
acquisition date and at the end of the reporting period.
• Interest paid may change because new loans are raised or existing loans have been paid off.
• Income or expenses related to leases will be allocated on a time basis, taking into account the
starting date of a new lease agreement or the termination date of a lease that has ended.
• Normal tax of the subsidiary for the current year should be apportioned in the ratio of the
taxable income for the periods before and since acquisition.

Allocation of items in other comprehensive income

Fair value adjustments – financial assets
Fair value adjustments on investment in equity shares, classified as subsequently measured at fair
value through other comprehensive income, are allocated to the period when the investment was
adjusted to fair value. It would need to be fairly valued at the acquisition date and at the end of
the reporting period.

Revaluation surplus
The revaluation surplus will be allocated to the specific period in which the revaluation surplus
arose. The revaluation may be done at the beginning of the reporting period (before the
acquisition date) or at the end of the reporting period, depending on the accounting policy of the
subsidiary.

Allocation of items in the statement of changes in equity

Items in the statement of changes in equity can be divided into the following categories for the
purpose of apportionment between the periods before and after the acquisition, i.e.:

Preference dividends
Cumulative preference dividends pertaining to issued preference shares of the subsidiary may be
regarded as a term cost, and should therefore be accounted for on a time basis. The cumulative
preference dividend must be accounted for even if it has not been declared (see IFRS 10.B95).
The only condition for accounting is that adequate profits must be available for distribution on the
current reporting date.

Ordinary dividends
Ordinary dividends are taken into account when the dividend is declared.
Year-end items
By their very nature, year-end items fall into the post-acquisition period. Examples of such items
are final dividends paid, and general transfers made between reserves (excluding those relating to
the derecognition of remeasured assets – such as revalued land, where the revaluation reserve is
transferred to retained earnings when the land was derecognised).

Adjustments in respect of previous financial years

Items that represent adjustments in respect of previous financial years will be included in the pre-
acquisition period. This will include the correction of prior period errors and the effect of a change
in accounting policy on the retained earnings of the subsidiary at the beginning of the year.

Special items
Such items will be treated according to their own merits and allocated on a time basis to the pre-
or post-acquisition period, depending on when the transaction concerned took place. Examples
of such items are interim dividends, and the transfers within equity relating to the derecognition of
remeasured assets – see above.

PRESENTATION OF THE CONSOLIDATED STATEMENTS

Consolidation procedures when there is an interim acquisition

If the acquisition of a subsidiary took place during the current reporting period, then the equity at
the date of acquisition will consist of the following:
• share capital;
• retained earnings at the beginning of the current reporting period;
• current profit or loss items that have accumulated from the beginning of the current year to
the date of acquisition;
• dividends declared before the date of acquisition;
• other reserves (such as a revaluation and mark-to-market reserve) at the beginning of the
current reporting period; and
• current items recognised in other comprehensive income that have accumulated from the
beginning of the current year to the date of acquisition.

This current profit or loss consists of revenue, cost of sales, other income, tax expense, etc.
Therefore, in the main elimination journal entry at the acquisition date of S Ltd, the pro forma
consolidation journals would need to include entries to remove, from the statement of profit or
loss and other comprehensive income line items, the portion attributable to the parent before the
subsidiary was acquired.
 DISCLOSURE REQUIREMENTS
The following information must be disclosed for each business combination that occurs during the
reporting period (IFRS 3.B64):

General information:
• The name and a description of the acquiree.
• The acquisition date.
• The percentage of voting equity interests acquired.
• The primary reasons for the business combination and a description of how the acquirer
obtained control of the acquiree.

Information about assets acquired and liabilities assumed:

• The amounts recognised at acquisition date for each major class of assets acquired and
liabilities assumed.
• A qualitative description of the factors that contributed to the recognition of goodwill, for
example, synergies expected from combining operations of the acquiree and the acquirer,
intangible assets that do not qualify for separate recognition or other factors.
• The total amount of goodwill that is expected to be deductible for tax purposes. In South
Africa, this will always be Rnil and, therefore, it would not be necessary to disclose this point.
• If there is a bargain purchase, the amount of the gain recognised and the line item in the
statement of profit or loss and other comprehensive income in which the gain is recognised
and a description of the reasons why the transaction resulted in a gain.
• Details of receivables acquired, including the fair value, the gross contractual amounts
receivable, and the best estimate of the uncollectible amounts. Each major class of
receivables, such as loans, direct finance leases and any other class of receivables, must be
disclosed.
• Disclosure of all contingent liabilities in terms of IAS 37 Provisions Contingent Liabilities and
Contingent Assets. If a contingent liability is not recognised because it could not be reliably
measured, the reasons why it could not be measured must be disclosed.

Information about the consideration transferred and transactions recognised separately

from the business combination:
• The acquisition-date fair value of the consideration transferred and the fair value at the
acquisition date of each major class of consideration, i.e. cash, tangible or intangible assets
transferred, liabilities incurred, for example, a contingent consideration liability, and equity
interests of the acquirer, etc.
• Details of contingent consideration arrangements and indemnification assets, including
amounts, descriptions and estimated outcomes.
• Disclosure of any transactions that are recognised separately from the business combination,
for example, acquisition-related costs expensed, including the amount, a description, how
they were accounted for and the line item in the financial statements in which each amount is
recognised. Disclosure of any amount of issue costs not recognised as an expense and how
they were recognised, shall also be made.
• Full details of the business combination achieved in stages (see chapter 13 for more detail),
including the acquisition-date fair value of the previously held interest and the resulting gain or
loss arising from the aforementioned remeasurement disclosing the line item in the statement
of profit or loss and other comprehensive income which contains the gain or loss.

Information about the non-controlling interests:

• If the acquirer holds less than 100% of the equity interest, the amount of the non-controlling
interests in the acquiree recognised at the acquisition date, the measurement basis, and if the
non-controlling interests were measured at fair value, the valuation techniques and key model
inputs used to determine the fair
Information about items in profit or loss:
The amounts of revenue and profit or loss of the acquiree since the acquisition date included in
the consolidated statement of profit or loss and other comprehensive income for the reporting
period, and the revenue and profit or loss of the combined entity for the current reporting period
as though the acquisition date for all business combinations acquired during the year had been
the beginning of the year.

In addition to the disclosure requirements above, IAS 7 Statement of Cash Flows requires the
presentation of the aggregate cash flows arising from obtaining control of subsidiaries or other
businesses (presented separately and classified as investing activities in the consolidated
statement of cash flows). The following items regarding the acquisition of a subsidiary during the
year must be disclosed (IAS 7.39–42):
• The total consideration paid or received.
• The portion of the consideration consisting of cash and cash equivalents.
• The amount of cash and cash equivalents in the subsidiaries or other businesses over which
control is obtained.
• The amount of the assets and liabilities other than cash or cash equivalents in the
subsidiaries or other businesses over which control is obtained, summarised by each major
category.

Disclosure requirements for subsidiaries (IFRS 12 Disclosure of

Interests in Other Entities)
The following are illustrative notes that are required to comply with IFRS 12 when preparing
consolidated financial statements for P Ltd Group (The notes below illustrate some of the core
aspects and are not meant to be complete in all aspects. Other formats/layout of information may
also be compliant with IFRS 12):