Example: How to Consolidate

What’s the situation?

Here’s the question:

Mommy Corp has owned 80% shares of Baby Ltd since Baby’s incorporation.

Below there are statements of financial positions of both Mommy and Baby at 31 December
20X4.
Prepare consolidated statement of financial position of Mommy Group as at 31 December 20X4.
Measure NCI at its proportionate share of Baby’s net assets.

Please note here that in the above statements of financial position, all assets are with “+” and all
liabilities are with “-“. I use it this way because for me it’s easier to verify and identify mistakes,
but it’s up to you.

 
3 Steps in Consolidation Procedures
I have described the consolidation procedures and their 3-step process in my previous article
with the summary of IFRS 10 Consolidated financial statements, but let me repeat it here and
follow these steps:

1. Combine like items of assets, liabilities, equity, income, expenses and cash flows of the
parent with those of its subsidiaries;
2. Offset (eliminate):
o the carrying amount of the parent’s investment in each subsidiary; and
o the parent’s portion of equity of each subsidiary;
3. Eliminate in full intragroup  assets and liabilities, equity, income, expenses and cash
flows relating to transactions between entities of the group.

Step 1: Combine
After you make sure that all subsidiary’s assets and liabilities are stated at fair values and all the
other conditions are met, you can combine, or add up like items.

It’s very easy when a parent (Mommy) and a subsidiary (Baby) use the same format of the
statement of financial position – you just add Mommy’s PPE and Baby’s PPE, Mommy’s cash
and Baby’s cash balance, etc.

 
In reality, companies use their own format for presenting their financial position and therefore it
can be difficult to combine. That’s exactly WHY so many groups use their “consolidation
packages” and subsidiaries’ accountants must fill them up along with preparing own financial
statements.
Therefore, when a group controller calls you every five minutes to remind you the consolidation
package, you’ll know why!

In our case study, combined numbers looks as follows:

Of course, there are some strange and redundant numbers, for example both Mommy’s and
Baby’s share capital, but we haven’t finished yet!

Step 2: Eliminate
After combining like items, we need to offset (eliminate):

 the carrying amount of the parent’s investment in each subsidiary; and

 the parent’s portion of equity of each subsidiary;
and of course, recognize any non-controlling interest and goodwill.

So let’s proceed. The first two items are easy – just remove Mommy’s investment into Baby (CU
– 70 000), and remove Baby’s share capital in full (CU + 80 000).

As there is some non-controlling interest of 20% (please see below), you need to remove its

share in Baby’s post-acquisition retained earnings of CU 9 000 (20%*CU 45 000).

Wait a second – how do we know that all Baby’s reserves (retained earnings) of CU 45 000 are
post-acquisition?

Well, the question says that Mommy has owned Baby’s shares since its incorporation, therefore
full Baby’s retained earnings are post-acquisition.

Be careful here, because you absolutely need to differentiate pre-acquisition retained earnings
from post-acquisition retained earnings, but here, we’re not going to complicate the things.

Then we need to recognize any non-controlling interest and goodwill.

Non-controlling interest at 31 December 20X4

Mommy has owned 80% of Baby’s share and therefore, non-controlling interest
owns remaining 20% of Baby’s net assets.

The question asks to measure non-controlling interest at proportionate share on Baby’s net
assets, so here’s how it looks like at the end of the reporting period:

Baby’s net assets are CU 125 000 as at 31 December 20X4, including Baby’s share capital of
CU 80 000 and Baby’s post-acquisition reserves of CU 45 000.

Non-controlling interest at 31 December 20X4 is 20% of Baby’s net assets of CU 125 000,
which is CU 25 000. Recognize it with minus, as we are crediting equity with non-controlling
interest.

Initial recognition of goodwill

There might be some goodwill arisen on initial recognition. If you’d like to learn more about
goodwill, please refer to the article about IFRS 3 Business Combinations.

Let’s calculate it. Please don’t forget that we calculate goodwill based on numbers on
acquisition, not on 31 December 20X4.

The goodwill is calculated as:

 Fair value of consideration transferred: in this case, we simply take Mommy’s

investment in Baby of CU 70 000;
 Add any non-controlling interest at acquisition: here, we’re not adding the non-
controlling interest calculated above, as it’s the measurement on 31 December 20X4. At
 acquisition, the value of non-controlling interest is 20% of Baby’s net assets on its
incorporation of CU 80 000 (share capital only). It equals CU 16 000.
 When a business combination was achieved in stages, you would need to add the
acquisition-date fair value of the acquirer’s previously-held equity interest in the
acquiree, but in this example, it’s not applicable,
 Deduct Baby’s net assets at acquisition: CU – 80 000.

Goodwill acquired in a business combination comes to CU 6 000 (70 000 + 16 000 – 80 000).

The elimination entry looks as follows (sign “+” indicates a debit entry; sign “-“ indicates a
credit entry):

Description Amount Debit Credit

-70 000 FP – Investment

Remove Mommy’s investment in Baby
in Baby

Remove Baby’s share capital in full +80 000 FP – Baby’s share capital

Remove 20% (NCI) of Baby’s post- +9 000 FP – Retained earnings

acquisition retained earnings

-25 000 FP – Non-

Recognize non-controlling interest on 31
controlling
December 20X4
interest

Recognize goodwill acquired in a +6 000 FP – Intangible assets

business combination (goodwill)

Check 0

I have transferred this journal entry into our consolidation worksheet and it looks as follows:
 

Eliminate Intragroup Transactions

Parents and subsidiaries trade with each other very often.

However, when you look at both parent and subsidiary as at 1 company, which is the purpose of
consolidation, then you find out that there’s no transaction at all.

In other words, group has not performed any transaction from the view of some external user.

Therefore you need to eliminate all transactions happening within the group, between a parent
and its subsidiaries.

Looking to above individual statements of financial position of Mommy and Baby you see
that Mommy has a receivable to Baby of CU 8 000 and Baby has a payable to Mommy of CU 8
000. Perhaps these 2 items relate to the same transaction between them and we need to eliminate
them, by debiting payables and crediting receivables:
Final steps
After we have completed all steps or consolidation procedures, we can add up all the combined
numbers with our adjustments and thus we arrive at consolidated statement of financial position.

You can revise all the steps and formulas in Excel file that you can download at the end of this
article.

Here’s how it looks like:

Please note the following facts:

 Consolidated numbers are simply sum of Mommy’s balance, Baby’s balance and all
adjustments or entries (Steps 1-3).
 Mommy’s investment in Baby’s shares is 0 as we eliminated it in the step 2. The same
applies for Baby’s share capital and consolidated statement of financial position shows
only a share capital of Mommy (parent).
 There’s a goodwill of CU 6 000 and non-controlling interest of CU 25 000, as we have
calculated above.
 Consolidated retained earnings are CU 98 000 and they consist of:
o Mommy’s retained earnings of CU 62 000 in full, and
o Mommy’s share (80%) on Baby’s post-acquisition retained earnings of CU 45
000, that is CU 36 000

Exam-style consolidation
I know that many of you prepare for your exams and this is NOT the way how you learned
consolidation during exam preparation courses.

OK, I understand.

I prefer this way of making consolidation by far, because here, you go systematically, step by
step. You can deal with each adjustment in a separate column and as a result, your numbers will
always balance. You will never forget anything.

The “exam-style” of making consolidated financial statements is good and easy when there are
just a few issues or complications.

But when you need to deal with more complex situations, then you can forget or omit the things
very easily. Trust me, I did it too.
However, to make you happy, you can find the same case study solved “by the exam-style” in
the attached excel file that you can download in the end of this article.

Is consolidation really easy?

Sometimes.

But in most cases, there is lots of issues or circumstances that you need to take into account and
exactly their significance and amount makes it all difficult.

What issues? For example:

 Consideration transferred for acquiring the shares may involve not only cash, but also
some other forms, such as share issue, contingent consideration, transfers of assets, etc.
 Non-controlling interest can be measured at fair value instead of at proportionate share.
 There might be some unrealized profit on transactions within the group and it needs to be
eliminated.
 There might be some transfer of property, plant and equipment at profit within the
group and as a result, you need to adjust both unrealized profit and depreciation charge,
too.
 Goodwill might be either positive or negative (=gain on a bargain purchase). Moreover, it
can be impaired.
 Subsidiary’s net assets might be stated in the amounts different from their fair value, or
even not recognized at all.
 Subsidiary may show both pre-acquisition retained earnings and post-acquisition
retained earnings. You need to be extremely careful in differentiating them and dealing
with them separately.