University of Ghana

Business School

Lecture Seven: Construction of CSoFP:

Further Complications

LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA)

 LEARNING OBJECTIVES
The objective of this study is to enable students;

• Adjust for pre and post acquisition reserves

• Perform fair value adjustments
• Understand the new requirement for pre-acquisition dividend
• Adjust intra-group Sales

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 Pre and Post Acquisition Reserves

 Reserves [of subsidiaries] that exist on the date of purchase are pre-
acquisition reserves and form part of the goodwill calculation – they do
not appear in the Consolidated Statement of Financial Position as
distributable reserves [as we have done in our earlier examples]

 Profits and losses [of subsidiaries] made after purchase [post- acquisition
reserves or (losses)] may be distributed to shareholders providing they are
realised and so they form part of the Consolidated Statement of Financial
Position’s retained earnings figure [In our examples, thus far, we have not
dealt with any post acquisition reserve]

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 Statement of Financial Statements as at 1st January, 2015

Yaw plc Kofi Ltd

GH¢ GH¢
Non current Assets 20,000 11,000
Investment in Kofi 15,000
Net Current Assets 8,000 3,000
Total Assets 43,000 14,000

Share Capital 16,000 10,000

Retained Earnings 27,000 4,000
Total 43,000 14,000
Statement of Financial Statements as at 31 st December, 2015

Yaw plc Kofi Ltd

GH¢ GH¢
Non current Assets 26,000 12,000
Investment in Kofi 12,000
Net Current Assets 13,000 4,000
Total Assets 51,000 16,000

Share Capital 16,000 10,000

Retained Earnings 35,000 6,000
Total 51,000 16,000
 STEP 1: 5 Basic Workings

• 1. Group Structure
• Yaw Plc owns 80% of Kofi Ltd’s share capital, which gives Yaw plc control over
Kofi Ltd.
• There is, thus, parent-subsidiary relationship between Yaw Plc and Kofi Ltd.
• Yaw Plc as a parent of Kofi Ltd is required to prepare Consolidated Statement
of Financial Position
 2. Net Assets of Subsidiary

  At acquisition Balance sheet date Post acquisition

 
Share capital 10,000 10,000  
Retained Earnings 4,000 6,000  2000
Total Equity 14,000 16,000 2000
 3. Goodwill
1. Proportionate Method

Goodwill
GH¢
Investment 12,000
Less Share Capital 80% x10000 8,000
Less Retained Earnings 80% 4000 3,200
Goodwill 800
 3. Goodwill-Alternative method
2. Full Goodwill Method (NCI at fair Value)

• Goodwill attributable to NCI must be calculated and added the parent’s

goodwill and; included in NCI at the year end (SoFS/Balance sheet date
[working 4 computation for NCI]
• If 80% of Kofi Ltd is worth GH¢12,000 then 100% of Kofi Ltd should be
worth GH¢12,000/80% which equals GH¢15,000.

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 3. Goodwill-Alternative method
Goodwill attributed to NCI: GH¢
Fair value of non-controlling interest at acquisition [20%*GH¢15,000] 3,000
NCI in net assets at acquisition [20%*GH¢14,000] (2,800)
NCI share of Goodwill 200

Now Full Goodwill:

Parent [Yaw Plc]’s Goodwill 800

Add NCI’s goodwill 200

Goodwill to consolidated statement of financial position 1,000

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 4. Non-Controlling Interest

• Under partial goodwill method

Non-Controlling Interest: 20%* GH¢16,000 = GH¢3,200

OR [further details]
GH¢
Share Capital ( 20% x 10000) 2,000
Retained Earnings (20% x 6000) 1,200
Total 3,200
 4. Non-Controlling Interest: Alternative Method

• Under Full goodwill method

Non-Controlling Interest: 20%* GH¢16,000 + NCI goodwill = GH¢3,200 + 200
OR [further details]
GH¢
NCI own 20% Share Capital (20% x 10000) 2,000
NCI own 20% Earnings (20% x 6000) 1,200
Sub-Total 3,200
Add NCI’s goodwill 200
Grand Total 3,400
 5. Group Retained Earnings

GHc
Parent Retained Earnings 35,000
Group Share of Kofi’s Post-Acquisition Retained Earnings
80%* [GH¢6,000 - GH¢4,000] 1,600
36,600
 Step 2: New Consolidated Statement of
Financial Position: Assets and Liabilities
Partial Full
GH¢ GH¢
Non current assets (26000+12000) 38,000 38,000
Goodwill as previously 800 1,000
Net Current Assets 13+4 17,000 17,000

Total 55,800 56,000

NB Goodwill Does Not Change – the calculation uses the share capital and retained
earnings at the date of purchase – in questions this information will be provided as
additional information
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 Step 3: New Consolidated Statement of Financial
Position – Equity and Retained Earnings
Partial Full
GH¢ GH¢
Share Capital – parent only 16,000 16,000
Retained earnings [W5] 36,600 36,600
NCI [W4] 3,200 3,400

Total To Balance 55,800 56,000

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Pre Consolidation Adjustments – some complications
 Fair Value Adjustments- Book value of subsidiary assets not at fair value on
date of acquisition
 Pre-acquisition dividend*** [no need to adjust it on cost of investment now
due to amendment to IAS 27]
 Intra-Group transfer of fixed assets
 Intra-Group Trading – elimination of profits
 Current Accounts with group members
 Dividend Payments
 Fair Value and Book Value
 In order to calculate goodwill accurately the assets of the subsidiary
company must be valued at their fair value
 i.e. the amount for which assets would be exchanged between
knowledgeable and willing parties in an arm’s length transaction

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 How to calculate fair values
 Tangible assets
• Fair Value based on market value
• Depreciated replacement cost if no market value available

 Intangible assets
• Fair Value based on market value
• Best arm’s-length estimate if no market value

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 How to calculate fair values
 Inventories
 Finished goods
• Selling price less cost of sale and reasonable profit
 Work-in-progress
• Selling price less cost to complete, cost of sale and reasonable profit
 Raw materials
• Current replacement cost

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 How to calculate fair values
 Monetary assets and liabilities [Examples are loans, interest payables, trade
payables, receivables, cash at bank]
• Amount to be received or disbursed
• Discounted if significant [time value]

 Marketable securities
• Current market values

 Non-marketable securities
• Estimated value based on performance
04/02/2023 20 DR C. AGYENIM-BOATENG
 Intra-group Transfers

A parent company and its subsidiaries often engage in a variety of transactions

among themselves.
For example, manufacturing companies often have subsidiaries that develop
raw materials or produce components to be included in the products of
affiliated companies.
 All aspects of intra-group transfers must be eliminated in preparing
consolidated financial statements so that the statements appear as if they were
those of a single company.
 Once the conditions for consolidation are met, group members become part of
a single economic entity and all transactions with related companies become
internal transfers that must be eliminated fully, regardless of the level of
ownership
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held.
 Intra-group transfer
 IAS 27 requires intra-group balances from trading, sales of assets and
dividend payments to be eliminated in full.
In particular, profits made between members of the group are not realised
and cannot form part of the Consolidated Income Statement [CIS]
 If Parent and group members accounting is up to date, then if one company
buys goods from another the same economic transaction will appear in both
accounts. In one as a sale – the other as a purchase
If Parent and group members accounting is up to date, then if one company
acquires non-current assets from another the same economic transaction will
appear in both accounts. In one as a disposal – the other as an acquisition
 Intra-group transfer

If Parent and group members accounting is up to date, then if one company
buys on credit or takes loan from the other the same economic transaction
will appear in both companies’ accounts.
In one as a receivable – the other as a payable/loan – Remember financial
assets and financial liabilities: Loans and Receivable!

 In practice there may be timing differences. In this case, update and cancel
out
Intra-group transfer –Intra-group Sales at no profit
• Selling company records the sale and reduces inventory
• Purchasing company records the purchase and increases inventory
Group impact:
• Inventory moves from one company to another, but remains in the group, so
there is no overall change.
Eliminate the transaction!
The journal to correct this would be:
Dr Group sales GH¢15 each Reducing sales
Cr Group purchases GH¢15 each Reducing cost of sales

Remember the transfer of a chair from one classroom to the other in the same
 Intra-group transfer –Intra-group Sales at profit
The first impression!

 Profit or loss from selling an item to a related party [group member] is

normally considered realized at the time of the sale from the selling
company’s perspective.

Upon reflection and remembering the single entity idea [your eureka!!!]

 The profit is not considered realized for consolidation purposes until resold
to an unrelated party.
 Intra-group transfer –Intra-group Sales at profit

The jigsaw! The why! Any better explanation/illustration?

 Firstly, the selling company has recognised profit on goods that it has sold, but
they still remain in the group.
This profit is unrealised from a group point of view and so must not be
recognised. [Come on! You can’t trade among yourself, it can never be an
arms’-length, it may be about inflating sales, tax driven – suspicion galore!
 Secondly, the inventory held by the purchasing company is being held at the
price that it paid, which from a group point of view effectively includes an
element of profit.
 Intra-group transfer –Intra-group Sales at profit
The jigsaw! The why! Any better explanation/illustration?
Illustration:
 A parent company purchases goods for GH¢10. This is the cost to the group as the
goods enter.
 The parent company then sells the goods to a subsidiary company for GH¢15 which
becomes the cost to the subsidiary.
 The subsidiary company sells the goods outside the group for GH¢20, which is the
selling price to the group as the goods have left.
 The goods cost GH¢10 as they enter the group and are sold for GH¢20 when they
leave it. These are the only two transactions that affect the group position.

 The middle transaction!!!! Does not affect the group and therefore, should be
eliminated for consolidation purposes
 Intra-group transfer –Intra-group Sales at profit
The jigsaw! The why! Any better explanation/illustration?

•Now let us consider what happens in the middle further and in detail.
Goods are sold for GH¢15 and purchased for GH¢15.
This records a second sale and a second purchase of the same goods, so this transaction must be cancelled from the group point
of view, leaving only one purchase (GH¢10) and one sale (GH¢20) to be recorded.
The journal to correct this would be:
DrGroup sales GH¢15 each Reducing sales
Cr Group purchases GH¢15 each Reducing cost of sales

If the goods transferred between group companies are all sold by the end of the year then no further adjustment is required. The
above adjustments are enough!
Intra-group transfer –Intra-group Sales at profit and
unrealised profit on the unsold inventory- cont
The jigsaw! The why! Any better explanation/illustration?

Now let’s consider what happens if some of the goods transferred remain in the purchasing company
at the end of the year.

The sale and purchase in the middle of the transaction at GH¢15 will be cancelled as above.

However, the goods that have not left the group (if for eg. half of the goods transferred between
the two group companies remains in the purchasing company) cause a problem within profit and
closing inventory.
 Intra-group transfer –Intra-group Sales at profit
and unrealised profit on the unsold inventory - cont
The jigsaw! The why! Any better explanation/illustration?

 Firstly, profit is overstated as the profit recorded by the parent company of GH¢5 per
unit (GH¢15 selling price - GH¢10 cost) on each of the remaining goods is unrealised
and cannot be included in group figures.

 Secondly, the goods recorded in the closing inventory of the subsidiary company B are
held at the GH¢15 they paid for them and not the original cost to the group of GH¢10.
They are in effect being held at a selling price which breaks basic inventory rules – held
at the lower of cost and net realisable value.
 Intra-group transfer –Intra-group Sales at profit and
unrealised profit on the unsold inventory [cont]

The jigsaw! The why! Any better explanation/illustration?

The journal to correct this would be:

Dr Group closing inventory in cost of sales
GH¢5 for each item remaining

Cr Group closing inventory in current assets

GH¢5 for each item remaining

Be mindful of the mark-up and margin principles! [draw on prior knowledge]

 Intra-group transfer –Intra-group Sales at profit and
unrealised profit on the unsold inventory [cont]
The jigsaw! The why! Any better explanation/illustration?

 This adjustment is often referred to as provision for unrealised profit (PUP). The Dr
to cost of sales will also have a reducing effect on group retained earnings.

 Where the sale/transfer was made by the subsidiary to parent, the Non-Controlling
Interest share in the provision for unrealised profit must be considered.
 Only the group share of the PUP will have a reducing effect on the group retained
earnings.
 Unrealized Profit Elimination [cont]
• When a sale is from a parent to a subsidiary, namely, a downstream sale,
any gain or loss on the transfer accrues to the shareholders of the parent
company.

• When a sale is from a subsidiary to its parent, namely, an upstream sale,

any gain or loss accrues to the shareholders of the subsidiary.

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 Unrealized Profit Elimination

 If the subsidiary is wholly owned, all the gain or loss ultimately accrues to
the parent company as the sole stockholder.

 If, however, the selling subsidiary is not wholly owned, the gain or loss on
the upstream sale is apportioned between the parent company and the
noncontrolling shareholders.

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 Unrealized Profit Elimination
 If the sale is a downstream transfer, all the unrealized profit is eliminated
from the controlling interest’s share of income when consolidated
statements are prepared.

 If, instead, the intra-group transfer is from subsidiary to parent, the

unrealized profit on the upstream sale is eliminated proportionately from
the interests of the controlling and non-controlling shareholders.

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 Profits on Intra-group sale

 Turnover is defined as sales to third parties, intra-group sales must be

eliminated for consolidation
(i) CIS - Profit on intra-group sales is unrealised and such profits may not be
recognised in the Consolidated Income Statement.
(ii) CSoFP Inventory must be at cost to the group

Profit is only recognised when goods are sold outside the group.
 Example – Impact on CSoFP Only
• During the full year Paul sold goods to Simon for a total of GH¢3000 which
represented cost + 25%
• At year end half of these goods were still in Simon’s stock
• Eliminate the unrealised profit by reducing the CSoFP inventory values
(credit) and the Consolidated profits (debit)
 CSoFP Elimination
Selling price is GH¢3000
Made up of cost + 25%
Thus profit is 3000 x 25/125 = 600 [margin and mark-up principles in
application here!]
Half of the goods are still in stock at year end – so half the profit has
not been realised
600 x ½ to be eliminated = 300
Reduce inventory and profit for CSoFP by 300
 End of lecture seven (7)
Thank you very much

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