THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SCOTLAND

FINANCIAL REPORTING

CONTENTS Page
VERTICAL GROUPS AND DISPOSALS .................................................................. 1 20.1 INTRODUCTION ............................................................................................... 1 20.2 OBJECTIVES ...................................................................................................... 1 20.3 VERTICAL GROUPS ......................................................................................... 1 20.3.1 Horizontal and vertical groups .................................................................... 1 20.3.2 Methods for consolidating vertical groups ................................................... 4 20.3.3 The direct method of consolidating .............................................................. 4 20.3.4 Internal transactions and balances within vertical groups ........................ 17 20.4 DISPOSAL OF SUBSIDIARIES ....................................................................... 21 20.4.1 Effect of disposal ........................................................................................ 21 20.4.2 Complete disposal ...................................................................................... 21 20.4.3 Partial disposal controlling interest retained.......................................... 27 20.5 FINANCIAL REPORTING STANDARDS ...................................................... 29 20.6 SUMMARY ....................................................................................................... 30

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MODULE 20

VERTICAL GROUPS AND DISPOSALS

20.1 INTRODUCTION
This module deals with two topics vertical groups and disposal of shares. In practice, group structures can be complex. In modules 16 and 17 discussion was confined to situations where the holding company itself acquired and held the shares in the subsidiary. It is quite common for a holding company to control a company, not by directly owning shares in it itself, but through another company which it also controls. This gives rise to a vertical group which requires slightly different consolidation calculations. It is common for a company to sell some or all of its shares in a subsidiary and as with the sale of any asset a gain or loss should be calculated and the accounts adjusted to reflect the sale.

notes

20.2 OBJECTIVES
After completing this module you should be able to: 1. calculate goodwill, minority interest and group shareholdings in vertical groups; 2. prepare consolidated balance sheets and income statements for vertical groups; 3. differentiate between a complete and partial disposal; 4. calculate the gain or loss on disposal arising in the holding companys own accounts and in its consolidated accounts and explain why the two figures might differ; 5. account for a complete disposal and a partial disposal (but still leaving a controlling stake) in the holding company and consolidated accounts. Completing these objectives will help you to meet learning outcomes 2 and 5 of the syllabus.

20.3 VERTICAL GROUPS 20.3.1 Horizontal and vertical groups

Horizontal Groups All of the illustrations and questions up to this point have concentrated on horizontal groups, ie where the parent holds shares in its subsidiaries directly and where there are only two levels in the group structure. The diagram below illustrates a horizontal group. H

80% S1

70% S2

75% S3

52% S4

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notes

Vertical Groups In practice group structures are often more complex than the above and a subsidiary may itself own a controlling interest in another company. In other words a third level is introduced into the group structure, ie the subsidiary of a subsidiary often referred to as a sub-subsidiary. For example, suppose H owns 80% of S and S in turn owns 55% of T. The group accounts of H should consolidate the financial statements of both S and T, as T is effectively controlled by H through its direct controlling interest in S. This can be seen from the following diagram: H 80% S 55% T MI 45% MI 20%

H controls S and S in turn controls T, hence indirectly (ie through S) H controls T. Despite the fact that H only has 80% x 55% (ie 44%) ownership in T, T is still controlled by H as H controls S and S controls T. It is control and not ownership that is relevant in deciding whether a company is a member of a group. H is referred to as the ultimate parent or ultimate holding company of T. Para 12 of IAS 27 requires all subsidiaries to be consolidated. Para 13 makes clear that this control can be direct, or indirect through subsidiaries. As in any other consolidation we need to establish the group structure. In the above example this is: S group owns MI owns T group owns (80% x 55%) MI (100% - 44%) 80% 20% 44% 56%

Alternatively the MI can be analysed as: T - Direct 45% (ie not owned by S) Indirect 11% (of the 55% owned by S, 20% belongs to the MI of S ie 20% x 55% = 11%.) Total = 45% + 11% = 56% It is easier to establish the group share and then the MI. Remember that group plus MI must equal 100%.
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Although S in the illustration above is legally required to prepare consolidated accounts for the group comprising itself and T, examination questions are more likely to require the consolidated accounts of the H group, ie H and all the companies that it controls - in this case S and T. Methods of consolidation for vertical groups are covered in 20.3.2. In practice, groups are usually larger than this and therefore more complex but the procedures for consolidation are applicable to both large and small groups. Coverage at this level does not go beyond dealing with sub-subsidiaries although sub-sub-subsidiaries would be dealt with in a similar way. Example 1 Calculate the group and MI percentage in each company in the H group. H 80% 70% S1 60% T1 60% T2 S2 S3 90% T3 60%

notes

Solution Company: S1 T1 S2 T2 S3 T3 Group Minority interest (100% - 80%) Group (80% x 60%) Minority interest (100% - 48%) Group Minority interest (100% - 70%) Group (70% x 60%) Minority interest (100% - 42%) Group Minority interest (100% - 40%) Group (60% x 90%) Minority interest (100% - 54%) % holding 80% 20% 48% 52% 70% 30% 42% 58% 60% 40% 54% 46%
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notes

The above group structure is an example of a vertical group. The parent (H) controls subsidiaries S1, S2 and S3. T1, T2, and T3 are members of the H group because H controls S1, S2 and S3. There is no requirement for H to hold shares directly in T1, T2 and T3. Because S1, S2 and S3 are not wholly owned by H there are indirect minority interests in T1, T2 and T3 via the intermediate holding companies S1, S2 and S3. H is the ultimate parent.

20.3.2 Methods for consolidating vertical groups

There are two basic methods: a) the indirect (or multi-stage) method b) the direct (or single-stage) method Under the indirect method the figures for the sub-subsidiary are consolidated with those of the subsidiary (ie its parent), giving the sub-group accounts, which are then consolidated with those of the ultimate parent giving the overall group accounts. In the illustrations above therefore, T and S would be consolidated to give the S group accounts which would then be consolidated with H to give the H group accounts. Obviously this indirect method is fairly time consuming (in example 1 four consolidations would be required) and therefore in examinations the direct method provides a speedier solution whereby the overall consolidation is achieved in a single stage. Under this method the effective group interests in the subsubsidiary are utilised to allow a single stage consolidation. Tutorial Note The direct method is the only method illustrated in the following examples.

20.3.3 The direct method of consolidating

The basic procedures for consolidation follow the same principles as for horizontal groups. The points to watch out for are: (i) calculation of goodwill on acquisition of a sub-subsidiary; (ii) impairment of goodwill; (iii) change in the minority interest in a sub-subsidiary. Always bear in mind that we are producing the H group accounts and the position, and the consolidation adjustments, must be considered from this perspective. (i) Goodwill

The critical date for determining pre-acquisition reserves is the date when control over a particular subsidiary is acquired by the ultimate parent whether directly or indirectly.

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Example 2 Cameron acquired 70% of Delaney on 30 June 2000 when Delaneys reserves were 100,000. Delaney acquired 80% of Eric in September 2004 when Erics reserves were 80,000. Erics reserves were 75,000 on 30 June 2000. Cameron paid 210,000 for its holding in Delaney. Delaney paid 190,000 for its holding in Eric. The share capital of the companies is as follows: Cameron Delaney Eric 500,000 1 ordinary shares 300,000 50p ordinary shares 400,000 25p ordinary shares

notes

The minority interest at the date of acquisition is deemed to be equal to their share of the net assets of each subsidiary at the date of acquisition. Note: remember that when MI is valued at their share of net assets the only goodwill recognised is that of the controlling company.
Required: In preparing the group accounts of Cameron, calculate the goodwill arising on the acquisition of Delaney and Eric.

Solution Firstly, we should establish the group structure and appropriate percentages: C 70% D 80% E Delaney Eric Group share MI - direct Group share (70% x 80%) Minority interest 70% 30% 56% 44%

Secondly, establish when Cameron first acquired control of its subsidiaries: Delaney Eric 30.6.00 30.9.04

In the goodwill calculations the reserves at these dates should be used.

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notes

Goodwill calculations: On acquisition of Delaney by Cameron This is a straightforward acquisition of a subsidiary by a parent and the calculation is as normal. Cost MI share of net assets (30% x 250,000) Share capital (300,000 x 50p) Reserves Goodwill All of the goodwill relates to Camerons holding. On acquisition of Eric by Delaney Cost MI share of net assets (20% x 180,000) Share capital (400,000 x 25p) Reserves (at 30.9.04) Goodwill 100,000 80,000 180,000 46,000 190,000 36,000 226,000 150,000 100,000 250,000 35,000 210,000 75,000 285,000

Delaney owns the shares in Eric, therefore the 46,000 goodwill is Delaneys. The ownership of Delaney is 70% group and 30% MI. Therefore from Camerons (the ultimate holding company) perspective the minority interest in the goodwill in Eric is therefore 30%. This point becomes significant when we look at impairment of goodwill in the sub-subsidiary below as any impairment would be split 70:30 between the group and the minority. Prior acquisition Where the subsidiary (S) bought its stake in the sub-subsidiary (T) before being acquired by the holding company (H) we have a prior acquisition. In this case T is not controlled by H until H acquires S and thus any profits earned by T prior to H acquiring S are pre-acquisition from Hs point of view. For goodwill purposes, therefore, we use the reserves of T at the date S is acquired by H. This is the earliest point at which H gains control of T. Example 3 Assume in the above example that Delaney had acquired Eric in 1998 when Erics reserves were 60,000. Erics reserves at 30 June 2000 were 75,000 (ie at the date Delaney became a member of the Cameron group).
Required: In preparing the group accounts of Cameron calculate the goodwill relating to Eric.
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Solution Cameron obtained control of its subsidiaries: Delaney 30.6.00 Eric 30.6.00 Eric is a prior acquisition and did not become a member of the Cameron group until Cameron acquired Delaney on 30 June 2000. We use the reserves of Eric at 30 June 2000 in the goodwill calculation. This gives a revised figure for goodwill for Eric. Cost MI share of net assets (20% x 175,000) Share capital Reserves (at 30.6.00) Goodwill 100,000 75,000 175,000 175,000 50,000 190,000 35,000 225,000

notes

Using the reserves at 30 June 2000 is reasonable as the price Cameron paid for the shares in Delaney would be influenced by Delaneys investment in Eric at that date. The accounts of Eric had net assets of 175,000 at that time. (ii) Impairment of goodwill It is important to establish whether the MI is based on their share of net assets or at fair value at the acquisition date, as this will affect how impairment is allocated to the group and to MI.. Impairment of goodwill in subsidary x if the MI at the date of acquisition is based on their share of net assets none of the goodwill relates to the MI and all of the loss should be charged to the parent. x if the MI at the date of acquisition is based on fair value then some of the goodwill relates to the MI in the subsidiary. Any impairment loss should be split between the parent and MI in proportion to their shareholdings. Using example 2, the impairment of goodwill in Delaney would be allocated 30% to MI.

Impairment of goodwill in sub-subsidiary x if the MI at the date of acquisition is based on their share of the net assets the goodwill relates to the immediate parent (the subsidiary in a three tier group). The MI element is the MI in the subsidiary. Using example 2, the impairment of goodwill in Eric is allocated 30% to MI in Delaney, because by charging Delaney with all of the goodwill impairment we have reduced its profit after tax for the year and so the MI in Delaney will have been based on overstated profits. x if the MI at the date of acquisition is based on fair value then the MI element of the impairment is based on the total MI in the subsubsidiary ie the MI in the sub-subsidiary from the parents perspective. Using example 2, the impairment of the goodwill in Eric is allocated 44% to MI.
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notes

Using the figures from Example 2, and assuming goodwill in both Delaney and Eric is impaired by 10%, the impact could be summarised as follows: MI measurement basis Impairment in goodwill of sub-subsidiary of 4,600 Share of net assets of the 4,600 x 70% to group sub at date of acquisition 3,500 charged to the 4,600 x 30% to MI (in group Delaney see note) Fair value at the date of 3,500 x 70% to group 4,600 x 56% to group acquisition 3,500 x 30% to MI (in 4,600 x 44% to MI (the Delaney) effective holdings %) Note The goodwill arising on the acquisition of Eric is attributable entirely to Delaney because the MI is based on the share of net assets of Eric and not fair value. As a result any impairment is charged wholly to Delaney. From the overall group perspective, Delaneys profit after tax that is reported in its individual accounts is overstated because the impairment is only charged on consolidation. MI share of Delaneys profit calculated in step 5 is based on this overstated figure. The impairment in goodwill of Eric is split 70/30 to take account of the fact that Delaneys profits are reduced by 4,600 on consolidation and the MI in Delaney must be charged with its share of that. The required adjustments are similar in type to those required for any unrealised profit in stock (Module 17). If the full impairment loss is for the current year adjusted through profit or loss and then the minority interest is adjusted for their share of the impairment loss. If the impairment loss occurred in a previous year the loss is debited to retained earnings (group) and MI (B/S). Impairment in goodwill of sub of 3,500

Example 4
Kestrel Ltd (Kestrel) owns 75% of Falcon Ltd (Falcon) which owns 90% of Gos. MI at valued at its share of net assets of the subsidiary at the date of acquisition. Goodwill of 100,000 arose in the acquisition of Falcon and 80,000 on the acquisition of Gos. If minority interest is valued at fair value at date of acquisition then the goodwill in Falcon would be 120,000 and in Gos 90,000. It is estimated that 20% of each goodwill figure requires to be written-off due to impairment in the current year.
Required: Calculate the amount of the impairment loss and prepare journal entries to record this in the group accounts, assuming: (a) the goodwill was based on MI being measured at its share of net assets at the date of acquisition; and (b) the goodwill was based on MI at fair value at the date of acquisition.

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Solution Group structure Kestrel 75% Falcon 90% Gos Group (75% x 90%) 67.5% MI 32.5% (direct = 10%; indirect = 25% x 90% = 22.5%) MI = 25%

notes

(a) MI based on share of net assets Falcon Impairment (20% x 100,000) 20,000 All attributable to the parent (Kestrel). Top left quadrant of table. Dr P/L impairment loss Cr Goodwill being impairment loss on goodwill Gos Impairment (20% x 80,000) Attributable to MI in Falcon (25%) Top right quadrant of table. Dr P/L impairment loss Cr Goodwill being impairment loss in goodwill Dr 16,000 16,000 20,000 20,000

16,000 4,000

MI (B/S) 4,000 Cr MI (P/L) 4,000 being MI share of impairment loss that reduces Falcons profit (b) MI based on fair value. In this case some of the goodwill in both Falcon & Gos relates to the MI and so MI is based on the effective percentage holding. Falcon Impairment (20% x 120,000) Attributable to MI in Falcon (25%) Bottom left quadrant of table. Dr P/L impairment loss Cr Goodwill being impairment loss on goodwill Dr MI (B/S) Cr MI (P/L) being MI share of impairment loss 24,000 24,000 6,000 6,000
9

24,000 6,000

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Gos Impairment (20% x 90,000) Attributable to MI in Gos (32.5% x 18,000) Bottom right quadrant of table. Dr P/L impairment loss Cr Goodwill being impairment loss on goodwill Dr 18,000

18,000 5,850

18,000

MI (B/S) 5,850 Cr MI (P/L) 5,850 being MI share of impairment loss that has reduced Falcons profit (iii) Minority interest in sub-subsidiary (STEP 4 and 5) In calculating MI amounts we must remember to use the total MI in the subsubsidiary. In the Cameron example we would use 44% MI for Eric. The form of the journal entries is as normal. Example 5 This follows from Example 2. The reserves of Delaney and Eric were: At 31/12/09 250,000 150,000 Acquisition 100,000 80,000

Delaney Eric

Required: Prepare step 4 journal entries to account for the change in minority interest from the date of acquisition to 31 December 2009, assuming Delaney acquired Eric in September 2004 (per example 2). Solution

Step 4 Change in MI from the date of acquisition Delaney Dr Reserves 45,000 Cr Minority interest (B/S) being increase in MI to 31.12.09 (30% x [250,000 100,000]) Eric Dr Reserves 30,800 Cr Minority interest (B/S) being increase in MI to 31.12.09 (44% x [150,000 80,000])

45,000

30,800

Note: Share of profit for the year in STEP 5 is also calculated based on effective percentage holdings.

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Example 6 Saturn, Mercury and Venus The following information is given for Saturn Ltd (Saturn) and its subsidiaries as at 30 November 2010. Saturn Ltd Mercury Ltd Venus Ltd Investment in subsidiary Other net assets Ordinary shares General reserves Retained earnings 91,000 149,000 240,000 200,000 30,000 _10,000 240,000 50,000 _80,000 130,000 100,000 18,000 _12,000 130,000 62,000 62,000 50,000 4,000 _8,000 62,000

notes

1. Saturn acquired 75% of Mercury Ltd (Mercury) in December 1997 at a cost of 91,000. At that date Mercury had 6,000 credit on general reserves and 4,000 credit on retained earnings. 2. Mercury acquired 80% of Venus Ltd (Venus) at a cost of 50,000 in December 1999 when Venus had a general reserve of 2,000 and a balance of 5,000 on retained earnings. The general reserve and retained earnings of Venus in December 1997 were 1,000 and 3,000 respectively. 3. In December 1997 the fair value of the minority interest in Mercury was estimated to be 28,000. The fair value of the minority interest in Venus in December 1999 was estimated to be 25,000. Saturn uses the fair value of the minority interest when calculating goodwill. 4. The goodwill of both Mercury and Venus was impaired by 50% in 2005. 5. The profit of Mercury and Venus for the year to 30 November 2010 was 3,000 and 1,000 respectively. The general reserves did not change in 2010.
Required: Prepare consolidation journal entries and the consolidated balance sheet of Saturn Ltd as at 30 November 2010.

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notes

Solution (1) Group structure Saturn 1997 - 75% General reserve 6,000 Retained earnings 4,000 Mercury 1999 - 80% General reserve 2,000 Retained earnings 5,000 Venus (2) Group and minority interest percentages Mercury Venus (3) Goodwill This is an example of a subsequent acquisition ie Venus (the sub-subsidiary) became a member of the group when acquired by Mercury in 1999. Mercury (the subsidiary) became a member of the group in 1997. Mercury joined the group in 1997 and Venus in 1999. Group MI (100% - 75%) Group (75% x 80%) MI 75% 25% 60% 40%

Acquisition of Mercury Cost FV of minority interest Less: Share capital General reserves Retained earnings Goodwill 100,000 6,000 4,000

91,000 28,000 119,000

110,000 9,000

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Acquisition of Venus Cost FV of minority interest Less: Share capital General reserves Retained earnings Goodwill (4) Change in minority interest to 30.11.09 Mercury (25%) General reserve 6,000 to 18,000 3,000 2,000 to 4,000 Retained earnings 4,000 to (12,000 3,000) 5,000 to (8,000 1,000) Consolidation journals: STEP 1 aggregate balances. See next page 1,250 4,250 50,000 2,000 5,000

50,000 25,000 75,000

notes

57,000 18,000 Venus (40%) 800 800 1,600

STEP 2 record goodwill and MI at date of acquisition (see working 2) 1) Dr Share capital - Mercury 100,000 General reserves - Mercury 6,000 Retained earnings - Mercury 4,000 Goodwill 9,000 Cr Investment in Mercury 91,000 MI (B/S) 28,000 being goodwill and MI arising on acquisition of Mercury

2)

Share capital - Venus General reserves - Venus Retained earnings - Venus Goodwill Cr Investment in Venus MI (B/S) being goodwill and MI arising on acquisition of Venus

Dr

50,000 2,000 5,000 18,000

50,000 25,000

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notes

STEP 3 record any impairment goodwill MI at the date of acquisition was measured at fair value for both acquisitions. MI shares in the goodwill and in any impairment of that goodwill. As the goodwill was written-off in 2005, entries are through retained earnings and MI(B/S). Group Goodwill of Mercury (50% x 9,000) x 75% (50% x 9,000) x 25% Goodwill of Venus (50% x 18,000) x 60% (50% x 18,000) x 40% 3) Dr Retained earnings MI (B/S) Cr Goodwill being write-off of goodwill 3,375 5,400 8,775 8,775 4,725 13,500 MI 1,125 3,600 4,725

Note: separate journals could have been used for each company. STEP 4 change in MI to 30.11.09 (see working 4) 4) General reserves - Mercury 3,000 Retained earnings - Mercury 1,250 Cr Minority interest (B/S) being change in minority interest in Mercury to 30.11.09 Dr General reserves - Venus Retained earnings - Venus Cr Minority interest (B/S) being change in minority interest in Venus to 30.11.09 Dr 800 800 4,250 1,600

5)

STEP 5 MI in profit for the year Mercury Venue 25% x 3,000 - 40% x 1,000 750 400 1,150

6)

Dr MI (P/L) Cr MI (B/S) being MI in profit for the year

1,150 1,150

Note: separate journals could have been used

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FINAL STEP 7) Dr Retained earnings 1,150 Cr Income statement being transfer of adjustments to retained earnings Note: JE6 is the only adjustment to affect the profit for the year.

notes

1,150

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Saturn Net assets Investment in subsidiaries 149,000 91,000

Mercury 80,000 50,000

Venus 62,000 -

DR 1 2 1 2 1 2 1 2 3 4 1 2 3 4 5 7 3 9,000 18,000 100,000 50,000 6,000 2,000 3,000 800 4,000 5,000 8,775 1,250 800 1,150 4,725 3

CR 91,000 50,000 13,500

Group Balances 291,000 -

Goodwill

_______ 240,000 200,000 30,000

______ 130,000 100,000 18,000

______ 62,000 50,000 4,000

13,500 ______ 304,500 200,000 40,200

Ordinary shares General reserves

Retained earnings

10,000

12,000

8,000

9,025

Minority interest -

1 2 4 5 6

28,000 25,000 4,250 1,600 1,150 214,500

55,275

240,000

130,000

62,000

214,500

304,500

Note: as only a balance sheet was required no postings affecting profit or loss are necessary.
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Saturn Ltd Consolidated Balance Sheet As at 30 November 2010 Other assets Goodwill Total assets Equity Ordinary shares General reserves Retained earnings Group shareholders funds Minority interest Total equity 291,000 13,500 304,500 200,000 40,200 9,025 249,225 _55,275 304,500

notes

You should now be able to complete the first two learning outcomes of the module.

20.3.4 Internal transactions and balances within vertical groups

Transactions occurring between the subsidiary and the sub-subsidiary will be eliminated on consolidation. If the profit of the subsidiary is affected by this elimination then this adjustment will also affect the MI as it is entitled to its share of that profit. The most common internal adjustments between subsidiary and sub-subsidiary are: x Unrealised profit on stock x Internal dividends In principle the normal adjustments apply ie. x eliminate the internal item x eliminate any unrealised profit x adjust MI for its share of the unrealised profit Minority interest in unrealised profit When a sub-subsidiary sells goods to another group companythe sale and any unrealised profit element on unsold stock is treated as usual. The MI will be adjusted for their share of the reduction in the profit of the sub-subsidiary. This adjustment must be based on the total MI% in the sub-subsidiary ie Hs share of T. Dividends paid by a subsidiary Dividends are paid to shareholders. Therefore when the sub-subsidiary (T) pays a dividend its immediate parent (S) will receive its share based on its percentage ownership of T. H will not receive any of this dividend as it does not own directly any shares in T. The journal to eliminate will be : Dr Investment income (in Ss P/L) MI (B/S) Cr Retained earnings being elimination of dividend paid by T X X X

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notes

We have now reduced Ss profit and the MI in Ss profit must now be reduced by: Dr MI (B/S) X Cr MI (P/L) X being adjustment to MI in S arising from elimination of internal dividend. The first journal is the same as that prepared in module 17. The second journal is an additional journal because of the vertical group structure, because the subsidiarys profit for the year has been adjusted. Example 7 Sprint owns 90% of Run which owns 70% of Jog. The income statements of the three companies for the year to 31 December 2010 are as follows. Sprint 000 Revenue Cost of sales Gross profit Operating expenses Investment income Profit before tax Taxation Profit for the period Additional information: 1. 2. During the year to 31 December 2010 Jog paid a dividend of 1m and Run a dividend of 2m. Jog sold goods to Sprint for 600,000 in October 2010. Sprint had one-quarter of these goods in stock at the year-end. Jog also sold goods to Run for 400,000. Run had half of these goods in stock at the year-end. Jog made a gross margin of 30% on both sales. 25,000 (16,000) 9,000 (2,000) 1,800 8,800 (2,100) 6,700 Run 000 20,000 (15,000) 5,000 (1,500) 700 4,200 (1,400) 2,800 Jog 000 18,000 (9,000) 9,000 (6,000) 3,000 (900) 2,100

Required: Complete Steps 5 & 6 of the consolidation process for the Sprint Group.

Solution Group structure and shareholdings Sprint Group MI Run Group (90% x 70%) MI (100% - 63%) Jog 63% 37% 90% 10%

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STEP 5 Run (2.8m x 10%) Jog (2.1m x 37%) JE1 MI (P/L) Cr MI (B/S) being minority interest in profits of Run Dr Dr 000 000 280 777 280 280 777 777

notes

JE 2

MI (P/L) Cr MI (B/S) being minority interest in profits of Jog Note: these could have been combined into one JE. STEP 6 Analysis of dividends paid Paid by Run (90 : 10) Paid by Jog (70 : 30) Internal 1,800 700

MI 200 300

Note: Run owns 70% of the shares in Jog and therefore receives 70% of the dividend. None of it goes to Sprint as Sprint owns no shares in Jog. JE 3 000 Investment income (Sprints) 1,800 MI (B/S) 200 Cr Retained earnings being elimination of dividend paid by Run to Sprint Dr Investment income (Runs) MI (B/S) Cr Retained earnings being elimination of dividend paid by Jog to Run Dr 700 300 1,000 000 2,000

JE 4

Note: these could have been combined into one JE. As JE4 has reduced the profits of Run by 700,000 the MI in the profit of Run that was calculated in STEP 5 above has to be adjusted downwards by 10% x 700,000 = 70,000. JE5 MI (B/S) Cr MI (P/L) being adjustment to MI in profit by Run Dr 70 70

There is no need for a similar adjustment regarding the dividend eliminated from the income statement of Sprint as Sprint is the holding company. There is no MI in the parent, Sprint.

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notes

Internal sales Sales to Sprint Total sales Profit element (30%) Unrealised () Sales to Run Total sales Profit element (30%) Unrealised () JE6 Revenue 1,000 Cr Cost of sales being elimination of internal sales (600,000 + 400,000) Dr Cost of sales 105 Cr Stock (B/S) being elimination of unrealised profit (45,000 + 60,000) Dr 39 39 Dr 600 180 45 400 120 60 1,000

JE7

105

JE8

MI (B/S) Cr MI (P/L) being adjustment to MI in profits of Jog (37% x 105K).

The last journal is required as the profits of Jog have been reduced by a total of 105,000. As an alternative to requiring JE5 and JE8, adjustments could have been made to the profits of Run and Jog before calculating the share of profits in (i) above. This would give: Run Profits per accounts Less: internal dividend : unrealised profit MI (10% and 37%) Equivalent to These net amounts would then be journalised as: JE1 Dr MI (P/L) Cr MI (B/S) being minority interest in profits of Run JE 2 Dr MI (P/L) Cr MI (B/S) being minority interest in profits of Jog 2,800 (700) 2,100 210 JE1 + JE5 Jog 2,100 (105) 1,995 738 JE2 + JE8 210 210 738 738

Journals 3 ,4, 6 and 7 would still be required as before.

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20.4 DISPOSAL OF SUBSIDIARIES

So far we have considered only the acquisition of subsidiaries. We will now study what happens when a group disposes of shares in a subsidiary.

notes

20.4.1 Effect of disposal

A parent may dispose of all (complete disposal) or part (partial disposal) of its holding in a subsidiary. A partial disposal has four possible outcomes: The parent: x x x x retains a controlling interest (! 50%) retains an interest as a venturer in a joint venture retains an interest which gives significant influence (normally 20%- 50%) retains a smaller interest which gives neither control nor significant influence (normally  20%).

In the latter three cases there will be a change of status of the investment as far as both the parent and the group are concerned. The change in status will be to either a JV, an associate or a simple investment. This module will only cover complete disposal of a subsidiary and a partial disposal where a controlling interest is retained by the parent. However, the principles covered can be applied to the other situations. Both complete and partial disposals affect the parents individual accounts and the consolidated accounts. The objective, however, is the same as for any disposal of assets: x x calculate and record any gain or loss on disposal, and adjust the balance sheet for the effect of the disposal (the precise adjustment will depend on whether there is a complete or partial disposal).

20.4.2 Complete disposal

As far as the parents accounts are concerned, disposal of a subsidiary is exactly the same as the disposal of any other fixed asset. The difference between the proceeds of the disposal and the carrying amount of the investment gives the profit or loss on sale. However, in the consolidated accounts the investment in the subsidiary is carried on a different basis from that in the parents accounts. The group disposes of its share of the subsidiarys net assets at the date of sale plus any goodwill not written-off through impairment. The difference between the proceeds and the share of the net assets plus goodwill disposed of gives the group profit or loss on disposal. If material, the profit or loss on disposal will normally appear as a separate item on the face of the consolidated income statement. Example 8 Ellis Ltd (Ellis) acquired 100% of the ordinary share capital of Gallacher Ltd (Gallacher) for 15m several years ago with 1m goodwill arising. This investment has continued to be held at cost in the accounts of Ellis. Goodwill has not been impaired.
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notes

At the date of acquisition Gallacher had share capital of 5m and reserves of 9m ie 14m of net assets. Ellis Ltd sold its entire holding in Gallacher for 22m. The net assets of Gallacher at the date of disposal were 19m.
Required: Calculate and compare the gain or loss on disposal of the holding in Gallacher in the individual and consolidated accounts of Ellis.

Solution Elliss individual accounts Ellis would show a gain of 7m (22m - 15m) in its individual accounts. As the investment has been held at cost the gain is simply the difference between proceeds and original cost. Elliss group accounts m Proceeds Net assets disposal of (100%) Goodwill disposed of Gain/(loss) Gain in parents accounts Difference (change in net assets since acquisition) 22 (19) (1) ___ 2 7 5

The difference is due to the fact the latest accounts of the subsidiary are included in the consolidated accounts each year. Therefore when the subsidiary is sold the group is losing ownership of that amount of net assets. The group will have included gains of 5m over the period of ownership. If goodwill had been impaired the carrying amount would have been deducted in the calculation of the gain. If the company is sold the related goodwill is also disposed of. Procedures for complete disposal: With a complete disposal in the group accounts we need to: (a) consolidate the results of the subsidiary up to the date of disposal; (b) calculate the gain or loss on disposal; and (c) remove the subsidiary from the group accounts as at the date of disposal and record any gain or loss. This can be done as part of STEP 6. The journal to record the gain or loss and remove the subsidiary is: Dr Bank/proceeds Minority interest (if applicable) Cr Goodwill Net Assets (100% of these) P/L - gain on disposal (DR if a loss) X X X X X

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In a detailed balance sheet net assets should be broken down to include individual items. Note the debit entry to MI. If we dispose of a partly owned subsidiary we lose control of 100% of the net assets (and as 100% of these are consolidated, 100% must be removed). Any related MI will no longer exist. Example 9 Black Ltd (Black) and Blue Ltd (Blue) Black acquired 80,000 shares in Blue for 160,000 on 1 January 2001. Reserves of Blue at the date of acquisition totalled 86,000. On 31 December 2009 Black sold its entire holding in Blue to Bruise Ltd (Bruise) for 300,000. Summarised balance sheets at 31 December 2009 and income statements for the year ended on that date are as follows: Balance sheets Non-current assets Investment in Blue Other net assets Share capital (1 ordinary shares) Retained earnings Black Group 200,000 160,000 111,000 471,000 150,000 321,000 471,000 Blue 150,000 189,000 339,000 100,000 239,000 339,000

notes

Income statements Profit before tax Taxation Profit for the year 104,000 (45,000) 59,000 42,000 (24,000) 18,000

None of the transactions relating to the disposal of the shares in Blue Ltd have been recorded in the above accounts. Blue did not pay any dividends in the year to 31 December 2009. The Black group accounts exclude Blue. All other subsidiaries of Black Ltd are wholly owned. Goodwill of Blue was impaired by 2,240 in 2002. Blue carries out a separate line of business from other companies in the group (ie it is a discontinued operation in the year ended 31 December 2009). The minority interest at the date of acquisition was based on its share of the net assets at that date. No tax arises on the disposal of Blue.
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Required: Prepare the consolidated income statement of Black for the year to 31 December 2009 and the consolidated balance sheet of Black at that date.

Solution As Blue is not included in the Black Group accounts we firstly have to consolidate up to the date of disposal. In this case this is to the year-end. STEP 1 Add together the accounts of group companies see worksheet STEP 2 Record goodwill on acquisition of Blue. Consideration MI share of net assets (20% x 186,000) Less net assets acquired: Share capital Retained earnings Goodwill arising on acquisition (1) Share capital 100,000 Retained earnings 86,000 Goodwill 11,200 Cr Investment MI (B/S) being elimination of investment and recording of goodwill Dr Dr Dr 100,000 86,000 (186,000) 11,200 160,000 37,200 197,200

160,000 37,200

STEP 3 Record goodwill impairment (2) Retained earnings Cr Goodwill being goodwill impairment in previous years Dr 2,240 2,240

STEP 4 Change in minority interest to last balance sheet date. (3) Dr Retained earnings (20% x (239-18-86)) Cr Minority interest (B/S) being change in the minority interest to last balance sheet date Calculate minority interest for year. 3,600 3,600 27,000 27,000

STEP 5 (4) Dr

Minority interest (P/L) Cr Minority interest (B/S) being minority interest share of profit for the year (20% x 18,000)

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Above are the standard steps adopted for consolidation of a partly owned subsidiary and adjustments (1) to (4) will be posted to the consolidation worksheet. Note that the disposal takes place at 31 December 2009 and therefore Black is entitled to a full years profits of Blue (less the above MI share). STEP 6 We will now calculate any gain or loss on sale of the subsidiary. The gain in the group accounts is calculated as follows: Proceeds Less: net assets disposed of (80% x [net assets at disposal date 339,000]) 271,200 goodwill less impairment (11,200 - 2,240) Gain on disposal of subsidiary 8,960 (280,160) 19,840 300,000

notes

The net assets of Blue included in the consolidated balance sheet and the minority interest must now be eliminated from the balance sheet since Blue has been disposed of at 31 December 2009. The journal entry to record the disposal in the consolidated accounts is: (5) Dr Bank 300,000 Dr Minority interest at disposal date 67,800 Cr Goodwill 8,960 Cr Non-current assets 150,000 Cr Other net assets 189,000 Cr P/L-gain on disposal 19,840 being the disposal of Blue This in effect deconsolidates the subsidiary. The MI in the disposal calculation will be the total after completing Steps 2-5. Final step. Adjust for effect on consolidated profits. JE 4 - MI in profit for the year JE 5 - gain on disposal (6) Dr (3,600) Dr 19,840 Cr 16,240 Cr

Income statement 16,240 Cr Retained earnings 16,240 being additional consolidated profit transferred to retained earnings.

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notes

Black Profit & loss account Profit before tax 104,000 Taxation (45,000) Profit for the year 59,000 Minority interests Group share of profit

Blue

Total

Adjustments Dr (5)

Cr 19,840

Consolidation

42,000 (24,000) 18,000

146,000 (69,000) 77,000 (4) 3,600 ____ 3,600 16,240

_____ 19,840

165,840 (69,000) 96,840 (3,600) 93,240

(6) Balance Sheet Fixed assets Intangible Investment in Blue Other net assets 200,000 150,000 350,000 (1) 160,000 111,000 ______ 471,000 150,000 321,000 189,000 _______ 339,000 100,000 239,000 160,000 300,000 ______ 810,000 250,000 560,000 (5)

11,200

(5) (2) (5) (1) (5)

150,000 2,240 8,960 160,000 189,000

200,000 411,000 ______ 611,000 150,000

300,000

Share capital Retained earnings

(1) (1) (2) (3) (5)

100,000 86,000 2,240 27,000 67,800 (6) 16,240

461,000

Minority interests

(1) (3) (4)

______ 471,000

_______ 339,000

______ 810,000

______ 614,080

37,200 27,000 3,600 ________ 614,080

_______ 611,000

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Black Ltd Consolidated income statement for the year ended 31 December 2009 Continuing operations Profit before tax Taxation Profit from continuing operations Profit from discontinued operations Profit for the period Attributable to: Equity holders of the parent Non-controlling interest 104,000 (45,000) 59,000 37,840 96,840 93,240 3,600 96,840

notes

Note: profit from discontinued operations is made up of: Profit before tax of Blue Gain on disposal of Blue Tax on profits of Blue 42,000 19,840 (24,000) 37,840

As Blue carries out a separate line of business and is material in relation to the group it is appropriate to treat is as a discontinued operation. Black Ltd Consolidated balance sheet as at 31 December 2009 Net assets Equity Share capital Retained earnings Equity shareholders funds 611,000 150,000 461,000 611,000

If Blue had been Blacks only subsidiary there would be no need to prepare a consolidated income statement or consolidated balance sheet as Black had no subsidiaries at the year end. Black would, of course, have to prepare its own income statement and balance sheet.

20.4.3 Partial disposal controlling interest retained

The profit or loss on disposal also differs between the parent and the group when only part of the investment in a subsidiary is disposed of. The reasoning is the same as for a complete disposal. The parent is disposing of part of the book value or cost, whereas the group is disposing of part of its share in the net assets of the subsidiary and any part of the goodwill on consolidation not impaired. The main difference between a partial disposal with a controlling interest retained and a complete disposal is that in the former case the company is still a subsidiary although the minority interest will have increased (as the group has sold some of its holding).
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The journal to record a partial disposal is: Dr Bank/proceeds Cr Minority interest (B/S) Retained earnings (or debit if a loss) X X X

The reasoning behind crediting the gain or loss to retained earnings in the group accounts is that this is a transaction within equity a transaction between the two equity owners i.e. the parents shareholders and the minority interest (noncontrolling interest) shareholders. Refer IAS 27 para 30. In the individual accounts of the parent the sale is treated as a normal sale with any gain or loss being taken to profit or loss. The journal entry is therefore: Dr Bank/proceeds Cr Investment P/L gain (or debit if a loss) Example 10 Sun Ltd (Sun) and Star (Star) Ltd Sun purchased 95,000 1 ordinary shares in Star for 350,000 in January 2001. On 1 July 2010 Sun sold 20,000 shares for 124,000 when the net assets of Star equalled 450,000. Stars issued share capital consists of 100,000 1 ordinary shares. The year end of the group is 31 December. The groups share of unimpaired goodwill at 1 July 2010 was 50,000. MI was based on its share of net assets when goodwill was originally measured.
Required: Calculate the gain or loss on disposal from the parents and groups perspective and prepare the necessary journal entries.

Solution Note: with a partial disposal you must be careful in identifying what has been sold. In this example 20,000 shares in Star are sold. This is equivalent to: 20% of the company (20,000/100,000); and 20/95 of the existing holding and results in a minority interest of 25% ie the group now owns 75%. 20/95 of the groups interest in the goodwill has also been sold ie their goodwill was based in the 95,000 shares acquired and 20,000 of these have been sold. Parents gain on disposal: Proceeds Less: Cost ((20/95 x 350,000) Gain on disposal 20/95 is used as 20,000 of 95,000 shares acquired are being sold. 124,000 (73,684) 50,316

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The journal entry to record the disposal in Suns individual account is: Dr Bank/Proceeds 124,000 Cr Investments in Star P/L gain on disposal being gain on disposal of shares in Star 73,684 50,316

notes

Group gain on disposal: Proceeds Less: book value of assets disposed of: (20% x 450,000) Less: 20/95 x 50,000 goodwill 124,000 (90,000) 34,000 (10,526) 23,474

450,000 represents the total net assets of Star we are selling 20,000 shares, therefore 20% of the company (or 20/95 x 95% x 450,000 = 90,000). When the group sells 20,000 shares Star Ltd is still a subsidiary but the minority interest has increased from 5% to 25%. The journal entry to record the disposal in the group accounts is: Dr Bank/Proceeds 124,000 Cr Minority interest 100,526 Retained earnings 23,474 being sale of 20,000 shares to non-controlling shareholders This would be done in STEP 6. MI in STEPs 2 and 4 would be based on MI% at the last balance sheet date. MI in the profit for the year at STEP 5 would be prorata for the year based on appropriate MI percentages.

You should now be able to achieve the final three learning outcomes of the module.

20.5 FINANCIAL REPORTING STANDARDS

There are no significant differences between the IAS position covered in modules 15, 16, 17, 19 and 20 and the UK requirements relating to consolidated accounts except for the treatment of goodwill. FRS 10 requires positive goodwill to be amortised if it has a finite useful life. There is also a difference relating to negative goodwill and this is detailed in module 22. In addition goodwill is the UK is always calculated assuming the MI is valued at its share of net assets.

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20.6 SUMMARY
Vertical Groups Eg H 80% S 55% SS Hs share in S = 80% (MI 20%) Hs share in SS = 80% x 55% = 44% (MI 56%) Treat S & SS both as subs of group Step (1): add across both S & SS GW/MI/other adjs for both S & SS Goodwill S SS : As normal : Dr Share capital of SS Dr Reserves of SS Dr Goodwill Cr Investment MI (45%) X X X X X

Minority interest S : As normal (at 20%)

Impairment of goodwill S SS : net asset basis all to group : FV basis split group and MI in S : net asset basis split group and MI in S : FV basis split group and overall MI in SS

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Disposals 2 calculations re profit on disposal Individual a/cs Group a/cs Proceeds X Proceeds X Less: cost of inv (X) Less: share of Gain/loss X NAs at disposal (X) Less: unimpaired goodwill (X) Gain/loss X Complete disposal Partial disposal

notes

Steps (1) & (2) as for complete disposal (3) Record proceeds, gain on disposal (1) Consolidate up to & increase MI date of disposal on shares sold (2) Calculate group profit on disposal Dr Bank X Cr MI (B/S) X * Cr Retained earnings) X

(* Dr if loss)

(3) Remove sub from group a/cs Dr Bank X Dr MI (B/S) X Cr Unimpaired GW Cr Net assets * Cr Gain on disposal

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