An introduction to consolidated accounts

This post has been produced by B J Harford FCCA, FIAB, Principal at Woodgrove Tutorials.

Woodgrove Tutorials is an IAB Accredited Training  Provider. Their  Principal, Brian J Harford FCCA is an Award Winning qualified Accountant with 36 years teaching experience in Bookkeeping & Accounts including 17 years as a Part Time Lecturer at the London Metropolitan University (formerly Guildhall University)

For website see: www.woodgrove-tutorials.co.uk.

Ordinary shares usually carry voting rights. If one person or a group of people who, between them, own more than 50% of the voting shares of a company they can control the election of the directors and as a result control the policies of the company. They are said to have a controlling interest in the company.

HOLDING AND SUBSIDIARY COMPANIES

If one company holds more than 50% of the voting shares in another company then the first company is called a holding company and the second company is called its subsidiary company.

Let us suppose that a company called Sub Ltd has 1,000 shares in issue and another company called Hold Ltd acquires 501 of these shares from another shareholder paying a price of £700 to that shareholder. We now have a group situation because Hold Ltd is a holding company and its subsidiary is Sub Ltd.

Let us assume that the acquisition took place on 1st January and the Balance Sheets appeared as follows:-

HOLD LTD BALANCE SHEET AT 31st DECEMBER

                                                                                                  £               £

                                FIXED ASSETS                                                       4,000
CURRENT ASSETS
Stock                                                 3,000
Debtors                                             2,000
Bank                                                 1,000
6,000
CURRENT LIABILITES
Creditors
                                                          (1,000)

                                TOTAL NET ASSETS                                             9,000

                                   REPRESENTED BY:

                                       Share capital                                                6,000
Profit and Loss account                               3,000
9,000

SUB LTD BALANCE SHEET AS AT 31st DECEMBER

                                                                                               £               £

                                FIXED ASSETS                                                    1,000
CURRENT ASSETS
Stock                                                 200
Debtors                                              100
Bank                                                  100
400
CURRENT LIABILITES
Creditors
                                                            (100)

                                TOTAL NET ASSETS                                              1,300

 

REPRESENTED BY:

                                       Share capital                                                  1,000
Profit and Loss account                                    300

1,300

After the acquisition of Sub Ltd., before  any trading took place the Balance Sheet of Hold Ltd would appear as follows:-

HOLD LTD BALANCE SHEET

                                                                                                 £             £

                                   FIXED ASSETS                                                4,000
INVESTMENT IN SUBSIDIARY                        700

                                   CURRENT ASSETS

                                    Stock                                               3,000
Debtors                                           2,000
Bank                                                  300

                                                                                                           5,300

CURRENT LIABILITES

                                       Creditors                                                   (1,000)

                                TOTAL NET ASSETS                                           9,000

REPRESENTED BY:

Share capital                                               6,000
Profit and Loss account
                              3,000

9,000

Note that the only changes in the Balance Sheet of Hold Ltd are:­

(i)   The introduction of the new asset classified as “Investment in subsidiary”, being the cost of the investment.

(ii)  The reduction of cash at bank by £700 as this amount has been paid to the person who sold the shares in Sub Ltd.

There would be no change to the accounts of Sub Ltd as the name of its shareholders has simply changed. However, in the notes to its accounts its new parent company would have to be disclosed.

When Sub Ltd subsequently proposes a dividend then that part of the dividend due to Hold Ltd will be shown as investment income (income from shares in a related company) in the Profit and Loss Account of Hold Ltd.

It is important to note that if anyone invests, ie purchases shares in Hold Ltd they are automatically investing in Sub Ltd as well although the investor will not be a shareholder in Sub Ltd they will receive shares in Hold Ltd only. Indeed Hold Ltd could have many subsidiaries so the shareholders in Hold Ltd require a consolidated set of accounts which shows the performance of Hold Ltd together with all of its subsidiaries.

Whenever two or more companies are in the above relationship a ‘group’ exists and consolidated accounts must be prepared.

CONSOLIDATION OF BALANCE SHEETS

Example 1

Where 100% of the shares are bought at more than book value.

Consider these two Balance Sheets:-

HOLDING COMPANY BALANCE SHEET

                                                        £                                                                                           £

            Share Capital               20,000                Fixed Assets                                              10,000

Profit & Loss Account             18,000           Investment in Subsidiary (1,000 shares)      23,000

            General Reserve            6,000                   Current Assets                                        11,000

44,000                                                                                   44,000 

SUBSIDIARY COMPANY BALANCE SHEET 

            Share Capital               10,000   Fixed Assets                                                9,000
Profit & Loss Account   4,000   Current Assets                                              8,000


General Reserve            3,000                                                                             

17,000                                                                       17,000

The holding company has paid £23,000 for 100 % of the share capital in Subsidiary Limited. The capital and reserves acquired were £17,000 so a figure of £6,000 arises for Goodwill. Goodwill is the excess amount paid over and above the book value of the net assets being acquired.

The Consolidated Balance Sheets will appear as follows:

­HOLDING CO & SUBSIDIARY CO – CONSOLIDATED BALANCE SHEET

                                                                    £                                                        £

                        Share Capital               20,000      Fixed Assets                  19,000
Profit & Loss Account 18,000      Goodwill                           6,000
General Reserve
            6,000      Current Assets               19,000
44,000                                             44,000

Note that it is only the Share Capital and reserves of Holding Company which appear in the Consolidated Balance Sheet. The Share Capital and Reserves of the subsidiary have been used in the Goodwill calculation which can be viewed as follows:-

£
Investment in subsidiary     23,000
Capital & Reserves acquired 17,000

Goodwill                                6,000

As a result the investment in subsidiary of £23,000 showing in the Balance Sheet of the holding company disappears as it is offset against the Share Capital and Reserves acquired to obtain the Goodwill figure which appears in the Consolidated Accounts.

Please note that if the investment in Subsidiary Limited was £17,000 this would merely be cancelled out against the Share Capital and Reserves acquired and there would be no Goodwill on consolidation.

Example 2

Where 100% of the shares in the subsidiary are bought at less than their book value:-

HOLDING COMPANY BALANCE SHEET

                                                       £                                                                                          £

            Share Capital             20,000           Fixed Assets                                                   10,000

Profit & Loss Account            18,000           Investment in Subsidiary (10,000 shares)   15,000

            General Reserve          6,000            Current Assets                                               19,000

                                                44,000                                                                                  44,000

       SUBSIDIARY COMPANY BALANCE SHEET

            Share Capital                10,000            Fixed Assets                              9,000
Profit & Loss Account     4,000             Current Assets                          8,000
General Reserve             3,000
17,000                                                              17,000

The holding company has paid £15,000 to acquire share capital and reserves of £17,000. This means that a Capital Reserve of £2,000 will appear in the Consolidated Balance Sheet.

HOLDING CO & SUBSIDIARY CO CONSOLIDATED BALANCE SHEET

£                                                             £

Share Capital                                 20,000         Fixed Assets                       19,000

Profit & Loss Account                    18,000        Current Assets                    27,000

General Reserve                              6,000

Capital Reserve                               2,000

                                                       46,000                                                    46,000

In the previous two examples it was assumed that 100% of the share capital had been acquired. As we saw earlier over 50% needs to  be acquired to give a controlling interest and this is the requirement for having to prepare consolidated accounts.

Example 3

Where less than 100% of the shares in a subsidiary are acquired:-

HOLDING COMPANY BALANCE SHEET

                                                         £                                                                                   £
Share Capital
                20,000     Fixed Assets                                                 10,000
Profit & Loss Account   17,000     Investment in Subsidiary (8,000 shares)   25,000
General Reserve             8,000     Current Assets                                              10,000
45,000                                                                           45,000

SUBSIDIARY COMPANY BALANCE SHEET

            Share Capital                10,000          Fixed Assets                                            15,000
Profit & Loss Account     5,000          Current Assets                                        15,000
General Reserve           15,000

                                                  30,000                                                                          30,000

The holding company has acquired 80% (8,000 out of 10,000 shares) of the share capital of the subsidiary company.

Goodwill on consolidation is calculated as follows:

£

Share Capital & Reserves acquired         24,000 (80% of 30,000)
Investment in subsidiary                       25,000

Goodwill on consolidation                          1,000

The 20% of the shares not acquired by the holding company are classified as a Minority Interest in the Consolidated Balance Sheet. The minority interest is calculated as follows:-

Total at acquisition

80% acquired by Holding Co.

Held by Minority Interests

£

£

£

Share capital

10,000

8,000

2,000

Profit & loss account

5,000

4,000

1,000

General reserve

15,000

12,000

3,000

30,000

24,000

6,000

          HOLDING CO. & SUBSIDIARY CO. – CONSOLIDATED BALANCE SHEET

£

£

Share capital

20,000

Fixed assets

25,000

Profit & loss account

17,000

Goodwill

1,000

General reserve

8,000

Current assets

25,000

Minority Interests

6,000

51,000

51,000

The minority interest shows as a liability in the Consolidated Balance Sheet as the holding company has no entitlement to this amount. The holding company has of course included 100% of the subsidiary’s fixed and current assets when it is entitled to only 80% of these. It is necessary therefore to show separately, as a liability, that part of the subsidiary company to which it has no ownership.

The previous examples all assumed that the Consolidated Balance Sheet was drawn up immediately after the acquisition took place. This is vital for determining the Goodwill or Capital Reserve value which will remain unchanged. However, profits (and losses) made by a subsidiary subsequent to it being acquired by its holding company belong to that holding company in the ratio of the holding, ie if 80% is owned then 80% of all profits and loses since acquisition belong the holding company. The balance would be classified as an increase (or decrease) to the minority interest.

The following Balance Sheets are drawn up at the end of year 5 but acquisition took place at the end of year 4:-

            HOLDING CO.  BALANCE SHEET AS AT 31 DECEMBER – YEAR 5

£

£

Share capital

20,000

Investment in Subsidiary:

8,000 shares acquired 31/12/5

28,000

Profit & loss account- to year 4

10,000

Profit for year 5

  8,000

Current assets

10,000

38,000

38,000

          SUBSIDIARY CO. – BALANCE SHEET AS AT 31 DECEMBER – YEAR 5

£

£

Share capital

10,000

Fixed assets

15,000

Profit & loss account

15,000

General reserve

5,000

Current assets

15,000

30,000

30,000

           CONSOLIDATED  BALANCE SHEET AS AT 31 DECEMBER – YEAR 5

£

£

Share capital

20,000

Fixed assets

15,000

Profit & loss account

22,000

Goodwill

8,000

Minority Interest

  6,000

Current assets

25,000

48,000

48,000

NOTE

The Goodwill is calculated as at 31st December year 4, the acquisition date as follows:-

£                        Capital reserves acquired

Share Capital                     10,000
Profit & Loss a/c                15,000                                        £

25,000   x   80%    =          20,000
Investment in subsidiary                                              28,000

Goodwill on consolidation                                                 8,000

The Minority Interest is calculated as follows:-

£
As at 31 December year 4 £25,000 x 20% =                   5,000
Year 5 profits = £5,000 x 20% =                                     1,000

Minority Interest at the end of year 5                               6,000

CONSOLIDATED PROFIT AND LOSS ACCOUNT

The Consolidated Profit and Loss Account reflects the profit (or loss) of all of the companies in the group. If all of the companies are 100% owned then it merely a matter of adding together all the separate Profit and Loss Accounts.

If the subsidiaries are not 100% owned then the whole of the profits are included in the Consolidated Profit and Loss Account and the whole of the Corporation tax liability is deducted. The Minority Interest’s share is then deducted.

The following examples illustrate this:-

Holding     Subsidiary

                                                                                         Co Ltd                Ltd

                                                                                               £                     £

                                 Profit for the year before tax       10,000              2,000
Corporation Tax                             (3,000)             (600)
Profit for the year after tax            7,000             1,400

On the assumption that Holding Co Ltd owns 60% of the shares in Subsidiary Ltd this means that the minority interest is entitled to 20% of the subsidiary’s profits after tax, ie 20% x £1,400 = £280.

The Consolidated Profit and Loss Account would appear as follows:-

£

                                       Group profits for the year before tax  12,000
Corporation Tax                                    (3,600)
8,400
Minority Interests                                    (280)
Profits for the year after tax
                  8,120

Once the consolidated profit has been found the appropriations (dividends etc) from that profit can be made.

Dividends paid by the subsidiary company to the holding company will be eliminated as this example shows:-

Holding     Subsidiary
Co Ltd                 Ltd
£                     £
Profit for the year                          4,000              2,400
Dividend from Subsidiary Ltd           200    *
4,200            

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