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Consolidation

Setting up and consolidating a subsidiary

At the beginning of period one, XYZ decided to establish a new subsidiary. After it sold some securities, it registered ABC as separate legal entity and transferred it startup capital.

XYZ liquidated a portion of the investment portfolio where it keeps excess cash:

Cash

10,000

 

 

Investments

 

10,000


Before and after.


XYZ

Before

 

After

Cash

1,000

 

11,000

Receivables

5,000

 

5,000

Inventory

10,000

 

10,000

Accruals

1,000

 

1,000

Current assets

17,000

 

27,000

Financial assets: Investments

18,000

 

8,000

Property plant and equipment

35,000

 

35,000

Intangible assets

30,000

 

30,000

Total assets

100,000

 

100,000

 

 

 

 

Payables

5,000

 

5,000

Loans

20,000

 

20,000

Total Liabilities

25,000

 

25,000

Paid in capital

50,000

 

50,000

Retained earnings

25,000

 

25,000

Total equity

75,000

 

75,000

Liabilities and equity

100,000

 

100,000

 

 

 

 


Financial assets: InterCo: Equity: ABC

10,000

 

 

Cash

 

10,000


ABC used the funds to buy a distribution license and initial inventory for 3,000 and 1,500 respectively. During the period, it also bought equipment, furniture and fixtures from various vendors for 5,500. At the end of the period, consolidated financial statements were prepared.

Receipt of startup funds:

 

 

Cash

10,000

 

 

Paid in capital

 

10,000


Expenditure of startup funds:

 

 

Inventory

1,500

 

License

3,000

 

Equipment, Furniture and fixtures

5,500

 

 

Cash

 

10,000


As no transactions between XYZ and ABC occurred, the only item to be eliminated was the InterCo investment.

XYZ

 

ABC

 

Adj.

XYZ / ABC

Cash

1,000

Cash

 

 

1,000

Receivables

5,000

Receivables

 

 

5,000

Inventory

10,000

Inventory

1,500

 

11,500

Accruals

1,000

Accruals

 

 

1,000

Current assets

17,000

Current assets

1,500

 

18,500

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

100,000

Total assets

10,000

 

100,000

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(25,000)

Retained earnings

 

 

(25,000)

Total equity

(75,000)

Total equity

(10,000)

 

(75,000)

Liabilities and equity

(100,000)

Liabilities and equity

(10,000)

 

(100,000)

 

 

 

 

 

 


Once the adjustment had been made, consolidated financial statements could be prepared.

XYZ / ABC

 

Cash

1,000

Receivables

5,000

Inventory

11,500

Accruals

1,000

Current assets

18,500

Financial assets: Investments

8,000

Property plant and equipment

40,500

Intangible assets

33,000

Total assets

100,000

 

 

Payables

5,000

Loans

20,000

Total Liabilities

25,000

Paid in capital

50,000

Retained earnings

25,000

Total equity

75,000

Liabilities and equity

100,000

 

 


In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.

XYZ

 

 

Cash

20,000

 

 

Revenue

 

20,000

Cost of sales

9,500

 

 

Inventory

 

9,500

Administrative expenses

5,000

 

 

Cash

 

5,000

Cash

3,000

 

 

Receivables

 

3,000


ABC

 

 

Cash

3,000

 

 

Revenue

 

3,000

Cost of sales

1,500

 

 

Inventory

 

1,500

Administrative expenses

500

 

 

Cash

 

500


To improve readability, the transactions are presented in aggregate.

As no transactions between XYZ and ABC occurred, the only item to be eliminated was the InterCo investment.

XYZ

 

ABC

 

Adj.

XYZ / ABC

Revenue

(20,000)

Revenue

(3,000)

 

(23,000)

Cost of sales

9,500

Cost of sales

1,500

 

11,000

Gross profit

(10,500)

Gross profit

(1,500)

 

(12,000)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(5,500)

Net income

(1,000)

 

(6,500)

 

 

 

 

 

 

Cash

19,000

Cash

1,000

 

20,000

Receivables

2,000

Receivables

 

 

2,000

Inventory

500

Inventory

1,500

 

2,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

22,500

Current assets

2,500

 

25,000

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

105,500

Total assets

11,000

 

106,500

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(30,500)

Retained earnings

(1,000)

 

(31,500)

Total equity

(80,500)

Total equity

(11,000)

 

(81,500)

Liabilities and equity

(105,500)

Liabilities and equity

(11,000)

 

(106,500)

 

 

 

 

 

 


Once the adjustment was made, consolidated financial statements could be prepared.

XYZ / ABC

 

Revenue

23,000

Cost of sales

11,000

Gross profit

12,000

Administrative expenses

5,500

Net income

6,500

 

 

Cash

20,000

Receivables

2,000

Inventory

2,000

Accruals

1,000

Current assets

25,000

Financial assets: Investments

8,000

Property plant and equipment

40,500

Intangible assets

33,000

Total assets

106,500

 

 

Payables

5,000

Loans

20,000

Total Liabilities

25,000

Paid in capital

50,000

Retained earnings

31,500

Total equity

81,500

Liabilities and equity

106,500

 

 


In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ

 

 

Inventory

25,000

 

 

Cash

 

25,000

Cash

35,000

 

Receivables

5,000

 

 

Revenue

 

40,000

Cost of sales

20,000

 

 

Inventory

 

20,000

Administrative expenses

5,000

 

 

Cash

 

5,000

Financial assets

22,000

 

 

Cash

 

22,000


ABC

 

 

Inventory

2,500

 

 

Cash

 

2,500

Cash

5,000

 

 

Revenue

 

5,000

Cost of sales

2,500

 

 

Inventory

 

2,500

Administrative expenses

500

 

 

Cash

 

500


Between themselves

XYZ

 

 

A/R (Interco)

1,700

 

 

Revenue (Interco)

 

1,700

COS (Interco)

750

 

 

Inventory

 

750


ABC

 

 

Inventory

1,700

 

 

A/P (Interco)

 

1,700


As transactions between XYZ and ABC had occurred, they had to be eliminated.

Consolidation involves combining non-InterCo and eliminating InterCo items.

As outlined in IFRS 10.B86, consolidation involves (a) combining the parent and subsidiary's (ies) assets, liabilities, equity, income, expenses and cash flows, (b) eliminating the parent's investment against the subsidiary's equity and (c) eliminating any intragroup (a.k.a. InterCo) assets and liabilities, equity, income, expenses and cash flows not forgetting that "profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full."

While not semantically accurate, the term InterCo is used considerably more in practice than the term intragroup even by professional organizations that should know better.

Rather than swimming against this tide, this site refers to these items as InterCo, just like everyone else.

While not identical, ASC 810-10-45-1 specifies that consolidation involves eliminating intra-entity balances and transactions including any open account balances, security holdings, sales and purchases, interest, dividends, etc. Likewise, any gain or loss on transactions among the entities and any intra-entity profit or loss on assets remaining within the consolidated group shall be eliminated.

The simplest way to make sure all InterCo items have been identified and eliminated is comparing financial results including InterCo items with those excluding them.

To improve readability, the differences on sub-total and total lines are not shown.

Including InterCo transactions

Excluding InterCo transactions

Difference

 

XYZ

ABC

XYZ + ABC

XYZ

ABC

XYZ + ABC

 

Revenue

(41,700)

(5,000)

(46,700)

(40,000)

(5,000)

(45,000)

1,700

Cost of sales

20,750

2,500

23,250

20,000

2,500

22,500

(750)

Gross profit

(20,950)

(2,500)

(23,450)

(20,000)

(2,500)

(22,500)

 

Administrative expenses

5,000

500

5,500

5,000

500

5,500

 

Net income

(15,950)

(2,000)

(17,950)

(15,000)

(2,000)

(17,000)

 

 

Cash

2,000

3,000

5,000

2,000

3,000

5,000

 

Receivables

8,700

 

8,700

7,000

 

7,000

(1,700)

Inventory

4,750

3,200

7,950

5,500

1,500

7,000

(950)

Accruals

1,000

 

1,000

1,000

 

1,000

 

Current assets

16,450

6,200

22,650

15,500

4,500

20,000

 

Financial assets: Investments

30,000

 

30,000

30,000

 

30,000

 

Financial assets: InterCo: Equity: ABC

10,000

 

 

10,000

 

 

 

Property plant and equipment

35,000

5,500

40,500

35,000

5,500

40,500

 

Financial assets: InterCo: Equity: ABC

30,000

3,000

33,000

30,000

3,000

33,000

 

Total assets

121,450

14,700

126,150

120,500

13,000

123,500

 

 

Payables

(5,000)

(1,700)

(6,700)

(5,000)

 

(5,000)

1,700

Loans

(20,000)

(20,000)

(20,000)

(20,000)

 

Total Liabilities

(25,000)

(1,700)

(26,700)

(25,000)

 

(25,000)

 

Paid in capital (XYZ)

(50,000)

(10,000)

(50,000)

(50,000)

(10,000)

(50,000)

 

Retained earnings (XYZ)

(46,450)

(3,000)

(49,450)

(45,500)

(3,000)

(48,500)

 

Total equity

(96,450)

(13,000)

(99,450)

(95,500)

(13,000)

(98,500)

 

Liabilities and equity

(121,450)

(14,700)

(126,150)

(120,500)

(13,000)

(123,500)

 

 

 

 

 

 

 

 

 


Note: the best way to make sure all InterCo items are easily identifiable is to use a CAO that keeps them completely segregated, even if this seems strange to some people.

This approach is especially useful at helping identify InterCo balances hiding in inventory or PP&E where separate InterCo accounts are (unlike for revenue, expenses, receivables or payables) rarely set up.

Separate InterCo accounts are commonly set up for loans, receivables, payables and similar balance sheet items. They are rarely used in inventory, PP&E and other non-monetary items even though it could be done.

XYZ

 

ABC

 

Adj.

XYZ / ABC

Revenue

(40,000)

Revenue

(5,000)

 

(45,000)

Revenue (InterCo)

(1,700)

 

 

1,700

 

Cost of sales

20,000

Cost of sales

2,500

 

22,500

COS (InterCo)

750

 

 

(750)

 

Gross profit

(20,950)

Gross profit

(2,500)

 

(22,500)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(15,950)

Net income

(2,000)

 

(17,000)

 

 

 

 

 

 

Cash

2,000

Cash

3,000

 

5,000

Receivables

7,000

Receivables

 

 

7,000

A/R (InterCo)

1,700

 

 

(1,700)

 

Inventory

5,500

Inventory

1,500

 

7,000

Inventory (InterCo)

(750)

 

 

750

 

 

 

Inventory (InterCo)

1,700

(1,700)

 

Accruals

1,000

Accruals

 

 

1,000

Current assets

16,450

Current assets

6,200

 

20,000

Financial assets: Investments

30,000

Financial assets: Investments

 

 

30,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

121,450

Total assets

14,700

 

123,500

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

 

 

A/P (InterCo)

(1,700)

1,700

 

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

(1,700)

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(46,450)

Retained earnings

(3,000)

 

(48,500)

Total equity

(96,450)

Total equity

(13,000)

 

(98,500)

Liabilities and equity

(121,450)

Liabilities and equity

(14,700)

 

(123,500)

 

 

 

 

 

 


XYZ

 

ABC

 

Adj.

XYZ / ABC

Revenue

(40,000)

Revenue

(5,000)

 

(45,000)

Revenue (InterCo)

(1,700)

 

 

1,700

 

Cost of sales

20,000

Cost of sales

2,500

 

22,500

COS (InterCo)

750

 

 

(750)

 

Gross profit

(20,950)

Gross profit

(2,500)

 

(22,500)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(15,950)

Net income

(2,000)

 

(17,000)

 

 

 

 

 

 

Cash

2,000

Cash

3,000

 

5,000

Receivables

7,000

Receivables

 

 

7,000

A/R (InterCo)

1,700

 

 

(1,700)

 

Inventory

4,750

Inventory

3,200

(950)

7,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

16,450

Current assets

6,200

 

20,000

Financial assets: Investments

30,000

Financial assets: Investments

 

 

30,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

121,450

Total assets

14,700

 

123,500

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

 

 

A/P (InterCo)

(1,700)

1,700

 

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

(1,700)

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(46,450)

Retained earnings

(3,000)

 

(48,500)

Total equity

(96,450)

Total equity

(13,000)

 

(98,500)

Liabilities and equity

(121,450)

Liabilities and equity

(14,700)

 

(123,500)

 

 

 

 

 

 


InterCo Revenue - InterCo COS = InterCo Profit.

As stated in IAS 10.B86.c ... profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full ...

While ASC 810-10-45-1 is not as specific, it does state:... consolidated financial statements ... shall not include gain or loss on transactions among the entities in the consolidated group. Accordingly, any intra-entity profit or loss on assets remaining within the consolidated group [like inventory] shall be eliminated...

Consequently, consolidated revenue was reduced by 1,700, consolidated cost of sales by 750 and the remaining 950, the intra-entity profit that had been recognized in inventory, was deducted from inventory.

Note: eliminating InterCo Revenue and InterCo COS decrease InterCo Profit, which is carried over into consolidated retained earnings. Consequently, an adjustment to retained earnings does not appear in the adjustments column.

Once all the InterCo balances had been eliminated, consolidated financial statements could be prepared.

XYZ / ABC

 

Revenue

45,000

Cost of sales

22,500

Gross profit

22,500

Administrative expenses

5,500

Net income

17,000

 

 

Cash

5,000

Receivables

7,000

Inventory

7,000

Accruals

1,000

Current assets

20,000

Financial assets: Investments

30,000

Property plant and equipment

40,500

Intangible assets

33,000

Total assets

123,500

 

 

Payables

5,000

Loans

20,000

Total Liabilities

25,000

Paid in capital

50,000

Retained earnings

48,500

Total equity

98,500

Liabilities and equity

123,500

 

 


In addition, XYZ and ABC could have also prepared individual financial statements.

XYZ

 

ABC

   

Revenue

41,700

Revenue

5,000

 

 

Cost of sales

20,750

Cost of sales

2,500

 

 

Gross profit

20,950

Gross profit

2,500

 

 

Administrative expenses

5,000

Administrative expenses

500

 

 

Net income

15,950

Net income

2,000

 

 

 

 

 

 

 

 

Cash

2,000

Cash

3,000

 

 

Receivables

8,700

Receivables

 

 

 

Inventory

4,750

Inventory

3,200

 

 

Accruals

1,000

Accruals

 

 

 

Current assets

16,450

Current assets

6,200

 

 

Financial assets: Investments

40,000

Financial assets: Investments

 

 

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

 

Intangible assets

30,000

Intangible assets

3,000

 

 

Total assets

121,450

Total assets

14,700

 

 

 

 

 

 

 

 

Payables

5,000

Payables

1,700

 

 

Loans

20,000

Loans

 

 

 

Total Liabilities

25,000

Total Liabilities

1,700

 

 

Paid in capital (XYZ)

50,000

Paid in capital (ABC)

10,000

 

 

Retained earnings (XYZ)

46,450

Retained earnings (ABC)

3,000

 

 

Total equity

96,450

Total equity

13,000

 

 

Liabilities and equity

121,450

Liabilities and equity

14,700

 

 

 

 

 

 

 

 


Business combination

At end beginning of period one, XYZ acquired ABC paying its previous owners 10,000 in cash and consolidated financial statements were prepared.

Important: for the sake of simplicity, this illustration assumes the book value of ABC's assets equaled their fair value.

In most cases, this is not true. The following examples thus illustrate more realistic scenarios.

A discussion of how to determine the fair value of an acquired entity's assets is provided at Non-Current Assets / Acquired in business combination.

Pre-acquisition XYZ

Pre-acquisition ABC

Adj.

Post acquisition ABC

Cash

18,000

Cash

200

 

200

Receivables

5,000

Receivables

300

 

300

Inventory

3,000

Inventory

1,000

 

1,000

Accruals

1,000

Accruals

 

 

 

Current assets

27,000

Current assets

1,500

 

1,500

Financial assets: Investments

8,000

Financial assets

 

 

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

5,500

Intangible assets

30,000

Intangible assets

3,000

 

3,000

Total assets

100,000

Total assets

10,000

 

10,000

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

 

Loans

(20,000)

Loans

 

 

 

Total Liabilities

(25,000)

Total Liabilities

 

 

 

Paid in capital

(50,000)

Paid in capital

(8,500)

(1,500)

(10,000)

Retained earnings

(25,000)

Retained earnings

(1,500)

1,500

 

Total equity

(75,000)

Total equity

(10,000)

 

(10,000)

Liabilities and equity

(100,000)

Liabilities and equity

(10,000)

 

(10,000)

 

 

 

 

 

 


ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.


Financial assets: InterCo: Equity: ABC

10,000

 

 

Cash

 

10,000



XYZ

ABC

Adj.

XYZ / ABC

Cash

8,000

Cash

200

 

8,200

Receivables

5,000

Receivables

300

 

5,300

Inventory

3,000

Inventory

1,000

 

4,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

17,000

Current assets

1,500

 

18,500

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

100,000

Total assets

10,000

 

100,000

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(25,000)

Retained earnings

 

 

(25,000)

Total equity

(75,000)

Total equity

(10,000)

 

(75,000)

Liabilities and equity

(100,000)

Liabilities and equity

(10,000)

 

(100,000)

 

 

 

 

 

 


Share swap

Same facts except, instead of cash, XYZ paid for the acquisition with its own shares.

XYZ

ABC

Adj.

XYZ / ABC

Cash

18,000

Cash

200

 

18,200

Receivables

5,000

Receivables

300

 

5,300

Inventory

3,000

Inventory

1,000

 

4,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

27,000

Current assets

1,500

 

28,500

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

110,000

Total assets

10,000

 

110,000

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(60,000)

Paid in capital

(10,000)

10,000

(60,000)

Retained earnings

(25,000)

Retained earnings

 

 

(25,000)

Total equity

(85,000)

Total equity

(10,000)

 

(85,000)

Liabilities and equity

(110,000)

Liabilities and equity

(10,000)

 

(110,000)

 

 

 

 

 

 


In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.


XYZ

 

 

Inventory

7,000

 

 

Cash

 

7,000

Cash

20,000

 

 

Revenue

 

20,000

Cost of sales

9,500

 

 

Inventory

 

9,500

Administrative expenses

5,000

 

 

Cash

 

5,000


ABC

 

 

Cash

300

 

 

Receivables

 

300

Inventory

500

 

 

Cash

 

500

Cash

3,000

 

 

Revenue

 

3,000

Cost of sales

1,500

 

 

Inventory

 

1,500

Administrative expenses

500

 

 

Cash

 

500



XYZ

ABC

Adj.

XYZ / ABC

Revenue

(20,000)

Revenue

(3,000)

 

(23,000)

Cost of sales

9,500

Cost of sales

1,500

 

11,000

Gross profit

(10,500)

Gross profit

(1,500)

 

(12,000)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(5,500)

Net income

(1,000)

 

(6,500)

 

 

 

 

 

 

Cash

16,000

Cash

1,000

 

17,000

Receivables

5,000

Receivables

 

 

5,000

Inventory

500

Inventory

1,500

 

2,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

22,500

Current assets

2,500

 

25,000

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

105,500

Total assets

11,000

 

106,500

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(30,500)

Retained earnings

(1,000)

 

(31,500)

Total equity

(80,500)

Total equity

(11,000)

 

(81,500)

Liabilities and equity

(105,500)

Liabilities and equity

(11,000)

 

(106,500)

 

 

 

 

 

 


In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ

 

 

Inventory

25,000

 

 

Cash

 

25,000

Cash

35,000

 

Receivables

5,000

 

 

Revenue

 

40,000

Cost of sales

20,000

 

 

Inventory

 

20,000

Administrative expenses

5,000

 

 

Cash

 

5,000

Financial assets

16,000

 

 

Cash

 

16,000


ABC

 

 

Inventory

2,500

 

 

Cash

 

2,500

Cash

5,000

 

 

Revenue

 

5,000

Cost of sales

2,500

 

 

Inventory

 

2,500

Administrative expenses

500

 

 

Cash

 

500


Between themselves

XYZ

 

 

A/R (Interco)

1,700

 

 

Revenue (Interco)

 

1,700

COS (Interco)

750

 

 

Inventory

 

750


ABC

 

 

Inventory

1,700

 

 

A/P (Interco)

 

1,700



XYZ

ABC

Adj.

XYZ / ABC

Revenue

(40,000)

Revenue

(5,000)

 

(45,000)

Revenue (InterCo)

(1,700)

 

 

1,700

 

Cost of sales

20,000

Cost of sales

2,500

 

22,500

COS (InterCo)

750

 

 

(750)

 

Gross profit

(20,950)

Gross profit

(2,500)

 

(22,500)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(15,950)

Net income

(2,000)

 

(17,000)

 

 

 

 

 

 

Cash

5,000

Cash

3,000

 

8,000

Receivables

10,000

Receivables

 

 

10,000

A/R (InterCo)

1,700

 

 

(1,700)

 

Inventory

4,750

Inventory

3,200

(950)

7,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

22,450

Current assets

6,200

 

26,000

Financial assets: Investments

24,000

Financial assets

 

 

24,000

Financial assets: InterCo: Equity: ABC

10,000

 

 

(10,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

121,450

Total assets

14,700

 

123,500

           

Payables

(5,000)

Payables

 

 

(5,000)

 

 

A/P (InterCo)

(1,700)

1,700

 

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

(1,700)

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(10,000)

10,000

(50,000)

Retained earnings

(46,450)

Retained earnings

(3,000)

 

(48,500)

Total equity

(96,450)

Total equity

(13,000)

 

(98,500)

Liabilities and equity

(121,450)

Liabilities and equity

(14,700)

 

(123,500)

 

 

 

 

 

 


A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Non-controlling interest

At end beginning of period one, XYZ offered each of ABC's five owners 2,000 in cash for their share. Four accepted. Nevertheless, as XYZ gained power | control over ABC, consolidated financial statements were prepared.


Financial assets: InterCo: Equity: ABC

8,000

 

 

Cash

 

8,000


Under in IFRS, consolidated is required if an investor has power over an investee.

IFRS guidance for how investments should be treated is relatively involved and spread over several standards.

In summary:

Step 1: investor evaluates interest in investee

 

Step 1.A: investor has power (to direct relevant activities) over investee (IFRS 10.7.a)

Yes

Step 1.A.i

No

Step 3

 

Step 1.A.i: investor is (IFRS 10.18)

Principal

Step 1.B

Agent

Stop: no consolidation

 

Step 1.B: investor has exposure / right to variable returns (IFRS 10.7.b)

Yes

Step 1.C

No

Step 3

 

Step 1.C: investor has ability to use power to effect returns (IFRS 10.7.c)

Yes

Control confirmed: Step 2

No

Step 3


Step 2: investor determines if control is shared

A third party (unrelated to investor) shares control (IFRS 11.4)

Yes

Step 3 (IFRS 11.7)

No

Stop: consolidation (IFRS 10.19 / IFRS 12)


Step 3: investor evaluates joint control

 

Joint control is contractually agreed (IFRS 11.7)

Yes

Joint arrangement: Step 4

No

Significant influence (20% + ownership) exists (IFRS 11.25)

Yes

Stop: equity method (IAS 28.16 / IFRS 12)

No

Step 7


Step 4: investor evaluates structure of joint arrangement

 

Joint arrangement structured as separate vehicle (IFRS 11.B16)

Yes

Right to assets and obligations for liabilities (IFRS 11.15)

Joint operation: Step 5

Right to net assets only (IFRS 11.16)

Joint venture: Step 6

No

Joint operation: Step 5


Step 5: investor selects accounting policy for joint operation

 

Joint control

Yes

Stop: share of assets, liabilities, revenue and expenses (formerly: proportional consolidation) (IFRS 11.20 / IFRS 12)

No

Right to assets and obligations for liabilities (IFRS 11.23)

Yes

Stop: share of assets, liabilities, revenue and expenses

No

Step 7


Step 6: investor selects accounting policy for joint venture

 

Joint control

Yes

Stop: equity method

No

Significant influence (IFRS 11.25)

Yes

Stop: equity method

No

Step 7


Step 7: investor evaluates structured entity

 

Investee is a structured entity (IFRS 12.6.d.ii)

Yes

Stop: fair value (IFRS 9 / IAS 39) and disclosure (IFRS 12)

No

Stop: fair value (IFRS 9 / IAS 39)


Supplemental step: separate (individual) financial Statements

 

The investor decides to publish separate financial statements

Yes

Apply IAS 27

No

Do not apply IAS 27


Under US GAAP, consolidation is required if an investor controls an investee.

While US GAAP's guidance is also spread over several topics, it is fairly straight forward.

As a rule of thumb, an investor consolidates if it controls an investee (owns over 50%), uses the equity method if it has significant influence (owns 20% or more) and treats the investment as passive (ASC 321) in other situations.

The first paragraph of ASC 810-10-25 states (edited): ... consolidation is appropriate if a reporting entity has a controlling financial interest in another entity ... The usual condition for a controlling financial interest is ownership of a majority (> 50% not ≥ 50%) voting interest... .

The remainder of the topic discusses situations where a majority voting interest may not lead to consolidation.

It is important to remember that subsection ASC 810-10-15-13 to 17D (variable interest entities) is designed to make the Enron like structuring of investments with the intent to avoid disclosing risky endeavors impossible. In the same vein, ASC 810-10-15-18 to 22 covers the consolidation of entities controlled by contract.

Consequently, the > 50% threshold is not a bright line in any, but the plain vanilla scenarios illustrated in this example.

As outlined in ASC 323-10-15-8, an investment (direct or indirect) of 20% or more indicates the investor has significant influence. However, ASC 323-10-15-10 also outlines various facts and circumstances where a 20% or greater stake does not bring this influence.

Therefore, assuming XYZ intended to operate ABC without regard to the views of the minority investor, applying ASC 323-10-15-10.c (assuming the investor was required apply US GAAP) would obviate the investor of the need to use the equity method.

Important: for the sake of simplicity, this illustration assumes the book value of ABC's assets equaled their fair value.

In most cases, this is not true. The next example thus illustrates more realistic scenario.

An discussion of how to determine the fair value of an acquired entity's assets is provided at Non-Current Assets / Acquired in business combination.

Pre-acquisition XYZ

Pre-acquisition ABC

Adj.

Post acquisition ABC

Cash

18,000

Cash

200

 

200

Receivables

5,000

Receivables

300

 

300

Inventory

3,000

Inventory

1,000

 

1,000

Accruals

1,000

Accruals

 

 

 

Current assets

27,000

Current assets

1,500

 

1,500

Financial assets: Investments

8,000

Financial assets

 

 

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

5,500

Intangible assets

30,000

Intangible assets

3,000

 

3,000

Total assets

100,000

Total assets

10,000

 

10,000

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

 

Loans

(20,000)

Loans

 

 

 

Total Liabilities

(25,000)

Total Liabilities

 

 

 

Paid in capital

(50,000)

Paid in capital

(8,500)

500

(8,000)

Retained earnings

(25,000)

Retained earnings

(1,500)

1,500

 

 

 

Minority interest

 

(1,700)

(1,700)

 

 

Minority interest retained earnings

 

(300)

(300)

Total equity

(75,000)

Total equity

(10,000)

 

(10,000)

Liabilities and equity

(100,000)

Liabilities and equity

(10,000)

 

(10,000)

 

 

 

 

 

 


XYZ's share of ABC's equity was 8,000. The remainder was reclassified as a non-controlling interest.

ASC 810-10-45-2 states: The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

While IAS 10 does not include similarly explicit guidance, applying the guidance it does provide would lead to the same conclusion.

Instead of keeping the retained earnings on ABC's books and eliminating it each time it consolidated, XYZ simply eliminated it at the date of the acquisition.

Note: unlike the previous illustrations, where XYZ could eliminate the entire R/E balance, here it had to retain the portion (300 = 1,500 x 20%) associated with the non-controlling interest.

As outlined in IFRS 3.19, a non-controlling (a.k.a. minority) interest may be measured at (a) its acquisition date fair value or (b) a proportionate share in the acquiree’s net assets, in that IFRS 3.B44 gives the acquirer the choice.

Since it was the simpler option, XYZ applied IFRS 3.19.b.

In contrast, ASC 805-20-30-1 does not give a choice. It requires the NCI to be measured at fair value.

Thus, rather than simply recognizing the NCI at 20% or 10,000, XYZ had to determine what the NCI was actually worth.

To do so, XYZ considered that, since ABC was not a traded entity, a valuation technique was, as outlined in ASC 805-20-30-1, appropriate.

Fortunately, after examining ABC's accounts, XYZ determined the book value of its assets (ABC had no liabilities) equaled their fair value. It also determined that the holder of the NCI, with a 20% stake, had not controlled ABC before the acquisition, so there was no control premium (ASC 805-20-30-8) to consider.

It thus concluded the NCI was worth 2,000 (in the following illustration, book value and fair value do not equal).

Note: as the portion of equity associated with the minority interest had no characteristics of a liability (ASC 810-10-45-17), the SEC’s guidance on "mezzanine equity" (ASC 480-10-S99-3A), was not applicable.

ABC's minority shareholders retained 20% of ABC's pre-acquisition capital or 2,000 on total.

Of that total, 300 (1,500 x 20%) was their share in ABC's pre-acquisition retained earnings.


XYZ

ABC

Adj.

XYZ / ABC

Cash

10,000

Cash

200

 

10,200

Receivables

5,000

Receivables

300

 

5,300

Inventory

3,000

Inventory

1,000

 

4,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

19,000

Current assets

1,500

 

20,500

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

8,000

 

 

(8,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

100,000

Total assets

10,000

 

102,000

           

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(8,000)

8,000

(50,000)

Retained earnings

(25,000)

Retained earnings

 

 

(25,000)

 

 

Minority interest

(1,700)

 

(1,700)

 

 

Minority interest retained earnings

(300)

 

(300)

Total equity

(75,000)

Total equity

(10,000)

 

(77,000)

Liabilities and equity

(100,000)

Liabilities and equity

(10,000)

 

(102,000)

 

 

 

 

 

 


Share swap

Instead of paying cash, XYZ acquired ABC exchanging 800 of its shares for 4,000 ABC shares (80% of its float). The market price of XYZ's shares was 10 per share.

XYZ

ABC

Adj.

XYZ / ABC

Cash

18,000

Cash

200

 

18,200

Receivables

5,000

Receivables

300

 

5,300

Inventory

3,000

Inventory

1,000

 

4,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

27,000

Current assets

1,500

 

28,500

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

8,000

 

 

(8,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

108,000

Total assets

10,000

 

110,000

           

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(58,000)

Paid in capital

(8,000)

8,000

(58,000)

Retained earnings

(25,000)

Retained earnings

 

 

(25,000)

 

 

Minority interest

(1,700)

 

(1,700)

 

 

Minority interest retained earnings

(300)

 

(300)

Total equity

(83,000)

Total equity

(10,000)

 

(85,000)

Liabilities and equity

(108,000)

Liabilities and equity

(10,000)

 

(110,000)

 

 

 

 

 

 


In period two, XYZ and ABC recognized the following transactions, all of which were with third parties, and consolidated financial statements were prepared.


XYZ

 

 

Inventory

7,000

 

 

Cash

 

7,000

Cash

20,000

 

 

Revenue

 

20,000

Cost of sales

9,500

 

 

Inventory

 

9,500

Administrative expenses

5,000

 

 

Cash

 

5,000


ABC

 

 

Cash

300

 

 

Receivables

 

300

Inventory

500

 

 

Cash

 

500

Cash

3,000

 

 

Revenue

 

3,000

Cost of sales

1,500

 

 

Inventory

 

1,500

Administrative expenses

500

 

 

Cash

 

500



XYZ

ABC

Adj.

XYZ / ABC

Revenue

(20,000)

Revenue

(3,000)

 

(23,000)

Cost of sales

9,500

Cost of sales

1,500

 

11,000

Gross profit

(10,500)

Gross profit

(1,500)

 

(12,000)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(5,500)

Net income

(1,000)

 

(6,500)

 

 

 

 

 

 

Net income attributable to parent

 

Net income attributable to parent

(800)

 

(6,300)

Net income attributable to minority owner

 

Net income attributable to minority owner

(200)

 

(200)

 

 

 

 

 

 

Cash

18,000

Cash

1,000

 

19,000

Receivables

5,000

Receivables

 

 

5,000

Inventory

500

Inventory

1,500

 

2,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

24,500

Current assets

2,500

 

27,000

Financial assets: Investments

8,000

Financial assets

 

 

8,000

Financial assets: InterCo: Equity: ABC

8,000

 

 

(8,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

105,500

Total assets

11,000

 

108,500

 

 

 

 

 

 

Payables

(5,000)

Payables

 

 

(5,000)

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

 

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(8,000)

8,000

(50,000)

Retained earnings

(30,500)

Retained earnings

(800)

 

(31,300)

 

 

Minority interest

(1,700)

 

(1,700)

 

 

Minority interest retained earnings

(500)

 

(500)

Total equity

(80,500)

Total equity

(11,000)

 

(83,500)

Liabilities and equity

(105,500)

Liabilities and equity

(11,000)

 

(108,500)

 

 

 

 

 

 


In period three, XYZ and ABC recognized the following transactions, including between themselves, and consolidated financial statements were prepared.

With third parties

XYZ

 

 

Inventory

25,000

 

 

Cash

 

25,000

Cash

35,000

 

Receivables

5,000

 

 

Revenue

 

40,000

Cost of sales

20,000

 

 

Inventory

 

20,000

Administrative expenses

5,000

 

 

Cash

 

5,000

Financial assets

16,000

 

 

Cash

 

16,000


ABC

 

 

Inventory

2,500

 

 

Cash

 

2,500

Cash

5,000

 

 

Revenue

 

5,000

Cost of sales

2,500

 

 

Inventory

 

2,500

Administrative expenses

500

 

 

Cash

 

500


Between themselves

XYZ

 

 

A/R (Interco)

1,700

 

 

Revenue (Interco)

 

1,700

COS (Interco)

750

 

 

Inventory

 

750


ABC

 

 

Inventory

1,700

 

 

A/P (Interco)

 

1,700



XYZ

ABC

Adj.

XYZ / ABC

Revenue

(40,000)

Revenue

(5,000)

 

(45,000)

Revenue (InterCo)

(1,700)

 

 

1,700

 

Cost of sales

20,000

Cost of sales

2,500

 

22,500

COS (InterCo)

750

 

 

(750)

 

Gross profit

(20,950)

Gross profit

(2,500)

 

(22,500)

Administrative expenses

5,000

Administrative expenses

500

 

5,500

Net income

(15,950)

Net income

(2,000)

 

(17,000)

 

 

 

 

 

 

Net income attributable to parent

 

Net income attributable to parent

(1,600)

 

(16,600)

Net income attributable to minority owner

 

Net income attributable to minority owner

(400)

 

(400)

 

 

 

 

 

 

Cash

7,000

Cash

3,000

 

10,000

Receivables

10,000

Receivables

 

 

10,000

A/R (InterCo)

1,700

 

 

(1,700)

 

Inventory

4,750

Inventory

3,200

(950)

7,000

Accruals

1,000

Accruals

 

 

1,000

Current assets

24,450

Current assets

6,200

 

28,000

Financial assets: Investments

24,000

Financial assets

 

 

24,000

Financial assets: InterCo: Equity: ABC

8,000

 

 

(8,000)

 

Property plant and equipment

35,000

Property plant and equipment

5,500

 

40,500

Intangible assets

30,000

Intangible assets

3,000

 

33,000

Total assets

121,450

Total assets

14,700

 

125,500

           

Payables

(5,000)

Payables

 

 

(5,000)

 

 

A/P (InterCo)

(1,700)

1,700

 

Loans

(20,000)

Loans

 

 

(20,000)

Total Liabilities

(25,000)

Total Liabilities

(1,700)

 

(25,000)

Paid in capital

(50,000)

Paid in capital

(8,000)

8,000

(50,000)

Retained earnings

(46,450)

Retained earnings

(2,400)

 

(47,900)

 

 

Minority interest

(1,700)

 

(1,700)

 

 

Minority interest retained earnings

(900)

 

(900)

Total equity

(96,450)

Total equity

(13,000)

 

(100,500)

Liabilities and equity

(121,450)

Liabilities and equity

(14,700)

 

(125,500)

 

 

 

 

 

 


A supplemental discussion of how the adjustment to inventory was determined is presented in the first illustration.

Text only

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