Accounting Standards for Consolidated Financial Statements (PDF)

CHAPTER 10 ACCOUNTING STANDARDS FOR CONSOLIDATED FINANCIAL STATEMENTS UNIT 1 ACCOUNTING STATDARD 21 CONSOLIDATED FINANCIAL STATEMENTS LEARNING OUTCOMES After studying this chapter, you w...

CHAPTER 10 ACCOUNTING STANDARDS FOR CONSOLIDATED FINANCIAL STATEMENTS UNIT 1 ACCOUNTING STATDARD 21 CONSOLIDATED FINANCIAL STATEMENTS LEARNING OUTCOMES After studying this chapter, you will be able to: ♦ Understand the concepts of Group, holding company and subsidiary company. ♦ Apply the consolidation procedures for consolidation of financial statements of subsidiaries with the holding companies. ♦ Prepare the consolidated financial statements and solve related problems © The Institute of Chartered Accountants of India  10.2 ADVANCED ACCOUNTING UNIT OVERVIEW Concept of Purpose and Minority Group, Components Calculation Elimination of method of Interests; Holding of of Goodwill/ Intra-Group preparing Profit or Company Consolidated Transactions and consolidated Capital Loss of and Financial other financial Reserve Subsidiary Subsidiary Statements Adjustments statements Company Company Note: As per the syllabus, the unit covers simple problems on consolidated financial statements with single subsidiary and excludes problems involving acquisition of Interest in Subsidiary at Different Dates, Cross holding, Disposal of a Subsidiary and Foreign Subsidiaries. 1.1 CONCEPT OF GROUP, HOLDING COMPANY AND SUBSIDIARY COMPANY In an era of business growth, many organizations are growing into large corporations by the process of acquisition, mergers, gaining control by one company over the other company, restructuring etc. Acquisitions and mergers ultimately lead to either cost reduction or controlling the market or sharing the material supplies or product diversification or availing tax benefits or synergy. Whatever the motto behind these ventures is, the ultimate result is the large-scale corporation. Formation of holding company is the most popular device for achieving these objectives. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.3 FINANCIAL STATEMENTS Group of Companies Many a time, a company expands by keeping intact its separate corporate identity. In this situation, a company (i.e. holding company) gains control over the other company (subsidiary company). This control is exercised by one company over the other by- 1. Purchasing specified number of shares i.e. ownership through voting power of that company or 2. Exercising control over the board of directors. The companies connected in these ways are collectively called as a Group of Companies. Holding Company and Subsidiary Company have also been defined in Section 2 of the Companies Act, 2013. Holding company As per Section 2(46) of the Companies Act, 2013, “Holding company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies. It may be defined as one, which has one or more subsidiary companies and enjoys control over them. Legally a holding company and its subsidiaries are distinct and separate entities. However, in substance holding and subsidiary companies work as a group. Accordingly, users of holding company’s accounts need financial information of subsidiaries also to understand the performance and financial position of the group (i.e. holding company and subsidiaries on a consolidated basis). Subsidiary Company Section 2(87) of the Companies Act, 2013 defines “subsidiary company” as a company in which the holding company - (i) controls the composition of the Board of Directors; or (ii) exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies: © The Institute of Chartered Accountants of India  10.4 ADVANCED ACCOUNTING A company shall be deemed to be a subsidiary company of the holding company even if there is indirect control through the subsidiary company (ies). The control over the composition of a subsidiary company’s Board of Directors means exercise of power to appoint or remove all or a majority of the directors of the subsidiary company. Section 19 of the Companies Act, 2013 prohibits a subsidiary company from holding shares in the holding company. According to this section, no company shall, either by itself or through its nominees, hold any shares in its holding company and no holding company shall allot or transfer its shares to any of its subsidiary companies and any such allotment or transfer of shares of a company to its subsidiary company shall be void. However, a subsidiary may continue to be a member of its holding company when (a) the subsidiary company holds such shares as the legal representative of a deceased member of the holding company; or (b) the subsidiary company holds such shares as a trustee; or (c) the subsidiary company is a shareholder even before it became a subsidiary company of the holding company. The subsidiary company shall have a right to vote at a meeting of the holding company only in respect of the shares held by it as a legal representative or as a trustee, as mentioned above in point (a) and (b). Applicable Accounting Standard Accounting Standard (AS) 21: Consolidated Financial Statements provides guidance on preparation of Consolidated Financial Statements, the purpose of which is discussed in Para 3 below. This Standard came into effect in respect of accounting periods commenced on or after 1-4-2001. AS 21 lays down principles and procedures for preparation and presentation of consolidated financial statements. Consolidated financial statements are presented by the parent (holding company) to provide financial information about the economic activities of the group as a single economic entity. The parent presenting consolidated financial statements should present such statements in accordance with this standard but in its separate financial statements, investments in subsidiaries would be accounted as per AS 13. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.5 FINANCIAL STATEMENTS 1.2 OBJECTIVES OF AS 21 The objective of this Standard is to lay down principles and procedures for preparation and presentation of consolidated financial statements. Consolidated Financial Statements are prepared by the holding/parent company to provide financial information regarding the economic resources controlled by its group and results achieved with these resources. These consolidated financial statements are prepared by the parent company in addition to the financial statement prepared by the parent company for only its own affairs. Hence parent company prepares two financial statements, one for only its own affairs and one for taking the whole group as one unit in the form of consolidated financial statements. Consolidated financial statements usually comprise the following:  Consolidated Balance Sheet  Consolidated Profit & Loss Statement  Notes to Accounts, other statements and explanatory material  Consolidated Cash Flow Statement, if parent company presents its own cash flow statement. While preparing the consolidated financial statement, all other ASs and Accounting Policies will be applicable as they are applied in parent company’s own financial statements. A parent which presents consolidated financial statements should consolidate all subsidiaries, domestic as well as foreign. Where an enterprise does not have a subsidiary but has an associate and/or a joint venture such an enterprise should also prepare consolidated financial statements in accordance with Accounting Standard (AS) 23, Accounting for Associates in Consolidated Financial Statements, and Accounting Standard (AS) 27, Financial Reporting of Interests in Joint Ventures respectively. Definitions as per Accounting Standard (AS) 21 Parent: A parent is an enterprise that has one or more subsidiaries. Subsidiary is an enterprise that is controlled by another enterprise (known as the parent). © The Institute of Chartered Accountants of India  10.6 ADVANCED ACCOUNTING Control: (a) the ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise; or (b) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise so as to obtain economic benefits from its activities. Group: A group is a parent and all its subsidiaries. Minority interest is that part of the net results of operations and of the net assets of a subsidiary attributable to interests which are not owned, directly or indirectly through subsidiary(ies), by the parent. Equity is the residual interest in the assets of an enterprise after deducting all its liabilities. Consolidated financial statements are the financial statements of a group presented as those of a single enterprise. Circumstances under which Consolidated Financial Statements are prepared AS 21 should be applied in the preparation and presentation of consolidated financial statements for a group of enterprises under the control of a parent. Consolidated financial statements are the financial statements of a group presented as those of a single enterprise. AS 21 does not mandate which enterprises are required to prepare consolidated financial statements – but specifies the rules to be followed where such financial statements are prepared. Consolidated Financial Statements will be prepared by the parent company for all the companies that are controlled by the parent company either directly or indirectly, situated in India or abroad except in certain cases. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.7 FINANCIAL STATEMENTS 1.3 WHOLLY OWNED AND PARTLY OWNED SUBSIDIARIES S. No. Wholly owned subsidiary Partly owned subsidiary company company 1. A wholly owned subsidiary In a partly owned subsidiary, all the company is one in which all the shares of subsidiary company are not shares are owned by the acquired by the holding company i.e. holding company. only the majority of shares (i.e., more than 50%) are owned by the holding company. 2. 100% voting rights are vested Voting rights of more than 50% but by the holding company. less than 100% are vested by the holding company. 3. There is no minority interest There is a minority interest because because all the shares with less than 50% shares with voting voting rights are held by the rights are held by outsiders other holding company. than the holding company. 1.4 PURPOSE OF PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS Consolidated financial statements (CFS) are the financial statements of a ‘group’ presented as those of a single enterprise, where a ‘group’ refers to a parent and all its subsidiaries. Parent company needs to inform the users about the financial position and results of operations of not only of their enterprise itself but also of the group as a whole. For this purpose, consolidated financial statements are prepared and presented by a parent/holding enterprise to provide financial information about a parent and its subsidiary(ies) as a single economic entity. CFS are intended to show the financial position of the group as a whole - by showing the economic resources controlled by them, by presenting the obligations of the group and the results the group achieves with its resources. © The Institute of Chartered Accountants of India  10.8 ADVANCED ACCOUNTING CFS normally include consolidated balance sheet, consolidated statement of profit and loss, and notes, other statements and explanatory material that form an integral part thereof. Consolidated cash flow statement is presented in case a parent presents its own cash flow statement. The consolidated financial statements are presented, to the extent possible, in the same format as that adopted by the parent for its separate financial statements. The logic for presentation of Consolidated Financial Statements can be appreciated with the help of an example below: Assume that you are holding 10 shares of Reliance Industries Limited, one of the largest conglomerates in India. If you look at Reliance Industries Limited’s separate (standalone) balance sheet, you can see investments in subsidiaries like Jio Platforms Limited, Reliance Jio Infocomm Limited, Reliance Retail Limited etc. Now, if we see the standalone financials of Reliance Industries Limited, the revenue is generated from Oil & Gas Business. However, we all know that equally significant for Reliance Industries Limited is the revenue generated from its subsidiary companies. Further, being a holding company, all operational decisions of the subsidiary companies are taken by Reliance Industries Limited. In other words, though the holding company and its subsidiaries are legally different entities, in substance, all the operations of the subsidiaries are merely an extension of the holding company, and the assets and liabilities of the subsidiaries are controlled by the holding company. Technically, Investments appearing in the balance sheet of Reliance Industries Limited represents proportionate share in the net worth of the respective subsidiary as well as is also a proportionate share in the profits earned by such subsidiaries. Accordingly, consolidating the incomes and expenses, as well as the assets and liabilities of the subsidiary companies with that of the parent company will result in a better presentation of the operations as well as the financial position of Reliance Industries Limited. Relevant provisions of the Companies Act 2013 Where a company has one or more subsidiaries or associate companies, it shall, in addition to the standalone financial statements, prepare a consolidated financial © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.9 FINANCIAL STATEMENTS statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with applicable accounting standards, which shall also be laid before the annual general meeting (AGM) of the company along with the laying of its financial statement. The company shall also attach along with its financial statement, a separate statement containing the salient features of the financial statement of its subsidiary or subsidiaries in Form AOC-1 as per Rule 5 of the Companies (Accounts) Rules, 2014. For the purpose of section 129, ‘subsidiary’ includes ‘associate company’ and ‘joint venture’ which means that the company would be required to prepare consolidated financial statements including associate/ joint venture even if there is no subsidiary of a company. The consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III of the Companies Act 2013 and the applicable accounting standards. In case of a company covered under sub-section (3) of section 129 which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions of consolidated financial statements provided in Schedule III of the Act. Exemptions from preparation of CFS: As per Companies (Accounts) Amendment Rules, 2016, preparation of consolidated financial statements by a company is not required if it meets the following conditions: (i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members, including those not otherwise entitled to vote, having been intimated in writing and for which the proof of delivery of such intimation is available with the company, do not object to the company not presenting consolidated financial statements; (ii) it is a company whose securities are not listed or are not in the process of listing on any stock exchange, whether in or outside India; and © The Institute of Chartered Accountants of India  10.10 ADVANCED ACCOUNTING (iii) its ultimate or any intermediate holding company files consolidated financial statements with the Registrar which are in compliance with the applicable Accounting Standards. AS21 also lays down the accounting principles and procedures for preparation and presentation of consolidated financial statements which have been covered in the later part of this chapter. It may be pertinent to note that in certain countries outside India, presentation of standalone financial statements is not mandatory. In fact, it is the preparation and presentation of consolidated financial statements that are mandatory, given the reasoning behind Consolidated Financial Statements already discussed in the example of Reliance Industries Limited above. In India, the statutory framework (such as the Companies Act, 2013 or the Income Tax Act, 1961) mandate presentation of standalone financial statements, thereby making standalone financial statements equally important as consolidated financial statements. 1.5 SCOPE OF AS 21 1. This Standard should be applied in the preparation and presentation of consolidated financial statements for a group of enterprises under the control of a parent. 2. This Standard should also be applied in accounting for investments in subsidiaries in the separate financial statements of a parent. 3. In the preparation of consolidated financial statements, other Accounting Standards also apply in the same manner as they apply to the separate statements. 4. This Standard does not deal with: a. methods of accounting for amalgamations and their effects on consolidation, including goodwill arising on amalgamation (see AS 14, Accounting for Amalgamations); b. accounting for investments in associates (governed by AS 13, Accounting for Investments); and © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.11 FINANCIAL STATEMENTS c. accounting for investments in joint ventures (governed by AS 13, Accounting for Investments). Note: AS 21 is mandatory if an enterprise presents consolidated financial statements. In other words, the accounting standard does not mandate an enterprise to present consolidated financial statements but, if the enterprise presents consolidated financial statements for complying with the requirements of any statute or otherwise, it should prepare and present consolidated financial statements in accordance with AS 21. 1.6 CONTROL The consolidated financial statements are prepared on the basis of financial statements of parent and all enterprises that are controlled by the parent, other than those subsidiaries excluded for the reasons set out in paragraph 11 of AS 21. Control exists when the parent owns, directly or indirectly through subsidiary(ies), more than one-half of the voting power of an enterprise. Control also exists when an enterprise controls the composition of the board of directors (in the case of a company) or of the corresponding governing body (in case of an enterprise not being a company) so as to obtain economic benefits from its activities. An enterprise may control the composition of the governing bodies of entities such as gratuity trust, provident fund trust etc. Since the objective of control over such entities is not to obtain economic benefits from their activities, these are not considered for the purpose of preparation of consolidated financial statements. For the purpose of this Standard, an enterprise is considered to control the composition of (i) the board of directors of a company, if it has the power, without the consent or concurrence of any other person, to appoint or remove all or a majority of directors of that company. An enterprise is deemed to have the power to appoint a director, if any of the following conditions is satisfied: a. a person cannot be appointed as director without the exercise in his favour by that enterprise of such a power as aforesaid; or © The Institute of Chartered Accountants of India  10.12 ADVANCED ACCOUNTING b. a person’s appointment as director follows necessarily from his appointment to a position held by him in that enterprise; or c. the director is nominated by that enterprise or a subsidiary thereof. (ii) the governing body of an enterprise that is not a company, if it has the power, without the consent or the concurrence of any other person, to appoint or remove all or a majority of members of the governing body of that other enterprise. An enterprise is deemed to have the power to appoint a member, if any of the following conditions is satisfied: a. a person cannot be appointed as member of the governing body without the exercise in his favour by that other enterprise of such a power as aforesaid; or b. a person’s appointment as member of the governing body follows necessarily from his appointment to a position held by him in that other enterprise; or c. the member of the governing body is nominated by that other enterprise. Note: It is possible that an enterprise is controlled by two enterprises – one controls by virtue of ownership of majority of the voting power of that enterprise and the other controls, by virtue of an agreement or otherwise, the composition of the board of directors so as to obtain economic benefits from its activities. In such a rare situation, when an enterprise is controlled by two enterprises as per the definition of ‘control’, the first mentioned enterprise will be considered as subsidiary of both the controlling enterprises within the meaning of AS 21 and, therefore, both the enterprises need to consolidate the financial statements of that enterprise. 1.7 EXCLUSION FROM PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS As per AS 21, a subsidiary should be excluded from consolidation when: (a) control is intended to be temporary because the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future; or © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.13 FINANCIAL STATEMENTS (b) it operates under severe long-term restrictions which significantly impair its ability to transfer funds to the parent. In consolidated financial statements, investments in such subsidiaries should be accounted for in accordance with AS 13 ‘Accounting for Investments’. The reasons for not consolidating a subsidiary should be disclosed in the consolidated financial statements. Where an enterprise owns majority of voting power by virtue of ownership of the shares of another enterprise and all the shares are held as ‘stock-in-trade’ and are acquired and held exclusively with a view to their subsequent disposal in the near future, the control by the first mentioned enterprise is considered to be temporary. It would be pertinent to note that merely holding all the shares as 'stock-in-trade', is not sufficient to be considered as temporary control. It is only when all the shares held as 'stock-in-trade' are acquired and held exclusively with a view to their subsequent disposal in the near future, that control would be considered to be temporary within the meaning of point (a) above. The period of time, which is considered as “near future” as mentioned above, primarily depends on the facts and circumstances of each case. However, ordinarily, the meaning of the words ‘near future’ is considered as not more than twelve months from acquisition of relevant investments unless a longer period can be justified on the basis of facts and circumstances of the case. The intention with regard to disposal of the relevant investment is considered at the time of acquisition of the investment. Accordingly if the relevant investment is acquired without an intention to its subsequent disposal in near future, and subsequently, it is decided to dispose off the investments, such an investment is not excluded from consolidation, until the investment is actually disposed off. Conversely, if the relevant investment is acquired with an intention to its subsequent disposal in near future, but, due to some valid reasons, it could not be disposed off within that period, the same will continue to be excluded from consolidation, provided there is no change in the intention. Exclusion of a subsidiary from consolidation on the ground that its business activities are dissimilar from those of the other enterprises within the group is not justified because better information is provided by consolidating such subsidiaries and disclosing additional information in the consolidated financial statements © The Institute of Chartered Accountants of India  10.14 ADVANCED ACCOUNTING about the different business activities of subsidiaries. Extending the above Reliance Industries Limited example, though the parent company is in the Oil and Gas Business, and its subsidiaries operate in industries such as telecom, retail trade, fashion and lifestyle, media etc., all the entities have to be consolidated as such consolidated financial statements will then provide better picture of the business and financial position of Reliance Industries Limited. For example, the disclosures required by AS 17 ‘Segment Reporting’, help to explain the significance of different business activities within the group. Consolidation of a subsidiary which is a Limited Liability Partnership (LLP) or a Partnership Firm As per rule 6 of Companies (Accounts) Rules, 2014, under the heading ‘Manner of consolidation of accounts’ it is provided that consolidation of financial statements of a company shall be done in accordance with the provisions of Schedule III to the Companies Act, 2013 and the applicable Accounting Standards. It is noted that relevant Indian Accounting Standard i.e., Ind AS 110, Consolidated Financial Statements provides that where an entity has control on one or more other entities, the controlling entity is required to consolidate all the controlled entities. Since, the word ‘entity’ includes a company as well as any other form of entity, therefore, LLPs and partnership firms are required to be consolidated. Similarly, under Accounting Standard (AS) 21, as per the definition of subsidiary, an enterprise controlled by the parent is required to be consolidated. The term ‘enterprise’ includes a company and any enterprise other than a company. Therefore, under AS also, LLPs and partnership firms are required to be consolidated. Accordingly, in the given case, holding company is required to consolidate its subsidiary which is an LLP or a partnership firm. Consolidation of Limited Liability Partnership (LLP) which is an Associate or Joint Venture If LLP or a partnership firm is an associate or joint venture of holding company, even then the LLP and the partnership firm need to be consolidated in accordance with the requirements of applicable Accounting Standards. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.15 FINANCIAL STATEMENTS 1.8 ADVANTAGES OF CONSOLIDATED FINANCIAL STATEMENTS Acquisition of Subsidiary Evaluation Single Advantages of of Holding Source Document Consolidation Company in the market Intrinsic value of share The main advantages of consolidation are given below: (i) Single source document: From the consolidated financial statements, the users of accounts can get an overall picture of the Group (i.e. holding company and its subsidiaries). Consolidated profit and loss account gives the overall profitability of the group. (ii) Intrinsic value of share: Intrinsic share value of the holding company can be calculated directly from the Consolidated Balance Sheet. (iii) Acquisition of subsidiary: The minority interest data of the consolidated financial statement indicates that the amount payable to the outside shareholders of the subsidiary company at book value which is used as the starting point of bargaining at the time of acquisition of a subsidiary by the holding company. (iv) Evaluation of holding company in the market: The overall financial health of the holding company can be judged using consolidated financial statements. Those who want to invest in the shares of the holding company or acquire it, need such consolidated statement for evaluation. © The Institute of Chartered Accountants of India  10.16 ADVANCED ACCOUNTING 1.9 COMPONENTS OF CONSOLIDATED FINANCIAL STATEMENTS As per AS 21, consolidated financial statements normally include the following: consolidated financial statements Consolidated Balance Sheet Consolidated Statement of Profit and Loss Account Consolidated Cash Flow Statement (in case parent presents cash flow statement) Notes and statements and explanatory schedules ♦ The consolidated financial statements are presented to the extent possible in the same format as that adopted by the parent for its separate financial statements. All the notes appearing in the separate financial statements of the parent enterprise and its subsidiaries need not be included in the notes to the consolidated financial statement. For preparing consolidated financial statements, the following principles may be observed in respect of notes and other explanatory material that form an integral part thereof: (a) Notes which are necessary for presenting a true and fair view of the consolidated financial statements are included in the consolidated financial statements as an integral part thereof. (b) Only the notes involving items which are material need to be disclosed. Materiality for this purpose is assessed in relation to the information © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.17 FINANCIAL STATEMENTS contained in consolidated financial statements. In view of this, it is possible that certain notes which are disclosed in separate financial statements of a parent or a subsidiary would not be required to be disclosed in the consolidated financial statements when the test of materiality is applied in the context of consolidated financial statements. (c) Additional statutory information disclosed in separate financial statements of the subsidiary and/or a parent having no bearing on the true and fair view of the consolidated financial statements need not be disclosed in the consolidated financial statements. In addition, the consolidated financial statements shall disclose the information as per the requirements specified in the applicable Accounting Standards including the following as per the requirements of Schedule III to the Companies Act, 2013 which contains the ‘General Instructions for Preparation of Consolidated Financial Statements’: (i) Profit or loss attributable to “minority interest” and to owners of the parent in the statement of profit and loss shall be presented as allocation for the period. (ii) “Minority interests” in the balance sheet within equity shall be presented separately from the equity of the owners of the parent. Students are also advised to refer the Schedule III to the Companies Act, 2013. It may be noted that companies do not maintain any separate set of journal entries for ‘Consolidated Set of Accounts’. Continuing the example of Reliance Industries Limited, Consolidated Financial Statements of Reliance Industries Limited is not based on “double entry book-keeping in the ‘group books of accounts’”, as there is no concept of ‘group books of accounts’. Practically, Consolidated Financial Statements are prepared from the separate / standalone financial statements of each entity (parent / subsidiary) to which consolidation adjustments are made in accordance with AS 21. Accordingly, the financial statements of each entity are finalized in accordance with the applicable Accounting Standards, and based on such financial statements, consolidation procedures are performed in accordance with AS 21. © The Institute of Chartered Accountants of India  10.18 ADVANCED ACCOUNTING 1.10 CONSOLIDATION PROCEDURES Rule 6 of the Companies (Accounts) Rules, 2014 states that the manner of consolidation of financial statements of the company shall be in accordance with the provisions of Schedule III of the Act and the applicable accounting standards. AS 21, lays down the procedure for consolidation of financial statements of the companies within the group. When preparing consolidated financial statements, the individual balances of the parent and its subsidiaries are combined or consolidated on a line-by-line basis, and then certain consolidation adjustments are made. For example, the cash, trade receivables and prepayments of the parent and each subsidiary are added together to arrive at the cash, trade receivables and prepayments of the group, before consolidation adjustments are made. The objective is that the consolidated financial statements should present the information contained in the consolidated financial statements of a parent and its subsidiaries as if they were the financial statements of a single economic entity. The various steps involved in the consolidation process are as follows: 1. the cost to the parent of its investment (cost of acquisition) in each subsidiary and the parent’s portion of equity of each subsidiary (acquirer’s interest), at the date on which investment in each subsidiary is made, should be eliminated. In case, cost of acquisition exceeds or is less than the acquirer’s interest, at the date on which investment in the subsidiary is made, goodwill or capital reserve should be recognized respectively in the CFS. 2. intragroup transactions, including sales, expenses and dividends, are eliminated, in full; 3. Adjustments in respect of unrealised profits/ losses should be made; 4. minority interest in the net income of consolidated subsidiaries for the reporting period are identified and adjusted against the income of the group in order to arrive at the net income attributable to the owners of the parent; and 5. minority interests in the net assets of consolidated subsidiaries should be identified and presented in the consolidated balance sheet separately from © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.19 FINANCIAL STATEMENTS liabilities and the equity of the parent’s shareholders. Minority interests in the net assets consist of: (i) the amount of equity attributable to minorities at the date on which investment in a subsidiary is made; and (ii) the minorities share of movements in equity since the date the parent- subsidiary relationship came in existence. Note: Where the carrying amount of the investment in the subsidiary is different from its cost, the carrying amount is considered for the purpose of above computations. 6. The results of operations of a subsidiary are included in the CFS as from the date on which parent-subsidiary relationship came in existence. The results of operations of a subsidiary with which parent-subsidiary relationship ceases to exist are included in the consolidated statement of profit and loss until the date of cessation of the relationship. The difference between the proceeds from the disposal of investment in a subsidiary and the carrying amount of its assets less liabilities as of the date of disposal is recognised in the consolidated statement of profit and loss as the profit or loss on the disposal of the investment in the subsidiary. In order to ensure the comparability of the financial statements from one accounting period to the next, supplementary information is often provided about the effect of the acquisition and disposal of subsidiaries on the financial position at the reporting date and the results for the reporting period and on the corresponding amounts for the preceding period. 7. An investment in an enterprise should be accounted for in accordance with AS 13, Accounting for Investments, from the date that the enterprise ceases to be a subsidiary and does not become an associate. 8. The carrying amount of the investment at the date that it ceases to be a subsidiary is regarded as cost thereafter. © The Institute of Chartered Accountants of India  10.20 ADVANCED ACCOUNTING Thus, Consolidation Adjustments are broadly categorized as under: Consolidation Adjustments MAJOR ADJUSTMENTS INTRA-GROUP ADJUSTMENTS Those which 'drive' the double entry: 1. Intra-group balances 1. Goodwill / Capital Reserve (i.e., 2. Unrealized profit cost of Control) 3. Inventory 2. Minority Interests 4. Non-Current Asset transfers 3. Consolidated Reserves 5. Minority Interests 4. Disposal of Subsidiary* * Disposal of Subsidiary is not examined at the Intermediate Level. 1.11.CALCULATION OF GOODWILL/CAPITAL RESERVE (COST OF CONTROL) As on the date of investment, the cost of investment and the equity in the subsidiary needs to be calculated. Equity is defined as the ‘residual interest in the assets of an enterprise after deducting all its liabilities.’ In other words, it is equal to the net worth of the enterprise. Once the above is calculated, goodwill or capital reserve is calculated as under: Goodwill = Cost of Investment - Parent’s share in the equity of the subsidiary on date of investment Capital Reserve = Parent’s share in the equity of the subsidiary on date of investment – Cost of investment The parent’s portion of equity in a subsidiary, at the date on which investment is made, is determined on the basis of information contained in the financial statements of the subsidiary as on the date of investment. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.21 FINANCIAL STATEMENTS However, if the financial statements of a subsidiary as on the date of investment are not available and if it is impracticable to draw the financial statements of the subsidiary as on that date, financial statements of the subsidiary for the immediately preceding period are used as a basis for consolidation. Adjustments are made to these financial statements for the effects of significant transactions or other events that occur between the date of such financial statements and the date of investment in the subsidiary. It may be mentioned that positive or negative differential is separately recognised only in purchase method. This differential calculated as cost of control is shown in the consolidated balance sheet. A detailed illustration below will help in understanding the concept of goodwill / capital reserve. Example 1 The following information is given as at 31 March 20X1 P Ltd. S Ltd. Non-current Assets: PPE 2,000 500 Investment in Subsidiary 1,000 Net Current Assets 2,000 500 5,000 1,000 Issued Capital 500 1,000 Reserves and Surplus 4,500 5,000 1,000 P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ` 1,000. Since P Ltd. has acquired S Ltd., we will have to determine goodwill / capital reserve. Let us understand why goodwill / capital reserve arises in case of consolidation, and what would be the interpretation of the same. In the given case, P Ltd. acquired all the shares of S Ltd. by paying ` 1,000. This payment (i.e., purchase consideration) would be made by P Ltd. to the shareholder(s) of S Ltd. (hence the transfer of this amount would not appear in the books of S Ltd.). © The Institute of Chartered Accountants of India  10.22 ADVANCED ACCOUNTING By paying ` 1,000, P Ltd. has acquired ‘control’ over S Ltd. This acquisition is quite different from the concept of amalgamation done in accordance with AS 14, though the concept of goodwill / capital reserve is similar. Under AS 14, the target company would generally liquidate, and all assets and liabilities would be transferred from the Selling Company to the Purchasing Company. In case of consolidation, P Ltd. is acquiring ‘control’ i.e., by way of acquiring equity shares in S Ltd.. Thus, S Ltd. continues to exist, and the assets and liabilities of S Ltd. are not transferred to P Ltd., but instead continue to remain with S Ltd. only. However, since in substance, acquisition has taken place (albeit through transfer of control), the purchase consideration of ` 1,000 will be compared with the net worth of S Ltd., which is ` 1,000. Since amount paid (i.e., purchase consideration) equals the net worth, no goodwill / capital reserve is recognized. In case the amount paid (i.e., purchase consideration) would be higher / lower than the net worth of S Ltd., such difference would be recognized in Goodwill / Capital Reserve respectively. The calculation of goodwill is presented below: Tangible Assets 500 Net Current Assets 500 1,000 Less: Liabilities NIL Net Worth of S Ltd. 1,000 Investment in S Ltd. (purchase consideration) 1,000 Goodwill / (Capital Reserve) NIL Example 2 Modifying example 1, the following information is given as at 31 March 20X1 P Ltd. S Ltd. Non-current Assets: PPE 2,000 500 Investment in Subsidiary 1,000 Net Current Assets 2,000 500 5,000 1,000 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.23 FINANCIAL STATEMENTS Issued Capital 500 700# Reserves and Surplus 4,500 300# 5,000 1,000 # As compared to Example 1 – There is a difference in the break-up of net worth of S Ltd. (Example 1 – Issued capital was 1,000 and Reserves and Surplus was Nil; The Net worth is 1,000). P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ` 1,000. Like Example 1 above P Ltd. has acquired ‘control’ over S Ltd. by paying ` 1,000. Accordingly, the purchase consideration of ` 1,000 will be compared with the net worth of S Ltd. which is ` 1,000. Since amount paid (i.e., purchase consideration) equals the net worth, no goodwill / capital reserve is recognized. In case the amount paid (i.e., purchase consideration) would be higher / lower than the net worth of S Ltd., such difference would be recognized in Goodwill / Capital Reserve respectively. The calculation of goodwill is presented below: Tangible Assets 500 Net Current Assets 500 1,000 Less: Liabilities NIL Net Worth of S Ltd. 1,000 Investment in S Ltd. (purchase consideration) 1,000 Goodwill / (Capital Reserve) NIL Example 3 Modifying example 2, the following information is given as at 31 March 20X1 P Ltd. S Ltd. Non-current Assets: PPE 2,000 500 Investment in Subsidiary 1,200 © The Institute of Chartered Accountants of India  10.24 ADVANCED ACCOUNTING Net Current Assets 2,000 500 5,200 1,000 Issued Capital 700 700 Reserves and Surplus 4,500 300 5,200 1,000 P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ₹ 1,200. Like Examples 1 and 2 above P Ltd. has acquired ‘control’ over S Ltd. by paying ` 1,200. Accordingly, the purchase consideration of ` 1,200 will be compared with the net worth of S Ltd. which is ` 1,000. Since amount paid (i.e., purchase consideration) exceeds the net worth, such excess of is recognized as goodwill. In case the amount paid (i.e., purchase consideration) would be lower than the net worth of S Ltd., such difference would be credited to Capital Reserve. The calculation of goodwill is presented below: Tangible Assets 500 Net Current Assets 500 1,000 Less: Liabilities NIL Net Worth of S Ltd. 1,000 Investment in S Ltd. (purchase consideration) 1,200 Goodwill / (Capital Reserve) 200 1.12 MINORITY INTERESTS Minority interest is that part of the net assets of a subsidiary attributable to interest which is held by outsiders. Minority interests in the net income of consolidated subsidiaries for the reporting period are identified and adjusted against the income of the group in order to arrive at the net income attributable to the shareholders of the holding company. Minority interests should be presented in the consolidated balance sheet separately from liabilities and the equity of the parent’s shareholders. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.25 FINANCIAL STATEMENTS Minority interest in the income of the group should be separately presented in the consolidated income statement. Minority interests in the net assets consist of: (i) The amount of equity attributable to minorities at the date on which investment in a subsidiary is made and (ii) The minorities’ share of movements in equity since the date the parent- subsidiary relationship came in existence. The losses applicable to the minority in a consolidated subsidiary may exceed the minority interest in the equity of the subsidiary. The excess, and any further losses applicable to the minority, are adjusted against the majority interest except to the extent that the minority has a binding obligation to and is able to make good the losses. If the subsidiary subsequently reports profit, all such profits are allocated to the majority interest until the minority’s share of losses previously absorbed by the majority has been recovered. Example 4 Modifying Example 2, the following information is given as at 31 March 20X1: P Ltd. S Ltd. Non-current Assets: Tangible Assets 2,000 500 Investment in Subsidiary 1,000 Net Current Assets 2,000 500 5,000 1,000 Issued Capital 500 700 Reserves and Surplus 4,500 300 5,000 1,000 P Ltd. acquired 80% of shares of S Ltd. on 31 March 20X1 for ` 1,000. In the given case, P Ltd. acquired 80% of the shares of S Ltd. by paying ` 1,000. This payment (i.e., purchase consideration) would be made by P Ltd. to the shareholder(s) of S Ltd. © The Institute of Chartered Accountants of India  10.26 ADVANCED ACCOUNTING By paying ` 1,000, P Ltd. has acquired ‘control’ over S Ltd. We cannot say that P Ltd. has acquired only ‘80% control’, since its shareholding in S Ltd. will enable it to take all the decisions regarding S Ltd.’s operations and usage of assets and repayment of liabilities. However, the fact remains that 20% stake does NOT belong to S Ltd. It belongs to outsiders, who are called ‘Minority Interest’ in accordance with AS 21. Accordingly, in this case, the purchase consideration of ` 1,000 will be compared with 80% of the net worth of S Ltd. Any excess or deficit would be recorded as goodwill / capital reserve respectively. 20% of the net worth on the date of acquisition would be recorded separately as Minority Interest. AS 21 defines Minority Interest as that part of the net results of operations and of the net assets of a subsidiary attributable to interests which are not owned, directly or indirectly through subsidiary(ies), by the parent. As per Schedule III to the Companies Act, 2013, “Minority Interests” in the balance sheet within equity shall be presented separately from the equity of the owners of the parent. In the given case, the calculation of goodwill is presented below: Tangible Assets: 80% being share of parent 400 Net Current Assets: 80% being share of parent 400 800 Less: Liabilities NIL Net Worth of S Ltd.: attributable to the parent's shareholding 800 Investment in S Ltd. (purchase consideration) 1,000 Goodwill / (Capital Reserve) 200 1.13.PROFIT OR LOSS OF SUBSIDIARY COMPANY For the purpose of consolidated balance sheet preparation, all reserves and profits (or losses) of subsidiary company should be classified into pre and post- acquisition reserves and profits (or losses). © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.27 FINANCIAL STATEMENTS Profits (or losses) earned (or incurred) by subsidiary company up to the date of acquisition of the shares by the holding company are pre acquisition or capital profits (or loss). Similarly, all reserves of subsidiary company up to the date of acquisition are capital reserves from the view point of holding company. If the holding interest in subsidiary is acquired during the middle or some other period of the current year, pre-acquisition profit should be calculated accordingly. The minority interest in the reserves and profits (or losses) of subsidiary company should be transferred to minority interest account which will also include share capital of subsidiary company held by outsiders / minority shareholders. Minority Interest = Share Capital of subsidiary belonging to outsiders + Minority interest in reserves and profits of subsidiary company The holding company’s interest in the pre-acquisition reserves and profits (or losses) should be adjusted against cost of control to find out goodwill or capital reserve on consolidation. The reserves and profits (or loss) of subsidiary company, representing holding company’s interest in post-acquisition or revenue reserves and profits (or losses), should be added to the reserves and profits (or losses) of holding company. 1.14 CONSOLIDATION ADJUSTMENTS A. Revaluation of Assets of Subsidiary Company It may be possible that the fair value of the assets of the subsidiary may be different from the book value. Hence, the parent may choose to perform a revaluation of the assets of the subsidiary for the purposes of consolidation. It may be noted that such revaluation is not performed in the standalone / separate financial statements of the subsidiary. The profit or loss on revaluation of fixed assets of subsidiary should also be treated as capital profit or loss. But if the fall in the value of the asset occurs after the date of acquisition, the loss should be treated as revenue loss. Adjustment for depreciation would be made in the profit and loss account of the subsidiary. © The Institute of Chartered Accountants of India  10.28 ADVANCED ACCOUNTING Depreciation on changed value of the assets shall be given effect to. Depreciation on revalued assets will be taken as capital or revenue depending on the period for which the depreciation belongs to. Hence the period for depreciation is important to be considered. Property, Plant and Equipment (PPE) Initial Recognition Subsequent Measurement Fair Value (-) Carrying Amount Additional Depreciation would arise in case of initial upward or Reversal of (As on the date of acquisition) excess depreciation would arise in case of initial downward valuation. PPE A/c Dr. xxx Post P/L Dr. xxx To Pre- P/L xxx To PPE xxx (In case of upward revaluation) (Additional depreciation) Pre- P/L Dr. xxx PPE Dr. xxx To PPE xxx To Post P/L xxx (In case of downward revaluation) (Reversal of excess depreciation) 1. The above entries are not recorded in the standalone books of either the subsidiary or the parent. These entries are only for understanding the impact in the consolidated financial statements and as such, only the effect of such entries will appear in the consolidated financial statements (and not the standalone / separate financial statements). 2. It is presumed that the subsidiary does not follow the revaluation model for accounting of fixed assets. If it had to follow, then the standalone balance sheet of the subsidiary would already contain the impact of the revaluation. The debit /credit on account of revaluation could alternatively be taken to the Revaluation Reserve or the P/L depending on whether it is a first-time upward / downward revaluation. However, as ultimately the reserves have to be analyzed between pre- and post-acquisition for the purposes of consolidation, the nature of reserves is irrelevant. © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.29 FINANCIAL STATEMENTS Example 5 H Ltd. acquires 70% of the equity shares of S Ltd. on 1.1.20X1. On that date, paid up capital of S Ltd. was 10,000 equity shares of ` 10 each; accumulated reserve balance was ` 1,00,000. H Ltd. paid ` 1,60,000 to acquire 70% interest in the S Ltd. Assets of S Ltd. were revalued on 1.1.20X1 and a revaluation loss of ` 20,000 was ascertained. The book value of shares of S Ltd. is calculated as shown below: ` 70% of the Equity Share Capital ` 1,00,000 70,000 70% of Accumulated Reserve ` 1,00,000 70,000 70% of Revaluation Loss ` 20,000 (14,000) 1,26,000 So, H Ltd. paid a positive differential of ` 34,000 i.e. ` (1,60,000 – 1,26,000). This differential is called goodwill and is shown in the balance sheet under the head intangibles. Example 6 A Ltd. acquired 70% interest in B Ltd. on 1.1.20X1. On that date, B Ltd. had paid-up capital of ` 1,00,000 consisting of 10,000 equity shares of ` 10 each and accumulated balance in reserve and surplus of `1,00,000. On that date, assets and liabilities of B Ltd. were also revalued and revaluation profit of ` 20,000 was calculated. A Ltd. paid ` 1,30,000 to purchase the said interest. In this case, the book value of Shares of B Ltd. is calculated as shown below: ` 70% of the Equity Share Capital `1,00,000 70,000 70% of Reserves and Surplus ` 1,00,000 70,000 70% of Revaluation Profit ` 20,000 14,000 1,54,000 In this case, a negative differential of ` 24,000 arises i.e. (1,54,000 – 1,30,000) which is called and presented as capital reserve. © The Institute of Chartered Accountants of India  10.30 ADVANCED ACCOUNTING Example 7 H Ltd. acquired 16,000 equity shares of ` 10 each, in S Ltd. on October 1, 20X1 for ` 3,06,800. The profit and loss account of S Ltd. showed a balance of `10,000 on April 1,20X1. The plant and machinery of S Ltd. which stood in the books at ` 1,50,000 on April 1,20X1 was considered worth ` 1,80,000 on the date of acquisition. The information of the two companies as at 31-3-20X2 was as follows: H Ltd.(` ) S Ltd. (` ) Shares capital (fully paid equity shares of ` 10 5,00,000 2,00,000 each) General reserve 2,40,000 1,00,000 Profit and loss account 57,200 82,000 Current Liabilities 1,69,800 33,000 Land and building 1,80,000 1,90,000 Plant and machinery 2,40,000 1,35,000 Investments 3,06,800 Current assets 2,40,200 90,000 In this case, Percentage of holding: No. of Shares Percentage Holding Co. : 16,000 (80%) Minority shareholders : 4,000 (20%) TOTAL SHARES : 20,000 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.31 FINANCIAL STATEMENTS Impact of Revaluation of Plant and Machinery will be as - ` Book value of Plant and Machinery as on 01-04-20X1 1,50,000 Depreciation Rate (1,50,000-1,35,000) = 15,000/1,50,000 X100 10% 1,50,000 Book value of Plant and Machinery as on 01-10-20X1 after six months 1,42,500 depreciation @10% (1,50,000-7,500) Revalued at 1,80,000 Revaluation profit (1,80,000-1,42,500) 37,500 Share of H Limited in Revaluation Profit (80%) 30,000 Share of Minority in Revaluation profit (20%) 7,500 Additional Depreciation on appreciated value to be charged from post- acquisition profits (10% of ` 1,50,000 for 6 months) + (10% of ` 1,80,000 for 6 months) 1500 less ` 15,000 (as already charged) Share of H Limited in additional depreciation that will reduce its share 1,200 (80%) in post-acquisition profit by Share of Minority Interest in additional depreciation 300 B. Dividend Received From SubsidiarY(IES) As per AS 13, ‘Accounting for Investments’, Interest, dividends and rentals receivables in connection with an investment are generally regarded as income, being the return on the investment. However, in some circumstances, such inflows represent a recovery of cost and do not form part of income. Example: When unpaid interest has accrued before the acquisition of an interest- bearing investment and is therefore included in the price paid for the investment, the subsequent receipt of interest is allocated between pre-acquisition and post- acquisition periods; the pre-acquisition portion is deducted from cost. When dividends on equity are declared from pre-acquisition profits, a similar treatment (i.e. as mentioned above) may apply. If it is difficult to make such an © The Institute of Chartered Accountants of India  10.32 ADVANCED ACCOUNTING allocation except on an arbitrary basis, the cost of investment is normally reduced by dividends receivable only if they clearly represent a recovery of a part of the cost. When holding company receives dividend from a subsidiary company, it must distinguish between the part received out of capital profits (i.e. pre-acquisition profits) and revenue profits (i.e. post-acquisition profits); capital profits are credited to Investment account (being capital receipts) and revenue profits are credited to the Profit & Loss Account. If the controlling interest was acquired during the course of a year, profit for that year must be apportioned into the pre-acquisition and post-acquisition portions, on the basis of time in the absence of information on the point. It must be understood that the term ‘capital profit’, in this context, apart from the generic meaning of the term, connotes profit earned by the subsidiary company till the date of acquisition. As a result, profits which may be of revenue nature for the subsidiary company may be capital profits so far as the holding company is concerned. Treatment in case of post-acquisition dividend Post acquisition dividend Accounted by the Not accounted by the In the books of the subsidiary subsidiary holding company No further adjustment Adjusted at the time of required consolidation Accounted by crediting P&L A/c of the holding company © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.33 FINANCIAL STATEMENTS Treatment in case of pre-acquisition dividend Accounted by holding Not accounted by Not accounted by company holding company subsidiary company If correctly accounted If wrongly accounted Adjust the same at Adjust the same at as reduction to the by crediting to P&L the time of the time of cost of investment A/c consolidation consolidation Reverse the entry Account for as Reduce the pre- No further passed and credit reduction to cost of acquisition profit of adjustment required investment in investment subsidiary and then subsidiary distribute it into holding and minority interest Also reduce the cost of investment Dividends received out of profits earned before purchase of investments normally also are credited to the Investment Account. Example 8 If shares in X Ltd., are purchased in January 20X2 and in April 20X2, X Ltd., declares a dividend in respect of 20X1, the dividend received by the holder of the shares correctly should not be treated as income but as capital receipt and credited to Investment Account. Note: In case of issue of bonus shares by the subsidiary company, the holding company, like other holders, record no entry; only the number of shares held is increased. Illustration 1 From the following data, determine in each case: (1) Minority interest at the date of acquisition and at the date of consolidation. (2) Goodwill or Capital Reserve. © The Institute of Chartered Accountants of India  10.34 ADVANCED ACCOUNTING (3) Amount of holding company’s profit in the consolidated Balance Sheet assuming holding company’s own Profit & Loss Account to be ` 2,00,000 in each case: Subsidiary % Cost Date of Consolidation Company shares acquisition Date owned 1.1.20X1 31.12.20X1 Case Share Profit & Share Profit & Capital Loss Capital Loss Account Account ` ` ` ` ` Case 1 A 90% 1,40,000 1,00,000 50,000 1,00,000 70,000 Case 2 B 85% 1,04,000 1,00,000 30,000 1,00,000 20,000 Case 3 C 80% 56,000 50,000 20,000 50,000 20,000 Case 4 D 100% 1,00,000 50,000 40,000 50,000 55,000 Solution (1) Minority Interest = Equity attributable to minorities Equity is the residual interest in the assets of an enterprise after deducting all its liabilities i.e. in this case it should be equal to Share Capital + Profit & Loss A/c Minority % Minority Minority interest Shares interest as at as at the date of Owned the date of consolidation acquisition [E] [E] x [A + B] ` [E] X [C + D] ` Case 1 [100-90] 10 % 15,000 17,000 Case 2 [100-85] 15 % 19,500 18,000 Case 3 [100-80] 20 % 14,000 14,000 Case 4 [100-100] NIL Nil Nil © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.35 FINANCIAL STATEMENTS A = Share capital on 1.1.20X1 B = Profit & loss account balance on 1.1.20X1 C = Share capital on 31.12.20X1 D = Profit & loss account balance on 31.12.20X1 (2) Calculation of Goodwill or Capital Reserve Shareholding Cost Total Equity Parent’s Goodwill Capital Portion Reserve of equity % [F] [G] [A] + [B] = [F] x [C] ` [G] – ` [H] – [C] =H [H] [G] Case 1 90 % 1,40,000 1,50,000 1,35,000 5,000 — Case 2 85 % 1,04,000 1,30,000 1,10,500 — 6,500 Case 3 80 % 56,000 70,000 56,000 Nil Nil Case 4 100 % 1,00,000 90,000 90,000 10,000 — (3) The balance in the Profit & Loss Account on the date of acquisition (1.1.20X1) is Capital profit, as such the balance of Consolidated Profit & Loss Account shall be equal to Holding Co.’s profit. On 31.12.20X1 in each case the following amount shall be added or deducted from the balance of holding Co.’s Profit & Loss account. % Share P & L as on P & L as on P & L post Amount to be holding 1.1.20X1 consolidati acquisition added / on date (deducted) from holding’s P & L [M] [K] [L] [N] = [M]-[L] [O] = [K] x [N] 1 90 % 50,000 70,000 20,000 18,000 2 85 % 30,000 20,000 (10,000) (8,500) 3 80 % 20,000 20,000 NIL NIL 4 100 % 40,000 55,000 15,000 15,000 © The Institute of Chartered Accountants of India  10.36 ADVANCED ACCOUNTING Illustration 2 XYZ Ltd. purchased 80% shares of ABC Ltd. on 1st January, 20X1 for ` 1,40,000. The issued capital of ABC Ltd., on 1st January, 20X1 was ` 1,00,000 and the balance in the Profit & Loss Account was ` 60,000. During the year ended 31st December, 20X1, ABC Ltd. earned a profit of ` 20,000 and at year end, declared and paid a dividend of ` 15,000. Show by an entry how the dividend should be recorded in the books of XYZ Ltd. What is the amount of minority interest as on 1st January, 20X1 and 31st December, 20X1? Also please check whether there should be any goodwill/ capital reserve at the date of acquisition. Solution Total dividend paid is ` 15,000 (assumed to be out of post-acquisition profits), hence dividend received by XYZ will be credited to P & L. XYZ Ltd.’s share of dividend = ` 15,000 X 80% = ` 12,000 In the books of XYZ Ltd. ` ` Bank A/c Dr. 12,000 To Profit & Loss A/c 12,000 (Dividend received from ABC Ltd credited to P&L A/c being out of post-acquisition profits – as explained above) Goodwill on consolidation (at the date of ` ` acquisition): Cost of shares 1,40,000 Less: Face value of capital i.e. 80% of capital 80,000 Add: Share of capital profits [60,000X 80 %] 48,000 (1,28,000) Goodwill 12,000 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.37 FINANCIAL STATEMENTS Minority interest on: - 1st January, 20X1: 20% of ` 1,60,000 [1,00,000 + 60,000] 32,000 - 31st December, 20X1: 33,000 20% of ` 1,65,000 [1,00,000 + 60,000 + 20,000 – 15,000] Illustration 3 Exe Ltd. acquires 70% of equity shares of Zed Ltd. as on 31st March, 20X1 at a cost of ` 70 lakhs. The following information is available from the balance sheet of Zed Ltd. as on 31st March, 20X1: ` in lakhs Property, plant and equipment 120 Investments 55 Current Assets 70 Loans & Advances 15 15% Debentures 90 Current Liabilities 50 The following revaluations have been agreed upon (not included in the above figures): Property, plant and equipment Up by 20% Investments Down by 10% Zed Ltd. declared and paid dividend @ 20% on its equity shares as on 31 st March, 20X1 (Face value - ` 10 per share). Exe Ltd. purchased the shares of Zed Ltd. @ ` 20 per share. Calculate the amount of goodwill/capital reserve on acquisition of shares of Zed Ltd. © The Institute of Chartered Accountants of India  10.38 ADVANCED ACCOUNTING Solution Revalued net assets of Zed Ltd. as on 31st March, 20X1 ` in lakhs ` in lakhs Property, plant and equipment [120 X 120%] 144.0 Investments [55 X 90%] 49.5 Current Assets 70.0 Loans and Advances 15.0 Total Assets after revaluation 278.5 Less: 15% Debentures 90.0 Current Liabilities 50.0 (140.0) Equity / Net Worth 138.5 Exe Ltd.’s share of net assets (70% of 138.5) 96.95 Exe Ltd.’s cost of acquisition of shares of Zed Ltd. (` 70 lakhs – ` 7 lakhs*) 63.00 Capital reserve 33.95 * Total Cost of 70 % Equity of Zed Ltd ` 70 lakhs Purchase Price of each share ` 20 Number of shares purchased [70 lakhs /` 20] 3.5 lakhs Dividend @ 20 % i.e. ` 2 per share ` 7 lakhs Since dividend received is for pre-acquisition period, it has been reduced from the cost of investment in the subsidiary company. Illustration 4 A Ltd. acquired 70% of equity shares of B Ltd. on 1.4.20X1 at cost of ` 10,00,000 when B Ltd. had an equity share capital of ` 10,00,000 and reserves and surplus of ` 80,000. In the four consecutive years, B Ltd. fared badly and suffered losses of ` 2,50,000, ` 4,00,000, ` 5,00,000 and ` 1,20,000 respectively. Thereafter in 20X5- X6, B Ltd. experienced turnaround and registered an annual profit of ` 50,000. In the © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.39 FINANCIAL STATEMENTS next two years i.e. 20X6-X7 and 20X7-X8, B Ltd. recorded annual profits of ` 1,00,000 and ` 1,50,000 respectively. Show the minority interests and cost of control at the end of each year for the purpose of consolidation. Solution The losses applicable to the minority in a consolidated subsidiary may exceed the minority interest in the equity of the subsidiary. In such cases, AS 21 prescribes that the excess, and any further losses applicable to the minority, are adjusted against the majority interest except to the extent that the minority has a binding obligation to, and is able to, make good the losses. If the subsidiary subsequently reports profits, all such profits are allocated to the majority interest until the minority's share of losses previously absorbed by the majority has been recovered. Where the minority interest has a binding obligation (say by way of a shareholders’ agreement), then the share of losses will be attributed to the minority interest even if it exceeds the minority interest in the equity (i.e., debit balance in minority interest). Since information on the existence of a binding obligation is not given in the question, we solve as if such obligation does not exist, and hence the minority interests will be computed as follows: Year Profit/(Loss) Minority Additional Minority's Share Cost of Interest Consolidated of losses borne Control (30%) P & L (Dr.) by A Ltd. Cr. (for the year ended balance) ` Balance At the time of - acquisition in 3,24,000 20X1 - (W.N.) © The Institute of Chartered Accountants of India  10.40 ADVANCED ACCOUNTING 20X1-X2 (2,50,000) (75,000) (1,75,000) 2,44,000 (W.N.) Balance 2,49,000 20X2-X3 (4,00,000) (1,20,000) (2,80,000) 2,44,000 Balance 1,29,000 20X3-X4 (5,00,000) (1,50,000) (3,50,000) 2,44,000 (21,000) Loss of 21,000 (21,000) 21,000 21,000 minority borne by Holding Co. Balance Nil (3,71,000) 20X4-X5 (1,20,000) (36,000) (84,000) 2,44,000 Loss of minority 36,000 (36,000) 36,000 57,000 borne by Holding Co. Balance Nil (1,20,000) 20X5-X6 50,000 15,000 35,000 2,44,000 Profit share (15,000) 15,000 (15,000) 42,000 of minority adjusted against losses of minority absorbed by Holding Co. Balance Nil 50,000 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.41 FINANCIAL STATEMENTS 20X6-X7 1,00,000 30,000 70,000 Profit share (30,000) 30,000 (30,000) 12,000 2,44,000 of minority adjusted against losses of minority absorbed by Holding Co. Balance Nil 100,000 20X7-X8 1,50,000 45,000 1,05,000 (12,000) Nil 2,44,000 (12,000) 12,000 Balance 33,000 1,17,000 Working Note: Calculation of Minority interest and Cost of control on 1.4.20X1 Share of Minority Holding Interest Co. 100% 70% 30% (`) (`) (`) Share Capital 10,00,000 7,00,000 3,00,000 Reserve 80,000 56,000 24,000 7,56,000 3,24,000 Less: Cost of investment (10,00,000) Goodwill 2,44,000 Illustration 5 Variety Ltd. holds 46% of the paid-up share capital of VR Ltd. The shares were acquired at a market price of ` 17 per share. The balance of shares of VR Ltd. are © The Institute of Chartered Accountants of India  10.42 ADVANCED ACCOUNTING held by a foreign collaborating company. A memorandum of understanding has been entered into with the foreign company providing for the following: (a) The shares held by the foreign company will be sold to Variety Ltd. The price per share will be calculated by capitalising the yield at 15%. Yield, for this purpose, would mean 40% of the average of pre-tax profits for the last 3 years, which were ` 30 lakhs, ` 40 lakhs and ` 65 lakhs. (b) The actual cost of the shares to the foreign company was ` 5,40,000 only. The profit that would accrue to them would be taxable at an average rate of 30%. The tax payable will be deducted from the proceeds and Variety Ltd. will pay it to the Government. (c) Out of the net consideration, 50% would be remitted to the foreign company immediately and the balance will be an unsecured loan repayable after two years. The above agreement was approved by all concerned for being given effect to on 1.4.20X1. The total assets of VR Ltd. as on 31st March, 20X1 was ` 1,00,00,000. It was decided to write down Property, Plant and Equipment by ` 1,75,000. Current liabilities of VR Ltd. as on the same date were ` 20,00,000. The paid-up share capital of VR Ltd. was ` 20,00,000 divided into 2,00,000 equity shares of ` 10 each. Find out goodwill/capital reserve to Variety Ltd. on acquiring wholly the shares of VR Ltd. Solution 1. Computation of Purchase Consideration (a) Yield of VR Ltd.:  40 × 30 + 40 +65  ` 18 lakhs  100 3  (b) Price per share of VR Ltd.: Capitalized Yield: 18 lakhs  ` 120 lakhs  0.15  No. of shares 2 lakhs Therefore, price per share ` 60 (c) Purchase Consideration for 54% shares in VR Ltd. 2 lakh shares x 54% x ` 60 per shares ` 64.80 lakhs © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.43 FINANCIAL STATEMENTS (d) Discharge of Purchase Consideration: 30 Tax at source (` 64.80 lakhs – ` 5.40 lakhs) × 100 ` 17.82 lakhs 50% of purchase consideration (net of tax) in cash ` 23.49 lakhs [` (64.80 – 17.82) x 50%] Balance – Unsecured Loan ` 23.49 lakhs 2. Goodwill / Capital Reserve to Variety Ltd. ` in lakhs Total Assets 100.00 Less: Reduction in Value of Property, Plant and (1.75) Equipment 98.25 Less: Current Liabilities (20.00) Net Assets of VR Ltd. on Date of Acquisition 78.25 Purchase Consideration: 54% purchased from Foreign 64.80 Co. Investment: 46% existing stake 15.64 (80.44) Goodwill on Date of Acquisition 2.19 Illustration 6 A Ltd. acquired 60% shares of B Ltd. @ ` 20 per share. Following is the extract of Balance Sheet of B Ltd.: ` 10,00,000 Equity Shares of ` 10 each 1,00,00,000 10% Debentures 10,00,000 Trade Payables 55,00,000 Property, Plant and Equipment 70,00,000 Investments 45,00,000 Current Assets 68,00,000 Loans and Advances 22,00,000 © The Institute of Chartered Accountants of India  10.44 ADVANCED ACCOUNTING On the same day B Ltd. declared dividend at 20% and as agreed between both the companies Property, Plant and Equipment were to be depreciated @ 10% and investment to be taken at market value of ` 60,00,000. Calculate the Goodwill or Capital Reserve to be recorded in Consolidated Financial Statements. Solution Since dividend is declared by B Ltd. on the date of acquisition itself, it would be out of the divisible profits of B Ltd. existing on the date of acquisition i.e., pre- acquisition profits from the perspective of A Ltd. Accordingly, as per AS 13, such pre-acquisition dividend would be reduced from the cost of investment, as seen below in the determination of Goodwill on the date of acquisition. ` ` Assets Property, Plant and Equipment 70,00,000 Less: Value written off (` 70 lakhs x 10%) (7,00,000) 63,00,000 Investments at Market Value 60,00,000 Current Assets 68,00,000 Loans and Advances 22,00,000 2,13,00,000 Less: Liabilities Trade Payables 55,00,000 10% Debentures 10,00,000 (65,00,000) Net Assets of B Ltd. 1,48,00,000 Share of A Ltd. in Net Assets of B Ltd.: 60% 88,80,000 Less: Cost of Investment in B Ltd. (60% stake): 10,00,000 Equity Shares x 60% x ` 20 per share 1,20,00,000 Less: Pre-acquisition dividend: 6,00,000 shares x `2 (12,00,000) (1,08,00,000) Goodwill on Date of Acquisition 19,20,000 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.45 FINANCIAL STATEMENTS Illustration 7 H Ltd. acquired 3,000 shares in S Ltd., at a cost of ` 4,80,000 on 31.7.20X1. The capital of S Ltd. consisted of 5,000 shares of ` 100 each fully paid. The Profit & Loss Account of this company for 20X1 showed an opening balance of ` 1,25,000 and profit for the year was ` 3,00,000. At the end of the year, it declared a dividend of 40%. Record the entry in the books of H Ltd., in respect of the dividend. Assume the profit is accruing evenly and calendar year as financial year. Solution The profits of S Ltd., have to be divided between capital and revenue profits from the point of view of the holding company: Capital Revenue Profit (Pre- Profit (Post- acquisition) acquisition) ` ` Balance on 1.1.20X1 1,25,000 — Profit for 20X1 (3,00,000 × 7/12) 1,75,000 (3,00,000×5/12) 1,25,000 Total 3,00,000 1,25,000 Proportionate share of H Ltd. (3/5) 1,80,000 75,000 Total dividend declared = ` 5,00,000 X 40 % = ` 2,00,000 H Ltd.’s share in the dividend = ` 2,00,000 X 3/5 = ` 1,20,000 There can be two situations as regards the treatment of dividend of ` 1,20,000: (1) The profit for 20X1 has been utilised to pay the dividend. The share of H Ltd in profit for the first seven months of S Ltd = ` 1,05,000 (i.e. ` 1,75,000 × 3/5) Profit for the remaining five months = ` 75,000 (i.e.` 1,25,000 × 3/5). © The Institute of Chartered Accountants of India  10.46 ADVANCED ACCOUNTING The dividend of ` 1,20,000 will be adjusted in this ratio of 1,05,000: 75,000 = ` 70,000 out of profits up to 31.7.20X1 and ` 50,000 out of profits after that date. The dividend out of profits subsequent to 31.7.20X1 will be revenue income and that out of earlier profits will be capital receipt. Hence the entry will be: ` ` Bank Dr. 1,20,000 To Investment Account 70,000 To Profit and Loss Account 50,000 (2) Later profits have been utilised first and then pre- acquisition profits. In such a case, the whole of ` 75,000 (share of H Ltd. in profits of S Ltd., after 31.7.20X1) would be received and treated as revenue income; the remaining dividend, `45,000 (`1,20,000 less ` 75,000) would be capital receipt. The entry would be: ` ` Bank Dr. 1,20,000 To Investment Account 45,000 To Profit & Loss Account 75,000 Note: Point (2) discussed above can arise only if there is definite information about the profits utilized. In practice, such treatment is rare. Illustration 8 A Ltd. and B Ltd. provide the following information: ` ‘000s A Ltd. B Ltd. Equity Shares 6,000 5,000 6% Preference Shares NIL 1,000 General Reserve 1,200 800 © The Institute of Chartered Accountants of India  ACCOUNTING STANDARD FOR CONSOLIDATED 10.47 FINANCIAL STATEMENTS Profit and Loss Account 1,020 1,790 Trade Payables 3,850 3,410 Dividend Payable 600 500 Goodwill 100 20 Property, Plant and Equipment