[DOCUMENT TYPE]

Advanced Financial Reporting

BAF332

Mulungushi University
School of Business
2 Unit 5 CONSOLIDATED INCOME STATEMENT

Unit 5

CONSOLIDATED INCOME
STATEMENT

Introduction
In the previous Unit for consideration, we focused more on group statement financial
position; this unit is the continuation of full consolidation with a focus on group income
statement.

Upon completion of this unit you will be able to:

 Understand and apply the Basic Principles of Consolidated

Income Statements

 Understand how to deal with inter-company trading

Outcomes transaction

 Understand and apply the concept relating to Acquisition of

subsidiary part way through the financial year.

Consolidated The statement that shows the income,

Income Statements: expenses and profit generated by the parent
and all its subsidiaries.

Terminology

Outcome 1: Understand and apply the Basic Principles of

Consolidated Income Statements.
The consolidated income statement follows these basic principles:
From revenue to profit for the year include all of P’s income and expenses plus
S’s income and expenses (reflecting control of S), subject to adjustments (see
below).
After profit of the year show split profit between amounts attributable to the
parent’s shareholders and the non- controlling interest (to reflect ownership)
The following similar steps should be followed when preparing the consolidation
Income Statement
1. Group structure diagram
2. Net assets of subsidiary at acquisition (required for goodwill calculation if
asked to calculate)
3. Goodwill calculation ( if asked to calculate goodwill or if required to calculate
an impairment that is to be charged to profits
4. Non-controlling interest (NCI) share of profit

The first three are optional depending on the requirement of the question but the
last one NCI share of the profit is mandatory as this will be used to show the split
in profit between the group and the NCI

The NCI is calculated as below

Non-controlling interest
NCI % x subsidiary’s profit after tax X
Less:
NCI % x fair value depreciation (X)
NCI % x unrealized Profit (when the sub is the seller only) (X)
NCI % x good will impairment (fair value method) (X)
X.
Note that if the net asset method is used impairment is not included.

Example
The income statements of P and S for the year ended 31 December 2021 are
shown below. P acquired
75% of the ordinary share capital of S several years ago.
P S
K K
Revenue 9,600 3,200
Cost of sales and expenses (8,640) (2,880)
Gross profit 960 320
Investment income:
Dividends received from S 56
Profit before tax 1,016 320
Tax (440) (128)
Profit for the year 576 192
Prepare the consolidated income statement for the year.

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4 Unit 5 CONSOLIDATED INCOME STATEMENT

Solution
P group consolidated income statement for the year ended 31

K000
Revenue (9,600 + 3,200) 12,800
Cost of sales and expenses (8,640 +2,880) (11,520)
Profit before tax 1,280
Tax (440+128) (568)
Profit for the year 712
Attributable to:
Group (bal fig) 664
Non- controlling interest (W1) 48

(W1) Non-controlling interest

NCI share of subsidiary profit for the year 25% x K192=48

Note that the NCI profit for the year should be removed so as to reflect the actual
profit for the group

Dividends from S is also removed as it’s an intergroup transaction

Outcome 2.Understand how to deal with inter-company trading

transaction

As explained in the previous unit, all intercompany transaction must be eliminated

as they do not represent an arm’s length transaction.
The following adjustment will be considered
1. Sales and purchases
2. Provision for unrealized profits
3. Interests
4. Dividends
5. Impairment of goodwill
6. Fair values

1 Sales and purchases

When one company in a group sells goods to another the relevant amount is added
to the sales revenue of the selling company and to the cost of sales of the buying
company. Yet as far as the entity’s dealing with outsiders are concerned no sale
has taken place.
The consolidated figures for sales revenue and cost of sales should represent sales
to and purchases from outsiders. An adjustment is therefore necessary to reduce
the sales revenue and cost of sales figures by the value of intra group sales during
the year. The values are calculated as follows

1. Consolidated sales revenue= P’s revenue + S’s revenue – intra-group sales

2. Consolidated cost of sales= P’s COS + S’s COS – Intra–group sales.
2 Provision for unrealized profits
Unrealized profits often arises due to intra group transaction such as sales
If any goods sold intra-group are included in closing inventory, their value must
be adjusted to the lower of cost and net realizable value (NRV) to the group as in
the Consolidated Statement of Financial Position.
The adjustment for unrealized profit should be shown as an increase to cost of
sales (return inventory back to true cost group and eliminate unrealized profit).The
unrealized profit is added to the cost of sales when consolidating because the sales
from which this profit was made is subtracted during the consolidation process
OR The adjustment of unrealized profit can be made on the gross profit then the
cost of sales will be a balancing figure
3. Interests
If there is a loan outstanding between the group companies the effect of any loan
interest received and paid must be eliminated from the consolidated income
statement.
The relevant amount of interest should be deducted from group investment income
and group finance costs.

4 .Dividends
A payment of a dividend by S to P will need to be cancelled. The effect of this on
the consolidated income statement is that only dividends paid by P to its own
shareholders appear in the consolidated financial statements. These are shown
within the consolidated statement of changes in equity
Any dividend incomes shown in the consolidated income statement must arise
from investments other than those in subsidiaries or associates

5. Impairment of goodwill
Once impairment has been identified during the year, the charge for the year will
be passed through the consolidation income statement. This will usually be
through operating expenses, however always follow instructions given according
to company policy.
If non-controlling interests have been valued at fair value, a portion of the
impairment expense must be removed from the non-controlling interest’s share of
profit. However no portion is removed if the net asset method is used

6 Fair values
If a depreciating non-current asset of the subsidiary has been revalued as part of a
fair value exercise when calculating goodwill, this will result in an adjustment to
the consolidated income statement.
The subsidiary’s own income statement will include depreciation charge based on
the value of the asset, included in the subsidiary’s own Statement of Financial
Position.

The consolidated income statement must include depreciation charge based on the
fair value of the asset, included in the consolidated Statement of Financial
Position.Extra depreciation must therefore be calculated and charged to an
appropriate cost category ( usually in line with question requirement)

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6 Unit 5 CONSOLIDATED INCOME STATEMENT

Example 2
On 1 January 20X9 P acquired 60% of the ordinary shares of S
The following income statement have been produced by P and S for the year
ended 31 December 20X9

P S
K K
Revenue 45,000 18,571
Cost of sales and expenses (15,000) (7,500)
Gross profit 30,000 11,071
Distribution costs (6,429) (2,142)
Administration expenses (4,286) (3,214)
Profit from operations 19,285 5,715
Investment income from S 1,286
Profit before taxation 20,571 5,715
Tax (4,643) (928)
Profit for the year 15,928 4,787

During the year ended 31 December 20X9 P had sold K3, 000 worth of goods to
S. these goods had cost P K2, 000. On 31 December 20X9 S still had half of those
goods in inventories at the year end.

Prepare the consolidated income statement to incorporate P and S for the year
ended 31 December 20X9

Solution
P consolidated income statement for the year ended 31 December 20X9
K
Revenue (45,000 + 18,571 -3000) 60,571
Cost of sales and expenses (15,000+7,500– 3000+500) (W1)) (20,000)
Gross profit 40,571
Distribution costs (6,429 + 2,142) (8,571)
Administration expenses (4,286 +3,214) (7,500)
Profit from operations 24,500
Tax (4,643 + 928) (5,571)
Profit for the year 18,929
Amount attributed to:
Equity holders of the parent (balancing figure) 17,015
Non- controlling interest ( W2) 1,914

(W1) Unrealized profit in inventory

Selling price 3,000
Cost of goods (2000)
Total profit 1000
Provision for unrealized profit (1/2x K1000) 500

(W2) Non –controlling interest NCI

share of subsidiary‘s profit after tax 40% x K4, 786= K1, 914
Example 3

P Corporation acquired 85 percent of S Company's voting shares of stock in 20X7.During

20X8, P purchased 50,000 circuit boards for K15 each and sold 28,000 of them to ship for K20
each. Ship sold all of the units to unrelated entities prior to December 31, 20X8, for K30 each.
Both companies use perpetual inventory systems. Show the consolidating entry that is needed
in preparing consolidated financial statements for 20X8 to remove all effects of the
intercompany sale?

Solution

This consolidating entry is needed in preparing consolidated financial statements for

20X8 to remove all effects of the intercompany sale.

Dr Sales 560,000

Cr Cost of Goods Sold 560,000

K560, 000 is computed as follows: 28,000 × $20. This sale is classified as an

intercompany sale and must be eliminated as it does not represent an arm’s length
transaction.

There is no unrealized profit since all the items have been sold to the third parties .If
there was unrealized profit the journal entry would have been.

Dr Cost of sales

Cr Inventory

Outcome 3: Understand and apply the concept relating to Acquisition of

subsidiary part way through the financial year.
If a subsidiary is acquired part way through the year, then the subsidiary’s results
should only be consolidated from the date of acquisition, i.e the date on which
control is obtained
In practice this will require the following
1. Identification of the net assets of S at the date of acquisition in order to
calculate goodwill
2. Time apportionment of the result of S in the year of acquisition. For this
purpose, unless indicated otherwise, assume that revenue and expenses accrue
evenly
After time apportioning S’s results, deduction of post acquisition intra-group items
as normal

Example

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8 Unit 5 CONSOLIDATED INCOME STATEMENT

The following income statements have been produced by P and S for the year
ended 31 March 20X9
P S
K K
Revenue 607,200 435,400
Cost of sales and expenses (287,600) (204,400)
Gross profit 319,600 231,000
Operating expenses (142,400) (102,600)
Profit from operations 177,200 128,400
Investment income 5,600 2,400
Profit before taxation 182,800 130,800
Tax (92,400) (65,200)
Profit for the year 90,400 65,600

On the 30 November 20X8 P acquired 75% of the issued ordinary share capital of
S.No dividend were paid by either company during the year. The investment
income is from quoted investments and has been correctly accounted for.The
profits of both companies are deemed to accrue evenly over the year

Prepare the consolidated income statement to incorporate P and S for the

year ended 31 March 20X9

Solution
P acquired 75% of the issued ordinary share capital of S on 30 November
20X8.this is a date on which control passed and hence the date from which the
results of S should be reflected in the consolidated income statement.
All reserves earned by S in the four months since that date are post acquisition
reserves
The remaining previous eight months’ profit from 1 April 20X8 to 30 November
20X9 are all pre -acquisition

P consolidated income statement for the year ended 31 December 20X9

K
Revenue (607,200 + (435,400 x 4/12)) 752,332)
Cost of sales and expenses (287,600+(204,400 x 4/12)) (355,732)
Gross profit 396,600
Operating expenses (142,400 + (102,600 x 4/12)) (176,600)
Profit from operations 220,000
Investment income (5,600 + (2,400 x4/12)) 6,400
Profit before taxation 226,400
Tax (92,400+ (65,200 x 4/12) (114,132)
Profit for the year 112,268
Amount attributable to:
Equity holders of the parent 106,801
Non- controlling interest (25% x (65,600 x4/12)) 5,467
 Reading

For more information read the following

1. Chapter 2 and 3 of the recommended text book Advanced Financial

Accounting: Pearl Tan; Lim Chu Yeong; Kuah EE and Chapter.

2. Chapter 1 to 5 the recommended text Advanced financial accounting:

Christensen, T.E., Cottrell, D.M. and Budd, C.J., 2019. Advanced financial
accounting.

Unit summary
In this unit you have Understood and applied the Basic Principles
of Consolidated Income Statements and how to deal with inter-
company trading transaction
Summary

Assessment
Try Practice questions that relate to income
statement under unit 4 intergroup trading
Assessment inventory posited on Moodle.