Chapter 19: Consolidated income statement

Chapter learning objectives

Upon completion of this chapter you will be able to

Describe the components of and prepare a consolidated statement of comprehensive income or extracts thereof including:

• Elimination of inter-company trading balances (excluding cash and goods in transit)
• Removal of unrealised profit arising on inter-company trading
• Acquisition of subsidiaries part way through the financial year

1 Introduction

The consolidated income statement shows the profit generated by all resources disclosed in the related consolidated statement of financial position, i.e. the net assets of the parent company (P) and its subsidiary (S).

2 The Basic Principles

The consolidated income statement follows these basic principles:

From revenue to profit for the year include all of P’s income and expenses plus all of S’s income and expenses (reflecting control of S), subject to adjustments (see below).

After profit for the year show split of profit between amounts attributable to the parent's shareholders and the non-controlling interest (to reflect ownership).

3 The mechanics of consolidation

As with the statement of financial position, it is common to use standard workings when producing a consolidated income statement

• group structure diagram
• net assets of subsidiary at acquisition (required for goodwill calculation if asked to calculate)
• goodwill calculation (if asked to calculate goodwill or if you are required to calculate an impairment that is to be charged to profits (see below)
• non-controlling interest (NCI) share of profit (see below)

Non-controlling interest

This is calculated as:

Depreciation on fair value adjustments and impairment of goodwill is not examinable for this syllabus.

4 Intra-group trading

Sales and purchases

The effect of intra-group trading must be eliminated from the consolidated income statement. Such trading will be included in the sales revenue of one group company and the purchases of another.

• Consolidated sales revenue = P’s revenue + S’s revenue – intra-group sales.
• Consolidated cost of sales = P’s COS + S’s COS – intra-group sales.

5 Interest

If there is a loan outstanding between 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.

Dividends

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:

• 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 which you will not be required to prepare for this examination.
• any dividend income shown in the consolidated income statement must arise from investments other than those in subsidiaries.

Illustration 1 – Simple CSI

The income statements for P and S for the year ended 31 August 20X4 are shown below. P acquired 75% of the ordinary share capital of S several years ago.

Prepare the consolidated income statement for the year.

Solution

P consolidate income statement for the year ended 31 August 20X4

(W1) Non-controlling interest

6 Provision for unrealised profits

Inventory

If any goods sold intra-group are included in closing inventory, their value must be adjusted to the lower of cost and net realisable value (NRV) to the group (as in the CSFP).

The adjustment for unrealised profit should be shown as an increase to cost of sales (return inventory back to true cost to group and eliminate unrealised profit).

Illustration 2 – PURP

On 1 January 20X9 P acquired 60% of the ordinary shares of S.

The following income statements have been produced by P and S for the year ended 31 December 20X9.

During the year ended 31 December 20X9 P had sold $42,000 worth of goods to S. These goods had cost P $28,000. On 31 December 20X9 S still had half of these 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

(W1) Unrealised profit in inventory

(W2) Non-controlling interest

Other CSI adjustments

Impairment of goodwill

Once any impairment has been identified during the year, the charge for the year will be passed through the consolidated income statement. This will usually be through operating expenses, however always follow instructions from the examiner.

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.

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 based on the value the asset is held at in the subsidiary's own SFP.

The consolidated income statement must include a depreciation charge based on the fair value of the asset, included in the consolidated SFP.

Extra depreciation must therefore be calculated and charged to an appropriate cost category (usually in line with examiner requirements).

7 Mid-year acquisitions

Mid-year acquisition procedure

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:

• Identification of the net assets of S at the date of acquisition in order to calculate goodwill.
• Time apportionment of the results 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.

Illustration 3 – Mid-year acquistions

The following income statements have been produced by P and S for the year ended 31 March 20X9.

• On the 30 November 20X8 P acquired 75% of the issued ordinary share capital of S. No dividends 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 consolidated income statement for the year ended 31 December 20X9

Note

P acquired 75% of the issued ordinary share capital of S on 30 November 20X8. This is the 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.

8 IAS 28 Investments in associates

Definition of an associate

IAS 28 defines an associate as:

An entity over which the investor has significant influence and that is neither a subsidiary nor an interest in joint venture.

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies.

Significant influence is assumed with a shareholding of 20% to 50%.

Principles of equity accounting and reasoning behind it

Equity accounting is a method of accounting whereby the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the investor’s share of net assets of the associate.

The effect of this is that the consolidated statement of financial position includes:

• 100% of the assets and liabilities of the parent and subsidiary company on a line by line basis
• an ‘investments in associates’ line within non-current assets which includes the group share of the assets and liabilities of any associate.

The consolidated income statement includes:

• 100% of the income and expenses of the parent and subsidiary company on a line by line basis
• one line ‘share of profit of associates’ which includes the group share of any associate’s profit after tax.

Note: In order to equity account, the parent company must already be producing consolidated financial statements (i.e. it must already have at least one subsidiary).

Test your understanding 1

Set out below are the draft income statements of P and its subsidiary S for the year ended 31 December 20X7.

On the 1 January 20X6 P purchased 75% of the ordinary shares in S.

• During the year S sold goods to P for $20,000, making a mark up of one third. Only 20% of these goods were sold before the end of the year, the rest were still in inventory.
• P values non-controlling interest using the fair value method.

Prepare the consolidated income statement for the year ended 31 December 20X7.

IAS 28 Investments in Associates

Accounting for associates according to IAS 28

The equity method of accounting is normally used to account for associates in the consolidated financial statements.

The equity method should not be used if:

• the investment is classified as held for sale in accordance with IFRS 5 or
• the parent is exempted from having to prepare consolidated accounts on the grounds that it is itself a wholly, or partially, owned subsidiary of another company (IAS 27).

9 Associates in the consolidated statement of financial position

Preparing the CSFP including an associate

The CSFP is prepared on a normal line-by-line basis following the acquisition method for the parent and subsidiary.

The associate is included as a non-current asset investment calculated as:

The group share of the associate’s post acquisition profits or losses and the impairment of goodwill will also be included in the group retained earnings calculation.

10 Associates in the consolidated income statement

Equity accounting

The equity method of accounting requires that the consolidated income statement:

• does not include dividends from the associate
• instead includes group share of the associate’s profit after tax less any impairment of the associate in the year (included below group profit from operations).

Trading with the associate

Generally the associate is considered to be outside the group.

Therefore any sales or purchases between group companies and the associate are not normally eliminated and will remain part of the consolidated figures in the income statement.

It is normal practice to instead adjust for the unrealised profit in inventory.

Dividends from associates

Dividends from associates are excluded from the consolidated income statement; the group share of the associate’s profit is included instead.

11 Chapter summary

Test your understanding answers

Test your understanding 1

P consolidated income statement for the year ended 31 December 20X7

(W1) Unrealised profit in inventory

(W2) Non-controlling interest

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