Basic Consolidation Question 90

QUESTION 90: BASIC CONSOLIDATION

In recent years Hillusion has acquired a reputation for buying modestly performing businesses and
selling them at a substantial profit within a period of two to three years of their acquisition. On 1
July 2002 Hillusion acquired 80% of the ordinary share capital of Skeptik at a cost of $10,280,000.
On the same date it also acquired 50% of Skeptik’s 10% loan notes at par. The market price of
each Skeptik share at the date of acquisition was $6.00. The summarized draft financial
statements of both companies are:

Statements of profit or loss and other comprehensive income: Year to 31 March 2003
Hillusion Skeptik
$000 $000
Sales revenue 60,000 24,000
Cost of sales (42,000) (20,000)
Gross profit 18,000 4,000
Operating expenses (6,000) (200)
Loan interest received (paid) 75 (200)
Operating profit 12,075 3,600
Taxation (3,000) (600)
Profit after tax for the year 9,075 3,000

Statements of financial position: as at 31 March 2003

Tangible non-current assets 19,320 8,000
Investments 11,280 Nil
30,600 8,000

Current assets 15,000 8,000

Total assets 45,600 16,000

Equity and liabilities

Ordinary shares of $1 each 10,000 2,000
Accumulated profits 25,600 8,400
35,600 10,400
Non-current liabilities
10% Loan notes nil 2,000

Current liabilities 10,000 3,600

Total equity and liabilities 45,600 16,000

The following information is relevant:

(i) The fair values of Skeptik’s assets were equal to their book values with the exception of its
plant, which had a fair value of $3·2 million in excess of its book value at the date of
acquisition. The remaining life of all of Skeptik’s plant at the date of its acquisition was four
years and this period has not changed as a result of the acquisition.

Depreciation of plant is on a straight-line basis and charged to cost of sales. Skeptik has
not adjusted the value of its plant as a result of the fair value exercise.

Page 1 of 5 (kashifadeel.com)
Basic Consolidation Question 90

(ii) In the post acquisition period Hillusion sold goods to Skeptik at a price of $12 million. These
goods had cost Hillusion $9 million. During the year Skeptik had sold $10 million (at cost to
Skeptik) of these goods for $15 million.

(iii) Hillusion bears almost all of the administration costs incurred on behalf of the group
(invoicing, credit control etc.). It does not charge Skeptik for this service as to do so would
not have a material effect on the group profit.

(iv) Revenues and profits should be deemed to accrue evenly throughout the year.

(v) The current accounts of the two companies were reconciled at the year-end with Skeptik
owing Hillusion $750,000.

(vi) Hillusion has a policy of valuing non-controlling interests at fair value at the date of
acquisition. For this purpose, the share price of Skeptik should be used.

(vii) An impairment test on 31 March 2003 showed that consolidated (full) goodwill should be
written down by $400,000.

Required:
(a) Prepare a consolidated statement of profit or loss and other comprehensive income
and statement of financial position for Hillusion for the year to 31 March 2003
(20 marks)
(b) Explain why it is necessary to eliminate unrealized profits when preparing group
financial statements; and how reliance on the entity financial statements of Skeptik
may mislead a potential purchaser of the company. (5 marks)
(25 marks)

Note: your answer should refer to the circumstances described in the question.

ACCA F7 – June 2003 – Q1

Page 2 of 5 (kashifadeel.com)
Basic Consolidation Question 90

ANSWER TO QUESTION 90: BASIC CONSOLIDATION

Part (a)
Hillusion Group
Consolidated Statement of profit or loss
For the year ended 31 March 2003
Hillusion Skeptic x 9/12 Adj. Group
$000 $000 $000 $000
Revenue 60,000 18,000 (12,000 J6) 66,000
Cost of sales (42,000 + 500J4) (15,000 +600J3) 12,000 J6 (46,100)
Gross profit 17,500 2,400 19,900
Operating expenses (6,000) (150 + 400J7) (6,550)
Interest (exp)/inc. 75 (150) (75)
Profit before tax 11,575 1,700 13,275
Taxation (3,000) (450) (3,450)
Profit after tax 8,575 1,250 9,825
Non controlling interest ($1,250 x 20%) (250)
Profit for group owners 9,575

Hillusion Group
Consolidated SFP as at 31 March 2003
Assets $000 $000
Non – current assets
Goodwill W3 930
Investments $11,280 – 11,280 J1 -
Tangible assets$19,320+8,000+3,200J2 – 600J3 29,920 30,850

Current assets $15,000+8,000 – 500J4 – 750J5 21,750

Total assets 52,600

Equity and liabilities

Equity:
Equity shares of $1 each 10,000
Retained earnings W6 26,100
36,100
Non Controlling interest W5 2,650 38,750

Non - current liabilities

10% loan notes $2,000-1,000J1 1,000

Current Liabilities $10,000+3,600 – 750 J5 12,850

Total equity and liabilities 52,600

W1 GROUP STRUCTURE
Skeptic Subsidiary Acquisition date:1 Jul 2002 Group = 80% NCI 20%
$000

Page 3 of 5 (kashifadeel.com)
Basic Consolidation Question 90

W2 NET ASSETS (of subsidiary) AT ACQUISITION S

Equity share capital 2,000
Retained earnings (pre) 6,150
J2 3,200
11,350

W3 GOODWILL S
InvestmentJ1 10,280
Less: 11,350 W2 x 80%W1 (9,080)
1,200
Fair value of NCI (2,000 x 20% x $6) 2,400
Less: 7,000 W2 x 20%W1 (2,270)
130
1,330
J7 (400)
930

W4 POST ACQUISITION RESERVES (of subsidiary) RE

Balance 2,250
J3 (600)
J7 (400)
1,250

W5 NON CONTROLLING INTEREST S

11,350 W2 x 20%W1 2,270
NCI goodwill W3 130
1,250 W4 x 20% W1 250
2,650

W6 GROUP RESERVES RE
Parent reserves 25,600
J4 (500)
25,100
1,250W4 x 80% W1 1,000
26,100

$ 000
JOURNAL ENTRIES WITH WORKINGS
Dr. Cr.

Investment in subsidiary 10,280

- 1 10% loan notes 1,000
Investments 11,280
As given in question.

Tangible assets 3,200

(i) 2
Reserves (S) 3,200
Recording of fair value in excess of book value

Page 4 of 5 (kashifadeel.com)
Basic Consolidation Question 90

COS / RE (S) 600

(i) 3
Tangible assets 600
Depreciation effect on fair value adjustment
$ 3,200/4 years x 9/12 = $600

COS / RE (P) 500

(ii) 4
Inventory 500
Unrealized profit in inventory
$12,000-10,000=2,000x3/12 (margin ratio) = $500

Payables 750
(v) 5
Receivables 750
Cancellation of intra group balances

Revenue 12,000
(ii) 6
COS 12,000
Cancellation of intra group sales and purchases

RE (S)/ Operating expenses 400

(vii) 7
Goodwill 400
Impairment of goodwill

Page 5 of 5 (kashifadeel.com)