# Group Accounts The Consolidated Income Statement (part b)

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The exam will test the whole syllabus of Paper F3, and therefore you must work through all of the free lectures on here (together with the Course Notes that go with the lectures).

You must also obtain a Revision/Exam Kit from one of the approved publishers. They contain lots of exam-standard questions to practice on, and practice is vital.

2. says

Hi. I have a question when substracting 28k from revenue and cgs.
I do understand why we are substracting 28k from revenue, but i dont get why we substract the same number from CGS. I dont understand why it isnt 20k (8k lesser, because of the profit)

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Hi Martynas

Remember that they are two separate companies and will have produced their own accounts separately.
If one company sells to the other for 28,000, the the selling company will have recorded sales of 28,000. The buying company will have paid 28,000 and will have recorded a purchase of 28,000.

When we consolidate, we only want to show sales outside the group, and so we subtract 28,000 from the total sales (and you are happy with this).
However, we only want to show purchase from outside the group, so since the buying company has recorded purchases of 28,000, we need to subtract 28,000 from the total purchases.

If you are still unsure, then imagine this. X buys goods for 10,000, sells them to Y for 15,000, and Y sells them outside for 18,000.
In their own accounts, X has sales of 15,000 and cost of 10,000, so has made a profit of 5,000. Y has sales of 18,000 and cost of 15,000, so has made a profit of 3,000.
When we consolidate, the total sales are 15,000 + 18,000 – 15,000 = 18,000
Total costs are 10,000 + 15,000 – 15,000 = 10,000
Total profit = 18,000 – 10,000 = 8,000

(The only time the profit element in the transfer is relevant is if any of the goods sold from X to Y are still in Y’s inventory at the year end – then we have a provision for unrealised profit to deal with. However that is covered in the next lecture and so I will not confuse things by going into it now).

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3. says

Dear John, just wanted to check if i have understood inter entity transactions as intended in the lectures:-

(i)All inter entity transactions are excluded to reflect profits from only outside the group.In a way, it reduces the problem of double counting which arises due to consolidation

(ii)Cost of sales and inventory are adjusted only if there are any unsold inventory. Adjustment is made by increasing the cost of sales equal to the amount of unrealized profit which reduces the retained earnings. Accordingly, inventory is reduced by an equal amount . Assets and liabilities should match since inventory and retained earnings are reduced by an equal amount.

4. says

I’m trying to understand why did u not just find 40% mark up which is 28000/1.4. Why did u find 1/4 of 28000, then 7000/1.4?????

Help me plz

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I have the same question as mentioned above. Please kindly help me. Thanks a lot.

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It is because only 1/4 of the sales remain in inventory. The rest have been sold and therefore all of the profit on those has been realised by the group.

5. says

Dear Mr. Moffat, since the unrealized profit on inventory was recorded by the selling company, would it not be easier (and the same effect) if we subtracted the profit from the sales revenue than adding it to the cost of sales? Arithmetically, it’s the same but I’m just wondering if it could be any different?

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Hi, although the end result would be arithmetically the same, your suggestion is not correct. The goods, when originally purchased, are in the buyer’s cost of sales (purchases) at say \$10 and closing inventory at \$10). The buyer sells for say \$15 and the other group company includes \$15 in its cost of sales (purchases) and closing inventory \$15. So now it’s in revenue at \$15 and in cost of sales at \$10 (original purchase) and at \$15 (intra-group sale / purchase) and in closing inventory at \$15. To get to the correct position, we need to cancel the intra-group sale dollar for dollar. Thus we eliminate \$15 from combined revenue and from combined cost of sales. That leaves us with +\$10 in cost of sales (original purchase) and -\$15 in cost of sales (closing inventory) To arrive at the correct position, we need to reduce that closing inventory by \$5. Thus, we must ADD \$5 to cost of sales and reduce combined closing inventory on the CSoFP.

Clear?

6. says

I would have a question concerning the following scenario:

A parent company sells goods to a subsidiary, and a part of these goods is still in the inventory of the subsidiary at the end of the year. What do we do with the unrealised profit? Should we deduct it? Is it different if the sale is from the subsidiary to the parent company?

I understand that we have to deduct the unrealised profit in any case. Am I right?

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@allanzhang2008, Tax is charged on the individual companies. The tax people do not change the tax payable because we consolidate – there remain two separate companies.

7. says

Very Good lectures – Thank you.
Can we calculate retained earnings or we have not enough information on this example?

8. says

Hi Very good lectures:)
Thank you
Can we calculate the movement of retained earnings or we have not enough information?
Regards

9. says

why did we subtracted \$28000 from reveune & cost of sales in example 3?
whats the reason behind it?

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@Miss A.., Yes. Included in S’s sales is 28,000 of sales to P, and included in P’s cost of sales is 28,000 which is what they were charged by 3.

In the consolidated income statement we only want to show sales and purchases outside the group, and so 28,000 needs removing from sales and from cost of sales.

10. says

Fantastic! I really enjoyed the joke about those that would be exempted from F3. The lecture makes things that appear difficult at first quite easy to understand. It’s a remarkable experience for me.

11. says

why is the profit 2000? as the inventory that was “left” was 1/4th.. which should mean that that 1/4th is the “not sold” inventory and so the profit should be taken as 28000-7000+21000, 21000/1.4(mark up)=15000
so the profit should be 6,000. PLEASE TELL ME IF I’M WRONG.

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@omarabbas, EDIT 28000-7000=21000 **
21000/1.4 (MARKUP) = 15000 COST PRICE
SO THE PROFIT SHOULD BE 21000 – 15000 = 6,000

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@omarabbas, Hi, Ah, it’s an F3 problem! You are correct – the profit achieved IS \$6,000. But the subsidiary has recognised the full \$8,000 within its Income Statement whereas 1/4 of that profit has not in fact yet been achieved. That’s why the profit adjustment relates to the profit included within the closing inventory.