Consolidated Statement of Financial Position

1 Why consolidated financial statements exist

When one company buys a controlling shareholding in another, the purchase shows up in the buyer's own statement of financial position as a single asset — Investment in S, carried at what was paid for it. That one line tells the buyer's shareholders almost nothing. It does not say what the subsidiary owns, what it owes, or what it has earned since it was bought. The whole of a group's trade can sit inside it and never be seen.

Consolidated financial statements replace that single line with the things behind it. The parent's own assets and liabilities are added to the subsidiary's, line by line, and the investment is cancelled against what it bought. The result is a set of financial statements for something that has no legal existence at all: P and S remain separate companies, each with its own accounts, its own tax return and its own creditors. What is reported is the substance of the relationship — one pool of resources under one management — rather than its legal form.

Consolidated financial statements are prepared for the shareholders of the parent. That single fact explains most of the mechanics in this chapter: why only the parent's share capital appears; why the parent's retained earnings are taken in full but the subsidiary's only from the date it was acquired; and why the other owners of the subsidiary are shown separately, as non-controlling interests (NCI), rather than being left out.

2 Control — the test that creates a subsidiary

IFRS 10 Consolidated Financial Statements decides whether a subsidiary exists and requires a parent to consolidate it. IFRS 10 defines control through three elements, and an investor controls an investee only when it has all three.

Control is normally achieved by acquiring more than 50% of the voting equity shares, and that is the signpost almost every exam question uses. It is a rule of thumb, not the definition. More than half the votes carries an ordinary resolution; an ordinary resolution appoints the directors; the directors direct the activities. The power element follows from the shareholding, which is why the shorthand works so often.

Because the test is control and not the percentage, control can exist on less than half the shares. A 40% holding may give control where the remaining shares are spread among many small holders who do not act together, so that 40% is enough to carry a vote in practice; or where a contractual arrangement with other shareholders gives the investor the right to direct the activities; or where the investor holds options or convertible instruments that are currently exercisable and would take it past half. The traffic runs the other way too: more than 50% may not give control, if the shares carry no votes, or if the investee is in administration and its activities are being directed by somebody else.

2.1 The standards this chapter applies

Group accounting is a small family of standards, and the syllabus names them, so it is worth being able to say which one does what.

3 The acquisition method

IFRS 3 Business Combinations requires every acquisition of a subsidiary to be accounted for by the acquisition method.

1. Identify the acquirer — the entity that obtains control. Usually obvious: it is the company that buys the shares.

2. Determine the acquisition date — the date control passes, which is not necessarily the date the contract was signed or the cash changed hands. Everything in the consolidation is measured at that date, and the subsidiary's results are consolidated only from it.

3. Recognise and measure the identifiable assets acquired and liabilities assumed, at their fair values at the acquisition date — not at the amounts sitting in the subsidiary's own books. This is what produces the fair value adjustments dealt with later in this chapter.

4. Recognise and measure goodwill, or, in the rare case where the calculation comes out negative, a gain on a bargain purchase.

Two consequences of control are worth fixing in mind before the first example, because between them they explain the shape of every consolidated statement of financial position in this chapter.

• All of the subsidiary's assets and liabilities are consolidated — 100% of them — whatever percentage the parent owns, because the parent controls all of them. The other shareholders' stake is shown once, in equity, as the non-controlling interests.

• Only the parent's share capital and share premium appear, because the consolidated statement reports to the parent's shareholders. The subsidiary's share capital never reaches the face of the statement: it is cancelled against the investment inside the goodwill working.

4 Basic consolidation

4.1 The basic steps

1. Add across 100% of the parent's and 100% of the subsidiary's assets and liabilities, line by line, and cancel the investment in the subsidiary — it has been replaced by the things it bought.

2. Show the parent's share capital and share premium only.

3. Consolidated retained earnings are the parent's own retained earnings in full, plus the parent's share of the subsidiary's post-acquisition retained earnings. Pre-acquisition reserves were bought and paid for; they are not the group's earnings.

Do those three things and the statement balances. In a question with no goodwill and no adjustments — which is what the first two examples are — that is the whole method.

5 Non-controlling interests

A parent does not have to own all of a subsidiary. A holding of 80% carries control just as a holding of 100% does, so the subsidiary is still consolidated in full: every one of its assets and liabilities, at 100%, line by line.

The other 20% of the subsidiary belongs to somebody else. Those owners are the non-controlling interests (NCI), and their stake is shown as a single figure within equity in the consolidated statement of financial position.

The non-controlling interests are equity, not a liability. The group does not owe the non-controlling shareholders anything — they are owners of part of the group's net assets, exactly as the parent's shareholders are. That is what the equity section of a consolidated statement of financial position is for: the top of the statement adds across everything the group controls, and equity answers the question who owns it. The answer is: the parent's shareholders, and the NCI.

5.1 The two ways of measuring the non-controlling interests

IFRS 3 allows the non-controlling interests in a subsidiary to be measured, at the acquisition date, in either of two ways:

• at the fair value of the non-controlling shareholders' interest — usually taken from the market value of the subsidiary's shares just before the acquisition; or

• at the NCI's proportionate share of the acquiree's identifiable net assets at the acquisition date.

The choice is made acquisition by acquisition. It is not an accounting policy that has to be applied consistently to every subsidiary a group owns: a group may measure the NCI in one subsidiary at fair value and the NCI in another at the proportionate share. In an exam question you will always be told which method applies to the acquisition in front of you — and the two methods give different figures for goodwill, for the NCI, and for the effect of any later impairment.

The last row is the one candidates lose marks on. Under the proportionate method the goodwill on the face of the statement is only the parent's share, so an impairment of it is only the parent's loss: none of it touches the non-controlling interests. Example 10 at the end of this chapter turns on exactly that point.

6 Goodwill

A parent usually pays more for a subsidiary than the fair value of the identifiable net assets it acquires. The excess is goodwill — what the parent is paying for things the subsidiary cannot recognise as assets in its own accounts:

• a loyal customer base;

• a reputation, and brand names the subsidiary built itself and so may not recognise;

• an assembled and trained workforce;

• the expectation that the two businesses together will earn more than the two apart.

Goodwill acquired in a business combination is recognised as a non-current asset in the consolidated statement of financial position. Goodwill a group generated itself is never recognised — internally generated goodwill fails the recognition requirements of IAS 38. This is the one place goodwill gets onto a statement of financial position, and it is why the goodwill working exists.

Goodwill = FV of consideration + NCI at acquisition − FV of identifiable net assets acquired

Both of the first two terms matter. The consideration is what the parent gave; the NCI figure brings in the other shareholders' stake, measured on whichever of the two bases the question specifies. Add them together and you have the value put on the whole of the subsidiary; take off what its identifiable net assets are worth and the remainder is goodwill.

6.1 Goodwill after the acquisition date

Goodwill is never amortised. It is carried at cost less accumulated impairment losses, and it is tested for impairment at least annually, and whenever there is an indication that it may be impaired. An impairment loss on goodwill is charged to profit or loss and, once recognised, is never reversed.

In the consolidated statement of financial position the goodwill line is shown net of the impairment to date, and the loss comes off retained earnings — split with the non-controlling interests only where the NCI was measured at fair value, for the reason given in the comparison table above.

6.2 A bargain purchase

Occasionally the calculation comes out negative: the consideration plus the NCI is less than the fair value of the net assets acquired. IFRS 3 requires the whole calculation to be reviewed first, because a negative figure is far more often a mis-measured asset or an omitted liability than a genuine bargain. If it survives that review, the excess is recognised immediately as a gain in profit or loss — not as negative goodwill on the statement of financial position, and not as a deferred credit released over time.

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7 The five standard workings

Everything in this chapter is done with the same five workings, in the same order, every time. Learning them as a method is worth more than learning any individual answer, because the objective-test questions ask for one figure out of the five and expect you to reach it without preparing the whole statement.

7.1 W1 — Group structure

You do not have to draw a group structure for a one-subsidiary question, but write down the three things it would have told you: the parent's holding, the NCI percentage, and the acquisition date. Getting the NCI percentage wrong here makes W3 and W4 wrong together, which is the quickest way to lose two marks with one slip.

7.2 W2 — Net assets of the subsidiary

Two rules make this working work. Share capital and share premium do not change between the two columns, unless the subsidiary has issued shares since the acquisition, so the same figures go in both. And only two numbers leave this working: the total at acquisition, which goes into W3, and the post-acquisition movement, which goes into W4 and W5.

7.3 W3 — Goodwill

7.4 W4 — Non-controlling interests

7.5 W5 — Group retained earnings

7.6 Other reserves

Every other reserve is treated exactly like retained earnings: the parent's in full, plus the parent's share of the subsidiary's post-acquisition movement in that reserve. There is one working per reserve, and they all have the same shape.

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8 Fair value adjustments at acquisition

Step 3 of the acquisition method requires the subsidiary's identifiable assets and liabilities to be brought into the consolidation at their fair values at the acquisition date, not at the carrying amounts in the subsidiary's own books. The subsidiary does not change its own accounts; the adjustment is made in the consolidation, in W2.

The mechanics are always the same, and there are three of them.

1. Put the uplift — fair value less carrying amount at the acquisition date — into both columns of W2: at acquisition, and at the reporting date. It is the same figure in both, unless the question tells you the asset has since been sold or revalued again.

2. Where the asset is depreciable, charge the extra depreciation on the uplift for the post-acquisition period, and put it in the reporting-date column only. The subsidiary has been depreciating the carrying amount in its own books; nobody has been depreciating the uplift.

3. Show the same two figures on the face of the consolidated statement of financial position. Property, plant and equipment is 100% of P, plus 100% of S, plus the uplift, less the extra depreciation.

Property, plant and equipment is much the most common fair value adjustment. Two others are worth recognising when they appear:

• Inventory — the fair value is usually lower than the carrying amount, so the adjustment reduces net assets and goes in brackets.

• Contingent liabilities — the subsidiary does not recognise a contingent liability in its own accounts, but IFRS 3 requires one assumed in a business combination to be recognised at its fair value where it is a present obligation arising from a past event and that fair value can be measured reliably, even though an outflow is not probable. It is a liability, so it reduces net assets in both columns.

9 Mid-year acquisition

Where a subsidiary is acquired part-way through a year, the question is what its retained earnings were on the acquisition date — the figure W2's acquisition column needs. Unless told otherwise, assume the subsidiary's profit for the year accrued evenly, and work backwards or forwards from a figure you are given.

Note what does not change. The subsidiary's assets and liabilities still go in at 100%: a statement of financial position is a snapshot at a date, and at the reporting date the group controls all of them however recently they were acquired. What the acquisition date changes is the split between pre-acquisition and post-acquisition reserves.

10 Intra-group adjustments

Consolidation treats the parent and its subsidiaries as one entity. An entity cannot owe money to itself, sell goods to itself, or make a profit out of itself, so anything that happened between group companies has to be taken back out.

10.1 Intra-group balances

Where the parent and the subsidiary trade with each other, the receivable in one company's accounts and the payable in the other's are the same debt seen from two sides. Both are removed:

Neither the group's net assets nor its profit changes — the two sides are equal and cancel — but leaving them in would overstate receivables and payables alike, and distort every liquidity ratio computed from the statement.

10.2 Cash in transit

The two intra-group balances should be equal. Where they are not, something is in transit at the year end: most often a payment sent by one company and not yet received, and so not yet recorded, by the other.

The fix has two steps, and they must be done in this order: record the item in the receiving company's books first, so that the two balances agree, and only then cancel them against each other. It helps to forget the phrase "cash in transit" altogether and treat it as an ordinary receipt from a credit customer.

10.3 Goods in transit

The same thing happens with goods. Where one group company has despatched goods before the year end and the other has not yet recorded their receipt, record the purchase in the receiving company's books — Dr Inventory, Cr Payables — so that the two intra-group balances agree, and then cancel them as usual.

Goods in transit have not been sold outside the group, so any profit the selling company took on them is unrealised, and is eliminated in the ordinary way described next.

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10.4 Unrealised profit

When one group company sells goods to another at a profit and the buyer still holds them at the year end, the group's inventory is carried at more than those goods cost the group. Nothing has been sold to anyone outside the group, so no profit has been realised. The provision for unrealised profit — the PUP — takes it back out:

Working out how much profit is in the goods is the other half of the job, and it turns on how the question states the profit.

Then multiply by the proportion of the goods still held at the year end. A mark-up is a percentage of cost; a margin is a percentage of selling price. Reading one as the other is the commonest arithmetic error in this chapter, and the figures above show why it matters: the same 20% gives $20,000 or $24,000 depending on which it is.

11 Consideration

The fair value of consideration at the top of W3 is the fair value, at the acquisition date, of everything the parent gave in order to obtain control. It is not always cash, and the alternatives each have their own measurement rule.

• cash paid at the acquisition date;

• a share-for-share exchange;

• deferred cash consideration;

• contingent consideration.

Cash paid at the acquisition date is the easy case: it goes into W3 at the amount paid, with nothing to value and nothing to discount. The other three are the ones questions are set on.

11.1 Share exchange

Instead of paying cash, the parent issues some of its own shares to the subsidiary's shareholders. Four steps, in order:

1. Calculate the number of subsidiary shares acquired — the parent's percentage × the subsidiary's total shares in issue.

2. Calculate the number of parent shares issued, from the exchange ratio the question gives.

3. Value them at the parent's share price at the acquisition date. The consideration is the fair value of what the parent has given, not the nominal value of the shares it issued.

4. Record the share issue: Dr Investment at the fair value; Cr Share capital with the nominal value of the shares issued; Cr Share premium with the balance.

11.2 Deferred consideration

A parent may agree to pay cash at a later date. Paying $1 in a year's time is not the same as paying $1 today, so deferred consideration is included in W3 at its present value at the acquisition date, discounted at the rate the question gives.

The liability is then unwound over the period to payment: each year it is increased towards the amount that will actually be paid, and the increase is charged as a finance cost.

The unwinding does not change goodwill. Goodwill is fixed at the acquisition date using the present value at that date. The unwinding is a post-acquisition financing expense of the group, not part of what was paid for the subsidiary.

11.3 Contingent consideration

The parent may promise to pay more if the subsidiary hits a target — an earn-out. That promise is contingent consideration, and IFRS 3 requires it to be included in the consideration at its fair value at the acquisition date: an estimate of what is likely to be payable, discounted where the timing makes the difference material.

It goes in even though it may never be paid. It is part of the price agreed for control, and a buyer who promises an earn-out has given something up for the subsidiary just as surely as one who pays cash.

What happens to it afterwards depends on how it is classified:

• contingent consideration that is a financial liability is remeasured to fair value at each reporting date, and the movement goes to profit or loss;

• contingent consideration to be settled by delivering a fixed number of the parent's own equity shares is classified as equity and is not remeasured at all.

12 Exam questions

The two examples that close this chapter are in the objective-test format the exam uses: three separate figures, each of which could be asked on its own. Work each one from the workings rather than by preparing the whole statement — that is the skill being tested.

13 Where this appears under IFRS 18

IFRS 18 Presentation and Disclosure in Financial Statements replaces IAS 1 Presentation of Financial Statements for accounting periods beginning on or after 1 January 2027. For this chapter its effect is easy to state: nothing changes.

14 Test your knowledge