consolidated financial statement

This is an F2 topic!

When we have to pay an amount at some point in the future (typically 3 years in ACCA examinations), we are required to account for that amount at its present value

Here’s an example:

We buy an item of PPE and the payment terms are that we shall pay $10,000 on 31 December each year for 2 years as well as an immediate payment of $5,000

Our cost of capital is 10%

At what value should we record the purchase cost of the asset?

$5,000 is payable immediately so that amount has a present value of $5,000

The first instalment of $10,000 is not payable until 12 months hence so what is the PRESENT value of that $10,000 in 12 months’ time?

Well, we could invest money today so that, in 1 year’s time we shall have $10,000 ready for paying as the first instalment. How much should we invest today at 10% interest?

$9,091 because $9,091 + 10% of $9,091 = $10,000

We arrived at the figure of $9,091 by discounting that $10,000 payment by the process of multiplying it by 1/ (1+r) where r is the cost of capital expressed as as percentage (in our case that’s 1/ (1+.10) or .90909

We can do the same exercise for the instalment payable at the end of year 2

Well, we could invest money today so that, in 2 years’ time we shall have $10,000 ready for paying as the second instalment. How much should we invest today at 10% interest?

$8,264 because $8,264 will earn 10% interest of $826 and the amount will have risen after 1 year to $9,090 and we already know that $9,090 equates to $10,000 after a further year

So the present value of our PPE is $5,000 + $9,091 + $8,264 = a total of $22,355 and the double entry on 1 January to record the acquisition is:

Dr TNCA $22,355
Cr Cash $5,000
Cr Payables $17,355

But that suggests that we’re only going to pay $22,355 whereas we know that we shall have to pay $25,000 and the difference is the discounted finance cost

At the end of the year, just before we need to make that first payment of $10,000 we should unroll the discounted finance cost

We achieve this by considering the $17,355 that we have ‘borrowed’ ie the deferred payment

Take that figure and multiply it by the cost of capital 10% and that gives us the figure of $1,735

This is the finance cost for the first year and we record this with the double entry on 31 December as:

Dr Finance costs $1,735
Cr Payables $1,735

Now we have a balance in the payables account of $17,355 + $1,735 = $19,090

Now pay that first $10,000

Dr Payables $10,000
Cr Cash $10,000

and leave a balance in Payables account of $9,090

At the end of the second year, take that figure and multiply it by the cost of capital 10% and that gives us the figure of $909

This is the finance cost for the second year and we record this with the double entry on 31 December as:

Dr Finance costs $909
Cr Payables $909

Now we have a balance in the Payables Account of $9,090.90 + $909.09 = $10,000

Now pay that second $10,000

Dr Payables $10,000
Cr Cash $10,000

and leave a balance in Payables account of $Zero

Is that a sufficient explanation?