In this session we shall continue to look at the Consolidated Statement of Profit or Loss. We shall look at how the group figures are adjusted when:
- Group companies sells goods or services to another group companies
- One group company holds inventories at the period-end that were purchased from another group company
It is important to remember that consolidated financial statements treat the parent and subsidiary as if there were a single company.
Now a single company cannot trade with itself, and cannot make profits from simply moving assets such as inventories between different parts of itself. When we prepare consolidated statements we must therefore:
- Remove the effects of intragroup purchases and sales; and
- Eliminate any profits made by the parent or subsidiary company from intragroup sales that remain in the group’s inventory at the period-end
Intragroup sales/purchases of goods
Where one group company has sold goods to another group company, the value of that company’s sale will be included in:
- The sales revenue of the company that sold the goods
- The cost of sales of the company that purchased the goods
The value of these intragroup sales must be deducted therefore from the group’s Revenue and its Cost of Sales.
Intragroup sales/purchases of services
Where one group company has provided services to another group company, the value of that company’s sale will be included in:
- The sales revenue of the company that provided the services
- An appropriate expense category of the company that received the services
The value of these intragroup sales must be deducted therefore from both the group’s Revenue and the expense category where the cost of the service received was recorded.
Medea Ltd owns all of the share capital of its subsidiary Medus Ltd. During the year ended 31/08/2019, Medus Ltd sold goods costing £40,000 to Medea Ltd for £50,000. At the year end none of these goods remained in inventory.
In addition, during the year Medea Ltd Ltd charged management fees of £10,000 to Medus Ltd who recorded them as administration expenses.
The statements of profit of loss for both companies are shown below:
The blank consolidated statement is as follows:
We will start by combining income and expenses but we must remember to eliminate the effects of the goods and services bought/sold over the year.
Revenue is calculated as:
Cost of sales is calculated as:
Administration expenses is calculated as:
The other expenses of parent and subsidiary do not require any adjustments and therefore will simply be added together.
The profits can now be calculated in order to complete the statement.
C Ltd owns all the issued shares of D Ltd and both companies have a year-end of 31st December. The companies’ statements of profit or loss for the year ended 31/12/2020 are shown below.
During the year D Ltd sold goods costing £105,000 to C Ltd for £142,000. In addition, C Ltd charged £50,000 to D Ltd for management fees. D Ltd recorded this cost as Administrative Expenses.
Prepare C Ltd’s consolidated statement of profit or loss for the year ended 31/12/2020.
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Unrealised profits on inventories
Where one group company has purchased goods from another group company it might still hold all or some of them in its inventories at the period-end. If those goods were sold at a profit, then the value of the items remaining in inventory will be over-valued when the statements are consolidated as a company cannot make a profit by selling goods to itself.
When consolidating the statement of profit or loss we must therefore eliminate this over-valuation of inventories which is known as an unrealised profits on inventories.
Eliminating unrealised profits in exam questions
Exam questions often require students to calculate and then adjust for unrealised profits on inventories using a limited amount of information about the total intragroup sales and the amount remaining in inventory at the period-end. The way to to do this is as follows:
- Calculate the profits made on the intragroup sale
- Calculate the portion of the goods purchased from another group company that are still held in inventories at the period-end
- Multiply the profits calculated in step 1 by the portion calculated in step 2 (this is the unrealised profit included in inventories
- Add the unrealised profit calculated in step 3 to the group’s Cost of Sales (note the unrealised profit will also be deducted from the value of the group’s inventories when preparing the consolidated statement of financial position)
We will continue to use the example of Medea Ltd and Medus Ltd but this time we will move to their next years’ financial statements, that is, for the year ended 31/08/2020. During this year, Medus Ltd sold goods costing £24,000 to Medea Ltd for £36,000. At the year-end Medea Ltd still held £9,000 of the goods purchased from Medus Ltd in its inventories.
The companies’ statements of profit or loss are shown below
The consolidated statement’s revenue is calculated by adding parent and subsidiary’s revenue together and then deducting the intragroup sales made by Medus Ltd to Medea Ltd during the year (as shown below).
Cost of sales
Cost of sales will be calculated by adding the cost of sales of Medea Ltd to Medus Ltd and deducting the value of the intragroup sales of £36,000. We will then have to add the unrealised profits in Medea Ltd’s inventories as purchased from Medus Ltd. The unrealised profits are calculated as follows:
- Calculate the profits made on the intragroup sale; £12,000 (i.e. £36,000 less £24,000)
- Calculate the portion of the goods purchased from another group company that are still held by the group at the period-end; 1/4 (i.e. £9,000/£36,000)
- Multiply the profits calculated in step 1 by the portion calculated in step 2 (this is the unrealised profit included in inventories; £3,000 (i.e. £12,000 x 1/4)
- Add the unrealised profit calculated in step 3 to the group’s Cost of Sales
The other expenses are calculated by adding the parent and subsidiary’s figures together and the profits can then be calculated and recorded as follows.
The consolidated statement is now complete.
Aged Ltd is the owner of the whole share capital of Younger Ltd. During the year ended 30 April 2020, Younger Ltd sold goods that cost £480,000 to Aged Ltd for £720,000. Of these goods, Aged Ltd still held £180,000 of them in its year-end inventories.
a) Calculate the profit made by Younger Ltd on this intragroup sale
b) Calculate the unrealised profit included in the value of the Aged Ltd’s inventories
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a) Younger Ltd made a profit of £240,000 on the sale of goods to Aged Ltd (i.e. £720,000 less £480,000)
b) The unrealised profit is calculated as the profit made on the intragroup sales (as calculated in part (a) above) multiplied by the portion of goods still held in inventories at the year-end. The portion of goods still held in inventories is the cost of the goods in inventories, that is, £180,000, divided by the amount Aged Ltd paid for all of the goods purchased, i.e. £720,000. The portion is therefore 0.25
The unrealised profit is £240,000 x 0.25 = £60,000
E Ltd owns all the issued shares of F Ltd and both companies have a year-end of 28th February. During the year, E Ltd sold goods costing £200,000 to F Ltd for £250,000. Of these goods F Ltd still held £100,000 of them in its year-end inventories.
The companies’ statements of profit or loss for the year ended 28/02/2020 are shown below.
Prepare E Ltd’s consolidated statement of profit or loss for the year ended 28/02/2020.