14.9 You are the management accountant of Faith plc. One of your responsibilities is the prep- aration of the consolidated financial statements of the company. Your assistant normally prepares the first draft of the statements for your review. The assistant is able to prepare the basic consolidated financial statements reasonably accurately. However, he has little idea of the principles underpinning consolidation and is unsure how to account for changes in the group structure. In these circumstances he asks you for guidance prior to beginning his work.
The profit and loss accounts of Faith plc, Hope Ltd and Charity Ltd for the year ended 30 September 2000 are given below:
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Gross profit 900 400 600
Other operating expenses (350) (150) (180)
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Operating profit 550 250 420
Investment income 68
Interest payable (80) (35) (45)
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Profit before taxation 538 215 375
Taxation (160) (65) (114)
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Profit after taxation 378 150 261
Proposed dividends (160) (70) (100)
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Retained profit for the year 218 80 161
Retained profit – 1 October 1999 780 330 526
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Retained profit – 30 September 2000 998 410 687
Notes to the profit and loss accounts
Note 1 – Investments
Faith plc has made investments in the other two companies as follows:
● On 1 July 1993, Faith plc purchased 50% of the equity shares of Hope Ltd for a cash payment of £220 million. The net assets of Hope Ltd on 1 July 1993 had a fair value of
£400 million. This value did not differ significantly from the carrying value in the bal- ance sheet of Hope Ltd. The profit and loss account at that date showed a credit balance of £200 million. This investment gave Faith plc a reasonably significant influence over the operating and financial policies of Hope Ltd. However, on more than one occasion since 1 July 1993, the other shareholders have combined to prevent Hope Ltd embark- ing upon a course of action that was proposed by Faith plc.
● On 1 October 1999, Faith plc purchased a further 30% of the equity shares of Hope Ltd for a cash payment of £179 million. The net assets of Hope Ltd on 1 October 1999 had a fair value of £530 million. This value did not differ significantly from the carrying value in the balance sheet of Hope Ltd. This additional investment gave Faith plc control over the operating and financial policies of Hope Ltd.
● On 1 October 1999, Faith plc made a medium-term loan of £100 million to Hope Ltd. The rate of interest chargeable on that loan was 12% per annum. Both companies have correctly reflected that interest in their financial statements.
● On 1 January 1992, Faith plc purchased 70% of the equity shares of Charity Ltd for a cash payment of £460 million. The net assets of Charity Ltd on 1 January 1992 had a fair value of £600 million. This value did not differ significantly from the carrying value in the balance sheet of Charity Ltd. The profit and loss account at that date showed a credit balance of £300 million. This investment gave Faith plc control over the operat- ing and financial policies of Charity Ltd.
The accounting policy for goodwill adopted by Faith plc is to amortise it over a 20-year period. Faith plc charges a full year’s amortisation in the year of investment but no amort- isation in the year the investment is sold.
Note 2 – Disposal
The business of Charity Ltd is significantly different from that of Faith plc and Hope Ltd. Following Faith plc’s additional investment in Hope Ltd, the directors of Faith plc took a strategic decision to concentrate on the core business of the group. Following this decision, Faith plc sold all its shares in Charity Ltd for £750 million on 31 May 2000. The proceeds of sale were credited to a suspense account in the books of Faith plc. No further entries have been made in connection with the sale. The tax department estimates that taxation of
£30 million will be payable in connection with the sale. A balance sheet was drawn up for Charity Ltd immediately prior to the sale of its shares by Faith plc. This showed net assets of £1000 million. The profits of Charity Ltd accrued evenly throughout the year ended 30 September 2000.
Note 3 – Inter-company trading
Following its securing control over the operating and financial policies of Hope Ltd, Faith plc began to supply Hope Ltd with a component that Hope Ltd was formerly purchasing from an outside supplier. For the year ended 30 September 2000, sales of this product from Faith plc to Hope Ltd totalled £60 million. In setting the selling price, Faith plc added a mark-up of one-third to the cost price. On 30 September 2000, the stocks of Hope Ltd included £20 million in respect of supplies of the component purchased from Faith plc.
(a) Write a memorandum to your assistant that explains the impact of the changes in the group structure during the year on the consolidated profit and loss account. Your memorandum should include instructions regarding:
● the change of treatment of Hope Ltd caused by the additional share purchase;
● the profits of Charity Ltd that need to be included in the consolidated profit and loss account for the year ended 30 September 2000;
● the treatment of the sales proceeds that are currently credited to a suspense account;
● any separate disclosures that are necessary on the face of the consolidated profit and loss account as a result of the sale of the shares.
Your memorandum should include references to appropriate Accounting Standards.
(b) Prepare the consolidated profit and loss account of Faith plc for the year ended 30 September 2000. You should start with turnover and end with retained profit carried forward. Your consolidated profit and loss account should be in a form suitable for publication. (30 marks)
CIMA, Financial Reporting, November 2000 (42 marks)