Elimination of Investments
Where
a holding company holds all the shares of a subsidiary or its assets belong to
the holding company, which is also liable for all its debts. In other words,
the investment by the holding company in the shares of subsidiary company
represents excess of assets over liabilities or capital.
While
preparing the consolidated balance sheet it is necessary to eliminate
investment & its complement of the paid up capital of subsidiary company.
Holding company’s investment which its subsidiary’s capital, which in turn is
equal to the excess of assets over liabilities of the subsidiary, become
internal items in the consolidated balance sheet. Hence, the two are cancelled
against each other & substituted by the assets & liabilities of the
subsidiary.
Pre
acquisition period is the period which falls on or before the date on which the
shares of the subsidiary company are acquired by the holding company.
Post Acquisition
Period
Post
acquisition period is the period which falls on after the date on which the
shares of the subsidiary company are acquired by the holding company.
Profits
The
profit of the subsidiary may be divided into
1.
Capital profit
2.
Revenue profit
Pre & Post Acquisition
of Profits
a.
General Reserve & Profit & Loss Account (credit balance)
appearing in the books of the subsidiary company on the date of acquisition are
treated as pre – acquisition profits. Since, they were not earned by the
holding company in the ordinary course of business they are capitalized &
set off against the purchase price of the shares.
b.
A pre – acquisition loss appearing in the books of the subsidiary
company is treated as a capital loss & debited to goodwill account.
c.
Post acquisition profits or losses are those that are made or
suffered by a subsidiary company after its shares have been purchased by the
holding company. Revenue profits are added to the profits of the holding
company if it acquires all the shares of the subsidiary company or to extent of
its share holding in the subsidiary company. A post acquisition loss is treated
as a revenue loss & deducted from the profits of the holding company.
d.
If the date of acquisition is during the course of the year it
becomes necessary to make an estimate of pre acquisition & post acquisition
periods on time basis so as to apportion profits.
Cost of Control
In practice
the holding company may pay more or less than the net worth of the subsidiary
company. If the holding company feels that a company the shares of which it
wants to acquire enjoys considerable reputation or exceptionary favourable
factor it may pay more than the paid up value of shares or net assets.
The excess of
acquisition price over net assets represents goodwill or cost of control. If on
the other hand the acquisition price is less than the paid up value of shares
the difference is again to the holding company & is known as capital
reserve.
Minority Interest
When
some of the shares in the subsidiary are held by outside shareholders they will
be entitled to a proportionate share in the assets and liabilities of that
company. The share of the outsider in the subsidiary is called minority
interest.
In
the consolidated balance sheet all the assets and liabilities of the subsidiary are consolidated with assets and liabilities
of the holding company and the minority interest representing the interest of
the outsider in the subsidiary is shown as a liability.
Revaluation of
Assets and Liabilities
At
the time of acquiring shares in a subsidiary it is usual for the holding
company to revalue the assets and liabilities of the subsidiary in order to
arrive at a fair price to be paid for the shares.
If
the altered values are not taken in the books of subsidiary it is necessary to
bring the assets and liabilities into the consolidated balance sheet at the
altered values. The difference between the book values and revised values
should be adjusted after ascertaining the share of the outsiders. Where the
assets are shown in the consolidated balance sheet at the increase values depreciation provision should be
increased and such increase should be deducted from capital reserve and
minority interest.
If
on the other hand the assets are brought in at reduced value depreciation value
should be reduced and such reduction should be added to capital reserve and
minority interest.
Treatment of
Unrealized Profits
An
unrealized inter-company profits exist where the company still holds (at the date of consolidation) stocks sold to it
by the other company at a profit.
It
is considered that only the holding company share of unrealized profit should
be eliminated since for the minority shareholders the profit is nothing but a
realized profit. Stock reserve is created whether the goods are sold by the
holding company to the subsidiary and vice versa. The amount of unrealized
profit (stock reserve) is deducted from the stock on the asset side and also
the profit and loss account on the liability side of the consolidated balance
sheet.
Example: A subsidiary sells goods
to the holding company goods worth Rs 30,000 on which the subsidiary company
made 20% profit on selling price (holding company share holds 3000 out of 4000
shares)
Unrealized profit = 20% of 30,000 = 6,000
Holding company’s share = ¾ *6,000 =
4,500.
Inter-Company
Balances
1. Internal Debts
When
loans are advanced to the subsidiary company by the holding and vice versa the
same will appear on the asset side of the lending company’s balance sheet and
on the liability side of the borrowing company’s balance sheet.
These being inter-company items
they should be eliminated from the consolidated balance sheet.
2. Bills of Exchange
Bills
drawn by the holding company on its subsidiary and vice versa appearing as
bills payable in one balance sheet and bills receivables on the other, cancel each other. However bills
discounted cannot get cancelled because of the liability in respect of bills payable by the accepting company and
a contingent liability in the company
getting the bills discounted.
a. The
company discounting the bill will include the proceeds of the bills in its bank
balance and will appear as a note to show the contingent liability.
b. In the
consolidated balance sheet the total of bills discounted appear as bills payable representing actual liabilities.
3. Debentures
Debentures
issued by one of the companies in the group and held as investment by another
in the same group gets cancelled in the consolidated balance sheet and should be eliminated.
4. Contingent Liability
Contingent
liabilities which may or may not materialise into liabilities are shown in the
usual way by appending a footnote in the individual balance sheet. For the
purpose of consolidation the treatment depends upon whether they are internal or external.
External
contingent liability between the company in the group and a third party continue to appear by way footnote.
Internal
contingent liability between holding and subsidiary are eliminated without being shown in the consolidated
balance sheet.
Dividends paid by Subsidiary Company: (no adjustments need be made in the books of subsidiary company)
Books of Holding Company
1.
if the dividends has been paid out of pre-acquisition profits the
dividends should be credited by the
holding company to investment account but not profit and loss account.
2.
on the other hand if the holding company has credited the dividend to profit
and loss account then the dividend should be debited to profit and loss account
and credited to the investment account.
3.
if the dividend has been paid by subsidiary company out of post -
acquisition profits the same should be
credited by the holding company to its profit and loss account. If it has
already credited the dividend to profit and loss account then no adjustment is
required.
Dividends
declared by the subsidiary company but not paid will appear as a liability in
the balance sheet of the subsidiary company. In the consolidated balance sheet
the proportion of unpaid dividend attributable to the holding company will be
deducted from liability of subsidiary company & the balance payable to the
outside shareholders will appear as a liability of the group.
Any
interim dividend paid during the accounting period by the subsidiary company to
the holding company should be added to the balance of profit & loss account
of the holding company & deducted from the balance of profit & loss
account of the subsidiary company if the adjustments have not taken place.
Bonus Shares
When
a company issues bonus shares out of its accumulated profits it is necessary to
distinguish between pre & post acquisition profits utilized for this
purpose. In case bonus shares are issued out of pre – acquisition profits no
adjustments are necessary for preparing the consolidated balance sheet because
in such a case the holding company’s share of such profits gets reduced &
the paid up value of the shares held by it will increase. As such the amount of
goodwill remains the same.
Bonus
shares issued out of post acquisition profits will reduce the holding company’s
share in revenue profits & increase the paid up value of the shares held.
Consequently, the amount of goodwill gets reduced.