Purple Co had made sales to Silver Co during the year of $5,000. Purple Co had originally purchased the goods at a cost of $4,000. Half of these items remained in the inventory of Silver Co at the year end.
What should the consolidated revenue be for the year ended 30 September 20X2?
A $104,700
B $95,230
C $108,700
D $104,200
Answer
Even though this question requires an extract from the consolidated statement of profit or loss, the principle is still the same as Illustration (2) – consolidate the group as if it is a single economic entity by adding in 100% line by line, and showing group performance with all non-group entities.
Therefore, answer B would not be selected as it incorrectly adds 100% of Purple Co and only 70% of Silver Co.
The other adjustment that requires careful consideration is the intra-group trading. In the consolidated statement of profit or loss we must always consider two steps:
- Has there been any intra-group trading during the year, irrespective of whether the goods are still included in inventory at the year end?
- Do any of the items remain in inventory at the end of the year?
In this question, $5,000 of sales have been made from Purple Co selling to Silver Co. This must be eliminated, irrespective of whether the items remain unsold at the year end. This is because the consolidated statement of profit or loss needs to show revenue and cost of sales which reflect group performance with external, non-group, entities only.
The journal entry required to remove the intra-group sale would be:
Dr Revenue $5,000
Cr Cost of sales $5,000
Therefore, the consolidated revenue is simply calculated as:
$79,300 + $29,900 – $5,000 = $104,200
The correct answer is D.
Had the question asked for the consolidated cost of sales figure, the next step would have been to identify the provision for unrealised profit (PUP). Note that although we refer to this as a provision, it is not a liability but an adjustment to the asset, inventory. Purple Co has made a profit of $1,000 (calculated as revenue of $5,000 – cost of $4,000). As only half of the items remain in inventory, the inventory value is overstated by half of that profit – that is, $500. Candidates should be aware that in many FA/FFA exam questions, you will be expected to calculate the profit made by using margins or mark-ups, which are not discussed here.
The consolidation adjustment required for this deals with the fact that the group has made a profit of $500 on items which have not been sold on to a third party/non-group entity. Effectively, if you did not make an adjustment for the PUP, the group would be recording a profit of $500 from selling inventory to itself. This inflates the value of the inventory held by the group in the statement of financial position and the profit in the statement of profit or loss. Remember, closing inventory is a component of cost of sales so the adjustment for PUP affects both the statement of profit or loss and the statement of financial position.
The adjustment required to eliminate this unrealised profit would be:
Dr Cost of sales $500
Cr Inventory (SOFP) $500
Therefore, the consolidated cost of sales would be calculated as:
$54,990 + $17,940 – $5,000 + $500 = $68,430
The PUP is added back to cost of sales, which eliminates the unrealised profit. (Effectively what you are doing is adjusting the closing inventory that is part of the cost of sales figure).
However, in this particular question, by reading the question carefully you will see that eliminating the unrealised profit was a red herring as we were simply being asked for the consolidated revenue.
Note: Answer A is incorrect, as although it correctly cancels the intra-group sale of $5,000, it incorrectly adds the $500 adjustment for unrealised profit to the revenue figure ($79,300 + $29,900 – $5,000 + $500 = $104,700).
Answer C is also incorrect because it omits the cancelling of $5,000 sales and deals incorrectly with the provision for unrealised profit of $500 ($79,300 + $29,900 – $500 = $108,700).
(4). How is goodwill calculated?
Another typical FA/FFA exam question will require you to calculate goodwill.
Under this syllabus, the non-controlling interest (NCI) will be recorded at its fair value. Therefore, goodwill is calculated as: