Consolidated accounts

Consolidated accounts

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As my knowledge of how to do consolidations is but a distant memory, I would be grateful for advice on a particular issue.

During the year the holding company acquired the shares in an existing trading company.  The subsidiary had bought a freehold property 12 years ago, which it had revalued in its own accounts, so there is a significant revaluation reserve in the subsidiary.  I can just about remember that the goodwill arising on consolidation is the price paid by the holding company for the shares less the net assets of the subsidiary, i.e: share capital and retained profits.

But what to do with the revaluation reserve?

  1. If we leave it out of the goodwill calculation, the subsidiary's net assets will effectively be valued at cost, the goodwill on consolidation will therefore be much greater and the revaluation reserve will come through into the consolidated accounts.
  2. If we include it in the calculation, the subsidiary's net assets will be acquired at their current value (which seems more logical), the goodwill premium on consolidation will be lower (which seems more realistic) and there will be no revaluation reserve in the consolidated accounts.

Second question.  The subsidiary is releasing its revaluation reserve in line with the depreciation of the revalued property.  If we go for option 2, will we have increasing goodwill each year or a negative revaluation reserve in the consolidated accounts?

My head is in a spin!  Any help would be greatly appreciated.

Replies (5)

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By johngroganjga
23rd Sep 2013 16:45

Assuming that the book values of the net assets of the subsidiary on acquisition are equal to their fair value (which is another story - but is the basis on which you appear to be proceeding) then the goodwill arising on consolidation is precisely what you say it is - with the proviso that net assets are not necessarily equal to share capital plus retained profits, especially when there is a revaluation reserve!

So option 2 is correct.

As to your second question, as under Option 2 you are ignoring the revaluation reserve (effectively treating it as a part of the undifferentiated pre-acquisition reserves) the annual revaluation reserve transfers are just ignored.  I don't see how they can have the effect you suggest. 

 

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Replying to stepurhan:
Euan's picture
By Euan MacLennan
23rd Sep 2013 18:12

Release of revaluation reserve

Thank you for confirming that option 2 is correct.

johngroganjga wrote:

As to your second question, as under Option 2 you are ignoring the revaluation reserve (effectively treating it as a part of the undifferentiated pre-acquisition reserves) the annual revaluation reserve transfers are just ignored.  I don't see how they can have the effect you suggest. 

Perhaps, I didn't explain myself too well.  Subsidiary acquired at start of year when revaluation reserve is £1M, but £50K is released during the year and credited to P&L to net off against the depreciation on the revalued total (and will be the same again in every subsequent year).  Revaluation reserve at the end of the first year is £950K in the subsidiary's accounts.  On acquisition of the subsidiary at the start of the year, we deduct the £1M from the price of the shares (along with the subsidiary's share capital and retained P&L) to arrive at the goodwill on consolidation and if we had been preparing consolidated accounts then, they would not include any revaluation reserve.  When we come to prepare the accounts at the end of the year, the subsidiary's revaluation reserve is only £950K.  Do we increase the goodwill on consolidation by £50K every year (surely the goodwill should be the same for ever) or do we show a release and hence, a negative balance, on the revaluation reserve in the consolidated accounts of £50K at the end of the first year, increasing by £50K in every subsequent year?  I realise that it will appear as a transfer to the credit of the P&L, so the explanation of the negative revaluation reserve will be obvious, but it does seem rather odd to have a negative reserve.

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By johngroganjga
23rd Sep 2013 21:37

Sorry I assumed the revaluation reserve reduction was a transfer in the reserves note, not a credit to the P&L. The way to deal with that in the consolidation schedules is to remove the revaluation reserve credit from the consolidated P&L. Does that make sense?

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Euan's picture
By Euan MacLennan
24th Sep 2013 09:54

Am I being thick?

It is a transfer in the Reserves note.  DR Revaluation Reserve  CR P&L, but as the consolidated Revaluation Reserve starts at nil (under option 2), any DR to it will result in a negative (DR) balance carried forward.  Also, the CR to P&L means an increase of the distributable profits, which is correct, isn't it?

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By johngroganjga
24th Sep 2013 09:58

So on consolidation your just reverse it because it is a nothing adjustment - a transfer between two accounts that are separate in the subsidiary but combined in the consolidated figures.

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