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 inventory at the year end.
What should be the consolidated revenue for the year ended 30 September 2012?
Even though this question requires an extract from the consolidated income statement, the principle is still the same as Illustration (3) – consolidate the group as if it is a single economic entity by adding in 100% line by line, and showing group performance with the outside world.
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 income statement we must always consider two steps:
- Has there been any intra-group trading during the year, irrespective of whether the goods are included in inventory?
- 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 income statement needs to show revenue (and costs of sales) and, therefore, performance with the outside world.
The second step here is to identify the provision for unrealised profit. 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, their value is overstated by half of that profit – that is, $500. Note: in many Paper F3 questions, you will be expected to calculate the profit made by using margins or mark-ups, which are not discussed here.)
The consolidation adjustment, in effect, is saying that the group has made a profit of $500 on items, which have not been sold on to a third party – so effectively selling inventory at a profit to itself, therefore inflating the value of the inventory held by the group in the statement of position and the profit in the income statement.
The adjustment would be:
Cr. Inventory (CSOFP) $500
Dr. Cost of sales $500
However, by reading the question stem carefully, you will see that eliminating the unrealised profit is a red herring, as we are being asked for consolidated revenue.
Therefore, the consolidated revenue is calculated as:
$79,300 + $29,900 – $5000 = $104,200
The correct answer is D.
Had the question stem asked for the consolidated cost of sales figure, the answer would be correctly calculated as:
$54,990 + $17,940 + $500 – $5,000 = $68,430
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 Paper F3 question will require you to calculate goodwill.
Under this syllabus, only the full goodwill method is examinable and is calculated as: