Fall 2019 MGT2205: Financial Accounting Consolidation Assignment

This assignment analyzes the financial statements of Pirate Ltd. and Sailor Ltd., focusing on consolidated financial statements. The solution includes individual and consolidated income statements and statements of financial position for October, November, and December, reflecting intercompany transactions. The assignment explains the concepts of separate legal entities versus one economic entity for consolidation, the holding-subsidiary relationship, and the importance of consolidated statements. Key accounting principles such as historical cost, revenue recognition, and the matching principle are discussed. The document also addresses why consolidated financial statements are crucial for assessing a company's financial performance and position, particularly for stakeholders like banks. The student demonstrates the correct application of these principles and their impact on financial reporting.

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced Financial Accounting
Name of the Student:
Name of the University:
Author’s Note:

1ADVANCED FINANCIAL ACCOUNTING
Table of Contents
Individual Financial Statements:................................................................................................2
Consolidated financial statements:.............................................................................................3
Notes supporting the arguments of preparing consolidated financial statement:......................4
Separate Legal Entity:............................................................................................................4
Holding subsidiary relationship:............................................................................................5
Concept of one economic entity for consolidation:...............................................................5
Historical cost concept:..........................................................................................................6
Concept of revenue recognition:............................................................................................6
Matching principle:................................................................................................................7
Importance of consolidated financial statement:....................................................................7
Bibliography:..............................................................................................................................8

2ADVANCED FINANCIAL ACCOUNTING
Individual Financial Statements:
Extract of Individual Income Statement
Pirate Ltd Sailor Ltd Pirate Ltd Sailor Ltd Pirate Ltd Sailor Ltd
Sales revenue -$ -$ -$ 125,000$ 162,500$ -$
Cost of goods -$ -$ -$ 100,000$ 125,000$ -$
Gross profit -$ -$ -$ 25,000$ 37,500$ -$
Expenses:
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
Total expenses -$ -$ -$ -$ -$ -$
Profit before tax -$ -$ -$ 25,000$ 37,500$ -$
Income tax expense -$ -$ -$ 5,000$ 7,500$ -$
Profit after tax -$ -$ -$ 20,000$ 30,000$ -$
October November December
Particulars

3ADVANCED FINANCIAL ACCOUNTING
Extract of individual Statement of Financial Position
Pirate Ltd Sailor Ltd Pirate Ltd Sailor Ltd Pirate Ltd Sailor Ltd
Current Assets:
- -$ -$ -$ -$ -$ -$
Accounts receivable -$ -$ -$ 125,000$ 162,500$ 125,000$
Inventory -$ 100,000$ 125,000$ -$ -$ -$
Total current assets -$ 100,000$ 125,000$ 125,000$ 162,500$ 125,000$
Non current assets:
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
Total non current assets -$ -$ -$ -$ -$ -$
Total Assets -$ 100,000$ 125,000$ 125,000$ 162,500$ 125,000$
Current Liabilities:
Accounts payable -$ 100,000$ 125,000$ 100,000$ 125,000$ 100,000$
Income tax payable -$ -$ -$ 5,000$ 7,500$ 5,000$
- -$ -$ -$ -$ -$ -$
Total current liabilities -$ 100,000$ 125,000$ 105,000$ 132,500$ 105,000$
Non current Liabilities:
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
- -$ -$ -$ -$ -$ -$
Total non current liabilities -$ -$ -$ -$ -$ -$
Total Liabilities -$ 100,000$ 125,000$ 105,000$ 132,500$ 105,000$
Net Assets -$ -$ -$ 20,000$ 30,000$ 20,000$
Equity:
- -$ -$ -$ -$ -$ -$
Retained earnings -$ -$ -$ 20,000$ 30,000$ 20,000$
Total Equity -$ -$ -$ 20,000$ 30,000$ 20,000$
Particulars October November December

4ADVANCED FINANCIAL ACCOUNTING
Consolidated financial statements:
Extract of Consolidated Income Statement
Particulars October November December
Sales revenue -$ -$ 162,500$
Cost of goods -$ -$ 100,000$
Gross profit -$ -$ 62,500$
Expenses:
- -$ -$ -$
- -$ -$ -$
- -$ -$ -$
- -$ -$ -$
Total expenses -$ -$ -$
Profit before tax -$ -$ 62,500$
Income tax expense -$ -$ 12,500$
Profit after tax -$ -$ 50,000$

5ADVANCED FINANCIAL ACCOUNTING
Extract of Consolidated Statement of Financial Position
Particulars October November December
Current Assets:
- -$ -$ -$
Accounts receivable -$ -$ 162,500$
Inventory 100,000$ 100,000$ -$
Total current assets 100,000$ 100,000$ 162,500$
Non current assets:
- -$ -$ -$
- -$ -$ -$
- -$ -$ -$
Total non current assets -$ -$ -$
Total Assets 100,000$ 100,000$ 162,500$
Current Liabilities:
Accounts payable 100,000$ 100,000$ 100,000$
Income tax payable -$ -$ 12,500$
- -$ -$ -$
Total current liabilities 100,000$ 100,000$ 112,500$
Non current Liabilities:
- -$ -$ -$
- -$ -$ -$
- -$ -$ -$
Total non current liabilities -$ -$ -$
Total Liabilities 100,000$ 100,000$ 112,500$
Net Assets -$ -$ 50,000$
Equity:
- -$ -$ -$
Retained earnings -$ -$ 50,000$
Total Equity -$ -$ 50,000$
Notes supporting the arguments of preparing consolidated financial statement:
Separate Legal Entity:
As per generally accepted accounting principles, every business organisation is
considered to be a separate and legal entity. Therefore, in this concept each business
organisation is having separate and legal entity distinct from its promoters or owners. It can

6ADVANCED FINANCIAL ACCOUNTING
own assets by its own name and also it is liable for responsibilities and obligations by its
own. No assets of the business organisation can be considered as the asset of the owner and
nor the owner is liable to pay off obligations of the business organisation. Further, the
concept explains that, the business organisation can enter into contracts and transaction by its
own name and it can sue against or be sued for any legal matters or disputes.
Hence, in the given case study, the Pirate Ltd and Sailor Ltd, both are having a
separate and legal entity completely distinct from each other. Assets of the Pirate Ltd are only
belonging to the Pirate Ltd and obligation the same applies for the Sailor Ltd too. On the
other hand, liabilities of each of the company belongs them respectively and no other
company is responsible for those liabilities.
Holding subsidiary relationship:
Merger and acquisition of business is a secondary or indirect route of growing
business. In this process one business organisation gets access to the assets and resources of
another organisation through the controlling power of controlling the operations of the latter
one. When a company acquires more than fifty percent of the voting rights of another
company then the former one is known as the holding company and the latter one is known as
the subsidiary company.
Concept of one economic entity for consolidation:
It can be understood from the above discussion that, company go for merger and
acquisition to gain access to the resources and assets of other companies for growing up
gaining more market share and growing up their business. As a holding company has control
over the resources and assets of the subsidiary company, those assets of the subsidiary
company can be considered as the assets of the holding company. In the same way the
respective liabilities of the subsidiary company should also be considered as the liability of

7ADVANCED FINANCIAL ACCOUNTING
the holding company. Hence, to express the actual financial position of the company, assets
and liabilities of the holding as well as the subsidiary company must be combined together.
Therefore, for preparation of the consolidated income statement, all the revenues and
expenses are combined together, subject to elimination of intercompany transactions, and for
preparation of the consolidated statement of financial position, all the assets and liabilities are
combined too for expressing the actual financial strength of the company as a whole.
Historical cost concept:
As per generally accepted accounting principles, all the transactions are recorded in
the financial books of accounts after the event has already occurred. Hence, the price at
which the transactions were carried out is historical in nature. As per the historical cost
concept, all the transactions are recorded in the financial books of accounts at their historical
costs and the same is carried out for the following financial years. Purchase of inventory may
not lead to earning of revenue. It may so happen that, the inventory was purchased at a past
but the revenue is recognised at present subject to sale of the respective inventory. To
understand the timing of revenue recognition, the principle of revenue recognition has been
discussed in the following paragraph.
Concept of revenue recognition:
Revenue is the form of earnings or income. It is recognised as and when the inventory
is actually sold to the outsiders or the services have been provided to the outsiders. Therefore,
as and when the right to receive income have been arisen due to certain event or transaction,
the revenue associated with such transaction should be recognised in the financial books of
accounts.
In the given case study, when the Pirate Ltd and Sailor Ltd prepare the individual
income statement, the revenue is recognised as and when they make sales. It can be observed

8ADVANCED FINANCIAL ACCOUNTING
from the individual income statement that, the Sailor Ltd recognises the revenue in the month
of November and the Pirate Ltd recognises the same in the month of December. As in this
case they have been considered as separate legal entity, the revenue has been recognised
accordingly based on the timing of sales.
While preparing the consolidated financial statement, Pirate Ltd and Sailor Ltd are
considered as one economic entity. Hence, the month in which the sales have been made to
the outsiders, the revenue has been recognised in that month. It can be observed from the
consolidated income statement that, as the actual sales to outsiders occurs in the month of
December, the revenue has been recognised in that month only.
Matching principle:
As per matching principle, all the expenses must be matched with the respective
revenues and all the incomes must be compared with the respective incomes to ascertain the
amount of profit or loss. It implies, with respect to recognition of sales revenue, cost of goods
sold must be recognised also. In the given case study, it can be observed from the individual
as well as consolidated financial statement that, as and when the sales have been recognised,
the respective cost that is the cost of goods sold has also been recognised.
Importance of consolidated financial statement:
Consolidated financial statements exhibits the true or the actual financial performance
and actual financial position of the company as a whole. Intercompany transaction makes the
repetition of the same transaction, which may show that the company is having a good
financial performance and position. Consolidated financial statement eliminates all those
errors and double counting of revenues and expenses thereby expressing the true financial
position and financial performance, on which the bank can rely upon and extend financing.

9ADVANCED FINANCIAL ACCOUNTING
Bibliography:
Aletkin, P. A. (2014). International financial reporting standards implementation into the
Russian accounting system. Mediterranean Journal of Social Sciences, 5(24), 33.
Cîrstea, A. (2014). The need for public sector consolidated financial statements. Procedia
Economics and Finance, 15, 1289-1296.
Erer, M., & Cömert, Ç. E. (2014). Timeliness of financial reporting in Turkey. Iktisat Isletme
ve Finans, 29(337), 73-94.
Hadi, K. T. (2015). Consolidated financial statements.
Hoyle, J. B., Schaefer, T. F., & Doupnik, T. S. (2018). Fundamentals of advanced
accounting. McGraw-Hill Education.
Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced accounting. McGraw Hill.
Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.
Müller, V. O. (2014). The impact of IFRS adoption on the quality of consolidated financial
reporting. Procedia-Social and Behavioral Sciences, 109, 976-982.