An 80% subsidiary: goodwill, two-way inventory sales, and whose profit the unrealised margin belongs to
Parent P acquired 80% of Subsidiary S on 1 April 20X2 for ¥520,000,000. At that date S's net assets were share capital ¥300,000,000 and retained earnings ¥250,000,000, and an office building with ten years of remaining life (straight-line, no residual value) was undervalued by ¥40,000,000. Goodwill is amortised over ten years. Both companies close on 31 March and the current year is the year ended 31 March 20X5. During the year P sold goods to S for ¥150,000,000; those goods had cost P ¥105,000,000, and one-third of them remained in S's closing inventory. S also sold goods to P for ¥60,000,000 at a 20% gross margin, and one-quarter of those goods were still held by P at year-end. The effective tax rate is 30%. S reported profit of ¥45,000,000 for the year and paid no dividends. P uses the partial-goodwill method.
1. Compute goodwill, the non-controlling interest at acquisition, and the two fair-value amortisation amounts, and write the opening elimination entry.
Read the worked answer
Goodwill. Fair value of S's identifiable net assets = 300,000,000 + 250,000,000 + 40,000,000 building uplift = ¥590,000,000. P's share = 590,000,000 × 80% = ¥472,000,000. Goodwill = 520,000,000 - 472,000,000 = ¥48,000,000, amortised at 48,000,000 / 10 = ¥4,800,000 a year.
Non-controlling interest at acquisition (partial method: proportionate share only) = 590,000,000 × 20% = ¥118,000,000.
Fair-value depreciation on the building = 40,000,000 / 10 = ¥4,000,000 a year. This is an additional expense of S, so 20% of it (¥800,000) is borne by the non-controlling interest.
Opening elimination entry:
- (Dr) Share capital 300,000,000
- (Dr) Retained earnings 250,000,000
- (Dr) Building 40,000,000
- (Dr) Goodwill 48,000,000
- (Cr) Investment in S 520,000,000
- (Cr) Non-controlling interest 118,000,000
Both columns total ¥638,000,000. Note what the entry does not do: the building uplift is a debit because the asset was understated, and it must be depreciated in later periods; goodwill is a debit because P paid more than its share of fair value. Amortising goodwill reduces only the parent's share of group profit - no part of goodwill amortisation is attributed to the non-controlling interest, because goodwill under the partial method represents only the parent's purchase.
2. Prepare the elimination entries for both intercompany inventory profits, including tax effects, and state how each is allocated between the parent's shareholders and the non-controlling interest.
Read the worked answer
Downstream (P to S). Gross margin = (150,000,000 - 105,000,000) / 150,000,000 = 30%. Unrealised profit = 150,000,000 × 1/3 × 30% = ¥15,000,000.
- (Dr) Cost of sales 15,000,000 / (Cr) Inventories 15,000,000
- (Dr) Deferred tax asset 4,500,000 / (Cr) Income taxes adjustment 4,500,000
The seller is the parent, so the whole net reduction of ¥10,500,000 falls on the parent's shareholders. No part is attributed to the non-controlling interest.
Upstream (S to P). Unrealised profit = 60,000,000 × 1/4 × 20% = ¥3,000,000.
- (Dr) Cost of sales 3,000,000 / (Cr) Inventories 3,000,000
- (Dr) Deferred tax asset 900,000 / (Cr) Income taxes adjustment 900,000
The seller is the subsidiary, so the profit eliminated was S's profit and the tax effect follows it. Net effect ¥2,100,000, split 80:20:
- (Dr) Non-controlling interest profit 420,000 / (Cr) Non-controlling interest 420,000
Why the split matters. Allocating downstream profit to the non-controlling interest would reduce the minority's profit for a margin the subsidiary never earned, and it would overstate the parent's share. A useful check: reconstruct S's contribution to group profit from S's own profit only - upstream inventory profit, the building depreciation and S's tax effects belong in that pool; downstream profit and goodwill amortisation do not.
3. Compute the profit attributable to non-controlling interests for the year, justifying each item you include or exclude.
Read the worked answer
Start from S's reported profit and adjust only for items that belong to S.
| Item | Amount | Include? |
|---|---|---|
| S's reported profit | 45,000,000 | yes |
| Additional depreciation on building uplift | (4,000,000) | yes - S's asset |
| Upstream unrealised profit, net of tax (3,000,000 - 900,000) | (2,100,000) | yes - S's sale |
| Downstream unrealised profit | - | no - P's sale |
| Goodwill amortisation 4,800,000 | - | no - parent's purchase only |
Adjusted S profit = 45,000,000 - 4,000,000 - 2,100,000 = ¥38,900,000.
Profit attributable to non-controlling interests = 38,900,000 × 20% = ¥7,780,000.
Two exclusions worth defending explicitly. Goodwill arises from P's purchase price; under the partial-goodwill method there is no goodwill attributable to the minority, so amortising it against their profit would be double-counting. Downstream inventory profit was earned by P and eliminated against P's profit; attributing any part of it to the minority would let the minority bear a cost it never incurred. By contrast, the extra depreciation on the building and the upstream inventory elimination both reduce the profit S actually generated in the group's eyes, so the minority shares them. The consolidated profit attributable to owners of the parent is then P's own profit plus 38,900,000 × 80% (¥31,120,000) minus goodwill amortisation ¥4,800,000 minus the downstream profit net of tax ¥10,500,000.