Question

Why is the Profit For the year less than the Post-Acquisition profit? (Retained Profit year-end - Pre-acquisition profit)

Example, I have an associate which I own 25% of share in it and it was acquired on 1 Jan. The accounting year end is 31 Dec. There is no any dividend distribution inside this situation.

Shouldn't I get the same amount for profit for the year with the post-acquisition profit? I am having Pre-acquisition retained profit of 247, abd the year-end retained profit(31 Dec) 355, which give me a 108 post-acquisition profit. However, inside the statement, there shows that my associate is having only 104 of Profit for the year.

May I know where is the missing 4, and what are the possible reasons resulting in this scenario?

Answer 1

Equity method is adopted for accounting of Associates

Under this method, the investment value is shown in the books of holding company at cost plus holdings company's portion of profits in the associates business less dividends receieved for his share in associate

For example 25% of stock in a associate is obtauned by holding company for $25,000. Later the associate has earned a profit of $200,000 for the year and distributed dividens of $50,000.

For recording purchase of shares in associate

Investment in associate a/c $25,000

To Cash a/c $25,000

For recording profits of associate

Investment in associate a/c $50,000

To Investment revenue a/c $50,000

For recording dividends

Cash a/c $12,500

To Investment in associate a/c $12,500

The profits may differ after applying the equity methods in cases like Unrealised Gain and unrealised losses recognition.

In the given case, the post acquisition combined profits are higher than the individual profits. The reason for such difference might be Unrealised Gain adjustment.

When there is Unrealised Gain in a transaction between the two entities then that portion of unrealised gain which belongs to his Investment in associate (25% in given case) will be reversed leading to increase in profit in the combined/ consolidated financials. So in the given case, there might be Unrealised Gain of $16 of which 25% i.e., $4 will be reversed leading to increase in Profits.