Gregory Co is a listed company and, until 1 October 20X5, it had no subsidiaries. On that date, it acquired 75% of Tamsin Co’s equity shares by means of a share exchange of two new shares in Gregory Co for every five acquired shares in Tamsin Co. These shares were recorded at the market price on the day of the acquisition and were the only shares issued by Gregory Co during the year ended 31 March 20X6.
The summarised financial statements of Gregory Co as a single entity at 31 March 20X5 and as a group at 31 March 20X6 are:
(a) Note: References to 20X6 and 20X5 are to the years ending 31 March 20X6 and 20X5 respectively
Comment (1)
I see the profit for the year has increased by $1m which is up 20% on last year, but I thought it would be more as Tamsin Co was supposed to be a very profitable company.
There are two issues with this statement: first, last year’s profit is not comparable with the current year’s profit because in 20X5 Gregory Co was a single entity and in 20X6 it is now a group with a subsidiary. A second issue is that the consolidated statement of profit or loss for the year ended 31 March 20X6 only includes six months of the results of Tamsin Co, and, assuming Tamsin Co is profitable, future results will include a full year’s profit. This latter point may, at least in part, mitigate the CEO’s disappointment.
Comment (2)
I have calculated the EPS for 20X6 at 13 cents (6,000/46,000 x 100 shares) and at 12·5 cents for 20X5 (5,000/40,000 x 100) and, although the profit has increased 20%, our EPS has barely changed.
The stated EPS calculation for 20X6 is incorrect for two reasons: first, it is the profit attributable to only the equity shareholders of the parent which should be used and second the 6 million new shares were only in issue for six months and should be weighted by 6/12. Thus, the correct EPS for 20X6 is 13·3 cents (5,700/43,000 x 100). This gives an increase of 6% (13·3 – 12·5)/12·5) on 20X5 EPS which is still less than the increase in profit. The reason why the EPS may not have increased in line with reported profit is that the acquisition was financed by a share exchange which increased the number of shares in issue. Thus, the EPS takes account of the additional consideration used to generate profit, whereas the trend of absolute profit does not take additional consideration into account. This is why the EPS is often said to be a more accurate reflection of company performance than the trend of profits.
Comment (3)
I am worried that the low price at which we are selling goods to Tamsin Co is undermining our group’s overall profitability.
Assuming the consolidated financial statements have been correctly prepared, all intra-group trading has been eliminated, thus the pricing policy will have had no effect on these financial statements. The comment is incorrect and reflects a misunderstanding of the consolidation process.
Comment (4)
I note that our share price is now $2·30, how does this compare with our share price immediately before we bought Tamsin Co?
The increase in share capital is 6 million shares, the increase in the share premium is $6m, thus the total proceeds for the 6 million shares was $12m giving a share price of $2·00 at the date of acquisition of Tamsin Co. The current price of $2·30 presumably reflects the market’s favourable view of Gregory Co’s current and future performance.
(b)
