6. Financial reporting by groups of companies Flashcards
Tea Limited is a new company which formed on 1 January 20x4. At the date of its formation, the ISC of Tea ltd consists of 100,000 equity shares of £1 each with equal voting rights. The directors of Tea ltd retained 49,000 equity shares and Teasold 51,000 equity shares to ilam ltd on 2 January 20x4 for the par value of the shares.
Does Ilam ltd meat the criteria of parent company?
Does Ilam Ltd meet the criteria of a parent company?
Ilam Ltd becomes the parent company of Tea Ltd from 1 January 20X4 because it meets all the three elements of control as defined by IFRS 10.
Power over the investee, through most of voting rights (owning more than 50% of the equity shares).
Exposure or rights to variable returns (a dividend).
It can control the composition of the board of directors and affect the amount of investor returns.
Why are the subsidiary’s identifiable assets and liabilities included at their fair value in the consolidated fin statements?
Consolidated accounts are prepared from the perspective of the group and
must reflect their cost to the group (to the parent), not the original cost to the subsidiary. The book values of the subsidiary’s assets and liabilities are largely irrelevant in the consolidated financial statements. The cost to the group is the fair value of the acquired assets and liabilities at the date of acquisition. Fair values are therefore used to calculate the value of goodwill.
Why are pre-acquisition profits of a subsidiary not included int he consolidated financial statements?
Pre-acquisition profits are the retained earnings of the subsidiary which exist at the date when it is acquired. They are excluded from group retained earnings as they belong to the previous shareholders and were earned under their ownership.
Gorkha plc acquired Ye Ltd on 1 January 20X0. Their retained
earnings at 1 January 20X0 amounted to £500,000 and £800,000
respectively. Explain how the retained earnings of Ye Ltd at 1
January 20X1 would be treated in the consolidated financial
statements.
The retained earnings of Ye Ltd have accrued during the period prior to
acquisition and were earned under the ownership of the previous shareholders.
They form a part of the shareholders’ equity at acquisition in the subsidiary for the purpose of computing goodwill arising on consolidation.
During the year ended 31 December 20xq, the parent company (P plc) sells goods to its subsidiary (S ltd) at cost plus a mark-up of 15%. Explain the accounting treatment of the intra-group trading and the profit arising from the sales.
Intra-group items including all transactions, balances and profits and losses
must be eliminated to avoid double counting. The consolidated totals shouldof only transactions, balances and profits and losses created through
transactions with parties outside the group. For consolidated financial
statements, it is therefore necessary to eliminate intra-group balances and transactions.
Company P will make the following accounting adjustments for unrealised profits:
Intra-group sales and purchases are eliminated. Reduce the retained
earnings of Company P by 15% (the mark-up) or 15 ÷ 115 (13% of the
selling price).
Any unrealised profit relating to intercompany trading is eliminated.
Reduce the inventory of Company B by 15% (the mark-up) or 13% of the
price. The above adjustments only apply to unsold inventory.
Parent and subsidiary company definitions
Parent company is An entity that controls one or more entities.
* A company is a parent company of another company, its subsidiary, if
a) it controls it through owning a majority of the voting shares.
b) through having the power to appoint the board, through a control
contract.
c) by a power in the subsidiary’s governing document or
d) through other mechanisms specified in the Companies Act 2006 or accounting standards.
Subsidiary company : An entity controlled by another entity (parent
company).
When do the companies need to prepare group accounts?
IFRS 10: If one company controls another, a single set of consolidated financial
statements need to be prepared to reflect the financial performance and position of
the group as one combined entity.
CA 2006 : If a business operates through more than one company, group accounts
have to be prepared that give a clear picture of the total activities that the
company controls.
What are the elements of control?
- Voting Rights
- Right to Variable returns
- Ability to use power over the investee to affect the amount of investor returns
Goodwill
The price paid for a company at acquisition (to gain control) will normally exceed the fair
market value of its net assets or equity. The difference is purchased goodwill.
This represents the additional amount paid for factors such as the reputation of the business, the experience of employees, the customer base and the brand of the business.
Purchased goodwill is the difference between the value of an acquired entity (including any NCI) and the net assets of that entity’s identifiable assets and liabilities
What is non-controlling interest
Where the parent owns less than 100% of the ordinary share capital of a subsidiary, the interest not controlled by the parent is called the NCI.
Pre-acquisition and post-acquisition profits
The share of the parent co of Pre acquisition profit is taken into the calculation of goodwill.
The share of the parent co of post-acquisition profit is included in the Consolidated
Retained Earnings.
Joint ventures
Businesses often go into partnership with other businesses on profitraising ventures under joint ventures, which are dealt with in IFRS 11 (Joint Arrangements).
* A joint venture is a business arrangement whereby the parties that have joint control of the arrangement agree to pool their resources and expertise to achieve a particular goal.
* They have joint rights to the assets and obligations for the liabilities relating to the arrangement. The risks and rewards of the enterprise are also shared
- Reasons behind the formation of a joint venture often include:
- business expansion
- development of new products
- moving into new markets, such as those overseas
The parties to a joint venture must recognise their interest in a joint venture as an investment and account for it using the equity method in accordance with IAS 28
IAS 28 Equity method
IAS 28 Equity Method
- International Accounting Standard 28 sets out the requirements for the application of the equity method when accounting for investments in associates and joint ventures.
- The equity method initially recognises the investment in an associate or a joint venture in the investor’s statement of financial position at cost. It adjusts the carrying amount thereafter with the change in the investor’s share of the post-acquisition profit (or loss) of the investee.
The equity method is sometimes called a ‘one-line consolidation’.
* International Accounting Standard 28 requires the use of the equity method of accounting for investments in associates and joint ventures (the investee), whereby the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the profit (or loss) of the investee.
* The value of the investment is cost plus the group’s share of the investee’s post-acquisition profits or losses
* Distributions received from an investee reduce the carrying amount of the investment, as these are cash inflows.
* Changes in the investee’s OCI that have not been included in profit or loss, such as a revaluation, may also require adjustments to the carrying amount of the investment.
* The value of the investor’s share of the investee’s profit or loss for the period is recognised in the investor’s profit or loss.
* However, dividends are excluded from the statement of profit or loss and OCI as this would be double counting.
- As associates and joint ventures are not controlled, their financial statements
may be prepared to a different date to that of the investor. - IAS 28 allows some latitude for differences in year ends, but only up to a threemonth difference.
- If the year-end dates are further apart than three months, special accounts would
be required from the associate or joint venture. - Any transactions such as sales or purchases between group companies and the associate or joint ventures are not normally eliminated: they will remain part of
the consolidated figures in the consolidated statement of profit or loss and OCI. - It is normal practice to adjust for the group share of any unrealised profit in
inventory. - As per IAS 28, the equity method is discontinued when significant influence or joint control is lost or if the investor’s interest changes to achieve control. At this point, the associate or joint venture will become a subsidiar
How does the difference between the equity method and the full
consolidation method affect the decisions of investing entities if the
investee were a highly geared entity?
There are substantial differences between consolidation and equity accounting,
thus influencing the behaviour of investing entities to structure transactions to
achieve their desired accounting outcome. If an investee is highly geared with
a lot of debt, the investor would bring 100% of the gross debt of the investee
onto its consolidated balance sheet through consolidation. It increases the
gearing for the group as a whole. This is avoided if the investee is treated as a
joint venture and accounted using the equity method.
A controlling interest in the investee is not desirable in this scenario. However, if
the investee were very profitable, the consolidated accounts would consolidate
100% of the investee’s profits in its accounts with any portion relating to NCI
disclosed at the foot of the balance sheet.
When is a parent exempted from preparing consolidated financial
statements?
A parent is exempted from preparing consolidated financial statements when:
the parent is itself a wholly owned subsidiary, or a partially owned
subsidiary and the non-controlling interests do not object;
its securities are not publicly traded or in the process of being traded; or
its ultimate or intermediate parent publishes IFRS-compliant financial
statements.
