Chapter 6 - Financial Reporting By Groups Of Companies

Question 1

What is the purpose and requirements of IFRS 10?

Answer 1

IFRS 10 (Consolidated FS) defines the principle of control and sets out the requirement for entities to consolidate for entities it controls.

Question 2

What are the requirements to prepare group accounts under statute?

Answer 2

CA2006 sets out requirements to consolidate. Small groups that meet 2 out of the 3 size criteria relating to turnover, balance sheet total and employees (on a consolidated basis) are exempt from preparing group accounts.

Agg turnover gross(net) - £12.2m (£10.2m)
Agg BS total gross(net) - £6.1m (£5.1m)
Agg no. of employees - 50

Question 3

What are the 3 control elements in accordance with IFRS 10?

Answer 3

1. Power (>50% voting rights)
2. Rights to Variable Returns (rights to returns/dividends)
3. Ability to use power over investee to affect amount of investor returns (control of board).

Question 4

What is the basic method of consolidation?

Answer 4

The parent and subsidiary accounts are simply added up line-by-line to create total figures for the group.
Items to be considered:

• Intra-group items: must be eliminated (include purchase and sale of inventories/assets between the group)
• The parent’s investment in the subsidiary, carried as an investment in its balance sheet, is eliminated
• The accounting policies of all group companies must be aligned
• Subsidiaries should have the same reporting date as the parent. Where impracticable, the most recent FS of the subsidiary are used with adjustments for significant transactions. Special accounts will need to be prepared if the difference is greater than 3 months
• Any share of a subsidiary’s results that belongs to a NCI or minority interest must be disclosed at the foot of the BS and income statement and in the statement of changes in equity.

Question 5

What is the purpose and requirement of IFRS 3?

Answer 5

Requires business combinations to be accounted using the “acquisition method”, meaning assets and liabilities of the investee are to be measured at their fair values at the acquisition/merger date.

IFRS 3 requires the reporting entity to:
- identify the acquirer (for example, when an acquirer entity buys another
using cash or its own shares as currency);
- determine the acquisition date (the date control passes to the acquirer);
- recognise and measure the identifiable assets acquired, the liabilities
assumed and any NCI in the acquiree; and
- recognise and measure goodwill or gain.

Question 6

What is goodwill?

Answer 6

Price paid at acquisition will normally exceed the fair market value of a company’s net assets. Difference = goodwill.

Amount paid for other factors e.g. reputation.

Goodwill can be negative which is called a “gain on a bargain purchase”. Negative goodwill should be re-calculated to ensure there are no errors and then recognised immediately in the PandL.

Question 7

How should you account for the impairment of goodwill?

Answer 7

• Should be capitalised in the consolidated SOFP and reviewed for impairment annually as per IAS 36.
• The asset is impaired when the carrying value exceeds its recoverable value.
• The fair market value of a goodwill asset could drop below carrying value as a result of; adverse economic conditions, increased competition, legal implications, loss of key personnel, declining revenue and market value.
• An impairment is recognised as loss in the PandL and as a reduction in the goodwill in BS.

Question 8

How should you account for the purchase consideration of a subsidiary?

Answer 8

To ensure accurate figures are calculated for goodwill, the consideration paid must be measured at fair value.

Consideration given by a parent entity can be split into four categories:

1) Cash
2) Shares in the parent company
3) Deferred consideration
4) Contingent consideration

Question 9

What is deferred consideration?

Answer 9

The amount payable at a future date by an acquirer to the acquiree in a business combination after a predefined time period (often linked to performance targets).

Primarily driven by tax and accounting considerations. Present value of the amount payable is recorded as the part of the consideration at the date of acquisition. Interest normally accrues on the deferred consideration.

Question 10

What is contingent consideration?

Answer 10

An uncertain amount that is payable at a future date by an acquirer to the acquire in a business combination which is linked to a specified future event or condition met within a pre-defined time period, such as financial performance of the acquiree.

Question 11

What are the main adjustments for consolidated SOFP?

Answer 11

• Investment in the subsidiary is replaced by the goodwill figure. Only the share capital and share premium balances related to the parent are used in the consolidation. Total of share capital and share premium from the subsidiary remains unchanged at both acquisition and reporting date and is therefore removed
• Intra-group items such as sales, purchased, unrealised profit and balances are eliminated to avoid double counting
• Profits – the group share of the subsidiary’s profit is calculated and added to the overall group retained earnings. Pre-acquisition profits are the retained earnings of the subsidiary which exist at the date when it is required and these are therefore excluded from group retained earnings as they belong to the previous shareholders. Post-acquisition profits are profits recognised in retained earnings by the subsidiary at the year-end but earned under the ownership of the new parent and therefore this is recognised in group retained earnings.
• Non-controlling interests – where the parent owns less than 100% of the ordinary share cap of the subsidiary, the profits attributable to NCIs is calculated and shown separately on the face of the consolidated SOFP.

Question 12

What are the main adjustments for consolidated SOCI?

Answer 12

Revenues and expenses of the parent and the subsidiary are added together with the following adjustments:

Intra-group sales and purchases are eliminated. Any unrealised profits on intra-group trading should also be excluded. The unrealised profit on unsold inventories of the purchasing company is therefore calculated to reduce from the consolidated gross profit. The unrealised profit will be eliminated against the inventory figure.

Net profits attributable to NCIs are calculated and split between amounts attributable to the equity holders of the group and the NCIs. Calculated as NCI% x profits after tax LESS NCI% x provision for unrealised profit

Question 13

What is the objective of IAS 28?

Answer 13

Prescribe the accounting for investments in associates and also sets out the application of the equity method when accounting for investments in associates and joint ventures.

Question 14

What are associates?

Answer 14

An entity over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture are classed as associates.

“significant influence” is defined as the “power to participate in the financial and operating policy decisions of the investee, by not to control or have joint control over those policies”. Significant influence is assumed with a shareholding of 20% to 50%.

Question 15

What is a joint venture?

Answer 15

A business arrangement whereby the parties have joint control and agree to pool their resources and expertise to achieve a goal. Obligations and liabilities and risks and rewards are joint. Reasons for forming joint ventures include: business expansion, development of new products or moving into new markets (such as overseas).

A joint venture must recognise its interest in a joint venture as an investment and account for it using the equity method.

Question 16

What is the IAS 28 equity method?

Answer 16

The equity method initially recognises the investment in an associate or a joint venture in the investor’s balance sheet 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 value of the investment is the cost plus the group’s share of the associates profits and losses.
• Distributions received from an investee reduce the carrying amount of the investment.
• Changes in the investee’s other comprehensive income, such as revaluation, that have not been included in profit or loss may also require adjustments to the carrying amount.
• The value of the investor’s share of the investee’s profit or loss after ta is recognised in the investor’s profit or loss
• Dividends are excluded from the statement of comprehensive income.

Question 17

What are the requirements of IAS 27?

Answer 17

A parent company produces its own single company FS as per IAS 27 rules.

• Where an entity invests in a “simple” or “trade” investment with neither control not significant influence, it is carried as an intangible non-current asset and any dividends received are reflected in the income statement
• Investments in subsidiaries, associates and jointly controlled entities are accounted for either (A) at cost, (B) in accordance with IFRS 9 or (C) using the equity method re IAS 28.
• Where subsidiaries are classed as held for sale in accordance with IFRS 5, they should be accounted for in accordance with IFRS 5.

Where separate financial statements are prepared in addition to consolidated financial statements, they must disclose:
• The fact that the statements are separate FS and the reasons why they have been prepared if not required by law; and
• Information about investments and the method used to account for them.

Question 18

When is a parent company exempt from preparing consolidated FS?

Answer 18

If all of the following conditions apply:

1) When the parent itself is a wholly owned subsidiary or a partially owned subsidiary and the NCIs do not object;
2) When its securities are not publicly traded or are in the process of trading in public securities market; and
3) When its ultimate or intermediate parent publishes IFRS-compliant FS.

If the exemption is taken, it must comply with IAS 27 rules, disclosing:

a) The fact that the exemption has been used, the name and country of incorporation of the entity whose consolidated FS that comply with IFRS have been published and the address where those are obtainable;
b) A list of significant investments in subsidiaries, jointly controlled entities and associates including the name, country of incorporation, proportion of ownership interest and, if different, proportion of voting power held; and
c) The method used to account for its investments.

Question 19

What are the rules on exclusion of a subsidiary from consolidation?

Answer 19

Rules on exclusions of subsidiaries are strict because entities may use them to manipulate results.

E.g. if a subsidiary with large gearing was not consolidated, it would make the overall group look healthier.

Subsidiaries held for sale are accounted for in accordance with IFRS 5 and the control must actually be lost for exclusion to occur.

IFRS 10 rejects the argument for exclusion on the grounds of dissimilar activities. Disclosures are required to provide further information on subsidiaries and different business activities of those subsidiaries.