2/09/2015. Applying the consolidation method. Applying the consolidation method. Chapter 15. Consolidation: controlled entities

Transcription

1 Chapter 15 Consolidation: controlled entities Prepared by Emma Holmes Applying the consolidation method AASB 10 requires the application of the consolidation method Consolidation process of preparing single set of financial statements for group of entities under control of one of those entities Involves combining financial statements of individual entities to show financial position and performance of group as if it were single entity Group a parent and it s subsidiaries Parent an entity that controls one or more entities Subsidiary an entity that is controlled by another entity Applying the consolidation method A Ltd B Ltd Parent control must exist on this later) Subsidiary (more The group is referred to as the A Ltd Group 1

2 Applying the consolidation method Consolidated financial statements are prepared by (i) Aggregating (combining), line by line, like items of assets, liabilities, equity, income and expenses (ii) Adjusting these combined figures for intergroup transactions between entities within the group (covered in following chapters) Applying the consolidation method Simple consolidation worksheet for the A Ltd group A Ltd B Ltd Consolidation Current assets = Non current assets = Total assets Total liabilities (80 000) + (30 000) = ( ) Net assets Control Criterion for identifying parent-subsidiary relationship is control Significant judgement is often required in determining whether control exists An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee 2

3 Control The following three elements are required in order for an investor to have control 1. power over the investee 2. exposure, or rights, to variable returns from its involvement with the investee 3. the ability to use its power over the investee to affect the amount of the investor s returns. All three elements must be present for control to exist Power is defined as existing rights that give the current ability to direct the relevant activities. Power arises from rights. Most rights arise from a legal contract. Examples in AASB 10 include: Voting rights Rights to appoint, reassign or remove members of the investee s key management personnel Rights to appoint or remove another entity that participates in management decisions Rights to direct the investee to enter into, or veto any changes to, transactions that affect the investee s returns Rights must be substantive the holder must have the practical ability to exercise the rights. Judgment is required in determining whether rights are substantive. Factors to consider per AASB 10 are: Whether the party that holds the rights would benefit from exercising the rights eg potential voting rights; Whether there are any barriers that prevent a holder from exercising rights. Where multiple parties are involved, whether there is a mechanism in place to enable those parties to practically exercise the rights. 3

4 If a right is protective, then the holder does not have power. Protective rights are designed to protect the interest of the party holding those rights without giving the party power over the entity to which the rights relate. Example of protective rights include the following: A lenders right to restrict a borrower from undertaking certain activities The right of a party holding a non-controlling interest to approve various transactions The rights of a lender to seize the assets of a borrower in the event of default. Requires the ABILITY to direct rather than actually directing. The ability to direct must be current. It must be relevant activities that are being directed, that is activities of the investee that significantly affect the investee s returns. Power is presumed to exist where an investor owns more than 50% of the voting rights of an entity unless there is evidence to the contrary Voting rights of less than 50% can result in an investor having power over an investee. The following factors need to be considered when assessing whether there is power in this case. Dispersion of other shareholders probability of shareholders attending meeting lessened by location and by size of share parcels Attendance at AGMs e.g. if only 60% of eligible votes attend meeting, 31% can control meeting Existence of contracts power by agreement with other investors 4

5 Problems relating to having power with less than 50% of the voting rights include: Temporary control eg 31% ownership can control if only 60% of eligible votes in attendance at AGM in Year 1, but not if 70% in attendance in Year 2 Friendly relationship can turn un-friendly Who controls C Ltd? A Ltd B Ltd A Ltd currently actively formulates the policies of C Ltd 48% C Ltd 52% B Ltd currently plays no part in the day-to-day management of C Ltd B Ltd controls C Ltd Even though A Ltd is currently running the day-to-day operations of C Ltd, B Ltd has the power over C Ltd. At any time that B Ltd disagrees with the management policies of A Ltd it can take control by virtue of its majority voting interests. Does A Ltd control B Ltd? Yes. A Ltd B Ltd 45% 20 shareholders each holding < 2% of the voting power. These shareholders rarely attend meetings and vote Based on the history of AGM attendance and dispersion of shareholders it appears that A Ltd exerts power over B Ltd in spite of holding < 50% of the voting rights 5

6 Does A Ltd control B Ltd? A Ltd 3 shareholders each 49% holding 17% of the voting B Ltd power. These shareholders regularly attend meetings and vote No. Based on the history of AGM attendance and involvement of shareholders it appears that A Ltd does NOT exert control over B Ltd. Control element 2 Exposure or rights to variable returns The second element of the control definition requires that the investor has the rights to variable returns from the investee. Examples of returns that can exist in parent-subsidiary relationship include: Dividends Obtaining scarce raw materials on priority basis Gaining access to subsidiary s distribution network, patents Economies of scale Denying or regulating access to subsidiary s assets to competitors Control element 3 Ability to use the power to affect returns The third element requires that the parent have the ability to increase its benefits and limit its losses from the subsidiary s activities. Remember, all three elements must be present for control to exist. No control = no parent-subsidiary relationship = no consolidation. 6

7 Preparation of consolidated financial statements AASB 10(paragraph 4) applies to all parents unless they meet all of the following conditions: i.it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners do not object to the parent not presenting consolidated financial statements; ii.its debt or equity instruments are not traded in a public market; iii.it is not required to file financial statements with a securities commission or other organisation for the purpose of issuing instruments in a public market; and iv.its ultimate or any intermediate parent produces consolidated financial statements available for public use and comply with AASBs. Presentation of consolidated financial statements NCI 10% A Limited 90% B Pty Ltd 80% C Pty Ltd No consolidation required for B + C sub-group if: i.10% NCI shareholders in B consent; ii.b is unlisted - YES in this case as a Pty Ltd company; iii.b is not issuing instruments in a public market YES in this case as not possible for a Pty Ltd company to do this; and iv.a Limited prepares compliant consolidated financial statements Preparation of consolidated financial statements AASB 10 Australian specific guidance: Aus4.2 Where condition iv is not met due to the effects of the Australian reduced disclosure requirements, paragraph Aus4.2 to AASB 10 extends the relief from preparing consolidated financial statements. To apply paragraph Aus4.2 a parent must still meet conditions i - iii. Aus4.1 Notwithstanding paragraph 4, an ultimate parent shall present consolidated financial statements when either the parent or the group is a reporting entity or both the parent and the group are reporting entities. 7

8 Business combinations and consolidation An acquirer is the combining entity that obtains control of the other combining entities in a business combination. In most cases the parent will be the acquirer. Exceptions arise when: A new entity is formed, which acquires all the shares of previously existing entities (refer Fig 15.5 of text) A reverse acquisition occurs (refer Figure 15.6 of text) 8