CONSOLIDATED FINANCIAL STATEMENTS(IND AS-110)

Transcription

1 36 C H A P T E R CONSOLIDATED FINANCIAL STATEMENTS(IND AS-110) 36.1 Objective The objective of this Standard is to present financial statements of a parent and its subsidiary (ies) as a single economic entity. In other words the holding company and its subsidiary (ies) are treated as one entity for preparation of these consolidated financial statements (CFS). Consolidated Statement of profit and loss and consolidated Balance Sheet are prepared for disclosing the total profit/loss of the group and total assets and liabilities of the group. The consolidated financial statements (CFS) presents the true and fair view of the position of the company as one economic entity for the financial year and are considered as the primary financial statements whereas the standalone financial statement projects only the position of the company in its individual performance and does not provide true and fair view to the shareholder about the overall performance of the company with its subsidiaries and associates. Consolidated financial statements are defined as the financial statements of a group, in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. The objective of this Indian Accounting Standard (Ind AS) is to establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities Control The single control model - Ind AS-110, Consolidated Financial Statements introduces a single control model for all entities. An investor controls an investee when: 807

2 Para 36.2 CONSOLIDATED FINANCIAL STATEMENTS (IND AS-110) 808 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. Under the new guidance, the control is the sole basis for consolidation. The structure of the investee is not relevant whether it is a partnership firm or LLP or a company or any other special purpose entities (SPEs). Consequently, the requirements of Ind AS-110 apply to all investor/investee relationships. The Ind AS-110 definition of control encompasses three distinct principles, which, if present, identify the existence of control by an investor over an investment, hence forming a parent-subsidiary relationship: u Power over the investee; u Exposure, or rights, to variable returns from its involvement with the investee; and u The ability to use its power over the investee to affect the amount of the investor s returns Power Over the Investee An investor has power over an investee if it has existing rights that give it the current ability to direct the relevant activities. An investor only needs to have the ability to control relevant activities, and it is not relevant whether the investor actually exercises this ability. Because of the way in which power is analyzed in accordance with Ind AS- 110, the distinction between substantive and protective rights is important. Protective rights- Protective rights are Rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate. An investor that only holds protective rights, which meet this definition, has no power over an investee and consequently does not control the investee. The standard follows the logic that protective rights are designed to protect interests of the holder without giving it power over the investee, and cannot prevent another party from having power over an investee. Examples of protective rights in the standard are: u A lender s right to restrict borrower s activities (if these could change credit risk significantly to the detriment of the lender) u Capital expenditure greater than that required in the ordinary course of business requiring approval by non-controlling interest holders

3 809 Control Para 36.2 u Issue of debt or equity instruments requiring approval by non-controlling interest holders u A lender s right to seize assets of a borrower in the event of default. Substantive rights: Only substantive rights are considered when power is assessed. In order for a right to be substantive, the holder must have the practical ability to exercise the right. Sometimes assessing power is straightforward, such as when power over an investee is obtained directly and solely from the voting rights granted by equity instruments such as shares, and can be assessed by considering the voting rights from those shareholdings. In other cases, the assessment will be more complex and require more than one factor to be considered, for example when power results from one or more contractual arrangements. Example: An investor holds a majority of the voting rights in the investee. The investor s voting rights are substantive because the investor is able to make decisions about the direction of the relevant activities when they need to be made. The fact that it takes 30 days before the investor can exercise its voting rights does not stop the investor from having the current ability to direct the relevant activities from the moment the investor acquires the shareholding. Potential voting rights: Potential voting rights are rights to obtain voting rights of an investee (e.g. convertible instruments, options and forward contracts). Ind AS-110 also requires an investor to consider the purpose and design of the instrument, as well as the purpose and design of any other involvement the investor has with the investee. This includes an assessment of the various terms and conditions of the instrument as well as the investor s apparent expectations, motives and reasons for agreeing to those terms and conditions. If the terms are such that the holder of the potential voting rights could not conceivably be expected to exercise them, they are disregarded. This might arise where the terms lack economic substance. For example if exercise price is set deliberately at prohibitively high level or exercise of the rights would be severely detrimental to the investor for other reasons. The assessment of substance is based on the terms rather than on the specific holder s intentions or financial ability. Substantive potential voting rights alone, or in combination with other rights, can give an investor the current ability to direct the relevant activities Example 1: Entity A and Entity B own 80% and 20% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of entity C. Entity A sells an interest of 50% of entity C to entity D buys a call option from Entity D that is exercisable at any time at a price that reflects a premium to the market price at issuance of the call option. If the option is exercised it would give Entity A its original 80% ownership interest and equivalent voting rights. The exercise price has economic substance and is not set deliberately high.

4 Para 36.2 CONSOLIDATED FINANCIAL STATEMENTS (IND AS-110) 810 The option held by Entity A is at a premium to the market price upon issue and is slightly out of the money at the reporting date. However, it is necessary to consider whether Entity A benefits for other reasons from the exercise of the options (for example, protection of interests and acquisition of assets). It should also consider the purpose and design of the option. Where the options are substantive Entity A should consolidate Entity C Exposure, or rights, to variable returns The second criterion an investor has to meet to have control over an investee is to be exposed to variable returns from the investee. Returns are variable if they are not fixed and have the potential to vary as a result of the performance of an investee. These returns can be positive, negative or both positive and negative. Examples of returns are: u Dividends u Interest from debt securities u Changes in the value of the investee u Fees for servicing an investee s assets or liabilities u Fees and exposure to loss from providing credit or liquidity support u Residual interests in the investee s assets and liabilities on liquidation u Tax benefits u Access to future liquidity Returns that are not available to other interest holders that enhance the value of the investor s other assets, such as: u Economies of scale cost savings u Sourcing scarce products u Access to proprietary knowledge u Limiting some operations or assets Ind AS-110 does not require an investor to be exposed to all (or even a majority of) variable returns of the investee. For example, non-controlling interests sharing returns with the investor do not preclude an investor from meeting the exposure to variable returns criterion. Example 2: H Ltd. is the sole guarantee of a well-known charity. The charity was established by H Ltd. under the Articles of Association, H Ltd. can appoint or approve members of the charity board. There are 5 board members and each board member has a voting right. The board is responsible for directing the charity s relevant activities and must act in the charity s best interests. H Ltd. allows the charity to use its name in marketing and sponsorship literature and similarly H Ltd. associates itself with the charity in promotional literature. H Ltd. provides funding to the charity on regular basis in the form of donations. In addition to this H Ltd. also provides the charity with administrative support, such as marketing, payroll, HR and finance functions.

5 811 Control Para 36.2 H Ltd. s guarantee gives it exposure to the charity s variable returns. If the charity is unable to pay its debts, the guarantee may be called and H Ltd. may suffer a loss. This is consistent with Ind AS-110, which states that an example of a variable return is exposure to loss from providing credit or liquidity support. The fact that H Ltd. provides the charity with administrative support and associates itself with charity in its promotional literature indicates that it has an exposure to variable returns from the charity. This is because to Ind AS-110 states that an investor might use its asset with the assets of the investee to enhance the value of the investor s other asset. From H Ltd. s perspective this could include the intangible benefit of being associated with a well-known charity and providing it with a support function. How the charity behaves will determine whether it has a positive or negative impact on the company s reputation and as such this is a variable return to which the company is exposed, although intangible The ability to use its power over the investee to affect the amount of the investor s Returns The third control criterion requires an investor to have the ability to use its power to affect the investor s variable returns. This criterion is included in the standard to address principal-agent relationships. In practice managed funds fall within this category. The key question is whether a fund is required to be consolidated by the fund manager. Example 3: A decision maker (fund manager) establishes markets and manages a publicly traded, regulated fund according to narrowly defined parameters set out in the investment mandate as required by its local laws and regulations. The fund was marketed to investors as an investment in a diversified portfolio of equity securities of publicly traded entities. Within the defined parameters, the fund manager has discretion about the assets in which to invest. The fund manager has made a 10% pro rata investment in the fund and receives a market based fee for its services equal to 1 per cent of the net asset value of the fund. The fees are commensurate with the services provided. The fund manager does not have any obligation to fund losses beyond its 10% investment. The fund is not required to establish, and has not established, an independent Board of directors. The investors do not hold any substantive rights that would affect the decision-making authority of the fund manager, but can redeem their interests within particular limits set by the fund. Although operating within the parameters set out in the investment mandate and in accordance with the regulatory requirements, the fund manager has decision-making rights that give it the current ability to direct the relevant activities of the fund-the investors do not hold substantive rights that could affect the fund manager s decisionmaking authority. The fund manager receives a market-based fee for its services that is commensurate with the services provided and has also made a pro rata investment in the fund. The remuneration and its investment expose the fund manager to variability of returns from the activities of the fund without creating exposure that is of such significance that it indicates that the fund manager is a principal. In this example, consideration of the fund manager s exposure to variability of returns from the fund together with its decision-making authority within restricted parameters

6 Para 36.3 CONSOLIDATED FINANCIAL STATEMENTS (IND AS-110) 812 indicates that the fund manager is an agent. Thus, the fund manager concludes that it does not control the fund. Example 4: AK Ltd. an asset management company (Fund manager) establishes market and manages a publically traded, regulated fund (in the form of an investment company IP Ltd.) for the best interest of shareholders as required by local laws and regulations. The fund was marketed to investors as an investment company. AK Ltd. has discretion about the asset class in which to invest. AK Ltd. receives a market based fee for its services equal to1% of the net asset value of the fund plus 10% of the profit exceeding ` 100 Crores. The fees are commensurate with the services provided. AK Ltd. has made 20% investment in IP Ltd. It does not have any obligation to fund losses beyond its 20% investment. Other shareholders do not hold substantive rights that could affect the fund manager s decision-making authority. The Board mostly manages administrative issues. Is AK Ltd. acting as a principal? Does it enjoy control over IP Ltd.? Solution: Although it must make decisions in the best interests of all investors, AK Ltd. enjoys extensive decision-making authority to direct the relevant activities of the fund. It is paid fixed and performance-related fees that are commensurate with services provided. In addition, the remuneration aligns the interests of AK Ltd. with those of the other investors to increase the value of the fund, without creating exposure to variability of returns from the activities of the fund that is of such significance that the remuneration, when considered in isolation, indicates that the fund manager is a principal. So AK Ltd. enjoys control over IP Ltd. However, the authority of other shareholders to remove AK Ltd. as a fund manager is also taken into account Whether franchise to be consolidated? Ind AS-110 has introduced specific guidance on franchise, which aims to provide more clarity on whether franchisors should consolidate their franchisees. In determining whether a franchisor controls a franchisee, judgment it required to determine whether the franchisor s rights over its franchisee are substantive or protective in nature. Ind AS-110 distinguishes decision making rights held by the franchisor that protect the franchise brand from decision making rights that significantly affect the franchise s returns, for example, the franchisee s funding structure. The franchisor does not have power over the franchisee if other parties have the current ability to direct the franchisee s relevant activities. The lower financial support provided by the franchisor and the lower the franchisor s exposure to variability of returns from the franchisee, the more likely it is that the franchisor only holds protective rights and have no control over the franchisee, hence not to be consolidated.

7 813 Scope Para Scope An entity which controls one or more other entities called a parent, shall present consolidated financial statements as per this Ind AS except as exempted by this Standard Exemptions A parent is not required to prepare consolidated financial statements if it meets all of the following conditions: u It is a wholly owned subsidiary or is a partially owned subsidiary of another entity and all of its owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements u Its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets) u It did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market u Its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with Ind ASs. In addition, Ind AS-110 does not apply to: u Post-employment benefit plans or other long term benefit plans to which Ind AS-19 Employee Benefits applies; and u Investment entities Investment Entities An investment entity need not present consolidated financial statements if it is required, in accordance to this Ind AS, to measure all of its subsidiaries at fair value through profit or loss. Except if an investment entity has a subsidiary that provides services that relate to the investment entity s investment activities. It shall consolidate that subsidiary in accordance with this Ind AS and apply the requirements of Ind AS-103 to the acquisition of any such subsidiary A parent of an investment entity shall consolidate all entities that it controls, including those controlled through an investment entity subsidiary but when the parent itself is an investment entity consolidation is not required. An investment entity is an entity whose business purpose is to make investments solely for capital appreciation, investment income, or both,