-> DEF: set of statements that presents (consolidates) a parent and subsidiary company as one company.
-> CONSOLIDATED FINANCIAL STATEMENT combines a set of financial documents (đ») of separated legal entities that are controlled by a parent company (hence a group) and present them as unique entity (it’s the external accountability for a group).
- Balance sheet;
- Income Statement;
- Cash flow statement;
- Statement of changes in equity;
- Notes to the financial statemens.
â PROBLEMâ : we don’t know the performance of each single company, just the overall result.
-> Example: FCA (Fiat Chrysler Automobiles) is a group.
Definition of Group of Comanies:
-> DEF: is an economic entity formed by a set of comanies (separate legal entitties) whici are either companies controlled by the same company, or the controlling company itself –> there are different representations.
-> TYPES:
- Holding + other companies, the holding just manages and do not perform any operating activity.
- Head company + other companies: the head company manages and also perform operating activities.
Other companies:
- SUBSIDIARIES: : fully controlled by another entity (the parent), more than 50% of the shares of the company (at least 50% + 1 share, so the parent has the majority of voting rights.)
- ASSOCIATE: the parent has significant influence (between 20% and 50%) on their activities.
- JOINT ARRANGEMENET: 2 companies decide to create a joint company, 2 or more parties have joint control.
-> Rules of consolidation:
đFor the other investments in other companies: financial instruments (IFRS 9/39).
Group Accounting
-> OBJ:
- Provide more reliable information about the composition of assets and liabilities.
Example: company Bâ has long-term assets, instead Bââ has current assets (Bâ and Bââ have the same value). Which company is actually represented by the consolidated statement?
- Provide more reliable information about the income of the group.
From a group point of view, an entity cannot recognize revenue (and related profit) from sales to itself; all sales must be to external entities. Infra-group transactions are eliminated.
-> In the notes fo the group is specified how subsidiaries are considered and how they performed the consolidation.
-> NET INCOME: is divided into:
- Net profit attributable to the group;
- Non-controlling interests: if we are not owning 100% of te subsidiaries, some of the income is due to the shareholders of the subsidiaries.
When is required:
-> TYPES:
- Control;
- Joint-control;
Control:
-> DEF: A company control another
- IFRS 10 regulate consolidation process;
-> Control Exist When:
- POWER: > 50% of the shares so we are able to take decisions about how the subsidiary company is managed.
- EXPOSURE TO VARIABLE RETURNS: if the subsidiary is having a great profit/losses, the parent company is going to decide what to do –> so in good or bad situations, the parent is the company who is going to respond and absorb the results
- ABILITY OF THE INVESTOR TO AFFECT ITS RETURN THROUGH ITS POWER: able to decide which actions need to be taken to improve the company. The investor is actively participating at the management level of the subsidiary.
-> All 3 conditions need to be present to assure that you have the full control.
Joint Control:
-> TYPE:
- JOINT VENTURE: third entity is constituted and jointly controlled by two organizations. The joint controlling companies do not have the rights on individual assets.
- JOINT OPERATION: there is not a third entity or there is a third entity by the joint controlling companies have the rights on individual assets. (This usually happens when 2 companies co-create something new).
đ Both subsidiaries and joint arrangements are disclosed in concolidated annual reports, but the approach to consolidation is different
-> The IFRS 11 provide the guideline to define what could be done:
Full Consolidation Method (line by line):
-> Consolidation process:
- Pre-consolidation adjustments;
- Consolidation adjustments;
Pre-Consolidation Adjustments:
- Collect the individual companies’ financial statements;
- Make them uniform as concerns:
- the accounting period they refer to (differences between reporting dates cannot be longer than 3 months);
- Accounting policies;
- Reporting currency (if necessary, translation must take place);
- Layout.
- Combine assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries; each item shall be added according to its accounting category to determine the aggregate financial statement.
Closing Period:
-> If one the closing date of financial statements of one or mor subsidiaries is different from the parent company => subsidiary prepares interim financial statements.
-> If it’s not feasible => FS of S and PC can be different, on condition:
- Difference of dates does not exceed three months;
- Duratin of FY and difference between closing dates remain constant over time;
- Adjustments are made for significant transactions and events.
Accountin Policiy:
-> If one or more S use different accounting policies => appropriate pre-consolidation adjustments are made as part of the consolidation process.
- Applying in the S account the accounting policies adopted by the group;
- Requiring the subsidiaries to provide individual statements for the consolidation process appropriately adjusted to be consistent with the accounting policies.
Reporting Currency;
-> If some S jas a currency different from the group one => It’s necessary to translate financial statements denominated in currencies other than the reporting currency of the consolidated FS.
- Income statement items (including the profit for the year) are translated at:
- The effective exchange rate at the date of each transaction, or
- The average exchange rate of the financial year
- Balance sheet items, except for the profit for the year, are translated at the exchange rate at the reporting (“closing”) date of the consolidated financial statements.
â If the rate used for translating income statement values does not coincide with the one used for the balance sheet, it causes a `translation difference‘ to be classified in a special ownersâ equity reserve named ‘translation reserve’.
Aggregation:
-> DEF: combining assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries; each item shall be added according to its accounting category
-> Ex. This is simply doing A + B and reporting all the voices together. This is the AGGREGATED information, NOT the CONSOLIDATED one
Consolidation Adjustments:
- Offset (eliminate) the carrying amount of the parent’s investment in each subsidiary against the parent’s proportionate share of equity of each subsidiary
- Recognise and measure the share of equity attributable to other shareholders in non wholly-owned subsidiaries (i.e. non-controlling interests);
- Eliminate any intra-group assets, liabilities, equity, income, expenses and cashflows relating to transactions between consolidated entities;
- Calculate and allocate the group’s and non-controlling interests‘ results:
- Prepare the final consolidated financial statements.
4)Offset of the Investment:
-> DEF: offetting (eliminating) the carrying amount of the parent’s investment in each subsidiary against the parent’s proportionate share of equity of each subsidiary.
- Otherwise we would be adding the investment 2 times. It is easy when the subsidiaries are 100% owned by the parent company, but when we have less that 100%, we need to take out the % of the investment;
-> EXAMPLE 1 – The value of the investment match the book value of the subsidiary equity:
-> A had acquired the assets and liabilities of B directly => we need to offset the item “Investments” Against B’s equity value.
â Since e the investment in B (i.e. the accounting item “Investments”) already incorporates the value of B’s assets and liabilities, we need to make sure that we are not counting those values twice:
Assumption:
- Acquisition involves 100% of the subsidiary’s shares (there are no non-controlling interests);
- There are no infra-group transactions;
- Value of the investment maches the book value of the subsidiary’s equity
-> The purchase price paid for the investment is ideally attributable to the following components:
| â | book value of subsidiaryâs equity |
| â/â | changes in assets and liabilitiesâ values* |
| â/â | tax effects on those changes** |
| â/â | goodwill*** |
*For unrecognized surpluses in assets’ and liabilities’ values we add the surpluses (positive or negative) to the subsidiary’s assets and liabilities values, so that all the subsidiary’s assets and liabilities are recognized at their fair values at the time control is acquired.
**The tax effects on such surpluses must be considered. The differences between the book and fair values of the recognized items may create âtemporary differencesâ that will give rise to (or will lower) taxes in the future (DEFERRED TAX). We want to recognize such future obligation (or benefit) though the separate recognition of deferred tax liabilities (or assets)
***The difference between (i) the cost of acquisition and (ii) the parent’s interest in the fair value of the subsidiary’s net assets/ liabilities at the acquisition date must be recorded in the following way:
- If positive (price paid > fair value of equity attributable to the parent), it must be included as an asset, the so called ‘goodwill’, in the consolidated financial statements;
- If negative (price paid < fair value of equity attributable to the parent), estimates of the fair values of assets/ liabilities of the subsidiary should be reviewed; the negative difference – if still existing – must be allocated to the income statement as a gain.
-> EXAMPLE 2: We buy a company X for 100. We made a revaluation at the fair value and the company X costs 120 –> price paid â fair value = -20 is the gain that we have received and must be allocated in the IS.
-> EXAMPLE 3 – The value of the investment does not match the book value of the subsidiary equity:
-> On 31 December X company MICKEY buys 100% of shares in company MOUSE. The cost of the investment is 2.700. The balance sheet of the two companies at the date of the acquisition is reported in the following table:
-> On the acquisition date, the fair value of the assets and liabilities of MOUSE equals their book value, except for plant, whose fair value is 1.000 higher that the carrying amount, and provisions, whose fair value is 200 higher than the book value.
-> The difference between the cost of the investment and owners’ equity is recorded as goodwill.
-> Consider that the tax rate applied by the two companies is 50%.
- Recognition of surplus on PPE and provisions [1.000 and 200, respectively]
- Elimination of investment [2.700] and subsidiary’s equity [1.500+500 = 2.000]
- Recognition of deferred tax liabilities 1.000×0,5 = 500 (increase of the assets counts as more taxes to pay because we produce more, so it’s a liability) and deferred tax assets [200×0,5 =100]
- Recognition of goodwill = 300
CALCOLATE GOODBILL:
2700 (investment) – 2000 (equity of subsidiaries)
â [1000 (surplus of the assets) – 500 (effect on the taxation)]
â [200 (surplus of the provisions) – 100 (effect on the taxation)] =
=2700 – 2000 – 500 + 100 = 300
đSubtract from the investment the surplus of the assets because itâs a gain; instead, the surplus on the provisions is a loss, so we add it to the investment. We also need to adjust the surpluses by applying taxes.
5)Non-Controlling Interests:
-> DEF: interests arises when a subsidiary is not wholly controlled by the parent;
-> EX: if a parent owns 85% of a subsidiary, it has to consolidate 100% of the subsidiaryâs net assets and results and report non-controlling interests of 15%.
-> Regarding the measurement of the non-controlling interests the investor may choose to measure a non-controlling interest in the investee, at the acquisition date, according to two approaches:
- At fair value â the so-called full goodwill accounting, or
- At the non-controlling interest’s proportionate share of the investee’s identifiable net assets.
-> EXAMPLE: STAR acquires LIGHT by purchasing 60% of its equity for 300 million in cash. The fair value of the noncontrolling interests is determined to be 200 million. The company’s tax rate is on a 40% basis.
| The key figures included in the Balance Sheet of LIGHT at the date of acquisition are summarized in the table below: | The fair values for all assets and liabilities of LIGHT are equal to their book values, except for a parcel of land, a building and a trademark. The fair values of those assets are given in the following table: |
FULL GOODWILL METHOD:
-> If the company chooses to apply the full goodwill method, the non-controlling interestsâ value is equal to their fair value (200 million). In such a case, the total value of the company is equal to the price paid by the parent company + fair value of non-controlling interests:
- Total value (100%) = fair value of non-controlling interests 200 (40%) + consideration paid by the parent company 300 (60%) = 500
- Goodwill = total value 500 â book value of equity 190 â [surplus 300 â effect on taxes 300*0,4 = 120] = 500 â 190 â (300-120) = 500 â 190 â 180 = 130
- Surplus = (140-50) + (75-30) + (255-90) = 90 + 45 + 165 = 300
PROPORTIONATE SHARE OF THE INVESTEE’S IDENTIFIABLE NET ASSETS:
-> If STAR chooses to record the non-controlling interests at their proportionate share of the amount of the investee’s identifiable net assets, the goodwill recognized and measured in the consolidated financial statements is only the amount attributable to the portion belonging to the parent company.
- The value of the non-controlling interests is 76 (book value of the proportionate share of the investeeâs identifiable net assets);
- The portion of net surpluses belonging to the controlling entity is 108 (180 x 60%);
Price paid (60%): 300
Book value of equity (60% of 190): 114
Net surplus on identifiable assets (60% of 180): 108
=> Goodwill = 300 â 114 â 108 = 78
6)Elimination of Intra-Group Transactions:
-> IFRS 10 requires the full elimination of intra-group transactions between entities of the group, that consist in
- Infra-group revenues and costs, receivables and payables;
- Intercompany profits and losses, related to inventories and fixed assets;
- Infra-group dividends.
-> Transactions are equivalent to transactions between group companies, that are equivalent to transactions between divisions/functions within a single company.
-> The consolidated financial statements must present only those transactions that group companies have made with third parties (outside the group).
Ex. The supply of goods from one company to another is equivalent to the transfer of goods from one warehouse to another within the same company.
Ex. Financing provided by a holding company to subsidiaries is equal to a cash transfer from a division to another within the same company.
-> Steps for payables/receivable & revenues/expenses:
- Identify the same amount of money: Identify which values of credit/debit and costs/revenues arising from intra-group transactions are recorded in the financial statements of the companies included in consolidated financial statement
- Make sure there is mutual equivalence between the accounts, if this equivalence is not present, reconcile intra-group values;
- Delete the mutual accounts (receivables and payables, costs, and revenues).
-> Steps for profits/losess related to fixed assets/inventories:
- Adjusting the carrying values of assets that have been the subject of the intra-group transaction and that are still recognized in the balance sheet of the acquiring company; the value of these goods must be brought back to the original value as if they had never been sold.
- Adjusting the income items related to those goods that are ‘generated’ by the infra-group transaction. The result of operations of companies involved in the transaction, in fact, may be changed as a result of the intra-group transaction, and this change must be eliminated.
Ex. Company A has an 80% stake in Company B. On 01/01/X Company A sold to Company B a plant for a total amount of 1.100 (book value: 900; yearly depreciation quota: 100). During the year X, Company B recorded depreciation for 110.
- Adjustment 1: eliminate the surplus gain recorded by A (1.100-900=200)
- Adjustment 2: bring back to 900 of the value of the asset recorded by B (purchased and recorded for 1.100)
- Adjustment 3: eliminate the amount exceeding the âoriginalâ depreciation quota (110 â 100 = 10)
> Elimination of Intra-Group Transactions > DIVIDENDS:
-> Dividends are income statement, bottom line (our net profit) => We have to re-integrate them.
-> Steps:
- Eliminating the financial income, recognized by the company that receives the dividends;
- Reintegrating the reserves of the company that distributes the dividends;
- Decreasing in shareholders’ equity attributable to non-controlling interests by the number of dividends received by them.
đDistribution of dividends by a Parent C. to its shareholders does not constitute an infra-group transaction (parent’s shareholders are external to group).
Equity Method:
-> DEF: applied when don’t have subsidiaries (there is no control), but associates (significan influence).
- Equity method is used when the investor holds significant influence over investee, but does not exercise full control over it, as in the relationship between parent and subsidiary
- Unlike in the consolidation method, there is no consolidation and elimination process.
- The investor reports a proportionate share of the investeeâs equity as an investment (at cost of acquisition):
- Profit / loss from the investee increase / reduce the investment account by an amount proportionate to the investorâs shares;
- Dividends paid out by the investee are deducted from this account
