Chapter 6 - Financial Reporting by Groups of Companies Flashcards
Why is it beneficial (from a shareholder perspective) to prepare consolidated financial statements?
Many larger businesses operate through several entities for reasons relating to tax, liability limitation and regulation.
From the point of view of the ultimate shareholders, who hold their investment in a parent entity, it would be inefficient to have to look at financial reports for each individual company in a group that is effectively operating as one business.
<br></br>
Tax and dividends are paid by reference to each individual entity’s financial statements but consolidated accounts give overall accountability to parent company shareholders for all activity in the group.
How is a ‘small group’ classified under CA2006?
Meet 2/3 criteria
* Aggregate turnover - £12.2 million (gross) / £10.2 million (net)
* Aggregate balance sheet total - £6.1 million (gross) / £5.1 million (net)
* Aggregate number of employees - 50
How does IFRS 10 define ‘control’ (parent of a subsidiary)
Three elements: power, variable returns and the ability to use this power.
* Power over the investee is typically existing rights, normally exercised through most of voting rights (owning more
than 50% of the equity shares).
* Exposure or rights to variable returns (a dividend) stems from the investor’s involvement with the investee.
* A crucial determinant of the control is the ability to use power over the investee to affect the amount of investor
returns.<br></br>
Controlling a company means having the right to direct the relevant activities that significantly affect the investee’s
returns, such as having the power to appoint the majority of its directors.<br></br>
- Power over the investee
- Rights to variable returns
- Ability to use power over the investee
What is an NCI?
NCI is the equity in a subsidiary not attributable, directly or indirectly, to the parent. It is also important to be aware of the date control was achieved or ceased.
What are some additional factors which need to be considered when preparing consolidated financial statements?
- To avoid double counting, intra-group items including all transactions, balances and unrealised profits and losses
arising from intra-group trading must be eliminated. Intra-group items include purchase and sales of inventories and
other assets between parent and subsidiary. The consolidated totals should only consist of transactions, balances
and profits and losses created through transactions with parties outside the group. - The parent’s investment in the subsidiaries, carried as investments in its own statement of financial position, are
also eliminated through the process of consolidation (specifically through the calculation of goodwill). - The accounting policies of all group companies must be aligned, so that like items are treated in the same way for
the group as a whole. Subsidiaries (such as those based overseas) that follow local accounting rules will need to be
adjusted just for the consolidation process. - Subsidiaries should have the same reporting date as that of the parent company. Where impracticable, the most
recent financial statements of the subsidiary are used with adjustments made for significant transactions between
the reporting dates of the subsidiary and the consolidated financial statements. The difference between the date of
the subsidiary’s financial statements and that of the consolidated financial statements shall be no more than three
months. Special accounts will need to be prepared for the consolidation if the difference is more than three months. - Any share of a subsidiary’s results or equity that belong to any NCI (previously known as the minority interest) must
be disclosed at the foot of each consolidated financial statement. - Consolidation will cease from the date the parent loses control of a subsidiary. If the control ceases or the subsidiary
is acquired part way through the year, the financial results must be time-apportioned during the consolidation
process.
IAS3 - Business combinations
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 (positive or negative). <br></br>
There are two main methods for NCI valuation:
* the fair value method the fair value of the controlling interest is usually the consideration paid by the parent
company for this interest. There is no parallel consideration transferred available to value the NCI. Therefore, the parent
has to use other valuation methods, often using market share trading prices in the weeks before and after the purchase
to evidence a valuation.<br></br>
-
the proportion of net assets method - the value of the controlling interest (and
the NCI) is valued as the proportion of equity acquired (or retained), multiplied by the net assets of the acquired company
at the date of the purchase. This provides a valuation methodology for the controlling interest and the NCI. It is based
directly on available accounting information and is therefore the most commonly used method.
What is the definition of ‘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.
Negative goodwill
Goodwill can be negative when the aggregate of the fair values of the separable net assets acquired may exceed what
the parent company paid for them. IFRS 3 refers to it as a ‘gain on a bargain purchase’.
For negative goodwill, an entity should reassess by measuring both the cost of the combination and the acquiree’s
identifiable net assets to identify any errors. Any excess remaining after such reassessment should be recognised
(credited) immediately in the statement of profit or loss and OCI.
6 Impairment indicators (carrying value exceeds recoverable amount)
- adverse economic conditions
- increased competition
- legal implications
- loss of key personnel
- declining revenue
- market value
Definition of ‘fair value’ (measurement) as per IFRS 13
Price that would be received to sell an asset/paid to transfer liability in an orderly transaction of market participants at the measurement date. The fair value measurement is used when calculating goodwill and NCIs.
Why might a subsidiary’s financial statements reflect the ‘fair value’ of acquired assets and liabilities?
- Because valued FAIR VALUE
- Reported in FS of the subsidiary at HISTORIC COST (less depreciation for non-current assets)
- Consolidated FS should reflect cost to the group, i.e. the parent, not the original cost(s) to the subsidiary
- Carrying amounts of assets and liabilities in the subsidiary’s FS will be largely irrelevant to group consolidated as the cost to the group is the fair value of the acquired assets.
Generally, the four categories that parent consideration for acquisition of a subsidiary be split into?
- cash
- shares in the parent company
- deferred consideration
- contingent consideration
Purchase consideration
Cash is the most straightforward form of consideration. In large companies, shares are often purchased for cash
plus deferred payments (often contingent upon achieving certain performance targets). For any deferred payments,
the present value of the amount payable should be recorded as part of the consideration transferred at the date of
acquisition. Where the part of the purchase consideration is settled in shares, the consideration is valued at the market
value of the parent entity’s shares at the date of acquisition. Direct costs of the acquisition, such as legal and other
consultancy fees, are expensed and not treated as part of the purchase consideration.
<br></br>
Deferred consideration is the amount payable at a future date by an acquirer to the acquiree in a business combination
after a pre-defined time period, often linked to post-acquisition performance targets. It tends to be driven primarily by tax
and accounting considerations. The 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.
<br></br>
<u>**Contingent consideration**</u> is an uncertain amount, that is payable at a future date by an acquirer to the acquiree 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.
5 Adjustments re assets/liabilities in group consolidated statements.
Once a parent-subsidiary relationship is established, along with the percentage shareholding of the parent and any NCI,
the assets and liabilities of the parent and the subsidiary are added together on a line-by-line basis with the following
adjustments.
<br></br>
* Investments
* Intra-group items
* Profits
* NCI(s)
* Dividends paid by subsidiary
How does IAS 28 evidence ‘significant influence or control’?
- representation on the board of directors (or equivalent) of the investee
- participation in the policy-making process
- material transactions between investor and investee
- interchange of management personnel
- provision of essential technical information
