Consolidation Techniques 2003-s1

GROUP REPORTING : 

GROUP REPORTING 10 September 2003 Antalya

Group Reporting Course Outline : 

Group Reporting Course Outline - Related IAS standards - Major consolidation concepts - Identification of subsidiaries, control concept - Subsidiaries that are exempt from consolidation - Investments - Joint ventures - Associates - Proportionate consolidation - Equity method - Intra-group balances and profits - Minority interests - Consolidation of subsidiaries abroad - Segment reporting

Group Reporting under IFRS – Related Standards and Interpretations: 

Group Reporting under I FR S – R elated S tandards and I nterpretations Business Combinations IAS 22 Consolidated Financial Statements and Accounting for Investments in Subsidiaries IAS 27 Accounting for Investments in Associates IAS 28 Financial Reporting of Interests in Joint-Ventures IAS 31 Special Purpose Entities SIC 12

PowerPoint Presentation: 

C onsolidation M ethods FULL CONSOLIDATION EQUIT Y METHOD PROPORTIONATE CONSOLIDATION Subsidiaries Associates Joint Ventures

Scope of IAS 27: 

Scope of IAS 27 Preparation and presentation of consolidated financial statements for a group of entities under the control of a parent Accounting for investments in subsidiaries in a parent's separate financial statements.

Definitions per IAS 27: 

Definitions per IAS 27 A group = parent and all its subsidiaries A subsidiary = an entity controlled by another entity (it’s Parent) A parent = entity that has one or more subsidiaries Control = the power to govern financial and operating policies of an entity so as to benefit from it’s activities Consolidated financial statements = the financial statements of a group presented as those of a single entity. Minority interest = is that portion of the profit or loss and of net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by th e parent

What is a subsidiary?: 

What is a subsidiary? P holds < 50% ordinary shares, but still controls the financial/operating policies P holds 50% + ordinary voting shares in S ‘‘ Control = the power to govern financial and operating policies of an entity so as to benefit from it’s activities ’’ “ to the strategic decisions taken by management affecting the business, rather than the routine day to day decisions “ CONTROL

What is a subsidiary?: 

How can P control the financial/operating policies of S when holding <50% ordinary shares? What is a subsidiary? Majority voting power by agreement with others Control by contract Power to appoint/remove the majority of the directors Power to cast the majority of votes at board meetings

PowerPoint Presentation: 

Subsidiary B Direct Interest: Indirect Interest: Effective Interest: Controlling Interest: CONTROL CONCEPT (*) Ownership percentages assumed to represent the control

PowerPoint Presentation: 

Subsidiary B Direct Interest: 10 % Indirect Interest: 39,78 % ( 78/100*51) Effective Interest: 49,78 % Controlling Interest: 88 % (10 + 78 ) CONTROL CONCEPT (*) Ownership percentages assumed to represent the control

PowerPoint Presentation: 

Example 1 Rainbow UK Yellow Ltd In which of the following examples is there a Parent/ Subsidiary relationship? Rainbow owns 45% of the voting rights for an investment in Yellow, but has an agreement with other shareholders (holding 20% of rights), such that the other shareholders always vote in the same way as Rainbow. (ii) Rainbow owns 55% of the voting rigts in Yellow. For major operational and financial decisions in both Directors and shareholders meetings, the approval of 2/3 of the votes is required.

PowerPoint Presentation: 

Example 1 Rainbow UK Yellow Ltd Parent/subsidiary relationhips exist here. Rainbow has power over more than 50% of the voting rights by vitue of an agreement with other investors. Together with the other investors, Rainbow forms a ‘control’ group. (ii) No not a subsidiary. Rainbow does not have control over the operational and financial decisions of Yellow.

Mechanics of Consolidation: 

Mechanics of Consolidation Accounting Policies Accounting Dates If S uses different accounting policies to P (i.e. local GAAP) accounts must be adjusted, or stated that the difference is immaterial Subsidiaries accounting dates must fall +/- 3 months from the accounting date of the Parent. Significant transactions / other events must be adjusted for.

Consolidation: 

Consolidation Consolidation = combining the accounts of the Parent and it’s Subsidiaries so as they are presented as one entity. Start Consolidation Cease Consolidation When control of S commences When control of S stops Exception - A parent that is a wholly owned subsidiary (or virtually wholly owned) need not present consolidated financial statements

Exclusions from Consolidation: 

Exclusions from Consolidation DISPOSAL LIQUIDATION MATERIALITY S was bought and is being held solely for the purpose of resale. No exclusion if S previously consolidated 3 6 Severe long term restrictions apply to the Subsidiary, which significantly impair S’s ability to transfer funds to P (i.e. liquidation) 3 No exclusion applies (but IAS apply only to material items) Do not exclude 2 or more subsidiaries who together are material 6 DISSIMILAR ACTIVITIES No exclusion because S’s business activities are dissimilar from those of the rest of the group 6

Disposal/part disposal of subsidiaries: 

Disposal/part disposal of subsidiaries TOTAL DISPOSAL Control now <50% but >20% Control now <20% Profit/loss on disposal = proceeds – carrying value of net assets + goodwill Consolidate pro rata Take profit/loss on disposal Continue to account under IAS 28, Associates Consolidate pro rata Take profit/loss on disposal Account as a fixed asset investment under IAS 39

Disclosure: 

Disclosure Accounting Policies List of significant Subsidiaries Effect of acquisition/disposal Statement of accounting policies used in relation to Subsidiaries. Significant subsidiaries are listed stating their name, country of incorporation, the proportion of equity shares held, and if different the proportion of voting power held. The effect of the acquisition and disposal of subsidiaries on the financial position at the reporting date results for the period, and the corresponding amounts for the preceding period .

Expected developments from the IASB: 

Expected developments from the IASB Severe long–term restrictions – control unlikely to exist Temporary control – disposal intended within one year, not longer Intermediate parent’s exemption on preparing consolidated financial statements – criteria tightened Minority interests presented within equity, but separately from parent shareholders’ equit y Uniform accounting policies Disclosure changes

Scope of IAS 28: 

Scope of IAS 28 An associate is an entity in which the investor has significant influence (neither a subsidiary nor a joint venture) Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control over those policies (control defined as in IAS 27)

Significant Influence: 

Significant Influence Hold 20%+ voting power of the investee (directly or indirectly through Subsidiaries) Hold < 20%+ voting power of the investee Substantial/majority ownership by another, does not preclude an investor from having significant influence Participation in policy making processes Provision of essential technical information. Representation on the board of directors or equivalent governing body of the investee Material transactions between the investor and the investee Interchange of managerial personnel Significant Influence demonstrated by;

Significant Influence: 

Significant Influence The principle of Significant Influence still applies, even when the investor does not exercise their influence !

Associates in consolidated accounts: 

Associates in consolidated accounts Use equity method in consolidated accounts except when… Investment is held exclusively with a view to disposal in the near future Associate operates under severe long term restrictions Apply IAS 39 accounting for investments

When to equity account in consolidated accounts: 

When to equity account in consolidated accounts Equity Accounting Commences Equity Accounting Ceases At the date Significant Influence is gained At the date Significant Influence ceases OR When severe long-term restrictions commence

Mechanics of Equity Accounting: 

Mechanics of Equity Accounting Accounting Policies Accounting Dates I must adjust A’s results for differences in accounting policies Use most recently available financial statements of A (usually same year end as I) Be consistent from period to period Where year-ends are different, make adjustments for significant events/transactions

Disclosure: 

Disclosure Accounting Policies List of significant Associate holdings Balance Sheet presentation Description of accounting policies used to account for associates (as required by IAS 1) Listing and description of significant associates, including the proportion of ownership interest and, if different, the proportion of voting power held. Investment in Associate (held as a long term asset) Income Statement presentation Share of Associates earnings - separate item above Profit before Tax Contingencies In accordance with IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’

Expected developments from the IASB: 

Expected developments from the IASB Definition of significant influence – excludes joint control Investments held by venture capital entities – apply IAS 39, unless it is a subsidiary Severe long-term restrictions – significant influence unlikely to exist Temporary investment – disposal within one year,not longer Reporting dates – 3 months rule Uniform accounting policies – no longer impracticability exemption Group’s holding, but exclude holdings held by group’s other associates or joint ventures Interest in associate includes goodwill and advances Display share of net after-tax profit – separately show discontinuing operations New disclosures include summarised financial information

Scope of IAS 31: 

Scope of IAS 31 Covers accounting for interests in Joint Ventures, and the reporting of Joint Venture assets, liabilities, income and expenses in the financial statements of venturers and investors (This is regardless of the structure or form under which the joint venture activities take place.)

Definition of a Joint Venture: 

Definition of a Joint Venture Joint Venture – a contractual agreement whereby two or more parties undertake an economic activity that is subject to joint control. Joint Control – the contractually agreed sharing of control over an economic activity. Control – the power to govern the financial and operating policies of an economic entity so as to obtain benefits from it.

Contractual agreement: 

Contractual agreement The contractual agreement Distinguishes interests with Joint Control from those where the investor has a significant influence Ensures no single venturer is in a position to exert universal control Within IAS 31, activities with no contractual arrangement to establish joint control are not joint ventures

Different Forms of Joint Ventures: 

Different Forms of Joint Ventures Jointly Controlled Entities Jointly Controlled Operations Jointly Controlled Assets An asset that is shared and jointly controlled No legal entity formed Each venturer bears own costs and takes a share of the proceeds An entity is created and jointly controlled Separate legal entity formed

Accounting for Jointly Controlled entities: 

Accounting for Jointly Controlled entities Jointly Controlled entities Benchmark treatment Proportionate Consolidation Alternative treatment Equity Method * * IAS 31 allows but does not recommend this method because proportionate consolidation better reflects the substance and economic reality of the Joint Venture Combine assets, liabilities, income and expenses on a line by line basis . Include separate lines for each of assets, liabilities, income and expenses Two methods

Expected developments from the IASB: 

Expected developments from the IASB No changes to IAS 31 expected. This is in relation to the ED of proposed Improvements to International Accounting Standards

SIC 12: Consolidation of Special Purpose Entities: 

SIC 12: Consolidation of Special Purpose Entities Circumstances indicating that an entity controls an SPE The entity obtains benefits from the SPE ’s operation The entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, has delegated these decision-making powers. The entity holds the majority of the risks and access to majority of the benefits of the SPE The entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities. An SPE should be treated as a Subsidiary.

PowerPoint Presentation: 

CONSOLIDATION METHODS FULL CONSOLIDATION EQUIT Y METHOD PROPORTIONATE CONSOLIDATION Subsidiaries Associates Joint Ventures

PowerPoint Presentation: 

CONSOLIDATION METHODS FULL CONSOLIDATION Minority Interest Calculation Investment / Equity Elimination and Goodwill Intra Group Balances and Profits

Mechanics of Consolidation: 

Mechanics of Consolidation Inter-company Eliminations The carrying amount of P's investment in S and P’s portion of pre-acquisition profits are eliminated Eliminate inter-company balances and transactions and resulting unrealised profits Unrealised losses from inter-company transactions should also be eliminated (unless cost cannot be recovered) .

PowerPoint Presentation: 

Consolidation Journal Entries Balance Sheet net-off entries - Investments/ Equity - Trade Receivables /Trade Payables - Loans given /Borrowings Bank deposits /Deposits Reverse repurchase agreements/ Deposits Balance sheet unrealised profit eliminations - Inventories - Property, plant and equipment - Investments

PowerPoint Presentation: 

Consolidation Journal Entries Income Statement net-off entries - Sales / cost of sales - Other income /expense - Financial income /expense Dividend income /distribution (* Be careful about the classifications of the intercompany balances in stand-alone financial statements of the subsidiaries!) - Minority interest adjustment

Example 2: 

Example 2

PowerPoint Presentation: 

A minority interest arises when the parent company owns less than 100% of the subsidiary. The shares that are not owned by the parent company are said to be owned by the minority shareholders. When the parent company does not own 100% of the subsidiary, the consolidation will be prepared in the following manner: * add all the subsidiary's net assets to those of the parent company, indicating the share of the subsidiary's net assets that are owned by the minority shareholders. This share is disclosed in the consolidated balance sheet as Minority Interest . Minority interest

PowerPoint Presentation: 

The minority interests computed on * Current year P/L * Retained Earnings and, * Capital, accordingly * All other items classified under equity (i.e.cumulative translation reserve, revaluation funds, available-for-sale reserve) L osses applicable to the minority in a consolidated subsidiary may exceed the minority interest in the subsidiary’s equity. The excess, and any further losses applicable to the minority, are charged against the majority interest except to the extent that the minority has a binding obligation to, and is able to, make an additional investment to cover the losses. If the subsidiary subsequently reports profits, such profits are allocated to the majority interest until the minority’s share of losses previously absorbed by the majority has been recovered. Minority interest

Example 3: 

Example 3

PowerPoint Presentation: 

CONSOLIDATION METHODS PROPORTIONATE CONSOLIDATION Full consolidation - minority interest

The application of Proportionate Consolidation: 

The application of Proportionate Consolidation Consolidated balance sheet of the venturer includes its share of the assets that it controls jointly and its share of the liabilities for which it is jointly responsible. Consolidated income statements of the venturer include its share of the income and expenses of the jointly controlled entity.

Example 4: 

Example 4 Parent company P owns 50% of the shares of a jointly controlled entity J. Parent P has receivables from J regarding the consultancy services rendered in the amount of TL 9,000 million as of 31 December 2002. Parent P earned TL 15,000 million consultancy fee from J during 2002. What would be the consolidation entries?

Example 4: 

Example 4 DR Accounts payables 4,500 CR Acoounts receivable 4,500 ii) DR Other operating income 7,500 CR Operating expenses 7,500

PowerPoint Presentation: 

CONSOLIDATION METHODS EQ U I TY METHOD SHAREHOLDERS EQUITY * SHARE PER C ENTAGE = INVESTMENT VALUE (Treatment of Dividend Income ! )

Subsequent recording in the Balance Sheet : 

Subsequent recording in the Balance Sheet The carrying value of an Associate investment increases/ decreases by the investors % of profit/loss each Goodwill is shown as an element of cost and is subsequently amortised over its useful life Any distribution of dividends will reduce the carrying value of the investment . Equity Method Value of Investment 200 % Investment 20% Profit made by associate 400 Share of profit 100 Carrying Value 300

Income Statement: 

Income Statement Investor’s share of Associate’s profit before tax is disclosed on one line Investor’s share of Associate’s tax and extraordinary items are added to the corresponding lines

Example 5: 

Example 5

TREATMENT FOR FOREIGN ENTITIES : 

TREATMENT FOR FOREIGN ENTITIES

Scope of IAS 21: 

Scope of IAS 21 Should be applied: In accounting for transactions in foreign currencies; and In translating the financial statements of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or by the equity method.

Classification : 

Classification Integral to the operations of the reporting entity Foreign entity Autonomous Extension of parent’s operations

Indicators of status of foreign entities: 

Indicators of status of foreign entities Foreign entity Activities carried out with autonomy Activities financed from own operations or local borrowings Low volume of transactions with parent Costs settled in local currency Sales in other than reporting currency Parent cash flows insulated from those of foreign operation

Integral operations: Translation: 

Integral operations : Translation Income statement - average rate Balance sheet Non monetary - historic al rates Monetary – closing rates FX differences – in income statement

Foreign entity: Translation: 

Foreign entity: Translation Income statement - average rate Balance sheet - closing rate FX differences - classify in equity Disposals - release FX differences to P&L

PowerPoint Presentation: 

Income and expense items of a foreign entity reports in the currency of a hyperinflationary economy should be translated at the closing rates. Income and expense items of a foreign entity translated at exchange rates at the dates of transactions should be restated to purchasing power at the closing date . Other key points

Expected developments from the IASB: 

Expected developments from the IASB Functional currency – currency of the primary economic environment in which entity operates Presentation currency – can be functional currency or another currency - SIC 30 Monetary / non-monetary items clarified Impairment of foreign currency non-monetary asset clarified Exchange component of revaluation gain / loss (IAS 16) also goes to equity Net investment in foreign entity – moved to IAS 39 Use of presentation currency other than functional currency – apply IAS 21 principles used for foreign entity “Convenience” translation must designate as supplementary information disclose method