Section 2 Consolidated financial statements Section 2 Consolidated ...

Chapter 3 IFRSs US GAAP Chapter 3
Section 2
Consolidated financial
statements
Section 2
Consolidated financial
statements
2.1 AUTHORITATIVE PRONOUNCEMENTS 2.1 AUTHORITATIVE PRONOUNCEMENTS
• IFRS 3
• IAS 27
• IAS 31
• IAS 32
• SIC-12
• FAS 94
• FAS 140
• FAS 144
• ARB 43, Chapter 12
• ARB 51
• APB 18
• FIN 46(R)
COMMENT
The IASB is engaged in two projects – Business Combinations (Phase II) and
Consolidation – that will impact the accounting treatment of subsidiaries. Phase II
of the Business Combinations project on application of the purchase method is
conducted jointly with the FASB. An Exposure Draft is expected in 2005 (with an
IFRS to follow later in that year, likely to be effective for periods beginning on or
after 1 January 2007). Application is expected to be prospective, with the inclusion
of special transitional arrangements. The Business Combinations Project Phase II
proposes, inter alia, that:
• consolidated goodwill would include the minority’s share of goodwill;
• the minority would bear their proportionate share of losses, even if these
reduced the minority interest (to be known as non-controlling interest) below
zero; and
• transactions between majority and minority shareholders, not resulting in a
loss of control over the subsidiary, would be treated as equity transactions
not giving rise to a profit or loss.
The Consolidation Project will lead to a new IFRS to replace IAS 27 Consolidated
and Separate Financial Statements and SIC-12 Consolidation – Special Purpose
Entities. It is likely to contain significant changes to the criteria giving rise to a
presumption of control. This is discussed further in sections 2.3 and 2.6.
COMMENT
Consolidations have been on the FASB’s agenda for almost 20 years and a final
Statement was planned but in January 2001, the FASB determined that there was
not sufficient Board member support to proceed.
The Board issued FIN 46 Consolidation of Variable Interest Entities an
interpretation of ARB 51 in January 2003 (revised December 2003). FIN 46(R)
introduces a new consolidation model—the variable interests model which provides
guidance on how to apply the controlling financial interest criteria in ARB 51 to
variable interest entities. See section 2.7.
Currently, the FASB is partnering with the IASB on a joint project that represents
the second phase of the Board’s overall project on business combinations –
reconsidering aspects of the purchase method of accounting that were not
deliberated in FAS 141 and FAS 142. Phase II will revise FAS 141 to require all
acquisitions of businesses to be measured at the fair value of the business acquired
and provide specific guidance for applying the purchase method. The FASB issued
a summary of tentative decisions on phase II of the business combinations project
as of July 2004. The FASB and IASB are developing common exposure drafts of
proposed standards which are expected to be issued in the first half of 2005.
IAS 27.1,9,12
IAS 27.10
2.2 CONSOLIDATION POLICY 2.2 CONSOLIDATION POLICY
A parent company shall prepare consolidated financial statements in which all
subsidiaries are consolidated.
A parent company need not prepare consolidated financial statements if and only if:
• it is a wholly owned subsidiary itself (or is a partially-owned subsidiary, and its
other owners, including those not entitled to vote, have been informed about,
and do not object to, the parent company not presenting consolidated
financial statements);
• the parent’s debt or equity instruments are not traded in a public market;
• the parent did not file, nor is in the process of filing, its financial statements
with a securities commission or other regulatory organisation for the purpose
of issuing any class of instruments in a public market; and
If an enterprise has one or more subsidiaries, consolidated statements rather than
parent company financial statements are the appropriate general-purpose financial
statements.
There is a presumption that consolidated statements are more meaningful than
separate statements and that they are usually necessary for fair presentation when
one company has an indirect or direct controlling financial interest in one or more
other companies.
Equity accounting is not a valid substitute for consolidation.
FAS 94.61
ARB 51.1
FAS 94.15(c)
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Chapter 3: Section 2 Consolidated financial statements – IFRSs US GAAP – Consolidated financial statements Chapter 3: Section 2
IAS 27.30
IFRS 3.Appx A
IAS 27.12
• the ultimate or any intermediate parent of the parent produces consolidated
financial statements available for public use that comply with International
Financial Reporting Standards.
A subsidiary is consolidated from its date of acquisition, the date on which the
acquirer effectively obtains control, until the entity ceases to have control.
Where a subsidiary is classified as held for sale under IFRS 5 Non-current Assets
Held for Sale and Discontinued Operations, the results and net assets of the
subsidiary are consolidated but the subsidiary is measured, presented and disclosed
in accordance with IFRS 5 (see section 1.9).
IAS 27.4,IG2,IG4
IAS 27.13
IAS 27.14-15
IAS 27.IG1-IG8
2.3 DEFINITION OF A SUBSIDIARY 2.3 DEFINITION OF A SUBSIDIARY
A subsidiary is an entity (including an unincorporated entity) that is controlled by
another entity, the parent. The parent has control when it has the power to govern
the financial and operating policies of an entity so as to obtain benefits from its
activities. It may be active or passive in nature and only one party will be the parent.
Control exists when the parent holds:
• directly or indirectly through subsidiaries, more than half of the voting power
of an entity unless, in exceptional circumstances, it can be clearly
demonstrated that such ownership does not constitute control;
• power over more than one half of the voting rights by virtue of an agreement
with other investors;
• power to govern the financial and operating policies of the entity under a
statute or an agreement;
• power to appoint or remove the majority of the members of the board of
directors or equivalent governing body; or
• power to cast the majority of votes at meetings of the board of directors or
equivalent governing body.
COMMENT
The IASB is engaged in a Consolidation Project will lead to a new IFRS to replace
IAS 27 and SIC-12. It is likely to contain significant changes to the criteria giving
rise to a presumption of control. The IASB has tentatively agreed that control
should be based on satisfaction of all of the following:
• power criterion – the ability to set strategic direction and to direct operating
policy and strategy. In particular, the IASB have tentatively agreed that
there should be a rebuttable presumption that the holdings of de facto agents
of the company (such as senior employees, related parties etc) are available to
the entity in assessing the power criterion. There will also be additional
clarification on potential voting rights;
• benefit criterion – the ability to access benefits; and
• the link – the ability to use power so as to protect or maintain benefits.
The existence and effect of potential voting rights (e.g. those arising from the
exercise of share options or conversion of convertible debt or equity) that are
currently exercisable or currently convertible are also considered when assessing
whether an entity controls another entity. Potential voting rights are not currently
exercisable or currently convertible when they cannot be exercised or converted
‘Subsidiary’ refers to a corporation that is controlled, directly or indirectly, by
another corporation. The usual condition for control is ownership of a majority
(over 50%) of the outstanding voting stock. However, the power to control may
also exist with a lesser percentage of ownership, for example, by contract, lease, and
agreement with other stockholders or by court decree. This definition excludes
entities that are controlled through only significant minority ownership of the
outstanding voting stock.
A
SEC registrants
In its rules on consolidation policy, the SEC emphasises the need to consider
substance over form to determine the appropriate consolidation policy. The SEC
notes that there may be situations where consolidation of an entity, notwithstanding
the lack of technical majority ownership, is necessary to present fairly the financial
position and results of operations of the registrant, because of the existence of a
parent/subsidiary relationship by means other than record, i.e. greater than 50%,
ownership of voting stock.
The definition of a subsidiary contained in Regulation S-X is based on control and
risk:
• Subsidiary – a subsidiary of a specified person is an affiliate (individual,
corporation, partnership, trust or unincorporated organisation) controlled by
such person directly or indirectly through one or more intermediaries.
• Control – means the possession, direct or indirect, of the power to direct or
cause the direction of management and policies of a person, whether through
the ownership of voting shares, by contract or otherwise.
• Voting shares – means the sum of all rights to vote for the election of
directors.
An entity may establish a controlling financial interest in another entity with little or
no equity investment through either a nominee structure or other contractual
arrangement. EITF 97-2 relates to contractual arrangements between physician
practices and entities established to manage the operations of those practices but the
SEC has concluded that the guidance should be applied to similar arrangements in
other industries. Under the consensus, if all of the following requirements are met,
then the management entity (entity ‘A’) has a controlling financial interest in the
physician practice (entity ‘B’):
APB 18.3(c)
S-X 3A-02(a)
S-X 1-02(x)
S-X 1-02(g)
S-X 1-02(z)
EITF 97-2
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Chapter 3: Section 2 Consolidated financial statements – IFRSs US GAAP – Consolidated financial statements Chapter 3: Section 2
until a future date or upon the occurrence of a future event. All potential voting
rights should be considered, including potential voting rights held by other entities.
All facts and circumstances should be considered including the terms of exercise of
the potential voting rights and possible linked transactions. However, in making
the assessment the intention of management and the financial ability to exercise or
convert should not be taken into account.
• The arrangement term is either (a) the entire remaining legal life of entity A or
(b) a period of 10 years or more; and is not terminable by entity B except in
the case of gross negligence, fraud, or other illegal acts by entity A.
• Entity A Controls all major, or central operations of entity B including
employee selection, hiring and firing and compensation arrangements.
• Entity A has a significant financial interest in entity B that is (a) unilaterally
saleable or transferable; and (b) provides entity A with the right to receive
income in an amount that fluctuates based on the performance, and therefore
fair value, of entity B.
Based on this guidance, a contractual arrangement with a term of less than 10 years
may not establish a controlling financial interest.
IAS 27.12,19
2.4 EXCLUSION OF SUBSIDIARIES FROM CONSOLIDATED
FINANCIAL STATEMENTS
Consolidated financial statements include all subsidiaries. A subsidiary is not
excluded from consolidation simply because the investor is a venture capital
organisation, mutual fund, unit trust or similar entity.
Where a subsidiary is classified as held for sale under IFRS 5 Non-current Assets
Held for Sale and Discontinued Operations, the results and net assets of the
subsidiary are consolidated but the subsidiary is measured, presented and disclosed
in accordance with IFRS 5 (see section 1.9).
2.4 EXCLUSION OF SUBSIDIARIES FROM CONSOLIDATED
FINANCIAL STATEMENTS
Consolidation is required of all majority-owned subsidiaries, i.e. all companies in
which a parent has a controlling financial interest directly or indirectly, except:
• if control does not rest with the majority owner; or
• if the subsidiary operates under foreign exchange restrictions, controls or
other governmental imposed uncertainties which cast significant doubt on the
parent’s ability to control the subsidiary.
The exemption from consolidation where control is likely to be temporary, in
ARB 51 Consolidated Financial Statements, as amended by FAS 94 Consolidation
of All Majority-Owned Subsidiaries an amendment of ARB No. 51, with related
amendments of APB Opinion No. 18 and ARB No. 43, Chapter 12, was removed
by FAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets. All
long-lived assets or groups of assets classified as held for sale, even where recently
acquired, should be recorded at the lower of carrying amount or fair value less cost
to sell. FAS 144 also requires the results of operations classified as held for sale to
be recognised in the period in which those operations occur.
FAS 144 governs the accounting for all planned dispositions of operations,
including planned dispositions of subsidiaries and supersedes APB 30 Reporting the
Results of Operations – Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (see section 1).
The presumption that all majority-owned investees should be consolidated may be
overcome in cases where the minority shareholders have substantive participating
rights that allow the minority shareholders to select management and establish
operating and capital decisions of the investee.
FAS 94.13
FAS 144.App C2
FAS 144.App B87
EITF 96-16
2.4.1 Unconsolidated subsidiaries 2.4.1 Unconsolidated subsidiaries
IAS 27.12 Consolidated financial statements include all subsidiaries. The equity method should not be used as a substitute for consolidation. However,
the equity method will generally be appropriate when conditions under which a
subsidiary would not be consolidated prevail – namely where the investee is in legal
reorganisation, bankruptcy or operates under foreign exchange restrictions etc.
APB 18.14 fn4
FAS 94.15(c)
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Chapter 3: Section 2 Consolidated financial statements – IFRSs US GAAP – Consolidated financial statements Chapter 3: Section 2
IAS 27.22
IAS 27.24-25
IAS 27.22
IAS 27.26-27
IAS 21.46
IAS 27.28
IAS 32.33
2.5 CONSOLIDATION PROCEDURES 2.5 CONSOLIDATION PROCEDURES
2.5.1 Intragroup transactions 2.5.1 Intragroup transactions
Preparation of consolidated financial statements requires the financial statements of
the parent and its subsidiaries to be combined on a line-by-line basis by adding
together like items of assets, liabilities, equity, income and expenses. In order to
present financial information about the group as if it were that of a single economic
entity, the following adjustments are required.
Intragroup balances, transactions, income and expenses and profits and losses
arising from intragroup transactions must be eliminated in full. Intragroup losses
may indicate that the asset involved is impaired.
The carrying amount of the parent’s investment in each subsidiary and the parent’s
portion of equity of each subsidiary must be eliminated, and the minority interests in
the profit or loss for the period and net assets of the subsidiary identified (see
section 2.5.5). The treatment of goodwill or the excess of the acquirer’s interest in
the net fair value of the acquiree’s identifiable assets, liabilities and contingent
liabilities is dealt with in IFRS 3 Business Combinations (see section 3).
ARB 51 Consolidated Financial Statements requires complete elimination of
intragroup profits or losses on assets remaining within the group.
Elimination is also required of:
• intragroup items and transactions between entities included in consolidated
financial statements; as well as
• unrealised profits and losses on transactions between entities in the group and
those which are accounted for under the equity method.
If such eliminations are not made, an explanation of the reasons and the treatment
of those transactions should be disclosed.
The amount of intragroup items and transactions is not affected by the existence of
a minority interest. However, the complete elimination of the profit or loss may
be allocated proportionately between the majority (group) and minority interests.
2.5.2 Non‐coterminous financial statements 2.5.2 Non‐coterminous financial statements
When the financial statements of a subsidiary are drawn up to a different reporting
date from that of the parent, additional financial statements should be prepared by
the subsidiary drawn up to the parent’s reporting date. If this is impracticable, the
financial statements of the subsidiary at a different date may be used (so long as the
difference between the reporting dates is no more than three months, and the length
of the reporting periods and any difference in reporting dates is the same from
period to period). It is necessary to make adjustments for the effects of significant
transactions or other events that occur between the reporting dates of the subsidiary
and that of the parent.
If the financial statements of a subsidiary with a different reporting date are
expressed in a currency different from the parent’s reporting currency, the assets
and liabilities are included in the consolidated financial statements at the exchange
rate ruling at the balance sheet date of that subsidiary. Adjustments are made for
significant changes in exchange rates up to the balance sheet date of the parent.
2.5.3 Different accounting policies 2.5.3 Different accounting policies
Consolidated financial statements are prepared using uniform accounting policies
for comparable transactions and other events in similar circumstances.
A difference in accounting year ends would not justify the exclusion of a subsidiary
from consolidation, but the subsidiary should prepare financial statements, for
consolidation purposes, for a period which corresponds with the parent company’s
year end. Financial statements of subsidiaries with accounting periods ending
within three months before or after of that of the parent company are usually
acceptable for consolidation. In such cases, the effect of intervening events that
materially affect the financial position or results of operations should be recognised
by disclosure, or otherwise.
The SEC has similar requirements to those in ARB 51. Where such differences in
fiscal years exist, the closing date of the entity should be disclosed and the necessity
for the use of different closing dates should be briefly explained.
Although there is no specific guidance, the consolidated financial statements are
based on the assumption that they represent the financial position and operating
results of a single business entity. Consequently, adjustment may be required to
conform the accounting policies of consolidated entities.
2.5.4 Shareholdings in the parent company 2.5.4 Shareholdings in the parent company
Treasury shares (‘own shares’), acquired by the parent or by other members of the
consolidated group, are presented as a deduction from equity and the purchase, sale,
issue or cancellation of an entity’s own equity instruments do not result in gains or
These should not be treated as outstanding stock in the consolidated balance sheet
but should be treated in a manner similar to treasury stock (see section 12.5.4).
ARB 51.6,14
S-X 3A-04
APB 18.19(a)
ARB 51.14
ARB 51.4
S-X 3A-02(b)
ARB 51.6
ARB 51.13
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Chapter 3: Section 2 Consolidated financial statements – IFRSs US GAAP – Consolidated financial statements Chapter 3: Section 2
IAS 32.34
losses recognised in profit or loss. Consideration paid or received is recognised
directly in equity.
The amount of treasury shares held is disclosed separately either on the face of the
balance sheet or in the notes. Disclosure in accordance with IAS 24 Related Party
Disclosures is given if the entity acquires its own shares from related parties.
IAS 27.4,22-23
IAS 27.IG5-7
IAS 27.35
IAS 27.36
IAS 27.33-34
IAS 32.AG29
2.5.5 Minority interests 2.5.5 Minority interests
Minority interest is the portion of the net assets and profit or loss of a subsidiary
attributable to equity interests that are not owned, directly or indirectly by the
parent, and is therefore based on the fair values of assets and liabilities included in
the consolidation. When potential voting rights exist, the proportion attributable
to the minority interest is determined on the basis of present ownership interests
and does not reflect the possible exercise or conversion of potential voting rights
(except for the eventual exercise of potential voting rights and other derivatives that
in substance give access at present to the economic benefits associated with an
ownership interest). Interests in potential voting rights and other derivatives which
do not in substance give a present ownership interest, are accounted for in
accordance with IAS 39 Financial Instruments: Recognition and Measurement.
However, the minority’s share in the losses may exceed the minority’s share in the
equity of the subsidiary. Where this is the case, the excess is charged against the
majority interest except to the extent that the minority has a binding obligation and
is able to make an additional investment to cover the losses. If the subsidiary later
reports profits, such profits are allocated to the majority interest until the minority
share of losses previously absorbed by the majority interest are recovered.
If a subsidiary has outstanding cumulative preference shares held by minority
interests and classified as equity, the parent computes its share of profits or losses
after adjusting for the dividends on such shares, whether or not dividends have been
declared.
The minority interest in any financial instrument classified as an equity instrument
by a subsidiary is presented by the parent in the consolidated balance sheet within
equity, separate from the parent shareholders’ equity. Minority interest in the
profit or loss of the group is not income or expense and is also disclosed separately.
A financial instrument classified as a financial liability by a subsidiary remains a liability
in the consolidated balance sheet unless eliminated on consolidation as an intragroup
balance. However, when classifying a financial instrument in the consolidated
financial statements, an entity considers all terms and conditions agreed between
members of the group and holders of the instrument in determining whether the
group as a whole has an obligation or settlement provision, and a financial liability.
Consequently, financial instruments correctly classified as equity by a subsidiary may
be classified as a financial liability in the consolidated balance sheet.
COMMENT
It is expected that Phase II of the Business Combinations project on application of
the purchase method which is conducted jointly with the FASB will amend the
treatment of minority interest.
Minority interests should be disclosed separately in the balance sheet, but not as part
of stockholders’ equity. Similarly, the minority interest in income of consolidated
subsidiaries should be separately disclosed. Most companies reflect minority
interests as part of non-current liabilities or between liabilities and stockholders’
equity (the ‘mezzanine’) in the balance sheet.
A
COMMENT
The FASB plans to expose its proposals related to the accounting for noncontrolling
(minority) interests by issuing a proposed Statement that would amend
and replace ARB 51, as amended by FAS 94. This project is another phase of the
Board’s project on business combinations. The Board expects to issue an exposure
draft in the second quarter of 2005 and a final Statement in the second quarter of
2006.
Minority interests
Minority interests are generally presented in the consolidated balance sheet at an
amount equal to the minority’s share of the carrying amount of the subsidiary’s net
assets. When consolidating the assets and liabilities of an acquired subsidiary that is
not wholly owned, the fair value adjustments are limited to the amount attributable to
the parent company’s ownership percentage. As a result, the assets and liabilities of
the subsidiary are included on a ‘mixed’ basis in the consolidated financial statements.
Profits or losses of the subsidiary undertaking should be consolidated in full, with an
allocation for equity minority interest based on the proportion held by the minority
shareholders.
In the case in which losses applicable to the minority interest in a subsidiary exceed
the minority interest in the equity capital of the subsidiary, the minority interest
should be reported as zero, as there is no obligation of the minority interest to make
good such losses (unless there is evidence indicating otherwise). Any loss in excess
of the minority balance should be charged against the majority interest. In the
event of future earnings, the majority interest should be credited for all those
earnings up to the amount of those losses previously absorbed.
B
Minority interests included in debt
Statement of Financial Accounting Concepts No. 6 Elements of Financial
Statements states that minority interests in the net assets of consolidated subsidiaries
do not represent present obligations of the consolidated company to pay cash or
distribute other assets to minority stockholders. Rather, those stockholders have
ownership or residual interests in components of a consolidated company.
However, it is possible that minority interests do represent present obligations of the
consolidated company to pay cash or distribute other assets to minority stockholders,
S-X 5-02.27
S-X 5-03.12
ARB 51.15
150 151