controlled entities
TRANSCRIPT
Controlled entities: The consolidation
method
Understand the nature and various forms of controlled entities
Explain how the consolidation method is applied Explain the key components of the term
‘control’ Discuss which entities should prepare
consolidated financial statements Understand the alternative concepts of
consolidation Explain the differences in report format between
single entities and consolidated entities
Business combinations can take a number of forms. Common examples are:• Acquisition of shares in another entity
• Formation of a new entity to acquire the shares of another entity
• Dual-listed entities – eg BHP Billiton Australian company : BHP Ltd UK company : Billiton Plc
Consolidation – process of preparing single set of financial statements for group of entities under control of one of those entities
Involves combining financial statements of individual entities to show financial position and performance of group as if it were single entity
Group – a parent and all its subsidiaries
Parent – an entity that has one or more subsidiaries
Subsidiary – an entity that is controlled by another entity
A Ltd
B Ltd
Parent
Subsidiary
“control” must exist
The economic entity is referred to as the “A Ltd Group”
Consolidated financial statements are prepared by(i) Aggregating (combining), line by
line, like items of assets, liabilities, equity, income and expenses
(ii) Adjusting these combined figures for inter- group transactions between entities within the group (covered in following weeks)
AASB 10 Consolidated Financial StatementsCriterion for identifying parent-subsidiary relationship is controlAn investor controls an investee when
the investor :is exposed, or has rights, to variable returns
from its involvement with the investee andhas the ability to affect those returns through its
power over the investee
Control
The following three elements are required in order for an investor to have control:1. Power over the investee2. Exposure or rights to variable returns from its involvement with the investee3. The ability to use its power over the investee to affect the amount of the investor’s returns
All three elements must be present for control to exist
1. Passive versus active control – entity having capacity to control may not actually be involved in management of controlled entity
2. Non-shared Control - Two or more entities cannot share control
3. Level of Share Ownership - Control may be unilateral or effective, depending on level of share ownership
Control element 1 – Power criterion
Requires CAPACITY to control - not ACTUAL control
Factors in determining the existence of capacity include:
Unilateral control Control is presumed to exist where the
parent owns (directly or indirectly) > 50% of the voting power of an entity unless there is evidence to the contrary
Unilateral control refers to the power to • appoint / remove > 50% of directors
and • cast majority of votes at AGM
Control element 1 – Power criterion
Effective control • < 50% can result in control.
• The following factors need to be considered when assessing effective control. Existence of contracts (power by agreement
with other investors) Size of voting interests (e.g. if only 60% of
eligible votes attend meeting, 31% can control meeting)
Dispersion of other shareholders (probability of shareholders attending meeting lessened by location and by size of share parcels)
Levels of disorganisation or apathy of other shareholders (most shareholders do not understand or care about day to day management)
Control element 1 – Power criterion
Effective control – cont.• Problems relating to effective control
Temporary control (eg 31% ownership can control if only 60% of eligible votes in attendance in Year 1, but not if 70% in attendance in Year 2)
Friendly relationship can turn un-friendly
Control element 1 – Power criterion
Who controls C Ltd?
Control element 1 – Power criterion
A Ltd
C Ltd48%
Even though A Ltd is currently running the day-to-day operations of C Ltd, B Ltd is considered to have passive control of C Ltd. At any time that B Ltd disagrees with the management policies of A Ltd it can take control by virtue of its majority voting interests.
B Ltd
52%
• A Ltd currently actively formulates the policies of C Ltd
• B Ltd currently plays no part in the day-to-day management of C Ltd
Does A Ltd control B Ltd?
Control element 1 – Power criterion
A Ltd
B Ltd
45% 20 shareholders each holding < 2% of the voting power. These shareholders rarely attend meetings and vote
Based on the size of voting interests and dispersion of shareholders it appears that A Ltd exerts effective control over B Ltd.
Does A Ltd control B Ltd?
Control element 1 – Power criterion
A Ltd
B Ltd
44% 3 shareholders each holding 22% of the voting power. These shareholders regularly attend meetings and vote
Based on the size of voting interests and involvement of shareholders it appears that A Ltd does NOT exert control over B Ltd.
Examples of returns include:• Dividends• Economies of scale• Cost savings• Sourcing scarce products• Gaining access to proprietary knowledge• Remuneration for servicing an investee’s assets or
liabilities
Benefit criterion excludes parties such as trustees and those with fiduciary relationship with the subsidiary from having to consolidate
Benefits that can exist in parent-subsidiary relationship
• Dividends• Obtaining scarce raw materials on priority basis• Gaining access to subsidiary’s distribution network, patents• Economies of scale• Denying or regulating access to subsidiary’s assets to competitors
Control element 3 – Benefit criterion
AASB 10 applies only to groups that are required to prepare general purpose financial reports
Required where there are users who rely on the entity’s general purpose financial statements for information useful to them for making decisions about the allocation of resources
Who are dependent users?• Resource providers • Recipients of goods and services• Parties having a review or oversight
function
Users of consolidated financial statements
Factors to assist in identifying possible dependent users
• Separation of management from economic interest
• Economic or political importance/ influence
• Financial characteristics When a group is formed as a result of a
business combination, the group is considered a reporting entity if users exist who require info about the group.
Users of consolidated financial statements
Users of consolidated financial statements
A Ltd
B Ltd
Assume A Ltd is a reporting entity. Is the A Ltd group also a reporting entity?
Shareholders of A Ltd would want a financial report on the combined entity as their wealth is now dependent on the combined performance of A and B. Therefore the group would be reporting entity
100%
How many reporting entities could exist in the group below?
Users of consolidated financial statements
A Ltd
B Ltd
ANSWER = 5 ?• Each individual entity may be reporting
entity – A Ltd, B Ltd and C Ltd• A Ltd group also probably reporting
entity - Shareholders of A Ltd dependent on performance of all companies
• B Ltd group also probably reporting entity - NCI shareholders of B have no financial interest in A Ltd, but interested in B+C
C Ltd
80%
100%
20%
NCI
AASB 10 provides exclusion for parent to present consolidated financial statements if, and only if:It is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners do not object to the parent not presenting consolidated financial statements
Its debt or equity instruments are not traded in a public market
It is not required to file financial statements with a securities commission or other organisation for the purpose of issuing instruments in a public market
Its ultimate or any intermediate parent produces consolidated financial statements available for public use and comply with IFRSs
ALL the 4 conditions must be met
Presentation of consolidated financial statements
Presentation of consolidated financial statements
A Ltd
B Ltd
C Ltd
90%
80%
10%
NCINo consolidation
required for B Ltd group if 10% NCI shareholders
in B consented to no consolidated financial
statements.
Assuming :B Ltd’s debt or equity instruments are not traded in a public market
B Ltd is not required to file financial statements with a securities commission or other organisation for the purpose of issuing instruments in a public market
A Ltd produces consolidated financial statements available for public use and comply with IFRSs
An acquirer is the combining entity that obtains control of the other combining entities in a business combination.
In most cases the parent will be the acquirer. Exceptions arise when:
a) A new entity is formed, which acquires all the shares of previously existing entities
b) A reverse acquisition occurs – a private company purchases a publicly traded
company and shifts its management into the latter normally involves renaming the publicly traded
company allows private companies to become publicly
traded while avoiding the regulatory and financial requirements associated with an IPO
Adopts entity concept of consolidation
• Group consists of the assets and liabilities of parent and all the assets and liabilities of the subsidiary (ies)
• Non Controlling Interest (NCI) is classified as an equity holder
• Transactions between group entities are adjusted in full. They are not affected by the % ownership interest
Concepts of Consolidation – Entity Concept