accounting for group structures chapter 24 24-1 powerpoint slides to accompany new zealand financial...

Accounting for Group Structures

Chapter 24

24-1PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin Slides adapted by Murugesh Arunachalam, © 2011 McGraw-Hill Australia Pty Ltd

Learning Objectives

• Understand the reasons for preparing consolidated financial statements.

• Understand the historical development of the accounting standards on consolidated financial statements.

• Understand alternative consolidation concepts.

• Be able to explain the factors to be considered in determining the existence of control.

• Understand the basics involved in preparing consolidated financial statements.


Learning Objectives

• Be able to provide the journal entries to account for any goodwill or gain on bargain purchase arising on consolidation

• Learn how to account for an acquisition where the subsidiary’s assets are not recorded at fair values.

• Understand how to use consolidation worksheet

• Understand the basics of preparing consolidated financial statements after the date of acquisition.

• Understand the disclosure requirements of NZ IAS 27 ‘Consolidated and Separate Financial Statements’.


Introduction• Common for groups of companies to combine in pursuit of

common goals.• Where a reporting entity controls another entity, NZ IAS 27

‘Consolidated and Separate Financial Statements’ requires that consolidated financial statements be prepared.

• Key issues examined in this chapter include:– Rationale for presenting consolidated financial statements.– Brief review of history of NZ consolidated accounting

requirements.– The importance of control to the decision to consolidate an

entity.– The basic mechanics of the consolidation process and how to

account for any goodwill or excess that might arise on consolidation.


Rationale for consolidating the financial statements of different legal entities

• Consolidated statements show the results and financial position of a group as if the subsidiary and parent companies were operating as a single economic entity.

• Consolidated statement of comprehensive income shows the result of operations with parties external to the group.

• Inter-group transactions are eliminated, since from the economic entity’s perspective income will not be derived as a result of transactions within the group, only from transactions with external parties.


Rationale for consolidating the financial statement of different legal entities

• Consolidated statement of financial position shows the total assets controlled by the economic entity and the total liabilities owed to parties outside the economic entity.

• Liabilities owing to organisations within the group will be eliminated in the consolidation process and will not be shown in the consolidated statement of financial position.


Development of the accounting standard on consolidated financial statements

• SSAP-8 ‘Consolidated Financial Statements’, issued in August 1978 by the New Zealand Society of Accountants.

• SSAP-8 amended in 1987 and again in 1990.• The 1990 amendment combined SSAP-8 and

SSAP-2 to form a new standard called ‘Accounting for Business Combinations’.

• Purpose of amendment was to eliminate innovative practices (through Partnerships and Unit trusts) of keeping debt off consolidated statement of financial position.



• Before the issue of the Companies Act 1993 , group consolidated accounts could only include entities that were companies.

• Results in a ‘partition effect’ caused by, for example, interposing a unit trust within a group structure (refer to Fig 24.3), everything from the trust down was partitioned off and excluded from the consolidation process.

• Often had the effect of providing a consolidated statement of financial position with lower debt ratios than would otherwise be the case and affecting the ‘true and fair’ view of financial position of the group.



• The introduction of the in-substance subsidiary and amendments to the Companies Act 1993 sort to overcome the loopholes of ‘partition effect’. – Any entity controlled by a reporting entity, regardless of legal

form, must be consolidated

• Financial Reporting Act 1993 requires the preparation of – Consolidated statement of financial position– Consolidated statement of comprehensive income, – Consolidated statement of cash flows and – notes or documents giving information relating to the balance

date.



• The consolidated financial statements must comply with GAAP.

• Two key standards– NZ IAS 27 ‘Consolidated and Separate Financial

Statements’.– NZ IFRS 3 ‘Business Combinations’.– Issued in Jan 2005 for adoption in 2007.

• Revised versions issued in Jan 2008– Must be applied for annual periods beginning on or after 1

July 2009.


Alternative consolidation concepts

• Generally, there are three major consolidation concepts:1. The entity concept (NZ IAS 27)

Entire group is viewed as a single economic entity. All assets and liabilities of the parent entity and

subsidiaries are included in consolidated statement of financial position. • Non-controlling interests are treated as part of consolidated

equity.• Non-controlling interests defined by NZ IAS 27 (par. 4) as

‘equity in a subsidiary not directly or indirectly, to a parent’. Example of non-controlling interest:

• Company A owned 80 per cent of Company B — remaining 20% owned by unrelated entity, non-controlling interest is 20%.



• 2. The proprietary concept– All assets and liabilities of the parent entity and only

a proportionate share of the subsidiaries’ assets and liabilities included in the consolidated statement of financial position.

– Non-controlling interest is not included in the consolidated statement of financial position.



• 3. The parent entity concept (adopted by SSAP-8)– All assets and liabilities of the parent and subsidiaries

are included in the consolidated statement of financial position.

– Non-controlling interest is treated as a liability.

• NZ IAS 27 requires adoption of the entity concept.


Concept of control

• Requirement to consolidate based upon existence of control:– Subsidiaries are considered to be entities that are under the

control of a parent entity.– The power to govern the financial and operating policies of an

entity so as to obtain benefits from its activities (NZ IAS 27, par. 4).

– The capacity to control both the financial and operating policies must exist prior to establishing the existence of control.

– Substance-over-form considerations are required to be used in determining the existence of control, a process that calls for the exercise of professional judgment.


Concept of control

• Factors that might indicate the existence of control (NZ IAS 27, par. 13)– Control is assumed to exist when the parent entity owns,

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.

– Holding of an ownership interest usually entitles the investor to an equivalent percentage interest in the voting rights of the investee, and consequently a majority ownership interest would normally, though not necessarily, be accompanied by the existence of control.


Concept of control

• Control can exist in the absence of any equity-ownership interest.– Control also exists when the parent owns half or less

of the voting power of an entity when there is (NZ IAS 27, par. 13):a) Power over more than half of the voting rights by virtue

of an agreement with other investors;b) Power to govern the financial and operating policies

of the entity under a statute or an agreement;c) Power to appoint or remove the majority of the members of the

board of directors or equivalent governing body and control of the entity is by that board or body; or

d) Power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body.


Concept of control

• Control can be passive — it might be possible to exert control over another entity, even though the option to exert such control might never have been exercised.

• Adoption of criteria of control for defining economic entity will enable a complete economic entity to be reflected in consolidated accounts even though, for example, some of the subsidiaries might be in the form of partnerships or trusts.


Concept of control

Subsequent loss of control (NZ IAS 27, par. 32):• A parent loses control over its subsidiary when it

loses the power to govern the financial and operating policies so as to obtain benefit from its activities. The loss of control can occur with or without a change in absolute or relative ownership levels. It could occur, for example, when a subsidiary becomes subject to the control of a government, court, administrator, or regulator. It could also occur as a result of a contractual agreement.


Concept of control

Direct Control:• Parent company has direct ownership interest in

subsidiary.• Example: Company A owns 70% of the issued

ordinary shares of Company B and therefore has direct control over Company B.

Indirect Control:• Example: Company A has 70% ownership interest

in company B which has 60% ownership interest in Company C. Therefore, Company A has indirect control of Company C.


Accounting for business combinations

• NZ IFRS 3 ‘Business Combinations’ requires use of acquisition method which involves:– identifying the acquirer– determining the acquisition date– recognising and measuring the identifiable assets acquired,

the liabilities assumed and any non-controlling interest in the acquiree; and

– recognising and measuring goodwill or a gain from a bargain purchase.



• Goodwill defined (NZ IFRS 3 ‘Business Combinations’):

‘An asset representing future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognised.’

• Goodwill is calculated as (NZ IFRS 3 paragraph 32):a) Fair value of consideration transferred, plus b) Amount of non-controlling interest plusc) Fair value of any previously-held equity interest in the

acquiree less d) Fair value of identifiable assets acquired and the liabilities

assumed



• Goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised (Basis for Conclusions on IFRS 3 Business Combinations).



Determination of goodwill•Only purchased goodwill, not internally generated goodwill, to be recognised for accounting purposes.•Goodwill is determined as the excess of the cost of acquisition over the fair value of the identifiable net assets acquired.

– Fair value is defined as the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.



Determination of goodwill: •Internally generated goodwill cannot be brought to account in the separate accounts of a reporting entity or in the consolidated financial reports — purchased goodwill will, however, be brought to account in the consolidation process.•Prior to 2005, goodwill acquired also had to be amortised systematically over the periods in which the benefits were expected to be provided (maximum of 20 years).•Goodwill amortisation now prohibited and goodwill is now required to be subject to impairment testing.



Goodwill impairment testing (NZ IFRS 3)•Goodwill acquired in a business combination is not to be amortised.•After initial recognition, goodwill acquired in a business combination is to be measured at cost less any accumulated impairment losses (par. 54).•The acquirer is to test it for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with ‘NZ IAS 36 Impairment of Assets’.



Goodwill impairment testing:•NZ IAS 36 ‘Impairment of Assets’ (par. 60) states:

– An impairment loss shall be recognised immediately in the profit and loss, unless the asset is carried at revalued amount in accordance with another standard (e.g. in accordance with the revaluation model in NZ IAS 16). Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with that other standard.

Note:•As goodwill cannot be revalued, an impairment loss pertaining to goodwill is to be recognised in the profit and loss.•NZ IAS 36 (pars 80–99) offer additional guidance in relation to impairment testing of goodwill.



First step in consolidation process:

•Substitute the assets and liabilities of the subsidiary for the investment account, which currently exists in the parent company.

•The investment account will be eliminated in full against the pre-acquisition equity of the subsidiary

•Where the net assets do not equal the value of the investment, this will lead to a difference on consolidation, i.e. the goodwill acquired.



Eliminating parent’s investment in subsidiary:•The investment account in the subsidiary will be eliminated in full against the pre-acquisition equity of the subsidiary.•This will avoid the double counting of assets, liabilities and shareholders’ funds of the subsidiary.•Procedural details contained in NZ IAS 27, paras 18–21.•Refer to Worked Example 24.2, ‘Calculation of goodwill on acquisition’.•Refer to Worked Example 24.3, ‘A simple consolidation’.

– Consolidation worksheet used to facilitate consolidation process.



Journal entry to eliminate investment in Subsidiary.•Recorded in a consolidation journal and posted to a consolidation worksheet.•Journal entry:

Dr Contributed Equity

Dr Retained earnings

Dr Goodwill

Cr Investment in Subsidiary Ltd


Gain on bargain purchase

• Possible for a company to gain control of an entity for amount less than fair value of proportional share of net assets acquired (i.e. acquired at a discount).

• Where an entity is acquired at a discount NZ IFRS 3 (par. 36) requires the following:– Reassess whether it has correctly identified all of the assets

acquired and liabilities assumed.– Recognise any additional assets or liabilities that are

identified in the review.– Review the procedures used to measure the amounts

required to be recognised at the acquisition date for…(cont).



• (continued):– Review the procedures used to measure the amounts

required to be recognised at the acquisition date for:a) Identifiable assets acquired and liabilities assumed.b) Non-controlling interest in the acquiree.c) For a business combination achieved in stages, the acquirer’s

previously held equity interest in the acquiree, andd) Consideration transferred.

Purpose of the review is to ensure measurements appropriately reflect consideration of all information as of acquisition date.



• Current treatment pursuant to NZ IAS 27 is to treat the gain on bargain purchase as a gain.

• Eliminate investment in subsidiary acquired at discount.

• Journal entry to eliminate:Dr Contributed EquityDr Retained earnings

Cr Gain on Bargain PurchaseCr Investment in Subsidiary Ltd

• Refer to Worked Example 24.4, Gain on Bargain Purchase.


Subsidiary’s assets not recorded at fair values

• If subsidiary’s assets not recorded at fair value adjustments will be required so that a reliable figure for goodwill (or discount) can be calculated.

• NZ IFRS 3 stipulates either:– Revalue the identifiable assets in the accounting records

of the subsidiary before consolidation — all the non-current assets of the subsidiary are revalued to their fair values in the accounting records of the subsidiary; or

– Recognise the necessary adjustments on consolidation — an adjustment would be processed to eliminate the investment and the corresponding equity in the subsidiary and to recognise any increments or decrements to the revaluation reserve to restate the carrying amounts of the identifiable net assets acquired to their fair values as at the date of acquisition (to the extent that accounting standards allow particular classes of assets to be revalued).



• Adjustment on consolidation:– To revalue assets to fair value:

Dr Non-current assetsCr Revaluation reserve

– To eliminate the investment in the subsidiary, as well as the revaluation reserve created in the previous entry:Dr Contributed EquityDr Retained earningsDr Revaluation reserveDr Goodwill

Cr Investment in subsidiary



• Refer to Worked Example 24.5, ‘Subsidiaries’ assets not recorded at fair value’.

• Refer to Worked Example 24.6, ‘Revaluation to fair value involving an excess’.


Consolidation after the date of acquisition

• Pre-acquisition shareholders’ funds of the subsidiary are eliminated on consolidation.

• Typically provides for goodwill on consolidation.

• In period following acquisition, subsidiary will generate profits or losses — to the extent that these results have been generated in the period after acquisition, they should be reflected in the results of the economic entity.


Consolidation after the date of acquisition

• Post-acquisition earnings (unlike pre-acquisition earnings) are considered to be part of the earnings of the economic entity.

• Refer to Worked Example 24.7, ‘Consolidation in a period subsequent to the acquisition of the subsidiary’.


Disclosure requirements• NZ IAS 27 disclosure requirements are extensive.

They include:– Nature of relationship between parent and subsidiary when

parent does not own, directly or indirectly, more than half the voting power.

– Reasons why ownership of more than half of voting power or potential voting power does not constitute control.

– Where subsidiary’s reporting date is different from that of the parent and subsidiary’s financial statements are included in consolidation, reporting date of the subsidiary and reasons for the difference.

– Nature and extent of significant restrictions on subsidiaries’ ability to transfer funds to parent in form of cash dividends or repayment of loans/advance.


Summary

• Consolidated financial statements: – Present aggregated information about the financial performance

and financial positions of various separate legal entities.– Provide a single set of financial statements that represent

the financial position and performance of the group as if it were operating as a single economic entity.

• Control is the determining factor in deciding which organisations should be included in the consolidation process.

• All controlled entities now to be included in the consolidation process regardless of legal form and field of activities.


Summary

• Investment in subsidiary must be offset on consolidation against the pre-acquisition capital and reserves of the subsidiary.

• An adjustment may be required to reflect the fair value of the subsidiary’s assets as at the date of acquisition, and any difference will be either goodwill or discount on acquisition.

• If balance represents goodwill, goodwill must be periodically reviewed for any impairment losses in accordance with .


Summary

• NZ IAS 36 ‘Impairment of Assets’.• If a discount arises on consolidation, the discount

is to be treated as a gain in the consolidated financial reports.

• Following consolidation, the consolidated retained earnings balance represents the parent entity’s retained earnings plus the economic entity’s share of the post-acquisition earnings of the controlled entities (subsidiaries).


Summary

• The balance in the various consolidated reserve accounts will represent the balance of the parent entity’s reserve accounts plus the parent entity’s share of the post-acquisition movements of the subsidiaries’ reserve accounts.

• Consolidation entries are to be performed in a separate consolidation worksheet/journal.


accounting for group structures chapter 24 24-1 powerpoint slides to accompany new zealand financial...

Documents

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powerpoint slides

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