Accounting for
Group Structures
Chapter 24
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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.
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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’.
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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.
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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.
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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.
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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.
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Development of the accounting standard
on consolidated financial statements
•
•
•
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.
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Development of the accounting standard
on consolidated financial statements
•
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.
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Development of the accounting standard
on consolidated financial statements
•
•
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.
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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%.
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Alternative consolidation concepts
•
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.
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Alternative consolidation concepts
•
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.
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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.
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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.
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Concept of control
•
Control can exist in the absence of any equityownership 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.
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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.
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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.
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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.
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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.
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Accounting for business
combinations
•
•
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 plus
c) Fair value of any previously-held equity interest in the
acquiree less
d) Fair value of identifiable assets acquired and the liabilities
assumed
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Accounting for business
combinations
•
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).
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Accounting for 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.
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Accounting for business
combinations
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.
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Accounting for business
combinations
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’.
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Accounting for business
combinations
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.
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Accounting for business
combinations
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.
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Accounting for business
combinations
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.
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Accounting for business
combinations
Journal entry to eliminate investment in
Subsidiary.
•
•
Recorded in a consolidation journal and posted
to a consolidation worksheet.
Journal entry:
Dr
Dr
Dr
Contributed Equity
Retained earnings
Goodwill
Cr
Investment in Subsidiary Ltd
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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).
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Gain on bargain purchase
•
(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, and
d) Consideration transferred.
Purpose of the review is to ensure measurements
appropriately reflect consideration of all information as of
acquisition date.
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Gain on bargain purchase
•
•
•
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
Dr
•
Contributed Equity
Retained earnings
Cr
Gain on Bargain Purchase
Cr
Investment in Subsidiary Ltd
Refer to Worked Example 24.4, Gain on Bargain
Purchase.
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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).
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Subsidiary’s assets not recorded at
fair values
•
Adjustment on consolidation:
– To revalue assets to fair value:
Dr Non-current assets
Cr
Revaluation reserve
– To eliminate the investment in the subsidiary, as well as the
revaluation reserve created in the previous entry:
Dr Contributed Equity
Dr Retained earnings
Dr Revaluation reserve
Dr Goodwill
Cr
Investment in subsidiary
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Subsidiary’s assets not recorded at
fair values
•
•
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’.
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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.
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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’.
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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.
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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.
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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 .
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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).
•
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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.
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