Consolidation and the concept of
control
ACCT3011 – Week 1
Semester 2, 2021
Presented by
Matthew Egan
The University of Sydney
Page 1
Introduction and welcome from Matt
– Dr Kaiying Ji is our unit coordinator for the semester
– You should all watch Kaiying’s welcome video first, noting her comments about
Canvas, the assessments, the textbook and other resources, and your classes
– I am lecturing for the first 6 weeks, followed by Kaiying in weeks 7-13. Lecture
slides will be released by the Friday of each preceding week, and the video
will be available to stream from each Tuesday at 10am.
– Assessments of relevance to my lectures:
– The mid-semester exam (20%) covers week’s 1-5 inclusive (week 6 onwards,
is examinable in the final exam)
– The individual assignment (10%) is based on this week’s material, and so
will be available to you in the assignment folder on Canvas, from 12pm on
the 10th of August. The Unit of Study Outline says it is due on 27 August
(week 3), however we have decided to give you an extra week – now due
in Turnitin by 4pm on September 3rd.
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Page 2
Lecture objectives
After completing this topic students should be able to:
– Describe the different classifications of investments
– Outline the objectives of preparing consolidated financial statements
(CFS)
– Understand the history and development of consolidation
– Explain the concept of a ‘group’ and describe the concept of ‘control’
per AASB10.
– Apply the definition of control to examples found in practice (you will
demonstrate this in your Individual Assignment)
– Understand the application of control within the Qantas group
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Page 3
Lecture references
– Text: Arthur et al Chapter 1
– Handbook: AASB 3 and AASB 10
– Readings pack:
• Egan and Xu (2020)
• PWC (2018)
• Qantas 2020 Annual Report
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Page 4
Before we begin - true and fair – an overarching requirement
we will question again and again this semester
– A key focus in this unit - development of your critical perspectives. Why is that
necessary?.... Because theory and practice do not always seem to align
– Corporations Law – financial reports must both comply with accounting
standards, and present a true and fair view
– Egan and Xu (2020) ask – does compliance with AASB also result in a true
and fair view?
– And do directors and auditors willing engage with,
and respond to this question?
– A question we’ll come back to again and again
this semester; what is ‘true and fair’, and do the
examples of financial reporting we see suggest
directors are sufficiently addressing this requirement?
– Or do they seem more concerned about reporting that ‘looks good’?
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Page 5
Let’s take stock first of where we are at…
–
Wasn’t Fin A (ACCT 2011) enough? Why are we still here?
–
Developing knowledge of accounting/financial reporting
– Level 1
• Double entry, accounting records, accruals and end of
period adjustments, financial statements, some accounting
rules (eg inventory, PPE)
– Level 2
• Regulatory and financial reporting framework, reporting
requirements for most R, E, A and L line items
– Level 3
• From single reporting entity to group financial reporting
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Rules focused
Professional
judgement
Page 6
Group accounting
You’ve looked at many example financial statements in ACCT1006 and ACCT2011.
… but did you ever question what that word ‘consolidated’ meant?
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Page 7
Types of interests in other entities
Possible Types of Investments
Controlled Entity
AASB3/AASB 10
Parent /
Subsidiary
Jointly Controlled
AASB 128/AASB 11
Joint
Operation
Joint
Venture
Full Consolidation
Proportional Consolidation
Weeks 1 to 6
Week 9
Control
Significant Influenced
AASB 128
Associate
Equity Method
(Single-Line Method or
One-Line Consolidation)
Week 7
Trading Investments
AASB 9
Held for
Trading
Fair Value
Week 10
No control
We can see “shades of influence” by investor over their investments in other entities on the above continuum
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Page 8
Possible Types of Investments
Control
Controlled Entity
AASB3/AASB 10
Parent / Subsidiary
Line-by-Line Full Consolidation Method
Week 1
Week 2
Week 3
Week 4
Do we have control?
Aggregate and eliminate the investment
Fair value adjustment
Eliminate intragroup transactions –
borrowing and inventory
Week 5 Eliminate intragroup transactions –
noncurrent assets
Week 6 Accounting requirements where we have
control, but not 100% ownership – NCI
Week 8 Provide complementary (i) segment and
(ii) related party disclosures to the
consolidated financial statements
Week 9 Accounting solutions where our
subsidiary is located overseas –
foreign currency translation
Week
11
Critical
reflection on group accounting
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Week 12 Accounting standard setting process
Jointly Controlled
AASB 128/AASB 11
Joint Operation
Week 9 Accounting
solutions for joint
operations
Trading Investments
AASB 9
Significant Influenced
AASB 128
Joint Venture
Line-by-Line
Proportional
Consolidation Method
No control
Associate
Equity Method (OneLine Consolidation)
Week 7 Accounting
solutions for
associates and
joint ventures
Week 11 Critical reflection
on group
accounting
Held for Trading
Fair Value
Week 10 Accounting
for
financial
instruments
and hedge
accounting
The need for critical reflection?
Week 11&12 Developing our own perspectives will help us understand
the
Page 9
merits and shortcomings of these group accounting processes
The Group
– Businesses often operate via group structures, where parent entity
controls one or more ‘subsidiaries’
– [Note here that a ‘subsidiary’ is a separate legal entity ‘controlled’
by a ‘parent’– you might recall that you had a different
understanding of the concept of ‘subsidiary’ in ACCT1006]
– Entrepreneurs do business through group structure for a number of
reasons:
-
legal (limited liability)
achieve diversification
vertical integration (acquiring entities in the supply chain)
to isolate different enterprises/ regional branches/ debt/ assets within one company.
Thereby ease of takeover etc
for tax/stamp duty reasons
International operations
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Page 10
Consider this imaginary group structure
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Page 11
AASB 10
Appendix A
Some definitions
Group – a parent and its subsidiaries
Parent – an entity that controls one or more entities
Subsidiary
– an entity that is controlled by another entity
Referring to the group structure on slide 11, those entities ‘controlled’ by A Ltd must be
‘consolidated’ together into the ‘A Ltd Group’. But which entities does A Ltd control?
We need to know the definition of ‘control’ (we’ll get to it on slide 16). Appreciate for now that while
share ownership is relevant, fundamentally the definition is qualitative and subjective, requiring an
examination of all of the facts of the relationship - professional judgement
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Page 12
Simple illustration of what ‘consolidation’ means
A Ltd
(Separate FS)
B Ltd
(Separate FS)
Adjustments
Group
(Consolidated FS)
Inventory
a
+
b
=
a+b
Sales
x
+
y
=
x+y
-
To consolidate means to group the financial performance and position of a number of entities on a line by
line basis into one aggregate position as a single economic entity
- Consider again the Qantas consolidated numbers on slide 7
- CFS include:
- statement of comprehensive income,
- statement of financial position,
- statement of changes in equity,
- statement of cash flows, and
- Notes to the financial statements (see AASB101)
All of which are presented for the ‘group’ only. There is very little information provided within group financial
statements about any individual ‘legal entities’ within the group
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The logic of consolidation
– The assumption of control is that all subsidiaries are acting on the direction of
the parent. There are therefore arguably all a part of just one single
‘economic entity’. So why not look ‘past the veil’ of incorporation, and present
the performance and position of just that one larger ‘economic entity’?
Furthermore:
– Accountability - if we have ‘control’ of a legal entity, then logically the
performance and position of that entity is fully our responsibility.
– Supply of relevant information – while investors of the parent entity only
have a legal interest in the parent, they have an economic interest in the
group as a whole
– Comparable information - investors can make useful comparisons between
economically cohesive entities that just happen to organise into potentially
hundreds of distinct legal entities for other reasons (slide 10). Provision of
hundreds of separate financial statements would be unhelpful to investors.
– Consistency - allows for consistent policies on asset measurement, revenue
recognition etc
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Page 14
History of consolidation (Arthur section 1.5.1)
–
–
–
–
–
–
1925: ASX required consolidation
1950s: Consolidated statements commonplace despite lack of legal requirement. Partly due
to cross-guarantees. What other motivation could there be to consolidate?
1961: Uniform Australian Companies Act contained consolidation requirement, but several
loopholes enabled non-consolidation. Definition of control focused only on corporate entities
and was understood to only apply with greater than 50% share interest. Groups interposed
trusts and reduced ownership below 50% where they didn’t want to consolidate. And so we
start to see that entrepreneurs are self-interested, and may be motivated to not consolidate.
1990: First consolidation accounting standard AASB 1024 requiring all controlled ‘entities’
to be consolidated. Control now based on ‘economic substance’ over ‘legal form’
2004: AASB 3 and AASB 127 issued – strengthening of ‘substance over form’ tests
2011: AASB 10 issued (effective periods starting 1 January 2013). Key test of control now
‘current ability to direct’
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The definition of control
Control exists when the investor is exposed, or has rights, to
variable returns from its involvement with the investee and has
the ability to affect those returns through its power over the
investee (AASB 10.6).
That is, an investor controls an investee if and only if the
investor has all the following (AASB 10.7):
a) Power over the investee; and
b) Exposure, or rights, to variable returns from its involvement
with the investee; and
c) The ability to use its power over the investee to affect the
amount of the investor’s returns.
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Page 16
The definition of control
Note what is not in the definition – no direct reference to % of
6. Control - AASB 10
share ownership. Why not?
Implications/thoughts:
– Control is defined in terms of “substance” rather than
“form”;
– Control can be passive; (contrast to active control)
– De facto control (less than 50% ownership)
– Can we have control with zero shares?
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Page 17
Control: Test a) - The power element
Power is defined as follows:
AASB 10.10
An investor has power over an investee when the
investor has existing rights that give it the current ability
to direct the relevant activities, ie the activities that
significantly affect the investee’s returns.
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Page 18
Control: Test a) - Rights and substantive rights
AASB 10.B22
Rights must be ‘substantive’.
– That is, the investor must have the practical ability to exercise those rights.
– If there are barriers that prevent the rights holder(s) from exercising the rights, rights
may not be substantive.
– Examples of barriers include financial penalties, or legal/regulatory requirements that
may prevent rights from being exercised.
– Rights that are protective are not relevant in determining control – eg the right of a
lender to seize assets if the borrower fails to meet loan repayment conditions.
See Practical Control Examples 3 and 3A within AASB10
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Page 19
Control: Test a) - Substantive versus protective rights
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Source: Clearly IFRS, IFRS 10-Consolidated Financial Statements, Deloitte, p.16
Page 20
Control: Test a) - Substantive versus protective rights
Relevant activities
Reason to
justify
conclusion
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From AASB10 Appendix B
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Control: Test a) - Rights and substantive rights
AASB10.B15 - Examples of rights that may give an investor power:
a) Voting rights;
b) Rights to appoint, resign or remove key management personnel;
c) Rights to appoint, resign or remove directors;
d) Rights to direct the investee to enter into transactions for the benefit of the
investor; or
e) Other rights.
See PWC (2018) “Consolidation – are you one big happy family?”
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Control: Test a) - The power element
What does ‘current ability’ to direct mean?
– The term ‘current ability’ refers to the fact that the investor is able to approve
or block decisions as the reporting date under consideration.
– Holding ordinary voting shares probably gives rise to a ‘current ability’,
whereas holding options which can be converted into ordinary shares in six
months time does not reflect ‘current ability’.
– Likewise, holding rights to direct the investee as at reporting date probably
gives rise to ‘current ability’.
What are ‘relevant activities’?
AASB 10.B11
Relevant activities include sales, purchases, managing
assets, research and development.
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Control: Test a) - The power element
What is the importance of voting rights?
AASB10.B35
An investor that holds more than half of the voting rights
of an investee has power in the following situations,
unless B36 or B37 applies:
(a) the relevant activities are directed by a vote of the holder
of the majority of the voting rights, or
(b) a majority of the members of the governing body that
directs the relevant activities are appointed by a vote of
the holder of the majority of the voting rights.
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Page 24
Control: Test a) - The power element
The importance of voting rights
AASB10.B36
Rights must be substantive and must provide the investor
with the current ability to direct the relevant activities
AASB10.B37
But, no power if that majority of voting rights are not
substantive
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Page 25
Control: Test a) - The power element
The importance of voting rights
AASB10.B38 An investor can have power with less than
a majority of the voting rights of an investee, for
example, through:
(a) a contractual arrangement between the investor and
other vote holders (see B39);
(b) rights arising from other contractual arrangements
(see B40);
(c) the investor’s voting rights (see B41-45);
(d) potential voting rights(see B47-50); or
(e) a combination of (a)—(d).
De facto
control
See PWC (2018) “Consolidation – are you one big happy family?”
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Page 26
Control: Test a) - The power element
The importance of voting rights
– In applying AASB 10.B38 some factors to consider include:
– Practical ability to direct the relevant activities (B41) – Example 5
– Size of the voting interest (B42) – Example 4
– Dispersion of other shareholders (B43) – Example 8
– Attendance at annual general meetings (B45) – Example 8
– Level of disorganisation or apathy of the remaining shareholders
Practical Control Examples 4, 5 and 8 from Appendix B of AASB10 follow on
following 3 slides
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Page 27
Control: Test a) - The power element - B41
Reason to
justify
conclusion
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Page 28
Control: Test a) - The power element – B42
Reason to
justify
conclusion
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Page 29
Control: Test a) - The power element – B43 and B45
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Reason to
justify
Page 30
conclusion
Control: Test a) - The power element
–
Potential voting rights
B47-50 if an investor holds an option to acquire shares from another
shareholder, and if that exercise price is reasonable, then those rights may
be assessed to be substantive (practical to exercise) and so may contribute
to our assessment that the investor has ‘power’
Market value of
ordinary share
@ $2.00/share
(In the Money)
Exercise price
of option
@ $1.00/share
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See Practical Control
Example 10
and
Market value of
ordinary share
@ $0.50/share
(Out of the Money)
Yr 1
Yr 2
PWC (2018)
“Consolidation – are you
one big happy family?”
Year
Page 31
Control: Test a) - The power element. B18 – Helpful guidance
on the investor’s influence on the Board of Directors
AASB10.B18 – Where it is difficult to determine whether rights are sufficient to give rise to
power the following may provide evidence that the rights are sufficient to give rise to
control:
a) The investor can, without having the contractual right to do so, appoint or approve the
investee’s key management personnel who have the ability to direct the relevant activities.
b) The investor can, without having the contractual right to do so, direct the investee to enter
into, or can veto any changes to, significant transactions for the benefit of the investor.
c) The investor can dominate either the nominations process for electing members of the
investee’s governing body or the obtaining of proxies from other holders of voting rights.
d) The investee’s key management personnel are related parties of the investor (for example,
the chief executive officer of the investee and the chief executive officer of the investor are
the same person).
e) The majority of the members of the investee’s governing body are related parties of the
investor.
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Page 32
Control: Tests b) and c) - Exposure or rights to variable returns
and ability to affect those returns
– Test 2 - The key words are ‘rights’ and ‘returns’. Returns can
be broadly interpreted and do not refer simply to dividends
and capital gains. Returns can take the form of synergistic
benefits. Nonetheless, we can see here that AASB10
effectively discriminates against non-equity holders
– Test 3 – consider a situation where investor controls more
than 50% of the seats on the board - we may need to
examine directors contracts to see if those positions have
authority over dividend policy
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Page 33
Control - reflection
– We know from the history of consolidation accounting that using ownership as the
basis for consolidation (a bright-line rule) permits abuse of the rule
– For example prior to AASB1024, it was easy for investors to divest of equity in
loss-making subsidiaries just prior to balance date so that the loss-makers were
not consolidated but the profit-makers were
– The AASB10 definition of control focuses on the substance of the relationship
between the investor-investee and so in this sense, this revised definition aims to
better meet the needs of users
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Page 34
Example of control questions – useful for your assignment





Arrow Ltd acquired 40% of the ordinary shares of Big Ltd on 1
March 20X5
The remaining 60% of ordinary shares are held by several
individually small shareholders each holding 2% each
On the basis of recent experience, an average of only 65% of
40 / 65 = 61.5%
voters attend AGMs
Arrow Ltd controls 2 of the 5 seats on the Board of Directors
of Big Ltd
The contracts of those 2 directors states that they may
participate in all decisions, including with respect to the
dividends of Big Ltd
Using AASB 10, develop an assessment of whether Arrow Ltd
controls Big Ltd.
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Page 35
How to answer a question on control
To answer
question
on control
welljudgement.
you must:
In thisaissue
we are exercising
our professional
There may be no simple right or wrong
•
•
•
•
•
answer and so it is critical to examine all of the facts. In examining the tute questions set for
this week:
Comment
on ALL of the facts that you have been given and consider how

note
of therelate
facts thatto
youthe
are definition
given. How many
there? and relevant provisions
they do (or doallnot)
of are
control,

Address each one in your response even if you think its not important – if you think its
of AASB10,
not important not you need to say why and not just ignore it. In any mid semester exa
Be preciseon and
accurate
inbeyour
usage
of key every
paragraphs
(eg para 7, para
this topic,
marks would
allocated
for addressing
fact
10, para
B15,
para
B35
and
para
B38)

Work systematically through the definition of control and/or para 13 and/or other
Write in a relevant
professional
style (not
bulletrequires
points)
provisions ofnarrative
AASB127. Sometimes
the question
a skew towards the
definition of control
andexplain
sometimes para
13 is morethat
relevant;
it depends on the
facts
Note the subjectivity
and
therefore
professional
judgement
is
you’ve
been
given.
required.
 –
It isthe
oftenbroad
important
to also talk about
important facts
that you would
like to knowforces
but
Consider
qualitative
definition
of control
effectively
you
have not been told. Think about it! And remember we are talking about professional
to explorejudgement
every fact.
However, we can only ever given you limited facts
and so we must make an effort to review all important details.
about the
relationship.
So it is important to also comment on other

You must write a structured narrative in a professional business tone. Bullet points are
important not
facts
that you
don’t
know now.
but Inwhich
will help
you
form a better
acceptable!
You are
professionals
that structured
narrative,
an to
appropriate
conclusion.
introduction and conclusion should be provided.
“please also provide information on … because ... ”
–
• Because
you have limited facts, good responses will not make categorical
conclusions.
“based on the limited information provided, we have
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some/limited/strong/little/weak evidence of control … ”
Page 36
How to answer a question on control
In this issue we are exercising our professional judgement. There may be no simple right or wrong
The structure
of your
is very
answer
and so narrative
it is critical to examine
all ofimportant!
the facts. In examining the tute questions set for
this week:

note
all of the facts that you are given. How many are there?
An introduction
is important
Address each one in your response even if you think its not important – if you think its
‘WHAT are we
not doing
important here?’
not you need to say why and not just ignore it. In any mid semester exa
on this topic, marks
would be control
allocated forAASB
addressing
every fact
‘WHY is it important?’
– define
10:6

Work systematically through the definition of control and/or para 13 and/or other
‘HOW are werelevant
goingprovisions
to doofit?’
– AASB
10:7
on the
three
elements
AASB127.
Sometimes
the question
requires
a skew
towards the of control
of control–
and
sometimes
13 isgoing
more relevant;
it depends on the facts
‘WHERE are definition
we going?’
what
arepara
you
to conclude
you’ve been given.
Body – perhaps
accordance
with
3 would
keylike
tests:

Itstructure
is often importantin
to also
talk about important
factsthe
that you
to know but
have not been told. Think about it! And remember we are talking about professional
Part 1: Power
– “current
relevant
activities”
(AASB 10:10)
judgement
and so weability
must maketo
an direct
effort to review
all important
details.

You must
write a structured narrative in a professional business tone. Bullet points are
Part 2: Variable
returns
not acceptable! You are professionals now. In that structured narrative, an appropriate
Part 3: Link –
abilityand
toconclusion
use power
affect returns
introduction
should beto
provided.
Additional
information required and why
–
Conclusion
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Page 37
Suggested guide to explain whether Arrow controls Big Ltd
using AASB 10
– Introduction
– Step by step – address AASB 10: usually start with para 6, 7. 3 criteria
Criteria 1
– AASB 10.7(a) - To establish if power exists you will generally need to draw on para
Power
10, and often others including B15, B35 and B38.
– (6) (7), does Arrow have the ‘current ability to direct’? (10)
– less than half of the voting rights (failing B35 - therefore need to look at B38)
– Any contractual arrangement between Arrow and the rest of the investors? (does
not meet B38(a)) (‘further information required’ ??)
– At the next general meeting it would seem that Arrow Ltd could dominate the
voting given the history of previous years and the fact that no other blocks of
votes are tightly held (B38(c-d)). However, this is speculation and so contributes
only weakly to our argument
– 2 out of 5 seats on the BoD gives Arrow ‘rights to direct’ but does that equate to
an ‘ability to direct’? What critical missing data do I need to know here
regarding the balance of power in the BoD?
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Page 38
Criteria 2
Return
–
Criteria 3–
Link
–
–
Suggested guide to explain whether Arrow controls Big Ltd
using AASB 10
AASB 10.7(b) generally assumed as Arrow is a shareholder
AASB 10.7(c) Arrow has the ability to affect the dividend policy but back to part
a), does it also have ‘power’?
Other important information we don’t have but which we could argue that we
would like to see – full details of directors agreements, minutes of board
meetings, any contracts between investors.
Overall conclusion? This is a tricky one! Maybe there is no parent. Good answers
might lean towards both control and not control. Remember, we generally can’t be
unqualified or absolute: “a reasonable conclusion on the basis of the limited data
…”; “the better judgement...”; “strong evidence for….”; “some suggestion that….
but we need more information on ….”; “it is highly likely/unlikely.....” We should
reiterate the key factor influencing our conclusion; “the key fact driving that
conclusion is….”
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Page 39
Looking back at the former accounting standard - AASB 127
–
–
–
AASB 127 para. 4 defined control as: “the power to govern the financial and operating
policies of an entity so as to obtain benefits from its activities”
AASB 127 provided two helpful tests in the former para 13:
1. Control is presumed to exist when the parent 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 ownership does not constitute control.
(this is a rebuttable presumption)
2. Control also exists if parent entity owns half or less of the voting power but has:
– a) Power over >50% of voting rights by virtue of an agreement;
– b) Power to govern the financial and operating policies by virtue of an
agreement;
– c) Power to appoint or remove the majority of the members of the board or
– d) Power to cast the majority of votes at meetings of the board of directors.
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Main differences between AASB 10 &AASB 127
– Under AASB10, an investor can achieve power over an investee in many ways, not just
through governing financial and operating policies as specified in AASB 127.
– Under AASB10, less weight is placed on ownership interests
– AASB 10 explicitly addresses agency relationships – providing guidance on when a
principal/agent relationship exists. That is, the principal (rather than the agent) controls
an entity over which the principal has delegated decision-making authority to the
agent.
– Places greater emphasis on linking power over an investee with the ability to generate
benefits.
– Why do you think standard setters changed the standards?
1. Control is exerted over a subsidiary in many different ways.
2. Using a concept of control, it can be applicable to more scenarios
 more subsidiaries?
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Page 41
AASB 12 – Disclosure requirements
Para 7 – disclose information about the judgments made in determining control
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Next week…
– First tutorial – focuses on writing a response to a control question. Go to
the tutorial, and then you can finalise your individual assignment (use
discussion board for any related questions). And remember, you have a
week’s extension – not due til 4pm on September 3rd.
– Topic 2: Principles of consolidation and the consolidation process
including:
- Aggregation (you already have some appreciate from today on how this
works)
- Elimination of the investment and accounting for goodwill
- Elimination of intra-group dividends
- The consolidation worksheet
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