Chapter 2 : Subsidiaries and consolidated statements
Introduction
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Companies can expand by internal growth or by purchasing shares in another
company
Significant share investments are classified by the level of control the investor has
types of significant share investments include:
Subsidiary (Wholly-owned, Partially owned)
Joint venture
Associates
Definitions (IFRS 10)
Control = when an investor has power over the investee, has exposure to, or rights to
variable returns, and can use its power to affect the amount of the investor’s returns
Holding company = a company that controls one or more other entities
Subsidiary = an entity controlled by another entity (holding company).
Wholly-owned subsidiary = a subsidiary that does not have any other shareholders other
than the holding company
Group = a holding company and all its subsidiaries
Consolidated financial statements = the financial statements of a group where the assets,
liabilities, equity, income, and expenses of the holding company and subsidiaries are
presented as if it is a single entity
Why the need for consolidated financial statements?
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Companies acquire assets directly or by purchasing an entity that owns the assets
Consolidated financial statements reflect the control the investor has over the
investee and its assets, which is not evident in separate financial statements6.
They are necessary for fair presentation and are required by The Companies Act No
71 of 2008.
These statements include a consolidated statement of financial position, statement
of comprehensive income, and statement of changes in equity (discussed in this
chapter)
Accounting treatment of significant investments
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The treatment depends on the degree of control
When one company controls another (holder and subsidiary), the accounting
treatment applied is consolidation
When does control exist? (IFRS 10)
Control is presumed when the investor has:
 Power over the investee
 Exposure, or rights, to variable returns
 The ability to use its power to affect the amount of returns
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Consolidated statements are prepared as if they are one company
Separate financial statements of the holding company are also presented.
Control is not solely determined by shareholding percentage; however, for FA288,
over 50% shareholding implies control
The definition of a subsidiary includes entities that are subsidiaries of subsidiaries or
jointly controlled by subsidiaries of the holding company
The relationship is based on control, not just direct shareholding
All subsidiaries must be included in consolidated financial statements
Consolidation procedures
1. Separate financial statements of the holding company and subsidiaries
are combined by adding line items
2. Financial statements used should preferably have the same reporting date, or differ
by no more than three months with adjustments for material transactions
3. Uniform accounting policies must be used
4. Consolidation is repeated from the start every year.
5. The holding company and subsidiary record their own financial information
separately
6. Share acquisition price can be equal to, higher than (premium), or lower than
(discount) the fair value of the subsidiary's net assets
Three steps in consolidation:
1. Elimination of intercompany balances
2. Elimination of intercompany transactions
3. Combination of remaining items
Wholly-owned subsidiaries: Consolidation on date of acquisition
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Basic consolidation involves eliminating the investment in subsidiary against the
subsidiary's equity (share capital and retained earnings)
Remaining items are added line by line
Consolidation journals are used and are not permanent
Goodwill:
= Arises when shares are acquired at a premium (price > fair value of net assets)
Goodwill = an asset representing future economic benefits from a business combination
that cannot be individually identified or recognised separately
- The surplus is allocated to undervalued assets first, with the remainder as goodwill
- Goodwill is recognised at cost (purchase price less fair value of net assets) less
impairment losses
- Goodwill is not amortised but tested for impairment annually
- The difference between cost price and fair value of net assets is identified
- Goodwill is recognised in the consolidated statement of financial position
Wholly-owned subsidiaries: Consolidation after date of acquisition
Statements of comprehensive income and changes in equity must also be consolidated.
 Profit before acquisition is "purchased profit" and is part of eliminated equity
 Profit after acquisition is distributable profit of the group and shown in the
consolidated statement of comprehensive income
These statements include items from both the holding company and subsidiary applicable to
the period after acquisition .
Wholly-owned subsidiaries: Intercompany transactions
Various types can occur, such as debtors/creditors, loans, interest, dividends, inventory
sales, and PPE sales
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Debtors / Creditors / Loan accounts / Debentures
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Intercompany assets and liabilities must be eliminated on consolidation
The same company cannot owe itself
Corresponding intercompany interest must also be eliminated
Dividends paid or received:
 Intercompany dividends must be eliminated
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Intercompany inventory sales:
A: No closing inventory with purchaser: Revenue and cost of sales are overstated but group
profit is correct; elimination of intercompany sales is needed
B: The purchaser has closing inventory: Unrealized profit in seller's books and overstated
inventory value in purchaser's books; unrealized profit must be eliminated, and inventory
cost adjusted
Tax effect is also considered
C: The purchaser has opening inventory that was purchased internally: Adjustment needed
at the start of the current year's consolidation to correct retained earnings
Intercompany sales of property, plant and equipment
- Unrealized profit on the sale must be eliminated
- The asset's cost and accumulated depreciation in the consolidated statements need
adjustment to reflect the original cost to the group
- "Excessive" depreciation based on the inflated cost must be eliminated
- The unrealized profit realizes over the asset's remaining life through reduced
depreciation
Subsidiaries: Consolidation on date of acquisition
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When the holding company controls but owns less than 100%, it's a subsidiary
with non-controlling interest (NCI) (previously called minority shareholders)
NCI's interest in the subsidiary's net assets and profit/losses is presented separately
NCI includes a share in at-acquisition equity and after-acquisition profit/loss50.
Analysis of shareholder's equity is used to calculate NCI
Goodwill often relates only to the holding company's interest (acquisition method)
Consolidation journal entry eliminates the parent's share of subsidiary equity,
recognises goodwill and NCI
Consolidated statement of financial position includes NCI as part of equity
Consolidated statement of changes in equity shows the movement in NCI
Subsidiaries: Consolidation after date of acquisition
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NCI's initial interest in equity at acquisition and share of profit since acquisition are
considered
Interest in current year's profit is in the consolidated statement of comprehensive
income
Total interest in net assets is in the consolidated statement of financial position
Movement in NCI is in the consolidated statement of changes in equity
Consolidation journals eliminate intercompany balances and recognise NCI's share of
equity and profit
Consolidated financial statements are prepared, showing profit attributable to both
owners of the holding company and NCI
2.14 Subsidiaries: Intercompany transactions
Elimination ensures correct asset and liability balances and does not affect NCI's share of
net assets or profit
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Debtors/ Creditors/ Loan accounts/ Debentures: Eliminated the same way as for
wholly-owned subsidiaries
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Dividends paid or received: Only the holding company's portion is eliminated against
dividend income; NCI's share reduces their equity
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Intercompany inventory sales: Eliminated similarly to wholly-owned subsidiaries,
but unrealized profit affects the subsidiary's profit and thus the NCI's share
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Intercompany sales of property, plant and equipment: Unrealized profit and
excessive depreciation are eliminated, affecting the subsidiary's profit and the NCI's
share
Conclusion:
The consolidation process involves:
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Eliminating the subsidiary’s pre-acquisition shareholders’ interest against the
investment
Recognising the NCI's portion of profit/loss and net assets in the consolidated
statements of comprehensive income, financial position, and changes in equity
Recognising goodwil
Eliminating all intercompany transactions
Adding similar line items
Journal entries :
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Holding company purchases 100% of subsidiary’s shares
DR Investment in subsidiary
CR Bank
Elimination of intercompany balances:
Elimination of intercompany transactions :
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Eliminating intercompany dividends :
Dividends received by holding company paid by subsidiary :
DR Dividend income
CR Dividend declared
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Eliminating intercompany debtors and creditors :
DR Creditors / Loan account ( liability / Debentures ( liability )
CR Debtors (liability) / Loan account (assets) /Investment in Debentures (asset)
If above is interest bearing : Eliminating intercompany interest :
DR Interest income
CR Interest expense
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Eliminating intercompany inventory sales :
1. No closing inventory with purchaser :
DR Revenue ( subsidiary)
CR Cost of sales ( holding company)
2.
Holding company has closing inventory :
DR Revenue ( subsidiary )
CR cost of sales ( holding company )
Correcting sales and cost of sales
DR Cost of sales ( subsidiary )
CR Inventory ( holding company )
Correcting profit and closing inventory
Tax impact :
DR Deferred tax (SFP)
CR Income tax expense (SCI)
(unrealised profit x 27%)
IF UNREALISED PROFIT IS ELIMINATED , PROFIT OF GROUP DECREASES. IF PROFIT DECREASES ,
TAX SHOULD ALSO DECREASE
3. Purchaser has opening inventory that was purchased internally during previous year
DR Retained earnings
DR Income tax expense
CR Cost of sales
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Eliminating intercompany sales of property, plant and equipment :
YEAR 1 :
Profit made from sale ( subsidiary sells to holding company) :
DR Profit with sale of asset
CR Equipment / vehicles
Tax associated with sale :
DR Deferred tax (SFP)
CR Income tax expense (profit x 27%)
Excessive depreciation :
DR Accumulated depreciation
CR Depreciation
Decreasing income tax expense due to carrying amount of asset being reduced :
DR Income tax expense
CR Deferred tax (SFP)
( amount = difference between tax base – carrying amount)
YEAR 2 :
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Must make adjustments again when Year 2’s line items are added so that opening balances
of year 2 matches closing balances of year 1
Opening balances of profit and tax :
DR Retained earnings (SCE)
DR Deferred tax (SFP)
CR Equipment
Opening balances of tax :
DR Accumluated depreciation
CR Retained earnings (SCE)
CR Deferred tax (SFP)
YEAR 2 closing balances :
Eliminate excessive depreciation:
DR Accumulated deprecation
CR Depreciation
Tax :
DR Income tax expense
CR Deferred tax (SFP)
Acquiring assets :
1. Company acquires assets themselves :
DR Fixed property
CR Bank
2. The company purchases the entity owning the assets :
DR Investment in (company purchased name)
CR Bank
Wholly-owned subsidiaries : consolidation ON date of acquisition
Eliminating intercompany balances :
DR ordinary share capital
DR retained earnings
DR goodwill
CR investment in (name of company purchased)
Eliminating equity of (name of company purchased) against the investment