Group Financial Reporting ACF 202 PART 1 Cynthia Fortin, CPA, CMA Spring 2018

Global companies form groups

Group accounting There is a need to see the overall results of a group not only that of its individual companies.

Group accounts framework IAS 27 Separate financial statements https://www.iasplus.com/en/standards/ias/ias27 IAS 28 Investments in associates https://www.iasplus.com/en/standards/ias/ias28 IFRS 3 Business combinations https://www.iasplus.com/en/standards/ifrs/ifrs3 IFRS 10 Consolidated financial statements https://www.iasplus.com/en/standards/ifrs/ifrs10 IFRS 11 Joint arrangements https://www.iasplus.com/en/standards/ifrs/ifrs11 IFRS 12 Disclosure of interest in other entities https://www.iasplus.com/en/standards/ifrs/ifrs12 IFRS 36 Impairment of assets https://www.iasplus.com/en/standards/ias/ias36 Group accounts framework

How is a parent-subsidiary relationship identified? Controls Subsidiary IAS 27 defines consolidated financial statements as ‘the financial statements of a group presented as those of a single economic entity.’ A group is made up of a parent and its subsidiary. We will focus on enterprises, e.g. companies Forms a group

What is meant by control? IFRS 10 Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Control = Power over Group structure W1 to cast the majority of the votes at meetings of the board of directors. more than 50% of the voting rights by virtue of agreement with other investors to govern the financial and operating policies to appoint or remove the majority of the members of the board of directors holds <50% of the voting rights, but the remainder are widely distributed Group structure W1

When is a parent not required to prepare CFS? If the parent itself is a wholly owned subsidiary and its parent produces CFS that comply with IFRS if the non current assets are immaterial. Only if (IFRS 5) the non-current assets are held for sale or discontinued operations If its other owners have been informed and do not object. Group structure W1

Illustration Green Co owns the following investments in other companies: Equity shares Non-equity shares held Violet Co 80% Nil Amber Co 25% 80% Black Co 45% 25% Green Co also has appointed five of the seven directors of Black Co. Which of the following investments are accounted for as subsidiaries in the consolidated accounts of Green Co Group? A Violet only B  Amber only C  Violet and Black D  All of them Answer Let’s consider each of the investments in turn to determine if control exists and, therefore, if they should be accounted for as a subsidiary. Violet Co – by looking at the equity shares, Green Co has more than 50% of the voting shares – ie an 80% equity holding. This gives them control and, therefore, Violet Co is a subsidiary. Amber Co – you must remember to look at the equity shares, as despite having the majority of the non-equity shares, these do not give voting power. As Green Co only has 25% of the equity shares, they do not have control and, therefore, Amber Co is not a subsidiary. Black Co – by looking at the percentage of equity shares, you may incorrectly conclude that Black Co is not a subsidiary, as Green Co has less than half of the voting rights. However, by looking at the fact that Green Co has appointed five of the seven directors, effectively they have control over the decision making in the company. This control should make you conclude that Black Co is a subsidiary. Therefore the correct answer is C.

Group accounts Parent’s Financials Subsidiary’s Financials Statement of Financial Position Statement of Comprehensive Income Statement of Cash Flows Subsidiary’s Financials Parent Group’s Financials

Reasons for group accounts Prevent preparing misleading accounts (true and fair reporting) ensure comparability of FS and remove temptation to structure combinations to produce desired accounting results Provide a more meaningful EPS ratio Only the purchase method is allowed (IFRS 3)

Example of a Consolidated Financial Position Statement babcock annual report.pdf Go to page 131

Five key workings (W) When considering the situation of a Parent and its Subsidiary we must determine: W1 The Group structure W2 Net assets of subsidiary at date of acquisition W3 Goodwill W4 Non-controlling interest W5 Group retained earnings Then prepare the group statement of financial position.

W1 The Group structure Parent Controls > 50% of voting shares Subsidiary At date of acquisiton ( doa) GROUP

W1 Group structure Date of acquisition P obtains control of S P starts directing operating and financial policies. P’s majority on BOD Written agreement P pays for shares and controls assets and assumes responsibility for liabilities P for Parent S for Subsidiary BOD board of directors W1 Group structure

W2 Net assets of Subsidiary at doa

W2 Net assets of Subsidiary at yearend

W2 subsidiary’s post acquisition Profits From doa to yearend At year end At doa

Subsidiary’s post acquisition profits S’s profits after date of acquisition When there is NCI, P and NCI split them according to the % of their shareholdings. P’s share is added in W5 NCI’s share is added in W4 Subsidiary’s post acquisition profits

W3 Goodwill When P controls 100% of voting shares, fair value of the P’s investment is compared to fair value of S’s net assets at the date of acquisition (doa) If P’s investment > S’s net assets, then the difference is purchase of Goodwill.

W3 Goodwill at date of acquisition Parent’s investment W2 Subsidiary’s net assets GOODWILL W3 Goodwill at date of acquisition

Positive goodwill Goodwill Recognized as an intangible asset Must be subject to annual impairment tests (IAS 36) Reflects reputation of the business: Prospects of making future profits Strong loyal customer base Skilled workforce When recognized impairment loss cannot be reversed Goodwill

Negative goodwill Goodwill Treat as a profit immediately and include in group retained earnings Reflects poor future prospects Bargain purchase Reassess amounts Identify errors if any If not Goodwill

W4 Non-controlling interest (NCI) Subsidiary Voting shares Parent controls NCI is nil 100% Subsidiary Voting shares Parent controls NCI is 25% of Subsidiary’s net assets 25% of W2 75%

W5 Group retained earnings Parent’s retained earnings at year end Parent’s % of Subsidiary’s post acquisition retained earnings refer to W2

Group statement of financial position Prepare consolidation Combine P’s assets and liabilities to S’s even if not wholly owned by P Retained earnings include P’s share capital, retained earnings per W5 and the NCI per W4 P’s investment in S is cancelled Goodwill per W3 is included as Intangible asset Group statement of financial position

Examples Rose and Tulip Bird and Flower Ghana Zambia Jamaica Trinidad Cyprus Croatia

A group of companies includes at a minimum, a parent (P) and its subsidiary (S). S is an entity that is controlled by P. P owns a majority of the ordinary shares in S. Groups accounts are prepared as if the group was a single entity and this reflects substance over form. Cross cast (combine) assets and liabilities of P and S. P’s investment in S is not a group asset, it is cancelled out when goodwill arises on consolidation. What I need to know

Positive goodwill is a premium and is recorded as an intangible asset and subject to an annual impairment review Negative goodwill is a bargain and recorded for as a group profit. The share capital of the group is that of the P only, ever and always. Group retained earnings are P’s plus P’s % of S’s post- acquisition profits. NCI at reporting date will be NCI at dao plus NCI % of S’s post-acquisition profits. What I need to know

References ACCA_F7_S16_Notes Chapter 6 Group Accounts and Introduction http://opentuition.com/acca/f7/ Clendon, Tom (2012), “A Student's Guide to Group Accounts, 2nd Ed.” Kaplan ISBN: 978-0-85732-764-2 chapters 1, 2, 3. Elliott, Barrie and Elliott, Jamie (2011) FINANCIAL ACCOUNTING AND REPORTING, 14 th Edition, pp 553 IFRSBOX https://www.youtube.com/watch?v=i5CCpERyNH8