Chapter 29 Further consolidation issues II: Accounting for non-controlling interests 1

Objectives of this lecture Understand the meaning and nature of non-controlling interests Understand why we calculate non-controlling interests Understand how to calculate non-controlling interests’ share in share capital and reserves, and current period profit Understand how to calculate goodwill (or bargain gain on purchase) in the presence of non-controlling interests Understand how non-controlling interests should be disclosed within consolidated financial statements 2

Non-controlling interest Economic entity Big Company 75% 25% Small Company Non-controlling interest

Non-controlling interests (cont.) Where a subsidiary is partly owned by a parent entity (i.e. less than 100% interest), both the parent entity and the non-controlling interests will have an ownership interest in the subsidiary’s profits, dividend payments, and share capital and reserves As part of the consolidation process, need to work out the amount to be attributed to non-controlling interests 20

Disclosure requirements Disclosure requirements: non-controlling interests AASB 10 requires separate disclosure of the non- controlling interest’s share of capital, retained profits or accumulated losses In relation to the non-controlling interest in profit or loss, AASB 10 states: An entity shall attribute the profit or loss and each component of other comprehensive income to the owners of the parent and to the non-controlling interests. The entity shall also attribute total comprehensive income to the owners of the parent and the non- controlling interests even if this results in the non-controlling interests having a deficit balance Refer to Exhibits 29.1, 2 and 3 on pages 964 and 965 for sample disclosures 21

Calculating non-controlling interests A key step in preparing consolidated financial statements is calculating non-controlling interests. In relation to the steps in preparing consolidated financial statements, AASB 10 states: (a) combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries; (b) offset (eliminate) the carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity of each subsidiary; (c) eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full). 20

Calculating non-controlling interests (cont.) Even in the presence of non-controlling interests we combine all the assets, liabilities, equity, income and expenses of the entities of the parent and the subsidiaries as part of the consolidation process. The only exception to this is where the assets, liabilities, equity, income or assets have been impacted by transactions within the group, in which case the effects need to be eliminated in full. When eliminating the investment in subsidiaries we only eliminate the parent entity’s interest in each subsidiary’s equity account. The remaining amounts in the subsidiaries’ equity accounts will relate to the non-controlling interests in the economic entity.

Calculating non-controlling interests (cont.) The dividends paid and payable by the subsidiary to the non-controlling interest will be included within the consolidated financial statements. The inclusion of non-controlling interests in the consolidated statement of financial position is consistent with the entity concept, according to which non-controlling interest is viewed as an owner within the group, in the same way as the shareholders of the parent entity. Where there are intragroup transactions, any related profit or loss should be eliminated in full as part of the consolidation process, not merely the percentage of the profit or loss equal to the parent entity’s interest in the subsidiary.

Calculating non-controlling interests (cont.) Non-controlling interest is calculated by taking three elements into account: 1. Non-controlling interests’ share in the net assets (equity) of subsidiaries at the dates the parent entity acquired the subsidiaries. This requires the non-controlling interests’ share of the pre-acquisition balances of contributed equity, retained earnings and reserves to be determined. 2. Non-controlling interests’ share in the changes in equity since acquisition date. This is achieved through calculating the non-controlling interests’ share of the post acquisition movements in retained earnings and reserves.

Calculating non-controlling interests (cont.) 3. Non-controlling interests’ share in the profit or loss of the subsidiaries in the current period. At the end of the reporting period the non-controlling interests’ share in profit for the year, distributions and transfers made, and movements in reserves for the year must be determined. As a result of recent amendments, AASB 3 provides preparers of financial statements with a choice in the measurement of the non-controlling interest

Calculating non-controlling interests (cont.) According to paragraph 19 of AASB 3, for each business combination the acquirer shall measure any non-controlling interest in the acquiree either: at fair value (including goodwill), or at the non-controlling interests’ proportionate share of the acquiree’s identifiable net assets (excluding goodwill) Specifically, paragraphs 18 and 19 of AASB 3 state: 18 The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values 19 For each business combination, the acquirer shall measure any non-controlling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets

Calculating non-controlling interests—the ‘choice’ The joint convergence work being undertaken by the IASB and the US Financial Accounting Standards Board (FASB) ultimately led to the choice between using the ‘full goodwill method’ and the ‘partial goodwill method’, being available within IFRS 3 (and, therefore, within AASB 3) The revised version of IFRS 3 was issued at the same time as the revised version of the US accounting standard, Statement of Financial Standards No. 141 Business Combinations Both Boards had issued exposure drafts on the revised standards, and within both of the exposure drafts only the ‘full goodwill method’ was supported FASB has retained only the ‘full goodwill method’, whereas the IASB introduced the option to use either the full goodwill method, or the partial goodwill method

Justifying the ‘choice’ in relation to calculating goodwill on consolidation In understanding the reasoning behind this change, we can refer to the Basis for Conclusions that was released with IFRS 3. the IASB was not able to agree on a single measurement basis for non-controlling interests because neither of the alternatives considered was supported by enough board members to enable a revised business combinations standard to be issued. The IASB decided to permit a choice of measurement basis for non-controlling interests because it concluded that the benefits of the other improvements to, and the convergence of, the accounting for business combinations developed in this project outweigh the disadvantages of allowing this particular option. Hence, the choice of two options within the IASB standard was the outcome of a political exercise to make sure the standard was approved, rather than on the basis that the approach was conceptually sound.

Elimination of pre-acquisition capital and reserves in the presence of non-controlling interests As with 100% owned subsidiaries, the carrying values of subsidiaries’ assets must be adjusted to fair value prior to the elimination of the parent entity’s investment This is necessary to prevent the amount of goodwill calculated on consolidation from being wrongly stated, as the equity (net assets) of the subsidiary would be undervalued (where the fair value of the net assets exceeds their carrying amount) The existence of non-controlling interests does not change the requirement for the assets and liabilities of a subsidiary to be measured at fair value as at acquisition date If the parent entity does not acquire all of the shares of the subsidiary it does not acquire an interest in all the share capital and reserves. There will be a non-controlling interest Refer to Worked Examples 29.1 and 29.2 (pp. 968 and 970)

Adjustments for intragroup transactions AASB 10 requires the elimination of the effects of all intragroup transactions before the consolidated financial statements are presented. The requirement to eliminate the effects of intragroup transactions holds whether or not there are non-controlling interests.

Intragroup payment of dividends In relation to dividends paid by a subsidiary, the consolidation worksheet journal entries will eliminate the proportion of the dividends that relates to the parent entity’s entitlement The non-controlling interest’s share of the dividends paid by the subsidiary will be shown in the consolidated financial statements The dividends distributed to the non-controlling interests will act to reduce the non-controlling interests’ share in the equity of the subsidiary The consolidated statement of financial position will show any dividends payable to the non-controlling interests as a liability together with those payable to the shareholders of the parent entity

Intragroup sale of inventory Calculate the subsidiary’s profit after adjustments to eliminate income and expenses of the subsidiary that are unrealised from the economic entity’s perspective If the gains or losses have been realised no adjustment is necessary when calculating non-controlling interest. Adjustments to the calculation of the non-controlling interest’s share of the subsidiary’s profits will be needed where some or all of the inventory sold by the subsidiary is still on hand with the parent entity at the end of the reporting period If there are unrealised profits in closing inventory, this will mean that in the next financial period there will be unrealised profits in opening inventory. In the next financial period we would need to adjust the non-controlling interest’s share of opening retained earnings and provide a corresponding increase in the non- controlling interest’s share of that period’s profits

Intragroup sale of non-current assets If a subsidiary sells a non-current asset to another entity within the group, to the extent that the asset stays within the group the gain or loss on sale has not been recognised from the group’s perspective and the non- controlling interests’ share of profits will need to be adjusted The gain or loss is considered to be realised across the life of the asset as the asset is used up. As the assets are used, the intragroup profit is considered to be realised as the service potential of the plant becomes embodied in goods produced by the plant Therefore, if a subsidiary sold an item of plant to another entity at the beginning of the financial year at a profit of $1000 and if that asset is to be depreciated over 10 years, only $100 of the gain could be recognised in the first year and $900 would be deemed to be unrealised. It would be realised over the next nine years

Intragroup services and interest payments To the extent that there is no related asset that is retained in the economic entity upon which any profit has accrued, no adjustments are necessary in calculating the non-controlling interest in the subsidiary’s profit There is no adjustment for such things as management fees when we are determining non- controlling interests as they are considered to be realised

Intragroup transactions that create gains or losses for the parent entity In calculating non-controlling interests we do not need to adjust for gains or losses in the parent entity’s accounts that are unrealised Only the unrealised intragroup profits or losses accruing to the subsidiary need to be eliminated before we calculate non-controlling interests Hence, if a subsidiary has acquired inventory from the parent entity no adjustment is required if the inventory is still on hand when calculating non-controlling interests, as the purchase of inventory has no implications for the equity of the subsidiary as they are simply acquiring one asset in exchange for another, or acquiring one asset by incurring a liability

Summary of some general principles for calculating non-controlling interests in profits or losses We only need to make adjustments to non-controlling interests’ share of profits where an intragroup transaction affects the subsidiary’s profit or loss We make adjustments for profits or losses made by the subsidiary to the extent they are unrealised from the economic entity’s perspective, that is the respective asset is still on hand at reporting date For profits relating to transactions that do not involve the transfer of assets, such as those relating to interest, management fees and so forth, no adjustments are necessary. The related profits are deemed to be recognised at the point of the transaction We do not need to make adjustments for unrealised gains or losses made by the parent entity when calculating the non- controlling interest in profits