1. Topic : Controlled entities: the consolidation method
Week 9 – Lecture 2
Topic : Controlled entities: the consolidation method
Reference: Text; Leo & Hoggett:
Chapter 14
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

2. Forms of controlled entities
Business combinations can take a number of forms. Common examples are:
Acquisition of shares in another entity
Formation of a new entity to acquire the shares of another entity
Dual-listed entities – DLC eg BHP Billiton & Brambles.
(BHP Billiton Limited and BHP Billiton Plc)
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

3. Applying the consolidation method
Consolidation – process of preparing single set of financial statements for group of entities under control of one of those entities
Involves combining financial statements of individual entities to show financial position and performance of group as if it were single entity
Group – a parent and all it subsidiaries
Parent – an entity that has one or more subsidiaries
Subsidiary – an entity that is controlled by another entity
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

4. Applying the consolidation method
A Ltd
Parent
“control” must exist (more on this later)
B Ltd
Subsidiary
The economic entity is referred to as the “A Ltd Group”
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

5. Applying the consolidation method
Consolidated financial statements are prepared by
(i) Aggregating (combining), line by line, like items of assets, liabilities, equity, income and expenses
(ii) Adjusting these combined figures for inter- group transactions between entities within the group (covered in following weeks)
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

6. Control
Criterion for identifying parent-subsidiary relationship is control
Definition of control - power to govern financial and operating policies of entity so as to obtain benefits from its activities
Note 2 elements
Power Criterion – ability to direct financial and operating policies
Benefit Criterion – ability to obtain benefits from other entity
Both elements must be present for control to exist
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

7. Control element 1 – Power criterion
Requires CAPACITY to control - not ACTUAL control
Factors in determining the existence of capacity include:
Passive versus active control – entity having capacity to control may not actually be involved in management of controlled entity
Non-shared Control - Two or more entities cannot share control
Level of Share Ownership - Control may be unilateral or effective, depending on level of share ownership
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

8. Control element 1 – Power criterion
Unilateral control
Control is presumed to exist where the parent owns (directly or indirectly) > 50% of the voting power of an entity unless there is evidence to the contrary
Unilateral control refers to the power to appoint / remove > 50% of directors and cast majority of votes at AGM
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

9. Control element 1 – Power criterion
Effective control
< 50% can result in control.
The following factors need to be considered when assessing effective control.
Existence of contracts (power by agreement with other investors)
Size of voting interests (e.g. if only 60% of eligible votes attend meeting, 31% can control meeting)
Dispersion of other shareholders (probability of shareholders attending meeting lessened by location and by size of share parcels)
Levels of disorganisation or apathy of other shareholders (most shareholders do not understand or care about day to day management)
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

10. Control element 1 – Power criterion
Effective control – cont.
Problems relating to effective control
Temporary control (eg 31% ownership can control if only 60% of eligible votes in attendance in Year 1, but not if 70% in attendance in Year 2)
Friendly relationship can turn un-friendly
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

11. Control element 1 – Power criterion
Who controls C Ltd?
A Ltd currently actively formulates the policies of C Ltd
B Ltd currently plays no part in the day-to-day management of C Ltd
A Ltd
B Ltd
48%
52%
C Ltd
Even though A Ltd is currently running the day-to-day operations of C Ltd, B Ltd is considered to have passive control of C Ltd. At any time that B Ltd disagrees with the management policies of A Ltd it can take control by virtue of its majority voting interests.
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

12. Control element 1 – Power criterion
Does A Ltd control B Ltd?
A Ltd
20 shareholders each holding < 2% of the voting power. These shareholders rarely attend meetings and vote
45%
B Ltd
Based on the size of voting interests and dispersion of shareholders it appears that A Ltd exerts effective control over B Ltd.
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

13. Control element 1 – Power criterion
Does A Ltd control B Ltd?
A Ltd
3 shareholders each holding 22% of the voting power. These shareholders regularly attend meetings and vote
44%
B Ltd
Based on the size of voting interests and involvement of shareholders it appears that A Ltd does NOT exert control over B Ltd.
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

14. Control element 2 – Benefit criterion
The second element of the control definition acts to exclude parties such as trustees and those with fiduciary relationship with the subsidiary from having to consolidate
Benefits that can exist in parent-subsidiary relationship
Dividends
Obtaining scarce raw materials on priority basis
Gaining access to subsidiary’s distribution network, patents
Economies of scale
Denying or regulating access to subsidiary’s assets to competitors
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

15. Users of consolidated financial statements
AASB 127 applies only to groups that are classified as reporting entities
Reporting entity: An entity for which there are users who rely on the entity’s general purpose financial statements for information useful to them for making decisions about the allocation of resources
Who are dependent users?
Resource providers
Recipients of goods and services
Parties having a review or oversight function
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

16. Users of consolidated financial statements
Factors to assist in identifying possible dependent users
Separation of management from economic interest
Economic or political importance/ influence
Financial characteristics
When a group is formed as a result of business combination, exists a reporting entity if users exist who require information about the group.
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

17. Users of consolidated financial statements
A Ltd
100%
B Ltd
Assume A Ltd is a reporting entity. Is the A Ltd group also a reporting entity?
Shareholders of A Ltd would want a financial report on the combined entity as their wealth is now dependent on the combined performance of A and B. Therefore the group would be reporting entity
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

18. Users of consolidated financial statements
How many reporting entities could exist in the group below?
ANSWER = 5 ?
Each individual entity may be reporting entity – A Ltd, B Ltd and C Ltd
A + B + C also probably reporting entity - Shareholders of A Ltd dependent on performance of all companies
B+ C also probably reporting entity - MI shareholders of B have no financial interest in A Ltd, but interested in B+C
A Ltd
NCI
80%
20%
B Ltd
100%
C Ltd
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

19. Users of consolidated financial statements
What about this group?... How many RE exist?
ANSWER = 4 ?
Each of the individual entities still reporting entity
A + B + C also probably still reporting entity
B+ C not a reporting entity from shareholders viewpoint, but maybe other parties
A Ltd
100%
B Ltd
100%
C Ltd
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

20. Presentation of consolidated financial statements
AASB 127 provides exclusion from need for parent to present consolidated financial statements if, and only if:
parent itself is subsidiary of another entity; and
its other owners do not object to parent not presenting consolidated financial statements.
A Ltd
No consolidation required for B + C group if 10% NCI shareholders in B consented to no consolidated financial statements.
NCI
90%
B Ltd
10%
80%
C Ltd
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

21. Identification of an acquirer
An acquirer is the combining entity that obtains control of the other combining entities in a business combination.
In most cases the parent will be the acquirer.
Exceptions arise when:
A new entity is formed, which acquires all the shares of previously existing entities (refer Fig 14.9 of text)
A reverse acquisition occurs (refer Figure of text)
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

22. Concepts of Consolidation
Having decided on criterion for consolidation (i.e. control), decision required on concept of consolidation
Proprietary Concept
Parent Entity Concept
Entity Concept
Differences between each concept only arise if parent does not own 100% of subsidiary (i.e. if “non-controlling interests” exist).
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

23. Concepts of Consolidation –
Entity Concept
While AASB 127 is not explicit, adopts entity concept implicitly
Under entity concept
Group consists of the assets and liabilities of parent and all the assets and liabilities of the subsidiary (ies)
NCI is classified as an equity holder
Transactions between group entities are adjusted in full. They are not affected by the % ownership interest
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

24. Format of consolidated financial statements
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

25. Format of consolidated financial statements
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

26. Format of consolidated financial statements
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.

27. Thank You
Compiled by; Mrs. Maheshwari Chand, Tr2,2014.