BFA301 Week 3 Tutorial - Solutions

Exercise 26.1

Parent-subsidiary relationship

Visit the website of Woolworths Ltd (www.woolworthslimited.com.au/) and retrieve the

most recent annual report.

Required
1. Identify and discuss the principles of consolidation used as disclosed in note 1 to the
consolidated financial statements.
2. Identify the subsidiaries, as disclosed in the notes to the consolidated financial
statements, describing the differences between the wholly owned and partially owned
subsidiaries.
3. Discuss potential reasons the regulators require Woolworths Ltd to prepare
consolidated financial statements.
(LO1, LO2 and LO3)

1. Students should read “Note 1. Significant Accounting Policies” from the annual report and
identify the basis for consolidation used by Woolworths Ltd paying attention to the following
aspects:
 that the consolidated financial statements incorporate the assets and liabilities as at the end
of the period and the results for the period of the parent and all its subsidiaries
 that the subsidiaries are fully consolidated from the date on which control is obtained until
the date when the control ceases
 that the non-controlling interests in the equity and results of the subsidiaries are separately
disclosed
 that the intragroup balances and intra-group transactions are eliminated when preparing the
consolidated financial statements.

2. Students should read the note which includes the list of subsidiaries paying attention to the
ownership interest of the group in each of them.

3. Students should discuss the following reasons for regulators to require the preparation of
consolidated financial statements as they may apply to Woolworths Ltd:
(i)To supply relevant information to investors in the parent entity.
(ii)To allow comparison of the group with similar entities.
(iii)To assist in the discharge of accountability by management of the group.
(iv)To report the risks and benefits of the group as a single economic entity.
(v)To ensure consistency of information provided to users.
Exercise 26.3

Options

Hewey Ltd, Dewey Ltd and Louie Ltd each own one-third of the ordinary shares that
carry voting rights at a general meeting of shareholders of Woodchuck Ltd. Hewey Ltd,
Dewey Ltd and Louie Ltd each have the right to appoint two directors to the board of
Woodchuck Ltd. Hewey Ltd also owns call options that are exercisable at a fixed price at
any time and, if exercised, would increase Hewey Ltd’s voting rights in Woodchuck Ltd
to 60%, while Dewey Ltd’s and Louie Ltd’s would become 20% each. The management
of Hewey Ltd does not intend to exercise the call options.

Required
Discuss whether Woodchuck Ltd is a subsidiary of any of the other entities. (LO2)

Facts:

Hewey Ltd
Dewey Ltd each have 1/3 of ordinary shares of Woodchuck Ltd
Louie Ltd

Hewey Ltd owns call options that would give it 60% of the voting rights of Woodchuck Ltd.

When considering potential voting rights, an investor shall consider the purpose and design of
the instrument, as well as the purpose and design of any other involvement the investor has
with the investee. This includes an assessment of the various terms and conditions of the
instrument as well as the investor’s apparent expectations, motives and reasons for agreeing to
those terms and conditions.

If the investor also has voting or other decision-making rights relating to the investee’s
activities, the investor assesses whether those rights, in combination with potential voting
rights, give the investor power.

An investor, in assessing whether it has power, considers only substantive rights relating to an
investee (held by the investor and others). For a right to be substantive, the holder must have
the practical ability to exercise that right. It is necessary to consider any barriers that might
prevent the holder from exercising the rights. Examples of such barriers include:
(i) Financial penalties and incentives that would prevent (or deter) the holder from exercising
its rights.
(ii) An exercise or conversion price that creates a financial barrier that would prevent (or deter)
the holder from exercising its rights.
(iii) Terms and conditions that make it unlikely that the rights would be exercised, for example,
conditions that narrowly limit the timing of their exercise.
(iv) The absence of an explicit, reasonable mechanism in the founding documents of an
investee or in applicable laws or regulations that would allow the holder to exercise its
rights.
(v) The inability of the holder of the rights to obtain the information necessary to exercise its
rights.
(vi) Operational barriers or incentives that would prevent (or deter) the holder from exercising
its rights (e.g. the absence of other managers willing or able to provide specialised services
or provide the services and take on other interests held by the incumbent manager).
(vii) Legal or regulatory requirements that prevent the holder from exercising its rights (e.g.
where a foreign investor is prohibited from exercising its rights).

In this situation, management do not intend to exercise the options, presumably because it is
not in their economic interest to do so. As such, the options are not substantive and therefore
they should not be considered in determining control.

In conclusion, Woodchuck Ltd is not a subsidiary of any of the three companies.

Exercise 26.8

Determining subsidiary status

During the current financial period, Heckle Ltd acquired 40% of the ordinary shares of
Jeckle Ltd. Under the company’s constitution, each share is entitled to one vote. On the
basis of past experience, only 65% of the eligible votes are typically cast at the annual
general meetings of Jeckle Ltd. No other shareholder holds a major block of shares in
Jeckle Ltd.
The directors of Heckle Ltd argue that they are not required under AASB 10/IFRS 10 to
include Jeckle Ltd as a subsidiary in Heckle Ltd’s consolidated financial statements as
there is no conclusive evidence that Heckle Ltd can control the relevant activities of Jeckle
Ltd. The auditors of Heckle Ltd disagree, referring specifically to the votes cast in the
past years.

Required
Provide a report to Heckle Ltd on whether it should regard Jeckle Ltd as a subsidiary in
its preparation of consolidated financial statements. (LO2)
40%
Heckle Ltd Jeckle Ltd

Discuss:
 The concept of control.
 The need for judgement.
 Factors to consider when determining the existence of control, such as:
- NCI is 60%
- 65% of voting power is exercised at AGM
- no block holdings of shares other than Heckle Ltd.

It is expected that Heckle Ltd is the parent of Jeckle Ltd due to its ownership of 40% of the
shares in Jeckle Ltd and the dispersion and lack of interest of the other shareholders.