Topic 8

Consolidation:
Controlled entities
Wholly owned subsidiaries
Chapter 18 & 19

Learning objectives
Controlled Entities
1. Explain the meaning of consolidated financial statements
(p. 906)
2. Discuss the meaning and application of the criterion of
control (p. 909)
3. Discuss which entities should prepare consolidated financial
statements
(p. 915)
4. Explain the nature of an investment entity (p. 917)
5. Outline the relationship between a parent and an acquirer in a
business combination (p. 918)
6. Explain the differences in disclosure requirements between
single entities and consolidated entities (p. 920)

Introduction
Consolidated financial statements

Involves the preparation of a single set of financial

statements
Involves combining the financial statements of the
individual entities in a group
So that they show the financial position and financial
performance of the group of entities
Presented as if they were a single economic entity

Questions:

Which entities do we include in the group?

What are the accounting procedures to prepare
consolidated accounts?
What is the purpose of consolidated financial statements?

Relevant standards:

AASB 10 Consolidated Financial Statements

AASB 3 Business Combinations

Consolidated financial
statements
Consolidated financial statements are the financial
statements of a group in which the assets, liabilities, equity,
income, expenses and cash flows of the parent and its
subsidiaries are presented as those of a single economic
Group
a parent
entity
and its subsidiaries

Parent an entity
that controls one or
more entities
Subsidiaries
an entity that is
controlled by
another entity

Consolidated financial
statements
A Ltd

Parent
control must exist (more
on this later)

B Ltd

Subsidiary

The group is referred to as the A Ltd

Group

Consolidated financial
statements
Consolidation involves combining financial

statements of individual entities to show financial

position and performance of group as if it were
single entity
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 chapters)

Consolidated financial
statements
Simple consolidation worksheet for the A Ltd
group
A Ltd

Current assets

B Ltd

Consolidati
on

50 000

20 000

70 000

Non current
assets

150 000

120 000

270 000

Total assets

200 000

Total liabilities

(80 000)

140 000
+

340 000

(30 =
(110 000)
000)
Consolidation
does not involve
adjustments in
of
Consolidation
involve
inthe
theaccounts
accounts230
ofthe
the
Net assets does not120
000adjustments
110 000
000
entities.
Consolidated
financial
statements
are
an
additional
set
of
entities. Consolidated financial statements are an additional set of
financial
financialstatements
statementsand
andare
areprepared
preparedin
inaaconsolidation
consolidationworksheet.
worksheet.

Consolidated financial
statements
Reasons for consolidation:
Supply of relevant
information
Comparable information
Accountability
Reporting of risks and
benefits

Control as the criterion for

consolidation
A parent is an entity that controls one
or more entities
Control is the criterion for identifying
when a parent-subsidiary relationship
exists
Significant judgement is often required
in determining whether control exists

Control as the criterion for

consolidation
The following three elements are required in order
for an investor to have control:
1. power over the investee
2. exposure, or rights, to variable returns from its
involvement with the investee
3. the ability to use its power over the investee to
affect the amount of the investors returns.
All three elements must be present for control to
exist

Control as the criterion for

consolidation Power
Power is defined as existing rights that give the
current ability to direct the relevant activities
Power arises from rights. Most rights arise from
a legal contract. Examples in AASB 10 include:
Voting rights
Rights to appoint, reassign or remove members of
the investees key management personnel
Rights to appoint or remove another entity that
participates in management decisions
Rights to direct the investee to enter into, or veto
any changes to, transactions that affect the
investees returns

Control as the criterion for

consolidation Power
Power arises from rights.
Rights must be substantive the holder must have
the practical ability to exercise the rights.
Judgment is required in determining whether rights
are substantive. Factors to consider per AASB 10
are:
Whether the party that holds the rights would
benefit from exercising the rights e.g. potential
voting rights;
Whether there are any barriers that prevent a
holder from exercising rights.
Where multiple parties are involved, whether
there is a mechanism in place to enable those
parties to practically exercise the rights.

Control as the criterion for

consolidation Power
Power arises from rights.
If a right is purely protective, then the holder does
not have power.

Protective rights are designed to protect the interest of the

party holding those rights without giving the party power
over the entity to which the rights relate.

Example of protective rights include the following:

A lenders right to restrict a borrower from
undertaking certain activities
The right of a party holding a non-controlling
interest to approve various transactions
The rights of a lender to seize the assets of a
borrower in the event of default.

Control as the criterion for

consolidation Power
Power is the ability to
direct rather than
actually directing.
The ability to direct
must be current.

E.g. consider the impact

of an investor that holds
call options

It must be relevant
activities that are
being directed

That is activities of the

investee that significantly

Control as the criterion for

consolidation Power

Level of share ownership

Share ownership normally provides voting rights

Power is presumed to exist where an investor owns more

than 50% of the voting rights of an entity unless there is
evidence to the contrary

Voting rights of less than 50% can result in an

investor having power over an investee consider
the following factors:

Dispersion of other shareholders probability of

shareholders attending meeting lessened by location and
by size of share parcels
Attendance at AGMs e.g. if only 60% of eligible votes
attend meeting, 31% can control meeting
Existence of contracts power by agreement with other
investors
Level of disorganisation or apathy of other

Control as the criterion for

consolidation Power
Level of share ownership
Does A Ltd control B Ltd?
A Ltd
20 shareholders each
holding < 2% of the
voting power. These
B Ltd
shareholders rarely
attend meetings and
Yes.
vote
Based on the history of AGM attendance and
dispersion of shareholders it appears that A Ltd
exerts power over B Ltd in spite of holding < 50%
of the voting rights
45%

Control as the criterion for

consolidation Power
Level of share ownership
Does A Ltd control B Ltd?
A Ltd
3 shareholders each
holding 17% of the
voting power. These
B Ltd
shareholders regularly
attend meetings and
No.
vote
Based on the history of AGM attendance and
involvement of shareholders it appears that A Ltd
does NOT exert control over B Ltd.
49%

Control as the criterion for

consolidation Power
Level of share ownership
Who controls C Ltd?
A Ltd
B Ltd
48%

C Ltd

52%

B Ltd 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

Even though A Ltd is currently running the day-to-day

operations of C Ltd, B Ltd has the power over 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.

Control as the criterion for

consolidation Exposure or
rights to variable returns
The second element of the control definition
requires that the investor has the rights to variable
returns from the investee.
Examples of returns that can exist in parentsubsidiary relationship include:
Dividends
Obtaining scarce raw materials on priority basis
Gaining access to subsidiarys distribution
network, patents
Economies of scale
Denying or regulating access to subsidiarys
assets
tomust
competitors
The
have
Thereturns
returnsmust
havethe
thepotential
potentialto
tovary
vary
according
accordingto
tothe
theperformance
performanceof
ofthe
theentity
entity

Control as the criterion for

consolidation Ability to use the
power to affect returns
The third element requires that the parent has the
ability to increase its benefits and limit its losses
from the subsidiarys activities.
Remember, all three elements must be present for
control to exist.

No Control

No parent
subsidiary
relationship

No
consolidatio
n

Preparation of consolidated
financial statements
AASB 10(paragraph 4) requires all parents to prepare
consolidated financial statements
Unless they (the parent entity) meet all of the
following conditions:
i.

it is a wholly-owned subsidiary or is a partially-owned

subsidiary of another entity and all its other owners do
not object to the parent not presenting consolidated
financial statements;
ii. its debt or equity instruments are not traded in a public
market;
iii. it is not required to file financial statements with a
securities commission or other organisation for the
purpose of issuing instruments in a public market; and
iv. its ultimate or any intermediate parent produces

Presentation of consolidated
financial statements
A Ltd
Figure 18.4

100%

B Ltd
100%

C Ltd

B Ltd a parent?

A Ltd a parent?

Is consolidation required for B Ltd

(i.e. B + C):
i. B Ltd is a wholly owned subsidiary;
ii. Does B Ltd have debt or equity
instruments traded on an
exchange?
iii.Has (or is) B Ltd filed financial
reports with a regulatory agency
for the purpose of issuing any class
of instruments?
iv.Has A Ltd prepared IFRS compliant
consolidated financial statements?

No

B Ltd required to prepare consolidated financial statements?

Disclosure
Disclosures required by AASB 12
AASB 10 does not specify disclosure requirements
AASB 12 Disclosure of Interests in Other Entities
Sets out the disclosure requirements for consolidated
financial statements

The key objective of AASB 12 (para. 1) is to provide

information
that enables users of its financial statements to evaluate:
(a) the nature of, and risks associated with, its interests in
other entities, and
(b) the effects of those interests on its financial position,
financial performance and cash flows.

Learning objectives Wholly Owned Subsidiaries

1. Prepare an acquisition analysis for the parents acquisition in a
subsidiary (p. 935)
2. Prepare the worksheet entries at the acquisition date, being
the business combination valuation entries and the preacquisition entries (p. 939)
3. Prepare the worksheet entries in periods subsequent to the
acquisition date, adjusting for movements in assets and
liabilities since acquisition date and dividends from preacquisition equity (p. 945)
4. Prepare the worksheet entries where the subsidiary revalues
its assets at acquisition date (p.957)

The consolidation process

Before consolidating, it may be necessary to adjust
subsidiarys financial statements where:
1. The subsidiarys balance date is different to the
parents. In such cases the subsidiary is required to
prepare adjusted financial statements as at the
parents reporting date.
E.g. 30 June vs. 31 December
2.

The subsidiarys accounting policies are different

to the parents. In such cases the subsidiary is
required to prepare adjusted accounts to ensure
accounting
policies
consistent
withforthe
parent.
E.g.
cost vs. revaluation
methods
of accounting
non-current
assets

The consolidation process

Consolidation involves adding together the financial
statements of the parent and subsidiaries and making
a number of adjustments:

Business combination valuation entries required to

adjust the carrying amount of the identifiable assets
acquired and the liabilities assumed of the
subsidiary to fair value

Pre-acquisitions entries required to eliminate the

carrying amount of the parents investment in each
subsidiary against the pre-acquisition equity of that
subsidiary

Transactions between entities within the group

Consolidation worksheets
It is the financial statements of the

parent and the subsidiary that are

added together
Not the underlying accounts

The financial statements added

together are the:

Statement of financial position
Statement of profit or loss and other

comprehensive income
Statement of changes in equity
Statement of cash flows (not covered in
this book)

Consolidation worksheets
P Ltd acquired all the shares of S Ltd on 1.1.X1 for $20,000. At
the date of acquisition the equity of S Ltd consisted of share
capital $15,000 and retained earnings $5,000.
To facilitate the addition process a consolidation worksheet is
used:
31.12.X1

No adjustments are made in the accounting records of the individual entities

Therefore the entries must be made each time a cons. worksheet is prepared

Acquisition analysis
An acquisition analysis compares the cost of
acquisition with the fair value of the identifiable net
assets and contingent liabilities (FVINA) that exist at
acquisition to determine whether there is: NOT the
book value

Goodwill on acquisition (where cost > FVINA)

Bargain purchase (where cost < FVINA)
Recall goodwill is:
An asset representing the FEB arising from other assets
acquired in a business combination that were not
individually identified and recognised
It is a residual value

Also recall that:

Net assets = Assets Liabilities = Shareholders equity

Acquisition analysis
Parent has no previously held equity interest in
the subsidiary
The FVINA includes:
All identifiable asset and liabilities of the subsidiary
As well as the fair value of any contingent liabilities the
acquiree may have

Recall that contingent liabilities are not recognised

in subsidiaries balance sheet
Rather they are recorded by way of note disclosure only.
AASB3 requires them to be recognised on the acquisition of
another business

We commonly determine the FVINA with reference

to the equity balances of the subsidiary, rather than
the individual asset and liability balances

Worksheet entries at acquisition

date
Business combination valuation entries
If the BV of subsidiary assets and liabilities > < FV
Or, if a contingent liability exists, then
business combination valuation adjustments are
required:

To increase or decrease subsidiarys recorded assets and

liabilities book values to fair value;
To recognise previously unrecognised assets (e.g. internally
generated intangibles) at fair value; or
To recognise subsidiarys contingent liabilities as liabilities
at fair value

Business Combination Valuation Reserve (BCVR)

account is used to record these adjustments.
The BCVR is similar to the Asset Revaluation Surplus
(ARS) account

Worksheet entries at acquisition

date
It is possible for some of these adjustments to be

made directly in the books of the subsidiary:

E.g. AASB 116 allows the use of the fair value basis for the

measurement of PPE assets

In some cases, other accounting standards prevent

the adjustment from being made in the subsidiaries
books:
AASB 102 requires all inventory to be recorded at the lower
of cost or NRV, therefore any increase to FV of inventory
cannot be made in the subsidiaries books
AASB 138 does not allow the subsidiary to recognise
internally generated goodwill

As a result, it is more likely that these adjustments

will be made via entries in the consolidation

worksheet

Worksheet entries at acquisition

date
Where the BCVR entry is done in the ARS account in
the subsidiarys books
it is recorded in the G/L and
therefore automatically carries forward to future periods
once entered

BUT
Where the entry is done in the BCVR on
consolidation (i.e. on the worksheet) it must be
manually carried forward to future periods

Worksheet entries at acquisition

date
Pre-acquisition entries
Equity balances that existed in the subsidiary prior
to acquisition date are referred to as pre-acquisition
equity
All movements after the date of acquisition are referred to
as post-acquisition

You cannot have an investment in yourself, nor can

you have equity in yourself.

From a consolidated viewpoint, these items should not exist

i.e. they must be eliminated to avoid double counting

Worksheet entries at acquisition

date
Subsidiary has recorded goodwill at acquisition
date
Goodwill is deducted in the determination of the
FVINA
Goodwill is not an identifiable asset and must be deducted
from the total equity of the subsidiary
Goodwill on the business combination is then determined
Note the example in the textbook (see p. 942)

Subsidiary has recorded dividends at acquisition

date
If there is a dividend payable when the parent
acquires the shares in the subsidiary they will be
either cum div. or ex div.
This will impact on the determination of the consideration

Worksheet entries subsequent to

acquisition date
So far, we have considered the

consolidation journals required if a

consolidation was being prepared on
the acquisition date
How do these journals change if a
consolidation is being prepared on a
later date?
How do transactions and events
occurring post-acquisition impact on
the business combination valuation
adjustment entries?
How do post-acquisition transactions
and events impact on the pre-

Worksheet entries subsequent to

acquisition date
Pre-acquisition entries
The pre-acquisition entry is required every time a
consolidation is completed
It does not change, except under the following
circumstances:
Transfers from the business combination
valuation reserve
Such as those just discussed (e.g. on the sale of the
land)

Transfers between pre-acquisition retained

earnings and other reserves

Such transfers are dealt with in the same way as BCVR

transfers

Bonus share dividends paid from pre-acquisition

equity
Refer to the example on p. 955

Revaluations in the records of

the subsidiary at acquisition
date
Revaluations to fair value can be recorded in the
books of the subsidiary for certain assets:
AASB 116 Property, Plant and Equipment

But not in all cases; e.g.

AASB 102 Inventories
AASB 138 Intangible Assets

Disclosures
AASB 3 Business Combinations
Disclosure requirements are contained in paragraphs B64B67 of
Appendix B
Examples are provided in Figure 19.17

AASB 12 Disclosure of Interests in Other Entities

Requires disclosures in relation to a parents interests in its
subsidiaries
Examples are provided in Figure 19.18
This standard is covered further in Chapter 18

Tutorial Week 9
Chapter 18
RQ 1, 4, 5
Chapter 19
RQ 1, 8, 10
PQ 19.1, 19.6, 19.9
All students are expected to have attempted all tutorial problems before
attending the tutorial. Specifically, the question(s) that has been bolded.
For further understanding, you are encouraged to attempt Demonstration
Problem.