Controlled Entities

Controlled entities: The consolidation

method

Understand the nature and various forms of controlled entities

Explain how the consolidation method is applied Explain the key components of the term

‘control’ Discuss which entities should prepare

consolidated financial statements Understand the alternative concepts of

consolidation Explain the differences in report format between

single entities and consolidated 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 – eg BHP Billiton Australian company : BHP Ltd UK company : Billiton Plc

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 its subsidiaries

Parent – an entity that has one or more subsidiaries

Subsidiary – an entity that is controlled by another entity

A Ltd

B Ltd

Parent

Subsidiary

“control” must exist

The economic entity is referred to as the “A Ltd Group”

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)

AASB 10 Consolidated Financial StatementsCriterion for identifying parent-subsidiary relationship is controlAn investor controls an investee when

the investor :is exposed, or has rights, to variable returns

from its involvement with the investee andhas the ability to affect those returns through its

power over the investee

Control

The following three elements are required in order for an investor to have control:1. Power over the investee2. Exposure or rights to variable returns from its involvement with the investee3. The ability to use its power over the investee to affect the amount of the investor’s returns

All three elements must be present for control to exist

1. Passive versus active control – entity having capacity to control may not actually be involved in management of controlled entity

2. Non-shared Control - Two or more entities cannot share control

3. Level of Share Ownership - Control may be unilateral or effective, depending on level of share ownership

Control element 1 – Power criterion

Requires CAPACITY to control - not ACTUAL control

Factors in determining the existence of capacity include:

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


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)


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


Who controls C Ltd?


A Ltd

C Ltd48%

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.

B Ltd

52%

• 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

Does A Ltd control B Ltd?


A Ltd

B Ltd

45% 20 shareholders each holding < 2% of the voting power. These shareholders rarely attend meetings and vote

Based on the size of voting interests and dispersion of shareholders it appears that A Ltd exerts effective control over B Ltd.

Does A Ltd control B Ltd?


A Ltd

B Ltd

44% 3 shareholders each holding 22% of the voting power. These shareholders regularly attend meetings and vote

Based on the size of voting interests and involvement of shareholders it appears that A Ltd does NOT exert control over B Ltd.

Examples of returns include:• Dividends• Economies of scale• Cost savings• Sourcing scarce products• Gaining access to proprietary knowledge• Remuneration for servicing an investee’s assets or

liabilities

Benefit criterion excludes 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

Control element 3 – Benefit criterion

AASB 10 applies only to groups that are required to prepare general purpose financial reports

Required where 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

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 a

business combination, the group is considered a reporting entity if users exist who require info about the group.



A Ltd

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

100%

How many reporting entities could exist in the group below?


A Ltd

B Ltd

ANSWER = 5 ?• Each individual entity may be reporting

entity – A Ltd, B Ltd and C Ltd• A Ltd group also probably reporting

entity - Shareholders of A Ltd dependent on performance of all companies

• B Ltd group also probably reporting entity - NCI shareholders of B have no financial interest in A Ltd, but interested in B+C

C Ltd

80%

100%

20%

NCI

AASB 10 provides exclusion for parent to present consolidated financial statements if, and only if: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

Its debt or equity instruments are not traded in a public market

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

Its ultimate or any intermediate parent produces consolidated financial statements available for public use and comply with IFRSs

ALL the 4 conditions must be met

Presentation of consolidated financial statements

Presentation of consolidated financial statements

A Ltd

B Ltd

C Ltd

90%

80%

10%

NCINo consolidation

required for B Ltd group if 10% NCI shareholders

in B consented to no consolidated financial

statements.

Assuming :B Ltd’s debt or equity instruments are not traded in a public market

B Ltd is not required to file financial statements with a securities commission or other organisation for the purpose of issuing instruments in a public market

A Ltd produces consolidated financial statements available for public use and comply with IFRSs

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) A new entity is formed, which acquires all the shares of previously existing entities

b) A reverse acquisition occurs – a private company purchases a publicly traded

company and shifts its management into the latter normally involves renaming the publicly traded

company allows private companies to become publicly

traded while avoiding the regulatory and financial requirements associated with an IPO

Adopts entity concept of consolidation

• Group consists of the assets and liabilities of parent and all the assets and liabilities of the subsidiary (ies)

• Non Controlling Interest (NCI) is classified as an equity holder

• Transactions between group entities are adjusted in full. They are not affected by the % ownership interest

Concepts of Consolidation – Entity Concept

Documents

Controlled Entities