Ch a pter 4 PDF

Preview

Summary

CHAPTER 4PFRS 3 deals with the accounting for a business combination at the acquisition date, while the PFRS 10 deals with the preparation and presentation of the consolidated financial statements after the business combination.Consolidated Financial Statements – the financial statements of a group ...

Description

CHAPTER 4 PFRS 3 deals with the accounting for a business combination at the acquisition date, while the PFRS 10 deals with the preparation and presentation of the consolidated financial statements after the business combination. Consolidated Financial Statements – 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 entity. Group – a parent and its subsidiaries Parent – an entity that controls one or more entities Subsidiary – an entity that is controlled by another entity All parent entities are required to prepare consolidated financial statements as follows 1. A parent is exempt from presernting consolidated financial statements if; a. it is a subsidiary of another entity (whether wholly-owned statements or partially-owned) and all its other owners do not object non-presentation of consolidated financial statements b. its debt or equity instruments are not traded in a public statements; market (or being processed for such purpose); and c. its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with PFRS. 2. Post-employment benefit plans or other long-term employee benefit plans to which PAS 19 applies. Control Control is the basis for consolidation. PFRS 10 requires an investor to determine whether it is a parent by assessing whether it controls the investee. Control of an investee - "an investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee." Control exists if the investor has all of the following: a. Power over the investee; b. Exposure, or rights, to variable returns from the investee; and c. Ability to the affect returns through use of power. Only one entity is identified to have control over an investee. If two or more investors collectively control an investee such as when they must act together to direct the investee’s relevant activities, none of them individually controls the investee.

Accordingly, each investor accounts for its interest in the investee in accordance with PFRS 11 Joint Arrangements, PAS 28 Investments it Associates and Joint Ventures or PFRS 9 Financial Instruments, as appropriate. Example: ABC Co. holds 70% of the voting shares of Alphabets, Inc. XYZ, Inc., the former majority owner of Alphabets, holds 10% of the voting shares of Alphabets but retains its power to appoint the majority of the board of directors of Alphabets. The other 20% is held by various shareholders holding shares of 1% or less. Decisions about the relevant activities of Alphabets require the approval of a majority of votes cast at relevant shareholders' meetings -75% of the voting rights of the investee have been cast at recent relevant shareholders' meetings. Analysis: Neither ABC Co. nor XYZ, Inc. has control over Alphabets Co. Power An investor has power over an investee when the investor has existing rights that give it the current ability to direct the investee's relevant activities. Relevant activities - "activities of the investee that significantly affect the investee's returns." An investor's current ability to direct the investee's relevant activities is often evidenced by the investor's ability to establish and direct the investee's operating and financing policies, e.g., making operating and capital decisions, and appointing, remunerating, and terminating key management personnel. Power arises from rights and it may be obtained directly from the voting rights conferred by shareholdings. However, power may also arise from other sources, such as contractual arrangements, Examples of rights that can give an investor power:

a. Voting rights (or potential voting rights); b. Rights to appoint or remove members of the investee's key management personnel or another entity that directs the relevant activities of the investee; c. Rights to direct the investee to enter into transactions for the benefit of the investor; and d. Other decision-making rights that give the investor the ability to direct the investee's relevant activities. Administrative rights When voting rights do not have a significant effect on an investee's returns, such as when voting rights relate to administrative tasks only and contractual arrangements determine the direction of the relevant activities, the investor needs to assess those contractual

arrangements in order to determine whether it has rights sufficient to give it power over the investee. Unilateral rights If two or more investors individually (unilaterally) have the ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee. Protective rights An investor can have power over an investee even if other entities have existing rights that give them the current ability to participate in the direction of the relevant activities, for example when another entity has significant influence. However, an investor that holds only protective rights does not have power over an investee, and consequently does not control the investee. Protective rights are "rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate."

CHAPTER 5 Intercompany sale of property, plant and equipment Intercompany sales of property, plant, and equipment are also identified as either downstream or upstream because only upstream sales affect non-controlling interests. Accounting procedures A. Any gain or loss is deferred and i. Amortized over the asset's remaining life, if the asset is i. depreciable. ii. Not amortized, if the asset is non-depreciable. B. If the asset is subsequently sold to an unrelated party or otherwise derecognized, the unamortized balance of the deferred gain or loss is recognized in profit or loss. C. In a downstream sale, the gain or loss is adjusted to the controlling interest only. Therefore, NCI is not affected. D. in an upstream sale, the adjustments for the gain or loss are shared between the controlling interest and NCI. Therefore, NCI is affected E. The unamortized balance of the deferred gain or loss is eliminated when consolidated financial statements are prepared

Intercompany dividends

When the investment in subsidiary is measured at cost or in accordance with PFRS 9, dividends received from the subsidiary are recognized in profit or loss. When the investment in subsidiary is measured using the equity method, dividends received from the subsidiary are recognized as reduction to the carrying amount of the investment. In any case, the dividends must be eliminated when the consolidated financial statements are prepared. It is as if the parent never received the dividends. Therefore: a. If the dividends were recognized in profit or loss, eliminate the dividend income in the consolidated statement of profit or loss. b. If the dividends were recognized as reduction to the investment account, add back the dividends to the investment account. Intercompany bond transaction When a parent or a subsidiary acquires bonds issued by the other both the investment in bonds and the bonds payable are eliminated in the consolidated financial statements The bonds payable are considered extinguished from the point of view of the group. Therefore a. The difference between acquisition cost of the investment in bonds and the carrying amount of the bonds payable on the acquisition date is recognized as gain or loss in the consolidated statement of profit or loss; and b. Any interest expense and interest income recognized after the intercompany transaction are eliminated in the consolidated financial statements. Impairment of Goodwill When NCI is measured at proportionate share, goodwill is med only to the owners of the parent. Therefore, any impairment of goodwill is also attributed only to the owners of the When NCI is measured at fair value goodwill is attributed to both the owners of the parent and NCI. Therefore, impairment of good will is allocated to both the owners of the parent and NCI. Intercompany items in-transit and restatements Each of the group members' individual financial statements are adjusted first for the following before consolidation: a. Accruals and deferrals of income and expenses and corrections of errors, b. In transit items - items arising from intercompany transactions that were already recorded by one party but not yet by the other (eg. intercompany deposits in transit, outstanding checks, credit memos, and debit memos).

c. Hyperinflationary economy - the financial statements of a group member that reports in a currency of a hyperinflationary economy are restated first in accordance with PAS 29 before they are consolidated. This is discussed in Chapter 9. d. Currency translations - the financial statements of a subsidiary whose functional currency is different from the group's presentation currency are translated first in accordance with PAS 21 before they are consolidated. This is discussed in Chapter 10 Continuous assessment An investor reassesses whether it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control. Changes in ownership interest not resulting to loss of control If the parent's ownership interest in a subsidiary changes but does not result to loss of control, the change is accounted for as an equity transaction. The carrying amounts of the controlling and non- controlling interests are adjusted to reflect the changes in their relative interests in the subsidiary. The difference between the adjustment to the NCI and the fair value of the consideration paid or received is recognized directly in equity and attributed to the owners of the parent. No gain or loss is recognized in profit or loss. Loss of control A parent can lose control of a subsidiary in much the same way it can obtain control. That is, with or without a change in absolute or relative ownership levels and with or without the investor being involved in that event. Examples: A. Control is lost even without a change in the parent's ownership interest when the subsidiary becomes subject to the control of a government, court, administrator or regulator, or as a result of a contractual agreement. B. Control is lost even without the parent being involved in that event if decision-making rights are given to another party or the decision-making rights previously granted to the parent have elapsed C. Control is lost if the parent ceases to be entitled to receive returns. D. Control is lost if the parent's previous status as a principal changes to an agent. When a parent loses control over a subsidiary, the parent shall. a. Derecognize the assets and liabilities of the former subsidiary from the consolidated statement of financial position. b. Recognize any investment retained in the former subsidiary at its fair value at the date control is lost and subsequently account for the investment in accordance with relevant PFRSS c. Recognize the gain or loss associated with the loss of control in profit or loss. This is attributed to the former controlling interest

Remember the following Change in ownership interest Do result to loss of control Accounting treatment As an equity transaction  

No gain or loss is recognized Consideration less Change in NCI – Direct Adjustment inequity

Results to loss of control As sale of subsidiary: 

Deconsolidate as follows: Cash consideration received Investment retained NCI Goodwill Net identifiable assets Gain on disposal

Sale of a subsidiary to an associate or joint venture If a parent loses control of a subsidiary by selling its interest in the subsidiary to an associate or a joint venture, the gain or loss from the transaction is recognized in the parent's profit or loss only to the extent of the unrelated investors' interests in that associate or joint venture. The remaining part of the gain is eliminated against the carrying amount of the investment in that associate or joint venture. Former subsidiary becomes an associate or joint venture ► If the parent retains an investment in the former subsidiary and the former subsidiary is now an associate or a joint venture, the parent recognizes the part of the gain or loss resulting from the remeasurement at fair value of the investment retained in that former subsidiary in its profit or loss only to the extent of the unrelated investors' interests in the new associate or joint venture. The remaining part of that gain is eliminated against the carrying amount of the investment retained in the former subsidiary. Former subsidiary becomes an associate or joint venture ► If the parent retains an investment in the former subsidiary that is now accounted for in accordance with PFRS 9, the part of the gain or loss resulting from the remeasurement at fair

value of the investment retained in the former subsidiary is recognised in full in the parent's profit or loss. Importance of consolidation 1. Consolidated financial statements provide true and fair view of the financial position and performance of the group. Users are provided with a clearer view of the risks and rewards surrounding the group of entities. 2. It would be burdensome for users to gather together all the individual financial statements of a parent and its many subsidiaries in order to get an idea of the financial position and performance of the group, so parent entities are required to prepare consolidated financial statements. 3. Consolidated financial statements lessen the temptation of hiding certain activities in the subsidiary's or special purpose entity's (SPE) separate financial statements. Although, a possible loophole in consolidated financial statements is that certain activities of subsidiaries or SPEs may be buried or obscured in the notes. SPEs will be discussed momentarily. 4. Consolidated financial statements eliminate the effects of transactions with related entities making the consolidated financial statements more useful than the aggregate of each of the group members' separate financial statements. Theories of consolidation Consolidation accounting has evolved over the years. The theories supporting this evolution are outlined below: A. Proprietary theory - this theory focuses on the parent's legal interest in the subsidiary. Advocates of this concept believe that since the parent acquires only a portion of the subsidiary y that portion should be shown on the consolidated financial statements. Consequently , non - controlling interests NCI is measured at proportionate share and presented as Theories of consolidation supporting this evolution are outlined below: (NCT) are excluded from the consolidated financial statements This concept supports the proportionate consolidation - wherein the consolidated financial statements include the parent's net identifiable assets plus the parent's share in the net identifiable assets of the subsidiary. Similar procedures applied for income and expenses. B. Parent company theory - this theory focuses on the parent's ability to control the subsidiary as a whole and not only up to the extent of its legal interest in the subsidiary. Advocates of this concept believe that the subsidiary is an extension of the parent company. Therefore, the consolidated financial statements should be prepared from the viewpoint of the owners of the parent . All of the subsidiary's net identifiable assets are included in the consolidated financial statements, irrespective of the parent's ownership interest in the subsidiary. Accordingly NCI is included in the consolidated financial statements but not as part of equity The following are peculiar characteristics of the parent company theory

a. 100% of the subsidiary's net identifiable assets included in the consolidated financial statements carrying amounts plus the parent's share in the fair value adjustments (FVA) at acquisition date. The NC's share FVA is not presented b. NCI is measured at proportionate share and presented as liability in the consolidated financial statements The subsequent evolution of the parent company theory changed the presentation from liability to a "mezzanine" line item, i.e., between liabilities and equity, but neither part of liabilities nor equity. c. Goodwill pertains only to the owners of the parent (also called partial goodwill'). d. Consolidated profit includes only the parent's own profit plus the parent's share in the subsidiary's profit. The NCI's share in the subsidiary's profit is deemed an expense. In other words, consolidated profit pertains only to the owners of the parent. e. Unrealized gains and losses from upstream sales are eliminated only up to the extent of the parent's ownership interest in the subsidiary. C. Entity theory (Contemporary theory) - similar to the parent company theory, the entity theory is also based on "control." However, advocates of this concept believe that the parent and the subsidiary are members of a group (the consolidated entity). Therefore, consolidated financial statements should be prepared from the viewpoint of the group rather than of the owners of the parent. All of the subsidiary's net identifiable assets are included in the consolidated financial statements, irrespective of the parent's ownership interest in the subsidiary. Accordingly, NCI is included in the consolidated financial statements within equity but separate from the equity of the owners of the parent. The following are peculiar characteristics of the entity theory: i.

ii.

iii. iv.

v.

100% of the subsidiary's net identifiable assets are included in the consolidated financial statements at carrying amounts plus the total FVA at the acquisition date. NCT is measured at either proportionate share or fair value and presented in the consolidated financial statements within equity but separate from the equity of the owner Goodwill pertains to both the owners of the parent and NCI (also called 'full goodwill’) particularly when NCI is measured at fair value. Consolidated profit combines the parent's and subsidiary's profits in total, irrespective of the parent's ownership interest in the subsidiary. The consolidated profit is then attributed to the (a) owners of the parent (b) NCI Similar treatment is comprehensive income. In other words, consolidated profit or comprehensive income pertains to both the owners of the parent and NCI. Unrealized gains and losses from upstream sales are eliminated in full

D. Hybrid theory (Traditional theory) - like the parent company and entity theories, the hybrid theory is also based on "control." As the name implies, the hybrid theory incorporates characteristics of both the parent company theory and the entity theory. However, the hybrid theory has the following peculiarities: i. 100% of the subsidiary's net identifiable assets are included in the consolidated financial statements at carrying amounts plus the total FVA at the acquisition date. ii. NCI is measured at proportionate share (i.e., no fair value option) and presented in the consolidated financial statements within equity but separate from the equity of the owners of the parent. iii. Goodwill pertains only to the owners of the parent (also called 'partial goodwill). iv. Consolidated profit combines the parent’s and subsidiary's profits in total, irrespective of the parent's ownership interest in the subsidiary. However, the profit attributable to the NCI deducted from the combined profits but not reported as expense. In other words consolidated profit pertains only to the owners of the parent v. Unrealized gains and losses from upstream sales are eliminated in full The current standards require the use of the entity theory All our previous discussions are based on this theory Historical background 



  

PAS 31 Interests in Joint Ventures, the predecessor of PFRS 11 Joint Arrangements re...