ACCT3011 NOTES
WEEK 1 (CH 1): INTRO TO CONSOLIDATION AND THE CONCEPT OF CONTROL
• Wasn’t Fin A enough? Why are we still here?
• Important to specify paragraph FOR EXAM
• Developing knowledge of accounting/financial reporting
o Level 1
§ Double entry, accounting records, accruals and end of period adjustments, financial statements, some
accounting rules (e.g. inventory, PPE)
o Level 2
§ Regulatory and financial reporting framework, reporting requirements
o Level 3
§ From single reporting entity to group financial reporting
DESCRIBE THE DIFFERENT CLASSIFICATIONS OF INVESTMENTS
LEIBLER’S PAPER
• A key focus in this unit is the development of critical perspectives. Why is that necessary? Because theory and practice
do not always seem to align
• ...starting with Leibler (2003)
• Corporations Law – financial reports must both comply with accounting standards, and present a true and fair view
• Leibler’s perspective - Directors are doing a reasonable job at the former, but not so well with the latter
• A question we’ll come back to again and again this semester; what is ‘true and fair’, and do the examples of financial
reporting we see suggest directors are sufficiently addressing true and fair, or more concerned about making the reporting
entity ‘look good’?
TYPES OF INTERESTS IN OTHER ENTITIES
• Possible types of investments include:
• We can see “shades of influence” by investor over their investments in other entities on the above continuum
ACCOUNTING FOR INTERESTS IN OTHER ENTITIES BY INVESTOR
1
,OUTLINE THE OBJECTIVES OF PREPARING CONSOLIDATED FINANCIAL STATEMENTS
(CFS)
CONCEPT OF CONSOLIDATION
• To consolidate means to group the financial performance and position of a number of entities on a line by line basis into
one aggregate position as a single economic entity
• CFS include:
o Statement of comprehensive income,
o Statement of financial position,
o Statement of changes in equity,
o Statement of cash flows, and
o Notes to the financial statements (see AASB101)
• All of which are presented for the ‘economic entity’ or ‘group’
• There is very little information provided within group financial statements for the individual ‘legal entities’ in the group
o E.g. the parent and its subsidiaries
THE LOGIC OF CONSOLIDATION
• We want to look ‘past the veil’ of incorporation and present the ‘economic truth’ of one larger ‘economic entity’
• Assumption of control is that all of these entities are acting as one
• Furthermore:
o Accountability
§ If we have ‘control’ of a legal entity, then logically the performance and position of that entity is fully
our responsibility
o Supply of relevant in formation
§ Investors of the parent entity have an interest in the group as a whole, not just in the parent entity
o Comparable information
§ Investors can make useful comparisons between economically cohesive entities that just happen to
organise into potentially hundreds of distinct legal entities for other reasons (slide 9), which may
therefore be unhelpful to investors
o Consistency
§ Allows for consistent policies on asset measurement, revenue recognition, etc
UNDERSTAND THE HISTORY OF CONSOLIDATION
HISTORY OF CONSOLIDATION (ARTHUR SECTION 1.3)
• 1925: ASX required consolidation
• 1950s: Consolidated statements commonplace despite lack of legal requirement. Partly due to cross-guarantees. What
other motivation could there be to consolidate?
• 1961: Uniform Australian Companies Act contained consolidation requirement but several loopholes enabled non-
consolidation. Definition of control focused on corporate entities and was understood to only apply with greater than
50% share interest. Groups interposed trusts and reduced ownership below 50% where they didn’t want to consolidate.
And so we see motivations to both consolidate and also to not consolidate. Why?
• 1990: First consolidation accounting standard AASB 1024 requiring all controlled ‘entities’ to be consolidated. Control
now based on ‘economic substance’ over ‘legal form’
• 2004: AASB 3 and AASB 127 issued – strengthening of ‘substance over form’ tests (loop hole)
• 2011: AASB 10 issued (effective periods starting 1 January 2013). Key test of control now ‘current ability to direct’
2
,UNDERSTAND THE DEVELOPMENT OF CFS
THE GROUP
• Businesses often operate via group structure where parent entity controls one or more ‘subsidiaries’
• [Note here that a ‘subsidiary’ is a separate legal entity ‘controlled’ by a ‘parent’– you might recall that you had a
different understanding of the concept of ‘subsidiary’ in ACCT1006]
• Entrepreneurs do business through group structure for a number of reasons:
o Legal (limited liability)
o To isolate different enterprises/ regional branches/ debt/ assets within one company
o Thereby ease of takeover etc
o For tax/stamp duty reasons
o International operations
EXAMPLE OF A GROUP STRUCTURE
SOME DEFINITIONS
• A group comprises a “parent entity” and each of its “subsidiaries” (AASB 10, Appendix A)
• A parent is an entity that controls one or more entities (AASB 10, Appendix A)
• A subsidiary is an entity controlled by another entity (AASB 10, Appendix A)
• Referring to the group structure on slide 10, where we have control over the investments, we have to group (or
consolidate) them together
• And the definition of ‘control’
• Appreciate for now that share ownership is relevant, but fundamentally the definition is qualitative and subjective
requiring an examination of all of the facts of the relationship – professional judgement
EXPLAIN THE CONCEPT OF A GROUP AND DESCRIBE THE CONCEPT OF CONTROL PER
AASB10
THE DEFINITION OF CONTROL
• Control exists 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 (AASB 10.6)
• That is, an investor controls an investee if and only if the investor has all the following (AASB 10.7):
o a) Power over the investee; and
o b) Exposure, or rights, to variable returns from its involvement with the investee; and
o c) The ability to use its power over the investee to affect the amount of the investor’s returns
• Note what is not in the definition – no direct reference to % of share ownership. Why not?
• Implications/thoughts:
o Control is defined in terms of “substance” rather than “form”
o Control can be passive
o Can we have control with zero shares?
§ E.g. a bank administering bankruptcy procedures of a company
3
, CONTROL: TEST A) – THE POWER ELEMENT (MOST IMPORTANT)
• AASB 10.10 – Power is defined as follows:
o An investor has power over an investee when the investor has existing rights that give it the current ability to
direct the relevant activities, i.e. the activities that significantly affect the investee’s returns
• What does ‘current ability’ mean?
o ‘Current ability’ refers to the fact that the investor is able to approve or block decisions as at reporting date
o Holding ordinary voting shares probably gives rise to a ‘current ability’, whereas holding options which can be
converted into ordinary shares in six months time does not reflect ‘current ability’
o Likewise, holding rights to direct the investee as at reporting date probably gives rise to ‘current ability’
• What are ‘relevant activities’?
o AASB 10.B11 – Relevant activities include sales, purchases, managing assets, research and development
• What is the importance of voting rights?
o AASB10.B35 – An investor that holds more than half of the voting rights of an investee has power in the
following situations, unless B36 or B37 applies:
§ (a) the relevant activities are directed by a vote of the holder of the majority of the voting rights, or
§ (b) a majority of the members of the governing body that directs the relevant activities are appointed by
a vote of the holder of the majority of the voting rights
• The importance of voting rights
o AASB10.B36 – Rights must be substantive and must provide the investor with the current ability to direct the
relevant activities
o AASB10.B37 – But no power if that majority of voting rights are not substantive
• The importance of voting rights
o AASB10.B38 – An investor can have power with less than a majority of the voting rights of an investee, for
example, through:
§ a) A contractual arrangement between the investor and other vote holders (see B39);
§ b) Rights arising from other contractual arrangements (see B40);
§ c) The investor’s voting rights (see B41-45); - look at the minutes to determine that someone might
have more power
§ d) Potential voting rights (see B47-50); or – looking at their ability to direct today even though in the
future they may have a majority allowing a change
§ A combination of (a)—(d)
o In applying AASB 10.B38 some factors to consider include:
§ Practical ability to direct the relevant activities (B41)
§ Size of the voting interest(B42)
§ Dispersion of other shareholders(B43)
§ Attendance at annual general meetings (B45)
§ Level of disorganisation or apathy of the remaining shareholders
• Potential voting rights
o B47-50 if an investor holds an option to acquire shares from another shareholder, and if that exercise price is
reasonable, then those rights may be assessed to be substantive (practical to exercise) and so may contribute to
our assessment that that investor has ‘power’
• AASB10.B18 – Where it is difficult to determine whether rights are sufficient to give rise to power the following may
provide evidence that the rights are sufficient to give rise to control:
o a) The investor can, without having the contractual right to do so, appoint or approve the investee’s key
management personnel who have the ability to direct the relevant activities.
o b) The investor can, without having the contractual right to do so, direct the investee to enter into, or can veto
any changes to, significant transactions for the benefit of the investor.
o c) The investor can dominate either the nominations process for electing members of the investee’s governing
body or the obtaining of proxies from other holders of voting rights.
o d) The investee’s key management personnel are related parties of the investor (for example, the chief executive
officer of the investee and the chief executive officer of the investor are the same person).
o e) The majority of the members of the investee’s governing body are related parties of the investor
4
WEEK 1 (CH 1): INTRO TO CONSOLIDATION AND THE CONCEPT OF CONTROL
• Wasn’t Fin A enough? Why are we still here?
• Important to specify paragraph FOR EXAM
• Developing knowledge of accounting/financial reporting
o Level 1
§ Double entry, accounting records, accruals and end of period adjustments, financial statements, some
accounting rules (e.g. inventory, PPE)
o Level 2
§ Regulatory and financial reporting framework, reporting requirements
o Level 3
§ From single reporting entity to group financial reporting
DESCRIBE THE DIFFERENT CLASSIFICATIONS OF INVESTMENTS
LEIBLER’S PAPER
• A key focus in this unit is the development of critical perspectives. Why is that necessary? Because theory and practice
do not always seem to align
• ...starting with Leibler (2003)
• Corporations Law – financial reports must both comply with accounting standards, and present a true and fair view
• Leibler’s perspective - Directors are doing a reasonable job at the former, but not so well with the latter
• A question we’ll come back to again and again this semester; what is ‘true and fair’, and do the examples of financial
reporting we see suggest directors are sufficiently addressing true and fair, or more concerned about making the reporting
entity ‘look good’?
TYPES OF INTERESTS IN OTHER ENTITIES
• Possible types of investments include:
• We can see “shades of influence” by investor over their investments in other entities on the above continuum
ACCOUNTING FOR INTERESTS IN OTHER ENTITIES BY INVESTOR
1
,OUTLINE THE OBJECTIVES OF PREPARING CONSOLIDATED FINANCIAL STATEMENTS
(CFS)
CONCEPT OF CONSOLIDATION
• To consolidate means to group the financial performance and position of a number of entities on a line by line basis into
one aggregate position as a single economic entity
• CFS include:
o Statement of comprehensive income,
o Statement of financial position,
o Statement of changes in equity,
o Statement of cash flows, and
o Notes to the financial statements (see AASB101)
• All of which are presented for the ‘economic entity’ or ‘group’
• There is very little information provided within group financial statements for the individual ‘legal entities’ in the group
o E.g. the parent and its subsidiaries
THE LOGIC OF CONSOLIDATION
• We want to look ‘past the veil’ of incorporation and present the ‘economic truth’ of one larger ‘economic entity’
• Assumption of control is that all of these entities are acting as one
• Furthermore:
o Accountability
§ If we have ‘control’ of a legal entity, then logically the performance and position of that entity is fully
our responsibility
o Supply of relevant in formation
§ Investors of the parent entity have an interest in the group as a whole, not just in the parent entity
o Comparable information
§ Investors can make useful comparisons between economically cohesive entities that just happen to
organise into potentially hundreds of distinct legal entities for other reasons (slide 9), which may
therefore be unhelpful to investors
o Consistency
§ Allows for consistent policies on asset measurement, revenue recognition, etc
UNDERSTAND THE HISTORY OF CONSOLIDATION
HISTORY OF CONSOLIDATION (ARTHUR SECTION 1.3)
• 1925: ASX required consolidation
• 1950s: Consolidated statements commonplace despite lack of legal requirement. Partly due to cross-guarantees. What
other motivation could there be to consolidate?
• 1961: Uniform Australian Companies Act contained consolidation requirement but several loopholes enabled non-
consolidation. Definition of control focused on corporate entities and was understood to only apply with greater than
50% share interest. Groups interposed trusts and reduced ownership below 50% where they didn’t want to consolidate.
And so we see motivations to both consolidate and also to not consolidate. Why?
• 1990: First consolidation accounting standard AASB 1024 requiring all controlled ‘entities’ to be consolidated. Control
now based on ‘economic substance’ over ‘legal form’
• 2004: AASB 3 and AASB 127 issued – strengthening of ‘substance over form’ tests (loop hole)
• 2011: AASB 10 issued (effective periods starting 1 January 2013). Key test of control now ‘current ability to direct’
2
,UNDERSTAND THE DEVELOPMENT OF CFS
THE GROUP
• Businesses often operate via group structure where parent entity controls one or more ‘subsidiaries’
• [Note here that a ‘subsidiary’ is a separate legal entity ‘controlled’ by a ‘parent’– you might recall that you had a
different understanding of the concept of ‘subsidiary’ in ACCT1006]
• Entrepreneurs do business through group structure for a number of reasons:
o Legal (limited liability)
o To isolate different enterprises/ regional branches/ debt/ assets within one company
o Thereby ease of takeover etc
o For tax/stamp duty reasons
o International operations
EXAMPLE OF A GROUP STRUCTURE
SOME DEFINITIONS
• A group comprises a “parent entity” and each of its “subsidiaries” (AASB 10, Appendix A)
• A parent is an entity that controls one or more entities (AASB 10, Appendix A)
• A subsidiary is an entity controlled by another entity (AASB 10, Appendix A)
• Referring to the group structure on slide 10, where we have control over the investments, we have to group (or
consolidate) them together
• And the definition of ‘control’
• Appreciate for now that share ownership is relevant, but fundamentally the definition is qualitative and subjective
requiring an examination of all of the facts of the relationship – professional judgement
EXPLAIN THE CONCEPT OF A GROUP AND DESCRIBE THE CONCEPT OF CONTROL PER
AASB10
THE DEFINITION OF CONTROL
• Control exists 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 (AASB 10.6)
• That is, an investor controls an investee if and only if the investor has all the following (AASB 10.7):
o a) Power over the investee; and
o b) Exposure, or rights, to variable returns from its involvement with the investee; and
o c) The ability to use its power over the investee to affect the amount of the investor’s returns
• Note what is not in the definition – no direct reference to % of share ownership. Why not?
• Implications/thoughts:
o Control is defined in terms of “substance” rather than “form”
o Control can be passive
o Can we have control with zero shares?
§ E.g. a bank administering bankruptcy procedures of a company
3
, CONTROL: TEST A) – THE POWER ELEMENT (MOST IMPORTANT)
• AASB 10.10 – Power is defined as follows:
o An investor has power over an investee when the investor has existing rights that give it the current ability to
direct the relevant activities, i.e. the activities that significantly affect the investee’s returns
• What does ‘current ability’ mean?
o ‘Current ability’ refers to the fact that the investor is able to approve or block decisions as at reporting date
o Holding ordinary voting shares probably gives rise to a ‘current ability’, whereas holding options which can be
converted into ordinary shares in six months time does not reflect ‘current ability’
o Likewise, holding rights to direct the investee as at reporting date probably gives rise to ‘current ability’
• What are ‘relevant activities’?
o AASB 10.B11 – Relevant activities include sales, purchases, managing assets, research and development
• What is the importance of voting rights?
o AASB10.B35 – An investor that holds more than half of the voting rights of an investee has power in the
following situations, unless B36 or B37 applies:
§ (a) the relevant activities are directed by a vote of the holder of the majority of the voting rights, or
§ (b) a majority of the members of the governing body that directs the relevant activities are appointed by
a vote of the holder of the majority of the voting rights
• The importance of voting rights
o AASB10.B36 – Rights must be substantive and must provide the investor with the current ability to direct the
relevant activities
o AASB10.B37 – But no power if that majority of voting rights are not substantive
• The importance of voting rights
o AASB10.B38 – An investor can have power with less than a majority of the voting rights of an investee, for
example, through:
§ a) A contractual arrangement between the investor and other vote holders (see B39);
§ b) Rights arising from other contractual arrangements (see B40);
§ c) The investor’s voting rights (see B41-45); - look at the minutes to determine that someone might
have more power
§ d) Potential voting rights (see B47-50); or – looking at their ability to direct today even though in the
future they may have a majority allowing a change
§ A combination of (a)—(d)
o In applying AASB 10.B38 some factors to consider include:
§ Practical ability to direct the relevant activities (B41)
§ Size of the voting interest(B42)
§ Dispersion of other shareholders(B43)
§ Attendance at annual general meetings (B45)
§ Level of disorganisation or apathy of the remaining shareholders
• Potential voting rights
o B47-50 if an investor holds an option to acquire shares from another shareholder, and if that exercise price is
reasonable, then those rights may be assessed to be substantive (practical to exercise) and so may contribute to
our assessment that that investor has ‘power’
• AASB10.B18 – Where it is difficult to determine whether rights are sufficient to give rise to power the following may
provide evidence that the rights are sufficient to give rise to control:
o a) The investor can, without having the contractual right to do so, appoint or approve the investee’s key
management personnel who have the ability to direct the relevant activities.
o b) The investor can, without having the contractual right to do so, direct the investee to enter into, or can veto
any changes to, significant transactions for the benefit of the investor.
o c) The investor can dominate either the nominations process for electing members of the investee’s governing
body or the obtaining of proxies from other holders of voting rights.
o d) The investee’s key management personnel are related parties of the investor (for example, the chief executive
officer of the investee and the chief executive officer of the investor are the same person).
o e) The majority of the members of the investee’s governing body are related parties of the investor
4
