Advanced Financial Accounting
PHP: CH 4
A&W: CH 12 & 13
Chapter 12: Consolidated Financial Statements
Consolidated financial statements (group accounts/group financial statements) which
presents the whole economic entity (MNCs = multinational companies).
Companies tend to develop on horizontal or vertical basis.
Vertical group (for example oil companies)
Companies with vertical basis typically have a production chain with:
- Extraction of raw materials
- Transport to manufacturing centers
- Manufacture of products
- Distribution through wholesale outlets
- Retailing to consumers
Horizontal group (for example, plastic moldings for motor moves to plastic moldings for toy)
Expands into different industries united by some similar product or process.
The conglomerate
Diversifies into non-related fields, with the aim of building up a profitable group that draws
strength from the fact that it consists of many diverse elements operating in different
economic environments (if one product is having a bad year, other products should not be
affected).
How can a group be built up?
1) Development of new subsidiaries by a company
2) The acquisition by takeover of other companies
3) Merger between companies (for accounting purposes always an acquirer and
acquiree)
4) (Joint venture)
No need to obtain 100% of the company to get full control, the biggest one (>50%) has the
voting majority.
If a potential investor only looks at the holding company, it might be misled as to the
strength of the group.
A company is required to consolidate an investee if it controls the investee. The definition of
control compromises three essential criteria (IFRS 10)
, 1) Power to direct
Current ability to direct the relevant activities (significantly affect the investee’s
return). For example, by voting rights granted by shareholdings (control >50). In
other cases, more difficult power resulting from contractual arrangements.
2) Exposure
Investor is exposed/has right to variable returns (pos or neg)
3) Linkage between power and returns
Ability to use its power to affect the investor’s returns
Principal-agent problem: Does the investor exercise his power for own benefit or behalf of
others. Also vice versa, is the entity acting as an agent.
Also, important to take into account potential voting rights, such as share warrants, share
call options, debt/equity instruments that are convertible into shares.
Preparing consolidated financial statements
- The investment by the holding company is eliminated and replaced by the assets and
liabilities of the subsidiary.
- Intragroup transactions and intra-group balances need to be eliminated
- Consolidation basics in acquisition method (IFRS 3 Business combinations,
complement of IFRS 10 Consolidated Financial Statements)
Acquisition method (purchase method) = accounting method to be used for business
combinations – when a company acquires another company, and the separate businesses
have to be brought together in one set of consolidated financial statements for the first
time.
Business combination = event in which an acquirer obtains control of another business –
acquisition (purchase) of a set of net assets.
Transition of control (acquirer obtains control) on the acquisition date.
When a company takes over another company, it pays money to the existing shareholders
(therefore not consolidated) and obtains the assets from the other company. However,
often the price paid to existing shareholders is higher (future profit potential), this is
recognized as the consolidation difference/goodwill (residual). The equity components of
the acquired company are called the pre-acquisition reserves and must be offset against the
investment.
However, when preparing the accounts of the new subsidiary for consolidation the parent
company must review the assets/liabilities and make two adjustments (only appear in
consolidated financial statements):
1) Recognize additional assets/liabilities that are not carried on the statement of
financial position but represent economic substance to the acquirer
For example, with brand names/patents/customer relationships (created by the
acquired company so not recognized on balance sheet yet – check CF)
2) Adjust the carrying amount to their fair value at acquisition date
PHP: CH 4
A&W: CH 12 & 13
Chapter 12: Consolidated Financial Statements
Consolidated financial statements (group accounts/group financial statements) which
presents the whole economic entity (MNCs = multinational companies).
Companies tend to develop on horizontal or vertical basis.
Vertical group (for example oil companies)
Companies with vertical basis typically have a production chain with:
- Extraction of raw materials
- Transport to manufacturing centers
- Manufacture of products
- Distribution through wholesale outlets
- Retailing to consumers
Horizontal group (for example, plastic moldings for motor moves to plastic moldings for toy)
Expands into different industries united by some similar product or process.
The conglomerate
Diversifies into non-related fields, with the aim of building up a profitable group that draws
strength from the fact that it consists of many diverse elements operating in different
economic environments (if one product is having a bad year, other products should not be
affected).
How can a group be built up?
1) Development of new subsidiaries by a company
2) The acquisition by takeover of other companies
3) Merger between companies (for accounting purposes always an acquirer and
acquiree)
4) (Joint venture)
No need to obtain 100% of the company to get full control, the biggest one (>50%) has the
voting majority.
If a potential investor only looks at the holding company, it might be misled as to the
strength of the group.
A company is required to consolidate an investee if it controls the investee. The definition of
control compromises three essential criteria (IFRS 10)
, 1) Power to direct
Current ability to direct the relevant activities (significantly affect the investee’s
return). For example, by voting rights granted by shareholdings (control >50). In
other cases, more difficult power resulting from contractual arrangements.
2) Exposure
Investor is exposed/has right to variable returns (pos or neg)
3) Linkage between power and returns
Ability to use its power to affect the investor’s returns
Principal-agent problem: Does the investor exercise his power for own benefit or behalf of
others. Also vice versa, is the entity acting as an agent.
Also, important to take into account potential voting rights, such as share warrants, share
call options, debt/equity instruments that are convertible into shares.
Preparing consolidated financial statements
- The investment by the holding company is eliminated and replaced by the assets and
liabilities of the subsidiary.
- Intragroup transactions and intra-group balances need to be eliminated
- Consolidation basics in acquisition method (IFRS 3 Business combinations,
complement of IFRS 10 Consolidated Financial Statements)
Acquisition method (purchase method) = accounting method to be used for business
combinations – when a company acquires another company, and the separate businesses
have to be brought together in one set of consolidated financial statements for the first
time.
Business combination = event in which an acquirer obtains control of another business –
acquisition (purchase) of a set of net assets.
Transition of control (acquirer obtains control) on the acquisition date.
When a company takes over another company, it pays money to the existing shareholders
(therefore not consolidated) and obtains the assets from the other company. However,
often the price paid to existing shareholders is higher (future profit potential), this is
recognized as the consolidation difference/goodwill (residual). The equity components of
the acquired company are called the pre-acquisition reserves and must be offset against the
investment.
However, when preparing the accounts of the new subsidiary for consolidation the parent
company must review the assets/liabilities and make two adjustments (only appear in
consolidated financial statements):
1) Recognize additional assets/liabilities that are not carried on the statement of
financial position but represent economic substance to the acquirer
For example, with brand names/patents/customer relationships (created by the
acquired company so not recognized on balance sheet yet – check CF)
2) Adjust the carrying amount to their fair value at acquisition date
