Accounting for Group Structures 1

What are consolidated Financial statements? Consolidated Financial Statements are the financial Statement of a group presented as those of a single economic entity” whereby that bring the holding (parent) company's subsidiaries into its aggregated accounting figure. Above definition, explicitly stresses about a group relationship which involves parent and its subsidiaries. Consolidated financial statements provide a comprehensive overview of all the business operations that a parent company is involved in and has control over. 2

The Rationale for Consolidating the Financial Statement of Different Legal Entities Consolidated financial statements are presented primarily for the benefit of the share holders, creditors, and other resource providers of the parent. Consolidated financial statements represent the means of obtaining clear picture of the total resources of the combined entity that are under the control of the parent company. It would be difficult or not practicable for an investor or financial analyst to gather together all the accounting reports of a parent company and its many subsidiaries in order to get an idea of the financial health of the total enterprise. So as to eliminate this confusion consolidated financial statement came to prominence. 3

Investor Controls over Investee (Contd.) Simply, Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefits from it. The control is presumed to exist when parent company owns more than half of the voting power of entities either directly or indirectly through subsidiaries. Thus control can be either direct or indirect or combination. – Direct Control The Direct control is presumed to exist when parent company owns more than half of the voting power of entities directly. – Indirect Control The Indirect control is presumed to exist when parent company owns more than half of the voting power of entities through its subsidiaries. 4

Investor Controls over investee (Contd.) Company A Company B 60% Non Controlling Interest Figure 1: Direct Control 40% 5

Investor Controls over investee (Contd.) Company A Company B Company C Figure 2: Indirect Control 45% 60% 75% Non Controlling Interest 25% Non Controlling Interest 40% 15% 6 Non Controlling Interest

Investor Controls over investee (Contd.) Company A Company B Company C Figure 3: Indirect Control 40% 75% Non Controlling Interest 25% Non Controlling Interest 35% 10% 7 Non Controlling Interest 25% 30%

Joint Control Joint control is the contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control. This concept is applicable to the circumstances where there is a joint venture which is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. 8

Joint Control (Contd.) Company A Company B Company C Figure 4 : Joint Control 60% Joint-venture 40% 9 Joint Control agreement

Significant Influence Significant influence is the power to participate in operating & financial policy decisions of an entity but it is not control over those policies. Influence can be exercised over a firm, if one firm holds 20% to 50% of shares are owned by a particular firm. 10

Significant Influence (Contd.) Company A Company B 40% 11 Figure 5 : Significant Influence

Preparation and Presentation of Consolidated Financial Statements-SLFRS10; LKAS 27 Defines the principle of control, and establishes control as the basis for consolidation; As per SLFRS 10 “An investor controls investee when it 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”. So it can be concluded that investor controls investee if and only if the investor poses all of the followings. – Power over the investee – Exposure or right to variable returns from its involvement with the investee. – The ability to use its power over the investee to affect the amount of the investor’s returns. 12

Preparation and Presentation of Consolidated Financial Statements-SLFRS10; LKAS 27 Sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee – Power over the investee An investor is considered to have power over the investee when the investor has existing rights that give it the current ability to direct the relevant activities Power can arise from voting rights or contractual arrangements or a combination of both – Exposure or right to variable returns from its involvement with the investee. An investor is considered to have a exposure or right to variable return, if investor’s returns from its involvement have the potential to vary as a result of an investee’s performance. Despite the fact that more than one party can share the returns of an investee only one party can control the investee. – The ability to use its power over the investee to affect the amount of the investor’s returns. The ability to use its power to affect the investor’s return from its involvement with the investee will also a determinant of control. In circumstance where decision making (financial & operational) authority has been delegated to the investee then investor is not the controller any more. Investor is considered as an agent. 13

Preparation and Presentation of Consolidated Financial Statements-SLFRS10; LKAS 27 Sets out the accounting requirements for the preparation of consolidated financial statements As per SLFRS 10 “A parent shall prepare consolidated financial statement using uniform accounting policies for like transaction & other events in similar circumstances” Consolidation of an investee is presumed to be commenced from the date investor obtain control of the investee and cease when the investor loses control of the investee. 14

Introduction to Investments In Associates An associate is an entity over which the investor has significant influence. (LKAS 28) 15

Significant Influence Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies. (LKAS 28) If an investor holds, directly or indirectly (e.g. through subsidiary) 20% or more of the voting power of investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrate that this is not the case.. 16

Significant Influence (Contd.) Conversely, if the investor holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. 17

Significant Influence (Contd.) The existence of significant influence by an investor is usually evidenced in one or more of the following ways: Representation on the board of directors or equivalent governing body of the investee; Participation in policy-making process, including participation in decisions about dividends or other distributions; Material transaction between the investor and the investee; Interchange of managerial personnel; or Provision of essential technical information. 18

Equity Method of Accounting Investment in associates should be accounted using Equity Method. Equity Method Equity Method is the method of accounting where by the investment is initially recognised at cost adjusted thereafter the post-acquisition change in investor’s share of investee’s net assets. (LKAS 28) 19

Joint Arrangement A joint arrangement is an of which two or more parties have joint control.

A joint arrangement has following characteristics Parties bound by contractual arrangement. Contractual arrangement gives two or more parties joint control of the arrangement.

Joint control Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control

Types of Joint Arrangements 1.Joint Operation 1.Joint Venture The classification of joint arrangement as a joint operation or joint venture depends upon the right and obligations of the parties to the arrangement.

Joint Operation A joint operation is a joint arrangement where by parties that have joint control of the arrangement have right to the asset, and obligation for liabilities, relating to arrangement. Those parties are called joint operators. Joint operator is a party to a joint operation that has joint control of that joint operation.

Joint Venture A joint venture is a joint arrangement where by the parties that joint control the arrangement have rights to net assets of the arrangement. These parties are called joint venturers. Joint venturer is a party to a joint venture that has joint control of that joint venture.