Introduction to group accounts

Learning objectives

By the end of this chapter, you should be able to:

• Define and describe the following terms in the context of group accounting: Parent, Subsidiary, Control, Consolidated (group) financial statements, Non-controlling interests, and Trade (simple) investment

Introduction

A major objective of business organizations is to increase their market share, and this is often achieved through growth or expansion. Businesses can grow using either organic or inorganic strategies.

In an organic growth strategy, a business uses its own resources (without the need to borrow) to expand its operations and grow the company.

In an inorganic growth strategy, growth is achieved by using resources or opportunities outside the company’s own operations. This often includes acquisitions (also called take-overs).

Definitions

Acquisition

It occurs when one entity takes ownership of another entity’s share capital or equity interests.

The number of shares acquired (either at a point in time or over a period) by the acquiring entity (the investor) determines how the acquisition or investment is accounted for in the financial statements.

Forms of acquisition

A business acquisition can result in any of the following arrangements:

1. Joint arrangements
2. Trade investment
3. Associate
4. Group

Definitions

Joint arrangements

It is a contractual agreement where two or more parties exercise joint control over an economic activity. Typically, where different entities or parties hold the same percentage of shares in the investee.

For example, if parties A, B, and C each hold 33% of the equity shares in company D, then A, B, and C are said to have joint control over D. These arrangements can be structured as joint operations (parties have rights to assets and obligations for liabilities) or joint ventures (parties have rights to net assets).

Definitions

Trade investment

Where a company acquires less than 20% interest in the other company. This is treated as a normal trade investment and accounted for using IFRS 9: Financial Instruments.

Associate

An associate is an entity over which an investor has significant influence but not control or joint control. This typically means the investor acquired 20-50% of voting rights. The investor accounts for associates using IAS 28: Equity Accounting.

Group

Typically, a company controls another by owning (acquiring) more than 50% of voting rights. The acquirer is said to be the parent and the acquiree, the subsidiary. The parent company together with the subsidiary (ies) and associate (where applicable) is called a group.

The parent and the subsidiary operate independently, and each prepares separate financial statements. However, they are also required to present financial information for the entities as a single economic unit (a group). This is done through consolidated financial statements.

Consolidation is accounted for using IFRS 10: Consolidated financial statements and IFRS 3: Business combinations.

This syllabus focuses on the last three (3) forms. For a group, we’ll focus on a basic consolidated financial statement. Note: Don’t proceed until you fully understand the type of investment/acquisition created when one company acquires an interest in another.

Group accounting

Definitions

Parent

An entity that controls one or more entities or an entity that has one or more subsidiaries.

Subsidiary

An entity that is controlled by another entity (known as the parent). Non-controlling interest

Equity in a subsidiary not attributable (not controlled), directly or indirectly, to (by) a parent.

Notice that these definitions all revolve around one central idea: control. If there is no control, there is no parent-subsidiary relationship, and consolidation (group) does not apply.

So, the key skill is being able to decide - based on a scenario - whether control exists and whether consolidated financial statements are required.

Control

Definitions

Control

According to IFRS 10, an investor controls an investee when

• the investor is exposed, or has rights, to variable returns from its involvement with the investee and
• can affect those returns through power over the investee.

An investor decides whether it is a parent by assessing whether it controls one or more investees. When making this assessment, the investor considers all relevant facts and circumstances.

An investor controls an investee if and only if the investor has all of the following elements:

• Power over the investee, i.e., the investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee’s returns)
• exposure, or rights, 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.

Definitions

Power

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

Power can be obtained directly from ownership of the majority of voting rights or can be derived from other rights, such as:

• Rights to appoint, reassign, or remove key management personnel who can direct the relevant activities
• Rights to appoint or remove another entity that directs the relevant activities
• Rights to direct the investee to enter into, or veto changes to, transactions for the benefit of the investor

A common (and often simplest) basis for establishing control is when the investor holds more than 50% voting rights in the investee. Other means by which control can be established

Control is not limited to situations where the investor holds more than 50% of the voting rights. Control can also exist with less than 50% voting rights in several scenarios:

• When an investor can effectively exercise majority voting power despite owning less than 50% (such as through proxies or agreements with other shareholders).
• Through contractual arrangements that grant the investor the decision-making authority over relevant activities.
• In situations where the investor holds a significant minority stake (less than 50%), while the remaining ownership is widely dispersed among many small shareholders.
• When the investor possesses instruments like options, warrants, or convertible securities that, if exercised, would provide sufficient voting rights to establish control.

These circumstances reflect the substance-over-form principle, recognizing that effective control can exist without majority ownership.

Accounting requirement

IFRS 10 states that, with certain exceptions, a parent must prepare consolidated financial statements for the group as a whole when control is established.

However, a parent need not present consolidated financial statements if it meets all of the following conditions:

Conditions under which consolidation may not be required

• It is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity, and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements
• its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets)
• it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market, and
• its ultimate or any intermediate parent of the parent produces financial statements available for public use that comply with IFRSs, in which subsidiaries are consolidated or are measured at fair value through profit or loss in accordance with IFRS 10.