Appunti di Accounting finance and control

FINANCIAL STATEMENT CONSOLIDATION

A group of companies is an economic entity formed by a set of companies (separate legal entities). In a group, you can find a controlling entity (parent/holding) and one or more controlled entities (subsidiaries).

The parent company can have different types of investments with other legal entities, and this is important since the accounting approach changes. Depending on the type of investment, the other entity can be:

• Subsidiary: a company is defined as a subsidiary if the parent company exercises control over it. The accounting method that is used is full consolidation (IFRS 10, IFRS 3). Usually, there is control when the parent holds more than 50% of voting rights.
• Associate: a company is defined as an associate if the parent company has a significant influence on it. The accounting method that is used is the equity method (IAS 28). Significant influence is defined as the power to participate in the financial and operating policy decisions of the invested company.

but it is NOT a control or Joint Venture. Usually there is a significant influence when parent holds more than 20% of voting rights.

Joint Venture: when the parent company, together with another parent company, exercise control on another legal entity (Joint Control), this entity is called Joint Arrangement. The accounting method used may vary (IFRS 11).

Equity method: is used when the investor holds significant influence over investee but does not exercise full control over it.

Initial recognition: at cost -> Investments in associate (BS) and Cash (CFS)

After the initial recognition, if the carrying amount of the investment is increased or decreased by the investor's share on investee's Net Profit or Loss after the acquisition date -> Investments in associate (BS) and Profit form associate (IS)

Distributions received from investee -> Cash and Investments in associate (BS)

Group accounting is needed to provide more reliable information

• It requires a parent that controls other entities to prepare a consolidated financial statement.
• It defines the principles of control.
• It sets out the accounting requirements and the procedures that must be followed in order to prepare a consolidated financial statement.
• It sets out the exception to consolidation requirements.

its involvement with the investee and has the ability to affect those returns through its power over the investee.

Three conditions should exist to talk about control:

• Power over subsidiaries: voting and contractual rights, practical ability to exercise the rights, current ability to direct relevant activities (activities that significantly affect the investee's returns. Ex: purchases/sales, working capital, investments, R&D and financing).
• Exposure to variable returns: vary in response to performance.
• Ability to affect returns: through involvement.

Consolidation Process

Pre-consolidation adjustments:

• Closing periods: the purpose is to have the same closing periods. When the closing date of the financial statement of one or more subsidiaries is different from that of the parent company, the subsidiary prepares interim financial statements at the closing date of the parent company. When this is not feasible, the closing date of the financial statements of the

1. The difference between the closing dates does not exceed three months.
2. The duration of the financial year and the difference between the closing dates remain constant over time.
3. Adjustments are made for significant transactions and events which occur between the closing date of the subsidiary and the closing date of the parent company.

Accounting policies: when one or more subsidiaries use different accounting policies than those adopted by the group for similar transactions, then appropriate pre-consolidation adjustments are made as part of the consolidation process. Operationally this can be achieved:

1. By applying in the subsidiaries' individual accounts the accounting policies adopted by the group, to the extent that these are not in contrast with local law.
2. By requiring the subsidiaries to provide individual statements for the consolidation process appropriately adjusted to be consistent.

with the accounting policies used for the consolidated financial statements.

• Reporting currency: if the scope of consolidation includes companies that keep their accounts in a currency that is different from the reporting currency of the consolidated financial statements, it is necessary to translate financial statements denominated in currencies other than the reporting currency of the consolidated financial statements.
• Income Statement items (including the profit of the year) are translated at the effective exchange rate at the date of each transaction OR at the average exchange rate of the financial year.
• Balance Sheet items, except for the profit for the year, are translated at the exchange rate at the reporting closing date of the consolidated financial statements.
• If the rate used for translating income statement values does not coincide with the one used for the balance sheet, it causes a translation difference to be classified in a special owners' equity.

reservenamed translation reserve.

Consolidation process:

• Combine like items of the parent with those of its subsidiaries: this step consists in combining assets, liabilities, equity, income, expenses, and cash flows of the parent with those of its subsidiaries. Each item should be added according to its accounting category. Items should be combined at their fair values at the time control is acquired (not the book values), deferred taxes and liabilities: the tax effects on such surpluses must be considered. The differences between the book and the fair values of the recognized items may create "temporary differences" that will give rise to (or will lower) taxes in the future — we want to recognize such future obligation of deferred tax liabilities (or assets).
• Offset (eliminate): the carrying amount of the parent's investment in each subsidiary and the parent's portion of equity of each subsidiary (and recognize any non-controlling interests

goodwill): our purpose is to represent the situations as if A had acquired the assets and liabilities of B directly and in order to do so, we need to offset the item "Investments" against B's equity. Since the investment in B already incorporates the value of B's assets and liabilities, we need to make sure that we are not counting those value twice (simplest scenario: investments = equity).

If investments ≠ equity, the difference between the cost of acquisition and the parent's interest in the fair value of the subsidiary's net assets/liabilities at the acquisition date must be recorded in the following way:

• If positive (price paid > fair value of equity attributable to the parent): it must be included as an asset (goodwill) in the consolidated financial statements.

Goodwill: fair value of consideration transferred (purchase price - book value of equity of subsidiary) + fair value of non-controlling interests (fair value of the part of

Non-controlling interests arise when a subsidiary is not wholly controlled. If a parent acquires less than 100% of the subsidiary, we combine 100% of assets and liabilities, but then we eliminate 15% of them, recognized as "non-controlling interests". The investor may choose to measure a non-controlling interest in the investee, at the acquisition date, according to two approaches:

1. At fair value: the so-called full goodwill accounting.
2. At the non-controlling interest's proportionate share of the investee's identifiable net assets.

Eliminate intra-group transaction: IFRS 10 requires the full subsidiary (which is not under control of parent company) – fair value of net assets at acquisition (fair value of assets – fair value of liabilities).

If negative: estimates of the fair values of assets/liabilities of the subsidiary should be reviewed. The negative difference, if still existing, must be allocated to the income statements as a gain.

The elimination of intra-group transactions between entities of the group consists of:

• Intra-group revenues and costs, receivables, and payables.
• Inter-company profits and losses, related to inventories and fixed assets.
• Intra-group dividends.

From the perspective of the consolidated financial statements, the transactions that occur between group companies are equivalent to transactions between divisions/functions within a single company. Such transactions cannot be presented in the consolidated financial statements, as these must present only those transactions that group companies have made with third parties.

Example: Mickey Mouse: on 31 December company Mickey buys 100% of shares in company Mouse. The cost of the investment is 2.700. The balance sheet of the two companies at the date of the acquisition is reported in the following table:

On the acquisition date, the fair value of the assets and liabilities of Mouse equals their book value, except for plant, whose fair value is 1.000 higher.

that the carrying amount, and provisions, whose fair value is 200 higher than the book value.

The difference between the cost of the investment and owners' equity is recorded as goodwill.

Consider that the tax rate applied by the two companies is 50%.

Solution:

1. Recognition of surplus on PPE and provisions.
2. Elimination of investment and subsidiary's equity (1.500 + 500 = 2.000).
3. Recognition of deferred tax liabilities (1000*0,5=500) and deferred tax assets (200*0,5=100).
4. Recognition of goodwill:
   • Fair value of consideration transferred: purchase price (2.700) - book value of equity of subsidiary (2.000) = 700
   • + Fair value of non-controlling interest = 0, Mickey buys 100% of Mouse.
   • - Fair value of net assets at acquisition: increase of PPE's value (1.000) - deferred tax liabilities (500) - increase in provisions' value (200) + deferred tax asset (100)
   UA 12 -> Goodwill = 2.700 - 2.000 - 1.000 + 500 + 200 - 100 = 300

Ex. Star