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CHAPTER 12 Group financial statements. Contents. Introduction – Company groups Rationale for group financial statements Current practice Acquisition accounting Associated companies Joint ventures. Group financial statements.
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Contents • Introduction – Company groups • Rationale for group financial statements • Current practice • Acquisition accounting • Associated companies • Joint ventures
Group financial statements • Group (or consolidated) financial statements are the financial statements of a set of two or more enterprises organised as an economic entity • Group is defined according to concept of “control” • Control = power (de jure or de facto) to govern the financial and operating policies of an entity so as to obtain benefits from its activities (IFRS)
Company groups • Company group characteristics • Vertical group • Horizontal group • Conglomerate • Group expansion • Development of new subsidiaries • Acquisition by takeover of other companies • Meger between companies
Shares - Rights • Membership rights : • Influence on management, voting power • Equity rights: • Right to participate in distribution of profits + equivalent part of liquidation balance • In principle: rights are proportional to capital share • Exceptions: preferent shares, limitations to voting power, multiple votes per share,...
Group structure Enterprise A 100% 25% 51% Enterpise B Enterprise C Enterprise D 9% 100% Enterprise E Enterprise F
Rationale for group financial statements • Interdependent relationships within a group (patrimonial, contractual, personal ties) • Loss of part of their independence of individual entities • Common or unified management • Economic interest of the group > individual interests of legal entities involved • It is economically more relevant to present the financial statement of the economic whole as an aggregate of all assets and liabilities under unified control
Current practice • IAS 27 Consolidated and Separate Financial Statements • IFRS 3 Business Combinations • IAS 28 Investments in Associates • IAS 31 Investments in Joint Ventures • Seventh EC Company law Directive
Acquisition accounting • Purchase method of accounting • Fair value adjustments of acquired assets and liabilities • Subsequent measurement of goodwill • Minority interests • Merger accounting • Group income statement
Purchase method of accounting • Acquisition (or purchase method of) accounting is the method used to account for business combinations • Goodwill arises as a consolidation difference if the purchase cost of the investment is not equal to the book value of equity in the subsidiary
Fair value adjustments of acquired assets and liabilities • The individual assets and liabilities of the acquired company have to be revised to their fair value at acquisition date • This exercise may imply (de-)recognition of new (old) assets and liabilities • Goodwill will be the difference between the revalued net assets and the investment by the parent • The fair value at acquisition date is considered to be the historical cost from the point of view of the parent
Subsequent measurement of goodwill • IAS before 2004 + European Accounting Directives: • Amortise goodwill on a systematic basis over the best estimate of its useful life • Rebuttable assumption of a maximum of 20 years • IFRS 3 “Business Combinations” (2004): • Test goodwill for impairment annually (or more frequently if indications)
Minority interests • Minority interests (or non-controlling interests) appear if the group does not own 100% of the shares in a subsidiary • They represent the part of the net assets and profit or loss of the subsidiary attributable to the equity interests that are not owned
Merger accounting • Two companies can combine by merging their activities and managements without one of them acquiring the other • Two types of merger • Fusion • Pooling of interests • IFRS3 Business Combinations (2004) banned merger accounting methods
Group income statement • In the group income statement, the effect of intra-group transactions has to be eliminated • Only income and expenses recognized with regard to parties outside the group will be retained • Follow-up effects of fair value adjustments over time have to be integrated • Amortization of goodwill or impairment losses on goodwill may also significantly impact the group income statement
Fig.12.1 Consolidation procedures Adjust recognition criteria / measurements of financial statements of subsidiaries to uniform principles (IFRS) Aggregation of financial statements of all subsidiaries Fair value adjustments / Remove investment in subsidiaries / Identify goodwill and minority interests Deduct amortization/ impairment losses on goodwill / Follow-up of fair value adjustments Remove intra-group transactions and balances Group financial statements
Associated companies • Associated companies are companies in which the investor company has “significant influence” • Different types of relationships between investor company and investee company mainly according to voting rights under control • Accounting rules differ according to the type of relationship
Illustration - Associated company Company A buys 20% of Company C
IAS 28 Investments in Associates • IAS 28 Investments in Associates assumes significant influence if the investor holds at least 20 per cent of the voting rights of the investee • IAS 28 requires the equity method to account for associated companies • The part of the investor in the profit and loss of the associated company is introduced as a separate caption in the group income statement (“income from associates”)
Joint ventures • A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to jount control (IAS 31 Investments in Joint Ventures) • IFRS recognizes three kinds of arrangement: • Jointly controlled operations • Jointly controlled assets • Jointly controlled entities • IFRS recommends use of proportionate consolidation for jointly controlled entities