In this article, we will continue to discuss about preparation of financial statements but this time, it will be the preparation and presentation of consolidated financial statements in IFRS 10. IFRS 10 Consolidated Financial Statements is the standard that governs the accounting requirements for the preparation of consolidated financial statements (or also commonly known as group account). Not sure what is consolidated financial statements? We got this covered in Preparation of separate financial statements under IAS 27.
IFRS 10 stipulates the following:
- An entity that is a parent that controls one or more of subsidiaries must present consolidated financial statements;
- The principle of control and establishes control as the basis for consolidation;
- The requirements on how to apply the principle of control;
- The requirements on the preparation of consolidated financial statements; and
- Definition of an investment entity and exception to consolidation for particular subsidiaries of an investment entity.
Let’s now go deeper to understand the requirements above.
Presentation of consolidated financial statements
As the general rule, all parents that control its subsidiaries must present consolidated financial statements. However, a parent does not need to present consolidated financial statements if it meets all the following conditions:
- The parent is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, (a) have been informed about and (b) do not object to, the parent not presenting consolidated financial statements;
- Its debt or equity instruments are not traded in a public market;
- 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 produces financial statements that are available for public use and comply with the International Financial Reporting Standards (“IFRSs”), in which subsidiaries are consolidated or are measured at fair value through profit or loss.
Nevertheless, in Malaysia, an ultimate Malaysian parent entity shall present consolidated financial statements. This means, although an ultimate Malaysian parent entity may have another parent in foreign jurisdiction which meets the above conditions, such ultimate Malaysian parent must still prepare the consolidated financial statements.
Another consolidation exception is also noted for a parent that is an investment entity. A parent entity which is an investment entity does not need to present consolidated financial statements if it is required to measure all of its subsidiaries at fair value through profit or loss. We will see further discussion on this in the investment entity section.
The control determination and assessment
IFRS 10 only requires a parent to consolidate the subsidiaries that it controls. The next question is then what is control? How do we know if a parent controls its subsidiaries? Do we only look at the ownership interest percentage? Can we assume a parent with ownership voting interests of more than half (>50% voting rights) controls the subsidiaries?
An entity or investor controls an 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. Accordingly, for an investor to control an investee, it must have the three control elements:
- Power over the investee
- Exposure/right to variable return from its involvement with the investee
- The ability to use its power over the investee to affect the amount of the its returns.
When assessing whether an entity controls an investee, the entity should consider all facts and circumstances. The decision made will only be re-assessed if facts and circumstances indicate that there are changes to one or more of the three elements of control.
In order to determine whether an entity has power over an investee, an entity must have existing rights that give it the current ability to direct the relevant activities of the investee. This requires an investor to determine what are the relavant activities of the investee – i.e., activities that significantly affect the investee’s returns. IFRS 10 provides examples of activities that, depending on circumstances, can be relevant activities. For examples: selling and purchasing of goods and services, selecting, acquiring or disposing of assets, determining funding structure or obtaining funding and others.
Power arises from rights. In assessing the rights that an investor have, such rights must be substantive rights – i.e., the holder have the practical ability to exercise that right – and this requires judgments to be exercised. Sometimes, rights can also be substantive even though they are not currently exercisable. It is also important for entities to be able to differentiate between substantive right and protective right. Protective rights relate to fundamental changes to the activities of the investee or are only apply in exceptional circumstances. Protective right is designed mainly to protect the interests of its holder without giving the holder power over the investee.
Right is generally obtained from the voting rights, although we can say that this is not always the case. Assessing whether an investor has power can be complex in certain scenarios and careful consideration based on facts and circumstances needs to be exercised. For example when power arising from one or more contractual arrangements. Generally, an investor that holds more than half of the voting rights has the power over the investee, if, the relevant activities are directed by a vote of the holder of the majority of the voting rights or a mojority of the members of the governing body that directs the relevant activities are appointed by a vote of the holder of the majority of the voting rights. Importantly, the voting rights must be substantive – an investor does not have power over an investee even though it holds the majority of the voting rights when those voting rights are not substantive. In contrast, an investor can also have a power even if it holds less than a majority of the voting rights of an investee.
An investor must also have exposure to variable returns from its involvement with the investee. This means the investor’s exposure varies as the result of the investee’s performance – i.e., returns from the investee can be only positive, only negative or both negative and positive. Examples of returns include dividends, other distribution of economic benefits from an investee, remuneration for servicing an investee’s assets and liabilities, fees and exposure to loss from providing credit or liquidity support and returns that are not available to other interest holders.
c) Link between power and returns
For an investor to control an investee, the investor must have the ability to use its power to affect the investor’s returns from its involvement with the investee. For this, an investor with decision-making rights must determine whether it is a principal or an agent. An agent is a party primarily engaged to act on behalf and for the benefit of another party and therefore does not control the investee when it exercises its decision-making authority. This requires judgments to be exercised to establish what kind of decision-making right that it has on the investee, including:
- the scope of its decision-making authority.
- the rights held by other parties.
- the remuneration to which it is entitled.
- the decision maker’s exposure to variability of returns from other interests it holds in the investee.
Preparation of consolidated financial statements
For the preparation of consolidated financial statements, the following requirements must be taken care or adhered to:
- Accounting policies – Uniform accounting policies must be applied by a member of the group for similar transactions and other events in similar circumstances. If any of the member uses different accounting policies, appropriate adjustments must be made to the member’s financial statements, for consolidation purposes, to ensure conmformity with the group’s accounting policies.
- The start and the end of consolidation – An investor starts consolidating an investee from the date the investor obtains control of the investee and ceases consolidating an investee when it loses control over it.
- Consolidation procedures – An investor should consolidate an investee by:
- Combine like items of assets, liabilities, equity, income, expenses and cash flows of the investor with those of its subsidiaries.
- Eliminate the carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity of each subsidiary.
- Eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group. Effects for temporary differences should also be considered.
- Reporting date – The financial statements of the parent and its subsidiaries used in the preparation of the consolidated financial statements must have the same reporting date. If subsidiaries have different reporting date from the parent, additional information and adjustments are required for consolidation purposes. The difference between the date of the subsidiary’s financial statements and that of the consolidated financial statements must not be more than 3 months. The length of reporting period should also be the same.
- Non-controlling interest (“NCIs”) – NCIs must be presented in the consolidated statement of financial position within equity, separately from equity of the owners of the parent. Profit or loss and each component of other comprehensive income must be attributed or apportioned between the owners of the parent and NCIs. When there is a change in a parent’s ownership interest that do not result in loss of control, the effects are equity transactions.
- Loss of control – When a parent loses control of a subsidiary, it:
- derecognises the assets, and liabilities of the subsidiary from its consolidated statement of financial position;
- recognises any investment retained in the former subsidiary at its fair value and subsequently accounts for it in accordance with the relevant IFRSs; and
- recognises the gain or loss arising from the loss of control.
An investment entity is defined as an entity that:
- obtains funds from one or more investors for the purpose of providing those investors with investment management services;
- commits to its investors that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both; and
- measures and evaluates the performance of substantially all of the investments on a fair value basis.
IFRS 10 also provides the typical characteristics of an investment entity. An investment entity that does not have all of the typical characteristics must provide additional disclosures required by IFRS 12 Disclosure of Interest in Other Entities. Any changes to the typical characteristcss or the definition of investment entity would require a parent to re-assess whether it is an investment entity.
IFRS 10 states that an investment entity should not consolidate its subsidiaries, instead should measure its investments in subsidiaries at fair value through profit or loss. However, if an investment entity has a subsidiary that is not itself an investment entity and whose main purpose and activities are providing services that relate to the investment entity’s investment activities, such subsidiary must be consolidated. This constitues an exception to the mandatory requirements to fair value investments of an investment entity.
It is important to note that a parent of an investment entity must consolidate all entities that it controls including those controlled through an investment entity subsidiary. Exception applies only if the parent itself is an investment entity.
IFRS 10 is in fact a complex and comprehensive standard. There are lots of judgments required in applying the principles and the requirements in practice. Nevertheless, we hope you got the key principles stated in the standard from this article.
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