INTRODUCTION:-
In business, consolidation or amalgamation is the
merger and acquisition of many smaller companies into
much larger ones. In the context of financial accounting,
consolidation refers to the aggregation of financial
statements of a group company as consolidated financial
statements. The taxation term of consolidation refers to
the treatment of a group of companies and other entities
as one entity for tax purposes. Under the Halsbury's Laws
of England, 'amalgamation' is defined as "a blending
together of two or more undertakings into one
undertaking, the shareholders of each blending company,
becoming, substantially, the shareholders of the blended
undertakings. There may be amalgamations, either by
transfer of two or more undertakings to a new company,
or to the transfer of one or more companies to an existing
company".
TYPES OF AMALGAMATION:There are three forms of business combinations:
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Statutory Merger: a business combination that results
in the liquidation of the acquired company’s assets
and the survival of the purchasing company.
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Statutory Consolidation: a business combination that
creates a new company in which none of the
previous companies survive.
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Stock Acquisition: a business combination in which
the purchasing company acquires the majority, more
than 50%, of the Common stock of the acquired
company and both companies survive.
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Variable interest entity
ECONOMIC MOTIVATION?
Access to new technologies
Access to new clients
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Access to new geographies
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Cheaper financing for a bigger company
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Seeking for hidden or nonperforming assets
belonging to a target company (e.g. real estate)
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Bigger companies tend to have superior bargaining
power over their suppliers and clients (e.g.Walmart)
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Types of business amalgamations:There are three forms of business combinations:
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Statutory Merger: a business combination that results
in the liquidation of the acquired company’s assets
and the survival of the purchasing company.
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Statutory Consolidation: a business combination that
creates a new company in which none of the
previous companies survive.
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Stock Acquisition: a business combination in which
the purchasing company acquires the majority, more
than 50%, of the Common stock of the acquired
company and both companies survive.
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Variable interest entity
ACCOUNTING TREATMENT:-
A parent company can acquire another company by
purchasing its net assets or by purchasing a majority
share of its common stock. Regardless of the method of
acquisition; direct costs, costs of issuing securities and
indirect costs are treated as follows:
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Direct costs, Indirect and general costs: the acquiring
company expenses all acquisition related costs as they are
incurred.
Costs of issuing securities: these costs reduce the issuing
price of the stock.
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Purchase of Net Assets
Treatment to the acquiring company: When
purchasing the net assets the acquiring company records
in its books the receipt of the net assets and the
disbursement of cash, the creation of a liability or the
issuance of stock as a form of payment for the transfer.
Treatment to the acquired company: The acquired
company records in its books the elimination of its net
assets and the receipt of cash, receivables or investment
in the acquiring company (if what was received from the
transfer included common stock from the purchasing
company). If the acquired company is liquidated then the
company needs an additional entry to distribute the
remaining assets to its shareholders.
Purchase of Common Stock
Treatment to the purchasing company: When
purchasing company acquires the subsidiary through
purchase of its common stock, it records in its books
investment in the acquired company and
disbursement of the payment for the stock acquired.
the
the
the
the
Treatment to the acquired company: The acquired
company records in its books the receipt of the payment
from the acquiring company and the issuance of stock.
FASB 141 Disclosure Requirements: FASB 141
requires disclosures in the notes of the financial
statements when business combinations occur. Such
disclosures are:
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The name and description of the acquired entity and
the percentage of the voting equity interest acquired.
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The primary reasons for acquisition and descriptions
of factors that contributed to recognition of goodwill.
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The period for which results of operations of acquired
entity are included in the income statement of the
combining entity.
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The cost of the acquired entity and if it applies the
number of shares of equity interest issued, the value
assigned to those interests and the basis for
determining that value.
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Any contingent payments, options or commitments.
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The purchase and development assets acquired and
written off.
Treatment of goodwill impairments:
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If Non-Controlling Interest (NCI) based on fair value of
identifiable assets: impairment taken against
parent's income & R/E
If NCI based on fair value of purchase price:
impairment taken against subsidiary's income & R/E
THE CONSOLIDATION CONCEPT:The consolidated financial statements can be said as the
combined financial statements of a parent company and
its
subsidiaries.
Because
consolidated
financial
statements present an aggregated look at the financial
position of a parent and its subsidiaries, they help to
measure the overall health of an entire group of
companies or organizations as opposed to one company's
stand-alone position.
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Consolidated financial statements present the financial
position and results of operations for a parent
(controlling entity) and one or more subsidiaries
(controlled entities) as if the individual entities actually
were a single company or entity. Consolidated financial
statements are generally considered to be more useful
than the separate financial statements of the individual
companies when the companies are related.
Whether the subsidiary is acquired or created, each
individual company maintains its own accounting records,
but consolidated financial statements are needed to
present the companies together as a single economic
entity for general-purpose financial reporting.
Some facts of Consolidation-Consolidation is done by Parent Entity.
-Consolidation should
reporting currency.
be
denominated
by
Parent’s
-Any periodicity gap should be neutralized.
-Non-Controlling Interests should be properly addressed.
-Mostly Equity Method is used for Consolidation.
-Approaches should be selected appropriately.
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Effectiveness of Consolidated Financial
Statements:Consolidated financial statements are presented primarily
for the benefit of the investors, creditors, and other
resource
providers
of
the
parent.
Significantly,
consolidated financial statements often represent the
only means of obtaining a clear picture of the total
resources of the combined entity that are under the
control of the parent company.
Consolidated financial statements report the financial
results of the parent company and all of its subsidiary
companies in one combined report. Some companies own
just one subsidiary, while others own many subsidiaries.
The consolidated financial statement includes just one set
of financial results. As each subsidiary reports its financial
results to the parent, the accounting staff at the parent
company gathers the individual financial results,
eliminates intercompany financial transactions and
consolidates the numbers into one statement. Several
benefits exist for companies who create consolidated
financial
statements.
The
Consolidated
Financial
Statement has following benefits1. Broad Picture: The basic advantage when
consolidating financial statements is the broad picture it
gives. Investors do not want to go through several
different financial statements to add up information and
find out how the corporation is doing overall. The
consolidated statements provided by the parent company
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accomplish the task automatically and make an excellent
reference point for shareholders, leaders and anyone
interested in how all the different parts of the business
are functioning as a whole.
2. Proper Balancing: Consolidating financial
statements also lets a corporation effectively balance its
appearance to outside parties. For example, during one
period a parent company may lose revenue and perform
poorly, but the subsidiaries may perform very well and
increase revenues. The consolidated statement will
balance the poor parent's performance with the positive
subsidiary performance, allowing the company to show
that through its diversification it remained profitable.
3. Exclusions: According to consolidated financial
statement guidelines, a corporation can also exclude
certain divisions from the statements. This is also an
advantage; because it allows investors to see --and
companies to show --that some financial aspects are not
long term. For example, subsidiaries are exempt if the
parent company's ownership of them is temporary or if
the control of the company does not actually rest with the
majority owner, which can happen through bankruptcy.
4. Less Paperwork: Another benefit of consolidated
financial statements is the reduced amount of paperwork
created for the statements. When a parent company
owns multiple subsidiaries, a set of financial statements
exists for each individual company. Each set of financial
statements includes four separate reports. If a parent
company owns nine subsidiaries, the complete set of
individual financial statements includes 40 reports. If the
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parent company consolidates the financial statements,
the set of financial statements only includes four reports.
5. Simplified: Consolidated financial statements also
provide a simplified view of the organization's results.
When one subsidiary sells products to another, it creates
an intercompany transaction. One company records a
sale, while another company records a purchase. The sale
and purchase cancel each other out from the complete
organization
perspective.
Consolidated
financial
statements eliminate these transactions and simplify the
financial statements.
6. Necessity: Consolidated financial statements are
required by most governments as an accurate
representation of a parent company's financial activity. In
general, tax laws require that a single accounting entity
be represented out of the net resources and operating
results of all the divisions that a company owns. As a
result, many companies have become used to producing
consolidated statements for governments, investors and
internal analysis.
7. Efficiency: One of the main advantages of the
consolidated financial statement is efficiency. Instead of
examining the financial statements of each company in a
network of dozens of companies, an investor or an
executive can examine a single financial statement to
determine the financial health of the entire network.
Nevertheless, consolidated financial statements are
usually considerably more complex than stand-alone
financial statements.
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8. Fraud Prevention: Another primary gain for
consolidated financial statements is the prevention of
fraud against investors. Without the requirement that
parent companies consolidate their financial statements,
companies could easily bury losses from underperforming
divisions and product lines in a web of subsidiaries and
cross-shareholdings. In this case, underperforming or
failing subsidiaries could be draining the finances of the
parent company to the point of near-bankruptcy, yet this
state of affairs would not become apparent by reading
the parent company's stand-alone financial statement.
The ultimate benefit of consolidated financial statements
should be ease of understanding and analysis of a
company's financial condition for investors, creditors,
vendors and anyone else who needs to know how secure
the company is with respect to being able to pay its bills
and continue as a profitable enterprise. However, a more
sinister benefit of consolidated finances is that they can
be manipulated to hide financial problems. It is extremely
difficult to ascertain from these statements whether there
are hidden problems and exactly where they are in the
enterprise.
Without consolidated financial statements the process of
evaluating a company for investment or financing
purposes would be a long complex affair that might
altogether miss important assets or liabilities. In fact,
many of the arguments that occur between company
management, accounting and auditing at year end
involve how the consolidation of reports should be done
in order to give the most accurate picture of the
company's financial health. It is the auditor's job to make
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sure this consolidation of accounting reports accurately
reflects the true condition of the company.
Boundaries of Consolidated Financial
Statements:While consolidated financial statements are useful, their
limitations also must be kept in mind. Some information is
lost any time data sets are aggregated; this is particularly
true when the information involves an aggregation across
companies that have substantially different operating
characteristics. Because subsidiaries are legally separate
from their parents, the creditors and stockholders of a
subsidiary generally have no claim on the parent, nor do
the stockholders of the subsidiary share in the profits of
the parent. Therefore, consolidated financial statements
usually are of little use to those interested in obtaining
information about the assets, capital, or income of
individual subsidiaries. The following clauses are the
boundaries of Consolidated Financial Statements-
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1. Lack of Subsidiary Information: The nature of
consolidated financial statements is that a group of
companies is viewed as one entity. By this assumption's
nature, the details of the individual companies are not
presented. In some cases, this is not important, as some
subsidiaries may not be material to the entire company's
operations and results. In other cases, the amalgamation
of financial results can hide unprofitable subsidiaries and
ventures. While the company in whole may be performing
well, consolidated statements may not show the entire
picture.
2. Elimination of Intercompany Transactions:
Generally accepted accounting principles require the
elimination
of
intercompany
transactions
upon
consolidation. Because of this rule, investors are unable
to ascertain the flow of funds between subsidiaries. This
could be important in determining which sections of the
company are viable in the long term. Furthermore, in
situations where subsidiaries operate using different
functional currencies, these eliminations can lead to
complex accounting and tax issues that may be in
accordance with accounting principles, but may be
confusing to even seasoned investors.
3. Higher Group Materiality: When looking at a
company on a consolidated basis, the threshold for
determining if accounting misstatements are material is
generally higher. For example, if a company had 10
subsidiaries that each had $1 million in annual sales, a
$10,000 sale would be more important to those
subsidiaries on an individual basis than to the group as a
whole. Because of this, companies and auditors need to
implement controls to ensure that the financial
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statements are fairly presented taken as a whole. This
may mean that companies need to reconsider an
appropriate level of accuracy in the financial statements
to reflect an acceptable amount of misstatement. Many
times this amount is in between the subsidiary and group
level of accuracy.
4. Significant Influence vs. Control: A major limitation
in the presentation of consolidated financial statements is
the creation of loopholes related to the consolidation of
joint ventures, variable interest entities, and other special
purpose entities. While revisions in accounting standards
have started to address these issues, the rules of
consolidation have allowed unscrupulous companies to
hide billions of dollars of debt from investors over the last
couple of decades, by creating entities that they do not
directly control, but only influence. While the accounting
for these entities is complex, investors should be aware
that the phenomenon exists and should be vigilant if the
performance of their investment appears too good to be
true.
5. Masks Poor Performance: When income statements
are brought together and reported on a consolidated
basis, the revenues, expenses and net profit are
presented as combined figures. This can hide any
profitability issues with one or more of the companies. For
example, if a subsidiary lost a substantial amount of
money in the year as a result of poor sales, financial
statement readers may not see that information if the
loss is combined with profits of the parent company.
6. Hides Inter-company Sales: All inter-company
transactions are removed in a consolidation. On one
hand, this presents a truer view of the companies by
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showing only financial activity with non-related parties.
However, it also hides the level of inter-company
transactions. If related companies spend most of their
time and resources selling products or services in the
group, an outside investor will not be able to assess
transfer prices or profit-shifting in the group. Both of
these things can be manipulated by companies and can
affect income taxes. Consolidation hides the extent of the
inter-company activity.
7. Skews Financial Ratios: One way that investors
assess the viability of a company is by its ratios. Ratios
are comparisons between financial statement lines. For
example, the current ratio is current assets divided by
current liabilities. This ratio tells investors how well the
company will be able to pay its near-term obligations. In a
consolidated financial statement, each company's assets,
liabilities and income are combined. Financial ratios
based on combined numbers may not be representative
of each company's ratios. If one of the companies has a
high level of debt compared to the equity of the owners,
that leverage would be hidden in a consolidated
statement.
Consolidated financial statements do not always give a
more accurate picture of the financial health of an
enterprise because the individual accounting reports from
the subsidiaries do not show up anywhere but in the
notes section of the consolidated finances. This makes it
possible to hide problems in the subsidiary reports, which
is how Enron managed to hide the losses and liabilities
some of its failed projects generated. It just buried them
in obscure subsidiaries created for the purpose of hiding
certain financial problems.
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Financial
Subsidiary:-
Statements
for
A company whose voting stock is more than 50%
controlled by another company, usually referred to as the
parent company or holding company. A subsidiary is a
company that is partly or completely owned by another
company that holds a controlling interest in the
subsidiary company. If a parent company owns a foreign
subsidiary, the company under which the subsidiary is
incorporated must follow the laws of the country where
the subsidiary operates, and the parent company still
carries the foreign subsidiary's financials on its books
(consolidated financial statements). For the purposes of
liability, taxation and regulation, subsidiaries are distinct
legal entities.
Though a Consolidated Financial Statement shows a
broad picture of a company, the parent and the
subsidiary both are responsible to prepare their own
separate financial statements according to the rules of
recording. Separate financial statements are helpful to
reveal the true environment of each of the subsidiary.
Investors can understand which one is more profitable
and which one is not. Consolidated Financial Statements
are not able to view the real state, the just shows the
combined picture of the company. So, each separate
entity is responsible to prepare & publish their financial
statements.
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Fundamentals of Acquisition:The Core principle of IFRS 3, IN5 states that, an acquirer
of a business recognizes the assets acquired and
liabilities assumed at their acquisition-date fair values
and discloses information that enables users to evaluate
the nature and financial effects of the acquisition.
The acquisition method states that, a business
combination must be accounted for by applying the
acquisition method, unless it is a combination involving
entities or businesses under common control. One of the
parties to a business combination can always be
identified as the acquirer, being the entity that obtains
control of the other business (the acquiree).Formations of
a joint venture or the acquisition of an asset or a group of
assets that does not constitute a business are not
business combinations. The IFRS establishes principles for
recognizing and measuring the identifiable assets
acquired, the liabilities assumed and any non-controlling
interest in the acquiree. Any classifications or
designations made in recognizing these items must be
made in accordance with the contractual terms, economic
conditions; acquirer’s operating or accounting policies
and other factors that exist at the acquisition date. Each
identifiable asset and liability is measured at its
acquisition-date fair value. Non-controlling interests in an
acquiree that are present ownership interests and entitle
their holders to a proportionate share of the entity’s net
assets in the event of liquidation are measured at either
fair value or the present ownership instruments’
proportionate share in the recognized amounts of the
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acquiree’s net identifiable assets. All other components of
non-controlling interests shall be measured at their
acquisition-date fair values, unless another measurement
basis is required by IFRSs.
The IFRS 3, IN9 provides limited exceptions to these
recognition and measurement principles:
(a) Leases and insurance contracts are required to be
classified on the basis of the contractual terms and other
factors at the inception of the contract (or when the
terms have changed) rather than on the basis of the
factors that exist at the acquisition date.
(b) Only those contingent liabilities assumed in a
business combination that are a present obligation and
can be measured reliably are recognized.
(c) Some assets and liabilities are required to be
recognised or measured in accordance with other IFRSs,
rather than at fair value. The assets and liabilities
affected are those falling within the scope of IAS 12
Income Taxes, IAS 19 Employee Benefits, IFRS 2 Sharebased Payment and IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations.
(d) There are special requirements for measuring a
reacquired right.
(e) Indemnification assets are recognised and measured
on a basis that is consistent with the item that is subject
to the indemnification, even if that measure is not fair
value.
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IN10 states that, IFRS requires the acquirer, having
recognised the identifiable assets, the liabilities and any
non-controlling interests, to identify any difference
between:
(a) The aggregate of the consideration transferred, any
non-controlling interest in the acquiree and, in a business
combination achieved in stages, the acquisition-date fair
value of the acquirer’s previously held equity interest in
the acquiree; and
(b) The net identifiable assets acquired.
The difference will, generally, be recognised as goodwill. If the acquirer
has made a gain from a bargain purchase that gain is recognised in profit
or loss.
The consideration transferred in a business combination (including any
contingent consideration) is measured at fair value. In general, an
acquirer measures and accounts for assets acquired and liabilities
assumed or incurred in a business combination after the business
combination has been completed in accordance with other applicable
IFRSs. However, the IFRS provides accounting requirements for
reacquired rights, contingent liabilities, and contingent consideration and
indemnification assets.
The Disclosure, IN13 refers, the IFRS requires the acquirer
to disclose information that enables users of its financial
statements to evaluate the nature and financial effect of
business combinations that occurred during the current
reporting period or after the reporting date but before the
financial statements are authorized for issue. After a
business combination, the acquirer must disclose any
adjustments recognised in the current reporting period
that relate to business combinations that occurred in the
current or previous reporting periods
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How to Consolidate?:The only responsibility goes to the parent company to
eliminate
all
inter-corporate
entries
to
prepare
consolidated financial statements. Elimination entries are
an advanced accounting tool used to simplify the
consolidated financial statement of affiliated companies.
When one company is the parent company of a subsidiary
company, a consolidated financial statement provides an
overall picture of the companies' combined financial
position. When two or more companies are affiliated
elimination entries are used for to avoid redundant
documentation of stock ownership of a subsidiary
company by stockholders, inter-company debt and intercompany revenue and expenses. Stock of a smaller
company acquired by a larger company is both an asset
of the larger company and a portion of the equity account
of each stockholder of both the larger and the smaller
company. Elimination entries are used to avoid reflecting
this ownership twice, as both a company asset and in the
equity accounts of each of the larger company's
stockholders. Furthermore, during an acquisition, a
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portion of the stock owned by each of the smaller
company's stockholders is purchased by the acquiring
company. Though these original stockholders interest is
still reported in their individual equity accounts, the
portion of their interest that was purchased is also
eliminated. Often a parent company makes an intercompany loan to a smaller company, whether for
purposes of expansion, to cover operating expenses or
any other business purpose. In such a case, the parent
company's financial statement shows a note receivable
as an asset, while the subsidiary company shows a note
payable as a liability. When combined, an elimination
entry removes both since what has essentially occurred is
just a cash transfer within the larger, consolidated entity.
Finally, inter-company revenue and expenses are
eliminated when companies sell one another goods or
services, pay rent or loan interest to one another or
perform any other transactions that are really a transfer
of assets in the same way an inter-company loan is a
transfer of cash.
ELIMINATION EXAMPLERecording at the date of Acquisition:
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Unrealized Gain:
Example: Suppose, Parent produces a phone
costing Rs.100, then parent sold it to its subsidiary
for Rs.150. The subsidiary should sell the phone to
the final customer for Rs.200. If somehow the
subsidiary was failed to sell the product to
customer then, an unrealized gain situation occurs
between parent & subsidiary transaction. The
unrealized gain amount will be Rs.50.
Commands for Elimination:1.Eliminate the parent company's investment in
each subsidiary as well as the retained earnings of the
subsidiary. Debit and zero out each subsidiary's common
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stock held at par or nominal value, additional paid-in
capital and retained earnings accounts. Retained earnings
are the accumulated net income of the company minus
dividend payments. The additional paid-in capital is the
excess over par received at stock issuance. Credit and
zero out the "investment in common stock of subsidiary"
account on the parent company's books.
2.Remove intercompany payables and receivables
from the consolidated account because a company
cannot borrow from or lend to itself. Intercompany refers
to transactions between different parts of the combined
entity. Debit and zero out intercompany accounts payable
and credit and zero out intercompany accounts
receivable.
3.Eliminate intercompany sales because consolidated
financial statements should reflect sales to external
entities only. For example, if you bought items from a
subsidiary at cost and paid cash, credit and zero out the
intercompany purchases account on your books; debit
and zero out the intercompany sales account on the
subsidiary's books; credit or reduce the cash account on
the subsidiary's books; and debit or increase the cash
account on your books by the amount of the
intercompany sales transaction.
4.Identify and remove unrealized profits in inventory
and retained earnings accounts. This refers to the fact
that intercompany sales and purchase transactions may
not always be at cost. Remove the excess amount from
both inventory and retained earnings. For example, if you
bought an item from a subsidiary at Rs 1,000 above cost,
debit or decrease the consolidated retained earnings
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account and credit or decrease the consolidated ending
inventory account by Rs 1,000 each.
The Acquisition Method:An entity shall determine whether a transaction or other
event is a business combination by applying the definition
in this IFRS, which requires that the assets acquired and
liabilities assumed constitute a business. If the assets
acquired are not a business, the reporting entity shall
account for the transaction or other event as an asset
acquisition
An entity shall account for each business combination by
applying the acquisition method. Applying the acquisition
method requiresA.Identifying the acquirer:
For each business combination, one of the combining
entities shall be identified as the acquirer.
B.Determining the acquisition date:
The acquirer shall identify the acquisition date, which is
the date on which it obtains control of the acquiree.
C.Recognizing and measuring the identifiable
assets acquired, the liabilities assumed and any
non-controlling interest in the acquiree:
Recognition Principle says, as of the acquisition date, the
acquirer shall recognize, separately from goodwill, the
identifiable assets acquired, the liabilities assumed and
any non-controlling interest in the acquiree. At the
acquisition date, the acquirer shall classify or designate
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the identifiable assets acquired and liabilities assumed as
necessary to apply other IFRSs subsequently. The
acquirer shall make those classifications or designations
on the basis of the contractual terms, economic
conditions, its operating or accounting policies and other
pertinent conditions as they exist at the acquisition date.
Measurement principle says, the acquirer shall measure
the identifiable assets acquired and the liabilities
assumed at their acquisition-date fair values.
The acquirer shall recognize and measure a deferred tax
asset or liability arising from the assets acquired and
liabilities assumed in a business combination in
accordance with IAS 12 Income Taxes. The acquirer shall
recognize and measure a liability (or asset, if any) related
to the acquiree’s employee benefit arrangements in
accordance with IAS 19 Employee Benefits.
D.Recognizing and measuring goodwill or a gain
from a bargain purchase:
The acquirer shall recognize goodwill as of the acquisition
date measured as the excess of (a) over (b) below:
(a) The aggregate of:
i.The consideration transferred measured in accordance
with this IFRS, which generally requires acquisition-date
fair value.
ii.The amount of any non-controlling interest in the
acquiree measured in accordance with the IFRS; and
iii.In a business combination achieved in stages the
acquisition-date fair value of the acquirer’s previously
held equity interest in the acquiree.
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(b) The net of the acquisition-date amounts of the
identifiable assets acquired and the liabilities assumed
measured in accordance with the IFRS.
Measurement PeriodIf the initial accounting for a business combination is
incomplete by the end of the reporting period in which
the combination occurs, the acquirer shall report in its
financial statements provisional amounts for the items for
which the accounting is incomplete. During the
measurement period, the acquirer shall retrospectively
adjust the provisional amounts recognised at the
acquisition date to reflect new information obtained about
facts and circumstances that existed as of the acquisition
date and, if known, would have affected the
measurement of the amounts recognised as of that date.
During the measurement period, the acquirer shall also
recognize additional assets or liabilities if new information
is obtained about facts and circumstances that existed as
of the acquisition date and, if known, would have resulted
in the recognition of those assets and liabilities as of that
date. The measurement period ends as soon as the
acquirer receives the information it was seeking about
facts and circumstances that existed as of the acquisition
date or learns that more information is not obtainable.
However, the measurement period shall not exceed one
year from the acquisition date.
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Determining what is part of the
Business Combination Transaction:
The acquirer and the acquiree may have a pre-existing
relationship or other arrangement before negotiations for
the business combination began, or they may enter into
an arrangement during the negotiations that is separate
from the business combination. In either situation, the
acquirer shall identify any amounts that are not part of
what the acquirer and the acquiree (or its former owners)
exchanged in the business combination, is amounts that
are not part of the exchange for the acquiree. The
acquirer shall recognize as part of applying the
acquisition method only the consideration transferred for
the acquiree and the assets acquired and liabilities
assumed in the exchange for the acquiree. Separate
transactions shall be accounted for in accordance with
the relevant IFRSs.
Acquisition-related Costs:
Acquisition-related costs are costs the acquirer incurs to
effect a business combination. Those costs include
finder’s fees; advisory, legal, accounting, valuation and
other
professional
or
consulting
fees;
general
administrative costs, including the costs of maintaining
an internal acquisitions department; and costs of
registering and issuing debt and equity securities. The
acquirer shall account for acquisition-related costs as
expenses in the periods in which the costs are incurred
and the services are received, with one exception. The
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costs to issue debt or equity securities shall
recognised in accordance with IAS 32 and IFRS 9.
be
Subsequent measurement and
Accounting:
In general, an acquirer shall subsequently measure and
account for assets acquired, liabilities assumed or
incurred and equity instruments issued in a business
combination in accordance with other applicable IFRSs for
those items, depending on their nature. However, this
IFRS provides guidance on subsequently measuring and
accounting for the following assets acquired, liabilities
assumed or incurred and equity instruments issued in a
business combination:
A.Reacquired rights:
A reacquired right recognised as an intangible asset shall
be amortized over the remaining contractual period of the
contract in which the right was granted. An acquirer that
subsequently sells a reacquired right to a third party shall
include the carrying amount of the intangible asset in
determining the gain or loss on the sale.
B.Contingent liabilities
acquisition date:
recognised
as
of
the
After initial recognition and until the liability is settled,
cancelled or expires, the acquirer shall measure a
33
contingent liability recognised in a business combination
at the higher of:
-The amount that would be recognised in accordance with
IAS 37 and
-The amount initially recognised less, if appropriate,
cumulative amortization recognised in accordance with
IAS 18 Revenue.
C.Indemnification Assets:
At the end of each subsequent reporting period, the
acquirer shall measure an indemnification asset that was
recognised at the acquisition date on the same basis as
the indemnified liability or asset, subject to any
contractual limitations on its amount and, for an
indemnification asset that is not subsequently measured
at its fair value, management’s assessment of the
collectability of the indemnification asset. The acquirer
shall derecognize the indemnification asset only when it
collects the asset, sells it or otherwise loses the right to it.
D.Contingent consideration:
Some changes in the fair value of contingent
consideration that the acquirer recognizes after the
acquisition date may be the result of additional
information that the acquirer obtained after that date
about facts and circumstances that existed at the
acquisition date. However, changes resulting from events
after the acquisition date, such as meeting an earnings
target, reaching a specified share price or reaching a
milestone on a research and development project, are not
measurement period adjustments. The acquirer shall
account for changes in the fair value of contingent
33
consideration that are not measurement period
adjustments as follows:
1.Contingent consideration classified as equity shall not
be remeasured and its subsequent settlement shall be
accounted for within equity.
2.Contingent consideration classified as an asset or a
liability that:
i.Is a financial instrument and is within the scope of IFRS
9 or IAS 39 shall be measured at fair value, with any
resulting gain or loss recognised either in profit or loss or
in other
comprehensive income in accordance with IFRS 9.
ii.Is not within the scope of IFRS 9 shall be accounted for
in accordance with IAS 37 or other IFRSs as appropriate.
Disclosures :The acquirer shall disclose information that enables users
of its financial statements to evaluate the nature and
financial effect of a business combination that occurs
either:
a)During the current reporting period or
b)After the end of the reporting period but before the
financial statements are authorized for issue.
The acquirer shall disclose information that enables users
of its financial statements to evaluate the financial effects
of adjustments recognised in the current reporting period
33
that relate to business combinations that occurred in the
period or previous reporting periods.
NON-CONTROLLING INTEREST:Non-controlling interest is an ownership stake in a
corporation where the held position gives the investor no
influence on how the company is run. The majority of
investor positions are deemed to be a non-controlling
interest because their ownership stake is so insignificant
relative to the total number of outstanding shares. For
smaller companies, any position that holds less than 50%
of the outstanding voting shares is deemed to be a noncontrolling interest. Non-controlling interest is ownership
of a company which does not give the shareholder the
control of the company. The control means that the
33
investor can govern the financial and operating policies of
its subsidiaries to gain benefits from the operations of
subsidiary. Usually the control can be gained if more than
50% of the voting rights are acquired by a party. This
means that any position that holds less than 50% of the
outstanding voting rights is deemed to be a noncontrolling interest.
Majority of the investor positions are considered to be
non-controlling interests because their voting power is so
insignificant relative to the total number of outstanding
shares. For most of the publically traded companies, the
number of outstanding shares is so large that a normal
shareholder cannot significantly affect higher level
decisions, which is why it is deemed to be a noncontrolling interest. Usually it is not until a party controls
about five to ten percent of the voting shares that it can
be elected for a seat on the board of directors.
The portion of the subsidiary net income assigned to the
non-controlling interest normally is deducted from
earnings available to all shareholders to arrive at
consolidated net income in the consolidated income
statement. Although this assignment of income does not
meet the definition of an expense, it normally is accorded
this expense-type treatment.
COMBINED
STATEMENTS:-
FINANCIAL
Unlike Consolidated Financial Statements, Combined
Financial Statement is a financial statement that merges
33
the assets, liabilities, net worth, and operating figures of
two or more affiliated companies. A combined statement
is distinguished from a consolidated financial statement
of a company and subsidiaries, which must reconcile
investment and capital accounts.
Financial statements sometimes are prepared for a group
of companies when no one company in the group owns a
majority of the common stock of any other company in
the group. Financial statements that include a group of
related companies without including the parent company
or other owner are referred to as combined financial
statements.
Different Approaches to
Consolidation:Several different theories exist that might serve as a
basis for preparing consolidated financial statements. The
choice of consolidation theory can have a significant
33
impact on the consolidated financial statements in those
cases where the parent company owns less than 100
percent of the subsidiary’s common stock. There are
three alternative theories of consolidation:
? Proprietary Theory
? Parent Company Theory
? Entity Theory
THE PROPRIETARY THEORY is where no fundamental
distinction is drawn between a legal entity and its owners,
i.e. the entity does not exist separately from the owners
for accounting purposes. The primary focus is to report
information useful to the owners, and therefore the
financial statements are prepared from their perspective.
The proprietary theory of accounting views the firm as an
extension of its owners. The assets and liabilities of the
firm are considered to be assets and liabilities of the
owners themselves. Similarly, revenue of the firm is
viewed as increasing the wealth of the owners, while
expenses decrease the wealth of the owners.
When applied to the preparation of consolidated financial
statements, the proprietary concept results in a pro rata
consolidation. The parent company consolidates only its
33
proportionate share of the assets and liabilities of the
subsidiary.
THE PARENT COMPANY THEORY is perhaps better
suited to the modern corporation and the preparation of
consolidated financial statements than is the proprietary
approach. The parent company theory recognizes that
although the parent does not have direct ownership of
the assets or direct responsibility for the liabilities of the
subsidiary, it has the ability to exercise effective control
over all of the subsidiary’s assets and liabilities, not
simply a proportionate share.
Under parent company theory, separate recognition is
given in the consolidated balance sheet to the noncontrolling interest’s claim on the net assets of the
subsidiary and in the consolidated income statement to
the
earnings
assigned
to
the
non-controlling
shareholders.
THE ENTITY THEORY is where a legal entity is regarded
as having a separate existence from the owners. The
financial statements are prepared from the perspective of
the entity, not its owners. The assumption is that the
economic activities of a business are distinct from those
of its owners. The entity theory maintains that the
activities of a business can be accounted for separately
from the activities of its owners; therefore the owners are
not personally responsible for loans or other liabilities
taken on by the company. The entity theory is
fundamental to modern accounting.
33
Emphasis under the entity approach is on the
consolidated entity itself, with the controlling and Noncontrolling shareholders viewed as two separate groups,
each having equity in the consolidated entity. Neither of
the two groups is emphasized over the other or over the
consolidated entity.
Current Practice:
The procedures used in practice represent a blending of
the parent company and entity approaches. The amount
of subsidiary net assets recognized in the consolidated
balance sheet at acquisition is the same in practice as
under the parent company approach. On the other hand,
the determination of consolidated net income is a
combination of the entity and parent company
approaches.
Future Practice:
The authority has proposed moving to an entity approach
in practice. This would result in classifying the noncontrolling interest in the stockholders’ equity section of
the consolidated balance sheet and labeling the total
income of the consolidated entity as consolidated net
income, with an allocation of consolidated net income
between the controlling and non-controlling interests in
the income statement.
KEY SUMMARY:-
33
Growing a company often involves buying out the
competition to acquire their customers and expanding
business through adding new products, services and
technology. These additions to a company's offering line
usually means purchasing smaller companies that service
particular niches through their own product lines or
technologies. The subsidiary companies normally
continue to operate as separate companies under the
control of the parent company but according to
accounting rules each must maintain separate accounting
records. These separate accounting records are then
consolidated with the parent company's accounting
records to produce the consolidated finances.
It would be difficult 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 parent
companies are now required to report their finances on a
consolidated basis. Occasionally the parent will make a
separate report of its own finances, but that cannot stand
alone and must be accompanied by the consolidated
report.
Some misappropriation could be, consolidated financial
statements do not always give a more accurate picture of
the financial health of an enterprise because the
individual accounting reports from the subsidiaries do not
show up anywhere but in the notes section of the
consolidated finances. This makes it possible to hide
problems in the subsidiary reports, which is how Enron
managed to hide the losses and liabilities some of its
failed projects generated. It just buried them in obscure
subsidiaries created for the purpose of hiding certain
financial problems.
Following IFRS
33
The ultimate benefit of consolidated financial statements
should be ease of understanding and analysis of a
company's financial condition for investors, creditors,
vendors and anyone else who needs to know how secure
the company is with respect to being able to pay its bills
and continue as a profitable enterprise. However, a more
sinister benefit of consolidated finances is that they can
be manipulated to hide financial problems. It is extremely
difficult to ascertain from these statements whether there
are hidden problems and exactly where they are in the
enterprise. The FASB (Financial Accounting Standards
Board) regularly visits this subject to correct definitions
and requirements that might serve as loopholes for
companies wishing to hide losses and liabilities. The IASB
(International Accounting Standards Board) is also
working to create definitions and rules that will make
evaluation easier and more reliable when examining the
financial reports of foreign companies and companies
with offshore subsidiaries.
Without consolidated financial statements the process of
evaluating a company for investment or financing
purposes would be a long complex affair that might
altogether miss important assets or liabilities. In fact,
many of the arguments that occur between company
management, accounting and auditing at year end
involve how the consolidation of reports should be done
in order to give the most accurate picture of the
company's financial health. It is the auditor's job to make
sure this consolidation of accounting reports accurately
reflects the true condition of the company.
BIBLIOGRAPHY:33
The following sources were referred to extensively during
the entire course of this assignment:
? www.wikipedia.org
? www.academia.edu
? www.budgetcontrol.com
33
doc_217975441.doc
In business, consolidation or amalgamation is the
merger and acquisition of many smaller companies into
much larger ones. In the context of financial accounting,
consolidation refers to the aggregation of financial
statements of a group company as consolidated financial
statements. The taxation term of consolidation refers to
the treatment of a group of companies and other entities
as one entity for tax purposes. Under the Halsbury's Laws
of England, 'amalgamation' is defined as "a blending
together of two or more undertakings into one
undertaking, the shareholders of each blending company,
becoming, substantially, the shareholders of the blended
undertakings. There may be amalgamations, either by
transfer of two or more undertakings to a new company,
or to the transfer of one or more companies to an existing
company".
TYPES OF AMALGAMATION:There are three forms of business combinations:
?
Statutory Merger: a business combination that results
in the liquidation of the acquired company’s assets
and the survival of the purchasing company.
33
?
Statutory Consolidation: a business combination that
creates a new company in which none of the
previous companies survive.
?
Stock Acquisition: a business combination in which
the purchasing company acquires the majority, more
than 50%, of the Common stock of the acquired
company and both companies survive.
?
Variable interest entity
ECONOMIC MOTIVATION?
Access to new technologies
Access to new clients
?
Access to new geographies
?
Cheaper financing for a bigger company
?
Seeking for hidden or nonperforming assets
belonging to a target company (e.g. real estate)
?
Bigger companies tend to have superior bargaining
power over their suppliers and clients (e.g.Walmart)
?
Types of business amalgamations:There are three forms of business combinations:
?
Statutory Merger: a business combination that results
in the liquidation of the acquired company’s assets
and the survival of the purchasing company.
33
?
Statutory Consolidation: a business combination that
creates a new company in which none of the
previous companies survive.
?
Stock Acquisition: a business combination in which
the purchasing company acquires the majority, more
than 50%, of the Common stock of the acquired
company and both companies survive.
?
Variable interest entity
ACCOUNTING TREATMENT:-
A parent company can acquire another company by
purchasing its net assets or by purchasing a majority
share of its common stock. Regardless of the method of
acquisition; direct costs, costs of issuing securities and
indirect costs are treated as follows:
?
?
Direct costs, Indirect and general costs: the acquiring
company expenses all acquisition related costs as they are
incurred.
Costs of issuing securities: these costs reduce the issuing
price of the stock.
33
Purchase of Net Assets
Treatment to the acquiring company: When
purchasing the net assets the acquiring company records
in its books the receipt of the net assets and the
disbursement of cash, the creation of a liability or the
issuance of stock as a form of payment for the transfer.
Treatment to the acquired company: The acquired
company records in its books the elimination of its net
assets and the receipt of cash, receivables or investment
in the acquiring company (if what was received from the
transfer included common stock from the purchasing
company). If the acquired company is liquidated then the
company needs an additional entry to distribute the
remaining assets to its shareholders.
Purchase of Common Stock
Treatment to the purchasing company: When
purchasing company acquires the subsidiary through
purchase of its common stock, it records in its books
investment in the acquired company and
disbursement of the payment for the stock acquired.
the
the
the
the
Treatment to the acquired company: The acquired
company records in its books the receipt of the payment
from the acquiring company and the issuance of stock.
FASB 141 Disclosure Requirements: FASB 141
requires disclosures in the notes of the financial
statements when business combinations occur. Such
disclosures are:
?
The name and description of the acquired entity and
the percentage of the voting equity interest acquired.
33
?
The primary reasons for acquisition and descriptions
of factors that contributed to recognition of goodwill.
?
The period for which results of operations of acquired
entity are included in the income statement of the
combining entity.
?
The cost of the acquired entity and if it applies the
number of shares of equity interest issued, the value
assigned to those interests and the basis for
determining that value.
?
Any contingent payments, options or commitments.
?
The purchase and development assets acquired and
written off.
Treatment of goodwill impairments:
?
?
If Non-Controlling Interest (NCI) based on fair value of
identifiable assets: impairment taken against
parent's income & R/E
If NCI based on fair value of purchase price:
impairment taken against subsidiary's income & R/E
THE CONSOLIDATION CONCEPT:The consolidated financial statements can be said as the
combined financial statements of a parent company and
its
subsidiaries.
Because
consolidated
financial
statements present an aggregated look at the financial
position of a parent and its subsidiaries, they help to
measure the overall health of an entire group of
companies or organizations as opposed to one company's
stand-alone position.
33
Consolidated financial statements present the financial
position and results of operations for a parent
(controlling entity) and one or more subsidiaries
(controlled entities) as if the individual entities actually
were a single company or entity. Consolidated financial
statements are generally considered to be more useful
than the separate financial statements of the individual
companies when the companies are related.
Whether the subsidiary is acquired or created, each
individual company maintains its own accounting records,
but consolidated financial statements are needed to
present the companies together as a single economic
entity for general-purpose financial reporting.
Some facts of Consolidation-Consolidation is done by Parent Entity.
-Consolidation should
reporting currency.
be
denominated
by
Parent’s
-Any periodicity gap should be neutralized.
-Non-Controlling Interests should be properly addressed.
-Mostly Equity Method is used for Consolidation.
-Approaches should be selected appropriately.
33
Effectiveness of Consolidated Financial
Statements:Consolidated financial statements are presented primarily
for the benefit of the investors, creditors, and other
resource
providers
of
the
parent.
Significantly,
consolidated financial statements often represent the
only means of obtaining a clear picture of the total
resources of the combined entity that are under the
control of the parent company.
Consolidated financial statements report the financial
results of the parent company and all of its subsidiary
companies in one combined report. Some companies own
just one subsidiary, while others own many subsidiaries.
The consolidated financial statement includes just one set
of financial results. As each subsidiary reports its financial
results to the parent, the accounting staff at the parent
company gathers the individual financial results,
eliminates intercompany financial transactions and
consolidates the numbers into one statement. Several
benefits exist for companies who create consolidated
financial
statements.
The
Consolidated
Financial
Statement has following benefits1. Broad Picture: The basic advantage when
consolidating financial statements is the broad picture it
gives. Investors do not want to go through several
different financial statements to add up information and
find out how the corporation is doing overall. The
consolidated statements provided by the parent company
33
accomplish the task automatically and make an excellent
reference point for shareholders, leaders and anyone
interested in how all the different parts of the business
are functioning as a whole.
2. Proper Balancing: Consolidating financial
statements also lets a corporation effectively balance its
appearance to outside parties. For example, during one
period a parent company may lose revenue and perform
poorly, but the subsidiaries may perform very well and
increase revenues. The consolidated statement will
balance the poor parent's performance with the positive
subsidiary performance, allowing the company to show
that through its diversification it remained profitable.
3. Exclusions: According to consolidated financial
statement guidelines, a corporation can also exclude
certain divisions from the statements. This is also an
advantage; because it allows investors to see --and
companies to show --that some financial aspects are not
long term. For example, subsidiaries are exempt if the
parent company's ownership of them is temporary or if
the control of the company does not actually rest with the
majority owner, which can happen through bankruptcy.
4. Less Paperwork: Another benefit of consolidated
financial statements is the reduced amount of paperwork
created for the statements. When a parent company
owns multiple subsidiaries, a set of financial statements
exists for each individual company. Each set of financial
statements includes four separate reports. If a parent
company owns nine subsidiaries, the complete set of
individual financial statements includes 40 reports. If the
33
parent company consolidates the financial statements,
the set of financial statements only includes four reports.
5. Simplified: Consolidated financial statements also
provide a simplified view of the organization's results.
When one subsidiary sells products to another, it creates
an intercompany transaction. One company records a
sale, while another company records a purchase. The sale
and purchase cancel each other out from the complete
organization
perspective.
Consolidated
financial
statements eliminate these transactions and simplify the
financial statements.
6. Necessity: Consolidated financial statements are
required by most governments as an accurate
representation of a parent company's financial activity. In
general, tax laws require that a single accounting entity
be represented out of the net resources and operating
results of all the divisions that a company owns. As a
result, many companies have become used to producing
consolidated statements for governments, investors and
internal analysis.
7. Efficiency: One of the main advantages of the
consolidated financial statement is efficiency. Instead of
examining the financial statements of each company in a
network of dozens of companies, an investor or an
executive can examine a single financial statement to
determine the financial health of the entire network.
Nevertheless, consolidated financial statements are
usually considerably more complex than stand-alone
financial statements.
33
8. Fraud Prevention: Another primary gain for
consolidated financial statements is the prevention of
fraud against investors. Without the requirement that
parent companies consolidate their financial statements,
companies could easily bury losses from underperforming
divisions and product lines in a web of subsidiaries and
cross-shareholdings. In this case, underperforming or
failing subsidiaries could be draining the finances of the
parent company to the point of near-bankruptcy, yet this
state of affairs would not become apparent by reading
the parent company's stand-alone financial statement.
The ultimate benefit of consolidated financial statements
should be ease of understanding and analysis of a
company's financial condition for investors, creditors,
vendors and anyone else who needs to know how secure
the company is with respect to being able to pay its bills
and continue as a profitable enterprise. However, a more
sinister benefit of consolidated finances is that they can
be manipulated to hide financial problems. It is extremely
difficult to ascertain from these statements whether there
are hidden problems and exactly where they are in the
enterprise.
Without consolidated financial statements the process of
evaluating a company for investment or financing
purposes would be a long complex affair that might
altogether miss important assets or liabilities. In fact,
many of the arguments that occur between company
management, accounting and auditing at year end
involve how the consolidation of reports should be done
in order to give the most accurate picture of the
company's financial health. It is the auditor's job to make
33
sure this consolidation of accounting reports accurately
reflects the true condition of the company.
Boundaries of Consolidated Financial
Statements:While consolidated financial statements are useful, their
limitations also must be kept in mind. Some information is
lost any time data sets are aggregated; this is particularly
true when the information involves an aggregation across
companies that have substantially different operating
characteristics. Because subsidiaries are legally separate
from their parents, the creditors and stockholders of a
subsidiary generally have no claim on the parent, nor do
the stockholders of the subsidiary share in the profits of
the parent. Therefore, consolidated financial statements
usually are of little use to those interested in obtaining
information about the assets, capital, or income of
individual subsidiaries. The following clauses are the
boundaries of Consolidated Financial Statements-
33
1. Lack of Subsidiary Information: The nature of
consolidated financial statements is that a group of
companies is viewed as one entity. By this assumption's
nature, the details of the individual companies are not
presented. In some cases, this is not important, as some
subsidiaries may not be material to the entire company's
operations and results. In other cases, the amalgamation
of financial results can hide unprofitable subsidiaries and
ventures. While the company in whole may be performing
well, consolidated statements may not show the entire
picture.
2. Elimination of Intercompany Transactions:
Generally accepted accounting principles require the
elimination
of
intercompany
transactions
upon
consolidation. Because of this rule, investors are unable
to ascertain the flow of funds between subsidiaries. This
could be important in determining which sections of the
company are viable in the long term. Furthermore, in
situations where subsidiaries operate using different
functional currencies, these eliminations can lead to
complex accounting and tax issues that may be in
accordance with accounting principles, but may be
confusing to even seasoned investors.
3. Higher Group Materiality: When looking at a
company on a consolidated basis, the threshold for
determining if accounting misstatements are material is
generally higher. For example, if a company had 10
subsidiaries that each had $1 million in annual sales, a
$10,000 sale would be more important to those
subsidiaries on an individual basis than to the group as a
whole. Because of this, companies and auditors need to
implement controls to ensure that the financial
33
statements are fairly presented taken as a whole. This
may mean that companies need to reconsider an
appropriate level of accuracy in the financial statements
to reflect an acceptable amount of misstatement. Many
times this amount is in between the subsidiary and group
level of accuracy.
4. Significant Influence vs. Control: A major limitation
in the presentation of consolidated financial statements is
the creation of loopholes related to the consolidation of
joint ventures, variable interest entities, and other special
purpose entities. While revisions in accounting standards
have started to address these issues, the rules of
consolidation have allowed unscrupulous companies to
hide billions of dollars of debt from investors over the last
couple of decades, by creating entities that they do not
directly control, but only influence. While the accounting
for these entities is complex, investors should be aware
that the phenomenon exists and should be vigilant if the
performance of their investment appears too good to be
true.
5. Masks Poor Performance: When income statements
are brought together and reported on a consolidated
basis, the revenues, expenses and net profit are
presented as combined figures. This can hide any
profitability issues with one or more of the companies. For
example, if a subsidiary lost a substantial amount of
money in the year as a result of poor sales, financial
statement readers may not see that information if the
loss is combined with profits of the parent company.
6. Hides Inter-company Sales: All inter-company
transactions are removed in a consolidation. On one
hand, this presents a truer view of the companies by
33
showing only financial activity with non-related parties.
However, it also hides the level of inter-company
transactions. If related companies spend most of their
time and resources selling products or services in the
group, an outside investor will not be able to assess
transfer prices or profit-shifting in the group. Both of
these things can be manipulated by companies and can
affect income taxes. Consolidation hides the extent of the
inter-company activity.
7. Skews Financial Ratios: One way that investors
assess the viability of a company is by its ratios. Ratios
are comparisons between financial statement lines. For
example, the current ratio is current assets divided by
current liabilities. This ratio tells investors how well the
company will be able to pay its near-term obligations. In a
consolidated financial statement, each company's assets,
liabilities and income are combined. Financial ratios
based on combined numbers may not be representative
of each company's ratios. If one of the companies has a
high level of debt compared to the equity of the owners,
that leverage would be hidden in a consolidated
statement.
Consolidated financial statements do not always give a
more accurate picture of the financial health of an
enterprise because the individual accounting reports from
the subsidiaries do not show up anywhere but in the
notes section of the consolidated finances. This makes it
possible to hide problems in the subsidiary reports, which
is how Enron managed to hide the losses and liabilities
some of its failed projects generated. It just buried them
in obscure subsidiaries created for the purpose of hiding
certain financial problems.
33
Financial
Subsidiary:-
Statements
for
A company whose voting stock is more than 50%
controlled by another company, usually referred to as the
parent company or holding company. A subsidiary is a
company that is partly or completely owned by another
company that holds a controlling interest in the
subsidiary company. If a parent company owns a foreign
subsidiary, the company under which the subsidiary is
incorporated must follow the laws of the country where
the subsidiary operates, and the parent company still
carries the foreign subsidiary's financials on its books
(consolidated financial statements). For the purposes of
liability, taxation and regulation, subsidiaries are distinct
legal entities.
Though a Consolidated Financial Statement shows a
broad picture of a company, the parent and the
subsidiary both are responsible to prepare their own
separate financial statements according to the rules of
recording. Separate financial statements are helpful to
reveal the true environment of each of the subsidiary.
Investors can understand which one is more profitable
and which one is not. Consolidated Financial Statements
are not able to view the real state, the just shows the
combined picture of the company. So, each separate
entity is responsible to prepare & publish their financial
statements.
33
Fundamentals of Acquisition:The Core principle of IFRS 3, IN5 states that, an acquirer
of a business recognizes the assets acquired and
liabilities assumed at their acquisition-date fair values
and discloses information that enables users to evaluate
the nature and financial effects of the acquisition.
The acquisition method states that, a business
combination must be accounted for by applying the
acquisition method, unless it is a combination involving
entities or businesses under common control. One of the
parties to a business combination can always be
identified as the acquirer, being the entity that obtains
control of the other business (the acquiree).Formations of
a joint venture or the acquisition of an asset or a group of
assets that does not constitute a business are not
business combinations. The IFRS establishes principles for
recognizing and measuring the identifiable assets
acquired, the liabilities assumed and any non-controlling
interest in the acquiree. Any classifications or
designations made in recognizing these items must be
made in accordance with the contractual terms, economic
conditions; acquirer’s operating or accounting policies
and other factors that exist at the acquisition date. Each
identifiable asset and liability is measured at its
acquisition-date fair value. Non-controlling interests in an
acquiree that are present ownership interests and entitle
their holders to a proportionate share of the entity’s net
assets in the event of liquidation are measured at either
fair value or the present ownership instruments’
proportionate share in the recognized amounts of the
33
acquiree’s net identifiable assets. All other components of
non-controlling interests shall be measured at their
acquisition-date fair values, unless another measurement
basis is required by IFRSs.
The IFRS 3, IN9 provides limited exceptions to these
recognition and measurement principles:
(a) Leases and insurance contracts are required to be
classified on the basis of the contractual terms and other
factors at the inception of the contract (or when the
terms have changed) rather than on the basis of the
factors that exist at the acquisition date.
(b) Only those contingent liabilities assumed in a
business combination that are a present obligation and
can be measured reliably are recognized.
(c) Some assets and liabilities are required to be
recognised or measured in accordance with other IFRSs,
rather than at fair value. The assets and liabilities
affected are those falling within the scope of IAS 12
Income Taxes, IAS 19 Employee Benefits, IFRS 2 Sharebased Payment and IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations.
(d) There are special requirements for measuring a
reacquired right.
(e) Indemnification assets are recognised and measured
on a basis that is consistent with the item that is subject
to the indemnification, even if that measure is not fair
value.
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IN10 states that, IFRS requires the acquirer, having
recognised the identifiable assets, the liabilities and any
non-controlling interests, to identify any difference
between:
(a) The aggregate of the consideration transferred, any
non-controlling interest in the acquiree and, in a business
combination achieved in stages, the acquisition-date fair
value of the acquirer’s previously held equity interest in
the acquiree; and
(b) The net identifiable assets acquired.
The difference will, generally, be recognised as goodwill. If the acquirer
has made a gain from a bargain purchase that gain is recognised in profit
or loss.
The consideration transferred in a business combination (including any
contingent consideration) is measured at fair value. In general, an
acquirer measures and accounts for assets acquired and liabilities
assumed or incurred in a business combination after the business
combination has been completed in accordance with other applicable
IFRSs. However, the IFRS provides accounting requirements for
reacquired rights, contingent liabilities, and contingent consideration and
indemnification assets.
The Disclosure, IN13 refers, the IFRS requires the acquirer
to disclose information that enables users of its financial
statements to evaluate the nature and financial effect of
business combinations that occurred during the current
reporting period or after the reporting date but before the
financial statements are authorized for issue. After a
business combination, the acquirer must disclose any
adjustments recognised in the current reporting period
that relate to business combinations that occurred in the
current or previous reporting periods
33
How to Consolidate?:The only responsibility goes to the parent company to
eliminate
all
inter-corporate
entries
to
prepare
consolidated financial statements. Elimination entries are
an advanced accounting tool used to simplify the
consolidated financial statement of affiliated companies.
When one company is the parent company of a subsidiary
company, a consolidated financial statement provides an
overall picture of the companies' combined financial
position. When two or more companies are affiliated
elimination entries are used for to avoid redundant
documentation of stock ownership of a subsidiary
company by stockholders, inter-company debt and intercompany revenue and expenses. Stock of a smaller
company acquired by a larger company is both an asset
of the larger company and a portion of the equity account
of each stockholder of both the larger and the smaller
company. Elimination entries are used to avoid reflecting
this ownership twice, as both a company asset and in the
equity accounts of each of the larger company's
stockholders. Furthermore, during an acquisition, a
33
portion of the stock owned by each of the smaller
company's stockholders is purchased by the acquiring
company. Though these original stockholders interest is
still reported in their individual equity accounts, the
portion of their interest that was purchased is also
eliminated. Often a parent company makes an intercompany loan to a smaller company, whether for
purposes of expansion, to cover operating expenses or
any other business purpose. In such a case, the parent
company's financial statement shows a note receivable
as an asset, while the subsidiary company shows a note
payable as a liability. When combined, an elimination
entry removes both since what has essentially occurred is
just a cash transfer within the larger, consolidated entity.
Finally, inter-company revenue and expenses are
eliminated when companies sell one another goods or
services, pay rent or loan interest to one another or
perform any other transactions that are really a transfer
of assets in the same way an inter-company loan is a
transfer of cash.
ELIMINATION EXAMPLERecording at the date of Acquisition:
33
Unrealized Gain:
Example: Suppose, Parent produces a phone
costing Rs.100, then parent sold it to its subsidiary
for Rs.150. The subsidiary should sell the phone to
the final customer for Rs.200. If somehow the
subsidiary was failed to sell the product to
customer then, an unrealized gain situation occurs
between parent & subsidiary transaction. The
unrealized gain amount will be Rs.50.
Commands for Elimination:1.Eliminate the parent company's investment in
each subsidiary as well as the retained earnings of the
subsidiary. Debit and zero out each subsidiary's common
33
stock held at par or nominal value, additional paid-in
capital and retained earnings accounts. Retained earnings
are the accumulated net income of the company minus
dividend payments. The additional paid-in capital is the
excess over par received at stock issuance. Credit and
zero out the "investment in common stock of subsidiary"
account on the parent company's books.
2.Remove intercompany payables and receivables
from the consolidated account because a company
cannot borrow from or lend to itself. Intercompany refers
to transactions between different parts of the combined
entity. Debit and zero out intercompany accounts payable
and credit and zero out intercompany accounts
receivable.
3.Eliminate intercompany sales because consolidated
financial statements should reflect sales to external
entities only. For example, if you bought items from a
subsidiary at cost and paid cash, credit and zero out the
intercompany purchases account on your books; debit
and zero out the intercompany sales account on the
subsidiary's books; credit or reduce the cash account on
the subsidiary's books; and debit or increase the cash
account on your books by the amount of the
intercompany sales transaction.
4.Identify and remove unrealized profits in inventory
and retained earnings accounts. This refers to the fact
that intercompany sales and purchase transactions may
not always be at cost. Remove the excess amount from
both inventory and retained earnings. For example, if you
bought an item from a subsidiary at Rs 1,000 above cost,
debit or decrease the consolidated retained earnings
33
account and credit or decrease the consolidated ending
inventory account by Rs 1,000 each.
The Acquisition Method:An entity shall determine whether a transaction or other
event is a business combination by applying the definition
in this IFRS, which requires that the assets acquired and
liabilities assumed constitute a business. If the assets
acquired are not a business, the reporting entity shall
account for the transaction or other event as an asset
acquisition
An entity shall account for each business combination by
applying the acquisition method. Applying the acquisition
method requiresA.Identifying the acquirer:
For each business combination, one of the combining
entities shall be identified as the acquirer.
B.Determining the acquisition date:
The acquirer shall identify the acquisition date, which is
the date on which it obtains control of the acquiree.
C.Recognizing and measuring the identifiable
assets acquired, the liabilities assumed and any
non-controlling interest in the acquiree:
Recognition Principle says, as of the acquisition date, the
acquirer shall recognize, separately from goodwill, the
identifiable assets acquired, the liabilities assumed and
any non-controlling interest in the acquiree. At the
acquisition date, the acquirer shall classify or designate
33
the identifiable assets acquired and liabilities assumed as
necessary to apply other IFRSs subsequently. The
acquirer shall make those classifications or designations
on the basis of the contractual terms, economic
conditions, its operating or accounting policies and other
pertinent conditions as they exist at the acquisition date.
Measurement principle says, the acquirer shall measure
the identifiable assets acquired and the liabilities
assumed at their acquisition-date fair values.
The acquirer shall recognize and measure a deferred tax
asset or liability arising from the assets acquired and
liabilities assumed in a business combination in
accordance with IAS 12 Income Taxes. The acquirer shall
recognize and measure a liability (or asset, if any) related
to the acquiree’s employee benefit arrangements in
accordance with IAS 19 Employee Benefits.
D.Recognizing and measuring goodwill or a gain
from a bargain purchase:
The acquirer shall recognize goodwill as of the acquisition
date measured as the excess of (a) over (b) below:
(a) The aggregate of:
i.The consideration transferred measured in accordance
with this IFRS, which generally requires acquisition-date
fair value.
ii.The amount of any non-controlling interest in the
acquiree measured in accordance with the IFRS; and
iii.In a business combination achieved in stages the
acquisition-date fair value of the acquirer’s previously
held equity interest in the acquiree.
33
(b) The net of the acquisition-date amounts of the
identifiable assets acquired and the liabilities assumed
measured in accordance with the IFRS.
Measurement PeriodIf the initial accounting for a business combination is
incomplete by the end of the reporting period in which
the combination occurs, the acquirer shall report in its
financial statements provisional amounts for the items for
which the accounting is incomplete. During the
measurement period, the acquirer shall retrospectively
adjust the provisional amounts recognised at the
acquisition date to reflect new information obtained about
facts and circumstances that existed as of the acquisition
date and, if known, would have affected the
measurement of the amounts recognised as of that date.
During the measurement period, the acquirer shall also
recognize additional assets or liabilities if new information
is obtained about facts and circumstances that existed as
of the acquisition date and, if known, would have resulted
in the recognition of those assets and liabilities as of that
date. The measurement period ends as soon as the
acquirer receives the information it was seeking about
facts and circumstances that existed as of the acquisition
date or learns that more information is not obtainable.
However, the measurement period shall not exceed one
year from the acquisition date.
33
Determining what is part of the
Business Combination Transaction:
The acquirer and the acquiree may have a pre-existing
relationship or other arrangement before negotiations for
the business combination began, or they may enter into
an arrangement during the negotiations that is separate
from the business combination. In either situation, the
acquirer shall identify any amounts that are not part of
what the acquirer and the acquiree (or its former owners)
exchanged in the business combination, is amounts that
are not part of the exchange for the acquiree. The
acquirer shall recognize as part of applying the
acquisition method only the consideration transferred for
the acquiree and the assets acquired and liabilities
assumed in the exchange for the acquiree. Separate
transactions shall be accounted for in accordance with
the relevant IFRSs.
Acquisition-related Costs:
Acquisition-related costs are costs the acquirer incurs to
effect a business combination. Those costs include
finder’s fees; advisory, legal, accounting, valuation and
other
professional
or
consulting
fees;
general
administrative costs, including the costs of maintaining
an internal acquisitions department; and costs of
registering and issuing debt and equity securities. The
acquirer shall account for acquisition-related costs as
expenses in the periods in which the costs are incurred
and the services are received, with one exception. The
33
costs to issue debt or equity securities shall
recognised in accordance with IAS 32 and IFRS 9.
be
Subsequent measurement and
Accounting:
In general, an acquirer shall subsequently measure and
account for assets acquired, liabilities assumed or
incurred and equity instruments issued in a business
combination in accordance with other applicable IFRSs for
those items, depending on their nature. However, this
IFRS provides guidance on subsequently measuring and
accounting for the following assets acquired, liabilities
assumed or incurred and equity instruments issued in a
business combination:
A.Reacquired rights:
A reacquired right recognised as an intangible asset shall
be amortized over the remaining contractual period of the
contract in which the right was granted. An acquirer that
subsequently sells a reacquired right to a third party shall
include the carrying amount of the intangible asset in
determining the gain or loss on the sale.
B.Contingent liabilities
acquisition date:
recognised
as
of
the
After initial recognition and until the liability is settled,
cancelled or expires, the acquirer shall measure a
33
contingent liability recognised in a business combination
at the higher of:
-The amount that would be recognised in accordance with
IAS 37 and
-The amount initially recognised less, if appropriate,
cumulative amortization recognised in accordance with
IAS 18 Revenue.
C.Indemnification Assets:
At the end of each subsequent reporting period, the
acquirer shall measure an indemnification asset that was
recognised at the acquisition date on the same basis as
the indemnified liability or asset, subject to any
contractual limitations on its amount and, for an
indemnification asset that is not subsequently measured
at its fair value, management’s assessment of the
collectability of the indemnification asset. The acquirer
shall derecognize the indemnification asset only when it
collects the asset, sells it or otherwise loses the right to it.
D.Contingent consideration:
Some changes in the fair value of contingent
consideration that the acquirer recognizes after the
acquisition date may be the result of additional
information that the acquirer obtained after that date
about facts and circumstances that existed at the
acquisition date. However, changes resulting from events
after the acquisition date, such as meeting an earnings
target, reaching a specified share price or reaching a
milestone on a research and development project, are not
measurement period adjustments. The acquirer shall
account for changes in the fair value of contingent
33
consideration that are not measurement period
adjustments as follows:
1.Contingent consideration classified as equity shall not
be remeasured and its subsequent settlement shall be
accounted for within equity.
2.Contingent consideration classified as an asset or a
liability that:
i.Is a financial instrument and is within the scope of IFRS
9 or IAS 39 shall be measured at fair value, with any
resulting gain or loss recognised either in profit or loss or
in other
comprehensive income in accordance with IFRS 9.
ii.Is not within the scope of IFRS 9 shall be accounted for
in accordance with IAS 37 or other IFRSs as appropriate.
Disclosures :The acquirer shall disclose information that enables users
of its financial statements to evaluate the nature and
financial effect of a business combination that occurs
either:
a)During the current reporting period or
b)After the end of the reporting period but before the
financial statements are authorized for issue.
The acquirer shall disclose information that enables users
of its financial statements to evaluate the financial effects
of adjustments recognised in the current reporting period
33
that relate to business combinations that occurred in the
period or previous reporting periods.
NON-CONTROLLING INTEREST:Non-controlling interest is an ownership stake in a
corporation where the held position gives the investor no
influence on how the company is run. The majority of
investor positions are deemed to be a non-controlling
interest because their ownership stake is so insignificant
relative to the total number of outstanding shares. For
smaller companies, any position that holds less than 50%
of the outstanding voting shares is deemed to be a noncontrolling interest. Non-controlling interest is ownership
of a company which does not give the shareholder the
control of the company. The control means that the
33
investor can govern the financial and operating policies of
its subsidiaries to gain benefits from the operations of
subsidiary. Usually the control can be gained if more than
50% of the voting rights are acquired by a party. This
means that any position that holds less than 50% of the
outstanding voting rights is deemed to be a noncontrolling interest.
Majority of the investor positions are considered to be
non-controlling interests because their voting power is so
insignificant relative to the total number of outstanding
shares. For most of the publically traded companies, the
number of outstanding shares is so large that a normal
shareholder cannot significantly affect higher level
decisions, which is why it is deemed to be a noncontrolling interest. Usually it is not until a party controls
about five to ten percent of the voting shares that it can
be elected for a seat on the board of directors.
The portion of the subsidiary net income assigned to the
non-controlling interest normally is deducted from
earnings available to all shareholders to arrive at
consolidated net income in the consolidated income
statement. Although this assignment of income does not
meet the definition of an expense, it normally is accorded
this expense-type treatment.
COMBINED
STATEMENTS:-
FINANCIAL
Unlike Consolidated Financial Statements, Combined
Financial Statement is a financial statement that merges
33
the assets, liabilities, net worth, and operating figures of
two or more affiliated companies. A combined statement
is distinguished from a consolidated financial statement
of a company and subsidiaries, which must reconcile
investment and capital accounts.
Financial statements sometimes are prepared for a group
of companies when no one company in the group owns a
majority of the common stock of any other company in
the group. Financial statements that include a group of
related companies without including the parent company
or other owner are referred to as combined financial
statements.
Different Approaches to
Consolidation:Several different theories exist that might serve as a
basis for preparing consolidated financial statements. The
choice of consolidation theory can have a significant
33
impact on the consolidated financial statements in those
cases where the parent company owns less than 100
percent of the subsidiary’s common stock. There are
three alternative theories of consolidation:
? Proprietary Theory
? Parent Company Theory
? Entity Theory
THE PROPRIETARY THEORY is where no fundamental
distinction is drawn between a legal entity and its owners,
i.e. the entity does not exist separately from the owners
for accounting purposes. The primary focus is to report
information useful to the owners, and therefore the
financial statements are prepared from their perspective.
The proprietary theory of accounting views the firm as an
extension of its owners. The assets and liabilities of the
firm are considered to be assets and liabilities of the
owners themselves. Similarly, revenue of the firm is
viewed as increasing the wealth of the owners, while
expenses decrease the wealth of the owners.
When applied to the preparation of consolidated financial
statements, the proprietary concept results in a pro rata
consolidation. The parent company consolidates only its
33
proportionate share of the assets and liabilities of the
subsidiary.
THE PARENT COMPANY THEORY is perhaps better
suited to the modern corporation and the preparation of
consolidated financial statements than is the proprietary
approach. The parent company theory recognizes that
although the parent does not have direct ownership of
the assets or direct responsibility for the liabilities of the
subsidiary, it has the ability to exercise effective control
over all of the subsidiary’s assets and liabilities, not
simply a proportionate share.
Under parent company theory, separate recognition is
given in the consolidated balance sheet to the noncontrolling interest’s claim on the net assets of the
subsidiary and in the consolidated income statement to
the
earnings
assigned
to
the
non-controlling
shareholders.
THE ENTITY THEORY is where a legal entity is regarded
as having a separate existence from the owners. The
financial statements are prepared from the perspective of
the entity, not its owners. The assumption is that the
economic activities of a business are distinct from those
of its owners. The entity theory maintains that the
activities of a business can be accounted for separately
from the activities of its owners; therefore the owners are
not personally responsible for loans or other liabilities
taken on by the company. The entity theory is
fundamental to modern accounting.
33
Emphasis under the entity approach is on the
consolidated entity itself, with the controlling and Noncontrolling shareholders viewed as two separate groups,
each having equity in the consolidated entity. Neither of
the two groups is emphasized over the other or over the
consolidated entity.
Current Practice:
The procedures used in practice represent a blending of
the parent company and entity approaches. The amount
of subsidiary net assets recognized in the consolidated
balance sheet at acquisition is the same in practice as
under the parent company approach. On the other hand,
the determination of consolidated net income is a
combination of the entity and parent company
approaches.
Future Practice:
The authority has proposed moving to an entity approach
in practice. This would result in classifying the noncontrolling interest in the stockholders’ equity section of
the consolidated balance sheet and labeling the total
income of the consolidated entity as consolidated net
income, with an allocation of consolidated net income
between the controlling and non-controlling interests in
the income statement.
KEY SUMMARY:-
33
Growing a company often involves buying out the
competition to acquire their customers and expanding
business through adding new products, services and
technology. These additions to a company's offering line
usually means purchasing smaller companies that service
particular niches through their own product lines or
technologies. The subsidiary companies normally
continue to operate as separate companies under the
control of the parent company but according to
accounting rules each must maintain separate accounting
records. These separate accounting records are then
consolidated with the parent company's accounting
records to produce the consolidated finances.
It would be difficult 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 parent
companies are now required to report their finances on a
consolidated basis. Occasionally the parent will make a
separate report of its own finances, but that cannot stand
alone and must be accompanied by the consolidated
report.
Some misappropriation could be, consolidated financial
statements do not always give a more accurate picture of
the financial health of an enterprise because the
individual accounting reports from the subsidiaries do not
show up anywhere but in the notes section of the
consolidated finances. This makes it possible to hide
problems in the subsidiary reports, which is how Enron
managed to hide the losses and liabilities some of its
failed projects generated. It just buried them in obscure
subsidiaries created for the purpose of hiding certain
financial problems.
Following IFRS
33
The ultimate benefit of consolidated financial statements
should be ease of understanding and analysis of a
company's financial condition for investors, creditors,
vendors and anyone else who needs to know how secure
the company is with respect to being able to pay its bills
and continue as a profitable enterprise. However, a more
sinister benefit of consolidated finances is that they can
be manipulated to hide financial problems. It is extremely
difficult to ascertain from these statements whether there
are hidden problems and exactly where they are in the
enterprise. The FASB (Financial Accounting Standards
Board) regularly visits this subject to correct definitions
and requirements that might serve as loopholes for
companies wishing to hide losses and liabilities. The IASB
(International Accounting Standards Board) is also
working to create definitions and rules that will make
evaluation easier and more reliable when examining the
financial reports of foreign companies and companies
with offshore subsidiaries.
Without consolidated financial statements the process of
evaluating a company for investment or financing
purposes would be a long complex affair that might
altogether miss important assets or liabilities. In fact,
many of the arguments that occur between company
management, accounting and auditing at year end
involve how the consolidation of reports should be done
in order to give the most accurate picture of the
company's financial health. It is the auditor's job to make
sure this consolidation of accounting reports accurately
reflects the true condition of the company.
BIBLIOGRAPHY:33
The following sources were referred to extensively during
the entire course of this assignment:
? www.wikipedia.org
? www.academia.edu
? www.budgetcontrol.com
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