ACCT 6010 Advanced Financial Reporting
Accounting for business combinations
The University of 1
2.1 Intro to consolidation
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2.2 Concept of control
2.3 Illustrative Example: Application of control 2.4 Disclosure requirements
2.5 BlueScope: Subsidiary disclosures
The University of 2
LS Class 1 1
Learning Objectives
Learning objectives:
After completing this topic students should be able to
1. Determine the entities that must prepare consolidated financial statements and identify the main uses and limitations.
2. Explain the uses and limitations of (i) parent entity and (ii) consolidated financial statements to shareholders of the parent entity, lenders and other stakeholders.
3. Apply the definition of control in AASB 10 and AASB 3 to examples likely to be found in practice.
4. Critically evaluate the definition of control in AASB 10 and AASB 3.
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Readings & Videos
§ Arthur et al. 8th Edition Chapter 1 (remainder) § AASB 10
§ eReserve readings
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LS Class 1 2
0. Recall: Multiple business entity
§ How should Alpha Ltd report its corporate investments to shareholders?
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100 % 90 %
Alpha Ltd Group
Beta Pty Ltd
Gamma Pty Ltd
Delta Pty Ltd
Alpha Ltd Group Consolidated Financial Statements
0. Recall: Types of investment
Financial asset at FV through OCI
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significant influence
Joint Venture
Joint Operation
joint control
Subsidiary
Fair Value AASB 9 (ACCT6001)
Equity method AASB 128 (week 9 &10)
Line-by-line method (week 10)
Consolidation AASB 10 (week 2- 8)
LS Class 1 3
0. Incentives for corporate investments
– Income/returns;
– Limited liability;
– Gearing or pyramiding;
– Takeovers to achieve diversification;
– Takeovers to achieve vertical or horizontal integration; – Ease of sale of business divisions;
– Legal requirements for investment overseas
ü Refer to benefits identified by the Australian Companies and Securities Advisory Committee (2000), Arthur et al. Section 1.3.
ü Refer also to van der Laan and Dean (2010) who describe the nature, composition and extent of corporate groups.
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0. Reporting entity
§ General purpose financial reports have to be prepared by reporting entities [SAC1.41]
§ Reporting entities are all entities (including economic entities) in respect of which it is reasonable to expect the existence of users dependent on general purpose financial reports for information which will be useful to them for making and evaluating decisions about the allocation of scarce resources. [SAC1.40]
§ Entity means any legal, administrative, or fiduciary arrangement, organisational structure or other party (including a person) having the capacity to deploy scarce resources in order to achieve objectives
§ Economic entity means a group of entities comprising a controlling entity and one or more controlled entities operating together to achieve objectives consistent with those of the controlling entity [SAC1.6]
The University of 8
LS Class 1 4
0. Accounting for inter-entity investments
How to present the financial position and performance of a group of companies?
Potential solutions:
Option 1: Record investment as an asset in the financial statements of Alpha Ltd
§ How to measure the investment asset?
§ Fair value (i.e. revalue periodically?) § How to measure the performance?
§ Dividend revenue when earned? § Share of profit?
§ Inter-entity transactions? The University of 9
Balance Sheet (Alpha)
Current assets:
Non-current assets:
Investment in Beta $ Investment in Delta $ Investment in Gamma $ ….
Income Statement (Alpha)
Revenue from operations:
Other revenue:
Revenue from Beta $ Revenue from Delta $ Revenue from Gamma $ ….
0. Accounting for inter-entity investments (cont.)
Option 2: Provide the single entity financial statements of each investment along with the financial statements of Alpha Ltd
§ Difficult to analyse the financial performance and financial position of each separate entity and determine impact on Alpha Ltd
§ Effect of inter-entity transactions may be difficult to disentangle
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Alpha Ltd FS
… Beta Ltd FS
… … Delta Ltd FS
… … Gamma Ltd FS …
… … …
LS Class 1 5
0. Accounting for inter-entity investments (cont.)
Option 3: Prepare a single set of financial statements that treats Alpha Ltd and its investments as a single economic entity and combines the financial information accordingly
§ If the group of companies is managed as a single business, presenting group information is useful for decision making and improves accountability
§ Forms the basis of consolidated financial statements
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Alpha Group Balance Sheet
Cash (Alpha+Beta+Delta+Gamma) $ …
Liabilities:
Payables (Alpha+Beta+Delta+Gamma) $ …
Alpha Group Income statement
Op. Rev (Alpha+Beta+Delta+Gamma) $ …
Op. Exp (Alpha+Beta+Delta+Gamma) $ …
ACCT 6010 Advanced Financial Reporting
Consolidated Financial Statements
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LS Class 1 6
1. Introduction – Consolidated financial statements
AASB 10: Consolidated Financial Statements
– To consolidate means to “group”
… grouping the financial performance and financial position of a number of entities into one aggregate position.
Important concepts and terminology [AASB 10 Appendix A]
– A group comprises a parent entity and its subsidiaries
– A parent is an entity that controls one or more entities
– A subsidiary is an entity controlled by another entity
– The consolidated financial statements are the financial statements of a group presented as a single economic entity
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1. Introduction – CFS (cont.)
Reporting entities that are commonly ‘controlled’ by one parent are combined into a single group reporting entity and prepare a:
Statement of comprehensive income (or income statement); Statement of financial position (balance sheet);
Statement of changes in equity;
Statement of cash flows; and
relevant notes to the accounts
for the “group” comprising the parent and every entity that it controls.
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LS Class 1 7
2. Alternate Concepts of Consolidation
Proprietary
Parent-entity
Point of view
Parent entity owners, other equity holders, other stakeholders
Parent entity owners only
Parent entity owners only
Form of consolidation
Full (100%) consolidation
Proportional consolidation (parent %)
Full (100%) consolidation
Non-controlling interest (NCI)
Classified as equity.
Not included in financial statements.
Classified as a liability
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ACCT 6010 Advanced Financial Reporting
Class 2: Control
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LS Class 1 8
3. Control definition
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3. Control – Definition (cont.)
Definition of control [AASB 10 Appendix A]
Control of an investee arises when the investor is exposed, or has rights, to variable returns from it’s involvement with the investee and has the ability to affect those returns through its power over the investee.
Power are the existing rights that give the current ability to direct the relevant activities.
Note what is not in the definition – no % ownership. Implications: – Controlisdefinedintermsof“substance”ratherthan“form”; – Definition captures passive as well as active control
v LSQ 1.2: What is “passive control”? The University of 20
LS Class 1 9
3. Control – Definition (cont.)
The definition of control has three factors:
– power over investee;
– exposure, or rights, to variable returns from its involvement with the investee; and
– the ability to use its power over the investee to affect the amount of the investor’s returns
[AASB 10.7]
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6. Control – AASB 10
3. Control – Definition (cont.)
– There must be power over the relevant activities, but not necessarily those activities that have little effect on returns.
– Control is not the same as “power” as in some situations entities act as agents on behalf of principals where the principal is exposed to the risks and returns.
– Examples later on this.
– Returns can be broadly interpreted and do not refer only to
dividends and capital gains.
– Returns can also take the form of synergistic benefits – Returns can be negative.
– Returns vary with the investee’s performance
[AASB 10.15-16]
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LS Class 1 10
3. Control – AASB 10: Overview
All references in square brackets are to AASB 10
Power [10-14 & B9-10]
Definition [6-7]
Link b/w power & returns [17-18]
Variable returns [15-16 & B55-57]
– Not fixed
– (+), (-) or (+/-) – Substance over form
Voting [B34]
Cont. next slide
The University of : Substantive vs protective [B14- 28]
Practical ability [B18]
Direct relevant activities [B11-13]
Special relationship [B19]
Delegated power: principal vs agent [B51-61]
3. Control – AASB 10: Overview (cont.)
All references in square brackets are to AASB 10
Voting [B34]
Cont. prev. slide
Contract w other vote holders [B39]
E.g. transfer of
voting rights
The University of w power [B35] vs no power [B36- 37]
Other contractual arrangements [B40]
E.g. decision- making rights + voting rights
No majority w power [B38]
Voting rights [B41-46]
E.g. relative voting power
Potential voting rights [B47-50]
E.g. convertible instruments or options
Combination [B51-54]
LS Class 1 11
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4. Control – application
4. Control – Application
– Rebuttable presumption that > 50% of voting power (typically ordinary shares) will give rise to control [AASB 10.B35-37]
– Examples where might have >50% of voting power and not control:
a) Someotherinvestormightcontroloperatingand financial policies [AASB 10.B36];
b) Agovernment,liquidatororreceivermightcontrol the entity [AASB 10.B37]
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LS Class 1 12
4. Control – Application (cont.)
Guidance (cont.)
– Factors that may give rise to control with <50% of the shares
[AASB 10.B38-B43]
a) Contractual arrangements between the investor and other vote holders [AASB 10.B39];
b) Rights from contractual arrangements [AASB 10.B40];
c) Voting rights [AASB 10.B41-B45];
d) Potential voting rights [AASB 10.B47-B50];
e) Some combination of the above
IFRS US GAAP Point of difference:
US GAAP contain no such specific guidance exists requiring consideration of potential voting rights.
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4. Control – Application (cont.)
Added guidance:
6. Control – added guidance
– Potential voting rights include call options over shares, share warrants, convertible notes.
– Need to consider the size of other shareholdings in making a judgement as to whether an investor has power.
– Refer to AASB10 application example #4
– Contractual arrangements between the investor and other vote holders (e.g. could take the form of shareholder agreements which give one investor the right to appoint management)
– Refer to AASB10 Application example #5
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LS Class 1 13
4. Control – Application (cont.)
Other evidence of factors that may give rise to control
(a) The investor can appoint or approve the investee’s key management personnel;
(b) The investor can direct the investee to enter into transactions that benefit the investor (or veto any changes to, transactions for the benefit of the investor);
(c) The investor controls the nominating process for the board or has proxies from other investors
(d) Key management of the investee are related parties – e.g. CEO of the investor = CEO of investee
(e) Majority of the board are related parties of the investor
[AASB 10.B18]
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4. Control – Application (cont.)
What does not constitute control:
– Joint arrangements, i.e. control ≠ joint control – Where the entity is a trustee
• Trustsarecontrolledbythebeneficiariesasthetrusteeis directed by the terms of the trust deed and acts in the best interests of the beneficiaries.
• Thetrusteeisan“agent”ofthebeneficiaries [AASB 10.B 58]
• Thebeneficiariesaretheprincipals
• ---> So in most cases the trustee will not consolidate the
The University of 30
LS Class 1 14
ACCT 6010 Advanced Financial Reporting
Class 2: Illustrative Example
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Illustrative Example: CPQ 1.3 (cont.)
ABC Ltd owns 60% of the shares in Investee Ltd. The other 40% of the shares in Investee Ltd are owned by DEF Ltd. DEF Ltd also owns call options that would give it the right to acquire half of the shares owned by ABC Ltd. The option is currently exercisable and expires 5 years after the end of the current accounting period. Based on conditions as at balance date, the option is considered to be deeply out of the money (the exercise price of the option is significantly greater than the market price of the shares). Over the past two years, ABC Ltd has been exercising its voting rights and has been directing the relevant activities of Investee Ltd.
Given the information above, determine whether ABC has control over Investee Ltd. Support your answer with specific reference to the requirements of AASB 10 and the relevant application guidance.
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LS Class 1 15
Illustrative Example: CPQ 1.3 (cont.)
Problem solving question
– Requires you to analyse the information presented
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Illustrative Example: CPQ 1.3 (cont.)
How to answer questions like these:
– You are providing your professional judgement so a professional, structured narrative is required;
– Address every relevant fact;
– Work systematically through the relevant elements of AASB 10
and AASB 3;
– Describe important information that you don’t have but need to
know in order to make an informed judgement;
– Where necessary, make assumptions
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LS Class 1 16
ACCT 6010 Advanced Financial Reporting
Class 2: Disclosure requirements
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5. Disclosures
AASB 12: Disclosure of Interests in Other Entities
– ‘significant judgements and assumptions’ made in determining
control [AASB 12.7]
– Information about subsidiaries, the composition of the group, and
details of non-controlling interest [AASB12.10]
– Information about interest in ‘unconsolidated structured entities’
[AASB 12.24]
vRefer to Bluescope Steel Annual Report Notes: Subsidiaries & Other Entities
The University of 36
LS Class 1 17
5. Disclosures (cont.)
AASB 124 : Related Party Disclosures
– A parent and subsidiary are “related parties” [AASB 124.9]
– Parent-subsidiary relationship, name of parent and ultimate
controlling entity (if not the immediate parent) [AASB 124.13] – Transactions between related parties [AASB 124.18]
– To be discussed further in later classes
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ACCT 6010 Advanced Financial Reporting
Class 2: BlueScope Ltd Subsidiary disclosures
The University of 38
LS Class 1 18
Case firm: Bluescope Steel Ltd – Subsidiary disclosures
We will try to determine:
– How many subsidiaries are controlled by Bluescope Steel Ltd?
– In which countries are they incorporated?
– What is the ownership interest in each?
– How many entities make up the BlueScope Steel Group?
– Has there been much change in the composition of the group
(compare previous year)?
– What is the carrying amounts of investments in associates and joint
– What is the carrying amounts of other investments (other than
subsidiaries, associates and joint ventures?
Note we examine other related disclosures in later weeks
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Next Class: Principles of Consolidation
Prepare for class
– Pre-read Chapter 2 of text
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LS Class 1 19
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