chapter 12 group financial statements

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts

CHAPTER 12Group financial statements


Contents

Introduction – Company groups Rationale for group financial

statements Current practice Acquisition accounting Associated companies Joint ventures


Group financial statements

Group (or consolidated) financial statements are the financial statements of a set of two or more enterprises organised as an economic entity

Group is defined according to concept of “control”

Control = power (de jure or de facto) to govern the financial and operating policies of an entity so as to obtain benefits from its activities (IFRS)


Company groups Company group characteristics

Vertical group Horizontal group Conglomerate

Group expansion Development of new subsidiaries Acquisition by takeover of other

companies Meger between companies


Shares - Rights Membership rights :

Influence on management, voting power Equity rights:

Right to participate in distribution of profits + equivalent part of liquidation balance

In principle: rights are proportional to capital share

Exceptions: preferent shares, limitations to voting power, multiple votes per share,...


Types of participating shareholdings

Type of relationship

Amount of voting rights

Qualification of shareholdings

1 Control 50% +1 Subsidiary

2 Significant influence

>= 20% Associated company

3 Only financial < 20% Financial investment


Group structure

Enterprise A

Enterprise CEnterpise B Enterprise D

Enterprise E

51%

Enterprise F

100% 25%

100%9%


Rationale for group financial statements

Interdependent relationships within a group (patrimonial, contractual, personal ties)

Loss of part of their independence of individual entities

Common or unified management Economic interest of the group > individual interests

of legal entities involved

It is economically more relevant to present the financial statement of the economic whole as an aggregate of all assets and liabilities under unified control


From individual to group accounts

Co. W Co. X W Group

€’000 €’000 €’000

Tangible assets 500 1000 1500

Investment in subsidiary 500 - -

Current assets 250 350 600

Totals 1250 1350 2100

Shares 500 500 500

Reserves 300 (50) 250

800 450 750

LT debt 300 700 1000

Trade creditors 150 200 350

Totals 1250 1350 2100

Debt/Equity ratio 37.5% 155% 133%


Current practice

IAS 27 Consolidated and Separate Financial Statements

IFRS 3 Business Combinations IAS 28 Investments in Associates IAS 31 Investments in Joint

Ventures Seventh EC Company law Directive


Offsetting the investment in a subsidiary

Holding S Co. Elimination Group

€m €m €m €m

Net fixed assets 100 20 - 120

Investment in subsidiary 25 - (25)

Current assets 30 10 - 40

Totals 155 30 (25) 160

Share capital 70 25 (25) 70

Reserves 30 - - 30

100 25 (25) 100

Current liabilities 15 5 - 20

Long-term liabilities 40 - - 40

Totals 155 30 (25) 160


Acquisition accounting Purchase method of accounting Fair value adjustments of acquired

assets and liabilities Subsequent measurement of

goodwill Minority interests Merger accounting Group income statement


Purchase method of accounting

Acquisition (or purchase method of) accounting is the method used to account for business combinations

Goodwill arises as a consolidation difference if the purchase cost of the investment is not equal to the book value of equity in the subsidiary


Goodwill as consolidation differenceHolding S Co. Elimination Group

€m €m €m €m


Investment in subsidiary 38 - (38)

Goodwill - - 13 13


Totals 155 30 (25) 160


Reserves 30 5 (5) 30

100 25 (25) 100



Totals 155 30 (25) 160


Fair value adjustments of acquired assets and liabilities

The individual assets and liabilities of the acquired company have to be revised to their fair value at acquisition date

This exercise may imply (de-)recognition of new (old) assets and liabilities

Goodwill will be the difference between the revalued net assets and the investment by the parent

The fair value at acquisition date is considered to be the historical cost from the point of view of the parent


Fair value adjustments appliedBook value

of SAdjustment Fair value

balance sheet

€m €m €m

Fixed assets- Intangible - 10 10

- Tangible 20 - 20

Current assets 10 - 10

Totals 30 10 40

Share capital 20 - 20

Reserves 5 10 15

25 10 35

Current liabilities 5 - 5

Totals 30 10 40


Goodwill after fair value adjustments

Holding Revised S Elimination Group

€m €m €m €m

Net fixed assets- Goodwill- Other intangibles- Tangibles

-100

1020

3--

310

120

Investment in S 38 - (38) -


Totals 155 40 (35) 160


Reserves 30 15 (15) 30

100 35 (35) 100



Totals 155 40 (35) 160


Subsequent measurement of goodwill

IAS before 2004 + European Accounting Directives:

Amortise goodwill on a systematic basis over the best estimate of its useful lifeRebuttable assumption of a maximum of 20 years

IFRS 3 “Business Combinations” (2004): Test goodwill for impairment annually (or more

frequently if indications)


Minority interests

Minority interests (or non-controlling interests) appear if the group does not own 100% of the shares in a subsidiary

They represent the part of the net assets and profit or loss of the subsidiary attributable to the equity interests that are not owned


Minority interests appliedL Co. M. Co Elimination Group

€’000 €’000 €’000 €’000

Intangibles - - 280 280

Tangibles 1200 300 - 1500

Investment in M 600 - (600) -


Totals 2350 525 (320) 2555

Share capital 800 300 (300) 800

Reserves 1150 100 (100) 1150

Minority interests 80 80

1950 400 (320) 2030


LT Creditors 200 - - 200

Totals 2350 525 (320) 2555


Merger accounting

Two companies can combine by merging their activities and managements without one of them acquiring the other

Two types of merger Fusion Pooling of interests

IFRS3 Business Combinations (2004) banned merger accounting methods


Illustration - Merger accounting Company A

before mergerIssue

sharesCompany A

after mergerCompany B Adjust Group

€m €m €m €m €m €m

Assets

Tangibles 1200 1200 900 2100

Investment in B +500 500 - -500 -

Current assets 420 420 350 770

Totals 1620 +500 2120 1250 -500 2870

Financing

Share capital 300 +500 800 300 -300 800

Reserves 420 420 730 -730+530

950

Debt 600 600 - - 600

Trade payables 300 300 220 - 520

Totals 1620 +500 2120 1250 -500 2870


Illustration - Acquisition accountingCompany A

before mergerIssue

sharesCompany A

after mergerCompany B Adjust Group

€m €m €m €m €m €m

Assets

Goodwill - - - - + 470 470

Tangible assets 1200 - 1200 900 - 2100

Investment in B - +1500 1500 - -1500 -

Current assets 420 - 420 350 770

Totals 1620 +1500 3120 1250 -1030 3340

Financing

Share capital 300 +500 800 300 -300 800

Reserves 420 +1000 1420 730 -730 1420

Debt 600 - 600 - - 600

Trade payables 300 - 300 220 - 520

Totals 1620 +1500 3120 1250 -1030 3340


Group income statement

In the group income statement, the effect of intra-group transactions has to be eliminated Only income and expenses recognized with regard

to parties outside the group will be retained Follow-up effects of fair value adjustments

over time have to be integrated Amortization of goodwill or impairment losses

on goodwill may also significantly impact the group income statement


Intra-group transactions

Subsidiary A

Expenses 1200

Sales to B 1500

Profit 300

Subsidiary B

Purchases from A 1500

Other expenses 5000

Sales to C 7500

Profit 1000

Subsidiary C

Purchases from B 7500

Other expenses 500

Sales to retailers 8500

Profit 500

Totals 15700 17500 1800


Deduct amortization/ impairment losses on goodwill / Follow-up of fair value adjustments

Aggregation of financial statements of all subsidiaries

Fig.12.1 Consolidation proceduresAdjust recognition criteria / measurements of financial

statements of subsidiaries to uniform principles (IFRS)

Fair value adjustments / Remove investment in subsidiaries / Identify goodwill and minority interests

Remove intra-group transactions and balances

Group financial statements


Associated companies

Associated companies are companies in which the investor company has “significant influence”

Different types of relationships between investor company and investee company mainly according to voting rights under control

Accounting rules differ according to the type of relationship


Types of participating shareholdings (bis)

1 Control 50% +1

Subsidiary Acquisition

accounting

2 Significant influence

>= 20%

Associated company

?

3 Only financial < 20% Financial investment

“Fair Value”Or “At Cost

(Locom)”


Illustration - Associated companyCompany C

ASSETS

Tangible fixed assets 600

Current assets 300

Total 900

FINANCING

Share capital 400

Reserves 50

450

Payables 200

Debt 250

Total 900

Company A buys 20% of Company C


Illustration - Equity method

Co A Co C Group

Net fixed assets 1050 1050

Investment in C 150 - 150

Goodwill - +60 60

Equity value +90 90

Current assets 420 420

Totals 1620 - 1620

Share capital 300 300

Reserves 420 420

720 720

Payables 300 300

Debt 600 600

Totals 1620 1620


Illustration - Proportionate consolidation

Co A Co C (20%) Eliminations Group


Investment in C 150 - -150

Goodwill - - + 60 60


Totals 1620 180 -90 1710

Share capital 300 80 -80 300

Reserves 420 10 -10 420

720 90 -90 720

Payables 300 40 - 340

Debt 600 50 - 650

Totals 1620 180 -90 1710


IAS 28 Investments in Associates

IAS 28 Investments in Associates assumes significant influence if the investor holds at least 20 per cent of the voting rights of the investee

IAS 28 requires the equity method to account for associated companies

The part of the investor in the profit and loss of the associated company is introduced as a separate caption in the group income statement (“income from associates”)


Joint ventures A joint venture is a contractual arrangement

whereby two or more parties undertake an economic activity that is subject to jount control (IAS 31 Investments in Joint Ventures)

IFRS recognizes three kinds of arrangement: Jointly controlled operations Jointly controlled assets Jointly controlled entities

IFRS recommends use of proportionate consolidation for jointly controlled entities

chapter 12 group financial statements

Documents

group patrimonial

parentthe fair value

book value of equity

acquired company

revalued net assets

unified controlfrom

purchase cost

powerequity rights