introduction to consolidation

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Mariano Rantz Teller, BP&I GD BA February 2010

Introduction to Consolidation

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Agenda

1. Introduction1.1. Purpose of the Info Session1.2. Why Consolidation1.3. Some Terms & Definitions

2. Consolidation Process2.1. Consolidation Process in a Glance2.2. Interunit Eliminations2.3. Elimination of Interunit Profit & Loss in Current Assets2.4. Elimination of Interunit Profit & Loss in Non Current Assets2.5. Accounting Techniques & Consolidation of Investments2.5.1. Accounting Techniques – Purchase Method2.5.2. Accounting Techniques – Proportional Consolidation2.5.3 Accounting Techniques – Equity Method

3. Examples

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1.1 PURPOSE OF THE INFO SESSION…

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The purpose of this info session is to introduce to the consolidation process and the different techniques and terms used to perform consolidation activities.

To adress a particular accounting standard is not intended in this session. Instead of this, we will give a general overview of the consolidation process and the terms associated with it.

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1.2 WHY CONSOLIDATION…

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The purpose of preparing consolidated financial statements is to report financial condition and operating result of a consolidated business group, which is assumed as one entity comprised of more than one companies under a common control. Because consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable you to gauge the overall health of an entire group of companies as opposed to one company's stand alone position.

Group 1

Group 2

Company1 Company 2

Group 3

Company 3

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Consolidated Financial Statements: The financial statements of a group presented as those of a single economic entity

Parent-subsidiary relationship: the result of a stock acquisition where the parent is the acquiring company and the subsidiary is the acquired company

Controlling Interest: When the parent company owns a majority of the common stock

Non-controlling interest or Minority interest: the rest of the commonstock that the other shareholders own

Control: the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities

“ Control is presumed when the parent acquires more than half of the voting rights of the entity. Even when more than one half of the voting rights is not acquired, control may be evidenced by power: [IAS 27.13] ”

1.3 SOME TERMS AND DEFINITIONS…

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2.1 CONSOLIDATION PROCESS IN A GLANCE…

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The consolidation process consist of adjusting and combining financial information from the individual financial statements to prepare consolidated financial statements that present information for the group as a single economic entity.

A typical consolidation process could involve the following activities:

1. Data Collection of Individual Statements (Normally in Local Currency)2. Validation of collected data3. Consolidation Adjustments of individual statements (to meet consolidation standards

and correct the information collected) in Local Currency.4. Currency Translation5. Consolidation Adjustments in Group Currency6. Validation of Adjusted data in Group Currency (Now the information is ready to be

consolidated)7. Eliminations

I. Interunit Eliminations: For example Elimination of IU payables and receivables, Elimination of IU Revenue and Expense , Elimination of investment income.

II. Elimination of Interunit Profit/Loss in Transferred Inventory III. Elimination of Interunit Profit/Loss in Transferred Assets IV. Consolidation of Investments

8. Reconciliation and Allocation of Elimination Differences9. Group Reporting

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2.2 INTERUNIT ELIMINATIONS…

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Interunit elimination (IU) enables you to eliminate business relationships, based on the trade of goods and services, between the consolidation units within a consolidation group. The business relationships to be eliminated exist between a pair of companies, such as:

Elimination of IU payables and receivables Elimination of IU revenue and expense Elimination of investment income

From the group’s perspective, these business relationships must be eliminated. For, when viewing the corporate group as a single entity, the group cannot have, for example, receivables and payables from and to itself.

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2.3 ELIMINATION OF INTERUNIT PROFIT & LOSS IN CURRENT ASSETS…

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Current assets, typically inventory items, are sold within consolidation groups (for example, corporate groups). These transactions lead to interunit profits or losses.

You should eliminate interunit (IU) profits and losses for the group.

To perform this elimination the consolidation group still owns all or part of the asset that was sold within the group as per the date of consolidation – that is, it has not been fully sold to a third party.

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2.4 ELIMINATION OF INTERUNIT PROFIT & LOSS IN NON CURRENT ASSETS…

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Interunit profits or losses are incurred when noncurrent assets (such as property, plant, and equipment) are sold by one consolidation unit to another consolidation unit within the same consolidation group (for example, a corporation).

Statutory accounting requirements and often management accounting policies require that the consolidated statements portray the group as a single entity. Hence, the sale of a noncurrent asset between two consolidation units needs to be treated as if the asset was merely moved from one plant to another.

The acquiring consolidation unit (buyer) records the asset in its own balance sheet with the amount it paid to the supplying consolidation unit (seller). This affects the amounts to be depreciated. The buyer also might use a method of depreciation that differs from the one used by the seller. You should perform this type of elimination to adjust the depreciation charges so that they are correct from the group’s point of view.

This elimination is similar to the transferred inventory but has the depreciation adjustment component beside the correction of the acquired asset.

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2.5 ACCOUNTING TECHNIQUES & CONSOLIDATION OF INVESTMENTS…

Consolidation of investments eliminates the interunit financial relationships within a

consolidation group. This is done by clearing the parent company’s investments against the

proportionate share in the equity capital of the subsidiary.

Consolidation of investments can employ the following accounting techniques.

The pooling-of-interests method may only be used for acquisitions that took place prior to the 30th of June, 2001.This method accommodates the concept of business mergers. The economic purpose of acquiring ownership another business lies in the decision of both businesses to pool their respective assets and their previously separated resources in the new combined business.

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2.5.1 ACCOUNTING TECHNIQUES.. PURCHASE METHOD

● Purchase Method

This method is normally used to display a controlling relationship between the investor and investee company (normally when the stock purchased is 50% of the outstanding common stock).

The individual financial statements of a fully-consolidated investee unit are included entirety in the consolidated financial statements.

The interunit relationships between the parent and the subsidiary are fully eliminated (payable/receivables, etc.).

Current Assets are adjusted to match group valuation correcting the effect of profit or losses incurred in the asset sale.

Non Current Assets are adjusted to match group valuation correcting the effect of profit or losses incurred in the asset sale and the depreciation effect.

Consolidation of investments completely eliminates both the investments holdings in the fully-consolidated investee unit and its corresponding stockholders’ equity. The portion of the subsidiary that is not hold by the parent company is recorded as minority interest.

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2.5.2 ACCOUNTING TECHNIQUES.. PROPORTIONAL CONSOLIDATION

● Proportional Consolidation

This method is normally used to display a significant influence, but not a controlling relationship, between the investor and investee company (normally when the stock purchased is between 20 and 50% of the outstanding common stock e.g. joint ventures).

The individual financial statements of the investee company are included proportionally in the consolidated financial statements.

The interunit relationships between the parent and the subsidiary are proportionally eliminated (payable/receivables, etc.).

Current Assets are proportionally adjusted to match group valuation correcting the effect of profit or losses incurred in the asset sale.

Non Current Assets are proportionally adjusted to match group valuation correcting the effect of profit or losses incurred in the asset sale and the depreciation effect.

Consolidation of investments completely eliminates the investments holdings against the proportionate stockholders’ equity. No minority interest arise.

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2.5.3 ACCOUNTING TECHNIQUES.. EQUITY METHOD

● Equity Method

This method is normally used to display small influence between the investor and investee company (normally when the stock purchased is between 20 and 50% of the outstanding common stock e.g. joint ventures).

The individual financial statements of the investee company are not included in the consolidated financial statements.

None interunit relationships between the investor and investee unit are eliminated.

If an investee unit is consolidated using the equity method, then its individual financial statement data is not included in the consolidated financial statements. Changes in investee equity or equity holdings adjustments result in an adjustment of investment book values. These units are not displayed in reporting.

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3. EXAMPLES… PURCHASE METHOD

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1- Company A acquires 80% of Company B in cash2- Company A buy Inventory for 280 to a third party3- Company A Sells The entire inventory to Company B with a profit of 20

Account Company A Company B EliminationsElimination

No.Consolidated Statements

Cash 20 100 120Investment in B 80 -80 1 0Inventory 300 -20 3 280IC Receivables 300 -300 2 0Payables Third Parties -280 -280IC Payables -300 300 2 0Common Stock -100 -100 100 1 -100Minority Interest -20 1 -20Retained Earnings B/S -20 20 3 0Cost of Good Sold 280 280Sales -300 -300Profit&Loss in Transferred Inventory 20 3 20Retained Earning P&L 20 -20 3 0

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3. EXAMPLES… PROPORTIONAL METHOD

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1- Company A acquires 40% of Company B in cash2- Company A buy Inventory for 280 to a third party3- Company A Sells The entire inventory to Company B with a profit of 20

Note that Inventory Account is 112. [300*40% (group share) = 120 less the amount of profit embedded in it that belongs to the group (20*40%) =8]

Account Company A Company BCompany B

Proportional EliminationsConsolidated Statements Elim. No.

Cash 60 100 40 100 Investment in B 40 0 -40 0 1Inventory 300 120 -8 112 3IC Receivables 300 0 -120 180 2Recl IC Rec to 3RD Party Rec. 180 180 2Payables Third Parties -280 0 -280 IC Payables -300 -120 120 0 2Recl IC Pay. to 3RD Party Pay. -180 -180 2Common Stock -100 -100 -40 40 -100 1Retained Earnings B/S -20 0 8 -12 3Cost of Good Sold 280 0 280 Sales -300 0 -300 Profit&Loss in Tran. Invent. 0 8 8 3Retained Earning P&L 20 0 -8 12 3

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3. EXAMPLES… EQUITY METHOD

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1- Company A acquires 10% of Company B in cash2- Company A buy Inventory for 280 to a third party3- Company A sells The entire inventory to Company B with a profit of 204- Company B sells the entire inventory to a third party

Note that nothing is performed while transferring the inventory in 3 (in spite that the inventory is sold afterwards to a third party.

Account Company AConsolidation Adjustments Total Company A

B Statements (not incorporated into A)

Cash 90 90 100Investment in B 10 2 12 Inventory 0 Receivables 300 300 320Payables 3rd Party -280 -280 -300Common Stock -100 -100 -100Retained Earnings B/S -20 -2 -22 -20Cost of Good Sold 280 280 300Sales -300 -300 -320Profit&Loss in Investments -2 -2 Retained Earning P&L 20 2 22 20

introduction to consolidation

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