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ACCT 3011
Issues in Consolidation:
Debates about the value of group accounting
12 May 2014
Todays Menu
- Feedback for student reps
- Exam review following this lecture. Merewether Seminar Room 10 (room

Lecture aims:
- Explain CFS and equity accounting
- Articulate arguments for and against CFS
- Discuss alternatives to CFS
Clarke, Dean and Egan. 2014. Group Accounting Shenanigans
The Debate about CFS: Background
As we know, ACCT3011 fundamentally looks at alternative methods
of accounting for investments.
We find that a number of qualitative and subjective principles based
largely on ability to direct and voting rights help us to decide
between significantly different accounting outcomes - AASB10
and AASB128 and AASB139.
The solutions developed over time have varied according to the degree of the
investors involvement, distinguishing between:
- (sole) control [Weeks 1-6 - CFS]
- joint control and significant influence [Week 7 - EM]
- Available for sale financial asset [week 11]
- Joint operation [week 12]
- Problem region (as we discovered in the equity lecture: 20-50% voting power)
The debate . . . : Background (cont.)
All the alternative methods reflect dissatisfaction with the cost
Recall - at the simplest level, in using the cost method the
- reports its investment in the investee at cost (Balance Sheet
- BS)
- reports dividends from investee as revenues (Income
Statement - IS)
In moving away from cost, all alternatives are trying to better
address the relevance principle. Try to look for better
words than accuracy
The debate . . . : Background (cont.)
Our professional judgment is therefore critical
The difference between strong significant influence and weak control
can be very little.
And yet if we compare the accounting outcomes (consol versus
equity), they are very different:
- elimination of the investment in CFS and replacement with the line
by line aggregation of R, E, A and L, versus the 'one line' approach
in the equity
- the 100% approach in CFS versus just our share in equity
accounting which requires a conception of NCI in the former but
not the latter
- the approach to accounting for inter-company transactions and
unrealised profits in each
The debate . . . : Background (cont.)
More differences in the accounting outcomes we can discuss:
- the approach to fair value adjustments in each
- the approach to accounting for goodwill in each; recognition in CFS
(with a choice of two methods) versus acknowledgement in equity
- What is disclosed?
- CFS statements highly aggregated however NCI
- CFS statements highly aggregated however, NCI
in NPAT and equity presented. And disclosures of
segment note, note detailing the names of all
subsidiaries etc
- Equity accounting 2 line items within the
statements and some disclosures of movements
- Lets look at a practical example to illustrate.
Sack Goldman Ltd assignment used in 2010
SG Ltd
Sack Goldman Ltd additional information
Sack Goldman Ltd chooses to use the partial method for calculating goodwill.
Sack Goldman Ltd only recognises dividends from investments when received. (Note that AASB 118.30 (c) states
that dividend shall be recognised when the shareholders right to receive payment is established).
On 15 June 20X8 Wall St Ltd sold inventory to Sack Goldman Ltd for a selling price of $300,000 at a mark up of
20% on cost. The inventory was still on hand at year end.
On 1 June 20X8 Wall St Ltd sold equipment to Sack Goldman Ltd for $1,000,000. The equipment had cost Wall St
Ltd $900,000 and had an accumulated depreciation at the date of sale of $400,000. At that date the equipment
had a remaining useful life of 2 years. Sack Goldman Ltd still owned that equipment at 31 December 20X8.
The transfer to general reserve made by Wall St Ltd was attributable to profit after acquisition.
The company income tax rate is 30%.
The accounts on the preceding page are shown prior to the application of AASB127 or AASB128. They are also
therefore shown prior to any impairment of Sack Goldman Ltds investment in Wall St Ltd. As at 31 December
20X8, the fair value of Sack Goldman Ltds investment in Wall St Ltd was $3,080,000.
In your equity method calculations, you may credit any accumulated impairment directly against the Investment in
Associate account. In your consolidation method calculations, you must impair goodwill by that same impairment
loss that you will calculate using the equity method. In other words, you will need to fully complete the equity
method before you can then revise as the consolidation method.
In addition to its investment in Wall St Ltd, Sack Goldman Ltd also held shares in Westpac Bank Limited which
have already been marked to market value at 31 December 20X8. The investment in Wall St Ltd and the
investment in Westpac Bank Limited are the only 2 investments Sack Goldman Ltd held at 31 December 20X8.
The remaining 55% shareholding of Wall St Ltd was made up of many small investors, none of whom had either
control or significant influence of Wall St Ltd.
It is Sack Goldman Ltds policy to record all entries required by the equity method of accounting directly into Sack
Goldman Ltds journals and ledgers.
Part 1 and 2 of the assignment:
1. Complete the Sack Goldman Ltd accounts by applying the equity
method to account for the investment in Wall St Ltd.
2. You then reconsider the investment in Wall St Ltd and realised that
your conclusions in part 1, above were wrong. You now realise that Sack
Goldman Ltd does not have significant influence over Wall St Ltd, it
actually has control. Revise Sack Goldman Ltds accounts for 31
December 20X8.
Note: The journal entries required under both methods are provided for
you in a spreadsheet in the lecture 9 folder on blackboard.... So you can
use this as a practice exercise.
[The journal entry approach to allocating Direct Non-Controlling Interest
(DNCI) is utilised as illustrated in section 5.4.5 of your textbook but it could
also have been done as the memorandum approach as we did in the
tutes this semester].
Comparing the outcomes
Questions for you to consider:
How can slightly different circumstances justify two very different accounting
Is all of that subjective-ness and professional judgment (and perhaps
devious behavior) best serving our fundamental accounting goals?
Would it be better if AASB 10 and 128 were more rules based and we simply
said that 45% was either control or significant influence? The answer must
come back to.
The purpose of accounting:
- Is it to make the business look good? No! - a couple of important concepts
you should appreciate earnings management and balance sheet
- Its about revealing truth (a true and fair view)
- and its about:
- accountability from managers to owners; and
- Information useful for decision making (where I do get this from SAC2)
- Reconsider Leibler reading from week 1
- But useful to whom? Just investors? No!
- AASB framework*:
- Para 9 the users of financial statements include present and
potential investors, employees, lenders, suppliers and other trade
creditors, customers, governments and their agencies and the public
Para 9 then goes on to explain many specific needs of each of these - Para 9 then goes on to explain many specific needs of each of these
distinct user groups
- See also SAC2 para 16ff
- So we have a difficult job! Our product should meet the diverse needs
of a diversity of users
*Note however, that a problem for the Framework is that it is not a mandatory consideration for reporting entities
(see application and purpose and status)
Are we neglecting our second duty?
Part 2M.3 Corporations Act 2001. Annual financial reports must:
- comply with accounting standards (s 296) and
- give a true and fair view (s 297)
- para 15 - reporting entities must present fairly
- para 19 - can depart from compliance if misleading but p p p g
- para Aus19.1 - little scope for departure
The TFV requirement is not overriding (it was prior to 2002 and still is in the
UK) and so detailed rules cannot be broken Chris Nobes this is the right
approach.... too dangerous otherwise
Nonetheless, we are called to consider whether compliance with AASB may
not align with a true and fair view... If we feel there is more to say, we should
be providing complimentary disclosures to explain
[See interview with Chris Nobes on true and fair in lecture 10 folder]
TFV the challenge
Leibler - It is generally accepted that reporting entities do a good job at
complying with AASB and ASX listing rules where required. But how well
do we consider a TFV? Do accountants, directors, auditors, ASIC etc,
largely take it that the former sufficiently addresses the latter?
Certainly the TFV requirement is vague, and AASB compliance adds
certainty to our responsibilities and lends comparability. And so I agree that
y p p y g
T&F should not override AASB compliance.
But we must invest some thought in what true and fair means and
consider complementary disclosures:
- no explanation in the Act
- True? A true reflection of performance, position and cash
flow. Leading and not misleading information. Facilitating informed and
correct decisions. Its not about making the reporting entity look good
- Fair? Equal utility to all users. Faithful representation.
4 types of accountants
Which of the following perspectives do you think is a more
appropriate dissection?
3 + 1 types of accountants identified by Godfrey, Hodgson and Holmes (week 8
l k
- rule-makers
- financial report preparers
- rule-enforcers
- (and lets add accounting academics to that list)
4 types of accountants identified by Macintosh:
- the truthteller
- the liar
- the humbugger
- the Bull----er
(Macintosh, NB (2009) Accounting and the Truth of Earnings Reports: Philosophical Considerations, European Accounting Review, 18:1 141-175)
NOW lets pull apart CFS - The Case FOR CFS
Imagine a simple case, involving parent P and subsidiary S, where:
Ps investment in S is one of its major assets, accounted for using the cost
Ps users dont see Ss accounts (although Ss users can of course command
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Ps BS would otherwise show the investment in S at cost year after year (ignoring
AASB128 and 139)
Dividends received from S may not reflect its current year performance, so Ps
Income Statement (IS) will be misleading
Consider also relevance versus reliability
Both IS & BS (of P) may be distorted by controlled/fake transactions between P &
S (related parties!)
Example management fees
The Case FOR CFS (cont.)
CFS seem to solve these problems. How?
CFS provide an overview of financial position and income; a
synoptic view of how well the group is being managed
(perhaps we can already see a flaw maybe its not the group
that our users want)
i b t l l f l k t th ' t
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economic substance vs legal form look past the 'corporate
Consider the concept of control; control implies that all of these
entities are acting as one; so our argument is that its meaningful
to paint a picture for that one group entity. By showing the
parent and all controlled entities as one, we see how well a
collection of commonly controlled assets and liabilities have
been managed by that common cohesive group of managers
The Case FOR CFS (cont.)
CFS are preferable to providing the individual financial
statements of all members of the economic entity a lot to
absorb and the point is that we see value in aggregating them
as one consider the number of subsidiaries in Qantas (note
Lets also go back to the purpose of accounting how is
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consolidated data useful for decision making? For addressing
Cross guarantees provide support to all of this logic:
- What is a cross guarantee?
- How does the existence of a cross guarantee agreement add to the
meaningfulness of consolidated financial information?
- See for example, Qantas note 34
Clarke Dean and Egan:
CFS are based upon fiction, unrealistic assumptions,
contain items and balances not found in any of the
related companies said to form the economic group,
and fail to respect the separate legal entity principles
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p p g y p p
fundamental to the centuries-old corporate form (p
IFRS defence:
CFS are the statements of a group presented as those
of a single economic entity (AASB 10, Appendix A)
The Case AGAINST CFS the fiction
P & S are separate legal entities which have real
financial/commercial implications. 'No group could own
assets or incur liabilities, for both the notion of 'asset' and of
'liability' entail the idea of property rights under the British-
based legal system' (p 132)
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'if there is to be form, there must be legal substance' (p 126)
unscrupulous operators will quickly use the accounting
fiction or alternatively the legal position when benefits accrue
to them from doing so directors schizophrenia (p 129). Eg
Palmers prospectus using MLC logo (p 130)
The Case AGAINST CFS - unrealistic assumptions
CFS assume that P will take responsibility for Ss
liabilities but P may have no intention of doing so.
CFS assume that Ps management can do as they want
with Ss assets but there are limits, e.g., where there
are non-controlling interests in S.
Nonetheless this assumption arguably has more
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Nonetheless, this assumption arguably has more
validity now with new definition of control under
More generally, P will also be limited in its control
by virtue of the impact of other managers
delegated with control, diversity of directors on
subsidiary's boards, technical needs and
limitations, distance etc
The Case AGAINST CFS (cont)
CFS are an amalgam of measurement methods:
They include assets stated at past (sometimes
amortised) and present costs (money gone), some at
estimated fair values (often costs to acquire assets
money wished for), cash balances (money possessed),
capitalised expenses (money often long gone) tax
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capitalised expenses (money often long gone), tax
effect debits and credits artifacts of the accounting
system (not money had in the past, guaranteed or
committed in the future), debts collectible (likely money
in the future); and liabilities owing (money committed).
(Clarke, F and Dean G. Group figures the underlying
ferals in the Australian Financial Review 6 September
2010 p 59) on blackboard
The Case AGAINST CFS (cont)
CFS may be an amalgam of 'earnings management' manipulations
undertaken by CFOs in cahoots with investment analysts.
Opportunities for earnings management include:
Subjectivity opportunism. Eg accruals, impairment.
Contradictions and ambiguities in GAAP eg between
framework and standards
Structuring transactions particularly for tax
ti / id
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Altering timing of sales and expenses
Negotiating with auditors
But appreciate:
CFS is not necessarily the culprit per se here
none of this necessarily implies non compliance with accounting
standards... But what about true and fair?
[Arguments taken from Macintosh (2009)]
The Case AGAINST CFS (cont)
CFS are aggregated. As a consequence, detail is hidden.
Disaggregation can be valuable as we saw in the segment lecture.
i) the disaggregation provided in the notes to the accounts may be
poorly accessed.
ii) both segment disclosures and related party disclosures have
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ii) both segment disclosures and related party disclosures have
limitations. Eg Qantas and Woolworths.
iii) segments are unlikely to also equate to separate subsidiaries
iv) The whole situation becomes even more confused given the
possibility of existing flaws in Ps & Ss accounts
The Case AGAINST CFS (cont)
As a result of the elimination of transactions between
group members, data is also lost. 'By virtue of highly
contestable elimination assumptions, they [CFS]
remove the legally based financial impact of many of
the most fundamental commercial transactions of the
i di id l ( lb it l t d) titi f th ' ( 129)
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individual (albeit related) entities of the group' (p 129).
Do related party disclosures overcome that?
The Case AGAINST CFS (cont)
Consolidation creates artifacts on consolidation
including assets which are not therefore owned by any
legal entity.
Consider goodwill:
Recognised only on consolidation
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Recognised only on consolidation
Not separable
Choice to adopt partial or full method
Impairment is professional judgment a good thing here
or not?
The capital boundary problem PATRICK STEVEDORES 1997
P 132-134
Sept 97. Employee subsidiaries sold their
valuable assets to other group members
Proceeds were used to pay debts owed to
other group members and then $60-70M
was used to buy back equity held by other
group members
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group members
Result: Nothing left for employee debts
CFS did not reveal these transactions
Cross guarantees imperfect; closed group
was only a part of the economic entity
Note; we are considering here employees
as a user groupbut is the framework
asking too much; in truth, are the financial
statements the place that employees go to
for related information?
Taken from
tm 10 March 2010
The Case AGAINST CFS other issues
CFS are of dubious value to users who are more interested in Ss
accounts. For example creditors of S. Although cross-guarantees
(c-gs) may help. But we have seen that c-gs are of limited value if
they dont cover ALL group members. Consider Qantas note 34
CFS are of dubious value to NCI. Especially where there are more
than 1 partly owned subsidiaries.
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Corporate groups are ungovernable see a short video of
Professor Graeme Dean interviewing Justice Neville Owen at (see esp from 8.00
minute mark). Justice Owen is a judge in the Supreme Court of
Western Australia and the former Commissioner of the Royal
Commission into the collapse of HIH. A major difficulty he faced as
a commercial law judge was seeing into corporate groups.
Other concerns
Off balance sheet items:
- keeping bad news items off the balance sheet (p 124),
largely through special purpose entities that might not be
considered subsidiaries. Solved now with AASB10? more
tinkering? (p 125). Will a widen of the ambit of control,
combined with a greater focus on disclosures (p 125-126)
just allow for more hiding?
- shadow banking (controlled special purpose entities
providing a finance function to the group which are not
subject to normal banking regulation)
Alternatives to CFS
1. Ban parents from investing in wholly owned subsidiaries? Thereby force all
such operations to become divisions or branches within one single legal entity
Pros?: Better able to be regulated (Justice Owen would be pleased about that);
our financial statements will then reflect the A, L, R and E attributable to a single
legal entity; eliminate scope for opportunistic intra group transactions
Cons?: What of partly owned subsidiaries?; what of interests overseas?; consider
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Cons?: What of partly owned subsidiaries?; what of interests overseas?; consider
the entrepreneurial advantages of isolating distinct elements of our business
within separate legal entities
We do not oppose the provision of group accounts per se. As noted, groups of
related companies are unquestionably the common business arrangement in
modern, Western-style commerce. Nor should there be entertained any doubt that
both management and investors need reliable, orderly, aggregative financial
information about related companies, preferably arranged so that the input of the
separate companies to the group performance can be sufficiently identified (p
Clarke and Dean alternatives to CFS (cont.)
2. Market price accounting for groups [MPAG]
See pp. 138-148
Some features of MPAG:
Comprehensive asset reporting based on current cash equivalents
(CCEs - roughly fair values, mark-to-market market selling prices for
physical assets); with changes in CCEs included in income
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physical assets); with changes in CCEs included in income.
Investments in listed entities are not eliminated but instead are adjusted
to CCE
Investments in unlisted entities reported at investors share of investees
net assets calculated on a CCE basis [similar to equity method]
Non-vendible items reported at zero
Clarke and Dean alternatives to CFS (cont.)
Some features of MPAG (cont):
Ps accounts are prepared on a CCE basis
Ps accounts are supplemented with a summary of Ps
subsidiaries accounts, also prepared on a CCE basis
A further statement of inter-entity indebtedness reveals details of
t d ithi th hil i t t ti
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amounts owed within the group; while intra-group transactions
could also be disclosed in the notes to the accounts. (Note strong
emphasis in this proposal on providing a lot of detail of related party
transactions and balances)
Clarke and Dean alternatives to CFS (cont.)
Some advantages of MPAG (cont) :
Assets are all reported on the same (contemporary)
basis; CCEs can be legitimately added, subtracted,
underpin financial analysis (apples and apples)
Reporting at CCE counteracts fake transactions within
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the group. Summarising the balances of all subsidiaries
will also discourage illegitimate movement of funds
between group entities
Transparency re (rather than elimination of) financial
flows within the group is emphasised
Clarke and Dean alternatives to CFS (cont.)
Any disadvantages or difficulties of MPAG?
The group concept is retained to some degree,
doesnt overcome all problems
Unlisted investments remain problematic
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Consider the understand-ability principle too much
data to absorb and isnt CFS a clever trick for
condensing all of that commonly controlled data into
one entity?
Clarke and Dean alternatives to CFS (cont.)
Some disadvantages or difficulties of MPAG (cont):
CCE-based accounting has been criticised, e.g.,
It anticipates profits. Lacking sufficient conservatism?
Not reliable? (a bit like the Nobes criticisms of equity
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Not reliable ? (a bit like the Nobes criticisms of equity
There is no progress towards this alternative and so a
reluctance to change is evident. Why arent users calling
for this apparently better informationis there anyone out
there other than investment analysists??
Potential exam essay questions
contrasting equity method with CFS
your perspective on the usefulness and limitations of CFS
from the perspective of specific users
Basic explanation of possible alternatives
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your perspective on professional judgment versus a more
rules based/quantitative approach to AASB10 and AASB128
Work on your writing skills - develop logical, clear structured
narratives that demonstrate your perspective. In essays, marks are
always given for an appropriate introduction and conclusion.
Examples are often useful. Students who simply provide bullet
points that do not demonstrate personal perspectives and
suggestions for improvement are not well rewarded.