Chapter 9

Consolidation: Controlled entities

Presenter

Associate Professor Parmod Chand

 Announcements

• MSE will be held on Friday 21st January (6-9pm).

Students will sit for the exam at their own registered
campuses.

• Tutes/Lectures - Tutes and lectures will resume on

Monday 31st January. No tutes or lectures on Thurs 20th
Jan.

• Assignment - The assignment is available on Moodle now.

It is due on 31st of January.
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 Applying the consolidation method

• AASB 10/IFRS 10 requires the application of the consolidation

method
• Consolidation – process of preparing single set of financial
statements for group of entities under control of one of those
entities
• Involves combining financial statements of individual entities to
show financial position and performance of group as if it were single
entity
• Group – a parent and it’s subsidiaries
• Parent – an entity that controls one or more entities
• Subsidiary – an entity that is controlled by another entity

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Applying the consolidation method

A Ltd Parent
“control” must exist (more
on this later)
B Ltd Subsidiary

The group is referred to as the “A Ltd Group”

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 Applying the consolidation method

Consolidated financial statements are prepared by

(i) Aggregating (combining), line by line, like items
of assets, liabilities, equity, income and expenses
(ii) Adjusting these combined figures for inter-group
transactions between entities within the group (covered in
following chapters)

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 Applying the consolidation method

Simple consolidation worksheet for the A Ltd group

A Ltd B Ltd Consolidation
Current assets 50 000 + 20 000 = 70 000
Non current assets 150 000 + 120 000 = 270 000
Total assets 200 000 140 000 340 000
Total liabilities (80 000) + (30 000) = (110 000)
Net assets 120 000 110 000 230 000

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 Control

• Criterion for identifying parent-subsidiary relationship is

control
• Significant judgement is often required in determining
whether control exists

• An investor controls an investee when the investor is

exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect
those returns through its power over the investee

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 Control

• The following three elements are required in order for an

investor to have control
1. power over the investee
2. exposure, or rights, to variable returns from its
involvement with the investee
3. the ability to use its power over the investee to affect the
amount of the investor’s returns.

• All three elements must be present for control to exist

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 Control element 1 – Power

• Power is defined as existing rights that give the current

ability to direct the relevant activities.
• Power arises from rights. Most rights arise from a legal
contract. Examples in AASB 10/IFRS 10 include:
• Voting rights
• Rights to appoint, reassign or remove members of the
investee’s key management personnel
• Rights to appoint or remove another entity that
participates in management decisions
• Rights to direct the investee to enter into, or veto any
changes to, transactions that affect the investee’s
returns
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 Control element 1 – Power

• Rights must be substantive – the holder must have the

practical ability to exercise the rights.
• Judgment is required in determining whether rights are
substantive. Factors to consider per AASB 10/IFRS 10 are:
• Whether the party that holds the rights would benefit from
exercising the rights – eg potential voting rights;
• Whether there are any barriers that prevent a holder from
exercising rights.
• Where multiple parties are involved, whether there is a
mechanism in place to enable those parties to practically
exercise the rights.

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 Control element 1 – Power

• If a right is protective, then the holder does not have power.

• Protective rights are designed to protect the interest of the
party holding those rights without giving the party power over
the entity to which the rights relate.
• Example of protective rights include the following:
• A lenders right to restrict a borrower from undertaking
certain activities
• The right of a party holding a non-controlling interest to
approve various transactions
• The rights of a lender to seize the assets of a borrower in
the event of default.
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 Control element 1 – Power

• Requires the ABILITY to direct – rather than actually

directing.
• The ability to direct must be current.
• It must be relevant activities that are being directed, that
is activities of the investee that significantly affect the
investee’s returns.
• Power is presumed to exist where an investor owns more
than 50% of the voting rights of an entity unless there is
evidence to the contrary

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 Control element 1 – Power

• Voting rights of less than 50% can result in an investor having

power over an investee.
• The following factors need to be considered when assessing
whether there is power in this case.
• Dispersion of other shareholders
probability of shareholders attending meeting lessened by
location and by size of share parcels
• Attendance at AGMs

e.g. if only 60% of eligible votes attend meeting, 31% can control
meeting
• Existence of contracts

power by agreement with other investors

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 Control element 1 – Power

• Problems relating to having power with less than 50% of

the voting rights include:

• Temporary control

eg 31% ownership can control if only 60% of

eligible votes in attendance at AGM in Year 1,
but not if 70% in attendance in Year 2

• Friendly relationship can turn un-friendly

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 Control element 1 – Power

Question 1 - Who controls C Ltd?

• A Ltd currently actively
A Ltd B Ltd formulates the policies of C Ltd
• B Ltd currently plays no part in
48% 52% the day-to-day management of
C Ltd C Ltd

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 Control element 1 – Power

Question 1 - Who controls C Ltd?

• A Ltd currently actively
A Ltd B Ltd formulates the policies of C Ltd
• B Ltd currently plays no part in
48% 52% the day-to-day management of
C Ltd C Ltd
B Ltd controls C Ltd
Even though A Ltd is currently running the day-to-day
operations of C Ltd, B Ltd has the power over C Ltd. At any
time that B Ltd disagrees with the management policies of A
Ltd it can take control by virtue of its majority voting interests.
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 Control element 1 – Power

Question 2 - Does A Ltd control B Ltd?

A Ltd
45%
20 shareholders each
holding < 2% of the
B Ltd voting power. These
shareholders rarely
attend meetings and vote

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 Control element 1 – Power

Question 2 - Does A Ltd control B Ltd?

A Ltd
45%
20 shareholders each
holding < 2% of the
B Ltd voting power. These
shareholders rarely
Yes. attend meetings and vote

Based on the history of AGM attendance and dispersion of

shareholders it appears that A Ltd exerts power over B Ltd
in spite of holding < 50% of the voting rights
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 Control element 1 – Power

Question 3 - Does A Ltd control B Ltd?

A Ltd
49%
3 shareholders each
holding 17% of the voting
B Ltd power. These
shareholders regularly
attend meetings and vote

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 Control element 1 – Power

Question 3 - Does A Ltd control B Ltd?

A Ltd
49%
3 shareholders each
holding 17% of the voting
B Ltd power. These
shareholders regularly
attend meetings and vote
No.
Based on the history of AGM attendance and involvement of
shareholders it appears that A Ltd does NOT exert control
over B Ltd.
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 Control element 2 – Exposure or rights to
variable returns
• The second element of the control definition requires that the
investor has the rights to variable returns from the investee.
• Examples of returns that can exist in parent-subsidiary relationship
include:
• Dividends
• Obtaining scarce raw materials on priority basis
• Gaining access to subsidiary’s distribution network, patents
• Economies of scale
• Denying or regulating access to subsidiary’s assets to
competitors

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 Control element 3 – Ability to use the
power to affect returns

• The third element requires that the parent have the ability to
increase its benefits and limit its losses from the subsidiary’s
activities.

• Remember, all three elements must be present for control to

exist.

• No control = no parent-subsidiary relationship = no

consolidation.

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 Preparation of consolidated financial
statements
AASB 10 (paragraph 4) requires all parents to prepare consolidated
financial statements unless they (the parent entity) meet all of the
following conditions:
i. it is a wholly-owned subsidiary or is a partially-owned subsidiary of another
entity and all its other owners do not object to the parent not presenting
consolidated financial statements;
ii. its debt or equity instruments are not traded in a public market;
iii. it is not required to file financial statements with a securities commission
or other organisation for the purpose of issuing instruments in a public
market; and
iv. its ultimate or any intermediate parent produces consolidated financial
statements available for public use and comply with AASBs/IFRSs.

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 Presentation of consolidated financial
statements

A Limited
NCI 90%

10%
B Pty Ltd
80%

C Pty Ltd
No consolidation required for B + C sub-group if:
i. 10% NCI shareholders in B consent;
ii. B is unlisted - YES in this case as a Pty Ltd company;
iii. B is not issuing instruments in a public market – YES in this case as not
possible for a Pty Ltd company to do this; and
iv. A Limited prepares compliant consolidated financial statements
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 Business combinations and consolidation

• An acquirer is the combining entity that obtains control of the

other combining entities in a business combination.

• In most cases the parent will be the acquirer.

• Exceptions arise when:

– A new entity is formed, which acquires all the shares of
previously existing entities
– A reverse acquisition occurs

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 Tute Questions

Leo 11e Chapter 9

1. Review Question 4
2. Review Question 10
3. Case Study 4
4. Case Study 6
5. Case Study 10

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