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Public Service Financial Reporting - Session 11, 12 and

13
Consolidation of financial statements

Workbook 7
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The Chartered Institute of

Public Finance & Accountancy
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IPSAS 34 IPSAS 35 IPSAS 36

Separate Consolidated Investments in
Financial Financial Associates and
Statements Statements Joint Ventures

IPSAS 37 IPSAS 38 Prepare

Disclosure of consolidated
Joint Interests in Other financial
Arrangements Entities statements

WB Ref: 7 3
Consolidation

Need to prepare
financial statements
for both:

Individual Groups – single

organisations economic entity

WB Ref: 7.1 4
 Entity A
Separate
accounts

Consolidated
(group)
accounts
Entity B
Separate
accounts

WB Ref: 7.3 5
Key definitions

Controlling entity:
• An entity that controls one or more entities

Controlled entity:
• An entity that is controlled by another entity

Economic entity:
• A controlling entity and its controlled entities

Associate:
• An entity over which the investor has significant influence
.
Joint venture:
• A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement

Separate financial statements:

• These are the statements presented by an entity which include its investments in other entities but reflect the entity as a single
entity

Consolidated financial statements:

• These are the financial statements of an economic entity in which the assets, liabilities, net assets/equity, revenue, expenses and
cash flows of the controlling entity and its controlled entities are presented as those of a single economic entity

WB Ref: 7.3 6
IPSAS 34 Separate Financial Statements

When an entity prepares separate • at cost

• in accordance with
financial statements, it shall standards relating to the
account for investments in recognition of financial
controlled entities, joint ventures instruments; or
• using the equity method
and associates either:

The investment will be presented as an asset in the

statement of financial position

WB Ref: 7.4 7
IPSAS 35 Consolidated Financial Statements

Principles for
consolidation

Presentation for
consolidation

Process for the

preparation of
consolidated
financial
statements

WB Ref: 7.5 8
IPSAS 35 Consolidated Financial Statements

Control
• An entity controls another entity when the entity is
exposed, or has rights, to variable benefits from its
involvement with the other entity and has the ability to
affect the nature or amount of those benefits through its
power over the other entity

Non-controlling interest

WB Ref: 7.5.1 9
IPSAS 35 Consolidated Financial Statements

An entity controls another entity if the entity

has all the following:

Power over the other entity

Exposure, or rights, to variable benefits from its

involvement with the other entity

The ability to use its power over the other entity to affect the
nature or amount of the benefits received

WB Ref: 7.5.2 10
Power over an other entity

Majority of votes at shareholders' meetings

Usually owning more than 50% of the ordinary

shares
Rights may stem from complex contractual or
binding arrangements

Consider potential voting rights

WB Ref: 7.5.2 11
Exposure, or rights, to variable benefits

Benefits can be financial and/or non-financial

Financial benefits include dividends

Non-financial benefits include advantages arising from

scarce resources that are not measured in financial terms
and economic benefits received directly by service
recipients of the entity

WB Ref: 7.5.2 12
Ability to use power to affect entity’s benefits

Strategy

Financial policies

Operational policies

WB Ref: 7.5.2 13
IPSAS 35 Consolidated Financial Statements

• Direct share ownership of a company by a public

sector entity
• Control by a government department of a
Public sector separately constituted government agency
arrangements • Requirement, by law or practice, to prepare
consolidated financial statements for a group of
leading to control entities such as all local authorities
could include: • Requirement, by law or practice, to prepare
consolidated financial statements for the whole of
government

WB Ref: 7.5.2 14
Now you try

Exercise 7.2

WB Ref: 7.5.2 15
Consolidation – general rule
IPSAS 35 requires
every controlling
entity to prepare a
set of consolidated
financial
statements
WB Ref: 7.5.3
Both the controlled
entity and the
controlling entity
will prepare
separate financial
statements initially
16
Exemptions from consolidation
It is itself a controlled entity and the information needs of users are
met by its controlling entity’s consolidated financial statements, or is a
partially-owned controlled entity and all its other owners, including
those not otherwise entitled to vote, have been informed about, and
do not object to, the entity not presenting consolidated financial
statements
Its debt or equity instruments
are not traded in a public
market
It did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organisation for the purpose of
issuing any class of instruments in a public market; and
Its ultimate or any intermediate controlling entity produces
consolidated financial statements that are available for
public use and comply with IPSASs

WB Ref: 7.5.4 17
Consolidation procedures

Combine on line-by-line basis

Post-acquisition retained surplus included

Goodwill

WB Ref: 7.5.5 18
Other considerations

Reporting dates

Accounting policies

Ceasing to be a controlled entity

WB Ref: 7.5.6 19
IPSAS 36 Investments in Associates and Joint Ventures

Associate Significant influence

• An entity over which the
investor has significant
influence
• Is defined as the power to
participate in the financial
and operating policy
decisions of the investee
without having control or
joint control over those
policies

WB Ref: 7.6.1 20
IPSAS 36 Investments in Associates and Joint Ventures
Joint venture
• A joint arrangement whereby
the parties that have joint
control of the arrangement
have rights to the net assets of
the arrangement. This type of
arrangement is a separate
legal or statutory entity
WB Ref:
Joint control
• The agreed sharing of control
of an arrangement by way of a
binding arrangement, which
exists only when decisions
about the relevant activities
require the unanimous consent
of the parties sharing control
7.6.1 21
IPSAS 36 Investments in Associates and Joint Ventures
Binding arrangement
• An arrangement that confers
enforceable rights and
obligations on the parties to it as
if it were in the form of a contract.
WB Ref:
Equity method
• A method of accounting whereby
the investment is initially
recognised at cost, and adjusted
thereafter for the post-acquisition
change in the investor’s share of
net assets/equity of the investee.
The surplus or deficit of the
investor includes its share of the
surplus or deficit of the investee.
7.6.1 22
Exemptions

IPSAS 36 does not apply if the investor is not required to prepare

consolidated financial statements under IPSAS 35

Exception applies where:

• the investor is a wholly owned controlled entity
• the investor does not have debt or equity instruments traded in a public market
• the investor's controlling entity prepares consolidated financial statements that are
publicly available and are prepared in accordance with IPSAS

WB Ref: 7.6.1 23
Significant influence

Significant influence - at least 20% of voting power

Equity method - used for associates and joint ventures

Changes in circumstances

Transactions between a venturer and joint venture

WB Ref: 7.6.2 - 5 24
Worked example

Example 1

WB Ref: 7.6.5 25
IPSAS 37 Joint Arrangements

Joint arrangements are established for a number of reasons

• share costs and risks

• provide access to new technology or markets

IPSAS 37 specifies that a joint arrangement is either

• Joint operation
• Joint venture

WB Ref: 7.7 26
IPSAS 37 Key definitions

Joint control

Binding arrangement

Joint arrangement

Joint operation

Joint venture

Separate vehicle

WB Ref: 7.7.1 27
IPSAS 37 Joint arrangements

Joint arrangement

Binding agreement Joint control

WB Ref: 7.7.2 28
Joint venture or joint operation?

To be a joint venture the joint arrangement:

• Must be structured through a separate vehicle, and
• Give the venturer rights to the net assets of the arrangement
• The rights must be to the net assets rather than separate rights to the
assets and obligations for the liabilities

If the joint arrangement is not structured through a

separate vehicle then it is a joint operation

WB Ref: 7.7.3 29
Accounting for joint arrangements

• Its assets, including its share of any assets

held jointly
• Its liabilities, including its share of any
Joint operation - a liabilities held jointly
joint operator • Its revenue, including its share of revenue
should recognise: from the joint operation
• Its expenses, including its share of expenses
from the joint operation

• IPSAS 36
Joint venture • Equity method

WB Ref: 7.7.4 30
Now you try

Exercise 7.4

WB Ref: 7.7.4 31
IPSAS 38 Disclosure of Interests in Other Entities

Disclosure requirements for IPSAS 34 – IPSAS 37

Nature, risks and financial effects

Significant judgements and assumptions

Interests in controlled entities

Interests in joint arrangements and associates

Interests in unconsolidated structures entities

WB Ref: 7.8.1 32
Preparation of consolidation financial statements

 Need to be able to prepare:

 Consolidated statement of financial position and Consolidated
statement of financial performance
 1 controlled entity (subsidiary); and/or
 1 associate

 Use step-by-step approach

WB Ref: WB 7 33
Consolidated statement of financial position
6 step approach

Step 1: Establish the structure of the economic entity

Parent
%
Subsidiary

WB Ref: 7.9.1
34
Consolidated statement of financial position
6 step approach

Step 2: Set out net assets of controlled entity

Net assets: At date of At date of

acquisition (£) reporting (£)

Share capital X X

Retained surplus1 X X

Total X X

WB Ref: 7.9.1
35
Consolidated statement of financial position
6 step approach

Step 3: Calculate any goodwill on acquisition (if relevant)

Cost of shares acquired X

Less: share of net assets at acquisition

(apply the group % in Step 1 to the net (X)
assets at the date of acquisition in Step 2)
Goodwill X

WB Ref: 7.9.1
36
Consolidated statement of financial position
6 step approach

Step 4: Calculate any Non-Controlling Interest (if relevant)

NCI = Share of net assets at reporting date - see Step 2

WB Ref: 7.9.1
37
Consolidated statement of financial position
6 step approach

Step 5: Calculate controlling entity retained surplus

WB Ref: 7.9.1
38
Consolidated statement of financial position
6 step approach

Step 6: Consolidate
 Bring in 100% of all assets and liabilities on a line-by-line basis
 Only include parent’s capital (contributed capital/share capital)
 Include goodwill, non-controlling interest and group retained earnings from workings

WB Ref: 7.9.1
39
Consolidated statement of financial position

Tangible non-current assets P+S X

Investment Investment in S cancelled out with S’s X

share capital (P+S-cost of shares in S-
inter co loan)
Goodwill Calculated in Step 3 X
Current assets P + S –inter co bal.–unrealised profits on X
intra co inventory
Total assets XX
Share/contributes capital P’s only, S’s cancelled by P’s investment X

Retained surplus Calculated in Step 5 X

Non controlling interest Calculated in step 4 X

Non-current liabilities P + S –inter co bal. (loan) X

Current liabilities P + S –inter co bal. X

Total liabilities & equity XX

WB Ref: 7.9.1 40
Worked example

Example 2

WB Ref: 7.9.1 41
Now you try

Exercise 7.5

WB Ref: 7.9.1 42
Now you try

Exercise 7.6

WB Ref: 7.9.1 43
Consolidation adjustments

Intra-entity balances
• Loans – these are cancelled in the consolidation
• Inter-company receivables and payables – eliminate
• Look for cash in transit and goods in transit
• Bank balances – bank overdraft should be shown
separately
• Unrealised gain in inventory - adjust

WB Ref: 7.9.2 44
Tutor led example

Example 3

WB Ref: 7.9.1 45
During the accounting period, P Agency sold goods to its
controlled entity S for £20 000, which gave P Agency a gain of
£4 000. One quarter of these goods were included in the closing
inventory of S at the end of the reporting period. (P sold to S)
Requirement
Show the required accounting entries when consolidating the
statements of P and S.
Dr:
Cr:

(need to remove the profit element from inventory in S)

WB Ref: WE 3 46
Please note

If S sold inventory to P Agency

Dr: S retained surplus

Cr: Closing inventory

Look out for this as it will impact on the consolidation process – who is selling to
who?

WB Ref: Pg 45 47
Tutor led example

Example 4

WB Ref: 7.9.1 48
Now you try

Exercise 7.7

WB Ref: 7.10 49
Consolidation adjustments

Intra-group non-current asset sales

 Eliminate gain on transfer
Parent sells: DR: Retained earnings (Parent)
CR: Non current asset
Sub sells: DR: Retained earnings (Subsidiary)
CR: Non current asset
 Adjust for depreciation - remove extra depreciation charged on
the element of the gain
 Do the opposite for a loss
WB Ref: 7.9.3 50
Tutor led example

Example 5

WB Ref: 7.9.3 51
Now you try

Exercise 7.8

WB Ref: 7.9.3 52
Consolidated statement of financial performance

Intra-group sales

Unrealised gains in inventory

Intra-group interest

Dividends from subsidiaries

Minority interest

Taxation

WB Ref: 7.10.1 53
Consolidated statement of financial performance
6 step approach

Step 1: Establish the group structure

Step 2: Calculate any unrealised gains in inventory
Step 3: Calculate consolidated revenue and operating expenses
 Intra-group sales
 Unrealised gains in inventory
Step 4: Investment income and interest payable
 Intra-group interest
 Dividends from subsidiary to parent

Step 5: Non-controlling interest (if relevant)

Step 6: Consolidate
WB Ref: 7.10.1 54
Tutor led example

Example 6

WB Ref: 7.10.1 55
Intra-entity adjustments – asset disposal

 Eliminate gain/loss on disposal

 Adjust for depreciation

WB Ref: 7.10.2 56
Now you try

Exercise 7.9

WB Ref: 7.10.2 57
Now you try

Exercise 7.10

WB Ref: 7.10.2 58
Consolidation of an associate
Consolidation of a controlled
entity (acquisition accounting)
Line by line consolidation:
Goodwill
Non-controlling interest:
Retained surplus:
Economic entity retained
surplus calculation.
Intra-entity balances
elimination
WB Ref:
Consolidation of an associate
(equity accounting)
No line by line consolidation:
One line is added to NCA –
‘investment in associates’.
No goodwill.
No non-controlling interest.
Retained surplus:
same approach.
Intra-entity balances not
eliminated.
7.11.1 59
Tutor led example

Example 7

WB Ref: 7.11.1 60
Now you try

Exercise 7.11

WB Ref: 7.11.1 61
Consolidated SF Position - Associates

Step 1 – establish the economic entity structure

Step 2 – calculate investment in associate

Step 3 – Calculate economic entity retained surplus

Step 4 - Consolidate

WB Ref: 7.11.2 62
Tutor led example

Example 8

WB Ref: 7.11.2 63
Now you try

Exercise 7.12

WB Ref: 7.11.2 64
Consolidated SF Performance - Associates

WB Ref: 7.11.3 65
Tutor led example

Example 9

WB Ref: 7.11.3 66
Now you try

Exercise 7.13

WB Ref: 7.11.3 67
IPSAS 36 – Dividends from associates

 Eliminate from investment income in statement of financial performance

 Eliminate from investment in associate:

Cost of investment X
Plus: Parent’s % (step 1) of associate’s post- X
acquisition surplus
Less: Dividend income from associate (X)
Less: Impairment loss (X)
Investment in associate X

 Eliminate from group retained surplus calculations for statement of

financial position
WB Ref: 7.11.4 68
Tutor led example

Example 10

WB Ref: 7.11.4 69
Intra-entity balances and gains

 No elimination of intra-group receivables/payables

 Adjust for group % of any unrealised gains

Parent is seller: Dr Operating costs / retained surplus

Cr Investment in associate

Associate is seller: Dr Operating costs / retained surplus

Cr Inventory

WB Ref: 7.11.5 70
Tutor led example

Example 11

WB Ref: 7.11.5 71
Reporting date and accounting policies

When consolidating an investor and associate;

• Same reporting date

• If different adjust financial statements for significant
transactions
• Uniform accounting policies

WB Ref: 7.11.6 72
What we covered

Prepare the
consolidated statement
of financial
performance and
statement of financial
position for a public
sector group consisting
of one subsidiary or
one associate

WB Ref: 73
Upcoming session…

 Next session we will cover interpretation of accounts and disclosures

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