Consolidated financial statements

A reporting entity prepares consolidated financial statements when it qualifies as a group, with some exceptions. The consolidation process entails merging the parent company with its subsidiaries, utilising consistent accounting policies for similar transactions, and aggregating similar items of assets, liabilities, equity, income, and expenses.

Concept of a group and consolidated financial statements

In IFRS 10, the concept of a “group” refers to a parent company and its subsidiaries. It is necessary to present the financial statements of a parent and its subsidiaries as a single economic entity. The consolidated financial statements are prepared to reflect the economic interests of both the parent entity investors and the non-controlling investors in partially owned subsidiaries, as if they were all part of a single entity. Non-controlling interests are considered to have an equity stake in the consolidated entity.

Equity transactions between a parent entity and the noncontrolling interests are handled as transactions between shareholders, as long as the transactions do not lead to a change of control. Transactions between the parent entity and the non-controlling interest do not result in gains or losses being recorded in profit or loss, unless control is lost. Recordings of transactions where control is maintained are accounted for in the equity.

The statement of comprehensive income, or income statement if separately presented, calculates the profit or loss for the financial year and analyses the allocation of profit or loss between:

• Profit or loss attributable to non-controlling interest. Profit or loss attributable to equity holders of the parent.
• Comprehensive income attributable to non-controlling interest.
• Comprehensive income attributable to equity holders of the parent.

Concept of control

IFRS 10 determines a unified definition of control that is applicable to all types of entities. This definition is backed up by comprehensive application guidance that provides explanations on the various methods through which a reporting entity (investor) can exercise control over another entity (investee).

Control is a fundamental principle here, and consolidation is necessary only when the investor has the authority, experiences variable returns, and can use its power to influence its outcomes. When a consolidated entity is formed, it combines the parent company and its subsidiaries to create the illusion of a single economic entity.

Scope

IFRS 10 requires that all entities acting as a parent must present consolidated financial statements, with a few exceptions. One exception pertains to post-employment benefit plans or other long-term employee benefit plans that fall under the scope of IAS 19.

Additionally, a parent is not required to provide consolidated financial statements if it fulfils specific criteria, as outlined.

Additionally, if the parent entity qualifies as an investment entity, it refrains from consolidating the majority of its controlled investments. Instead, it records the majority of controlled investments at fair value through profit or loss.

If an entity sets up an employee benefit plan for a share option scheme or a similar share-based payment scheme that falls outside the scope of IAS 19, such plans are considered within the scope of IFRS 10.

Exemption from preparing consolidated financial statements

If a parent entity meets all of the following criteria, it is exempt from presenting consolidated financial statements:

• It is a wholly owned subsidiary or a partially owned subsidiary of another entity and all of its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements.
• The parent’s debt or equity instruments are not publicly traded.
• The parent did not file, and is not filing, its financial statements for the purpose of issuing publicly traded instruments.
• The entity’s ultimate parent, or any intermediate parent, produces IFRS financial statements in which subsidiaries are consolidated or measured at fair value through profit or loss that are available for public use.

If the parent is not required to prepare consolidated financial statements, it can choose to present separate financial statements instead of consolidated financial statements.

For the exemption to apply, the ultimate/intermediate parent must explicitly and unequivocally state their compliance with IFRS when preparing consolidated financial statements.

Most controlled investments are recorded at fair value through profit or loss by entities that meet the definition of an investment entity. This requirement also extends to investments in associates and joint ventures. All other investments are subject to the standard regulations of IFRS 9 (IAS 39).

Exemption from preparing consolidated financial statements Exemption from preparing consolidated financial statements Facts Entity A has the following interests in other entities: ·        100% interest in entity B; and entity B owns a 60% interest in entity C. ·        80% interest in entity D; and entity D owns a 60% interest in entity E. The structure is illustrated as follows: Entity A is a listed company and prepares IFRS consolidated financial statements. Entities B and D do not have their securities publicly traded, and they are not in the process of issuing securities in public markets. Entity A does not require entity D to prepare consolidated financial statements. Entity B is a wholly owned subsidiary of entity A, and is not required to prepare consolidated financial statements.

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Local legislation and exemptions from preparing consolidated financial statements Local regulations determine the timing and duration for which an entity must present consolidated or separate financial statements. Local regulations may permit (or mandate) an intermediate parent to generate individual financial statements prepared in accordance with IFRS rather than consolidated financial statements. If local legislation or regulations permit an entity to forgo producing consolidated financial statements, the entity should still assess the exemptions in IFRS 10 and determine if it is exempt from preparing consolidated financial statements under IFRS.

Reporting entities and entities

IFRS 10 uses the term ‘entity’ without providing a specific definition. An entity is typically used to describe an organisation or institution that has a tangible or distinct existence.

Parent and subsidiaries

The term ‘parent’ is defined as “an entity that controls one or more entities” . A subsidiary is defined as “an entity that is controlled by another entity”.

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Determining whether an entity exists Group entities Some arrangements, such as syndicates, might not have a separate legal personality: Syndicate members might enter into contracts and investments in their own names. Legal action might only be taken against the syndicate members rather than the syndicate itself. The day-to-day running of the syndicate’s assets might be performed by a managing agent, who might or might not be a subsidiary of one of the syndicate members. Question What factors should be considered in determining whether a structure is an entity for the purposes of assessing whether it is within the scope of IFRS 10? Solution An Entity can only be formed if its members have a means of collaborating and making decisions that affect everyone involved. This could involve the capacity to designate and dismiss a managing agent or individuals with similar roles. If there is no mechanism in place to facilitate this, a member will only have a stake in assets (such as a proportional share of a property or investments) rather than an actual entity being formed. An entity will exist if one of the following conditions is met: ·        The structure has a separate legal existence which is distinct from its investors. Factors which indicate this include: o   legal personality; o   governing documents which establish the structure; o   the structure is able to contract in its own name; and o   the structure can be sued. ·        A contractual agreement exists allowing the investors to make decisions over the relevant activities of the structure. Factors which indicate this include: o   a management committee or similar body exists; o   the investors are able to remove the managing agent; o   dissenting investors are bound by majority decisions; o   the arrangement has a tax status separate from that of its investors; o   the arrangement is able to open a bank account in its own name; and o   the liabilities of the investors are not limited to the amount of their investment. ·        The indicating factors set out above are not exhaustive lists. All facts and circumstances should be considered when determining if an entity exists for the purposes of applying IFRS 10. Entities might include: ·        Corporations. ·        Partnerships. ·        Trusts. ·        Governmental bodies or agencies. ·        Universities. ·        Any other organizations or bodies of persons. ·        A ring-fenced portion of a larger entity (sometimes referred to as a ‘silo’). ·        A group including one or more of the entities identified above. ·        Appendix A to IFRS 10 defines a group as “a parent and its subsidiaries”, so any of the entities noted above would need to meet the definition of a parent or a subsidiary to be part of a group.

Control is determined by the investor’s ability to exert influence over the investee, the potential for variable returns, and the capacity to use that influence to impact the investor’s own returns.

Investor and investees

IFRS 10 uses the term ‘investor’. This is not defined by the standard; however, an investor is generally regarded as a reporting entity that has an interest in another entity. IFRS 12 describes an interest in another entity as “contractual and non-contractual involvement that exposes an entity to variability of returns from the performance of the other entity” .

Forms of interest in another entity Entities can have an interest in other entities through equity holdings or other forms of involvement. Possible interests in an entity may include, but are not limited to: ·        Equity or debt instruments. ·        Credit enhancement and guarantees. ·        Certain derivatives. ·        Liquidity support. ·        Obligations arising from sponsoring an employee benefit trust. ·        A participation right. ·        A residual interest. ·        A lease. ·        The provision of funding. ·        Other contractual arrangements. ·        Any non-contractual means by which an entity has control, joint control or significant influence over any entity.

Some investments offer investors a predetermined or specified rate of return, while others grant investors privileges or the opportunity to benefit from the entity’s future economic gains.

IFRS 12 also states “ An entity does not necessarily have an interest in another entity solely because of a typical customer-supplier relationship ”.

An investor evaluates if it has control over an investee. Following this evaluation, if an investor concludes that it exercises control over an investee, it will be considered the parent company and the investee will be its subsidiary.

This chapter utilises the terms ‘entity’, ‘investor’, and ‘investee’ with the specified meanings.