UNIT 8 :CONSOLIDATED FINANCIAL STATEMENTS
Key unit competence: To be able to consolidate financial statements
Introductory activity
Companies frequently refer to the use of aggregate reporting of the
entire firm when using the term “consolidation” in the company’s financial
reporting.
1. What are the financial statements that are important for the financial
reporting of group companies?
8.1. Introduction to consolidated financial statements
Learning Activity 8.1
There are few fundamental strategies to expand business operations, like
purchasing a foreign company or its shares, launching altogether a new
company, forming a joint venture with someone else
1. Define the following terms;
i) A parent Company
ii) A subsidiary Company
iii) A group
8.1.1 An overview on Groups and consolidation
This topic discusses issues in relation to group accounting and the provisions
of the IFRSs that give guidance on how to disclose items in the financial
statements. It gives important definitions and explains the need for consolidation
and how relevant consolidated financial statements are for the users. One of the
IFRSs that guide consolidation process is IFRS 10, the objective of IFRS 10
‘Consolidated Financial Statements’ is to establish principles for preparation
and presentations of consolidated financial statements when an entity controls
one or more other entities.
The need to develop an IFRS to deal specifically with issues of consolidated
accounts arose due to inherent weaknesses in IAS 27. While recognizing that
the basic model for consolidated accounts was fine in IAS 27, inconsistency in
applying the provisions of IAS 27 necessitated the need for a single combined
model that meets the needs of both those preparing financial statements andthe end users of financial information in a consistent manner.
Non-controlling interest: Equity in a subsidiary not attributable, directly or
indirectly.
IFRS 10 establishes principles for presenting and preparing consolidated
financial statements when an entity controls one or more other entities. IFRS 10:
• Requires an entity (the parent) that controls one or more other entities
(subsidiaries) to present consolidated financial statements;
• Defines the principle of control, and establishes control as the basis for
consolidation;
• Sets out how to apply the principle of control to identify whether an
investor controls an investee and therefore must consolidate the investee;
• Sets out the accounting requirements for the preparation of consolidated
financial statements; and
• Defines an investment entity and sets out an exception to consolidating
particular subsidiaries of an investment entity.
Consolidated financial statements are financial statements that present the
assets, liabilities, equity, income, expenses and cash flows of a parent and its
subsidiaries as those of a single economic entity.
Consolidation means presenting the results, assets and liabilities of a group ofcompanies as if they were one company.
Example
There are two companies, Mukungu and Shaiga. Mukungu owns 70% of the
shares in Shaiga. Mukungu has a land worth 120 FRW million. Shaiga has
buildings worth RWF100 million. Keep in mind that consolidation refers to thepresentation of the results of two or more businesses as if they were one.
Answer
You add together all the values of the land and buildings to get the values of the
assets. In group accounts take the share for Mukungu plus the share for Shaiga
and this is how is done;
FRW120 Million + FRW 100 million=FRW 220 Million. So, this what is
consolidation?
Intra-group debts
a) Suppose Mukungu has receivables of FRW 60 Million and FRW40
million for shaiga. Shaiga owes Mukungu 4Million (included in his
receivables).
Consolidation = FRW 60Million + FRW40 Million-FRW 4Million= FRW96Million.
This implies that, figures as treated as for one company. What Shaiga owes
Mukungu is there internal matters.
b) Suppose Mukungu has FRW50Million payables and Shaiga has
FRW30Million payables still Shaiga owes Mukungu FRW 5Million
payables.
Consolidation payables =50Million+30Million-5Million= 75Million
The total receivables and payables show that correct figure in the books of
Mukungu company.
From the above we conclude that Mukungu controls Shaiga and mukungu’s
directors have the right to control shaiga as a subsidiary company. In this case,
the total assets for the company is equal to FRW 220Million.
From the above activity FRW 142,000 Million is the total non-current assets ofMukiza ltd.
8.1.2 Subsidiary
A subsidiary is an entity controlled by another entity.
There are relevant IFRS standards for consolidation;
ISA 27 Separate Financial statements
ISA 28 Investments Associates and joint ventures
IFRS 3 Business Combination
IFRS 10 Consolidated Financial Statements
ISA 27 consolidated and separate financial statement is set out to enhance
the relevance, reliability and comparability of information provided by the parent
company in its separate financial statements and in its consolidated financial
statements where it has entities under control.
It outlines the conditions under which consolidated financial statements are
necessary, how to account for the changes in the ownership and how to account
for the loss of control. Additionally, it specifies disclosure rules pertaining to the
connection between the parent company and its subsidiaries.
The standard applies to a group of entities under control of a parent and to
associate and joint ventures where they elect, or are required to present separate
financial statements.
ISA 28 Investment in associates
ISA 28 outlines the accounting treatment of investment in associates which also
provides specifics on how to apply the equity method to account for investmentsin associates and joint ventures.
IFRS 3 Business combinations
When a parent company acquires control of a business, the accounting rules
for goodwill on acquisition and non-controlling interests are outlined in IFRS
3 Business combinations. It also establishes what information must be made
available to financial statement users.
IFRS 10 Consolidated financial statements
When an entity controls one or more other entities, IFRS 10 consolidated
financial statements specifies the guidelines for production and presentation
of consolidated financial statements. It provides controls as the foundation for
consolidation, mandates that the parent entity presents consolidated financialstatements and defines the principle of control.
Definitions
Although some of the concepts will be covered in greater depth later, they are
helpful now because they offer you a general idea about consolidation.
Control: when an investor is exposed to, has a claim to, variable returns as
a result of its participation with an investee and has power to influence those
returns due to that power over investee, the investor is said to have control over
the investee.
Power: Existing rights that allow the present to control the essential activities.
Subsidiary: is an entity that is controlled by another entity known as the parent
Parent: is an entity that control one or more entities
Group: is a parent and all of its entities (subsidiaries)
Consolidated Financial Statements: The financial statements of a group
in which the assets, liabilities, equity, income, expenses and cash flows of the
parent company and the subsidiaries are presented as of those of a singleeconomic entity.
Non-Controlling interest: The equity in subsidiary that is not directly or
indirectly related to the parent company. Please refer to IFRS 10
A trade or investment: is a stake kept foe wealth accumulation in the stockof another company is not an affiliate or subsidiary.
Investments in subsidiaries
You should be able to tell from the definitions above the concept of control.
The parent or the holding company will often control the majority of ordinary
shares in the subsidiary company (to which normal voting rights are attached).
There are circumstances, however, when the parent company owns merely
minority of the voting rights in the subsidiary, yet the parent still have control
over the subsidiary. For example, when the parent company own more than
a half of the company’s voting rights i.e more than 50%, control is typically
considered to exist until it can be demonstrated that such ownership does not
constitute control but these situations will be rare.
What about the circumstances in which this ownership criterion is absent?
Below examples illustrate instances in which control even exists when a parent
owns just 50% or less of the voting entity.
• By agreement with other investors, the parent has control over more
than 50% of the voting rights.
• By statute or agreement, the parent has the authority to control the
entity’s financial and operational policies.
• The parent has the authority to control or dismiss the majority of the
board of directors
• At the board of directors meeting, the parent has the power to vote forthe majority of votes.
For example:
kawu co has invested its share in the following companies;
Name of the company Equity shares Non-equity shares held
Koco co 70% Nil
Koba co 35% 90%Kabu co 48% 25%
Kawu co has appointed five out of seven directors of Kabu co
Which of the above investments is considered as subsidiary in the consolidated
accounts of Kawu co group?
Answer
Let’s examine each invest in turn to see if the control exists and if so, whether
they should be treated as a subsidiary in accounting terms.
Koco co –By looking at the equity shares, Kawu has more than 50% (i.e. 70%)
so, it is a subsidiary
Koba co- has less than 50 % of equity shares, despite having majority of non
equity shares (these do not give voting power) Kawu co does not have control,
so it is not a subsidiary
Kabu co- has less than 50% of equity shares you may incorrectly conclude that
it doesn’t have control over Kabu co but because it appointed five directors out
of seven, it has the voting right, thus its decision will impact on the returns of thecompany. In conclusion therefore, Kabu co is a subsidiary.
8.1.3 Associates and trade investments
Associate is a business that is partially owned by the parent company. A parent
company will hold minority or non-controlling interests. A corporation in which
another has sizeable portion of voting shares, typically, 20-50% in accounting
and business valuation. Associates are accounted in the consolidated statementsof a group using equity method.
Investment in Associates
Investment in associates is less than investment is subsidiary but more than a
simple trade investment. Here the key criterion is the significant influence.
Significant influence means the ability to influence the investee’s financial and
operational policy decisions without having sole or shared control over those
decisions. Similar to control, considerable influence can be assessed based on
who holds voting rights (which are typically linked common shares) in the entity.
According to IAS 28, unless it can be demonstrated clearly that this is not the
case it can be assumed that an investor has significant control over the entity
if they hold 20% or more of the voting power of the entity. If the investor owns
less than 20% of the entity’s voting power, significant influence can generally
be assumed to not exist unless proven differently.
The existence of significant influence by an entity is usually evidenced in one or
more of the following ways:
a) Representation on the board of directors or equivalent governing body
of the investee;
b) Participation in policy-making processes, including participation in
decisions about dividends or other distributions;
c) Material transactions between the entity and its investee;
d) Interchange of managerial personnel; ore) Provision of essential technical information.
Equity method
For investments in associates, IAS 28 mandates the use of the equity method of
accounting (often known as “equity accounting”) (with certain exceptions, butthese are beyond the scope of this syllabus).
Trade investments
A trade investment is a simple investment in the shares of another entity that is
not an associate or a subsidiary.
Trade investments are simply shown as investments under non-current assets inthe consolidated statement of financial position of the group
8.1.4 Content of consolidated financial statements
Consolidated financial statements present the results of the group; they do not
replace the separate financial statements of the individual group companies.
Consolidated financial statements do not replace parent or subsidiary individual
statements. Consolidated financial statements are issued to the shareholders
of the parent company and provide information for those shareholders on all the
companies controlled by the parent company.
Most of the parent companies present their own individual accounts and their
group accounts in a single package. The package typically comprises the
following.
Parent Company financial statements, which will include investments in
subsidiary undertaking’ as an asset in the statement of financial position, and
income from subsidiaries (dividends) in the statement of profit and loss andother comprehensive income
Consolidated statement of financial position
Consolidated statement of profit and loss and other comprehensive income
Note: The other comprehensive income elements of the consolidated financialstatements will not be covered in this unit.
Application activity 8.1
Mukiza ltd own 60 %of Ruzinda ltd. Mukiza has non-current assets of FRW
100 Million and Ruzinda has non-current assets of FRW70Million.Required: Calculate the consolidated non-current assets
8.2 Consolidated Financial statements
Learning Activity 8.2
During the consolidation process, a
parent company has to compile financial reports from the subsidiaries.
Required: What are the procedures of consolidated statement of financialposition?
8.2.1 Consolidated Statement of Profit or Loss
The main principle of equity accounting states that whether or not as associate,
GARU ltd, pays its gains as dividends, the investing business MURT ltd, should
account for its portion of those gains. MURT ltd accomplishes this by including
the group’s portion of GARU Ltd’s post tax profit in the consolidated earnings.
Take note of the distinction between this method and consolidating the financial
performance of a subsidiary firm. If MURT ltd owned 100% of GARU ltd, it
would be entitled to all of GARU Ltd’s sales revenues, cost of sales, etc.
Using the equity accounting, sales revenues, cost of sales and other financial
measures for associate are not combined with those of the group instead the
profit after tax of associate is merely added to the group profit in the form of thegroup share.
8.2.2 Consolidated statement of financial position (Balance sheet)
In this lesson we are going to learn about the statements of financial position
also known as the Balance sheet.
Consolidated financial statements are financial statements of a group presented
as those of a single economic entity (IFRS 10). When a parent company issues
consolidated financial statements, it should consolidate all subsidiaries, both
domestic and foreign. The first step in any consolidation is to identify the
subsidiaries using the definitions as set out in IFRS 10.
Consolidated financial position includes investments in associate’s amount that
must be declared at the cost at the moment the associate was acquired.
This amount will arise or fall annually in proportion to the group’s portion of theconnected company’s post-acquisition retained reserve growth or decline.
Basic steps
The following are the procedures for consolidated statements of financial
position;
• In the individual statements of the parent company and each subsidiary,
items that appear as an asset in one company and a liability in another
should be cancelled out.
• After cancellation, add together the remaining assets and liabilitiesthrough the group.
Items to be cancelled may include;
• The assets, investment or shares in subsidiary in the parent company’s
statement of financial position will be matched with the share capital in
the subsidiaries’ accounts.
• Any intra-group trading needs to be cancelled accordingly. E.g the
parent company records a receivable for selling goods to its subsidiary
and the subsidiary likewise recording a payable relating to the parent
company. This means that there is a trading between a parent andsubsidiary company (trading group).
ExampleStatement of financial position as at 31 December 2021
Consolidated statement of financial position as at 31 December 2021
Intra-group trading
We are going to look the consolidated financial statements specifically on intra
group trading explain what it is and have examples.
If intra-group trading transactions are undertaken at cost, there would be no issue
in dealing with profits due to intra-group trading. However, with each company
in a group being a separate trading entity, other group companies are treated
in the same way as any other outside customer. In this case, if a company is
selling say a parent company to a subsidiary company or a subsidiary company
to another, their selling prices should be the same as they say to outsiders.
In the consolidated statement of financial position, the only profits recognized
should be those earned by the group in providing goods or services to outsiders.
Inventory should also be valued at cost to the group.
Scenario
GAGA ltd (subsidiary) buys goods at one price and sells them at a higher price
to kaka ltd (a parent company). The accounts of GAGA ltd will properly include
the profit earned on sales to KAKA ltd. KAKA Ltd’s statement of financial position
will also include inventories at their cost of purchase from GARU ltd.
The problem arising from the above transaction
1. Although GAGA ltd makes a profit as soon as it sells goods to KAKA
ltd, the group does not make a sale or achieve a profit until an outside
customer buys the goods from KAKA ltd. This is because the inventories
are still in the group until they get an outsider to come and buy goods.
2. Any purchases from GAGA ltd which remain unsold by KAKA ltd at the
end of the year will be included in KAKA Ltd’s inventory. Their value in the
statement of financial positions will be at their cost to KAKA ltd, which isnot the same as their cost to the group.
EXAMPLE
GAGA ltd buys goods for FRW 5,000 and sells to its parent company KAKA ltd
for FRW 7,000. The goods are in KAKA Ltd’s store at the end of the year and
appear in KAKA Ltd’s statement of financial position at FRW 7,000.
In this case GAGA ltd made a profit of FRW 2,000 as it bought goods on FRW
5,000 and sold them to KAKA ltd a parent company at FRW 7,000. This will
be recorded in GAGA Ltd’s individual account. Let’s see how to record in an
intra- group
Consolidated financial statement for intra-group company
Cost of the group FRW 5,000
External sales
Closing stock at the cost to the group FRW 5,000
Profit or loss to the group
Because the group account is overstated by FRW 2,000 from KAKA ltdindividual statement of financial position, it must be cancelled.
Consolidation adjustment
Dr Cr
Group retained earnings 2,000Group inventory 2,000
Steps to follow when you have non-controlling interest
1. Intra-group sales and purchases should be eliminated
2. Any unrealized profit is eliminated by trading to the cost of sales
3. I f the subsidiary made the sale; the figure for the subsidiary’s net profit
used to non-controlling interest must be adjusted for the unrealized profit.
4. If the parent made a sale, there will be no effect on the non-controllinginterest.
Example
KAKA ltd acquires 75% of the ordinary shares of the GAGA ltd, which it has
owned since GAGA Ltd’s incorporation. The summarized statements of profit
or loss of the two companies for the year ending 31 December 2021 are given
below. GAGA ltd sold goods to KAKA ltd for FRW8, 000. It has bought these
goods for FRW 6,000. 40% of these goods remained in KAKA Ltd’s inventoryat 31 December 2021.
Goodwill arising on consolidation
Goodwill is simply reputation of the business. Goodwill is recognized only
when it has been acquired for the value consideration and represents advance
payment made by the acquirer for the future economic benefit.
On consolidation, goodwill is reported as an intangible asset in consolidated
group balance sheet. One of the simplest methods of calculating goodwill is by
subtracting the fair market value of a company’s net identifiable assets from theprice paid for ....
Example
Muko ltd buys all the shares of 50,000 FRW 1,000 of Musi ltd at 80 million in
by using cheque. The following is the statement of financial position before theacquisition of Musi ltd.
Statement of financial position as at 31 December 2021
NOTE: Since MUKO Ltd bought 50,000 shares at FRW 1,000 and paid 80
Million which is above the value of the shares, the difference (the premiumamount) is the goodwill. In this case, 30 Million is goodwill
Application activity 8.2
1) Why do parent companies need to prepare consolidated financial
statements?
2) Outline their limitations of financial statement
3) Mucyo Co ltd acquired 100% of Mukama Co ltd at a cost of FRW
100M. On the date of acquisition, the fair value of the identifiable
assets of Mukama Co ltd was FRW 75M.Required: Calculate the goodwill arising on acquisition.
End unit assessment
1. The following statements of financial position were extracted from the
books of two companies-GIKI LTD and KAWU LTD at 31 December 2020
GIKI LTD acquired all of the share capital of KAWU LTD one year ago. The
retained earnings of KAWU LTD stood at FRW 2,000,000 on the day of
acquisition. Goodwill is calculated using the fair value method and there
has been no impairment of goodwill since acquisition.
Required: Prepare the consolidated statement of financial position of GIKILTD as at 31 December 2020.