ACCT7104

Corporate Accounting
Seminar One: Introduction to Consolidation
Course coordinator details 2

Course Coordinator & Lecturer: Associate Professor Julie Walker

Phone: 3346 8073 Email: UQBS-ACCT7104@business.uq.edu.au

Campus: St Lucia
Building: Colin Clark Building (Building 39) Room: 436
Consultation: Monday 2-4 or by appointment

Administrative matters 3

Welcome!

To enrol in ACCT7104 you should have passed at least an introductory

accounting course (ACCT7101 or equivalent).

Knowledge of ACCT7102 material would be advantageous, but not

compulsory.

ACCT7104 is required for entry to either CPA Australia or CAANZ

 Key learning resources 4

Prescribed textbook:
Arthur, N., Luff, L., Keet, P, Egan, M., Howeison, B. and Ram, R., "Accounting for Corporate
Combinations and Associations", (2017), Pearson Education Australia, 8th edition.

Please note that ACCT7104 is written to the 8th edition of the text and earlier editions may not
reflect recent changes to Australian Accounting Standards.

Also required for the final topic of external administration and liquidation:
Dagwell, R., Wines, G. and Lambert, C. 2012. Corporate Accounting in Australia, Pearson
Australia Chapter 20 only re External Administration

You can access this chapter through the UQ library at http://www.library.uq.edu.au/lr/acct7104

Key learning resources 5

Not prescribed, but very necessary:

Access to the current Australian Accounting Standards

You can access Australian Accounting Standards at

http://www.aasb.gov.au/Pronouncements/Current-standards.aspx
Blackboard and other resources 6

BlackBoard:
Announcements
Seminar slides, set questions & solutions
Pencasts of selected problems
Specific additional content
General information
Moderated Discussion Board

ECP Course Profile

Consultation:
Julie: Monday, 2.00 pm 4.00 pm (Bld 39-436)
Assessment summary 7

Assessment Due Date Weighting

In-class Mid-Semester Examination* Monday 3 April and Friday 7 April 30%
Individual Case Study Thursday 11 May 20%
Final Examination During examination period 50%

*Please note: At this stage the mid-semester exam will be held in the usual seminar rooms at the
usual seminar times. Students must attend their sinet registered seminar.
 Seminar notes, homework and solutions 8

Seminar slides on ACCT7104 Blackboard site by Monday of every week

Each week, a list of questions/problems is set from the text and other sources

Some of these are covered in seminars, but the remainder are for you to
prepare in your own time

Solutions to weekly problems/questions posted on the Monday of the week

after the relevant seminar

The next slide shows the detailed semester roadmap for ACCT7104. The
roadmap is posted on Blackboard and referenced each week
S01 2017 Week Date Lecture Reading Set Work Assessment

1 27/02 Introduction to Consolidation Arthur et al Chapter 1 and 2; AASB 10 Consolidated Financial Statements; AASB 12 Disclosure of Interests in
Other Entities Q1.1; Q1.2; Q1.3; Q1.9; Q1.11.

2 06/03 Consolidation: Basic Principles Arthur et al Chapter 1 and 2; AASB 3 Business Combinations; AASB 13 Fair Value Measurement Case Study and rubric available this
week
Q2.3; Q2.4; Q2.5; Q2.6; E2.1; E2.2; E2.8; E2.10.

3 13/03 Consolidation: Fair Value Adjustments and Tax Effects Arthur et al Chapter 3; AASB 112 Income Taxes; AASB 6 Exploration for and Evaluation of Mineral Resources.
Q3.1; Q3.3; Q3.6; Q3.8; E3.3; E3.7.

4 20/03 Consolidation: Intra-Group Transactions Arthur et al Chapter 4; AASB 102 Inventories; AASB 116 Property, Plant & Equipment
Q4.2; Q4.3; Q4.11; E4.1; E4.5; E4.7.

5 27/03 Consolidation: Partly Owned Subsidiaries (DNCI) Arthur et al Chapter 5; AASB 101 Presentation of Financial Statements
(Census #1 date 31 March)
Q5.1; Q5.3; Q5.8; E5.1; E5.3; E5.9.

6 03/04 or Mid-Semester Exam (30%) In-Class exam. Students must attend their sinet registered seminar session.
07/04 Mid semester exam

Good Friday 14/04. 7 10/04 Consolidation: Partly Owned Subsidiaries (INCI) Arthur et al Chapter 6; AASB 127 Separate Financial Statements; AASB 1024 Consolidated Accounts.
No Friday seminar Q6.1; Q6.5; Q6.6; Q6.8; E6.1; E6.3; E6.8,

Easter Monday 17/04 Semester break: no classes or consultation this week

17/04

Anzac Day Tuesday 25/04 8 24/04 Accounting for Joint Arrangements/Joint Ventures Arthur et al Chapter 8; AASB 11 Joint Arrangements Q8.2; Q8.3; Q8.6; Q8.7; E8.1; E8.5; E8.8.
(Census #2 date 30 April)

May Day 9 01/05 The Equity Method Arthur et al Chapter 9; AASB 128 Investments in Associates and Joint Ventures Q9.1; Q9.2; Q9.4; Q9.9; E9.2; E9.3; E9.8.
Monday 01/05
No Monday seminar

10 08/05 Foreign Currency Translation Arthur et al Chapter 10; AASB 121 The Effects of Changes in Foreign Exchange Rates Case Study due Thursday 11 May.
Q10.1; Q10.3; E10.2; E10.6

11 15/05 Segment Reporting Arthur et al Chapter 11; AASB 8 Operating Segments.

QQ11.1; Q11.8; Q11.11; E11.1; E11.6.

12 22/05 External Administration and Liquidation Dagwell et al Chapter 20 available at http://www.library.uq.edu.au/lr/acct7104

Q20.2; Q20.3; Q20.4; Problem 20.9;

Comprehensive Exercise 20.13.

13 29/05 Review and sample paper walkthrough Sample final paper available on Blackboard Centrally organised final exam

SWOTVAC
 What is this course about? 10
So far, you have dealt with financial reporting issues for independently trading
single business entities, such as a company or a sole trader

ACCT7104 deals with accounting issues that arise in business combinations and
other business relationships and how to account for them.

Such business combinations involve multiple entities such as parent + subsidiaries,

associates & joint arrangements

We also look at external administration and liquidation of companies as part of

this group theme

Most listed Australian entities are parent entities operating in a group structure
Course aims 11

A. Gain an appreciation of how different levels of control between entities effect the
accounting treatment of such entities, being able to delineate each situation and
display practical ability to do so;

B. Develop an ability to link a variety of concepts in corporate accounting, displaying a

wider appreciation of the complexity & inter-relatedness of the concepts;

C. Achieve sufficient awareness of current developments in accounting standards through

research and critical evaluation to interpret and communicate their effect on entities;
and

D. Relate core material to real world scenarios, developing an awareness of how reporting
entities adopt these concepts and whether there are any ethical issues.
Seminar 1 objectives 12

Investments in other entities some basic concepts

Describe the broad classification for investments in other entities and the
accounting methods that apply to each
Explain the meaning and indicators of the power to control
Contrast control with other business relationships
Explain the concept of a group
Demonstrate the importance of consolidation accounting
Determine the entities that must prepare consolidated financial statements
Seminar 1 reading and set work 13

Reading: Arthur et al Chapter 1 and (skim) 2; AASB 10 Consolidated Financial

Statements; AASB 12 Disclosure of Interests in Other Entities

Questions and problems from Arthur et al: Q1.1; Q1.2; Q1.3; Q1.9; Q1.11.
Accounting standards 14

A number of Australian Accounting Standards are relevant to this course

Each week 2 or 3 of the most relevant standards are selected for students
to read
There are often many other relevant standards because International
Financial Reporting Standards (IFRS) are principles-based
You should become familiar with accessing and reading accounting
standards
Each week I assume that students have read the accounting standards
previously set
You can access the Australian Accounting Standards online
Brief background to international
15
accounting regulation
Two accounting standards boards:
FASB (USA based) & IASB

Overall Aims of Convergence Project:

Standardise accounting reporting worldwide
Harmonisation & convergence
Adopt the Fair Value principle into all aspects of accounting

Each have different views on accounting

Differing standards leads to confusion, therefore a determined effort
to standardise accounting across the globe is underway
 Process to adopt a new Australian
16
Accounting Standard
Australia follows IASB (International Accounting Standards Board):

1. IASB selects topic to standardise, proposes what is required, and seeks views from
IASB members
2. Australia makes submissions to overall IASB
a) Considered with submissions from other members
b) Periods of consultation and amendments
3. IASB issues an IFRS (International Financial Reporting Standard) intended to be
adopted unchanged by all member countries
4. Australia receives this, facilitated by AASB (Australian Accounting Standards Board)
a) May issue an AIFRS initially, adding specific differences
b) Then final standard is issued as an AAS (Australian Accounting
Standard)
Recent major changes in Australia 17

Consolidation suite of AASs (AASBs 10, 11, 12 & 13)

Issued August 2011
Effective for all accounting periods beginning on or after 1 January
2013

AASB 10 Consolidated Financial Statements

AASB 11 Joint Arrangements
AASB 12 Disclosure of Interests in Other Entities
AASB 13 Fair Value Measurement
Investments in other entities 18

This course is concerned with the treatment of investments in other

entities in the external reports of the investor entity
(separate/consolidated accounts)

Such investments can take a vast range of formats - deals with

anything where more than one entity involved

This part of the Seminar is intended to provide a brief overview of

the various types of business transactions, combinations &
investments
Investment transactions overview 19

We will consider, in order of increasing complexity, the purchase of:

A single asset
A collection of assets (not a business)
A collection of assets (constituting a business)
Shares directly from a shareholder (private company) or on a stock
exchange (public company):
1. Gaining an investment
2. Gaining significant influence
3. Gaining joint control
4. Gaining control
Single asset acquisitions 20

Previous courses covered the acquisition of a single asset:

Tangible assets generally are initially recorded at cost as per AASB 116:
Property, Plant & Equipment, may later be subject to revaluation
Cost means the amount of cash or cash equivalents paid or the fair value
of other consideration given to acquire an asset
If necessary, asset is then depreciated and is subject to impairment testing
as per AASB 136 Impairment of Assets
Similar situation for intangible assets acquisition subject to rules of AASB138
Intangible Assets (patents, copyrights, etc.)
This course will cover the effect of asset sales between entities in business
combinations
Single asset acquisitions 21

An example just to refresh:

Suzy Ltd purchased a piece of equipment on 1 July 2013 for $50,000 cash. The
equipment has an economic life of 5 years with a zero salvage value at the end
of that time. Suzy Ltd uses straight-line depreciation for financial reporting.
On 2 July 2015 impairment tests revealed the equipment net book value was
impaired by $6,000.

Required: Show the general journals to account for the equipment on 1 July
2013, 1 July 2014, 1 July 2015 and 2 July 2015.
 Single asset acquisitions 22

1/7/13
Dr Equipment 50000
Cr Cash 50000
1/7/14
Dr Depreciation 10000
expense
Accumulated depreciation 10000
Cr - equipment
 Single asset acquisitions 23

1/7/15
Dr Depreciation 10000
expense
Cr Accumulated depreciation 10000
- equipment
2/7/15
Dr Impairment 6000
expense
Accumulated impairment - 6000
Cr equipment
Acquiring a collection of assets: direct
24
acquisition from vendor
Now consider the acquisition of a collection of assets from a 3rd
party vendor:

The acquisition method (AASB 3) must be applied

Different methodologies apply dependent on whether the collection of

assets constitutes a business
Acquiring a collection of assets: direct
25
acquisition from vendor
Need to determine if the collection of assets constitutes a business as
defined in AASB 3 Business Combinations

AASB 3 (Appendix A) defines a business as:

An integrated set of activities and assets that is capable of being conducted

and managed for the purpose of providing a return in
the form of dividends, lower costs or other economic benefits
directly to investors or other owners, members or participants.

It will consist of inputs and processes applied to those inputs that

have the ability to create outputs. (Appendix B)
Acquiring a collection of assets: direct
26
acquisition from vendor

If the collection of assets acquired does not constitute a business, then

the total amount paid for the assets is allocated to the individual assets
based on their relative fair values at the date of acquisition (AASB3.3)

If the collection of assets does constitute a business, (a business

combination) we must account for the acquisition in accordance with
AASB 3 as a business combination
 Acquiring a collection of assets: direct
27
acquisition from vendor

Determining whether a particular set of assets and activities is a business

should be based on whether the integrated set is capable of being
conducted and managed as a business by a market participant. Thus, in
evaluating whether a particular set is a business, it is not relevant
whether a seller operated the set as a business or whether the acquirer
intends to operate the set as a business (AASB 3B.11)

In the absence of evidence to the contrary, a particular set of assets and

activities in which goodwill is present shall be presumed to be a business.
However, a business need not have goodwill. (AASB 3B.12)
 Acquiring a collection of assets: direct
28
acquisition from vendor
An example:
OConnor Ltd purchased a parcel of assets from Lyneham Pty Ltd. This
parcel of assets constituted a business. The cost of the acquisition was
$100,000 cash. The estimated fair values of the assets at acquisition is as
follows:
Asset Fair Value
Plant $ 25,000
Land 40,000
Vehicles 20,000
Office equipment 5,000
Total $ 90,000
 Acquiring a collection of assets: direct
29
acquisition from vendor
Show the journal entry in OConnor Ltds books to account for the acquisition
of the assets.
General Journal of OConnor Ltd

Dr Plant 25,000
Dr Land 40,000
Dr Vehicles 20,000
Dr Office equipment 5,000
Dr Goodwill 10,000
Cr Cash 100,000
Acquiring a collection of assets: business
30
combinations
Often there is a difference between the amount paid for the business
combination and the fair value of the net identifiable assets acquired.
Assuming the transaction constitutes a business, such a difference is
either:

goodwill (an overpayment)

or
gain on bargain purchase (an underpayment)

In the previous example OConnor Ltd paid $10,000 more than the total
of the fair values for the parcel of assets from Lyneham Pty Ltd.
Business combinations: goodwill 31

Goodwill is defined in AASB 3 (Appendix A) as:

An asset representing the future economic benefits arising

from other assets acquired in a business combination that are
not individually identified and separately recognised

Goodwill usually arises in the form of an overpayment in excess

of the fair value of a collection of assets.
Business Combinations: goodwill 32

Goodwill is initially measured as the excess of the cost of acquisition

after deducting the fair value of the subsidiarys identifiable net assets

Goodwill is an unidentifiable intangible asset

Subsequent accounting treatment is that goodwill is not amortised but

is impairment tested at least annually in accordance with AASB 136
Impairment of Assets

Any impairment expense associated with goodwill is recognised

immediately

We will return to goodwill later in the semester

Business Combinations: gain on bargain
33
purchase

Gain on bargain purchase is relatively rare (why?)

In circumstances where the cost of acquisition is less than the

fair value of the net assets acquired, then AASB 3.36 requires
the investor to undertake a review process

If after the review, the gain on bargain purchase remains then it

should be immediately recognized as a gain in the consolidated
statement of comprehensive income
Time for a short break

34

R. Godfrey Rivers (1859-1925), Under

the jacaranda 1903, Oil on canvas,
143.4 x 107.2cm. Purchased 1903,
Collection: Queensland Art Gallery
 Business combinations 35

If the collection of assets does constitute a business, (a business combination) we

must account for the acquisition in accordance with AASB 3 Business
Combinations

AASB 3 distinguishes 2 types of acquisitions that result in business combinations:

1. Direct acquisition from a vendor of a collection of assets that constitute a
business

2. Acquisition of sufficient shares to control the board of directors of a

company that owns the business

Lets look now at business combinations through the acquisition of shares in the
investee
Acquisition of a business via acquisition
36
of shares in the business
Rather than directly purchasing the business from the vendor, an
investment in another entity can be made by the investor acquiring shares
in that other entity

This can be achieved by acquiring the shares directly from a known

shareholder (in the case of a private company) or by acquiring the shares
on the stock exchange (in the case of a public company)

This type of investment is called

an equity investment
 Classification of equity investments 37

Categories:
1. Financial assets no special business relationship between investor and
investee
2. Investments providing the power to exert control, joint control or significant
influence
 Classification of equity investments 38
Category 1:
AASB 9 Financial Instruments or AASB 139 Financial Instruments: Recognition
and Measurement are the relevant accounting standards for financial assets and
are covered in ACCT7102. For the types of equity investment that we consider,
the relevant possible accounting treatments are to measure the asset as either a
financial asset at fair value through profit or loss (AASB 139.9) or in some cases
at fair value through other comprehensive income. The important point for our
purposes is that this type of equity investment does not give rise to significant
influence, joint control or control by the investor over the investee. AASB 9 and
139 do not apply to category 2 investments (AASB 9.2.1).

Our focus in ACCT7104 is category 2 investments conferring significant

influence, joint control or control by the investor over the investee.
 Acquisitions conferring significant
39
influence
The next type of equity investment we consider are acquisitions that give
the investor significant influence over the investee

Significant influence is defined as:

the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control
over those policies.
Acquisitions conferring significant
40
influence
AASB 128 Investments in Associates and Joint Ventures is the relevant
accounting standard for investments involving significant influence over
the investee via the acquisition of shares

The relevant accounting treatment of equity investments conferring

significant influence is Equity Accounting

We will spend a couple of seminars later in the semester looking at

Equity Accounting in some depth

For now, just note that significant influence requires the investment to
be accounted for using the equity method
 Acquisitions conferring joint control 41

Some equity investments provide the investor with shared control of the
investees economic resources

In this case, the investor shares control with another investor(s) such that
there is a contractual obligation to obtain unanimous consent from all
controlling parties for all strategic decisions involving the investees
economic resources

In such a situation, the investors have joint control over the investee
 Acquisitions conferring joint control 42

AASB 128 Investments in Associates and Joint Ventures or AASB 11 Joint

Arrangements are the relevant standards for investments involving joint
control

We will look at the accounting treatment of equity investments involving

joint control later in the semester
Acquisitions conferring the power to
43
control

Lets turn now to the category of equity investment that confers

power on the investor to control the board of directors of the investee
entity
Acquisitions conferring the power to
44
control

A share acquisition can give control of the investee to the investor

Control is defined as (AASB 10A.6):
An investor controls an investee when it 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.

Note the three limbs of this definition as follows:

 Acquisitions conferring the power to
45
control
1. power over the investee
An investor has power over the investee when the investor has existing rights
that give it the current ability to direct the relevant activities of the investee
(AASB 10.10)

. Relevant activities are activities of the investee that significantly affect

the investors returns (AASB 10A)
. Common examples of relevant activities are the buying and selling of goods
or services; managing financial or non-financial assets or developing
intellectual property (AASB 10B.11)
. Investor must have current ability. The investor can be passive but still
have power. Must have current capacity to exercise power if it wanted.
 Acquisitions conferring the power to
46
control
2. Exposure or rights to variable returns
That is, the investor entitys own returns are potentially affected by its
involvement in the investee.

Returns must potentially be variable rather than fixed the returns depend
on the investees performance (AASB 10B.56)
 Acquisitions conferring the power to
47
control
3. Link between power and returns
The investor must be able to use its power over the investee to affect the
amount of return generated by the investee.

Not sufficient to be exposed to variable returns from the investee, the

investor must be able to use its power over the investee to impact the
amount of the return

Consider whether investor is acting as agent or principal

 Acquisitions conferring the power to
48
control
Control must be unilateral

Control can be via indirect interests

When an investee has a range of operating and financing activities that

significantly affect the investees returns and when substantive decision-
making with respect to these activities is required continuously, it will be
voting or similar rights that give an investor power, either individually or in
combination with other arrangements
 Acquisitions conferring the power to
49
control

When voting rights cannot have a significant effect on an investees

returns, such as when voting rights relate to administrative tasks only and
contractual arrangements determine the direction of the relevant
activities, the investor needs to assess those contractual arrangements in
order to determine whether it has rights sufficient to give it power over
the investee.

AASB 10 Appendix B provides guidance

 Financial reporting consequences of
50
control
If an investor entity controls an investee, then a parent-subsidiary
relationship exists

In combination, the investor entity and its subsidiary(s) form a group

Where the group is a reporting entity, it must prepare consolidated

accounts

This means that the parent entitys recorded investment in subsidiaries is

eliminated against the pre-acquisition equities acquired and the
subsidiarys assets, liabilities and post-acquisition equities are included in
the consolidated statements.
Overview of accounting for investor-
51
investee relationships
Nature of Name given Name given to Relevant Accounting
investor/investee to investee investor entity accounting method for
relationship entity standard(s) investors interest
No special Investee Investor AASB139 or Fair value
relationship AASB 9

Significant Associate Investor AASB 128 Equity method

influence

Joint control Joint Venturer or AASB 11 or Line by line

arrangement operator AASB 128 method or equity
method
Control Subsidiary Parent AASB 10 Consolidation
Financial reporting for investor/investee
52
relationships
Hopefully you can see that the nature of the investor/investee
relationship determines the investor entitys financial reporting of
the investment

The accounting consequences of the various categories of

relationship are significant

Considerable professional judgement is sometimes needed to

evaluate the investor/investee relationship

Accounting standards provide some guidance

Acquisitions conferring the power to
53
control
Lets stop for a moment and think about the parent-subsidiary relationship
and what we know so far about AASB 10 and group reporting.

Q1.1 from Arthur et al asks the following (this is part of your set work this
week):

Define what is meant by the terms parent entity, ultimate parent

entity, subsidiary and group. Construct a simple organisational design
in which there is a parent entity, a subsidiary directly controlled by the
parent entity and a subsidiary indirectly controlled by the parent entity.
Identify the relationships and groups in this design.
Acquisitions conferring the power to
54
control
Users dependent on
general purpose financial
reports

A Ltd (parent)
The A Ltd group
Control

B Ltd (subsidiary)

Control The B Ltd group

C Ltd (subsidiary)
Acquisitions conferring the power to
55
control

Parent entity: A parent is an entity that has one or more subsidiaries (AASB
10 Appendix A). In the previous diagram, A Ltd is the parent entity of B Ltd
and C Ltd because it has direct control over B Ltd and indirect control over
C Ltd. Note that B Ltd is also a parent entity to C Ltd.

Ultimate parent entity: The ultimate parent entity in the previous diagram
is A Ltd because it has ultimate control over the A Ltd Group, B Ltd, the B
Ltd Group and C Ltd.
 Acquisitions conferring the power to
56
control
Subsidiary: A subsidiary is an entity, including an unincorporated entity
such as a partnership that is controlled by another entity known as the
parent (AASB 10 Appendix A). In the previous diagram, B Ltd and C Ltd are
subsidiaries to A Ltd because A Ltd controls them through a singular line of
power. C Ltd is also a subsidiary to B Ltd.

Group: A group consists of a parent (entity) and all its subsidiaries (AASB
10 Appendix A). In the previous diagram, the A Ltd group comprises A Ltd
and its controlled entities B Ltd and C Ltd. Note that there is also a B Ltd
group made up of B Ltd (parent entity of the B Ltd group) and C Ltd (its
subsidiary).
Consolidated reporting 57

This seminar and the next 5 seminars will deal with various aspects of
consolidated financial reporting

The rest of this seminar will introduce some basic history and concepts in
consolidated reporting
 Consolidated reporting 58

Recall that consolidated financial statements are required where a group

entity (parent + subsidiary(s)) is a reporting entity

A reporting entity is An entity (including an economic entity) in respect of

which it is reasonable to expect the existence of users dependent on
general purpose financial reports for information which will be useful to
them for making and evaluating decisions about the allocation of scarce
resources. A reporting entity prepares general purpose financial
statements. (SAC 1.40)
 Consolidated reporting 59

What financial statements must be prepared in consolidated financial

statements?

Consolidated financial statements are required for:

o A statement of financial position

o A statement of profit and loss and other comprehensive income
o A statement of changes in equity
o A cash flow statement
o notes
 Consolidated reporting 60

Do group entities have to prepare consolidated financial statements in

addition to financial statements for the parent entity?

Since 2010, the Australian Corporations Act has stated that if accounting
standards require consolidated financial statements then only consolidated
statements are required to be provided to the shareholders of the parent
entity.
 Consolidated reporting 61

Consolidation involves treating the group entity consisting of parent and

subsidiaries as if it was a single entity

As stated earlier, consolidation involves eliminating the parents investment

against the pre-acquisition equities acquired while simultaneously including
the subsidiarys assets and liabilities in the consolidated statement of financial
position

Post-acquisition movements in the equity of the subsidiary are included in

subsequent consolidated financial statements after elimination of any intra-
group transactions
 Importance of consolidated reporting 62

Consolidated reporting has a long history, traceable back to 1882 in Australia

(Arthur et al see also Table 1.2)

Conducting business as a group can bring advantages e.g. economies of scale

But group structures can also be used opportunistically to reduce transparency

and accountability

This has happened in recent times e.g. Enron and its use of unconsolidated
Special Purpose Entities (SPEs)
 Importance of consolidated reporting 63

Previously there were 3 main loopholes in the Australian regulation of

consolidated reporting

1. Interposed unit trusts: The Companies Act (1981) had application to

corporations only. Avoidance of consolidation was possible by interposing a
non-corporate entity such as a trust between a parent company and its
subsidiary. Under the prevailing legislation the trust was not a company
and did not have to be consolidated and neither did any of the companies
in which the trust held shares.
Importance of consolidated reporting 64

2. Dissimilar operations: It was common practice in the 1980s to omit

subsidiaries with dissimilar operations from the consolidated
accounts on the basis that their operations were fundamentally
different from other companies in the group. This was particularly
common practice for finance subsidiaries. The omitted finance
subsidiaries were often highly geared, so their inclusion would
have impacted on the financial position of the group.
Importance of consolidated reporting 65

3. Form over substance: The definition of subsidiary in the

Companies Act 1981 led to the accepted interpretation that
ownership of more than half of the issued shares of another
company was needed for that company to be defined as a
subsidiary. It became accepted practice that majority ownership
of the ordinary voting shares of another company was needed to
classify that company as a subsidiary, irrespective of whether de
facto control existed.
 Importance of consolidated reporting 66

Current Australian (and IFRS) accounting regulation have overcome many of

these accounting loopholes

The Corporations Act and Australian Accounting Standards apply to reporting

entities

The definition of control is not based on % ownership

 For your consideration Q1.9 67

You are a manager with a firm of accountants. You have been approached
for advice. Determine whether or not consolidated financial statements
need to be prepared in the following scenarios:

a. Mr P holds 100% of the voting shares in See Pty Ltd (See), which is a
large proprietary company. See owns 100% of the voting shares of Q Pty
Ltd, which is a small proprietary company. The directors of both
companies are Mr P and his sons. The only external user of the
financial statements of See is BMI Ltd (BMI), the companys bankers.
See owes a substantial amount to BMI and this is secured against the
assets of See. As part of the terms of the loan, See provides BMI with
detailed monthly cash flow information.
For your consideration Q1.9 68

a. It appears that See Pty Ltd only has to provide financial information for
inside shareholders (Mr P and his sons) and its banker (BMI Limited).
Both of these users are in a position to command the specific financial
information that they need (i.e., specific purpose financial reports). For
example, as part of the terms and conditions of the loan agreement See
Pty Ltd must provide monthly cash flow data to BMI Limited. It follows
that See Pty Ltd and the See Pty Ltd group entity are non-reporting
entities.

Conclusion: See Pty Ltd is not required to prepare consolidated financial

statements.
For your consideration Q1.9 69

b. The Smith family owns 80% of the ordinary voting shares of A Ltd (A), a
public company listed on the Australian Securities Exchange. A owns
100% of the ordinary shares of B Pty Ltd, a large proprietary company
with no external borrowings and no known users of its financial
statements other than its holding company.
 For your consideration Q1.9 70

b. The definition of reporting entity specifically includes a group with a

parent entity that is a listed corporation (i.e., listed on the ASX) as a
reporting entity. In addition to this, 20% of shareholders of A Ltd
presumably do not participate in the management of A Ltd and as such
would be unable to command the information they require about A Ltd or
the A Group. It follows, therefore, that the A Group has users who rely on
general purpose financial reports for information for decision making.
Thus the A Group is a reporting entity.

Conclusion: A Ltd must prepare consolidated financial statements.

 For your consideration Q1.9 71

c. B Pty Ltd is a large proprietary company that is owned by Mr B and his

three children. B Ltd has 10 subsidiaries and is the largest building
contractor in Victoria, employing a workforce of over 700 people. B Ltd
provides its bankers with special purpose financial reports.
 For your consideration Q1.9 72

c. SAC 1.21 includes economic or political importance/significance as an

indicator of a reporting entity. Where there are hundreds of employees
that are dependent on a corporate group for their economic welfare and
many customers that are reliant on the satisfactory performance of
contracts, it would seem appropriate to classify the group entity as a
reporting entity. This result holds irrespective of the tight ownership
interests in the group.

Conclusion: B Pty Limited must prepare consolidated financial statements.
 For your consideration Q1.9 73

d. B Ltd is an investment company that has entered into significant

borrowing arrangements with several financial institutions. Owing to the
current economic climate, it recently defaulted on a principal payment
of $500 million and related interest payments to Northpac. With the
consent of the other financial institutions, Northpac has acted under the
terms of the loan contract and appointed a receiver to protect the
interest of Northpac and the other secured creditors.
 For your consideration Q1.9 74

d. The third arm of AASB 10.7 definition of control relates to the ability of
the entity to use its power to obtain benefits from the activities of the
other entity. The receiver appointed by Northpac is instructed under a
fiduciary arrangement to act as an agent to protect the interests of
Northpac and the other secured creditors. The receiver will only be paid
fees for services rendered and will not be obtaining any other benefits.

Conclusion: The receiver is not required to consolidate B Ltd.

Self study and next seminar 75

Todays seminar covered a range of conceptual and regulatory issues in

group reporting to provide context

From next week our focus will be more technical as we look more closely
at the process of consolidation and begin preparing simple consolidated
financial statements

As part of your weekly study routine for this course you should attempt
the homework problems set for each week

Solutions are posted on the ACCT7104 blackboard site

Thats all for now see you next week! 76