Chapter 7

Introduction to Groups

Presented by:
Hailemichael Tesfay (Asst. Professor)
Yitbarek Abrha (Asst. Professor)

Department of Accounting and Finance

College of Business and Economics
Mekelle University

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 Chapter Outline
 Introduction
 Group Accounts
 Consolidated Financial Statements
 Content of group Accounts and group Structure

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Introduction
Many large businesses consist of several companies
controlled by one central or administrative company.
Together these companies are called a group.

The controlling company, called the parent or holding

company, will own some or all of the shares in the other
companies, called subsidiaries.

 This chapter focuses on matters that are fundamental to

the comprehension of group accounts.

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Group Accounts
 There are many reasons for businesses to operate as groups;
for the goodwill associated with the names of the subsidiaries,
for tax or legal purposes and so forth.
 In many countries, company law requires that the results of a
group should be presented as a whole.
 It is not possible simply to add all the results together and this
chapter will introduce you how to consolidate all the results of
companies within a group.
 In traditional accounting terminology, a group of companies
consists of a parent company and one or more subsidiary
companies which are controlled by the parent company.

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Defined Terms
 Control. 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
power over the investee.
 Power. Existing rights that give the current ability to direct the
relevant activities of the investee.
– Rights to appoint, reassign or remove key management personnel who
can direct the relevant activities
– Rights to appoint or remove another entity that directs the relevant
activities
– Rights to direct the investee to enter into, or veto changes to,
transactions for the benefit of the investor
– Other rights, such as those specified in a management contract
 Subsidiary. An entity that is controlled by another entity.
 Parent. An entity that controls one or more subsidiaries.
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 Cont…

 Group. A parent and all its subsidiaries.

 Associate. An entity over which an investor has significant influence
and which is neither a subsidiary nor an interest in a joint venture.
 Significant influence. The power to participate in the financial and
operating policy decisions of an investee but it is not control or joint
control over those policies.

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Investments in Subsidiaries
 The important point here is control. In most cases, this will
involve the holding company or parent owning a majority of
the ordinary shares in the subsidiary (to which normal voting
rights are attached).
 There are circumstances, however, when the parent may own only a
minority of the voting power in the subsidiary, but the parent still
has control.
 Three separate elements of control (IFRS 10):
• An investor controls an investee if and only if it has all of the
following.
(a) Power over the investee
(b) Exposure to, or rights to, variable returns from its involvement with the
investee
(c) The ability to use its power over the investee to affect the amount of the
investor's returns
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Investments in Associates
 This type of investment is something less than a subsidiary, but
more than a simple investment. The key criterion here is
significant influence. This is defined as the 'power to
participate', but not to 'control‘ (which would make the
investment a subsidiary).
 Significant influence can be determined by the holding of voting
rights (usually attached to shares) in the entity. IAS 28 states
that if an investor holds 20% or more of the voting power of
the investee, it can be presumed that the investor has
significant influence over the investee, unless it can be clearly
shown that this is not the case.
 Significant influence can be presumed not to exist if the
investor holds less than 20% of the voting power of the
investee, unless it can be demonstrated otherwise.
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 Cont…

 The existence of significant influence is evidenced in one or

more of the following ways.
(a) Representation on the board of directors (or equivalent) of
the investee
(b) Participation in the policy making process
(c) Material transactions between investor and investee
(d) Interchange of management personnel
(e) Provision of essential technical information
 IAS 28 requires the use of the equity method of accounting for
investments in associates.
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 Cont…

Section Summary

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Consolidated Financial Statements
 IFRS 10 requires a parent to present consolidated financial
statements.
 Consolidated financial statements - the financial statements of
a group in which the assets, liabilities, equity, income,
expenses and cash flows of the parent and its subsidiaries are
presented as those of a single economic entity.

 When a parent issues consolidated financial statements, it

should consolidate all subsidiaries, both foreign and domestic.

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Exemption from preparing group accounts
 A parent need not present consolidated financial statements if
and only if all of the following hold.
(a) The parent is itself a wholly-owned subsidiary or it is a partially
owned subsidiary of another entity and 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.
(b) Its securities are not publicly traded.
(c) It is not in the process of issuing securities in public securities
markets.
(d) The ultimate or intermediate parent publishes consolidated
financial statements that comply with IFRS.
 A parent that does not present consolidated financial statements
must comply with the IAS 27 rules on separate financial statements.
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Potential Voting Rights
 An entity may own share warrants, share call options, or other
similar instruments that are convertible into ordinary shares in
another entity.

 If these are exercised or converted they may give the entity

voting power or reduce another party's voting power over the
financial and operating policies of the other entity (potential
voting rights).

 The existence and effect of potential voting rights, including

potential voting rights held by another entity, should be
considered when assessing whether an entity has control over
another entity (and therefore has a subsidiary).
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Exclusion of a Subsidiary from Consolidation
 The rules on exclusion of subsidiaries from consolidation are
necessarily strict, because this is a common method used by entities
to manipulate their results. Entities may, for example, take large
debts out of the consolidated statement of financial position (to
improve the gearing of the group as a whole).
 Question 1: Should subsidiaries be excluded from consolidation on
the grounds of dissimilar activities?
 According to IFRS 10 exclusion on these grounds is not justified
because better (relevant) information can be provided about such
subsidiaries by consolidating their results and then giving additional
information about the different business activities of the subsidiary.
 Question 2: Should exclusion be permitted where the subsidiary
operates under severe long-term restrictions and these significantly
impair its ability to transfer funds to the parent?
 No, control must actually be lost for exclusion to occur.
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Different Reporting Dates
 In most cases, all group companies will prepare accounts to
the same reporting date. One or more subsidiaries may,
however, prepare accounts to a different reporting date from
the parent and the bulk of other subsidiaries in the group.
 In such cases the subsidiary may prepare additional
statements to the reporting date of the rest of the group, for
consolidation purposes.
 If this is not possible, the subsidiary's accounts may still be
used for the consolidation, provided that the gap between the
reporting dates is three months or less.
 Where a subsidiary's accounts are drawn up to a different
accounting date, adjustments should be made for the effects
of significant transactions or other events that occur between
that date and the parent's reporting date.
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Uniform Accounting Policies
 Consolidated financial statements should be prepared using
uniform accounting policies for like transactions and other
events in similar circumstances.

 Adjustments must be made where members of a group use

different accounting policies, so that their financial statements
are suitable for consolidation.

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Date of Inclusion/Exclusion
 IFRS 10 requires the results of subsidiary undertakings to be
included in the consolidated financial statements from:
(a) The date of 'acquisition', i.e., the date on which the
investor obtains control of the investee, to
(b) The date of 'disposal', i.e., the date the investor loses
control of the investee.

 Once an investment is no longer a subsidiary, it should be

treated as an associate under IAS 28 (if applicable) or as an
investment under IFRS 9.

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Accounting for Subsidiaries and Associates in
the Parent's Separate Financial Statements
 A parent company will usually produce its own single
company financial statements and these should be prepared in
accordance with IAS 27.

 In these statements, investments in subsidiaries and associates

included in the consolidated financial statements should be
either:
(a) Accounted for at cost, or
(b) In accordance with IFRS 9

 Where subsidiaries are classified as held for sale in accordance

with IFRS 5 they should be accounted for in accordance with
IFRS 5 in the parent's separate financial statements.
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Disclosure – Individual Financial Statements
 Where a parent chooses to take advantage of the exemptions
from preparing consolidated financial statements, under IAS 27
the separate financial statements must disclose:
(a) The fact that the financial statements are separate financial
statements; that the exemption from consolidation has been used;
the name and country of incorporation of the entity whose
consolidated financial statements that comply with IFRSs have been
published; and the address where those consolidated financial
statements are obtainable
(b) A list of significant investments in subsidiaries, jointly controlled
entities and associates, including the name, country of
incorporation, proportion of ownership interest and, if different,
proportion of voting power held
(c) A description of the method used to account for the investments
listed under (b)
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 Cont…
 When a parent prepares separate financial statements in
addition to consolidated financial statements, the separate
financial statements must disclose:

(a) The fact that the statements are separate financial

statements and the reasons why they have been prepared if
not required by law

(b) Information about investments and the method used to

account for them

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Content of Group Accounts and Group
Structure
 A group has no separate/legal existence, except for accounting
purposes.
 Consolidated accounts are one form of group accounts which
combines the information contained in the separate accounts of a
holding company and its subsidiaries as if they were the accounts of a
single entity.
 In simple terms a set of consolidated accounts (group accounts) is prepared
by adding together the assets and liabilities of the parent company and
each subsidiary. The whole of the assets and liabilities of each company are
included, even though some subsidiaries may be only partly owned.
 The 'equity and liabilities' section of the statement of financial position
will indicate how much of the net assets are attributable to the group and
how much to outside investors in partly owned subsidiaries.
 These outside investors are known as the non-controlling interest (NCI).
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 Cont…
 Non-controlling interest - the equity in a subsidiary not
attributable, directly or indirectly, to a parent.
 NCI should be presented in the consolidated statement of
financial position within equity, separately from the parent
shareholders' equity.
 Most 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 undertakings‘ as an asset in the SFP,
and income from subsidiaries (dividends) in the SPL
 Consolidated SFP
 Consolidated SPLOCI
 Consolidated SCF
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Group Structure
 Let us now look at group structures. The simplest are those in
which a parent company has only a direct interest in the shares
of its subsidiary companies.
For example:

 S1 Co is a wholly owned subsidiary of P Co. S2 Co, S3 Co and S4

Co are partly owned subsidiaries; a proportion of the shares in
these companies is held by outside investors.
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 Cont…
• Often a parent will have indirect holdings in its subsidiary companies.
This can lead to more complex group structures, involving sub-
subsidiaries.
For example:

 P Co owns 51% of the equity shares in S Co, which is therefore its

subsidiary. S Co in its turn owns 51% of the equity shares in SS Co. SS Co
is therefore a subsidiary of S Co and consequently a subsidiary of P Co.
 SS Co would describe S Co as its parent (or holding) company and P Co
as its ultimate parent company.
 Note that although P Co can control the assets and business of SS Co by virtue
of the chain of control, its interest in the assets of SS Co is only 26% (51%*51%).
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• End of chapter Notes!

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 ‘’
Chapter end questions
1. When can control be assumed?

2. Distinguish between ‘investment in subsidiary’ and ‘investment in

associate’.

3. How is ‘significant influence’ determined?

4. Explain the term ‘non-controlling interest’.

5. Discuss the rationale for consolidating the financial statement of

different legal entities. Who makes the consolidation? Why?

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 ‘’
6. Calculate the NCI in Company B.

Company A

60% Non Controlling

Interest
?%
Company B

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 ‘’
7. Calculate the NCI (1) and NCI (2) in Company B and C. Also,
determine the interest of Company A in Company C.

Company A

75%

?% Non Controlling
Company B ?% Interest (1)
60%
?%
Company C Non Controlling
?% Interest (2)

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 ‘’
8. Calculate the NCI (1) and NCI (2) in Company B and C. Also,
determine the interest of Company A in Company C.

Company A

75%

25% ?% Non Controlling

Company B ?% Interest (1)
40%
?%
Company C Non Controlling
?% Interest (2)

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