31-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Chapter.

31-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Chapter 31Further consolidation issues

III:Accounting for indirect

ownership interests

31-2 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Learning objectives• Understand that the determination of the total ownership

interest in a subsidiary must take account of both direct and indirect ownership interests

• Understand what an indirect equity ownership interest represents and how it is calculated

• Understand that the parent entity’s interest in the post-acquisition movements of a subsidiary’s retained earnings and other reserves will be based upon the sum of the direct and indirect ownership interests

• Understand that even in the presence of indirect ownership interests, the pre-acquisition capital and reserves of a subsidiary will be eliminated on consolidation on the basis of only the direct ownership interests

31-3 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests• AASB 127 requires that

– the consolidated financial report include all subsidiaries of the parent

• Subsidiary defined as (AASB 127)– an entity (including a partnership) that is controlled by

another entity (the parent)• Control

– is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities

– can arise through indirect interests, i.e. without any direct ownership interest – hence, a parent entity does not need to have any direct ownership in another entity for that other entity to be considered a subsidiary

31-4 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)• Example of an indirect controlling interest

– consider Figure 31.1 (reproduced on following slide)

31-5 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

31-6 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Calculating direct and indirect interests• We can calculate the percentage interest by

constructing a table – consider the following slide

31-7 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

A Ltd B Ltd

(% interest) (% interest)

Parent Entity interest: Direct 70 –

Indirect – 42

Minority interest Direct 30 40

Indirect – 18

100 100

31-8 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)• Minority interests

– are that portion of the profit or loss and net assets of a subsidiary attributable to equity interests that are not owned by the parent

• Also possible to hold both direct and indirect interests in a particular entity– consider Figure 31.2 (p. 1069)

31-9 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)• Consolidation in the presence of indirect interests

– refer to Worked Example 31.1 (p. 1070)• Choice of two methods in performing consolidation

1. Sequential-consolidation approach – consolidation of each separate legal entity with its controlled

entities is performed sequentially (time-consuming and messy)2. Multiple-consolidation approach

– in eliminating investments held by the immediate parent entities only direct interests are taken into account

– post-acquisition movements in subsidiaries’ shareholders’ funds allocated to ultimate parent entity on basis of sum of direct and indirect interests

31-10 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

• We need to know both the direct and indirect ownership interests before we are able to prepare the consolidated financial statements

• Indirect interests are relevant only for apportioning post-acquisition movements in share holders’ funds

• Any pre-acquisition allocations or distributions are to be apportioned on the basis of direct ownership interests only

31-11 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)Journal entries• To eliminate parent’s investment in subsidiary

Dr Share capitalDr Retained earningsDr Goodwill Cr Investment in subsidiaryThe investment elimination is undertaken on the basis of direct ownership interests

• To recognise impairment of goodwill associated with acquisitionDr Impairment expense—goodwill Cr Accumulated impairment losses—goodwill

31-12 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)Journal entries (cont.)• To eliminate dividends proposed by subsidiary

Dr Dividend payable (balance sheet) Cr Dividend proposed

(statement of changes in equity)

Dr Dividend revenue (income statement) Cr Dividend receivable (balance sheet)

After eliminations, the consolidated financial statements should show the dividends paid and proposed by the parent entity as well as the direct minority interests in the dividends paid and proposed by the subsidiaries – that is, total dividends paid and proposed are those dividends that flow away from the economic entity.

31-13 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Indirect ownership interests (cont.)• Minority interests (AASB 127)

– to be presented separately from the parent shareholders’ equity in the consolidated balance sheet within equity

– to be separately disclosed in the profit or loss of the group

31-14 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Minority interests• Minority interests in profit are calculated on the basis

of the sum of both direct and indirect ownership interests

• Apportionment of minority interest in pre-acquisition share capital and reserves is based on direct ownership interests only

• Apportionment of post-acquisition movements in retained earnings and other reserves is based on the sum of both direct and indirect ownership interests

31-15 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Minority interests in current period profitsWhere there is an intermediate parent entity there are a number of adjustments that must be made to subsidiaries’ profits before we can determine minority interests in profits

• Intragroup dividends paid to an ‘intermediate parent’ from a subsidiary are subtracted from the profits of that intermediate parent before the minority interest in profits of that organisation is calculated

• where there is an intermediate parent entity, any goodwill impairment expense that is recognised in relation to a subsidiary under the control of the intermediate subsidiary is to be added back to the intermediate parent entity’s reported profit before minority interests are calculated

• See Worked Example 31.1 for a detailed explanation of the above adjustments

31-16 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Sequential and non-sequential acquisitions• Examples would include• The parent acquires its interest in the intermediate

subsidiary before the intermediate subsidiary acquires its interest in the other subsidiary (this is referred to as sequential acquisition and is represented in the following slide); and

• The parent acquires its interest in the intermediate subsidiary after the intermediate subsidiary acquires its interest in the other subsidiary (this is referred to as non-sequential acquisition and is represented in the slide following the next slide).

31-17 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Sequential acquisition

31-18 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Non-sequential acquisition

31-19 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Non-sequential acquisitions• In a sequential acquisition, the consolidated financial statements

will be accounted for in the same manner as when acquisitions occur simultaneously. Since we have considered simultaneous acquisitions up to now, we should have no trouble accounting for sequential transactions.

• In a non-sequential acquisition - the situation where the parent entity acquires its control of the intermediate subsidiary after the intermediate subsidiary acquired its interest in another subsidiary. The ultimate parent (Organisation A) is acquiring an interest in the B Group, rather than solely in Organisation B.

• In determining the fair value of the assets acquired in Organisation B, which is necessary for our consolidation entry that eliminates the investment in Organisation B against the pre-acquisition capital and reserves of Organisation B, we need to consider the value of both Organisation B and Organisation C.

31-20 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Non-sequential acquisitions• The value of Organisation B’s investment in

Organisation C will be affected by post-acquisition profits and reserve movements in Organisation C.

• Therefore, Organisation A’s investment in Organisation B must be eliminated against Organisation A’s share of the owners’ equity of the B Group (Organisation B plus Organisation C) as at the date of Organisation A’s investment.

• The profits earned by Organisation C, after Organisation B acquired its interest in Organisation C, but prior to Organisation A’s acquisition of the B Group are treated as part of pre-acquisition reserves, and therefore eliminated on consolidation.

• Consider Worked Example 31.3 (p. 1092)

31-21 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Summary• The chapter showed that it is possible to control

another entity - and therefore be required to consolidate it - without necessarily having any direct ownership in that separate legal entity.

• When consolidating in the presence of indirect interests, the elimination of the investments held by the immediate parent entities is to be undertaken on the basis of the direct ownership interest.

• The economic entity’s interest in the post-acquisition profits of subsidiaries and post acquisition movements in reserves will be based on the sum of both the direct ownership interests and the indirect ownership interests