ACCT7104: Corporate Accounting
Introduction to Business Combinations
Arthur et al. Chapter 1, Chapter 2 (section 2.1)
AASB 10, AASB 3
Required Reading
2
Questions (Textbook): Q1.1; Q1.2; Q1.3; Q1.9; Q1.13
Workshop Questions
3
• 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 control
• Contrast control with other business relationships
• Explain the concept of a group
• Determine the entities that must prepare consolidated financial statements
• Demonstrate the importance of consolidation accounting
Objectives
4
• 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 relevant accounting standards
• You can access the Australian Accounting Standards online
Accounting standards
5
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
Brief background to international accounting regulation
6
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 unchangedly
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)
Process to adopt a new Australian Accounting Standard
7
Consolidation suite of AAS’s (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
➢ Also note AASB 3 Business Combinations relevant to almost all topics covered in ACCT7104
Relevant accounting regulation in Australia
8
COURSE OVERVIEW- Life Cycle of a Corporate Entity
9
• Incorporation
• Regulation
• Funding
• Shares/Borrowing
• Reporting
Establishment
(ACCT7101, 7102)
• Acquisition of Assets
• Acquisition of Entities
• (Topic 1- 9)
Growth/Expansion
• External & Voluntary
Administration
• Receivership
• Liquidation
• (Topic 10)
Decline
ACCT7104
10
Investments in other entities
• 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
11
Investment transactions overview
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
Growth by Acquisitions
12
Asset Acquisitions
Non-operations or
business asset acquisition
Business operations or
business acquisition.
Single
Asset
Collection
of
Assets
Direct
Acquisition
Indirect
Acquisition
SharesPurchase of
net assets
Business expansion
takes various forms
Focus of
ACCT7104
AASB 116 – PPE
Measurement at initial recognition:
• Measured at cost (fair value (FV) if no cost)
Measurement after recognition:
• Asset subject to depreciation and impairment
• Measured by asset class using either:
- Cost model (cost less any accumulated depreciation/accumulated impairment losses) or,
- Revaluation model (FV less any subsequent accumulated depreciation/ accumulated impairment losses. Must be
applied with sufficient regularity to avoid material variation from FV)
For Intangible Assets: AASB 138
For Financial Assets: AASB 139 (options, futures, receivables)
Acquisition of a Single Asset
13
Recap
ACCT7101 &
ACCT7102
We will cover the effect of asset sales between entities in business combinations
so it is important you remember how to do all of these journals.
An example just to refresh:
• Elite Ltd purchased a piece of equipment on 1 July 2020 for $50,000 cash. The equipment has an
economic life of 5 years with a zero salvage value at the end of that time. Elite Ltd uses straight-
line depreciation.
• On 2 July 2022, following signs of impairment, impairment tests revealed the equipment
recoverable amount was $24,000.
• Required: Show the general journals to account for the equipment on 1 July 2020 to 2 July 2022
(For simplicity, we will ignore tax in this question)
Single Asset - Example
14
Recap
ACCT7101 &
ACCT7102
15
Equipment a/c
1/7 Cash 50,000
30/06 bal 30,000
2/07 bal 24,000
30/6 Dep’n 10,000
30/6 Dep’n 10,000
Impairment ??
6,000
Single Asset - Journals
16
Date Details Dr Cr
1/7/2020 Equipment 50,000
Cash 50,000
(Purchase of equipment)
30/6/2021 Depreciation expense 10,000
Accumulated depreciation 10,000
(Depreciation expense Yr 1)
30/6/2022 Depreciation expense 10,000
Accumulated depreciation 10,000
(Depreciation expense Yr 2)
2/7/2022 Impairment loss 6,000
Accumulated impairment 6,000
(Impairment loss recorded as CA
$30,000 – RA $24,000)
• Now consider the acquisition of a collection of assets from a 3rd party 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:
“It will consist of inputs and processes applied to those inputs that have the ability to create
outputs”. (Appendix B)
17
“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.”
Acquisition: Collection of Assets (direct business acquisition)
Acquiring a collection of assets: direct acquisition from vendor
18
➢ 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”
• How are individual costs recorded for multiple asset purchases not
comprising a ‘business’ acquisition?
• Assume the assets acquired for $500,000 do not constitute a
business.
Acquisition: Collection of Assets (not a business acquisition)
Asset Fair Value
Plant 200,000
Land 150,000
Vehicles 175,000
Total FV of assets acquired $525,000
Purchase consideration $500,000
19
Acquisition: Collection of Assets - Allocation
(not a business acquisition)
20
Asset Fair Value Apportion* Portion of
Cost
Plant $200,000
Land $150,000
Vehicles $175,000
Total $525,000
Purchase consideration $500,000
“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)
Acquisition: Collection of Assets - Allocation
(not a business acquisition)
21
Asset Fair Value Apportion* Portion of
Cost
Plant $200,000 200/525 x 500 $190,476
Land $150,000 150/525 x 500 $142,857
Vehicles $175,000 175/525 x 500 $166,667
Total $525,000 $500,000
Purchase consideration $500,000
“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)
Acquisition: Collection of Assets - Journal
(not a business acquisition)
22
As it is not a business combination
• Overpayment would not be treated as goodwill
• Underpayment is not treated as a gain on bargain purchase
Date Details DR CR
1/7/2016 Plant 190,476
Land 142,857
Vehicles 166,667
Cash 500,000
(record acquisition of collection of assets not considered a
business combination)
If the collection of assets acquired constitute a business (a business
combination), we must account for the acquisition in accordance with AASB 3
as a “business combination”.
Poppy Ltd acquired the following assets, constituting a business, from Daisy Ltd
at an acquisition cost of $600,000:
Acquisition: Collection of Assets (constitute a business)
23
Asset Fair Value
Plant 200,000
Land 150,000
Vehicles 175,000
Total FV of assets acquired $525,000
Purchase consideration $600,000
If the collection of assets acquired constitute a business (a business
combination), we must account for the acquisition in accordance with AASB 3
as a “business combination”.
Poppy Ltd acquired the following assets, constituting a business, from Daisy Ltd
at an acquisition cost of $600,000:
Acquisition: Collection of Assets
(constitute a business)
24
Asset Fair Value
Plant 200,000
Land 150,000
Vehicles 175,000
Total FV of assets acquired $525,000
Purchase consideration $600,000
Difference $75,000
• 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 in excess of the fair value of a collection of assets)
or
• gain on bargain purchase (an underpayment)
Acquisition: Business combination
25
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 is initially measured as the excess of the cost of acquisition after deducting the fair value of
the … identifiable net assets.
Recall: Goodwill is an unidentifiable intangible asset.
Subsequent accounting treatment:
• impairment tested at least annually in accordance with AASB 136 Impairment of Assets. any
impairment loss associated with goodwill is recognised immediately.
• We will return to goodwill later in the semester.
Business combination: goodwill
26
• 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 recognised as a gain in the consolidated
statement of comprehensive income.
Business combination: Gain on bargain purchase
27
• To record the acquisition in the books of Poppy Ltd
Recall:
Acquisition: business combination with goodwill
28
Date Details DR CR
1/7/2016 Plant 200,000
Land 150,000
Vehicles 175,000
Goodwill 75,000
Cash 600,000
(record acquisition of collection of assets considered a business
combination)
As it is a business combination, overpayment would be treated as goodwill
• Now presume Poppy Ltd acquired the same assets (as a business
combination) for $500,000.
• What is the journal entry?
Business combination: Gain on bargain purchase
29
Date Details DR CR
1/7/2016 Plant 200,000
Land 150,000
Vehicles 175,000
Gain on bargain purchase 25,000
Cash 500,000
(record acquisition of collection of assets considered a business
combination)
Checkpoint
30
• Goodwill OR
• Gain on bargain purchase
• No goodwill
• No gain on bargain purchase
• No goodwill
• No Gain on bargain purchase
DIRECT
ACQUISITION
Single Asset
Not a Business
DIRECT
ACQUISITION
Collection of Assets
Not a Business
DIRECT ACQUISITION
Collection of Assets
Business
Combination
INDIRECT
ACQUISITION
Acquisition of shares in
investee
Business Combination
Break
[Presentation Title] | [Date] 31
Business combination
32
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
Let’s look now at business combinations through the acquisition of
shares in the investee
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
Acquisition of shares in the business
33
• This can be achieved by
acquiring the shares directly
from a known shareholder
(private company) or by
acquiring the shares on the
stock exchange (public
company)
• This type of investment is
called an equity investment
Categories
Classification of equity investments
34
1. Financial assets – no special business relationship between
investor and investee (ACCT7102)
2. Investments providing the power to exert control, joint
control or significant influence (ACCT7104)
Category 1:
• AASB 9 Financial Instruments or
• AASB 139 Financial Instruments: Recognition and Measurement
• Measure the asset as either a financial asset
- at fair value through profit or loss; or
- 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.
Equity Instrument Classification – Cat 1
35
Category 2:
Investments which confer three possible relationships by
the investor over the investee
- significant influence
- joint control or
- control.
Equity Instrument Classification – Cat 2
36
ACCT7104
FOCUS
• 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.”
Significant Influence AASB 128:3
37
• Representation on the investee’s Board or equivalent governing
body
• Participation in policy-making processes, including decisions
about dividends and other distributions
• Material intra-entity transactions (economic dependency)
• Interchange of management personnel (organisational
dependency)
• Provision of essential technical information (technological
dependency)
Indicators of Significant Influence AASB 128:6
38
If the investor holds, directly or indirectly,
20% or more of the voting power of an
investee, it is presumed that the investor
has significant influence, unless it can
be clearly demonstrated that this is not
the case.
At a holding of < 20%, directly or
indirectly, it is presumed that the
investor does not hold significant
influence, unless such influence can be
clearly demonstrated.
Indicators of Significant Influence
AASB 128:5 – Rebuttable Presumption
39
Published in ‘The Australian’ No details provided
• Acquisitions that give the investor shared control of the
investee’s economic resources
• Joint Control is defined as:
• “The contractually agreed sharing of control of an
arrangement, which exists only when decisions about
the relevant activities requires the unanimous
consent of the parties sharing the control.”
Joint Control AASB 128:3; AASB 11:7
40
• Acquisitions that give the investor power to control the investee’s
economic resources
• Control is defined as:
“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.” [AASB10:6]
Control AASB10:6
41
An investor controls an investee if and only if the investor has all the
following: (3 essential criteria)
Control AASB 10:7
42
THREE ESSENTIAL CRITERIA FOR ESTABLISHING CONTOL
a) power over the investee; (para 10-14) (App B9–54)
b) exposure, or rights, to variable returns from its
involvement with the investee; (para 15-16) (App B55-B57)
and
c) the ability to use its power over the investee to
affect the amount of the investor’s returns. (para 15-
16) (App B58-72)
“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” (AAS B10:10)
Control: 1. Power over the investee (AASB 10: 10-14)
43
Relevant activities: are “activities of the investee that
significantly affect the investor’s returns” (AASB 10:10)
• 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)
Current ability: Investor must have current capacity to exercise
power if it wanted. The investor can be passive but still have
power.
Existing rights: power arises from rights. (AASB 10:11)
Control – Power arises from rights
44
“Sometimes assessing power is straightforward, such as when power
over an investee is obtained directly and solely from the voting rights
granted by equity instruments such as shares, and can be assessed
by considering the voting rights from those shareholdings. In other
cases, the assessment will be more complex and require more than
one factor to be considered, for example when power results from one
or more contractual arrangements.” (AASB 10:11)
“ An investor is exposed, or has rights, to variable returns from its
involvement with the investee when the investor’s returns from its
involvement have the potential to vary as a result of the investee’s
performance. The investor’s returns can be only positive, only negative
or both positive and negative.” (AASB10:15)
• Returns must potentially be variable rather than fixed – the returns depend
on the investee’s performance (AASB 10B.56)
• Some examples: Dividends, other distributions, changes in value of
investors investment, remuneration for servicing, etc. etc. (Read B57)
Control: 2. Exposure or rights to variable returns (AASB 10:15-16)
45
That is, the investor entity’s own returns are potentially
affected by its involvement in the investee.
“An investor controls an investee if the investor not only has power over
the investee and exposure or rights to variable returns from its
involvement with the investee, but also has the ability to use its power
to affect the investor’s returns from its involvement with the investee.”
(AASB 10:17)
• Consider whether investor is acting as agent or principal
Control: 3. Link between power and returns
(AASB 10:17-18)
46
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
• 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
investee’s 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
Control (cont)
47
AASB 10: Appendix B provides guidance on all of the limbs of control.
• Substantive rights
• Protective rights
• Power with majority of voting rights
• Majority of voting rights but no power
• Power without a majority of the voting rights
• Delegated power
• And many more concepts…
Assessing control: Guidance
48
You need to read the Appendix
to fully understand these concepts
An investor that holds more than half of the voting rights of an investee has power in
the following situations, unless paragraph B36 or paragraph B37 applies:
a) the relevant activities are directed by a vote of the holder of the majority of the
voting rights, or
a) a majority of the members of the governing body that directs the relevant
activities are appointed by a vote of the holder of the majority of the voting rights.
Power: Majority of voting rights (App B35)
49
Often an investor has the current ability, through voting or similar
rights, to direct the relevant activities. (App B34)
HOWEVER…
• Majority of the voting rights but no power if rights are
not substantive rights (App B36 & App B37)
• Power without a majority of the voting rights (App B38 –
App B50)
Power: Majority of voting rights
50
• When voting rights cannot have a significant effect on an investee’s
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.
Power: Via Contractual arrangement
51
Investment Type & Accounting Method
52
Equity
Investment
Associate
Joint
Arrangement
Subsidiary
No Significant
Influence,
Joint Control
or Control
Significant
Influence
Joint
Control Control
Cost or FV Method
(AASB 9)
Equity Method
(AASB 128)
JV = Equity Method
JO = Share of interest
(AASB 128 / AASB 11)
Consolidation Method
(AASB 10, AASB 3)
ACCT7102 Topic 7 Topic 1 - 6
Summary
Topic 8
Criteria Summary
53
Criteria Definition
Significant
Influence
“is the power to participate in the financial and
operating policy decisions of the investee but is not
control or joint control of those policies” AASB 128:3
Joint
Control
“is the contractually agreed sharing of control of an
arrangement, which exists only when decisions about
the relevant activities require the unanimous consent
of the parties sharing control” AASB 128:3; AASB 11:7
Control “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” AASB 10:6
Summary
Share ownership and/or voting rights are often an indicator of the relationship given
that shareholding results in rights (power).
Shareholding as an Indicator of relationship
54
These are indicators only. Note the rebuttable presumptions.
Must meet the definition in the relevant standard.
Summary
• The nature of the investor/investee relationship determines the investor entity’s 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 extensive guidance
Financial reporting for investor/investee relationships
55
Summary
Break
[Presentation Title] | [Date] 56
• 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 financial statements
• A statement of financial position
• A statement of profit or loss and other comprehensive income
• A statement of changes in equity
• A cash flow statement
• Notes
Financial reporting consequences of CONTROL
57
AASB 10 requires use of the consolidation method
Consolidation – process of preparing single set of financial statements for group of entities provided control exists
This is an indirect acquisition of business combination
Financial reporting consequences of CONTROL
58
A Ltd
B Ltd
Parent
Subsidiary
“control” must exist
The group is referred to as the “A Ltd Group”
Group : a parent and its subsidiaries
Parent: an entity that controls one or
more entities
Subsidiary: an entity that is controlled by
another entity
Who controls C Ltd?
Power: shareholding and voting rights
59
A Ltd
C Ltd
48%
B Ltd controls C Ltd
Even though A Ltd is currently running the day-to-day operations of C
Ltd, B Ltd has the power over C Ltd. At any time that B Ltd disagrees
with the management policies of A Ltd it can take control by virtue of
its majority voting interests.
B Ltd
52%
• A Ltd currently actively
formulates the policies of C
Ltd
• B Ltd currently plays no part
in the day-to-day
management of C Ltd
Does A Ltd control B Ltd?
Power: shareholding and voting rights
60
A Ltd
B Ltd
46%
3 shareholders each holding
18% of the voting power.
These shareholders
regularly attend meetings
and vote
Does A Ltd control B Ltd?
Power: shareholding and voting rights
61
A Ltd
B Ltd
46%
3 shareholders each holding
18% of the voting power.
These shareholders
regularly attend meetings
and vote
No.
Based on the history of AGM attendance and involvement of
shareholders it appears that A Ltd does NOT exert power over B Ltd.
Does A Ltd control B Ltd?
Power: voting rights
62
A Ltd
B Ltd
46%
3 shareholders each holding
18% of the voting power. These
shareholders regularly attend
meetings and vote
Would your decision change if A Ltd had an
agreement with the three shareholders giving A
Ltd the right to appoint and remove directors
and determine management remuneration?
Does A Ltd control B Ltd?
Power: voting rights
63
A Ltd
B Ltd
46%
3 shareholders each holding
18% of the voting power. These
shareholders regularly attend
meetings and vote
Yes.
A: Power – through existing contract to control the board of directors
B: Right to returns – shareholder therefore rights to dividends
C: Use power to affect returns – through decisions of the board of
directors
Would your decision change if A Ltd had an
agreement with the three shareholders giving A
Ltd the right to appoint and remove directors
and determine management remuneration?
Shareholding and Voting Rights
64
Orange
Maroon Pink Red
Crimson
80%
80%
40%
30%
40%
a) Identify the corporate (consolidated)
group
b) What is the relationship between each
company?
c) How many votes does Orange
command over:
a) Maroon
b) Pink
c) Crimson
d) What is Orange’s interest
(shareholding) in each entity
• Shareholding can be direct or indirect (through another entity)
• If a Parent controls an entity, it can control the votes that entity has in other
entities.
Note: In this question, we will presume that shareholding/voting rights is
sufficient for control given no other information provided.
Identifying the (Consolidated) Group
65
Orange
Maroon Pink Red
Crimson
80%
80%
40%
30%
40%
Group
Orange – Parent
Maroon, Pink and Crimson – Subsidiaries
Red is NOT part of the Group as not a Subsidiary
Orange Ltd Group
Shareholding and Voting Rights
66
Orange
Maroon Pink Red
Crimson
80% 80% 40%
30%
40%
O’s Direct Indirect Total
M 80% 0% 80% Control Subsidiary
P 80% 0% 80% Control Subsidiary
C 0% (M) 80% x 30% = 24%
(P) 80% x 40% = 32%
56% Control Subsidiary
R 40% 40% Not control Not Subsidiary
Shareholding
O’s Voting Rights
M 80%
P 80%
C 70% (30% + 40%) (Because
Orange controls Maroon and Pink, it controls
their votes in Crimson)
R 40%
Consolidation is the process of combining the financial statements of
individual entities to show financial position and performance of group
as if it were single economic entity
Consolidated financial statements are prepared by:
i. Aggregating (combining), line by line, like items of assets,
liabilities, equity, income and expenses
ii. Adjusting these combined figures for intra-group transactions
between entities within the group
Consolidation Process
67
We will spend 5 weeks on this process – Topics 2, 3, 4, 5, 6
Checkpoint
68
Concept of CONTROL
Accounting consequences of
CONTROL
Introduction to
Consolidations
Summary
Something for your to think and research ….
69
• 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
70
• 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
71
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
72
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
73
• 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
Importance of consolidated reporting
74
• Today’s 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
Self study and next seminar
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Summary Investor-Investee Relationships
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Source: Arthur et al (2017)
Summary
Review Questions
apps.elearning.uq.edu.au/poll/59981
UQ Active Learning Suite
[Presentation Title] | [Date] 78
[Entity Name]
a) 100% of any surplus of Y Ltd’s assets over its liabilities.
b) 100% of profits made by Y Ltd since its acquisition by X Ltd.
c) nothing.
d) none of the above.
X Ltd has a wholly (100%) owned subsidiary, Y Ltd. If Y Ltd went into liquidation, X Ltd would be entitled to:
79
a) 100% of any surplus of Y Ltd’s assets over its liabilities.
b) 100% of profits made by Y Ltd since its acquisition by X Ltd.
c) nothing.
d) none of the above.
X Ltd has a wholly (100%) owned subsidiary, Y Ltd. If Y Ltd went into liquidation, X Ltd would be entitled to:
80
Cassius Ltd and Brutus Ltd agreed to merge by forming another company, Casca Ltd, which acquired all
the issued capital of the two companies in a share exchange. Cassius Ltd was a much larger company
than Brutus Ltd, with several large equity stakeholders, so that the board of Cassius Ltd emerged from the
business combination with the power to dominate the operating and financial policies of the merged entity.
Based on these facts:
a) Casca Ltd must be the acquiring entity because it acquired the issued capital of Cassius Ltd and Brutus
Ltd.
b) Cassius Ltd is the acquiring entity because its management emerges as the dominant power in the
merged entity.
c) neither Cassius Ltd nor Brutus Ltd can be the acquiring entity because their equity securities have been
acquired by Casca Ltd.
d) none of the above.
81
Cassius Ltd and Brutus Ltd agreed to merge by forming another company, Casca Ltd, which acquired all
the issued capital of the two companies in a share exchange. Cassius Ltd was a much larger company
than Brutus Ltd, with several large equity stakeholders, so that the board of Cassius Ltd emerged from the
business combination with the power to dominate the operating and financial policies of the merged entity.
Based on these facts:
a) Casca Ltd must be the acquiring entity because it acquired the issued capital of Cassius Ltd and Brutus
Ltd.
b) Cassius Ltd is the acquiring entity because its management emerges as the dominant power in the
merged entity.
c) neither Cassius Ltd nor Brutus Ltd can be the acquiring entity because their equity securities have been
acquired by Casca Ltd.
d) none of the above.
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What kind of tea is hard to swallow?
A final question before you go
[Presentation Title] | [Date] 83
[Entity Name]
What kind of tea is hard to swallow?
Reali-tea (Reality)!
A final question before you go
[Presentation Title] | [Date] 84
[Entity Name]
Thank you