Consolidation Accounting

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1 Consolidation Accounting Indian GAAP Sailesh Patel (CA)

2 Topics to be discussed: Why consolidation Consolidation Requirement Definition of subsidiary, associate, joint venture Exclusion from consolidation Steps to consolidate Calculation for Goodwill and Minority Interest Foreign operation and consolidation Issues in consolidation accounting Overview of key changes and impact Auditing of consolidated financial statements Key difference as compared to IFRS Page 2

3 Why consolidation? Standalone financials do not reflect economic reality Mergers and acquisitions including cross border transactions Significant Impact on all profit and loss and even balance sheet ratios Page 3

4 Consolidation requirements Legal Requirements: Neither Companies Act 1956 Nor AS mandate Consolidation SEBI regulations require listed companies to prepare Annually Quarterly (Optional) Requirements under Companies Bill, 2013 Mandates preparation of CFS for all companies that have one or more subsidiaries subsidiary would include associate companies and joint ventures In the consolidated financial statements of the parent: Present economic position and results of operations as if there was essentially one single entity Page 4

5 Contents AS 21 Consolidated Financial Statements AS 23 Accounting for Investments in Associates in Consolidated Financial Statements AS 27 Financial reporting of Interests in Joint Ventures Page 5

6 Accounting for the economics Control AS21 - Line by line Consolidation Joint control AS 27 - Proportionate consolidation Corporate relationship Significant Influence AS 23- Equity Method Neither control nor joint control nor significant influence Cost or Fair Value Method Page 6

7 General rule Control <20% Ownership 20% to 50% Ownership >50% Ownership Consolidate Significant Influence Less than significant influence AS-13 Accounting for Investment Equity Accounting Joint Control Page 7

8 Control Subsidiary under the AS 21: - Direct or indirect ownership of more than half of the voting power Control of the composition of the Board of Directors AS 21 read with AS 23 - potential equity shares of the investee are not considered for determining voting power Subsidiary under Companies Act 2013 A company in which the holding company Controls the composition of the board of directors, or Exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies. As per rules, total share capital = Paid-up equity and convertible preference share capital Relevant only for subsidiary and associate definition Control as per Companies Act control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner Page 8

9 Key Impact Definition of subsidiary under the 2013 Act is different from the definition under AS 21 Whether a company will use AS 21 definition or definition under the 2013 Act for identifying subsidiaries for CFS! Definition is broader than the notion of control envisaged in the subsidiary definition Suggests that control may exist through other mechanism as well, say, management rights or voting agreements Control definition seems more relevant from regulatory purposes Page 9

10 Control example-1 Company A 60% Holding Representation of 3/4 directors Company B Company C Both B and C will consolidate A in their books as per AS 21, as both the companies have control over A Page 10

11 Control example-2 Company A 100 % 100 % Company B Company C 30 % Company D 30 % Is Company D controlled by Company A? Page 11

12 Significant influence AS 23 - Significant influence may be exercised in several ways: Representation on the Board of directors Participation in policy making process Material intercompany transactions Interchange of managerial personnel Dependence on technical information Share ownership - 20 % or more Definition as per Companies Act 2013: Associate company, in relation to another company, means a company in which the other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company. Significant influence means control of at least 20% of total share capital, or of business decisions under an agreement. Page 12

13 Definition of the term associate Key Impact Control of business decisions is an indicator of control not significant influence In accordance with AS 23, Ind-AS and IFRS: A company may demonstrate that 20% share ownership does not constitute significant influence Significant influence can be evidenced by other ways as well even if company does not hold 20% shares in other company. No such provision under 2013 Act.. The meaning of words and includes a joint venture company, used in the definition of associate company, is not clear A person holding optionally convertible preference shares, which is atleast 20% of total-share capital, may be deemed to exercise significant influence Whether a company will use AS 23 definition or definition under the 2013 Act for accounting purposes! Page 13

14 AS 27 Interests in Joint Venture Three Types of Joint Venture: Jointly controlled operations (accounted in separate financial statements) Manufacture of an aircraft Jointly controlled assets (accounted in separate financial statements) Oil pipeline Building Jointly controlled entity (accounted in consolidated financial statements) Separate legal entity Page 14

15 AS 27 Interests in Joint Venture A jointly controlled entity is a joint venture which involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The entity operates in the same way as other enterprises, except that a contractual arrangement between the venturers establishes joint control over the economic activity of the entity. A jointly controlled entity maintains its own accounting records and prepares and presents financial statements in the same way as other enterprises in conformity with the requirements applicable to that jointly controlled entity. Joint control is the contractually agreed sharing of control over an economic activity Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefits from it. Accounting of partnership firm/aop in separate and consolidated financial statements Page 15

16 Accounting for JV which is a subsidiary Company A Company B 60% Company JV 40% (Contractual arrangement for joint control) Whether Company should consolidate Company JV as a subsidiary under AS 21 or as a Joint Venture under AS 27? Enterprises by a contractual arrangement establishes Joint Control in a subsidiary, to be consolidated as per AS 21 and not treated as JV as per AS 27 [earlier treated as JV] The other JV partners may continue treating the same as JV Page 16

17 Accounting for share of losses Subsidiary Full Associates Restricted to the carrying amount of investment* Joint Venture Proportion of their shares in the venture* * Unless there is a binding obligation Page 17

18 Start and end of consolidation Start Date from which holding subsidiary/associate/joint control relationship comes into existence End Date upto which holding subsidiary/associate/joint control relationship ceases to exist Page 18

19 Exclusion from consolidation When control/significant influence/joint control is intended to be temporary Severe long-term restrictions over transfer of funds Control/significant influence/joint control is temporary: Near future - not more than 12 months from acquisition unless a longer period can be justified Intention of disposal should be at time of acquisition Page 19

20 Steps to consolidate Eliminate cost of investment and related equity accounts Record goodwill / capital reserve computed based on the net worth of investee at the date of investment Identify minority interest in the equity and the net income for the year, of the subsidiary, and record in the CFS. Eliminate intercompany payables and receivables Eliminate intercompany sales, purchases and profit in unsold inventory and fixed assets Eliminate effects of other intercompany transactions Associates - Goodwill/Capital Reserve included in the carrying amount of investment and to be disclosed separately Outstanding cumulative preference shares held outside the group preference dividend to be adjusted whether declared or not Carrying amount of investments reduce to recognise a decline other than temporary Page 20

21 Steps to consolidate (contd) Treatment of Proposed Dividend and Dividend received Distributions received to be reduced from carrying amount of investment Share in profits of associate is considered without considering proposed dividend Adjustments to the carrying amount of Investment arising from changes in equity that that have not been included in the statement of profit and loss. Such changes include those arising from the revaluation of fixed assets and investments, from foreign exchange translation differences and from the adjustment of differences arising on amalgamations. Adjustments to the carrying amount of investment in an investee arising from changes in the investee s equity that have not been included in the statement of profit and loss of the investee are directly made in the carrying amount of investment without routing it through the consolidated statement of profit and loss. The corresponding debit/credit is made in the relevant head of the equity interest in the consolidated balance sheet. Page 21

22 Inter Group transactions Transactions between the following require intra-group adjustments Parent & subsidiary (AS 21) Subsidiary & subsidiary (AS 21) Parent/subsidiary & Associate (AS 23) Parent/subsidiary & JV (AS 27) Transactions between the following do not require intra-group adjustments Associate & Associate JV & JV Associate & JV Page 22

23 Calculation of GW and MI Step by step basis Example An investing parent A invests Rs 65 lacs on October 1, 2013, to acquire 60% of the equity of B, thereby making it a subsidiary. On that date, the net assets of the subsidiary aggregated Rs 50 lacs. Subsequently, A invested, on January 1, 2014, Rs 22 lacs to acquire a further 20% of B s equity shares, on which date the net assets of B were Rs 80 lacs. At March 31, 2014, the net assets of the subsidiary were Rs 120 lacs. Assuming that there are no intra group transactions between A & B and that both have their reporting date as March 31, How is the amount of goodwill and minority interest calculated for the purpose of CFS of A? Page 23

24 Calculation of GW and MI Step by step basis Acquisition cost % share holding Net Assets Own Share Minority Interest Goodwill Oct % Oct Dec 60% Dec Jan % Jan Mar 80% Mar % Page 24

25 Classification of Foreign Entity As per AS 11 (revised), all foreign entities should be classified either as integral operations or non-integral operations. AS 11 (revised) provides following certain indicators which should be considered for determining classification while the reporting enterprise may control the foreign operation, the activities of the foreign operation are carried out with a significant degree of autonomy from those of the reporting enterprise transactions with the reporting enterprise are not a high proportion of the foreign operation s activities the activities of the foreign operation are financed mainly from its own operations or local borrowings rather than from the reporting enterprise costs of labour, material and other components of the foreign operation s products or services are primarily paid or settled in the local currency rather than in the reporting currency the foreign operation s sales are mainly in currencies other than the reporting currency cash flows of the reporting enterprise are insulated from the day-to-day activities of the foreign operation rather than being directly affected by the activities of the foreign operation, etc However, such assessment is usually very subjective Page 25

26 Foreign operations/ subsidiaries Appropriate classification of foreign operations is critical for proper disclosure of assets and liabilities and accounting of translation gains and losses. Integral Operations Non-monetary assets are stated at historical rate Monetary items at closing rate Translation gain or loss is accounted in profit and loss a/c Income/Expenditure should be translated at rates on the date of transaction Non-Integral Operations Non-monetary/monetary assets/liabilities are translated at closing rate Translation gain or loss is accounted in foreign currency translation reserve. Goodwill/capital reserve of non-integral operations - Closing rate Income/Expenditure should be translated at rates on the date of transaction Page 26

27 Other Considerations The tax expense to be shown in the CFS should be the aggregate of the amounts of tax expense appearing in the separate financial statements of the parent and its subsidiaries FS should be of same reporting date. Not practicable then drawn up to different reporting dates Adjustments for significant transactions between those dates Difference between reporting dates to be not more than six months Use of uniform accounting policies, else adjusted. If not practical then disclose Use of CFS of Associate/Joint Venture Consolidation tool Use of accounting/consolidation software (uniform chart of accounts) or excel for preparation of CFS (need to careful for groupings when various auditors are involved) Page 27

28 Key issues - Goodwill Issue View Whether goodwill arising on consolidation is required to be amortised? Practice under Indian GAAP on goodwill is divergent. Amortisation is not mandatory under AS 10 (mandatory under AS 14) AS 21, AS 23 and AS 27 are silent on goodwill amortisation. IFRS & US GAAP - Only tested for impairment!! Goodwill other issues Whether goodwill arises on further investment in 100% subsidiary Setting off of goodwill and capital reserves of different subsidiaries Setting off CFS Goodwill against Securities premium or General Reserve Page 28

29 Key Issues - others Preparing CFS of a Group having FS under different GAAP certain key considerations Indian GAAP a/cs or uniform accounting policies Inventory valuation method Depreciation method and useful life Deferred tax Deemed disposal arising from new issue of shares by subsidiary Accounting for changes in shareholding of subsidiaries held by minority interest Page 29

30 Key issues - others Subsidiaries during the reporting period but not at the balance sheet date is consolidation required? First CFS Adjustment of intra-group unrealized profits/losses of earlier years Whether preferential capital stockholders have 20% voting power but do not participate in the net results or assets of the company other than to the extent of a guaranteed IRR or dividend rate minority interest or a liability Page 30

31 Overview of key changes and impact Overview and key changes As per the 2013 Act, preparation of CFS mandatory for all companies having subsidiaries For preparation of CFS, subsidiary includes associate and joint ventures Rules clarify that CFS will be made in accordance with Schedule III and AS A proviso in the rules states as below A company covered under sec 129(3) which is not required to prepare CFS under the accounting standards, it is sufficient compliance, if the company complies with provisions on CFS of schedule III Schedule III lays down general instructions for preparation of CFS CFS to be prepared in the same form and manner as SFS of the parent Additional disclosures %net assets and profits List of Components not consolidated along with reasons Separate statement containing financial information of subsidiaries, associates and JVs to be given in prescribed form Key impact Meaning of the proviso in the rules is not clear Differing views possible Whether rules can override the Act w.r.t. preparation of CFS? No separate exemption for non-listed intermediate (not wholly owned) holding companies Whether companies without any subsidiary but having associate/ JV need to prepare CFS! Non-listed and private companies to gear up their financial reporting process (effective FY subsidiaries else FY ). Impact on companies currently preparing CFS under IFRS Presentation of comparatives in the first set of CFS AS 21 (optional) and Schedule III (mandatory to give) Mandatory disclosure of statutory information in CFS Exemption in AS 21 may not override Schedule III Page 31

32 Audit of consolidated financial statements Guidance note issued by ICAI deals with the auditing of CFS Guidance note covers the following aspects Responsibility of parent company Responsibility of auditors Audit considerations relating to audit of CFS Using of the work of another auditors Audit of consolidated adjustments Permanents adjustments and current adjustments Management representations Reporting requirements Page 32

33 Objective of audit of CFS Objective of audit of Consolidated Financial Statements; To satisfy that the Consolidated financials statements have been prepared in accordance with (AS)-21Consolidated Financial Statements, Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of Interests in Joint Ventures; and to enable himself to express an opinion on the true and fair view presented by the consolidated financial statements. The auditor should note that Auditing and Assurance Standards and Statements and Guidance Notes on auditing matters issued by ICAI apply in the same manner to audit of consolidated financial statements as they apply to audit of separate financial statements such as planning the work, obtaining an understanding the accounting and internal control system, design audit procedures to esure that the risk reduced to acceptable level, etc Page 33

34 Specific features of audit of CFS Specific features of audit of consolidated financial statements; As the consolidated financial statements are prepared on the basis of separate financial statements of parent and its subsidiaries and associates and/or joint ventures, the auditor may have to use the work of other auditors unless the auditor is also the auditor of the Component. When an auditor accepts the audit of consolidated financial statements, the auditor should assess whether based on his work alone he would be able to express an opinion on the true and fair view presented by the consolidated financial statements. If the auditor is of the view that his own participation may not be enough or sufficient, he should consider using the work of 'other auditors'. For this purpose, (SA)-600, Using the Work of an Another Auditor establishes standards when an auditor, reporting on the financial statements of an entity uses the work of another auditor on the financial information of one or more components included in the financial statements of the entity. Page 34

35 Relying on the work of other auditor While complying with (SA)-600, the auditor shall perform the following procedures; The auditor should determine the information/assurance required by the other auditor; Advise the other auditor of the use that is to be made of his work and report and make sufficient arrangements for coordination of their efforts at the planning stage of the audit; Advise the other auditor of the significant accounting, auditing and reporting requirements and obtain representation as to compliance with them. Also inform the other auditor of matters such as areas requiring special consideration, procedures for the identification of inter-component transactions that may require disclosure and the timetable for completion of audit. The principal auditor would not be responsible in respect of the work entrusted to the other auditors, except in circumstances which should have aroused his suspicion about the reliability of the work performed by the other auditors. Page 35

36 Reporting requirement When the principal auditor is not the auditor of the Component; When the parent's auditor decides that he will make reference to the audit of the other auditors, the auditor's report should disclose clearly the magnitude of the portion of the financial statements audited by the other auditor(s) as follows; We did not audit the financial statements of certain subsidiaries, whose financial statements reflect total assets of Rs. XXX as at 31st March 2014, the total revenue of Rs. XXX and cash flows amounting to Rs. XXX for the year then ended. These financial statements and other financial information have been audited by other auditors whose report(s) has (have) been furnished to us, and our opinion is based solely on the report of other auditors. If the other auditor issues, or intends to issue, a modified auditor's report, the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the financial information of the entity on which the principal auditor is reporting, that it requires a modification of the principal auditor's report Page 36

37 Auditing the consolidation The auditor should confirm that consolidated financial statements include all subsidiaries, associates, jointly controlled entities other than those for which exceptions are provided (review of PY work-paper, RPT disclosures, investment schedules, board minutes, agreements, statutory records, etc) and also any changes in ownership The auditor should confirm that all the intercompany transactions and balances are eliminated in the consolidated financial statements Permanent adjustments Determination of goodwill or capital reserve, minority interest on the date investment Current period adjustments intra group sales, purchases, interest income, interest expense, etc Uniform accounting policies and uniform reporting date Goodwill impairment testing Subsequent events review from date of component financials to date of group financials Page 37

38 Some differences between IGAAP and IFRS Control - definition Determination of control AS 21 IFRS 10 Ownership of more than one half of the voting power or control of the composition of board of directors Potential voting rights not considered 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. Potential voting rights (options) considered Goodwill determination Based on carrying value Based on fair value Reporting periods Difference between the reporting dates shall not be more than 6 months Difference between reporting dates shall not be more than 3 months Page 38

39 Some differences between IGAAP and IFRS AS 21 IFRS 10 Special purpose entity There is no specific guidance for consolidation of SPE. SPE s are consolidated as it would meet the definition of control. Deferred tax on intragroup elimination Uniform accounting policy No deferred tax recognized on elimination of intra-group transactions. CFS prepared using uniform accounting policies. If not practicable to use uniform policies then disclosure required. Deferred tax is calculated on temporary differences arising from elimination of intra-group transactions. Compliance with uniform accounting policies is mandatory. Page 39

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