1. a Group of Enities and Its Financial Statements - Chapter 1 Gs

Page | 34

Learning Unit 1 & Vol 1

1. A GROUP OF ENITIES AND ITS FINANCIAL STATEMENTS - CHAPTER 1 GS

CONTROL IFRS 10

·  IFRS 10 requires that the investor determine whether it is a parent of the investee.

ELEMENTS OF CONTROL:

1)  Power over Investee

2)  Exposure, or rights to, variable return from involvement with the investee

3)  Ability to use power over investee to affect the amount of the investor's returns.

1) Power comes form rights:

·  voting rights

·  rights embedded in a contract

Rights that gives an investor power:

·  Voting rights through owning equity

·  Potential voting rights

·  Rights to appoint, reassign or remove key management positions that have the ability to direct the relevant activities

·  Rights to direct the investee to enter into or veto any changes to, transactions for the benefit of the investor

·  Other rights that give the holder the ability to direct the relevant activities

2) Exposure/rights to variable returns:

·  To control an investee, the investor must have exposure or rights to the variable returns of the investee from its involvement with it

·  Returns include: dividends, other distributions embodying economic benefits (e.g interest on loans), remuneration for services, fees and exposure to losses from providing credit/liquidity/other financial support and returns through synergy benefits.

3) Link between POWER and RETURN:

·  A parent must not only have power over and investee and exposure/rights to returns - BUT it must ALSO have the ABILITY to USE its POWER over the investee to AFFECT its RETURN from its involvement with the investee.

GROWTH

·  Company itself can grow

·  Can combine with other entities

SHARES, THE CAPACITY IN WHICH THEY ARE HELD AND VOTING RIGHTS

I.T.O THE COMPANIES ACT, 2008

·  Every share, regardless of its class, has associated with it one general voting right, unless provided for otherwise by

o  Companies Act

o  Preferences, rights & limitation etc as determined by the MOI

·  To determine whether a person controls all or a majority of the voting rights, voting rights which are only exercisable in specific circumstances must only be taken into account when those circumstances arise and for as long as they continue

·  Voting rights exercisable on the instruction of another are treated as being held by a nominee for that other person

·  Voting rights held by a person in a fiduciary capacity are treated as being held by the beneficiary of those voting rights.

·  Every share has associated with it an irrevocable right of the shareholder to vote on any proposal to amend preferences, rights and limitations and other terms.

The acquisition of a shareholding in another entity can result in one of the following: SG p9

·  Where the investor (the entity which acquired the shareholding in another entity) exercises some form of control over the investee, the investor is the parent of the investee, which is called its subsidiary.

·  The investee is an associate of the investor if the investor exercises significant influence over the investee.

·  If two or more entities hold shares in an investee and have joint control of the investee in terms of a contractual arrangement, the investor is in a joint arrangement with the other investor.

Group (FAC2602)

·  Where a parent is linked with a subsidiary to form a larger economic unit, it is customary to refer to the entity as a group.

·  The basic characteristic of such a group is that the management of the different independent parent and subsidiary entities comprising the group is co-ordinated in such a way that they are managed on a central and unified basis in the interest of the group as a whole.

·  This management on a unified basis is possible because of the control which the parent exercises over its subsidiaries.

GROUP STRUCTURES

Simple Group example:

P Ltd

S Ltd

Complex group example:

P Ltd

S1 Ltd S2 Lted S3 Ltd

SS1 Ltd

Vertical Group

P Ltd

S Ltd

SS Ltd

Simple group with spread shareholding 1

P Ltd

48%

S Ltd

Simple group with spread shareholding 2:

P Ltd

40%

S Ltd

S Ltd is not subsidiary of P Ltd - thus no parent-subsidiary relationship exists between P and S, the size of P's interest relative to the size of the other two shareholders' intetersts are sufficient to conclude that P has no power over S, the only two other investors just need to cooperate to prevent P from directing the relevant activities of S.

Associate controls subsidiary

P Ltd

40%

S Ltd

51%

SS Ltd

S Ltd is not a subsidiary of P Ltd, but just an associate as P doesn't hold enough equity interest to direct the relevant activities of S, but SS is a subsidiary of S, which is the parent SS and an associate of P. S holds 51% in SS which gives it the current ability to direct the relevant activities of SS.

SS is also not a subsidiary of P because P doesn't have control over S.

The following arrangement would completely change the scenario:

If the remaining 60% of S shares are held by 12 shareholders each having only a 5% interest in S Ltd and a shareholder agreement gives P Ltd the power to appoint or remove and set the remuneration for management responsible for directing the relevant activities and a 2/3 majority vote is required to change the arrangement, then:

·  The shareholding of P Ltd and the relative shareholding of the other 12 shareholders is not enough to determine whether P Ltd can exercise control over S Ltd, but taking into account P Ltd's ability to determine S Ltd's management that direct the relevant activities, it becomes clear that P Ltd controls S and is therefore its parent.

Subsidiaries together controls a sub-subsidiary

P Ltd holds 60% of the share capital in S1 Ltd and S2 Ltd. S1 Ltd and S2 Ltd each hold 30% of SS Ltd's shares. Each share gives a holder one vote at the AGM. S1, S2 and SS have no other classes of shares.

P Ld

S1 Ltd S2 Ltd

SS Ltd

·  S1 & S2 are fellow subsidiaries of P Ltd, who is the parent, holding 60% interest in both of them.

·  If no other conditions apply, the majority shareholdings give P Ltd the power to direct the relevant activities of its subsidiaries S1 and S2

·  It controls both S1 and S2 and therefore it also controls SS Ltd because S1 and S2 interest makes a majority interest together and both are controlled by P

Control through directors at board meetings:

P Ltd holds 40% of the shares in S Ltd, but has i.t.o. an agreement with the other shareholders the right to appoint 4/6 directors of S Ltd, each director has one vote at BOD meetings.

P Ltd

40%

S Ltd

S Ltd is a subsidiary of P Ltd and P is the parent of S as P has the right to appoint directors of S Ltd that has a majority of the voting rights of S Ltd on director's meetings which direct its relevant activities.

Arrear Preference Dividends

P Ltd holds 51% of Class A shares and 10% of Class B shares and 5% preference shares of S Ltd. Each class A shares entitles the holder to 1 vote at the AGM which directs the relevant activities of S Ltd. I.t.o the MOI, each class B share entitles the holder to 1 vote per share when the preference dividend is in arrears. The preference dividend have been in arrears for the past 5 years. S Ltd's share capital comprises 100 000 class A ordinary shares and 50 000 Class B 5% preference shares.

Interest in class A (ordinary) shares: P Ltd

51%

S Ltd

Under present circumstances, S Ltd is not a subsidiary of P Ltd as P Ltd only holds 37% of the current voting rights

((100 000 x 51%) + (10% x 50 000))/(100 000 ordinary class A shares + 50 000 5% class B pref shares)

As long as the preference dividends are in arrears, L Ltd has no control over S Ltd as it cannot direct the relevant activities of S, but as soon as the preference dividends is not in arrears anymore, P Ltd will regain control over S Ltd.

See illustrations 1 and 2; p10 SG

·  The objective of consolidated financial statements or group statements is to provide information about the financial position, the performance and changes in the financial position of a group of entities to the users of the financial statements of those entities.

·  It is important to note that an investor (parent) may control an investee (subsidiary) regardless of the percentage interest held by the investor in that investee.

·  An investor controls an investee when it has all three elements of control.

Accounting for groups: (FAC2602)

·  The essence of consolidations is that the parent is able to control the policy and management of the subsidiary.

·  The group should therefore be seen as an economic unit.

·  Although the parent shows investments in its subsidiaries on its statement of financial position, it is highly probable that the value of the investments may have changed considerably since the investments were made.

·  The statements may therefore not be an accurate reflection of the activities of the group.

·  For this reason it is in the interests of the shareholders of the parent that a single set of annual financial statements should be drawn up for the group so that the shareholders can gain an idea of the earnings per share and the assets and liabilities of the group.

Presentation of consolidated financial statements:

Consolidation of subsidiaries

When are group statements not required?

·  IFRS 10 allows a parent not to present consolidated financial statements, if and only if it meets all of the following conditions:

1)  The parent itself is a wholly or partially owned subsidiary of another entity and all the other owners have been informed and they do not object to the parent not presenting group statements.

2)  The parent's debt or equity instruments are not traded on a public market.

3)  The parent did not file, nor is it in the processing of filing its financial statements with a securities commission for the purposes of issuing any class of instruments on a public market

4)  The ultimate or intermediary parent do present consolidated/group statements that's compliant with IFRS.

·  A parent that selects, in terms of the above-mentioned, not to present consolidated financial statements, may present separate financial statements as its only financial statements (FAC2602)

·  The consolidated financial statements are the financial statements of a group and include all the parent's domestic and foreign subsidiaries presented as those of a single economic entity. There is no exception for a subsidiary whose business is of a different nature than the parent’s, nor is there an exception for a subsidiary for which control is intended to be temporary.

·  Once an investment ceases to fall within the definition of a subsidiary, it should be accounted for as an associate under IAS 28, or as a joint arrangement under IFRS 11, or as an equity investment under IFRS 9 (IFRS 10.25(b)).

General Principles:(FAC2602)

·  Group statements should be a fair reflection of the state of affairs of the parent and its subsidiaries as at the accounting date.

·  Profits/losses that have arisen as a result of transactions within the group, where such profits/losses have not been realised in respect of persons outside the group, should be eliminated.

·  All intragroup balances must be eliminated when determining the total assets and liabilities of the group.

·  Elimination of the carrying amount of the parent s investment in the subsidiary.

Accounting for investments

·  2 main types of investments in other entities are distinguished:

o  simple share investments

o  significant share investments which give the investor entity an influence over or control of the affairs of the investee entity

·  When accounting for significant share investments, it is necessary to determine the degree of influence exercised by the investor over the investee's financial and operating policies as this determines the appropriate accounting method.

·  It is also essential to determine the ownership interest as this determines the degree to which the investor shares in the equity of the investee.

Different bases for accounting for investments:

DEGREE OF INFLUENCE / APPLICABLE TO / ACCOUNTING METHOD
Control / Subsidiary / Consolidation
Joint Control / Joint operation / Account for the assets, liabilities, revenues and expenses relating to its interest in a joint operation in accordance with the IFRSs applicable to the particular assets, liabilities, revenues and expenses – IFRS 11
Significant Influence / Associate / Equity method -- IAS 28
No Influence / Simple Investment / Fair Value - IFRS 9

·  In order to determine the degree of influence, it is necessary to understand the definitions of control, joint control and significant influence.

·  Once you have determined the degree of influence you must ensure that you are familiar with the specific accounting method that must be used to account for the group structure.

Separate Financial Statements:

·  Separate financial statements are those presented in addition to consolidated financial statements.