IFRS 10 – Consolidated Financial Statements
IFRS 10 provides guidance as to when consolidated financial statements (CFS) will be prepared, what is the accounting for consolidation and what disclosures are to be made in the CFS.
Consolidated Financial Statements: Combined financial statements of a parent company and its subsidiaries (and associates, joint ventures and joint operations) (known as a group), if applicable, presented together to represent a single economic Entity. In the consolidated financial statements, items of income, expenses, assets and liabilities are added together to show a total in the financial statements of the group after adjusting for intercompany balances and transactions.
Control of Investee: When an investor is exposed to variable returns (in terms of profit, dividends and other benefits) from its involvement with the investee or has the rights to such returns, and it can impact those returns due to its significant influence over the investee.
Decision Maker: An Entity who has the rights to make decisions for other parties and it can be a principal or an agent.
Group: A parent and its subsidiaries together are called a Group.
- Which invests in a large number of shares and other instruments on behalf of other people (who provides the funds for such investments) and it provides management services for such investments
- Whose purpose is to act as a trustee and helping the fund investors to earn gains by increase in value i.e., capital appreciation or by selling such instruments and
- Which values substantially all such investments at fair value to assess their performance.
Non-controlling Interests: Equity pertaining to the shareholders in a Group other than those who have the control.
Parent: An Entity that has the control over other Entities.
Power: Currently existing rights that give an Entity the power and influence to direct and impact the relevant activities of another Entity.
Protective Rights: These rights protect the party to such rights, but it does not have power over the Entity to such rights.
Relevant Activities: The activities that significantly impact the returns from an investee.
Removal Rights: Rights that can deprive a decision maker from its decision-making authority.
Subsidiary: An Entity that is controlled by another Entity.
Which Companies Does this Standard Applies to?
All companies that have a control over other Entities are required to prepare consolidated financial statements in accordance with this standard.
However, there is exception for a Company having Control over another Entity, NOT TO prepare consolidated financial statements in case, all the below requirements are fulfilled:
- Such Company is fully owned by another company (parent company) or partially owned, and the minority shareholders of the partially owned company have been informed that no CFS will be prepared, and they do not object to the non-preparation of such CFS.
- Company is not listed nor,
- Is in the process of listing its shares or other instruments in a public market, AND
- The ultimate parent or other immediate parent of such Companies prepares CFS in which these companies are consolidated in accordance with this standard.
Another exception is the Investment Entity which will be described later in this section.
What is the Control?
As we discussed above, for a company to prepare CFS and to apply this standard, it must have Control over one or more of other companies called as subsidiaries, so, the next question is what is the control?
An Entity is defined to have Control over the other Entity when:
- It is exposed to or has the rights to variable returns due to its involvement with the investee; and
- Has the capability to impact those returns through its influence over the investee.
In some cases, where two investors control an Entity collectively, in such cases, it is deemed that no one alone is the controller and hence is not required to prepared CFS. In such cases, other standards are applicable such as IFRS 11, IAS 28, IFRS 9 etc.
What is Power in Relation to above Definition?
A power exists when an investor has rights that allows it to direct the relevant activities to affect the investees’ return.
Rights can be assessed from the agreements or laws or regulations. In most of the cases, having shares gives the investors right to vote and direct the activities of an investee. In such cases, having majority shares (in the absence of any other agreement giving or restricting rights through other arrangements) will be deemed to have control over the investee.
However, in other cases, when shares are not giving exclusive rights to control and there are other agreements or other arrangements, those cases need to be evaluated to find out who has the control in those circumstances.
Key input here is the “existing rights”. Sometimes investors hold potential shares warrants that are convertible to shares in future will not be considered for the assessing the control in the current period.
What are Returns?
Returns mean the profits or dividends that can accrue to an investor or other benefits accruing to shareholders on liquidation. These returns should have the potential to vary as a result of involvement of investor in the activities of the investee, in order to meet the definition of “control”.
Returns are also shared by other parties such as minority shareholders (called as non-controlling interests or NCI) but they do not have the control and the ability to affect these returns.
The ability to use the power to exercise control has important ramifications. This means an agent who is holding shares on behalf of another company and acting on their advice is not a controller as he does not have the ability to exercise the power on his own.
Accounting for the Consolidation
A parent company preparing consolidating financial statements will add line items of subsidiaries along with its own financial statements line items and a total is shown in the CFS.
However, before adding the total line items, there will be adjustments made for intercompany transactions such as sales of goods from one subsidiary to the other is cancelled against the cost of sales recorded in the other subsidiary or parent company.
All the policies applied for the preparation of financial statements for all subsidiaries should be aligned with the parent Company for similar transactions and situations. For example, if a subsidiary is recording its inventories on a Last in First out method while the parent records on weighted average basis (and there is no difference in the nature of these inventories), the inventories of subsidiary should be adjusted on a weighted average basis and this amount will be recorded in CFS.
When does Consolidation Starts and When does it End?
Consolidation is done from the date the Entity obtains the control of another Entity and it ends the day when the control is lost for the subsidiary.
For example, if an Entity acquires a subsidiary on 4 June 2021, it will prepare consolidated financial statements for the current period end i.e., 31 December 2021 and consolidation adjustment will take effect from 4 June 2021.
How to Record Non-Controlling Interests (NCI)?
In consolidated statement of financial position, NCI are shown within equity but clearly separated from the equity of the owners of the parent company.
In consolidated Statement of Profit or Loss, income for the year is shown and at the end an appropriation of profit is presented between owners of parent company and the NCI and same is the case with Statement of Changes in Other Comprehensive Income.
In Consolidated Statement of Changes in Equity, a movement of NCI is provided separately in the same manner as it is given for the retained earnings / accumulated losses for the parent shareholders.
How is Loss of Control of a Subsidiary Accounted For?
In case of loss of control:
1) All assets and liabilities of the subsidiary will be derecognized from the Consolidated Statement of Financial Position (i.e., the assets and liabilities of the Subsidiary are no longer added with the assets and liabilities of the parent company). First such financials statements that will be prepared after the date of loss of control, will not consolidate this subsidiary.
For example, if a control of a subsidiary is lost on 4 January 2021, and the period end of the Group preparing such CFS is 31 December 2021, the subsidiary will not be consolidated in the balance sheet in preparing the financial statements as of 31 December 2021.
2) If any investment is retained after disposal such that no control exists with the retained interest, this retained interest will be remeasured (i.e., fair valued) at the date of loss of control. The remeasured amount will be recognized as an investment either in accordance with IFRS 9, IFRS 11 or IAS 28 etc.
3) Gain on loss on losing control will be included in profit or loss statement.
What are Investment Entities and How are they Accounted For?
An Investment Entity has the following three characteristics:
- It invests in a large number of shares and other instruments on behalf of other people (who provide the funds for such investments) and it provides management services for such investments,
- The purpose is to act as a trustee and helping the fund investors to earn gains by increase in value i.e., capital appreciation or by selling such instruments, and
- It values substantially all of such investments at fair value to assess their performance.
The key aspects of the definition of an Investment Entity and consideration of other factors include:
- More than one investor and investments
- Investors are not related parties
- Investments pertain to equity interests in investees or other similar type of interests
Other factors also need to be taken into consideration while making this assessment.
A reassessment will be made to assess whether an Entity is still an Investment Entity when facts and circumstances change that could have an impact on the aspects of the definition of the Investment Entity. For example, if investors have decreased or more related parties enter as investors, the assessment needs a revision to ensure if the Entity is still an Investment Entity or else it has ceased to be so.
IFRS 10 is not applicable to Investment Entities, and they shall not prepare consolidated financial statements. Such investments will be measured, recorded and accounted for in accordance with IFRS 9.
However, there are two EXCEPTIONS to this rule:
a) An Investment Entity that has a subsidiary and such subsidiary;
- is not an Investment Entity, and
- its main purpose is to provide services to the parent Entity (i.e., the Investment Entity) relating to its investment activities.
In such a case, this subsidiary will be consolidated.
b) The parent Entity who is not an Investment Entity will consolidate all its subsidiaries that it controls including those controlled through investment subsidiary.