ACCT6005 Company Accounting Tutorial Questions

Module 1.1
Chapter 9: Consolidation: controlled entities

Review questions

1. What is a subsidiary? (LO1)

A subsidiary is an entity that is controlled by another entity, a parent.

2. What is meant by the term ‘control’? (LO2)

An investor controls an investee when the investor 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.

3. For what purposes are the consolidated financial statements prepared? (LO1)

Possible objectives are:

 Supply of relevant information.
 Supply of comparable information.
 Accountability of management.
 Reporting of risks and benefits.

4. What are the key elements of control? (LO2)

There are 3 key elements:

 Power over the investee.
 Exposure or rights to variable returns from the parent’s involvement with the subsidiary.
 The ability to use the power over the subsidiary to affect the amount of the parent’s
returns.

5. When does an investor have power over an investee? (LO2)

Power is defined as “existing rights that give the current ability to direct the relevant activities”
An investor has power over an investee when it has the current right to direct the relevant
activities of the investee.

Suggested Solutions taken from the Solutions Manual to accompany Leo, Knapp, McGowan, Sweeting (2018).
Company Accounting, 11th edition, Wiley Australia
 ACCT6005 Company Accounting Tutorial Questions

6. What are ‘relevant’ activities? (LO2)

Relevant activities are activities of the subsidiary that significantly affect the investee’s returns.

Examples are:
 selling and purchasing of goods or services
 managing financial assets during their life (including upon default)
 selecting, acquiring or disposing of assets
 researching and developing new products or processes
 determining a funding structure or obtaining funding.

11. What benefits could be sought by an entity that obtains control over another entity?
(LO2)

Consider:
 Dividends.
 Returns from structuring activities with the investee e.g. obtaining a supply of raw
material, access to a port facility.
 Returns from denying or regulating access to a subsidiary’s assets e.g. a patent for a
competing product.
 Returns from economies of scale.
 Remuneration from provision of services such as servicing of assets, and management.

Case study 7 - Relevant activities

Caspar Ltd and Spooky Ltd decide to establish a new entity, Ghosts Ltd. The purpose of Ghosts
Ltd is to develop and market a new car seat designed for use by babies when travelling in a car.
Caspar Ltd and Spooky Ltd have specific roles in the new company and have unilateral ability
to make all decisions in relation to their specified roles. Caspar Ltd has agreed that it will be
responsible for developing the new car seat and obtaining all the approvals from the relevant
safety bodies in Australia. Once the seat has been designed and all safety approvals have been
received, Spooky Ltd will manufacture and market the product.

Required

Discuss the activities undertaken by the Caspar Ltd and Spooky Ltd in relation to the
determination of which entity controls Ghosts Ltd.

Power is defined as ‘existing rights that give the current ability to direct the relevant activities’.

Relevant activities are ‘activities of the investee that significantly affect the investee’s returns’.

Discuss whether either or both activities affect the returns of Ghost Ltd.

If the activities of Caspar Ltd and Spooky Ltd both affect the investee’s returns then it is necessary to
determine which activities – developing and obtaining regulatory approval or manufacturing and
marketing – MOST significantly affect the investee's returns.
ACCT6005 Company Accounting Tutorial Questions

In determining this, it would be necessary to consider:

the purpose and design of the investee

the factors that determine the profit margin, revenue and value of the investee as well as the value of
the car seat product

the effect on the investee’s returns resulting from each investor’s decision-making authority with
respect to the factors in the dot point above

the investors’ exposure to variability of returns.

In this particular example, the investors would also consider:

the uncertainty of, and effort required in, obtaining regulatory approval (considering the investor’s
record of successfully developing and obtaining regulatory approval of car seat products)

which investor controls the car seat product once the development phase is successful.

Suggested Solutions taken from the Solutions Manual to accompany Leo, Knapp, McGowan, Sweeting (2018).
Company Accounting, 11th edition, Wiley Australia
 ACCT6005 Company Accounting Tutorial Questions

Case study 13 Determining subsidiary status

Required: In the following independent situations, determine whether a parent–subsidiary

relationship exists and which entity, if any, is a parent required to prepare consolidated
financial statements under AASB 10/IFRS 10.

(a) Tom Ltd and Toots Ltd each hold 50% of the shares in Jerry Ltd, all companies being
involved in the computer software industry. Tom Ltd agrees that Toots Ltd should
provide the management of Jerry Ltd because of the expertise provided by its
managing director, Bob Gates. Toots Ltd receives a management fee for providing its
expertise.
(b) Spike Ltd has recently acquired a 35% interest in Tyke Ltd, a company that has
discovered large deposits of iron ore. Spike Ltd has extensive experience in the mining
industry and, as a result, has been able to have four of its directors elected to the board
of Tyke Ltd, which has six directors in total.
(c) Butch Ltd holds 30% of the shares issued by Toodles Ltd. The other shareholders come
from mixed backgrounds, but each holds on average 10% of shares in Toodles Ltd.
There are seven directors of Toodles Ltd. Four of these are appointed by Butch Ltd.
The other three directors are appointed by three of the other shareholders who have an
interest in the management of the company. Most of the remaining shareholders live
outside Australia and rarely attend board meetings of Butch Ltd unless they have other
business to attend to in Australia around the same time as the board meetings are held.

In each of these circumstances the following principles from the Basis of Conclusions to AASB
10/IFRS 10 should be used:

B2 To determine whether it controls an investee an investor shall assess whether it has all the
following:
(a) power over the investee;
(b) exposure, or rights, to variable returns from its involvement with the investee; and
(c) the ability to use its power over the investee to affect the amount of the investor’s returns.

B3 Consideration of the following factors may assist in making that determination:

(a) the purpose and design of the investee;

(b) what the relevant activities are and how decisions about those activities are made;
(c) whether the rights of the investor give it the current ability to direct the relevant activities;
(d) whether the investor is exposed, or has rights, to variable returns from its involvement
with the investee; and
(e) whether the investor has the ability to use its power over the investee to affect the amount
of the investor’s returns

Suggested Solutions taken from the Solutions Manual to accompany Leo, Knapp, McGowan, Sweeting (2018).
Company Accounting, 11th edition, Wiley Australia
ACCT6005 Company Accounting Tutorial Questions

(a) Both Tom Ltd and Toots Ltd hold 50% of the shares in Jerry Ltd, with Toots Ltd actually
directing Jerry Ltd because of its management expertise.
In this circumstance, Jerry Ltd is not a subsidiary of either company.

Neither investor has the power over Jerry Ltd, as neither investor holds existing rights to enable it
to direct the relevant activities of Jerry Ltd. Although Tom Ltd allows Toots Ltd to currently
manage the investee, it can step in at any time and challenge the management arrangements.

As neither investor holds more than 50% of the shares, neither has power. Hence there is no need
for any consolidated financial statements to be prepared.

(b) Spike Ltd currently has the ability to elect a majority of directors of Tyke Ltd. This has
occurred potentially just because of its expertise in the mining industry. As in (a) above, this
does not give it power over Tyke Ltd.

There is no information to suggest that the other 65% of shareholders in Tyke Ltd could not get
together and change the management of Tyke Ltd. Spike Ltd does not have power over Tyke Ltd.

Spike Ltd does not have to prepare consolidated financial statements.

(c) Currently Butch Ltd holds 30% of the shares of Toodles Ltd. The remaining shareholders
consist of 7 shareholders having on average 10% of Toodles Ltd’s shares. In relation to these
investors:
 most live outside Australia
 most do not attend AGMs.

Where an investor has less than a 50% holding of shares in the investee, judgement is required to
determine whether control exists. It is necessary to examine the potential actions of the holders of
the other shares in Toodles Ltd.
In this case, it is difficult to make a decision as:

 The fact that there are only 7 others shareholders with 10% each, only 3 of these need to
get together to have the same voting capacity as Butch Ltd. This lessens the likelihood of
Butch Ltd having control.
 The fact that most live outside Australia lessens the probability of these shareholders
getting together to take control. However, they could give their proxies to each other.
 The attendance at AGMs is low by the other shareholders. This however can change if
these shareholders become dissatisfied with Butch Ltd as a manager.
 The other shareholders have an interest in management shown by their appointing 3 of the
directors – only 1 less than Butch’s 4 directors. As the shareholders have an interest – as
opposed to being apathetic – the probability of becoming involved if they become
dissatisfied with Butch Ltd is higher.

On balance, Butch Ltd is probably not a parent of Toodles Ltd as it does not have sufficient
power to continue to direct the relevant activities of Toodles Ltd.
Suggested Solutions taken from the Solutions Manual to accompany Leo, Knapp, McGowan, Sweeting (2018).
Company Accounting, 11th edition, Wiley Australia