Introduction 

Consolidated accounts are required when one company controls other companies. This can happen in
many ways, but you will only be expected to deal with the simplest situation, which is where one
company controls one other company. Each company will prepare its own set of accounts. However,
another set of accounts will be prepared for the group as a whole. These are known as the consolidated
accounts.

Definitions and Basic concepts

 We will look at some of these definitions in more detail later, but they are useful here in that they give
you an overview of all aspects of consolidation. 
 -- 'Control. 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.' 
The precise definition of control contains several provisions, but the most common situation is where one
company owns more than 50% of the ordinary share capital of the other company.  
-- 'Power. Existing rights that give the current ability to direct the relevant activities.' 
-- 'Subsidiary (if an investor holds over 50% of the voting power of the entity). An entity that is
controlled by another entity (known as the parent).' 
--'Parent. An entity that controls one or more entities.' 
--'Group. A parent and all its subsidiaries.' 
--'Consolidated financial statements. The financial statements of a group in which the assets, liabilities,
equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a
single economic entity.' 
-- 'Non-controlling interest. The equity in a subsidiary not attributable, directly or indirectly, to a parent.'
--Associate (if an investor holds 20% or more of the voting power of the entity):  An associate is an entity
over which another entity exerts significant influence. Associates are accounted for in the consolidated
statements of a group using the equity method.
--A trade (or 'simple') investment (if an investor holds less than 20% of the voting power of the entity).
An investment in the shares of another entity, that is held for the accretion of wealth, and is not an
associate or a subsidiary.  

Investments in subsidiaries: You should be able to tell from the definitions given above that the
important point here is control. In most cases, this will involve the holding company or parent owning a
majority of the ordinary shares in the subsidiary (to which normal voting rights are attached). There are
circumstances, however, when the parent may own only a minority of the voting power in the subsidiary,
but the parent still has control. Control can usually be assumed to exist when the parent owns more than
half (i.e. over 50%) of the voting power of an entity unless it can be clearly shown that such ownership
does not constitute control (these situations will be very rare).

What about situations where this ownership criterion does not exist? The following situations show where
control exists, even when the parent owns only 50% or less of the voting power of an entity:
(a) The parent has power over more than 50% of the voting rights by virtue of agreement with other
investors. 
(b) The parent has power to govern the financial and operating policies of the entity by statute or under an
agreement. 
(c) The parent has the power to appoint or remove a majority of members of the board of directors (or
equivalent governing body). 
(d) The parent has power to cast a majority of votes at meetings of the board of directors. 

Example:
Socket Co has 100,000 shares of $1 each. On 1 January 20X3, Power Co acquired 45,000 of these shares.
In addition, Power Co is able to appoint 4 out of the 5 directors of Socket Co, thus exercising control over
their activities. How should Socket Co be treated in the consolidated financial statements of Power Co? 
--Power holds less than 50% of the ordinary shares of Socket. Nevertheless, Socket is a subsidiary of
Power because its status is determined by a number of factors other than percentage of shares held. 
The key point is control rather than share ownership. Socket will be treated as a subsidiary if any of the
following apply:
(a) It holds more than half the voting power. 
(b) It has power over more than half the voting rights by virtue of an agreement with other investors. 
(c) It has power to govern the financial and operating policies of the entity under a statute or agreement. 
(d) It has power to appoint or remove the majority of the members of the board of directors. 
(e) It has power to cast the majority of votes at meetings of the board of directors.  
Socket should be treated as a subsidiary on the grounds that Power is able to appoint four out of the five
directors (criterion (d)). Assuming that the other criteria do not apply, if Power did not have such a
power, consolidation would not be appropriate because Socket would not be a subsidiary.
 
Investments in associates:
This type of investment is something less than a subsidiary, but more than a simple trade investment. The
key criterion here is significant influence. This is the 'power to participate', but not to 'control' (which
would make the investment a subsidiary). 
Associate. 'An entity over which the investor has significant influence'. 
Significant influence. 'The power to participate in the financial and operating policy decisions of the
investee but which is not control or joint control of those policies.' As with control, significant influence
can be determined by the holding of voting rights (usually attached to ordinary shares) in the entity. IAS
28 states that if an investor holds 20% or more of the voting power of the entity, it can be presumed that
the investor has significant influence over the entity, unless it can be clearly shown that this is not the
case. Significant influence can be presumed not to exist if the investor holds less than 20% of the voting
power of the entity, unless it can be demonstrated otherwise. 

The existence of significant influence is usually evidenced in one or more of the following ways:
(a) Representation on the board of directors (or equivalent) of the investee 
(b) Participation in the policy making process 
(c) Material transactions between investor and investee
(d) Interchange of management personnel
(e) Provision of essential technical information
 
Trade investments:
A trade investment is a simple investment in the shares of another entity that is not an associate or a
subsidiary. 

A trade investment is a simple investment in the shares of another entity, that is held for the accretion of
wealth, and is not an associate or a subsidiary. 

Trade investments are simply shown as investments under non-current assets in the consolidated
statement of financial position of the group.

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QUESTION (to identify Subsidiary/Associate/Trade or Simple investment)

Which two of the following investments would be treated as an associate in the consolidated financial
statements of Smith Co? 

A Smith Co owns 15% of the ordinary shares of Red Co and has significant influence over Red Co. 
B Smith Co owns 45% of the ordinary shares of Pink Co and can appoint 4 out of 5 directors to the board
of directors of Pink Co. 
C Smith co owns 40% of the preference shares (non-voting) and 15% of the ordinary shares of Yellow
Co. 
D Smith Co owns 60% of the preference shares (non-voting) and 40% of the ordinary shares of
Aquamarine Co. 
 
ANSWER 
The correct answers are A and D. 
Red Co is an associate of Smith Co, as Smith Co has significant influence over Red Co. 
Pink Co is a subsidiary of Smith Co, as Smith Co's ability to appoint 4 out of 5 directors gives it control
over Pink Co. 
Yellow Co is a trade investment of Smith Co, as Smith Co holds less than 20% of the voting rights of
Yellow Co, so is assumed not to have significant influence. 

Note that the preference shares do not have voting rights so do not have any influence over the running of
the company. 
Remember that shareholdings are not the only way of demonstrating control or significant influence. If it
could be shown in another way that Smith Co does have significant influence over Yellow Co, Yellow Co
would be classified as an associate. 
Aquamarine Co is an associate of Smith Co, as Smith Co holds more than 20% of the voting rights of
Aquamarine Co and is therefore presumed to have significant influence over Aquamarine Co.