CHAPTER 5: INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS

LEARNING OUTCOMES
• Understand what is groups and types of investment
• Understand the requirement, basic principles and content of consolidated financial statements

SUMMARY

Introduction to consolidated
financial statement

Introduction to group Consolidated financial statements

Definition
•
Typ es of
Requirement
T
Basic principles Content
investment

I. INTRODUCTION TO GROUPS

1. Definition

A group exists where one entity, the parent (referred to as 'the investor'), has control over another entity, the subsidiary (referred
to as 'the investee').

A parent is an entity that controls one or more entities.

To reflect the financial performance and position of the group, consolidated financial statements are prepared. We will define it
more detail in Section II.

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2. Types of investment

Types of investment

Subsidiaries Associates Trade investments

Control Significant influence Other

• More than 50% of ordinary Other than control and significant

• More than 20% of ordinary
(equity) shares influence (Normally less than 20%)
(equity) shares
• Less than 50% and the parent
• Less than 20% and the parent:
has power to:
o represent on the BOD of the
o Govern the financial
investee
and operating policies
o participate in the policy
of the entity
making process
o appoint or remove a majority
o Had material transactions
of members of BOD
with investee
o cast a majority of votes at
o Had interchanged of
meeting of BOD
management personnel
o Had provision of essential
technical information.

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Exam focus: Classification types of investment

Example: Black Co owns the following investments in other companies:

Equity shares Non-equity shares held

Red Co 75% Nil

Blue Co 30% 80%

Yellow Co 45% 30%

Green Co 18% Nil

Orange Co 10% 30%

Black Co also has appointed five of the seven directors of Yellow Co.

Directors of Black Co having two of the five places on the board of Green Co.

Classifying each companie as subsidiary, associates or trade investments

Subsidiary, Associates, Trade investments,

Red Co,

Blue Co,

Yellow Co,

Green Co,

Orange Co,

Guidance:

Start from the percentages of equity share hold by investor, you can identify possible types of
investment and then classify base on the differences of each types identified.

Percentages of equity
Type of investment How to classify
share hold by investor

>50% Subsidiary Subsidiary

20-50% Subsidiary or associate Company has control power or not(or

significant influence)

Control power=> Subsidiary

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 No control power/ significant influence
=> Associate

<20% Associate or Trade Company has significant influence

investment power or not.

Significant influence=> Associate

No significant influence => Trade

investment
2.1. Subsidiaries

2.1.1. Definition

A subsidiary is an entity controlled by another entity.

2.1.2. Accounting treatment

Accounting treatment

The accounts of the parent and subsidiaries

Consolidated financial statements ignore
are combined and presented as a single
the legal boundaries
entity

We will consider the mechanics of preparing consolidated accounts in chapter 17: The
consolidated statement of financial position and chapter 18A: The consolidated statement of
profit or loss.

2.2. Trade

investments

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; and
• shown as investments under non-current assets in the consolidated statement of financial
position of the group.
F3 (FA) syllabus only requires you to define and describe a trade investment. To get deeper
understanding about trade investment, visit F7 Lecture Note chapter 8: Financial instrument.

II. CONSOLIDATED FINANCIAL STATEMENTS

1. Requirement to prepare consolidated financial statements

If one entity controls another, company is required to prepare consolidated financial statements
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(consolidated FS) to reflect the financial performance and position of the group as one combined
entity.

To be more specific, revenues, expenses, assets and liabilities of the parent and subsidiaries
are combined for ease of understanding and analysis. It helps shareholders make decision about
their investment.

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2. The basic principles of preparing a consolidated statement of financial position

Consolidation means adding together.

Basic Consolidation means cancellation of like items to the

group. principles
Consolidate as if you owned everything then show the extent to which you do
not own everything.

Explanation of these basic principles are described in illustration below:

There are two companies, Lens and Sweet.

• Lens owns 80% of the shares in Sweet.

• Lens has a head office building worth $150,000. Sweet has a factory worth $120,000.
• Lens has receivables of $60,000 and Sweet has receivables of $45,000. Included in the
receivables of Lens is $5,000 owed by Sweet.
• Lens has payables of $75,000 and Sweet has payables of

$67,500. Apply Basic principles in preparing consolidated financial

statement:

• Adding together: Revenues, expenses, assets and liabilities are added together

You add together the values of the head office building and the factory to get an asset, land and
buildings, in the group accounts of $150,000 + $120,000 = $270,000.

• Cancellation of like items to the group

To arrive at a fair picture, we eliminate both the receivable of $5,000 in Lens's books and the
payable of $5,000 in Sweet's books. Only then do we consolidate by adding together.

Consolidated receivables
= $60,000 + $45,000 - $5,000
= $100,000
Consolidated payables
= $75,000 + 67,500 - $5,000
= $137,500
• Consolidate as if you owned everything then show the extent to which you do not own
everything
o Consolidate as if you owned everything

Lens have 80% of shares of Sweet=> Lens controls Sweet, including all of Sweet's asset,
not just 80% of it. So, in order to reflex group as one combined entity, the figure for
consolidated land and buildings is $100,000 + $80,000 = $180,000 as stated above, not
$100,000 + 80% X $80,000 = $164,00

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 o Show the extent to which you do not own everything

There may well be one or more shareholders who own the remaining 20% of the shares
in Sweet Ltd. These shareholders cannot visit 20% of the factory or tell 20% of the
workforce what to do, but they do have an interest in 20% of the net assets of Sweet,
called "non-control interest". So, we have to show this non-controlling interest in the
equity section of the consolidated statement of financial position.

3. Content of consolidated financial statements

V) V) Parent company financial statements, which will include

.9'! 'investments in subsidiary undertakings' as an asset in the
(]) C:
E statement of financial position, and income from
re E
t;:; o subsidiaries (dividends) in the statement of profit or loss
u
r
+-'
c:
and other comprehensive income
·u
e
c: re
re a. Consolidated statement of financial position
.§ ..>
Additional
c
4-
0 "'C Consolidated statement of comprehensive income set of
(]) (])
tl.O 1=(]) financial
re
_:,,,:
u Vl Consolidated statement of cash flows (this is beyond the statements
re ,
(] )
._ scope of the FFA/FA syllabus)
a.. a.

In next two chapter we will describe how to prepare a simple consolidated statement of financial
position and consolidated statement of comprehensive incom

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EXAM-STANDARD QUESTIONS

QUESTIONS

Question 1:

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 share of
Yellow Co.
D. Smith Co owns 60% of the preference shares (non-voting) and 40% of the ordinary shares of
Aquamarine Co.

Question 2:

How should trade investments be accounted for in the consolidated financial statements of the
investor?

A. They should be consolidated on a line-by-line basis.

B. They should be equity accounted for.
C. A percentage of the investment's profits and assets and liabilities should be consolidated on a
Iine-by-line basis.
D. The amount paid for the investment at cost should be shown in the statement of financial
position.
Question 3:

A Co acquired 80% of B's Co ordinary share capital on 1 January 20X2.

As at 31 December 20X2, extracts from their individual statements of financial position showed:
A Co($) B Co($)
Receivables 75,000 45,000
Payables 105,000 63,000
As a result of trading during the year, Pink Co's receivables balance included an amount due from
Scarlett of $6,900. What should be shown as the consolidated figure for receivables and payables?

Receivables($) Payables($)
A. 120,000 168,000
B. 113,100 168,000
C. 111,000 155,400
D. 113,100 161,100

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