ACCA F7 (INT) Financial Reporting - Study text - 2010

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Chapter 19: Consolidated accounts: intra-group adjustments

5.4 Preference shares in a subsidiary

A subsidiary might have some preference shares in issue. If it does, the parent

company might own some of them.

The method of accounting for preference shares in a subsidiary depends on whether

the preference shares are treated as equity, as debt or as a combination of the two.

 If the preference shares are treated as equity, any shares that are not owned by

the parent (or other group companies) are treated as a non-controlling interest.

 If the preference shares are treated as debt, the liability to the outside

shareholders is treated as a liability in the consolidated statement of financial

position, and preference dividends paid to the outside shareholders are a

finance charge in the consolidated profit or loss for the period. To the extent that

the preference shares are owned by the parent company, the investment of the

parent and the liability of the subsidiary should be self-cancelling items.

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Intra-group dividends

 Dividends paid by a subsidiary: 100%-owned subsidiary

 Dividends paid by a subsidiary: partly-owned subsidiary

 Dividends paid by a subsidiary out of pre-acquisition profits

 Dividends payable by a subsidiary and declared before the end of the financial

year

6 Intra-group dividends

IAS10 states that if an entity declares a dividend for the financial year after the

reporting period, the dividend must not be shown as a current liability in the

statement of financial position. (The proposed dividend should be disclosed by way

of a note to the accounts).

Dividends are therefore normally accounted for, in the statement of financial

position (retained earnings) and in the statement of changes in equity, on a

‘dividends paid’ basis and not on a ‘dividends payable’ basis.

This ruling applies to dividends paid or payable by a subsidiary.

6.1 Dividends paid by a subsidiary: 100%-owned subsidiary

If a subsidiary pays a dividend during the financial year, the dividend reduces the

retained earnings of the subsidiary.

However, if the subsidiary is 100% owned, the dividends paid by the subsidiary are

dividends received by the parent. The retained earnings of the subsidiary are

reduced by the dividends paid, but the income (and so the retained earnings) of the

parent company are increased. The dividend payment is self-cancelling.

Dividend payments

In the consolidated accounts, the dividend paid by a subsidiary is not included in

the consolidated income statement. A dividend payment is a change in equity

during the year, and is shown in the statement of changes in equity (SOCIE) in the

financial statements of the subsidiary.

If the subsidiary is 100% owned, the payment of the dividend is not shown in the

consolidated statement of changes in equity (SOCIE) because the decrease in the

subsidiary’s retained earnings is matched by an increase in the parent’s retained

earnings.

Dividends paid by the parent company are treated in the same way as dividend

payments in the financial statements of individual entities, and are reported in the

consolidated statement of changes in equity (consolidated SOCIE). They also reduce

Chapter 19: Consolidated accounts: intra-group adjustments

the retained earnings attributable to owners of the parent in the consolidated

statement of financial position

Dividends received by the parent from other group companies

Dividends received by the parent from subsidiaries are included as ‘other income’

in the income statement of the parent company.

However, these dividends received by the parent should be excluded from the

consolidated income statement. This is because the consolidation process brings in

the whole of the subsidiary’s profit, including any dividends paid by the subsidiary.

If we also accounted for the divided income of the parent from the subsidiary, there

would be ‘double counting’ of this part of the profit.

Example

A parent company P owns 100% of a subsidiary S. At the beginning of the year, the

retained earnings of the companies were as follows:

 Parent: $300,000

 Subsidiary: $200,000.

All the profits of S are post-acquisition profits and there was no goodwill on

acquisition.

During the year, P made a profit after tax of $70,000, excluding the dividend income,

and S made a profit after tax of $50,000. P paid a dividend of $80,000 and S paid a

dividend of $30,000.

The situation is as follows.



P S Onconsolidation

 $ $ $

Retainedearningsatthestartoftheyear 300,000 200,000500,000

Profitexcludingdividendincome 70,000 50,000120,000

Dividendreceivedfrom/paidbyS 30,000 (30,000) ‐

DividendpaidbyP (80,000)‐(80,000)



–

–––––

–

–––––  ––––––

Retainedearningsattheendoftheyear 320,000 220,000540,000



–

–––––

–

–––––  ––––––

This figure of $540,000 is the retained earnings for the group on consolidation at the

end of the year (because there is no goodwill and goodwill impairment, and all

profits are post-acquisition).

The profit for the year in the consolidated income statement should be $120,000, and

should exclude the dividend received by P from S.

The statement of changes in equity (SOCIE) will show a reduction in retained

earnings of $80,000, for the dividend paid by the parent P.

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6.2 Dividends paid by a subsidiary: partly-owned subsidiary

When a subsidiary is partly owned, the same rules apply, with just one exception.

The dividend received by the parent from the subsidiary is only a portion of the

total dividend.

The dividend paid to the non-controlling interest reduces the non-controlling

interest’s share of the retained profits of the subsidiary. In the SOCIE, there should

be a separate column for non-controlling interest, and dividends paid to the non-

controlling interest are shown as a reduction in its equity interest during the year.

Example

Take the same data as in the previous example, but assume that the subsidiary is

only 80% owned, and 20% of the subsidiary is owned by non-controlling interests.

The situation would be as follows:



Parent Subsidiary

On

consolidation





Parent

share

Non‐

controlling

interest



 $ $ $ $

Retainedearningsatthestartofthe

year

300,000 160,000 40,000500,000

Profitexcludingdividendincome 70,000 40,000 10,000120,000

Dividendreceivedfrom/paidbyS 24,000 (24,000) (6,000) (6,000)

DividendpaidbyP (80,000) ‐  ‐ (80,000)



–

–––––

–

––––– ––––––––––––

Retainedearningsattheendofthe

year 314,000 176,000 44,000534,000



–

–––––

–

––––– ––––––––––––

The profit of the subsidiary for the year is $50,000. The parent’s share is $40,000 and

the non-controlling interest share is $10,000 (= 20%).

The non-controlling interest is paid a dividend of $6,000 (= $30,000 × 20%). This

goes outside the group and reduces the non-controlling interest. The dividend paid

within the group is self-cancelling,

The dividend paid to the non-controlling interest is reported in the consolidated

statement of changes in equity (SOCIE).

The non-controlling interest in the subsidiary’s retained earnings in the

consolidated statement of financial position is:

20% × $(200,000 + 50,000 – 30,000) = $44,000. (Or, more simply, 20% of the retained

earnings of S at the year-end = 20% × $220,000 = $44,000.)

Chapter 19: Consolidated accounts: intra-group adjustments

6.3 Dividends paid by a subsidiary out of pre-acquisition profits

In the year that a parent company acquires a new subsidiary, the subsidiary might

pay a dividend, and some or all of the dividend might be paid out of pre-acquisition

profits.

Before the issue of an amendment to IAS 27 in May 2008, any dividend paid out of

pre-acquisition profits was treated as a return to the parent of a part of the cost of

the investment. In that case the parent reduced the cost of the investment in its

statement of financial position by the amount of the dividend received out of the

pre-acquisition profits of the subsidiary.

Now (since the amendment) any pre-acquisition dividend is recognised as income

in the parent’s profit or loss for the year and there is no reduction in the cost of the

investment in the parent’s statement of financial position.

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6.4 Dividends payable by a subsidiary and declared before the end of the

financial year

The normal rule in IAS10 is that if an entity declares a dividend after the end of a

reporting period, it must not be included as a liability in its statement of financial

position. The proposed dividend must be disclosed in a note to the financial

statements. This rule applies even if the dividend payment has been appropriately

authorised by the shareholders of the company.

In rare circumstances, a subsidiary might declare an equity dividend before the end

of its financial year, where the dividend will not be payable until after the end of the

year.

When a dividend is declared payable before the end of the year, the dividend can be

reported in the statement of financial position as a current liability because it meets

the definition of a liability as at the end of the reporting period.

If a 100%-owned subsidiary declares a dividend before the end of its financial year,

payable after the year end:

 the dividend payable by the subsidiary (a current liability) is matched by

 a dividend receivable by the parent (a current asset)

The two items should be cancelled out on consolidation.

If a partly-owned subsidiary declares a dividend before the end of its financial year,

payable after the year end:

 The dividend payable by the subsidiary to the parent (a current liability) is

matched by a dividend receivable by the parent (a current asset). The two items

should be cancelled out on consolidation.

 This will leave some of the dividend payable by the subsidiary ‘not cancelled’ or

‘uncancelled’. This is the dividend payable to the non-controlling interest.

 This dividend payable to the non-controlling interest is included in the

consolidated statement of financial position as a current liability.

Dividends (actual or proposed) are not included in the consolidated income

statement or consolidated statement of comprehensive income; therefore the

consolidated income statement is not affected.

Paper F7 (INT)

Financial reporting

CHAPTER

Associates

Contents

1 Definition of associate

2 Accounting for investments in associates: equity

method

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Definition of associate

 The nature of the accounting problem

 Definition of an associate

 Method of accounting for associates

1 Definition of associate

1.1 The nature of the accounting problem

The previous chapters have explained the ‘purchase method’ of accounting for

subsidiaries. The principle underlying the purchase method is that subsidiaries are

under the control of the parent entity; therefore it is appropriate to present financial

statements for the parent and its subsidiaries as if the group were a single operating

entity.

The parent’s share of the equity in the group and the non-controlling interest share

(minority interest) of the equity are both included, but are shown separately.

Consolidation using the purchase method is not required where there is an

investment in shares of another company, but the investment does not give control.

If an entity owns a fairly small interest in the equity shares of another company,

and the investment is long-term:

 the shares are shown in the statement of financial position as a long-term assets

(an investment) and valued in accordance with IAS39

 any dividends received for the shares are included in the income for the year as

‘other income’.

Some investments in the equity shares of another company are fairly substantial

without giving control. They are more than simple small investments, because the

entity owning the shares has a reasonable degree of influence through the size of its

shareholding. However, the investment does not give control; therefore it cannot be

treated as a subsidiary.

These fairly substantial investments are accounted for as an investment in an

associate. IAS28: Investments in associates deals with accounting for associates.

1.2 Definition of an associate

An associate is defined by IAS28 as: ‘an entity… over which the investor has

significant influence… that is neither a subsidiary nor an interest in a joint venture.’

Significant influence is defined as the power to participate in the financial and

operating policy decisions of the entity, but is not control or joint control.

Chapter 20: Associates

IAS28 states that if an entity holds 20% or more of the voting power (equity) of

another entity, it is presumed that significant influence exists, and the investment

should be treated as an associate.

If an entity owns less than 20% of the equity of another entity, the normal

presumption is that significant influence does not exist.

Holding 20% to 50% of the equity of another entity therefore means as a general rule

that significant influence exists, but not control; therefore the investment is treated

as an associate, provided that it is not a joint venture.

The ‘20% or more’ rule is a general guideline, however, and IAS28 states more

specifically how significant influence arises. The existence of significant influence is

usually evidenced in one or more of the following ways:

 representation on the board of directors

 participation in policy-making processes, including participation in decisions

about distributions (dividends)

 material transactions between the two entities

 an interchange of management personnel between the two entities

 the provision of essential technical information by one entity to the other.

An entity loses significant influence when it loses the ability to participate in

financial and operating policy decisions of the entity in which it has invested (the

‘investee ‘ entity). This might occur, for example, if the investee becomes subject to

the control of a government, a court or a regulator.

1.3 Method of accounting for associates

IAS28 states that associates must be accounted for in consolidated financial

statements using the equity method of accounting.

Paper F7: Financial reporting (International)

Accounting for investments in associates: equity method

 The nature of the accounting problem

 The main features of equity accounting

 Trading with an associate: unrealised profit in closing inventory

 Comparing the purchase method for subsidiaries and the equity method for

associates

2 Accounting for investments in associates: equity

method

2.1 Applying the equity method to account for associates

IAS28 states that an investment in an associate must be accounted for using the

equity method of accounting. This rule applies whether or not the entity also has

subsidiaries and prepares consolidated financial statements. An examination

question might include an investment in an associate together with an investment in

a subsidiary, with a requirement to prepare consolidated financial statements for the

parent, subsidiary and associate combined. Consolidated financial statements

should be prepared for the parent and subsidiary using the rules described in the

previous chapters, and the associate should be included using the equity method of

accounting.

The only exceptions to the requirement to use the equity method to account for

investments in associates are:

 when the reporting entity presents separate financial statements in accordance

with IAS27, or

 when the associate is acquired and held with a view to disposal within 12

months of acquisition, so that it is classified as ‘held for sale’ in accordance with

IFRS5.

Differences in financial year-ends

IAS28 states that when the financial year of the reporting entity (the ‘investor’

entity) and the associate are different, the associate should prepare for the investor a

set of financial statements with the same year end, unless it is impracticable to do

so.

When different year-ends have to be used, the difference in the reporting date of the

investor and the reporting date of the associate must be no more than three months.

In addition, adjustments should be made for any significant transactions or events

affecting the associate after the year-end of the investor but before its own year-end.

ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing

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