Financial Reporting: Control, Associates, and Consolidation Rules
Scenario Analysis: Bell Ltd Acquiring 51% of Chime Ltd
Note: Calculations are not required; explain the relevant adjustments in words.
If Bell Ltd had acquired 51% of the shares in Chime Ltd, the answer regarding Part B would differ significantly because 51% ownership constitutes control, requiring full consolidation rather than the equity method used for associates.
- Consolidated accounts would be required.
- This involves the consolidation of revenue, expenses, assets, and liabilities (as opposed to revaluation of the asset ‘Investment in Associate’).
- Pre-acquisition elimination of equity would be necessary.
- Elimination of intercompany transactions and associated adjustments (e.g., depreciation, tax effects) would be required in full.
- Adjustments would also be required for Non-Controlling Interest (NCI).
Defining Significant Influence (AASB 128)
- In general, significant influence refers to an interest of 20% to 50% in another entity. Based on percentage shareholdings, WHSP’s interest in Brickworks, and Brickworks’ interest in WHSP, can be classified as ‘significant influence’.
- AASB 128 paragraph 2 states: Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies.
- To determine whether significant influence exists (i.e., does WHSP have the power to participate in Brickwork’s financial and operating policy decisions, or does it effectively have control?), the following indicators can be assessed:
- Influence due to shareholding percentage.
- Representation on the Board of Directors.
Accounting for Investments in Associated Entities
How are investments in associated entities to be accounted for in the books of the holder of such investments?
- Based on AASB 128, investments in associates should be accounted for using the equity method.
- This is commonly referred to as the ‘single-line’ method or ‘one-line consolidation’ method because of similar principles and procedures used in consolidation.
- In the statement of financial position, all entries are recorded against the single line investment account: Investment in Associate (recorded by the investor).
Evaluating the WHSP and Brickworks Relationship
Based on the information presented, evaluate the purported nature of the relationship between WHSP and Brickworks.
Closer examination of the relationship between the two entities suggests they are more than associates:
- Given effective control with respect to the shareholding interest (the 20 largest shareholders hold 81.93% of the company, of which, WHSP holds 49.84%), and
- Potential control of the board (Brickworks board comprises 7 members – 2 are directors also of WHSP and are Chairman and Deputy Chairman of both companies).
When Does Significant Influence Become Control?
When is significant influence replaced by ‘control’ over other companies?
- As a general guideline, significant influence is replaced by control when the shareholding interest exceeds 50%. Other specific factors to be considered include control (actual, potential, or effective) by way of votes at meetings (i.e., majority ownership of voting shares) or through control of the Board of Directors.
- In this case, the accounting treatment is questionable given the close relationship between the two companies:
- Control may be possible in practice given WHSP’s shareholding in Brickworks is close to 50%.
- Depending on the identity and association of the other Board members, the current representation by WHSP on the Brickworks Board also suggests the relationship may be more than significant influence.