HA2032 Assignment Sample
This assignment aims to develop understanding of the consolidation and equity methods of accounting, profit allocation in intra-group transactions and disclosure requirements of the NCI and issues related to consolidation process.
From this study, it is identified that consolidation method is more appropriate due to providing high reliability and time saving approach as compared to equity method. In intra-group transactions, profits are omitted completely.
In addition, it is required for the parent firms to make all disclosure about the NCI that are portion of the subsidiary not owned by other subsidiary companies by the parent firm.
Consolidated process cause issues in relation to the reporting based on currency differences, data quality and collection errors, late delivery from reporting units, lack of validation and controlling procedure, improper integration and lacking integration.
This assignment explains the business combinations, the corporate group, acquisition methods, intra-group transactions and non-controlling interests through the use of accounting standards. In part A, key concepts and differences are provided in respect to the consolidation and equity.
Part B discusses the intra-group transactions and allocation of the profit. In addition, part C is based on the disclosure requirements of the NCI and issues related to consolidation process.
Equity method is the way of accounting that is preferred for the investments. In this method, investor holds the impact over the investee but does not have full control over it as there is a link between a parent company and its subsidiary.
In this method, terminologies like associate and affiliate are used. However, an investor can have control and impact over an investee on having between 20% and 50% of the investee’s shares or voting rights.
If the investor has less than 20% shares of investee with the considerable impact in its operations, then it is effective to use the equity method rather than cost method. With reference to AASB 3, there is no consolidation and elimination in the consolidation method.
In this, investor reports its proportionate share of the equity of investee as an investment. There is a significant impact of profit and loss from investee on the investment account by part of the shares of the investors in investee (Hoyle et al., 2015).
Apart from this, the dividends are deducted from this account. For example, if a firm A purchases 5000 shares of firm B at $5 per share; the investment cost will be recorded for $25,000 for the initial period. The income or loss in coming time will be reflected in the changes in the investment value.
On the other hand, consolidation method allows the investor to have full control over its investee. In this method, terminology parent and subsidiary are used. In this method, the investor is known as the parent company while investee is referred as the subsidiary of the parent company.
In such case, the parent company makes investments in the subsidiary and uses the consolidation method.
This method allows to record investment in subsidiary as an asset on the balance sheet of the parent company whereas the same transaction is recorded on the equity side of the subsidiary balance sheet.
In this method, the assets, liabilities, profit and loss of the subsidiary are recorded in the consolidated financial statements of the parent firm (Hoyle et al., 2018).
For example, if the firm A has a 50% control over firm B, then the firm A will make investment record at 50% of assets, liabilities, profit and loss of the firm B. Like, firm A earns revenues of $50 million and firm B earns revenue of $20 million then the firm A will report $60 million in total.
Consolidation method is more appropriate as compared to equity method because it provides a more accurate and detailed record by breaking down how well a joint venture performs.
But at the same time, if the subsidiary uses different currency then it is required for the parent company to convert its financial statements by adding an additional consolidation accounting step (Beams et al., 2016).
It is also helpful to make the financial statements more quickly and provides higher level of precision needed to prepare more accurate financial statements.
This section explains the Intra-group transactions and how profit is allocated.
Intra-group transactions are the part of consolidation process due to being eliminated at consolidation time. With reference to AASB 128, these are the part of the accounting close related to cut-off tracking and prediction deviations that can lead to disputes or arbitration.
In the closing process, time saving and reliability can be improved by considering the optimisation of the reconciliation process. It means the sources of differences can be recognized easily.
These transactions are the commercial transactions that are related to the two companies of the same group at the same time (Merz and Overesch, 2016).
For example, the issuing a sales invoice for supplying services an example of the Intra-group transaction. Invoice will be reported as the receivable in the balance sheet and revenue will be recorded will be reported on the income statement and the purchasing firm will report the payable on the balance sheet and expenses on the income statement.
On the closing date, there will be an asset and liability in the consolidated balance sheet because of the reciprocal transaction that does not exist within the group.
Apart from this, the income statement will overvalue the revenues and expenses with the inclusion of the internal transactions for the period. Intra-group transactions are not included in the equity, holdings, intangible and tangible assets and inventory accounts.
There are some reasons for the intra-group differences including difference in close dates, entry date discrepancies, currency differences, sales accounted as fixed assets, VAT, and rediscounting of debt (Greil and Schilling, 2016).
In the intra-group transactions, unrealised profits should be removed completely. Unrealized losses resulting from intra-group transactions need to be removed till cost can be recovered.
Apart from this, unrealised profits that are recorded in the carrying amounts of assets like fixed assets or inventory are also removed completely. The unrealised losses which are deducted to arrive at carrying amount of assets are also removed until costs cannot be recovered (Merz and Overesch, 2016).
If any subsidiary reports profits then these profits are allocated to the majority interest until the losses partition of the minority absorbed by the majority has been recovered.
The amount of profit from the intra-group must be eliminated and the assets are declined to cost of the group. The group sells goods to another and earns profits on those sales.
The unrealised profits on closing inventories can be eliminated from the profit of the group. In addition, the closing inventory will be recorded at the group cost.
If the parent company sells goods to the subsidiary then the all profit made will be eliminated without the consideration of the proportion of shares of the parent company in the consolidated group (Simamora, and Hermawan, 2017). It means it is not allowed to the group to take credit for the profit share.
In addition, the unrealised profits from the intra-group transfers of the fixed assets like machinery, plant and property will also be eliminated from the financial statement of the consolidated group.
The following part explains the disclosure requirements of the NCI and also discusses Issues raised from the consolidation process.
Disclosure requirements of the NCI
Non-controlling interest (NCI) is the portion of the subsidiary that is not owned by other subsidiary companies by the parent firm. There are variations in the treatment of the NCI in the consolidated statements on the basis of the approach to the consolidated financial statements.
As per the proprietary theory, there is no NCI recognized because the portion of the subsidiary is considered for accounting purpose in consolidated statements.
This method is appropriate when the parent company owns the less than 100% of the subsidiary. The parent company theory and economic unit theory considers full consideration of the subsidiary ownership.
As per parent company theory, the portion of not-wholly owned subsidiary is considered as the liability, however, this theory is not considered in accounting standard (Gluzová, 2016).
Economic unit theory is widely considered currently and makes the reporting of NCI based on the concept of reporting entity being the single economic unit that is separated from the parent firm.
Under this approach, consolidated statements are based on the financial information related to the parent company as well as subsidiary at full by considering the net assets. NCI is reported by making separately as part of the equity of shareholders (Lopes et al., 2017).
There are some requirements that make it mandatory to disclose information for the subsidiary having NCI (non-controlling interest that is material to the reporting entity. It is required for the reporting entity to disclose the disaggregated information from the amounts that are present in the consolidated financial statements of the reporting entity.
It is mandatory for the reporting entity to disclose the information of the subsidiary on the basis of the separate financial statements the subsidiary. In addition, it is also mandatory to disclose the information of the subgroup of the subsidiary with it investees. T
he basis of this information is the consolidated amounts for the subgroup.
To enhance the usefulness of the consolidated statements to the investors, it is required to make it clear the composition of the group ad underline the significance of NCI. The IASB also made it mandatory to make disclosure related to interest in other entities.
According this, it is mandatory for the parent companies to disclose detailed information regarding the each subsidiary with NCI material to the reporting entity (Casajus and Labrenz, 2017). The quality of the disclosed information and level of the disclosure are needed to be considered while making disclosures.
Issues raised from the consolidation process
Consolidation process provides benefits as well as causes some issues that create hurdles in its adoptions. With reference to AASB 128, data quality and collection errors is one the issues that arise with the consolidation process, the firms which consolidates with different branches at different locations face issue related to collecting the right-first time financial consolidation process.
It is because this becomes difficult for the firms to normalise the data and overcome the issues related to manual data errors, late delivery from reporting units, lack of validation and controlling procedure, improper integration and lacking integration.
It is not easy to scale up the multiple systems as the multiple levels of consolidation cause complexity and make it difficult for the staff to integrate the consolidation system. Another issue is intercompany reconciliation in which intercompany transactions may cause difficulty to make close cycle on time (Trigo, Belfo, and Estébanez, 2016).
It is because the staff at parent company and subsidiary has to spend time on resource-intensive tasks including elimination of intercompany transactions, computation of group ownership and minority interests.
Apart from this, it is also a big issue from the consolidated statements that consolidated applications show the weak performance due to need of many rounds of review, consolidation and adjustment before making the process finalised.
At the same time, the limitations of the financial close software in relation to the consolidated process also cause issue in the whole process. Currency issues also make it problem for the firms to consolidate their statements that are difficult to track the value over time.
It is also difficult for the firms to determine the money each division really make after the eliminations in the consolidation process. In consolidation, it is required for the subsidiary to present both pre-acquisition retained earnings and post-acquisition retained earnings (Morrison, 2019).
So, it is complex for the company to differentiate them and deal with them separately. At the same time, there is a need to make some transfer of property, plant and machineries at profit within the group that lead to need of adjusting both unrealized profit and depreciation charges.
In this process, goodwill can be positive or negative as thee is possibility of impairment of goodwill. So it can be troublesome for the firms to adopt consolidation process due to possibility of the impaired goodwill.
Moreover, the net assets of the subsidiary can be considered in the amount that is different from their fair value (Greil and Schilling, 2016).
Based on the above discussion, it can be concluded that in consolidation method, there is control over investee and recording of assets, liabilities, profit and loss of the subsidiary in the consolidated financial statements of the parent firm, but in equity method, there is no control over investee.
At the same time, profits in Intra-group transactions that are related to consolidated statements are eliminated fully. Consolidated process raises issues related to data quality and collection errors, late delivery from reporting units, lack of validation and controlling procedure, improper integration and lacking integration.
Beams, F.A., Anthony, J.H., Bettinghaus, B. and Smith, K.A., 2016. Advanced accounting. Pearson Education Limited 2018.
Casajus, A. and Labrenz, H., 2017. Recognition of Non-Controlling Interest in Consolidated Financial Statements Based on Property Rights. Review of Law & Economics, 13(3).
Gluzová, T., 2016. Disclosure of subsidiaries with non-controlling interest in accordance with IFRS 12: case of materiality. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 64(1), pp.275-281.
Greil, S. and Schilling, D., 2016. Cross-Border Intra-Group Financial Transactions-Evidence from Germany. Available at SSRN 2761719.
Hoyle, J.B., Schaefer, T. and Doupnik, T., 2015. Advanced accounting. McGraw Hill.
Hoyle, J.B., Schaefer, T.F. and Doupnik, T.S., 2018. Fundamentals of advanced accounting. McGraw-Hill Education.
Lopes, A., Lourenço, I., Soliman, M.T. and Branco, M.C., 2017. Is the Relation between Non-Controlling Interests and Parent Companies Misleading?.
Merz, J. and Overesch, M., 2016. Profit shifting and tax response of multinational banks. Journal of Banking & Finance, 68, pp.57-68.
Morrison, M., 2019. Risk Management in Automation of the Accounting Process. In Multiple Perspectives in Risk and Risk Management (pp. 231-239). Springer, Cham.
Simamora, B.E.P.P. and Hermawan, A.A., 2017, August. Transfer Pricing Analysis on Intra-Group Services and the Related Transfer Pricing Disputes from Indonesian Tax Perspectives. In 6th International Accounting Conference (IAC 2017). Atlantis Press.
Trigo, A., Belfo, F. and Estébanez, R.P., 2016. Accounting Information Systems: evolving towards a business process oriented accounting. Procedia Computer Science, 100, pp.987-994.